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Month: April

Reassessment — Notice after four years — Notice should clearly specify material not disclosed by the assessee — Expenditure on account of advertisement and sales promotion allowed by the AO after applying his mind to details furnished by the assessee — No failure on part of the assessee to disclose all material facts truly and fully — Notice under section 148 on the ground that in A. Y. 2015-16, the same has been treated as capital expenditure — Notice unsustainable.

6 Asian Paints Ltd vs. ACIT
[2023] 451 ITR 45 (Bom)
A. Y. 2014-15
Date of order: 9th January, 2023
Sections 147 and 148 of ITA 1961

Reassessment — Notice after four years — Notice should clearly specify material not disclosed by the assessee — Expenditure on account of advertisement and sales promotion allowed by the AO after applying his mind to details furnished by the assessee — No failure on part of the assessee to disclose all material facts truly and fully — Notice under section 148 on the ground that in A. Y. 2015-16, the same has been treated as capital expenditure — Notice unsustainable.

The assessee was a manufacturer and seller. It evolved a marketing strategy or scheme called “colour idea store” which envisaged a specified and designated area in the shops of the dealers for exclusive display of its products. The assessee accordingly entered into agreements with dealers as regards sharing of costs incurred for setting up of the designated area for use and display of its products but the stores continued to belong to the dealers. Such expenditure was claimed as deduction, and advertising and sales promotion expenses. For the A. Y. 2014-15, the AO accepted the assessee’s claim and passed an order under section 143(3) r.w.s. 144C(3) of the Income-tax Act, 1961. On 31st March, 2021, a notice was issued under section 148 to reopen the assessment under section 147 on the basis of assessment proceedings for the A. Y. 2015-16, in which the expenses for “colour idea store” were considered as capital expenditure on which depreciation of 10 per cent was allowed. The assessee’s objections were rejected.

The Bombay High Court allowed the writ petition filed by the assessee and held as under:

“i)    During the scrutiny assessment, the Assessing Officer had sought the relevant details with regard to the advertisement and sales promotion expenses which were furnished by the assessee. The Assessing Officer had also disallowed some of the expenses which were shown in the break-up under the head “details of advertisement and sales promotion expenses” while passing the order of assessment which showed that the Assessing Officer had applied his mind to the assessee’s claim while passing the order u/s. 143(3) read with section 144C(3).

ii)    The reasons for reopening the assessment did not state what material or fact was not disclosed by the assessee. Therefore, it was clear that there was a complete disclosure of all the primary material facts on the part of the assessee and there was no failure on its part to disclose fully and truly all the facts which were material and necessary for the assessment. The notice u/s. 148 did not satisfy the jurisdictional requirement of section 147 and therefore, was unsustainable and accordingly quashed.”

Penalty — Levy of penalty — Limitation — Limitation starts from date of assessment when the AO initiates penalty proceedings and not from date of sanction for penalty proceedings.

5 Principal CIT Vs. Rishikesh Buildcon Pvt Ltd and Ors.
[2023] 451 ITR 108 (Del)
A. Y. 2006-07
Date of order 17th November 2022
Section 275 of ITA 1961

Penalty — Levy of penalty — Limitation — Limitation starts from date of assessment when the AO initiates penalty proceedings and not from date of sanction for penalty proceedings.

For A. Y. 2006-07, the AO passed the assessment order on 17th December, 2008 and recorded that penalty proceedings were to be initiated. A reference was made by the AO to the prescribed authority on 18th March, 2009. The prescribed authority issued a show-cause notice to the assessee on 24th March, 2009. The penalty order was passed on 29th September, 2009.

The Tribunal held that the penalty order was passed after the expiry of the time limit laid down under section 275(1)(c) of the Income-tax Act, 1961 and accordingly set aside the penalty order.

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

“i)    Where the Assessing Officer has initiated penalty proceedings in his/her assessment order, that date is to be taken as the relevant date as far as section 275(1)(c) of the Income-tax Act, 1961 is concerned.

ii)    The quantum proceedings were completed by the Assessing Officer on December 17, 2008, and the Assessing Officer initiated the penalty proceedings in December, 2008. Thus, the last date by which the penalty order could have been passed was June 30, 2009. The six month period from the end of the month in which action of imposition of penalty was initiated would expire on June 30, 2009.

iii)    However, in this case, admittedly, the penalty orders were passed on September 29, 2009, and therefore, the Tribunal rightly concluded that the orders were barred by limitation.”

Offences and prosecution — Willful attempt to evade tax — Failure to produce accounts and documents — Concealment of income — Failure to disclose foreign account opened in year 1991 when the assessee was 55 years of age — Admission regarding foreign bank account after investigation by the department and issue of notices and levy of penalty — Assessee cannot take the benefit of circular recommending no prosecution where the assessee is aged 70 years or more at time of offence — Prosecution justified.

4 Rajinder Kumar vs. State
[2023] 451 ITR 338 (Del)
A. Y.: 2006-07
Date of order: 16th December, 2022
Sections 271, 271(1)(b), 274, 276C(1), 276D and 277 of ITA 1961

Offences and prosecution — Willful attempt to evade tax — Failure to produce accounts and documents — Concealment of income — Failure to disclose foreign account opened in year 1991 when the assessee was 55 years of age — Admission regarding foreign bank account after investigation by the department and issue of notices and levy of penalty — Assessee cannot take the benefit of circular recommending no prosecution where the assessee is aged 70 years or more at time of offence — Prosecution justified.

In the year 2011 based on the information received from France that the assessee had opened an account in a bank in London on 20th August, 1991, a search and seizure was conducted under section 132 of the Income-tax Act, 1961 at various business premises and residence of the assessee on 23rd August, 2011. A notice under section 153A was issued to the assessee to file a return. A penalty was levied for the failure to comply with notices issued under section 142(1). The assessee filed a revised return for the A. Y. 2006-07 declaring the balance in the bank account in London as income from other sources on the basis of details provided at the time of search and assessment proceedings.

A notice under section 277, r.w.s 279(1) was issued and the assessee furnished details of payment of the entire taxes, penalties and interest. Thereafter, criminal complaints under section 276C(1)(ii) and 277 were filed against the assessee. The assessee filed an application under section 245(2) of the Code of Criminal Procedure, 1973 for discharge on the grounds that he was 80 years old citing Instruction No. 5051 dated 7th February, 1991 issued by the CBDT. The application was rejected. Against this, the assessee filed a criminal writ petition.

The Delhi High Court dismissed the writ petition and held as under:

“i)    The assessee could not take benefit of Instruction No. 5051 dated February 7, 1991. He had opened the account in the bank in London on August 20, 1991 and it was only after the Government of France brought to the knowledge of the competent authorities that the assessee disclosed it in the year 2011. During the period relevant to the A. Y. 2006-07 the assessee allegedly had the maximum credit balance in his foreign bank account. The foreign account was opened in the bank in London on August 20, 1991 and was not disclosed.

ii)    Taking the date of birth of the assessee, as claimed by him, as March 30, 1936, at the time of commission of offence in the year 1991 he was 55 years of age. Instruction No. 5051 dated February 7, 1991 stated that prosecution normally be not initiated against a person who has attained the age of 70 years at the time of commission of offence. Therefore, in terms of Instruction No. 5051 dated February 7, 1991, the age of the assessee had to be taken at the time of commission of offence and not when the proceedings were initiated. It was only after the notice u/s. 274 read with section 271 of the Act was issued and penalty u/s. 271(1)(b) of the Act for failure to comply with notice u/s. 142(1) of the Act was also levied on September 26, 2013 that the assessee had chosen to file a revised return on February 16, 2015. By doing so he could not evade the judicial process of law for not disclosing his correct income and foreign account since the year 1991.”

Interest under section 220(2) — Original assessment order set aside and matter remanded — Fresh assessment order — Interest payable from such fresh assessment order.

3 Principal CIT vs. AT and T Communication Services (India) Pvt Ltd
[2023] 451 ITR 92 (Del)
A. Y.: 2004-05
Date of order: 17th November, 2022
Section 220(2) of ITA 1961

Interest under section 220(2) — Original assessment order set aside and matter remanded — Fresh assessment order — Interest payable from such fresh assessment order.

The assessee is engaged in the business of network design, management, communication, connectivity services and related products. For the A. Y. 2004-05, the assessee filed its return of income on 30th October, 2004 declaring an income of Rs. 29,30,15,180. However, the income was assessed at Rs. 32,15,72,740 vide original assessment order dated 28th December, 2006. The Tribunal vide its order dated 30th September, 2014, set aside the original assessment order dated 28th December, 2006 and restored the matter to the file of the AO for determining the issue of taxability of the amounts received as brand building fund, the allowability of brand building expenses as well as a separate claim for other expenses. On 29th March, 2016 the AO reframed the assessment and passed a fresh assessment order under section 143(3) r.w.s 254 of the Act. The AO reconfirmed the disallowance of the brand expenses for a sum of Rs. 2,66,42,537 and the total income was determined as Rs. 31,96,57,720.

In the Income-tax Computation Form (ITNS 50) issued pursuant to the aforesaid assessment order, the AO levied interest under section 220(2) of the Act and raised a demand of Rs. 1,75,74,756 computed on the basis of the original assessment order dated 28th December, 2006.The Tribunal held that the interest under section 220(2) of the Act can be charged only after expiry of the period of 30 days from the date of service of demand notice issued pursuant to the fresh assessment order dated 29th March, 2016.On appeal by the Revenue, the Delhi High Court upheld the decision of the Tribunal and held as under:

“i)    Where an issue arising out of the original assessment is restored to the file of the Assessing Officer by the higher appellate authorities, there is an extinguishment of the original demand, i. e, the demand raised under the first assessment order.

ii)    Interest u/s. 220(2) of the Income-tax Act, 1961, can be levied only after expiry of the time limit prescribed in the fresh demand notice issued by the Assessing Officer in pursuance of the fresh reframed assessment order. The reframed order is the subsisting assessment order. Section 220(2) of the Act does not contemplate a levy of interest which relates back to the date of the passing of original order which was subsequently set aside by appellate authorities or applies to pendency of proceedings. This also becomes clear from Circular No. 334 dated April 3, 1982 ([1982] 135 ITR (St.) 10). Para 2.1 of the circular expressly states that if the assessment order is “set aside” by the appellate authority, no interest u/s. 220(2) of the Act can be charged pursuant to the original demand notice. No interest is payable on the demand raised by the original order when the original order of the Assessing Officer is set aside by the appellate authority and a fresh assessment order is passed.

iii)    The Tribunal by order dated September 30, 2014, set aside the original assessment order dated December 28, 2006, and restored the matter to the file of the Assessing Officer for determining the issue of taxability of the amounts received as brand building fund, the allowability of brand building expenses as well as a separate claim for other expenses. On remand, the Assessing Officer on March 29, 2016 reframed the assessment and passed a fresh assessment order u/s. 143(3) of the Act read with section 254 of the Act. The Assessing Officer reconfirmed the disallowance of brand expenses.

iv)    The Tribunal was right in holding that interest u/s. 220(2) of the Act could be charged only after expiry of the period of 30 days from the date of service of demand notice issued pursuant to the fresh assessment order dated March 29, 2016.”

Corporate social responsibility expenditure — Business expenditure — Amendment providing for disallowance of such expenditure — Circular issued by the CBDT stating amendment to have effect from A. Y. 2015-16 onwards — Binding on the Department — Corporate social responsibility expenditure for earlier years allowable.

2 Principal CIT vs. PEC Ltd and Anr
[2023] 451 ITR 436 (Del):
A. Ys.: 2013-14, 2014-15
Date of order: 29th November, 2022
Section 37 of ITA 1961

Corporate social responsibility expenditure — Business expenditure — Amendment providing for disallowance of such expenditure — Circular issued by the CBDT stating amendment to have effect from A. Y. 2015-16 onwards — Binding on the Department — Corporate social responsibility expenditure for earlier years allowable.

For the A.Ys. 2013-14 and 2014-15, the AO disallowed the claim of the assessees under section 37 of the Income-tax Act, 1961 of the expenses on account of corporate social responsibility endeavor undertaken by them. According to the Department, the funds utilized by the assessees to effectuate their corporate social responsibility obligations involved application of income and not an expense incurred wholly and exclusively for carrying on the business.

The Tribunal relied upon Circular No. 1 of 2015 dated 21st January, 2015 issued by the CBDT and held that the amendment brought about in section 37(1) by the way of Explanation 2 was prospective in nature and was not applicable for the A. Ys. 2013-14 and 2014-15, and accordingly deleted the disallowances.

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

“i)    Explanation 2 was inserted in section 37 of the Income-tax Act, 1961 by the Finance (No. 2) Act, 2014 with effect from April 1, 2015. The Memorandum which was published along with the Finance (No. 2) Bill, 2014 clearly indicated that the amendment would take effect from April 1, 2015 and, accordingly, would apply in relation to A. Y. 2015-16 and subsequent years. This position is also exemplified in the circular dated January 21, 2015 ([2015] 371 ITR (St.) 22) issued by the CBDT.

ii)    Circulars issued by the CBDT were binding on the Department. Therefore, the Tribunal had not erred in allowing the deduction claimed by the assessees u/s. 37 of the expenses incurred for their corporate social responsibility endeavours.”

Charitable purpose — Registration — Cancellation of registration — Condition precedent for cancellation — Registration granted after considering genuineness of the institution — Cancellation of registration on same provisions in trust deed — Not valid.

1 Sri Ramjanki Tapovan Mandir vs. CIT(Exemption)
[2023] 451 ITR 458 (Jhar)
Date of order: 3rd November, 2022
Section 12AA of ITA 1961:

Charitable purpose — Registration — Cancellation of registration — Condition precedent for cancellation — Registration granted after considering genuineness of the institution — Cancellation of registration on same provisions in trust deed — Not valid.

The assessee was registered under section 12AA of the Income-tax Act, 1961. By order dated 4th September, 2018 the CIT (Exemptions), Ranchi cancelled the registration. This was upheld by the Tribunal.

On appeal by the assessee the Jharkhand High Court framed the following substantial questions of law:

“(1)    Whether the registration once granted under section 12AA of the Income-tax Act, 1961 could be cancelled on the basis of same set of provision of the trust which were examined earlier ?

(2)    Whether the Income-tax authorities have the jurisdiction under section 12AA(3) of the Income-tax Act, 1961 to question the legality and propriety of the trust deed of the assessee or its inquiry is limited to the conditions stipulated under section 12AA(3) namely,—

(i)    that the activities of the trust are not genuine, or

(ii)    are not being carried out in accordance with the objects of the trust?

(3)    Whether in the facts and circumstances of the case, the findings of the learned Income-tax Appellate Tribunal that the appellant failed to give satisfactory explanation regarding the sale proceeds which is utilized for charitable objects of the trust, is perverse?”

The High Court allowed the appeal and held as under:

“i)    Section 12AA(3) of the Income-tax Act, 1961, contemplates existence of two contingencies for cancellation of the registration already granted, namely: (i) If the activities of the trust are not genuine ; or (ii) are not being carried out in accordance with the objects of the trust.

ii)    The trust deed is an understanding between the author of the trust and its trustee, and, the Income-tax Department is not authorized to comment on execution of the trust deed. Once registration has been granted to a charitable trust u/s. 12AA of the Act after being satisfied about the genuineness of the activities of the trust, it cannot be cancelled on the basis of the same set of provisions of the trust which were examined earlier.

iii)    It is trite law that the Tribunal cannot travel beyond the reasons recorded in the order before it and develop a complete de novo case for the Revenue, which was not the basis of the order passed by the authority.

iv)    It was an admitted fact that registration u/s. 12AA of the Act was granted to assessee-trust on the basis of the trust deed dated September 20, 2005. It was further an admitted fact that in the trust deed dated September 20, 2005, it was specifically recorded, inter alia, that the lands of the trust were under threat of encroachment by local inhabitants, and, in order to save the land in question, it was felt necessary to utilize the land by giving it for development for construction of buildings and flats and the proceeds received from consideration amount were to be utilized for the purposes of the trust. On the basis of the same trust deed, the benefit of exemption u/s. 12A of the Act was granted by granting registration to the trust u/s. 12AA. However, notice was issued to the trust dated December 18, 2017 directing the trust to show cause, inter alia, as to why its registration should not be cancelled for violation of the aims and objectives mentioned in the trust deed and memorandum of association. Thereafter, the CIT (Exemptions) passed order dated September 4, 2018 cancelling the registration granted in favour of the assessee-trust.

v)    The CIT(Exemptions), while cancelling the registration, went beyond the terms of the trust deed and proceeded to cancel the registration recording, inter alia, that the trust deed dated September 20, 2005 was contrary to the wishes of the founder of the trust and the earlier instruments of trust, i. e., trust deeds of the years 1948 and 1987. Thus, the CIT(Exemptions) clearly travelled beyond the scope of inquiry as contemplated u/s. 12AA(3) for declaring that the activities of the trust were not genuine. The Supreme Court, in clear terms, held that u/s. 44 of the Bihar Hindu Religious Trust Act, 1950, a religious trust has power to transfer its immovable property after taking previous sanction, and, that the deity could transfer its land for fulfilling its objectives. Thus, the finding rendered by the CIT(Exemptions) for cancellation of the registration certificate was directly contrary to the order passed by the Supreme Court in the case of the assessee-trust itself.

vi)    The Tribunal had upheld the order of the CIT(Exemptions). The Tribunal despite the order of the Supreme Court, being brought to its notice, held that the activity of the trust was not genuine and bona fide, as the Pujari of the trust changed the original trust deeds and had violated the objects of the trust in transferring the property of the trust. This finding of the Tribunal was not sustainable in the eye of law. That apart, the Tribunal had clearly travelled not only beyond the show-cause notice, but, also the order passed by the CIT(Exemptions). In an earlier proceeding pertaining to the year 2013-14, the Tribunal had clearly held that the trust deeds were not relevant for allowing the benefit of exemption and the income derived from transfer of property was as per the objects of the trust. The CBDT Instruction No. 883-CBDT F. N. 180/54/72-IT (AI) dated September 24, 1975 stated that the investment of net consideration received on the transfer of a capital asset in fixed deposit with a bank for a period of six months or above would be regarded as utilization of the net consideration for acquiring another capital asset within the meaning of section 11(1A) of the Income-tax Act. Admittedly, the assessee-trust had deposited the sale proceeds in fixed deposit with the bank for a period of more than six months and, thus, it could not be said that the assessee-trust had utilised the sale proceeds contrary to the objects of the trust. The cancellation of registration was not valid.

vii)    Accordingly, the instant appeal is allowed and the questions of law framed at the time of admitting the appeal are answered in the affirmative in favour of the appellant.”

Section 69A r.w.s. 115BBE and section 153A – Where cash deposits made in bank accounts of the proprietorship concern during demonetization period were routed through regular books of account of the assessee which were not rejected by AO and no incriminating material was found during the search conducted at the premises of the sister concern of the assessee to point out that she introduced her own unaccounted money in her proprietorship concern in the garb of sale to its sister concern then additions made by the AO in respect of such cash deposit were merely based on surmise and conjectures and, thus, same were to be deleted.

3 Tripta Rani vs. ACIT

[2022] 97 ITR(T) 389 (Chandigarh – Trib.)

ITA No.: 135 (CHD.) OF 2021

A.Y.: 2017-18

Date of order: 13th June, 2022

Section 69A r.w.s. 115BBE and section 153A – Where cash deposits made in bank accounts of the proprietorship concern during demonetization period were routed through regular books of account of the assessee which were not rejected by AO and no incriminating material was found during the search conducted at the premises of the sister concern of the assessee to point out that she introduced her own unaccounted money in her proprietorship concern in the garb of sale to its sister concern then additions made by the AO in respect of such cash deposit were merely based on surmise and conjectures and, thus, same were to be deleted.

FACTS

The assessee was a proprietor of two concerns namely; ‘W’ and ‘S,’ and was engaged in the business of trading of textiles. The assessee was also engaged in the purchase and sale of cloth to its sister concern one R group. A search was conducted at premises of R group under section 132(1). Consequently, notice under section 153A was issued to the assessee. Pursuant to the said notice, the assessee filed return of income which reflected same income as filed in original return.

During the assessment proceedings, the AO observed that during the demonetization period, the assessee deposited Rs. 10 lakhs and Rs. 17 lakhs in the bank accounts of her proprietorship concerns ‘W’ and ‘S’ The AO required the assessee to submit details related to cash deposits along with certified copies of bank statements. The assessee explained to the AO that the cash deposits in the bank accounts of respective proprietorship concerns were out of sales made to its sister concern ‘R’ group. However, despite such explanation, the AO held that in case of proprietorship concern ‘S’, the assessee failed to submit any satisfactory reply and thus made additions under section 69A on the grounds that the assessee introduced own unaccounted money in the garb of sales to sister concern during the demonetization period.

On appeal, the CIT (A) upheld the decision of the AO. Aggrieved by the order of CIT(A), the assessee filed further appeal before the ITAT.


HELD
The Tribunal observed that the AO had no sound reason to reject the contention of the assessee especially when the cash deposits in the bank account of ‘S’ have been routed through the regular books of account of the assessee. Even the books of account have not been rejected and the AO had accepted the sales as well as purchases and also the expenses claimed by the assessee and had only found fault with the quantum of cash deposits during the demonetization period. Thus, apparently, this impugned addition had been made without any foundation and the AO had acted on mere surmise and conjectures without duly appreciating the undisputed fact that he himself had accepted the books of account. The CIT (A) had also upheld the findings of the AO without assigning any cogent reason and he also seemed to have simply approved the addition without proper appreciation of facts. Further, on the same set of facts, the AO had accepted the cash deposit of Rs. 17 lakhs in another proprietorship concern of the assessee namely ‘W’ but had proceeded to doubt the cash deposited in the proprietorship concern ‘S’ without any cogent reason.

It was also noted by the Tribunal that the captioned case was a search case and even during the course of search no incriminating material was found which would point out towards the assessee introducing her unaccounted cash into the books of account under the garb of sales or receipts from sister concern.

Therefore, the view taken by the CIT (A) in upholding the addition of Rs. 10 lakhs was set aside by the Tribunal and the AO was directed to delete the same.

Section 80-IB r.w.s 154 and Section 143 – Where the assessee’s claim for deduction under section 80-IB was rejected for want of filing of an audit report, in view of CBDT’s Circular No. 689, dated 24th April, 1984, the AO was required to consider rectification application filed by the assessee-company since a copy of said report in Form 10CCB was uploaded by the assessee on receipt of intimation under section 143(1).

2 Satish Cold Storage vs. DCIT

[2022] 97 ITR(T) 601 (Lucknow – Trib.)

ITA Nos.: 76 & 77 (LKW.) of 2021

A.Y.: 2017-18 & 2018-19

Date of order: 25th May, 2022

Section 80-IB r.w.s 154 and Section 143 – Where the assessee’s claim for deduction under section 80-IB was rejected for want of filing of an audit report, in view of CBDT’s Circular No. 689, dated 24th April, 1984, the AO was required to consider rectification application filed by the assessee-company since a copy of said report in Form 10CCB was uploaded by the assessee on receipt of intimation under section 143(1).

FACTS

The assessee had claimed deduction under section 80-IB of the Income-tax Act, 1961. However, the auditor of the assessee omitted to upload the audit report in FORM-10CCB along with the return of income. The deduction under section 80-IB was denied in the intimation issued under section 143(1). After the receipt of intimation under section 143(1) of the Income-tax Act, 1961, the assessee uploaded the copy of audit report in FORM 10CCB and filed a rectification application under section 154 against the said intimation. The audit report was rejected by the Central Processing Unit (CPC).

Thereafter an appeal was filed before Ld. CIT (A) against the order passed by the CPC under section 154.

The CIT (A) dismissed the appeal by holding that no mistake was apparent from the record. Aggrieved by the order of CIT(A), the assessee filed further appeal before the ITAT.


HELD
The Tribunal observed that CIT (As) while rejecting the appeal, had escaped the contents of Circular No. 689 dated 24th August, 1984. which clearly directs the Officers to allow rectification under section 154 for non-filing of audit report or other evidence which could not be filed with the return of income.

The Tribunal, by relying upon the decision of the Hon’ble High Court of Karnataka in the case of Mandira D Vakharia [2001] 250 ITR 432 (Kar.), held that the assessee would be entitled to the deduction in rectification under section 154 to the extent permitted by the Board’s Circular No.669 dated 25th October, 1993 and Circular No.689 dated 24th August, 1984. The AO was not right in law in disallowing the rectification application only on the grounds that the assessee had failed to furnish the audit report along with the return of income.

Section 10 (38) r.w.s. 68 – Where the assessee claimed an exemption under section 10(38) towards long-term capital gains earned on the sale of shares alleged to be penny scrip and furnished various documentary evidences in the form of copies of contract notes, DEMAT account, details of share transactions, etc. in support of the claim, then onus casted upon assessee in terms of section 68 was discharged and therefore impugned addition made against alleged bogus LTCG was to be deleted.

1 Jatinder Kumar Jain vs. ITO

[2022] 97 ITR(T) 403 (Chandigarh – Trib.)

ITA No.: 338 (CHD) OF 2018

A.Y.: 2013-14        

Date of order: 14th June, 2022

Section 10 (38) r.w.s. 68 – Where the assessee claimed an exemption under section 10(38) towards long-term capital gains earned on the sale of shares alleged to be penny scrip and furnished various documentary evidences in the form of copies of contract notes, DEMAT account, details of share transactions, etc. in support of the claim, then onus casted upon assessee in terms of section 68 was discharged and therefore impugned addition made against alleged bogus LTCG was to be deleted.

FACTS

The assessee-company had purchased shares of Maple Goods Ltd (MGL) through cheque and the identity of the broker had been furnished. Due to the order of High Court Kolkata, MGL along with Seaview Supplier Ltd (SSL) and Matrix Barter Pvt Ltd (MBL) were amalgamated and as a consequence, the assessee was allotted 7,900 shares of Access Global Ltd (AGL). Subsequently, the assessee sold these shares of AGL through a bank channel. It claimed long-term capital gain arising on sale of the said shares as exempt under section 10(38).

The AO received the report of the Investigation Wing wherein AGL had been allegedly identified as one of the penny stock companies. In the said report, it was alleged that the price of shares of AGL had been artificially rigged to create a non-genuine long-term capital gain. On the basis of the said report, The AO inferred that the assessee had allegedly earned bogus long-term capital gain on sale of shares of AGL through another alleged bogus client company, namely Ashok Kumar Kayan (AKK) and accordingly, came to conclusion that AKK had provided bogus long term capital gain to the assessee and other companies, and thus denied the assessee’s claim of exemption and made addition of the long term capital gain under section 68.

During the course of the assessment proceedings, the assessee had furnished documentary evidences which included copies of contract notes, DEMAT account, details of share transactions, contract notes giving details like trade number, trade time, contract note number, settlement number, details of service tax payment, securities transaction tax paid and the brokerage paid to the broker. It was also demonstrated by the assessee that the purchase of shares of MGL had been made through cheque in June, 2011. The assessee had also demonstrated that, subsequently, the sale proceeds from the shares of AGL were received again through banking channel. Apart from this, the assessee had also filed the judgment of the High Court ordering amalgamation of three companies MGL, SSL and MBL as a consequence to which the assessee was allotted 7,900 shares of AGL. The assessee had also furnished a copy of letter addressed to the assessee by MGL which showed the distinctive number of shares allotted to the assessee along with the certificate number and the share folio number.

The CIT(A) upheld the addition made by the AO. Aggrieved by the order of CIT(A), the assessee filed further appeal before the ITAT.

 

HELD

It was observed by the Tribunal that all these documents have apparently been accepted by the lower authorities in as much as neither the AO nor the CIT (A) had pointed out any defect in these documents. The statements of various persons were recorded. But nowhere in the statements, the name of the assessee was referred to.

The assessee had demonstrated with substantial evidence before the AO that the actual purchase and sale of the shares took place, such shares had distinctive numbers, the transactions were routed through the normal banking channels and the shares had been allotted to the assessee subsequently under an order of amalgamation/merger.

The Tribunal also observed that when the AO had received the report of the Investigation Wing, he ought to have conducted an independent enquiry to examine and verify the involvement of the assessee in the alleged bogus long-term capital gain claim rather than simply and blindly following the report and the statement to make a case against the assessee.

Accordingly, the Tribunal held that since the assessee had successfully discharged the onus casted upon him in terms of section 68, the impugned addition had no feet to stand.

How Happy We Are?

Every year the 20th of March is celebrated as the “International Day of Happiness”. In July 2011, the UN General Assembly adopted resolution 65/309 Happiness: Towards a Holistic Definition of Development inviting member countries to measure the happiness of their people and to use the data to help guide public policy.

While the UN makes things global through such means, the timeless scriptures of Bharat have pointed out Joy or Ananda to be the ultimate goal of humans.  We spend our whole life in pursuit of happiness through every activity. A question which remains unanswered despite all progress is: Where is happiness located? How do we find it? Through career, money, wealth, fame, power, and positions we have tried to reach the elusive goal, only to find it fleeting. It is like ordering something that comes with a ‘very near expiry date’. Not only that, when one desire is satisfied,  the other lures us with the powerful force of attraction. This loop is endless. We seek and we lose; we lose, and we seek again. In fact, the constant pursuit wears us out with stress, strife and discontentment. Thus, the eternal question remains: how can we be happy?

In today’s scenario, this question is more relevant for our fraternity than others. We find that practising CAs are facing various challenges on multiple fronts. The level of stress, risk of reputation and harassment by agencies have increased manyfold, which prompts one to think: is it all worth it? What am I doing and why I am doing this and where will it lead me?

Medical research says anatomical happiness comes from four happy hormones, namely, Dopamine, Serotonin, Oxytocin and Endorphins. Each of these hormones has unique qualities, for example, Dopamine is a ‘feel-good’ hormone associated with pleasurable sensations, learning, memory, etc. Serotonin helps to regulate our mood as well as sleep, appetite, digestion, learning ability, and memory. Oxytocin is known as the ‘love hormone’ that helps to promote trust, empathy, and bonding in relationships. Endorphins act as the body’s natural pain reliever, which is produced by our body when we are engaged in physical activities such as eating, exercising, etc. These hormones can be produced and regulated through various activities, meditation, food as well as empowering relationships, etc.

However, bereft of chemistry, what is the source of happiness? Ms. Karen Hamilton writes in her poem:

 

“What is happiness I hear you say,

What helps us smile on dreary days,

What sends a tingle through our bones,

What helps us talk in cheerful tones?+

 

How does it pick and how does it choose

When to arrive or when to move.

How does it know to run right through

Every person, like me and you?

 

Some people try as hard as they can,

To steal it from another man

It’s yours forever, it’s yours to keep

Don’t let them take something so deep

 

You must search within when times are blue

For, Happiness lives inside of you”

 

Many understand this in varied ways. Some through action – being present and fully engaged or in giving. Swami Chinmayananda said, “bring your mind where your hands are”. That’s mindfulness. When we are fully engrossed in our work, we touch our excellence. We all experience this during the peak season of our work. In such work, there is involvement without expectation of the outcome (which causes stress). There is pressure, and there is tremendous expending of energy, but psychologically, we are not drained. Today many tools of technology, practice management software, judicious use of Artificial Intelligence (AI), a good team, and most importantly delegation can help us to reduce stress.

However, we need to maintain a fine work-life balance to reduce stress and lead a meaningful and joyous life. After all, what is the use of all the money that we earn, if we can’t live a happy life? Fortunately, many CAs are engaged in philanthropic activities and contributing a lot to society. They render pro bono services to Charitable Trusts and NGOs. Such activities help secret a happy hormone called Oxytocin. We must spend quality time with our family and should not entertain clients at unreasonable hours unless necessary. We should be objective in rendering our services without getting involved in the business and financial affairs of our clients. We should do our best without getting attached to the outcome. A good Surgeon would operate on his close relative with precision and professionalism; we should also work in that manner. If we are attached to results, then the high-pitched assessments, penalties for late filings, long-lasting litigation, compounding, etc. will make us stressed.

Here are my top 5 activities to reduce stress and live a balanced life:

1. Philanthropy

2. Inner Work like Meditation, Pranayama, Asanas

3. Short vacations

4. Exercise and Walking

5. Loving what I do

We are embarking on the New Financial Year which is coinciding with many traditional Nav Varsha (New Years) in India, like Gudi Padava (Maharashtrian New Year), Bohag Bihu (Assamese New Year), Ugadi (Telugu and Kannada New Year), Baisakhi (Punjabi New Year) or Navroz (Central Asian and Persian New Year). Let’s take stock of our lives, our days, and our happiness. Let’s find and watch our own happiness index! and not trade it for anything! It’s the Index whose gains need not face any tax, its sale should only take it higher!

Wish you all the best for a truly happy new Financial Year!

Best Regards,
Dr. CA Mayur B. Nayak
Editor

Accounting of Pre-IPO Instruments

Pre-IPO investors are issued equity instruments at a lower valuation compared to retail investors. However, these equity instruments come with certain restrictions such as lock-in restrictions, and the accounting can be complex. This article deals with the accounting of convertible instruments issued to financial institutions as a part of pre-IPO funding.

FACT PATTERN

The new company will be soon launching its IPO. As a part of its pre-IPO funding, it has issued CCPS (Compulsorily Convertible Preference Shares) to SBI. These instruments are convertible into equity shares on the IPO taking place. The conversion ratio is variable depending upon the timing of the IPO and the valuation of the company at IPO, after deducting from the valuation a discount is typically available to pre-IPO investors. All pre-IPO investors that are issued these instruments are treated equally. The pre-IPO investors are provided a discount over the valuation of the company to compensate for the lock-in restrictions applicable to pre-IPO investors and for the uncertainty on the occurrence of the IPO and the timing of the IPO. If the IPO does not happen by a certain date, then the conversion will occur by a formula predetermined on the date of issue of the CCPS, that will provide as many shares, as are required to settle the liability, for e.g., if the CCPS amount is R100, and the share price is Rs. 1 the liability will be settled by providing 100 shares to the holder of the CCPS.

QUERY

How does the new company, the issuer, account for this instrument? Is the discount on the valuation a one-day loss that needs to be amortised over the period of the instrument?

RESPONSE

Technical Literature

Ind AS 32 Financial Instruments: Presentation

11. A financial liability is any liability that is: (a) a contractual obligation : (i) to deliver cash ………(b) a contract that will or may be settled in the entity’s own equity instruments and is: (i) a non-derivative for which the entity is or may be obliged to deliver a variable number of the entity’s own equity instruments; or (ii) a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity’s own equity instruments. ………..

Ind AS 109 Financial Instruments

4.2.1 An entity shall classify all financial liabilities as subsequently measured at amortised cost, except for:  (a) financial liabilities at fair value through profit or loss. Such liabilities, including derivatives that are liabilities, shall be subsequently measured at fair value………

4.3.3 If a hybrid contract contains a host that is not an asset within the scope of this Standard, an embedded derivative shall be separated from the host and accounted for as a derivative under this Standard if, and only if: (a) the economic characteristics and risks of the embedded derivative are not closely related to the economic characteristics and risks of the host (see paragraphs B4.3.5 and B4.3.8);  (b) a separate instrument with the same terms as the embedded derivative would meet the definition of a derivative; and  (c) the hybrid contract is not measured at fair value with changes in fair value recognised in profit or loss (i.e. a derivative that is embedded in a financial liability at fair value through profit or loss is not separated).  

