BCAJ | Bombay Chartered Accountant Journal

CSR expenses, if given by way of donation to a trust eligible for 80G deduction, can be claimed under Section 80G. Restriction under Explanation 2 Section 37 does not apply to claim under section 80G

22 Naik Seafoods Pvt. Ltd. vs. PCIT [TS-1157-ITAT-2021(Mum)] A.Y.: 2016-17; Date of order: 26th November, 2021 Sections: 37, 80G, 263

CSR expenses, if given by way of donation to a trust eligible for 80G deduction, can be claimed under Section 80G. Restriction under Explanation 2 Section 37 does not apply to claim under section 80G

FACTS
During the previous year relevant to the assessment year under consideration, assessee company in its computation of total income disallowed a sum of Rs. 2.80 lakh being CSR expenses debited to Profit & Loss Account but claimed the same under Section 80G. While assessing assessee’s total income under Section 143(3) of the Act, the Assessing Officer (AO) did not disallow the claim so made under Section 80G.

The PCIT issued a show-cause notice to the assessee interalia observing that claim of Rs. 1.40 lakh has been made under Section 80G regarding CSR expenses of Rs. 2.80 lakh. CSR expenses are the assessee’s responsibility as per the Companies Act, 2013, and if it is spent through other trusts, then also, as per Rule 4(2) of CSR Rules, it is spent on behalf of the assessee. Therefore, the assessee cannot give a donation of CSR expenses even if it is given to a trust eligible for an 80G deduction. Hence, the same is not allowable. Failure of AO to consider CSR expense as disallowable as rendered the assessment order erroneous in so far as it is prejudicial to the interest of the revenue.

In response, the assessee made its submission (the submission made by the assessee to the PCIT on this issue is not reproduced in the order of the tribunal). However, the PCIT rejected the submission by holding that since both CSR expense and 80G donations are two different modes of ensuring fund for public welfare, treating the same expense under two different heads would defeat the very purpose of it. In the budget memorandum as well, the legislative intent was to ensure that companies with certain strong financials make the expenditure towards this purpose and by allowing deduction, the Government would be subsidizing one-third of it by way of revenue foregone thereon and hence the same was required to be disallowed in the assessment. Failure of the AO to examine the CSR expense as disallowable expense and to examine disallowance of deduction under Section 80G rendered the order erroneous and prejudicial to the interest of the revenue. He set aside the order of the AO with a direction to the AO to examine the above aspects with regard to allowability of deduction claimed under Section 80G as per law and frame a fresh assessment after affording an opportunity to the assessee of being heard.

Aggrieved, the assessee preferred an appeal to the Tribunal where relying on the decisions of the Bangalore Bench of the Tribunal in the case of FNF India Pvt. Ltd. vs. ACIT in ITA No. 1565/Bang./2019 dated 5th January, 2021 and Goldman Sachs Services Pvt. Ltd. vs. JCIT in ITA(TP) No. 2355/Bang./2019 it supported the action of the AO by contending that Explanation 2 under Section 37 is restricted to Section 37 only and nothing more and since the Explanation has been inserted below Section 37, it can be invoked only when expenditure is claimed as deduction as being for the purpose of business under Section 37 of the Act. Since the assessee has not claimed the said expenditure under Section 37 but has claimed it under Section 80G and the Act nowhere states that expenditure disallowed in terms of Explanation 2 to Section
37 cannot be allowed by way of deduction in terms of Section 80G.

HELD
The Tribunal noted that the Bangalore bench of the Tribunal in FNF India Pvt. Ltd. vs. ACIT (supra) while deciding the issue of deduction under Section 80G relating to donations which is part of CSR has remitted the issue to the AO to verify the additions necessary to claim deduction under Section 80G of the Act with a clear direction to the AO. Since in the present case the AO himself allowed the deduction under Section 80G, as claimed by the assessee, and the issue is debatable issue and the AO has taken one of the possible view, the Tribunal held that PCIT cannot invoke the provisions of Section 263 of the Act in order to bring on record his possible view.

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AUDIT QUALITY MATURITY MODEL – WHAT IS YOUR SCORE?

The Institute of Chartered Accountants of India (ICAI) has issued the Audit Quality Maturity Model – Version 1.0 (“AQMM” or the “Model“) in June, 2021. In the ICAI Council meeting held on 9th January, 2021, it was decided that both the Peer Review Board and the Centre for Audit Quality (CAQ) would need to develop an ecosystem that is acceptable to both. Such a collaborative approach would have the advantage of the CAQ developing the quality standards and the Peer Review Board testing the said standards.

Quality has always been the focus of ICAI. Recently, the Hon’ble Supreme Court told Bar Council of India’s lawyer, while asking to refrain from lowering the standards of entrance exams for law schools, “Look at how ICAI does it for Chartered Accountants. They control intake and also the quality.” The audit profession always had an enhanced focus on quality. The Model spells out the expectations from the audit firms in terms of audit quality, and Peer Review Board can test the implementation of these standards.

AQMM is initially recommendatory. In the Explanatory Memorandum on Applicability of AQMM, it is stated that the ICAI Council will review, after one year, the date from which it would become mandatory. Its applicability to firms is determined based on the firm’s audit clients. If a firm has the below types of audit clients, AQMM applies to them:
– A listed entity; or
– Banks other than co-operative banks (except multi-state co-operative banks); or
– Insurance companies.
Firms auditing only branches are not covered in the applicability.

MODEL TO MEASURE AUDIT QUALITY OF DIFFERENT FIRMS
When the user or consumer selects any service or product, he looks for the highest quality. Then why should audit as a service not have the highest quality that audit firm can deliver? It should have. However, how to measure the quality of audit that different firms provide? The final output, i.e. the audit report, is written based on Standards on Auditing. Nevertheless, the underlying audit on which it is based is a quality that stakeholder expects. Has the firm evaluated its audit quality? To answer these questions, ICAI has issued AQMM – the Model that has a scoring system based on the firm’s competencies. With this, the firm will be able to evaluate, in an objective manner, the quality of its audit and will also get guidance on its quality improvement areas. Every competency against which the firm scores low points indicates room for improvement.

Even though it is recommendatory, the drive has to come from within. By very nature itself, the audit profession has far-reaching consequences if quality is not followed. It is not similar to any other generic service available in the market. Through his audit report, the auditor assures various stakeholders of the financial statements of entities that carry out businesses affecting the entire economy. Every audit firm should regularly evaluate whether its service is of the highest quality. Just like good product brands enjoy a good reputation in the market due to their highest standards on quality, audit as a service also need to go through rigorous quality checks before it is delivered to the stakeholders. One may argue that when auditing standards are followed, it is good enough to ensure that audit quality is maintained. However, such an argument is not correct. The auditing standards help the auditor obtain reasonable assurance on the financial statements that he seeks to provide his opinion. However, complying with auditing standards, which is bare minimum expectation from auditor, by itself does not speak of audit quality. If one understands the difference between a product and another similar product that has gone through quality tests, AQMM exactly does that to the audit as a service. It adds quality tests to an audit being delivered by the auditor.

For an audit firm’s quality system, a quality audit is a critical part of the system. The audit landscape has changed over the years and is changing rapidly. Technology supports the audit in a big way – be it data analytics, various audit software being used by the audit firms or artificial intelligence in various audit tools.

VARIOUS QUALITY CONTROL MEASURES
There are several initiatives taken by the regulators to improve and review the audit quality. For example, ICAI has already issued Standard on Quality Control (SQC) 1, which requires the firms to establish system of quality controls. ICAI has also established the Financial Reporting Review Board (FRRB) that reviews general purpose financial statements and auditor’s reports to determine compliance with disclosure and presentation requirements. ICAI has also established Peer Review Board to conduct peer reviews. Since 2007, the Central Government has constituted Quality Review Board. AQMM is another such initiative that aims to improve audit quality.

AUDIT COMPETENCIES INCLUDED IN AQMM
AQMM is meant to identify which audit competencies are good, which are lacking and develop a roadmap for upgrading where the competencies are lacking. It is a self-evaluation guide for the audit firms to know their level of audit maturity. The guide looks at the overall firm as a whole and not only audit process. It considers the firm’s HR department, administration, IT support, legal department, etc. From an operations perspective, it considers the engagement team, leadership team, audit tools, networking team, MIS, etc.

The Model considers a firm’s competencies in the following three main areas:

1. Practice Management – Operation.
2. Human Resource Management.
3. Practice Management – Strategic / Functional.

Each of these areas is further sub-divided into specific elements in that area. The Model provides a scoring mechanism, i.e. the firm shall based on self-evaluation, calculate its score based on the score criteria and basis given in the Model. Therefore, this Model is like a marking mechanism for the audit firms to understand their Audit Quality Maturity. The Model provides various competencies that the firm should have. A score is given based on the presence or absence of such competency. For example, if the firm has the stated competency, it will get the score indicated in the Model. If the firm does not have such competency, it gets a zero score for such (non)competency. The Model also provides negative points for certain negative observations, which are described later in the article. The total maximum score that the Model provides is 600 points divided as a maximum of 280 points for Practice Management – Operation, a maximum of 240 points for Human Resource Management and a maximum of 80 points for Practice Management – Strategic / Functional. However, the Model does not give the basis for allotting a specific score to a particular competency. Therefore, there could be differing views where one may argue that a specific competency should have been given more weightage than to the other.

Let us understand the competencies included in each of the above areas.

1. Practice Management – Operation
The total of 280 points in this area is sub-divided into the following competencies:

Competencies

Maximum score

Practice areas of the firm

Work flow – practice manuals

Quality review manuals or audit tool

Service delivery – effort monitoring

Quality control for engagements

Benchmarking of service delivery

Client sensitisation

Technology adoption

Revenue, budgeting and pricing

Total

280

As expected, this area has maximum scoring because a large part of audit quality is reflected in the operational practice management of the firm. Within this, quality control for engagements carries the highest score. Quality control includes: competencies related to partner / quality review; percentage of engagements with ‘satisfactory’ rating based on a quality review; proportion of engagements without findings requiring significant improvements by ICAI or other regulatory bodies; audit documentation in compliance with Standard on Quality Control (SQC) 1; availability of accounting and auditing knowledge resources in soft copy archive form for Q&As, thought leaderships, dedicated technical desk, etc.; time spent on understanding the business of the client, identification of risks and planning audit engagement, etc.
How can firms improve their score in this area?

Though the scoring matrix gives a detailed break-up for various competencies, there are specific competencies that, in my view, the firms should focus on initially. These are very important from an audit quality perspective and will help them significantly improve the score.
These are:

1. Develop standard templates for the firm for engagement letters, management representation letters, audit documentation, audit reports, etc. The firms can also consider using templates issued by ICAI.

2. Develop standard checklists to ensure compliance with accounting and auditing standards.

3. Develop a practice manual of the firm that contains audit methodology ensuring compliance with auditing standards and their implementation.

4. Focus on the audit planning stage, including maintenance of documentation for hours budgeted, etc. Discuss and document client’s business understanding, risk assessment of material misstatement in accordance with Standard on Auditing 315, Identifying and Assessing the Risk of Material Misstatement through Understanding the Entity and its Environment.

5. Monitor audit progress, backlogs, unfinished engagements and client interactions so that audit can be completed within agreed timelines.

