BCAJ | Bombay Chartered Accountant Journal

I S. 2(47), 54EC- Transfer of shares is completed only on final delivery of shares and upon all covenants of the share purchase agreement becoming finally irrevocable and not on the date of execution of the share purchase agreement.

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46 2009-TIOL- 789-ITAT- MUM

Mrs. Hami Aspi Balsara vs ACIT

ITA No. 6402/Mum/2008

Assessment Year: 2005-06.
Date of Order: 22.5.2009

I S. 2(47), 54EC- Transfer of
shares is completed only on final delivery of shares and upon all covenants of
the share purchase agreement becoming finally irrevocable and not on the date of
execution of the share purchase agreement.

II Ss. 28(va), 55(2)(a)- Section
28(va) would be attracted where the assessee was carrying on business and not
where the assessee only had right to carry on business in the form of capital
asset— Where capital asset is in the nature of right to carry on business, then
the consideration for non-compete will come within the ambit of capital gains
tax.

Fact I:

The assessee, on 27.1.2005, entered into an agreement for the
sale of shares held by the assessee and other persons in three companies viz.
Balsara Home Products Ltd., Balsara Hygiene Products Ltd. and Besta Cosmetics
Ltd. (i.e. target companies) to Dabur India Ltd. (the buyer). A sum of Rs
10,65,06,753 was received by the assessee on 28.1.2005. As per the terms of the
share purchase agreement, the transfer of shares was effective from 1.4.2005.
The assessee regarded 1.4.2005 to be the date of transfer, and investments
qualifying for exemption u/s 54EC were made within a period of six months from
1.4.2005.

The Assessing Officer (AO) held that since various covenants
in the share purchase agreement resulted in substantial extinguishment of the
rights of the assessee in the target company, and also since the sale
consideration was not refundable to the assessee, the transfer of shares had
taken place on 27.1.2005, it being the date of the share purchase agreement. He
taxed capital gains in the assessment year 2005-06. He also held that the
investment had not been made within six months from the date of transfer and,
therefore, denied exemption u/s 54EC.

Aggrieved, the assessee preferred an appeal to CIT(A) who
confirmed the action of the AO.

Aggrieved, the assessee preferred an appeal to the Tribunal.

Fact II:

The sale consideration for shares of companies having
Intellectual Property Rights, was in excess of the book value of the shares.
Since the share purchase agreement had a non-compete covenant and no specific
consideration was assigned to it, the AO considered the difference between the
sale consideration for the transfer of shares and the book value of the shares —
which was approximately 80% of the sale consideration — to be the consideration
for non-compete, and charged it to tax u/s 28(va).

The CIT(A) confirmed the action of the AO.

Aggrieved, the assessee preferred an appeal to the Tribunal.

Held I:

(i) `Sale’, as contemplated u/s 2(47)(i), and
extinguishment of rights, as contemplated u/s 2(47)(ii), are not mutually
interchangeable. If a particular transaction is a transaction of sale, then,
unless the sale is complete, no transfer can be said to have taken place;
because there will always be extinguishment of rights in the case of a sale —
and if a single right out of the entire bundle of the property in a capital
asset is extinguished, then, the transfer would be complete. This will lead to
an absurd situation.

(ii) A case of sale and that of extinguishment of rights
are mutually exclusive. It could not be said that there was extinguishment of
rights on 27.1.2005 because extinguishment of rights implies that the right
cannot be revived. However, till the time the right is revocable, it could not
be said that there was extinguishment of rights. At best it can be said to be
a case of suspension of rights till all the requirements for completing the
sale were over. It was only on execution of the second amendment to the share
purchase agreement on 1.4.2005 that the Escrow Agreement and the power of
attorney became incapable of being revoked, modified or altered unilaterally
by the sellers. Therefore, prior to this date, the sellers had the right to
revoke the share purchase agreement.

(iii) Clause (c) of Section 372A of the Companies Act, 1956
mandates that a company cannot acquire by way of subscription, purchase or
otherwise the securities of any other corporate body, unless previously
authorized by a special resolution passed in a general meeting. This special
resolution was passed by Dabur India Ltd. on 28.3.2005. Therefore, in any
case, prior to this date, it cannot be said that the shares of the assessee
were acquired by Dabur India Ltd.

(iv) The definition of the term `sale’ as per the Sale of
Goods Act assumes importance since this term is not defined in the Income-tax
Act. On a reading of S. 4 of the Sale of Goods Act, it becomes evident that an
agreement to sell becomes complete when the conditions contemplated in the
agreement are fulfilled.

(v) S. 65 of the Indian Contract and Specific Relief Act
makes it very clear that if, for any reason, the terms of a contract cannot be
fulfilled, then the assessee is bound to restore the benefits she had
received, including the consideration to the purchaser.

(vi) The decision of the Amritsar Bench of ITAT, in the
case of Maxtelcon Ventures Ltd. (301 ITR (AT) 90), was rendered with reference
to K N Narayanan (145 ITR 373)(Ker) without considering the subsequent
decision of the same High Court in the case of 203 ITR 663.

Nirav Shah

S. 45, S. 48 and S. 55(2) — Assessee, CHS, owned land and building — Upon enactment of DCR, assessee became entitled to additional FSI which was transferred for consideration — Is right transferred covered by S. 55(2) — Held, No. Whether since right trans

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Part B — Unreported Decisions

(Full texts of the following Tribunal decisions are available
at the Society’s office on written request. For members desiring that the
Society mails a copy to them, Rs.30 per decision will be charged for
photocopying and postage.)

24 New Shailaja CHS Limited
v. ITO, 22(1)(4)

ITAT ‘B’ Bench, Mumbai

Before R. S. Syal (AM) and

V. Durga Rao (JM)

ITA No. 512/Mum./2007

A.Y. : 2003-04. Decided on : 2-12-2008

Counsel for assessee/revenue : Tarun Ghia/

Pitamber Das

S. 45, S. 48 and S. 55(2) of the Income-tax Act, 1961 (‘the
Act’) — A.Y. 2003-04 — Assessee, a co-operative housing society, owned land and
building — Upon enactment of Development Control Regulations, 1991 (DCR), the
assessee became entitled to additional FSI of around 11,000 sq.ft. which
additional FSI was transferred by the assessee for a consideration of
Rs.48,96,225 — Is the right transferred covered by any of the items mentioned in
S. 55(2) of the Act — Held, No. Whether since the right transferred emanated
from amendment to DCR and is not covered by any of the items of S. 55(2) and
does not have any cost of acquisition no capital gain can be charged on transfer
of additional FSI — Held, Yes.

Per R. S. Syal :

Facts :

The assessee, a co-operative housing society, had acquired
land in the year 1972 along with building thereon constructed by use of FSI of
approx. 11,000 sq.ft. Upon enactment of Development Control Regulations, 1991
(DCR) the assessee became entitled to an additional FSI of around 11,000 sq. ft.
The assessee sold such entitlement/right to M/s. D. K. Builders for a
consideration of Rs.48,96,225. The Assessing Officer (AO) computed capital gain
arising on sale of this entitlement to be Rs.1.22 crores, by considering the
value of residential flat as arrived at by stamp valuation authorities. The
assessee preferred an appeal to the CIT(A) who dismissed the same. Aggrieved,
the assessee preferred an appeal to the Tribunal.

Held :

The Tribunal noted that the concept of transferable
development right has been introduced in Mumbai in the Development Control
Rules, 1991 of the Bombay Municipal Corporation. These rights are given in the
form of a Development Right Certificate (DRC) which is issued by the Municipal
Corporation. TDR means the development potential. The FSI of a plot of land is
separated from the plot and is allowed to be transferred. TDR can be used by the
person/ owner/lessee in whose favour it is granted on his land in the receiving
zone. He can use it fully or partly or sell it fully or partly at will. The
Tribunal stated that while it is true that such right is a capital asset as per
the provisions of S. 2(14) but in order to compute capital gain, apart from the
existence of capital asset there should be sale consideration accruing as a
result of the transfer of capital asset as well as the cost of acquisition of
the asset along with the cost of improvement, if any. The Tribunal observed that
the cost of land and the existing building structure could not be attributed in
the additional FSI received by means of 1991 rules since the assessee was the
owner of the land and building and continued to remain the same even after the
transfer of the said capital asset. The Tribunal noted that the Apex Court has
in B. C. Srinivasa Shetty’s case held that transfer of capital asset which does
not have any cost of acquisition does not result into capital gain chargeable
u/s.45. The Tribunal held that there is a difference in the situation when cost
of acquisition is Rs.Nil and where the cost of acquisition cannot be ascertained
or no cost of acquisition has been incurred. The Tribunal noted that the items
of capital assets specified in S. 55(2) are those for which the cost of
acquisition shall be taken to be Nil for computing capital gain. It held that if
the assessee had not incurred any cost of acquisition on a capital asset and
such capital asset does not fall in the category of the capital assets specified
in S. 55(2), then the judgment of the Apex Court in the case of B. C. Srinivasa
Shetty shall apply and no capital gains shall be charged. In the light of the
above, the Tribunal held that the right transferred emanated from the 1991 rules
making the assessee eligible to additional FSI. The right transferred is not
covered by any of the items mentioned in S. 55(2) and it does not have any cost
of acquisition and therefore no capital gain can be charged on transfer of
additional FSI for sale consideration of Rs.48.06 lakhs for the reason that it
has no cost of acquisition. It held that its view is fortified by the decision
of the Mumbai Bench in Jethalal D. Mehta, which decision has not been modified
or reversed by the Hon’ble High Court.

Cases referred to :

(1) Jethalal D. Mehta v. DCIT, (ITA No. 672/Mum./2000)
(Mum.)

(2) CIT v. B. C. Srinivasa Shetty, (1981) 128 ITR 294 (SC)

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Nirav Shah

Establishment of Branch Office (BO) / Liaison Office (LO) in India by Foreign Entities – Eligibility Criteria and Procedural Guidelines

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Part C:
FEMA

Given below are the highlights of certain RBI
circulars, press notes and notifications

33 A. P. (DIR Series) Circular No. 23, dated December
30, 2009

Establishment of Branch Office (BO) / Liaison
Office (LO) in India by Foreign Entities – Eligibility Criteria and Procedural
Guidelines

This circular places in public domain the
eligibility criteria and procedural guidelines for the establishment of Branch
Offices and Liaison Offices by foreign entities in India.

The broad criteria regarding eligibility for
opening of BO and LO, documents required, etc., are given in Annex A. The scope
of activities permitted and other procedural guidelines (additional offices /
activities, renewal, closure) are given in Annex B.

Application for establishing a BO/LO has to be made
to designated AD Category – I Bank in Form FNC given in Annex C. The same, along
with the relevant documents, will be submitted by the Bank to the RBI. However,
applications from foreign banks and insurance companies will continue to be
received directly by the RBI. Comfort letter to be given by applicants who do
not satisfy the eligibility criteria and are subsidiaries of other companies is
given in Annex D.

All BO and LO (new as well as existing) will be
allotted a Unique Identification Number which needs to be quoted in all
references to RBI.

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Nirav Shah

Part B: Some recent judgements

Service Tax

I. High Court :

Renting of Immovable property service :

Constitutional validity of levy of service tax on commercial
renting and retrospective amendment, w.e.f., 1-6-2007.

Shubh Timb Steels
Limited v. Union of India, 2010 (20) STR 737 (P & H)

The petitioner, owner of commercial immovable property, let
it out to business entities on rental basis. The petitioner challenged the levy
of service tax on renting of immovable property covered u/s.65(90a) and S.
(65)(105)(zzzz) of the Finance Act, 1994 and its retrospective amendment under
the said category as ultra vires the legislative competence of the Parliament.
The gist of contentions of the petitioner was that the matter of levy of service
tax on providing service of renting of immovable property was covered by Entry
49 of List II and not by Entry 92C or 97 of List I, and retrospective levy was
beyond legislative competence. Further, the transfer of property without any
value addition by way of service could not be covered by the levy of service tax
as renting of a building was a transaction of land & building covered by Entries
18, 45 and 49 of List II in respect of which exclusive jurisdiction to legislate
under Article 246(3) was vested in the State Legislature. Leasing was a transfer
of rights and not a service and was, therefore, not covered by Entry 92C of List
I. Reliance was placed on the decision of the Delhi High Court in the case of
Home Solution Retail India Limited v. Union of India and Others, 2009 (14) STR
433 (Del.), wherein it was held that service was to be provided in relation to
the renting of property and the property by itself could not be regarded as
service as it did not involve any value addition. As against this, the Revenue
contended that under Article 246(1), the Parliament had exclusive power to make
laws in respect of matters covered under List I including residue entry and that
the amendment with retrospective effect was only clarificatory in nature, such
levy was already provided under unamended provisions. The scope of Entry 49 List
II was limited to direct tax on property and not on activity in relation to
property. In any case, Entry 49 List II had to be read subject to Entries 92C
and 97 of List I. It was further argued that the judgment of the Delhi High
Court [Home Solution Retail India Ltd. v. Union of India and Others (supra)] did
not involve the issue of validity of the levy but involved question of validity
of the Notification and the Circular to recover service tax from the lessors of
property on the proceeds of renting out of property. The retrospective amendment
made the renting of immovable property itself a service covered by the
definition of taxable service.

The Court held as follows:

Service tax is a destination-based consumption tax being not a charge on business but on consumer and is leviable on service provided, hence, is a value added tax. Such service can be property-based or performance-based.

In case of overlapping, the doctrine of pith and substance is to be applied and the Court has to look at the substance of the matter. List I has priority over List II, though predominance of List I does not prevent the State Legislature from dealing matters under List II.

Considering various judgments it was observed that Entry 49 of List II relates only to tax on land and buildings and not any activity relating thereto. It cannot be held that renting of property did not involve any service as service could only be in relation to property and not by renting of property.

The aspect of service element in renting transaction is an independent aspect covered under Entry 92C read with Entry 97 of List I. The subject-matter of impugned levy being outside the scope of Entry 49 of List II, power of the Union Legislature is undoubted.

As regards the retrospective amendment, the High Court observed that the object of validating law is to rectify the defect in phraseology or lacuna and to effectuate and to carry out the object for which the earlier law was enacted.

Based on the above, the petition was dismissed holding that renting of immovable property for commercial purposes is a service having a value for the service receiver and therefore, service tax is leviable on the renting of immovable property as being covered under Entry 92C read with Entry 97 of List I on the value of taxable services referred to in S. 65(105)(zzzz) read with S. 65(90a) of the Finance Act, 1994. Further, the retrospective amendment retrospectively with effect from 1-6-2007 was also upheld.

II. Tribunal:

2. CENVAT credit:

(a) Can CENVAT credit be availed on the strength of debit notes?

Godrej Consumer Products Ltd. v. Commissioner of C.Ex., Indore, 2010 (20) STR 609 (Tri.-Delhi)

The appellants took CENVAT credit of Rs.7,327 based on debit notes and the credit was denied. Penalty of Rs.20,000 was imposed on the appellants for wrong availment of credit.

Rule 9(1) of the CENVAT Credit Rules, 2004 mentions the documents on the basis of which CENVAT credit can be availed. Such documents are invoice, challans, supplementary invoice and bills of entry. Therefore credit was denied by the departmental authorities considering debit notes as ineligible document for availing CENVAT credit. Rule 15 of the CENVAT Credit Rules, 2004 prescribes penalty for wrong availment of CENVAT credit at Rs.2,000 or amount of service tax, whichever is higher, at the discretion of the authority. The appellant was levied penalty of Rs.20,000 and no finding was given for levying such penalty. Considering the amount of penalty arbitrary, it was reduced to Rs.2,000 and as such the appeal was partially allowed.

(b) Can CENVAT credit be taken on service tax paid on repair and maintenance service for residential staff colony?

Commissioner of C. Ex., Trichy v. Madras Cements Ltd., 2010 (20) STR 672 (Tri.-Chennai)

The respondents paid service tax on repair and maintenance service for residential staff colony of workers. It was held that nexus is required between the services and the manufacture or clearance of excisable goods before the benefit of CENVAT credit could be taken in respect of such services. The assessees failed to establish any such nexus between the services which were considered by them to be input services and therefore, benefit of CENVAT credit was not allowed.

(c) Whether CENVAT credit of telephone installed in residential premises of chief executive and CHA service for clearance of import and export goods is allowable?

Mileen Engineers v. Commissioner of C. Ex., Mumbai-III, 2010 (20) STR 668 (Tri.-Mumbai)

The appellants availed the facility of CENVAT credit of duty paid on the inputs as well as service tax paid on the services of CHA and the telephone installed in the residential premises of the Chief Executive. The same was denied by the lower authorities as per the CENVAT Credit Rules, 2004. The Tribunal allowed CENVAT credit on CHA service but denied in case of telephone installed in the residential premises and held that credit is admissible only in case of exclusive use of telephone for business purpose.

3. Export of service:

Whether services for procuring purchase orders in India for foreign suppliers satisfy conditions under Export of Services Rules, 2005?

Em Jay Engineers v. Commissioner of Central Excise, Mumbai, 2010 (20) STR 821 (Tri.-Mumbai)

The appellant filed a refund claim of Rs.6,71,439 on the ground that their activities are considered as export of service and exempted from payment of service tax. After scrutiny of the claim, a show-cause notice was issued and the Adjudicating Authority sanctioned the refund claim partially rejecting an amount of Rs.1,40,268 on the ground that the claim was not admissible as per Notification 2/2007-ST.

This Notification provided that the two conditions needed to be fulfilled for considering any taxable service as export of service, viz.: service is provided from India and used outside India, and payment for such service provided outside India is received by the service provider in convertible foreign exchange. The appellant received commission from their foreign principal in foreign currency for introducing the Indian clients to the foreign suppliers. The foreign principal used these services outside India and exported those goods to the buyers in India and directly collected payments from the buyers. The appellants were not required to pay service tax and were entitled for refund. The appellant claimed rebate of service tax under Rule 5 of the Export of Service Rules, 2005. It was held that refund was allowable.

4. Input service:

In respect of overseas commission paid, whether input service has connection with manufacture or sale?

Commissioner of C. Ex., Jalandhar v. Ambika Forgings, 2010 (20) STR 662 (Tri.-Delhi)

A manufacturer sold the goods to foreign buyers and paid commission to overseas parties. This commission was considered by the assessee as ‘input service’. The question that arose is whether the commission had nexus with manufacture or sale. Credit was denied relying on the meaning of ‘promotion’ as in the dictionary. As per Rule 2(l)(ii) of the CENVAT Credit Rules, broad activities which are having nexus to business and are integrally connected to business fall under the definition of ‘input service’. It was observed that once legislative mandate is apparent, no technical meaning need to be assigned to deny credit. As per common business parlance, business promotion adds to revenue of the seller/manufacturer. If business promotion adds to the revenue, it would have nexus with the sale activities. Therefore, the respondent would take credit of input service on overseas commission paid and excise duty payable on manufacturing activity. The case of the Department was thus dismissed and the manufacturer was allowed credit.

5. Principle of natural justice:

Is it justified to deny CENVAT credit to the assessee when documents relied upon while denying the credit were not made available to the assessee by the Authority?

Idea Mobile Communication Ltd. v. Commissioner of C.Ex., Meerut-I, 2010 (20) STR 775 (Tri.-Delhi)

Rule 9(2) of the ‘CCR’, provides discretion to the adjudication authority to give concession to the assessee in relation to procedural irregularity regarding maintenance of documents, on the basis of which CENVAT credit can be availed. In the instant case even before ascertaining the liability of the assessee and applying its mind, the authority arrived at final conclusion and passed the order denying credit. The matter was remanded to the Adjudicating Authority for fresh decision. The assessee produced all original invoices for verification before the Authority. However, the Revenue failed to take notice of the same and no reply was issued to the letter addressed to the Superintendent. The Adjudicating Authority relied on certain documents which the assessee was not aware of. It was held that the principle of natural justice was denied to the assessee as the document on which the order relied upon were not disclosed to the assessee. The Tribunal allowed the appeal and remanded the case back to the lower authority for fresh adjudication.

6. Penalty:

(a) Whether penalty can be imposed in case there is ignorance for payment of tax

Sri Krishna Smelters Ltd. v. Commissioner of Central Excise, Salem, 2010 (20) STR 780 (Tri.-Chennai)

The assessee was held for non-payment of service tax and penalty was imposed u/s.78 of the Finance Act, 1994 and contended that the assessee cannot be held responsible for non -payment of service tax as there was no intention to evade payment of tax, as the entire amount of tax was available by way of credit. It was further held that S. 78 was invoked on the ground that the assessee failed to file the returns. The Tribunal held that failure to file returns was not sufficient to hold the assessee guilty of suppression and considering that the entire amount of tax was available as credit, there was no intention to evade payment of tax. Hence, the penalty imposed u/s.78 was set aside.

(b) Whether penalty can be imposed u/s.76 and u/s.78 if service tax has been paid along with interest willingly?

Idial Security Organisation v. Commissioner of S.T., Ahmedabad, 2010 (20) STR 787 (Tri.-Ahmd.)

The appellant was providing security agency services. Penalties under various Sections of the Finance Act, 1994 were also imposed. On coming to know of the liability, immediately full amount of service tax along with interest was deposited. The appellant did not pay the service tax only because he was not aware of the law. It was a one -man show and he had not collected service tax from the customers. Even though it can be said that ignorance of law cannot be an excuse, it is one of the factors while considering imposition of penalty. Considering this a fit case for waiver of penalty, S. 80 of the Finance Act, 1994 was extended and the appeal was allowed.

(c) Whether penalty is imposable in case of ad-justment of excess tax of a particular month in subsequent months?

Chettinad Cement Corporation Ltd. v. Commissioner of Central Excise, Trichy, 2010 (20) STR 815 (Tri.-Chennai)

The appellant intended to adjust excess service tax paid for the month of March towards subsequent month’s liability. This not being a case of delayed payment of service tax or failure to pay service tax and in way it could be said to be tax paid in advance, it was held that the assessee could not be penalised u/s.76 of the Finance Act, 1994 which is applicable in case of failure to pay tax. However, u/s.77, penalty of Rs.1000 was imposed and the appeal was allowed.

7. Valuation : Sales tax paid on materials:

A. N. Palaniappan v. Commissioner of Central Excise, Trichy, 2010 (20) STR 781 (Tri.-Chennai)

Materials consumed during the course of carrying out the activity of retreading of tyres under the service head ‘Maintenance and Repair Services’ could take benefit of Notification No. 12/2003-ST, dated 20 -6-2003. As per this Notification, so much of the value of taxable services, which is equal to the value of goods and materials sold by the service provider to the service recipient, is exempted from payment of service tax. In the instant case, the assessee was paying sales tax on the materials consumed and hence, the order levying service tax on such material component was set aside.

Nirav Shah

Real Estate Laws: Recent Developments-I

LawsI. Introduction

Can an LLP be an SEZ Developer under the Special Economic
Zone Act, 2005 ? S. 2(g) of this Act defines the term developer to mean a person
who has been granted a letter of approval. S. 2(v) of the Act defines a person
to include a company, a firm, an association of persons or body of individuals,
whether incorporated or not. An LLP is none of the above but it is a ‘body
corporate’. Again an amendment to the SEZ Act would be highly desirable to
accommodate LLPs.

II. Collector’s NOC

2.1 Some years ago, the collector woke up from slumber and
started demanding that sale of all apartments /offices situated in buildings
constructed on land leased by the collector, should be done only after obtaining
a prior ‘No Objection Certificate’ from him. It went without saying that this
NOC was given only after payment of the ‘Collector’s Charges’ which were based
on the area of the property transferred. Thus, an NOC was required for
transferring a flat on any of the collector’s lands, e.g., at Nariman Point,
Cuffe Parade, etc., and this was proving to be a hurdle for several property
transactions.

2.2 A few months ago, the Revenue and Forest Department
issued a circular which simplified the process of conveyance of immoveable
properties in the state. It stated that it is possible to register a property
without waiting for a no-objection certificate from the various authorities,
e.g., the collector, etc.

2.3 However, the collector’s circular was still valid and
subsisting. A recent Bombay High Court decision in the case of Mr. Aspi Chinoy v
State of Maharashtra, Writ Petition No. 713 of 2001, has quashed the impugned
circular of the collector. The court held that the state government does not
have the right to ask the petitioner to seek its prior approval before entering
into the transaction. Therefore, it does not have any power to demand any
premium before transferring the flat. The petition is allowed. Hence, no
permission, either of the state government or of the collector, is necessary. In
this case, the petitioner had paid the premium which had been demanded.
Accordingly, the amount of the premium was refunded with interest at the rate of
8% per annum from the date of deposit till refund, and payment was to be made
within a period of two weeks from the date of disposal of the writ petition.
This is a very good decision by the Bombay High Court. The court order does not
specify what happens to other flat owners who also have paid such premium; would
their premiums, collected by the collector, also be refunded?

III. Redevelopment of Housing Societies

3.1 A single judge of the Bombay High Court, in a very recent
decision delivered on 5th December, 2009, in the case of Acknur Constructions P
Ltd v Sweety Rajendra Agarwal & Others, Suit 1404 of 2009, held that even if one
member of a co-operative housing society objects to a redevelopment, then the
redevelopment would be stalled. In this case, a majority of the flat owners had
assented to the redevelopment but a small minority had objected to the same.
Actually, four out of its twelve members had objected to the development on
grounds that the redevelopment was not in the society’s interest. The developer
went to court seeking a stay on the objections of the minority and permission to
continue with the redevelopment work.

3.2 The High Court refused to permit the developer to
continue with the work. According to the court, the builder had failed to make
out a prima facie case that he could remove members or that the agreement was
binding on all members. Further, the developer has no higher right than that of
the society. It held that the activity should not compromise the rights of the
members and must always safeguard the existence of the society. It held that it
was difficult to contend that a minority in number cannot obstruct the
implementation of the development agreement. It also held that the co-operative
society movement is a socio-economic and moral movement to fulfill the
constitutional aim of distribution of wealth and is not a profit-making
activity.

3.3 In a subsequent decision of the larger bench (which
included the Chief Justice) of the Bombay High Court, in the case of Girish
Mulchand Mehta v Mahesh M Mehta, Appeal No 338 of 2009, delivered on 10th
December, 2009, the Bombay High Court has taken an exactly contrary view.

In this case, the court held that the general body of the
society is supreme and had taken a conscious decision to redevelop the building.
The general body of the society thus has also resolved to appoint the developer.
The members of the society were bound by the said decisions. The general body of
the society has approved the terms and conditions of the development agreement
by an overwhelming majority. Merely because the terms and conditions of the
development agreement are not acceptable to the appellants, who were a minority
(only two out of twelve members), that by itself cannot be the basis for not
abiding by the decision of the overwhelming majority of the general body of the
society. It further laid down a principle that that once a person becomes a
member of the cooperative society, he loses his individuality with the society
and he has no independent rights except those given to him by the statute and
bye-laws. The member has to speak through the society or rather the society
alone can act and speaks for him qua the rights and duties of the society as a
body. It is not open to the court to sit over the said wisdom of the general
body as an appellate authority. Merely because some a minority of members
disapprove of the decision, cannot be the basis to negate the decision of the
general body, unless it is shown that the decision was obtained by fraud or
misrepresentation or was opposed to some statutory prohibition. In this case,
the general body had taken a decision after due deliberations for over five
years to redevelop its property. Even with regard to the appointment of the
Respondent No.1 as the developer, the decision had been taken by the general
body of the society after examining the relative merits of the proposals
received from the developers and interviewing them. Thus, the court upheld the
majority’s verdict.

3.3 It is being respectfully submitted that the single judge’s decision needs a rethink and that the larger bench’s decision is more rational. Can one individual hold the entire society to ransom? If yes, then what is the meaning of a majority? What if one cankerous individual refuses in the hope of making some extra personal gains? Does not the principle of the socio-economic movement also require that col-lective good should be placed over individual gains and losses?

IV. Demolition of Illegal Construction

4.1 A very important decision was rendered by the Bombay High Court in the case of a writ petition filed by Sudhir M. Khandwala, Writ Petition No 1077 of 2007. The case pertained to the demolition of illegally constructed build-ings and the petition was filed by flat owners seeking respite from the BMC’s orders. The High Court refused to stay the demolition and refused to regularise the unauthorized construction.

4.2 The Division Bench held that while consider-ing such matters, not only the interests of the petitioners but also of those residing in the nearby areas should be taken into account. The court came down harshly on the petitioners and held that “….if they purchase flats without

bothering to make enquiries and seeking details of the construction, then they are themselves to blame. If they are carried away by the brochure and the public advertisements and do not make such inquiries they cannot turn around and seek assistance of the courts.”

4.3 The court further held that every application for regularisation is to be viewed on a case-to-case basis and that there is no blanket rule that allows all applications to automatically accepted and approved. Essential supplies like power, water and infrastructure are scarce and unauthorized construction adds to the burden on these facilities. Hence, the BMC can refuse to regularize a particular application. The court upheld the demolition order for 17 out of 24 floors.

4.4 This decision is a wake-up call for all flat buyers. It is very important for buyers to check whether or not the title documents of the building and various permissions are in order. A reputed solicitor’s certificate would be helpful. Further, while dealing with buildings constructed on forest land, CRZ land, etc., the buyers should be extra cautious.

Registration Fees

5.1 The Maharashtra State Government has issued a notification a few weeks ago which states that the Rs. 30,000 cap on registration fees has been removed. Registration fees in the state were 1% of the fair market value of the property or Rs. 30,000, whichever was lower. Thus, even if the registration fees were coming to Rs. 1,00,000, they would be capped at Rs. 30,000. Accordingly, now, the combined amount of the stamp duty and registration fees would be 6% (5% + 1%) of the fair market value. The FMV would be computed as per the Stamp Duty Ready Reckoner. The state government had earlier issued a similar notification which was subsequently withdrawn.

5.2 Such a move by the government would act as a dampener to flat purchasers. Registration is a service by the government and not a tax. It is unfortunate that the government is us-ing registration of documents as a means of increasing the state’s revenue.

VI. Information about Tenants

6.1 The Thane police has made it mandatory for owners of a home, club, hotel, hospital, etc., to give information about foreign nationals residing in their premises.

6.2 The owner of such premises is required to intimate the nearest police station about any foreigner arriving at their premises within 24 hours of their arrival. The police has issued this notification under Section 144 of the Criminal Procedure Code which empowers the issuance of such orders in urgent cases of nuisance or apprehended danger. Failure to do so may entail prosecution of the owners.

VII. Eviction of Tenant from Commercial Premises

7.1 The Supreme Court, in the case of Ashok Kumar vs. Ved Prakash (CA 8417 of 2009), has held that a tenant can be evicted from not only residential premises but also commercial premises to meet the bona fide requirements of the landlord for self-occupation. This was a case under S.13 of the Haryana Urban (Control of Rent and Eviction) Act, 1973. S.13 of this Act is as hereunder:

“Eviction of tenants-

1) A tenant in possession of a building or rented land shall not be evicted therefrom except in accordance with the provisions of this section.

2) A landlord may apply to the controller for an order directing the tenant to put the landlord in possession-

    b) in case of residential building, if-

    i) he requires it for own occupation, is not occupying another residential building in the urban area concerned and has not vacated such building without sufficient cause after the commencement of 1949 Act in the said urban area.”

7.2   In this case, the two courts had ordered eviction of the tenant/appellant from a shop constructed on the ground floor at a plot in Gurgaon district in Haryana.

However, the tenant challenged the eviction and the judgments of the two courts on the ground that under Section 13 of the Haryana Urban (Control of Rent and Eviction) Act, 1973, a tenant can be evicted only from residential premises.

7.3 The Supreme Court held that there cannot be any discrimination vis-a-vis residential and non-residential premises for evicting a tenant, as otherwise it would be a violation of Article 14 (equality before law) of the Constitution.

It dismissed the appeal filed by the tenant challenging the eviction order passed by the Rent Controller and affirmed by Punjab and Haryana High Court.

The apex court held that if the landlord is able to prove his bona fide needs, the tenant can be evicted not only from residential premises but also commercial premises.

This judgment would have far reaching con-sequences in all the states which have Rent Control Acts since almost all of them contain provisions similar to S.13 of this Act. S.16(1) of the Maharashtra Rent Control Act, 1999 provides that a landlord may recover possession if the premises are reasonably and bona fide required by the landlord for occupation by himself. The wordings used in this section are much broader than those under S.13 of the Haryana Act. Further, the definition of the word ‘premises’ in S.7 means ‘any building’. Hence, under the Maharashtra Act, a land-lord could have recovered possession even of a commercial property. The position has now become clearer by virtue of the Supreme Court’s decision.

Nirav Shah

Cosmetic and Plastic Surgery

Service Tax

1. Introduction

Cosmetic and plastic surgeries
impact public perception in as much as our society places high value on physical
appearances of people they interact/deal with at a personal or business level.
Personal aspects such as appearance and presentability have gained increased
importance in the era of globalisation and in the general outlook of our society
at large. People, who are born with visible deformities or have been deformed
subsequent to accidents, diseases, etc., are often perceived to face social
difficulties and generally develop reduced confidence levels. For others, who
work in glamorous fields like films, TV, media, fashion, modelling, beauty care,
product marketing, airlines, etc., physical appearance is of prime importance.
And surgeries are often resorted to in order to help them in keeping their
appearance youthful or beautiful so as to enable them to conduct their
respective business/ profession with higher confidence levels and aggression in
a highly competitive business environment.

When beauty treatment services
provided by ‘beauty parlours’ were brought under the tax net, the board, vide
Para 3 of its Circular No. B11/1/2002 TRU, dated 1.8.02 clarified that beauty
treatment services do not include plastic surgery/cosmetic surgery which help
improve one’s appearance, as they are not the kind of services provided by
beauty parlours. These are more appropriately classifiable as medical services.

In this regard, it is worthwhile
to note that in CCE vs New Look Cosmetic Laser Centre (2009) 18 STT 555 (Ahd –
CESTAT), it was held that laser treatment given either by doctors or under a
doctor’s supervision and guidance for curing physical disorders and deformities
and for removal of facial and body hair, have to be held as “Cosmetic Surgical
Service” and will not be taxable under “Beauty Treatment Services”.

Increased prominence of cosmetic
and plastic surgery under the modern business and social scenario and judicial
views cited above, could have prompted the government to tax the said service
specifically.

A Cosmetic and Plastic Surgery
Services category has now been accordingly introduced and made effective from
1.9.2009. Hence, one can say, a beginning has been made to tax medical services
in a restricted manner.

2
Relevant Statutory
Provisions

Section 65(105) (zzzzk) of the Finance Act, 1994
(as amended) [Act]

Taxable Service provided or to
be provided, means and applies

“to any 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”

3
Scope of Services

a) The terms “Cosmetic Surgery”
and “Plastic Surgery” are not specifically defined under the Act.

The understanding of the said
terms in common parlance is as under:

‘Cosmetic
Surgery’ usually involves techniques intended for the betterment and
enhancement of physical appearance through surgical and medical techniques,
and is specifically concerned with maintaining normal appearance, restoring
it, or enhancing it beyond the usual level towards some aesthetic objective
employing modern technological advancement.

‘Plastic Surgery’
is usually understood as the functional and structural removal of all types of
defects/deformities of the human body (for example, skin transplant of a
person who has met with a fire accident). Modern plastic surgery has evolved
along two broad areas, viz. reconstruction of anatomic defects and aesthetic
betterment of usual form.

Although both surgeries have
identical techniques and approaches, there are differences. Plastic surgery is
usually performed to treat birth and other subsequent defects, and to remove
skin blemishes such as, acne scars, or birthmarks. Cosmetic Surgery, on the
other hand, is usually performed to make a client look younger, better and more
beautiful than earlier or to enhance his/her appearance in other ways.

b) As regards the Scope of
Cosmetic and Plastic Surgery Services, the Department vide its Circular Letter
D.O.F. No. 334/13/2009 – TRU, dated 6.7.09, has clarified as under:

Para 2.4.1

“Beauty treatment services
provided by saloons, beauty parlours and beauticians are taxable since 2002. The
services now proposed to be taxed are cosmetic surgery and plastic surgery which
are undertaken to preserve or enhance physical appearance or beauty. As per the
common definition, surgery is a medical technology consisting of a physical
intervention on tissues. As a general rule, a procedure is considered surgical
when it involves cutting of a patient’s tissues or closure of a previously
sustained wound. Commonly, surgery is performed in a sterile environment with
anaesthesia and antiseptic conditions using surgical instruments. It also
includes non-invasive surgery.”

c) The Department, in the above
cited circular has in Para 2.4.2 specified that some of the commonly known
aesthetic/cosmetic surgeries are as under :

Abdominoplasty
(tummy tuck)
Bletharoplasty
(eyelid surgery)
Mammoplasty
Buttock augmentation and lift
- Rhinoplasty (reshaping of nose)
- Otoplasty (ear surgery)
- Rhytidectomy (face lift)
- Liposuction (removal of fat from the body)
- Brow lift
- Cheek augmentation
- Facial implants
- Lip augmentation
- Forehead lift
- Cosmetic dental surgery
- Orthodontics
- Aesthetic dentistry
- Laser skin surfacing, etc.
   4. Specific Exclusion of Certain Surgeries

Any reconstructive surgery carried out as a part of the treatment of a disease is excluded from the ambit of service tax. The Department, in its “Circular Letter” dated 6.7.2009, has clarified as under:

Para 2.4.3

“Any reconstructive surgery undertaken to restore one’s appearance, anatomy or bodily functions affected due to congenital defects, developmental abnormalities, degenerative diseases, injury or trauma would be outside the scope of this service. These processes could be undertaken to correct im-pairment caused by burns, fractures or congenital abnormalities like cleft lip, etc.”

A few examples of degenerative diseases are:

   Parkinson’s Disease

   Cancer

   Diabetes

   Heart Ailments

   Prostatitis

   Arthritis

   5. Clarification Required on Scope of Services

Considering the technicalities of the matter, issues are likely to arise as to what can be included or not included within the scope of “Cosmetic & Plastic Surgery” liable to service tax.

Hence, in order to avoid litigations, it is felt that detailed clarifications explaining the scope of surgeries liable to service tax may be issued by CBEC after seeking detailed inputs from the Indian Medical Association or any other reputed body having expertise on the subject matter.

   6. Essential Criteria for Taxability

The essential criteria for taxability can be sum-marised as under:

   a) Services can be provided to any person, by any other person

   b) Services should be provided in relation to cosmetic surgery or plastic surgery

   c) Any surgery undertaken to restore or recon-struct the anatomy or the functions of body affected due to
- Congenital defects
- Developmental abnormalities
- Degenerative diseases
- Injury or
- Trauma
are specifically excluded from the scope of taxable service.

   7. Some Issues

X is a science graduate and has done specialized courses which enable him to advise/carry out cosmetic surgery for the betterment and beautification of the appearance of his clients. Would X be liable to service tax under “Cosmetic & Plastic Surgery Services”?

7.1A Unlike some taxable services (like architect, practising CA, etc), the statutory definition of taxable service U/s 65 (105)(zzzzk) of the Act, does not specify any particular qualification which a person providing the ‘cosmetic and plastic surgery service’ should possess. Therefore, services rendered by any person whether he is a qualified doctor or otherwise which constitutes Cosmetic of Plastic Surgery Services, would become taxable.

In this regard, attention is drawn to the ruling in the case of Parasmal Bam v. CCE [2007] 3 STR 73 (Delhi- CESTAT), wherein it was held that “management consultancy services’ rendered by any person would be taxable inasmuch as the definition of management consultant services does not prescribe any specific qualification; and, therefore, even if the person acquires the consultancy skill by way of experience, the services rendered by him would be taxable.

Hence, X would be liable to service tax, subject to available exemptions (like Ten Lakhs Threshold Exemption).

A reputed hospital in Mumbai, equipped with the latest and technologically advanced infrastructure, has a division which conducts cosmetic and plastic surgeries. The surgeons who actually carry out the surgery are not employed by the hospital but are engaged on a professional basis. They are paid per surgery.

As per the policy of the hospital, a person intend-ing to undergo surgery has to avail presurgery/ post-surgery services provided at the hospital. Ac-cordingly, the hospital bill raised for surgery usually includes the following charges:

   a) Indoor Hospitalisation

   b) Pre-operation Care

   c) Clinical/Pathological Tests

   d) Charges of Anaesthesiologist

   e) Surgery Charges

   f) Operation Theatre Charges

   g) Room Charges

   h) Cost of Medicines

   i) Post-surgery Care

Who would be liable to service tax under “Cosmetic & Plastic Surgery Services” and on what amount?

7.2A Cosmetic and plastic surgery services are rendered by the hospital to a patient. In order to provide the said service, the hospital avails services of surgeons on a professional basis. Hence surgeons are sub-contracted services providers. According to clarifications issued by CBEC through its Master Circular dt. 23.8.07, it would appear that exemption to sub-contracted service providers may not be available as per the government’s line of thinking. Hence, if the amounts charged by a surgeon for cosmetic and plastic surgery exceeds Rs. 10 lakhs during the period 1.9.2009 to 31.3.2010, service tax could become payable on amounts exceeding Rs. 10 lakhs.

Since the ultimate service provider to a patient is the hospital, there would be a liability of service tax under cosmetic and plastic surgery services on the hospital.

As regards the value on which service tax would become payable, under Section 67 of the Act, Value of taxable services is the gross amount charged for providing such taxable service. Hence, it would appear that the amount received by a service provider must have nexus to the taxable services rendered by him in order to constitute that amount as value of taxable service.

CBEC had, vide its erstwhile Circular No. 65/14/2003, dated 5.11.2003, clarified as under:

“In this regard it may be noted that Rule 6 only prescribes the procedure of payment of tax. The liability to tax is created by Section 66 of the Finance Act, 1994 as amended from time to time. The liability to pay tax is fastened on the service provider by Section 68 of the said Act. These two sections read together imply that service tax is pay-able by the service provider on the value of taxable services. Thus if a service provided is taxable, tax has to be paid on its value. Section 67 also clarifies value of service as the amount charged for the tax-able service when it has a nexus with the service provided. That is the reason why the expression used in Rule 6 is “value of taxable services” and not amount. The implication is that the tax has to be paid on the value of taxable services attribut-able to the service provided in a month / quarter as and when it is received. Thus Rule 6(1) cannot be read in isolation”.

In this regard, it may be noted that in a case under Central Excise [viz Acer India Ltd., (2004) 172 ELT 289 (SC)], the Hon’ble Supreme Court has held that the value of manufactured goods cannot be deter-mined by over-riding the provisions of the charging section. The amount received by the manufacturer must have nexus to the goods manufactured by him. [In this case, the Supreme Court was concerned with the issue of inclusion of value of software in the value of computer.]

In light of the foregoing, a reasonable view is possible that service tax is payable only on the surgery charges identified and included in the bill raised by the hospital on a patient.

However, it needs to be expressly noted that Section 65(105) (zzzzk) of the Act which defines the taxable service, employs the terminology “in relation to Cosmetic Surgery or Plastic Surgery”. The term “in relation to” has a very wide connotation as interpreted by the Supreme Court from time to time. Hence, service tax authorities could take a view that service tax is payable on the total amount of the bill, on the ground that all charges (other than surgery charges) are levied in or in relation to providing cosmetic and plastic surgery services.

In either scenario, in cases where a surgeon charges service tax on a bill raised on a hospital, the hospital would be in a position to avail the benefit of CENVAT Credit.

Nirav Shah

Part A — Supply of tangible goods for use

New Page 1

1. Introduction :

In most of the States, VAT (commonly known as Lease Tax) is
charged on the amount received by the supplier, permitting right to use the
goods where the possession and control is transferred to the user. However in
many cases, more particularly where machinery or equipment is of a highly
technical nature and operation of the same requires special skills and
experience, possession and effective control of such machinery or equipment is
not transferred to the user. Such transactions do not attract sales tax/VAT.

Under service tax, generally transactions of hire/lease of
moveable assets hitherto did not constitute taxable service under the Finance
Act, 1994 (Act). (However, transactions in the nature of financial lease, were
being taxed under Banking & Other Finance Services category.)

Hence, transactions of hire/lease of movables, wherein
effective control and possession of such goods is not transferred by the
supplier to the user, there was no liability to VAT as well as service tax.

2. Position under VAT/Sales Tax :

Before analysing the newly introduced services category of
“supply of tangible goods for use”, it is felt that, understanding of the
conceptual aspects as to the existing levy of lease tax under sales tax/VAT is
essential. The same are explained hereafter briefly.

(a) Transfer of Right to Use :

As per Article 366(29A)(d) of the Constitution of India,
‘sale’ includes a transfer of right to use any goods for any purpose (whether or
not for a specified period) for cash, deferred payment or other valuable
consideration.

Definition on similar lines has been adopted in S. 2(g)(iv)
of Central Sales Tax Act, 1956 and many State VAT legislations.

(b) ‘Transfer’ implies exclusive possession to transferee :

In a Supreme Court ruling having far-reaching implications
viz. Bharat Sanchar Nigam Ltd. V. UOI, (2006) 146 STC 91 (SC 3-Member
Bench), the following important observations have been made by the Apex Court :

Para 97 :

“To constitute
a transaction for the transfer of the right to use the goods, the transaction
must have the following attributes :

(a) there
must be goods available for delivery;

(b) there
must be a consensus ad idem as to the identity of goods

© the
transferee should have a legal right to use the goods — consequently all legal
consequences of such use including any permissions or licences required
therefor should be available to transferee

(d) for the
period during which the transferee has such legal right, it has to be to the
exclusion to the transferor — this is the necessary concomitant of the plain
language of the statute viz. a ‘transfer of the right to use’ and not
merely a licence to use the goods.

(e) having
transferred, the owner cannot again transfer the same right to others.”

Relying on the
BSNL case stated above, the Gauhati High Court in the case of HLS Asia Ltd.
V. State of Assam, (2007) 8 VST 314 has held that the delivery of physical
possession of goods is not essential precondition for levy of sales tax. The
relevant observations in paras 26 and 27 are as under :

“The
equipment, plants and machinery were available and identified by the parties.
Under the contract, OIL derived the legal right to use the goods having hired
the same on payment of charges. Customs duty had also been paid by it on the
equipment imported by the contractor for executing the works. Under the
stringent contractual terms, the contractor was bound to keep the equipment
engaged exclusively for the works. The fact that the same had been operated by
its technically qualified personnel does not militate against the element of
exclusiveness in the use thereof for the services and benefit of OIL. During
the subsistence of the contract, the appellant-company was neither authorised
nor permitted to transfer the equipment or detain the same for others. The
parties consciously limited the tax liability to the rental component only.

The
provisions of the contract understandably have to be construed in the context
of the service accorded to be rendered. The transfer of right to use the
equipments has to be perceived in the context of the nature, manner and extent
of engagement thereof. The retention of physical possession thereof by the
appellant company cannot be decisive. The parties entered into the contract
understanding the implications of each and every provision thereof, which
according to us, demonstrate an obvious dominion and control of OIL over the
equipment used by the appellant for the execution of the works during the
period of the contract. We, thus, have no hesitation to hold that the
transaction in question involved transfer of right to use the equipment,
plants and machinery under the lease within the meaning of S. 2(33)(iv) of the
Act.”