4.3.4 If an embedded derivative is separated, the host contract shall be accounted for in accordance with the appropriate Standards. This Standard does not address whether an embedded derivative shall be presented separately in the balance sheet.  

4.3.5 Despite paragraphs 4.3.3 and 4.3.4, if a contract contains one or more embedded derivatives and the host is not an asset within the scope of this Standard, an entity may designate the entire hybrid contract as at fair value through profit or loss unless:  (a) the embedded derivative(s) do(es) not significantly modify the cash flows that otherwise would be required by the contract; or  (b) it is clear with little or no analysis when a similar hybrid instrument is first considered that separation of the embedded derivative(s) is prohibited, such as a prepayment option embedded in a loan that permits the holder to prepay the loan for approximately its amortised cost.  

5.1.1A However, if the fair value of the financial asset or financial liability at initial recognition differs from the transaction price, an entity shall apply paragraph B5.1.2A.

B5.1.2A The best evidence of the fair value of a financial instrument at initial recognition is normally the transaction price (i.e., the fair value of the consideration given or received, see also Ind AS 113). If an entity determines that the fair value at initial recognition differs from the transaction price as mentioned in paragraph 5.1.1A, the entity shall account for that instrument at that date as follows: (a) at the measurement required by paragraph 5.1.1 if that fair value is evidenced by a quoted price in an active market for an identical asset or liability (i.e., a Level 1 input) or based on a valuation technique that uses only data from observable markets. An entity shall recognise the difference between the fair value at initial recognition and the transaction price as a gain or loss.  (b) in all other cases, at the measurement required by paragraph 5.1.1, adjusted to defer the difference between the fair value at initial recognition and the transaction price. After initial recognition, the entity shall recognise that deferred difference as a gain or loss only to the extent that it arises from a change in a factor (including time) that market participants would take into account when pricing the asset or liability.

ANALYSIS AND CONCLUSION

1. The hybrid instrument comprises two elements, namely, (a) financial liability representing, conversion terms that allow the holder to convert the financial liability into the number of shares equal to the carrying amount of the financial liability at maturity that results in a contractual obligation to deliver a variable number of its own equity instruments and therefore it is a financial liability. [Ind AS 32.11 (b)(i)], and (b) the instrument contains an embedded derivative that provides an upside if an IPO were to happen; this embedded derivative should be viewed as a purchased call option, that is net share settled.

2. As per paragraph 4.2.1 of Ind AS 109, an entity shall classify all financial liabilities as subsequently measured at amortised cost, except for financial liabilities at fair value through profit or loss.

3. In accordance with paragraph 4.3.3 of Ind AS 109, an embedded derivative shall be separated from the host and accounted for as a derivative if, and only if: (a) the economic characteristics and risks of the embedded derivative are not closely related to the economic characteristics and risks of the host;  (b) a separate instrument with the same terms as the embedded derivative would meet the definition of a derivative; and  (c) the hybrid contract is not measured at fair value with changes in fair value recognised in profit or loss (i.e. a derivative that is embedded in a financial liability at fair value through profit or loss is not separated).

4. As per paragraph 4.3.4 of Ind AS 109, the embedded derivative will be separated and accounted for separately from the host financial liability contract. However, as per paragraph 4.3.5, if the embedded derivative has a significant impact on the combined instrument, it need not be separated.  In such a case, under paragraph 4.3.5, the entity may designate the entire hybrid contract at fair value through profit or loss (FVTPL).

5. Therefore, the entire CCPS financial liability may be fair valued to profit or loss or the CCPS may be broken up into two, namely, the host contract and the embedded derivative, and each of them accounted for separately. Whichever approach is taken, the overall impact on financial statements will not be materially different.

6. The other question that needs to be addressed is that the new company has issued the instrument at a discount to SBI. Therefore, should it attribute a one-day loss when accounting for the instrument at inception as per paragraph 5.1.1A, followed by amortising such a loss over the contract period in accordance with paragraph B5.1.2A.

7. Typically, the pre-IPO investors are provided a discount over the valuation of the company to compensate for the lock-in restrictions applicable to pre-IPO investors and for the uncertainty on the occurrence of the IPO and the timings of the IPO. Therefore, the discount provided to the pre-IPO investor is not out of any benevolent act. Rather the transaction price is reflective of the fair value of such instruments, keeping in mind the restrictions on such instruments and the uncertainty of the IPO.  Consequently, the author believes there is no one-day loss in the instant case, and the instrument is accounted for at the transaction price, which is the fair value of the instrument.

CONCLUSION

At inception, the instrument is accounted for at the transaction price which in the instant case is the fair value of the instrument. The instrument may be accounted for in its entirety at FVTPL, which is the more straightforward approach compared to splitting the instrument into a host component and an embedded derivative component.

As the entity approaches the IPO and uncertainty diminishes, the fair value of the financial liability will keep increasing, if the valuation of the company keeps increasing, resulting in a corresponding charge to P&L, in the books of the new company.  Assuming the shares are priced at Rs. 200 based on valuation of the company, on IPO date the fair value of the financial liability just before the conversion, will be Rs. 200 less discount.  Once the IPO concludes, the CCPS (financial liability) will get converted into equity shares (equity), therefore, the fair value of the financial liability as determined on the date of conversion is derecognised with corresponding credit being recognised in the equity in the books of the new company. There is no gain or loss on conversion. The fair value gain /loss on CCPS at each reporting period till the conversion date is recognised in the Statement of Profit or Loss.

Namaskaar

Good thoughts are expressed in every language. However, Sanskrit language is specially known for the noble and valuable thoughts intelligently and succinctly expressed in the form of ‘Subhashits’. Compilation of thousands of such Subhashits is a priceless treasure for the world. It is full of deep thinking and wisdom. One such Subhashit is

This sets the priorities in one’s life. It tells how many other things should be left aside for a particularly important thing.

This means, while having food, you should keep aside hundred other things. Today, we see that many so-called high-profile people pretend to be so busy that they don’t take food regularly, at the appropriate time. They take pride in saying that they have no time even to take lunch or dinner.

Further, while eating, many people keep on discussing business, thinking about some work, watching television, or watching their mobile phone. It has been scientifically proven that such distractions while eating are harmful to health. Our Indian culture treats food  as ‘Purna Brahma’ (God). Not eating with concentration is insulting to God. Moreover, if you concentrate, you can enjoy the appearance, smell and taste of the food.

 For having a bath, one should leave aside thousand other things. This underlines the importance of cleanliness and hygiene. Before performing any worship or doing an auspicious thing, having a bath is a must. It is not only physical cleanliness, but this also implies to cleansing and purification of the mind. i.e.

 ‘Daan’ or charity is regarded in very high esteem. One should not leave any opportunity of giving something (good) to others. Today experts teach you the ‘Art of Giving’. It is also said even when a person is in difficulty, he should keep on helping others and giving to others. That is the highest form of Punya, (Good Karma). In Mahabharata, Karna was ready to sacrifice even his life to ‘give’ any person whatever he wanted. There were many kings who performed ‘yagyas’ (sacrifice) to give away their entire treasure. Therefore, leave aside one lakh things to grab an opportunity to ?give’. Even if you are not able to give anything in your lifetime, you can pledge to donate your eyes and other organs or even your whole body to someone after your death. You can also give a part of your wealth to charity through a Will.

Finally,  means leave aside everything else to worship God. This is a message about spirituality. This does not mean that one should be engrossed only in Pooja, bhajans and kirtan. It only means leaving aside one crore of things to do ‘bhakti’ (express devotion to God) or prayers. Performing your duty religiously is also a worship of God.

We Chartered Accountants, should take a message for ourselves. We claim that we are too busy, always slogging and not having time to do any other thing. Actually, food, bath, charity and spirituality give us a lot of strength and energy. This needs to be experienced. That will make us more efficient in many ways.

In the 17th Chapter of Bhagavad Gita, the different categories of food (diet), charity and devotion (bhakti) have been described. Good (sattvik), medium (Rajas) and bad (Tamas). If you select good food, the good donee (Satpatra or deserving) and a good Guru (Mentor) in spiritual pursuits, you will have a healthy and peaceful life. The physical, intellectual and mental energy will keep you fit and agile. That adds to physical, mental and moral strength.

In our ancient Indian culture, each year is given a particular name. The samvat year that commenced from Gudhi Padwa is named ‘Shobhan’ i.e. beautiful. Let us try to make not only the year but the entire life beautiful with good food, cleanliness, charity, and spiritual prayers.

The Retroactive Application of Special Criminal Laws – Recent Supreme Court Decisions

“The entire Community is aggrieved if the economic offenders who ruin the economy of the State are not brought to books. A murder may be committed in the heat of moment upon passions being aroused. An economic offence is committed with cool calculation and deliberate design with an eye on personal profit regardless of the consequence to the Community. A disregard for the interest of the Community can be manifested only at the cost of forfeiting the trust and faith of the Community in the system to administer justice in an even handed manner without fear of criticism from the quarters which view white collar crimes with a permissive eye unmindful of the damage done to the National Economy and National Interest.”

– State of Gujarat v. Mohanlal Jitamalji Porwal & Ors. (1987) 2 SCC 364

The above quote of the Supreme Court (SC) may seem general – but it puts the importance given to economic offenses in context. In the never-ending game of cat and mouse, it is always the law enforcement that seems to play catch up with the offenders. The last decade has seen an increased focus on special laws with the aim of curbing economic offenses. These laws are special – they have special agencies with special powers for investigation, special courts for prosecution and special procedures – for specific offenses, all justified to prevent economic offenders from escaping punishment. However, some of the amendments brought about to these Acts have raised a peculiar problem that gives the public a cause for concern. Can I be punished for an act that was not an offence at the time of its commission? Can criminal liability be fastened upon me by a retrospective amendment? What repercussions does this have for the concept of mens rea?

The SC has examined two different Acts in two different judgments, both in 2022. Both these judgments are considered a landmark in their own field and the legislations that they consider are of particular interest to Chartered Accountants – The Prohibition of Benami Transactions Act,  1988 (the Benami Act) and the Prevention of Money Laundering Act, 2002 (the PMLA). The issue, however, is still live – very recently, the Bombay High Court issued notice on a petition that challenges what it considers the retrospective application of the Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015 and contends that this Act should not penalize transactions that were entered into before it came into force.

The words “retrospective” and “retroactive” have different meanings in law. However, often these terms work in tandem like in the two SC judgments covered in this article. The SC in the case of Vineeta Sharma v. Rakesh Sharma, 2020 (9) SCC 1, described the nature of prospective, retrospective, and retroactive laws as follows: “The prospective statute operates from the date of its enactment conferring new rights. The retrospective statute operates backwards and takes away or impairs vested rights acquired under existing laws. A retroactive statute is the one that does not operate retrospectively. It operates in futuro. However, its operation is based upon the character or status that arose earlier. Characteristic or event which happened in the past or requisites which had been drawn from antecedent events.”

Readers may read this article and interpret these terms accordingly.

A. THE PROHIBITION OF BENAMI TRANSACTIONS ACT, 1988

The Benami Act was one of those Acts that stood quietly on the sidelines waiting to fulfill its avowed objectives. In 2016, sweeping changes were made to the Act in line with the government’s objective to crack down on economic offences and undesirable practices. The Benami Act has been the subject of much debate and discussion especially as benami transactions in India are neither new nor rare. Traditional civil remedies were often exercised in those transactions that were benami in nature. The courts had dealt with various civil disputes with regard to benami properties. Though the Benami Act was brought out in order to prohibit benami transactions, it was widely considered toothless and was rarely invoked.

Post-2016 amendments, however, the Benami Act is looked upon as having the colour of being criminal legislation. This is primarily because though entering a benami transaction was prohibited even prior to 2016, the criminal provisions lacked teeth. In recent years a variety of legislations have been enacted for special purposes and these are an amalgam of both civil and criminal provisions. The name of the Benami Act is self-explanatory, it seeks prohibition of benami transactions. This is a clear indication that the Act does not exist merely to punish, its raison d’être is to prohibit them altogether. It cannot, however, be doubted that the amending Act brought in wide-ranging changes to the original Act.

The judgment of the SC in UOI v. Ganpati Dealcom Pvt. Ltd. (2023) 3 SCC 315 is a watershed moment for many reasons. The judgment reaffirms the basic principle of the criminal law of not imposing criminality retroactively. How can it be that an act that is not an offence at the time of its commission be considered an offence subsequently? While this may seem like common sense, the manner in which the SC  arrives at this conclusion while considering Sections 3 and 5 of the Benami Act warrants consideration.

What is a Benami Transaction?

Post the 2016 amendment, the definition of ‘benami transaction’ given in section 2(9) of the Benami Act is as follows:

“benami transaction” means,—

(A)    a transaction or an arrangement—

(a)    where a property is transferred to, or is held by, a person, and the consideration for such property has been provided, or paid by, another person; and

(b)    the property is held for the immediate or future benefit, direct or indirect, of the person who has provided the consideration,

except when the property is held by—

(i)    a Karta, or a member of a Hindu undivided family, as the case may be, and the property is held for his benefit or benefit of other members in the family and the consideration for such property has been provided or paid out of the known sources of the Hindu undivided family;

(ii)    a person standing in a fiduciary capacity for the benefit of another person towards whom he stands in such capacity and includes a trustee, executor, partner, director of a company, a depository or a participant as an agent of a depository under the Depositories Act, 1996 (22 of 1996) and any other person as may be notified by the Central Government for this purpose;

(iii)    any person being an individual in the name of his spouse or in the name of any child of such individual and the consideration for such property has been provided or paid out of the known sources of the individual;

(iv)    any person in the name of his brother or sister or lineal ascendant or descendant, where the names of brother or sister or lineal ascendant or descendent and the individual appear as joint-owners in any document, and the consideration for such property has been provided or paid out of the known sources of the individual; or

(B)    a transaction or an arrangement in respect of a property carried out or made in a fictitious name; or

(C)    a transaction or an arrangement in respect of a property where the owner of the property is not aware of, or, denies knowledge of, such ownership;

(D)    a transaction or an arrangement in respect of a property where the person providing the consideration is not traceable or is fictitious.

Explanation.—For the removal of doubts, it is hereby declared that benami transaction shall not include any transaction involving the allowing of possession of any property to be taken or retained in part performance of a contract referred to in section 53A of the Transfer of Property Act, 1882 (4 of 1882), if, under any law for the time being in force,—

(i)    consideration for such property has been provided by the person to whom possession of property has been allowed but the person who has granted possession thereof continues to hold ownership of such property;

(ii)    stamp duty on such transaction or arrangement has been paid; and

(iii)    the contract has been registered;”

What are the broad repercussions of entering into a Benami Transaction?

Chapter II of the Benami Act deals with the prohibitions of benami transactions. Section 3 and Section 5 deal with the repercussions of entering into a benami transaction as amended in 2016 while Sections 4 and 6 deal with certain consequences with regard to civil remedies. Section 5 is punitive in nature while Section 3(2) and 3(3) make entering into a benami transaction a criminal offense.

Sections 3 and 5 are reproduced below:

“Section 3 – Prohibition of benami transactions.

3. (1) No person shall enter into any benami transaction.

(2)    Whoever enters into any benami transaction shall be punishable with imprisonment for a term which may extend to three years or with fine or with both.

(3)    Whoever enters into any benami transaction on and after the date of commencement of the Benami Transactions (Prohibition) Amendment Act, 2016, shall, notwithstanding anything contained in sub-section (2), be punishable in accordance with the provisions contained in Chapter VII.

“Section 5 – Property held benami liable to confiscation.

5.    Any property, which is subject matter of benami transaction, shall be liable to be confiscated by the Central Government.”

The case for Retroactive Application

Though the amendments were carried out in 2016, the effect of the 2016 amendment Act to the Benami Act (amending Act) was that transactions that could be captured under the definition of ‘Benami Transaction’ entered into before the year 2016 were also liable for prosecution. The stand of the Union of India, in this case, was clear – the 2016 amendments, according to the Union of India, only clarified the unamended 1988 Act (unamended Act) and were made to give effect to the older Act. It was in a sense enacted to fill up certain lacunae in the unamended Act and therefore could be given a retroactive application. It was the case of the Union of India that the 1988 Act had already created substantial law for criminalising the offence of entering into a benami transaction and therefore the 2016 amendments were merely clarificatory and procedural.

The SC’s Judgement with regard to retroactive Application

As the basic argument advanced on behalf of the Union of India was that the amending Act was merely clarificatory in nature, the SC decided to first consider the provisions of Section 3 of the Benami Act as it stood prior to its amendment. It is reproduced for ready reference as hereunder –

“3. Prohibition of benami transactions.—

(1)    No person shall enter into any benami transaction.

(2)    Nothing in sub-section (1) shall apply to—

(a)    the purchase of property by any person in the name of his wife or unmarried daughter and it shall be presumed, unless the contrary is proved, that the said property had been purchased for the benefit of the wife or the unmarried daughter;

(b)    the securities held by a—

(i)    depository as registered owner under sub-section (1) of section 10 of the Depositories Act, 1996

(ii)    participant as an agent of a depository.

Explanation.—The expressions “depository” and “Participants shall have the meanings respectively assigned to them in clauses (e) and (g) of sub-section (1) of section 2 of the Depositories Act, 1996.

(3)    Whoever enters into any benami transaction shall be punishable with imprisonment for a term which may extend to three years or with fine or with both.

(4)    Notwithstanding anything contained in the Code of Criminal Procedure, 1973 (2 of 1974), an offence under this section shall be non-cognizable and bailable.”

The SC observed that the criminal provisions envisaged under the unamended Section 3(2)(a) along with Section 3(3) did not expressly contemplate mens rea and that mens rea is an essential ingredient of a criminal offense.

This observation is interesting because it was the cornerstone for the SC to strike down the retrospective criminality put in place by this act. The importance of the existence of the ‘mental intention’ to be convicted in criminal proceedings is the fundamental cornerstone of criminal law. An individual cannot be said to commit a crime without intent, and where the requirement of intent is whittled down, without knowledge (As in the cases of the second part of Section 304 of the Indian Penal Code – culpable homicide not amounting to murder).

The SC found that the absence of mens rea creates the harsh result of imposing strict liability. The Court further found that ignoring the essential ingredient of beneficial ownership exercised by the real owner also contributes to making the law stringent and disproportionate with respect to benami transactions that are tri-partite in nature and that Section 3 as it stood prior to the amendment was susceptible to arbitrariness. The Court alluded to Article 20(1) of the Constitution of India to emphasise that a law needs to be clear, not vague and should not have incurable gaps that were “yet to be legislated/ filled in by judicial process”. The SC also held that a reading of Section 3(1) with Section 2(a) of the unamended Act would have created overly broad laws susceptible to being challenged as manifestly arbitrary.

It was also considered by the Court that the Union of India fairly conceded that the criminal provision had never been utilised as there was a significant hiatus in enabling the function of the provision.

Having considered the above four broad factors – the SC concluded that Section 3 which contained the criminal proceedings with regard to the unamended benami Act was unconstitutional. The Court held that the criminal provisions in the unamended Act had serious lacunae which could not have been cured by judicial forums, even through harmonious forms of interpretation. Regarding Section 5 of the unamended Act, the Court observed that the acquisition proceedings contemplated therein were in rem against the property itself – and that such rem proceedings transfer the guilt from the person who utilised a property which is a general harm to the society on to the property itself.

The SC held that Section 3 (and Section 5) of the unamended Act did not suffer from gaps that were merely procedural but that the gaps were essential and substantive. In absence of such substantive positions, the omissions in the unamended Act created a law which was both fanciful and oppressive at the same time and that such an overly broad structure would be ‘manifestly arbitrary’ as it did not incorporate sufficient safeguards. The Court held that as the Sections were stillborn (never utilised) in the first place, the said Section 3 was unconstitutional right from the inception.

As a natural corollary to Section 3 (and 5) of the unamended Act being held to be unconstitutional, the SC held that the 2016 amendments are in effect, creating new provisions and offences. The Court held that the law cannot retroactively reinvigorate a still-born criminal offence and therefore, “There was no question of retroactive application of the 2016 Act.”

The Fundamental take away from Ganpati Dealcom

The fundamental takeaway from the judgment of the SC in the case of Ganpati Dealcom with regard to the retroactive application of criminal statutes is that the retroactive application of the amended Section 3 of the Act was struck down not merely on the broadly accepted principles that criminal statutes cannot operate retroactively, but the reasoning was deeper. The primary reason of why the statute could not operate retroactively was that the provisions of the Act prior to the 2016 amendments were held to be unconstitutional and void ab initio. This automatically meant that the 2016 amendment could not claim to be merely ‘procedural or clarificatory’ but gave rise to substantial new offences – for the first time. Given the peculiar nature of the factual matrix of this statute, the retroactive operation of the amended Section 3 was held to be bad in law.

However, the Ganpati Dealcom Judgement is significant for another important reason – the SC had just a few months earlier passed another landmark Judgement in the case of Vijay Madanlal Choudhary & Ors. v. Union of India & Ors. 2022 SCC OnLine SC 92.

The Indian SC does not sit en banc – as a whole, but as a combination of various ‘divisions’ and benches of various strengths. That is the reason why it’s often been called ‘Many Supreme Courts in one.’ Within a few months of the Vijay Choudhary Judgment, some apprehensions were already being cast upon its veracity – one such apprehension has been explicitly mentioned in Ganpati Dealcom.

B. THE PREVENTION OF MONEY LAUNDERING ACT, 2002

The PMLA also seemed to wait in the wings for fulfilling its objectives until post-2014, when it started being invoked in earnest to curb the menace of money laundering. The PMLA, its provisions and its applications have all been criticised in the recent past for their draconian nature. A preventive law rather than a prohibitive one like the Benami Act, it was not ‘still born’. It had been amended from time to time in line with India’s global commitments. The Scheme of the PMLA clearly shows that it does not seek only to punish the offence of money laundering but also to prevent it. A substantive part of the legislation is dedicated to compliance and preventive powers given to the authorities under the PMLA.

While benami transactions were primarily a problem in India (and perhaps in the Indian sub-continent), PMLA is global in its outreach.  Primarily set up to combat some of the greatest evils in the form of drug trade, arms trade and flesh trade, today the framework covers a very wide variety of subjects, each perhaps not as dire as the other. The  PMLA, however, has the most motley assortment of legislations included in its Schedule. Various offences under the Indian Penal Code, Narcotic Drugs and Psychotropic Substances Act, Explosive Substances Act, Unlawful Activities Prevention Act, Arms Act, Companies Act, Wildlife Protection Act, Immoral Traffic (Prevention) Act, Prevention of Corruption Act, Explosives Act, Antiques and Art Treasures Act, Customs Act, Bonded Labour Law, Child Labour Law, Juvenile Justice Law, Emigration, Passports, Foreigners, Copyrights, Trademarks, Biological Diversity, Protection of plant varieties and farmer’s rights, Environment Protection Act, Water / Air Pollution Control law, Unlawful Acts against safety of Maritime Navigation and fixed platforms on Continental Shelf, etc.

What is Money Laundering according to the PMLA?

Section 3 of the PMLA defines the offence of money laundering –

“3.     Whosoever directly or indirectly attempts to indulge or knowingly assists or knowingly is a party or is actually involved in any process or activity connected with the [proceeds of crime including its concealment, possession, acquisition or use and projecting or claiming] it as untainted property shall be guilty of offence of money-laundering.

Explanation.—For the removal of doubts, it is hereby clarified that,—

(i)    a person shall be guilty of offence of money-laundering if such person is found to have directly or indirectly attempted to indulge or knowingly assisted or knowingly is a party or is actually involved in one or more of the following processes or activities connected with proceeds of crime, namely:—

(a)    concealment; or

(b)    possession; or

(c)    acquisition; or

(d)    use; or

(e)    projecting as untainted property; or

(f)    claiming as untainted property,
    in any manner whatsoever,

(ii)    the process or activity connected with proceeds of crime is a continuing activity and continues till such time a person is directly or indirectly enjoying the proceeds of crime by its concealment or possession or acquisition or use or projecting it as untainted property or claiming it as untainted property in any manner whatsoever.”

But this definition is incomplete without considering the definition of proceeds of crime as laid out in Section 2(1)(u) of the PMLA:

Proceeds of crime is defined u/s 2(1)(u) of  PMLA as under:

“(u) “proceeds of crime” means any property derived or obtained, directly or indirectly, by any person as a result of criminal activity relating to a scheduled offence or the value of any such property [or where such property is taken or held outside the country, then the property equivalent in value held within the country or abroad.

Explanation. —For the removal of doubts, it is hereby clarified that “proceeds of crime” include property not only derived or obtained from the scheduled offence but also any property which may directly or indirectly be derived or obtained as a result of any criminal activity relatable to the scheduled offence;”

It would be incorrect to assume that the offence of money laundering would be triggered upon the laundering of money. In fact, Section 3 of the PMLA makes even the possession of proceeds of crime a part of the offence of money laundering. If the section as reproduced above are read, it can be observed that both of them contain ‘explanations’. The retrospective application of these explanations were some of the issues that were brought up before the SC.

What are the broad repercussions of the offence of money laundering?

The broad repercussions of money laundering activity are laid down in Section 4 of the PMLA.

What is the most troublesome though is that the maximum punishment for money laundering that may arise out of all the above-assorted activities is the same – up to seven years (not less than three years) and a fine of five lakh rupees, with a single exception of Narcotic Drugs and Psychotropic Substances Act – the money laundering relating to which attracts a sentence of up to ten years (not less than three years) and a fine of up to five lakh rupees. This punishment is not graded based upon the severity of the scheduled offense.

The case for Retroactive/Retrospective Application

The landmark case on the PMLA is Vijay Madanlal Choudhary & Ors. v. Union of India & Ors. 2022 SCC OnLine SC 92. In this, the case for retrospective/retroactive application of the amendments made in 2019 made to Sections 3 and 2(1)(u) was fairly simple – what was inserted were merely explanations as a part of the statute. It was contended, inter alia, that these explanations were clarificatory in nature and did not increase the width of the definition itself.

What is important is that the constitutional validity of the provisions of Section 3 prior to the insertion of the explanation was not in doubt. What contended was that this amendment was merely clarificatory. It is trite law that the parliament is empowered to make laws that operate retroactively and retrospectively, and such action cannot be challenged especially if the changes are merely clarificatory and/or procedural in nature.

The Supreme Court’s Judgement with regard to Retroactive Application

In Vijay Madanlal Choudhary the SC held that the Explanation as inserted in 2019 in Section 3 of the PMLA (making the offence of money laundering a continuous one) did not entail expanding its purport as it stood prior to 2019. It held that the amendment is only clarificatory in nature in as much as Section 3 is widely worded with a view to not only investigate the offence of money laundering but also to prevent and regulate that offence. This provision (even de hors explanation) plainly indicates that any (every) process or activity connected with the proceeds of crime results in offence of money laundering. The Court held that projecting or claiming the proceeds of crime as untainted property is in itself an attempt to indulge in or being involved in money laundering, just as knowingly concealing, possessing, acquiring, or using of proceeds of crime, directly or indirectly. The Court held the inclusion of Clause (ii) in the Explanation inserted in 2019 was of no consequence as it does not alter or enlarge the scope of Section 3 at all as the existing provisions of Section 3 of the PMLA  as amended until 2013 which were in force till 31.7.2019, have been merely explained and clarified by it.

Similarly, for the changes in the definition of ‘proceeds of crime’ and ‘property’ it was held that the Explanation added in 2019, did not travel beyond that intent of tracking and reaching upto the property derived or obtained directly or indirectly as a result of criminal activity relating to a scheduled offence. Therefore, the Explanation was in the nature of a clarification and not to increase the width of the main definition of “proceeds of crime”. The Court held that the Explanation inserted in 2019 was merely clarificatory and restatement of the position emerging from the principal provision i.e., Section 2(1)(u) of the PMLA.

There is a stark difference in the approach of the SC in both cases. However, it cannot be challenged that the statutory matrix and the circumstances of the application of both laws were also very different. The PMLA was hardly in a state of stasis before the 2019 amendment. The constitutional validity of the sections sought to be amended was not in doubt, the challenge was limited to the amendment itself. However, it would be curious to see if the ‘continuing nature’ of the offence of PMLA will stand up to judicial scrutiny if dissected in a manner similar to the way it has been done in Ganpati Dealcom.

The Fundamental take-away from Vijay Madanlal Choudhary

The key take-away from the Vijay Madanlal Choudhary Judgment with regards to retrospective/retroactive application of criminal statutes is that the manner in which such amendments are brought about in the statute book does matter. Though the law as interpreted by the apex court now states that the explanations are merely clarificatory, the repercussion of making the offence of money laundering a continuing activity is far more sinister.

Though money laundering is an offence by itself, it is what can be termed as a predicate offence, it does not exist in the absence of a primary offence. That primary offence may be any of the offences that have been included in the schedule to the PMLA. By making the offence of money laundering a continuing one, however, the statute has empowered itself to virtually prosecute those accused of offences that may have been committed not only before their insertion into the schedule to the PMLA, but also before the PMLA ever came into force. It is possible that someone may be prosecuted for the offence of money laundering decades after the primary offence is committed, even though such an accused may not have been involved in the commission of the primary offence. This aspect of the retroactive application of the PMLA has been the subject of much litigation before various High Courts. The Vijay Madanlal Choudhary Judgment paves the way for such prosecutions at will, by upholding the explanation that states that the offence of money laundering never ends and also by upholding the explanation that makes proceeds of crime include any property ‘directly or indirectly’ obtained as a result of any criminal activity related to the scheduled offence.

It is not that the concept of manifest arbitrariness of various provisions of the PMLA has not been considered. Those claims however, have been dismissed.

C. CONCLUSION

The retrospective/retroactive application of criminal provisions of special laws cannot be countered by a broad sweeping observation that ‘Criminal legislation does not have retrospective application’. The approach of the Courts is always nuanced. Though certain amendments to the criminal provisions of the Benami Act were held to be prospective and certain amendments to the criminal provisions of the PMLA were considered retroactive/retrospective, this was done given due weightage to the type of amendment contemplated in the amending Act and the sort of lacunae that were sought to be filled by the amendments. The two judgments are harmonious in law, but a view can be taken that there is a difference in the approach and the jurisprudential philosophy between the both of them. It’s telling that just a few months after the Vijay Madanlal Choudhary judgment, in Ganpati Dealcom with regard to the principles regarding confiscation / forfeiture provisions the SC observed:

“In Vijay Madanlal Choudhary v. Union of India 2022 SCC OnLine SC 929, this Court dealt with confiscation proceedings under Section 8 of the Prevention of Money Laundering Act, 2002 (“PMLA”) and limited the application of Section 8(4) of PMLA concerning interim possession by the authority before conclusion of final trial to exceptional cases. The Court distinguished the earlier cases in view of the unique scheme under the impugned legislation therein. Having perused the said judgment, we are of the opinion that the aforesaid ratio requires further expounding in an appropriate case, without which, much scope is left for arbitrary application”.

Justice YK Sabharwal (the then Chief Justice of India) is said to have said in 2006 “We are final not necessarily because we are always right – no institution is infallible – but because we are final.”

The Supreme Court may be final – but that may not hold necessarily true for its judgments. Both these Judgments have come out in 2022. Review Petitions by aggrieved parties were filed against them and the Apex Court has already agreed (albeit separately) to consider the review of both of them, though such a review may take place well into the future.

 

Internal Financial Controls over Financial Reporting (ICFR) and Reporting Considerations

Assessment and reporting of internal financial controls over financial reporting is a vital responsibility of the auditor. The Companies Act, 2013 introduced Section 143(3)(i) which requires statutory auditors of companies (other than the exempted class of companies) to report on the internal financial controls over the financial reporting of companies. Globally, an auditor’s reporting on internal controls is together with the reporting on the financial statements and such internal controls reported upon relate to only internal controls over financial reporting. For example, in the USA, Section 404 of the Sarbanes Oxley Act of 2002, prescribes that the registered public accounting firm (auditor) of the specified class of issuers (companies) shall, in addition to the attestation of the financial statements, also attest the internal controls over financial reporting. The objective of Internal Financial Control (IFC) testing is to assist the management in evaluating and testing the effectiveness of financial controls that are in place to mitigate the risks faced by the Company and thereby achieve its business objectives.

The Institute of Chartered Accountants of India (ICAI) has issued Guidance Note on the Audit of Internal Financial Controls over Financial Reporting (‘Guidance Note’). The Guidance Note covers aspects such as the scope of reporting on the IFC, essential components of internal controls, technical and implementation guidance on the audit of the IFC, illustrative reports on the IFC, etc.

The auditor needs to obtain reasonable assurance to opine whether an adequate internal financial controls system was maintained and whether such internal financial controls system operated effectively in the company in all material respects with respect to financial reporting only, along with the audit of financial statements.

WHAT IS INTERNAL FINANCIAL CONTROL (IFC)?

Clause (e) of sub-section 5 of Section 134 explains the meaning of internal financial controls as “the policies and procedures adopted by the company for ensuring the orderly and efficient conduct of its business, including adherence to company’s policies, the safeguarding of its assets, the prevention and detection of frauds and errors, the accuracy and completeness of the accounting records, and the timely preparation of reliable financial information.”

RESPONSIBILITY OF STAKEHOLDERS

Company Management Auditors Audit committee/
Independent Director		 Board of Directors
• Create and test the framework of internal controls.

• IFC (including operational & compliance).

• Control documentation.

 • Focus on internal controls, to the extent these relate to
financial reporting.• Auditor’s responsibility is limited to the evaluation of
‘Financial reporting controls’ and to preparing IFC Audit documentation.		 • Would like to see a robust framework that is aligned with
acceptable standards.• Review & question the basis of controls, design &
ongoing assessments.		 • Would rely on the assessment & view of the audit
committee.• It may ask for additional information.