6. Use of audit tools, analytics, artificial intelligence-based audit procedures, etc.

7. Implement quality review process in the firm.

2. Human Resource Management
The total of 240 points in this area is sub-divided into the following competencies:

Competencies

Maximum score

Resource planning and monitoring as per
firm’s policy

Employee training and development

Resources turnover and compensation
management

104

Qualification skill set of employees and use
of experts

Performance evaluation measures carried out by the firm

Total

240

As this area relates to Human Resources (HR), its focus is on resources turnover and compensation. This competency has a maximum score compared to any other competency in the three main areas. Audit quality largely depends on the staff working on the engagement. Therefore, HR forms a critical area to ensure that quality staff is available for audits and resources turnover is well managed to ensure timelines are met. It is given that resources turnover cannot be eliminated, and therefore, the Model recognises this fact by stating the question as “Does the firm identify measures to keep the employee turnover minimal?” Compensation structuring goes hand in hand with resources turnover. This also includes building appropriate team structure, maintaining minimal employee turnover ratio, retention policy, identification of employee relationship with the firm, statutory contributions and other benefits made available by the firm, revolving door for audit staff, engagement level reviews and performance evaluation, access to technology and favourable remote working policies, gender diversity, holiday policies, staff well-being policies, employee surveys, recruitment policies and compensation mapped to knowledge and experience, etc. Many firms run specific programs to increase gender diversity. With additional family responsibilities compared to men, women may find path to leadership difficult which demands more of their time. There could have been more specific parameters to assess the quality of the resources and score based on such parameters, for example, the average number of years of audit experience per person the firm has, industry specialisation of the firm, etc.

How can firms improve their score in this area?

To start with, firms may consider implementing the following steps:
1. Develop a pyramid structure required to carry audits.
2. Determine training hours in a year per employee.
3. Maintain minimal employee turnover ratio, develop revolving door policy, holiday policy, compensation
policy.
4. Develop written key performance indicators for employees and partners.

3. Practice Management – Strategic / Functional
The total of 80 points in this area is sub-divided into the following competencies:

Competencies

Maximum score

Practice management

Infrastructure – Physical and others

Practice credentials

Total

Though this area shows a lesser score than the other two areas, this also has negative scoring. For negative scoring (non)competencies, the score considered is zero when such criteria are absent. If such criteria are present, it will give a negative score to the firm in this Model. For example, if the practice has an advisory as well as a decision, to not allot work due to unsatisfactory performance by the CAG office, it gets a negative five score. But if the firm does not have such non-competency, then the score is zero. Similar is the case if the firm has a negative assessment in the report of the Quality Review Board or if there has been a case of professional misconduct on the part of a member of the firm where he has been proved guilty.

Therefore, though the total shows a lesser maximum score in this area, there are many attributes that need to be considered here. Infrastructure competency in this area has a lot of significance. It includes branch network, centralised/decentralised branch activities, information security, data analytics tools, adequate infrastructure such as internet, etc., for remote working. As the name of the competency goes, it covers both types of infrastructures – physical and others. In the current times, physical infrastructure is losing relevance. As we have seen during the Covid pandemic, remote working has become a new normal. Technology has overcome the need for having a physical infrastructure, office space, meeting rooms, etc. For similar reasons, it is possible for the firms to work for clients in different geographies globally without having a branch presence in such geography. During Covid times, many global companies have outsourced their work to low-cost countries. It is possible for such country entrepreneurs to deliver the output only because of technology, without having any place of business in the client’s country/region. Therefore, the competency of physical infrastructure has become irrelevant now. Another concern over this competency is its relevance to audit quality. Having more branches and, therefore, getting higher score in the Model has no relation to the firms’ audit quality. A small firm with no branch may also have a very good quality in its audits. Therefore, keeping other factors the same, if such a firm scores less than other firms with more branches, does such score really speak of audit quality? Of course, not. The other competency of Practice Management includes balanced mix of experienced and new assurance partners, the firm’s independence as per ICAI Code of Ethics, Companies Act, 2013 and other regulatory requirements, whistle-blower policy, etc.

If based on the evaluation of performance by a government body or regulatory authority has resulted in debarment or blacklisting of the firm, it will have negative scoring.

How can firms improve their score in this area?

Some of the initial steps firms can consider in this area are:
1. Develop network through branches, affiliates, etc.
2. Get good connectivity through an intranet, internet, VPN and other means.

DETERMINING A FIRM’S LEVEL
Based on the total score, the Model defines four levels of firms. Level 1 is very nascent, and level 4 is a firm that has adopted standards and procedures significantly. These four levels are based on percentage in each section as less than 25%, 25% to 50%, 50% to 75% and above 75%. AQMM also clarifies that the status should not be publicised or mentioned by audit firms on any public domain such as professional documents, visiting cards, letterheads or signboards, etc., as it may amount to solicitation in view of the provisions of the Chartered Accountants Act, 1949.

CONCLUSION
Though AQMM is recommendatory, it is an excellent tool for self-evaluation by audit firms. Having said that, one may argue that a lesser score does not necessarily mean that audit quality is not ensured by the firm. But there needs to be an objective assessment of the quality, and AQMM would go a long way in such assessment. If audit firms follow the Model and improve their competencies, it will bring high quality across the audit profession. Therefore, it is a welcome step of providing such a standard Model to audit firms. In the coming years, if the firms voluntarily adopt this Model and improve their competencies, they will gain higher credibility in the eyes of the client given that their product, i.e. audit, has assured quality.

[The views expressed in this article by the author are personal.]

shailesh.kwebmaker

DOES TRANSFER OF EQUITY SHARES UNDER OFFER FOR SALE (OFS) DURING THE PROCESS OF LISTING TRIGGER ANY CAPITAL GAINS?

The calendar year 2021 was a blockbuster year for Indian primary markets, with 63 companies collectively garnering Rs. 1.2 lakh crore through initial public offerings. The Indian primary market witnessed the largest and most subscribed public offers in this period. A large part of public offering was by way of Offer For Sale (OFS), i.e. promoters offloading (selling) their stake in companies to financial institutions / public. What follows the transfer of equity shares is the determination of capital gains income and income-tax liability thereon.

Finance Act, 2018 brought a paradigm shift in taxation of long-term capital gains arising from the transfer of equity shares and equity-oriented mutual funds. Finance Act, 2018 withdrew the exemption granted on long-term capital gains arising on transfer of equity shares and equity-oriented mutual funds. With the withdrawal of exemption, special provisions in the form of Sections 112A and 55(2)(ac) of the Income Tax Act, 1961 (‘the Act’) were inserted to determine capital gains income.

This article seeks to examine capital gains tax liability arising from the transfer of equity shares under an OFS in an IPO process under the new taxation regime.

BRIEF BACKGROUND OF THE PROVISIONS
Section 112A of the Act provides for a tax rate of 10% in case where (a) total income includes income chargeable under the head capital gains (b) capital gains arising from the transfer of long-term capital asset being equity shares (c) securities transaction tax is paid on acquisition and transfer of those equity shares1.

Section 55(2)(ac) of the Act provides a special mechanism for computation of cost of acquisition in respect of assets covered by Section 112A. Cost of acquisition of equity shares acquired prior to 1st February, 2018 is higher of (a) or (b) below:

(A) Cost of acquisition of an asset.
(B) Lower of:

1. Fair market value of the asset as on 31st January, 2018, and
2. Full value of consideration received or accruing on the transfer of equity shares.

The essence of the insertion of Section 55(2)(ac) is to provide grandfathering in respect of gains up to 31st January, 2018 regarding equity shares. This is with a rider that adopting fair market value does not result in the generation of loss.

1 Section 112A(4) of the act provides relief
from payment of securities transaction tax on acquisition of shares in respect
of certain transaction covered by Notification No. 60/2018 Dated 1^st
October, 2018.

CASE UNDER EXAMINATION AND ANALYSIS

Mr. A, an individual, is the promoter of A Ltd. Mr. A had subscribed to equity shares of A Ltd. on 1st April, 2011 when the company was unlisted at their face value of Rs. 10. Since then, Mr. A has been holding these equity shares as a capital asset. Mr. A decides to sell the equity shares under the IPO process as an offer for sale at Rs. 1,000 per share in February, 2022. The question to be examined is: what should be the cost of acquisition of the shares, and how should one compute the capital gains?

In this case, the transfer of shares is covered by Section 112A of the Act since (a) total income of Mr. A includes income chargeable under the head ‘capital gains’; (b) capital gains arise from the transfer of long-term capital asset2 being equity shares; (c) in terms of Section 98 (entry no. 6) r.w.s. 97(13)(aa) of Finance (No.2) Act, 2004, Mr. A is required to pay securities transaction tax on the transfer of equity shares; (d) the requirement of payment of securities transaction tax on acquisition of equity shares is relieved in terms of Notification No. 60/2018 dated 1st October, 20183 as shares were acquired when equity shares of A Ltd. were not listed on a recognised stock exchange.

The provisions of Section 112A cover the case on hand and therefore the cost of acquisition of equity shares shall be determined in terms of Section 55(2)(ac), which requires identification of three components, namely cost of acquisition, fair market value as on 31st January, 2018 and full value of consideration. In the facts of the case, the cost of acquisition of each equity share is Rs. 10, and the full value of consideration accruing on the transfer of each share is Rs. 1,000. What remains for determination is the fair market value of the asset as on 31st January, 2018 to compute the cost of acquisition under Section 55(2)(ac).

Before determining the fair market value of equity shares as on 31st January 2018, one may refer to Section 97(13)(aa) of Finance (No. 2) Act, 2004, which provides that sale of unlisted equity shares under an OFS to the public in an initial public offer and where such shares are subsequently listed on recognised stock exchange shall be considered as taxable securities transaction and securities transaction tax is leviable on the same.

From the above, it is pertinent to note that when the equity shares are transferred under an OFS, such shares are unlisted and are listed on a recognised stock exchange only subsequent to the transfer. Further, the practical experience of applying for shares under an IPO suggests that consideration for equity shares is paid, and equity shares are credited to the purchaser’s account, prior to the date of listing of equity shares on a recognised stock exchange. This also corroborates that when the promoter transfers the equity shares under an OFS, such shares are still unlisted.

2 Equity
shares held by Mr. A qualifies as ‘long-term capital asset’ as equity shares
are held for a period exceeding 12 months.

3 Notification
No. 60/2018/F. No.370142/9/2017-TPL.

Determination of fair market value of equity shares as on 31st January, 2018

Clause (a) of Explanation to Section 55(2)(ac) of the Act provides a methodology for the determination of fair market value.

Sub-clause (i) of clause (a) of Explanation to Section 55(2)(ac) provides that where equity shares are listed on a recognised stock exchange as on 31st January, 2018, the highest price prevailing on the recognised stock exchange shall be the fair market value. In the present case, shares will only be listed post the IPO in February, 2022 (i.e. Equity shares were not listed on a recognised stock exchange as on 31st January, 2018). Accordingly, the case is not covered by said sub-clause.

Sub-clause (ii) of clause (a) of Explanation to Section 55(2)(ac) does not apply to the present case as the subject matter of transfer is equity shares and not units of equity-oriented mutual fund/business trust.

Sub-clause (iii) of clause (a) of explanation to Section 55(2)(ac) provides that where equity shares are not listed on any recognised stock exchange as on 31st January, 2018, but listed as on the date of transfer, the fair market value of equity shares shall be the indexed cost of acquisition up to F.Y. 2017-18.