‘Transfer’ in
the context of Lease Tax implies exclusiveness to the user. For example, if a
passenger boards a bus, can it be said that the bus owner has ‘transferred’
right to use the bus to the passenger ? Obviously the answer is No. The bus
owner has only ‘allowed’ or ‘permitted’ the use of the bus to the passenger on a
non-exclusive basis.

(d) Lease tax is attracted only on ‘goods’ and not on
immovable property :

Lease is taxable only if it is in respect of goods (viz. movable property). Tax cannot be levied if plant and machinery fixed in building is leased, as it is immovable property and not ‘goods’ – Reference can be made to Karthik Engineering Works v. State of Kamataka, (2000) 119 STC 88 (Karn HC DB) – same view in CTO v. Sadulshshar Krai Vikrai Sahakari Samiti, (2004) 135 STC 90 (Raj HC).

In CST v. Bombay Sound Service, (1999) 112 STC 290 (Born HC DB), it was held that hire of recording studio with instruments embedded to earth is not transfer of right to use ‘goods’ as it is not movable property. Similarly in CST v. Pralhad Industries, (1999) 112 STC 548 (All HC), it was held that lease of factory along with plant and machinery fastened to earth is not transfer of ‘goods’, as plant and machinery is immovable property. Reference can also be made to DCST v. Bobby Rubber Industries, (1998) 108 STC 410 (Ker HC DB).

However, in such cases, there could be liability to service tax under ‘Renting of Immovable Property’ services category, subject to satisfaction of taxability criteria specified therein.

e) When is hire of goods taxable under sales tax/ VAT? :

It is commonly found that goods (e.g., furniture, utensils, machinery, equipments, etc.) are given on hire. These are returned after prescribed period and hire charges are paid by the user. This is ‘transfer of right to use for consideration’ and can be treated as ‘sale’ within extended definition of ‘sale’.

In Rashtriya Ispat Nigam v. CTO, (1990) 77 STC 182 (AP HC DB), [confirmed by the Supreme Court in 126 STC 114 (SC)], it was held that hire charges are taxable only when full possession and control is given to the hirer. If the owner (person giving equipment) retains effective control over the equipment, it is not ‘transfer of right to use’. In this case, the assessee had given sophisticated machinery to the contractors for execution of work entrusted to them. However, the machinery continued to be in possession of assessee. The contractor was not free to use the machinery for other work, and hence there is no ‘transfer of right to use’.

The principle enunciated above is popularly referred to as ‘concept of effective control and ownership’.

Some judicial rulings are given hereafter for reference:

In New Central Group Engg. v. ACCT, (2001) 124 STC 637 (WBTT), a dealer provided machines (dumpers, loaders and cranes) with his men and machines to carry out specified work. It was held that it is not a ‘transfer of right to use goods’ [same view in case of excavators given on hire in Alpha Clays v. State of Kerala, (2004)135 STC 107 (Ker HC DB)].

In Great Eastern Shipping v. State of Karnataka, (2004) 136 STC 519 (Karn HC DB), a dealer supplied tug (towing vessel) on hire to port trust under Charter Party Agreement. Agreement provided for handing over possession and control in all respect of the tug to the port trust. It was held that this is agreement to transfer right to use the tug. It was also held that since the tugs were within territorial waters, it is a sale within the State, as powers of the State Government extend to the territorial waters adjacent to the State.

In Lakshmi Audio Visual Inc. v. ACCT, (2001) 124 STC 426 (Kar HC), the petitioner was providing audio visual and multimedia equipment to customers for specified period and collecting hire charges. He was taking equipment to site, installing, operating, dismantling and bringing it back. Possession and effective control always remained with petitioner. It was held that it is not ‘deemed sale’ as customer never got right to use the equipment.

3. Effective date of levy :

The new levy of ‘Supply of Tangible Goods for Use’ has been notified w.e.f. 16-5-2008 and hence would apply to transactions for the period on or after 16-5-2008.

4. Scope of the levy :

The scope of the new levy has been explained vide Ministry’s Circular D.O.F. No. 334/1/2008 – TRU, dated 29-2-2008, as under:

4.4 Supply of tangible goods for use:

4.4.1 Transfer of the right to use any goods is leviable to sales tax/VAT as deemed sale of goods [Article 66(29A)(d) of the Constitution of India]. Transfer of right to use involves transfer of both possession and control of the goods to the user of the goods.

4.4.2 Excavators, wheel loaders, dump trucks, crawler carriers, compaction equipment, cranes, etc., off-shore construction vessels & barges, geo-technical vessels, tug and barge flotillas, rigs and high-value machineries are supplied for use, with no legal right of possession and effective control. Transaction of allowing another person to use the goods, without giving legal right of possession and effective control, not being treated as sale of goods, is treated as service.

4.4.3 Proposal is to levy service tax on such services provided in relation to supply of tangible goods, including machinery, equipment and appliances, for use, with no legal right of possession or effective control. Supply of tangible goods for use and leviable to VAT/ sales tax as deemed sale of goods, is not covered under the scope of the proposed service. Whether a transaction involves transfer of possession and control is a question of fact and is to be decided based on the terms of the contract and other material facts. This could be ascertainable from the fact whether or not VAT payable or paid.”

5. Essential criteria for taxability:

S. 65(105)(zzzzj) of the Act defines taxable service as under:

Any service provided or to be provided to any person –

by any other person in relation to supply of tangible goods including machinery, equipment and appliances for use, without transferring right of possession and effective control of such machinery, equipment and appliances.

The essential criteria for taxability can be summarised as under:

The service provider can be any person
The service receiver can be any other person
The service must be in relation to supply of goods
The goods so supplied must be tangible goods
The supply of tangible goods must be for use
The supply of tangible goods must be without transferring right of possession and effective control of those goods.

6. Specific tax exemption for goods carriage to Goods Transport Agency (GTA) :

Representations were made to the Govt. by the All India Confederation of Goods Vehicle Owners’ Association and also the All India Motor Transport Congress requesting to provide relief on account of levy of service tax on supply of goods carriage to GTA for use in transport of goods. It stated that GTAs often provide services in relation to transportation of goods by road using the goods carriage obtained on rent or hire basis. The relief was sought on various grounds inter alia that the service tax paid on renting/hiring of goods carriage, without right of possession and effective control, could not be taken as input credit for payment of service tax towards GTA service.

Service tax for the GTA service provided is payable only on 25% of the amount charged for providing the GTA service tax. In view of this provision, GTAs are not entitled to take input credit under Cenvat Credit Scheme on goods and services used for GTA service. Moreover service tax for GTA services provided in seven specified cases is not required to be paid by the GTA service provider but by the person making payment towards the freight. Services provided in relation to supply of tangible goods for use, without transfer of possession and effective control, has been made as separate taxable service w.e.f. 16-5-2008. Consequently, supply of goods carriage to the GTA, without transfer of possession and effective control, for using the said goods carriage for transport of goods by road had become leviable to service tax.

The Central Government has issued Notification No. 29/08 ST, dated 26-6-2008 to exempt fully from levy of service tax the supply of transport vehicles (goods carriage) to GTA to be used for transport of goods by road.

The exemption granted is in line with the intention of the Govt. as stated in the Union Finance Minister’s Budget Speech on 8-7-2004 while introducing service tax on GTA, that truck owners would not be subjected to service tax.

7. Some issues:

7.1 X is engaged in the business of giving equipments on hire for a specific period of time, wherein the said goods would effectively remain in the custody and control of the user. X has not been registered under VAT and accordingly is not charging VAT.X has now registered himself with Service Tax Dept. under the new category ‘Supply of Tangible Goods for Use’. Can the sales tax authorities demand and recover VAT from X ?

7.1A Comments:

The intention of the Govt. behind introduction of the new levy has been. very clear to tax those cases of hire/lease, which were escaping sales tax/VAT liability. Under the facts of X, it appears that since effective control and possession of equipments is transferred to the users, it would be liable to sales tax/VAT and not service tax. The mere fact that X has decided to pay service tax, though there was no liability for the same, cannot absolve X from discharging liability to sales tax/VAT. Hence Sales Tax authorities can demand sales tax/VAT from X for the past period as well as for the period during which X has paid service tax.

7.2 Y, a partnership company, is engaged in the business of giving cranes on hire to foreign companies, whereby effective control and possession re-mains with Y through their technical and operating staff. Hence there was no sales tax/VAT liability on hire transactions. Y has entered into an annual contract in March 2008 with a foreign company for hire of cranes during the period 1-4-2008 to 31-3-2009. The entire annual hire of Rs.90 lakh has been received by Y before 31-3-2008. Whether Y would be liable to service tax for the period 16-5-2008 to 31-3-2009. If yes, whether Rs.10-lakh exemption can be availed of by them and what would be the time within which service tax liability is to be discharged by Y?

7.2A Comments:

Though service tax payment to the Government is linked to receipt of consideration for services (either actual or advance), taxable event for levy of service tax, is ‘provision of service’ and not receipt of consideration’. Hence, it would reasonably appear that, Y would be liable to service tax on hire charges attributable to the period 16-5-2008 to 31-3-2009.

This position is impliedly made clear under Rule 6(1) of Service Tax Rules, relevant extract of which is reproduced hereafter:

Rule 6(1) – Payment of Service Tax

The service tax shall be paid to the credit of the Central Government by the 5th of the month immediately following the calendar month in which the payment is received, towards the value of taxable services :

Provided that where the assessee is an individual or proprietary firm or partnership firm, the service tax shall be paid to the credit of the Central Government by the 5th of the month immediately following the quarter in which the payments are received, towards the value of taxable services:

Provided further that notwithstanding the time of receipt of payment towards the value of services, no service tax shall be payable for the part or whole of the value of services, which is attributable to services provided during the period when such services were not taxable:

Provided also that the service tax on the value of taxable service received during the month of March, or the quarter ending in March, as the case may be, shall be paid to the credit of the Central Government by the 31st day of March of the calendar year.

Explanation – For the removal of doubt it is hereby clarified that in case the value of taxable service is received before providing the said service, service tax shall be paid on the value of service attributable to the relevant month, or quarter, as the case may be.

It is felt that if conditions under ten-lakh Exemption Notification are satisfied, one can avail exemption up to ten lakh for the period 16-5-2008to 31-3-2009.

Service tax liability for the entire period (16-5-2008 to 31-3-2009) would have to be discharged by 5th July 2008.

7.3 Z is in the business of giving specialised machines on hire, wherein effective control and possession remains with Z. During the year ended 31-3-2008, Z has purchased 5 new machines on which substantial amount of Excise Duty has been paid. Can Z avail Cenvat Credit of Excise Duty paid on the said machines and set off the same against service tax to be paid on hire charges on or after 16-5-2008 ?

7.3A Comments:

a) In this connection, attention is invited to CBEC Clarification vide letter F No. 137/120/2008 – Cx 4, dated 24-6-2008,extracts of which, are reproduced hereafter:

1. “M/ s. Hindustan Construction Company (HCCL) imported an aircraft last year, which was cleared on payment of appropriate customs duty (i.e., CVD). After its import, the aircraft was being let out by HCCL on hire basis without transferring right of possession and effective control. From 16-5-2008, ‘supply of tangible goods for use, without transferring right of possession and effective control’ is brought under taxable service. After 16-5-2008, such activity attracts service tax on the hire charges received by HCCL. In this regard, it has been requested that HCCL should be allowed to take credit of the CVD paid on the aircraft and utilise it for paying service tax. The modality suggested is to amend the Cenvat Credit Rules, 2004 so as to specifically include aircraft within the definition of capital goods, as has been done in case of motor vehicles for providing specified services.

The matter has been examined. It is noticed that in this specific case, the aircraft was imported last year and till 15-5-2008,the service provided by HCCL was outside the scope of the S. 66 of the Finance Act and thus was covered under the definition of the term ‘exempted services’ under the Cenvat Credit Rules, 2004. As per Rule 6(4),no Cenvat Credit can be taken on capital goods, which are used in providing only exempted services. Therefore, ab initio, HCCL was not eligible to take credit of CVD. Such being the case, the credit which was ab initio ineligible, does not become eligible after the service tax is imposed on the service at a later date. It is therefore clarified that no Cenvat credit of the CVD paid on the said aircraft should be taken, even if it is specifically included within the definition of ‘capital goods’.”

The above is self-explanatory.

b) In this regard, attention is also drawn to a Larger Bench ruling in the case of Spenta International Ltd. v. CCE, (2007) 216 ELT 133 (Tri – LB, WZB), wherein it has been held that eligibility to credit is to be determined with reference to the dutiability of the final product as on the date of receipt of capital goods. The ratio of the said ruling would be relevant for service tax as well.

c) In light of (a) and (b) above, it would appear that, if Cenvat Credit is availed by Z upon compliance of stipulated conditions (non-claiming of depreciation, etc.), the same would be disputed by service tax authorities.

Nirav Shah

Death be not proud

Namaskaar

Death had snatched away Shri Haribhai Kothari from us. But we
can tell death ‘Do not be proud’ — You cannot really take him away from us. To
live in hearts of people is not to die. Haribhai will live for ever in our
hearts.

Let us all then do Namaskar to this great soul and pray that
the God Almighty give him eternal peace.

Haribhai has been addressing us under the auspices of Amita
Memorial Trust since past 14 years. He was scheduled to speak to us for the 15th
time on 31st January 2011. But this was not to be. He passed away on 5th January
2011.

During our life we come across various people who are good
thinkers, who are good speakers. But very rarely do we come across a person
whose thinking, speaking and living are totally aligned. Haribhai taught what he
believed in and practised in his life. He walked his talk. He was truly a saint.

Haribhai was easy to get along with. In arranging all the 14
lectures, never had I to even write a letter to him. Even selection of the topic
was done on phone. To lend us comfort he would come 15 minutes ahead of the
appointed time of the lecture, to ensure that we were not put to any uneasy
feeling. He came on his own, and went on his own. No arrangements were required
to take him back to his residence in Mulund.

Haribhai was a great exponent of ‘Bhagvad Gita’. He
repeatedly taught us that one should not grieve at the death of someone. Quoting
Bhagwad Gita :

Just as we cast off old clothes and put on new clothes, the
soul gives up the old body and acquires a new one. The soul is neither born nor
does it die. Why should then one grieve ?

My mind goes back to my childhood. As a small boy, I along
with my grandfather, had an occasion to visit an Ashram in Songadh in Saurashtra.
In the morning when we were to leave, a person was singing a bhajan in a
melodious voice to the strains of a sarangi. He was blind and he was also
playing the sarangi. I remember the bhajan that he was singing written by
Anandghanji :

During the last month of his life he uttered these prophetic
word “He only is afraid of that who has done things which he should not do or
not done things which he should have done. I have always done what I should have
done and never done things I should not have done. Why then should I fear
death ?”

Let us learn from the life of Haribhai how to live, so that
we do not fear death. Let us spend our time doing things that we should live. As
expressed in the Upanishads “Better a moment of glow than a lifetime of smoke.”
Let Haribhai’s noble life be a guiding torch to enable us to live a better life
that will be our true Namaskar to the great soul.

“We live in deeds, not years;

In thoughts, not breaths;

We should count time by heartthrobs.

He most lives, who thinks most.

Feels the noblest, acts the best”

— Philips James Bailey

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Nirav Shah

Comparison

NamaskaarShakespeare said “Comparisons are odious”. Yet,
‘compare’ and ‘contrast’
are the two traits which control our behavior. The issue is:
Are we conscious of the
fact that they rule our lives?
Comparisons and contrasts are obvious in every aspect: for example, we have good
and bad, black and white, high and low, love and hate, etc. However,
‘comparison’, in particular, is a tool by which we evaluate our actions always
in comparison to others. For example, we ask of ourselves: Am I

* successful?

* acting fairly?

* rich or poor?

* knowledgeable?

* socially oriented?

* charitable?

* handsome – beautiful?

All these questions are in comparison to someone else. A
comparison could be with one’s idol or idea or it could be with one’s teacher,
relative, friend, colleague, peer, senior or subordinate. Comparisons compel and
motivate us to improve. On the other hand, we should not forget that comparisons
also have a dark side: it leads to jealousy — a destructive emotion. A
comparison can also be drawn out of insecurity that is rooted in a sense of
inferiority. It can also be based on the concept ‘I am better than someone’.
These comparisons always lead to unhappiness, anyway. The art of living lies in
making use of comparisons constructively, that is, to improve our lives, make
life more fruitful, rewarding, successful and happy. Comparisons will always be
there irrespective of whether we compare consciously or unconsciously; hence,
let us consciously compare ourselves with the best in every sphere and
constantly endeavor to improve ourselves. Let us see how comparisons may have
helped some achieve greatness. For example:

* Gandhi probably
compared himself to Buddha;

* Martin Luther King’s
model was Gandhi;

* Obama models his
actions on Lincoln.

Comparison also leads to emulate in our economic policies. At
one point of time, we were emulating Russia. Today, we find ourselves emulating
the ‘free world’. However, in my opinion, despite comparisons, we should take
care to evolve policies that suit India’s peculiar needs, and not blindly
emulate or compare ourselves with the ‘free world’ and repeat the mistakes we
made in adopting socialistic policies. Our success in avoiding the financial
meltdown of 2008 is largely attributable to the Reserve Bank of India, which
over the past few years, despite comparing India with the free world, has
followed policies which were ‘Indiacentric’. We should do the same with our
other economic policies. The mantra, therefore, is: Compare with the best, but
do our own thing.

However, I also believe:

.1. ‘Comparison’ is not always in relation to others, but
also sometimes with our own past thoughts and actions. We always judge the
present or project the future in comparison to our past or the present.

.2. ‘Comparison’ leads to emulating and copying. It can kill
originality. Hence, in using comparison as a tool to improve ourselves, we have
to consciously innovate in order to suit ourselves to our environment and avoid
being cast into a mould. In short, ‘comparison’ should not kill ‘originality’.

Hence, let us consciously avoid the negative impact of
comparison; let us consciously use it to improve our thoughts and actions; and,
last but not the least, let us consciously use comparison to motivate ourselves
to do better.

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Nirav Shah

Health and Mind

Namaskaar

Each one of us perceives the world in our own individual way.
Hence we experience health, disease and the purpose of disease individually.

The words ‘health’ and ‘heal’ originate from the word
‘whole’, which means ‘complete’, or to ‘integrate’. The subjective experience of
feeling whole from within is very individual and unique to each one of us. Thus
one’s experience of health (physical and emotional) may be radically different
from another’s understanding of the same.

In this era of modernisation and standardisation, society
offers us certain norms that define health and disease. These norms were
originally designed to assist us in our already inherent and intuitive
understanding of our own inner balance, of how it feels to be whole. In an
almost comic twist of events, we lost touch with our inner health-barometer and
we now find ourselves dependent on the judgment of a system outside us, when the
most powerful healer lies within. Health is basically a state of being, an ‘avastha’,
an experience of ease, joy and peace.

Disease is nothing but the loss of ease. When there is a lack
of ease in a part or in the mind, it is a clear indicator that there is
something that requires attention. Attention is different from judgment or
action. Those come much later. Let us give it that attention. Today the
perspective toward health is principally focussed on finding where and what is
diseased. The investigative thought process is directed towards all that can go
wrong. The time has come for us to shift the focus from disease to wellness;
from knowledge to wisdom . . .

Every event has the potential of the exact opposite. Peace
cannot be realised in an already existing state of peace. It can be realised
only when it is born out of a thirst created out of non-peace. Let us respect
that distress or disturbance for helping us realise peace.

Every illness brings with it a very specific personal
message. Once the disease is understood in the light of this learning, it ceases
to be a disease and becomes an opportunity to understand that part of oneself
that lies yet undiscovered deep in the ocean of the unconsciousness. The choice
to discovery is up to us. Once the discovery has been made, the disease has
completed its purpose and finds its own way out of the system. There is no
question of making it happen, but simply of letting it happen.

Had Columbus not lost his way, he would not have discovered
his destiny. Let us respect the apparent disharmony of things just so that the
experience of harmony can be more thrilling . . .

Everything here has a purpose — the day the purpose is
fulfilled, it dissolves !

To heal ourselves and have a healthy life we need to develop
positive thinking by synchronising mind and body. Intention is all it takes to
make it happen !

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Nirav Shah

Is it fair to continue the provisions of S. 297 of the Companies Act, 1956 as they stand today ?

Is It Fair?

S. 297, S. 299 and S. 300 of the Companies Act, 1956
(hereinafter referred to as ‘the Act’) embody and codify the principles
regarding fiduciary duties of directors of a company. S. 299 of the Act enjoins
upon the directors a statutory duty to make disclosure of interest in the
contract or arrangement in which they are interested. S. 300 of the Act debars
interested directors in certain cases from being counted for the purpose of
quorum and voting. S. 297 of the Act provides for the consent of Board of
Directors of a company and in certain cases approval of the Central Government,
to certain contracts in which directors are interested.

We are attempting to throw light on two aspects of S. 297 of
the Act in this article :

(a) Is it fair to exclude foreign companies/bodies
corporate from the provisions of S. 297 of the Act ?

(b) Is it fair to keep exemption amount provided under the
proviso to S. 297(2)(b) to Rs 5,000 only ?

Parties u/s.297 of the Act :

We will first look at the parties which are covered u/s.297
of the Act. Ss.(1) of S. 297 specifies parties and types of contracts to which
the Section applies. The provisions of S. 297 applies, when out of two parties
to the contract, one is a company (say ‘A’) and other is any one of the
following :

(a) Any director of the company A;

(b) Any relative of the director of the company A;

(d) Any partnership firm in which any relative of the
director of the company A is a partner;

(e) Any partner of the partnership firm in which the
director of the company A is a partner;

(f) Any partner of the partnership firm in which any
relative of the director of the company A is a partner;

(g) Any private limited company in which the director of
the company is a member;

(h) Any private limited company in which the director of
the company is a director.

Types of contracts to which this Section applies are as
follows :

(a) for the sale, purchase or supply of any goods,
material or services; or

(b) for underwriting the subscription of any shares in,
or debentures of, the company.

If we look at the above, we will come to know that the term
‘bodies corporate’ is not used in the parties covered U/ss.(1) of S. 297 of the
Act.

Transactions between foreign subsidiaries/joint venture with
entities abroad :

In the current scenario of the industry and due to
liberalisation of the Foreign Direct Investment Policy, many foreign entities
prefer India to expand their businesses.

Such foreign entities form subsidiaries or enter into joint
venture with Indian partners. These companies’ import/export/provide
goods/materials/services to their parent companies or group companies outside
India or vice versa.

They require technical support/consultancy from their parent
company or a joint venture partner in the initial stages or sometimes on a
regular basis. Such contracts/transactions between Indian company and a foreign
company fall under the purview of contracts mentioned u/s.297(1) of the Act.

Applicability of S. 297 of the Act in above case :

As foreign companies are bodies corporate, they are excluded
from the applicability of S. 297 of the Act. Hence, S. 297 does not apply to
such contracts or transactions between an Indian company and a Foreign Company
though directors are interested as stated under the Section. Further, no
approval of the Central Government is needed in such cases as the Section itself
is not applicable.

It means, any director of an Indian company who is director
or member of a foreign company with which the Indian company is
transacting/entering into a contract, need not obtain approval of the Board of
Directors and the Central Government.

Position of an Indian company transacting with an Indian
company :

If the above transactions would have been entered between two
Indian private limited companies covered under the parties to the contract, the
situation would have been reversed. It means where directors are interested as
stated in S. 297(1) of the Act entering into transactions falling under that
Section, approval of the Board of Directors and the Central Government in
certain cases would be required.

It means in case of two Indian companies where paid-up
capital exceeds the criteria laid down under the proviso to S. 297(1) approval
of the Central Government is required if :

(a) the transaction or contract is between the parties
covered u/s.297(1), and

(b) the transaction or contract is covered u/s. 297(1).

Is it fair to exclude foreign companies from the ambit of S.
297 when the same is applicable in the case of Indian companies ?

Now we will examine the exemption provided u/s.297(2)(b) of
the Act :

S. 297(2)(b) reads as follows :

(2) Nothing contained in clause (a) of Ss.(1) shall affect :

“(b) any contract or contracts between the company on one side and any such director, relative, firm, partner or private company on the other for sale, purchase or — supply of any goods, materials and services in which either the company or the director, relative, firm, partner or private company, as the case may be, regularly trades or does business.

Provided that such contract or contracts do not relate to goods and materials the value of which, or services the cost of which, exceeds Rs 5,000 in the aggregate in any year comprised in the period of the contract or contracts;”

The provisions of S. 297 of the Act are not applicable if the above conditions are fulfilled i.e.,

(a) the parties to the contract regularly trade or do business

(b) the cost of such contract(s) does not exceed rupees five thousand in the aggregate in any year comprised in the period of contract(s).

The said Ss.(2) was substituted by the Amendment Act, 1960. This figure of Rs 5000 is unchanged since at least 1960 (50 years?!). In spite of so many amendments to the Act, surprisingly this proviso has not been amended. We know basic economics — value of a rupee is diminishing day by day. The inflation rate on many occasions is intwo digits. Is it not funny to keep such unrealistic figure in the exemption? Is there any possibility that a company in a year will trade or provide services restricting it to Rs 5000?

Conclusion:

S. 297 is not applicable to transactions or contracts entered by an Indian company with a foreign company. But it is applicable in case of two Indian companies. This is unfair towards Indian companies. To make the law fair:

(a) the Section may be amended for treating both Indian as well as foreign companies at par; or
(b) the term ‘body corporate’ can be inserted in the list of parties stated u/s.297(1) of the Act. The limit of Rs 5000 may be increased or eleminated alotgether.

Nirav Shah

Is it fair to deny exemption to charitable or religious trusts for using a part of its income for the benefit of specified persons of section 13?

Is It Fair

The Income Tax Act, 1961 (‘the Act’) provides exemption to
income of charitable or religious and other institutions under Section 11 of the
Act. This exemption is dependent on compliance with conditions prescribed in the
law. However, the exemption provisions are stringent and on non compliance, the
institution may altogether lose its exemption.

Section 13 of the Act prescribes situations under which
exemption can be denied. Section 13(1)(c) states that exemption under Section 11
shall be denied if any part of income or property of the trust or institution is
used or applied directly or indirectly for the benefit of persons referred to in
Section 13(3) of the Act (hereinafter referred to as specified persons).
Further, Section 13(2) lists down an inclusive list of instances where income or
property of the trust can be said to have been applied for the benefit of
specified persons. The persons referred in Section 13(3) are mainly the author
of the trust, any person who has made substantial contribution, trustee, etc. A
substantial donor is one who has donated Rs.50,000, not in a year but since the
inception of the trust.

However, Section 13(6), read with Section 12(2) of the Act
provides a little bit of relief in the sense that it states that incase a
charitable or religious trust or institution, running an educational or medical
institution or hospital, provides educational or medical facilities to persons
referred in Section 13(3) free of cost or at a concessional rate, the trust
shall not be denied exemption, but only the value of such benefit (in the form
of free or concessional services) shall be considered as income for the purposes
of Section 11. The
benefit of exemption under Section 11(1) shall not be available to such income
and such deemed income will be taxed at the maximum marginal rate under Section
164 (2) of the Act.

The net effect of the above provisions is that while a
charitable or religious trust running an educational or medical institution or a
hospital is allowed to enjoy the exemption even after providing free or
concessional services to certain specified persons, any other trust or
institution other than this is denied exemption merely because only some part of
its income or property is used or applied for the benefit of certain specified
persons.

Is it fair to deny
trusts or institutions (other than those running hospitals or educational
institutions) their entire exemption just because a part of their income or
assets are used for the benefit of certain specified persons?

Further, certain clauses of Section 13(2) and Section 13(3)
are rather impractical and difficult to follow. For instance clause (g) of
Section 13(2) mentions that where income or property of above Rs. 1000 is
diverted in favour of specified persons referred to in Section 13(3), the same
shall be deemed to be for the benefit of such persons, and thus the entire
exemption shall be denied. The ceiling of Rs. 1000 was introduced by the Finance
Act, 1972 when one thousand rupees could be considered to be a considerable
amount. However, no increment in this ceiling has been done so far. In recent
days, the amount of rupees one thousand has become so nominal that it becomes
almost impossible to get away from this provision. Again, the specified persons
mentioned in Section 13(3) include a person whose total contribution
upto
the end of previous year exceeds fifty thousand rupees. The word ‘upto’
indicates the aggregate of contributions made, including the contributions of
prior years. Thus, for a person who makes a contribution almost every year, it
shall not take much time for his aggregate contribution to exceed fifty thousand
rupees. Thereafter, any transaction, howsoever insignificant, with such person
shall be subjected to restriction of Section 13 of the Act.

This implies that anyone from the public at large can avail
benefits of the charitable or religious trust in the form of financial or other
help. However, any of the specified persons, even in genuine cases, cannot avail
the benefit of the trust. Further, any benefit in almost all circumstances is
bound to be more than rupees one thousand. It is understandable that it will be
taxed in the hands the trust. But does it really justify a total denial of
exemption?

Further, low limits as explained above, make it rather
difficult for the charitable trust or institution to work. In case of many
specified persons, the trust or institution may have to prepare a separate list
of such specified persons and transactions entered into with them. In case of
numerous transactions, it may also become difficult for the auditor to verify
and certify. Though, the basic intent behind the provisions of Section 13 is
noble — so as to ensure that the funds of the trust, meant to be for the benefit
of public the at large, are not spent on prohibited persons — the said
provisions are so strict that they seem to defeat the basic intent and purpose
of the Act which is to encourage charitable and religious trusts / institutions
and to make their working easier.

On the other hand, as mentioned earlier, a much more lenient
and rather logical treatment is given to charitable or religious trusts or
institutions running educational or medical facilities or hospitals. Section
13(6), read with section 12(2), states that when a charitable or religious trust
running educational or medical facilities or a hospital provides educational or
medical facilities to persons specified in Section 13(3) free of cost or at a
concessional rate, only the value of such benefit shall be considered as income
instead of denying the whole exemption. The irony is that the draft direct ‘tax
code’ contains the same provisions.To make the law fair, the author recommends
that the law be amended to:

1. Increase the limit of Rs. 50,000 for determining a
substantial donor;

2. The principle enshrined in Section 12(2) be extended to
any benefit derived by persons mentioned in Section 13(3) and transactions
covered in Section 13(b) of the Act;

3. The list of relatives be reduced to one generation.

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Nirav Shah

Disaster Risk : Risk Management — Case study

Risk

Disasters can be broadly classified as ‘Natural’ and
‘Man-made’. The following are a few examples:

Natural Disasters:
earthquakes, cyclones, tsunamis, hurricanes, famines, floods and droughts, etc.

Man-made Disasters –
wars, riots and terrorist attacks (it is not known when and where a terrorist
strike will take place), etc.

According to a United Nation study, the annual economic loss
associated with natural disasters averaged US $75.5 billion in the sixties, US
$18.4 billion in seventies, US $213.9 billion in the eighties and US $659.9
billion in the nineties. Most of these losses were incurred by developed
countries. The study also points out that:

The severest impact is on the people in the low
income groups, and

85% of the people exposed to natural disasters
live in less or underdeveloped communities/countries.

Disaster Risk Reduction
– DRR – is a term adopted by the United Nations for developing an international
strategy on promoting disaster risk reduction, as it is shown to be
cost-effective. Initiatives that are focused on disaster risk reduction will
either seek to reduce the likelihood of a disaster occurring (flood protection
work by way of construction of dykes, levees and stopbanks, for example) or
enhance the community’s ability to respond to an emergency (ensuring three days
food and water). Initiatives also include increasing knowledge and creating
legal and policy frameworks. Disaster results in people being homeless, becoming
economically weak, education coming to a standstill, infrastructure being
damaged and normal everyday activity being virtually paralysed. The 2001
earthquake in Gujarat is an example of what disaster entails.

A living example of man-made or industrial disaster is the
Bhopal Gas Leak tragedy that resulted in widespread death and has left many
surviving victims still suffering without resolution of the social or legal
issues and reparation of the damages suffered, even after more than two decades!
The anniversary of the tragedy is still observed in Bhopal and religiously
reported by the media, but little action is taken, it seems, beyond paying lip
service to the cause. Hence, businesses operating in hazardous areas or
involving hazardous materials should look at their own risk exposure and
vulnerabilities, and consider appropriate ways of reducing their risks through
appropriate actions and investments in hazard monitoring and risk mitigation,
and by creating resilience. Many governments and international NGOs have begun
to look more carefully at DRR as an important part of sustainable human
development.

Businesses planning for resilience, through financial and
operational risk mitigation measures, also contribute to the resilience of the
local economic environment. This can be achieved by supporting appropriate
regulations and building social capital, as employers and employees are a part
of the community living in the area where the business operates.

Let us not forget that a disaster, wherever it may occur,
impacts both the social and economic environment of the people living in the
affected area, and also the society at large.

Disaster risk and business

Disaster at micro level adversely impacts the businesses
operating in the area where disaster happens. At the macro level it adversely
affects insurance companies. The hospitality industry in Mumbai, especially the
hotels attacked by terrorists in 2008, have still not fully restored the damage
caused to the infrastructure. The economic loss has been shared by the
shareholders in terms of their expected and actual returns, the government in
terms of loss of tax revenue and costs incurred, and the insurance companies in
terms of the compensations and losses, not to forget the trauma suffered by the
public, especially the inhabitants of South Mumbai. On the other hand, the
businesses of security agencies, suppliers of security personnel and insurance
companies, post 26/11, have increased. The Government of Maharashtra, in
collaboration with the Government of India, is, therefore, adopting DRR
measures.

Case study of the month: A beverage company

Coolsip Ltd. is a beverage company that produces and
distributes the Coolcan range of beverages like juices, soft drinks and colas in
Mumbai and across several locations in India and across the Middle East.

The CEO of the company recently attended a seminar on
“Dealing with Disasters” and is wondering whether in the event of a disaster
like a major fire, earthquake or flood or even a man-made one like a terror
strike, the company’s facilities, supply chain, distribution facilities are
well-protected and secured; and whether the company will be able to withstand a
major disaster, especially in view of what happened to the plant in Mumbai
during the 2006 floods.

He consults the CFO on the matter, who is of the opinion that
disasters are practically insurmountable and too large for a company to cope
with and are best left to the government and authorities. The other argument he
put forth was that since its inception 25 years ago, the company or its
facilities have not been affected by any major disaster except once during the
Mumbai 2006 floods, when operations were resumed within two days and losses were
covered by the insurance company. Also, if disaster strikes, with the
authorities and everyone acting swiftly, the situation normalizes in a few days.
In his opinion, the loss to physical assets is insured and, therefore, the
actual loss would work out to be much lesser compared to the elaborate costs of
being prepared for disasters. Therefore, he advised status quo.

The CEO approaches you, an external consultant, for your
views. Give your comments.

The risk management advisor’s first suggestion was that he
should be allowed to:

1. Initially visit at least two facilities including the
one in Mumbai which was affected by the 2006 flood;

2. Talk to the people at the selected two plants to
understand risks involved;

3. Discuss and determine the risks involved with a few key
executives at the corporate office in Mumbai.

After assessment work spread over three weeks, the Risk Management Consultant suggested the following ‘Disaster Risk Reduction’ – DRR measures:

1. Initially, to create a water drainage facility next to the plant in Mumbai to reduce water clogging;

2. Raising the plinth level of the area in which critical machines were installed to reduce the risk of damage;

3. Acquire on rent a godown/storage facility outside the plant premises in Mumbai for storing enough finished goods to meet at least 3 days’ demand, in order to ensure continuity of supply to customers. The plant was already carrying four days inventory of finished goods. The additional cost involved was only rent and cost of a few persons. He suggested that HRD be consulted whether some existing persons could be shifted to reduce additional cost. This was to minimize loss of revenue and retain customer loyalty.

4. The other facility he visited was at Chiplun, a city close to Koyna, an earthquake sensitive area. The suggestion was to consult an architect and ascertain how to strengthen the construction and enable it to withstand earthquake shocks, as mild tremors continue to occur. Even in January of 2010, mild tremors originating in Koyna were felt in Mumbai.

5. He also suggested a detailed review of electrical installations at both the plants to assess the likely impact of floods and/or earthquakes on them, as damage to the power receiving and/or generating facilities could affect production.

6. To insure against ‘loss of profit’ by making a ‘loss of profit’ insurance policy.

7. To consider the possibility of insuring people and property against acts of terrorism.

The CEO and even the CFO who was initially sceptical of the exercise, appreciated and implemented the suggestions. The Risk Management Consultant was also commissioned to carry out a detailed review and suggest DRR measures.

Nirav Shah

Simplification of Tax Laws and the Lion’s Den

Light Elements

Once upon a time, the Indian Finance Minister lost his way
and found himself in a dense jungle just before presenting the union budget in
parliament. Perhaps, while mulling over how to boost tax collection, one way or
the other, he lost his way. Anyway, he kept strolling through the jungle,
holding the draft finance Bill and New Tax Code in his arms. Suddenly he
realized somebody was following him. He looked back over his shoulder. Oh, it
was a jackal– the most cunning animal of the jungle; the protagonist of most
Aesop’s fables we’ve heard during our childhood. Both the minister and the
jackal stopped short of each other. It was the jackal who broke the silence,
leading the conversation. “Hey! Hello Finmin, how are you?” “Fine”, answered the
Finmin with a heavy tone.

After swapping information as to the general state of affairs
in their respective personal lives (I mean—how are you? how is your health? How
is your family?, etc, the jackal fired an impromptu salvo which made the Finmin
shudder. “How is the economy?”he asked. “Oh, better than other developing
countries,” mumbled the Finmin. “But not up to the mark?” questioned the jackal.
“You know there is recession in the world and we are not an exception,” retorted
the Finmin, looking at the ground (rather ground realities maybe). “I heard the
prices of essential goods such as food grains and vegetables are on the rise
with every passing day, after your party assumed power at the centre, making the
aam aadmi’s life miserable,” was the next salvo fired by the jackal.

The Finmin shifted awkwardly in a clumsy attempt to avoid the
jackal’s penetrating eyes. He seemed to be struggling to find a convincing
enough answer. Looking at him fumbling, the jackal promptly changed the subject
and started discussing other matters like growing terrorism, global warming,
decline in population of wild animals, population explosion, falling moral
standards, etc. Having exhausted all topics of mutual interest, it was the
jackal’s turn to fidget. So he decided to march onwards on his original mission
to meet the King of the jungle. “So it was nice seeing you Finmin. Take care of
the economy and have a nice budget session in parliament. It’s time for me to
leave now,” said the jackal. As he walked ahead, he heard the Finmin call out, “Jackalbhai,
jackalbhai, just a moment”. So he retraced his steps hurriedly. “What’s the
matter, Finmin?”, he asked. “Actually, me and my predecessors have been obsessed
with one issue,” said the Finmin. “What is it?”, asked the jackal. “How to boost
tax collection,” finally the Finmin blurted out.

“Oh, a most interesting issue. Once upon a time, the king of
our jungle, I mean, the Lion, was facing a similar kind of problem. One day, I
called on the king in his den located at a high altitude, at his request.
Somehow I managed to get there after several bruises on my body. I fumbled a
number of times on the rocks on the way to the den. It was quite a bumpy path to
tread. When I climbed half way, I even thought of postponing the visit to some
other day and as soon as I turned back, I heard the Lion roar. I climbed back. I
felt like riding on the high tide when eventually I reached the den. The king
asked me to enter his den. It was difficult entering the den and the den wasn’t
big enough to accommodate more than two or three persons. Well, the king
narrated his problem. He had become old and he was starving. Old age meant he
could not hunt as frequently as he used to earlier. Not a single animal, big or
small, had appeared in his area since quite some time. He asked me how to get to
the prey.

I thought for a while and then came up with the solution,
which was based on my own experience of reaching the den. I first told the king
that he should change the location of his den, making it neither too high nor
too low. I meant his den should be located ideally so that he could keep a watch
on possible prey without being seen. Around the den, there should be sufficient
flat land on which grass can grow. The opening of the den should be wide enough
plus it should be sufficiently deep inside so that if an animal enters
reluctantly, the king can capture him effortlessly.

I explained to the king the reasoning behind this arrangement
of the den. If the den was located at a reasonable height from the ground, one
might be tempted to venture there. Green grass, being a favorite fodder for
small animals, it would attract them into his den.

He understood my strategy, “simple and easy access with some
attraction keeping the prey engaged for a while so that he could attack the prey
easily”. The king thanked me from the bottom of his heart. Thereafter, he
changed the location of his den as suggested by me and started living retired
life comfortably.

“So Finmin, the moral of the story is that you should evolve
simple tax compliance procedures, particularly about tax collection matters.
Your existing procedures are like the erstwhile den of the king. So, you have
been starving for tax collection…”

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Nirav Shah

Non-resident tax updates: Non-residents can work on Indian projects only on employment visa; business visa norms to be tightened

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50
Non-resident tax updates: Non-residents can work on Indian projects only on
employment visa; business visa norms to be tightened

In the present liberalized economic environment, Indian
companies are awarding work for execution of projects/contracts to foreign
companies, including the Chinese. This has resulted in inflow of foreign
nationals, including the Chinese, for execution of projects/contracts in several
sectors e.g. steel, power etc. It has come to the notice of the government that
a large number of foreign nationals, including Chinese were coming for execution
of projects/contracts to India on business visas instead of employment visas.

The matter has, therefore, been reviewed by the government
and it has been decided that henceforth a business visa will be issued only to
bona fide foreign businessmen who want to visit India to establish an
industrial/business venture or to explore possibilities to set up an
industrial/business venture in India or who want to purchase/sell industrial or
commercial products or consumer durables, etc., according to provisions of the
official visa manual.

It has also been decided that all foreign nationals coming
for execution of projects/contracts to India, will have to come only on an
employment visa. And that such visa will be granted only to skilled and
qualified professionals appointed at a senior level, skilled position such as
technical expert, senior executive or in a managerial position, etc., and will
not be granted for jobs for which a large number of qualified Indians are
available. Suitable instructions/guidelines have been issued to the Indian
missions abroad to effectively regulate employment and business visa regimes and
ensure that these are issued strictly as per the prescribed norms.

As per the guidelines issued by the government, employment
visas for foreign personnel coming to India for execution of projects/ contracts
may be granted by Indian missions to highly skilled personnel and professionals,
to the extent of 1% of the total persons employed on the project and subject to
a maximum of 20. However, this has been raised to 1% or maximum of 40 for the
power and steel sector projects till June 2010. In case more foreign nationals
are required for any project, then a clearance from the Ministry of Labour &
Employment is required.

(Source: Internet & Media Reports, dated 04.01.2010)

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Nirav Shah

Introduction of the UTN, which tax payers need to quote along with PAN, shelved

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49
Introduction of the UTN, which tax payers need to quote along with PAN, shelved

The government has decided to shelve the introduction of the
Unique Transaction Number (UTN) which tax payers need to quote along with
Permanent Account Number (PAN), when tax is deducted/collected at source. The
scheme was to come into force from the New Year.

(Source:
Internet & Media Reports, dated 31.12.2009)

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Nirav Shah

Declaration of Assets by SC Judges under RTI Act -Supreme Court should accept verdict

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48
Declaration of Assets by SC Judges under RTI Act -Supreme Court should accept
verdict

The ruling by a three-member bench of the Delhi High Court is
truly historic. It upheld an earlier judgment of a single judge of the same
court, dismissing an appeal by the Supreme Court (SC) that the office of the
Chief Justice of India (CJI) comes within the ambit of the Right to Information
(RTI) Act. Doing so, the High Court has sent a clear message: No one is above
the law.

This is the most sacred principle in any democratic society
and it is heartening that the High Court sees no case as an exception. The prime
minister and the president are already covered by the RTI Act; so why not the
apex court judges? The ruling comes in a dispute over whether assets declared by
SC judges to the CJI should be disclosed under the RTI Act.

“The higher the judge is placed in the judicial hierarchy,
the greater the standard of accountability and the stricter the scrutiny of
accountability of such mechanism,” said the bench. We could not agree more.

(Source: The Economic Times, dated 14.01.2010)

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Nirav Shah

Late or dozing in court? Judges may be in dock

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47
Late or dozing in court? Judges may be in dock

Schoolchildren who resent being penalised for coming in late
or for falling asleep in the class can take heart. Hopefully, from the next
year, even the Supreme Court and High Court judges will be in serious trouble if
they come late to court or nod off during arguments. Indeed, they can face
inquiry and risk incurring punishment stretching from censure to removal.

These are among the high standards and accountability
criteria proposed for judges of the higher judiciary in the new Judicial
Standards and Accountability Bill, 2009, which, after undergoing 18 drafts, is
ready to go before the cabinet in a day or two, law ministry sources told TOI.
Courts have not been immune to the problem of lack of punctuality, seen by many
as a national trait because of its spread across regions, demographics and
institutions. The late “latifs” among SC and HC judges have so far got away
because of the absence of any mechanism to chastise these holders of
constitutional posts. The government now seems keen to wean them off their
fondness for Indian Standard Time — a euphemism used to describe the cultural
problem that sees punctuality as alien to desi ethos. 5-yr jail is likely for
bid to frame judge

The new Judicial Standards and Accountability Bill, 2009, a
brainchild of the law minister Veerappa Moily, and drafted and re-drafted with
assistance from the Attorney General G E Vahanvati and Solicitor General Gopal
Subramaniam, has a provision that will surely make the judges of the higher
judiciary sit up and take notice—”punctuality and devotion towards duty’’.

Anyone who finds a judge not punctual or not devoted to duty,
dozing off once too often during hearings or being habitually late in delivering
judgments, could lodge a complaint against that judge with an Oversight
Committee, specifically provided to receive such complaints.

The committee would thoroughly scrutinise the complaint and
its veracity. If the complaint was found to be false, the complainant would be
proceeded against and could end up behind bars for up to five years.

Apart from making voluntary asset declaration by judges,
according to the apex judiciary’s resolution of May 7, 1997 a statutory
requirement, the bill gives a wider meaning to assets and liabilities.

(Source: Internet & Media Reports, dated 12.01.2010)

(Note: What about similar accountability bill for our
law makers who are passing legislation without debate and discussion in the
Parliament? Why are they not made accountable?)

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Nirav Shah

Court backlog must be cut, but a cess isn’t the solution

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46
Court backlog must be cut, but a cess isn’t the solution

The law ministry is considering a cess to help clear the
three crore cases clogging the courts. Though the proposal is only at a
discussion stage, it must be nipped in the bud. We’ve already had an education
cess and it is unclear how much of this has reached the real beneficiaries and
if it has led to any perceptible improvement.