LEGAL REQUIREMENTS

Relevant clauses Requirements Applicability
Directors’ Responsibility Statement: Section 134(5)(e) Directors’ Responsibility Statement should state that the
directors have laid down internal financial controls to be followed by the
company and such controls are adequate and were operating effectively.		 Listed companies.
Section 143(3)(i) – Auditor’s Report The auditor’s report should state the adequacy and operating
effectiveness of the company’s internal financial controls.		 All companies except private companies with turnover of less
than Rs. 50 crores as per the latest audited
MCA vide its notification dated 13th June 2017 (G.S.R.
583(E)) amended the notification of the Government of India, In the Ministry
of Corporate of Affair, vide No G.S.R. 464(E) dated 05th June 2015 providing
an exemption from Internal Financial Controls to certain private companies.		 financial statement or which has aggregate borrowings from
banks or financial institutions or body corporate at any point of time during
the financial year less than Rs. 25 crores.
Section 177(4) – Audit Committee Audit Committee may call for the auditor’s comments on
internal control systems before their submission to the board and may also
discuss any related issues with the internal & statutory auditors and the
management of the company.		 All companies having an Audit Committee.
Schedule IV Independent Directors The independent directors should satisfy themselves on the
integrity of financial information and ensure that financial controls &
systems of risk management are robust and defensible.		 All companies.
Board Report: Rule 8(5)(viii) of the Companies (Accounts)
Rules, 2014		 Board of Directors to report on the adequacy of internal
financial controls with reference to financial statements.		 All companies

The Guidance Note states that though the Standards on Auditing (SA) do not address the auditing requirements for reporting on IFC, certain portions of the SAs may still be relevant. The procedures prescribed in the Guidance Note are supplementary in that the auditor would need to consider for planning, performing and reporting in an audit of IFC–FR under section 143(3)(i) of the Companies Act, 2013. The audit procedures would involve planning, design and implementation, operating effectiveness, and Reporting. The auditor should report if the company has adequate internal control systems in place and whether they were operating effectively at the balance sheet date.

REPORTING CONSIDERATIONS.

Circumstances when a Modification to the Auditor’s Opinion on Internal Financial Controls over Financial Reporting are required:

The auditor should modify the audit report on internal financial controls if –

a. The auditor has identified deficiencies in the design, implementation or operation of internal controls, which individually or in combination has been assessed as a material weakness.

b. There is a restriction on the scope of the engagement.

The auditor should determine the effect of his or her modified opinion on internal financial controls over financial reporting have, on his or her opinion on the financial statements.

Additionally, the auditor should disclose whether his or her opinion on the financial statements was affected by the modified opinion on internal financial controls over financial reporting. Based on the results of audit procedures, which may include testing the effectiveness of alternative controls established by the management, the auditor should evaluate the severity of identified control deficiencies.

A deficiency in internal control exists if a control is designed, implemented, or operated in such a way that it is unable to prevent, or detect and correct, misstatements in the financial statements on a timely basis; or the control is missing.

EXAMPLES OF CONTROL DEFICIENCIES:

Deficiencies in the Design of Controls – Inadequate design of internal control over the preparation of the financial statements being audited.

Failures in the Operation of Internal Control – Failure in the operation of effectively designed controls over a significant account or process, for example, the failure of control such as dual authorization for significant disbursements within the purchasing process.

Significant Deficiencies – Controls over the selection and application of accounting principles that are in conformity with generally accepted accounting principles.

Material Weaknesses – Identification by the auditor of a material misstatement in the financial statements for the period under audit that was not initially identified by the entity’s internal control, identification of fraud, whether or not material, on the part of senior management; errors observed in previously issued financial statements in the current financial year;

The auditor should also consider additional considerations as mentioned below while reporting:

a) Evaluation of control not operating effectively on account of the hybrid mode of working and absence of the concerned person in the office.

b) Identify alternate controls.

c) Company’s ability to close the financial reporting process in time.

d) Perceived opportunity for fraudulent financial reporting or misappropriation of assets may exist when an individual believes internal control could be circumvented, for example, because the individual is in a position of trust or has knowledge of specific weaknesses in the internal control system.

Circumstances when a Modification to the Auditor’s Opinion on Internal Financial Controls Over Financial Reporting are required:

Effect of a modified report on internal financial controls over financial reporting on the audit of financial statements:

A modified report on internal financial controls over financial reporting does not imply that the audit report on financial statements should also be qualified. In an audit of financial statements, the assurance obtained by the auditor is through both internal controls and substantive procedures. Hence, substantive procedures are to be performed for all assertions, regardless of the assessed levels of material misstatement or control risk. Further, as a result of substantive procedures, if sufficient reliable audit evidence is obtained and if it addresses the risk identified or gains assurance on the account balance being tested, the auditor should not qualify the audit opinion on the financial statements.

For example, if a material weakness is identified with respect to customer acceptance, credit evaluation and establishing credit limits for customers resulting in a risk of revenue recognition where potential uncertainty exists for the ultimate realisation of the sale proceeds, the auditor may modify the opinion on internal financial controls in that respect. However, in an audit of financial statements, the auditor when performing substantive procedures obtains evidence of the confirmation of customer balances and also observes that all debtors as of the balance sheet date have been subsequently realised by the date of the audit, the audit opinion on the financial statements should not be qualified, though the internal control deficiency exists.

[e.g.- Refer to Mahanagar Telephone Nigam Limited1 -Consolidation Report for 31st March 2022, where ICFR Report is qualified as material weakness is being identified in Capitalisation, Provisions, Reconciliations but overall, it does not impact the auditor’s opinion on the ‘Consolidated Ind –As financial statement’ of the Holding Company.]

1. https://www.bseindia.com/bseplus/AnnualReport/500108/77259500108.pdf

The management relies on its internal financial controls for the preparation of financial statements, whereas the auditor tests controls as well as carries out substantive procedures to opine on financial statements. For companies that prepare and publish unaudited financial information (such as listed entities), internal controls related to the preparation of financial statements determine the company’s ability to accurately prepare such information. In such cases, even if an audit report on financial statements is unmodified, it does not give any indication of whether unaudited interim financial information prepared by the company is reliable or not. Therefore, if the report on internal financial controls over financial reporting is modified, the auditor needs to consider the effect of such modification in his review of interim financial information for the subsequent period.

An unmodified audit opinion is not a guarantee of error-free financials but is rather the conclusion by an auditor – using audit procedures and professional judgement that are reasonable to the circumstances – that the statements are fairly presented.

Inter-play between substantive procedures and operating effectiveness of internal controls:

Even if the operating effectiveness of internal controls is predominantly determined by testing controls, findings from substantive procedures carried out as part of an audit of financial statements also affect the auditor’s conclusion on the operating effectiveness of internal controls. The auditor needs to consider, inter alia, the risk assessment used to select substantive procedures, findings of illegal acts and related party transactions, management bias in making estimates and selecting accounting policies and the extent of misstatements detected by substantive procedures.

FINANCIAL STATEMENTS CLOSE PROCESS (FSCP)

Though internal controls over financial reporting are required for each type of transaction, FSCP is a significant process for which internal controls need to exist. Though there is no definition of FSCP, usually it refers to the process of how transactions are recorded in the books of account and the preparation, review, and approval of interim or annual financial statements including required disclosures therein.

Similar to carrying out the audit of internal controls related to all types of transactions, an auditor needs to perform a walkthrough of FSCP to understand the risks of material misstatements and related controls, including relevant IT controls.

Example of separate modified (qualified/adverse) audit report for an audit of internal financial controls over financial reporting

Nature
of Industry/Name of the Company		 Opinion
in Main Audit Report FY 21-22		 Opinion
in IFCR Reporting		 Material
Weakness
NEL Holdings South Limited2

– Standalone-

 Adverse Qualified • Granting of unsecured advances for acquiring various immovable
properties.• Compliance with the provision of the Companies Act• Obtaining year-end balance confirmation certificates in respect of
trade receivables, trade payables, vendor advances, advances from customers
and other advances.

• To ascertain the realizable value of Inventory and also does not have
a documented system of regular inventory verification.

• Ascertaining tax assets/liabilities and payments of statutory dues
including Income Tax and Goods and Service Tax and other relevant Taxes.

• Maintaining the details of pending litigations and ascertaining
corresponding financial impact to report on the contingent liability of the
Company.
• Ascertain and maintain employee-wise ageing
details of the salary payable and other employee
benefit expenses like gratuity payable.
Imagicaaworld Entertainment Limited – Standalone3 Adverse Adverse • Preparation of Financials on Going Concern.

• Impairment testing.
Reliance Infrastructure Limited –
Standalone4		 Disclaimer Disclaimer • Evaluating about the relationship, recoverability and possible
obligation towards the Corporate Guarantees given.
Hindustan Construction Company Ltd.

-Consolidation5

 

 Qualified Qualified • Compliance with the provisions of section 197 of the Companies Act,
2013 relating to obtaining prior approval from lenders for payment/ accrual
of remuneration exceeding the specified limits.• Internal financial system with respect to assessment of recoverability
of deferred tax assets were not operating effectively.		 
2 https://www.bseindia.com/bseplus/AnnualReport/533202/73138533202.pdf
3 https://www.bseindia.com/bseplus/AnnualReport/539056/74434539056.pdf
4 https://www.bseindia.com/bseplus/AnnualReport/500390/73190500390.pdf
5 https://www.bseindia.com/bseplus/AnnualReport/500185/76791500185.pdf

The Companies Act does not spell out or specify any particular framework to be followed while establishing an Internal Financial Control System, but the Guidance Note provides detailed guidance. Therefore, the first and foremost duty of auditors regarding Internal Financial Controls over Financial Reporting is to see and get satisfied with the framework set in place as specified in the Guidance Note and as declared in the Directors’ Responsibility Statement duly vetted by the Audit Committee and independent directors, are fool-proof, infallible and watertight. To achieve that, a checklist of internal controls is to be installed for each area so that the adequacy of controls is ensured in all respects. Further for companies to which ICFR is not applicable but have control deficiencies, the auditor will have to ascertain and apply professional judgment whether any modifications are required to be reported. Internal controls may change or fail to be performed, or the processes and procedures for which the controls were created may change, rendering them less effective or ineffective. Because internal controls are effective only when they are properly designed and operating as intended, it is of huge importance to determine the quality of internal control’s performance over a period of time. In scenarios, where ICFR is applicable for the first time or ICFR is applicable to the company and is not implemented by the company or there are no adequate controls, the auditor will have to assess and conclude whether modification or disclaimer of opinion in reporting is required.

Liberalised Remittance Scheme – How Liberal It Is? (An Overview And The Recent Amendments)

This article looks at recent amendments in the
Liberalised Remittance Scheme (LRS) under Foreign Exchange Management
Act (FEMA) and in the provisions of Tax Collection at Source (TCS) on
remittances under LRS under the Income-tax Act. The changes are
significant and people should be aware of these issues. Along with the
recent amendments, we have dealt with some important & practical
issues also.

A. FOREIGN EXCHANGE MANAGEMENT ACT:

1. Background:

1.1 In February 2004, RBI introduced the LRS with a small limit (vide A.P.
Circular No. 64 dated 4.2.2004). Any Indian individual resident could
remit up to US$ 25,000 or its equivalent abroad per year from his own
funds. It was introduced to provide exposure to individuals to foreign
exchange markets. Dr. Y. V. Reddy, ex-Governor of RBI in his book titled
“Advice & Dissent” on Page 352 mentions that the funds could be
used for almost any purpose. It was supposed to be a “No questions asked” window and was in addition to all existing facilities. Late Finance Minister Mr. Jaswant Singh in a gathering said “Go conquer the world, we will be your supporters”. That was the underlying theme of the LRS.

1.2 There was a small negative list of purposes for which remittance could
not be made. The negative list included payments prescribed under
Schedule I and restricted under Schedule II of Current Account
Transaction Rules such as lotteries and sweepstakes; and payments to
persons engaged in acts of terrorism. Remittances also could not be made
to some countries. Later in 2007 remittance under LRS for margin
trading was also prohibited.

1.3 Over the years, the scheme has been modified. The limits have been increased periodically
(except for a brief period from 2013 to 2015). Today the limit is US$
2,50,000 per year per person. Thus, every individual Indian resident can
remit US$ 2,50,000 per year for any permitted purpose. At the same
time, restrictions have been introduced on current account transactions
and investments under LRS and such restrictions have kept on increasing.
The spirit of the original theme has been diluted to a significant extent. Let us see the current provisions of LRS including its main issues.

2. The present LRS:

2.1 The present LRS is dealt with by the following rules, regulations and circulars. FAQs provide some more clarifications.

i) Foreign Exchange Management (Permissible Capital Account Transactions) Regulations, 2000 (FEMA Notification no. 1).

ii) Foreign Exchange Management (Permissible Current Account Transactions) Rules, 2000.

iii) Foreign Exchange Management (Overseas Investment) Rules, 2022 (hereinafter referred to as “OI Rules”).

iv) Foreign Exchange Management (Overseas Investment) Directions, 2022
vide AP circular no. 12 dated 22.8.2022 (hereinafter referred to as “OI
Directions”).

v) Master Direction No. 7 on LRS updated up to 24.8.2022.

vi) FAQs updated up to 21.10.2021 (these have not been updated with the
rules and regulations of August 2022. However, these contain some
important clarifications.)

The statutory documents are the first
three documents – Rules and Regulations. The fourth and fifth documents
are essentially directions to Authorised Persons – i.e. Banks for
implementation of the rules and regulations. The sixth document – FAQs –
doesn’t have a binding effect. These are clarifications and wherever
helpful, these can be used.

However, if one reads only the
statutory documents, one does not get the full picture. One has to read
all the documents together to understand the entire scheme with its
nuances. At times, A.P. Circulars and Master Directions contain
additional provisions which are nowhere covered in the statutory
documents. Hence it is necessary to consider all the documents.

Also,
as is the case with several rules and regulations under FEMA, one
cannot get the entire picture merely by reading the documents. Some
things go by practice. Many such issues and practical problems will be
dealt with subsequently. Needless to say, it will not be possible to
deal with all issues. The focus is on important issues and issues arising out of amendments to LRS in August 2022 and TCS provisions in Finance Act 2023.

2.2 The present LRS in brief:

2.2.1
Under the present scheme, an Indian resident individual (including a
minor) can remit up to US$ 2,50,000 or its equivalent per financial
year. This limit has been there since May 2015. The remittance can be
made for any “permitted” Current Account Transaction or a “permitted”
Capital Account Transaction. The word “permitted” is a later addition.
As per the 2004 circular, the LRS was overriding all restrictions
(except those stated in the circular itself).

For remittance
under LRS, the simple compliance is the submission of Form A2 with some
basic details. [No form is required for making a rupee gift or a loan.
However, the person must keep a track to see that aggregate of such
rupee payments (discussed later) and foreign exchange remitted during a
year are within the LRS limit.]

Remittances during one year have to be made through one bank only.

2.2.2 Remittance has to be made out of person’s own funds.
In a family, one member can gift (not loan) the funds to another family
member and all the relatives can remit the funds under LRS. This has
been an accepted position.

Source of funds:

Loans: A person cannot borrow funds in India and remit them abroad for capital account transactions.
The restriction on taking loans continues right from the beginning
(i.e., February 2004). One can refer to these provisions in Paragraphs 8
and 10 in Section B of the present Master Direction on LRS.

A person also cannot borrow funds from a non-resident to invest. Thus,
buying a home abroad with a foreign loan is not permitted even if the
loan repayment is within the LRS limit. Foreign builders offer schemes
where the person can get a completed house, but payment can be made over
the next few years after completion. This will clearly be a violation
as the payment option over a few years is a loan.

Primarily a loan also cannot be taken for current account transactions. However, in the FAQs dated 21st October 2021, FAQ 16 clarifies that banks can provide loans or guarantees for current account transactions
only. Here, FAQ is being relied upon. Strictly, FAQs have no legal
authority. In practice, it goes on. Thus, a loan can be taken from a
bank for education and funds can be remitted abroad. However, no loans
can be taken from anyone else even for a current account transaction.

Other prohibited sources:

Remittances out of “lottery winnings, racing, riding or any other
hobby” are prohibited. These are stated in Schedule I of the Current
Account Rules. Hence even if the person has his own funds but earned
from these sources, he cannot remit the same under LRS. This is an issue
that is missed by many people. Further, ‘hobby’ is a broad term. What
seems to be prohibited is income from hobbies which involve gambling and
chance income.

LRS covers both Current and Capital Account Transactions.

2.2.3 Current Account Transactions –

Under clause 1 of Schedule III of Foreign Exchange Management (Current
Account Transactions) Rules, 2000, the following purposes are specified
for which remittance can be made:

i) Private visits to any country (except Nepal and Bhutan).
ii) Gift or donation.
iii) Going abroad for employment.
iv) Emigration.
v) Maintenance of close relatives abroad.
vi) Travel for business or attending a conference or specialised
training or for meeting medical expenses, or check-up abroad, or for accompanying
as an attendant to a patient going abroad for medical treatment/check-up.
vii) Expenses in connection with medical treatment abroad.
viii) Studies abroad.
ix) Any other current account transaction.

Prior to May 2015, there was no limit on remittance for
Current Account transaction. Since May 2015, the limit has been brought
in. Item (ix) above seems to be a misplacement in the Current Account
Transaction rules. This raises some difficulties. Import of goods is a
Current Account transaction. An individual who is doing trading business
in his individual name could import goods worth crores of rupees. Now
can he import above the LRS limit? The view is that for Import, there is
a separate Master Direction laying down procedures and compliances.
Under that Master Direction, there is no limit for imports. Hence
whatever is covered under the Master Direction on Imports, can be
undertaken freely. All other expenses are restricted by the LRS limit.
Thus, expenses for services, travel, etc. will be restricted by the LRS
limit. It would be helpful if Central Government could come out with a
clarification.

We would like to state that India has accepted
Article VIII of the IMF agreement. Under the agreement, a country cannot
impose restrictions on Current Account transactions. However, some
reasonable restrictions can be placed. This is the stand adopted by
India also (refer Section 5 of FEMA). Under this section, a person is
allowed to draw foreign exchange for a Current Account Transaction.
However, the Government can impose some “reasonable restrictions”. This
can mean restrictions on some kinds of transactions or imposition of
some conditions. However, a blanket ban above US$ 2,50,000 on all
current account transactions may not come within the purview of
“reasonable restrictions”. A business entity owned by an individual can
remit any amount for a Current Account Transaction. But the same
individual cannot, if he is doing business in his individual name
(except import of goods and services). In our view, this is not logical.

Specified current account transactions allowed without any limit:

i) Expenses for emigration are permitted without limit. However,
remittances for making an investment or for earning points for the
purpose of an emigration visa are not permitted beyond the LRS limit.

ii)
For medical expenses and studies abroad also, one can incur expenses
more than the LRS limit subject to an estimate given by the hospital/
doctor or the educational institution.

2.2.4 Capital Account Transactions

– The permitted Capital Account transactions can be referred to in
Clause 6 – Part A of the Master Direction on LRS dated 24th August 2022.
Earlier the list was a little more elaborate. Now the list is truncated
after the Overseas Investment Rules have been enacted. The permitted
transactions are:

i) opening of foreign currency account abroad with a bank.
ii) acquisition of immovable property abroad, Overseas Direct
Investment (ODI) and Overseas Portfolio Investment (OPI), in accordance with
the provisions contained in OI Rules, 2022; OI Regulations, 2022 and OI
Directions, 2022.
iii) extending loans including loans in Indian Rupees to
Non-resident Indians (NRIs) who are relatives as defined in the Companies
Act, 2013.

The LRS is primarily used for opening bank accounts, portfolio
investment, acquiring immovable property and giving loans abroad. Prior
to 24th August 2022, the circular referred to specific kinds of
securities – listed and unlisted shares, debt instruments, etc. Now the
reference has been made to Overseas Portfolio Investment (OPI)
and Overseas Direct Investment (ODI) under the New Overseas Investment
regime. This is discussed more in detail in para 2.2.5 below.

It may be noted that a foreign currency account cannot be opened in a bank
in India or an Offshore Banking Unit. The bank account should be outside
India.

2.2.5 Overseas Portfolio Investment (OPI) – OPI has been defined in Rule 2(s) of OI Rules to mean “investment, other than ODI, in foreign securities, but not in any unlisted debt instruments or any security issued by a person resident in India who is not in an IFSC”.
(It has been clarified that even after the delisting of securities, the
investment in such securities shall continue to be treated as OPI until
any further investment is made in the entity.)

Basically, OPI
means investment in foreign securities. Then, there are exclusions to
the same – ODI, unlisted debt instruments and securities issued by a
resident [except by a person in the International Financial Services
Centre (IFSC)].

ODI includes investment in the unlisted equity capital
of a foreign entity. Equity Capital includes equity shares and other
fully convertible instruments as explained under Rule 2(e) of OI Rules.
Thus, now it is clear that investment even in a single unlisted share of
a foreign entity falls under ODI and it requires separate compliance.

Listed foreign securities have not been defined. However, “listed foreign
entity” has been defined in Rule 2(m) of OI Rules to mean “a foreign
entity whose equity shares or any other fully and compulsorily convertible instrument is listed on a recognised stock exchange outside India.”

Para
1(ix)(a) of OI Directions provides further prohibitions under OPI which
are not covered under the OI Rules. It provides that OPI is not
permitted in derivatives and commodities.

This brings out the following:

OPI means Investment in foreign securities. However, investment in the following are not covered under OPI:

i) Investments considered as ODI:

a) Investment in unlisted equity capital;

b) Subscription to Memorandum of Association;

c) Investment in 10% or more of listed equity capital;

d) Investment of less than 10% of listed equity capital but with control in the foreign entity.

ii) Unlisted debt instruments.

iii) Security issued by a person resident in India (excluding a person in an IFSC).

iv) Derivatives unless specifically permitted by RBI.

v) Commodities including Bullion Depository Receipts.

Debt instruments are defined in clause (A) of Rule 5 of OI Rules. These mean:

i) Government bonds.

ii) Corporate bonds.

iii) All tranches of securitisation structure which are not equity tranches.

iv) Borrowings by firms through loans.

v) Depository receipts whose underlying securities are debt securities.

Other investments:
Apart
from listed securities, investment is permitted in units of mutual
funds, venture funds and other funds which can be considered as “foreign
securities”.

Investment in Gold (precious metal) bonds is not permitted as it amounts to a corporate bond.

Buying physical gold or other precious metals outside India is also not permitted under LRS.
Also, see para 2.2.12 for more prohibitions under LRS.

2.2.6 Bank fixed deposits

– Is investment in fixed deposits of banks permitted? Can these be
considered as loans? Extending loans is specifically permitted under
LRS. What is prohibited is borrowing by firms. Banks are not firms.
These are companies.

Bank FDs are also not corporate bonds.
Bonds have a specific meaning. It means a security or an instrument
which can be transferred. A bank FD cannot be transferred.

However,
OPI means investment in foreign securities. A Bank Fixed Deposit is not
a “security”. Hence in our view, keeping funds in Bank FDs is not
considered as OPI.

One view is that bank fixed deposit is like a bank balance. Hence funds remitted under LRS may be kept in bank fixed deposits.
However, funds remitted abroad have to be used within 180 days. (See
para 3 for more discussion). Hence such FDs cannot be held beyond 180
days and should be used for some permitted purpose within 180 days.

2.2.7 Unlisted shares of a foreign company – A background:

From 2004 till 22nd August 2022, the Master Directions were abundantly clear that investment under LRS could be made in unlisted and listed equity shares. However, vide A.P. Circular 57 dated 8th May 2007, the RBI introduced the sentence – “All other transactions which are otherwise not permissible under FEMA …… are not allowed under the Scheme.”
Under this clause, RBI took a view that investment in unlisted shares
was not permitted. According to RBI, investment in unlisted shares was
permitted only as per ODI rules applicable at that time (Old ODI Regime
under FEMA Notification 120 which was in effect before 22nd August
2022). Under those rules, individuals were not permitted to make
business investments outside India. Hence, investments made by resident
individuals in unlisted foreign companies to undertake business were
considered as a violation. With due respect, the stand taken by RBI does
not go in line with the language of the Master Directions – right till
22nd August 2022. All penalties imposed for investment in unlisted
shares by resident individuals – are not in keeping with the law – FEMA.

The phrase “which are otherwise not permissible” applies
to all investments. For example, investment in immovable property
abroad is otherwise not permissible. But under LRS it is permissible.
Loans abroad are otherwise not permissible. But under LRS they are
permissible. The LRS was supposed to apply in addition to all existing facilities.
In Master Circular on Miscellaneous Remittances from India – Facilities
for Residents dated 1st July 2008, the phrase was amended to “The facility under the Scheme is in addition to those already included in Schedule III of Foreign Exchange Management (Current Account Transactions) Rules, 2000”. From May 2015, the Current Account Rules were changed and from Master Circular dated 1st July 2015 onwards, the phrase “in addition to”
has been dropped. However, the fact remains that till 22nd August 2022
investment in unlisted shares was permitted as per Master Direction.
From 23rd August 2022, the phrase “unlisted shares” was dropped in the
Master Direction.

On representation, RBI formally introduced the
scheme of ODI for resident individuals from August 2013 (generally
called “LRS-ODI”). It permitted individuals to invest in unlisted shares
of a foreign company having bonafide business subject to compliances
pertaining to ODI. However, RBI considered investments made prior to
August 2013 as a violation which required compounding. This did leave a
bad taste for Indian investors.

Thus, now the investment in
unlisted securities is covered under the ODI route and has a separate
set of rules and compliances. This was the position since August 2013
under the Old ODI regime as well as under the New OI regime notified on
22nd August 2022. It is not dealt with more in this article as that is a
subject by itself.

2.2.8 Listed securities abroad of Indian companies – Up to Master Circular dated 1st July 2015, the language was that investment could be made under “assets” outside India.
It did not specifically state that investment could be only in
securities of foreign entities. Hence investment made in say GDRs or
securities of Indian companies listed abroad was possible. Later, Master
Circulars were replaced with Master Directions. From Master Direction
dated 1st January 2016, it was provided that investment could be in “shares of overseas company”. Hence, it should be noted that under LRS, an individual can invest in listed securities of a foreign entity.
One cannot invest in securities of an Indian company which are listed
abroad. Some people have invested in bonds of Indian companies listed
abroad. Such investments are not permitted under LRS. One should sell
such investments and apply for compounding of offence. Under the OI
Rules as well, investment in securities issued by a person resident in
India is not permitted under OPI. There is only one exclusion to the
prohibition – investment in securities issued by an entity in IFSC is
allowed.

2.2.9 Investment in permissible security of an entity in IFSC is permitted under LRS. Under the Notification No. 339 dated 2.3.2015, any entity in an IFSC is treated as a non-resident.

OPI as discussed in para 2.2.5 above means investment …. in foreign securities, but not in any unlisted debt instruments or any security issued by a person resident in India who is not in an IFSC”.
This language creates some confusion. Investment is not permitted in
any security issued by an Indian resident which is not in IFSC. Does it
mean that investment in any security such as “unlisted debt instrument”
issued by an entity in IFSC is permissible? We would not take such a
view. One has to equate an IFSC entity with a foreign entity. Whatever
security of a foreign entity one can invest in, similar security of an
IFSC entity can be invested in. Thus, investment should be in assets
discussed in paras 2.2.4 and 2.2.5.

2.2.10 Extending Loans:
Under LRS, extending loans to non-residents is allowed. However, this
is allowed in the case of outright loans to third parties. For instance,
Mr. A (an Indian resident) can give a loan to his friend Mr. B (a US
Resident) or to B Inc (a US company).

However, if Mr. A has made
ODI in the USA (whether in his individual capacity or through an Indian
Entity), then a loan by Mr. A to the investee entity in the USA is not
considered under LRS. Mr. A will have to comply with the ODI Rules in
such a case. Under ODI Rules, only equity investment can be made by
individuals. One cannot take a view that investment in equity of a
foreign entity will be under ODI and loan to that entity will be under
LRS. If there is any equity investment in a foreign entity as ODI, then
all conditions of the ODI route shall be fulfilled. Hence, no loan can
be given.

2.2.11 Transactions in Indian rupees – Indian
residents are allowed to give gifts and loans to NRI/ PIO relatives (as
defined under the Companies Act 2013) in rupees in their NRO account.

Para
6(iii) of the Master Direction initially refers to NRIs. Later, it has
been clarified that gifts and loans can be given to PIOs also (i.e.,
foreign citizens but Persons of Indian Origin).

It was represented to RBI that under LRS, foreign exchange can be remitted
outside India to anyone. However, if payment has to be made in rupees in
India, it is not permitted! RBI has since then permitted gifts and
loans in rupees in India but only to NRI/PIO relatives within the
overall LRS limit.

2.2.12 Prohibited transactions – Apart from restrictions discussed in para 2.2.5, the following transactions are prohibited:

i) Transactions specified in Schedule I and Schedule II of Current
Account Transactions Rules. This includes remittances for lottery
tickets, banned magazines, etc.

ii) Remittances to countries identified by FATF as non-co-operative countries.

iii) Remittance for margin trading. Thus, dealing in derivatives and options is not permitted.

iv) Trading in foreign exchange. (This is stated in FAQs updated up to 21.10.2021. No other document states this.)

3. Retaining funds abroad:

3.1 Background: This is the most important change in the LRS.

The individual who has remitted funds under LRS can primarily retain
the same abroad, reinvest the funds and retain the income earned from
such investments abroad. This has now undergone a change with effect
from 24th August 2022. The change has been carried out without any
specific announcement.

The Overseas Investment rules and
regulations were notified on 22nd August 2022. The Master Direction on
LRS was amended on 23rd August 2022 to factor in the changes in capital
account transactions as per the OI Rules as explained in paras 2.2.4 and
2.2.5 above. Paragraph 16 of the Master Direction amended on 23rd
August 2022 stated that – “Investor, who has remitted funds under LRS
can retain, reinvest the income earned on the investments. At present,
the resident individual is not required to repatriate the funds or
income generated out of investments made under the Scheme.” Till
23rd August 2022 funds remitted under LRS and income from the same could
be retained and used abroad without any restrictions.

The Master
Direction on LRS was amended again on 24th August 2022 (just one day
later). This amendment includes an important change in the scheme and
has been dealt with in the next para 3.2.

3.2 Main amendment: Under the LRS Master Direction amended on 24th August 2022, Paragraph 16 provides the following:

“Investor, who has remitted funds under LRS can retain, reinvest the income earned on the investments. The received/realised/unspent/unused foreign exchange, unless reinvested, shall be repatriated and surrendered to an authorised person within a period of 180 days
from the date of such receipt/ realisation/ purchase/ acquisition or
date of return to India, as the case may be, in accordance with
Regulation 7 of Foreign Exchange Management (Realisation, repatriation
and surrender of foreign exchange) Regulations, 2015 [Notification No.
FEMA 9(R)/2015-RB]”.

It is provided that the received or
realised or unspent or unused foreign exchange should be repatriated to
India, unless it is reinvested. The time limit of 180 days is provided.
This condition of repatriating the unused or uninvested funds back to
India within 180 days is a major change. No specific announcement was
made. It was simply brought in the Master Direction on 24th August 2022.

The language is broad. The terms “received” and “realised” can
refer to the amount received on sale of investment, or income on
investment. The terms “unspent” and “unused” can refer to amount
received on sale of investments, or income on investment, or amount remitted from India under the LRS. The amounts have to be reinvested within 180 days from the date of receipt, realisation, acquisition or purchase of foreign exchange.

While the word “reinvested” is used, it cannot be mandatory that the funds
should only be “reinvested”. The intention seems to be that funds should
not be parked idle. They should be “reinvested” or “used” within 180
days. Let us assume a person makes an investment under LRS, then sells
the same and receives the sale proceeds. These proceeds can be used for
any permitted Current Account Transaction (expenditure) or Capital
Account Transaction (investment) within 180 days. That is the purpose of
LRS. Here also it will be helpful if RBI could provide a clarification.

3.3 Retrospective amendment: The requirement to
repatriate the idle funds within 180 days applies not only to fresh
remittances but also to the existing funds lying abroad which were
remitted before 24th August 2022. It is effectively a retrospective amendment. Many people are not aware of this.

Let
us take a case where funds were remitted under LRS since 2018 and funds
were lying idle in the bank account since then. These are unspent funds
and the amendment made on 24th August 2022 applies to such funds as
well. Hence, the person will have 180 days to invest the funds from 24th
August 2022. If it is not done, the funds should be repatriated.

Thus, by 19th Feb 2023 the funds remitted prior to 24th Aug 2022 had to be
utilised, if they were lying unspent or unutilised. If the funds are not
used by then and are still lying abroad, it is a contravention of FEMA.

3.4 Issues: This will cause difficulties for several people. Let us consider some issues.

3.4.1 Small amounts to be tracked and invested: The
income earned on investments abroad should also be invested abroad
within 180 days, or these should be remitted back to India. The income
on LRS funds could be small. Let us take a case where funds are remitted
to a brokerage account in the USA and investment is made in listed
shares. A small amount of income is received and lying in the brokerage
account. Or some funds are kept in the brokerage account to pay an
annual fee. One will have to keep track of all these incomes and
reinvest them. Keeping such a track and investing small funds is
difficult. Further remittance of funds to India also costs money by way
of bank charges, etc.

3.4.2 Time-consuming investments: Let
us consider another case. Let us say the person has purchased a flat
and after few years, he sells the same. He would like to buy another
flat abroad. The sale proceeds of the first flat should be used within
180 days. Either he should buy the flat or invest the funds in permitted
investments. At times, to finalise the transaction for a flat takes lot
of time. Therefore, one will have to plan to invest within 180 days
from the sale of flat.

3.4.3 Consolidation of funds over multiple years for high-value investments:

Some people have sent funds over a few years to buy an immovable property
abroad as one year’s limit under LRS may not be sufficient. However,
with the 180 days’ time limit, the accumulation of funds is not
possible. In such cases, the funds remitted abroad should be invested in
portfolio investment. And when the funds are sufficient to buy the
property, the securities can be sold. This however means that the person
undertakes risks associated with the securities. A fall in prices of
the securities will jeopardise the purchase of property.

3.5 Can the person invest the funds in bank fixed deposits?

See
para 2.2.6 above where it is stated that Bank FDs do not fall within
the definition of OPI. Remitting funds under LRS and keeping them in
Bank FDs for up to 180 days is all right. However, bank fixed deposits
are not securities and can be considered equivalent to funds in a bank
account. Hence, in our view, placing funds in bank fixed deposits will
not be considered an “investment” of funds. It will be ideal if RBI
comes out with a clarification on the same.

3.6 Some cases where the 180-day limit will not apply:

As mentioned in para 2.2.4, Indian residents can give loans and gifts
to NRI relatives. Here, there is no question of utilising foreign
exchange. Hence there is no limit of 180 days or any other time period.
The limit of 180 days applies only for foreign exchange remitted abroad
or lying abroad.

Let us take another illustration. A student
remits funds under LRS for education purposes to his foreign bank
account. Before leaving India, he is an Indian resident. All funds may
not be utilised within 180 days. Some funds may be lying for ongoing and
future expenses. However, when the student leaves India for education
abroad, he becomes a non-resident. In such a case, the 180-day limit
will not apply. Once a person is a non-resident, the funds outside India
are not liable to FEMA restrictions. Hence, the condition of
repatriating the funds within 180 days will not apply.

3.7 Consequences of violation:

What are the consequences of a violation of not using the funds within
180 days? The person concerned has to apply for compounding. Compounding
is a process under which the person concerned admits to the violation.
RBI then levies a penalty for the violation. There is no option to pay
Late Submission Fee (LSF) and regularise the matter. LSF is for delays
in submitting the documents/forms.

There is however, a hitch. Before applying for compounding, the transactions have to be regularised. How does one regularise?