The literal reading of sub-clause (iii) of clause (a) of Explanation to Section 55(2)(ac) of the Act suggests that the case of Mr. A will not be covered by said sub-clause as equity shares are not listed as on the date of transfer.

Considering the above, an important issue arises that when the fair market value of an asset cannot be determined basis the methodology provided in clause (a) of Explanation to Section 55(2)(ac), what shall be the impact of the same?

TAX AUTHORITIES MAY PUT FORTH FOLLOWING ARGUMENTS
With the withdrawal of exemption under Section 10(38) of the Act, the intent of insertion of Section 55(2)(ac) of the Act is to provide grandfathering of gains on equity shares up to 31st January, 2018. The legislature, in its wisdom, may provide the grandfathering in any manner.

In respect of equity shares, which are not listed on a recognised stock exchange as on 31st January, 2018, legislature has provided for the benefit of indexation in terms of sub-clause (iii) of clause (a) of Explanation to Section 55(2)(ac) of the Act.
In the case under consideration, Mr. A’s equity shares were unlisted as on 31st January, 2018 and the transfer of shares took place subsequently. And although the equity shares held by Mr. A were not listed as on the date of transfer, considering the legislative intent, the case of Mr. A shall be covered by sub-clause (iii) of clause (a) of Explanation to Section 55(2)(ac) of the Act. Accordingly, capital gains computation does not fail. In this regard, reference may be made to Supreme Court (‘SC’) ruling in the case of CIT vs. J. H. Gotla [1985] 156 ITR 323. In this case, the taxpayer had suffered a significant business loss in the earlier assessment years, which were carried forward. The taxpayer gifted certain oil mill machinery to his wife. A partnership firm was floated where the wife and minor children were partners. Income earned by wife and minor children from the firm was clubbed in the hands of the taxpayer, who claimed set-off of clubbed income against the business losses carried forward. Tax authorities denied such set off on the ground that for setting off losses business was required to be carried on by taxpayer and in this case, business was carried out by the firm and not the taxpayer. SC allowed the set-off of losses in the hands of the taxpayer against the clubbed income and made the following observations on interpretation of the law:

“Now where the plain literal interpretation of a statutory provision produces a manifestly unjust result which could never have been intended by the legislature, the Court might modify the language used by the legislature so as to achieve the intention of the legislature and produce a rational construction. The task of interpretation of a statutory provision is an attempt to discover the intention of the legislature from the language used. If the purpose of a particular provision is easily discernible from the whole scheme of the act which, in the present case, was to counteract, the effect of the transfer of assets so far as computation of income of the assessee was concerned, then bearing that purpose in mind, the intention should be found out from the language used by the legislature and if strict literal, construction leads to an absurd result, i.e., result not intended to be subserved by the object of the legislation found out in the manner indicated above, then if other construction is possible apart from strict literal construction, then that construction should be preferred to the strict literal construction. Though equity and taxation are often strangers, attempts should be made that these do not remain so always so and if a construction results in equity rather than in injustice, then such construction should be preferred to the literal construction.”

In the present case, legislative intent for providing grandfathering benefit in respect of equity shares which are not listed as on 31st January, 2018 and transferred subsequently can be gathered from the language employed in sub-clause (iii) of clause (a) of Explanation to Section 55(2)(ac) of the Act and accordingly, the said sub-clause covers the case of Mr. A.

AS AGAINST THE ABOVE, THE TAXPAYER MAY SUBMIT AS UNDER
The computation of capital gains is carried out in terms of Section 48 of the Act. The computation of capital gains begins with the determination of full value of consideration which is reduced by (a) expenditure incurred wholly and exclusively in connection with transfer, (b) cost of acquisition of capital asset, and (c) cost of improvement of a capital asset. Accordingly, the before mentioned are four important elements of computing capital gains.

Section 55(2) of the Act provides for the determination of the cost of acquisition of capital assets for the purpose of Sections 48 and 49 of the act. Section 55(2)(ac) is a special provision for determining the cost of acquisition in certain specified cases. Unlike Section 55(2)(b) of the act4, Section 55(2)(ac) of the Act is not optional. Once the taxpayer’s case is covered by provisions of Section 55(2)(ac), the cost of acquisition of a specified asset has to be determined under that Section.

Clause (a) of Explanation to Section 55(2)(ac) defines the term ‘fair market value’ in an exhaustive manner, and accordingly, no other methodology can be read into Section 55(2)(ac) of the Act to determine the fair market value.

In order to determine the cost of acquisition under Section 55(2)(ac), one of the important components is the fair market value of the asset as on 31st January, 2018. In the absence of a determination of the same, the exercise of determination of cost of acquisition under Section 55(2)(ac) of the Act cannot be completed.

The SC, in the case of CIT vs. B. C. Srinivasa Setty [1981]128 ITR 2945, held that since the cost of acquisition of self-generated goodwill cannot be conceived, the computation of capital gains fails. On failure of computation provision, it was held that such asset is not covered by Section 45 of the Act and hence not subjected to capital gains. Similarly, in the case of Sunil Siddharth Bhai vs. CIT [1985] 156 ITR 509 (SC)6, where the taxpayer had contributed capital asset to a partnership firm, it was held that full value of consideration accruing or arising on transfer of capital asset cannot be determined and accordingly such asset is beyond the scope of capital gains chapter. Also, in the case of PNB Finance Ltd. vs. CIT [2008] 307 ITR 757, on the transfer of undertaking by the taxpayer pursuant to the nationalisation of the bank, SC held that undertaking comprises of various capital assets and in the absence of determination of cost of acquisition of undertaking, the charge fails and accordingly, capital gains cannot be charged.

4 Section
55(2)(b) of the act provides an option to taxpayer to either adopt the actual
cost of acquisition or fair market value as on 1st April, 2001 where capital
asset is acquired prior to 1st April, 2001.

5 Rendered
prior to insertion of Section 55(2)(a) of the Act.

6 Rendered
prior to insertion of Section 45(3) of the Act.

Reference may also be made SC ruling in case of Govind Saran Ganga Saran vs. CST [1985] 155 ITR 144 rendered under Bengal Finance (Sales Tax) Act, 1941 (‘Sales Tax Act’) as applied to the Union Territory of Delhi. The case revolved around the interpretation of Sections 14 and 15 of the Sales Tax Act. Cotton yarn was classified as one of the goods of special importance in inter-state trade or commerce as envisaged by Section 14 of the Sales Tax Act. Section 15 of the Sales Tax Act provided that sales tax on goods of special importance should not exceed a specified rate and further that they should not be taxed at more than one stage. The issue arose because the stage itself had not been clearly specified, and accordingly, it was not clear at what stage the sales tax shall be levied. The Financial Commissioner held that in the absence of any stage, there was a lacuna in the law and consequently, cotton yarn could not be taxed under the sales tax regime. The Delhi High Court reversed the decision of the Financial Commissioner. However, SC held that the single point at which the tax may be imposed must be a definite ascertainable point, and in the absence of the same, tax shall not be levied. While rendering the ruling, SC has made the following observations which are worth quoting:

“The components which enter into the concept of a tax are well known. The first is the character of the imposition known by its nature which prescribes the taxable event attracting the levy, the second is a clear indication of the person on whom the levy is imposed and who is obliged to pay the tax, the third is the rate at which the tax is imposed, and the fourth is the measure or value to which the rate will be applied for computing the tax liability. If those components are not clearly and definitely ascertainable, it is difficult to say that the levy exists in point of law. Any uncertainty or vagueness in the legislative scheme defining any of those components of the levy will be fatal to its validity.”

The SC ruling in the case of Govind Saran Ganga Saran (supra) has been approved by Constitution Bench of SC in case of CIT vs. Vatika Township (P.) Ltd. [2014] 367 ITR 466. In the facts of the case, the measure or value to which the rate will be applied is uncertain in the absence of determination of cost of acquisition, and accordingly, a levy will be fatal.

The cardinal principles of interpreting tax statutes centre around the observations of Rowlatt J. In the case of Cape Brandy Syndicate vs. Inland Revenue Commissioner [1921] 1 KB 64, which has virtually become the locus classicus. In the opinion of Rowlatt J.:
“. . . . . . . . . in a Taxing Act one has to look merely at what is clearly said. There is no room for any intendment. There is no equity about a tax. There is no presumption as to a tax. Nothing is to be read in, nothing is to be implied. One can only look fairly at the language used.”8

AUTHOR’S VIEW
Considering that: (a) in terms of a literal reading, fair market value of equity shares as on 31st January 2018 cannot be determined, (b) computation provision and charging provision both together form an integrated code, and on the failure of computation provision, charge fails, (c) judicial precedents holding that uncertainty or vagueness in legislative scheme lead to the levy becoming invalid, and (d) requirement of taxing provisions to be construed in terms of language employed only, in the view of the author, the taxpayer stands on a firm footing that in the absence of a determination of the fair market value of equity shares as on 31st January, 2018 in terms of methodology supplied in Section 55(2)(ac) of the act, cost of acquisition of equity shares cannot be determined. In the absence of a determination of the cost of acquisition, the computation mechanism fails. Accordingly, one may vehemently urge that the equity shares transferred under the OFS are beyond the capital gains chapter.

One may also note that the issue discussed herein may not be restricted in its applicability to promoters transferring their equity shares under an offer for sale. It may equally apply to private equity players, institutions, financial investors, individuals etc., who have either subscribed to the shares of an unlisted company or have purchased the shares of an unlisted company from the market and are selling the shares under an offer for sale.

One shall note that courts may be slow in adopting a position of total failure of charge and transfer of capital asset falling beyond the provisions capital gains chapter. Further, considering the impact of the position stated above, one may expect high-rise litigation.

[The views expressed by author are personal. One may adopt any position in consultation with advisors.]

________________________________________________________________
8 The above passage has been quoted with approval in several SC rulings. Illustratively, refer PCIT vs. Aarham Softronics [2019] 412 ITR 623 (SC), CIT vs. Yokogawa India Ltd. [2017] 391 ITR 274 (SC), Orissa State Warehousing vs. CIT [1999] 237 ITR 589 (SC), Smt. Tarulata Shyam vs. CIT [1977] 108 ITR 345 (SC), Sole Trustee, Loka Shikshana Trust [1975] 101 ITR 234 (SC), CIT vs. Ajax Products Ltd. [1965] 55 ITR 741 (SC), CIT vs. Shahzada Nand and Sons [1966] 66 ITR 392 (SC).

shailesh.kwebmaker

THE GHOST OF B.C. SRINIVASA SETTY IS NOT YET EXORCISED IN INDIA

In this article, the taxability of capital gains arising on the transfer of internally generated goodwill and other intangible assets has been deliberated upon. We have also discussed whether the ratio laid down by the Hon’ble Supreme Court in CIT vs. B.C. Srinivasa Setty [1981] 128 ITR 294 (SC) still holds the field in the case of self-generated goodwill and other internally generated intangible assets. Before we do so, it would be relevant to understand briefly the history of past litigation on this issue and the series of judicial amendments made.

DECISION IN B.C. SRINIVASA SETTY’S CASE AND INSERTION OF SECTION 55(2)(a)
The question as to whether ‘goodwill’ generated in a newly commenced business can be described as an ‘asset’ for the purposes of Section 45 came for consideration before a 3-judge bench of the hon’ble supreme court in the case of B.C. Srinivasa Setty’s case (supra).