Obviously the ever-increasing pile-up of cases in our courts
is a major cause for concern. Of the three crore cases pending in the courts,
roughly 2.5 crore are in lower courts, 40 lakh in the high courts and around
52,000 in the Supreme Court. The backlog has not only paralysed delivery of
justice but also exacted a high economic cost. Finance minister Pranab Mukherjee
recently said that delays in the courtroom were having an adverse impact on the
country’s GDP. This is mainly because of the inordinately long time taken to
enforce a contract in India.

Among the other proposals include the filling up of vacancies
in courts quickly. It has been suggested that some 15,000 judges be appointed in
trial courts for a two-year term who will work in three shifts. There are other
proposals that could also be considered. Retired judges could be drafted to help
tackle the shortage of personnel; the long vacation for judges, a holdover from
colonial times, should be reduced; out-of-court settlements should be
encouraged; and there should be better pay for judges to attract the best talent
from among the legal profession. The Law Commission has also rightly suggested
that adjournments be resorted to only if absolutely necessary.

(Source: The Times of India, dated 30.12.2009)

(Note: The government is the biggest litigant. The
officials in all departments issue Show Cause Notices / Penalty Notices, even
for minor or technical infractions of law and file appeal against judicial
orders as a routine, without application of mind. There is no accountability on
the part of litigant officials. Litigation is used as a means to harass the
citizens and extract a price. The judiciary has commented upon this time and
again but to no avail. If frivolous litigation by the government stops, the
problem of backlogs would be sold substantially.)

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Nirav Shah

Corporate governance cannot be mandated: Irani

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45
Corporate governance cannot be mandated: Irani

Tata Sons Ltd Director Jamshed Irani has said that corporate
governance is a culture that cannot be mandated, but has to be built up
gradually with strong link between the board and the management of the company.

Delivering a lecture on ‘’Corporate governance through the
lens of an Indian corporate’’ here last night, Mr Irani said corporate
governance has become a major cause of concern following the Satyam scam. He
believes that frequency of financial reporting is not so important, but accuracy
and efficiency of the same is more crucial to ensure quality governance.

Asserting that with change in business environment ‘’we
should also change the way we look at the governance and also our mindset,’’ Mr
Irani said corporate governance and financial governance are two main parts of
the governance.

As far as corporate governance is concerned, he said,
provisions like clause 49 can make some difference, but if the Chief Executive
Officer or Chief Financial Officer is determined to do something wrong, no one
can stop him.

‘’But when it comes to punishment, certainty is more crucial
than its severity. Hopefully, the new law will also bring in transparency and
proper disclosure norms, which will ultimately lead to desired accountability in
the entire system,’’ he said.

[UNI, January 9 2010]

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Nirav Shah

ASIC cracks down on auditors

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44
ASIC cracks down on auditors

ASIC has accepted enforceable undertakings from two partners
of accounting firm Moore Stephens Sydney after an investigation found that
audits they had conducted were inadequate.

The enforceable undertakings provide that Christopher
Chandran and Scott Whiddett must not practice as registered auditors for 12
months.

They must both participate in an additional 15 hours of
continuing professional audit-related education during that 12 month period and
have their next five audits following the 12 month period reviewed by an ASIC
approved registered auditor.

An ASIC investigation found that an audit of Estate Property
Group for the financial year ended 30 June 2006 conducted by Chandran was
inadequate, and that as lead auditor he failed to ensure the audit complied with
Australian Auditing Standards as required by the Corporations Act 2001.

[www.moneymangement.com.au 11 January, 2010]

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Nirav Shah

Music helps lower cholesterol

New Page 1

42. Music helps lower cholesterol

Doctors have found that prescribing music can improve heart
health and lower cholesterol levels. Their research found that if a patient
listens to 30 minutes a day of their favourite music, it can go far beyond
simply relaxing them mentally — it benefits them physically by expanding and
clearing blood vessels. Doctors have tried the method on some patients in
America and it has been welcomed by British experts. It is believed to work by
triggering the release into the bloodstream of nitric oxide, which helps prevent
the build-up of blood clots and harmful cholesterol.

The findings are part of a growing body of research into the
effects of music on the human body. Scientists have found that songs can improve
endurance, while 18th century symphonies can improve mental focus.

When it comes to the effect on the bloodstream, however, the
key is not the type of music, but what the listener prefers. The same is true of
volume and tempo. “The music effect only lasts in the bloodstream for a few
seconds, but the accumulative benefit of favourite tunes lasts and can be very
positive in people of all ages,” said Michael Miller, Director of the Center for
Preventive Cardiology at Maryland University, who carried out the research. He
added : “We were looking for cheaper, non-pharmacological aids to help us
improve our patients’ heart health, and we think this is the prescription.”

The Maryland study, based on healthy non-smoking men and
women with an average age of 36, found the diameter of blood vessels in the
upper arm expanded by 26% in volunteers listening to music they found enjoyable.

Miller said blood vessel expansion indicated that nitric
oxide is being released throughout the body, reducing clots and LDL, a form of
cholesterol linked to heart attacks. He also warned that listening to stressful
music can shrink blood vessels by 6% — the same effect, according to previous
studies, as eating a large hamburger.

(Source : The Times of India, dated 23-12-2008)

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Nirav Shah

One in four company accounts flagged by auditors

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43
One in four company accounts flagged by auditors

One in four financial statements lodged by Australian listed
companies were flagged by auditors in the past year, as the global financial
crisis cast doubt on asset values and the ability of companies to refinance
debt.

According to figures provided by the Australian Securities
Exchange, 25 per cent of the 967 financial statements lodged up to June 30 —
those of 239 companies — contained a modified independent audit report, with
most related to whether the company would continue to operate as a ‘’going
concern’’. The figures exclude junior mining companies.

A modified audit report means the auditor has decided to
include information not contained in a standard report. Most audit modifications
are likely to involve an ‘’emphasis of matter’’ paragraph, which highlights
potential problems that may affect a company’s status as a going concern — its
ability to pay debts and continue operating. A ‘’qualified opinion’’ is a more
serious modification.

[Sydney Morning Herald, January 11, 2010]

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Nirav Shah

Pay Rs.10k for wrong info in Govt. survey

New Page 1

41. Pay Rs.10k for wrong info in Govt. survey

You may soon have to give authentic socio-economic data
sought by the Government. And if you don’t, you may be fined.

The Rajya Sabha passed an important legislation making it
mandatory for citizens and commercial establishments to part with accurate
information during the annual survey. Accordingly, every individual in the
country and private establishment will have to share desired information with a
designated statistical officer, else they will have to pay penalty which may, in
certain cases, extend up to Rs.10,000.

The Collection of Statistics Bill — introduced in the RS in
2007 — also provides for empowering the Centre to make rules to avoid
duplication and to maintain technical standard in data collection, which is
currently lacking during the annual survey in the absence of any legal backing.

Before pressing the House to pass the Bill, Union Minister
for Statistics and Programme Implementation G. K. Vasan said : “The new law will
have elaborate provisions to ensure that the information collected will not be
used for any purpose other than for statistical purpose. Identities of
individuals or companies will not be revealed to anyone during use/transfer of
such data within Government agencies which may need it for policy making.”

As against the existing law which only facilitates collection
of statistics of certain kinds relating to industries, trade and commerce, the
new law will empower the Government to collect data on economic, demographic,
social, scientific and environmental aspects of individuals and households.
Though the Government has been collecting such data under the National Sample
Survey, it is done voluntarily.

Stating the purpose of such a legislation, Vasan said : “It
is felt that the provisions of the current law are not adequate to meet the new
challenges arising out of liberalisation and globalisation regime manifested by
the WTO agreement.”

The Bill also has the provision of empowering panchayats and
municipalities to collect statistics through due procedures. Once the new law
comes into force, the Government will appoint statistical officers for each
subject of data collection at the district and block levels.

(Source : The Times of India, dated 20-12-2008)

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Nirav Shah

Neta-builder nexus will sell Mumbai : Maharashtra CM

New Page 3

51 Neta-builder nexus will sell
Mumbai : Maharashtra CM

Maharashtra chief minister
Prithviraj Chavan said that there was a “dirty nexus among government officials,
politicians and builders in Mumbai,” and that these forces have the intention to
‘sell’ the city.

(Source : Times of India, dated 10-1-2011)

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Nirav Shah

Inflation and reforms — You can’t fight inflation by dithering on reform

New Page 3

49 Inflation and reforms —
You can’t fight inflation by dithering on reform

The common man’s headache
just got bigger. Food inflation spiked to 18.32% for the week ended December 25.
Worse, non-food prices seem northbound as well, including for petrol and
consumer durables. Borrowing costs too are up. Fears about the double whammy of
price rise and possible RBI rate hikes made the sensex nosedive last week, FIIs
exiting massively on the assumption of dented corporate earnings. Balancing the
persisting need to push growth with concerns on generalised inflation, RBI and
the government will have to take a tough call soon on more aggressive hardening
of monetary and fiscal policy, as IMF suggests.

(Source : Times of India, dated 10-1-2011)

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Nirav Shah

Why food is costlier

New Page 3

50 Why food is costlier

Twenty years ago, a Maruti
800, with an air-conditioner fitted, cost a little less than Rs.2 lakh. Today it
costs about Rs.2.5 lakh. Twenty years ago, a branded 1.5 tonne window
air-conditioner cost about Rs.30,000; today, you can get a split AC unit for
that price. Then, Videocon was offering large refrigerators for more than
Rs.30,000; you can get better units today for much less. TV prices have crashed
too, and one can go on with this list. In a period when salaries in the
corporate sector have gone up by about 15% annually, and inflation-adjusted per
capita income has roughly trebled, consumer durables of virtually every hue have
become infinitely more affordable.

Why has that not happened
with onions ? In 1980, Indira Gandhi swept back to power on the back of an
election campaign that talked of onions costing the then stratospheric sum of
Rs.5 per kg. Now it is Rs.70. Home-grown apples (not the ones from Down Under)
cost over Rs.100 in Delhi, and lentils of various sorts have also hit
triple-digits. These price increases far outdo income increases, rapid though
they have been for most people, and it is simply not enough to seek palliatives
in short-term measures like raising interest rates. Nor is it enough to say that
there has been demand growth for proteins because of higher incomes. There has
been comparable demand growth for eggs, but they have not seen similar price
inflation. Nor is it good enough to argue that there are global shortages in
commodities — both cyclical (as in sugar) and structural (lentils).

The truth is that we face
inflation in agricultural products, on a scale that we don’t see in manufactured
products, because agriculture has not been reformed, whereas industry has. There
is talk of collusion in onion prices — which raises the question of reforming
trade. Everyone knows that the difference between farmgate and retail prices is
unusually high in India, in part because of multiple intermediaries. But the
country has not been able to benefit from supply chain efficiencies because
organised retail has not been allowed to grow, and to link producer and consumer
prices more closely by squeezing out middlemen. Politicians who for two decades
have opposed reforms in both agriculture and trade will be loath to own up
responsibility for today’s food price inflation; they should know that the
situation will get worse if reforms are not introduced even at this late stage.

The prime minister should do
for agriculture and domestic trade what he did for industry and export trade 20
years ago.

(Source : Business Standard, dated 8-1-2011)

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Nirav Shah

Visa, MasterCard business model threatened

New Page 3

48 Visa, MasterCard business
model threatened

Visa Inc and MasterCard Inc
may face permanent damage to the fastest-growing part of their business after
the US Federal Reserve proposed rules that could cut debit-card transaction fees
by 90%.

The Fed proposed capping
so-called interchange fees at 12% each. Currently, the networks charge merchants
an average of 1% of the purchase price, regardless of cost, and pass that money
along to card-issuing banks.

The change, if approved by
the Fed after a public comment period, would wipe out most of an estimated $ 15
billion in annual revenue for US lenders that issue Visa and MasterCard debit
cards, including Bank of America, JPMorgan Chase & Co and Wells Fargo & Co.

(Source : Business Standard, dated 18-12-2010)

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Nirav Shah

Other banks in firing line

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47 Other banks in firing line :

The Deutsche Bank settlement
is part of a wider US drive to crack down on banks that help wealthy Americans
evade taxes and could herald similar settlements with other banks.

(Source : Business
Standard, dated 23-12-2010)

(Comment : What are
the authorities in India doing ? What is the outcome ?)

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Nirav Shah

Deutsche Bank settles US Tax case for $ 553 million

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46 Deutsche Bank settles US
Tax case for $ 553 million

Deutsche Bank admitted
criminal wrongdoing for taking part in fraudulent tax shelters that let clients
hide billions of dollars, and agreed to pay $ 553.6 million to settle the case,
US prosecutors said on Tuesday.

The settlement is part of a
larger US government effort to crack down on banks that help wealthy Americans
evade taxes. Prosecutors last year settled with Swiss bank UBS, which paid $780
million in fines for helping clients with roughly $20 billion in assets hide
their accounts from the US Internal Revenue Service.

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Nirav Shah

Binayak Sen — Political dissent isn’t sedition, that’s the law

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45 Binayak Sen — Political
dissent isn’t sedition, that’s the law

The judgment of the
Chhattisgarh trial court, sentencing Binayak Sen to life imprisonment on charges
of sedition and conspiracy, isn’t just shocking due to the concerned judge’s
apparent waiver of the gaps in the prosecution’s case. In a wider context, it
posits the spectre of intolerance against critics of state policy. The intent
behind the law on sedition in the Indian Penal Code, as introduced by the
British, was to enable the colonial state to deal with the fundamental
contradiction between the illegitimacy of its rule and its attempt to try and
legitimise that rule by criminalising those who sought to underline that
contradiction. That rupture between the state and the people it governs
disappeared, in principle, with Independence. And so the Supreme Court in 1962
defined S. 124A (on sedition) as being applicable only when there was a clear
incitement to violence or armed rebellion. Implicit in that definition is the
recognition of the Constitutional right to free speech, and political activity,
as long as it does not violate that red line of violent disaffection against the
state.

(Source : Economic
Times, dated 28-12-2010)

(Comment : Should not
we jettison the British legacy of law in such matters ?)

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Nirav Shah

Nitish’s move to scrap LAD fund may find more takers

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44 Nitish’s move to scrap
LAD fund may find more takers

As expected, the Cabinet
formally approved the proposal to abolish the Local Area Development (LAD) fund
meant for the legislators, a decision which other states may emulate. “Some
alternative arrangement will we worked out which will enable the legislators to
have a say in the approval of the schemes,” the Principal Secretary, Cabinet
Coordination department Afzal Amanullah said.

All along the Nitish
government in its previous tenure harped on the credo of good governance and in
keeping with what it promised earlier, the Cabinet formally approved a detailed
agenda for good governance. “The core issues of good governance and what the
government proposed to do in this connection have now been spelt out in the
17-page document which was placed before the Cabinet meeting,” the principal
secretary said, adding there will be zero tolerance on corruption “Already armed
with stringent laws, the government will now bring a legislation — Right to
Service Bill — to weed out corruption in the delivery of the public utility
service,” he said.

(Source : Economic Times, dated 15-12-2010)

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Nirav Shah

E&Y sued for hiding Lehman fraud for 7 years

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43 E&Y
sued for hiding Lehman fraud for 7 years

New York attorney general
Andrew Cuomo sued Ernst & Young, accusing the firm of facilitating a ‘major
accounting fraud’ by helping Lehman Brothers deceive the public about its
financial condition.

For more than seven years
before Lehman declared bankruptcy in 2008, the investment bank engaged in
transactions approved by E&Y whose purpose was to move debt off its balance
sheet and make it appear less leveraged, Cuomo said. This was done through what
are known as ‘Repo 105’ transactions. “This practice was a house-of-cards
business model designed to hide billions in liabilities in the years before
Lehman collapsed,” Cuomo said on Wednesday in one of his last cases as attorney
general. “Just as troubling, a global accounting firm, tasked with auditing
Lehman’s financial statements, helped hide this crucial information from the
investing public.” The state seeks to recover more than $ 150 million in fees
collected by E&Y for performing Lehman’s work between 2001 and 2008, plus
investor damages and equitable relief, Cuomo said.

(Source : Times of India, dated 23-12-2010)

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Nirav Shah

Finance Ministry probes overseas deals for tax evasion

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42 Finance
Ministry probes overseas deals for tax evasion

The finance
ministry has begun its maiden investigation into over 100 offshore ‘financial
structuring deals’, undertaken by Indian business entities in foreign tax havens
to allegedly evade the taxman’s net.

The multi-pronged
probe has been undertaken by the international taxation wing of the Income Tax
department and the foreign taxation unit in the Central Board of Direct Taxes
(CBDT).

A number of
investments and deals to the tune of hundreds of crores of rupees have already
been executed in tax havens like the Mauritius, Isle of Man, Cyprus, British
Virgin Islands and Bermuda, among others.

The finance
ministry is already working to finalise Tax Information Exchange Agreements
(TIEAs) with countries like the UAE, Kuwait, Oman, Saudi Arabia, Qatar, Jordan,
Syria, China, Indonesia, Israel, Japan, Malaysia, Mongolia, South Korea and
Vietnam.

Furthermore,
Double Taxation Avoidance Agreements (DTAAs) with more than 70 countries are
being finetuned.

The I-T department
is also looking into evasion of Tax Deducted at Source (TDS) by some companies
while making payments to purchase overseas shares, but sources declined to name
the entities involved.

(Source :
Business Standard, dated 13-12-2010)

(Comment : People
shall eagerly await the tangible outcome of the probes !)

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Nirav Shah

Part A: Services vis-à-vis Builders and Developers

Service Tax

Background in brief :

Services in relation to construction activity are covered in
the service tax law under the three main categories of services in the Finance
Act, 1994 (the Act) viz.

Commercial or
industrial construction [S. 65(105)(zzq)]

Construction of
residential complex [S. 65(105)(zzzzh)]

Works contract service [S. 65(105)(zzzza)]

These taxing entries were introduced in the service tax law
at different times during 2004 to 2007.

A tremendous amount of controversy has been generated
recently on account of insertion of the following explanation in the sub-clause
(zzzzh) of S. 65(105) of the Act by the Finance Act, 2010 with effect from
1-7-2010 :

“Explanation — For the purposes of this sub-clause,
construction of a complex which is intended for sale, wholly or partly, by a
builder or any person authorised by the builder before, during or after
construction (except in cases for which no sum is received from or on behalf of
the prospective buyer by the builder or a person authorised by the builder
before the grant of completion certificate by the authority competent to issue
such certificate under any law for the time being in force} shall be deemed to
be service provided by the builder to the buyer.”

(A similar explanation is also inserted in sub-clause (zzq)
of the Act).

Consequent upon the Tribunal decision in the case of Daelim
Industrial Co. Ltd. v. Commissioner, 2006 (3) STR 124 (Trib.-Del.) and later
dismissal of Special Leave Petition filed by the department against the above
decision, already a debate was generated as to whether or not construction
services provided under any works contract were at all liable for service tax
prior to 1-6-2007 i.e. at the time of introduction of works contract service in
the service tax law.

To add to this controversy, the Supreme Court’s decision in
the case of K. Raheja Development Corporation v. State of Karnataka, 2006 (3)
STR 337 (SC) and ruling of the Authority for Advance Rulings in Re : Hare
Krishna Developers 2008 (10) STR 341 (AAR) created a controversy as regards
service tax applicability to builder/developer in cases where construction was
undertaken by a builder for a prospective customer under an agreement for sale.
The issue remained contentious on account of various clarifications and judicial
pronouncements although it was almost settled when the Board issued a
clarification vide its Circular No. 108/2/2009-ST dated 29-1-2009 inter alia
that the activity of a builder amounted to ‘self service’ and would not be
subject to service tax.

However, with the insertion of the above explanation in the
two cited sub-sections of the Act, the issue has resurfaced with even greater
force. The Government vide its Circular DOF No. 334/1/2010-TRU dated 26-2-2010
clarified the nature, background and reasons for the imposition of service tax
on the activity of sale of unit of commercial/industrial or residential complex.
An extract from the same is reproduced below :

“8.5 These different patterns of execution, terms of payment
and legal formalities have given rise to confusion, disputes and discrimination
in terms of service tax payment.

8.6 In order to achieve the legislative intent and bring in
parity in tax treatment, an Explanation is being inserted to provide that unless
the entire payment for the property is paid by the prospective buyer or on his
behalf after the completion of construction (including its certification by the
local authorities), the activity of construction would be deemed to be a taxable
service provided by the builder/promoter/developer to the prospective buyer and
the service tax would be charged accordingly. This would only expand the scope
of the existing service, which otherwise remains unchanged”.

The insertion of the explanation in both the categories of
services of construction has given rise to a number of issues as the explanation
seemingly has created a deeming fiction whereby money received by a builder or
developer for units under construction is considered a receipt towards taxable
service of construction even though the money is received towards the sale of
such unit for the reasons stated in the above circular. Assuming for the time
being that builders are liable for service tax unless they have sold the fully
completed residential or commercial unit, some important issues that emerge in
the scenario are discussed below :

It is required to note that the scope of definitions of
taxable services is extended only in respect of commercial or industrial
construction and construction of residential complex and not in the definition
of ‘works contract’ which also specifically includes contracts for construction
of commercial/industrial buildings or civil structure and contracts for
construction of new residential complex. Therefore, the question that arises is
whether intentionally no explanation was inserted under the works contract
service based on the reasoning that contracts entered into by the builders with
flat purchases are not works contracts.

Whether construction service provided for personal use of
buyer is taxable on account of the new explanation ?

The definition of the term ‘residential complex’ in S. 65(91a) of the Act specifically excludes a complex which is constructed by a person directly engaging any other person for designing/planning/ construction and is intended for personal use as residence by such person. The definition further provides that personal use includes permitting use of such property as residence by another person on rent or even without consideration. At this point, it is also relevant to note that applying criterion of personal use, CBEC in a clarification provided in respect of construction contract awarded by Government to NBCC contended to the effect that the Government buying property for its personal use from a builder viz. NBCC, the transaction of sale would not be covered by service tax. If one extends the interpretation to the situation of buying property for one’s personal use from a developer/builder, isn’t it in the fitness of things to contend that every person buying a residential unit for ‘personal use’ in terms of the definition of ‘residential complex’ inherently falls out of the purview of service tax in terms of the definition of ‘residential complex’ itself? A clarification from CBEC would put to rest the uncertainty over the vital and contentious issue at least in the case of builders of residential units to a large extent. The issue however as to the units bought for other than personal use and commercial or industrial properties still would remain open.

On going contracts as on July 01, 2010:

As the deeming provision vide Explanation is effective from 1-7-2010, services provided from this date only would be leviable to service tax. In case of ongoing construction of buildings as on this date, the issue of calculation of service tax liability arises as a number of permutations and combinations of situations are possible; such as construction completed partially, construction completed but completion certificate not received, bookings made and advances received partially and of different amount, in respect of different units etc. Further complications may arise on account of receipt of full amount in case of completed construction in respect of some units and partial receipt in respect of other units in the same building as on 1-7-2010. Further, in the same complex, some units may be only partially completed as on 1-7-2010 and therefore service as well as payment of money would be completed only after 1-7-2010. The builders/developers therefore would require proper accounts and records to facilitate such bifurcation. Typically all civil contractors issue running bills but builders/developers do not issue ‘running bills’ on prospective buyers as they only book units or flats to be sold to prospective purchasers. However, in any scenario, the ‘taxable event’ arising only on provision of service. Therefore, services provided before 1-7-2010 are not liable for service tax in case of liability arising out of deeming provisions. To ascertain the extent and stage of completion, one may have to obtain a certificate from an architect or a chartered engineer. The explanation has referred to ‘authority competent to issue completion certificate’. Vide order No. 1/2010 dated 22-6-2010, the Government has issued Service Tax (Removal of Difficulty) order, 2010 whereby it is provided that besides any Government authority, the following persons are authorised to issue a completion certificate for the purposes of sub-clauses (zzq) and (zzzzh) of S. 65(105) of the Act:

Registered architect

Chartered engineer

Licensed surveyor

Any of the above persons thus may issue a completion certificate in respect of residential or commercial or industrial complex as a pre-condition for its occupation.

Service tax liability on advances:

When any advance is received towards a taxable service, service tax is liable to be paid. Accordingly, in normal course, advance received for services provided post July 01, 2010, the service tax liability would have arisen. However, Notification No. 36/2010 dated 28 -6-2010 has been issued to provide exemption to any amount of advance re-ceived prior to 1-7-2010 for various taxable services provided on or after 1-7-2010. The said Notification inter alia also applies to construction services in respect of residential and commercial/industrial construction services. Therefore, the entire sum of money received as advance from prospective purchasers towards any unit in a building by a builder or a developer prior to 1-7-2010 is not liable for service tax in case of construction services remaining pending to be provided in the period post 1-7-2010.

Valuation of element of ‘service’ for a builder/ developer:
Builders and developers have the options available under the law for determining their service tax liability.

Pay service tax at prevailing rate on 25% of the gross value received where the price of the land is included.

Pay service tax at prevailing rate on 33% of the gross value where the price of the land is not included.

[Note: In both the above options, while determining the ‘gross value’, value of goods and material supplied, provided or used is required to be added as per the condition laid down in Notification 1/2006-ST. Therefore, if the customer has supplied any material, its value will have to be added to the ‘gross value’ before working out 25% or 33% as the case may be. Further, no CENVAT credit is available, if any of the above options is selected].

Pay service tax at prevailing rate taking benefit of Notification 12/2003-ST of 20-6-2003 under which value of the goods sold/transferred would be completely excluded and exempted.

Whether constitutional validity of the provision challengeable?

The above deeming provision applicable to build-ers/developers was challenged by them before various High Courts. The Bombay High Court in the case of Maharashtra Chamber of Housing and Industry v. UOI, (2010 TIOL 526 HC Mum.-ST) granted an interim stay to the petitioners. The Madras High Court also granted an interim stay in the case of A. P. Ravi v. UOI, (2010 TIOL 604 HC Mad.-ST).

However, recently in the case of G. S. Promoters v. UOI, 2011 (21) STR 100, Punjab & Haryana High Court has pronounced its judgment and upheld the validity of the Explanation inserted in S. 65(105) (zzzzh) . In this case, the petitioner sought to declare the Explanation to S. (105)(zzzzh) of the Act and CBEC Circular No. 334/3/2010 -TRU dated 1-7-2010 as unconstitutional. According to the peti-tioner, the Explanation enlarged the scope of the levy beyond the concept of service by including therein sale. It was pleaded that sale and purchase was beyond the legislative competence of the Union legislature. If construction activity is not undertaken by a builder, then the builder cannot be considered to be a service provider in relation to services of construction activities. The petitioner relied upon the stay granted by the Bombay High Court on this issue. They also placed reliance on the decision in the case of Magus Construction P. Ltd. v. UOI, 2008 TIOL 321 HC wherein it was held that if construction activity is not undertaken by a builder, the builder cannot be considered a service provider of construction service.

The High Court did not accept the contentions of the petitioner and made the following observations:

Referring to the Supreme Court’s judgment in All India Federation of Tax Practitioners & Others 2007 (7) STR 625 (SC), it was observed that the Supreme Court has upheld the power of the Central Government to levy tax on services under Residuary Entry 92 of the Union List and that legal back-up was further provided by Article 268-A in the constitution vide the 88th Amendment in 2003.

On the scope of the legislative entry, it observed that “the entries in the lists being merely topics or fields of legislation, they must receive a liberal construction inspired by a broad and generous spirit and not in a narrow pedantic sense.

The High Court took note of the fact that there was no challenge to the effect that there was any encroachment in the legislative power of the State legislature through the above amendment except the submission that there was element of sale which was sought to be taxed.

Relying on the decisions of State of Madras v. Gannon & Dunkerley & Co. (Madras) Ltd., AIR 1958 SC 560, Imagic Creative P. Ltd. v. CCT, 2008 TIOL 04 SC VAT and Tamil Nadu Kalyana Mandapam Association v. UOI, 2004 (167) ELT 3 (SC), the High Court observed that service tax is a tax on service and not on a service provider. Quantification of tax should not be confused with the nature of tax and discussed at length on the aspects of ‘nature of tax’ and ‘measure of tax’.

The High Court distinguished the judgment of the Gauhati High Court in the case of Magus Constructions Pvt. Ltd. 2008 (11) STR 225 (Gauhati) by merely observing that the Circular dated 1-8-2006 issued by CBEC taken note of by the Single Member Bench of the Gauhati High Court would not apply when service recipient is a purchaser of flat. The levy of tax is on service and not on the service provider. Construction services are certainly provided even when a constructed flat is sold. Taxing of such transaction is not outside the purview of the Union legislature when it does not fall in any of the taxing entries of the State List.

In terms of the above observations made by the High Court, it was held that the contention that there is no element of service of construction involved in a builder selling a flat cannot be accepted. Whether there is a service or not has to be obtained not only from builder’s angle but also from the recipient’s angle. Only service in relation to construction is sought to be taxed and it is definitely involved when construction is carried out or before construction and before flat is sold and therefore the levy could not be held unconstitutional.

The judgment being the first final ruling by a High Court on the issue of constitutional validity has generated sharp reactions among legal fraternity on account of various issues in addition to the legal or technical issue of relevance of Article 268A of the Constitution of India and insertion of Entry 92C in the Union List as the Court has referred to it as ‘legal back-up’. Leaving this aspect aside for the time being, the other issues that arise are:

Whether or not, the aspects of ‘nature of tax’ and ‘measure of tax’ while delivering the judgment had relevance as on examining the Explanation inserted in S. 65(105)(zzzzh), the question that arises is whether it merely deals with ‘measures of tax’ and that it maintains a nexus with the essential character of having ‘element of service’ of the levy? Or does it create only a deeming fiction by declaring the construction activity as ‘service’, when a part payment is received by a builder from a prospective buyer when essentially the trans-action is of sale of immovable property.

Further, while distinguishing the case of Magus Construction (supra), only reference to CBEC Circular dated 1-8-2006 is made and the P & H Court has stated that the circular will not apply when service recipient is a purchaser of flat and the levy is on the service and not service provider and construction service is certainly provided. Comparing the facts of both the cases, one may hardly find any difference and therefore the ground on which the distinction is made appears not easily digestible.

Conclusion:

In view of the above, it appears almost certain that the decision would be challenged before the Hon. Supreme Court. Further, there may not be any consequence of the judgment in the jurisdiction of the Bombay High Court and the Madras High Court as they have granted the interim stay in the matter. Yet elsewhere uncertain and untoward situation for the builders as well as flat buyers may continue as attempt by the department for the recovery of service tax may be made. The issue being highly complex and contentious, judicial testing seems inevitable.

[Note: Readers may note that the subject being complex, only preliminary issues are discussed above. A few other issues including a vital issue relating to builders involved in redevelopment activity would be discussed in subsequent issue of BCAJ.]

Nirav Shah

PM-Seize the Moment

New Page 3

41 PM-Seize the Moment

So the country is in a mess,
our institutions stand tarnished in the public eye, and the government faces a
credibility crisis. People are right to be both disillusioned and worried about
where matters are headed. The transition from unreal optimism to cynical gloom
in just a few weeks is breathtaking. This is a time for leadership, not
vacillation and hiding in corners.

What are the issues to be
addressed ? First is the quite incredible paralysis of Parliament, with
belief in the efficacy of its functioning so low that there is no discernible
public response to the loss of a whole session; what kind of democracy do we
have that it does not matter if Parliament is non-functional ? Second is
the growth of crony capitalism into a national cancer that corrupts any and
everything in sight. The third is linked to the second, namely the shady
sourcing of election funds — which, in turn, has become a cover story for
unchecked loot on an unprecedented scale. Fourth is the chaotic style
that has come to mark coalition governments, whereby each minister thinks he is
a law unto himself. And fifth is the state of affairs in the judiciary,
with even the Supreme Court and former chief justices coming under a cloud.

There is a second set of
five troubling issues. One is the steady emaciation and co-option, if not
downright subversion, of supposedly autonomous institutions that could keep the
rich and powerful in check, like the Central Bureau of Investigation, the Lok
Ayuktas, the Central Vigilance Commission . . . .; the result is not only that
the country’s rulers are effectively above the law, but also that they can
invade the privacy of private citizens through gross actions like telephone
tapping. Two, there is the suborning of the bureaucracy, which now mostly
comprises willing accomplices in the shenanigans of political masters, and which
asserts itself only to corner privileges for itself. Third is the defence brass,
whose reputation and image have taken a severe knock after the Adarsh scandal,
not to mention the general assumption of its involvement in corrupt purchase
deals. Fourth is the media, whose credibility has reached its lowest point ever,
in the wake of paid news scandals and now the Radia tapes which show up some
leading media personages as completely compromised individuals. And last, there
is the growing feeling that the state’s capacity to deliver is fundamentally
deficient, at a time when the state is being asked to do ever more.

These 10 overlapping crises
— involving politicians, civil servants, judges, businessmen, armed service
officers, journalists and publishers — have boiled over at the end of a long
process of deterioration in efficacy levels and standards of probity. It has
reached the point where business cannot go on as usual; the system must be
rescued because it is at risk — many countries that seemed on a rapid growth
track have been arrested in mid-stride by corrosion from within, resulting in
violent implosion. Think Indonesia.

But with such a daunting
list of challenges, you could be forgiven for asking where one begins. In fact,
though, the task is not very difficult. All that the prime minister and other
leaders need to do is to tap the latent desire for a change from today’s
dreadful situation. If they are seen doing that, there will be a groundswell of
support that itself creates an environment which facilitates other corrective
action. The specific steps are in themselves not difficult to design. If our
leaders cannot or will not take these steps, then they deserve to go. The
country deserves better.

(Source : Business Standard, dated 18-12-2010)

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Nirav Shah

Vision

New Page 3

40 Vision

When you can clearly see
where you’re going, you greatly improve your chances of getting there. The more
clearly you can visualise your goals, the more likely you are to reach them.
It’s slow and difficult to make any progress, and even when you arrive you may
not know you are there. Yet when goals are clear, specific, and filled with rich
details, all kinds of great opportunities for moving towards them will continue
to come in view. —
Anonymous

To
believe in the things you can see and touch is no belief at all. But to believe
in the unseen is both a triumph and a blessing. — Bob Proctor

Vision without action is a dream. Action without vision is simply passing time.
Action with vision is making a positive difference. — Joel Barker

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Nirav Shah

Tax Department slams BCCI, says its activities are commercial

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58
Tax Department slams BCCI, says its activities are commercial

The Board of Control for Cricket in India (BCCI) has become
totally commercial and all its activities are being carried on commercial lines.
Cricket is only incidental to its scheme of things. It is more into prize money
for every run or wicket, which is nothing short of a gimmick.

This is what the income-tax department has to say about the
BCCI in its assessment order dated December 30 last year, while disallowing tax
exemptions for the BCCI. The exemptions were earlier being granted on the
grounds that promoting cricket was a charitable activity.

The BCCI’s net income for 2006-07 was Rs 274.86 crores. The
I-T assessment order means that the body will have to pay Rs 120 crores as tax
plus the yet-to-be-quantified penalty amount.

The exemption for BCCI from being taxed was there till
2006-2007 and was withdrawn after the cricket body amended its memorandum and
rules twice. The added objectives included establishing coaching academies and
holding 20-over matches. Income-tax norms stipulate that the changed objectives
should be brought to its notice; this, say I-T officials, was not done by the
BCCI.

The order further says: The conduct of certain activities and
receipt of income from these activities clearly show that these activities are
totally commercial and there is no element of charity in the conduct of the BCCI.
It is evident that the major income arises not from the game of cricket but from
the business of cricket. The order adds: The characteristics of volume,
frequency and regularity of the activities accompanied by profit motive on the
part of the assessee have been held to indicate an intention to continue the
activity as business. The I-T order also says that BCCI’s rules are very
stringent and that it imposes a blanket ban on unapproved tournaments. The BCCI
is exercising complete control over the revenue of tournaments and is not
interested in the promotion of cricket, the order says. The money recovered by
way of media rights and sponsorship is not only to meet the expenses of
organising tournaments but is bound to create a huge surplus. And the surplus
generated by the BCCI is shared with players instead of being used for promoting
the game, the order says, adding that only 8% is spent on promotion of sports.
The BCCI has not developed any infrastructure nor has it built any stadium or
other amenities. Referring to the IPL, a BCCI wing that organises the hugely
popular T-20, the assessment order says: Acts indicate the intention.

Referring to an agreement between the BCCI and Nimbus
Communications for coverage of its events from March 1, 2006 to March 31, 2010,
where the BCCI intended to generate revenue through mobile rights, official film
rights, fixed media rights and public exhibition rights, the I-T department has
said: The very foundation of the agreement is based on commercial exploitation
and benefit which explains the colossal amount of media rights fees of Rs
2,724.2 crore paid by Nimbus. In its sponsorship agreement with Nike, the BCCI
was entitled to Rs 45 lakhs and Rs 58 lakhs as compensation for every
international one-day and test match respectively. Besides this, the BCCI was
paid minimum guarantee royalty of Rs 13.5 crores for 2007 and performance
bonuses which came to Rs 1 crore.

The investments of the BCCI (fixed deposits with banks) have
also witnessed a jump of 36.74% in the last two years (from Rs 545 crores to Rs
745 crores). In the same period, the fixed assets have seen a rise of 179 per
cent (from Rs 3.3 crores to Rs 9.4 crores). According to the income and
expenditure account for the year 2008-2009, BCCI’s income was Rs 726 crores,
down from Rs 1,000 crores in 2007-2008; but this will be audited only in
December 2010.

(Source: The Times of India, dated 14.01.2010)

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Nirav Shah

Govt Panel to Push Reforms in Foreign Investment Norms

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57
Govt Panel to Push Reforms in Foreign Investment Norms

The government is looking to rationalise existing norms of
foreign portfolio and NRI investment, a move that is to have a major impact on
the flow of venture capital and private equity money into the country. A working
group of industry experts has been formed which includes members of both the
government as also the industry, to consider reforms.

Among the top issues in the agenda for the working group will
be to review the existing policy on foreign inflows (other than Foreign Direct
Investments) and ways to attract more foreign investment and reduce policy
hurdles while maintaining the “Know Your Customer” (KYC) requirements.

The group will also identify challenges in meeting the
financing needs of the Indian economy through foreign investment. It would look
at various forms of foreign investment including investment in listed and
unlisted equity, derivatives and debt, including the markets for government
bonds, corporate bonds and external commercial borrowings.

The group will also re-examine the rationale of taxation of
transactions through the STT and stamp duty. Although the government has in the
past refrained from scrapping STT, despite demands from capital market
participants, any change in the policy related to STT will have a major impact
on the stock markets.

(Source: Internet & Media Reports, dated 14.01.2010)

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Nirav Shah

Accounting norms (AS-11) under Bombay HC scanner

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56
Accounting norms (AS-11) under Bombay HC scanner

The union government’s move to suspend Accounting Standards
11, allowing companies to show foreign currency liabilities as assets, has come
under the Bombay High Court’s scanner. The petition, filed by an organisation of
city-based legal experts, “Just Society”, has claimed that this permits firms
that might otherwise be sick to “paint a rosy picture”.

The government had introduced AS 11 in 2006, which required
companies to record foreign currency monetary assets and liabilities at the
exchange rate on the balance sheet date. Last year, in the midst of the global
recession and swings in the exchange rate, the Confederation of Indian Industry
and the Associated Chambers of Commerce and Industry of India made
representations to the government, according to the petitioner.

Subsequently, the National Advisory Committee on Accounting
Standards (NACAS), a government-appointed body, suspended the implementation of
AS 11.

(Source: The Times of India, dated 13.01.2010)

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Nirav Shah

Transfer Pricing – CBDT panel to formulate safe harbour provisions

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55
Transfer Pricing – CBDT panel to formulate safe harbour provisions

The Central Board of Direct Taxes (CBDT) has set up a
committee to formulate rules for the safe harbour provisions—a set of rules that
would enable the income tax (I-T) authorities to accept the transfer pricing
returns without scrutiny.

Foremost among the committee’s tasks is to set an acceptable
margin which would act as a benchmark for the industry. For example, if the safe
harbour rules stipulate that the margin in a particular industry is 20%, and if
the transfer price declared by a company engaged in that industry is not less
than the margin, the I-T authorities would accept the return without questions.

The rules, once introduced, will lend an investment friendly
image to India. It will also put an end to the requirement of collecting huge
amounts of data regarding transfer pricing transactions, thereby saving time and
energy.

(Source: The Economic Times, dated 11.01.2010)

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Nirav Shah

Tax records of politicians under scrutiny

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53
Tax records of politicians under scrutiny

The Finance Ministry and the Central Board of Direct Taxes (CBDT)
have initiated a process of verification of the income-tax returns of all MPs
whose records are not available with the income-tax department, and to help them
verify whether they have paid appropriate taxes or not.

The decision has been taken by the Finance Ministry after
they found that many of them have paid partly or no taxes at all; and many of
their PAN details are not available with the department. So, it becomes really
tough for the department to ascertain their actual income. Those who are found
to be purposely involved in tax evasion will invite a heavy penalty and
scrutiny.

(Source: Internet & Media Reports, dated 05.01.2010)

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Nirav Shah

Govt to match netas’ I-T returns

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54
Govt to match netas’ I-T returns

The finance ministry has quietly initiated a process of
opening up the income-tax files of politicians belonging to all parties and
tallying their income statements with the affidavits filed by them with the
Election Commission during the 2009 parliamentary polls.

Verification of the assets declared by the Lok Sabha
candidates, many of whom have now become MPs and even ministers, will help the
department to assess if they had paid appropriate taxes as declared in their
statements with the two different authorities.

The finance ministry initiated the exercise after it found
that many of the candidates had made astounding declarations in their affidavits
to the EC, while initial scrutiny revealed that some of them had paid paltry or
no taxes. However, as many as 50% of the candidates in the 2009 LS polls had not
furnished their Permanent Account Numbers, making it difficult for the
department to ascertain the actual income of these people.

The department will be scrutinizing the I-T returns of all
Lok Sabha candidates irrespective of whether they ended up winning or not. A
letter from the Central Board of Direct Taxes (CBDT) has been circulated to all
those MPs whose records are not available with the I-T department or whose PAN
have not matched with the department’s records.

The details sought pertain to assessment years 2006-07 and
2007-08. The letter said: A verification exercise is being carried out by the
I-T Department, Ministry of Finance, in respect of affidavits filled by you at
the time of filing nomination for the general elections 2009.

For fear of being disqualified if statements made in the
affidavits were found to be untrue when elected, candidates had made some
astounding declarations. One candidate declared assets worth more than Rs 600
crores, while those having assets between Rs 100 crores and Rs 200 crores were
found in dozens during the 2009 polls.

(Source: Internet & Media Reports, dated 04.01.2010)

(Note: One sincerely hopes that vested interests are
not successful in sabotaging the whole exercise.)

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Nirav Shah

Foreign arms of Indian cos under tax net likely – Introduction of CFC Rules

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Foreign arms of Indian cos under tax net likely – Introduction of CFC Rules

The forthcoming budget may contain provisions for taxing the
undistributed dividends of foreign corporations that are controlled or owned by
Indian companies. Controlled Foreign Corporations (CFCs) laws enable the
authorities to tax the income of a resident derived from a foreign corporation.
This is irrespective of whether the profit/dividend of the foreign entity is
transferred to India or not.

Countries adopt CFC laws mainly for checking the probable
loss of revenue arising from the transfer of profit of foreign corporations to
offshore havens, such as the Isle of Man and Cayman Islands.

CFC laws are in force in at least 25 countries with varying
rules and regulations. In the US, for instance, 50 per cent of the voting rights
or 50 per cent of the value of shares constitutes a CFC.

The Indian tax authorities think it is time India had a law
that will tax the profits of foreign corporations that are controlled by Indian
companies. Since cross-border acquisitions by Indian companies have been on the
rise in the recent past, the government may find it difficult to ignore the
demand of the tax authorities.

(Source: The Economic Times, dated 05.01.2010)

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Nirav Shah

Finmin opposes FDI maths, wants review

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Finmin opposes FDI maths, wants review

Under the new rules for indirect foreign investments, issued
through Press Notes 2 and 3 last year, all investments by an Indian-owned and
controlled company will be classified as domestic investments, even if the
company has significant foreign stakes. The earlier norms counted only the
proportionate amount as FDI in the downstream subsidiary.

For example, if a 51 per cent Indian-owned company floats a
subsidiary with a 50 per cent stake, and the balance 50 per cent is held by
foreign investors, its entire 50 per cent investment in the subsidiary would be
counted as local investment under the new norm. This will allow the company to
invest in any sector, even those closed to foreign investment.

In telecom, for instance, which has a foreign investment
limit of 74 per cent, companies can now get foreign investment above the allowed
cap through a multilayered subsidiary structure. The flip side for companies is
that the total investments of those with more than 50 per cent foreign holding
in a subsidiary would be counted as foreign investment.

Leading Indian banks such as ICICI Bank, HDFC Bank and
Development Credit Bank would be considered foreign for the same reason.
Investments of these banks in a subsidiary would also be classified foreign.
This is not only a check on their investments in sectors with limits on foreign
investments, but also branch expansion.

Though the finance ministry had written to the DIPP earlier,
the communications were largely centred around the impact of the new FDI norms
on the banking sector. The ministry’s missives came after the RBI highlighted
the implications of the new norms on the banking sector.

(Source: The Economic Times, dated 05.01.2010)

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Nirav Shah

Agricultural land laws : btala, 1948

1. Introduction:

In the previous two articles, we examined the Maharashtra Land Revenue Code, 1966. We continue with our study of laws pertaining to agricultural lands in the State of Maharashtra by examining Acts which impose a ceiling on agricultural land. Agricultural land ceiling and use in Maharashtra is governed by the following two Acts :

(a) Bombay Tenancy and Agricultural Lands Act, 1948 (‘BTALA’)

(b) Maharashtra Agricultural Lands (Ceiling on Holdings) Act, 1961.

This Article gives a bird’s-eye view of the BTALA (also ‘the Act’). This Act is relevant to companies since it lays down the situations under which an agricultural land can be transferred to a non-agriculturist. This would be relevant to ascertain how and when can a company acquire agricultural land. If a Company acquires agricultural land in contravention of the Act, it can have serious consequences. The prohibition on companies acquiring agricultural land is also found under other laws. For instance, sometime ago, the Enforcement Directorate raided the offices of a large real estate developer company since it had acquired agricultural land with the proceeds of Foreign Direct Investment.

2. Applicability:

2.1 The Act is applicable to the Bombay Area of the State of Maharashtra. The Bombay Re-organisation Act, 1960 divided the State of Bombay into two parts, namely, Maharashtra and Gujarat. Thus, the BTALA is in force in the whole of Maharashtra except the Marathwada (Latur, Nanded, Aurangabad) and Vidarbha (Nagpur, Akola, etc.) regions.

2.2 The Act seeks to govern the relationships between tenants and landlords of agricultural lands. Further, it lays down the law in respect to fixation of rent, rights of tenants, etc. Thus, it is similar to the Maharashtra Rent Control Act, 1999.