Regularising
means doing something now, which should have been done earlier. In our
view, the violation can be regularised in two manners – one is by
remitting the funds back to India. The other is to invest/use the funds
abroad as permitted – although with a delay. It is however doubtful
whether utilising the funds after the 180-days’ period will be
considered as regularisation. It will be better for the funds to be
repatriated to India. Once the funds are repatriated, a Compounding
Application should be filed with RBI.

3.8 Alternate views:

3.8.1
There is a view that the provision of use of funds within 180 days
applies to an “investor” only (see para 16 of Master Direction). Thus,
if funds are remitted by an investor for investment, one has to use the funds within 180 days. Whereas, if a person has remitted the funds for expenses
such as education, one can use the funds beyond 180 days also. However,
the language does not suggest such an intention. While the provision
starts with the term “investor”, the provision goes on further to add
that the funds have to be surrendered to the bank “in accordance with
Regulation 7 of Foreign Exchange Management (Realisation, repatriation
and surrender of foreign exchange) Regulations, 2015 [Notification No.
FEMA 9(R)/2015-RB]”. Regulation 7 of Notification 9(R) provides as under:

“A person being an individual resident in India shall surrender the
received/realised/unspent/unused foreign exchange whether in the form of
currency notes, coins and travellers cheques, etc. to an authorised
person within a period of 180 days from the date of such
receipt/realisation/purchase/acquisition or date of his return to India,
as the case may be.”

Regulation 7 applies to all individual
Indian residents and for all purposes. Hence even if the funds have been
remitted for expenses, they have to be utilised within 180 days.
Otherwise, the same should be remitted to India.

3.8.2 There is
another view as to when is the amount to be considered as unused/
unspent. The view is that once the amount is remitted abroad, it has to
be used on the first day. If it is not used on the first day, then it is
unused/unspent. If it unused/unspent, it has to be remitted back to
India. The time of 180 days is only to remit the funds back to India.

While
literal reading suggests this – in our view, this is neither the
correct interpretation, nor the intention. One cannot use the funds on
day one. It takes time for the funds to be used. If the funds are not
used within 180 days, then they have to be remitted back to India.

4. Some more issues:

4.1 Purpose Codes: At
the time of remittance, one has to state the purpose code in the form.
For example, one mentions the purpose code as S0023 (remittance for
opening a bank account abroad). After remittance, can the funds be used
for investment in shares? Or the purpose code stated is investment in
real estate (S0005) and one is not able to invest in real estate within
180 days, and hence invested in shares. Can it be done? Technically it
could be considered an incorrect purpose code. However, if one considers
the substance of LRS, remittance for any permitted purpose is allowed.
One may have the original intention for one purpose, but then the
purpose has changed, and it should be all right. After the remittance of
funds, change of use has always been permitted. Assume that a person
has remitted the funds to open a bank account abroad. Under the present
LRS scheme, funds have to be used within 180 days. To comply this
condition, funds are invested. This means the “use of funds” has changed
from keeping funds in bank account to investment. Or the funds are sent
for investment in shares, and then the shares are sold. Does it mean
the sale proceeds have to be reinvested only in shares? No. The funds
have to be used or reinvested for any permissible purpose.

It
will be better that after remitting the funds for the first time, if
there is a change in the use, one should write to the bank and inform
the change of use. This is however out of abundant caution. In substance
after sending the funds, the same can be used for any permitted
purpose. Also see para 3.2 of Part B on TCS provisions.

4.2 Joint holding:

There are people who open bank accounts and make investments in joint
names. Investment is made by one person (say the first holder). Funds
belong to the first holder. That is how it is declared in the income tax
returns. However, to take care of situations where the investor dies or
becomes incapacitated, the account or the investment is held in the
joint name. Otherwise, the funds may be blocked. The process of
producing a Will or succession document is a time-consuming process. So,
the second name is added for the sake of convenience. Hence in our
view, holding an investment or bank account in a joint name is all
right. It is a prudent step. There cannot be any objection to this.

5. Co-ownership and Consolidation of funds:

5.1 Co-ownership

– Assume that funds are sent by two or more relatives in one bank
account. From there investment has to be made. It is necessary that the
investment should be made in the proportion in which the funds are
remitted. Assume that Mr. A remits US$ 1,00,000 and Mrs. A remits US$
50,000, and together they invest US$ 1,50,000 in shares. The holding
ratio in the shares should be 2:1 between Mr. A and Mrs. A. If the
investment holding is 50:50, it means Mr. A has given a gift to Mrs. B.
Gift outside India from one resident to another resident is an
impermissible transaction. It will become a violation.

5.2 Consolidation of funds

– Master Direction prior to 23rd August 2022 permitted consolidation of
remittances by the family members. It further provided that clubbing is
not permitted by family members if they are not the co-owners of bank account/ investment/ immovable property. Here, the condition for co-ownership does not mean being just a co-owner. It means that ownership ratio in the asset should be commensurate with the ratio in which payment is made.
This is prima facie in line with the LRS that the owner should remit
the funds. If another person becomes the owner without remitting the
funds it is as good as a gift from the person who has remitted the
funds. This is different from being a joint holder (without remittance
or payment) for the sake of convenience discussed in para 4.2 above.

It may be noted that “family members” have not been explained. It should
be considered as a family comprising relatives under the Companies Act
2013.

5.3 Consolidation of funds for acquiring immovable property

– The amended Master Direction on LRS has retained the above-mentioned
condition of consolidation of funds and co-ownership. However, the
reference to the immovable property has been removed. The Master
Direction has stated that remittances for the immovable property should
be in accordance with OI rules.

Under the OI rules, an Indian
resident can acquire immovable property by remitting funds under LRS.
Further, an Indian resident can acquire property as a gift from another
resident also, subject to the condition that the donor should have
acquired such property in line with FEMA provisions applicable at the
time of acquisition.

Further, proviso to Rule 21(2)(ii)(c) of OI Rules states that “such
remittances under the Liberalised Remittance Scheme may be consolidated
in respect of relatives if such relatives, being persons resident in
India, comply with the terms and conditions of the Scheme”.

Does this mean that relatives can consolidate/ club the remittances, but
property can be owned by one person? As discussed above, an Indian
resident cannot gift funds to another Indian resident outside India.
When consolidated funds are remitted, purchase by one person actually
amounts to a gift of funds – which is not permitted. If the property is
acquired and then later the share in the property is gifted, it is
permissible.

However, if one considers the draft rules on Overseas investment published in 2021 for public consultation, it
provided that if funds were consolidated, the immovable property has to
be co-owned. In the final OI rules notified by Central Government and
the amended Master Direction, the language is different. The condition
of co-ownership is not present for the purchase of immovable property
abroad. While it seems like a specific amendment to relax the condition
for co-ownership, it does not come out clearly that funds can be
remitted by relatives but property can be purchased by one person.

At present, where remittances are consolidated amongst relatives, one
should avoid purchasing immovable property without complying with the
condition of co-ownership. It will be helpful if RBI can provide a
specific clarification.

5.4 In some cases, banks have permitted remittance under LRS from one account of an individual for say
4 different people by obtaining PAN of all 4 people. This is incorrect.
Remittance is not based on PAN. It is per person. One individual
can remit only up to the LRS limit and that too for himself/ herself.
If funds have to be remitted by other Indian resident family members,
then the account holder should first gift the funds to others and then
others may remit the funds from their account. Of course, if the bank
account is a joint account and funds in that account belong to all joint
holders, then each joint holder can remit up to the balance available
under his ownership. Consolidated funds can be remitted subject to what
has been discussed in para 5 above. In such cases, one should keep a
proper account of the funds, ownership and remittances.

Summary:

LRS was started in the year 2004 as the first step towards capital account
convertibility of the rupee. Subsequent amendments have imposed too many
conditions and restrictions. This clearly goes back from
liberalisation.

B. INCOME-TAX ACT – TAX COLLECTION AT SOURCE ON REMITTANCES UNDER LRS:

1. Provisions in force till 30th June 2023:

1.1 Basic provision:

Sub-section (1G) was introduced in Section 206C vide Finance Act, 2020
w.e.f. 1st October 2020. It provides for Tax Collection at Source (TCS)
at the rate of 5% on remittances out of India under LRS. There is
a threshold of INR 7,00,000 for the same, i.e., there is no TCS on
remittances up to INR 7,00,000. The rate of 5% is applicable for amount
in excess of Rs. 7,00,000. It should be noted that TCS is applicable per
person per financial year.

Thus, the bank which sells foreign exchange to the individual for remittance under LRS, will collect tax @
5% over and above the rupee amount required for sale of foreign
exchange. This TCS is like an advance tax. The individual can claim the
TCS as tax paid while filing his income-tax return. Many laymen are
under the impression that this is a straight loss. However, that is not
the case. The issue is that the funds of the person get blocked for some
time.

1.2 Non-applicability of TCS:

1.2.1 Remittance not covered under LRS: TCS applies only where remittance is made under the LRS. For instance – if
an NRI remits funds from his NRO/ NRE Account, TCS will not apply in
such case. It is because this is not a remittance under LRS. Similarly,
TCS is not applicable to remittances by persons other than individuals.

1.2.2 Remitter liable to TDS: It has been provided that if the remitter is liable to deduct tax at
source under any provisions of the Income-tax Act, and has deducted such
tax, then this TCS provision will not apply. The intention seems that
TCS is not applicable only if the remitter is liable to deduct tax at
source on the “concerned LRS remittance” and has deducted the same.

However, the language is not clear whether the remitter should be liable to
deduct tax at source on “the concerned remittance under LRS” or “any
transaction”. The literal reading suggests that it is not necessary that
TDS should be applicable on the concerned LRS remittance. The person
may be liable to deduct tax at source on any payment. Consider some
examples. Some individuals have to deduct tax at source where the
turnover or gross receipts from business/profession exceeds the
prescribed thresholds; or on purchase of immovable property u/s. 194-IA;
or on payment of rent u/s. 194-IB. These transactions on which TDS is
deductible are unrelated to the LRS remittance. The language suggests
that TCS is not applicable where the person has deducted tax at source
under any provisions. In our view, this is not the intention. It would
be better if the Government brings clarity in respect of the provision.

1.3. Concessional rate in case of loan taken for education:

A concessional rate of TCS @ 0.5% is applicable instead of 5% where:

the remittance is for the purpose of pursuing education; and
the amount being remitted is from loan funds obtained from a financial institution as defined u/s 80E.

In other words, if the remittance under LRS is made for the purpose of
education out of own funds then the concessional rate of TCS will not be
applicable and one needs to pay TCS @ 5 per cent.

1.4. Overseas Tour Program Package:

While the threshold of INR 7 Lakhs is prescribed for all purposes, such a
threshold is not applicable where the remittance is for the purpose of
an overseas tour program package. Hence, in such cases, TCS @ 5% is applicable without any threshold.

This is the position of TCS on remittances under LRS as of now. Let us take a look at the amendments proposed in Budget 2023.

2. Amendment vide Finance Act 2023 as passed by the Lok Sabha on 24.3.2023 – TCS rate to be increased to 20%:

2.1 Vide Finance Act 2023, the rate of TCS has been increased from the
existing 5% to 20% for remittances made under LRS w.e.f. 1st July 2023.

2.2 Further, the threshold of INR 7,00,000 has been restricted only to
cases where remittance is for the purpose of education or medical
treatment.

2.3 Consequently, the rate of TCS will now be 20% without any threshold for all purposes except education and medical treatment.

2.4 One more amendment is that the phrase “out of India” has been removed
for the purpose of TCS. Under the original provision, TCS was applicable
only where remittance was done “out of India” under LRS. As discussed
above in Para 2.2.11, LRS can be used for giving gift or loan in rupees
to NRI/ PIO relatives in their NRO account as well. In such case, TCS
was not applicable as per existing provision.

From 1st July 2023, TCS will be applicable on such rupee transfers as well. It is not
required that there is remittance out of India. It should be noted that
for rupee payments discussed in para 2.2.11 of Part A, there is no
mechanism to report to the bank. The remitter has to keep track of rupee
payments and see that all payments in rupees and foreign exchange
should be within the limits of LRS. For remittance abroad, formal
reporting must be made to the bank and thus bank will know that the
funds are being remitted under LRS. In the case of rupee payments, RBI
should work out a mechanism for reporting. Alternatively, the remitter
should himself provide the details to the bank and the bank should
collect TCS.

2.5 The concessional rate of 0.5% where remittance
is out of educational loan (discussed in Para 1.3 above) remains the
same after amendment.

The table below summarises the TCS rate for various transactions before and after the proposed amendment.

Particulars Vide
Finance Act 2020 1st
October 2020 to 30th June 2023		 Vide
Finance Act 20231st
July 2023 onwards
Remittance out of educational loan taken from
financial institution defined u/s 80E		 0.50% on amount exceeding INR
7,00,000
Education & medical treatment 5% on amount exceeding INR
7,00,000
Overseas tour program package 5% without any threshold 20% without any threshold
All other purposes 5% on amount exceeding INR 7,00,000 20% without any threshold

3. Other issues:

3.1 Payment through International Credit Cards:

It should also be noted that payments made by International Credit Card
(ICCs) for foreign tours or any other Current Account Transaction are
not captured within the purview of LRS. The limit of LRS, of course,
applies whether payment is made through bank transfer or through ICC.
There is however no mechanism to collect TCS when payment is made by
ICC.

Finance Minister – Smt. Nirmala Sitharaman, while passing
the Finance Bill in Lok Sabha on 24th March 2023 has made a statement on
this. The Central Government has requested the RBI to develop a
mechanism to capture payment for foreign tours and TCS by ICC.

3.2 Change in use of funds – As mentioned in para 4.1 of Part A, the purpose can be changed after remitting the funds. This can have some issues.

Normally the TCS rate is 20%. If the purpose of remittance is changed to
education, the TCS should have been lower at 5%. As excess tax is
collected, there is no difficulty. In any case, TCS is like advance tax.
It will be claimed as such in the income tax return.

However, let us assume that funds are remitted for education and TCS is 5%. Later
the use is changed to investment, then there is a shortfall in the TCS.
Banks would of course have collected the tax based on declaration and
documents provided by the remitter. The change in use would not cause
any liability on the bank. Will it cause any liability on the remitter?
There should be no implication for a bonafide case. For example, The
original remittance was for education purpose but some funds could not
be used within 180 days. In order to comply with the condition of
investing the funds within 180 days, the funds were invested.
Subsequently the investments were sold and funds were used for
education. This should not be an issue. Even otherwise there is no
specific provision for change of use. Please note that we are discussing
bonafide change in use and not false declarations. Out of abundant
caution, the remitter may inform the bank on change of use and if
necessary, ask the bank to collect additional tax from him and pay the
same to the Government. It may even collect interest. The remitter will
in any case claim the additional TCS in his tax return.

Summary:

20% is a very high rate for TCS. There are no thresholds. The threshold of
INR 7 Lakhs has also been removed. Sometimes, remittances are made for
pure expenses or gift to relatives which do not lead to any potential
incomes. However, with the steep hike in its rate, it appears that the
government does not wish to encourage remittances under LRS. Hence it is
making remittances costlier.

Conclusion:

There are significant changes in the LRS in terms of inserting some
restrictions and disincentives. Before making remittances under the LRS,
one should carefully understand the implications and then go ahead with
the remittance.

(Authors acknowledge contributions from CA Rutvik Sanghvi, Ms. Ishita Sharma and CA Nidhi Shah.)

Report On 55th BCAS Residential Refresher Course

After a year’s hiatus, which witnessed the 54th Residential Refresher Course (RRC) of the BCAS being held in the virtual mode for the very first time in January of last year, the possibility of hosting the 55th RRC as a physical event sent the blood coursing through the veins of everyone associated with its organisation.
With the venue for this year’s RRC being the holy town of Nashik, surely the stars were aligned in our favour! Think ‘Nashik’ and the much-revered Shirdi Sai Baba also comes to mind. A visit to the temple to pay obeisance and seek Baba’s blessings was a definite given. Those of a certain vintage may remember the lyrics of the popular song ‘Shirdiwale Sai Baba…’ from the movie ‘Shirdi Ke Sai Baba’,
…Tujhe sab maante hain,
Tera ghar jaante hain,
Chale aate hain daude,
Jo khush kismat hain thode,
Yeh har rahi ki manzil,
Yeh har kashti ka sahil…

To those who look upon the RRC as an annual pilgrimage – and there are many – these words apply as much to Shirdi Baba as they do to the RRC. ?

Of course, given that the third wave was still holding sway, the RRC – from Thursday, 24th February to Sunday, 27th February 2022 – was planned in hybrid mode – both physically and virtually. The expectation was that participants might prefer to wait out and not register during the early-bird phase (which normally happens); however, within a few days of the announcement, we had 100 plus registrations! Well, as the line goes, chale aate hain daude, jo khush kismat hain thode…

The venue was the newly opened Radisson Blu, Nashik. We had 110 participants who joined us physically at the venue and 43 who joined us virtually; the participants hailed from 22 cities across India at this 4-day conference.

The first day, post a sumptuous lunch with old friends and new acquaintances, the event was formally inaugurated with the traditional lighting of the lamp by the eminent Chief Guest, CA Dr. Vinayak Govilkar; the President, CA Abhay Mehta; the Vice President, CA Mihir Sheth; and the Chairman of the Seminar, Public Relation & Membership Development Committee, CA Narayan Pasari. The Chief Guest spoke lucidly on the highly engaging and pertinent topic of ‘Journey of Currency – from Barter to Bitcoin’.

The RRC was kick-started with the ice-breaking Presentation Paper on Practice Talks. The engaging trio of new generation practitioners, CA Anand Bathiya, CA Mayank Lakhani and CA Jeenendra Bhandari traversed all practical issues and aspects of modern-day practice. The audience was pulled into the conversation through the innovative use of technology which required them to answer questions by logging into a link created for the event. The answers to the poll questions were available for all to see and mull over – it gave the practitioners a quick fact check on where they stood as far as the others. CA Hitesh Gajaria ably chaired the talk.

Friday morning saw most participants getting into the coaches organised to take them for darshan at the Shirdi Sai Baba temple. Once back at the hotel, the group discussion (GD) on ‘Case Studies in Accounting, Auditing and Company Law’ began. The quartet of vibrant Group Leaders – CA Kaustubh Deshpande, CA Manoj Chandalia, CA Monica Challani and CA Ronak Rambhia ensured that the discussion among the participants – both physical and virtual – was fruitful and engaging.

GD-1 was followed up by a thought-provoking Paper Presentation on ‘Valuation of New Age Tech Companies’ by CA Ravishu Shah, chaired by Past President CA Deepak Shah. During the calendar year 2021, 63 companies had come out with an initial public offering (IPO) and raised around Rs 1.3 lakh crore from investors. The practical approach adopted by the speaker by discussing the recent IPOs and their valuations offered the attendees a good macro and micro insight on the topic, thus prompting some pertinent questions from the participants. The last session of the day was the presentation by a paper-writer, a veteran professional and Past President, CA Himanshu Kishnadwala, who enlightened the participants with solutions to the case studies discussed earlier by the various groups.

Saturday morning witnessed the participants dive into the brainstorming GD on ‘Case Studies on Direct Taxes’. Once again, the group leaders, CA Divya Jokhakar, CA E. Chaitanya, CA Kinjal Bhuta and CA R.Harishably steered the discussion on the case studies. This was followed by a thought-provoking session by CA Aseem Trivedi on the ‘Recent Issues on Disciplinary Cases and Code of Ethics’. The session of Ethics was intricately chaired by Past President CA Uday Sathaye. Critical aspects of recent ethical issues faced by Chartered Accountants were discussed. This was followed by the Direct Tax session ably chaired by our BCAS veteran and Past President, CA Anil Sathe. Advocate Devendra Jain, the paper writer, ably discussed each case study in an erudite manner.

The last session on Sunday morning, a Panel Discussion on the concept of ‘Related Party Transactions’ under various laws such as the Companies Act, Accounting Standards, Income Tax Act and the GST Law had the panelists CA Parind Mehta, CA Sonalee Godbole and CA Sudhir Soni, share their subject expertise on 11 case studies with the audience. The session was moderated by the BCAJ Editor and Past President, CA Raman Jokhakar. The participants found the panel discussion truly enriching as the discussion was focused on various practical issues faced by professionals.

The event concluded with Chairman CA Narayan Pasari acknowledging the tireless efforts of Convenors of Seminar, Public Relations & Membership Development Committee – CA Kinjal Bhuta, CA Manmohan Sharma, CA Mrinal Mehta and CA Preeti Cherian and thanking all those who worked towards delivering a successful RRC.

Till we gather next year under one umbrella, let’s pay an ode to our dear RRC with that evergreen number yet again…

Tareef teri nikli hai dil se,
Aayi hai lab pe, ban ke qawaali!

Highlights of Volume 53 (Y.E. 31st March, 2022)

•    67 Articles (an average of more than 5 articles a month) in addition to 24 Regular Features.
•    3 New Series during the year [International Taxation – MLI Series; Accountancy and Audit – CARO 2020 Series; Practice Management and Technology – Digital Workplace Series].
•    2 Reader Surveys.
•    A Unique Industry Article – JDA Structuring: A 360-degree View.
•   Annual Special Issue – Effects of the Pandemic on the CA Profession, the Economy, and the Human Psyche [July 2021].
•    Cryptocurrencies – Covered holistically under the sections on Laws and Business, Taxation & Accounts and Audit.

At a Glance: Listing of Articles Published in Volume 53

Accountancy and Audit
•    Revisiting Auditing Standards [April, 2021]
•    Audit: Building Public Trust [June, 2021]
•    CARO 2020 Series: New Clauses and Modifications: Property, Plant & Equipment & Intangible Assets [June, 2021]
•    Auditor’s Reporting – Unveiling the Ultimate Beneficiary of Funding Transactions [July, 2021]
•    Covid Impact on Internal Controls Over Financial Reporting [August, 2021]
•    CARO 2020 Series: New Clauses and Modifications – Inventories and Other Current Assets [August, 2021]
•    CARO 2020 Series: New Clauses and Modifications- Loans & Advances, Guarantees & Investments [October, 2021]
•    Going Concern Assessment by Management [October, 2021]
•    Auditors Evaluation of Going Concern Assessment [November, 2021]
•    CARO 2020 Series: New Clauses and Modifications – Deposits, Loans and Borrowings [November, 2021]
•    CARO 2020 Series: Frauds and Unrecorded Transactions [December, 2021]
•    Accounting Treatment of Cryptocurrencies [December, 2021]
•    NOCLAR (Non-Compliance with Laws and Regulations) [December, 2021]
•    CARO 2020 Series: Non-Banking Finance Companies (NBFCs) [Including Core Investment Companies] [January, 2022]
•    Audit Quality Maturity Model – What is Your Score? [February, 2022]
•    CARO 2020 Series: Reporting on Financial Position [February, 2022]
•    Auditor’s Reporting – Group Audit and Using the Work of Other Auditors [March, 2022]
•    Internal Control Considerations for Upcoming Audits [March, 2022]
•    The ESG Agenda and Implications for C-Suite and Corporate India [March, 2022]
•    CARO 2020 Series: Resignation of Statutory Auditors and CSR [March, 2022]

Corporate and Other Laws
•    Cognizance of the Offence of Money-laundering [April, 2021]
•    Understanding Prepack Resolution [April, 2021]
•    Valuation of Contingent Consideration [August, 2021]
•    Introduction to Accredited Investors – The New Investor Diaspora [August, 2021]
•    Special Purpose Acquisition Companies – Accounting and Tax Issues [September, 2021]
•    Implications of Key Amendments to Companies Act, 2013 on Management and Auditors [September, 2021]
•    India’s Macro-economic & Financial Problems and Some Macro-level Solutions [September, 2021]
•    Empowering Independent Directors [October, 2021]
•    Person in Control (PIC):  New Modification in the Entity [November, 2021]
•    SEBI Tightens Regulations for Related Party Transactions – Key Amendments and Auditor’s Responsibilities [January, 2022]
•    Do Conglomerate Structures Facilitate Business Efficiency? [January, 2022]

Direct Taxes
•    Covid Impact and Tax Residential Status: The Conundrum Continues [April, 2021]
•    I Had a Dream [April, 2021]
•    Changes in Partnership Taxation in Case of Capital Gain by Finance Act, 2021 [May, 2021]
•    JDA Structuring: A 360-degree View [May, 2021]
•    Unfairness and the Indian Tax System [June, 2021]
•    Faceless Regime under Income-tax Law: Some Issues and the Way Forward [July, 2021]
•    Slump Sale – Amendments by Finance Act, 2021 [July, 2021]
•    Should Charity Suffer the Wrath of Section 50C? [August, 2021]
•    The Ghost of B.C. Srinivasa Setty is not yet Exorcised in India [February, 2022]
•    Does Transfer of Equity Shares Under Offer for Sale (OFS) During the Process of Listing Trigger any Capital Gains? [February, 2022]
•    Fungibility Of Direct Tax and Indirect Tax For Individual Income Taxpayers And Income Tax Returns Filers [March, 2022]

International Taxation
•    MLI Series: Introduction and Background of MLI, Including Applicability, Compatibility and Effect [April, 2021]
•    MLI Series: Dual Resident Entities – Article 4 of MLI [May, 2021]
•    MLI Series: Anti-tax Avoidance Measures for Capital Gains: Article 9 of MLI [June, 2021]
•    MLI Series: MAP 2.0 – Dispute Resolution Framework under The Multilateral Convention [August, 2021]
•    MLI Series: Analysis of Articles 3, 5 & 11 of the MLI [September, 2021]
•    MLI Series: Article 13: Artificial Avoidance of PE through Specific Activity Exemption [October, 2021]
•    TLA 2021 – A Dignified Exit from a Self-Splashed Mess: An Analysis of Reversal of Retrospective Amendment [October, 2021]
•    MLI Series:  Article 10 – Anti-Abuse Rule for PEs Situated in Third Jurisdictions (Part 1) [December, 2021]
•    Value chain analysis – Adding Value to Arm’s Length Principle [December, 2021]
•    MLI Series: Article 10- Anti-Abuse Rule for PEs Situated in Third Jurisdictions (Part 2) [January, 2022]
•    MLI Series: Purpose of a Covered Tax Agreement, Prevention of Treaty Abuse: Article 6 and 7 of MLI [February, 2022]

Practice Management and Technology
•    Rolling out ‘Coaching’ in Professional Services Firms [April, 2021]
•    Youtube- How to Use it As a Branding Tool [May, 2021]
•    Strategy: The Heart of Business – Part II [May, 2021]
•    Personal Branding for CAs [May, 2021]
•    Creating Your Digital Persona on Twitter #tweetandgrow [July, 2021]
•    Digitial Workplace – A Stitch in Time Saves Nine [August, 2021]
•    Digital Workplace – When All Roads Lead to Rome… [September, 2021]
•    Digital Workplace: Finding the Right Balance [October, 2021]
•    Change is Constant [December, 2021]
•    Smallcase Investing – An innovative concept for retail investors [January, 2022]

Indirect Taxes
•    Latent Issues Under GST Law on Interception, Detention, Inspection & Confiscation of Goods in Transit [October, 2021]

Annual Special Issue – Effects of the Pandemic on the CA Profession, the Economy, and the Human Psyche
•    CA Profession in the Post-Covid Era: Doom or Boom? [July, 2021]
•    Effect of Covid on Economy [July, 2021]
•    Into that Heaven of Freedom, My Father…. [July, 2021]

Surveys
•    Auditors’ Report – BCAJ Survey of Auditors, Users and Preparers [July, 2021]
•    Statutory Audit – BCAJ Survey on Perspectives on NFRA Consultation Paper [November, 2021]

CENTRAL GOVERNMENT BUDGETS: RECEIPTS SIDE TRENDS AND LEARNINGS FOR FUTURE ACTIONS

We are all aware that the Budget document is a Receipts and Payments Statement of the Central Government for the year the Budget is prepared for and the comparative previous years.

The Central Government Budgets Statement of Receipts has four main breakups:

1)    Actual Receipts of the accounting year previous to the accounting year the Budget is being announced in.

2)    Budget Estimates of the current ongoing year as submitted when the Budget is presented to Parliament.

3)    Revised Budget Estimates of the current ongoing year ending being informed to Parliament.

4)    Budget Estimates for the year the Budget is submitted for Parliamentary approval.

Therefore, the Budget document for the year 2022-23 would have Actuals for 2020-21, Budget Estimates and Revised Budget Estimates for the year 2021-22 and Budget Estimates for the year 2022-23.

We need to understand that effective July 2017, GST replaced multiple indirect taxes. GST implementation was followed by periods of tightening controls and the two-year pandemic impact. The GST collections for the last three months (January – March, 2022) show buoyancy, and it is hoped that the buoyancy will stay intact as consumption revives, though inflation could impact consumption.

Table A – Composition of Central Government Budget Receipts

(In Rs.Crores)

Types of Receipts

Actuals
2014-15

Actuals
2017-18

Actuals
2020-21

Revised Estimate
2021-22

Budget Estimate
2022-23

Revenue Receipts

 

 

 

 

 

Corporation Tax

428,925

571,202

457,719

635,000

720,000

Income Tax

265,733

430,772

487,144

615,000

700,000

Wealth Tax

1,086

63

12

–

–

Total – Direct Taxes

695,744

1,002,037

944,875

1,250,000

1,420,000

Indirect Taxes

549,141

916,971

1,082,228

1,266,059

1,337,820

 

 

 

 

 

 

Gross Tax Revenue

1,244,885

1,919,008

2,027,103

2,516,059

2,757,820

Non-Tax Revenue

197,857

192,744

207,633

313,791

269,651

Total Revenue Receipts

1,442,742

2,111,752

2,234,736

2,829,850

3,027,471

 

 

 

 

 

 

CAPITAL RECEIPTS

484,448

702,650

1,883,105

1,516,877

1,739,735

Gross Total Receipts

1,927,190

2,814,402

4,117,841

4,346,727

4,767,206

 

 

 

 

 

 

Less – States share of Tax collection

(337,808)

(673,005)

(594,997)

(744,785)

(816,649)

Transfers to NCCF/NDRF

(3,461)

(3,515)

(5,820)

(6,130)

(6,400)

Total Receipts-Centre (Net)

1,585,921

2,137,882

3,517,024

3,595,812

3,944,157

 

 

 

 

 

 

Ratios

 

 

 

 

 

Direct Tax as % of Gross

Total Receipts

36.10

35.60

22.95

28.76

29.79

Indirect Tax as % of
Gross Total Receipts

28.49

32.58

26.28

29.13

28.06

States share of taxes – %
of Total Tax Revenues

27.14

35.07

29.35

29.60

29.61

Total Taxes as % of
Gross Total Receipts

64.60

68.19

49.23

57.88

57.85

Capital Receipts (incl. divestment) as % of
Gross Total Receipts

25.14

24.97

45.73

34.90

36.49

Income Tax as % of  Gross Total Receipts

13.79

15.31

11.83

14.15

14.68

Source: Budget Documents uploaded on Internet

The Budget process could be used for the following disclosures and computations purposes:

1)    Disclose amounts the Government of India (GOI) may have to pay towards various forms of subsidies to state governments, corporates, devolution of tax revenues etc. Let the dues be computed on an accrual basis less the amounts considered as paid through the budget process. The balance liability should be shown as dues payable.

2)    What is the future pension liability on an actuarial basis the GOI is carrying?

3)    What are claims against the GOI from domestic/overseas corporates or governments (including state governments) though they may be in dispute from the GOI end.

4)    If there are tax or other commercial claims by the GOI against corporates – these claims could be split into private sector corporates and public sector corporates. If there is a commonality between disputes by both private and public sector units, instead of the revenue authorities wasting taxpayer money by proceeding against companies on the strength that their tax claims are correct, should they not have serious discussions within themselves and review whether the tax claims made by them are tenable and they have not gone into a classic tax overreach. This could be a very important decision because much of judicial time and taxpayer money could be saved.

In the disclosures of the above four restricted points, the Government of India is being requested to provide information that all Indian corporates are expected to provide at the time they submit their audited accounts to stakeholders. It makes for superior disclosures quality and would be very useful at the time of country ratings and review of financial and economic management.

The time has come for India to not just have an Inflow/Outflow of Funds Budget, but also to reveal that which has not been considered in the Budget process as liabilities which may have to be settled in the future or look at the tenability of claims that they are raising. The fair value of assets in terms of claims would then be known. Recognition of assets and liabilities are important elements of a budgetary process. You can manage inflows/outflows until the day of reckoning arrives but being aware of liabilities and assets, and open disclosure of the same will force an action mode.

SOME RECENT DEVELOPMENTS – SEBI’S GUIDANCE ON CROSS-REFERRALS, NSE RULING AND AMENDMENT TO FUTP REGULATIONS

Securities laws continue to remain interesting by constant tweaking of the regulations by the SEBI to keep them with times, even if some of which may be ill-considered. Some SEBI orders too create good precedents and, at times, place on record happenings in companies which can be disturbing and even disillusioning. Then there are informal guidances handed out, which are akin to advance ruling in substance which, even if they do not have binding effect, usually reflect the view that SEBI is likely to take even in other cases. Let us discuss some of such developments in recent weeks briefly.

SEBI’S INFORMAL GUIDANCE – EARNINGS BY INTERMEDIARIES FROM REFERRALS OF CLIENTS TO OTHERS
Providing as many services as possible under one roof makes business sense and good customer service, helping common branding and savings in costs in the financial services industry. However, this also presents scope for conflicts of interest. For example, a merchant banker who manages an issue could face a conflict with other departments which recommend investments to clients. An investment adviser who must give an impartial recommendation to clients on their investment portfolio faces a potential conflict with other entities in the group, such as mutual funds. SEBI’s general approach to dealing with such conflicts has been multi-pronged. Firstly, full disclosure must be made of all conflicts by various intermediaries. Secondly, certain conflicts are wholly prohibited and cannot be cured even by disclosure. Yet another method is requiring that entities in the same group will not give the same client two types of conflicting services.

Introducing many such provisions initially resulted in resistance, but this was eventually accepted as good practice for all. A recent informal guidance by SEBI (in the case of HDFC Securities Limited, dated 14th February, 2022) presents an interesting way of how one organization proposed to deal with the issue in the interests of all. It proposed that it would recommend and refer selected external investment advisors to its clients. The advisor then would pay a referral fee to the organization. This would appear to be a win-win situation for all. The organization would earn from the referral of a client who otherwise would have consulted an investment advisor in their own group. The investment advisor would get a client. The client would be saved from hunting afresh for yet another intermediary for services he needs. In its informal guidance, SEBI allowed this, stating that this is a correct interpretation of the law and, hence, permissible.

However, this, in the author’s submission, creates an imbalance amongst intermediaries. An investment advisor, for example, faces far more and stricter restrictions under Regulation 15, 22 and other provisions of the Regulations governing investment advisors. He absolutely cannot earn directly or indirectly any fees, commissions, etc., from providing any distribution service to its clients. For example, if he advises his clients to invest in certain mutual funds, it cannot act as an agent of such fund and sell units of such fund to the client and earn commission thereon. Indeed, even a family member cannot provide such distribution services to that client. As stated above, while some restrictions can be cured by disclosures to client, the restrictions generally on investment advisors are far wider and more strict.