While concluding that the self-generated goodwill was undoubtedly an asset of the business, the court, however held that self-generated goodwill was not an asset within the contemplation under Section 45.

The court took note of the provisions relating to capital gains and laid down the important principle that the charging section and the computation provisions together constitute an integrated code. When there is a case to which the computation provisions cannot apply, it is evident that such a case was not intended to fall within the charging section. The court observed that Section 48(ii) required deduction of the cost of acquisition from the full value of consideration in computing the capital gains chargeable under Section 45. Thus, the court held that what is contemplated under the provisions of Section 45 and 48 is an asset for which it is possible to envisage a cost of acquisition. Taking note of the fact that in case of goodwill of a new business acquired by way of generation, no cost element can be identified or envisaged, the court reached the conclusion that the goodwill of a new business, though an asset could not be regarded as an asset within the contemplation of the charge under Section 45.

In paragraph 12 of the said judgement, the court has observed that in the case of internally generated goodwill, it is not possible to determine the date when it comes into existence. It has been observed that the date of acquisition of the asset is a material factor in applying the computation provisions pertaining to capital gains. It has been held that the ‘cost of acquisition’ mentioned in Section 48 implies a date of acquisition.

To overcome the above decision in B.C. Srinivasa Setty’s case (supra), Section 55(2)(a) was inserted vide Finance Act, 1987 with effect from 1st April, 1988. The said section originally contained two clauses. Clause (i) dealt with capital asset being goodwill of a business acquired by purchase from a previous owner, and clause (ii) dealt with the residual clause.

However, a reading of the memorandum to Finance Bill, 1987 would indicate that the amendment sought to deal with two classes of goodwill being – a) purchased goodwill and b) self-generated goodwill.

Section 55(2)(a)(ii), which dealt with the latter, i.e. self-generated goodwill, provided that for the purposes of Sections 49 and 50, the cost of acquisition of such self-generated goodwill would be taken to be nil.

The said section has been amended from time to time to include various classes of intangible assets.

PERIOD OF HOLDING AND LEVY OF TAX IN CASE OF SELF-GENERATED GOODWILL AND INTERNALLY GENERATED INTANGIBLE ASSETS

As discussed earlier, in order to overcome the decision in B.C. Srinivasa Setty’s (case), Section 55(2)(a)(ii) [currently Section 55(2)(a)(iii)] was inserted to deem the ‘cost of acquisition’ of the self-generated goodwill and other classes of internally generated intangible assets to be nil.

However, while making such an amendment, the legislature has not made any amendment to the provisions of the act to provide for the manner of computation of the period of holding in case of such assets.

As discussed earlier, it was observed by the Supreme Court that the date of acquisition in case of self-generated goodwill cannot be determined. The court has also observed that the date of acquisition is a material factor in applying the computation provisions relating to capital gains. It has also been held that the ‘cost of acquisition’ mentioned in Section 48 implies a date of acquisition.

The date of acquisition is a material factor in applying computation provisions considering that 2nd proviso to Section 48 replaces the ‘cost of acquisition’ in Section 48(ii) with ‘indexed cost of acquisition’ in case of gains arising from transfer of a long-term capital asset. The determination of whether a capital asset is a long-term capital asset would entail the determination of the period of holding in the hands of the assessee, which would, in turn, require the date of acquisition. Since the date of acquisition in the case of self-generated goodwill cannot be determined, the computation under Section 48 would not be possible.

By providing that the cost of acquisition in case of self-generated goodwill and other internally generated intangible assets as referred to in Section 55(2)(a) would be nil, the legislature may overcome the issue relating to the benefit of indexation under 2nd proviso to Section 48. However, this is not the end of the matter.

It would be pertinent to note that once the capital gains under Section 48 are computed and the charge under Section 45 is attracted, the tax payable on such capital gains would have to be determined based on whether such capital gain is a ‘short-term capital gain’ under Section 2(42B) or a ‘long-term capital gain’ under Section 2(29B). This exercise would, in turn, involve the determination of whether the capital asset is a ‘short-term capital asset’ under Section 2(42a) or a ‘long-term capital asset’ under Section 2(29AA).

A combined reading of sub Sections 42A, 42B, 29AA and 29B of Section 2 would indicate the following:

• The period of holding of a capital asset will have to be determined in the hands of the assessee. In determining the same one will have to reckon the actual period for which the capital asset has been held by the assessee.

• Having determined the period of holding in respect of the capital asset in the hands of an assessee, one will have to examine whether the capital asset would fall within the definition of ‘short-term capital asset’ under Section 2(42A) read with the provisos thereto based on such period of holding.

• If such capital asset meets the definition of ‘short-term capital asset’, the gain arising from the transfer of the same would amount to short-term capital gain by virtue of Section 2(42B).

• If such capital asset does not meet the definition of ‘short-term capital asset’ under section 2(42A), it will become a ‘long-term capital asset’ by virtue of Section 2(29AA). Thus, in order to invoke the residuary provision of Section 2(29AA), such a capital asset must clearly not be a ‘short-term capital asset’ within the meaning of Section 2(29AA). Thus, where it cannot be conclusively concluded that a capital asset is not a ‘short-term capital asset’, it cannot, by virtue of the residuary provision under Section 2(29aa), become a ‘long-term capital asset’.

• This is clear from the fact that ‘long-term capital asset’ has been defined to mean a capital asset that is not a ‘short-term capital asset‘. Firstly, the use of the word ‘means’ in Section 2(29AA) indicates that the definition given under Section 2(29aa) to the term ‘long-term capital asset’ is exhaustive. In this regard, reliance is placed on Kasilingam vs. P.S.G. College of Technology [1995] SUPP 2 SCC 348 (SC), wherein it has been held that the use of the term ‘means’ indicates that the definition is a hard and fast definition. Secondly, Section 2(29AA) defines a ‘long-term capital asset’ to mean a capital asset which is not a short-term capital asset. Thus, only where a capital asset is conclusively found not to be a ‘short-term capital asset’ within the meaning contemplation of Section 2(42A), it would fall within the purview of Section 2(29AA), and any gain arising from the transfer of the same would be a ‘long-term capital gain’ by virtue of Section 2(29B).

Since the period of holding of self-generated goodwill and other internally generated intangible assets cannot be determined, it would not be possible to conclusively rule out that such capital assets are not ‘short-term capital assets’ under Section 2(42A). Resultantly, such assets cannot be ‘long-term capital assets’. As a result, it would not be possible to determine whether the capital gains arising from the transfer of such assets are ‘short-term capital gains’ or ‘long-term capital gains’.

A fortiori, the applicable tax rates in respect of such capital gains cannot be determined as the nature of capital gains is unknown.

It may be noted that the impossibility in determination of the period of holding would further impact an assessee who acquires it from such previous owner who generated the goodwill or other intangible assets, under any of modes provided in clauses (i) through (iv) of Section 49(1).

In such case, by virtue of explanation 1(b) to Section 2(42A), in determining the period of holding in the hands of such assessee, the period of holding of the previous owner is required to be included. Since, the period of holding in the hands of the previous owner cannot be determined, the period of holding in the hands of the assessee would also be
indeterminate.

Can one argue that where the period of holding in the case of the previous owner is indeterminate, such period will have to be ignored for the purposes of explanation 1(b) to Section 2(42A)? However, such a view is clearly contrary to the mandate of the said explanation which provides that the period of holding of the previous owner ‘shall be included’.

Such being the case, it would also not be possible to determine the tax rates applicable to an assessee who acquires self-generated goodwill or internally generated intangible assets under the modes mentioned in Section 49(1)(i) to (iv), upon subsequent transfer of such assets by him. In Govind Saran Ganga Saran vs. CST, 1985 SUPP SCC 205 : 1985 SCC (Tax) 447 at page 209:

‘6. The components which enter into the concept of a tax are well known. The first is the character of the imposition known by its nature which prescribes the taxable event attracting the levy, the second is a clear indication of the person on whom the levy is imposed and who is obliged to pay the tax, the third is the rate at which the tax is imposed, and the fourth is the measure or value to which the rate will be applied for computing the tax liability. If those components are not clearly and definitely ascertainable, it is difficult to say that the levy exists in point of law. Any uncertainty or vagueness in the legislative scheme defining any of those components of the levy will be fatal to its validity.’

From the above extract, it can be observed that there are four components of tax:

•   The first component is the character of the imposition,
•   The second is the person on whom the levy is imposed,
•   The third is the rate at which tax is imposed, and
•   The fourth is the value to which the rate is applied for computing tax liability.

Further, the court has held that if there is any ambiguity in any of the above four concepts, the levy would fail.

In the following cases, the ratio laid down in Govind Saran Ganga Saran’s case (supra) has been followed:

•   CIT vs. Infosys Technologies Ltd. [2008] 297 ITR 167 (SC) (para 6);
•   CIT vs. Vatika Township (P.) Ltd. [2014] 367 ITR 466 (SC) (para 39);
•   Commissioner of Customs (Import) vs. Dilip Kumar & Co. [2018] 95 taxmann.com 327 (SC) (para 42);
•   CIT vs. Govind Saran Ganga Saran [2013] 352 ITR 113 (Karnataka) (para 15);
•   CIT vs. Punalur Paper Mills Ltd. [2019] 111 taxmann.com 50 (Kerala) (para 9).

Thus, it is clear that the rate of tax is one of the important components of tax and any uncertainty in the legislative scheme in defining it will be fatal to the levy.
Thus, in case of self-generated goodwill and other intangible assets, the charge under Section 45 in respect of capital gains upon transfer of the same would fail as the rate of tax cannot be determined. The charge would fail not only in respect of the assessee who acquired it through self-generation but also another assessee who acquires it from the former under modes provided in Section 49(1).

COMPARISON WITH SECTION 45(4) AS RECAST BY FINANCE ACT, 2021
Section 45(4), as inserted by Finance Act, 2021 with effect from 1st April, 2021, creates a charge in respect of profits or gains arising from a receipt of any money or capital asset or both by a specified person from a specified entity in connection with the reconstitution of such specified entity. It also provides the formula for the determination of such profits
or gains.

The said section provides that such profits or gains shall be chargeable to income tax as income of such specified entity under the head ‘capital gains’ and shall be deemed to be the income of such specified entity of the previous year in which the specified person received such money or capital asset or both.

It may be noted that in a given case, a specified person may receive two or more capital assets from the specified entity, comprising of a combination of short-term and long capital assets. In such a case, it would not be possible to apportion the aggregate profits or gains between short-term and long-term capital gains as no such mechanism has been provided in Section 45(4).

Further, there may be cases where only cash is received by the specified person from the specified entity. In such case, there is no transfer of a capital asset (be it long-term or short-term) by the specified entity to the specified person.

However, irrespective of the above situations, the entire profit or gain as determined by applying the provisions of Section 45(4) would be chargeable to tax in the hands of the specified entity under the head ‘capital gains’.

Thus, Section 45(4) is indifferent to whether there is actually a transfer of a capital asset, let alone whether such capital asset is long-term or short-term. Likewise, it is indifferent to the classification of the gains as ‘short-term capital gains’ or ‘long-term capital gains’. The trigger point in Section 45(4), unlike Section 45(1), is not the transfer of a short-term or long-term capital asset, but is rather the receipt of any money or capital asset or both by a specified person from a specified entity in connection with the reconstitution of such specified entity.