3. Definitions:

3.1 The Act defines the term ‘agriculture’ to include the following :

(a) horticulture

(b) raising of crops, grass or garden produce

(d) the use of any land for the purposes of rab manure

However, it states that the following are not agriculture :

(a) allied pursuits

(b) cutting of wood alone

Since the definition is an inclusive one, it retains its common parlance meaning as well as something more — Official Asssignee v. Maheshri Firm of Chandulal, 71 IC 657.

This is a definition which has been the series of a spate of controversies. Even under other Acts such as the Income-tax Act, there are several decisions on what constitutes agriculture. The decision of the Supreme Court in the case of CIT v. Benoy Kumar Sahas Roy, AIR 1957 SC 768 is relevant in this respect. It held that the term agriculture cannot be disassociated from the primary significance thereof, which is cultivation of the land and even though it can be extended in the manner both in regard to the process of agriculture and the products which are raised upon the land, there is no warrant for extending it to the land.

The expression emphasises the cultivation of land. Any operation which has something to do with the land, any operation which helps the land to yield the fruits or its crops, any operation which proves the natural produce of the land, may come within the expression — N. G. Desai v. State of Bombay, 57 Bom. LR 199.

3.2 The term ‘agriculturist’ is defined to mean someone who cultivates land personally.

4. Tenant:

4.1 A tenant is defined to mean a person who holds land on lease and includes :

(a) A person who is deemed to be a tenant u/s.4

(b) A person who is a protected tenant; and

4.2 A permanent tenant means one who was considered accordingly prior to 1955 or someone whose commencement or duration of tenancy cannot be satisfactorily proved by reason of antiquity.

4.3 Deemed tenant:

4.3.1 A person lawfully cultivating any land belonging to another person is deemed to be a tenant if such land is not cultivated personally by the owner. Further, such a person should not be a part of the owner’s family or be his servant or be a mortgagee in possession.

4.3.2 Lawful cultivation is of prime importance and hence, the landlord must have placed his tenant in lawful possession of the land. If a litigation is pending in respect of the title to the land, cultivation on that land would not be lawful.

4.3.3 Land is said to be cultivated personally if a land is cultivated on one’s own account by :

(a) one’s own labour. An agriculturist lady continues to be so even after her marriage and she can continue her occupation as an agriculturist — Babib Doshi v. Dy. Collector, 1986 CLH 845. The cultivation must not be as an agent of the owner.

(b) by labour of family members, i.e., spouse, children or siblings in case of a joint family. A joint family is defined to mean an HUF and in case of other communities, a group or unit the members of which are by custom joint in estate or residence. In one case, even a married sister living with her husband has been regarded as a part of the family — Case No. 8953 O/154 of 1954.

(d) cultivation through an agency on behalf of the juristic person does not come within the meaning of the words to cultivate personally in S. 2(b). An idol or juridical person is not capable of cultivating personally

— Shri Kalanka Devi Sansthan Patur v. Pandu Marotti, 1963 Mah LJ 249

4.3.4 A relative of a landlord does not automatically become a deemed tenant unless the relationship of landlord and tenant is proved — Smt. Amtibai Jesangbai v. Patel Purshottamdas, AIR 1983 (Guj.) 84.

4.3.5 The onus is on the person who alleges that he is a tenant to demonstrate that he is a tenant. All persons other than those specifically excluded and who are lawfully cultivating land belonging to others are deemed to be tenants.

4.3.6 If a person is cultivating a land under an Agreement of Sale he does not become a deemed tenant
— Ambalal v. Mangalbai, (1978) 19 GLR 799.

4.4 A protected tenant means one who has been afforded such protection under the earlier Tenancy Act of 1939.

5. Ceiling Area:
5.1 Ceiling Area means the area of land fixed as ceiling area u/s.5 or u/s.7 in relation to land held as an owner or a tenant. It may be noted that this ceiling is different and separate from the ceiling fixed under the Maharashtra Agricultural Lands (Ceiling on Holdings) Act, 1961. The objective of fixing a ceiling is to give each family a fair amount of subsistence, secondly to arrive at the economic unit or cultivation and thirdly to enable larger cultivation areas to those who can afford them in-sofar as it does not hamper equitable distribution of land.

5.2 The ceiling, depending upon the type of land, is as follows:

48 acres of jirayat land, i.e., dry crop land

24 acres of seasonally irrigated land or paddy or rice land

12 acres of perennially irrigated land

If the land consists of a combination of the above, then the ceiling shall be determined as follows:

1 acre of perennially irrigated land = 2 acres of seasonally irrigated land/paddy land = 4 acres of jirayat land

Warkas land, i.e., land used for rab manure for rice cultivation is to be excluded. Further, potkahraba land, i.e., one which is not fit for cultivation is not to be included in computing the land.

5.3 The Economic Holding is as follows:

16 acres of jirayat land

8 acres of seasonally irrigated land or paddy or rice land

4 acres of perennially irrigated land

If the land consists of a combination of the above, then the ceiling shall be determined as specified for ceiling computation.

While people should be allowed to own land to the maximum extent possible, the cultivators must be given enough to at least maintain themselves and their family’s proper standard of living. This is taken care of by economic holding.

6. Rent control and tenancy protection:

6.1 The Act contains provisions for the following:

(a)    Fixing the minimum and maximum rent for agricultural land
(b)    Fixing the rent by the mamltadar for different classes of land situate in a village
(c)    Liability of tenant to pay land revenue, irrigation cess and certain other cesses
(d)    Termination of tenancy under certain cases, such as, non-payment of rent, unlawful assignment/sub-letting, permanently damaging the land, etc.
(e)    Surrender of tenancy by the landlord
(f)    Provisions for dwelling houses of tenants
(g)    Tenants right to certain trees planted by him and produce thereon
(h)    Prohibition on a tenant from sub-dividing, sub-letting or assigning the land
(i)    The landlord is entitled to recover possession of the land if he requires it bona fide for cultivation personally or for any non-agricultural purpose. However, the landlord needs to give a notice to the tenant for the same.

Nirav Shah

Partnership Firm — Stamp Duty Issues

Laws and Business

1. Introduction :

1.1 Partnership is probably the oldest form of doing
business. Even today, a majority of the businesses in India are organised as a
‘partnership’.

1.2 Stamp duty is an important source of revenue for the
Maharashtra Government.

1.3 This article deals with some issues relating to stamp
duty, which are peculiar to partnership.

2. Charge of stamp duty :

2.1 The Bombay Stamp Act, 1958 (‘the Act’), which is
applicable to the State of Maharashtra, levies stamp duty u/s.3 of the Act,
which reads as follows :

“3. Instrument chargeable with duty

Subject to the provisions of this Act and the exemptions
contained in Schedule I, the following instruments shall be chargeable with
duty of the amount indicated in Schedule I as the proper duty therefor
respectively, that is to say :

(a) every instrument mentioned in Schedule I, which is
executed in the State . . . . . . ;

(b) every instrument mentioned in Schedule I,
which . . . . . ., is executed out of the State . . . ., relates to any
property situate, or to any matter or thing done or to be done in this State
and is received in this State :”

From the analysis of S. 3, the following points emerge :

(a) The stamp duty is leviable on an instrument and
not on a transaction.

(b) The stamp duty is leviable only on those instruments
which are mentioned in Schedule I to the Act.

(c) The stamp duty is leviable on the instrument if it is
executed in the State of Maharashtra or on the instrument which, though
executed outside the State of Maharashtra, relates to any property situate, or
to any matter or thing done or to be done in the State and is received in the
State. Hence, for example, even if the instrument of partnership is executed
outside the State of Maharashtra, but if the partnership is located in
Maharashtra, and the instrument of partnership is received in Maharashtra,
then it would be subject to stamp duty under the Act.

(d) The charge of stamp duty is subject to the provisions
of this Act and the exemptions contained in Schedule I.

2.2 Instrument :

The term ‘instrument’ is defined in S. 2(1) of the Act as
follows :

“(1) ‘instrument’ includes every document by which any
right or liability is, or purports to be, created, transferred, limited,
extended, extinguished or recorded, but does not include a bill of exchange,
cheque, promissory note, bill of lading, letter of credit, policy of
insurance, transfer of share, debenture, proxy and receipt.”

Stamp duty is leviable only on a written document which falls
within the definition of instrument.

2.3 Schedule I :

Since stamp duty is levied only on the instruments specified
in Schedule I, let us look at Schedule I. Only Article 47 of Schedule I
specifically provides for levy of stamp duty on partnership.

2.4 The term ‘instrument of partnership’ and the term
‘partnership’ have not been defined in the Act.
Hence, the term ‘partnership’ would have to be under-stood as defined in the
Indian Partnership Act, 1932.

3. Stamp duty on formation of partnership :

3.1 Stamp duty on formation of partnership is levied under
Article 47(1).

3.2 According to that Article, the stamp duty on the
instrument of partnership or the deed of partnership depends upon the capital
contribution made by the partners as explained below :

(a) If the capital contribution is made only by
way of cash, then the minimum amount of stamp duty is Rs.500. Where the
contribution brought in cash is in excess of Rs.50,000, the stamp duty is
Rs.500 for every Rs.50,000 or part thereof. However, the maximum amount of
stamp duty payable is Rs.5,000. In other words, if the capital ranges from
Rs.50,000 to Rs.500,000, the stamp duty would range from Rs.500 to Rs.5,000.
If the capital contributed in cash is in excess of Rs.500,000, then the stamp
duty payable would be the maximum amount of Rs.5,000.

(b) Where capital contributed by partners is
by way of property other than cash, then the stamp duty payable is
that leviable on a conveyance under Article 25.

3.3 Article 25 :

Since Article 25 is made applicable to partnership, the
relevant provisions of Article 25 are summarised below :

Clause (a) levies stamp duty on movable
property @ 3%.

Clause (b) levies stamp duty on immovable
property. The stamp duty depends upon the location of the property, that is,
whether it is in a rural area or in an urban area and also upon the class of
municipality. The stamp duty for the city of Mumbai, is 5%.

Clause (c) provides that if it relates to both movable
and immovable property, then stamp duty will be payable at rates specified in
clauses (a) and (b), respectively. In other words, in respect of movable
property at 3% and in respect of immovable property at the rates applicable
under clause (b).

Clause (d) has two sub-clauses and both apply only to
residential premises and provide a concessional slab-rate levy in the case
of flats in a co-operative housing society.

4. Admission of partner or additional capital by
partners :

4.1 Since admission of a partner requires a fresh instrument of partnership, the question of payment of stamp duty under Article 47 would arise. However, it would be restricted only to the share of contribution brought in by the incoming partner or additional contribution brought in by the existing partners. If the incoming partner does not bring in any capital, stamp duty payable would be the minimum sum of Rs. 500.

4.2 If in an existing partnership, additional capital is brought in by one or more partners, whether it would attract stamp duty under Article 47(1) ? It is submitted that if a fresh partnership deed is not executed, then stamp duty is not payable, otherwise it would be payable only on the additional capital. The following decisions under the Income-tax Act have held that a registered document is not required when a partner introduces his immovable property into a partnership firm as his capital contribution, but a registered document is required when a partner wants to withdraw an immovable property from the firm:

a) Abdul Kareemia & Bros. v. CIT, (1984) 145 ITR 442 (AP)

   b) CIT v. S. R. Uppal, (1989) 180 ITR 285 (Punj. & Har.)

    c) Ram Narain & Bros. v. CIT, (1969) 73 ITR 423 (All.)

   d) Janson v. CIT, (1985) 154 ITR 432 (Kar.)

e) CIT v. Palaniappa Enterprises, (1984) 150 ITR 237 (Mad.)

5. Retirement of a partner or dissolution of partnership:

5.1 Earlier there was no express provision for levy of stamp duty in the case of retirement of a partner. Now, it is expressly provided, and the stamp duty payable is the same as in the case of the dissolution discussed below.

5.2 Where on dissolution of a partnership (or on retirement of a partner), any property is taken as his share by a partner other than a partner who brought in that property as his share of contribution in the partnership, stamp duty is payable as on a conveyance under Article 25, clauses (a) to (d), on the market value of the property so taken by a partner. In any other case, the stamp duty of only Rs.200 is payable.

5.3 The implications of these provisions are as follows:

a) If a partner has introduced certain property in partnership and on dissolution of the partnership or on his retirement from that partnership, he takes that property, then the stamp duty of only Rs. 200 would be payable.

b) If a partner has introduced certain property in partnership and on dissolution of the partnership or on retirement of another partner from that partnership, that partner takes the property, then the stamp duty as is leviable on a conveyance under Article 25 would be payable. Hence, if the property is an immovable property, then the stamp duty would be 5% as explained above.

If the property is a movable property, then the stamp duty would be payable at the rate of 3%.

c) If the property acquired by the firm itself has been given to a partner on retirement or dissolution, then stamp duty of only Rs.200 is payable.

5.4 An issue arises in the case of a simultaneous admission-cum-retirement of partners done by the same deed, would the stamp duty be payable on the amount brought in by the incoming partner (gross amount) or this amount should be net of the withdrawals ? S. 5 of the Act states that if an instrument relates to several distinct matters, it shall be chargeable with the aggregate amount of duties with which separate instruments each relating to separate matters would have been chargeable under the Act. Hence, the stamp duty on the instrument of partnership should be payable with reference to the gross amount brought in by the incoming partner and should not be with reference to the net amount. In addition, the stamp duty would be payable also as on a deed of retirement, under Article 47(2).

6. Arrangements resembling a partnership:

6.1 In several cases, the owner and the builder enter into a profit-sharing arrangement, which is quite similar to that under a partnership. An issue in such a case would be, whether the arrangement is one of a Development Rights Agreement or is a partnership? The stamp duty consequences on the owner and the developer would vary depending upon the nature of the arrangement.

6.2 S. 4 of the Partnership Act defines a partnership as “the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all”.

Thus, a partnership must contain three elements:

a) there must be an agreement entered into by all the persons concerned;

b) the agreement must be to share the profits of a business; and

c) the business must be carried on by all or any of the persons concerned, acting for all.

6.3 Element of profit sharing:

Thus, sharing of profits is an essential element. The instrument must demonstrate that what is happening in effect is that the net profits are being shared and not the gross returns. Various English decisions such as J. Lyons & Co. v. Knowles (1943) 1 KB 366 (CA) have held that a mere agreement to share gross returns of any property would be very little evidence of a partnership between them and there is much less possibility of there being a partnership between them. In certain English cases such as, Cox v. Coulson (1916) 2 KB 177 (lessee of a theatre and manager of a theatrical company) French v. Styring (1892) 2 CBNS 357, (joint owners of a race horse – expenses jointly borne)]; it was held that the mere circumstance of their sharing gross returns would be very little evidence of the existence of partnership.

In Sutton & Co. v. Gray, (1894) 1 QB 285, S a share-broker entered into an agreement with G, a sub-broker, that G should introduce his clients to S, receive half the brokerage in respect of the transactions of such clients put through on the exchange by S and should bear the losses in respect thereof; it was held that this did not create partnership between Sand G as no partnership was intended, and that the agreement was merely to divide gross returns and not profits of a common business.

b) Further, S. 6 of the Partnership Act is also relevant. It provides that the sharing of profits or of gross returns arising from property by persons holding a joint or common interest in the property does not of itself make such persons partners.

The relevant extracts are given below:

“6. Mode of determining existence of partnership. In determining whether a group of persons is or is not a firm, or whether a person is or is not a partner in a firm, regard shall be had to the real relation between the parties, as shown by all relevant facts taken together.

Explanation 1. – The sharing of profits or of gross returns arising from property by persons holding a joint or common interest in that property does not of itself make such persons partners.

Explanation II. – the receipt by a person of a share of the profits of a business, or of a payment contingent upon the earning of profits or varying with the profits earned by a business, does not of itself make him a partner with the persons carrying on the business; and, in particular, the receipt of such share or payment

a) by lender of money to person engaged or about to engage in any business,

b) by a servant or agent as remuneration,

c) by the widow or child of a deceased partner, as annuity, or

d) by a previous owner or part-owner of the business, as consideration for the sale of the goodwill or share thereof,

does not of itself make the receiver a partner with the persons carrying on the business.

c) A relevant case in this respect is the decision of the Madras High Court in the case of Vijaya Traders, 218 ITR 83 (Mad). In this case, a construction partnership was entered into between two persons, wherein one partner S contributed land while the other was solely responsible for construction and finance. S was immune to all losses and was given a guaranteed return as her share of profits. The other partner who was the managing partner was to bear all losses. The Court held that the relationship is similar to the Explanation 1 to S. 5 and there were good reasons to think that the property assigned to the firm was accepted on the terms of the guaranteed return out of the profits of the firm and she was immune to all losses. The relationship between them was close to that of lessee and lessor and almost constituted a relationship of licensee and licensor and was not a valid partnership.

d) The profit sharing need not always be a percentage share in the profits and it can also be a fixed sum payable to some of the partners. This would not invalidate the concept of a valid partnership. The shares do not always need to be stated in proportion to the profits. – Raghunandan Nanu Kotharev. Hormasji Bamji, AIR 1927 Born. 187 and CIT v. J. K. Doshi and Co., 176 ITR 371 (Born).

6.4 Mutual agency concept:

6.4.1 Mutual agency is also a key condition of the partnership. Each partner is an agent of the firm and of the other partners. The business must be carried on by all or any partner on behalf of all.

6.4.2 What would constitute a mutual agency is a question of fact. For instance, in the case of K. D. Kamath & Co., 82 ITR 680 (SC), the Court held that control and management of the business of the firm can be left by agreement between the parties in the hands of one partner to be exercised on behalf of all the partners.

Consequently, in the case of M. P. Davis, 35 ITR 803 (SC), it was held that the provisions of the deed taken along with the conduct of the parties clearly indicated that it was not the intention of parties to bring about the relationship of partners, but they only intended to continue under the cloak of a partnership the pre-existing and real relationship of master and servant. The sharing of profits or the provision for payment of remuneration contingent upon the making of profits or varying with the profits did not itself create a partnership.

6.4.3 The Bombay High Court in the case of Sanjay Kanubhai Patel, 2004 (6) Bom C.R. 94 had an occasion to directly deal with this issue. The Court after reviewing the Development Rights Agreement, held that it is settled law that in order to constitute a valid partnership, three ingredients are essential. There must be a valid agreement between the parties, it must be to share profits of the business and the business must be carried on by all or any of them acting for all. The third ingredient relates to the existence of mutual agency between the concerned parties inter se. The Court held that merely because an agreement provided for profit sharing, it would not constitute a partnership in the absence of mutual agency.

6.5 AOP v. Partnership:

If, instead of a partnership, an association of persons is selected as an entity for the development business, then there could be some issues from a stamp duty perspective. The Bombay Stamp Act (Article 47) contains an express provision for levying stamp duty on introduction of property in the firm by way of capital contribution by a partner. However, there is no provision for introduction of property by way of capital contribution in an AOP by a member. The moot point which arises in this case is, whether Article 25 levying stamp duty (@5%) on a conveyance would apply or Article 5(h)(B) would apply under which the stamp duty would be Rs.100 only.

6.6 From the above discussions, it would be clear that a proper structuring of the transaction and a proper drafting of the relevant documents is essential to achieve the desired results.

Nirav Shah

Giving and accepting compliments

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40. Giving and accepting compliments

In this insecure world that we live in, people often feel
awkward receiving compliments, viewing them as unearned praise and start
questioning their motive, running the risk of appearing defensive or
unintentionally rude by not responding graciously.

The following steps will help you give and take compliments
easily :

Listen :

Focus on the person giving the compliment, allowing him/her
time to complete their sentence. Silence your inner critic, which may question
the motive or genuineness; instead, accept the compliment at its face value.

Positive body language :

Don’t frown, shrink or look away when accepting compliments.
Instead smile and maintain a direct gaze, even if you don’t believe the
sincerity.

Accept, not reject :

A simple ‘thank you’ is the only reply expected and no
lengthy explanations. When paying a compliment, one frequently encounters such
avoidable comments in return.

Objecting :

“Oh no, I look like a mess . . . !”

Minimising :

“Oh, it was no big deal . . . “

Arguing :

“No, I spotted several weak points in my
presentation . . . !”

Acting cocky :

“Thanks ! I paid an arm and a leg, it better be nice . . . “

Changing the topic :

“So, how is business ?”

At a complete loss for words

Give, not just take :

Giving compliments improves our relationships greatly, as
they force us to focus on the positive attributes of another person. While most
people are good at complimenting their bosses and clients, try doing the same
with your staff and peers and see them enjoy that extra dash of unexpected
praise.

Culture :

Culture has a role to play in giving and accepting
compliments. Eastern cultures use an indirect mode of giving compliments and
excessive compliments make them suspect an ulterior motive. Japanese tend to
downplay giving and accepting compliments about themselves, preferring to
compliment achievements. Chinese feel they are showing humility by rejecting
compliments. On the other hand, Americans are a direct compliments-driven
culture, showering compliments on personal appearances. At times, the American
exuberance appears insincere to other cultures. Although Indians are not
comfortable complimenting on a person’s appearance, especially between genders,
socially, we are expected to compliment the hostess/lady of the house.

Lastly, while women give more compliments, men tend to take
them more seriously.

(Source : Shital Kakkar Mehra

— The Economic Times, dated 19-12-2008)

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Nirav Shah

Fast track courts for dishonoured cheques : Govt. examining report

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39. Fast track courts for dishonoured cheques : Govt. examining report

The Law Commission of India in its 213th Report on “Fast
Track Magisterial Courts for Dishonored Cheque Cases” has made the following
recommendations :

(i) Fast Track Courts of Magistrates should be created to
dispose of dishonoured cheque cases S. 138 of the Negotiable Instruments Act,
1881;

(ii) The Central Government and State Governments must
provide necessary funds to meet the expenditure involved in the creation of
Fast Track Courts, supporting staff and other infrastructure. The report is
under examination of the Government. This information was given by Mr
K.Venkatapathy, Minister of State in the Ministry of Law and Justice in the
Lok Sabha today.

(Source : Internet, 22-12-2008)

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Nirav Shah

ICAI — A seat at the high table

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38. ICAI — A seat at the high table

Last month witnessed two significant events essential for the
coming of age of the Indian accounting profession. To start with, The Institute
of Chartered Accountants of India (ICAI) signed an MoU with the Institute of
Chartered Accountants of England & Wales (ICAEW) permitting the members of
either institute to acquire membership of the other by clearing a minimal number
of exams. This, definitely, is a great achievement for the ICAI, and the entire
leadership behind it deserves to be congratulated. This is a goal which was
being pursued for more than one and a half decade. Mutual recognition between
India and the UK was undone in the early ‘90s by measures taken by the Board of
Trade in the UK and the Indian leg of the recognition was withdrawn in the mid
‘90s. At the same time when industry, trade & commerce was increasingly becoming
borderless, Indian accountants were fenced within the political boundaries of
India. This MoU has the potential of defeating the isolation decade and making
the Indian profession become a truly global player. The European Commission (EC)
made a landmark announcement last week. The Generally Accepted Accounting
Principles (GAAP) of six countries of the world — United States, Japan, Canada,
India, China and South Korea — were declared to be equivalent to International
Financial Reporting Standards (IFRS). This followed a positive opinion given by
the European Parliament and all member states to the European Securities
Committee in the previous month. While this is a testimony to the application
and rigor of accounting standards in India, it also acknowledges the fact that
the fundamental genetic material of Indian accounting standards are the purveyor
of IFRS. Though these developments would definitely bring cheer in these gloomy
times, but at the same time, there is a pertinent clause added to it. In its
announcement, the EC said that the situation in four of these six countries,
i.e., India, China, Canada and South Korea, would be reviewed no later than
2011. Also the EC would regularly monitor the ongoing status of equivalence and
report to the member states and Parliament. Thus, we cannot remove our foot from
the accelerator of convergence to global standards. India’s growing clout in the
accounting world has a lot to do with its status as an emerging economy with a
strong growth rate and deep-pocket investors who are venturing abroad. It is a
matter of pride that India has more than 200 companies, many of them medium
sized, whose debt or equity is listed in Europe. Membership of this exclusive
club brings many responsibilities and expectations. In addition to converging
with IFRS by 2011, and continuing to satisfy EC equivalence criteria in the
forthcoming equivalence tests, we would have to converge our auditing standards,
—particularly the standards for joint audits. The market place, regulators and
ICAI will have to move towards the international goal of ‘qualification free’
public balance sheets, where accounts are recast in order to remove audit
qualifications before they are accepted in a public domain. The MCA in its new
Companies Bill has proposed independence requirements, which would help in
achieving convergence with global independence standards. The logical extension
of all such convergences is to encourage multi-disciplinary partnerships and the
Government has already done its bit by amending the CA Act to permit it. The
Securities Exchange Commission (SEC) has also voted on the necessity of its 500
largest companies to file financial reports from 2009 using the Extensible
Business Reporting Language (XBRL). Similar adoption of XBRL by a number of
other developed countries would mean that India would also have to soon walk on
that path. Sebi has already constituted a committee and this will be the next
big thing that will occupy our attention. A seat at the high table comes with a
lot of obligations, but also with unique opportunities. Opportunities to place
the concerns of the emerging economies on the world stage; opportunities to take
leadership in developing SME (Small, Medium Enterprise) focussed standards;
opportunities to highlight the talent in the country; opportunity to open up new
horizons of global mobility for our professionals.

(Source : Internet, 22-12-2008)

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Nirav Shah

Chartered Accountant held in I-T graft case

New Page 1

37. Chartered Accountant held in I-T graft case

The anti-corruption bureau (ACB) of the Central Bureau of
Investigation (CBI) arrested chartered accountant Rakesh Makhija in connection
with the corruption case involving Additional Commissioner of Income-tax R. K.
Gupta. According to the CBI, Gupta had invested Rs.50 lakh in benami properties
through Makhija, an associate of another chartered accountant, Chandan Parmar.
Earlier, Parmar had been under the scanner of the Delhi CBI in connection with
another corruption case, involving A. K. Gautam, Commissioner of Income-tax.

His laptop has also been seized. Gupta, an Indian Revenue
Officer of the 1994 batch, was arrested on charges of accepting a bribe of Rs.4
lakh from a tax consultant for clearing a pending assessment.

Gupta had demanded Rs.10 lakh and asked the assessee to pay
the remaining Rs.6 lakh the next day, officials said. Later, the Central Bureau
of Investigation found another Rs.8 lakh stashed away in his office drawer.

Joint Director of CBI Rishi Raj Singh told that Gupta had
investments running into over Rs.3 crore. “We have identified five flats
belonging to him and further investigations are on,’’ Singh added.

(Source : The Times of India, 24-12-2008)

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Nirav Shah

New tax code to stop treaty shopping

New Page 1

36. New tax code to stop treaty shopping

The Government may introduce provisions in the new direct tax
code to prevent misuse of double taxation avoidance agreements India has with
other countries. The new code is likely to be unveiled before the year ends. A
Government official said a discussion paper on the code, a major initiative
undertaken under the guidance of the former Finance Minister and present Home
Minister P. Chidambaram, is being fine-tuned. “A discussion paper on the code
explaining the rationale behind every change would be placed in the public
domain,” the official added. A draft bill on the code may also accompany the
paper to enable everyone to express their views on the proposed changes. Double
taxation treaties are essentially agreements between two countries that seek to
eliminate the double taxation of income or gains arising in one country and paid
to residents/companies of the other country. The idea is to ensure that the same
income is not taxed twice. In many instance, however, these agreements are
misused to evade taxes. This is called ‘treaty shopping,’ where usually
residents of a third country take advantage of a tax treaty between two
countries. For example, many companies in other countries route their
investments into India through Mauritius or Cyprus to take advantage of the tax
treaty that these countries have with New Delhi. Both, India-Mauritius and
India-Cyprus tax treaties provide that capital gains arising in India from the
sale of securities can only be taxed in Mauritius and Cyprus. This means no
capital gains tax on investments in securities routed through Mauritius and
Cyprus, as they do not levy tax on capital gains. The discussion paper on the
code would explore ways to check this treaty- shopping. Mr. Chidambaram was
actively involved in the exercise of drafting the code. At the Economic Editors
Conference in November, he had said the draft code would be placed in the public
domain soon. Some options like a general anti-avoidance rule(GAAR), provisions
allowing examination of the real nature of a transaction and a limitation of
benefits clause are being actively examined. Many countries like Singapore and
Canada have a general avoidance provision, GAAR in their domestic income-tax
laws to ensure that treaty benefits accrue only to genuine investors. Singapore
also allows examination of the real nature of a transaction. Earlier, an
internal panel in the Income-tax Department, which examined the issue of treaty
abuse and ways to prevent it, had also made recommendation in favour of GAAR and
a special provision for examination of real nature of transaction.

(Source : Media reports & Internet, 22-12-2008)

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Nirav Shah

Undue hardship faced by assesses in filing signed acknowledgement (i.e. ITR-V) of the Return of Income in view of directions contained in the Circular issued by the Central Board of Direct Taxes (‘CBDT’) – Circular No. 03/2009 dated 21.05.2009

Representation

30th December 2009

The Chairman
Central Board of Direct Taxes
Department of Revenue
Ministry of Finance
Government of India
North Block
Delhi-110 001

Dear Sir,

Sub:
Undue hardship faced by
assesses in filing signed acknowledgement (i.e. ITR-V) of the Return of Income
in view of directions contained in the Circular issued by the Central Board of
Direct Taxes (‘CBDT’) – Circular No. 03/2009 dated 21.05.2009

We refer to the CBDT Circular No. 03/2009 dated 21.05.2009 (‘CBDT
Circular’) in connection with the filing of returns of income for assessment
year 2009 2010. We appreciate the efforts made by CBDT with regard to e-filing
of the returns of income.

Background

An assessee is required to file its return of income on or
before the due date mentioned in section 139(1) of the Income-tax Act, 1961
(‘Act’).

From AY 2006-07, certain assessees are mandatorily required
to upload the return of income electronically. In case the return is furnished
with digital signature, the date of uploading the return electronically as
mentioned in ITR-V is treated as the date of filing of the return of income. In
case the return is not uploaded with digital signature, the acknowledgement form
of the return of income, i.e., ITR-V is required to be signed by the assessee
manually and then furnished to the Income-tax Department within a certain time
limit.

Prior to the existing CBDT Circular, an assessee was required
to file the ITR-V post uploading its return on the income-tax website, with the
respective Assessing Officer (‘AO’) within 15 days of filing the return
electronically. This enabled assessees to get an acknowledgement from the
Department for having furnished ITR-V with the concerned Officer having
jurisdiction.

A number of claims such as carry forward and set of losses
and allowances, claim of deduction under Chapter VI-A of the Act and various
other benefits depend very much upon filing of the return on or before due date
mentioned under section 139 of the Act. Any failure on the part of the assessee
to file the return of income on or before the due date will lead to disallowance
of claims mentioned above.

The assessee is concerned primarily with proof of filing the
return of income with the Department. The acknowledgement bearing the stamp of
income-tax office is very much preserved and used by the assessees for various
purposes including compliances under the Act; obtaining bank loan; obtaining
visa/ passport; registration with various government authorities, etc.

As per the existing CBDT Circular, from assessment year
2009-10, the ITR-V duly signed by the assessee has to be furnished by
ordinary post
to “the Income-tax Department, Centralised Processing Centre, Post Box No.1,
Electronic City Post Office, Bangalore – 560 100, Karnataka” within 60 days of
uploading the return or 30 September, whichever is later.

Hardships and practical difficulties

The position has been drastically changed and made difficult
after the issue of the above CBDT Circular. Those assessees furnishing the
returns without digital signature are facing and are also likely to continue to
face unintended difficulties and hardships for the following reasons:

The assessee does not have in his possession any
acknowledgement as the ITR-V is to be sent by only Ordinary Post.
Unfortunately, no other
mode of sending the same is feasible under the new system and hence, the
assessees will have to rely only on the efficiency of the postal department.

Further, the assessee gets to know about the fact and date of
receipt of such ITR-V by the CPC at Bangalore only when he receives the
intimation by e-mail to that effect from the CPC and till then, uncertainty
continues (for minimum 3 to 4 weeks) and the assessee is
effectively helpless
to do anything in that regard.

Also, the assessee will be at the
mercy of Postal Department
(India) over which neither the CBDT nor
the assessee has any control.

Further, any failure or delay on the part of the Postal
Department may lead to the return of income not being filed before the due date
and consequentially lead to disallowance of claims made by the assessee. The
onus that is likely to be cast on the assessee is going to be of a serious
nature over which the assessee has no control whatsoever.

If such ITR-V does not reach the CPC at Bangalore within the
specified period of 60 days, the ROI electronically transmitted by the assessee
will become automatically invalid. Since the return will be deemed to have not
been furnished at all in case the duly signed ITR-V is, for some reason or
other, not delivered to CPC within the due date, besides other consequences, the
assessee will be saddled with liability for payment of interest under sections
234A and 234B and levy of penalty under section 271(1)(c) of the Act.

Accordingly, assessees will have to face undue hardships
without any fault on their part, since they would have no proof that they had
sent the ITR-V to the specified address well within the time limit of 60 days.
Apart from this, it is not fair to expect every assessee in the country from
different places to send such ITR-V to Bangalore by post.

It has also been experienced this year that several assesses
who had sent the ITR-V immediately after uploading their returns but had not got
any intimation about receipt sent the same again and in some cases this was done
twice or thrice after which they received the intimation that their form had
reached Bangalore. It is quite natural that in their anxiety, assessees who have
no proof or intimation of their form being received would tend to send the same
repeatedly. It is also not fair to place extra burden the already over burdened
postal department.

On the other hand there are several assesses who after
sending the ITR-V felt they had completely complied with the law and did not
send the same again. How can they escape the consequences of not furnishing a
valid return if the same for any reason has not reached the given address, since
they have no proof whatsoever of sending the ITR-V as it was mandated to be sent
by Ordinary Post.

Prayer

In light of the above, we humbly request that taxpayers be permitted to furnish such ITR-V at their respective places in the office of the Assessing Officer or at any centralized place in the local income-tax office from where, the De-partment can thereafter forward the same to CPC at Bangalore. This will also enable the assessee to get proper acknowledgement with regard to the date on which such ITR-V is submitted so that there remains no ambiguity about the date of their furnishing the same and the consequent date of furnishing the return of income.

Further, we are informed that for the assessment year 2009-10, many assesses who have uploaded their returns without digital signature within the prescribed time but have not yet received intimation of their ITR-V having reached Bangalore and having been processed ought to be allowed to file their ITR-V with their respective Assessing Officers till 31st January, 2010.

It is, therefore, humbly submitted that CBDT may kindly consider the request and modify the regulations.

We shall be pleased to provide any information or clarification that your goodself may need in respect of the above.

Thanking you,
Yours faithfully,

CC:

(1) Shri S.S. Palanimanickan,    Hon.Union Minister of State for Finance.

Ameet Patel    Kishor Karia    Rajesh Shah

President     Chairman,    Co-chairman,

                   Taxation    Taxation

                    Committee    Committee

(2)    Shri Pranab Mukherjee, Hon’ble Union Finance Minister.

(3)    Shri Rahul Gandhi, Gen.Secretary, Indian National Congress.

Nirav Shah

Purchase Price Allocation (PPA)

M & A

Introduction :

As referred in my previous article on ‘Valuation of
Intangible Assets’, a purchase price allocation process is one exercise where
valuation of intangible assets plays an important part. Purchase Price
Allocation (PPA) is relatively new in India. However with the amount of mergers
and acquisitions (M&A) activity happening and with the roadmap for IFRS
convergence chalked out (beginning 2011), it cannot and should no longer remain
new.

PPA, very crudely put, can be defined as a process of
assigning values to acquired assets and liabilities. Unlike a normal valuation
exercise where ones efforts are driven towards finding and arriving at a value
of the target, in a PPA the value of the target is already known and where the
valuation of target ends, the process of PPA starts. The focus in a PPA exercise
is to allocate the total value paid for the target to individual assets and
liabilities acquired.

Rationale :

Just as a PPA is the reverse of a normal valuation, in order
to understand the full meaning of a PPA, the words have also to be read in
reverse. Purchase Price Allocation is ‘the process of ALLOCATION of the PRICE
paid for the PURCHASE of shares or of assets.’ The process is carried out to
ascertain the rationale behind paying a purchase price. The process identifies
the tangible and intangible assets/liabilities that have been purchased/taken
over, for which the purchase price has been paid. Most of us would be surprised
to know how much more a price has been paid if we compare the price paid for a
target to the book value of the target and that surprise element is the precise
reason why carrying out such a process is required by standards under US GAAP
and IFRS and with India’s planned convergence to IFRS, the knowledge of this
process along with its application is imperative. With this process, not only
would the shareholders of the acquirer understand why or why not a particular
purchase price was paid for a target but it would also bring to light the
inherent value of intangibles which may not get captured in the book value or in
the share price of a company. The following are the primary reasons why a PPA
would be carried out :

For transparency to shareholders

For the management to ascertain the reason for overpayment/underpayment

For
getting benefits of amortisation under revenue laws

Guiding Accounting Standards :

Currently the requirement of a PPA is mandatory only for
companies preparing financial statements under IFRS and US GAAP; however with
the much awaited convergence of Indian Accounting Standards with IFRS, the same
will be mandatory for companies preparing financial statements under Indian GAAP
as well.

Broad steps under the PPA process :

Business Enterprise Valuation to estimate the Internal Rate of Return (“IRR”)

Identification of Intangible Assets

Valuation Analysis of Intangible Assets

Reconciliation of Results

This is the first of the series of articles on PPA. Each
article in this series will explain the various steps in carrying out a PPA
process and how to value intangible assets forming part of a PPA. The series
will cover in detail the following aspects and the practical issues under each :

1. General Overview

2. Glossary of Business Terms and Definitions under a PPA

3. Computation of Purchase Price to be allocated

4. Calculation of IRR

5. Computation of Weighted Average Cost of Capital (‘WACC’)

6. Possible reasons for differences between the IRR and the WACC

7. Identification of Intangible Assets

8. Remaining Useful Life

9. Tax Amortisation Benefit Factor

10. Valuation Approaches and Methods

11. Tangible assets — Identification and

Valuation

12. Weighted Average Return on Assets

13. Reconciliation of Results

14. Non reconciliation of Results

15. Interpretation of Results

16. Negative Goodwill

17. Value additions

18. Case Study

19. Discussion of questions and answers received over the period of the series

20. Chartered Accountants as Valuers

21. Useful links and resources

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Nirav Shah

Appealing Against Rejection of Takeover Exemption

Securities Laws

A recent decision of the
Securities Appellate Tribunal (‘SAT’) has perhaps for the first time reversed a
SEBI Order refusing to grant an exemption from an open offer. Such exemption, as
will be explained later, is a discretionary one from the otherwise mandatory
open offer under the SEBI Takeover Regulations. This decision is in the case of
Dr. Arvindkumar B. Shah (HUF) v. SEBI, (2010) 104 SCL 559 (SAT-Mum.). To me, it
is also an important and perhaps controversial precedent of SAT deciding on the
merits of SEBI’s decision in such a case.

To briefly review the
relevant law and scheme of the Regulations as relevant to the present case, it
may be recollected that the SEBI (Substantial Acquisition of Shares and
Takeovers) Regulations, 1997 (‘the Regulations’) require an open offer to be
made by certain persons typically in certain cases of acquisition of shares of
listed companies. Such persons, generally stated, are required to offer to
acquire at least 20% of the shares held by the public. This is usually when they
make substantial acquisition of shares. This open offer is mandatory though
there are certain statutorily exempted acquisitions. However, between these two
extremes, a mechanism has been provided to grant discretionary exemption on a
case-to-case basis. The mechanism involves a Takeover Panel which is really an
independent committee that reviews each application and renders its
recommendation to SEBI. SEBI then considers the recommendation and then applies
its own discretion again and grants or rejects exemption (irrespective of the
recommendation).

In the light of this scheme
of Regulations, let us consider, first very broadly, the facts of the present
case.

The applicant company sought
to set up a plant to manufacture certain pharmaceutical products. For this
purpose, a large amount of funds was to be raised from lenders who made it a
condition of their lending that a sum of Rs.50 crores shall also be raised as
equity. The company had various alternatives of raising the equity in the form
of rights issue, preferential issue, etc. At the end, in consultation with the
Promoters, the company decided to issue shares on a preferential basis to the
Promoters and persons acting in concert. Essentially, the important consequence
was that post such preferential issue, the holding of the Promoters and persons
acting in concert (referred to together as ‘Promoters’ herein) would increase
from 25.32% to 45.91%. Regulation 11 of the Regulations provide that an acquirer
holding 15% or more of shares or voting rights can, to simplify a little,
acquire further shares only up to 5% in a financial year. Clearly, the acquirers
would in the normal course be required to make an open offer if the acquisition
was of more than 5% of the shares.

The company obtained the
required approvals under the Companies Act, 1956, which particularly required
approval of the shareholders by way of a special resolution through a postal
ballot. In the postal ballot, only about 10% (in number) of the shareholders
sent in their votes but of those who so voted, 99.10% voted in favour of the
resolution.

The Promoters then applied
to the Takeover Panel for exemption from the open offer. The Panel, after due
consideration, recommended grant of exemption. SEBI, however, considered the
matter and refused to grant the exemption.

The main reasons cited by
SEBI were that, firstly, the company could have raised the funds through a
rights issue where all the shareholders could have benefited. If the
shareholders did not subscribe, then of course, the Promoters could subscribe
and cover up the shortfall. Secondly, if an exemption was granted, the public
shareholders would lose the benefit of an exit. Thirdly, SEBI stated that
usually it grants exemption in such cases if the company is a sick/turnaround
company and the infusion of funds is under a Corporate Debt Restructuring (CDR)
package or similar situation. In view of this, SEBI refused to grant the
exemption.

The company appealed against
this decision to the SAT. The SAT allowed the appeal and granted the exemption.

Firstly, the SAT found fault
in SEBI’s view that the company could have raised the funds by a rights issue.
The SAT felt that SEBI should not advise a company on which alternative it could
use to raise funds. It observed, :

“The whole-time member has
found fault with the target company for not raising the funds through a rights
issue as, according to him, the method of preferential allotment denied to the
shareholders an equal opportunity in the fund raising exercise. He appears to be
of the view that since the shareholders had been denied that opportunity, they
be given an exit option through an open offer by declining the exemption. He is
totally wrong in his approach and perception of the shareholders’ interests.
First of all, it is not for the Board to advise or insist on any company as to
how and in what manner it should raise its further equity capital when the law
gives the aforesaid three options to a company . . . . the target company and
its shareholders had considered the option of the rights issue for raising the
equity and for good business reasons and without jeopardising the interest of
the shareholders abandoned this option . . . . Since time was of the essence,
the target company had to choose the quickest way without sacrificing the
interests of its shareholders to raise the necessary funds including the equity
of Rs.50 crores which was a pre-disbursement condition imposed by the banks. We
agree with the learned counsel for the appellants that preferential allotment
was not only the quickest but also the surest method of raising equity. The
option of rights issue if resorted to would have consumed good bit of the 30
months that were available with the target company to start commercial
production. Apart from the delay which that process would have caused, there was
no certainty that the target company would be able to raise Rs.50 crores through
that method. Even in the best case scenario of full subscription in the rights
issue at 1 : 1 ratio, the total money that could be raised would have been Rs.36
crores only leaving a deficit of Rs.14 crores for the project.”

The SAT also pointed out the
risks of uncertainty and costs to the company in a rights issue. It observed, :

“There was also no certainty that all the share-holders would participate in the rights issue. The average market price of the share of the target company during the last six months was around Rs.1.89 and it could at the most offer shares to the shareholders in a rights issue at Rs.1.39 per share, if not lower. It is axiomatic that unless the target company offers the shares at a price lower than the market price, the shareholders would not participate. If the option of rights issue had been adopted, the existing shareholders would have paid at the most at the rate of Rs.1.39 per share, whereas the Promoters to whom preferential allotment has been made have paid Rs.2.25 per share. Has the preferential allotment not added value to the company and in turn enhanced the shareholders’ value. There is yet another reason why the target company did not pursue the rights issue option. This process causes not only uncertainty and delay but also involves extra cost. The appellants pointed out and which fact has not been disputed on behalf of the Board that the total cost of the rights issue would have been close to Rs.56 lakhs and the target company could ill afford at that point of time to spend this amount on this exercise as it had recently wound up its project at Haridwar and was operating at low margins.”

The SAT also held that the prescribed procedure for obtaining approval for the preferential allotment by a postal ballot as prescribed under the Companies Act, 1956, was duly followed in letter and spirit. There was due disclosure of the facts and the relevant and prescribed majority duly approved the resolution. It said that the shareholders were the best judge of their interests and if they have approved something, their judgment cannot be interfered with.

The SAT also rejected the argument of SEBI that an exit route should have been provided to the shareholders through an open offer. The SAT observed :

“We also do not agree with the whole-time member that, in the circumstances of the present case, the shareholders of the target company should have been provided with an exit route by requiring the appellants to make a public of-fer. There has been no change of management or control over the target company consequent upon the preferential allotment as notified to the shareholders. This is also not a case where a rank outsider had acquired a large chunk of shares in the company and was seeking exemption from the takeover code. Such an acquisition or change in management or control over the target company brings with it an element of uncertainty and the takeover code provides that in such an eventuality the existing shareholders be provided with an exit route by requiring the acquirer to make a public offer. In the case before us, there was no element of uncertainty and there was no change of management or control and we are satisfied that the shareholders of the target company did not get affected in any manner by the acquisition.”

At the end, after reversing SEBI’s Order and allowing the exemption, the SAT further observed that in an earlier case on similar facts, SEBI had granted exemption. Thus, SEBI should have granted exemption in the present case too. It observed, “It must be remembered that it is in public interest that a statutory regulator like the Board should be consistent in its approach as that would send the right signals to the capital market and would also insulate the Board from the charge of discrimination.”

While this decision will act as a precedent in future cases and also act as deterrent in arbitrary or inconsistent Orders of SEBI, I respectfully submit that some aspects of this decision of SAT require reconsideration.

Firstly, SAT has, in my opinion, substituted its own judgment in place of the clearly discretionary approval process of SEBI. This is not a case where SEBI has levied, say, a penalty using its discretion whether or not to levy a penalty. It was considering a case of grant of approval which is a concession or benefit given to the Promoters/ other allottees in the present case. SAT also has not found any patent error of fact or law on the face of the record.

Secondly, it may be recollected that till 2002, the Regulations allowed for exemption from open offer to preferential allotment provided certain conditions particularly relating to disclosures were complied with. This exemption has been consciously dropped as a matter of policy. Thus, it could be fair to accept that normal preferential allotment ought not be granted exemption, even if the other formalities in law were duly complied with. With due respect, this decision may indirectly lead to a situation that all allotments through preferential allotments in similar cases of need for fund raising should be exempted. This would make a nullity of the conscious amendment to the law.

Thirdly, the ground that SEBI should be consistent in its Order is of course an advisable and fair ground generally to avoid being seen as arbitrary. However, in cases of grant of discretionary exemption, it is submitted, with respect, that it would mean rigidity and exemptions being taken for granted.