Indeed, this problem has wider ramifications, particularly since there are multiple intermediaries and even multiple regulators – SEBI, IRDA, PFRDA, etc. So there are even further potential areas of conflict that could be detrimental to investors. It is perhaps time that a holistic view is taken by individual regulators of their multiple regulations and even together as regulators so that cross-regulator arbitrage is eliminated.

SEBI’S RULING – NATIONAL STOCK EXCHANGE AND OTHERS
SEBI passed a final order (Reference No. WTM/AB/MRD/DSA/21/2021-22 dated 11th February, 2022) in the case of Chitra Ramkrishna, National Stock Exchange (NSE) and others levying penalties on them for violations of various regulations governed by SEBI. While there are several perspectives from which the order can be seen, it is also the factual matrix asserted in the order which deserves attention. The order talks of events that have allegedly taken place in the Exchange which are bizarre on one hand but, on other hand, in the submission of the author, not uncommon. But they do present a disturbing state of affairs of management of large companies and question whether well-meaning practices of corporate governance which are mandated by law actually exist in practice or are flouted easily. It is possible that the order may be contested in appeal and that some of the factual assertions made or directions may be rejected/set aside. But taking at face value, let us discuss what the order asserts.

Firstly, the Order says that the Managing Director and CEO of NSE appointed a deputy of sorts and gave extremely wide powers to him and huge remuneration that was reviewed substantially upwards over his tenure. In the opinion of SEBI, this was not only unreasonable considering his background and qualifications but did not even pass through the regular performance appointment and review processes mandated for senior management (e.g., review and recommendation by the Nomination and Remuneration Committee). Further, though having such wide powers, which even resulted in several very senior executives reporting to him, he was not given the designation of Key Managerial Personnel (KMP). Appointment of a person as KMP involves certain approval and review processes and places him accountable in terms of being directly liable for defaults in areas falling within his purview. As asserted by SEBI, what was also disturbing is the alleged silence of the various persons who could have been aware of this and who would then be expected to play the role of checks and balances in such a large organization. It was asserted that the MD/CEO took these decisions single-handedly. Such revelations raise yet again questions whether the elaborate provisions in law (and at times voluntarily adopted) exist primarily on paper or can otherwise be easily flouted?

On the other hand, in the author’s submission, it is common not just in corporates but also in different fields, including politics, that an executive assistant is appointed to assist the top leader. Such executive assistant often has the total trust of the leader and is given wide powers to execute on behalf of the leader. Such executive assistants could individually become very powerful and command authority far beyond his status and accountability. The question then is how corporate governance and law requirements and their actual practice should ensure that they do not become power centers without the requisite supervision and accountability.

The second major and perhaps more disturbing aspect in the order is that the MD/CEO regularly consulted a ‘Spiritual Guru’ on important matters relating to the running of NSE. She even allegedly shared confidential corporate information with such a person. The said Guru not only had no official connection with NSE but was asserted by the MD not even to have physical coordinates and could manifest at will! But equally curiously, the Guru could still access emails sent to him and reply to them. Further, he gave detailed advice on important policy matters relating to the running of NSE and even used sophisticated corporate management jargon in such emails. Thus, instead of running NSE through modern corporate practices and teamwork, such a person appeared to have a decisive say on important matters. It is again surprising that the checks and balances in the organization and the corporate governance framework did not detect/prevent these alleged happenings.

Now, again, it is indeed a tradition in India to seek the guidance of spiritual Gurus. Perhaps a leader faces the proverbial loneliness at the top, which makes the compulsion to seek out advice even more. Such Gurus are also known to be approached to resolve family or business disputes. But it is one thing to seek advice and solace on personal life outlook and spiritual matters. It is totally different when blind reverence leads to them having a vital say in running a large organization. Saddeningly, this also places even corporates in the global stereotype of India being a place of snake charmers and superstitions. And, finally, yet again, the question arises whether the checks and balances of good corporate governance either do not exist beyond paper or whether they can be flouted and thus provide false assurance?

SEBI REGULATIONS AMENDMENT – FRAUD AND UNFAIR TRADE PRACTICES
SEBI has amended the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Markets) Regulations, 2003 (“the Regulations”) with effect from 25th January, 2022 by replacing the existing clause (k) to Regulation 4(2). What is interesting is the wide wording and hence implications of this revised clause. The clause forms part of a list of those acts/omissions which are deemed to be manipulative, fraudulent or unfair trade practice. This short clause is worth reproducing verbatim here so that its implications as analysed can be appreciated:

“(k) disseminating information or advice through any media, whether physical or digital, which the disseminator knows to be false or misleading in a reckless or careless manner and which is designed to, or likely to influence the decision of investors dealing in securities;”

While the earlier clause in substance had a similar objective, certain additions/changes expand its scope and possibly overcome some legal hurdles faced in preventing such practices.

The clause intends to prevent the dissemination of false/misleading information that would influence investors in entering into dealing in securities. It has been found that persons spread rumours, tips, etc., to influence investors into transactions in securities. This could be done fraudulently, to earn profits at the cost of investors who may, sometimes, end up holding dud securities. A practice referred of this type, referred to as ‘pump and dump’ has been found in several cases by SEBI. Social media such as messaging services have also been found to be used for such fraudulent practices.

However, SEBI has now sought to expand the scope, particularly by adding “in a reckless or careless manner”. This apparently could lower the bar of proof and perhaps even shift the onus at least partly on the person who shares such information. Thus, he may have to demonstrate that he had shared such information after due diligence/care. He may even be required to show documentation to prove such care.

Sharing ‘tips’ casually with friends/relatives/colleagues, etc., is indeed quite common. Such tips/information may not necessarily be a product of documented analysis of the scrip. They can often be just a gut feeling based on the reading of some news or developments. Whatsapp and other social media/messaging services are replete with groups where investments are discussed and recommended. Recently, discussions on certain groups on Reddit were widely reported in media, particularly involving the scrip Gamestop.

While fraudulent practices certainly need a stop, the question is whether the new clause goes too far? The clause still retains an important pre-requisite for a person to be charged with violating it – that such a person should know that the information is false or misleading. But yet, the question is whether adding the words “in a reckless or careless manner” could cover even casual discussions. Price discovery in stock markets is the sum result not just of informed and expert analysis but also a continuous process of such analysis coupled with informed guesswork. The question is whether having such a widely worded clause would stifle otherwise healthy discussions.

PART PERFORMANCE OF CONTRACT

INTRODUCTION
It is said that possession is nine-tenths of the law. Taking a cue from this maxim, s. 53A of the Transfer of Property Act, 1882 (“the Act”) has enacted the concept of part performance of a contract. This concept is based upon the law of possession.

The Income-tax Act at several places makes references to any transaction allowing the possession of any immovable property in part performance of a contract. The concept of part performance of a contract is found in s. 2(47) relating to the definition of ‘transfer’ for capital gains, s. 27 relating to the definition of ‘owner’ under House Property Income and the erstwhile s. 269UA relating to ‘transfer’ for Form 37-I. Thus, it becomes important to understand the meaning of this concept.

DEFINITION
The Supreme Court in  Shrimant Shamrao Suryavanshi vs. Pralhad Bhairoba Suryavanshi [2002] 3 SCC 676 has stated that certain conditions are required to be fulfilled if a transferee wants to defend or protect his possession under s. 53A of the Act. The necessary conditions are:

(1)    there must be a contract to transfer for consideration of any immovable property;

(2)    the contract must be in writing, signed by the transferor, or by someone on his behalf;

(3)    the writing must be in such words from which the terms necessary to construe the transfer can be ascertained;

(4)    the transferee must in part-performance of the contract take possession of the property, or of any part thereof;

(5)    the transferee must have done some act in furtherance of the contract; and

(6)    the transferee must have performed or be willing to perform his part of the contract.

If the above mentioned elements are present, then the transferor is debarred from enforcing against the transferee any right in respect of the property in possession of the transferee other than a right expressly provided by the contract. Thus, this section protects certain types of transferees from any action by the transferor. The principle laid down has been explained by the Supreme Court in Sheth Maneklal Mansukhbhai vs. Messrs. Hormusji Jamshedji, AIR 1950 SC 1 as follows:

“The s. is a partial importation in the statute law of India of the English doctrine of part performance. It furnishes a statutory defence to a person who has no registered title deed in his favour to maintain his possession if he can prove a written and signed contract in his favour and some action on his part in part-performance of that contract.”

Let us examine each of the above key elements.

CONTRACT
The starting point of s. 53A is that there must be a contract that must relate to the transfer of specific immovable property. Without a contract, this section has no application. Since a contract is a must, it goes without saying that all the contract prerequisites also follow. Thus, if the contract has been obtained by fraud, misrepresentation, coercion, etc., then it is void ab initio, and the section would also fail – Ariff vs. Jadunath (1931) AIR PC 79.

WRITTEN CONTRACTS
Another important requirement is that the contract must be in writing. Oral contracts are valid under the Indian Contract Act but not for the purposes of s. 53A. The transfer must be by virtue of a written contract. If the contract merely refers to a previous oral understanding, then the same would not fall within the purview of s. 53A – Kathihar Jute Mills Ltd. vs. Calcutta Match Works, AIR 1958 Pat 133.

In Sardar Govindrao Mahadik vs. Devi Sahai, 1982 (1) SCC 237, it was held that to qualify for the protection of the doctrine of part performance it must be shown that there is an agreement to transfer immovable property for consideration and the contract is evidenced by a writing signed by the person sought to be bound by it and from which the terms necessary to constitute the transfer can be ascertained with reasonable certainty. In Mool Chand Bakhru vs. Rohan, CA 5920/1998 (SC), letters were written by a landowner offering to sell half his property in exchange for money which he needed. The Supreme Court letters denied the benefit of s. 53A to the transferee by observing that the letters written could not be termed as an agreement to sell, the terms of which had been reduced into writing. At the most, it was an admission of an oral agreement to sell and not a written agreement. Statutorily the emphasis was not only on a written agreement but also on the terms of the agreement as well which could be ascertained with reasonable certainty from the written document. There was no meeting of minds. The letters did not spell out the other essential terms of an agreement to sell, such as the time frame within which the sale deed was to be executed and who would pay the registration charges etc.

REGISTRATION
Earlier, s. 53A provided that the section would take effect even if the agreement for the transfer of the immovable property had not been registered. However, the Registration and Other Related Laws (Amendment) Act, 2001 modified this position. Now for s. 53A to operate, the agreement must be registered. Hence, registration has been made mandatory, and in its absence, the section would be inoperative. Since the agreement is to be in writing, stamp duty would also follow. Accordingly, if the agreement is inadequately stamped, it would not be admissible as evidence in a Court.

In a recent judgment of Joginder Tuli vs. State NCT of Delhi, W.P.(CRL) 1006/2020 & CRL.M.A. 8649/2020, the Delhi High Court has stated that it is well settled that in order to give benefits of s. 53A, the document relied upon must be a registered document. Any unregistered document cannot be looked into by the court and cannot be relied upon or taken into evidence in view of s. 17(1A) read with s. 49 of the Registration Act. Thus, the benefit of s. 53A would be given, if and only if the Agreement to Sell cum Receipt satisfied the provisions of s. 17(1) A of the Registration Act. It relied upon an earlier decision in the case of Arun Kumar Tandon vs. Akash Telecom Pvt. Ltd. & Anr. MANU/DE/0545/2010.

Another decision of the Delhi High Court, Earthtech Enterprises Ltd. vs. Kuljit Singh Butalia, 199 (2013) DLT 194, has observed that a person can protect his possession under s. 53A on the plea of part performance only if it is armed with a registered document. Even on the basis of a written agreement, he cannot protect his possession.

The decision of the Supreme Court in the case of CIT vs. Balbir Singh Maini, (2017) 398 ITR 531 (SC) under the Income-tax Act has succinctly summed up the relationship between registration of the instrument and s. 53A. It held that the protection provided under s. 53A is only a shield and can only be resorted to as a right of defence. An agreement of sale which fulfilled the ingredients of s. 53A was not required to be executed through a registered instrument. This position was changed by the Registration and Other Related Laws (Amendment) Act, 2001. Amendments were made simultaneously in s. 53A of the Transfer of Property Act and sections 17 and 49 of the Indian Registration Act. By the aforesaid amendment, the words ‘the contract, though required to be registered, has not been registered, or’ in s. 53A of the 1882 Act have been omitted. Simultaneously, sections 17 and 49 of the Registration Act have been amended, clarifying that unless the document containing the contract to transfer for consideration any immovable property (for the purpose of s. 53A) is registered, it shall not have any effect in law other than being received as evidence of a contract in a suit for specific performance or as evidence of any collateral transaction not required to be effected by a registered instrument.

The effect of the aforesaid amendment was that, on and after the commencement of the Amendment Act of 2001, if an agreement, like the Joint Development Agreement in the impugned case, was not registered, then it had had no effect in law for the purposes of s. 53A. In short, there was no agreement in the eyes of the law which could be enforced under s. 53A of the Transfer of Property Act. Accordingly, in order to qualify as a ‘transfer’ of a capital asset under s. 2(47)(v), there must be a ‘contract’ which could be enforced in law under s. 53A of the Transfer of Property Act.

IMMOVABLE PROPERTY ONLY
The contract must pertain to the ‘transfer of an immovable property’. The Act defines this phrase as an act by which a living person conveys property, in present or in future, to one more other living persons or to himself, and one or more other living persons. This is also known as transfer inter vivos. The Act then proceeds to deal with various types of transfer of immovable property – a sale, an exchange, a mortgage and a lease. All these transfers would be covered within the scope of s. 53A. A gift of an immovable property is also a transfer but is not covered within the purview of s. 53A as explained below. Anything which is not a transfer is not covered by s. 53A. For instance, a leave and licence is an easement / personal right and hence, would be outside the purview of this section. Similarly, various Supreme Court decisions have held that a family arrangement is not a transfer, and hence, a family arrangement would be outside the scope of this section.

A movable property would be out of the purview of this section – Bhabhi Dutt vs. Ramlalbyamal (1934) 152 IC 431. The Act defines the term immovable property in a negative manner by stating that it does not include standing timber, growing crops or grass. The General Clauses Act defines it to include land, benefits to arise out of land, and any anything attached to the earth or permanently fastened to anything attached to the earth. The Maharashtra Stamp Act, 1958, defines the term to include land, benefits to arise out of land, and things attached to the earth or permanently fastened to anything attached to the earth. The scope of this section even applies to agricultural properties – Nakul Chand Polley vs. Kalipada Ghosal, AIR 1939 Cal 163.

The Supreme Court has held in UOI vs. M/s. KC Sharma & Co., CA No. 9049-9053 /2011 that the defence under s. 53A was even available to a person who had an agreement of lease in his favour though no lease had been executed and registered. It also protected the possession of persons who have acted on a contract of sale but in whose favour no valid sale deed was executed or registered. The benefit was available, notwithstanding that where there is an instrument of transfer, that the transfer has not been completed in the manner prescribed by the law for the time being in force. In all cases where the section was applicable, the transferor was debarred from enforcing against the transferee any right in respect of the property of which the transferee had taken or continued in possession.

CONSIDERATION
The transfer of immovable property must be for consideration. Hence, gratuitous transfers or gifts of immovable property would be outside the purview of s. 53A – Hiralal vs. Gaurishankar (1928) 30 Bom LR 451. As is the norm in India, adequacy of consideration is immaterial. For instance, in the USA, not only is consideration a must for a valid contract, it must also be adequate. In India, all that is necessary, both for a valid contract as well as for s. 53A, is that there must be consideration.

SIGNATURE
The contract must be signed by the transferor or any person on his behalf, say the power of attorney holder.

TERMS OF CONTRACT
The terms of the contract must be ascertainable with reasonable certainty. If they are ambiguous or cannot be ascertained with reasonable certainty, then the contract cannot be enforced u/s. 53A – Bobba Suramma vs. P Chandramma 1959 AIR AP 568.

POSSESSION
The transferee must take possession of the property for this section to apply – Sanyasi Raju vs. Kamappadu (1960) AIR AP 83. Alternatively, if he is already in possession of the property, then he must continue with such possession. Possession of a part of the property is also enough – Durga Prasad vs. Kanhaiyalal (1979) AIR Raj 200. Further, the possession of the property must be pursuant to part performance of the agreement to sell the property. The onus of proof is on the defendant – Thakamma Mathew vs. Azamathulla Khan 1993 Suppl. (4) SCC 492.

In the case of Roop Singh (Dead) Through Lrs vs. Ram Singh (Dead) Through Lrs, JT 2000 (3) SC 474, the plaintiff pleaded that he owned certain agricultural land. As the land was in illegal possession of the defendant, he filed a suit. The defendant submitted that 14 years prior to the date of institution of the suit, he had purchased the suit land for consideration, had paid full sale consideration to the plaintiff, and since then, he was in possession of the suit land. He contended that his possession is protected under s. 53A. He also pleaded that he had acquired the title by adverse possession (adverse possession is a means of acquiring title to a property by physically occupying it for a long period of time. A person can acquire property if one possesses it long enough and meets the legal requirements). The Supreme Court held that the plea of adverse possession and retaining the possession by operation of s. 53A were inconsistent with each other. Once it was admitted by implication that the plaintiff came into possession of the land lawfully under the agreement and continued to remain in possession till the date of the suit, then the plea of adverse possession would not be available to the defendant.     

WILLINGNESS OF TRANSFEREE
The transferee must be willing to complete his part of the contract. Failure on his part to complete his contract, e.g. payment of monthly instalments, would not entitle him to the defence of part performance – Jawaharlal Wadhwa vs. Chakraborthy 1989 (1) SCC 76.

In Ranchhoddas Chhaganlal vs. Devaji Supadu Dorik, 1977 SCC (3) 584, the purchaser paid a portion of the consideration and claimed shelter u/s.53A. Despite demands from the plaintiff, he failed to pay the balance sum. The Supreme Court held that the defendant was never ready and willing to perform the agreement as alleged by the appellant. One of the ingredients of part performance under s. 53A was that the transferee had taken possession in part performance of the contract. In the case on hand there was no performance in part by the respondent. The true principle of the operation of the acts of part performance required that the acts in question must be referred to some contract and must be referred to the alleged one; that they proved the existence of some contract and were consistent with the contract alleged. S. 53A was a right to protect his possession against any challenge to it by the transferor contrary to the terms of the contract.

Again in Ram Kumar Agarwal vs. Thawar Das, (1999) (1) SCC 76, it was held that a plea under s. 53A of the Transfer of Property Act raised a mixed question of law and fact and therefore could not be permitted to be urged for the first time at the stage of an appeal. Further, performance or willingness to perform his part of the contract was one of the essential ingredients of the plea of part performance. The defendant, having failed in proving such willingness, protection to his possession could not have been claimed by reference to s. 53A.

The section does not create a title in the defendant. It only acts as a deterrent against a plaintiff asserting his title. It does not permit the defendant to maintain a suit on title – Ram Gopal vs. Custodian (1966) 2 SCR 214.

NULL AND VOID TRANSACTIONS
The section has no application to transactions which are null and void for any reason. The Supreme Court held in Biswabani (P.) Ltd vs. Santosh Kumar Dutta, 1980 SCR (1) 650 that if a lease was void for want of registration, neither party to the indenture could take advantage of any of the terms of the lease. No other terms of such an indenture inadmissible for want of registration can be the basis for a relief u/s. 53A.

Again in Ligy Paul vs. Mariyakutti, RSA No. 79/2020, the Kerala High Court has reiterated that s.53A is applicable only where a contract for transfer is valid in all respects. It must be an agreement enforceable by law under the Indian Contract Act, 1872.

EXCEPTION
This section does not impact the rights of a buyer who has paid consideration and who has no notice of the contract or the part performance of the contract.

CONCLUSION
The doctrine of part performance is a concept with several important cogs in the wheel. Each of them is vital for the doctrine to be applied correctly. Although it is one of the fundamental tenets in the field of conveyancing, its importance under the Income-tax Act also cannot be belittled!

NSE’S HIGH-TECH STOCK MARKET SCANDAL: WILL THE MASTERMINDS GO SCOT FREE?

NSE was hit by a co-location trading scandal sometime in 2015 when a whistle-blower first complained to the Securities and Exchange Board of India (SEBI). Author and Journalist Palak Shah has done a deep dive investigation into the NSE co-location scam. His book The Market Mafia, published in November 2020, is a full-scale exposé of the deep rot in India’s financial market ecosystem. As a journalist working with some of the leading Business newspapers in Mumbai, Palak has much insight into the working of markets, exchanges, SEBI and regulations. Considering certain constraints, BCAJ sent him questions and carried this e-interview to throw light on how the NSE scam has unfolded and the delay in investigating it. Hope you enjoy reading it!

Q.1. Can you briefly explain the matter relating to the Colo scam and corporate governance issues at NSE?
Co-location (Colo) is nothing but proximity hosting of broker servers with NSE’s master order matching engine in the exchange premises at Bandra-Kurla Complex (BKC). It gives a superior trading speed and advanced information on price moves and order books. As I have detailed in my book, The Market Mafia, the Colo scandal goes back to 2010. When NSE started co-location trading, it lacked the necessary study from the market regulator SEBI and hence safeguards. There were flaws in the system, which investigations post 2015 revealed were deliberate. The flaws gave a few an advantage in connecting first and hence faster data and so on. Had SEBI made a proper study of NSE trading systems in 2010 or carried out a thorough audit and then given its go-ahead after a public consultation, the scenario would have been different. The deliberate flaws in the system were a result of corporate governance lapses at NSE, for which the accountability has to be fixed.   

Q.2. How was the matter unearthed?
In January 2015, an unknown whistle-blower first informed SEBI about the co-location scandal and certain flaws in the system. The then SEBI whole time-member Rajeev Agarwal pushed his officials into action, and the probe started in the weeks following the whistle-blower complaints. But even after Agarwal set the ball rolling, SEBI was slow in its approach and investigations since NSE’s top bosses enjoyed high patronage in New Delhi, and the regulators were scared to take them head-on. Multiple forensic and system audits by IIT Mumbai were carried out under SEBI’s instructions. NSE’s top management was hostile towards these investigations since they would not share the data and other inputs with the investigators. Yet certain facts on governance lapses and flaws in the system emerged. CBI registered an FIR in 2018 on the basis of a complaint but for four years the Co-location file kept gathering dust since no major investigation was done by the agency. It was believed by many that key players in the scam were difficult to identify. In November 2020, I published my book The Market Mafia – Chronicle of India’s High Tech Stock Market Scandal & The Cabal That Went Scot Free. The book detailed the nuts and bolts of NSE’s trading system and, for the first time, gave an inside into the working of a Co-location scam and other aspects that most of the market investors were unaware about. The book also gave vital details of the key characters in the co-location scam and brought into the public domain several hidden communication between NSE officials and SEBI with regard to the ongoing probe. The book laid bare how NSE flouted norms with relative ease and impunity, and even senior SEBI officials looked the other way. The Market Mafia carries a detailed account of brokers, NSE officials, financial market experts and policymakers who benefited from the Co-location scam and the happening within NSE. For the first time in 30 years after the Harshad Mehta scam, a book has revealed true events to show how India’s stock markets are rigged by those very people who are supposed to protect the system.

In February 2022, SEBI released an order against former NSE MD and CEO Chitra Ramkrishna, who was among the key managerial persons when the co-location scam was taking place and was later in charge of NSE between 2013 and 2016. The SEBI order stated that Ramkrishna was taking instructions from an unknown person to run the exchange, whom she called a Yogi dwelling in the Himalayas. All this attracted public attention to the NSE scandal, which I say is several times bigger than the Harshad Mehta scam.

Q.3. As the first line of oversight, has NSE performed its obligation when the matter came to light?


From the beginning, NSE has been lax in diving deep into the scandal, which came to light in 2015. It has shielded and protected its officials who could have turned a blind eye to the various lapse or who could have engineered the flaws in the trading system. Simple instance of NSE shielding its officials can be gauged from the fact that Ramkrishna was allowed to exit NSE with dignity and was also paid Rs 44 crore in dues in 2016. Instead, the exchange was required to conduct investigations into her bad governance practices and slap some serious charges. Several other instances, like sharing data illegally with Ajay Shah and Susan Thomas, the two well-known market researchers by NSE, show that the officials within the exchange were complacent with the scamsters.

Q.4. Was SEBI aware of the irregularities at NSE, and for how long?

SEBI officials can be charged with ‘Omission and Commission of Duty’ which implies complacency in the scandal. It is one of the directions in which the CBI is now probing SEBI officials. The regulator is alleged to have hidden facts from the public, investigators and government about the scam. This is clear from the various arguments of CBI in the court.

Q.5. As a regulator, has SEBI been fair in investigating the matter and discharging its obligation in terms of timeliness of action, quality of investigation, quantum of punitive action taken and taking corrective action?

SEBI failed to conduct due diligence of NSE co-location trading systems from the day it started in January 2010. SEBI has been very slow in ordering proper investigations and even conducting its own probe. It left the probe to NSE to investigate itself. SEBI’s orders are childish and loosely knit. It has broken down the scam into various instances of small violations and not imposed charges of fraud and other stringent provisions laid down in the SEBI Act. The regulator has wide-ranging powers to probe such scandals, which it has not used at all. The list of SEBI’s inaction is long. All this points to SEBI’s lack of willingness in bringing the real culprits to book.

Q.6. Was a similar matter also detected at any other exchanges, and has SEBI dealt with other exchanges differently?

Yes, a forensic audit by TR Chaddha and Co. points out a scandal in sharing data by MCX with Susan Thomas and one New Delhi based algo trading Chirag Anand in an unauthorised manner. But SEBI and MCX have buried this scandal. NSE data, which was illegally obtained by Ajay Shah and Susan Thomas was going into algo trading work. Similarly, data obtained from MCX without following proper checks and balances were also going into algo trading work. SEBI has failed to take the MCX probe further and bring the actual culprits to book.

Q.7. How, in your view, will these irregularities impact the credibility of the Indian securities market, especially when one out of two exchanges and its regulator is found inactive or even complicit?

Both foreign investors and domestic institutions strongly believe that India follows the rule of law. Retail investors believe that Indian markets are most efficient and scam free. All the investors have placed their faith in SEBI and exchanges like NSE, BSE and MCX who are the larger players. They invest and trade billions of dollars at the blink of an eye. But the scandal at NSE and data sharing at MCX in a dubious manner, both of which show SEBI in poor light, can erode the trust of these investors. The credibility of the market has already been impacted but would be in ruins till the time the culprits are not found and brought to book by the government.

Q.8. You have been covering the colo and corporate governance matter at NSE in detail at various forums for quite a long time and have also covered these irregularities in detail in your book – ‘The Market Mafia’ – What is the whole idea behind this book?

You will find that The Market Mafia is a unique book since it gives all the real names of those behind the scandal at NSE and dubious happenings at MCX. The book exposes SEBI and the government’s lack of will for the past few years to investigate the scandal. It also reveals the conflict of interest that prevails in the governing structures of the stock markets and, above all, the bureaucratic rut that has exposed SEBI as a lame paper tiger.

JURISDICTION OF SEBI IN TAKING ACTION AGAINST PRACTISING CHARTERED ACCOUNTANTS

BACKGROUND
With the onset of the infamous Satyam scam of 2008-2009, where major accounting frauds were exposed, SEBI initiated a detailed investigation in the books of accounts of Satyam. Post investigation, SEBI issued a Show Cause Notice to the statutory auditor of Satyam, namely Price Waterhouse Co. (PWC). The power of SEBI to issue such a Show Cause Notice to a Chartered Accountant (firm) was challenged by PWC before the Hon’ble Bombay High Court (Writ Petition No. 5249 of 2010) under Article 226 of the Constitution. The Hon’ble Bombay High Court (vide its order of 13th August, 2010) put the controversy to rest by allowing SEBI to initiate action and bring Chartered Accountants within its fold – subject to not encroaching on the ICAI’s powers under the Chartered Accountants Act, 1949 (CA Act).

The Hon’ble Bombay High Court emphasized the fact that only if the Chartered Accountant was involved in falsification and fabrication of books of a listed company, then SEBI could invoke its powers under Section 11(4) r.w.s. 11B of the SEBI Act, which reads as under:

Section 11B.

(1)    Save as otherwise provided in section 11, if after making or causing to be made an enquiry, the Board is satisfied that it is necessary:

(i)    in the interest of investors, or orderly development of securities market; or

(ii)    to prevent the affairs of any intermediary or other persons referred to in section 12 being conducted in a manner detrimental to the interest of investors or securities market; or to secure the proper management of any such intermediary or person

it may issue such directions:

(a)    to any person or class of persons referred to in section, or associated with the securities market; or

(b)    to any company in respect of matters specified in section 11A, as may be appropriate in the interests of investors in securities and the securities market.

An important facet of the aforesaid definition is whether an auditor of listed companies (and registered intermediaries) can be considered to be a ‘person associated with the securities market’ and thereby under the jurisdiction of SEBI. The Hon’ble Bombay High Court clarified that if SEBI concludes that there was no ‘mens rea or connivance’ to fabricate and fudge the books of accounts, then SEBI ought not to issue any direction(s) against the auditor.

Within the aforesaid contours, the proceedings (qua PWC) continued at the SEBI level and finally concluded with an Order against PWC (on 10th January, 2018), inter-alia, imposing a restraint on PWC on issuing a certificate to a listed company for two years, amongst other directions. PWC challenged the SEBI Order before the Hon’ble Securities Appellate Tribunal (SAT). In the said case (decided on 9th September, 2019), the Hon’ble SAT went into the question as to whether SEBI could have proceeded against an auditor in connection with the work which they have undertaken for a listed company in respect of maintaining its books of accounts. After deliberation, the Hon’ble SAT ruled that SEBI’s enquiry ought to be only restricted to the charge of conspiracy and involvement in ‘fraud’. SEBI cannot take action against the auditing firm on the charge of professional negligence – since the CA firm was under the jurisdiction of ICAI. The said SAT Order has been challenged by SEBI before the Hon’ble Supreme Court – in which the regulator obtained a limited stay in its favour (Supreme Court Order dated 18th November, 2019 in Civil Appeal No(s). 8567-8570/ 2019). Until the Hon’ble Supreme Court finally adjudicates the matter – the question of SEBI’s jurisdiction of taking action against the Chartered Accountant(s) remains an open-ended one.

However, in the recent past, SEBI has been penalizing auditors of listed companies and registered intermediaries in respect of their auditing functions by alleging that the concerned auditor had violated Sections 12A(a), 12A(b) and 12A(c) of the SEBI Act, which reads as under:

12A. No person shall directly or indirectly:

(a)    use or employ, in connection with the issue, purchase or sale of any securities listed or proposed to be listed on a recognized stock exchange, any manipulative or deceptive device or contrivance in contravention of the provisions of this Act or the rules or the regulations made thereunder;

(b)    employ any device, scheme or artifice to defraud in connection with issue or dealing in securities which are listed or proposed to be listed on a recognised stock exchange;

(c)    engage in any act, practice, course of business which operates or would operate as fraud or deceit upon any person, in connection with the issue, dealing in securities which are listed or proposed to be listed on a recognised stock exchange, in contravention of the provisions of this Act or the rules or the regulations made thereunder.

RECENT RULING BY HON’BLE SAT

Through recent decisions in the M. V. Damania case (Appeal No. 335 of 2020 decided on 17th January, 2022) and Mani Oommen case (Appeal No. 183 of 2020 decided on 18th February, 2022); the Hon’ble SAT has set aside the SEBI orders penalising the auditors:

I.    In the M. V. Damania case, the concerned auditor had certified the expenditure incurred by Paramount Printpackaging Ltd (PPL) towards Initial Public Offering (IPO) expenses out of the IPO proceeds. The crux of SEBI’s allegation was that auditor negligently certified that an amount of Rs. 36.60 crores was utilized towards objects of the IPO. SEBI had alleged that:

(i)    PPL made payment to the various vendors in crore of rupees without having any invoices;

(ii)    in some cases, bills from the vendors were issued at a later date, post remittance by PPL; and

(iii)    the auditor did not raise any red flag against doubtful payments made by PPL.

In view of the aforesaid, SEBI imposed a monetary penalty of Rs. 15 lakhs on the auditor firm (and its partner), jointly and severally, for alleged violation of provisions of Section 12A(a), 12A(b) and 12A(c) of the SEBI Act r.w. Regulations 3 and 4 of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003 (PFUTP Regulations).

In Appeal, the concerned auditor contended the following, amongst other arguments:

(i)    audit of the financial statements of PPL was based on the information provided by the management;

(ii)    in the process of the audit, the endeavour was to obtain audit evidence that is sufficient and appropriate to provide a basis for forming an independent opinion;

(iii)    all the payments made by PPL were supported by bank statements; and

(iv)    in any case, SEBI had no jurisdiction to proceed against Chartered Accountants, who are members of the ICAI.

The Hon’ble SAT ruled that the provisions of Section 12A(a) and 12A(b) of the SEBI Act do not apply to Chartered Accountants since ‘they are not dealing in the securities’. Similarly, the provisions of Section 12A(c) cannot be made applicable because the concerned auditor has carried out no ‘fraud’. Most importantly, the Hon’ble SAT ruled that in the absence of connivance, deceit, or manipulation by the auditor, the provisions of Regulation 3 and 4 of the PFUTP Regulations cannot be made applicable. Consequently, the SEBI Order was set aside.

II.    In the Mani Oommen case, SEBI alleged that DCHL (a listed company) had understated its outstanding loans to the tune of Rs. 1,339.17 crores in 2008-09 and wrongly disclosed the difference between the actual and reported outstanding loans for 2009-10 and 2010-11. Also, its promoters, the owner of the Deccan Chronicle Marketers (DCM) had wrongly transferred loans on the last day of the financial year and reversed on the first day of the next financial year. SEBI had alleged that:

(i)    As per Sections 224 and 227 of the Companies Act, 1956, an auditor owes an obligation to the shareholders to report true and correct facts about the company’s financials, and the auditor was duty bound to report correct facts under Section 227 of the Companies Act.

(ii)    SEBI opined that the concerned auditor overlooked the reporting of the outstanding loans, and he was not diligent in his obligation to check outstanding loans details from the bank and other independent sources.

In view of the aforesaid, SEBI held that the auditor did not adhere to the Auditing and Assurance Standard – 5 (AAS) prescribed by ICAI. SEBI alleged that the concerned auditor had violated the provisions of Section 12A(a) and 12A(b) of the SEBI Act r.w. Regulations 3 and 4 of the PFUTP Regulations. Consequently, SEBI penalized the said auditor and prohibited him from issuing any certificate of audit and rendering any auditing services to any listed companies and registered intermediaries for one year. Additionally, SEBI directed listed companies and intermediaries registered with SEBI not to engage any audit firm associated with the said auditor in any capacity for issuing any certificate w.r.t compliance of statutory obligations, which SEBI is competent to administer and enforce.