Further, Section 45(4), unlike Section 45(1), provides the mechanism for the computation of the profits and gains. The said computation is independent of the existence of any capital asset or, if it existed, the nature of such capital asset (i.e. short-term or long-term), unlike the computation under Section 48.

At this juncture, the question that would arise is what rate of tax would apply to the capital gains under Section 45(4). This is for the reason that the tax rate is dependent on the classification of the gains as ‘short-term capital gains’ or ‘long-term capital gains’ as discussed earlier.

According to the authors, the normal tax rates applicable to the assessee as per the first schedule to the relevant finance act would be applicable. This would be similar to the case of short-term capital gains other than those referred to in Section 111A.

A reference may be made to Section 2(1) of the Finance Act, 2021. The said Section, subject to exceptions under Sections 2(2) and 2(3) of the said Act, provides for charge of income-tax at the rates specified in part I of the first schedule. In other words, the tax rates mentioned in Section 2(1) read with part I of the first schedule of the Finance Act, 2021 would generally apply for computing the tax chargeable subject to the exceptions provided in Sections 2(2) and 2(3) of the said Act. One of the exceptions under Section 2(3) of the Finance Act, 2021 is with respect to cases falling under Chapter XII of the Income Tax Act where the said Chapter prescribes a rate. In such a case, the rate provided in the said Chapter would be applicable and not the rates provided in Part I of First Schedule to the Finance Act, 2021.

It may be noted that Section 111A, falling within Chapter XII, deals with short-term capital gains arising from transfer of certain capital assets and provides the rate of tax in respect of the same. Sections 112 and 112A deal with long-term capital gains and provide the tax rates in respect of the same. However, with regard to short-term capital gains other than those covered under Section 111A, no rate of tax is provided either in Chapter XII or any other provisions of the Income Tax Act. Thus, by virtue of Section 2(1) read with Section 2(3) of the Finance Act, 2021, with respect to such short-term capital gains, the rates provided in Part I of First Schedule to Finance Act, 2021 would apply.

The capital gains under Section 45(4) are not covered by Sections 111A, 112 and 112A. Such gains, therefore, form part of normal income and would suffer normal rates of tax as provided in Part I of First Schedule to Finance Act, 2021.

From the above, it can be observed that wherever the legislature has sought to do away with the requirement of the classification of the gains as short-term or long-term, it has done so.

However, the above would not apply in the case of self-generated goodwill and other internally generated intangible assets. Unless the period of holding of these assets is found, it cannot be determined whether they are ‘long-term capital assets’ or ‘short-term capital assets’ and the gains arising from the transfer thereof as short-term capital gain or long-term capital gain. In the absence of such determination, it would not be known whether such gain would fall under Section 112 and hence covered by Section 2(3) of the Finance Act. Unless its case is conclusively excluded from Section 2(3) of the Finance Act, Section 2(1), which provides for the normal rate cannot be pressed into service. Thus, the determination of the correct rate of tax becomes impossible, thereby frustrating the very levy.

CONCLUSION
Based on the foregoing analysis, it would not be unreasonable to take a stand that the charge under Section 45 and the subsequent levy of tax in respect of capital gains arising from transfer of capital assets, being self-generated goodwill and other intangible assets, would fail, despite the amendment under Section 55(2)(a). Thus, it would not be wrong to state that the ratio laid down by the Hon’ble Supreme Court in the case of B.C. Srinivasa Setty’s case (supra) is still good law, and the same continues to hold the field.

shailesh.kwebmaker

CARO 2020 SERIES: NEW CLAUSES AND MODIFICATIONS REPORTING ON FINANCIAL POSITION

(This is the seventh article in the CARO 2020 series that started in June, 2021)

BACKGROUND

One of the most important assumptions underlying the preparation of the financial statements is ‘going concern’. The trigger for the same rests on two underlying pillars- namely, cash losses and the ability to meet the existing financial liabilities within the foreseeable future, generally within one year from the balance sheet date.

The reporting requirements discussed hereunder on the above two pillars are very relevant in the scenarios whereby the companies are facing financial stress, or net worth has been eroded or in case of companies where there are significant doubts on their continuing as a going concern. These situations are particularly relevant in current times of stress on the business due to the COVID pandemic.

SCOPE OF REPORTING
The scope of reporting can be analysed under the following clauses:

Clause No.	Particulars	Nature of change, if any
Clause 3(xvii)	*Cash Losses:*	New Clause
Whether the company has incurred cash losses in the financial year and in the immediately preceding financial year, if so, state the amount of cash losses.
Clause 3(xix)	Financial Position Including Financial Ratios:	New Clause
On the basis of the financial ratios, ageing and expected dates of realisation of financial assets and payment of financial liabilities, other information accompanying
(continued)	the financial statements, the auditor’s knowledge of the Board of Directors and management plans, whether the auditor is of the opinion that no material uncertainty exists as on the date of the audit report that company is capable of meeting its liabilities existing at the date of balance sheet as and when they fall due within a period of one year from the balance sheet date.

Clause No.

Particulars

Nature of change, if any

Clause 3(xvii)

Cash Losses:

New Clause

Whether the company has
incurred cash losses in the financial year and in the immediately preceding
financial year, if so, state the amount of cash losses.

Clause 3(xix)

Financial Position
Including Financial Ratios:

New Clause

On the basis of the
financial ratios, ageing and expected dates of realisation of financial
assets and payment of financial liabilities, other information accompanying

(continued)

the financial statements,
the auditor’s knowledge of the Board of Directors and management plans,
whether the auditor is of the opinion that no material uncertainty exists as
on the date of the audit report that company is capable of meeting its
liabilities existing at the date of balance sheet as and when they fall due
within a period of one year from the balance sheet date.

PRACTICAL CHALLENGES IN REPORTING

The reporting requirements outlined above entail certain practical challenges, which are discussed below:

Cash Losses [Clause 3(xvii)]

Keeping in mind the above reporting requirements, the following are some of the practical challenges that could arise in reporting under this Clause:

a) No clarity on the definition of Cash Losses: The term ?cash losses’ is neither defined under the Companies Act, 2013 nor in the Accounting Standards / Indian Accounting Standards. However, the ICAI, in its Guidance Note on Terms Used in the Financial Statements issued in 1983, has defined the term ?Cash Profit’ as ?the net profit as increased by non-cash costs, such as depreciation, amortisation, etc. When the result of the computation is negative, it is termed as cash loss’. This definition is too inclusive and needs to be updated to keep pace with the changing trends and developments on the accounting front in the past couple of decades, like accounting for Deferred Tax, Unrealised Forex gains or losses, fair value adjustments, actuarial gains and losses for employee benefits etc. While the ICAI Guidance Note has touched upon some of these aspects, there is no authentic guidance/clarity, making it open to differing interpretations and difficulty in comparing and analysing different entities. It would be desirable to disclose the mode of arriving at the cash loss in the financial statements. Necessary changes could be considered by the ICAI and / or the regulators.

b) Companies adopting Ind AS: For such entities, the profit/loss after tax excludes items considered under Other Comprehensive Income (OCI) and hence it is imperative that proper care is taken to identify and give effect to only the cash components of items recognised in OCI like realised fair value/revaluation changes and forex gains and losses. For this purpose the cash component recognised under OCI should be considered for the period under report. Further, for computation of the cash profit/loss for the immediately preceding financial year, the restatements, if any, as per Ind AS-8 – Accounting Policies, Changes in Accounting Estimates and Errors, especially for prior period errors relating to periods earlier than the corresponding previous year. This should be clearly disclosed whilst reporting under this clause.

Financial Position including Financial Ratios [Clause 3(xix)]:

Before proceeding further it would be pertinent to note the following statutory requirements:

Additional Disclosures under amended Schedule III:

While reporting under this Clause, the auditor will have to keep in the mind the amended Schedule III disclosures which are as under:

The following ratios need to be disclosed:
a) Current Ratio

b) Debt Equity Ratio

c) Debt Service Coverage Ratio

d) Return on Equity Ratio

e) Inventory Turnover Ratio

f) Trade Receivables Turnover Ratio
g) Trade Payables Turnover Ratio

h) Net Capital Turnover Ratio

i) Net Profit Ratio

j) Return on Capital Employed

k) Return on Investment

Explanation to be provided for any changes by more than 25% compared to the preceding year.

Whilst reporting, the auditor should refer to the above disclosures for the relevant ratios such as current ratio, inventory turnover ratio, trade receivables turnover ratio, trade payables turnover ratio and capital turnover ratio, amongst others, made in the financial statements to ensure that there are no inconsistencies.

Before proceeding further, it is important to analyse the definition of Financial Assets and Financial Liabilities under Ind AS-32 since these terms are neither defined under the Companies Act, 2013 nor under Indian GAAP, since the reporting is with respect to these items as opposed to the other items in the financial statements.

Accordingly, companies to whom Ind AS is not applicable should also consider the said definitions for identifying financial assets and liabilities.

Definition of Financial Assets and Financial Liabilities under Ind AS-32

A financial asset is any asset that is:
(a) cash;

(b) an equity instrument of another entity;

(i) to receive cash or another financial asset from another entity; or

(ii) to exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity; or

(d) a contract that will or may be settled in the entity’s own equity instruments and is:
(i) a non-derivative for which the entity is or may be obliged to receive a variable number of the entity’s own equity instruments; or

(ii) a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity’s own equity instruments. For this purpose the entity’s own equity instruments do not include puttable financial instruments classified as equity instruments in accordance with paragraphs 16A and 16B, instruments that impose on the entity an obligation to deliver to another party a pro rata share of the net assets of the entity only on liquidation and are classified as equity instruments in accordance with paragraphs 16C and 16D, or instruments that are contracts for the future receipt or delivery of the entity’s own equity instruments.

A financial liability is any liability that is:
(a) a contractual obligation :

(i) to deliver cash or another financial asset to another entity; or

(ii) to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity; or

(b) a contract that will or may be settled in the entity’s own equity instruments and is:

(i) a non-derivative for which the entity is or may be obliged to deliver a variable number of the entity’s own equity instruments; or

(ii) a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity’s own equity instruments. For this purpose, rights, options or warrants to acquire a fixed number of the entity’s own equity instruments for a fixed amount of any currency are equity instruments if the entity offers the rights, options or warrants pro rata to all of its existing owners of the same class of its own non-derivative equity instruments. Apart from the aforesaid, the equity conversion option embedded in a convertible bond denominated in foreign currency to acquire a fixed number of the entity’s own equity instruments is an equity instrument if the exercise price is fixed in any currency. Also for these purposes the entity’s own equity instruments do not include puttable financial instruments that are classified as equity instruments in accordance with paragraphs 16A and 16B, instruments that impose on the entity an obligation to deliver to another party a pro rata share of the net assets of the entity only on liquidation and are classified as equity instruments in accordance with paragraphs 16C and 16D, or instruments that are contracts for the future receipt or delivery of the entity’s own equity instruments. As an exception, an instrument that meets the definition of a financial liability is classified as an equity instrument if it has all the features and meets the conditions in paragraphs 16A and 16B or paragraphs 16C and 16D.