Though not directly on the point, it may be recollected that the Supreme Court (in SEBI v. Saikala Associates Ltd., Civil Appeal No. 3696 of 2005 with Civil Appeal No. 4640 of 2006, decided on April 21, 2009) on the limits and nature of appellate power of the SAT had held that the SAT could not travel beyond the statutory powers in terms of exercising its discretion. The Court observed, “When something is to be done statutorily in a particular way, it can only be done that way. There is no scope for (SAT) taking shelter under a discretionary power”.

To conclude, an appellate window is now open, apparently for the first time, for refusal to grant exemption from open offer by SEBI. However, one trusts that the spirit of discretionary approvals is not defeated by it becoming it mandatory.

Nirav Shah

Satyam — is pledge of shares insider trading ?

Securities Laws

This series of articles introducing securities laws for
listed companies to the lay reader continues . . .

(1) Not one more Satyam article, please ! There is certainly
an overdose of reports, articles, blogs, even Twitter messages covering the
latest buzz or views on the Satyam episode. There is serious competition on the
net on how one writer could outdo others in eloquent outrage. However, the fact
remains that at least at the time of writing this article, which is many days
after Mr. Ramalinga Raju’s ‘confession letter’ that, except this very letter,
there are very little other facts brought out. Even the veracity of the contents
of this very letter is being questioned by some. However, as is usually the case
in Trial-by-Media, many parties have been already presumed to be guilty.

(2) However, for the purposes of this column, the Satyam
episode is a dream case study for students of securities laws. If one believes
even some of the reported statements in the press and elsewhere to be true, it
seems that violation of a host of securities laws would be alleged. There would
be question of violations of the SEBI DIP Guidelines while making of
disclosures. There would be allegations of fraud and unfair trade practices in
dealings in securities and making of statements by the Promoters of Satyam and
others. There would be allegations of violation of numerous provisions of
corporate governance requirements. There would be concerns about violations of
the Insider Trading Regulations, since it is reported that shares of Satyam have
been sold by the Promoters over the last many years, either directly or by the
lenders who lent funds against the securities of the shares and then sold the
shares. There could be violation of the Regulations and Code of Conduct for
intermediaries such as merchant bankers, brokers, etc. in their dealings in
relation to Satyam. And so on and on.

(3) However, as stated, it may be worth for us, as students
of this field, to examine one or more of such issues from time to time and then,
in the context of specific ‘facts’ as reported, examine the law and see how it
could apply. This way, we can understand the law in practice.

(4) Let us then, in this context, consider one such
allegation and that is that there has been violation of Insider Trading
Regulations in dealing of shares by the Promoters of Satyam. More specifically,
it is being alleged that the Promoters of Satyam pledged their shares in Satyam
to lenders who, in turn, on default or on margin calls, sold their shares. It is
alleged that this amounts to Insider Trading by the Promoters. It is also
reported that the SEBI Committee examining this issue will also consider whether
the law should be amended, whereby pledge of Promoters’ shares would now be
required to be disclosed. Let us examine here, in the light of the alleged
facts, whether pledge of shares can be held to be Insider Trading under the
existing law. Let us also examine the implications of the recommendation that
the law be amended to require disclosures of pledge of shares by Promoters.

(5) Let us examine the reasoning given in support of the view
that pledge of shares should amount to Insider Trading. The first line of
argument is that pledge of shares is indeed Insider Trading, apparently by
taking an extended meaning of ‘dealing’ in ‘securities’. It is stated that the
word ‘dealing in securities’, the very substance of Insider Trading, is broad
enough to include all transactions relating to securities including, therefore,
even pledge. However, I wonder if the wording of the scheme provides for
coverage of a bona fide pledge. The existing definition of ‘dealing in
securities’ in the SEBI Insider Trading Regulations is quite specific and
exhaustive though a bit clumsy. It says that ‘dealing in securities’ means
‘an act of subscribing, buying, selling or agreeing to subscribe, buy, sell or
deal in any securities by a person either as a principal or an agent’. Pledging
of shares is not subscribing or buying or selling of securities, nor is it
agreeing to do so.

(6) The definition has some clumsiness in terms of being
circumlocutory when it uses the word ‘deal’ again in the latter part of the
definition, but I doubt whether even this would be sufficient to cover bona
fide pledge of shares.

(7) Consider also the intention of these Regulations
prohibiting Insider Trading. It is obviously to restrict insiders from dealing
ahead of material disclosures, at a time when the price is significantly
different from what it may be if these disclosures were made. In Satyam, it is
being alleged that the Promoters pledged shares when prices were high and thus
obtained monies based on valuations that did not reflect the reality and which
reality was disclosed much later. The lenders allegedly sold shares when market
price started falling and Promoters could not meet margin calls. However, this,
by itself only, cannot make bona fide pledge of shares insider dealing.

(8) When a person pledges shares, he keeps the risks and
rewards in the shares with himself. When the lender sells the shares on default
or margin calls, he sells at a time when the prices may have already fallen, but
then it is the borrower who has to bear such fall. He would be credited
obviously only to the extent of the amount realised by sale. If the borrower
bears the risk of such fall, then this goes against the very concept of Insider
Trading where the dealer profits from a fall in price that may be the result of
adverse information published later.

(9) The second and incidental line of argument is that the
definition of ‘securities’ — Insider Trading involves dealing in ‘securities’ —
under the Securities Contracts (Regulation) Act, 1956 includes ‘rights or
interest in securities’. It is argued, and to that extent rightly so, that
pledge of shares may involve grant of right or interest in securities. However,
from this, a conclusion is apparently being inferred that thereby dealing in
‘securities’ would cover pledge of shares.

10. One possible answer to this is that what is covered under Insider Trading is ‘dealing’ in securities i.e., the process and action itself. It is the word ‘securities’ that has been given an extended meaning under SCRA to cover ‘rights or interest’. The word ‘dealing’ has not so been artificially extended and in fact, as discussed above, is quite specific and exhaustive (except for the quirk, also discussed). If pledge of shares is held to be Insider Trading, then Insider Trading is being interpreted to mean ‘dealing in (dealing in securities)’!

11. Interestingly, the Takeover Regulations exempt acquisition of shares by ‘banks and public financial institutions as pledgees’. One may wonder whether, therefore, pledge was thus understood to be acquisition, since otherwise there was no need to specifically give this exemption. However, this conclusion may not be correct since, even here, what is really exempted is ‘acquisition of shares’ as ‘pledgees’ and not the pledge itself. In other words, the pledge has to be an acquisition first – e.g., in the case where the pledgee actually transfers the shares in its name and also does further acts. Also, there are decisions (of SAT,etc., not discussed here) that have held that pledge does not amount to acquisition of shares.

12. The above discussion though applies to bona fide pledge of shares and the moot question of course is whether the pledge of shares in Satyam was bona fide. Obviously, no one knows this yet and it may take a long time before the truth is established. However, clearly, if a pledge is not a bona fide pledge and is actually a sale in disguise, then it would be sale of securities and in that case the Insider Trading Regulations would squarely apply. But this would be by applying the regular and plain inter-pretation of Insider Trading and not by a crisis-driven, extended meaning.

13. If in the heat and pressure of action, to some-how find the Promoters of Satyam guilty of Insider Trading, a stretched interpretation is taken that any pledge of shares should also be deemed to be Insider Trading, it can cause a serious crisis to the whole corporate world generally. Firstly, Promoters of numerous other companies would also be deemed to have committed Insider Trading through pledge. Secondly, this process may bring out the real picture of the status of finances of Promoters in India post-stock market meltdown !

14. It is then that the second suggestion of SEBI can be discussed and that is whether Promoters should be required to disclose the pledge of their shareholdings. I think this is a sensible suggestion and it would be valuable information for shareholders and the markets in general to know to what extent the Promoters are vulnerable and what is their real, net and clear holding and stake. Not that there is anything per se wrong in pledging shares or that it is ‘disclosure’ of Insider Trading. Pledge may be for many reasons – for raising of finance for persons or corporate purposes or even further acquisition of shares, etc. In fact, if funds are raised by Promoters for financing further acquisitions of shares, then this may be even indicative of their own confidence in the Company. Of course, in some cases, this disclosure may help initiating investigation of the bona fide nature of the pledge.

15. However, as stated earlier, making Promoters to disclose, at this juncture, the pledge of their holding would also result in the discovery – probably shocking – of the reality as suggested by the oftquoted statement of Warren Buffet – “You only find out who is swimming naked when the tide goes out”. We may thus find out how many Indian Promoters are swimming dressed very skimpily and how many are swimming stark naked!

Nirav Shah

Rebirth Of Stock Lending – Opportunities, Confusion and Contradictions

This series of articles introducing securities laws for listed companies to the lay reader continues…

1) A recent and relatively minor amendment suddenly infuses life into the otherwise dead instrument, that is, scheme of stock lending. The amendment provides that now Stock Lending can be for one year, thereby increasing the period from 30 days, which, incidentally initially was, for just seven days. This short lending period was probably the main reason why there was practically no interest in using stock lending, though the scheme has existed since 1997!

2) Let us broadly understand what Stock Lending is and understand some important developments till date. I may add that, as we will see later, numerous other things in securities laws and outside have to be resolved but this latest amendment is, I think, sufficient reason to take Stock Lending seriously now.

3) Stock Lending, as the name suggests, is lending of shares by an owner to a borrower. The borrower pays charges for “using” the shares and is required to return the borrowed stock by the end of the borrowing period. The Borrower normally cannot close the transaction in cash. The arrangement provides that all other benefits of ownership go to the Lender, such as dividends, bonus issue, etc. Hence, if a company makes a 1:1 bonus issue, the Borrower would then have to return double the number of shares he has borrowed. However, all benefits of ownership cannot be protected, such as the ‘right to vote’.

4) The Borrower normally sells the shares in the market, as he is bearish on the scrip and believes that the price of the shares will fall in the ‘borrowing period’. Thus, he will be able to buy shares back at a lower price and return them to the Lender and earn profit.

5) Conceptually, thus, the Lender would have to be a person who is either a long term investor or a promoter who is bullish on the scrip and desires to earn return in the interregnum. Another reason for not selling the shares himself could be that the Promoter may be interested in retaining the shares for the long term for the benefit of control through the shares.

6) In theory, private parties could carry out Stock Lending amongst themselves. The Lender would lend the shares to the Borrower by a private arrangement. The Borrower would sell the shares, buy them back at a later date and return the shares. However, there would be several complexities. The Lender would also have concerns about default in recovery of his shares. Further, the Lender/Borrower would have to search for counter parties and there would not be the benefits of an open market of Stock Lending where parties could find many counter parties. In an open market, the Stock Lending rates would be market determined owing to wider participation.

7) The advantages of a statutory lending scheme are many and in theory, many of the above disadvantages can be overcome. However, SEBI has been struggling, since 1997, to lay down a scheme that retains the aforesaid advantages while ensuring that the terms and conditions do not create problems. However, it has not been successful so far.

8) SEBI had introduced in 1997 a Scheme of Stock Lending. The principal concept was of approved intermediaries, who would act as intermediaries for parties on both sides, i.e., lending and borrowing. Strict approval norms were laid down for approval of intermediaries so that the intermediaries were strong in terms of net worth, which may lend confidence to the Lender. The intermediaries would also be under regulatory control of SEBI. For various reasons, including tax uncertainty (which since 1997 was partly resolved), the Stock Lending Scheme did not take off at all.

9) A decade later, around 2007, SEBI took steps to revive it. A principal change made was that that the stock exchanges themselves would be the intermediaries. It appears that the objective was also of allowing Stock Lending transactions to be effected through the stock exchange. Thus, one could theoretically borrow and lend in a manner similar to buying and selling shares or derivatives. The stock market would also protect the parties for due honour of the terms such as return of the shares and corporate benefits.

10) However, SEBI was unduly cautious. Stock Lending is actually intended to facilitate
short-selling. And short-selling is incorrectly and unfairly seen as a stigmatic act. So much so that the recent recession in the US is blamed on short-sellers. Even in India, a few years earlier, short-sellers were claimed to be behind the huge fall in the stock markets. However, short-selling and speculative buying are two sides of the same coin. If markets are undervalued, a spirited speculator is seen as heroic when he buys, raises the market and then sells the same. The same speculator who feels that the market is overpriced, becomes a villain if he short sells. Speculation is part of the market. But if speculation is indulged in for price manipulation, then, and only then, it should be punished. However, short-selling continues to be stigmatic, at least in perception.

a) Having stated this, Stock Lending is better than naked short-selling in which any quantity of shares could be sold. In Stock Lending, every short sale has to be backed by available shares.

11) Hence, as said earlier, SEBI was unduly cautious. It initially allowed barely 7 days of lending, as if prices would move towards a particular value in such short period. Such a Scheme was bound to fail and it did. It remained a failure when the lending period was increased in 2008 from 7 to 30 days. Now, SEBI has, in one stroke, increased the period to 12 months and there is some excitement in the market. This move has the potential to be the proverbial Tipping Point, when there is a major take-off on account of a small change, though some minor issues in the Scheme and tax and other uncertainties remain.

12) As the revised scheme is now in place, let us note some important features which make the Scheme attractive:-

a) Any person can carry out stock lending and thereby short-selling. The Borrower and the Lender can be any person, individual, corporate, institutional investor, etc.

b) Initially, Stock Lending will be allowed in shares in which futures and options are allowed. SEBI will review this list from time to time.

c) The lending/borrowing period is upto one year.

d) The Lender can request an early termination and the Approved Intermediary can, on a best effort basis, seek to get shares from another lender and give them to the original Lender.

e) The Borrower can also return the shares earlier and the Approved Intermediary can attempt to find another borrower.

f) Timely disclosures will have to be made of the shares that are sold using the Stock Lending mechanism.

g) The clearing corporation/clearing house of the stock exchanges having nationwide terminals will be registered as Approved Intermediaries, through which the Stock Lending would be carried out. The Borrowers and Lenders would approach authorized Clearing Members for their transactions.

h) The Stock Lending would be through the screen-based, order-matching platform. Thus, like derivatives, parties can find out orders available on either side and carry out “trades” of borrowing/lending.

i) There will be a contractual/statutory framework between the parties involved, viz., the Borrowers, Lenders, Approved Intermediaries and the Clearing Members. However, there will not be any direct agreement between the Borrower and the Lender.

j) The contracts would effectively be standardized and thus comparable and capable of being valued uniformly.

k) The Approved Intermediaries will lay down the risk management mechanism so as to ensure that shares lent are recovered or due compensation is otherwise received from the Borrower. This is an important pillar of the Scheme, which would give comfort to the Lender.

l) There are overall limits of shares that can be lent as a percentage of capital. At least in this respect, SEBI has been realistic and has allowed a fairly high percentage of the share capital—10%—though one could argue that even this is arbitrary. There are sub-limits though, at various lower levels.

m) The lending and borrowing would not be deemed to be sale and purchase of shares for various purposes such as for Takeover Regulations. However, one will have to look at actual amendments in the law, if there would be any.

13) Note that while the Stock Lending scheme is approved, steps would have to be taken by stock exchanges and others concerned to lay down the systems and procedures for the same to make it operational.

14) While the Scheme is attractive generally, there are various concerns.

15) The tax law remains uncertain, and though there is a specific but old Section 47(xv) that deals with Stock Lending, some questions worth considering are:-

a) Will lending be deemed to be a sale and borrowing deemed to be a purchase in the revised statutory framework, particularly where there

are no direct agreements between Borrower and Lender? Similarly, what will be the treatment of the reverse transactions when shares are returned from the Borrower to the Lender through the Approved Intermediaries?

An incidental question would be how would the period for which the stock is lent be treated? Will it be part of the continuous period for which the shares were held by the Lender?

b) The Borrower would be in a peculiar position. Assuming that he is not deemed to be a purchaser, he would be selling the shares first and then buying them back. How would the surplus/loss be treated? How would he account for his position for tax purposes at the yearend when he has sold shares but he has not yet bought them back? Will he be able to book a provisional loss if the market price is higher than the price at which he sold? How much of such loss will he be able to book?

c) How would the income from Stock Lending be treated? How would the Stock Lending charges paid be treated? How will the treatment differ for those who hold the shares as stock in trade and for those who hold it as capital assets?

d) If there is finally a default in return of the shares and the Lender is compensated in money, what would be its tax treatment? When would the “transfer”/sale be deemed to have taken place?

I must confess that I have only scratched the surface and I am sure readers will think of more issues.

16) Apart from tax, there would be other issues such as:-

a) Can Stock Lending be deemed to be insider trading? In other words, would a Stock Lend-ing by an insider be deemed to be insider trading if he had access to unpublished price sensitive information?

b) How would the lending and borrowing be treated for accounting purposes? How will it differ for shares held as investments and shares held as stock in trade? How will the potential loss on account of rise in price be accounted by the Borrower at the yearend?

c) Will Stock Lending be treated as borrowing for the purposes of Section 58A of the Companies Act, 1956?

d) Will stock lending be deemed to be a financial activity for the purposes of regulations relating to NBFCs?

17) Then there are other aspects. Should an act of a Promoter who lends shares be viewed negatively? Should it show an indication that he is himself bearish on his shares and thus he is protecting himself? By lending, is he not encouraging fall in the share price since there would be selling pressure? Or should a view be taken that the fact that the Promoter is only lending and not selling shows that he is actually confident of his company since he would want his shares back eventually? Whatever the theoretical arguments, on either side, may be, a Promoter who lends his shares may face publicity and, often, publicity relating to such transactions is automatically negative publicity!

18)To conclude, Stock Lending offers a new and attractive instrument but with complex issues that Chartered Accountants, whether in industry or in practice, will have to address.

Nirav Shah

Our perspective

Internal Audit

Introduction :

1.1 Corporate governance, as we all know, has been under a
strong and critical public spotlight currently and in recent years, because of a
succession of blows to capital market confidence, particularly in the United
States but also echoed in India and other countries. The stakeholders’
expectations of boards and senior management, and of those charged with
providing an independent review of a company’s operations and
financial statements, have increased. To meet those expectations,
governments and regulatory authorities around the globe have initiated concerted
efforts to improve standards of corporate behaviour and transparency through :

stress on efficacy of internal controls both in the Sarbanes-Oxley Act in the
U.S.A. and clause 49 of the listing agreement in India.

mandatory compliance with accounting standards to ensure adequacy and
uniformity in disclosure practices — this will further get strengthened with
the adoption of IFRS in India.

emphasis on risk assessment and risk mitigating procedures.

1.2 Clause 49 of the Listing Agreement casts an obligation on
the ‘Audit Committee’ to :

Ensure adequacy of internal controls.
Review internal audit reports.
Recommend appointment and remuneration of internal auditors.
Ensure independence of internal auditors.

Clause 49 also requires CEO and CFO to certify the
effectiveness of the internal controls in the company.

1.3 With the emphasis on the above issues internal audit has
become an integral tool of corporate governance. An internal auditor today
reviews not only accounting procedures, but also reviews and reports on the
effectiveness of manufacturing and marketing function. Hence, internal audit in
the present context is a multi-disciplinary function.

1.4 This article offers our perspective on the role of
internal audit and its structure.

The role of Internal Audit :

2.1 Paragraph 3.1 of the Preface to the Standards on Internal
Audit, issued by the Council of the Institute of Chartered Accountants of India
in 2004, describes internal audit as follows :

“Internal audit is an independent management function,
which involves a continuous and critical appraisal of the functioning of an
entity with a view to suggest improvements thereto and add value to and
strengthen the overall governance mechanism of the entity, including the
entity’s strategic risk management and internal control system.”

2.2 The definition of internal audit approved by the Board of
Directors of the Institute of Internal Auditors is :

“Internal auditing is an independent, objective assurance
and consulting activity designed to add value and improve an organisation’s
operations. It helps an organisation accomplish its objectives by bringing a
systematic, disciplined approach to evaluate and improve the effectiveness of
risk management, control, and governance processes.”

2.3 The above definitions are highly contextual as a
distinction between internal audit and risk management needs to be drawn. As
we see it, the basic function of internal audit is an independent appraisal of
an organisation’s internal controls, including controls over financial reporting
and business processes having financial ramifications. It does not stop at only
pointing out weakness, but extends to making of recommendations on internal
control and process improvements that could be made to increase efficiency of
operations.

2.4 Risk management, on the other hand, is about
identifying and assessing inherent risks in the products and activities of an
organisation, and ensuring that appropriate risk management limits, control
mechanisms and mitigation strategies are in place to contain risk within the
organisation’s risk appetite and capital adequacy. A monitoring function
(similar to internal audit) is often involved to ensure that the risk control
framework is in place and operating as intended. Internal audit plays a
facilitative role in evaluating whether the controls are practical and
functional and whether they can be circumvented. The distinction is that ‘risk
management’ team has the continuous responsibility of understanding how actual
risks facing the organisation are changing. This requires continuous review by
the management.

2.5 The function of the internal auditor in risk
management is to review and report on the adequacy of the procedures and report
on adherence to the limits prescribed by the Board or senior management. Barring
of U.K. went down because limits prescribed by senior management in London were
not adhered to by a dealer in Singapore. Recently, the century-old France Union
General — a financial institution — failed because of speculative lending where
internal control limits were not adhered to.

2.6 The above view is in line with what is prescribed in Para
15 of the Internal Audit Standard 4 dealing with ‘Reporting’ amongst other
issues includes as a function of internal audit :

‘evaluating the overall entitywide risk management and
governance framework.’

2.7 This cooperation between the internal auditor and risk management team is also recognized in an alternative definition which is given in an HA Research Foundation publication of 1999 – Competency : Best Practices and Competent Practitioners.

“Internal auditing is a process by which an organisation gains assurance that the risk exposures it faces are understood and managed appropriately in dynamically changing contexts.”

This is a functional definition and in our view a direct appreciation of the current expectations from internal audit.

Structure and resources, independence and approach:

3.1 The starting point is evaluating whether the internal audit function is in-house or outsourced, and whether this arrangement is appropriate in given circumstances. The following crucial benchmarks need to be in place for internal audit team keeping in mind the standards and professional practice advisories and guidelines of The Institute of Internal Auditors.

i) Structure and resources:

The structure of the internal audit function is established and an assessment made about the key internal audit personnel, their roles and responsibilities, skillsand experience, irrespective ofwhether the internal audit function is ‘in-house’ or ‘outsourced.’

ii) Independence:

Firstly, the company board should ensure that independence of the internal audit function is maintained. The internal auditor should not report to CFO,but should report to CEO and the audit committee or the Board of Directors.

It needs to be mentioned that managements in India have been resisting the concept of internal auditor reporting directly to the CEO or the audit committee. However, we believe it is essential to have direct reporting to ensure independence. We also believe that reporting to the CEO or the audit committee should be after discussion and having obtained response of the management, because the CEOand/ or the audit committee would callfor the response of the management on any issue reported by the internal auditor. This mode of reporting also meets with the criteria of transparency.

Secondly, the internal auditor should not be directly involved in execution of risk management or operations. The internal audit function may provide valuable input to those responsible for risk management or operations, but should not have direct risk management responsibilities. In practice, some organisations (particularly small ones) may give internal audit initial responsibility for developing a risk management programme. Where this is the case, organisations should see that the responsibility for day-to-day risk management is an independent function. We reiterate that internal auditor should in no manner be involved in operations, though the internal auditor should understand operations.

Thirdly, significant issues raised by the internal auditor even if satisfactorily resolved need to be reported to the CEO and the audit committee.

Fourthly, where the internal audit function is outsourced there should not be any conflicts of interest – for example – internal auditor should not be involved in rendering other services. The Institute of Chartered Accountants of India have recently barred an internal auditor from being appointed even as a Tax auditor.

iii) Approach:

The approach taken by internal audit should be clear. It could be :

risk-based – the focus is on the high-risk areas of the organisation;

review-based – the focus is on review of various parts of the organisation, usually chosen both at random or in line with a predetermined internal audit plan;

compliance-based – the focus is on compliance with policies and procedures.

It could however be a combination of all three. Normally, it would be a combination of at least two of the above.

The board and/ or the audit committee should approve the approach. However, there should be sufficient scope to change the emphasis where necessary on an ongoing basis in order to react quickly to issues that get identified and require internal audit involvement – for example – recent losses incurred by companies in foreign exchange derivatives. In short, the internal auditor has to be agile to respond to changing environment. He should always be vigilant.

i) Establishing the authority of internal audit:

The CEO must send out a clear message that internal audit function is necessary and not a compliance gimmick. The seriousness and the attitude of the CEO is the only means of establishing internal auditor’s authority.

Internal audit must be recognised as a core part of governance and not as some form of necessary burden or add-on. On the other hand, the internal auditor by the professionalism and quality of internal audit work should show boards, management, regulators and even those whose work he reviews and comment on that the function does add value. It should be understood that the message that internal audit sends will not carry weight unless it can be demonstrated that the message is founded on both technical and commercial competence – a balancing of technique and real world experience.

In other words the internal auditor has to establish that his function goes beyond compliance. To achieve this the team skill mix needs to be broad embracing accounting, compliance checking, industry specialist, IT skills and if possible to include a strategist – CAATs. This at times can be achieved by:

where necessary, ‘in-sourcing’ or ‘out-sourcing’ (if not already done) by having specialist skills to supplement full-time audit resources;

ensuring that internal audit technology keeps pace with developments in the business – for example – use of Balanced Score Card, Self Assessment, CAATs; and

demonstrating professionalism and objectivity by standing strong amidst the management and others, when this is justified in the interests of other stakeholders.

ii) Conflict situation:

Regulators can cite many examples where weak corporate governance exists because of an overbearing CEO who has undermined the financial soundness of an organisation, whether through unfocussed expansion – that is – pursuit of growth for growth’s sake, or the dominant desire to always give ‘good news’ – show growth where there is none or cover up losses. The recent Satyam fiasco is a startling example of an overbearing CEO. Internal auditor should be alert to such and similar signs of weakness and raise these issues with the Audit Committee. This kind of approach, though at times goes beyond the normal call of duty, will add immense value. Let us not forget that virtually all analysts have come to the conclusion that the current financial crisis which has gripped the world economy is because of the desire of CEOs and the corporate managements to achieve one of the two or both the objectives. Somewhere in fulfilling these objectives both the internal control procedures and risk limits have been violated. We believe that though it may be a tough call, the internal auditor will have to bite the bullet. The newspapers report that in the case of Satyam, SEBI’s investigation is being extended to Satyam’s internal auditors – Business Standard 16 Jan. 2009.

3.2 To retain his independence and effectiveness the internal auditor should also be conscious of the fact that:

no controls are absolutely perfect and will always require improvement.

managements are always tempted to by-pass controls, sometimes in the interest of business and at times in self-interest.

Hence, he should be aware of what is happening in the entity and should also never lose sight of ‘professional skepticism’.

3.3 Ultimately, it is the board, which has to take ownership of problems and institute appropriate remedies. The issues is :

What should the internal auditor do where the organisation is facing major problems and the management continues to ignore or take remedial action?

There is no easy answer, since each situation is unique. Nonetheless, it is surely incumbent on the internal auditor to take the right professional action and not let the situation fester. In the end, the head of internal audit or the internal auditor might have to step down and part ways gracefully if the organisation’s culture does not allow internal audit to function appropriately and serious problems are not being addressed. This is the ultimate test of the professionalism and ethics. This is a hard decision. The fact is that after any failure the internal auditor is inevitably one of the sacrificial lambs on the altar of accountability. In these difficult situations, professional standards, support from the professional body and peers and where appropriate, support of the regulators can help to strengthen the position of the internal auditor. Internationally regulators have required external auditors to whistleblow to the regulator in extreme circumstances, while granting them protection in the form of qualified privilege. We may need to consider similar protection for internal auditor in our environment.

Concluding remarks :

The ever-increasing pressure on organisations to manage their affairs and risks prudently poses considerable challenges for corporate governance structures including internal audit, a key line of defence in these structures. Every challenge, however, is an opportunity. For ‘internal audit’ as a profession, the current business environment is both an opportunity and a challenge to cement our presence in corporate India to demonstrate our skills and resolve to play a contributory role. We have full support of the regulator and the audit committees. We perceive that in addition to an opportunity and challenge the ‘internal audit profession’ has an obligation to assist in making corporate governance transparent and effective. Let us therefore “look at the right things, whilst doing the right thing”.

Nirav Shah

PART A: Decisions of CIC

Section 7(1) of the RTI Act Vide RTI application dated 5-7-2011, the appellant sought information regarding illegal accounts of Indians in Liechtenstein, obtained from the German government and steps taken by the Government of India to deal with black money.

Not satisfied with the response of the PIO and FAA, before the Central Information Commission, the appellant in support of his argument referred to the Supreme Court decision dated 4-7-2011, in W/P (Civil) 176 of 2009, Ram Jethmalani vs. Union of India, and submitted that exemption u/s. 8(1)(a) and (f) as claimed by the CPIO was not tenable. He also made a reference to CIC decision (appeal OK/C/2008/00897 dated 15-7-2011) supporting his argument. The CPIO submitted that the government has filed a modification petition which is pending in the Supreme Court.

The public authority brought to the notice of the Commission a para of the judgement dt 4.7.2011 of Honourable Supreme Court in W.P (Civil) 176 of 2009, Ram Jethmalani & Ors vs. Union of India which reads as follows:

“That the special investigation, constituted pursuant to the orders of today by this court, shall take over the matter of investigation of the individuals whose names have been disclosed by Germany as having accounts in Banks in Liechtenstein and expeditiously conduct the same. The Special Investigation Team shall review the concluded matters also in this regard to assess whether investigations have been thoroughly and properly conducted or not, and on coming to the conclusion that there is a need for further investigation shall proceed further in the matter. After conclusion of such investigation by Special Investigation Team, the respondents may disclose the names with regard to whom show cause notices have been issued and proceedings initiated.”

The public authority has also submitted that the Union of India has moved application for seeking recall and/or modification of orders dated 4-7-2011.

The Commission decided that since the information sought by the appellant was sub-judice, the appeal be dismissed.

[Paras Nath Singh vs. CBDT, New Delhi: CIC/ DS/A/2011/003377 & 003607/RM: Decision dated 12-11-2012]

Section 8(1)(j) of the RTI Act

The appellant had sought certain information from the CPIO including names of assessees/cases in which scrutiny is complete. The CPIO held that Trusts/assessees are public authority and their activities are of public nature and hence information about them should be in the public domain. Accordingly, the number of cases in which scrutiny was completed, was provided. However, names of such assessees were withheld citing that no public interest will be served. The Commission held that disclosure of names of assesssees whose returns have been scrutinised, would constitute an unwarranted invasion of privacy of the assessee, if this information is placed in the public domain and hence it is exempted from disclosure u/s. 8(1)(j) of the RTI Act. [Rakesh Kumar Gupta vs. Asst. Director of IT (Exemptions), Trust Circle-II & Addl. Director of IT (Exemptions), Range-1, Delhi: CIC/DS/A/2011/ 003072/RM decided on 6-11-2012]

Section 6(1) of the RTI Act

The issue was whether the applicant can extend the scope of his RTI application at the Appellate stage.
Vide RTI application dated 6-9-2010, the appellant had sought comments of the public authority to a complaint which had been filed by him earlier on 11-5-2010 regarding alleged misuse of government vehicles by Smt. C. Chandrakanta, the then Joint Commissioner, Income Tax Range-IV, Jalandhar and other unlawful activities.

Before the CIC, the applicant submitted that he had sought to know whether any enquiry was conducted regarding leaving of the headquarters by Smt. C. Chandrakanta without prior permission from a competent authority. The CPIO had responded that no enquiry was conducted. The AA in his order stated that the appellant had not sought any reasons for not initiating any action in his RTI. As such the order of the CPIO was justified. The appellant insisted that the public authority should provide him the reasons. In support of his submission he quoted CIC order dated 11-9-2008 – Smt. Sarla Rastogi vs. ESIC.

In hearing before CIC, the appellant submitted that in response to his query as to whether any enquiry was conducted in regards to the leaving of headquarters by Smt. Chandrakanta, the CPIO responded that no enquiry was conducted. The appellant submitted that reasons for the same should be provided and referred to section 4(1)(d) of the RTI Act as also CIC decision in the case of Smt. Sarla Rastogi vs. ESIC (Appeal No. CIC/MA/A/2008/01106 dated 11-9-2008). The AA had upheld the decision of the CPIO on the grounds that in his RTI, the appellant has not sought reasons.

Decision:

The Commission observed that the CPIO had replied to the specific queries raised in the RTI by the appellant. With the said reply, the query of RTI application is satisfied. There is no provision to raise subsequent questions as an extension of the RTI query, as sought by the appellant in his first appeal. Hence, the Commission does not find any merit in the appeal. The case is disposed of. [R.K. Mahajan vs Income Tax Department, Jalandhar: CIC/DA/A/2011/0001476/RM: decision dated 7-6-2012]

RTI (Regulation of Fee and Cost) Rules, 2005

The Commission decided that it was in agreement with submissions of the appellant that the application fee sent by him in favour of Accounts Officer, DGIT, New Delhi, should not have been returned and the CPIO was not correct, in asking the appellant to redeposit the application fee in favour of ZAO, CBDT, New Delhi. Rule 3 of the Right to Information (Regulation of Fee and Cost) Rules, 2005 stipulates that the amount is payable to the Accounts Officer of the public authority.

Decision:

The Commission directs the public authority to ensure that in the future, the application fee sent in the name of Accounts Officer is not returned. DoPT orders issued on 5-12-2008 (OM No. F.10/9/2008-IR) shall be brought to the notice of all concerned officials handling RTI matters. Insofar as the RTI request is concerned, the Commission sees no reason to interfere with the order of the CPIO/AA.

[Nitesh Kumar Tripathi vs DGIT (Vigilance), New Delhi: CIC/DS/A/2011/002840/RM: decision dated 21-9-2012]

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Nirav Shah

Transmission Formalities (Part I)

Introduction “Mors certa est, vita non est” The above latin phrase meaning “Death is Certain, Life is Not” sums up the reality of life. As certain as Death is, it’s very timing is extremely uncertain and unpredictable. More often than not, it catches you when one least expected it!! Hence, Life is Uncertain.

An unexpected demise of a close relative comes as a bolt from the blue for the family and while they are yet mourning, they have to grapple with several succession formalities, such as, death certificates, execution of wills, transmission formalities, etc.

Ironic as it may sound, it is this certainty of death which throws up several uncertainties for the heirs which a deceased may leave behind. Quite often, the family, in its period of grief, overlooks some formalities which snowball into major problems subsequently. Let us look at some of the important formalities which the family of a deceased are faced with and some practical suggestions to deal with them.

‘Transmission’, ‘Succession’ and ‘Inheritance’ are three terms which one often comes across when dealing with the property of a deceased. It would be gainful to understand the meaning of these three terms:

Succession – Black’s Law Dictionary defines the term to mean the devolution of title to property under the law of descent and distribution. Inheritance – succession by descent – East v. Twyford, 9 Hare, 729

Transmission – Stroud’s Judicial Dictionary defines the term as transmission by operation of law, unconnected with any direct act of the party to whom the property is transmitted.

Doctor’s Certificate

The first formality which the deceased’s family needs to immediately comply with when a person dies, is to obtain a Doctor’s Death Certificate. This is the most important document which sets in motion a chain of events. Hence, it always helps to have a family physician. There have been cases where there is no family doctor and when a person dies at home, no doctor is willing to give the certificate.

The Doctor’s Certificate is required in Form 4A under Rule 7 of the Maharashtra Registration of Births and Death Rules, 2000, framed under the Registration of Births and Deaths Act, 1969. The Forms are issued by the Municipal Corporation of Greater Mumbai. It is very important that the Doctor mentions the name of the deceased correctly just as it appears in all legal documents. If the deceased used aliases, it may be worthwhile to add them also in the Certificate. Get multiple copies of this document since the original would have to be surrendered to the Municipality.

Police Report

Consider a situation where a person is pronounced dead on admission to a hospital or has died at home, but is unsuccessfully taken for resuscitation efforts to the hospital. The hospital would like to rule out foul play in such cases and also the need for a post-mortem.

Hence, in addition to a Doctor’s Death Certificate, the hospital would also require the family to lodge a Police Report. The local Police Station would take down the close relative’s statement in Marathi which would include, the number of members living with the deceased, their ages, occupation and whether or not the family suspects any foul play. The Police Station would also fill up two Forms, Form 4 and Form 5, and obtain the relative’s signature on the Report. The family would be well advised to understand the contents of the Report before signing the same. The Report would be retained by the Police Station.

If the Police suspect a foul play, then they would insist upon a post-mortem before allowing cremation. The hospital would also not hand over the body of the deceased, without this Police NOC or a post-mortem. One age-old issue which often crops up is that of Police jurisdiction. Which Police Station should the family go to? Should it be the one where the deceased resided or the one where the hospital was situated?

Death Certificate from Municipality

A cremation (assuming a Hindu deceased) would be allowed only on the basis of a Doctor’s Death Certificate. The original of the Doctor’s Death Certificate and Police Form 4 along with a copy of Police Form 5 should be handed over to the office of the crematorium where the cremation of the deceased is to take place. The office would hand over a receipt in lieu of all these documents which should be carefully preserved. These documents are transmitted by the crematorium to the local Municipality office. As always, get copies made of this document.

BMC’s Death Certificate

An application for a Death Certificate should be made to the office of the local ward of the Municipality in which the deceased resided. Normally, this application is to be made about a week after the death. Along with the application, a copy of the crematorium’s receipt should also be submitted. Care should be taken to fill in the details of the deceased as they appear in all legal documents.

The family can obtain as many copies of the Death Registry Certificate as they desire. It would be desirable to make copies of this Certificate and to get them Notarised by a Notary Public, since this is the most important document which would be required at several places.

Nomination

If the deceased has made Nominations in respect of his flat, bank account, Public Provident Fund, Insurance Policies, Demat Accounts, Mutual Funds, etc., then the nominee should intimate the fact of death along with a copy of the Death Certificate to these organisations. The assets would then stand in the name of the Nominee. It may be noted that the nominee is only a stop-gap arrangement till such time as the Will is executed or the assets are distributed in accordance with the Succession Law in case of intestate succession.

However, in the case of physical shares and demat accounts, the Nominee is both the legal and the beneficial owner and overrides what is stated in the Will. This is borne out by section 109A of the Companies Act, 1956 as well as the Bombay High Court’s decision in the case of Harsha Nitin Kokate v. The Saraswat Co-op. Bank Ltd, 112 (5) Bom. L.R. 2014. Clause 72 of the New Companies Bill, 2011 also carries forth this position. Hence, a person making his Will should ensure that the Nominee of his demat account is the same person who is the beneficiary of the same under the Will.

Will

Assuming that there is a valid Will left behind by the deceased, the same should then be placed before the family of the deceased by the Executor of the Will. The Executor should start taking steps for transmission of the properties of the deceased. Again, it would be desirable to make copies of this Will and to get them Notarised by a Notary Public, since the Will would be required at several places.

Transmission of Flat where there is no Nomination

On the death of a person, his flat in a co-operative society can be transferred by the Society to his nominee, if a nomination was made, or to his Legal Heir. Section 30 of the Maharashtra Co-operative Societies Act, 1960 provides that in the event of the death of a member of a Society, the Society is required to transfer the member’s interest to the nominee or to such person as may appear to the Committee to be the heir or legal representative of the deceased member.

The Act does not define the term “heir”. The Supreme Court in the case of N. Krishnammal v. R. Ekambaram, 1979 AIR SC 1298, has defined the term as follows:

“…The word “heirs”, as pointed out by this Court in Angurbala Mullick v. Debabrata Mullick (1) cannot normally be limited to “issues” only. It must mean all persons who are entitled to the property of another under the law of inheritance.”

The Act also does not define who is a “Legal Representative”. Hence, one may refer to the Civil Procedure Code. Section 2(11) of the Code of Civil Procedure, 1908 that defines a “Legal Representative” as follows:

“(11) ” legal representative ” means a person who in law represents the estate of a deceased person, and includes any person who intermeddles with the estate of the deceased and where a party sues or is sued in a representative character the person on whom the estate devolves on the death of the party so suing or sued;”

The decision of the Bombay High Court in the case of Om Siddharaj Co-Op. Hsg. Society Ltd v. The State of Maharashtra, 1998 (4) Bom. CR 506 is relevant:

“…On a plain reading of section 30, it is clear that on death of a member of the society, it is incumbent on the society to transfer the share or interest of the deceased member to” a person or persons nominated in accordance with the Rules”. It is only in the event of there being no nomination of any person, the society can transfer the share or interest of the deceased member to “such person as may appear to the committee to be the heir or legal representative” of the deceased member. The language of the section is clear and unambiguous. …..It is only if there is no nomination in favour of any person, that the share and interest of the deceased member has to be transferred to such person as may appear to the committee of the society to be the heir or legal representative of the deceased member.”

Hence, a co-operative society would be well within its rights to transfer the flat to the legal heirs of the deceased, if there is no nomination. The Society may, for its protection, insist upon a No Objection Certificate from the other legal heirs/representatives (if there are others than the transferee) and an Indemnity Bond from the transferee.

Transmission of Tenanted Property

A common misconception which most people have is that tenancy can be transferred or bequeathed by way of a will. Tenancy is a personal right of the tenant and hence, it cannot be transferred by way of any testamentary document. This principle has also been upheld by the Supreme Court in the case of Vasant Pratap Pandit vs Dr. Anant Trimbak Sabnis, 1994 SCC (3) 481. Tenancy passes on a tenant’s death to any member of his family who was residing with him at the time of his death. In the absence of such a member, it passes to any heir of the tenant. The Supreme Court in the above case has held that from a plain reading of the Rent Act, it is obvious that the legislative prescription is first to give protection to the members of the family of the tenant residing with him at the time of his death. The basis for such prescription seems to be that, when a tenant is in occupation of the premises, the tenancy is taken by him not only for his own benefit, but also for the benefit of the members of the family residing with him. Therefore, when the tenant dies, protection should be extended to the members of the family who were participants in the benefit of the tenancy and for whose needs as well the tenancy was originally taken by the tenant. It is for this avowed object, that the Legislature has, irrespective of the fact whether such members are ‘heirs’ in the strict sense of the term or not, given them the first priority to be treated as tenants. It is only when such members of the family are not there, the ‘heirs’ will be entitled to be treated as tenants as decided, in default of agreement, by the court. In other words, all the heirs are liable to be excluded, if any other member of the family was staying with the tenant at the time of his death.

Transmission of Land

In respect of any land belonging to the deceased, a Probate of the Will would be required, in case the deceased was a Christian or a Hindu, Sikh, Jain or Buddhist whose immovable properties are situated within the territory of West Bengal or the Presidency Towns of Madras and Bombay. A Probate would be required for effecting a change in the Record of Rights, 7/12 Extract, Property Card, etc.

Agricultural Lands of Deceased

U/s. 63 of the Bombay Tenancy and Agricultural Lands Act, 1948, any transfer, i.e., sale, gift, exchange, lease, mortgage with possession of agricultural land in favour of any non-agriculturist shall not be valid, unless it is in accordance with the provisions of the Act. An important exception to the provisions of section 63 is the case of succession to agricultural land by a non-agriculturist. Thus, even if the legal heirs of an agriculturist are non-agriculturists or the legatees under his will are non-agriculturists, the succession/bequest in their favour would be valid. In law, succession to property cannot lie in a vacuum and the Act would not override succession laws. The Act has no application to transmission of interest of holder on his death to his successor by any mode of succession of lands held by tenants.– Ghanshyambhai Nakheram v State of Gujarat, (1999) 2 Guj LR 1061.

If any person acquires any right by virtue of succession, survivorship, inheritance, etc., in any land, then, as per the Maharashtra Land Revenue Code, 1966, he must give a notice of the same to the Talathi within 3 months of such event. The Talathi would then enter such changes in a Register of Mutations which would alter the original record of rights.

U/s. 4 of the Maharashtra Agricultural Lands (Ceiling on Holdings) Act, 1961, the ceiling on the holding of agricultural lands is per “Family Unit”. This is a very unique and important concept introduced by this Act. It is very essential to have a clear picture as to who is and who is not included in one’s ceiling computation, since that could make all the difference between holding and acquisition of the land. A family unit is defined to mean a person and his spouse or more than one spouse if that be the case – thus, if a person dies leaving two or more widows, then they would constitute one consolidated family unit for considering the ceiling – State of Maharashtra v. Smt. Banabai And Anr. (1986) 4 SCC 281. His minor children are also included in the definition of a family unit.

A very interesting scenario arises in the case of testate/intestate succession. For instance, there is a person who is holding land up to the maximum limit permissible. His major son is also independently holding another piece of land up to the maximum limit permissible. The father dies and his sole legal heir is his son. On his death, the land becomes that of the son. Can the son contend that since he has received the land by inheritance, the ceiling should not apply to the second land received by him? The Supreme Court had an occasion to consider this issue in the case of State of Maharashtra v. Annapurnabai and others, AIR 1985 SC 1403. The facts were that the declarant died pending determination of excess ceiling area. A contention was raised that consequently on his death the proceedings stand abated and that therefore, the authorities have no jurisdiction to proceed further with the determination of the excess land under the Act. The Supreme Court held that until the proceedings are completed, there is no abatement and the excess ceiling land has to be computed pursuant to the declaration under the provisions of the Land Ceiling Act and that therefore, the

Government continues to have jurisdiction to determine the excess land. It held that the heirs and legal representatives of a deceased holder cannot be treated as independent tenure holders for fixing ceiling. Therefore, each heir would not be treated as independent tenure holders for fixing the ceiling in respect of agricultural land.

Similarly, the Supreme Court in Bhikoba Shankar Dhumal v. Mohan Lal Punchand Tathed 1982 SCR (3) 218 held that the persons on whom his ‘holding’ devolves on his death would be liable to surrender the surplus land as on the appointed day, because the liability attached to the holding of the deceased would not come to an end on his death. The heirs of the deceased cannot be permitted to contend to the contrary and allowed to get more land by way of inheritance than what they would have got if the death of the person had taken place after the acquisition of surplus land by the Government.

Further, a person holding surplus land, i.e., land in excess of the ceiling area, cannot transfer the same. In Kewal Keshari Patil v State of Mah, 1966 Mah LJ 94 it was held that a Will is not a transfer. When the Will was executed, it is not a transaction which is contravening the ceiling under the Act.

Dwelling House

The Hindu Succession Act earlier made a special provision in respect of partition of dwelling-houses which has now been omitted with effect from 9th September, 2005. A dwelling house has been defined as a house wholly inhabitated by one or more members of the family of the deceased at the time of his death – Narsimaha Murthy v. Susheelabai (1996) 3 SCC 644. It has also been held to mean the home or abode or residence of a person – K Ratnsawamy, (1980) 2 SCC 548.