In Appeal, the concerned auditor contended the following, amongst other arguments:

(i)    as a statutory auditor, the responsibility was to express an opinion on the financial statement based on the internal audit;

(ii)    the auditor was not involved in the preparation of the books of accounts of the company; and

(iii)    the accounting adjustment, namely non-disclosure of the loans by transferring the same to the another entity was brought to his notice for the first time during audit of the books of accounts of DCHL in October-2012 (at a later point in time).

The Hon’ble SAT ruled that, in the entire SEBI Order, there is no finding that the concerned auditor was instrumental in preparing false and fabricated accounts or has connived in the falsification of the books of account. The only finding by SEBI was that due diligence was not carried out by the said auditor. There was no finding (by SEBI) that the auditor had manipulated the books of accounts with knowledge and intention, in the absence of which, there is no deceit or inducement by the auditor. In the absence of any inducement, the question of fraud committed by the auditor does not arise. Consequently, the SEBI Order was set aside.

FRAUD VIS-À-VIS NEGLIGENCE

It is clear from the aforesaid rulings of the Hon’ble SAT that lack of due diligence can only lead to professional negligence, which would amount to misconduct – which could be under the purview of other regulators (like ICAI / NFRA). While the much-needed clarity on the jurisdiction of the SEBI vis-à-vis auditors is being awaited from the Hon’ble Supreme Court, the Chartered Accountant(s) must bear in mind that presently SEBI can act against them – if found that there was an element of ‘fraud’ while auditing listed companies and regulated intermediaries.

The Regulation 2 (c) of PFUTP Regulations define the term ‘fraud’ in two parts:

(i)    First part includes any act, expression, omission, or concealment committed whether in a deceitful manner or not by a person or by any other person with his connivance or by his agent while dealing in securities in order to induce another person or his agent to deal in securities, whether or not there is any wrongful gain or avoidance of any loss; and

(ii)    The second part includes specific instances which may tantamount to be fraudulent.

In the Kanaiyalal Baldevbhai Patel case (2017 15 SCC 1 – decided on 20th September, 2017), the Hon’ble Supreme Court has ruled that the term ‘fraud’ under the PFUTP Regulations is an act or an omission (even without deceit) if such an act or omission had the effect of ‘inducing’ another person to ‘deal in securities’.

The term ‘negligence’ as quoted in the PWC Order (SAT Appeal No. 6 of 2018) means the failure to use such care as a reasonably prudent and careful person would use under similar circumstances; it is the doing of some act which a person of ordinary prudence would not have done under similar circumstances or failure to do of a person of ordinary prudence would have done under similar circumstances (Black’s Law Dictionary, 6th edition).

RISK OF REGULATORY OVERREACH

The regulatory overlaps between SEBI and other regulators in the financial service space has been an ongoing issue. With SEBI having powers under the Securities and Exchange Board of India Act, 1992 (SEBI Act), there arises a situation where SEBI exercises jurisdiction against all persons on the ground that they are ‘associated with the securities market’. Consequently, the casualty is usually the regulated entities and professionals who advise them on lawfully navigating this complex regulatory space. In the past, there have been instances of such regulatory overlaps of SEBI with Insolvency and Bankruptcy Board of India (IBBI), Competition Commission of India (CCI), Reserve Bank of India (RBI), Central Electricity Regulatory Commission (CERC), etc.

One cannot deny that the SEBI is an apex regulator when it comes to protecting the sanctity of the securities market and, in fact, has been armed with powers to protect the interest of investors. If the regulator demonstrates that an auditor was involved in fabricating and fudging the financial statements or had ‘colluded’ with the listed company / promoters, a charge of fraud can be fastened. However, the question is whether SEBI ought to adjudicate on issues pertaining to professional conduct of practising Chartered Accountant(s). At the end of the day, the bible for Chartered Accountants is the auditing standards – which are prepared and deliberated upon by the ICAI. The hazard of over-regulation may result in moving away from a solution-oriented regime and create a situation where every audit report will carry more caveats than it already carries. There being a thin line between a ‘fraudulent’ and ‘negligent’ act, to avoid anomaly, inter-agency coordination is desirable.

THE WAY FORWARD

In October 2010, the central government constituted Financial Stability and Development Council (FSDC) – an apex regulatory Council to resolve regulatory overlaps. FSDC’s role is to enhance inter-regulatory coordination and promote financial sector development. The Chairman of the Council is the Finance Minister, and its members include the heads of financial sector Regulators (RBI, SEBI, PFRDA, IRDA, etc.), Finance Secretary and/or Secretary, Department of Economic Affairs, Secretary, Department of Financial Services, and Chief Economic Adviser. The Council is empowered to invite experts to its meetings as and when required. FSDC may consider inviting representatives from the ICAI and NFRA for inter-regulatory coordination to resolve the regulatory overlap.

ASSET ACQUISITIONS AND DEFERRED TAXES

This article deals with a scenario concerning the creation of deferred taxes where the shares of a company are acquired, and the acquisition is classified as an asset acquisition.

BACKGROUND
•    A Ltd acquires 100% shares of B Ltd, having one Building (a PPE) and accumulated loss of INR 30 for a cash consideration of INR 100.

•    This transaction is not a business combination (i.e., the transaction is accounted for as an asset acquisition).

•    Tax rate applicable – 30%.

•    The carrying value and tax base of the Building in the standalone financial statement (SFS) of B Ltd is INR 80 and INR 70, respectively. The taxable temporary difference of INR 10 arose after the initial recognition of the Building by B Ltd, and accordingly, a deferred tax liability of INR 3 has been recognised.

•    B Ltd has accumulated a loss of INR 30, which it expects to be able to utilise and accordingly, a deferred tax asset of INR 9 has been recognised.

•    A Ltd also expects to be able to utilise all of the available losses of B Ltd, and it is probable that future taxable profit will be available against which the tax losses can be utilised.

•    The fair value of Building on the date of acquisition is INR 91.

ISSUE
Whether any deferred tax should be recognised in the consolidated financial statements (CFS) of A Ltd.?
RESPONSE

Ind AS References

Ind AS 103, Business Combinations

Paragraph 2 – This Ind AS does not apply to:
(a) ………..
(b) the acquisition of an asset or a group of assets that does not constitute a business. In such cases the acquirer shall identify and recognise the individual identifiable assets acquired (including those assets that meet the definition of, and recognition criteria for, intangible assets in Ind AS 38, Intangible Assets) and liabilities assumed. The cost of the group shall be allocated to the individual identifiable assets and liabilities on the basis of their relative fair values at the date of purchase. Such a transaction or event does not give rise to goodwill.

Ind AS 12, Income Taxes

Definitions
Para 5 – The following terms are used in this Standard with the meanings specified:
Deferred tax assets are the amounts of income taxes recoverable in future periods in respect of:

(a) deductible temporary differences;

(b) the carry forward of unused tax losses; and

(c) the carry forward of unused tax credits.

Taxable temporary differences
Para 15 – A deferred tax liability shall be recognised for all taxable temporary differences, except to the extent that the deferred tax liability arises from:

(a) the initial recognition of goodwill; or

(b) the initial recognition of an asset or liability in a transaction which:

(i) is not a business combination; and

(ii) at the time of the transaction, affects neither accounting profit nor taxable profit (tax loss).

Deductible temporary differences
Para 24 – A deferred tax asset shall be recognised for all deductible temporary differences to the extent that it is probable that taxable profit will be available against which the deductible temporary difference can be utilised, unless the deferred tax asset arises from the initial recognition of an asset or liability in a transaction that:

(a) is not a business combination; and

(b) at the time of the transaction, affects neither accounting profit nor taxable profit (tax loss).

ANALYSIS
• An entity recognises a deferred tax asset for unused tax losses/credits carried forward to the extent that it is probable that future taxable profits will be available against which the unused tax losses/credits can be utilised. In Author’s view, this principle should be applied to both:

• internally generated tax losses; and

• tax losses acquired in a transaction that is not a business combination.

• The initial recognition exception in paragraph 15 of Ind AS 12 applies only to deferred tax relating to temporary differences. It does not apply to tax assets, such as purchased tax losses that do not arise from deductible temporary differences. The definition of ‘deferred tax assets’ (see above) explicitly distinguishes between deductible temporary differences and unused losses and tax credits [Ind AS 12.5]. Therefore, the Author believes that on initial recognition, an entity should recognise a deferred tax asset for the acquired tax losses at the amount paid, provided that it is probable that future taxable profits will be available against which the acquired tax losses can be utilised. The deferred tax asset is then remeasured in accordance with the general measurement principles in Ind AS 12. Therefore, the Author believes that deferred tax assets of INR 9 on the accumulated loss of B Ltd is recognised by A Ltd in its CFS.

• The initial recognition exception applies to the difference between the cost of the Building in the CFS of A Ltd of INR 91 and its tax base of INR 70, in exactly the same way as if the property had been legally acquired as a separate asset rather than through the acquisition of the shares of B Ltd [Ind AS 12.15(b)]. Therefore, no deferred tax is recognised by A Ltd in respect of the Building at the time of its acquisition. At this point, A Ltd has an unrecognised taxable temporary difference of INR 21 (INR 91 less INR 70).

CONCLUSION
As can be seen from the above example, deferred taxes are not created on initial recognition of an asset. It does not matter whether the acquisition was by way of underlying shares of a company which owns the asset, or the asset is acquired directly. The response would be the same in either scenarios.

MATERIALITY WITH REFERENCE TO THE FINANCIAL STATEMENTS

INTRODUCTION
Materiality is a widely used concept for the preparation and presentation of financial statements and reporting thereon. Management assesses the materiality with respect to the preparation and disclosures made in the financial statements, aiming at the information needs of the primary users of the financial statements (i.e., existing and potential investors, lenders and other creditors) that can influence their decisions regarding investments, and providing their services or resources to the entity.

Auditors, on the other hand, assess the materiality while making judgements about the nature, timing and extent of the audit procedures to be performed and the implications of the misstatements observed during the audit to express an opinion as to whether the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework.

Further, from the auditor’s perspective, there could be other considerations like the type of audit opinion based on the pervasiveness of misstatements, reporting under CARO 2020, internal financial controls with reference to the financial statements, and the restatement of financial statements etc., wherein materiality plays a crucial role.

In this article, an attempt has been made to discuss the importance of materiality for the preparers and the auditors along with the key aspects of the guidance available for its assessment.

MATERIALITY FROM MANAGEMENT’S PERSPECTIVE
The Institute of Chartered Accountants of India (‘ICAI’) had issued SA 320 – Materiality in Planning and Performing an Audit, and Implementation Guide to Materiality in Planning and  Performing An Audit (‘Implementation Guide’) to define the auditor’s responsibility to apply the concept of materiality in planning and performing an audit of financial statements, and SA 450 – Evaluation of misstatements, to explain how materiality is applied in evaluating the effect of identified misstatements on the audit and of uncorrected misstatements, if any, on the financial statements. However, there is limited guidance for determining the materiality for the preparation and presentation of the financial statements from the management’s perspective.

Materiality, amongst others, is a fundamental qualitative characteristic to identify the types of information that are likely to be most useful for the primary users of the financial statements, as described in the Conceptual Framework for Financial Reporting under Ind AS, as issued by ICAI. As per Ind AS 1 – Presentation of Financial Statements and Ind AS 8 – Accounting Policies, Changes in Accounting Estimates and Errors, ‘Information is material if omitting, misstating or obscuring it could reasonably be expected to influence decisions that the primary users of general-purpose financial statements make on the basis of those financial statements, which provide financial information about a specific reporting entity. Materiality depends on the nature or magnitude of information, or both. An entity assesses whether information, either individually or in combination with other information, is material in the context of its financial statements taken as a whole’. The Guidance note on Ind AS Schedule III, also suggests the same guidance with exceptions for items of income or expenditure which exceeds 1% of revenue from operations or Rs. 10,00,000 whichever is higher, and continuing defaults in repayment of borrowings for consolidated financial statements.

In the above definition, the emphasis is placed on the below two statements, to define materiality:

Assessing whether an omission, misstatement or obscuring could influence economic decisions of users

The materiality assessment can be done by considering the characteristics of the potential users of the financial statements. Here it is worth noting that the users of the financial statements include present and potential investors, employees, lenders, suppliers and other trade creditors, customers, governments and their agencies and the public. Each of these users uses financial statements to satisfy some of their different needs for information. For example:

•    investors might be interested in the various disclosures related to revenue, profitability, dividend, credit risk, capital management, etc.;

•    customers might be interested in the disclosures related to going concern of the entity due to long term supply contract and service dependency;

•    lenders and suppliers might be interested in disclosers related to cash flows and assessment of the ratios to know the economic health of the entity; and

•    the public might be interested in knowing if the entity  has a significant contribution in its sector, or to the overall economy of the country.

Further, it is important to understand that information is said to be obscured if it is communicated in a way that would have a similar effect for primary users of financial statements to omitting or misstating that information. Some of such examples may include disclosure of material information by using vague or unclear language, disclosure of material information in scattered way, aggregating dissimilar information etc.

Nature and magnitude of information

At times the size and nature of the information itself determine its relevance. For example:

•    the reporting of a new segment may affect the assessment of the risks and opportunities facing the entity irrespective of the materiality of the results achieved by the new segment in the reporting period;

•    Mergers and acquisitions by the entity;

•    Change in the government policies for the sector in which the entity operates;

•    Exceptional or additional line items, headings and subtotals in the statement of profit and loss, when such presentation is relevant to an understanding of the entity’s financial performance;

•    Related party transactions; etc.

The Framework for the Preparation and Presentation of Financial Statements in accordance with Indian Accounting Standards issued by ICAI also states that the materiality assessment needs to take into account how users could reasonably be expected to be influenced in making economic decisions. Further, the information about complex matters like fair valuation assumptions and methodologies for the valuation of financial instruments, disclosures related to expected credit loss of financial assets, sensitivity analysis, ratio analysis, income tax reconciliation, etc. that should be included in the financial statements because of its relevance to the economic decision-making needs of users should not be excluded merely on the grounds that it may be too difficult for certain users to understand.

Based on the above guidance, the standard emphasizes the qualitative evaluation of information to be presented in the financial statements, including any misstatements, rather than restricting it to any quantitative threshold.

The above methodology will require management to do a detailed deliberation on all the disclosures required to be presented in the financial statements, including any omissions and misstatements, both individually and collectively with others, at the financial statements level to conclude if a required disclosure or misstatements is material, considering the primary users of the financial statements.

For example, as per Ind AS 8, an entity shall correct material prior period errors retrospectively in the first set of financial statements approved for issue after their discovery by:

(a) restating the comparative amounts for the prior period(s) presented in which the error occurred; or

(b) if the error occurred before the earliest prior period presented, restating the opening balances of assets, liabilities and equity for the earliest prior period presented.

In the above guidance, though the standard talks about correcting the material prior period errors, it does not give additional guidance on what is considered material in quantitative terms or any methodology to quantify it.

Here again, the emphasis is placed on the qualitative aspects of the misstatements. If management believes that the prior period errors are so material that it can adversely affect the true and fair presentation of the financial statements or influence the economic decision of the primary users of the financial statements, then such prior period errors are required to be corrected in accordance with the guidance given under Ind AS 8.

On the other hand, the audit team is required to evaluate any such prior period errors based on the materiality assessed for the audit of the financial statements.

A reference can also be drawn to ‘Practice Statement 2, Making Materiality Judgements’, which is a non-mandatory guidance published by the International Accounting Standards Board (‘IASB’).

The IASB, in the said practice statement, has introduced a four-step model illustrating the role of materiality in the preparation of financial statements and clarifies how a materiality judgement needs to be made. A brief overview of the model is as under:

Step
1 Identify

 

Identify
information that primary users might need to make decisions about providing
resources to the entity.

 

Step
2 Assess

 

Assess
whether information is material based on both quantitative and qualitative
considerations.

 

Step
3 Organise

 

Based
on the output of materiality judgement and different roles of the primary
financial statements and the notes, decide whether to present an item of
information separately in the primary financial statements, to aggregate it
with other information and/or to disclose the information in the notes.

 

Step
4 Review

 

Review
the information from an

aggregated
perspective, once the draft financial statements are prepared to see if
entity needs to revisit the assessment made in Step 2, to provide/reorganise/
remove information.

 

The materiality for the financial statements must also be discussed with management and Those Charged with Governance (TCWG) by the auditors as per the requirement of SA 260 (Revised) – Communication with Those Charged with Governance while planning the audit of the financial statements.

As during the said discussion, materiality for the financial statements is discussed in detail by both the parties, taking into account all the relevant quantitative and qualitative factors. Management may decide to follow the same quantitate threshold as materiality for the preparation of financial statements unless it chooses to follow a lower threshold by considering a different methodology that is more suitable for the entity.

MATERIALITY FOR THE AUDIT OF THE FINANCIAL STATEMENTS
SA 320 and the Implementation Guide provides detailed guidance for the identification of materiality for the audit of the financial statements. However, considering that the identification of materiality requires significant professional judgement, below are two case studies that can be helpful in exercising the professional judgement:

Case study 1

A Ltd is a public listed entity operating in the telecom sector. A is a well-established telecom service provider from the last decade and presently in the process of incurring significant capital expenditure, to upgrade its infrastructure with latest 5G technology. A is able to maintain a consistent revenue from operations. However, its profit before tax (‘PBT’) is at a lower end, with a declining trend, due to its product pricing to tackle competition.

The Engagement Partner of the audit firm XYZ & Associates LLP, the statutory auditor of the Company, has decided to consider PBT as a benchmark for materiality, considering the following reasons:

• The Company’s PBT margin is presently at par with the other market participants in the industry,

• Being an established listed entity, the retail investors are more focused on profitability and dividends,

• Lenders of the Company have imposed financial covenants for maintaining profitability in the lending arrangement, and

• A Ltd. is already an established player in the industry. Hence, capital expenditure for technological upgradation is to secure the future market presence and hence not the present primary focus of the users of the financial statements.

Here it is important to note that:

• if the Company’s profitability had been volatile, then revenue from operations or gross profits would be a more suitable benchmark, and

• if the Company had been a new entrant in the industry and in the process of creating the required infrastructure, then net assets or total assets would have been a suitable benchmark.

Case study 2

Continuing with the above example, post deciding on the benchmark, the audit team is now identifying a suitable percentage to be applied on the PBT to quantify the materiality for the financial statements as a whole and the performance materiality. Below are a few more facts that the audit team has considered in quantifying the materiality:

• PBT includes an exceptional expenditure of Rs 20 crores,

• There were no audit qualifications given in the previous year’s audit reports,

• The Company operates in a highly regulated environment,

• There are significant related party transactions, and

• The Company carries significant debt.

The Engagement Partner of the audit firm, has decided the materiality for the financial statements as a whole and the performance materiality, based on the following:

• PBT will be normalised by excluding the exceptional expenditure of Rs 20 crores. The said normalisation is done as the transactions that are exceptional, unusual or non-recurring in nature tend to distort the actual state of affairs of the business, if not excluded.

• 5% of the normalised PBT will be used to quantify the materiality for the financial statements as a whole. SA 320 and the Implementation Guide do not prescribe any specific percentage for any of the benchmarks of materiality, however one can use a range for gross and net benchmarks, for example, 5% to 10% for net benchmarks like profit before tax and 0.5% to 2% for gross benchmarks like revenue from operations or total assets.

• The engagement partner, in the above example, has followed the range of 5% to 10% for PBT and has decided to adopt a lower materiality of 5%, considering that A Ltd is a new audit client and operates in a highly regulated environment with significant related party transactions, and as such indicates higher audit risk.

• The engagement partner has decided performance materiality to be 70% of the materiality for the financial statements as a whole. Like materiality, SA 320 and the Implementation Guide do not prescribe any specific percentage for performance materiality. As per SA 320, performance materiality is set to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements in the financial statements exceeds materiality for the financial statements as a whole, and as such professional judgement is required to be exercised to determine how much reduction is required to the materiality at the financial statements as a whole. This can again be done by following a range which may be between 50% to 80% based on the risk assessment procedures and misstatements identified in earlier year’s audit.

• The engagement partner in the above case study has considered a moderate performance materiality of 70%, considering it a new audit engagement and moderate risk of material misstatement.

However, here it is important to note that the concept of materiality should not be applied while ensuring the compliances with laws and regulation, for example compliance of various sections of Companies Act like sections 185, 186, 188 etc., or where the law specifically require reporting without following the materiality like reporting under specific clauses of CARO 2020.

MATERIALITY FOR THE AUDIT OF INTERNAL FINANCIAL CONTROL WITH REFERENCE TO THE FINANCIAL STATEMENTS
Though we discussed above that ICAI has issued SA 310 and SA 405 to provide guidance on the audit of the financial statements, there may be a question if the said guidance can also be applied to determine the materiality for the audit of internal financial control with reference to the financial statements. The said question was answered in the ‘Guidance Note on Audit of Internal Financial Controls Over Financial Reporting (‘Guidance Note’)’ issued by ICAI, which states that the auditor should apply the concept of materiality and professional judgment as provided in the Standards on Auditing and this Guidance Note while reporting under section 143(3)(i) on the matters relating to internal financial controls with reference to the financial statements for both standalone and consolidated financial statements. The Guidance note has further clarified that the audit team should use the same materiality consideration as they would use in the audit of the entity’s financial statements as provided in SA 320.

Similar guidance is also given in the Technical Guide on Audit of Internal Financial Controls in Case of Public Sector Banks issued by ICAI.

However, it is important to note that the for the purpose of internal financial control, the audit team should consider the misstatements at an aggregate level rather than netting them off.  For example, control deficiencies that lead to an overstatement of expenses and overstatements of income may have a net impact that is less than the materiality, but at an aggregate level, they may have a material financial implication on the financial statements that may lead to material weakness and modification in the audit report on internal financial control.

MATERIALITY CONSIDERATION FOR REPORTING UNDER COMPANIES (AUDITOR‘S REPORT) ORDER, 2020 (‘CARO’)
The Guidance Note on CARO 2020 issued by ICAI also requires auditors to use materiality while evaluating the reporting considerations and ensure adequate documentation wherein any unfavourable comments have not been reported in view of the materiality of the item. The Guidance Note further states that for the purpose of CARO reporting, the auditor should consider the materiality in accordance with the principles enunciated in SA 320.

For example, in the case of clause 3(iii) of the CARO, while reporting on the repayment schedule of various loans granted by the company, the auditor examines the loan documentation of all large loans and conducts a test check examination of the rest, having regard to the materiality.

However, for certain clauses reporting should be made, irrespective of the materiality, for instance:

• Any discrepancies of 10% or more in the aggregate for each class of inventory and, whether they have been properly dealt with in the books of account, is required to be reported irrespective of the materiality, considering the specific reporting requirement of clause 3(ii)(a) of CARO.

• In case of reporting for consolidated financial statements, if a qualification/adverse remark is given by any individual component, then there is a presumption that the item is material to the component and hence not required to be re-evaluated from the materiality at the consolidated financial statement level. Hence every qualification/adverse remark made by every individual component including the parent should be included while reporting under clause 3(xxi).

IN SUMMARY
Materiality with reference to the financial statements is subject to significant judgement both by the management and the audit team. While from the management’s perspective its determination depends on the qualitative aspects, except where specific quantitative threshold has been prescribed like in Schedule III, whereas from the auditor’s perspective its determination is driven from both qualitative and quantitative factors. However, for both parties, materiality plays a pivotal role in ensuring the preparation of financial statements that are free from material errors and contains all the required disclosures relevant to the primary users of the financial statements, including issuance of audit report thereon.

Article 5 of India-Japan DTAA – Presence of personnel of foreign parent in premises of Indian subsidiary to render services did not constitute, either fixed place PE, or Supervisory PE of foreign company

1 FCC Co. Ltd. vs. ACIT
[2022] 136 taxmann.com 137 (Delhi – Trib.)
ITA No: 54/Del/2019
A.Y.: 2015-16; Date of order: 9th March, 2022                        

Article 5 of India-Japan DTAA – Presence of personnel of foreign parent in premises of Indian subsidiary to render services did not constitute, either fixed place PE, or Supervisory PE of foreign company

FACTS
Assessee, a tax resident of Japan (FCO), received the following income from its wholly owned-subsidiary (ICO) in India:

• Royalty and FTS income offered to tax at 10% under DTAA, and

• Income from the supply of raw material, components and capital goods treated as not taxable in India in the absence of PE.

AO considered that the premises of ICO was the office or branch of FCO in India. Accordingly, he taxed income from the supply of material by treating premises of ICO as fixed place PE of FCO in India. AO further held that FCO constituted supervisory PE as employees visited India to help ICO in setting up a new product line in India. DRP upheld AO’s order.

Being aggrieved, the assessee appealed to ITAT.

HELD
Fixed place PE

• To constitute a Fixed Place PE, it is a prerequisite that premises must be at the disposal of the enterprise.

• Access to ICO’s premises to provide services by FCO would not amount to the place being at its disposal. Such access was for the limited purposes of rendering services to ICO without FCO having any control over the said premises.

•    ICO was an independent legal entity carrying on its business with its own clients. FCO provided technical assistance to ICO from time to time as was required by ICO. FCO had not carried out its business from the alleged Fixed Place PE.

•    FCO had manufactured goods outside India; FCO had sold sale goods outside India; title in the goods had passed outside India; and FCO had also received consideration outside India. Thus, FCO had not carried out any operation in India in relation to the supply of raw material and capital goods.

Supervisory PE

•    FCO employees had visited India for assisting ICO in relation to supplies made by ICO to its customers; resolving problems relating to production; for fixing machines; maintenance of machines; checking safety status at the premises; suggesting ways for enhancing safety; support in quality control; IT-related services; and, support for the launch of new segment line. Said services were not supervisory in nature.

•    Further, as no assembly or installation work is going in ICO premises, services rendered by FCO were also not in connection with any construction, installation, or assembly project.

Where revenue had been duly informed about dissolution of trust and still chose to continue proceeding on dissolved entity which was no more in existence, such trust was a substantive illegality and not a procedural violation of nature adverted to in section 292B

5 Varnika RPG Trust vs. PCIT
[2021] 91 ITR(T) 1 (Delhi-Trib.)
ITA No.: 451 to 453 (Delhi) of 2021
A.Y.: 2016-17;
Date of order: 9th September, 2021  
                
Where revenue had been duly informed about dissolution of trust and still chose to continue proceeding on dissolved entity which was no more in existence, such trust was a substantive illegality and not a procedural violation of nature adverted to in section 292B

FACTS
Assessee trust was formed for the sole benefit of the settlor’s minor grand-daughter.

As per the trust deed, all the trust property including accumulation of yearly income along with the rights of ownership, use, possession and dispossession, were to vest with the granddaughter on attaining majority or on 31st March 2015, whichever was later and the term of the trust would expire on such date. The beneficiary attained majority on 3rd September, 2015 (i.e. A.Y. 2016-17).

Regular Assessment was completed u/s 143(3) in the year 2018 wherein it was brought on record that the trust stood dissolved from 3rd September, 2015 on account of granddaughter attaining majority. However, the PCIT on 15th March, 2021 initiated the revisionary proceedings u/s 263 against the assessee trust and revised the assessment order. The assessee contended that the order passed by the PCIT was invalid as the said trust was not in existence as on the date of initiating such revisionary proceedings.

HELD
The ITAT held that the trust was in existence only upto A.Y. 2016-17 and that the revenue had been duly informed about the dissolution of trust; but still the PCIT chose to continue the proceeding on the dissolved entity which was no more in existence. Hence, impugned order passed by the PCIT u/s 263 in the name of the dissolved trust was a substantive illegality and not a procedural violation of the nature adverted to in section 292B. It therefore held that the order passed on non-existent entity was a nullity.

In arriving at the conclusion, the ITAT applied the ratio of the judgment in Pr. CIT vs. Maruti Suzuki India Ltd. [2019] 107 taxmann.com 375/265 Taxman 515/416 ITR 613 (SC).

Proviso to section 68 inserted vide Finance Act, 2012 requiring the Assessee to prove source in respect of share premium money; operates prospectively from A.Y. 2013-14. Merely because the lender parties did not respond to summons/notices of the Assessing Officer; that cannot be sole ground to make addition u/s 68 when otherwise the documentary evidences were duly produced by the Assessee

4 AdhoiVyapar (P.) Ltd. vs. ITO
[2021] 91 ITR(T) 582 (Mumbai-Trib.)
ITA No.: 7308 to 7311 (MUM.) of 2019
A.Ys.: 2009-10 to 2012-13;
Date of order: 1st October, 2021

Proviso to section 68 inserted vide Finance Act, 2012 requiring the Assessee to prove source in respect of share premium money; operates prospectively from A.Y. 2013-14. Merely because the lender parties did not respond to summons/notices of the Assessing Officer; that cannot be sole ground to make addition u/s 68 when otherwise the documentary evidences were duly produced by the Assessee

FACTS
Assessee-company received share application money from various parties. As evidence, the assessee furnished various documents like share application form, PAN Card, confirmation from share-applicants regarding investment, relevant pages of bank passbook/statement, income-tax acknowledgement for the year, statement of income, financials for the relevant year and letter of allotment. It also submitted copies of Board Resolution, Memorandum and Articles of Association in case of corporate applicants. The assessee summarized the net worth position of all the share-applicants which substantiated that all the entities had sufficient net worth to make the investment in the assessee-company and were filing their ITRs since past several years ranging from 5 to 15 years.

Because few of the applicants failed to respond to summons u/s 131, the Assessing Officer concluded that the receipts shown by the assessee were accommodation entry in the garb of share capital /share premium and made addition u/s 68. It also alleged that commission payments must have been made for the same and made some addition u/s 69C also. The CIT(A) upheld the said addition.

Aggrieved, the assessee filed an appeal before the ITAT.

HELD
The ITAT allowed the assessee’s appeal on the following grounds:

The ITAT observed that the shareholder entities had sufficient net worth to invest in the assessee-company. It was also observed that there was no immediate cash deposits before making investment in the assessee company.

As regards attendance of summons u/s 131, the ITAT concluded that the assessee does not have any legal power to enforce the attendance of the share-applicants.

The ITAT also remarked that as the said year was the first year of operation, it was difficult to presume that the assessee generated unaccounted money in the first year itself and routed the same in the garb of share-application money.

Therefore, on the above grounds, the ITAT concluded that assessee had discharged the initial onus of proving these transactions in terms of the requirements of Section 68 and the onus had shifted on Assessing Officer to dislodge the assessee’s documentary evidences and bring on record cogent material to substantiate his adverse allegations. The additions made could not be sustained merely on the basis of suspicion, conjectures and surmises.

The proviso to Section 68 as inserted vide the Finance Act, 2012 requiring the assessee to substantiate the source of share application/premium money was applicable only from A.Y. 2013-14, and the same is not retrospective in nature. Therefore, the assessee was not even otherwise obligated to prove the source of share application money in the years under consideration which is A.Ys. 2009-10 to 2012-13.

Thus, the addition made u/s 68 was deleted. Consequently, the addition made u/s 69C was also deleted.

Where source of funds is clearly established, clubbing provisions do not apply

3 Abhay Kumar Mittal vs. DCIT
[TS-152-ITAT-2022 (Delhi)]
A.Y.: 2013-14; Date of order: 8th February, 2022
Sections: 10(13A), 64

Where source of funds is clearly established, clubbing provisions do not apply

FACTS
The assessee, an individual, in his return of income, claimed exemption of HRA in respect of rent of Rs. 5,34,000 paid by him to his wife. The Assessing Officer (AO), in the course of assessment proceedings, asked the assessee to explain the capacity of the assessee’s wife to purchase the property giving details of sources of funds for the same. The assessee explained that the property was worth Rs. 1.15 crore of which amount of Rs. 87.50 was funded by the assessee himself, and the balance was invested out of her own sources. The AO noticed that the assessee’s wife, in fact, had no independent source of income to make the investment in FDRs and a major share of Rs. 87.50 lakh was funded by the assessee. The AO held that rental income earned by the assessee’s wife is liable to be clubbed in the hands of the assessee since the investment to have purchased the property was made by her without having an independent source of income. The AO clubbed the rental income of Rs. 5,34,000 after allowing deduction u/s 24 and made an addition of Rs. 3,73,800 in the hands of the assessee.

Aggrieved, the assessee preferred an appeal to the CIT(A) who confirmed the action of the AO by holding that the contention that the investment has been made by her out of her independent source is not acceptable. He relied on the income summary statement of the assessee’s wife for A.Ys. 2001-02 and 2003-04 wherein she had shown income from profession of Rs. 57,400 and Rs. 1,48,900 respectively. He also relied on total income shown in ITR filed from A.Ys. 2001-02 to 2012-13.

Aggrieved, the assessee preferred an appeal to the Tribunal.

HELD
The Tribunal found that the assessee’s wife, who has low returned income, had received a loan from the assessee, which has been repaid by her from the redemption of mutual funds and liquidation of fixed deposits. It held that there is no bar on the part of the assessee to extend a loan from his known sources to his wife. Similarly, there is no bar on the assessee’s wife to repay the loan from her own mutual funds and fixed deposits. The assessee has paid house rent and the recipient, wife of the assessee, declared the same under the head `income from house property’ in her returns which has been accepted by the revenue. It held that the observations of the CIT(A) that the assessee’s wife has got meagre income hence she cannot afford to purchase a house was found to be not acceptable as the source for the purchase of the house in her hands are proved and never doubted. It also held that the contention of the CIT(A) that the husband cannot pay rent to the wife is devoid of any legal implication supporting any such contention. The Tribunal allowed the appeal filed by the assessee.

For the purpose of section 54, it is the date of possession which should be taken as the date of purchase and not the date of registration of agreement for sale

2 Raj Easow vs. ITO
[TS-155-ITAT-2022 (Mum.)]
A.Y.: 2015-16; Date of order: 8th March, 2022
Section: 54

For the purpose of section 54, it is the date of possession which should be taken as the date of purchase and not the date of registration of agreement for sale

FACTS
In May 2011, the assessee, along with his wife booked a residential flat (Flat No 203) in an under construction building named `Bankston’ at Thane (a new house) for a consideration of Rs. 1,40,51,500. In December 2012, the assessee made majority payments to the builders by availing a mortgage/housing loan. Thereafter, on 21st May, 2014, the assessee and his wife, being co-owners holding 50% share, sold a residential house (original house) and utilised the sale proceeds for making repayment of housing loan taken for new house.

In the return of income for A.Y. 2015-16, the assessee claimed a long-term capital gain of Rs. 79,92,015 arising on transfer of original asset as a deduction u/s 54 of the Act. According to the Assessing Officer (AO), the new house was purchased on 15th February, 2012 being the date on which the agreement for sale dated 7th February, 2012 was registered. Since this date was 2 years and 3 months prior to the date of sale of the original house The AO denied the benefit of deduction u/s 54 on the ground that the assessee has not purchased a new residential house within a period specified in section 54, which is one year before or two years after the date of sale of the original asset.