Keeping in mind the above reporting requirements, the following are some of the practical challenges that could arise in reporting under this Clause:

a) Inclusive nature of various parameters/data points: This clause requires the auditors to comment based on the following parameters/data points:

• Financial Ratios

• Ageing and expected dates of realisation of financial assets and repayment of financial liabilities

• Other information accompanying the financial statements in the Annual Report e.g. Directors Report, MD&A etc.

• Auditors knowledge of the plans of the Board of Directors and other management plans.

Whilst the parameters described in this clause appear to be inclusive, the auditors would have to go on the basis of the data and information which is available, except for the financial ratios, which are now mandatory as per Schedule III requirements. Certain specific challenges, especially for non-NBFC entities and MSMEs, are highlighted subsequently since they may not have all the information stated above, or the same may be sketchy or incomplete.

b) Companies adopting Ind AS: Such companies are likely to face certain specific challenges which need to be kept in mind whilst considering the various reporting requirements which are as under:

• The financial liabilities need to be considered based on the legal form rather than the substance of the arrangements as is required in terms of Ind AS-32 and 109. Accordingly, redeemable preference shares though considered financial liabilities/borrowings under Ind AS will not be considered for reporting under this clause since legally they are in the nature of share capital. Similarly, optionally or fully convertible debentures though considered compound financial instruments or equity under Ind AS will not be considered for reporting.

• Ind AS-107 requires disclosure of the maturity analysis of the financial liabilities showing the contractual repayments under different liquidity buckets. The auditors shall cross-check the work papers for reporting under this clause with Ind AS disclosures.

c) Challenges for non NBFCs and Small and Medium Enterprises: Non NBFCs, may not have a formalised Asset Liability Management (ALM) system, which is required to be maintained in terms of the RBI guidelines to identify liquidity and maturity mismatches. Accordingly, the auditors of such entities would need to take greater care to review the data and come to appropriate conclusions to report under this clause. It would not be a bad idea to impress upon the Management of such entities to adopt the RBI guidelines and build up an appropriate ALM framework to the extent possible and based on cost-benefit analysis. In the case of MSMEs, whilst it may not be possible to have formalised ALM reporting systems, the auditors would have to ensure that data about the ageing of financial assets and liabilities is generated based on appropriate assumptions as per the conditions in which the entity is working. Further, in terms of capabilities, MSME entities may not be equipped enough to ensure the quality of the data and the controls governing the same. A greater degree of professional scepticism needs to be exercised in such cases, as discussed below.

d) Applying significant judgements and heightened level of professional scepticism: The auditors would have to use professional judgement and an increased level of professional scepticism in respect of the following matters whilst performing their audit procedures for reporting under this clause:

(i) Financial Ratios:
• Financial ratios may not always provide conclusive evidence, and hence auditors will have to also consider various other documents / information as discussed in the following bullets rather than relying only on the quantitative thresholds which they represent. An example is that of an ideal current ratio of 1.33:1 which is the benchmark to reflect strong liquidity. However, for a capital intensive industry even a lower current ratio may be acceptable due to higher level of funds blocked in long term capital intensive assets.

• These ratios cannot be standardised for all the entities, and the same needs to be tailored to the industries. A comparison would also be required with the peer group/competitors. It would be a good practice for auditors to obtain from the Management the basis of certain key ratios based on specific facts and circumstances.

• Each entity operates under different conditions hence ratios relevant to entities shall be considered whilst reviewing the data.

• While calculating ratios auditor should ensure that proper classification is done for current and non-current assets and liabilities. The same may not always be in line with the definition under Schedule III or under the Accounting Standards since certain items which may be current under these definitions may not necessarily be payable within the following year. An example could be the provision made for leave encashment which could be entirely classified as current as per the definitions under Schedule III or the accounting standards since legally the entity does not have an unconditional right to defer settlement beyond the next twelve months if all the employees decide to encash their leave though practically this is a remote possibility. Accordingly, for analysis and reporting under this clause, only the current portion as identified by the actuary would need to be considered since that is the most likely amount which would be settled within the next twelve months.

(ii) Expected date of realisation of financial assets and financial liabilities: In the case of NBFCs it will be easy to verify the expected date of realisation of assets and liabilities as those entities will have Asset Liabilities Management mechanism to analyse the due dates, as required in terms of the RBI guidelines. However, such a mechanism may not exist in case of other entities. Consequently, the auditor will have to put extra effort while reviewing the expected date of realisation of assets and repayment of liabilities in entities other than NBFCs, especially where the contractual terms are not specified. The auditors should prevail upon such entities to develop and strengthen their MIS and internal controls to capture the necessary data, and the same should be subject to proper verification in accordance with relevant auditing standards.
(iii) Other Information accompanying the Financial Statements: These documents generally comprise the Directors Reports and Management Discussion and Analysis Report, wherever required to be prepared. As per SA-720 – The Auditor’s Responsibility in Relation to Other Financial Information, the auditors are expected only to review the said information included as a part of the Annual Report accompanying the audited financial statement for any material factual inconsistencies and also include the same in the audit report. Further, in many cases there are practical challenges in getting this data before finalising the accounts and issuing the audit report. However the auditor should ensure that at least draft versions of these documents are made available by the Management. Finally, he should not only read the same for inconsistencies but also perform certain procedures as outlined below.

(iv) Review of the Board of Directors and Management Plans:
• Since the plans are forward-looking, the auditors would not be in a position to confirm the correctness thereof. However, while reviewing these plans, they will have to look into the historical performance and review various assumptions considered for the preparation of these plans and corroborate the same based on their understanding of the entity and the business in which it operates and other publicly available information.

• Auditors will also have to ensure that approved plans are in line with industries / peer group estimates.

(v) Audit Documentation: While taking the above judgements, auditors would have to ensure adequate documentation of the audit procedures performed as above to arrive at appropriate conclusion(s). In addition, they should also obtain Management Representation on specific aspects as deemed necessary. However, the Management Representation Letter shall not be a substitute for audit procedures to be performed but would serve as additional evidence.

CONCLUSION
The additional reporting responsibilities have placed very specific responsibilities on the auditors to provide early warning signals on the financial health of an entity. As is the case with most of the other clauses, where the auditors are expected to be playing varied and versatile roles, this clause is no exception since they are expected to play the role of a soothsayer!.

shailesh.kwebmaker

MLI SERIES- ARTICLE 6 – PURPOSE OF A COVERED TAX AGREEMENT AND ARTICLE 7 – PREVENTION OF TREATY ABUSE

1. BACKGROUND

Multinational companies and large global conglomerates transitioned from country-specific operating models to global business models – thanks to the continuously-improving information and communication technology, internet reach and integrated supply chains. However, the tax laws failed to catch up with the speed and advancement of such business models, leading to gaps in the interplay between domestic and international tax laws resulting in double non-taxation of income. Companies artificially shifted profits to low tax jurisdictions or tax havens where they had little or no business, famously referred to as ‘Base Erosion and Profit Shifting (‘BEPS’). BEPS led to widespread tax evasion causing serious concerns to the already revenue deficit developing economies unable to collect their fair share of taxes.

The bilateral tax treaties signed by the countries also could not prevent improper use of treaties by companies to pay no or minimum taxes leading to treaty shopping or tax treaty abuse. The Organisation for Economic Co-operation and Development (‘OECD’) has been trying to address such issues through its model tax convention or commentary by introducing concepts such as ‘beneficial owner’, ‘conduit companies’, ‘object and main purpose of arrangement or transaction’ etc. over the years. However, multi-nat`ional companies continued treaty shopping and evaded billions in taxes.

Considering the above, a need was felt for international cooperation to tackle the BEPS risks by arriving at a consensus-based solution. The OECD developed a strategy to address BEPS issues in a harmonized and comprehensive manner to counter weaknesses in the taxation system and confront gaps and mismatches in tax treaties. Hence, the concept of Multilateral Instrument (‘MLI’) was introduced whereby existing tax treaties stood modified to incorporate treaty-related BEPS measures via a single instrument called MLI. Multiple action plans were devised as a part of the BEPS project, and one such plan was Action Plan 6 – Prevention of tax treaty abuse.

2. OVERVIEW OF ACTION PLAN 6

BEPS Action Plan 6 deals with a variety of measures to control treaty abuse. It recommended a three-way approach to deal with treaty abuse, i.e., a) introduction of a preamble to the treaty; b) introduction of purpose based anti-abuse provision called ‘principal purpose test’; and c) introduction of objective based anti-abuse provision called ‘limitation on benefits’. These recommendations have been considered in the MLI.

The MLI contains multiple articles, which are divided into 7 parts. Part III, containing Articles 6 to 11, deals with the prevention of treaty abuse. Article 6 covering ‘Purpose of Covered Tax Agreement’ and Article 7 on ‘Prevention of Treaty Abuse’ has been discussed in this article.

Primarily, BEPS Action Plan 6 includes, inter-alia, introduction of title and preamble to every treaty as a minimum requirement along with the insertion of the clause on principal purpose test as well as limitation on benefits.

3. ARTICLE 6 OF MLI – PREAMBLE AS MINIMUM STANDARD

The preamble text which is introduced / replaced by MLI reads as under:

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

The main crux of the preamble as the minimum standard is to indicate the intention of the treaty countries to:

a) Eliminate double taxation;

b) Restrict opportunities for non-taxation or reduced taxation through tax evasion/avoidance strategies; and

c) Discourage treaty shopping or treaty abuse.

There is a possibility that the existing treaties may already have a preamble on similar lines. However, considering that multiple nations have commonly agreed upon the comprehensive text, it is desired that the countries adopt modified language of preamble as a substitute or in absence of the current text. However, if two countries believe that the language of preamble in the tax treaty is sufficient, they may continue with the text of preamble in the tax treaty by making a reservation without adopting change as suggested above.

The preamble forms part of the tax treaty and sets the tone and context in the right manner. It constitutes a statement of the object and purpose of the tax treaty.

With regards to the methodology of incorporating new preamble into existing treaties, it being a minimum standard, the countries who subscribe to MLI are presumed to have agreed to the change unless otherwise notified. If a country remains silent on its position without expressing any explicit reservation, it will be presumed that the country has agreed to the adoption of the minimum standard.

4. OPTIONAL ADDITION TO PREAMBLE
MLI provides an option to add following text in the preamble discussed above:

?Desiring to further develop their economic relationship and to enhance their cooperation in tax matters’

The additional text is offered as an option to the signatories of MLI with respect to the treaties that do not already have such a language as a part of its preamble. Only when both the countries expressly agree to adopt additional language will their tax treaty stand modified to include said text as part of the preamble. For example, the UK and Australia have opted for the inclusion of additional language as a part of the preamble. Hence, the UK-Australia tax treaty will have this additional language in addition to the language required as a minimum standard.

5. INDIA’S POSITION TO PREAMBLE AND OPTIONAL ADDITION
India is silent on the adoption of Article 6. Therefore, preamble text as stated above, being a minimum standard shall be deemed to have been adopted by India for its tax treaties. However, India has not opted for optional addition, and hence the same will not be included in the tax treaties.