The Act originally provided that where a Hindu (male or female) died intestate leaving behind both male and female heirs specified in Class I, and his/her property included a dwelling-house wholly occupied by members of his/her family, then, any such female heir could not claim partition of the dwelling-house until the male heirs choose to do so. However, the female heir was entitled to have a right of residence in such house. If such female heir was a daughter, then she was entitled to a right to residence in the dwelling-house only if she was unmarried or had been deserted/separated from her husband, or was a widow. Thus, the section prevented female members from claiming partition of a dwelling-house till such time as the male members decided to do so.

In 2005, this section has been deleted altogether to remove the inequalities. Now, a daughter of the family will also inherit a dwelling house under the provisions of the Act and she can also ask for a partition of such dwelling house where the male members are residing. Thus, a married daughter has a right to ask for a partition of a house where her brother is residing on the death of their father. This is an important provision which should be borne in mind.

Transmission of Demat Account in case of Joint Holders

In several cases, it so happens that the names of the husband and wife are added as first and second holders in demat accounts. The Will of the husband also provides that after his demise, all his assets go to his wife. In such an event, transmission of the demat account from the first holder to the second holder is a relatively easy process.

An application needs to be made to the depository for simultaneous closure of the joint account and transfer of all the securities to a new sole account of the second holder, i.e., the wife. Thus, as a result, all the securities would stand transmitted to a new sole account belonging to the wife, who was the second holder in the husband’s joint account. This application only requires a copy of the Death Certificate and KYC details of the second holder.
(to be continued….)

Nirav Shah

I Hope the Tea is Hot

This story is of an extraordinary person, the best that I have come across in my thirty nine years in public life. Since he has always been low key and shunned publicity, I would not like to mention his name. I also have to camouflage the identity of the other actors involved in this episode.

About fifteen years ago, we were in the midst of the aftermath of the Harshad Mehta scam. The times were in one respect very similar to, but in one respect very different, from the present. The media was screaming that the corrupt be punished severely and quickly, but there was no 24×7 news coverage, and outside the Government very few people had heard of the Central Vigilance Commission. Vigilance work could thus be carried on the way it was supposed to. Systems, when allowed to function, could still deliver. There is an important lesson in this story, for those who are looking for instant solutions to the problem of corruption.

I had joined the Central Vigilance Commission (CVC) as its Additional Secretary just two months earlier. My room was flooded with voluminous files, and I returned home quite late in the evening every day. Even so, I woke up one fine December morning feeling very relaxed. The sun was shining brightly and the air was very crisp. It had rained the previous night, but when I opened my bedroom window overlooking Delhi Haat, a clear blue sky greeted me. I had got through all the pending files the night before; for a change, I had a little time to myself, and I decided to wear my new suit. When I reached my office at Bikaner house, near India Gate, all hopes of being complimented on how smart I was looking quickly vanished.

“The CVC wants you immediately, Sir. The meeting he was to take in the afternoon has been advanced. He wants HA as well. I have already informed him; he’ll be with you in a few minutes.” my secretary told me breathlessly.
“Thanks a lot, S— sahib.” I said. “Do I have time for quick cup of tea or not?” I asked.

“No Sir. K, his secretary, said you should see the CVC as soon as you arrive.

In a few minutes, my colleague HA entered my room. He was looking after the All India services and the Home Ministry. He asked me “Sir, did you get time to read the case?”

“Yes; I did. I’ve already recorded my note and sent it to the CVC.” “I’m sure you’re aware of the complexities involved.”HA told me as we were travelling from Bikaner House to Jaisalmer House, a distance of about a kilometre. “The man we’re dealing with is honest. Do you know Sir, he has topped in every examination that he has taken. He has all the right credentials and many important people, including some of the CVC’s batchmates have spoken to him. So do be careful.”

I thanked HA for this briefing, but before we could carry on the conversation any further, we reached our destination. In the anteroom, we were greeted by a stout middle aged man who gave the impression of being very competent and in total charge of his little office. The moment he saw us he spoke on the intercom and smiled.

“The CVC is expecting both of you,” he said.

The CVC was a short, spectacled, fair complexioned person. He looked detached, austere and gentle, but when warranted could be hard as nails. He was also decisive and quick and brooked no nonsense from his subordinates. Every word he spoke was carefully measured. He never promised anything easily, but if he did, he made sure he delivered. Despite an enormous workload, he always had time at his hands and complete control over the organisation that he headed with so much distinction.

He looked at both of us. “Good morning. Do come in and sit down. Hardayal, I have been through your note and gather that both of you are familiar with the facts.”

“Yes, Sir,” I replied.

“So what is the case that the State Vigilance Department has made out?” “They have argued that the officer caused an undue loss to the Government, and an undue gain to a trust in which the then Chief Minister had an interest. He sold a plot of land at a very low rate. The organisation he headed sold the adjacent plot at about the same time at a much higher rate. So, I guess a case under the Prevention of Corruption Act has been made out. The State Government is seeking permission to prosecute him.”

“Do you see anything going in his favour?” he asked looking as detached as ever. “HA has more knowledge than I do, Sir; but I do sympathise with him. To be very honest, I don’t think he had much choice. He had to choose between the devil and the deep blue sea”. I said. “Given the circumstances, very few people would have been able to say no. The present Government is prosecuting the Chief Minister separately. They feel that this person also played a part in furthering his criminal design.”

HA then pointed out, “But for this case, we have nothing against him. As an officer, he is rated highly and is reputed for his integrity.” I nodded my head in agreement. I knew the CVC had read the file thoroughly himself. He was making me speak, to test out how much I had learnt in the last two months and get some inputs which he needed. But he had such a pleasant way of doing things that I was totally at ease. Then came the inevitable question:

“What advice should we give.” “I am afraid we don’t have much choice in the matter. We have to act according to policy. If we don’t advise prosecution in this case, we’ll not be able to recommend it in other cases, where power is misused to cause a gain to a private person and loss to the government. It will also be unfair to others in whose case we have already advised prosecution on more or less similar facts.”As I said these words, I wondered whether I had spoken too much.

“What about the extenuating circumstances in this case?”

“Those will have to be taken into account by the court, if it convicts him. I gather this has always been our policy, Sir.” He gave me piercing look. “It’s easy for us to sit in judgement and use the benefit of hindsight to judge his conduct. Can you imagine what he must have gone through?” I nodded in agreement.

He went through certain portions of the file; he was only refreshing his memory to see if any vital aspect had been lost sight of. He looked up again and said, “But I totally agree with you. There can be no relaxation of policy. These are professional hazards of being a civil servant, but we have to act correctly. Hardayal, the file will come back to you within an hour, please advise the Ministry today itself to sanction prosecution at the earliest.”

Before I got up, I realised how difficult it must have been for him to come to this decision. He may not have spoken much, but I could see that he could empathise with the plight of the officer – his excellent track record must have reminded him of his own career. Whether he knew him at all, I’ll never know. One doesn’t ask these questions. What weighed with him, in the ultimate analysis, was an important principle which he had sworn to uphold: the Commission can’t decide cases on the basis of its likes and dislikes. It has at all times to be fair, objective and consistent in its approach.

When we stepped out of his office, we found the weather had changed. The sky was overcast and it had begun raining again. Since my staff car was going to take a few minutes, we got tempted into accepting K.’s offer for a quick cup of tea. I was in the midst of sipping it, when the CVC opened the door and gave a few instructions to K. I immediately got up in respect as he was talking. Seeing my unease, he smiled and said: “I am glad K. is looking after you. I hope the tea is hot.”

Postscript: the officer was prosecuted and later sentenced to a term in prison. He took bail and then appealed to the High Court. The latter reviewed the evidence on record and came to the conclusion that the adjacent plot of land which was sold at a much higher price was qualitatively different from the plot under consideration; in other words, it could not form the basis for valuing the latter. He was honourably acquitted. His subsequent career was quite uneventful. He retired from a respectable position and rose as much in his service as he would have, had the incident not occurred. In other words, he did in the end get some justice.

The beauty of this case lies in the fact that, at every stage every functionary who dealt with it performed his duty efficiently and quickly. Contrary to what happens often with disastrous consequences, due processes were not short-circuited. As a consequence, the system delivered. Here is a lesson for all those who want a quick fix solution for dealing with the problem of corruption: there is none.

Nirav Shah

Tenancy – Determination of Annual ratable – Property exempt from Rent Control Legislation – Value – Mumbai Municipal Corporation Act, 1888, section 154(1) and Maharashtra Rent Control Act, 1999 section 3.

Municipal Corporation of Greater Mumbai & Ors. vs. Dalamal Tower Premises Co-operative Soc. Ltd & Anr. 2012 Vol. 114(5) Bom. L.R. 3159

On a difference of opinion in a Division Bench, in an appeal arising out of the decision of a Single Judge, the following question of law was sent for reference to a third judge:

In view of the repeal of the Bombay Rent Act and enactment of the Maharashtra Rent Control Act, is the Bombay Municipal Corporation justified in taking into consideration the actual amount of rent received or receivable by the landlord in relation to the units which are let out, but where the lease is exempted from the provisions of the Rent Act for determination of annual letting value with effect from 1st April 2000?

The issue which falls for determination relates to the consequences, if any, that would ensue in computing the ratable value of land or building where the premises in a building are exempt from the provisions of the Rent Control legislation. According to the Municipal Corporation, when the premises are exempt from the operation of the Rent Control legislation, the contractual bargain between a landlord and a tenant is not circumscribed by the provision for the fixation of standard rent in the Rent Act. Moreover, once the premises are exempt from the Rent Act, it is not unlawful for a landlord to receive rent in excess of the standard rent. On the other hand, according to the property owners, the true test to be applied is whether the Rent Control legislation is in operation in the area in which the premises are situated and if it is, it would make no difference that the premises are exempt from the operation of the Rent Control legislation. Hence, according to the property owners, even if the premises are exempt from the Rent Act, the annual value for the purposes of municipal legislation cannot exceed the standard rent under the Rent Control legislation.

The Hon’ble Court observed that where the premises are exempt from the operation of the Maharashtra Rent Control Act, 1999, by the provisions of section 3, the Assessing Authority in determining the annual rent at which the premises might reasonably be expected to let from year to year u/s. 154(1) is not constrained by the outer limit of the standard rent determinable with reference to the provisions of the Rent Act and secondly, where the premises are exempt from the provisions of the Maharashtra Rent Control Act, 1999, it is not unlawful for the landlord to claim or receive an amount in excess of the standard rent, since the provisions of section 10 would not be attracted. In such a case, the actual rent received by the landlord is in the absence of special circumstances a relevant consideration which may be borne in mind by the Assessing Authority while determining the rateable value for the purposes of municipal taxation u/s. 154(1) of the MMC Act, 1888. The Assessing Authority must have regard to all relevant facts and circumstances while applying the standard of reasonableness u/s. 154(1), including the prevalent rate of rents of lands and buildings in the vicinity of the property being assessed, the advantages and disadvantages relating to the premises, such as, the situation, the nature of the property, the obligations and liabilities attached thereto and other features, if any, which enhance or decrease their value.

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Nirav Shah

Registration – Property – Refusal to Register document – None can transfer a better title than what he has – Indian Registration Act:

Chairman/Secretary, Deep Apartment CHS Ltd vs. The State Maharashtra & Ors. 2012 Vol. 114 (6) Bom. L.R. 3728

Writ petition was filed challenging the orders of the Registering Authority and the Appellate Authority refusing to register a conveyance executed by and between a private limited company which was the builder of the building and the co-operative housing society of flat purchasers which had been registered under the Maharashtra Co-operative Societies Act. The order of refusal set out various provisions of various legislations which are claimed not to have been complied. The order further referred to section 72(3) of the Maharashtra Registration Manual, Part II which requires compliance with sections 19 to 26 and 33 to 35(b) of the Indian Registration Act. Under the impugned orders the Registering Authorities had consistently maintained that the vendor mentioned in the conveyance deed had no title.

The Registering Authority is required to register a document executed by the parties who present themselves before the Registering Authority and admit execution thereof.

Hence, it is seen that the document would have to be presented before the Registration office by the executors or their representatives. Once that is done, the Registering Authority would see that the executors are personally present before him or their representative is present before him. The Registering Authority will also ask whether they admit the execution. The Registering Authority will satisfy himself that the persons before him are the persons they claim to be. If that is done, the Registering Authority must register the document.

It may be mentioned that the registration of a document shows nothing other than the fact that the document which is executed is admitted to have been executed or is executed before the Registering Authority. It does not prove the contents of the document. It is settled law that even certified copies issued by the Registering Authority do not prove the truth of the contents of the documents. They only prove the fact that the document was indeed registered as per procedure. [See Omprakash Berlia vs. UTI, AIR 1983, Bom 1].

The Court observed that the Registering Authority persisted in refusing to register the document on the ground that the title of the vendor had not been shown. It is only the Civil Court which would consider the title. There is nothing in the Registration Act or the Registration Manual, to empower the Registrar to see or satisfy himself about the title of the vendor. Hence, registration entails nothing more than the factum that the executants or their agents attended before the Registrar and admitted the execution of the document.

It is contended on behalf of the respondents that there are many instances where the parties without any title seek to transfer such purported title which they do not have and legitimise the illegal act by the process of registration. That may be the ground reality. The Registering Authority, being conscious of such a fact, may consider himself obliged to prevent transfers by such illegal acts. However, the jurisprudential rule that none can transfer a better title than what he has, is indeed as elementary as it is basic. The Registering Authority, therefore, need not be take upon itself the duty of a Civil Court which alone would go into question of title upon it being challenged. The Registry Authority was directed to register the document within 4 months from the date of order.

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Nirav Shah

Contract – Repayment of time barred debt – Enforceability of debtor liability Contract Act, 1872.

Dinesh B. Chokshi vs. Rahul Vasudeo Bhatt and the State of Maharashtra, 2012 Vol. 114(6) Bom. L.R. 3766

The reference to Division Bench was for deciding the two questions which were:-

(i) Does the issuance of a cheque in repayment of a time barred debt amount to a written promise to pay the said debt within the meaning of section 25(3) of the Indian Contract Act, 1872?

(ii) If it amounts to such a promise, does such a promise, by itself, create any legally enforceable debt or other liability as contemplated by section 138 of the Negotiable Instruments Act, 1881?

If there is a promise to pay an amount and if a breach thereof is committed, a suit for recovery is required to be filed within the stipulated period of limitation provided under the law of Limitation. After the time provided for filing a suit for recovery expires, the promise ceases to be enforceable. Section 10 of the Contract Act provides that all agreements are contracts, if they are made by free consent of the parties competent to contract for a lawful consideration and with a lawful object and which are not expressly declared to be void under the Contract Act. Section 20 of the Contract Act incorporates a category of void agreements. Sections 19 and 19A provide for categories of agreements which are voidable. Section 23 provides that if the consideration or the object of an agreement is forbidden by law or is immoral or is opposed to public policy, the consideration or object of the agreement is unlawful and the agreement is void. Sections 26 to 30 of the Contract Act also provide for different categories of agreements which are void. Therefore, apart from the agreements which cease to be enforceable by reason of bar of limitation, there are other categories of agreements which are void and, therefore, obviously not enforceable by law.

On a plain reading of section 13 of the Negotiable Instruments Act, 1881, a negotiable instrument does contain a promise to pay the amount mentioned therein. The promise is given by the drawer. U/s. 6 of the said Act of 1881, a cheque is a bill of exchange drawn on a specified banker. The drawer of a cheque promises to the person in whose name the cheque is drawn or to whom the cheque is endorsed, that the cheque on its presentation, would yield the amount specified therein. Hence, it will have to be held that a cheque is a promise within the meaning of s/s. (3) of section 25 of the Contract Act. What follows is that when a cheque is drawn to pay wholly or in part, a debt which is not enforceable only by reason of bar of limitation, the cheque amounts to a promise governed by the s/s. (3) of section 25 of the Contract Act. Such promise which is an agreement becomes exception to the general rule that an agreement without consideration is void. Though on the date of making such promise by issuing a cheque, the debt which is promised to be paid may be already time barred, in view of s/s. (3) of section 25 of the Contract Act, the promise/agreement is valid and, therefore, the same is enforceable. The promise to pay a time barred debt becomes a valid contract. Therefore, the first question was answered in the affirmative.

The Court further observed that u/s. 118 of the said Act of 1881, there is a rebuttable presumption that every negotiable instrument was made or drawn for consideration. Section 139 creates a rebuttable presumption in favour of a holder of a cheque. The presumption is that the holder of a cheque received the cheque of the nature referred to in section 138 for discharge, in whole or in part of any debt or liability. Thus, under the aforesaid two sections, there are rebuttable presumptions which extend to the existence of consideration and to the fact that the cheque was for the discharge of debt or liability.

Under the Explanation to section 138, the debt or other liability referred to in the main section has to be a legally enforceable debt or liability. Merely because a cheque is drawn for discharge, in whole or in part of the debt or other liability, section 138 of the said Act of 1881 will not be attracted. The provision will apply provided the debt or other liability is legally enforceable. Thus, section 138 will not apply to a cheque drawn in discharge of a debt or liability which is not legally enforceable. There may be several categories of debts or other liabilities which are not legally enforceable. A debt or liability is legally enforceable if the same can be lawfully recovered by adopting due process of law. A debt or liability ceases to be legally enforceable after expiry of the period of limitation provided in the law of Limitation for filing a suit for recovery of the amount. Thus, a time barred debt by no stretch of imagination can be said to be a legally enforceable debt within the meaning of the Explanation to section 138.

While considering the second question, the court specifically dealt with a case of promise created by a cheque issued for discharge of a time barred debt or liability. Once it is held that a cheque drawn for discharge of a time barred debt creates a promise which becomes an enforceable contract, it cannot be said that the cheque was drawn in discharge of debt or liability which was not legally enforceable. The promise in the form of a cheque drawn in discharge of a time barred debt or liability becomes enforceable by virtue of s/s. (3) of section 25 of the Contract Act. Thus, such a cheque becomes a cheque drawn in discharge of a legally enforceable debt as contemplated by the Explanation to section 138 of the said Act of 1881. Therefore, the second question was also answered in the affirmative.

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Nirav Shah

Consumer complaint – Builder – Flat sold to other person – Builder to return the amount with interest @ 15% and pay cost: Consumer Protection Act.

Consumer Welfare Association vs. Trimurti Developers & Builders Complaint Case No. CC/12/89, dated 12-12-2012 (Maharashtra) (State Consumer Disputes Redressal Commission.)

Complainant was a flat purchaser and the complainant had booked a flat with the Opponent by agreement dated 20-4-2005. As per the said agreement, flat no.B-203 admeasuring 1100 sq.ft. super built up area on the second floor of the building Palm Towers Co-op. Hsg. Society was agreed to be sold to the Complainant. However, the said flat was sold by the Opponent after construction and possession of the said flat was not given. In respect of the said flat, the complainant had paid an amount of Rs. 19,80,000/-. However, since the flat was not delivered, there was subsequent MOU between the parties dated 5-9-2011. By the said MOU, earlier agreement was cancelled by the Opponent and the Opponent agreed to pay an amount of Rs. 30 lakh to the Complainant. The said amount was to be paid by three installments to be paid on 5-9-2011, 15-10-2011 and 25-12-2011. Out of this Rs. 30 lakh, an amount of Rs. 10 lakh was paid on 5-9-2011 and since the remaining amount had not been paid, the complaint was filed.

It was held that in view of the MOU executed between the parties, the Opponents was under obligation to return the amount as agreed. Since the amount had not been returned, the Opponents were also liable to pay interest on the said amount. Not only that, but since the flat had been sold to another person, naturally, he must have obtained price higher than the price which was agreed between the Complainant and the Opponent. The prayer in respect of allotment of the flat was not allowed in view of the fact that the Complainant had not pressed for the said prayer.

The complaint was allowed and the Opponent was directed to pay the balance amount of Rs.20 lakh with interest @ 15% p.a. from 25-12-2011 onwards till the actual realisation of the amount. By way of costs of the complaint, the Opponent was directed to pay Rs. 25,000/- to the Complainant.

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Nirav Shah

Arbitration – Impleadments of party to arbitration proceeding in absence of arbitration agreement

JSW Ispat Steel Ltd vs. Jeumont Electric and Anr. 2012 Vol. 114(5) Bom. L.R. 3320

The Plaintiff had filed the suit for a declaration that there is no arbitration agreement between the Plaintiff and Defendant No. 1

The Plaintiff had also taken out a notice of motion, praying for an order of restraint restraining Defendant No. 1 from proceeding with or prosecuting the arbitration proceeding initiated by it before the International Chamber of Commerce. Defendant No. 2 is a subsidiary of the plaintiff, had an independent existence and, as such, independent contracting capacity.

The Court observed that the present case was squarely covered by the law laid down by the Apex Court in the case of Indowind Energy Ltd. vs. Wescare (I) Ltd. AIR 2010 SC 1793 wherein the Apex Court in clear terms had held that to constitute an arbitration agreement, it is necessary that it should be between the parties to the dispute and should relate to or be applicable to the dispute. The Apex Court in unequivocal terms observed that, unless the party who is sought to be implicated in the arbitration proceeding is signatory to the agreement, it cannot be roped in the arbitration proceedings. In the present case, it could clearly be seen from the contract as well as the correspondence between the Defendant No.1 and the Defendant No.2, that the Plaintiff was not a contracting party or even a consenting party to the contract between the Defendant No.1 and the Defendant No.2. Not only that, but the entire correspondence with regard to the claim of the Defendant No.1 was only between the Defendant No.1 and the Defendant No.2. It was only for the first time that in the arbitration proceedings the Plaintiff had been implicated and as the words used by the Defendant No.1 itself in the claim “to drag in this arbitration”. Thus, there was no agreement at all between the Plaintiff and the Dr. K. Shivaram Ajay R. Singh Advocates Allied laws Defendant No.1 and therefore, the Plaintiff could not be roped in the arbitration proceedings.

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Nirav Shah

Ind AS 105 – Non-current assets held for sale and Discontinued Operations

Background

Current Indian GAAP does not prescribe comprehensive guidance on Non-current assets held for sale and discontinued operations. Under Indian Accounting Standards (Ind AS) that are converged to International Financial Reporting Standards (IFRS), Ind AS 105 has been aligned with IFRS 5 and there are no major differences between Ind AS and IFRS. Ind AS 105 also covers in an appendix the requirements specified in IFRIC 17 – Distribution of non-current assets to owners.

Scope and Definitions

Ind AS 105 provides guidance with respect to classification, measurement and presentation of all noncurrent assets/disposal groups held for sale and assets classified as held for distribution. The standard also covers classification and presentation requirements of Discontinued Operations.

Definitions

Non-current assets are assets which do not meet the definition of current assets as defined in Ind AS 1. In practical terms, non-current assets are assets which are not expected to be realised within a period of twelve months from the reporting period.

Disposal Group is a group of assets to be disposed of, by sale or otherwise, together as a group in a single transaction, and liabilities directly associated with those assets that will be transferred in the transaction. Thus, disposal group may contain assets or liabilities which are current in nature or assets which do not fall within the purview of this standard. Here, when an entity applies the measurement requirements of this standard it has to consider the Disposal group as a whole.

Discontinued Operation is a component of an entity that either has been disposed of or is classified as held for sale and:
• represents a separate major line of business or geographical area of operations;
• is part of a single co-ordinated plan to dispose of a separate major line of business or geographical area of operations; or
• is a subsidiary acquired exclusively with a view to resale.

Criteria for Classification as “Held for sale”

Under Ind AS 105, an entity shall classify a non-current asset (or disposal group) as held for sale if its carrying amount will be recovered principally through a sale transaction rather than through continuing use.

There are mainly two conditions which must be satisfied for an asset (or disposal group) to be classified as “Held for sale”.

1) An Asset must be Available for Immediate Sale in the Present Condition Subject to Terms that are Usual and Customary i.e. Common Practices which Exist for Sales of such Assets (or disposal groups) For example, an entity intends to sell second hand machinery and there is demand for second hand machinery in the market, however there are very few users of this particular machinery and usually it takes three to six months of time to close the sale transaction. In this case, the asset can be said to be available for immediate sale and can be considered as “held for sale” if other criteria is met.

2) Sale must be Highly Probable:

The Standard provides detailed guidance on this second condition about when can sale be said to be highly probable. The standard specified that for the sale to be highly probable:

• Appropriate level of management must be committed to a plan to sell the asset (or disposal group) and active programme to locate a buyer and complete the plan has been initiated.

• Assets (or disposal group) under consideration must be marketed at a price that is reasonable to its current fair value.

• The sale should be expected to qualify for recognition as a completed sale within one year from the date of such classification i.e. an entity expects to complete the sale transaction within one year from the date on which theses assets are classified as held for sale.

Measurement Principles

There are mainly three stages of measurement of assets (or disposal group) held for sale:

• Before initial classification as held for sale – Assets (or disposal group) held for sale before such classification are measured according to applicable Indian accounting standard e.g. Plant and machinery as per Ind AS 16.

• At the time of initial classification – Non-current asset (or disposal group) classified as held for sale is measured at the lower of its carrying amount and fair value less costs to sell.

• Subsequent measurement – After the classification of assets (or disposal group) as held for sale during subsequent reporting period, these assets (or disposal group) as a whole is measured at the lower of carrying amount and fair value less costs to sell.

Ind AS 105 also provides guidance on impairment testing of assets (or disposal group) classified as held for sale. Impairment testing is carried out on initial classification as well as during the subsequent measurement period. Write down of assets to fair value less cost to sell that has not been recognised as per the above mentioned criteria is recognised as impairment loss. For example, if carrying amount of non-current asset held for sale is 1,000 and fair value less cost to sell is 900, 100 will be included in profit and loss account as impairment loss.

Also, at the time of subsequent measurement, if there is any gain due to increase in fair value less cost to sell of an asset the same should be recognised to the extent of cumulative impairment loss recognised previously. For example, continuing above if there is gain of 120 based on re-measurement of non-current asset, gain to the extent of only 100 i.e. to the extent of impairment loss recognised earlier will recognised as gain in profit and loss.

Disposal group may contain assets or liabilities that are not non-current in nature or not within the scope of Ind AS 105. At the time of initial classification or during subsequent measurement, these assets or liabilities are measured or remeasured as per the standard applicable to such assets or liabilities. The measurement criteria i.e. amount lower of carrying amount and fair value less costs to sell is applied to disposal group as a whole i.e. for the disposal group itself.

For example, Disposal group contains PP&E (non-current asset) and also has inventories (current asset – not covered under Ind AS 105). Based on the individual assessment of assets applying relevant accounting standard value of disposal group let’s say is 20,000. If after applying the measurement criteria of Ind AS 105 to this disposal group as a whole value comes to 18,000 then 2,000 will be recognised as impairment loss. However, as per the standard this loss of 2,000 will be proportionately allocated only to non-current assets within the disposal group. Another important aspect that merits consideration is that the non-current assets held for sale shall not be depreciated (or amortised) individually or as a part of disposal group.

Changes to a Plan of Sale

If non-current asset (or disposal group) classified as held for sale, no longer meet the criteria specified, then such assets cease to be classified as held for sale.

In such a case, non-current asset (or disposal group) is measured at lower of:

• its carrying amount before the asset (or disposal group) was classified as held for sale, adjusted for any depreciation, amortisation or revaluations that would have been recognised had the asset (or disposal group) not been classified as held for sale, and

• its recoverable amount at the date of the subsequent decision not to sell.

The impact of the above change is recognised in profit and loss account.

There can be a case where some of the non-current assets of disposal group still meet the criteria of held for sale’ whereas disposal group as a whole does not meet the requirement. In such cases, these non-current assets shall be measured as per the measurement criteria of this standard in their individual capacity.

Disclosure in Financial Statements

There are mainly two disclosure requirements as per Ind AS 105 viz. disclosure requirements for:

• Non-current assets (or disposal group)
These are presented separately from other assets and liabilities (which are part of disposal group).

Also, an entity should not offset such assets and liabilities.
• Discontinued operations
There are mainly two disclosure required with respect to discontinued operations. These include (a) post-tax profit or loss and post-tax gain or loss recognised on the measurement to fair value less costs to sell or disposal group constituting discontinued operations. Both these can be presented as a single amount in the statement of profit or loss. (b) related income tax expenses as per Ind AS 12 on above.
Similarly, cash flows from discontinued operations will also form part of disclosure in cash flow statement. An entity has a choice of presenting above either in statement of profit or loss/cash flow or in notes to accounts.

Apart from above there are certain additional disclosures required by Ind AS 105 which mainly includes description of non-current assets (or disposal group), facts and circumstances leading to sale or disposal etc.

Distribution of Non-current Assets to Owners

The essence of the above guidance is that distribution of non-current assets to owners is akin to dividend distribution and hence should be accounted as such.

Appendix C of Ind AS 105 and Appendix A of Ind AS 10 contain this guidance.

This part of the standard mainly covers two types of transactions:

• Distribution of non-cash assets; and
• Distribution that give owners a choice of receiving either non-cash assets or a cash alternative.

The standard does not cover transactions where non-cash assets distributed are controlled by the same party or parties who controlled such assets before distribution or transactions where entity distributes ownership in a subsidiary but retains control.

Measurement and Presentation Requirements

As per the standard, when a company declares to distribute assets to its owners, the company should recognise liability for dividend payable when dividend is appropriately authorised and is not at the discretion of the entity.

Dividend payable liability will be measured by an entity at the fair value of the assets to be distributed where non-cash assets are distributed as dividend. Further, the standard specifies that when an entity settles the dividend payable, it shall recognise the difference, if any, between the carrying amounts of the assets distributed and the carrying amount of the dividend payable in profit or loss. The same is disclosed as a separate line item in profit or loss account.

An entity shall disclose carrying amount of the dividend payable at the beginning and end of the period and any changes in carrying amount of such liability due to changes in fair value which is reviewed at the end of each reporting period and necessary adjustments are made.

Conclusion

This accounting standard provides specific guidance on measurement and classification of Non-current assets held for sale, which does not exist under current Indian GAAP. The guidance requires measurement of such assets at lower of carrying amount and fair value less costs to sell.

Further, the standard also lays down criteria to be met for an operation to be classified as discontinuing operation.

The guidance on distribution of non-cash assets to owners requires accounting for such transactions as dividend.

The above guidance would change the accounting and disclosure requirements for the above transactions/events as compared to existing Indian GAAP.

Nirav Shah

Section A: Revision of Financial Statements since 31st March 2009 pursuant to approval obtained from the Ministry of Corporate Affairs (MCA)

Essar Oil Limited (31-3-2012)

From Directors’ Report Re-opening of books of accounts for financial years 2008-09, 2009-10 and 2010-11

As a consequence of the above-referred Supreme Court order, to reflect a true and fair view in the books of account for the three financial years ended on 31st March, 2009, 31st March, 2010 and 31st March, 2011 based on the permission received from the Ministry of Corporate Affairs, the Company proposes to re-open the books of accounts and financial statements for the said three financial years. Necessary resolution seeking approval of shareholders for re-opening of the said financial statements has been incorporated in the Notice convening the ensuing Annual General Meeting. Except for reflecting true and fair view of the sales tax incentives/liabilities etc. concerning the Government of Gujarat, there is no material change in the reopened and revised accounts of the Company.

Consequent to reopening of the books of account for the above three financial years, the financial statements for these years have been revised. The statement containing the salient features of the reopened and revised audited Balance Sheets, Statements of Profit and Loss, Cash Flow statements and auditors, reports on the abridged revised financial statements for the financial years 2008-09 to 2010-11 along with Auditors’ report on full revised financial statements and amendments to Directors’ Reports for respective financial years form part of the Annual Report. With amendment in the aforementioned financial statements, there are corresponding changes in the consolidated financial statements of the Company and its subsidiaries prepared in accordance with Accounting Standard AS 21 for the financial years ended on 31st March, 2009 and 31st March, 2010. Accordingly, statements containing the salient features of the reopened and revised audited Consolidated Balance Sheets, Statements of Profit and Loss, Cash flow statements and auditors’ reports on the abridged revised consolidated financial statements for the financial years 2008-09 and 2009-10 form part of the Annual Report.

From Auditors’ Report

2. We had previously audited the Balance Sheet of the Company as at 31st March, 2012, the Statement of Profit and Loss and the Cash Flow Statement for the year ended on that date, both annexed thereto (“the original financial statements”) which were approved by the Board of Directors of the Company in its meeting held on 12th May, 2012. Our report dated 12th May, 2012 on the original financial statements, expressed a modified opinion with respect to the matter described in paragraph 3(a)(ii) of the said report.

As explained in Note 38 to the attached revised financial statements, the original financial statements have been revised pursuant to revision of the financial statements for the years ended 31st March, 2009, 31st March, 2010 and 31st March, 2011 (“the prior years”) in accordance with the approval of the Ministry of Corporate Affairs (“the MCA”) obtained during the financial year 2012-13, subsequent to the approval of the original financial statements by the Board of Directors of the Company. The said note explains the effect of the revision of the financial year 2011-12. As explained in the Note, the effect of the revision of the financial statements of the prior years on the opening balances include decrease of opening balance of Reserves and Surplus as at 1st April, 2011 by Rs. 3,006.17 crore. In view of the above, our report dated 12th May, 2012 on the original financial statements stands replaced by this report. 4.

Attention is invited to:

(a) Note 38 of the revised financial statements wherein it is stated that, the Honorable Supreme Court of India has vide its order dated 17th January, 2012, set aside the order of the Honourable High Court of Gujarat dated 22nd April, 2008 which had earlier confirmed the Company’s eligibility to the ‘Capital Investment Incentive Premier/Prestigious Units Scheme 1995 – 2000’ of the State of Gujarat (“the Scheme”), making the Company liable to immediately pay Rs. 6,168.97 crore being the sales tax collected under the Scheme (“the sales tax dues”). The Company has deposited Rs. 1, 000 crore on account of the sales tax as per the directive of the Honourable Supreme Court on 26th July, 2012. In response to a Special Leave Petition filed by the Company with the Honourable Supreme Court seeking payment of the sales tax dues in installments and without interest, the Honorable Supreme Court has, on 13th September, 2012, passed an order allowing the payment of the balance sales tax dues in eight equal quarterly installments beginning 2nd January, 2013 with interest of 10% p.a. with effect from 17th January, 2012.

Consequent to the above and having regard to the revision of the financial statements for the prior years referred in paragraph 2 above, the Company has reversed income of Rs. 978.59 crore recognised during 1st April 1, 2011 to 31st December, 2011 by defeasance of the deferred sales tax liability under the Scheme, reversed liability of Rs. 45.21 crore recognised during the said period towards contribution to a Government Welfare Scheme for being eligible under the Scheme, recognised interest income of Rs. 155.13 crore (net of break up charges of Rs. 10.57 crore) on account of interest receivable from the assignee of the defeased sales tax liability and recognised interest of Rs. 83.39 crore (net of Rs. 43.33 crore capitalised as cost of qualifying fixed assets) on sales tax dues; and presented the same under ‘Exceptional Items’ in the Revised Statement of Profit and Loss.

(b) Note 7(ii)(c) of the revised financial statements detailing the recognition and measurement of the borrowings covered by the Corporate Debt Restructuring Scheme (“the CDR”) as per the accounting policy consistently followed by the Company in the absence of specific guidance available under the Accounting Standards referred to in s/s. (3C) of section 211 of the Companies Act, 1956 and consideration of the CDR exit proposal submitted by the Company which has been recommended for approval to the CDR Core Group by the CDR Empowered Group. (c) Note 7(ii)(a) of the revised financial statements describing the fact about accounting of interest on certain categories of debentures on a cash basis as per the Court order.

37. Exceptional items

38. Sales tax

The Company was granted a provisional registration for its Refinery at Vidinar, Gujarat under the Capital Investment Incentive to Premier/Prestigious Unit Scheme 1995-2000 of Gujarat State (“the Scheme”). As the commercial operations of the Refinery could not be commenced before the timeline under the Scheme due to reasons beyond the control of the Company viz, a severe cyclone which hit the Refinery Project site in June 1998 and a stay imposed by the Honourable Gujarat High Court on 20th August, 1999 based on a Public Interest Litigation which was lifted in January 2004 when the Honourable Supreme Court of India gave a ruling in favour of the Company, representations were made by the Company to the State Government for extension of the period beyond 15th August 15, 2003 for commencement of commercial operations of the Refinery to be eligible under the Scheme. As the State Government did not grant extension of the period as requested, the Company filed a writ petition in Honourable Gujarat High Court which vide its order dated 22nd April, 2008, directed the State Government to consider the Company’s application for granting benefits under the Scheme by excluding the period from 13th July, 2000 to 27th February, 2004 for determining the timeline of commencement of commercial production. Based on the order of the Honourable High Court, the Company started availing the benefits under the deferral option in the Scheme from May 2008 onwards and simulta-neously defeased the sales tax liability covered by the Scheme to a related party. An amount of Rs. 6,308.94 crore was collected on account of sales tax covered by the Scheme and defeased at an agreed present value of Rs. 1,892.82 crore resulting in a net defeasement income of Rs. 4,416.12 crore which was recognised during the period 1st May, 2008 to 31st December, 2011. The Company also recognised a cumulative liability of Rs. 189.27 crore towards contribution to a Government Wel-fare Scheme which was payable, being one of the conditions to be eligible under the Scheme.

The State Government had filed a petition on 14th July, 2008 in the Honourable Supreme Court of India against the order dated 22nd April, 2008 of the Honourable Gujarat High Court. The Honourable Supreme Court of India has vide its order dated 17th January, 2012, set aside the order of the Honourable High Court of Gujarat dated 22nd April, 2008 which had earlier confirmed the Company’s eligibility to the Scheme, making the Company liable to pay Rs. 6, 168.97 crore (net of payment of Rs. 236.82 crore) being the sales tax collected till 16th January, 2012 under the Scheme (“the sales tax dues”). Consequently, the Company had reversed the income of Rs. 4,416.12 crore recognised during 1st May, 2008 to 31st December, 2011, reversed the cumulative liability of Rs. 189.27 crore towards contribution to a Government Welfare Scheme and recognised income of Rs. 264.57 crore (net of breakup charges of Rs. 32.09 crore) on account of interest receivable from the assignee of the defeased sales tax liability, and had presented the same under ‘Exceptional Items’ in the Statement of Profit and Loss forming part of the financial statements for the year ended 31st March, 2012 which were approved by the Board of Directors in its meeting held on 12th May, 2012. These financial statements are hereinafter referred to as ‘the original financial statements’.

The Company has deposited Rs. 1,000 crore on account of the sales tax as per the directive of the Honourable Supreme Court of India on 26th July, 2012. In response to a Special Leave Petition filed by the Company with the Honourable Supreme Court of India seeking payment of the sales tax dues in installments and without interest, the Honorable Supreme Court has, on 13th September, 2012, passed an order allowing the payment of the balance sales tax dues in eight equal quarterly installments beginning 2nd Janu-ary, 2013 with interest of 10% p.a. with effect from 17th January, 2012.

The Company has since reopened its books of account for the financial years 2008-09 to 2010-11 (“the prior years”) in accordance with approval of the Ministry of Corporate Affairs (“the MCA”) obtained during the financial year 2012-13 subsequent to the approval of the original financial statement by the Board of Directors of the Company, for the limited purpose of reflecting true and fair view of the sales tax incentives/liabilities, etc. consequent to the order dated 17th January, 2012 of the Honourable Supreme Court of India. Accordingly, the income aggregating to Rs. 3,437.53 crore recognised during 1st May, 2008 to 31st March, 2011 by defeasance of the sales tax liability and the cumulative liability of Rs. 144.06 crore pertaining to the prior years towards contribution to a Government Welfare Scheme were reversed, and interest of Rs. 109.44 crore (net of breakup charges of Rs. 21.52 crore) recoverable from the assignee of the defeased sales tax liability was recognised and the net effect was presented as ‘Exceptional Items’ in the Revised Statement of Profit and Loss for the respective prior years.

The effects of the revisions have been explained in detail in the revised financial statements for the prior years.

In view of the above, the original financial statements for the year ended 31st March, 2012 have now been revised. Consequent to the said revision and having regard to the revision of the financial statements for the prior years described above, the Company has reversed income of Rs. 978.59 crore recognised during 1st April, 2011 to 31st December, 2011 by defeasance of the deferred sales tax liability under the Scheme, reversed liability of Rs. 45.21 crore recognised during the said period towards contribution to a Government Welfare Scheme for being eligible under the Scheme, recognised interest income of Rs. 155.13 crore (net of break-up charges of Rs. 10.57 crore) receivable from the assignee of the sales tax liability and recognised interest of Rs. 83.39 crore (net of Rs. 43.33 crore capitalised as cost of qualifying fixed assets) on the sales tax dues; and presented the same under ‘Exceptional Items’ in the Revised Statement of Profit and Loss.

The revised financial statements also consider the effect of subsequent events after the approval of the original financial statements in accordance with Accounting Standard 4, (AS 4), ‘Contingencies and Events Occurring after the Balance Sheet Date’.

The effects of the revisions of the financial statements for the prior years on the opening balances for 2011-12 have been summarised below:

The summary of changes in the original financial statements has been given below:

a) Statement of Profit and Loss:

Nirav Shah

GAP in GAAP? Virtual Certainty vs. Convincing Evidence

The principles of virtual certainty continue to remain challenging for many Indian enterprises. Paragraph 17 of AS-22 Accounting for Taxes on Income states as follows: “Where an enterprise has unabsorbed depreciation or carry forward of losses under tax laws, deferred tax assets should be recognised only to the extent that there is virtual certainty supported by convincing evidence that sufficient future taxable income will be available against which such deferred tax assets can be realised.”

Explanation to paragraph 17 states as follows: Determination of virtual certainty that sufficient future taxable income will be available is a matter of judgment based on convincing evidence and will have to be evaluated on a case to case basis. Virtual certainty refers to the extent of certainty, which, for all practical purposes, can be considered certain. Virtual certainty cannot be based merely on forecasts of performance such as business plans. Virtual certainty is not a matter of perception and is to be supported by convincing evidence. Evidence is a matter of fact. To be convincing, the evidence should be available at the reporting date in a concrete form, for example, a profitable binding export order, cancellation of which will result in payment of heavy damages by the defaulting party. On the other hand, a projection of the future profits made by an enterprise based on the future capital expenditures or future restructuring etc., submitted even to an outside agency, e.g., to a credit agency for obtaining loans and accepted by that agency cannot, in isolation, be considered as convincing evidence.

Author’s analysis of virtual certainty

Let us analyse the above requirements of virtual certainty.

1. Virtual certainty has to be supported by convincing evidence of future taxable income. The evidence has to be very strong, such as a non cancellable order, the cancellation of which will result in heavy penalty. The explanation provides non cancellable order as an example. There could be many other examples, which do not entail a non cancellable order, but nonetheless provide virtual certainty. For example, an oil well with proven oil reserves, or FDA approval of a blockbuster drug or a toll road between two very busy cities, for which there is no alternate commute (monopoly situation).

2. Virtual certainty is not a matter of perception, but judgment needs to be exercised. Judgment is based on detailed analysis of facts and circumstances; whereas perception is not based on a detailed analysis or evidence.

3. Mere projections will not suffice. There has to be virtual certainty of future taxable income. Projections would certainly be required to determine future taxable income. However, those projections would have to be supported by virtual certainty of future profits. The virtual certainty could come from non cancellable confirmed orders or other factors.

The Expert Advisory Committee (EAC) has also opined on several occasions on the concept of virtual certainty. Some of the key views of the EAC in addition to those already described above are set out below.

1. An unlimited period of carry forward in respect of unabsorbed depreciation is not a basis for recognising DTA and on its own does not demonstrate virtual certainty.

2. The fact that the company has made book profits (DTA is with respect to tax losses) does not on its own demonstrate virtual certainty.

3. Orders secured by the company, may be considered while creating deferred tax asset, provided these are binding on the other party and it can be demonstrated that they will result in future taxable income. However, mere projections made by the company indicating the earning of profits from future orders, or financial restructuring proposal under consideration or the fact that the books of account of the company are prepared on going concern, or the upward trend in the business or economy, may not be considered as convincing evidence of virtual certainty.

Apparently, the “virtual certainty” criteria laid down in AS 22 for the recognition of DTA is difficult to implement. Given below are the author’s perspectives on some of the key challenges:

(i) The explanation to paragraph 17 gives an example of a profitable binding order for the recognition of DTA and disallows recognition of DTA on the basis of mere projections of future profits based on capital expenditure/restructuring plans.

In practice, there will be many situations that fall between the two scenarios. Let us consider the following scenarios:

(a) A newly set-up entity (New Co) incurred significant losses in the first three years of operations due to reasons such as advertising and initial set-up related costs, significant borrowing costs and lower level of activity in the first two years of operations. Over the years, there has been a significant increase in the operations of New Co and its advertisement cost has stabilized to a normal level. Further, it has raised new capital during the year and repaid its major borrowing. The cumulative effect of all the events is that the New Co has started earning profits from the fourth year. It is expected to make substantial profits in the next three years that will absorb the entire accumulated tax loss of the entity.

(b) A battery manufacturer (Battery Co), which had incurred tax losses in the past, enters into an exclusive sales agreement with a car manufacturer (Car Co). According to the agreement, all the cars manufactured by Car Co will only use batteries manufactured by Battery Co. Though Car Co has not guaranteed any minimum off-take, there is significant demand for its cars in the market.

A perusal of both the aforementioned scenarios indicates that entities have significant additional evidence than mere projections of future profitability to support the recognition of DTA. However, since they do not have any binding orders in hand, or other concrete evidence, it may lead to the conclusion that the virtual certainty criterion laid down in AS 22 for recognition of DTA is not met.

(ii) There are certain sectors such as retail or building material, which generally do not have any binding sale orders. This indicates that these sectors, unless they are monopolies, cannot recognise DTA if they have unabsorbed depreciation and/or carry forward of tax losses. This may not be fair, as the principle of virtual certainty is tilted in favour of entities that work on binding orders such as construction, IT or engineering companies.

(iii) If the intention is that profits are to be virtually certain for the recognition of DTA in case of carry forward losses/unabsorbed depreciation, then it is not clear why the virtual certainty principles are applied only for revenue and not for input costs or availability of inputs.

The virtual certainty principle has a fatal flaw; nothing in this world is virtually certain. Even profitable binding orders could be cancelled without receiving any penalty as the buyer/seller could end up getting bankrupt. Interestingly, both Ind-AS 12 (Ind-AS are notified in the Companies Act, but are not yet applicable) and IAS 12 on Income Taxes lay down the criteria of “probability” to recognise DTA, including on unabsorbed depreciation and/or carry forward of tax losses. However, when an entity has a history of recent losses, it should recognise DTA only to the extent it has convincing evidence that sufficient taxable profit will be available. The principle of convincing evidence under Ind-AS and IAS is not only fair, but is also practical to apply, compared to the “virtual certainty” principle under AS 22. In the two examples referred to in this article, the principles of convincing evidence (under Ind-AS and IFRS) would probably result in recognition of DTA, but under Indian GAAP principles of virtual certainty, no DTA can be recognised.