Aggrieved, the assessee preferred an appeal to CIT(A), who moving on the premise that the date of registration of agreement for sale is to be considered as the date of purchase of new residential house, decided the appeal against the assessee holding that purchase of the property was beyond the specified period of 2 years. The CIT(A) also rejected the alternative argument that since the property being purchased was under construction, the benefit of section 54 of the Act can be extended to the assessee by treating the transaction as a case of ‘construction’ and not ‘purchase’ and since the construction was completed and possession of new house taken on 2nd April, 2016, which date is within 3 years from the date of original asset.

Aggrieved, the assessee preferred an appeal to the Tribunal.

HELD
The Tribunal, having noted that the AO and CIT(A) have taken 15th February, 2011, the date of registration of agreement for sale as the date of purchase, proceeded to examine the nature of this agreement and its terms. It observed that the said agreement is not a sale / conveyance deed but only an agreement for sale entered into between the builders who have agreed to sell to the assessee a flat in a multi-storied building. It also observed that when the agreement for sale was registered, the multi-storied building was not yet constructed and the obligation of the assessee to make the payment is linked to construction. The agreement was required to be registered and was governed by provisions of MOFA. Having noted the provisions of section 4 of MOFA and clause 53 of the agreement for sale, held that the purchaser is put in possession only as a licensee and to that extent, the assessee acquired an interest in the premises on entering into possession. Since by that date the assessee has already paid entire/majority of consideration for purchase, it held that the assessee has on the date of taking possession purchased the property for the purposes of section 54 of the Act as has been held by the Bombay High Court in CIT vs. Smt Beena K. Jain 217 ITR 363. The Tribunal held that the date on which possession is taken by the assessee (i.e. 2nd April, 2016) should be taken as the date of purchase. The requirement of section 54 is that the assessee should purchase a residential house within the specified period, and the source of funds is quite irrelevant. Since the date of purchase falls within 2 years from the date of sale of original house it held that the assessee is entitled to benefit of deduction u/s 54. It observed that the alternate contention of the assessee that the benefit of section 54 be granted to the assessee by treating the transaction as a case of construction is now academic and does not require consideration.

BLOCKED CREDITS

The previous articles discussed the various restrictions imposed u/s 17 (5) on input tax credit claims. In this concluding article on blocked credits, we will discuss clauses (b) and (g) of Section 17 (5).

INTRODUCTION
The erstwhile CENVAT Credit Rules, 2004 permitted the claim of credit of tax paid on inputs, input services or capital goods. An inward supply was required to fall within the purview of the said terms, as defined u/r 2 thereof. The definition of inputs and input services provided therein specifically excluded the following goods/ services from being classified as inputs/ input services:

Exclusion from scope of inputs:

Exclusion from scope of input services:

(E) any goods, such as
food items, goods used in a guesthouse, residential colony, club or a
recreation facility and clinical establishment, when such goods are used
primarily for personal use or consumption of any employee; and

(C) such as those
provided in relation to outdoor catering, beauty treatment, health services,
cosmetic and plastic surgery, membership of a club, health and fitness
centre, life insurance, health insurance and travel benefits extended to
employees on vacation such as Leave or Home Travel Concession, when such
services are used primarily for personal use or consumption of any employee.

The above indicates that the legislature’s intention has always been to deny CENVAT credit in respect of such goods or services which have an element of being used primarily for personal use or consumption of any employee. This approach has been inherited under GST as well with two specific clauses – (b) and (g) u/s 17 (5) with clause (b) specifically restricting credit on specified inward supplies, subject to exceptions provided therein (nexus with outward supplies/ obligatory for an employer to provide the facilities) while clause (g) is more in the nature of a use-based restriction, as it restricts input tax credit on goods or services or both, used for personal consumption.

One important distinction in the provisions under the CENVAT regime and GST regime is that under the CENVAT regime, clauses (b) & (g) were under a single entry and therefore, the restrictions complemented each other, i.e., the specified goods/services were not eligible for CENVAT credit when used for personal consumption of an employee. However, under GST, the restriction is split into two different entries. Therefore, items covered under clause (b) shall not be eligible for input tax credit (subject to exceptions), irrespective of whether the same are used for personal consumption or not. However, when it comes to clause (g), there will be a need to identify and demonstrate ‘personal consumption’ first. Once the item is classified as meant for ‘personal consumption’, the input tax credit shall not be allowed, even if is covered within the exceptions under clause (b) or other sub-clauses.

Another distinction that needs to be noted is that under the CENVAT regime, the ineligibility to claim credit was attracted when the goods/ services were used for the personal consumption of the employees. However, under GST, the restriction applies only for personal consumption, which gives rise to the question as to whether it intends to refer to the personal consumption of the taxpayer/ the employees of the taxpayer. In this article, we have analysed both clauses.

CLAUSE (b) – SPECIFIC ITEMS COVERED U/S 17 (5)
Clause (b) is reproduced below for reference:

(5) Notwithstanding anything contained in sub-section (1)
of section 16 and sub- section (1) of section 18, input tax credit shall not be available in respect of the following, namely:—

(a) … …

(b) the following supply of goods or services or both—

(i) food and beverages, outdoor catering, beauty treatment, health services, cosmetic and plastic surgery except where an inward supply of goods or services or both of a particular category is used by a registered person for making an outward taxable supply of the same category of goods or services or both or as an element of a taxable composite or mixed supply;

(ii) membership of a club, health and fitness centre;

(iii) rent-a-cab, life insurance and health insurance except where–

(A) the Government notifies the services which are obligatory for an employer to provide to its employees under any law for the time being in force; or

(B) such inward supply of goods or services or both of a particular category is used by a registered person for making an outward taxable supply of the same category of goods or services or both or as part of a taxable composite or mixed supply; and

(iv) travel benefits extended to employees on vacation such as leave or home travel concession;

AMENDMENT W.E.F 1st FEBRUARY, 2019
The above was amended w.e.f 1st February, 2019 by way of substitution as under:

(b) the following supply of goods or services or both—

(i) food and beverages, outdoor catering, beauty treatment, health services, cosmetic and plastic surgery, leasing, renting or hiring of motor vehicles, vessels or aircraft referred to in clause (a) or clause (aa) except when used for the purposes specified therein, life insurance and health insurance:

Provided that the input tax credit in respect of such goods or services or both shall be available where an inward supply of such goods or services or both is used by a registered person for making an outward taxable supply of the same category of goods or services or both or as an element of a taxable composite or mixed supply;

(ii) membership of a club, health and fitness centre; and

(iii) travel benefits extended to employees on vacation such as leave or home travel concession:

Provided that the input tax credit in respect of such goods or services or both shall be available, where it is obligatory for an employer to provide the same to its employees under any law for the time being in force.

The effect of the above amendment is tabulated below for ease of reference:

Restriction for

Pre-amendment

Post-amendment

Sub-clause
(i)

Food & beverages

Restricted subject to condition that the
inward supply is used for making an outward supply of same category of goods
or services or both, or as a part of a composite or mixed supply

Restricted subject to two conditions:

• Inward supply is used for making an
outward supply of same category of goods or services or both, or as a part of
a composite or mixed supply

• Where it is obligatory for an employer to
provide such goods or services or both to its’ employees

Outdoor catering

Beauty treatment,
health services, cosmetic and plastic surgery

Leasing, renting or hiring of motor
vehicles, vessels or aircraft referred to in clause (a) or clause (aa)

–

Life insurance, health insurance

–

Sub-clause
(ii)

Membership of a club, health and fitness
centre

Blanket restriction

Restricted subject to two conditions:

• Inward supply is used for making an
outward supply of same category of goods or services or both, or as a part of
a composite or mixed supply

• Where it is obligatory for an employer to
provide such goods or services or both to its’ employees

Sub-clause
(iii)

Rent-a-cab

Restricted subject to condition that the
inward supply is used for making an outward supply of same category of goods
or services or both, or as a part of a composite or mixed supply,

OR

when obligatory for employer to provide
such service to employees

Deleted as shifted to sub-clause (i)

Life insurance and health insurance

Deleted as shifted to sub-clause (i)

Sub-clause
(iv)

Travel benefits extended to employees on
vacation such as leave or home travel concession

Blanket restriction

Renumbered as sub-clause (iii) and
exception provided when it is obligatory on the part of employer to provide
such goods or services or both to its’ employees

We now proceed to discuss each item covered under clause (b).

FOOD AND BEVERAGES
The first item under clause (b) on which input tax credit is blocked is ‘food and beverages’. In our view, the following points need analysis:

• Whether the restriction would apply on receipt of goods, being food and beverages or even services with an element of food and beverages would be covered?

• What shall be the scope of the terms – ‘food’ and ‘beverages’?

• Whether the ‘and’ need to be read as ‘or’ while interpreting the restriction?

Clause (b), as reproduced above, applies to the supply of goods or services or both, of food and beverages. The first question which needs analysis is whether this restriction has to be applied when the food and beverages are being supplied as standalone goods, or as part of service and therefore, deemed as service in view of entry 6(b) of Schedule II? This is relevant because if it is the former, when food and beverages would be supplied as part of a service, the same would be deemed to be a supply of service and therefore, unless such food or beverages are supplied as a part of a service and specifically mentioned under the restrictive clause, the same would not be an ineligible input tax credit. One reasoning to support this view is that after food and beverages, clause (b) refers to outdoor catering. If the supply of food and beverage as a part of service was supposed to be covered within the first item, i.e., food and beverage, there was perhaps no need to specifically cover outdoor catering under the restriction list.

Per contra, it may be contended that a restaurant also supplies food and beverages, with the only distinction being that the food and beverages are not sold as such but are supplied by way of service. One may rely on the decision in the case of Northern India Caterers’ case [1980 SCR (2) 650] wherein the Hon’ble SC has held as under:

The appellant prepared and served food both to residents in its hotel as well as to casual customers who came to eat in its restaurant, and throughout it maintained that having regard to the nature of the services rendered there was no real difference between the two kind of transactions. In both cases it remained a supply and service of food not amounting to a sale. … … (only relevant extracts).

In other words, even in the case of restaurant service, there is a supply of food and beverage, though the same may not be sold in the restaurant itself owing to it being consumed. Therefore, a strong view prevails that the restriction under food and beverages extends to restaurant services as well.

Food & Beverages – scope

This takes us to the second question, i.e., the scope of the terms – ‘food’ and ‘beverages’ for the purpose of this clause. The general meaning of both the terms is something which is consumed by a person. Generally, food refers to something which can either be in solid/ semi-solid/ liquid stage, while beverages refer to liquid items for consumption. What constitutes food has been dealt with by the Hon’ble SC in the case of Swastik Udyog vs. Commissioner [2006 (198) ELT 485 (SC)] wherein the Hon’ble SC held that food is a substance which is taken into the body to maintain life and growth. Similarly, in the context of beverages, in the case of Hamdard (Wakf) Laboratories [1999 (113) ELT 20 (SC)], the SC has held as under:

5. Beverages, broadly speaking are liquids for drinking, other than water, which may be consumed neat or after dilution.

This takes us to the first issue, i.e., whether preparatory items used to cook such food and beverages can be treated as food/ beverages per se or not? For instance, whether coffee beans/powder used to make coffee can be treated as an item classifiable as ‘food’ or ‘beverage’ and therefore, input tax credit on the same is blocked? For instance, while dealing with the question of whether Rasna powder, which is used for preparing a beverage, can itself be treated as a beverage or is it a mere preparatory material to make the beverage? In the case of P. Sukumaran [(1989) 74 STC 185], the Delhi HC held that Rasna is only a concentrate and not a liquid. Therefore, it would not come within the ambit of the expression ‘beverage’. However, while dealing with the classification of Rooh Afza, the Hon’ble SC in the case of Hamdard (Wakf) Laboratories held as under:

7. The Tribunal would also appear to have concluded that the said sharbat was not a beverage but a preparation for the same. The fact that three table spoonfuls of the said sharbat have to be added to a glass of water to make it drinkable does not, in our view, make the said sharbat not a beverage but a preparation for a beverage. Were that so, many beverages which are classified as such, as for example, tea, coffee, orange squash and lemon squash would not be beverages. (See, for example, paragraph 5 of this Court’s judgment in the case of Parle Exports P.Ltd. [1988 (38) E.L.T. 741 (S.C.) = 1989 (1) SCC 345] and paragraph 12 et seq of the Tribunal’s judgment in the case of Northland Industries [1988 (37) E.L.T. 229]. It seems to us that the phrase `preparations for lemonades or other beverages’ in clause (j) of Note 5 of Chapter 21 was intended to refer to the industrial concentrates from which aerated waters and similar drinks are mass produced and not to preparations for domestic use like the said sharbat.

Of course, both the products are different in nature. While Rasna powder cannot be consumed as such, Rooh Afza can be consumed, as held by the Hon’ble Court, without mixing with any other liquid. However, a prudent view would be to not only treat such items which can be consumed directly as ‘food’ or ‘beverage’, but also such items, which with minimal process would result in the ‘food’ or ‘beverage’ being prepared, for instance, ready to eat meals, such as Maggi, soups, etc., Infact, such items were also referred to under the Central Excise Tariff as ‘food preparations’. Not doing so may defeat the intention of the legislature, which is to deny input tax credit on items that are meant for personal consumption.

‘And’ vs. ‘Or’

This takes us to the next question as to whether while analysing the first item, i.e., ‘food and beverages’, the ‘and’ needs to be read ‘as is’ or as ‘or’. In this regard, one may refer to the decision in the case of Kamta Prasad Aggarwal vs. Executive Engineer, Ballabhgarh [1974 (4) SCC 440] wherein the Hon’ble SC held that depending upon the context, ‘or’ may be read as ‘and’ but the Court would not do it unless it is so obliged because ‘or’ does not generally mean ‘and’ and ‘and’ does not generally mean ‘or’. In other words, the context needs to be looked into while determining if ‘and’ can be read as ‘or’.

In this regard, let us look into the intention of the legislature to understand the context behind the entry. The purpose of this entry is to restrict credit, i.e., deny a benefit to the taxpayer. In such a scenario, reading ‘and’ as ‘and’ instead of ‘or’ would deny the purpose of the entry. This is because the ‘and’ would necessitate both ‘food’ and ‘beverages’ to be present in a supply. This would mean the existence of two different supplies, one of food and another of beverage. However, such a situation would be theoretically impossible since both the supplies would be taxed independently as GST is a transaction-based tax and therefore, there cannot be a scenario where food and beverage are being supplied under a single contract. On the other hand, if the ‘and’ is read as ‘or’, the scope of the restriction entry would drastically expand, as the likelihood of a person receiving only food or only beverages in a single supply is higher. One may also refer to the service tariff entry, which also refers to the tax rate on supply of food and beverage. If the ‘and’ is read as ‘and’, the rate notification itself would also fail.

Lastly, it is an industry practice to refer to any person dealing in the food or beverage industry as a part of Food & Beverage Industry.

OUTDOOR CATERING
This takes us to the next restriction for outdoor catering. The first question that comes into mind is the need for specifically referring to ‘outdoor catering’ under clause (b), especially when food & beverages are also restricted in the same clause. The only probable reason is that outdoor catering is a wider activity as compared to the mere supply of food and beverages. This aspect has been dealt with by the Hon’ble SC in the Tamil Nadu Kalyana Mandapam Associations vs. UOI [2006 (3) STR 260 (SC)] wherein the Hon’ble SC held as under:

55. … … …

Similarly the services rendered by out door caterers is clearly distinguishable from the service rendered in a restaurant or hotel inasmuch as, in the case of outdoor catering service the food/eatables/drinks are the choice of the person who partakes the services. He is free to choose the kind, quantum and manner in which the food is to be served. But in the case of restaurant, the customer’s choice of foods is limited to the menu card. Again in the case of outdoor catering, customer is at liberty to choose the time and place where the food is to be served. In the case of an outdoor caterer, the customer negotiates each element of the catering service, including the price to be paid to the caterer. Outdoor catering has an element of personalized service provided to the customer. Clearly the service element is more weighty, visible and predominant in the case of outdoor catering. It cannot be considered as a case of sale of food and drink as in restaurant. … …

BEAUTY TREATMENT, HEALTH SERVICES, COSMETIC AND PLASTIC SURGERY
This restriction is directly borrowed from the definition of input services u/r 2 (l) of CENVAT Credit Rules, 2004. While what is meant by the above terms has not been defined under GST, the same were defined under the Finance Act, 1994, and it would therefore be appropriate to refer to the definitions provided therein to understand what may and may not get covered within it:

• ‘beauty treatment’ includes hair cutting, hair dyeing, hair dressing, face and beauty treatment, cosmetic treatment, manicure, pedicure or counselling services on beauty, face care or make-up or such other similar services.

• ‘health and fitness service’ means service for physical well-being such as, sauna and steam bath, Turkish bath, solarium, spa, reducing or slimming salons, gymnasiums, yoga, meditation, massage (excluding therapeutic massage) or any other like service.

• ‘any service provided or to be provided to any person, by any other person, in relation to cosmetic surgery or plastic surgery, but does not include any surgery undertaken to restore or reconstruct anatomy or functions of body affected due to congenital defects, developmental abnormalities, degenerative diseases, injury or trauma’.

As can be seen, the above terms actually refer to services that are personal in nature. However, clause (b) specifically does not restrict that the said services should only be used for personal consumption. Rather it imposes a general restriction with an exception where such supplies are used by a registered person for making an outward taxable supply of the same category of goods or services or both or as an element of a taxable composite or mixed supply. In other words, either there is a direct nexus where the registered person supplies the same class of service, or such registered person is engaged in making a composite or mixed supply, i.e., more than one supply with one of the supplies being either beauty treatment, health services or cosmetic and plastic surgery.

This necessitates the need to understand the meaning of the terms ‘composite supply’ or “mixed supply”. The relevant definitions are reproduced below for reference:

(30) ‘Composite supply’ means a supply made by a taxable person to a
recipient consisting of two or more
taxable supplies of goods or services or both, or any combination thereof, which
are naturally bundled and supplied in conjunction with each other in the
ordinary course of business, one of which is a principal supply;

(74) ‘Mixed supply’ means two or more
individual supplies of goods or services, or any combination thereof,
made in conjunction with each other by a taxable person for a single price
where such supply does not constitute a composite supply.

Both the above terms indicate that there must exist more than one supply of goods or services or both being made in conjunction with each other. Therefore, it becomes necessary to understand what is meant by the phrase “two or more taxable supply of goods or services or both, supplied in conjunction with each other” for the purpose of this entry. Let us understand this with the help of an example. A company organizes a 4-day residential training course in a 5-star hotel charging a lump sum fee of Rs. 1,00,000 plus GST per participant. The same includes, apart from training charges, charges towards participants stay, food & beverage, travel arrangements (including hiring vehicles for airport/ railway station pick-up/ drop), one-time spa coupon, etc.,

There are more than two supplies involved in this case, such as training service, F&B, rent-a-cab services, health and fitness centre, etc. In this case, it can be said that there are two or more taxable supplies involved as the recipient of supply actually receives/consumes the said supplies. Therefore, the supplier will be eligible to claim input tax credit even of such specified items, as they are used for making a taxable supply of goods or services or both. It is imperative to note that each of the activities undertaken for the recipient is taxable in nature, and the same is undertaken in conjunction with each other while providing the main service of training.

However, even the above example can have some twists. If out of 100 participants, 70 participants have paid for the course, 20 are free participants, and 10 are employees of the organizer who also attend the seminar, the eligibility to claim input tax credit gets a bit changed. Free participants would imply no taxable supply as there is no consideration, and therefore, tax is not leviable. Since there is no taxable supply involved, the question of the inward supplies being used to make a composite or mixed supply does not arise and therefore, eligibility to claim input tax credit to the extent of 20 participants would be an issue. The same treatment would apply even when own employees are attending the course or organizing team members avail the same service. To the extent own employees are attending the course for free/employees of the team organizing the course are also using the said facilities, it cannot be said that the same is used for making an outward taxable supply and therefore, the input tax credit to that extent would not be eligible.

Similarly, there can be instances where though there are various activities undertaken by the supplier, the question of composite/mixed supply does not arise. For instance,

• A film producer undertaking production of a film has entered into an agreement for a lock-stock-barrel transfer of all rights in the movie, once the shooting is completed. GST is paid at the applicable rates on the outward supply, i.e., transfer of copyrights. In the course of shooting, the film producer incurs the expense of beauticians for the acting crew. The beauticians’ levy GST on their service charges. Can it be said that the film producer has actually further supplied the said service of beauticians to the distributor along with the main supply, i.e., transfer of copyrights or there is a single supply only, and therefore the question of mixed and composite supply does not arise?

• Similar example applies in the context of news channel/entertainment channel where the service provided is the sale of advertising slots. However, in order to create the content/ news broadcasting, expenses of beauty parlour are incurred, and GST is paid on the same. The same would also be covered under the blocked credit list,
and input tax credit would not be eligible on the same as well.

• Another example would be of an actor/ actress who has undergone  cosmetic surgery with the intention of getting a new assignment and paid GST on the charges levied by the Doctor. Can the actor/actress claim input tax credit on the grounds that the services are used as a part of a composite / mixed supply? The answer to this is apparently negative.

We may also need to look into a scenario where the service recipient arranges for the material used in the delivery of the above service, and the supplier of service merely performs the said service. The question then remains whether the recipient can claim the input tax credit of GST paid on materials. Is a view possible that the restriction of beauty treatment, health services, cosmetic and plastic surgery is to be read in the context of the supply of services only? Such a view is possible for the simple reason that all the three terms refer to an activity done on another person, i.e., a service. However, such a view is likely to be litigative since the Revenue is going to interpret it strictly, and any expense which has a distant relation to the above items would be treated as blocked credits only.

MEMBERSHIP OF A CLUB, HEALTH AND FITNESS CENTRE
A plain reading of the entry would indicate that the restriction applies to membership of a club or membership of a health and fitness centre. This would mean that the restriction applies when there is an inward supply of service and not goods. This implies that if a taxable person has set up a health and fitness centre within his Place of Business and procures various equipment, the same would not get covered within the purview of health and fitness centre service and therefore, restriction might not apply. One may refer to the decision in the case of ITC Ltd. vs. Commissioner [2018 (12) GSTL 182 (Tri. – Kol.)] wherein the Hon’ble Tribunal had allowed the credit in respect of health and fitness centre opened in the premises of the taxpayer for the benefit of the employees. Similarly, if certain services are received with respect to such a centre, the restriction would not apply as the same applies only for membership services of a club or a health and fitness centre.

Let us first analyse the restriction w.r.t membership of a club. The term ‘club’ has not been defined under GST. However, the term ‘club or association’ was defined under service tax vide section 65 (25aa) as under:

“club or association” means any person or body of persons providing services, facilities or advantages, primarily to its members, for a subscription or any other amount, but does not include —

(i) any body established or constituted by or under any law for the time being in force; or

(ii) any person or body of persons engaged in the activities of trade unions, promotion of agriculture, horticulture or animal husbandry; or

(iii) any person or body of persons engaged in any activity having objectives which are in the nature of public service and are of a charitable, religious or political nature; or

(iv) any person or body of persons associated with press or media;

From the above, it is apparent that under the service tax regime also, the levy of service tax was on club or association service, but the claim of credit was restricted only to the extent of membership of a club. It, therefore, becomes necessary to understand the distinguishing factor between clubs and associations.

In layman’s terms, a club may be a for-profit/non-profit organization established with the end objective to provide various facilities to its’ members. A club can be in the form of a members’ club, such as CCI, Bombay Gymkhana, etc., or even non-member clubs, such as Club Mahindra, Country Club, etc. Such clubs offer services which are purely personal in nature and meant for consumption of the member. In the context of membership clubs providing services that are personal in nature/ meant for personal consumption, there has been substantial litigation on the same under the CENVAT regime before the amendment of the definition of input services, specifically excluding the same from its’ scope. In Racold Thermo Ltd. vs. Commissioner [2016 (42) STR 332 (Tri. – Mum.)], the Hon’ble Tribunal had allowed the CENVAT credit on annual club membership, concluding that the same was used to promote sales and purchase activity by attending to clients and holding conferences. On the contrary, for periods after 1st April, 2011, the Tribunal has consistently denied the CENVAT credit on club membership services [Cenza Technologies Pvt. Ltd. – 2017 (4) GSTL 150 (Tri. – Che.) and Marathon Electric India Pvt. Ltd. – 2016 (45) STR 253 (Tri. – Hyd.)].

On the other hand, an association is an organization, generally non-profit, established with the end objective of the collective benefit of members. Some examples of an association can be:

• a co-operative housing society which is an association of members/ owners of houses who have come together with the objective of benefiting the members by maintaining the building/ complex and its’ facilities.

• Trade associations, such as CII, NASSCOM, etc., are associations where industry participants join hands with a stated objective of representing the industry before various forums, working towards the welfare of the members, etc.

• Recently, a new organization called BNI has started its’ Chapters across various cities. It is nothing but a networking organization where different businesses can take annual memberships and get a chance to showcase their business offerings at the periodic meetings organized by the Chapter. The members can also transact between them through the BNI network, which is advertised as one of the key benefits of joining the BNI network.

As such, it can be said that a club is an organization that provides services personal in nature/ meant for personal consumption and not for the general welfare of all members. On the other hand, an association works towards the general cause for the benefit of all members with no element of personal nature/ personal consumption being involved. This aspect has also been recognized under the CENVAT regime wherein in the case of BCH Electric Ltd. vs. Commissioner [2013 (31) STR 68 (Tri. – Del.)], the Tribunal had allowed the CENVAT credit of service tax paid on membership fees of IEEMA, an association of engineering products manufacturers. Even after the amendment in 2011, in Commissioner vs. Zensar Technologies Ltd. [2016 (42) STR 570 (Tri. – Mum.)], the Tribunal had allowed the CENVAT credit on service tax paid on membership fees of CII. In essence, though there is no specific exclusion for membership services provided by professional associations, the same should not be covered under the blocked credit entry.

It should also be kept in mind that while under the pre-amendment regime, there was no exception provided for claiming input tax credit on such supplies, post-amendment, exception is provided when it is obligatory on the part of the employer under any law, for the time being in force, to arrange for such facilities for his employees.

RENT-A-CAB
This restriction has been discussed in detail in the previous article [BCAJ, March 2022], dealing with the restriction under clauses (a), (aa) & (ab) of Section 17 (5). Readers may kindly refer to the same.

LIFE AND HEALTH INSURANCE
The terms ‘life insurance’/ ‘health insurance’ has not been defined under the GST law. The general interpretation would be that policy instruments titled  life insurance/health insurance shall be covered by the restriction provided u/s 17 (5) (b). However, when a business takes a life insurance/health insurance, it is generally for their employees, and at times because it is mandatory on such business to extend the insurance cover to the employees.

However, there are different types of policies that an employer takes for his employees. For instance, the Workmen Compensation Insurance Policy taken for construction workers to meet mandatory labour laws. In such policies, it is actually the employer who gets insured and not the employees, as it safeguards the employer in case of any untoward accident resulting in injury to the employee. It is an insurance policy where the risks of the employer are subsumed by the insurance company. In the context of such policies, the Hon’ble Karnataka HC in the case of Ganesan Builders Ltd. vs. CST, Chennai [2019 (20) GSTL 39 (Mad.)] had held that the CENVAT credit was allowable as the insurance policy was employer-specific and not employee-specific. This was despite the fact that the definition of input service did not provide any exception to cases where it was obligatory to provide insurance facilities to their employees. Also, under the CCR, 2004, the exclusion applied only when the said services were used for personal consumption of the employee, w.r.t which the HC has held to the contrary.

Of course, the restriction applies only to specific insurance policies and not for other policies such as travel insurance, fire insurance, etc., on which the input tax credit will be allowed.

TRAVEL BENEFITS EXTENDED TO EMPLOYEES ON VACATION
At times, employers themselves arrange for vacation travel of employees and their family members by booking them for a travel package or reimbursing the cost of travel. In such cases, the benefit of the input tax credit is specifically restricted subject to the exception that it is obligatory on the employer’s part to provide such facilities to the employee.

However, there are also other instances where an employer extends travel benefits to the employees, such as:

•    Relocation – An employee working in one location may be transferred to another location, and the employer might arrange for travel of the employee/ his family members as well as transportation of their belongings.

•    Joining – This is similar to relocation, with the only difference being that this occurs when a company hires an employee belonging to another city. As a joining incentive, the company arranges/bears the cost of relocation.

•    Training – An employer might arrange for the employee to undergo certain training which necessitates the employee to travel to a different city/ country, and the cost incurred during such travel for training is borne by the employer.

•    Marketing – In the course of employment, an employee might be required to travel extensively, especially when involved in a sales/ marketing role. The entire travel expenses are borne by the employer. In Ramco Cements Ltd. vs. Commissioner [2017 (5) GSTL 105 (Tri. – Che.)], the Tribunal has allowed the CENVAT credit of tax paid on air travel agency services /tour operator services used to book tickets for travel of employees for marketing/business promotion. In Netcracker Technologies Solutions India Private Limited vs. Chief Commissioner [2017 (4) GSTL 10 (Tri. – Hyd.)], the Tribunal had held that travel insurance of employees for business travel was eligible for CENVAT credit.

Though the above are in the nature of travel benefits, they cannot be categorized as being extended to employees on vacation. Therefore, the restriction to claim input tax credit cannot be extended to the above.

CLAUSE (g) – GOODS OR SERVICES OR BOTH USED FOR PERSONAL CONSUMPTION
This takes us to clause (g), which restricts the claim of an input tax credit on goods or services or both used for personal consumption. For the purpose of this clause, the scope of the term ‘personal consumption’ needs to be analysed.

Neither the term ‘personal consumption’ nor ‘personal’ has been defined under GST. Therefore, we need to refer to the dictionary meaning to understand the scope of the term ‘personal’. The Oxford Dictionary refers to ‘personal’ as “your own; not belonging to or connected with anyone else”.

At this juncture, we should also refer to section 37 (1) of the Income-tax Act, which specifically prohibits the claim of expenses that are personal in nature. While analysing the scope of section 37 (1), in the case of Galgotia Publications Private Limited vs. ACIT [ITA No. 1857/Del/2015], the Hon’ble Tribunal has held that there cannot be a nature of personal expenses when the assessee is a company, an entity recognized by law as a legal person and existing independently with its’ own rights & liabilities. Therefore, no element of personal expenses by Directors/ Office bearers can be attributed unless there is sufficient documentary evidence in support.

The above indicates that while interpreting the term ‘personal consumption’, it has to be referred to as the consumption of the taxable person in the context of whom the eligibility to claim input tax credit needs to be looked into. Owing to the decision of the ITAT, even expenses incurred for Key Managerial Personnel, i.e., directors, office bearers, etc., may be covered within the scope of personal expenses/ consumption. The question that therefore remains is if any expenses are incurred for the welfare of the employees and not covered under any other clauses of section 17 (5), whether the same would be hit by clause (g) or not?

For instance, a Mumbai based company has hired a new employee who will be relocating to Mumbai along with his family. As a facilitation measure, the company arranges for the travel of the employee and his family members and the transportation of their belongings to Mumbai. The company also arranges for  temporary accommodation in a hotel for ten days to assist the employee in settling. The company also pays brokerage to a real estate agent for helping the employee find permanent accommodation. None of the expenses incurred by the employer in the above activities is specifically covered under any of the clauses of section 17 (5) – except perhaps the F&B expenses incurred during hotel stay for ten days.

The question that remains is whether this can be treated as a personal expense of the employer as it is consumed by the employee? It is important to note that such expense is allowable u/s 37 (1) as business expenses as this is nothing but personnel expenses, i.e., the expense incurred for the staff. However, the Bombay HC has, in the case of Commissioner vs. Manikgarh Cement [2010 (20) STR 456 (Bom.)] held that mere allowability of expense under income tax cannot be a yardstick to determine eligibility to claim the  credit. A nexus between the input/input service has to be established with the business activity of the taxpayer in order to demonstrate eligibility to claim the credit.

While a strong view to suggest that such expenses are not covered u/s 17 (5) (g) would prevail, it is also important to note that the Authority for Advance Ruling (AAR) has held to the contrary. For instance, in Chennai Port Trust’s case [2019 (28) GSTL 600 (AAR-GST)], the Authority has held that input tax credit on expenses incurred (procurement of inputs/ capital goods/ services) for in-house hospital is for personal consumption of the employees and therefore covered u/s 17 (5) (g).

The entry can also be analysed from a different perspective, especially in the context of goods. Let us take an example of a company having constructed a housing colony for its’ employees. The company also acquires various household equipment, which are installed at each of the houses in the colony. As per entry 4 (b) of Schedule II, where, by or under the direction of a person carrying on a business, goods held or used for the purposes of the business are put to any private use or are used, or made available to any person for use, for any purpose other than a purpose of the business, the usage or making available of such goods is a supply of services. In other words, a view can be taken that the act of making available the goods at the houses in the housing colony for the personal use of employees is actually a supply of service, and therefore, the corresponding input tax credit cannot be denied. Of course, there would be implications on the same from an output liability perspective, in view of entry 2 of Schedule I.

The scope of clause (g), therefore, appears to be controversial, especially till the term ‘personal consumption’ is not defined/ analysed by the Judiciary to provide more clarity.

CONCLUSION
Be it Direct Taxes or Indirect Taxes, when it comes to allowing the benefit of expenses/tax paid on expenses where there is an element of personal nature, the legislature’s intention has always been to deny the same. The same is further implemented by overzealous tax officers who do not miss any opportunity to label a particular expense as being personal in nature and deny the benefit. Therefore, taxpayers always need to be very careful when claiming input tax credit in respect of goods or services where there is an element of ‘personal’ consumption prevailing. Clauses (b) and (g), both revolve around this mindset of the legislature, and therefore, the taxpayers need to tread cautiously when analysing the same.

On maturity of life insurance policy, where section 10(10D) does not apply, it is only net income which is chargeable to tax

1 Sandeep Modi vs. DCIT
[TS-184-ITAT-2022 (Kol.)]
A.Y.: 2017-18; Date of order: 4th March, 2022
Sections: 10(10D), 56

On maturity of life insurance policy, where section 10(10D) does not apply, it is only net income which is chargeable to tax

FACTS
The assessee, an individual, took a single premium life insurance policy from SBI Life Insurance Co. Ltd., paying a premium of Rs. 10,00,000. The policy was to mature after three years. No deduction was claimed u/s 80C. During the previous year relevant to the assessment year under consideration, on the maturity of the policy, the assessee received a sum of Rs. 13,09,000 and included a sum of Rs. 3,09,000 in his total income under the head `Income from Other Sources’.

When the return of income was processed by CPC, a sum of Rs. 10,00,000 was added to the total income under the head Income from Other Sources. Aggrieved, the assessee preferred an application for rectification u/s 154 of the Act. The assessee’s application was rejected without giving any specific reason for rejection.

Aggrieved, the assessee preferred an appeal to CIT(A), who confirmed the action of the CPC in enhancing the total income by Rs. 10,00,000, which according to the assessee, was premium paid by the assessee to SBI Life Insurance Co. Ltd.

Aggrieved, the assessee preferred an appeal to the Tribunal.