6. IMPACT OF PREAMBLE ON INDIA’S EXISTING TREATIES

The impact of India’s adoption under Article 6 on few important tax treaties entered into by India is discussed below:

Country	Whether the country is a signatory to MLI?	Whether treaty with India is notified for MLI purpose?	Impact
Singapore	Yes	Yes	The existing preamble in the tax treaties contain objective of prevention of double taxation and fiscal evasion. The preamble language is likely to get widened with new preamble which provides for ?without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance and anti-treaty shopping objective.’
Netherlands
United Kingdom
France
UAE
Mauritius	Yes	No	New preamble shall not be added and hence existing treaty shall continue to operate as it is. The existing preamble provides for its object as ‘the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital gains and for the encouragement of mutual trade and investment.’
Germany	Yes	No	New preamble not to be added and hence existing treaty shall continue to operate without any change.
USA	No	Not Applicable	India-USA treaty shall remain unchanged. However, based on BEPS Action Plan, countries may amend treaty based on bilateral negotiations.
China	Yes	No	Neither country had notified counterparty. However, both the countries recently amended tax treaty based on the bilateral negotiations. The treaty has been amended based on the measures recommended in BEPS Action Plan. The amended tax treaty includes new preamble including optional additional text. The same is reproduced as under: ‘Desiring to further develop their economic relationship and to enhance their cooperation in tax matters, Intending to eliminate double taxation with respect to taxes on income without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining reliefs provided in this Agreement for the indirect benefit of residents of third States).’

Country

Whether
the country is a signatory to MLI?

Whether
treaty with India is notified for MLI purpose?

Impact

Singapore

Yes

The existing preamble in the tax treaties contain objective of
prevention of double taxation and fiscal evasion.

The preamble language is likely to get widened with new preamble
which provides for ?without creating
opportunities for non-taxation or reduced taxation through tax evasion or
avoidance and anti-treaty shopping objective.’

Netherlands

United Kingdom

France

UAE

Mauritius

Yes

New preamble shall not be added and
hence existing treaty shall continue to operate as it is.

The existing preamble provides for
its object as ‘the avoidance of double taxation and the prevention of
fiscal evasion with respect to taxes on income and capital gains and for the
encouragement of mutual trade and investment.’

Germany

Yes

New preamble not to be added and hence existing treaty shall
continue to operate without any change.

USA

Not
Applicable

India-USA treaty shall remain
unchanged. However, based on BEPS Action Plan, countries may amend treaty
based on bilateral negotiations.

China

Yes

Neither country had notified counterparty. However, both the
countries recently amended tax treaty based on the bilateral negotiations.
The treaty has been amended based on the measures recommended in BEPS Action
Plan.

The amended tax treaty includes new preamble including optional
additional text. The same is reproduced as under:

‘Desiring to further develop their economic
relationship and to enhance their cooperation in tax matters, Intending to
eliminate double taxation with respect to taxes on income without creating
opportunities for non-taxation or reduced taxation through tax evasion or
avoidance (including through treaty-shopping arrangements aimed at obtaining
reliefs provided in this Agreement for the indirect benefit of residents of
third States).’

7. INTENT OF PREAMBLE
The main intention behind binding countries which are signatory to the MLI to include new preamble as a minimum requirement is to ensure prevention of inappropriate use of tax treaties leading to double non-taxation or reduced taxation. However, recognizing what is ‘appropriate’ vis-à-vis ‘inappropriate’ use of tax treaty is often complex and strenuous.

In a situation where a company is set up with no / minimum business activity in a particular jurisdiction it may be viewed to be a typical case of inappropriate use of tax treaty. Further, in case of a company being engaged in genuine commercial activities which incidentally leads to double non-taxation may not viewed to be a case of inappropriate use of tax treaty. In such cases, the effect of double non-taxation is not on account of any tax evasion arrangement but in line with the overall object and intent of the tax treaty.

The tax treaty also intends to encourage economic development and co-operation amongst countries. One such case is of India-Mauritius tax treaty wherein the preamble manifests the philosophy of encouraging mutual trade and investment as object of the treaty. In the landmark judgment of Union of India vs. Azadi Bachao Andolan ([2003] 263 ITR 706), the Supreme Court referred to the text of the preamble of the Mauritius Treaty and legitimized treaty shopping as being consistent with India’s intention at the time when the Mauritius treaty was entered. It is pertinent to evaluate whether Supreme Court would have rendered the decision on similar lines if preamble would not bear reference to the text relating to economic development. Further, it would be interesting to see how Courts interpret tax treaties considering the text of new preamble in the tax treaties.

Mandatory adoption of new preamble is a step in right direction as an anti-abuse measure which keeps a check on treaty shopping and would help countries in collecting taxes in a fair and equitable manner.

8. ARTICLE 7 OF MLI – PREVENTION OF TREATY ABUSE
The BEPS Action Plan 6 Report provides for three alternatives to mitigate treaty abuse viz. the principal purpose test (‘PPT’), simplified limitation of benefit (‘SLOB’) provision and detailed limitation of benefit (‘DLOB’) provision. Under Action Plan 6, as a minimum standard, countries are provided with a choice between adopting the following options for prevention of Treaty Abuse:

(i) Only PPT.

(ii) PPT along with SLOB.

(iii) PPT along with DLOB.

(iv) DLOB supplemented by a mechanism that would deal with conduit arrangements not already dealt with in tax treaties.

The MLI provides for the PPT and SLOB provisions. However, it does not include a draft of the DLOB provision since it may require substantial bilateral customization and may be difficult to incorporate in a multilateral instrument. Further, since the PPT, by itself, can constitute compliance with the minimum standard, the same has been provided for as the default option for prevention of treaty abuse under Article 7 of MLI. However, countries are free to adopt either of the other three approaches as provided above.

9. CONCEPT OF PPT
The concept of PPT provides that where having regard to all relevant facts and circumstances, it is reasonable to conclude that one of the principal purposes of any transaction or arrangement was to obtain treaty benefit, such benefit would be denied unless it is established that the granting of such benefit would be in accordance with the object and purpose of the provisions of the treaty.

The concept of PPT may be dissected as under:

(i) Overriding Provision – The provisions of the PPT are notwithstanding other provisions of the treaty, namely they override the other provisions of the treaty.

(ii) Subjective Test – The test of PPT is subjective. While all relevant facts and circumstances needs to be considered in determining fulfilment of PPT, what constitutes the principal purpose of an arrangement and whether the principal purpose was to obtain a treaty benefit may be subject to varying interpretations.

(iii) Onus of Proof – The onus of proof (namely reasonable basis) required for the tax department to contest non-compliance of PPT is lower than the onus of proof (namely establish with certainty) required for the taxpayer to contend that granting of benefit is in accordance with the object and purpose of the treaty.

(iv) Application of PPT – PPT may fail even if one of the principal purposes of the transaction or arrangement was to obtain treaty benefit. One way to interpret this could be that where the transaction or arrangement would not have taken place or would have taken place in a different manner in the absence of the treaty benefit, then in such cases principal purpose may be said to have been to obtain treaty benefit.

(v) Transaction or Arrangement – The MLI does not define the terms ‘transaction’ or ‘arrangement’. However, the term ‘arrangement’ is defined in section 102(1) of the Income-tax Act, 1961 (‘IT Act’), although for the limited purpose of Chapter XA relating to the General Anti-Avoidance Rule. However, these terms could be interpreted widely and may also include setting up an entity in a particular jurisdiction.

(vi) Benefit – The term ‘benefit’ has also not been defined in the MLI. However, the same has been defined in section 102(3) to include a payment of any kind, whether intangible or intangible form. Further, section 102(10) defines ‘tax benefit’ to include reduction, avoidance or deferral of tax, increase in refund, reduction in incomeor increase in loss. The term ‘benefit’ in the context ofMLI is also intended to be wide in nature to cover the above.

(vii) Taxability in case PPT is not satisfied – Where PPT is not satisfied, the benefit under the treaty may be denied. However, the taxability may not be altered under the treaty by recharacterizing the transaction, disregarding an arrangement, looking through the transaction etc.

(viii) Object and purpose of tax treaty – Even where the PPT is not satisfied, treaty benefit may still be granted where it is proved that the granting of such benefit is in accordance with the objects and purpose of the treaty. The object and purpose of treaty may be gauged from the treaty’s preamble, text of the relevant provision etc. Typically, treaties/treaty provisions include elimination of double taxation, promotion of exchange of goods and services, movement of capital and persons, fostering economic relations, trade and investment, provision of certainty to taxpayers, elimination of discrimination etc. as their objects.

Some of the situations where PPT may be applied to deny treaty benefits are setting up of an intermediate holding company for treaty shopping, assignment of the right to receive a dividend to a beneficial treaty country, holding of board meetings in a particular country to demonstrate residence of the entity in such country etc. Further, some of the situations where the treaty benefit may be provided under the exception to the PPT Rule (i.e. treaty benefit in accordance with object and purpose of tax treaty) include choice of a treaty country for setting up a new manufacturing plant as compared to setting up in a country with no treaty, allowing benefit to an investment fund or a collective investment vehicle set up in a country where majority investors are of that country while some minority investors may be of a different country etc.

In addition to the PPT, the MLI also provides an option to include an additional para empowering the competent authority of a contracting state to grant the treaty benefit upon request from the person even where the same has been denied as a result of the operation of PPT. This shall be the case where the competent authority determines that such benefits would have been granted even in the absence of the transaction or arrangement.

10. APPLICATION OF PPT TO COVERED TAX AGREEMENTS
The PPT applies ‘in place of’ or ‘in absence of’ any existing similar provisions in the treaty. Where a similar PPT provision (which either covers all benefits or is applicable to specific benefits under treaty) is already present in the treaty and the same is notified by both the parties to the CTA, the said provision would be replaced by the PPT under the MLI. Thus, the scope of existing PPT provisions under a CTA would get expanded by the operation of the MLI. Where no such provision is present, the PPT under MLI would be added to the treaty. Further, where only one of the parties to the CTA notifies a similar existing provision in the treaty or where none of the parties to the CTA notify a similar existing provision, the PPT under MLI would apply and prevail over the existing provision and the MLI PPT would supersede the existing provision to the extent that such existing provision is incompatible with the MLI PPT.

However, the optional para empowering the competent authority to grant treaty benefit would only apply where both the parties to CTA have chosen to adopt the same.

11. CONCEPT OF SLOB
As discussed earlier, the SLOB provision is an optional provision which may be adopted as a supplement to the PPT. It provides for objective conditions for entitlement to benefits under a CTA. Basically, the SLOB test provides that a resident of a contracting state would be entitled to treaty benefits which are otherwise available under the CTA only where such resident:

(i) Is a ‘qualified person’; or

(ii) Is engaged in active conduct of business; or
(iii) At least 75% beneficial interest in such person is directly or indirectly owned by equivalent beneficiaries; or

(iv) Is granted benefit by the competent authority irrespective subject to fulfilment of PPT.

However, the following benefits under the treaty are not subject to the SLOB test:

(i) Determination of residence of dual resident entities (Para 3 of Article 4).

(ii) Corresponding adjustment (Para 2 of Article 9).

(iii) Mutual agreement procedure (Article 25).

Some of the important concepts for test of SLOB are outlined below:

Qualified person

(i) Individual,

(ii) Contracting jurisdiction,
political subdivision or local authority thereof or instrumentality thereof,

(iii) Entity whose principal class of
shares is regularly traded on stock exchange(s),

(iv) Mutually agreed NGOs,

(v) Entities established and operated
to administer retirement benefits etc.,

(vi) Person other than individual, if
at least 50% of shares of the person are owned directly or indirectly by
persons who are residents and qualify for treaty benefit under (i) to (v)
above. The shares should be held on at least half the days of a twelve-month
period that includes the time when the benefit would otherwise be provided.