The ICAI should look into the matter and align the requirement of Indian GAAP with Ind-AS.

Nirav Shah

S/s. 92A, 92B – ‘Deemed international transaction’ fiction is not applicable to transactions between Indian entities. Indian JV’s transaction with ‘Indian JV partner’ is not hit by transfer pricing provisions.

Facts:

S Pvt Ltd (taxpayer) is a joint venture company (JV Co), with Andhra Pradesh Housing Board (APHB) and an Indian company (ICo) as JV partners. ICo is a subsidiary of a foreign group (FCo Group). APHB and ICo are the shareholders of the taxpayer in the ratio of 49:51. The taxpayer JV Co was responsible for the construction and implementation of the housing projects as contemplated by APHB and was bound by the policy framework of the Government of Andhra Pradesh (GAP).

During the year, the JV Co entered into transactions with ICo. The Transfer Pricing Officer (TPO) treated these transactions as ‘deemed international transactions’ u/s. 92B(2) and held that though the transactions were entered into by the taxpayer with IJMII, the terms of such transactions were determined in substance between the taxpayer and FCo Group (Associated Enterprise). On appeal, Dispute Resolution Panel (DRP) upheld TPO’s view. Aggrieved, the taxpayer appealed before the Tribunal.

Held:

In order to determine deemed associated enterprise relationship u/s. 92B(2), the international transaction should be between enterprises wherein at least one of enterprise is a non-resident. In the facts of the case, both the parties are residents and hence the same should not constitute international transaction.

Further on scope of s/s. 92A and 92B(2) the tribunal held as below:

One of the essential limbs/constituents of an international transaction is “associated enterprise”. Section 92B(2) outlines the circumstances under which a transaction between two persons would be deemed to be between associated enterprises. Such deeming fiction is in addition to the one created u/s. 92A(2) i.e., parameters of management, control or capital. Section 92B(2) should be read as an extension of definition of AE u/s. 92A.

U/s. 92A two or more enterprises once determined to be AEs remain so for the entire financial year. However, the fiction embodied in section 92B(2) is transaction specific and does not apply to all transactions between the enterprise.

The legal fiction created u/s. 92B(2) in respect of the specified transaction can be used only for the purpose of examining whether such transaction constitutes an ‘international transaction’ u/s. 92B(1). In case section 92B(1) is not attracted, the fiction u/s. 92B(2) ceases to operate.

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Nirav Shah

S/s. 195A and 206AA – The grossing up of the payment in case of net of tax contracts is to be made at “rates in force” and should not be made at the higher rate of 20% specified u/s. 206AA.

Facts:

Taxpayer, an Indian company, entered into repairs contracts with its foreign supplier, a resident in Germany. Further, as per the contracts, taxpayer was required to pay on net-of-tax-basis. The Tax Authority contended that
(a) the payments were in the nature of technical services and constituted FTS, both under the Act and the India-Germany DTAA.
(b) Also, section 206AA overrides all other provisions of the IT Act and, hence, nonresidents are also required to furnish their PAN to the payer of income
(c). Accordingly, in the absence of PAN, higher rate of 20% should be applied and consider net of tax payments grossing up also should be done at 20%. CIT(A) upheld tax authority’s observations. Aggrieved, the taxpayer filed an appeal before the Tribunal.

Held:

Section 206AA overrides all the other provisions of the ITL and applies to all recipients of income, irrespective of the recipients’ residential status. Therefore, a nonresident whose income is chargeable to tax in India has to obtain a PAN and provide the same to the payer of income/taxpayer. In the absence of PAN, section 206AA is applicable and tax is required to be withheld at 20%.

A literal reading of the grossing up provisions u/s. 195A implies that the income should be increased by the “rates in force” for the relevant tax year and not the rate at which the “tax is to be withheld” by the taxpayer. Meaning and effect has to be given to the expression used in a section, as held by the SC in the case of GE India Technology [(2010) 327 ITR 456 (SC)]. Thus, the grossing up of the amount is to be done at the “rates in force” and not at the rate of 20% specified u/s. 206AA.

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Nirav Shah

Taxpayer expected to charge separate royalty from the person who uses know-how for manufacture & supply of goods to the taxpayer itself. • Taxpayer has a right to legally arrange its affairs so as to reduce its incidence of tax.

New Page 1

Part C : Tribunal & AAR International Tax Decisions

17 Robert Bosch GmbH v. ACIT

(2010) TII 149 ITAT-Bang.-Intl.

Article 5, 12 of India Germany DTAA,

S. 9(1)(vi) of ITA

A.Y. : 2004-05. Dated : 23-7-2010

Taxpayer is not expected to charge separate royalty from the person who uses
know-how for manufacture and supply of goods to the taxpayer itself.

Taxpayer has a right to legally arrange its affairs so as to reduce its
incidence of tax.

Facts :

Taxpayer, a German company (GCO), entered into a
collaboration agreement with MICO, an Indian company (MICO), for supply of the
right to use technology, patent, design, etc. The supply of technology enabled
MICO to manufacture products which were exported to taxpayer as well as to other
third parties.

Terms of the agreement, as existed up to 31-12-2000, provided
for payment of products supplied (by GCO to MICO) as well as separate payment
for know-how (by MICO to GCO). Payment for know-how was 5% of value of all sales
made by MICO. On this basis, till 31-12-2010, the taxpayer was of-fering royalty
income (including in respect of goods supplied to the taxpayer itself) to tax.

The terms of the agreement, were revised, w.e.f. 1-1-2001,
such that no royalty was payable by MICO to the taxpayer for goods supplied to
the taxpayer.

The comparative position of contract terms concerning supply
and know-how fees which persisted between GCO and MICO before and after 1st
January 2001 was as under :

Tax authority rejected the claim of the taxpayer, and imputed royalty of 5% on the basis that the revised terms of agreement resulted in evasion of taxes by the taxpayer as royalty was no longer offered for tax.

Held :

ITAT rejected the contentions of the Tax Authority and held as under :

Effect of terms of the agreement, prior to 1-1-2001, was that the royalty income was taxable in the hands of taxpayer in India and simultaneously it would be allowable expenditure in the country to where the taxpayer belonged. In order to avoid this situation the taxpayer had arranged its affairs in such a way that the receipt of royalty was eliminated and to that extent payment for purchases from MICO was reduced.

The taxpayer is not expected to make royalty income with reference to the sale effected to taxpayer itself by MICO, when know-how for manufacture of the same is supplied by the taxpayer. When the know-how belongs to the taxpayer, it is its prerogative to charge royalty for use of its know-how for manufacture of goods to be supplied to the taxpayer.

Taxpayer has every right to arrange its affairs such that it is in a position to reduce its tax incidence.

The Tax Authority’s finding was based only on presumption that royalty is deemed to have been paid to the taxpayer by MICO without deduction of tax.

The Tax Authority who concluded the assessment in the case of MICO had neither disputed the amount payable to the taxpayer by MICO, nor raised the issue on TDS implication.

Nirav Shah

Consideration simplicitor for supervising erection, assembling and commissioning of machinery does not fall within the exclusion clause provided for ‘construction/assembly project’ u/s.9(1)(vii). •Payments for technical services though covered under Artic

New Page 2

Part C : Tribunal & AAR International Tax Decisions

16 Aditya Birla Nuvo Limited v. ADIT

ITA 7527/Mum./2007

Articles 5, 13 of India-Italy DTAA;

S. 9(1)(vii) & S. 195 of ITA

Dated : 30-11-2010

Consideration simplicitor for supervising erection, assembling and
commissioning of machinery does not fall within the exclusion clause provided
for ‘construction/assembly project’ u/s.9(1)(vii) of ITA.

Payments for technical services though covered under Article 13 of DTAA (FTS),
would be excluded from Article 13 if payments are for services that are
effectively connected with a PE or fixed base in India.

Non-fulfilment of threshold period of stay would not trigger supervisory PE in
terms of Article 5(2) of the DTAA. In the absence of PE, payment for
supervisory services would not be taxable in India.

Facts :

Taxpayer, an Indian company (ICo), was engaged in the
business of yarn, filament, garments, fertilisers, textiles and insulators. It
entered into an agreement with an Italian company (GTA) for supervising the
reassembling and re-commissioning of machinery at the taxpayer’s factory
premises in India.

Key features of obligations of GTA were as under :

Supervising job of uninstalling textile plant, located at South Africa and
reinstalling at ICo’s premises in India.

Deputing skilled engineers for supervision of re-installation/re-commissioning
of plant in India.

Deputing two engineers to India, who worked for 30 days and 22 days
concurrently.

All equipments/facilities were provided by ICo. Further actual erection of
machines was to be done by local workers, provided by ICo.

The taxpayer made an application u/s.195(2) of the ITA for
remitting funds, to GTA, without deduction of tax on the basis that payments
would fall under exclusion clause (‘for any construction, assembly, mining or
like project’) of definition of ‘fees for technical services’ u/s.9(1)(vii) of
ITA. In any case, in terms of DTAA, amount would not be taxable in India, as the
services were connected to PE/fixed base of GTA in India.

Though the activities of GTA were mainly supervisory in
nature, its duration did not exceed the time threshold, of six months,
prescribed for constituting a supervisory PE under Article 5 of the DTAA. Hence
payments in relation to such activities would not be taxable in India.

Held :

Under ITA

The technicians of GTA were in India only for supervising the erection of
machines and giving advice on reassembling, erecting and commissioning of
machinery. Actual erection of machines was done by local workers, supplied by
the taxpayer.

The payments in question thus could not fall under the exclusion clause of FTS
under ITA as the project of construction/assembly was not of ICo.

Under the DTAA

The nature of service rendered by GTA was technical, being supervisory in
nature. However Article 13 of the DTAA excludes payments for services
connected to PE or a fixed base in India under Article 5 of DTAA.

AAR in the case of Horizontal Drilling Inter-national (94 Taxman 142) held
that PE rule and FTS definition of the DTAA must be read harmoniously. Hence,
payments made in consideration for supervision or construction or installation
project should be excluded from purview of FTS taxation.

Though GTA, by virtue of technicians’ presence in India, would be covered
within supervisory PE in India, since their stay did not exceed time threshold
of 6 months, the same would therefore not constitute PE in India under the
DTAA.

Once proposed remittance was held as non-taxable, question of considering
taxability of reimbursement of expenditure was not required.

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Nirav Shah

Credit for taxes withheld cannot be denied to the taxpayer on the basis of subsequent refund to deductor when all obligations complied with.Lawful implications of validly issued TDS certificates cannot be declined on the ground that payer has been refund

New Page 2

Part C : Tribunal & AAR International Tax Decisions

15 Lucent Technologies GRL LLC v. DCIT

ITA No. 6353/Mum./2009

Article 12 of India-US DTAA, S. 195, S. 200 of Income-tax Act
(ITA)

A.Y. : 2006-07. Dated : 31-12-2010

Credit for taxes
withheld cannot be denied to the taxpayer on the basis of subsequent grant of
refund to tax deductor (against indemnity bond), when all obligations under
provisions of ITA relating to tax deduction and issue of TDS certificate, etc.
have been duly complied with.

Lawful
implications of validly issued TDS certificates cannot be declined on the
ground that payer has been refunded taxes that were deposited with Government.

Facts :

The taxpayer, resident of USA, was in the business of supply
of copyrighted software for a telecommunication project. The taxpayer received
consideration from R Info (payer) for supply of software. The consideration
received was after deduction of tax. To illustrate, from supply consideration of
Rs.100, taxpayer received Rs.85 after deduction of tax @15%. The tax deduction
was pursuant to the AO’s order which directed that the remittance should be made
after deduction of tax.

The payer deposited TDS with the Government and also issued
TDS certificate to the taxpayer.

However, being aggrieved with AO order directing TDS, the
payer filed an appeal before the CIT(A). The payer was refunded the amount that
it had deducted and deposited while making remittance to the taxpayer. The CIT(A)
decided the issue in favour of the payer. It appears, refund to the payer was
granted against indemnity bond to the effect that taxes refunded would be
re-deposited with the Government.

The taxpayer claimed credit for the taxes withheld on the
basis of TDS certificates issued by the payer. On inquiry from the AO of the
taxpayer, the payer stated that it has executed an indemnity bond to the effect
that the taxes refunded to it will be re-deposited with the Government.

The AO of the taxpayer, however, held that since tax has been
refunded to the payer, the TDS certificates were not valid and hence no credit
for TDS could be granted to the taxpayer.

The AO also observed that since no confirmation of TDS being
re-deposited was made, credit of taxes would not be available to the taxpayer.
The CIT(A) also confirmed the stand taken by the AO, but directed him to verify
whether the TDS refunded to payer has been re-deposited by it with the
Government.

Aggrieved by the CIT(A) order, the taxpayer went in appeal
before the ITAT.

Held :

The ITAT rejected contention of the tax authority and held
that :

Since the taxes have been deducted from the payment made to the taxpayer
and the taxpayer is also in receipt of the appropriate TDS certificates,
credit for TDS cannot be declined on the basis of an administrative action
of refund, which is neither envisaged by the provisions of the Act, nor in
the control of the taxpayer.

Refund of taxes to the payer is a matter that has to be dealt with by Tax
Authorities who must have protected their interests effectively while
granting refund; and by now the payer may even have re-deposited the monies.
But the taxpayer (recipient of income from which tax is deducted and to whom
valid TDS certificate is issued) is generally not expected to get into these
aspects of the matter.

All the requirements for grant of TDS credit such as deduction of tax
u/s.195, fulfilment of obligations by tax deductor u/s.200 and issue of TDS
certificate were duly complied with. Fairness of these procedures had also
not been questioned by the Tax Authority.

Refund of tax to a tax deductor is not prescribed under the scheme of the
ITA and is an administrative exercise. Such exercise cannot take away,
curtail or otherwise dilute the rights of the person from whose income taxes
are so deducted and to whom such certificate is issued.

The Tax Authority is bound to grant credit of taxes to the taxpayer on the
basis of original TDS certificates produced by the taxpayer and in
accordance with the provisions of the ITA.

This ruling shall, in no way dilute the remedies that the Tax Authority
may pursue qua the tax deductor, for recovery of taxes that were
inappropriately refunded to them.

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Nirav Shah

Search and seizure: Block assessment: S/s. 69A, 80-IB(10) and 158BB: Block Period 1-4- 1995 to 21-2-2002: Assessee in construction business eligible for deduction u/s. 80-IB(10): Disclosure of construction income: Assessee is entitled to deduction u/s. 80-IB(10):

CIT vs. Sheth Developers (P) Ltd.; 254 CTR 127 (Bom):

The assessee carried on business as a builder and was entitled to deduction u/s. 80-IB(10). In the course of the search action u/s. 132 of the Act, on 21/02/2002, the assessee had made a declaration of undisclosed income of Rs. 7 crore. In the block return, the assessee offered undisclosed income of Rs. 3.5 crore. The assessee claimed that at the time of making the statement, the director of the assessee was unaware of the deduction u/s. 80-IB of the Act. The Assessing Officer did not allow the claim for deduction u/s. 80-IB(10) of the Act and computed the undisclosed income at Rs. 7.68 crore. CIT(A) and the Tribunal allowed the assessee’s claim.

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

“i) Consequent to the amendment by the Finance Act, 2002 with retrospective effect from 1-7-1995, the total income or loss has to be computed in accordance with the provisions of the Act. Consequently, w.e.f. 1-7-1995, the total income/ loss for the block period has to be computed in accordance with the provisions of the Act and the same would include Chapter VI-A. Section 80-IB is a part of Chapter VI-A. In view of the above, while computing the undisclosed income for the block period, the respondent assessee is entitled to claim deduction from its income u/s. 80-IB.

ii) It is not the case of the Revenue that the money found in possession of the assessee could not be explained and/or its source could not be explained to the satisfaction of the Assessing Officer. In the present case, undisclosed income found in the form of cash was explained as having been acquired while carrying on business as builder and this explanation was accepted by the Assessing officer by having assessed the undisclosed income for the block period as income from profits and gains of business or profession.

iii) In the present case, no question of application of sections 68, 69, 69A, 69B and 69C arises as the same has not been invoked by the Department. It is an admitted position between the parties as reflected even in the order of the Assessing Officer that undisclosed income was in fact received by the assessee in the course of carrying out its business activities as a builder. In view of the above, the order of the Tribunal cannot be faulted.”

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Nirav Shah

Reassessment: S/s. 115AD, 147 and 148: A. Y. 2006-07: Validity to be determined with reference to reasons recorded for belief: Assessment u/s. 143(1) determining Nil income: Notice u/s. 148 on the ground that that section 115AD may be applicable: Not valid:

Indivest Pte Ltd. vs. Addl. DIT; 350 ITR 120 (Bom):

The assessee company was owned by the Government of Singapore. For the A. Y. 2006-07, in the return of income, the assessee had claimed that the profits earned from the transactions in Indian securities are not liable to tax in India in view of Article 7 of the India-Singapore tax treaty. Accordingly, the assessee had returned Nil income. The assessment was completed u/s. 143(1) of the Income-tax Act, 1961 determining Nil income. Subsequently, the Assessing Officer issued notice u/s. 148 dated 16-3-2011 on the ground that the possibility of escapement of income taxable as STCG under the Act may not be ruled out.

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

“i) The Assessing Officer has power to reopen an assessment, provided there is “tangible material” to come to the conclusion that there is escapement of income from assessment. Reason must have a live link with the formation of the belief. The validity of the notice reopening the assessment u/s. 148 of the Act, has to be determined on the basis of the reasons which are disclosed to the assessee. Those reasons constitute the foundation of the action initiated by the Assessing Officer of reopening the assessment. Those reasons cannot be supplemented or improved upon subsequently.

ii) Reading the reasons of the Assessing Officer, it was evident that there was absolutely no tangible material on the basis of which the assessment for the A. Y. 2006-07 could have been reopened. Upon the return of income being filed by the assessee both in electronic form and subsequently in the conventional mode, the assessee received an intimation u/s. 143(1).

iii) While disposing of the objections of the assessee, the Assessing Officer had purported to state that the assessee had filed only sketchy details in its return filed in the electronic form. The relevant provisions expressly make it clear that no document or report can be filed with the return of income in the electronic form.

iv) The notice was not valid and was liable to be quashed.”

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Nirav Shah

Industrial undertaking: Deduction u/s. 80-IC: A. Y. 2004-05: Interest received for delay in payment for goods: Is income derived from industrial undertaking: Eligible for deduction u/s. 80-IC:

CIT Vs. Universal Pipes (P) Ltd.; 254 CTR 311 (Gau):

The assessee was engaged in the manufacture and sale of PVC pipes. The assessee was entitled to deduction u/s. 80-IC. In the relevant year, the assessee had received an amount of Rs. 3,13,19,602/- by way of interest from the irrigation department, as per the order of the High Court, for the delay involved in the payment in connection with delivery of goods. The Assessing Officer disallowed the claim for deduction u/s. 80-IC in respect of this amount. The Tribunal allowed the assessee’s claim.

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

“Interest received from the Irrigation Department as per the order of the Court for the delay involved in the payment in connection with delivery of goods to Irrigation Department constituted income derived from the industrial undertaking of the assessee and is eligible for deduction u/s. 80-IC.”

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Nirav Shah

Income from undisclosed sources: Reference to DVO: S/s. 69 and 142A: A. Y. 1989-90: Rejection of books of account is prerequisite for valid reference to DVO for valuation u/s. 142A: Report of DVO pursuant to invalid reference could not be a basis for addition u/s. 69:

Goodeluck Automobiles (P) Ltd. vs. ACIT; 254 CTR 1 (Guj):

In the previous year relevant to the A. Y. 1989-90, the assessee had constructed a building and had declared the cost of construction to be Rs. 13,23,321/-. The Assessing Officer made a reference to the DVO for valuation who computed the cost of construction at Rs. 19,13,100/-. The Assessing Officer made the addition of the difference of Rs. 5,89,779/- as undisclosed income u/s. 69 of the Income-tax Act, 1969. The reference to the DVO and the addition was upheld by the Tribunal.

On appeal by the assessee, the Gujarat High Court reversed the decision of the Tribunal and held as under:

“i) Expression used by the Legislature in the heading of section 142A as well as in the opening part of the said section is “estimate”. Question of estimate arises only when the books of account of the assessee are not reliable. For the purpose of resorting to the provisions of section 142A, the Assessing Officer is first required to record a satisfaction that the assessee has made investments which are not recorded in the books of account. As a necessary corollary, he would then reject the books of account as not reflecting the correct position and then proceed to make the assessment on the basis of the estimation. Thus, it is apparent that the question of estimating the value of any investment would arise only when the books of account are not reliable. Accordingly, the Assessing Officer is first required to reject the books of account before making a reference to the Valuation Officer.

ii) Report of the Valuation Officer cannot form the foundation for rejection of the books of account. In the instant case, the Assessing Officer has categorically recorded a finding to the effect that the assessee’s accounts are duly audited and complete details are available. He made reference to the valuation Officer merely to seek expert advice regarding the cost of construction. There is nothing in the assessment order to suggest that the Assessing Officer had any doubt regarding the cost of construction or that he was not satisfied regarding the correctness or completeness of the books of account.

iii) Prior to making the reference to the valuation Officer, the Assessing Officer has not ascertained what was the defect in the cost of construction disclosed by the assessee in its return. Except for the difference between the estimated cost determined by the Valuation Officer and the actual cost shown by the assessee, the Assessing Officer has not brought any material on record to establish that the assessee has made any unaccounted investment in the construction of the building in question and that the books of account do not reflect the correct cost of construction.

iv) Hence, the reference made to the Valuation Officer not being in consonance with the provisions of law was invalid. Accordingly, the report made by the valuation Officer pursuant to such invalid reference could not have been made the basis of the addition u/s. 69.

v) In view of the above discussion, the Tribunal was not justified in holding that the reference made by the Assessing Officer to the Valuation Officer for estimating the cost of construction was not invalid. The Tribunal was also not justified in holding that the addition made by the Assessing officer u/s. 69 of the Act was correct.”

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Nirav Shah

Income: Accrual of: Section 5: A. Y. 2004-05: Amount (Rs. 3,037 crore) for transfer of indefeasible right of connectivity for 20 years: Assessee correctly spread the entire fee of Rs. 3,037 crore over a period of 20 years and accordingly paid tax: Entire amount was not assessable during the relevant year:

CIT vs. Reliance Communication Infrastructure Ltd.; 254 CTR 251 (Bom):

In the previous year relevant to the A. Y. 2004-05, the assessee had received an amount of Rs. 3,037 crore as fees for grant of Indefeasible Right of Connectivity for a period of 20 years. The assessee spread the amount over a period of 20 years and accordingly paid the tax. The Assessing Officer allowed the claim. Exercising the powers u/s. 263 of the Income-tax Act, 1961, the Commissioner held that the entire amount was income accrued to the assessee in the relevant year i.e. A. Y. 2004-05 itself. The Tribunal upheld the assessee’s claim.

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

“i) The Tribunal has on examination of the agreement dated 30-4-2003 entered into between RI Ltd and the assessee concluded that RI Ltd in terms of the agreement had only a right to use the network during the tenure of 20 years agreement. Further, the agreement was liable to be terminated at the sole discretion of RI Ltd. and consequently, the amount received as advance for 20 years lease period would have to be returned on such termination for the balance unutilised period.

ii) Further, the Tribunal held that the agreement dated 30-4-2003 was only in the nature/form of a lease agreement. On application of AS-19 formulated by the ICAI, a lease income arising from operating lease should be recognised in the statement of profit and loss in a straight line method over the term of the lease. Therefore, the assessee had in terms of AS-19 correctly spread the entire fee of Rs. 3,037 crore over the period of 20 years and to pay tax thereon over the entire period.”

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Nirav Shah

Expenditure: Capital or revenue: Section 37: A. Y. 1997-98: Amounts paid by assessee to clubs for obtaining membership is revenue expenditure:

CIT vs. Infosys Technologies Ltd. (No. 3); 349 ITR 598 (Kar):

In the relevant year, the Assessing Officer disallowed the claim of the assessee for deduction of the amount paid to the clubs for obtaining membership holding the same as capital expenditure. The Tribunal allowed the assessee’s claim.

On appeal by the Revenue, Karnataka High Court upheld the decision of the Tribunal and held that the amount paid to the clubs for obtaining membership is revenue expenditure.

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Nirav Shah

Charitable trust: Registration: S/s 12A and 12AA: Statute does not prohibit or enjoin the CIT from registering trust solely based on its objects, without any activity, in the case of a newly registered trust:

DI vs. Foundation of Opthalmic and Optometry Research Education Centre; 254 CTR 133 (Del):

The assessee society had applied for registration u/s. 12AA on 10-7-2008. The Director of IT(Exemption) refused to grant registration on the ground that no charitable activity had in fact taken place since the society was a newly established one. The Tribunal allowed the assesse’s appeal.

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

“i) Facially, the provisions of section 12AA would suggest that there are no restrictions of the kind which the Revenue is reading into this case. In other words, the statute does not prohibit or enjoin the CIT from registering trust solely based on its objects, without any activity, in the case of a newly registered trust. The statute does not prescribe a waiting period, for a trust to qualify itself for registration.

ii) Tribunal was right in holding that while examining the application u/s. 12AA(1)(b) r.w.s. 12A, the concerned CIT/Director is not required to examine the question whether the trust has actually commenced and has, in fact, carried on charitable activities.

iii) The appeal is accordingly dismissed.”

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Nirav Shah

Reassessment: S/s. 143(1), 143(3), 147 and 148: A. Y. 2002-03: No distinction to be made while interpreting the words “reason to believe” vis-à-vis section 143(1) and 143(3): In the absence of “fresh material” assessment cannot be reopened: Change of opinion is not a valid basis for reopening assessment:

CIT vs. Oriented Craft Ltd.(Del); ITA No. 555 of 2012 dated 12/12/2012:

For the A. Y. 2002-03, the assessee filed the return of income claiming deduction of Rs. 13.35 crore u/s. 80HHC of the Income-tax Act, 1961. The returned income was accepted by an order u/s. 143(1) of the Act. Subsequently, the Assessing officer issued notice u/s. 148 of the Act and reopened the assessment on the ground that the sale proceeds of the quota was wrongly considered as export turnover and that it was business profits and 90% thereof had to be reduced for computing deduction u/s. 80HHC. The assessee challenged the reopening on the ground that there was no “fresh material” as contemplated by the Supreme Court in the case of CIT Vs. Kelvinator of India Ltd; 320 ITR 561 (SC). The Tribunal accepted the assessee’s contention and held that the Assessing Officer had no jurisdiction to reopen the assessment made u/s. 143(1) of the Act.

On appeal by the Revenue, the Delhi High Court upheld the decision of the Tribunal and held as under:
“i) Section 147 permits an assessment to be reopened if there is “reason to believe”. It makes no distinction between an order u/s. 143(3) or an intimation u/s. 143(1) of the Act. Accordingly, it is not permissible to adopt different standards while interpreting the words “reason to believe” vis-à-vis section 143(1) and 143(3). The Department’s argument that the same rigorous standards which are applicable in the interpretation of the expression when it is applied to the reopening of a section 143(3) assessment cannot apply to a section 143(1) intimation is not acceptable because it would place an assessee whose return is processed u/s. 143(1) in a more vulnerable position than an assessee in whose case there is a full-fledged scrutiny assessment u/s. 143(3).

ii) Whether the return is put to scrutiny or accepted without demur is not a matter which is within the control of assessee. An interpretation which makes distinction between the meaning and content of the expression “reason to believe” between a case where a section 143(3) assessment is made and one where an intimation u/s. 143(1) is made may lead to unintended mischief, be discriminatory and lead to absurd results.

iii) In CIT vs. Kelvinator India Ltd; 320 ITR 561(SC) it was held that the term “reason to believe” means that there is “tangible material” and not merely a “change of opinion” and this principle will apply even to section 143(1) intimation.

iv) On facts, the Assessing Officer reached the belief that there was escapement of income on going through the return of income filed by the assessee. This is nothing but a review of the earlier proceedings and an abuse of power by the Assessing Officer. There is no whisper in the reasons recorded of any tangible material which came to the possession of the Assessing Officer subsequent to the issue of the intimation. It reflects an arbitrary exercise of power conferred u/s. 147.

v) Appeal of the Revenue is accordingly dismissed.”

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Nirav Shah

Appeal to High Court – High Court should not overrule the findings of the Tribunal and Commissioner (Appeals) on the factual aspects and in case of doubt should remit the matter for deciding the matter afresh after giving reasonable opportunity to the assessee.

M.K. Shanmugam vs. CIT [2012] 349 ITR 384 (SC)

The assessee was engaged in the business of jewellery and money-lending. He was the proprietor of M/s. Sri Velmurugan Financiers, M/s. Sri Raja Jewellery, M/s. Sri Raja Silks and M/s. M.K.S. Finance. He was also the managing director of M/s. Shanmugaraja Chit Funds Pvt. Ltd. and partner in M/s. Sri Raja Chit Funds, M/s. Sri Velmurugan Chit Funds, Coimbatore and M/s. United Fabrics, Tiruppur. A search was conducted in the business premises of the assessee on 31st January, 2001, u/s. 132 of the Income-tax Act, 1961, hereinafter referred to as “the Act”, by the Investigation Unit II, Coimbatore. During the course of the search, various incriminating documents were seized, which indicated that the assessee did not disclose the correct income earned by him in the returns filed by him before conducting such a search. Before the date of the search, the assessee filed returns of income only up to the assessment year 1998-99. Therefore, a notice u/s. 158BC of the Act was issued to the assessee on 28th February, 2001. The search was concluded on 13th March, 2001. On 18th September, 2002, block return in Form 2B was filed by the assessee for the period from 1st April, 1990 to 13th March, 2001, declaring a loss of Rs. 16,47,844. In response to the notices and the letters issued, the assessee made written as well as oral submissions in respect of his income and investments during the said block period. The documents seized from his business premises and the documents produced by him were scrutinised and after hearing the assessee, the Assessing Officer completed the assessment. The Assessing Officer made additions of (i) Rs. 42 lakh on account on-money received from sale of Raja Street properties; (ii) Rs. 60,72,900 being bogus outstanding deposit in jewellery; (iii) Rs. 3,83,000 being bogus outstanding fixed deposits in Sri Velmurugan Finances; (iv) Rs. 26,63,130 in respect of unexplained payments made to various parties, and (v) Rs. 2,00,000/- being sale proceeds of A.P. Lodge.

As against the assessment order, the assessee filed an appeal before the Commissioner of Income Tax (Appeals) II, Coimbatore, who by order dated 25th March, 2004, allowed the appeal in part. Aggrieved by the said order of the Commissioner of Income Tax (Appeals), the Revenue filed an appeal before the Income Tax Appellate Tribunal and the assessee filed cross-objection in respect of the disallowed portion. The Income Tax Appellate Tribunal, by its common order dated 23rd November, 2006, dismissed the appeal filed by the Revenue and partly allowed the cross objection filed by the assessee. Challenging the same, the Revenue filed appeal before the High Court.

The High Court allowing the appeal held that
(i) the Assessing Officer had not committed any error in making the addition of Rs. 42 lakh, while completing the block assessment,
(ii) out of Rs. 60,92,900/- a sum of Rs. 21,21,400/- was assessable as undisclosed income,

(iii) the addition of Rs. 13,83,000 was justified and
(iv) the amount of Rs. 26,63,130/- was rightly treated as undisclosed income [349 ITR 369 (Mad)].

On appeal to the Supreme Court by the assessee, the Apex Court, after going through the judgment of the High Court, observed that the High Court had overruled the decisions of the Income Tax Appellate Tribunal and of the Commissioner of Income Tax (Appeals) on factual aspects also. By way of illustration, the Supreme Court pointed out that the High Court had stated that cash flow statements submitted by the assessee were not supported by the documents. According to the Supreme Court, in such a case, the High Court should have remitted the case to the Commissioner of Income Tax (Appeals) giving opportunity to the assessee to produce relevant documents. The Supreme Court, for the aforestated reasons, set aside the judgement of the High Court and remitted the case to the Commissioner of Income Tax (Appeals), to decide the matter uninfluenced by the judgment of the High Court.

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Nirav Shah

Business Expenditure – Disallowance under section 40A(9) – The Supreme Court refrained from going into the scope and applicability of section 40A(9) when the proper foundation of facts had not been laid.

Sandur Manganese And Iron Ores Ltd. vs. CIT [2012] 349 ITR 386 (SC)

The assessee, a limited company engaged in the business of extraction of manganese and iron ore had claimed in the return of income filed for the assessment years 1985-86, 1986-87, 1989-90, 1990-91 and 1992-93, deductions for the payments made to Sandur Residential School and Sandur Educational Society.

In the orders of assessments passed for the assessment years 1985-86, 1986-87, 1989-90, 1990-91 and 1992-93, the Assessing Officer disallowed the deductions claimed for the payments made to Sandur Residential School and Sandur Educational Society by applying the provisions of section 40A(9) of the Act r.w.s. 40A(10) of the Act.

The assessee after exhausting the remedy of the first appeal before the Appellate Commissioner, filed the second appeal before the Income Tax Appellate Tribunal. The Tribunal allowed the deductions claimed, on the ground that the expenses had been incurred fully and exclusively for the purpose of business and welfare of the employees’ children. Therefore, the deduction was allowable for the assessment year 1983-84 in view of the non-obstante clause of section 40A(10) of the Act and for the assessment years 1985-86 till 1992-93 in view of section 37(1) of the Act. The Tribunal placed reliance on the decision in the case of Mysore Kirloskar Ltd. vs. CIT [1987] 166 ITR 836 (Karn).

The Tribunal inter alia referred the following question of law to the High Court for its consideration and opinion.

“Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal was right in allowing the payments made by the assessee to Sandur Residential School and Sandur Educational Society as business expenditure for the assessment years 1985-86, 1986-87, 1989-90, 1990-91 and 1992-93?” The High Court held that a reading of the Budget speech of the Finance Minister would indicate that under the provisions of section 40A(9) of the Act, no deduction is permissible on the contribution made by the corporate bodies to the so-called welfare funds, except the contributions made to such funds which are established under the statute or an approved provident fund, superannuation fund or gratuity fund.

The High Court did not accept the view expressed by the Kerala High Court in P. Balakrishnan, CIT v. Travancore Cochin Chemicals Ltd. (2000) 243 ITR 284 (Ker) and by the Bombay High Court in CIT v. Bharat Petroleum Corporation Ltd. (2001) 252 ITR 431 (Bom) in view of the decision of the Supreme Court in Larsen and Toubro Institute of Technology v. All India Council for Technical Education, AIR 1995 (SC) 1585. The High Court answered the question in favour of the Revenue and against the assessee.

On an appeal to the Supreme Court, on the issue of the allowability of the sum spent as welfare expenses towards providing education to its employees’ children, the Supreme Court observed that section 40A(9) was inserted as a measure for combating tax avoidance. The application of section 40A(9) would come into play only after the assessee has established the basic facts. According to the Supreme Court, the facts were not clear inasmuch as the assessee had made payments to other educational institutions and also not only to the school or the society promoted by the assessee. According to the Supreme Court, from each assessment year, the Tribunal would have to record a separate finding as to whether the claim for deduction was being made for payments to the school promoted by the assessee or to some other educational institutions/ schools and thereafter apply section 40A(9). The Supreme Court accordingly restored the matter to Tribunal, for de novo consideration for each of the assessment years and directing it to give a clear bifurcation between payments made by the assessee to Sandur Residential School and Sandur Education Society and payments made to schools other than the above two institutions. The Supreme Court however, refrained from going into the scope and applicability of section 40A(9) in the absence of proper facts.

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Nirav Shah

Responsible Budget

It is February again and everybody has started talking and thinking about the Union Budget. The Budget for the year 2012–13 and the Finance Bill presented along with it were controversial on account of the substantial retrospective amendments that were proposed. The debate regarding the desirability and its impact continues.

When Mr. Pranab Mukherjee took over as the Finance Minister, he lost no time in reversing some of the amendments made to the Income Tax Act during the tenure of Mr. P. C. Chidambaram. Mr. Mukherjee withdrew the controversial Fringe Benefit Tax, rolled back the time limits for completing the assessments and introduced Service Tax on legal services which Mr. Chidambaram had refrained from doing.

It is Mr. Chidambaram’s turn to undo what Mr. Mukherjee did before he was elevated to the Rashtrapati Bhavan. Soon after donning the cap of the Finance Minister, Mr. Chidambaram ordered a review of the GAAR and the retrospective amendments made to the Income Tax Act. It is also mentioned that he directed the tax officers to complete the time-barring assessments before December, 2012 although the statutory limit is March 2013.

In this background, one is curious as to what is in store in the ensuing Budget. Will the Finance Minister again bring back the Fringe Benefit Tax or introduce a new controversial tax? Will he withdraw the GAAR or defer it by a few more years? What will be the fate of the retrospective nature of the amendments that were introduced during Mr. Mukherjee’s tenure? Will Mr. Chidambaram continue the shadow boxing match with Mr. Mukherjee? The Finance Minister has been talking like a socialist; he mentioned about the desirability of introducing inheritance tax. (Remember, till 1985 we had the Estate Duty.) There is a flurry amongst the wealthy for arranging their affairs, to consult professionals for succession planning to minimise the impact of inheritance tax, just in case it is actually introduced in the forthcoming Budget.

The Finance Minister has hinted at increasing the tax burden on the so-called super rich. Will he do that? What will be the burden and who will be considered as super rich in the Indian context?

The Government has been talking about various reforms. But at the ground level, very little has been done. Except for formally permitting FDI in multi-brand retail, while leaving the final decision to the State Governments and a marginal increase in the diesel prices, there is hardly anything that one can talk about as reforms. The investment climate has not been very conducive and confidence of India Inc. and foreign investors is low.

The next General Elections are due in 15 months, in 2014. Depending on when the elections are held, this may turn out to be the last full-fledged Budget of the present Government. So, there will always be a temptation to present a populist budget.

Mr. Chidambaram, intelligent and unpredictable that he is, has kept everybody guessing. Recently, while addressing foreign investors in London and elsewhere, he stated, `the Budget that will be presented in February will be a responsible Budget’. One doesn’t know what he means by a responsible Budget. Did he mean that the earlier Budgets presented by his predecessor were irresponsible? Everybody is keeping their fingers crossed and waiting!!

In this issue, we bring you an article relating to corruption by Mr. Hardayal Singh, former Income Tax Ombudsman. We always talk about the gap between what the society expects from auditors and what auditors can deliver. There is a similar expectation gap between the system combating corruption and what the society expects. The author mentions that the story he is narrating has an important lesson for those who expect instant solutions. When one reads the article, one is left wondering whether the system really delivered if an honest officer had to go through the prosecution, conviction and sentencing by a lower court before being acquitted by the High Court. Or whether the officer indeed acted under pressure of a politician and was guilty, at least, to that extent.

While rules and systems are extremely important, they should prevent corruption; yet not be such that they stifle the decision making process itself. In appropriate cases, the officer must be able to exercise and should have the courage to exercise discretion and take decisions. Today, honest officers avoid taking decisions out of fear that they will be implicated for the decision that they took. Is it a solace to the officer that ultimately some higher court will acquit him?

Nonetheless, the article brings to us a point of view which we need to think about.

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Nirav Shah

Do Not Exist. Live!

We feel that the span of life is short. We make it still shorter by wasting time. The greatness of one’s life depends not on the years lived but the effect one leaves on the minds of one’s generation. The immortals live after their death through their work. So, it is not the years that count, it is what we do with them that matters. Doing good needs sacrifice. The immortals lived a full life and did not squander time. God compensates our mediocrity with more number of years – giving us more chance to serve mankind.

So, one has a choice; of simply Existing in this world or of Living, in the real sense of the word. But how do we do this?

So, if we plan to teach moral values to our children, we, in our life, need to become a role model. To influence and inspire people — setting an example is not only necessary but it is THE ONLY WAY!

In a recent book — Honest Truth about Dishonesty — by Dan Ariely, the author has explored revealing, unexpected and astonishing traits that run through modern humankind, to ask us questions: What makes us cheat? How and why do we rationalise deception of ourselves and other people, and make ourselves ‘wishfully blind’ to the blindingly obvious? How a whole company can turn a blind eye to evident misdemeanours within their ranks? Whether people are born dishonest? And whether we can really be successful by being totally, brutally honest?

Let us just see one example from his book. He gave tough questions to a bunch of seemingly highly respected people from different walks of life and after they completed the same, he asked them to destroy the answer sheet. He then asked them to state how many they had answered. They were not aware that hidden cameras were recording everything. It was found that almost all inflated the answer!

So the question is, how moral are we when nobody is looking! If not, then how do we expect honesty from others! He further shows that how many of these, when caught, tried to rationalise by saying — stealing a needle is not as same as stealing an elephant! Can anybody teach such persons? Or can they teach anything to anybody? Learning, like charity, has to begin from self. So as Gautama Buddha said — Ap divo bhava – everybody has to be his own candle. Be the change you want to see.

Further, to do something worthwhile in one’s life, one must know that it is easier to criticise but difficult to improve. There is this famous story of the painter who painted a superb painting and then placed it on the road with a request to the patrons to point out mistakes or suggestions for improvement, if any. Soon, he was flooded with hundreds of suggestions. He was quite perturbed and felt very inadequate. But his friend had an idea. On his prodding, he again painted a new painting and placed it there with a request to patrons to themselves correct/paint the mistakes if any. This time there were hardly any suggestions! Great men concentrate on the work on hand and not waste time criticising others.

We have to leave the chalta hai, hota hai attitude! In India, we celebrate mediocrity. People are happy and accept work half done. Sweepers not cleaning properly, driver not cleaning cars properly… while those who try to do jobs fully are ridiculed as fastidious and perfectionists! Should we accept this? It is because we accept this, which is why the country, our cities, villages or whole society is in bad shape. Let us resolve to be different. Once we take up any task, let us do it with our heart and soul! Let us become role models.

“We are what we repeatedly do. Excellence then, is not an act, but a habit” – said Aristotle

Essentially, it means, excellence in any field is not a onetime feat. It is a cumulative outcome of a series of acts performed by an individual over a period of time in pursuit of excellence. We cannot hope to be excellent in one field, say our workplace while we are sloppy in our personal life or the way we interact with people.

The trick to live then, is doing things with excellence, finding fulfilment in doing whatever we are working on and having extreme gratitude to the almighty for making our life meaningful and not shallow and mindless. I hope we all can live with this spirit and enrich our life!

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Nirav Shah

The scope of ‘services’ in the context of Section 44BB is not restricted and they need not be only those which are other than ‘technical services’ under Section 9(1)(vii).

New Page 2

17 Geofizyka Torun Sp Zo O, In
re [2009] 32 DTR (AAR) 139

Sections 9(1)(vii), 44BB, 44DA,
I T Act

7th December, 2009

Issue

The scope of ‘services’ in the context of Section 44BB is not
restricted and they need not be only those which are other than ‘technical
services’ under Section 9(1)(vii).

Facts

The applicant was a tax resident of Poland (“PolCo”). It was
in the business of providing geophysical services to the international oil and
gas industry. It conducted seismic surveys and provided onshore seismic data
acquisition and other associated services such as processing and interpretation
of such data to global and oil companies. Seismic surveys are used to identify
hydrocarbons, increase exploration success, maximise production, better target
the oil and gas reserves and to reduce the overall exploratory drilling risks.
The short question before AAR was whether income derived by PolCo in India was
covered under section 44BB of the Act.

Before the AAR, the tax authorities contested the
applicability of Section 44BB on the ground that the services contemplated in
Section 44BB were other than those coming within the purview of Explanation 2 to
Section 9(1)(vii) of the Act, whereas the services provided by PolCo were
covered under the said provision. Further, ‘fees for technical services’ under
Section 9(1)(vii) should be computed under Section 44DA where the service
provider has a PE in India. It was also contended that PolCo itself was not
undertaking any mining or like project (which was being undertaken by someone
else), and that Section 44BB would come into play only if the services were out
of the purview of Section 9(1)(vii).

The AAR observed that it was an undisputed and undeniable
fact that PolCo was engaged in business in India. The AAR then referred to
Sections 44BB, 44DA and 115A and proceeded to consider the meaning of the
expression ‘in connection with’.

Held

Having regard to the meaning of the expression ‘in connection
with’, it is clear that the services provided by PolCo were in connection with
the prospecting for or extraction of mineral oils and there was real, intimate
and proximate nexus between the services performed by PolCo in India and
prospecting for or extraction of mineral oils.

The expression ‘services’ should be understood in its plain
and ordinary sense and in the absence of any limitation or exclusion in the
statute. There was no reason to assign narrow and restricted meaning and confine
it to ‘services other than technical, consultancy or managerial services’.
Section 44BB and Section 44DA being competing provisions, and Section 44BB being
a more specific provision, it should prevail.

End notes:

1. In its decision, the Supreme Court did not
examine this issue. It reversed Gujarat High Court’s decision merely because of
retrospective amendment to section 10(15)(iv)(c) whereby usance interest was
exempted but, only in case of an undertaking engaged in the business of ship
breaking. Hence, it is doubtful whether the Supreme Court could be said to have
reversed the ratio of Gujarat High Court’s decision.

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Nirav Shah

S/s. 4, 163 – Where necessary RBI approval was not obtained for remitting amounts in foreign exchange and such amount was still payable during the relevant year, such amount cannot be taxed in the hands of recipients, despite the claim for deduction by the payer.

Facts 1:

Taxpayer is a foreign partnership firm established in Germany, having a branch office in India through which it renders management and technical consultancy services. During the relevant year, taxpayer obtained services from overseas group entities and the consideration for services was shown as ‘payable’ in the books of accounts. However, the actual payments were not made, as Reserve Bank of India (RBI) approval for the same was not obtained.

The taxpayer was incurring losses and did not have sufficient funds and therefore did not even make an application to RBI seeking its approval to remit the amount. These amounts were debited to Profit & Loss Account of PE of taxpayer in India and deduction on the same was claimed.

The tax authority treated the taxpayer to be the representative assessee of the recipient group entities and considered the amounts payable by the taxpayer as income in the hands of recipients. CIT(A) upheld tax authority’s order. Aggrieved, the taxpayer appealed to the Tribunal.

Held 1:

Income on account of amounts payable by the taxpayer to the overseas group entities could be said to have accrued to the said entities only on receipt of the required approval from RBI and there being no such approval received during the year under consideration, the same could not be taxed as income in that year. Reliance was placed on the Bombay High Court decision in the case of Kirloskar Tractors Ltd. [(1998) 231 ITR 849) (Bom)] and in the case of Dorr-Oliver (India) Ltd. [(1998) 234 ITR 723 (Bom)], wherein it was held that accrual of income takes place only on obtaining of necessary approval required from RBI.

S/s. 9, 90 – In respect of recipient from treaty country, income in the nature of FTS should be ‘paid’ during the relevant previous year to be taxed in the hands of recipients.