HELD
The Tribunal noted that since SBI deducted 1% TDS on the entire receipt of Rs. 13,09,000, the CPC, while processing the return of income found that out of Rs. 13,09,000 received by the assessee, only Rs. 3,09,000 has been offered for taxation and, therefore, the balance of Rs. 10,00,000 was added as income of the assessee. It also noted that vide the Finance Bill, 2019, while increasing the TDS rate from 1% to 5% the problem has been taken note of. “…… Several concerns have been expressed that deducting tax on gross amount creates difficulties to an assessee who otherwise has to pay tax on net income (i.e. after deducting the amount of insurance premium paid by him from the total sum received). From the point of view of tax administration as well, it is preferable to deduct tax on net income so that income as per TDS return of the deductor can be matched automatically with the return of the income filed by the assessee. The person who is paying a sum to a resident under a life insurance policy is aware of the amount of insurance premium paid by the assessee.”

The Tribunal, upon noting the above-stated observations as well as taking note of the contention of the assessee that the addition of Rs. 10,00,000 tantamounts to double taxation and also the fact that the assessee had neither availed any deduction u/s 80C of the Act in respect of premium paid to SBI nor claimed any deduction u/s 10(10D) of the Act and offered Rs. 3,09,000 for tax in his return of income held that the addition made by the AO is not warranted.

S. 264 – Revision – Maintainability – Error / Mistake committed by assessee – Application maintainable

2 Hapag Lloyd India Pvt. Ltd. vs. Principal Commissioner of Income-Tax, Mumbai – 5;
[W.P. No. 2322 of 2021;
Date of order: 9th February, 2022
(Bombay High Court)]

S. 264 – Revision – Maintainability – Error / Mistake committed by assessee – Application maintainable

The Petitioner is a private limited company. It is a successor of United Arab Shipping Agency India Company Pvt. Limited (‘UASAC’), which amalgamated with the Petitioner with effect from 1st April, 2019, pursuant to an order by National Company Law Tribunal. The UASAC, the predecessor company, had distributed a dividend of Rs. 10,16,75,641 to its holding company, United Arab Shipping Company Limited, a company incorporated under the laws of Kuwait. The UASAC paid Dividend Distributed Tax (‘DDT’) at 16.91% (including surcharge and cess), aggregating to Rs. 2,06,99,127. A return of income for A.Y. 2016 – 2017 was filed by UASAC on 30th November, 2016. A revised return of income was filed on 23rd December, 2016.

In the original as well as revised return, the benefit of Article 10 of India – Kuwait DTAA was, however, not claimed. Under the said article, the dividend distributed during F.Y. 2015–2016, was taxable at 10%. The Petitioner was, thus, entitled to a refund of Rs. 84,61,650, being the excess tax paid. The Petitioner thus preferred an application u/s 264 of the Act before Pr.CIT / Respondent no. 1.

By the impugned order, Pr. CIT rejected the application as untenable primarily on the ground that the UASAC had not made a claim for the return of excess DDT at the time of filing original return of income as well as the revised return of income. Consequently, the assessment order u/s 143(3) was passed on 18th December, 2018. Thus, there was no apparent error on the record in the said assessment order which warranted exercise of jurisdiction u/s 264 of the Act.

The Petitioner has invoked the writ jurisdiction on the ground that Pr.CIT has completely misconstrued the scope of jurisdiction u/s 264. This incorrect approach of Pr.CIT has resulted in an unjustified refusal to exercise the jurisdiction vested in him by Section 264 of the Act.

The Petitioner submitted that Pr.CIT committed a grave error in law in holding that an application u/s 264 was not maintainable when the assessee had not made a claim for refund of excess tax paid in the original return. The Petitioner submitted that the view of Pr.CIT that, for the exercise of jurisdiction u/s 264 of the Act, the order impugned ought to be apparently erroneous, is completely misconceived. Under Section 264 of the Act, the Commissioner is empowered to call for the record of any proceeding and make an inquiry or cause an inquiry to be made and thereafter pass such order, as he thinks fit, but not being one prejudicial to the assessee. The scope is thus not restricted to correction of error apparent on the face of the record.

In opposition to this, the Respondent sought to justify the impugned order on the premise that the refund was not claimed in the original as well as revised return and thus the order passed u/s 143(3) by the Assessing Officer, which was sought to be revised cannot be said to be prejudicial to the assessee and, therefore, Respondent was well within his rights in refusing to exercise the revisional jurisdiction.

The Hon. Court observed that on the perusal of the aforesaid reasons, it becomes evident that two factors weighed with Respondent no. 1. First, the assessee had not claimed a refund in the original and revised return and, thus, there was no error in the assessment order passed u/s 143(3) on 18th December, 2018. Second, Respondent no. 1 was of the view that the jurisdiction u/s 264 was confined to correct the order, which is found to be apparently erroneous.

The Court observed that the Respondent no. 1 was justified in recording that the assessee had not claimed a refund of excess tax paid by it in the original and revised return. However, Respondent no. 1 committed an error in constricting the scope of revisional jurisdiction in the backdrop of the said undisputed factual position. In fact, the very foundation of the application u/s 264 was that the assessee had inadvertently failed to claim the benefit of Article 10 of the India – Kuwait DTAA, under which the dividend distribution was taxed at a lower rate. The Court held that the approach of Respondent no. 1 in refusing to exercise the jurisdiction u/s 264, on the premise that it can be lawfully exercised only where such a refund was claimed and considered by the Assessing Officer is neither borne out by the text of Section 264 nor the construction put thereon by the precedents.

The aforesaid reasoning indicates that Respondent no. 1 failed to appreciate the distinction between revisional and review jurisdiction. The principles which govern the exercise of review were sought to be unjustifiably imported to the exercise of power u/s 264 and thereby imposing limitations which do not exist on exercise of such power. Undoubtedly, revisional jurisdiction is not as wide as an appellate jurisdiction. At the same time, revisional jurisdiction cannot be confused with the power of review, which by its very nature is limited. The Division Bench Judgment of this Court in the case of Geekay Security Services (P) Ltd. vs. Deputy Commissioner of Income Tax, Circle – 3(1)(2) [2019] 101 taxmann.com 192 (Bombay) wherein the Court considered an identical question as to whether the revisional authority was justified in rejecting the revision application solely on the ground that the applicant had not claimed the benefit in the original return. Section 264 does not limit the power to correct errors committed by the sub-ordinate authorities and could even be exercised where errors are committed by the assessee and there is nothing in Section 264 which places any restriction on the Commissioner’s revisional power to give relief to the assessee in a case where assessee detects mistakes after the assessment is completed.

The Court held that since Pr.CIT / Respondent no. 1 has not considered the revision application on merits, matter was remitted back to Pr.CIT for de novo consideration on merits.

S. 80IB (10) – Housing Project – commencement of development of residential project – Date of approval/ sanction – Developer – Eligibility

1 Commissioner of Income Tax-24 vs. Abode Builders;
[Income Tax Appeal No. 2020 of 2017;
Date of order : 16th February, 2022
(Bombay High Court)]

S. 80IB (10) – Housing Project – commencement of development of residential project – Date of approval/ sanction – Developer – Eligibility

Assessee Firm is a developer and builder who developed a residential project called ‘Trans Residency’ on a piece of land admeasuring 12,540 sq. metres in the Andheri Area of Mumbai. The assessee firm entered into a Joint Venture Agreement with another concern M/s. Vaman Estate to develop the property vide agreement dated 28th August, 2001. The residential project ‘Trans Residency’ has 7 wings in Building No. I (A to G) and 3 wings in building No. III (A to C). The construction activity was undertaken for Wings E & F first, and residential units were sold before 31st March, 2005. The project for E & F Wing was completed in 2005 and profits were offered for tax (deduction u/s 80IB was claimed on the same) in the return of income filed for A.Y. 2005-06, while the rest of the project was completed in March, 2007, and proceeds on sale of residential units was shown in the return of income filed for A.Y. 2007-08. The return of income was filed on 19th October, 2007, declaring a total income of Rs. 18,16,656. The only addition was made on account of disallowance of claim u/s 80IB(10) of the Income Tax Act, 1961, amounting to Rs. 17,94,05,681.

The Assessing Officer (AO) scrutinized the assessee’s claim keeping in view two major criteria having a direct bearing on the legitimacy of the claim. The AO observed that the land on which the Trans Residency Project had been built was not owned by the assessee but by Malad Satguru Sadan CHS Ltd. and that the Conveyance Deed for the said land had been executed in the name of the society in pursuance to the directions of the High Court vide Consent Decree passed on 18th July, 1995. The AO also noted that the assessee had been engaged as a ‘developer’ by the Malad Sadguru Sadan CHS and has made payment on behalf of the society. Based on this, the AO concluded that the assessee was not the owner of the said land. Then the AO proceeded to examine whether the assessee could be considered as a developer. The AO observed that the assessee entered into a Joint Venture Agreement with M/s. Vaman Estate on 28th August, 2001 and observed that as per the agreement, the development and construction of the building was to be done by M/s. Vaman Estate at its own cost, and both the parties were to share the gross sale proceeds in the ratio of 50:50. The AO concluded that the assessee did not incur any expenditure on the project, nor did he do any construction activity, and the proceeds from the project were its net profit. The AO observed that once the Joint Venture Agreement was entered into, the status of the assessee changed from that of a ‘developer’ to that of a ‘facilitator’. The AO, thus, observed that the assessee was neither ‘the owner’ nor ‘the Developer’ of the property, and accordingly, the assessee was not eligible for claiming deduction u/s 80IB(10).

A supplementary agreement had been executed between the assessee and M/s. Vaman Estate on 14th March, 2005. Based on various clauses of both the above-mentioned agreements, the AO concluded that the BMC had given sanction to the Plan submitted by the assessee through letter dated 21st September, 1996. He observed that the Explanation to section 80IB(10) of the Act stipulated that where the approval for the concerned project was given more than once, the date of initial approval would be the operative date of approval. Thus, the assessee was not eligible to claim deduction u/s 80IB(10). Accordingly, the AO rejected the assessee’s claim of deduction u/s 80IB(10) of the Act amounting to Rs. 17,94,05,681. The assessment was completed u/s 143(3) of the Act on 24th December, 2009, assessing the total income at Rs. 18,12,22,340.

The Respondent-Assessee firm challenged this order before the Commissioner of Income Tax (Appeals). The CIT (Appeals) allowed the claim of deduction under section 80IB(10) of the Act. Aggrieved by this order of CIT (Appeals), Revenue preferred an appeal before the Income Tax Appellate Tribunal, Mumbai (‘ITAT’). The ITAT dismissed the appeal by an order dated 26th August, 2016.

The Hon. Court observed that the Revenue had originally raised three points, namely, (a) lack of ownership of land on which the project was constructed; (b) Assessee not having invested in the construction activity or done construction, could not be considered as a developer; and (c) Project was approved and commenced before the stipulated date of 1st October,1998. On these three grounds, the claim of the assessee under section 80IB(10) of the Act was denied by the Assessing Officer.

The Court observed that as regards the first issue regarding the ownership of the land, though it was raised before the ITAT, has not been raised in this present appeal. The ITAT has given a finding of fact which is not disputed inasmuch as the ITAT has observed that Respondent through, its partner one Liaq Ahmed, has been involved in the project right from the beginning with the signing of the Principal Agreement and primary acquisition of the development rights for the land in question. The AO has not even disputed that Intimation of Disapproval (‘IOD’) issued by the Municipal Corporation was in the name of assessee. So also the Commencement Certificate (CC). It is also noted that all tax related to the land in question were paid by the assessee from 1998 onwards. It is also noted that assessee has even made payment for the development rights. What the AO has missed out is unless the Respondent had any role in the development of the project, the joint venture partner would not agree to share 50% profit in the project with the assessee. Therefore, on this issue, the Court agreed with the findings of ITAT.

As regards the other objection that the project was commenced much before the stipulated date of 1st October, 1998, it was argued that the assessee had submitted the original Plan to the concerned authorities on 7th November, 1996 for which the IOD was granted in 1997, and therefore, even if a subsequent IOD has been obtained, as per the Explanation to section 80IB(10), where the approval for the concerned project was given more than once, the date of final approval would be the operative date of approval.

The Court further observed that the ITAT has once again come to a finding of fact that the project, as completed, was different from the project for which initial approval had been obtained. It is true that the original plan which was submitted and for which IOD was granted was in 1997. The life of the IOD once granted as per the Maharashtra Regional Town Planning Act, 1966 is four years. This finding has not been disputed by the Revenue. The original Lay-out Plan became invalid after 7th January, 2001. The assessee applied for IOD for the second time on 22nd November, 2001 and was granted permission on 21st July, 2002. The ITAT has come to a conclusion on facts, which is also not disputed, that the second project proposal was for only three buildings as against the four for which the permission was sought earlier, and IOD for different buildings was granted on different dates. The ITAT has concluded that, therefore the project for which permission was granted on 24th July, 2002 was not the same as that, for which the IOD lapsed in 2001.

The Court held that Tribunal has not committed any perversity or applied incorrect principles to the given facts and when the facts and circumstances are properly analysed, and correct test is applied to decide the issue at hand, then, no substantial question of law arises in the matter. The appeal was accordingly dismissed.

Settlement of cases — Interest u/s 220(2) — Order of Commissioner (Appeals) directing AO to withdraw investment allowance granted u/s 32A set aside by Tribunal — Order passed by Settlement Commission reducing interest u/s 220(2) — Need not be interfered with

8 UOI vs. Dodsal Ltd.
[2022] 441 ITR 47 (Bom)
A.Y.: 1989-90; Date of order: 9th December, 2021
Ss. 32A, 156, 220(2), 245D(4) of ITA, 1961

Settlement of cases — Interest u/s 220(2) — Order of Commissioner (Appeals) directing AO to withdraw investment allowance granted u/s 32A set aside by Tribunal — Order passed by Settlement Commission reducing interest u/s 220(2) — Need not be interfered with

For the A. Y. 1989-90, the Assessing Officer passed an order u/s 143(3) of the Income-tax Act, 1961. The assessment order was rectified u/s 154 on 27th July, 1992 revising the total income after allowance of set-off of unabsorbed investment allowance brought forward from the A.Ys. 1986-87, 1987-88 and 1988-89. The assessee made an application u/s 245C before the Settlement Commission, which passed an order u/s 245D(4). The Assessing Officer gave effect to the order u/s 245D(4) and also calculated the interest payable u/s 220(2). The quantum of interest was rectified, and a revised order was passed. The assessee sought rectification of the order passed by the Settlement Commission on the ground that since the order u/s 245D(4) was silent on the point of charging interest u/s 220(2), it should be considered to have been waived. The Settlement Commission held that it did not consider it to be a good case for waiver of interest chargeable u/s 220(2). However, regarding the method of charging of interest, the Settlement Commission directed the Assessing Officer to take the income as determined by him in his order dated 27th July, 1992, adjust it in accordance with its order u/s 245D(4), but without withdrawing the benefit of set-off of brought forward investment allowance u/s 32A. The Department filed an application contending that the Settlement Commission could not have granted the assessee the benefit of set-off of brought forward investment allowance. The Settlement Commission rejected the application filed by the Department.

The Bombay High Court dismissed the writ petition filed by the Department and held as under:

“i) The language used in sub-section (2) of section 220 of the Income-tax Act, 1961 is that the interest on demand is payable by the assessee for every month or part of a month comprised in the period commencing from the day immediately following the end of the period mentioned in sub-section (1) and ending with the day on which the amount is paid. Accordingly, the first proviso to sub-section (2) of section 220 provides that where as a result of an appellate order, the amount on which interest was payable under this section is reduced, the interest shall be reduced accordingly. Therefore, the effect of the first proviso to sub-section (2) of section 220 will be that the amount on which the interest is payable under sub-section (2) of section 220 will get modified according to the appellate order. There can be variation in charging interest if ultimately due to the result of the appellate order, the liability to pay the original amount on which interest is levied u/s. 220 ceases, and accordingly, the assessee needs to be given the benefit of reduction in interest resulting in reduced payment of interest.

ii) According to the proviso to sub-section (2) of section 220, once the amount on which interest was charged got extinguished the liability of the assessee to pay interest on such amount would also be extinguished. The order of the Commissioner (Appeals) directing the Assessing Officer to withdraw the investment allowance granted u/s. 32A was set aside by the Tribunal. Therefore, interference with the orders passed by the Settlement Commission reducing the liability of the assessee to pay interest u/s. 220(2) would result in directing the assessee to pay interest on an amount which had been extinguished and consequently would result in miscarriage of justice.

iii) The power under article 226 of the Constitution of India needs to be exercised to prevent miscarriage of justice. It will be exercised only in furtherance of interest of justice and not merely on the making out of a legal point.

iv) Therefore, we refuse to interfere in the exercise of power under article 226 of the Constitution of India in its extraordinary discretionary jurisdiction. The petition stands dismissed.”

Return of income — Revised return — Delay in filing revised return since sanction from National Company Law Board for demerger was received after expiry of time limit for filing revised return — Rejection of revised return not valid

7 Deep Industries Ltd. vs. Dy. CIT
[2022] 441 ITR 307 (Guj)
A.Y.: 2018-19;
Date of order: 29th September, 2021
S. 139(5) of ITA, 1961

Return of income — Revised return — Delay in filing revised return since sanction from National Company Law Board for demerger was received after expiry of time limit for filing revised return — Rejection of revised return not valid

The company DIL had its business of oil and gas exploration and production and oil and gas services. It decided to demerge its oil and gas services business, and a scheme of arrangement was formulated and a company application was moved before the National Company Law Tribunal. The scheme of arrangement was sanctioned on 17th March, 2020, and the appointed date was 1st April, 2017. The certified copy of the scheme was received on 20th May, 2020, and it was filed with the Registrar of Companies on 20th June, 2020.

DIL had filed the original return of income for the A.Y. 2018-19 on 30th March, 2019. On the sanction of the scheme being effective from 1st April, 2017 the erstwhile DIL’s assets, liabilities, incomes, etc., were deemed to be that of the resulting company, the assessee. However, the time for filing the revised return for the A.Y. 2018-19 had lapsed, and there was no mechanism to file it online. The assessee raised a grievance on the income tax portal on 26th June, 2020 through the e-Nivaran facility. Thereafter, it physically filed the revised return along with the letter dated 28th July, 2020, explaining the cause of revision. The Deputy Commissioner rejected the revised return of income filed by the assessee and passed an assessment order on a protective basis making an addition.

The Gujarat High Court allowed the writ petition filed by the assessee and held as under:

“i) Once there was no response to the grievance raised on the Income-tax portal, the assessee had physically filed the revised return on 28th July, 2020. The Department therefore ought to have considered the physical filing of the revised return.

ii) Resultantly, the assessment which has been finalized shall need to be quashed permitting the respondent to process considering the revised return which has been filed by the petitioner. If it is not filed in an electronic manner as has been reflected in the affidavit-in-reply, he should be permitted to do that by a specific order and granting him reasonable time of minimum one week to so do it. Otherwise, his physical copy which he has dispatched shall be taken into consideration.

iii) As a parting note the court needs to make a mention that the matter has travelled to this court only because the revised return was not permitted beyond the prescribed time limit as set under section 139(5) of the Act. Thus, the apex court in the case of Dalmia Power Ltd. vs. Asst. CIT [2020] 420 ITR 339 (SC) has categorically held and observed that section 119 of the Income-tax Act in such matters also would not be applicable and therefore, when the respondents are desirous of operating in the regimes of electronic mode and faceless assessment, it shall need to improvise the software and allow the revised return more particularly, when the law has been made quite clear by virtue of the direction of the apex court. Let care be taken in improvising the software wherever necessary since its limitations have tendency to swell the court litigation. The petitioner could have been saved from this ordeal, had such a care taken to permit the revised return in an electronic mode once the direction of the National Company Law Tribunal (NCLT) was communicated along with the decision of the apex court.”

Reassessment — Notice u/s 148 after four years — Condition precedent — Failure by assessee to disclose material facts necessary for assessment — Notice not stating which fact had not been disclosed — Mere statement that there had been failure to disclose material facts is not sufficient — All documents and details submitted by assessee during original assessment and examined by TPO and original order passed by AO thereafter — No failure on part of assessee to disclose material facts fully and truly — Notice and reassessment on change of opinion — Impermissible

6 Skoda Auto Volkswagen India Pvt. Ltd. vs. ACIT
[2022] 441 ITR 74 (Bom)
A.Y.: 2004-05; Date of order: 4th December, 2021
Ss. 92CA(3), 143(3), 147, 148 of ITA, 1961

Reassessment — Notice u/s 148 after four years — Condition precedent — Failure by assessee to disclose material facts necessary for assessment — Notice not stating which fact had not been disclosed — Mere statement that there had been failure to disclose material facts is not sufficient — All documents and details submitted by assessee during original assessment and examined by TPO and original order passed by AO thereafter — No failure on part of assessee to disclose material facts fully and truly — Notice and reassessment on change of opinion — Impermissible

For the A.Y. 2004-05, the Assessing Officer issued a notice u/s 148 of the Income-tax Act, 1961 after four years for reopening the assessment u/s 147. The reasons recorded stated that on verification of the records it was found that the assessee had capitalized an amount paid towards lump sum payment of technical know-how fees and claimed depreciation but had calculated the operating loss considering the actual payment of technical know-how fees instead of only the depreciation as claimed by the assessee, that therefore, the working profit calculated by the assessee was not correct and that the arm’s length price calculated was short by Rs. 116.20 crores and hence such amount had escaped assessment within the meaning of section 147. The assessee filed objections to the reopening. Before the objections were disposed of, various further notices were issued.

The assessee filed a writ petition and challenged the reopening. An ad interim stay was granted till the next date of hearing. However, when the stay did not get extended, reassessment was completed, and an order was passed pursuant to the order passed by the Transfer Pricing Officer on a reference made u/s 92CA(1). The Bombay High Court allowed the writ petition and held as under:

“i) The reasons recorded for reopening were based on a change of opinion which was not permissible. The proviso to section 147 applied and the Assessing Officer had to make out a case that income chargeable to tax had escaped assessment by reason of the failure on the part of the assessee to disclose fully and truly all material facts necessary for its assessment. The reasons recorded did not indicate which were those material facts that the assessee had failed to truly and fully disclose.

ii) The assessee had in its annual report mentioned the technical know-how fee, royalty and technical assistance fee that it had paid and had also filed form 3CEB in which it had disclosed the details and description of the international transactions in respect of technical know-how and patents and regarding the royalty paid and lump-sum fees paid for the technical services. Before the original order was passed u/s. 92CA(3), the Transfer Pricing Officer also had raised all these queries and had considered the royalty, technical know-how fees paid. The assessee had not only filed its account books and other evidence but those had been considered by the Transfer Pricing Officer whose order also had been considered by the Assessing Officer while passing the original order u/s. 143(3). Therefore, there could be nothing which had not been truly and fully disclosed.

iii) The contention of the Department that Explanation 1 to section 147 provided that production before the Assessing Officer of account books or other evidence from which material evidence could with due diligence should have been discovered by the Assessing Officer was no defence, was not tenable. The notice issued u/s. 148 and the reassessment order were quashed and set aside.”

Non-resident — Income deemed to accrue or arise in India — Royalty — Meaning of “royalty” — Transfer authorising transferee to use licensed software — No transfer of copyright — Amount received cannot be termed royalty

5 EY Global Services Ltd. vs. ACIT
[2022] 441 ITR 54 (Del)
Date of order: 9th December, 2021
S. 9 of ITA, 1961

Non-resident — Income deemed to accrue or arise in India — Royalty — Meaning of “royalty” — Transfer authorising transferee to use licensed software — No transfer of copyright — Amount received cannot be termed royalty

EYGBS was an Indian company that provided back-office support and data processing services. It entered into an agreement with the EYGSL (UK) whereby it received ‘right to benefit from the deliverables and/or services’ from the UK company. The Authority for Advance Rulings held that the amount received was assessable as royalty in India.

The assessee company filed a writ petition and challenged the ruling. The Delhi High Court allowed the writ petition and held as under:

“a) In Engg. Analysis Centre of Excellence P. Ltd. vs. CIT [2021] 432 ITR 471 (SC), the Supreme Court observed that the definition of royalty that is contained in Explanation 2 to section 9(1)(vi) of the Income-tax Act, 1961 would make it clear that there has to be a transfer of “all or any rights” which includes the grant of a licence in respect of any copyright in a literary work. The expression “including the granting of a licence” in clause (v) of Explanation 2 to section 9(1)(vi) of the Act, would necessarily mean a licence in which transfer is made of an interest in rights “in respect of” copyright, namely, that there is a parting with of an interest in any of the rights mentioned in section 14(b) read with section 14(a) of the Copyright Act, 1957.

(i) Copyright is an exclusive right, which is negative in nature, being a right to restrict others from doing certain acts.

(ii) Copyright is an intangible, incorporeal right, in the nature of a privilege, which is quite independent of any material substance. Ownership of copyright in a work is different from the ownership of the physical material in which the copyrighted work may happen to be embodied. An obvious example is the purchaser of a book or a CD/DVD, who becomes the owner of the physical article, but does not become the owner of the copyright inherent in the work, such copyright remaining exclusively with the owner.

(iii) Parting with copyright entails parting with the right to do any of the acts mentioned in section 14 of the Copyright Act. The transfer of the material substance does not, of itself, serve to transfer the copyright therein. The transfer of the ownership of the physical substance, in which copyright subsists, gives the purchaser the right to do with it whatever he pleases, except the right to reproduce the same and issue it to the public, unless such copies are already in circulation, and the other acts mentioned in section 14 of the Copyright Act.

(iv) A licence from a copyright owner, conferring no proprietary interest on the licensee, does not entail parting with any copyright, and is different from a licence issued under section 30 of the Copyright Act, which is a licence which grants the licensee an interest in the rights mentioned in section 14(a) and 14(b) of the Copyright Act. Where the core of a transaction is to authorize the end-user to have access to and make use of the “licensed” computer software product over which the licensee has no exclusive rights, no copyright is parted with and consequently, no infringement takes place, as is recognized by section 52(1)(aa) of the Copyright Act. It makes no difference whether the end-user is enabled to use computer software that is customised to its specifications or otherwise.

(v) A non-exclusive, non-transferable licence, merely enabling the use of a copyrighted product, is in the nature of restrictive conditions which are ancillary to such use, and cannot be construed as a licence to enjoy all or any of the enumerated rights mentioned in section 14 of the Copyright Act, or create any interest in any such rights so as to attract section 30 of the Copyright Act.

(vi) The right to reproduce and the right to use computer software are distinct and separate rights.

b) For the payment received by the UK company from EYGBS to be taxed as “royalty”, it is essential to show a transfer of copyright in the software to do any of the acts mentioned in section 14 of the Copyright Act, 1957. A licence conferring no proprietary interest on the licensee, does not entail parting with the copyright. Where the core of a transaction is to authorise the end-user to have access to and make use of the licenced software over which the licensee has no exclusive rights, no copyright is parted with and therefore, the payment received cannot be termed as “royalty”.

c) EYGBS, in terms of the service agreement and the memorandum of understanding, merely received the right to use the software procured by the UK company from third-party vendors. The consideration paid for the use thereof therefore, could not be termed “royalty”. The rights acquired by the UK company from the third-party software vendors were not relevant. What was relevant was the agreement between the UK company and EYGBS. As the agreement did not create any right to transfer the copyright in the software, the payment would not fall within the ambit of the term “royalty”.

Income — Income or capital — Investment of funds before commencement of operation in fixed deposits and mutual funds as per directive of Government — Income generated to be utilised for purposes of business of company — Income not revenue receipt

4 ClT vs. Bangalore Metro Rail Corporation Ltd.
[2022] 441 ITR 113 (Kar)
A.Ys: 2007-08 and 2008-09;
Date of order: 23rd November, 2021
S. 4 of ITA, 1961

Income — Income or capital — Investment of funds before commencement of operation in fixed deposits and mutual funds as per directive of Government — Income generated to be utilised for purposes of business of company — Income not revenue receipt

The assessee was a company incorporated under the Companies Act, 1956 and was a wholly-owned undertaking of the Government of Karnataka. It was established with the approval of Government of India to implement a rail-based mass rapid transit system in five years in five stages. The project’s cost was to be financed by both the Union and the State Governments. The assessee had received funds during the A.Y. 2007-08 which were not immediately required for execution of the project and these were invested in fixed deposits and mutual funds. As a result, interest and dividends were received. The assessee contended that the dividend income on mutual funds received from State Bank of India and Unit Trust of India was exempt u/s 10(35) of the Income-tax Act, 1961. Apart from this, the assessee also claimed a short-term loss of Rs. 5,02,05,005 arising out of redemption of units with a mutual fund. The Assessing Officer rejecting the contention of the assessee and brought the income of Rs. 10,30,48,755 that was earned by the company through deposits to tax.

The Tribunal held that the amount was not taxable.

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

“It was apparent that the unutilized funds of the project, before the commencement of the functional operation of the project, was invested by the assessee in fixed deposits and mutual funds as per the directions of the Government. A perusal of the Government order dated 25th March, 2008, it was clear that the income generated out of earlier release of State Government for its project would have to be converted into State’s equity towards the project and could not be counted as income of the assessee. Thus, there was no profit motive as the entire funds entrusted and the interest accrued therefrom had to be utilized only for the purpose of the scheme. Thus, it had to be capitalized and could not be considered as revenue receipts.”

Charitable purpose — Exemption u/s 11:- (i) Charitable institution engaged in imparting education — Effect of proviso to s. 2(15) and CBDT circular No. 11 of 2008 [1] — Surplus income generated by educational activities — Would not affect entitlement to exemption u/s 11; (ii) Effect of s. 13 — Disqualification for exemption — Charitable institution running educational institution — Alleged excess of remuneration to employees — Revenue has no power to interfere — Exemption could not be denied

3 CIT(Exemption) vs. Krupanidhi Education Trust
[2022] 441 ITR 154 (Kar)
A.Ys.: 2009-10 and 2010-11;
Date of order: 20th September, 2021
Ss. 2(15), 11 & 13 of ITA, 1961

Charitable purpose — Exemption u/s 11:- (i) Charitable institution engaged in imparting education — Effect of proviso to s. 2(15) and CBDT circular No. 11 of 2008 [1] — Surplus income generated by educational activities — Would not affect entitlement to exemption u/s 11; (ii) Effect of s. 13 — Disqualification for exemption — Charitable institution running educational institution — Alleged excess of remuneration to employees — Revenue has no power to interfere — Exemption could not be denied

The assessee-trust ran various institutions in Bangalore offering degrees and training in various academic courses and was granted registration u/s 12A of the Income-tax Act, 1961. The Assessing Officer held that the assessee had violated the provisions of section 13(1)(c) of the Act and therefore, the assessee was not entitled to claim exemption u/s 11, 12 and 13 of the Act. The two trustees were being paid remuneration or salary not proportionate to the pay scales of a professor and administrative officer, respectively. The Assessing Officer completed the assessment for the A.Ys. 2009-10 and 2010-11 u/s 143(3) of the Act by order dated 30th December, 2011 denying the exemption u/s 11 of the Act and making certain additions.

The Commissioner (Appeals) and the Tribunal held that the assessee was entitled to exemption.

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

“i) Under Circular No. 11 of 2008 dated 19th December, 2008 ([2009] 308 ITR (St.) 5) issued by the CBDT having regard to the proviso inserted to section 2(15) amended by the Finance Act, 2008 wherein, it has been clarified that the newly inserted proviso to section 2(15) will not apply in respect of the first three limbs of section 2(15), i. e., relief of the poor, education and medical relief. Consequently, where the object of trust or institution is relief to the poor, education or medical relief, it will constitute “charitable purpose” even if it incidentally involves in carrying of commercial activities.

ii) The Revenue cannot sit in the armchair of an assessee and decide the pattern of working, methodology to be adopted for administration of an educational trust including the payment structure of salary or remuneration to be paid to the professors or administrative staff. In other words, the Department cannot manage or control the managerial affairs of the educational trust. These aspects would not come within the purview of the authorities to decide the Income-tax liability merely on suspicion that the assessee is claiming huge expenditure to get the corresponding benefits of allowable deductions.

iii) The Assessing Officer merely on surmises and conjectures had come to the conclusion that the salary and remuneration paid to the two trustees was highly excessive and not proportionate to the services rendered by them. The Department cannot regulate the management of the assessee-trust. Indeed, the salary or remuneration paid to the trustees were duly accounted and reflected in their returns as income. Merely on imagination, exemption u/s. 11 of the Act could not be denied.

iv) Hence, the substantial question of law deserves to be answered against the Revenue and in favour of the assessee.”

Business expenditure — Disallowance — Expenses prohibited in law — CBDT Circular No. 5 dated 1st August, 2012 disallowing expenses in providing free gifts or facilities to medical practitioners by pharmaceutical and allied health sector industry — Circular not applicable retrospectively — Expenses deductible for earlier years

2 Principal CIT vs. Goldline Pharmaceuticals Pvt. Ltd.
[2022] 441 ITR 543 (Bom)
A.Y.: 2010-11; Date of order: 14th January, 2022
S. 37(1) of ITA, 1961

Business expenditure — Disallowance — Expenses prohibited in law — CBDT Circular No. 5 dated 1st August, 2012 disallowing expenses in providing free gifts or facilities to medical practitioners by pharmaceutical and allied health sector industry — Circular not applicable retrospectively — Expenses deductible for earlier years

The assessee manufactured and traded in medicines. For the A.Y. 2010-11, the assessee claimed deduction u/s 37 of the Income-tax Act of expenditure incurred towards tour and travel expenses of medical practitioners to enable them to attend conferences held in different parts of the world. The Assessing Officer applied CBDT Circular No. 5 of 2012 and disallowed proportionate expenditure.

The Tribunal allowed the assessee’s claim and held that the disallowance of expenditure on the basis of Board’s Circular No. 5 of 2012, dated 1st August, 2012 was without merit.

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

“i) Under the Indian Medical Council (Professional Conduct, Etiquette and Ethics) Regulations, 2002 as amended on 10th December, 2009 the Medical Council of India imposed a prohibition on medical practitioners and their professional associations from taking any gift, travel facility, hospitality, cash or monetary grant from pharmaceutical and allied health sector industries. According to Circular No. 5 of 2012, dated 1st August, 2012 ([2012] 346 ITR (St.) 95) issued by the CBDT claim of any expense incurred in providing the aforesaid or similar freebees in violation of the provisions of the said regulations were held inadmissible u/s. 37(1) of the Income-tax Act, 1961 being an expense prohibited in law. It was further stated that such disallowance would be made in the hands of such pharmaceutical or allied health sector industries or other assessee which had provided such freebees.

ii) The Board’s Circular No. 5 of 2012, dated 1st August, 2012 could not have been applied retrospectively to the A.Y. 2010-11. The circular imposed a new kind of imparity and therefore, the Tribunal had consistently held that the Board’s Circular No. 5 of 2012 would not have any retrospective effect but would operate prospectively from 1st August, 2012. These decisions of the Tribunal were not assailed before the High Court. The Tribunal was justified in deleting the disallowance and its order need not be interfered with.”

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.