Facts 2:

In addition to the above, taxpayer had received certain technical services from other overseas entities, amounts for which were also ‘payable’ during the year. However, the same was not offered to tax on the premise that as per the relevant tax treaties the same was taxable only on actual receipt. The tax authority brought these amounts to tax as FTS in the hands of these overseas entities.

Held 2:

Following the decision of Bombay High Court in the case DIT (IT) v. Siemens Aktiengesellschaft [TS-795-HC- 2012(BOM)] as well as the decisions of the Tribunal in the case of DCIT vs. UDHE GmbH [(1996) 54 TTJ 355 (Bom)] and in the case of CSC Technology Singapore Pte. Ltd. vs. ADIT [(2012) 50 SOT 399 (Del)], Tribunal held that the amounts payable by taxpayer to the overseas group entities could not be brought to tax in India during the year under consideration as FTS as per the relevant provisions of the tax treaties, since the same had not been ‘paid’ to the said entities.

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Nirav Shah

(2011) 133 ITD 77 (Mum) RBS equities India Ltd. vs. Deputy Commissioner of Income Tax Assessment Year : 2004-05 Date of order: 26-08-2011

Section 271(1)(c) Explanation 7 – AO charged penalty for – Concealment in computation of Arm’s Length Price (ALP). The assessee – RBS equities India Ltd. had computed ALP as per Transactional Net Margin Method (TNMM) which resulted in reduced tax liability of Rs.2,13,25,474 and AO was of the view that the same should have been calculated as per Comparable Uncontrolled Price Method(CUP).

Facts

AO exercised option u/s. 92CA(1) to calculate ALP with reference to the transaction between the assessee and ABN Amro Asia (Mauritius) Ltd (Associated Enterprise). The assessee had provided stock broking services in respect of clearing house trade to Associated Enterprise (AE) and had earned brokerage at the rate of 0.24%. The assessee had provided the same service to FIIs @ 0.408% & to FIs @ 0.22%. The AO contended that AE being FII should have charged @ 0.408%. The AO levied penalty u/s. 271(1)(c) under Explanation 7 to section 271(1)(c). The AO rejected TNMM on the ground that CUP method could be applied to facts of case and accordingly rejected the method without any specific reasons for inapplicability of said method and on the ground that direct method was preferable.

Held:

ALP (Arms Length Price) was computed by assessee in accordance with section 92C in good faith and due diligence as per rule 10C. AO’s view is that ALP could be computed correctly by CUP method only and hence, it cannot be the proper ground to invoke provisions of section 271(1)(c). As the assessee was of the view that TNMM was the appropriate method to determine ALP and the same was derived by assessee in accordance with the provisions of section 92C and as per Rule 10C, deeming fiction under 271(1)(c) cannot be invoked.

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Nirav Shah

(2011) 132 ITD 604(Mum.) Momaya Investments (P) Ltd. vs. ITO AY : 1996-97 Date of order : 22-06-2011

Section 73 – Not applicable if the principal business of the company is banking or granting of Loans and Advances – The business of Banking need not be necessarily mentioned in the Memorandum of Association of the company – But the actual nature of the business is to be looked at.

Facts:

The assessee company was mainly engaged in the business of providing loans and advances that formed about 68% of the income. The original assessment dated 30th September, 1998 was passed assessing the total income at Rs. 8,58,522/- This was eventually followed by a revision order passed which stated that the assessee dealt in shares and hence Explanation to section 73 was attracted since the main income did not consist of “Interest on securities, income from House Property, Capital Gains or Income from Other sources.” The assessee had appealed to the tribunal which remanded the matter back to CIT to re-examine certain aspects. The matter was then remanded back to the AO. In the fresh assessment, the assessee submitted that it was mainly engaged in the business of providing loans and advances and rediscounting bill. And therefore, Explanation to section 73 was not applicable. The AO however, objected to assessee’s contention that it was in business of granting loans and advances on the basis that main object of the memorandum of association was only to acquire, hold or deal in stocks and shares. Further, he also held that the activity of bill rediscounting cannot be called as granting of loans and advances.

Held:

What is important is not the object stated in the memorandum of association, but it is also important to look at the actual activity of the assessee. Therefore, merely because the business of granting loans was not mentioned in the memorandum, would not mean that actual nature of business cannot be looked at. It was even concluded that the activity of bill rediscounting has to be treated as only granting of loans. This was because the word “discount”, in regard to financial transactions, represents interest.

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Nirav Shah

(2012) 80 DTR 23 (Mum) Genesys International Corporation Ltd. vs. ACIT A.Ys.: 2008-09 & 2009-10 Dated: 31-10-2012

Facts:

While computing tax liability u/s. 115JB, the assessee deducted income of its Mumbai unit which was a SEZ unit and eligible for tax benefit u/s. 10A. The Assessing Officer disputed the claim of the assessee on the ground that the Finance Act, 2007 amended section 115JB w.e.f. A.Y. 2008-09 for bringing the amount of income to which provisions of section 10A or 10B apply within the purview of MAT.

Held:

By SEZ Act, 2005 w.e.f. 10th February 2006, a new section 10AA has been inserted which provides exemption to the units located in SEZ. Section 2 of SEZ Act, defines SEZ as under:

“(za) Special Economic Zone means each Special Economic Zone notified under the proviso to s/s. (4) of section 3 and s/s. (1) of section 4 (including free trade and warehousing zone) and includes an existing Special Economic Zone.”

It is evident from the relevant provisions that an existing SEZ unit will also be governed by SEZ Act, 2005. Therefore, the benefits which are to be provided to the newly established unit in SEZ as per section 10AA will also be available to the existing units in SEZ. Moreover, section 4(1) of SEZ Act provides that an existing SEZ unit shall be deemed to have been notified and established in accordance with provisions of SEZ Act and the provisions of SEZ Act shall apply to such existing SEZ units. It is also observed that by the SEZ Act, s/s. (6) to section 115JB was also inserted providing that provisions of section 115JB shall not apply to the income accrued C. N. Vaze, Shailesh Kamdar, Jagdish T. Punjabi, Bhadresh Doshi Chartered Accountants Tribunal news or arisen on or after 1st April, 2005 from any business carried on, or services rendered, by an entrepreneur or a developer, in a unit or SEZ, as the case may be. Hence, income of units located in SEZ will not be included while computing book profit for the purpose of MAT as per section 115JB(6). In view of above, irrespective of the fact that amendment has been made in clause (f) of Explanation 1 to section 115JB(2) to apply the provisions of MAT in respect of units which are entitled to deduction u/s. 10A or section 10B, the units which are in SEZ will continue to get benefits from the applicability of provisions of MAT in view of s/s. (6). Section 115JB(6) does not refer section 10A or section 10AA but it only refers that provisions of section 115JB will not apply to the income accrued or arisen on or after 1st April, 2005 from any business carried on in a unit located in SEZ. Hence, the unit in SEZ will be covered by s/s. (6) to section 115JB irrespective of the fact that those units were claiming deduction u/s. 10A.

levitra

Nirav Shah

Waiver of interest: Section 220(2A): Provision to be construed liberally: Application for stay of recovery proceedings cannot be construed as non-cooperation: Partial relief granted:

Arun Sunny vs. CCIT ; 350 ITR 147 (Ker):

For the A. Y. 2006-07, the Chief Commissioner rejected the assessee’s application for waiver of interest u/s. 220(2A) of the Income-tax Act, 1961 on the ground that the assessee blocked recovery by obtaining stay against attachment notices and the assessee had not cooperated in recovery proceedings and payment of interest would not cause any genuine hardship to the assessee.

On a writ petition challenging the rejection order, the Division Bench of the Kerala High Court directed the Assessing Officer to reduce 25% of interest and held as under:

“i) Section 220(2A) is an incentive to defaulter assessee to co-operate with the Department and to remit the tax voluntarily at the earliest and, therefore, compliance should be rewarded by taking a liberal view and approach. What is indicated by the provision is that relief to be granted u/s. 220(2A) should be proportionate to the extent of satisfaction of the conditions stated therein. In other words, if the conditions are partially satisfied, the assessee should be given partial relief, i.e. partial waiver which should be in proportion to the extent of satisfaction of the conditions.

ii) The right to move for stay against recovery during pendency of an appeal is a statutory right, exercise of which cannot be said to be an indication of assessee’s lack of co-operation. Lack of co-operation happens when the assessee makes recovery difficult for the Revenue by transferring or siphoning off his assets leading to protracted enquiry and continuation of recovery proceedings by the Department.

iii) The assessee voluntarily remitted the entire amount of tax before the Department started chasing the assessee with steps for recovery such as attachment of movables and immovables, sale thereof in public auction etc. In fact, the entire arrears were paid within six months from the date of payment based on the assessment. During the pendency of the stay, the assessee was not required to remit the tax which was contested in appeal. Therefore, all the three conditions were to some extent satisfied and the refusal of the Chief Commissioner to grant reduction in interest was not justified. Partial relief had to be granted, taking into account the amount of tax paid by the assessee on the interest earned on term deposits, the retention of which delayed payment of tax that led to levy of default interest.”

levitra

Nirav Shah

Sale in course of Import vis-à-vis Works Contract

VAT

As per Article 286 of the Constitution of India, the
transactions taking place in the course of import and export are made immune
from levy of sales tax. In pursuance of the said article, the transactions of
sale/purchase in course of import/export are defined in S. 5 of the CST Act,
1956. The transaction of sale in course of import is defined in S. 5(2) of the
CST Act, 1956. The said Section is reproduced below.

“S. 5. When is a sale or purchase of goods said to take
place in the course of import or export :

(2) A sale or purchase of goods shall be deemed to take place
in the course of import of the goods into the territory of India only if the
sale or purchase either occasions such import or is effected by a transfer of
documents of title to the goods before the goods have crossed the Customs
frontiers of India.”

It can be seen that there are two limbs. As per the first
limb, the sale/purchase occasioning the movement of goods from foreign country
is considered to be in course of import. Therefore, the transaction of direct
import is covered by this category. In addition to the above, there is scope to
cover further transaction also as in course of import under this limb. For
example, after import of goods, they may be required to be delivered to local
party by way of sale. If inextricable link between import and such local sale is
established, then such local sale will also be deemed to be in the course of
import covered by the above first limb and it will be exempt.

The second limb covers transactions which are effected by
transfer of documents of title to goods before the goods crosses Customs
frontiers of India. However, discussion herein is about first limb and hence
this limb is not discussed further.

In relation to the first limb, there are a number of
judgments. However, in spite of the above, it is always a debatable issue. More,
there was no direct judgment of the Supreme Court in relation to first limb
vis-à-vis works contract transactions. Therefore, there were different views
in favour and against. However, now the Supreme Court had an occasion to deal
with the said controversy. The Supreme Court has given its judgment in the case
of Indure Ltd. & Another v. Commercial Tax Officer & Others, (34 VST 509)
(SC).

The facts of this case are that N.T.P.C. invited global bids
for its ash handling plant, Farakka Super Thermal Power Project. The contract
was termed as ‘on turnkey basis’. Indure Ltd. was one of the bidders. After
submission of the bid, there were personal meetings and Indure Ltd. was the
successful bidder. The contract was divided into two separate contracts, (i)
supply contract, and (ii) erection contract. However, even if the two contracts
were stated to be separate, the Supreme Court has observed that it was only one
contract, as N.T.P.C. kept right with it, with regard to cross-fall breach
clause, meaning thereby that default in one contract would tantamount to default
in another. Therefore the issue was decided considering the transaction as works
contract. Amongst others, there were terms about imported material. The said
clauses are reproduced in the judgment as under :

“4.5.1 . . . . . . . . . For equipment of non-Indian
origin, you shall submit the details of the indices and co-efficient in line
with the provisions of bid documents within three months of the date of this
award letter.

4.5.2 The list of components/material/equipment to be
imported by you, for which the adjustment on exchange rate variation is to be
made under US$, DM and J yen will be furnished by you within three months of
the date of this award letter. The items as declared as per these lists shall
only be eligible for exchange rate variation claims.”

In light of further deliberations with N.T.P.C., Indure Ltd.
was to import MS pipes from South Korea. The company thereafter submitted
application before the DGTD, Import Export Directorate, for Special Imprest
Import Licence against the above turnkey contract. The licence was granted
mentioning in it that all components to be imported were to be exclusively used
by Indure Ltd. for the above project. On the MS pipes so imported, special
markings mentioning the name of the project were made.

The above sale by Indure Ltd., to N.T.P.C. was claimed as
sale in course of import and hence exempt. The West Bengal Sales Tax authority
held that it was not obligatory for Indure Ltd. to import the goods. It was
contended that the only obligation of the company was to complete the project
and the components should meet the required specification, irrespective of fact
whether they are imported or otherwise. Therefore, the contention was that there
is no inextricable link and S. 5(2) of the CST Act, 1956 will not apply. The
above position was confirmed up to the High Court.

The Supreme Court dealt with the issue elaborately. It also
made reference to earlier decided cases. Citing judgment in the case of K.G.
Khosla & Co. (P) Ltd. v. Deputy Commissioner of Commercial Taxes, (17 STC
473) (SC), the Supreme Court reproduced the following para from the said
judgment :

“The next question that arises is whether the movement of
axle-box bodies from Belgium into Madras was the result of covenant in the
contract of sale or an incident of such contract. It seems to us that it is
quite clear from the contract that it was incidental to the contract that the
axle-box bodies would be manufactured in Belgium, inspected there and imported
into India for the consignee. Movement of goods from Belgium to India was in
pursuance of the conditions of the contract between the assessee and the
Director-General of Supplies. There was no possibility of these goods being
diverted by the assessee for any other purpose. Consequently we hold that the
sales took place in the course of import of goods within S. 5(2) of the Act,
and are, therefore, exempt from taxation.”

The Supreme Court also referred to the judgment in the case
of State of Maharashtra v. Embee Corporation, (107 STC 196) (SC). Further, the
Supreme Court also referred to the judgment in the case of Deputy
Commissioner of Agricultural Income-tax and Sales Tax, Ernakulam v. Indian
Explosives Ltd., (60 STC 310) (SC). The Supreme Court reproduced
observations from the above judgment and the following portion from the said
reproduced part is reproduced below :

“A sale in the course of export predicates a connection between the sale and export, the two activities being so integrated that the connection between the two cannot be voluntarily interrupted without a breach of the contract or the compulsion arising from the nature of the transaction. In this sense to constitute a sale in the course of export it may be said that there must be an intention on the part of both the buyer and the seller to export, there must be an obligation to export, and there must be an actual export. The obligation may arise by reason of statute, contract between the parties, or from mutual understanding or agreement between them, or even from the nature of the transac-tion which links the sale to export. A transaction of sale which is a preliminary to export of the commodity sold may be regarded as a sale for export, but is not necessarily to be regarded as one in the course of export, unless the sale occasions export. And to occasion export, there must exist such a bond between the contract of sale and the actual exportation, that each link is inextricably connected with the one immediately preceding it. Without such a bond, a transaction of sale cannot be called a sale in the course of export of goods out of the territory of India.

Conversely, in order that the sale should be one in the course of import, it must occasion the import and to occasion the import, there must be integral connection or inextricable link between the first sale following the import and the actual import provided by an obligation to import arising from statute, contract or mutual understanding or nature of the transaction which links the sale to import which cannot, without committing a breach of statute or con-tract or mutual understanding, be snapped.”

The Revenue sought to rely upon the judgment in the case of Binani Bros. (P) Ltd. v. Union of India, (33 STC 254) (SC). However the Supreme Court distinguished the same on facts.

In conclusion the Supreme Court allowed claim as in course of import in relation to the above works contract transaction. The judgment will certainly be a guiding one to resolve issue of sale in course of import vis-à-vis works contract transactions.

Nirav Shah

Nature of Lease Transaction – Update in Light of Recent Judgments

VAT

Nature of Lease Transaction – Update in Light of Recent
Judgments

The issue whether a transaction is taxable lease transaction
under Sales Tax Law or not, is a very debatable one. It is a judgment based
issue as the term ‘Lease Transaction’ (transfer of right to use goods) is not
defined in sales tax laws. From judgments delivered so far, it can be seen that
if there is delivery of possession to client, then taxable lease transaction
takes place. On the other hand, if there is no delivery of possession, i.e., if
effective control is not transferred to client, then there is no lease
transaction. Landmark judgments on the issue are as hereunder:

Rashtriya Ispat Nigam Ltd. 126 STC 114 (SC)

In this case amongst others, the Supreme Court has held that
in order to be a lease transaction, there should be delivery of possession to
the lessee. Unless effective control is given to the party, no lease transaction
takes place. The facts in this case were that Rashtriya Ispat Nigam Limited
allowed its contractor to use its machinery for the contract being executed for
it. One of the conditions of the contract was that the contractor was not free
to use the said machinery for any other work except for the contract executed
for Rashtriya Ispat Nigam Limited. The contractor was not allowed to move the
machinery outside the project area. Under above circumstances, the Supreme Court
held that there was no delivery of possession to amount as ‘transfer of right to
use goods’. Therefore, if the use is allowed under specified circumstances,
without freedom to the user, it cannot amount to taxable lease transaction.

Bharat Sanchar Nigam Ltd. 145 STC 91 (SC)

This is the latest case from the Supreme Court in the given
series. The issue in this case was about levy of lease tax on services provided
by telephone companies. The Supreme Court held that no sales tax was applicable
as the transaction pertained to service. While holding so, one of the learned
judges on the Bench observed the following (Para 98 below) about taxable lease
transaction:

“98. To constitute a transaction for the transfer of the
right to use the goods the transaction must have the following attributes:

There must be
goods available for delivery;

There must be a
consensus ad idem as to the identity of the goods;

The transferee
should have a legal right to use the goods – consequently all legal
consequences of such use including any permissions or licenses required
therefore should be available to the transferee;

For the period
during which the transferee has such legal right, it has to be the exclusion
to the transferor – this is the necessary concomitant of the plain language of
the statute – viz. a “transfer of the right to use” and not merely a licence
to use the goods;

Having
transferred the right to use the goods during the period for which it is to be
transferred, the owner cannot again transfer the same rights to others.”

At present, reliance is placed on above paragraph to decide
on the nature of the lease transaction. Subsequent judgments, relying and
analyzing on above judgments, are also now available. Reference can be made as
hereunder:

Alpha Clays 135 STC 107 (Ker)

In this judgment, the Hon. Kerala High Court has considered
the above judgment in case of Rashtirya Ispat Nigam Ltd. (Supra).

The Kerala High Court, amongst others, observed the
hereunder:

“From all the aforesaid decisions, it is clear that in order
to attract the provisions of section 5(1)(iii) of the Act, particularly the
expressions “transfer of the right to use goods”, there must be a parting with
the possession of the goods for the limited period of its use by the assessee in
favour of the lessees. In other words, so long as effective control of the goods
is with the assessee, the rent received from the customers for use of the goods
will not attract the provisions of section 5(1)(iii) of the Act. It is in those
circumstances, it has been held by this Court in Bahulayan’s case (1992) 1 KTR
137, that the hire charges received for use of the lorry is not exigible to tax
under section 5(1)(iii) of the Act, the effective control of the lorry was
always with its owner. It is on this principle, it was held in Rohini Panicker’s
case [1997] 104 STC 498 (Ker), that lending of video cassette for use by the
customers is exigible to tax under the Act, for the possession of the video
cassette is given to the customers for their use according to their will. It is
in view of this legal position, the Supreme Court in Aggarwal Brother’s case
[1999] 113 STC 317, has held that shuttering material is exigible to tax under
law.”

Similarly, based on
BSNL, now there
are a few more judgments. Reference can be made to the following recent
judgments:

Commissioner of Sales Tax v. Rolta Computers & Industries Pvt.
Ltd. 25 VST 322 (BHC)

In this case, the transaction was that the party allotted its
computer time to certain parties on exclusive basis. The Sales Tax Department
wanted to consider the said transaction as lease transaction relating to
computers. However, the Bombay High Court rejected the above plea. The Hon.
Bombay High Court, amongst others, observed the following:

“75.In our opinion, the essence of the right under article
366(29A)(d) is that it relates to user of goods. It may be that the actual
delivery of the goods is not necessary for effecting the transfer of the right
to use the goods but the goods must be available at the time of transfer, must
be deliverable and delivered at some stage. It is assumed, at the time of
execution of any agreement to transfer the right to use, that the goods are
available and deliverable. If the goods, or what is claimed to be goods by the
respondents, are not deliverable at all by the service providers to the
subscribers, the question of the right to use those goods, would not arise.”

In light of above, the Hon. Bombay High Court has held that allowing computer time does not fall in the category of lease transaction as no delivery of computer is made to the customer at any time.

Commissioner, VAT, Trade and Taxes Department v. International Travel House Ltd. 25 VST 653 (Delhi)

In this one more recent judgment, the Hon’ble Delhi High Court has observed the following:

“13.Sub-paras (b) and (c) of para 97 are important with reference to the facts of the case to determine as to whether or not there is a sale by virtue of transfer of right to use goods as envisaged in article 366(29A)(d). The admitted position which emerges is that the transferee, namely, NDPL, has not been made available the legal right to use the goods, viz., the permissions and licences with respect to the goods. In the present case, the permissions and licences with respect of the cabs are not available to the transferee and remained in control and possession of the respondent. It is the driver of the vehicle, who keeps in his custody and control the permissions and licences with respect to the Maruti Omni Cabs or the said permissions and licenses remained in possession of the respondent. These are never transferred to M/s NDPL. It, therefore, cannot be said that there is a sale of goods by transfer of right to use the goods. It is absent, namely, the ingredient as stated in para 97(c) of the Bharat Sanchar Nigam Ltd.’s case (2006) 3 VST 95 (SC); (2006) 145 STC 91 (SC); (2006) 3 SCC 1.”

A further observation is as follows:

“We may note that it has been held in the Division Bench judgment of the Allahabad High Court in Ahuja Goods Agency v. State of Uttar Pradesh (1997) 106 STC 540, that unless specified vehicles are transferred pursuant to the contract, there is no sale of the goods. It was also held that when it is the duty of the transporter to abide by all the laws relating to motor vehicles and excise, the custody remains with the owners of the vehicles and not the persons who have hired the vehicles, and, which again shows that there is no sale. We respectfully agree with the reasoning in Ahuja Goods Agency’s case (1997) 106 STC 540 (All). In the case before us also there are no identified goods as intended in para 97(b) of the Bharat Sanchar Nigam Ltd.’s case (2006) 3 VST 95(SC); (2006) 145 STC 91 (SC); (2006) 3 SCC 1 and hence no sale of goods. We also agree with the reasoning of the judgment in Lakshmi Audio Visual Inc. v. Assistant Commissioner of Commercial Taxes (2001) 124 STC 426 (karn) wherein R. V. Raveendran, J. (as he then was) held that when there is only hiring of audio visual and multimedia equipment, which equipment is at the risk of the owner and possession and effective control remain with the owners then, in such circumstances, it cannot be said that the customer had got the right to use the equipment and there was, therefore, no deemed sale. We may note that there are other single Bench judgments of the Allahabad High Court which follow the view of the Division Bench in the Ahuja Goods Agency’s case (1997) 106 STC 540 and we need refer to only on such judgments reported as Mohd. Wasim Khan v. Commissioner of Trade Tax, U.P., Lucknow (2009) 20 VST 196(All); (2006) 30 NTN 233, in which the contracts were those to providing buses for transportation of the employees of the companies from one place to another and which transaction was held to be not a sale because the driver and other employees of the vehicles were employees of the owners, the road permit was in the names of the owners who had to take insurance for the vehicles and the workmen and consequently it was held that there was no case of transfer of the right to use the goods because the effective control of the vehicle remained with the owners of the buses.”

Thus, the concept of the nature of lease transaction gets clear from the above judgments. Whether effective control is with the client, so as to make the transaction a taxable lease transaction has to be decided in light of such judgments .

Nirav Shah

Lease vis-à-vis License of Trade Mark

VAT

The State Governments are entitled to levy Sales Tax on the
transactions of ‘Transfer of right to use goods’ (also referred to as lease
transactions). This is possible as per provisions of Article 366 (29A) of the
Constitution of India. However, the nature of lease transaction is not defined
in the Constitution or in Sales Tax Laws. Therefore, whether lease transaction
has taken place or not has to be decided based on judicial interpretation
available so far. We can say that the interpretation about nature of taxable
lease transaction is still under development. However, some guidelines are
available from the recent judgment of the Supreme Court in the case of M/s.
Bharat Sanchar Nigam Ltd. (145 STC 91). Hon. Supreme Court has observed as under
for finding out taxable lease transaction :

“98. To constitute a transaction for the transfer of the
right to use the goods, the transaction must have the following attributes :

(a) There must be goods available for delivery;

(b) There must be a consensus ad idem as to the
identity of the goods;

(c) The transferee should have a legal right to use the
goods — consequently all legal consequences of such use including any
permissions or licences required therefor should be available to the
transferee;

(d) For the period during which the transferee has such
legal right, it has to be the exclusion to the transferor — this is the
necessary concomitant of the plain language of the statute — viz. a
‘transfer of the right to use’ and not merely a licence to use the goods;

Having transferred the right to use the goods during the
period for which it is to be transferred, the owner cannot again transfer the
same rights to others.”

Thus certain guidelines are available from the above
observations. However still a difficulty is experienced in relation to
intangible goods like trade mark, copy rights, etc. In relation to tangible
goods there cannot be difficulty in applying above guidelines. But in relation
to intangible goods the difficulty persists mainly due to nature of intangible
goods. Tangible goods, once delivered to lessee, cannot be further delivered to
any other person simultaneously and the above guidelines can be applied very
easily. However, intangible goods can be allowed to be used by number of persons
at a time, unless exclusive transfer of right to use is made to one lessee. In
respect of such type of transactions, i.e., where intangible goods are
involved, in Maharashtra, there is direct judgment of the Bombay High Court in
case of Dukes & Sons (112 STC 370).

In this case the issue before the Bombay High Court was about
tax on royalty amounts received for leasing of trade mark. The argument was that
since the trade mark is not given for exclusive use to one party, but is given
or is capable of being given for use to more than one party, there is no lease
transaction. The transaction was referred to as Franchise transaction. The
requirement of exclusive use or exclusive possession to transferee, for
considering transaction as lease, was given stress before the High Court.
However, the Bombay High Court held that since the nature of goods in this case
is intangible goods, the condition of exclusive use cannot apply. Accordingly,
the High Court held that even if the goods i.e., trade mark is leased to
more than one party, still the transaction is taxable as lease transaction.

Therefore, there was a situation that in relation to
intangible goods, the transactions were considered to be lease transactions in
spite of non-exclusive transfer of right. This judgment was delivered on 22nd
Sep. 1998. Therefore, after having the judgment of the Supreme Court in BSNL,
delivered on 02nd March, 2006, it was a feeling that the above judgment in case
of Dukes & Sons cannot be a good law.

A similar issue has now been decided by the Maharashtra Sales
Tax Tribunal. The reference is to the recent judgment of the Tribunal in case of
M/s. Smokin Joe’s Pizza Pvt. Ltd. (A.25 of 2004, dated 25-11-2008). In this case
the facts were that the appellant M/s. Smokin Joe’s was holding registered trade
mark for pizza i.e., “Smokin Joe’s”. The appellant has allowed this trade
mark to be used by others on franchise basis. In other words, due to franchise
agreement the franchisees were entitled to use the said trade name on their
premises as well as on the T shirts of the delivery boys, on packing materials,
etc. The appellant has entered into franchise agreement with such other parties
for above purpose. As per the franchise agreement, in addition to allowing above
use, the appellant has to provide number of other services, like helping in
layout of the premises, selection of raw materials, training to the staff,
instructions/know-how for method of manufacture of pizzas and delivery, etc. The
appellant was of the opinion that this is a licensing transaction and not a
lease transaction. In the alternative it was understood to be composite
transaction of lease and service and in absence of any authority to divide the
transaction into lease and service, it was considered as non-taxable transaction
under the then Maharashtra Lease Act. However for sake of legal order, an
application for determination was filed before the Commissioner of Sales Tax as
per the provisions of the Lease Act read with S. 52 of BST Act, 1959. In
determination order the Commissioner of Sales Tax held that the transaction is
covered by the Lease Act and hence liable to sales tax as leasing of trade mark.

In appeal before the Tribunal the appellant reiterated his
arguments. In addition, reliance was also placed on the judgment of the Supreme
Court in the case of Gujarat Bottling Co. Ltd. & Others (AIR 1995 Supreme Court
2372) where the nature of lease and licensing of trade mark has been discussed.
The appellant also relied upon judgment in the case of BSNL as referred to above
and also further fact that he is discharging liability under Service Tax
considering the transaction as of service. The clarification issued by the
Service Tax Authority, namely, vide Circular dated 28-6-2003, clarifying the
meaning of franchise was also relied upon.

The Tribunal made reference to the above position and came to the conclusion that in the given circumstances the transaction of franchise of trade mark is not lease transaction but amounts to licensing transaction. Therefore, the Tribunal held that no tax is payable on the above transaction under the Sales Tax Law.

The Tribunal in concluding Para observed as under:

“This Departmental clarification of the concerned authorities will be helpful to us to some extent to know the nature of the franchise agreement. It may be noted that in the franchise agreement as commonly understood the use of trade mark may not be involved. The basic equipment of franchisee agreement is that the franchisee has to follow the concept to business operation, managerial expertise, market techniques, etc. of the franchisor and to maintain standard and quality of such production as required by the franchisor. Thus only because the permission to use the trade mark has also been granted while entering into the franchise agreement, the said item of the agreement cannot be carved out from the main agreement of franchisee to hold that it as a transfer of right to use.

As such, after giving anxious consideration to all pros and cons of the matter, we are of the view that the impugned transaction does not involve the transfer of right to use the trade mark. It is a licence granted to use the trade mark simultaneously to various persons. It is a composite agreement of providing various services to ensure the standard and quality of the product in order to maintain the reputation of the franchisor and permission to use the trade mark is incidental. It is therefore, not covered under the Lease Act and the levy is not justified.”

In the light of above judgment of the Tribunal it can also be said that the judgment of Dukes & Sons is indirectly overruled by the judgment in the case of BSNL.The ratio of the above Tribunal judgment will also apply to many other intangible goods, like copyright, technical know-how, etc., if in relation to such transactions it can be shown that there is no exclusive right given to the lessee. It will not be a lease transaction, but it will be a licensing transaction not covered by Sales Tax Laws. In other words, the law explained by the Supreme Court in para 98 reproduced above will apply to all goods, whether tangible or intangible. The taxability as a lease transaction is to be decided in the light of above judgment of BSNL. This judgment will also clarify the position as to when a transaction will be other than lease, where Service Tax can be attracted.

Nirav Shah

Discounted Cash Flow (DCF) Valuation

Introduction

In business, ‘Cash flow is the king’ and Discounted Cash Flow uses cash flows to arrive at the value of an enterprise. The term Discounted Cash Flow (DCF) has gained popularity in the financial world, especially in the world of valuation. With the Indian economy going through the ‘developing’ phase and private sector booming, there is a spurt in mergers and acquisitions, corporate restructuring, and foreign investments in India. At the same time, Indian entrepreneurs are exploring foreign shores. It is important, in this backdrop, to know what DCF is all about and also to learn about DCF’s importance.

DCF calculations have been used in some form or the other, since money was first lent at interest during the ancient times. It gained popularity as a method for valuation of stocks after the market crash of 1929. Irving Fisher, in 1930, in his book “The Theory of Interest” and John Burr Williams, in 1938, in “The Theory of Investment Value” first formally expressed the DCF method in the modern economic terms.

Basically, the DCF method is a method whereby an enterprise as a whole or its shares are valued, using the concept of the time value of money and estimating future cash flows of the enterprise. The cash flows that an enterprise will generate over a fairly long period, are discounted to their present value, to arrive at the value of the enterprise or shares, as the case may be.

Equity valuation vs. Enterprise valuation

The DCF method of valuation is used not only for valuation of equity, but also for the enterprise valuation. When valuing an enterprise, we consider the cash flows before debt commitments unlike in equity valuation where we consider the cash flows available to equity shareholders of the company after fulfilling all other commitments.

Enterprise valuation, also called business valuation of the company is used for arriving at the purchase consideration during amalgamations, absorptions, mergers, demergers, etc. This method also helps credit rating companies like CRISIL, ICRA, etc. to arrive at the ratings to be assigned to a company.

Three Important factors to be considered for DCF
Discount Rates

Discount rates applied to cash flow should be commensurate with the risk involved in the business. Discount is based on the cost of capital to the enterprise which considers the risk involved. Cost of capital is the weighted average of cost of equity and after tax cost of debt.

Cost of Equity is mainly dependent on market risk and the expected return for that investment. There are various types of risks involved in a business – project risk, competitive risk, political risk, economic risk, etc. Cumulatively, all these are called as market risk.

The most common and widely used model for measuring the risk is Capital Asset Pricing Model (CAPM). In CAPM, all the market risk is captured in ‘Beta’. We derive the risk measure ‘Beta’ as follows:

Covariance of asset with market portfolio

———————————————————-

Variance of market portfolio

Assets having risk higher than average (market portfolio) will have a Beta greater than 1, while less riskier assets than average will be less than 1. A riskless asset will have a Beta of 0. There are three main factors that affect ‘Beta’.
i) Type of Business
ii) Degree of operating leverage
iii) Degree of financial leverage

Determination of Beta becomes quite difficult in private and closely held businesses. In such cases, we generally consider comparable Betas of publicly traded companies. Risk free rate is also an important part of determination of cost using CAPM. Generally, risk free rate is the rate of return on government securities of appropriate maturity. But not all government securities are risk–free.

Last part of CAPM model is ‘equity risk premium’. This is the extra return that investors demand over and above the risk–free rate. It is the return for taking higher risk by not investing in riskfree asset. It normally ranges from 4% to 12%.

Next we come to the cost of the debt. Determining the cost of debt is comparatively simple. It is the interest rate on the money borrowed by the enterprise to finance its operations. Interest being a tax deductible expense, the cost of debt to the enterprise should be considered, after taking into account the tax benefit on the interest paid. This is arrived at, using the following formula: After tax Cost of Debt = interest rate *(1-tax rate)

Finally, we determine the Weighted Average Cost of Capital (WACC) by taking the weighted average of the cost of equity and debt according the proportion in which they have been utilised in the enterprise. This WACC is the discount rate for discounting future cash flows. Estimating Future Cash Flows Now, the important thing is to estimate the future cash flows. These are the key to DCF valuation. The term cash flows means free usable earnings. Free Cash Flow is derived as follows:

Free Cash Flow = Net Income – (Capex – Depreciation) – Change in non-cash working capital + (Debt raised – Debt repayment).

The above formula is used for equity valuation. While valuing a business or an enterprise, adjustments on account of debt is not required to be made.

This is just the basic formula, but practically, one needs to do many adjustments to the accounting earnings to arrive at the correct free cash flow to the equity. For example: R. and D. Expenses: Future benefits of these expenses are uncertain. Where benefits are expected, these may be capitalised and amortised over their life while estimating the cash flows. Similarly, for advertisement expenses if benefits are expected over a long period one may take the same stand.

One Time Expenses: All onetime expenses, extraordinary expenses which are not expected to recur in future should be ignored.

Expenses/receipts of fluctuating nature: Items such as foreign currency fluctuation whether positive or negative should be appropriately considered.

Tax subsidies: Government often offers tax subsidies and credits to specified businesses in the form of tax holiday. In such cases, particularly if tax holiday has a sunset clause, then tax is calculated at normal rates ignoring the tax holiday. Cash flows should be after considering the tax impact.

While past earnings may be used as a guide, what is important is to estimate future cash flows. Forecasting period is also an important factor as for how many years the cash flows are to be estimated and discounted. Normally, we estimate the cash flows for a period of five years. But it can be more or less, depending upon the industry and market conditions and certainty with which future cash flows can be estimated. It is subjective and depends upon the valuer and assumptions made.

Terminal Value

Since it is impossible to estimate cash flows for a long period, we estimate cash flows for a finite period, for which estimate can be made and calculate Terminal Value which is liquidation value of the enterprise at that point. Here, we assume, a growth rate of the enterprise. It is a rate at which the enterprise is expected to grow on a year-on-year basis after the terminal year. As we are assuming growth rate for a fairly long period, the rate should not be higher than the overall growth of the economy.

Cash flow (n+1)

Terminal Value = ————————————-

Cost of equity – Growth rate

During enterprise valuation, we replace cost of equity with cost of capital in the above equation.

Final Valuation
Finally, the enterprise is valued by discounting the future estimated cash flows along with terminal value calculated in the final estimated year with the cost of capital or cost of equity as the case may be. Sum of all these present values will be the enterprise value for an enterprise. For equity value we deduct debts from the enterprise value. We can find value per share by dividing equity value with number of shares outstanding.

Advantages of DCF

•   The DCF model considers the projected cash flow of a company while determining share value of the company. Investors as well as the management are interested in the future growth, rather than the present assets.
•   It gives a more realistic value of shares if the cash flow projections can be made realistically.
•   DCF assumes the going concern approach unlike other valuation techniques.

Limitations of DCF
• In case of newly incorporated company/non operative company, it is difficult to project future cash flow and DCF may give inappropriate valuation.

• It is also not suitable for companies with large asset base with negative cash flows, as use of this method will not depict the real value of the company.

• Assumptions have a big impact on the value arrived at by using DCF. Any change in the estimation of core rates will change the entire value and the purpose of valuation might not be fulfilled.

DCF and Statutory Provisions
FEMA guidelines for issue of shares

The Reserve Bank of India (RBI), by Notification no. FEMA 205/2010-RB, dated 7th April, 2010, amended the pricing guidelines applicable for issue of shares by an Indian company to a non-resident and for the transfer of shares of an Indian company from a resident to a non-resident. The new guidelines stipulate that the value of shares is to be determined using the DCF method, in the case of shares of an unlisted limited company. Prior to this change, valuation was required to be done on the basis of guidelines issued by erstwhile Controller of Capital Issues. These guidelines prescribed valuation based on historical earnings and asset values.

However, the DCF method posed a problem in valuation of shares of a new company. So, recently, RBI issued a Circular No. 36 dated 26th September 2012 under which shares can be issued to non-residents at face value if these are by way of subscription directly to Memorandum of Association which clarified the uncertainty on this issue.

Income-tax Act

Section 56(2)(viib) as inserted in the Finance Act, 2012 provides that if a closely held company issues shares at a higher price than Fair Market Value (FMV), then the difference over and the FMV if exceeding Rs. 50,000 will be taxable in the hand of issuing company.

Recently, vide Notification No. 52/2012 dated 29-11- 2012 amending Rule 11UA of Income Tax, the CBDT introduced DCF valuation as one of the two the methods for determining the FMV of unquoted shares for the purposes of section 56(2)(viib).

ITAT (Chennai) in a recent case of Ascendas (India) Pvt. Ltd. (ITAT No. 1736/Mds/2011) held valuation of shares under DCF method as an appropriate method to determine Arm’s Length Price (ALP). In the said case, assessee sold shares to its ‘Associated Enterprise’ and considered the value as per CCI guidelines for the purpose of determining the ALP. The Transfer Pricing Officer (TPO) rejected the valuation technique and directed to consider the value as per the DCF method for the purpose of determining ALP. The Tribunal held that none of the six methods specified in section 92C and Rule 10B of the Income-tax Rules were appropri-ate in this case. It further held that CCI guidelines were issued for a different purpose and cannot be used for calculation of ALP and held that the DCF method of valuing shares and enterprise which is the method accepted internationally should be used. The Tribunal finally held that the DCF method adopted by the TPO was in accordance with section 92C(1) of the Act and it would give the value as per ‘comparable uncontrolled price’.

Conclusion

Considering the volume of cross–border FDI transactions, the use of the DCF method for valuation has increased substantially. DCF valuation will prove as a great opportunity for the young generation of chartered accountants to expand their services by providing valuation services.

Finally, the valuation itself is a subjective and varies from valuer to valuer. As Warren Buffet says “Price is what you pay and value is what you get”. Value is an intrinsic value derived from the asset unlike price, which is negotiated between the buyer and the seller.

Nirav Shah

Election to Central and Regional Council

The following members are elected to Central Council from western Region and to the western India Regional Council in the elections held in December, 2012. Our greetings and best wishes to all the elected members.

(i) Central Council from Western Region Sarvashri Dhinal Shah (Ahmedabad), Jay Chhaira (Surat), Nilesh Vikamsey, Nihar Jambusaria, Prafulla Chhajed, Pankaj Jain, Rajkumar Adukla, S.B. Zaware (Pune), Sanjeev Maheswari, Shriniwas Joshi and Tarun Ghia.

(ii) Western India Regional Council Sarvashri Abhishek Nagori (Vadodara), Anil Bhandari, Dhiraj Khandelwal, Dilip Apte (Pune), Girish Kulkarni (Aurangabad), Hardik Shah (Surat), Julfesh Shah (Nagpur), Mangesh Kinare, Mahesh Madkholkar (Thane), Neel Majithia, Parag Raval (Ahmedabad), (Ms) Priti Savla (Thane), Priyam Shah (Ahmedabad), Sushrut Chitale, Sunil Patodia, Shardul Shah, Satyanarayan Mundada (Pune), (Ms) Shruti Shah, Sandeep Jain, Subodh Kedia (Ahmedabad), Sarvesh Joshi (Pune) and Vishnu kumar Agarwal.

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Nirav Shah

ICAI Publication

ICAI has released its publication ”Manual on Concurrent Audit of Banks” (Revised – 2012 Edition). (Refer 1152 of CA Journal for January, 2013.

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Nirav Shah

EAC Opinion – Determination of Normal capacity for the purpose of allocation of Fixed Overheads of cost of inventories and inclusion of various costs in the valuations of Inventories.

Facts: A public sector undertaking was established in the year 1976 under the administrative control of the Ministry of Steel, to develop the mine and plant facilities to produce 7.5 million tons of concentrate per year. The mines and plant facilities were commissioned in the year 1980 and the first shipment of concentrate was made in October, 1981. A pelletisation plant with a capacity of 3 million tons per year was commissioned in the year 1987 for production of high quality blast furnace and direct reduction grade pellets for export. However, in view of the Hon’ble Supreme Court verdict, the mine of the company was closed w.e.f. 31st December, 2005. After the closure of the mine, the company’s activities are restricted to production of pellets on bought out ore from outside source.

Since 1st January 2006, the mining activities of the company were stopped and hence, the production facilities of the pellet plant are wholly dependent on iron ore bought from external sources. It is, therefore, felt that under the circumstances, the average production during past five years can be considered as normal capacity for allocation of fixed overheads, in accordance with AS-2.

Expenses such as general expenses, welfare expenses, interest, advertisement and publicity, opportunity costs of loans and other income (interest recovered from employees on their loans), etc. are considered for valuation of inventories.

The company is of the view that all the expenses and other income related to the pellet plant unit only can be considered for the valuation of inventories (i.e. pellet). Such costs and other income are accumulated separately which are entirely connected to and arising from the production activity of the unit. Thus, according to the Company, the valuation of finished goods is as per AS 2.

Query:

Based on the above background, the Company has sought the opinion of the EAC regarding valuation of closing stock of finished goods as to (a) whether the average production for the last five years is to be reckoned as normal production or the budgeted production for the year under review is to be taken as normal production for the purpose of valuation of inventory? (b) Whether the expenditure on staff welfare, i.e. expenditure on township maintenance, health centre, etc. which are being maintained exclusively for the employees of that unit, general expenses, tender notice advertisement expenses and other income (interest recovered from employees on their loans) are to be considered for the purpose of valuation of inventory?

Opinion:

(i) After considering paragraph 9 of AS 2, the EAC is of the opinion that the normal capacity may be determined at the average of production of the last five years, provided it approximates the production expected to be achieved in the future periods also. However, if there are significant changes in circumstances, then such estimation would not be appropriate. In such a situation, budgeted production should be considered for determining normal capacity.

(ii) After considering paragraphs 6,7,11 & 13 of AS 2, EAC is of the view that the test for determining whether or not the cost for carrying out a particular activity should be included in the cost of inventories is whether the particular activity contributes to bringing the inventory to their present location and condition or not. Further, administrative overheads which do not contribute to bringing the inventories to their present location and condition are not to be included in the cost of inventories and are to be expensed when incurred. The overheads that are incurred to administer the factory in relation to production activities are factory or production overheads which contribute to bringing the inventories to their present location and condition and therefore such costs should be included in the cost of inventories.

The staff welfare expenditure i.e. expenditure on township maintenance and health centre, to the extent these are used by the employees of factory/production unit who render their services in relation to production activities, should be considered for inclusion in the cost of inventories. General expenses may be considered for the purpose of valuation of inventory only if these are incurred in bringing the inventories to their present location and condition. Tender notice, advertisement expenses cannot be included in the cost of inventories, as these expenses are incurred for exploring the possible supplies of materials and services and accordingly, cannot be considered as cost of purchase of inventories or other costs that are directly attributable to the acquisition. As regards interest income recovered from the employees, it is clarified that these are part of ‘other income’ and, therefore should not be adjusted in the cost of inventories.

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Nirav Shah

Related Party Disclosures-AS 18

The Financial Reporting Review Board (FRRB) of ICAI has noticed that there has been non-compliance in the matter of reporting of Related Party Disclosures by some companies. The report of FRRB is published on Pages 1140-1141 of C.A. Journal for January, 2013. Some of these issues are as under.

(i) Some enterprises, while giving the Related Party disclosures, simply state that there are no material individual transactions with the related parties during the year which are not in the normal course of their business or at arm’s length basis and, accordingly, do not provide any disclosures. Others provide disclosures for “significant transactions with the related parties.”

In the opinion of the FRRB Para 23 of AS 18, it does not prescribe for classification of transactions with related parties as significant/insignificant or material/ immaterial transactions. It is also felt that all transactions with related parties must be disclosed rather than just disclosing the significant transactions. Accordingly, non-disclosure of related party transactions on the pretext that no significant transactions have taken place or that only significant transactions are required to be disclosed is not in line with AS 18.

(ii) It may be noted that paragraph 21 of AS 18, Related Party Disclosure, requires that the name of the related party and the nature of the related party relationship where control exists should be disclosed, irrespective of whether or not there have been transactions between the related parties. Following non-compliances have been commonly noted from review of the Related Party disclosures of various enterprises.

• In some cases, the names of related parties have been disclosed, but the nature of the relationship with them has not been disclosed.

• In other cases, the names and the nature of only those related parties have been disclosed with whom transactions have taken place during the year.

(iii) It is often noted from the annual reports of various enterprises that while the schedules/notes to accounts/ Cash Flow Statements/Corporate Governance Reports, either individually or together, contain the information about the transactions taking place with related parties, the same are not reported under Related Party disclosure. It has been viewed that if any transaction has taken place during the year with the related party, then the reporting enterprise is required to disclose the details of the transactions as required under paragraph 23 of AS 18. Non-disclosure of such details is contrary to AS 18.

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Nirav Shah

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