Active conduct of business

(i) Person must be engaged in active conduct of business in the
residence state and income derived from the other state emanates from or is
incidental to such business.

(ii) Following activities do not qualify as “active conduct of
business”:

? Holding company,

? Overall supervision or administration of a group of companies,

? Group financing (including cash pooling),

? Making or managing investments.

Equivalent beneficiaries

(i) Treaty
benefit would be available if equivalent beneficiaries directly or indirectly
own at least 75% of the beneficial interest of the resident income recipient.
The interest must be held on at least half of the days of any twelve-month
period that includes the time when the benefit would otherwise be accorded.

(ii) Equivalent
beneficiary means a person, who would have been entitled to an equivalent or
more favourable benefit either under its domestic law or treaty or any other
international instrument.

12. APPLICATION OF SLOB TO CTAs
The SLOB applies to a CTA only where both the parties to CTA have chosen to apply it. Where only one of the parties or none of the parties have adopted the SLOB, the PPT would apply.

Further, where one of the parties to a CTA has chosen to apply the SLOB while the other party has not, the first party has an option to opt-out of Article 7 in its entirety namely Article 7 (including PPT) would not apply in such a case. In order to discourage such a situation, MLI provides the party not applying the SLOB to opt for either of the following:

(i) Symmetrical application of SLOB: SLOB would apply symmetrically under CTAs with parties that have originally chosen to apply SLOB. For example, where State X has opted for SLOB while State Y has opted only for PPT, State Y may opt for application of SLOB symmetrically to X-Y treaty. In such a case from the perspective of State Y, SLOB clause would apply only for the limited purpose of X-Y treaty. SLOB would not be applicable to any of the Y’s treaties with other States where such other States have not chosen to apply SLOB.

(ii) Asymmetrical application of SLOB: In the earlier example, where State Y opts for asymmetrical application, State X would test both PPT and SLOB while granting treaty benefits while State Y would only test for PPT.

It may be noted that opting for either of symmetrical or asymmetrical option is not mandatory for State Y. If none of the options is opted, the SLOB shall not apply, and only PPT shall apply. However, State X would then have an option of opting out of the entire Article 7, and if such option is exercised, neither PPT nor SLOB shall apply. However, in such a scenario it is expected that countries should endeavour to each a mutually satisfactory solution that meets minimum standard for preventing treaty abuse. In the context of Indian treaties, considering that India has opted for Article 7, the application of PPT or PPT and SLOB would depend upon how the other country chooses to apply Article 7. The impact of Article 7 on select Indian tax treaties is discussed in the subsequent paragraphs.

SLOB also applies ‘in place of’ or ‘in absence of’ similar provisions in the CTA. Where a treaty already has existing similar SLOB provisions, the states may notify the same and the MLI SLOB shall apply in place of the existing SLOB provision upon notification by both the states. The application of SLOB would be similar to that or PPT as discussed in
para 10.1.

13. INDIA’S POSITIONS ON ARTICLE 7
India has chosen to apply PPT as an interim measure in its final notification. However, where possible, it intends to adopt a LOB provision, in addition to or in replacement of PPT, through bilateral negotiation. India has not opted to apply the optional provision empowering the competent authority to grant treaty benefit even where PPT is not met. Further, India has also opted to apply the SLOB to all its treaties.

14. IMPACT OF ARTICLE 7 ON INDIA’S TREATIES
The impact of MLI on some of India’s prominent tax treaties is outlined in the Table below. The analysis in the below Table is considering that India has opted for PPT and SLOB provisions.

Treaty Partner	Notification by Treaty Partner	Impact of Article 7 of MLI
USA	Not adopted MLI	Since USA has not adopted MLI, none of the provisions of MLI would apply to India – US Treaty. Accordingly, neither PPT nor SLOB would apply to India – US Treaty.
Mauritius / China	Not covered treaty with India as a CTA	Since treaty with India is not notified as a CTA by Mauritius, none of the provisions of MLI (including PPT and SLOB) would apply to India – Mauritius treaty. Neither India nor China have notified India-China tax treaty as CTA. However, both the countries recently
(continued)		amended tax treaty based on the bilateral negotiations. India-China tax treaty has been amended vide protocol notified by CBDT vide Notification No. 54/ 2019 dated 17^th July, 2019 where PPT has been incorporated under Article 27A of the treaty.
Japan / France	Only PPT	Only PPT would apply to the treaty.
UAE / Australia / Singapore / Netherlands / Luxembourg / UK	PPT plus optional provision empowering competent authority to grant treaty benefit despite failure of PPT	Only PPT would apply. Since India has not adopted the optional provision empowering competent authority, the same would not apply to any of India’s CTAs.
Russia	PPT and SLOB	Both PPT and SLOB would apply.
Denmark	PPT and Symmetrical Application of SLOB	Both PPT and SLOB would apply.
Greece	PPT and Asymmetrical Application of SLOB	Greece would apply only PPT in granting treaty benefit while India would apply both PPT and SLOB in granting treaty benefit

Treaty Partner

Notification
by Treaty Partner

Impact
of Article 7 of MLI

USA

Not adopted MLI

Since USA has not adopted MLI, none of the
provisions of MLI would apply to India – US Treaty. Accordingly, neither PPT
nor SLOB would apply to India – US Treaty.

Mauritius
/ China

Not
covered treaty with India as a CTA

Since treaty with
India is not notified as a CTA by Mauritius, none of the provisions of MLI
(including PPT and SLOB) would apply to India – Mauritius treaty.

Neither India nor
China have notified India-China tax treaty as CTA. However, both the
countries recently

(continued)

amended tax treaty based on the bilateral negotiations.
India-China tax treaty has been amended vide protocol notified by CBDT vide
Notification No. 54/ 2019 dated 17^th July, 2019 where PPT has been
incorporated under Article 27A of the treaty.

Japan / France

Only
PPT

Only PPT would
apply to the treaty.

UAE / Australia / Singapore
/ Netherlands / Luxembourg / UK

PPT plus
optional provision empowering competent authority to grant treaty benefit
despite failure of PPT

Only PPT would apply.

Since India has not adopted the optional
provision empowering competent authority, the same would not apply to any of
India’s CTAs.

Russia

PPT and SLOB

Both PPT and SLOB
would apply.

Denmark

PPT and
Symmetrical Application of SLOB

Both PPT and SLOB would apply.

Greece

PPT and Asymmetrical Application of SLOB

Greece would
apply
only PPT in granting
treaty benefit while India would apply both PPT and SLOB in granting treaty
benefit

15. INTERPLAY OF PPT, SLOB AND GAAR

In the case of CTA where both PPT and SLOB apply, since SLOB deals with whether a particular “person” per-se is eligible for treaty benefit and provides for objective criteria as compared to PPT, the fulfilment of SLOB needs to be tested first. Where the SLOB itself is not fulfilled, treaty benefit would not be available irrespective of the fulfilment of PPT.

Once the SLOB is fulfilled, as a next step, the arrangement or transaction resulting in the income would also need to satisfy the PPT. Where SLOB is met, however, in case where a particular arrangement or transaction does not meet PPT, treaty benefit in respect of income from such arrangement or transaction may still be denied.

It is also pertinent to consider the interplay of PPT and General Anti-Avoidance Rules (‘GAAR’) under the IT Act. The table below provides a comparative analysis of these provisions.

Particulars	PPT	GAAR
Subject matter of test	Transaction or arrangement.	Arrangement which inter-alia includes a transaction.
Applicability	One of the principal purposes is to obtain treaty benefit. Tainted element test not required to be fulfilled.	(i) Main purpose is to obtain tax benefit; and (ii) Any of the four tainted elements are present (namely creates rights or obligations not at arm’s length, results in misuse or abuse of provisions, lacks commercial substance or entered in manner not ordinarily employed for bona fide purpose).
Consequences	Denial of treaty benefit.	Disregarding or recharacterization of arrangement, disregarding parties to arrangement, reallocation of income between parties, reassessment of residency or situs, looking through corporate structure etc.
Carveouts	Treaty benefit provided where the same is in accordance with object and purpose of treaty.	None.
Safeguards for judicious application	None.	Invocation to be approved by Approving Panel.
Grandfathering	None.	Income from investments made prior to 1^st April, 2017 grandfathered.
Threshold	None.	Applicable only where the tax benefit exceeds Rs. 3 crores in a financial year.

Particulars

PPT

GAAR

Subject matter of test

Transaction or arrangement.

Arrangement which inter-alia includes a transaction.

Applicability

One of the principal
purposes is to obtain treaty benefit.

Tainted element test not
required to be fulfilled.

(i)
Main purpose is to obtain tax benefit; and

(ii) Any of the four tainted elements are
present (namely creates rights or obligations not at arm’s length, results in
misuse or abuse of provisions, lacks commercial substance or entered in
manner not ordinarily employed for bona fide purpose).

Consequences

Denial
of treaty benefit.

Disregarding or recharacterization of
arrangement, disregarding parties to arrangement, reallocation of income
between parties, reassessment of residency or situs, looking through
corporate structure etc.

Carveouts

Treaty benefit provided
where the same is in accordance with object and purpose of treaty.

None.

Safeguards
for judicious application

None.

Invocation to be approved by
Approving Panel.

Grandfathering

None.

Income from investments made prior to 1^st April, 2017
grandfathered.

Threshold

None.

Applicable only where the tax benefit
exceeds Rs. 3 crores in a financial year.

It may be noted from the above that the test under PPT is more stringent than under GAAR. Accordingly, it is less likely that GAAR would apply where the PPT is satisfied. However, it would be interesting to see the manner in which GAAR provisions may apply where treaty benefit is provided under the exception to the PPT rule taking into account the object or purpose of the treaty.

16. CONCLUSION
With the introduction of the preamble in all CTAs, the same is likely to assume increasing significance in the interpretation of tax treaties and the provision of benefits thereunder, including by judicial forums. Any double non-taxation or treaty shopping case is likely to be subject to extensive scrutiny. Further, group holding structures, cross border transactions and arrangements planned by multinational corporations would need extensive examination with respect to the fulfilment of PPT in addition to already existing anti-avoidance measures. Further, since many countries have not opted for SLOB, the impact of SLOB provisions would be limited to select treaties entered into by India.

The importance of commercial substance and rationale is likely to assume prime significance and it is imperative that business decisions be driven by commercial factors rather than primarily by tax reasons. Going forward, the significance of adequate documentation for demonstrating the commercial rationale of entering into any transaction / arrangement cannot be undermined.

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THE MISSING MIDDLE – MADHYODAYA

Can we say that DONE includes NOT DONE/HALF DONE, just as income includes loss? How do we factor in the impact of not doing something? While Budget making is super difficult as there are innumerable impossible expectations from diverse interest groups, one can break up its OUTCOMES into the following baskets:

1. Antyodaya – pulling out those in dire need for basics – health, education, food, homes, water. These must reach them to bring them out of despair and helplessness and find dignity and opportunities.

2. Madhyodaya – rising of the taxpayers, MSMEs, risk-takers, working-class, consumers etc.; the middle class

3. Bhavishyodaya – beneficial creation whose outcome is in the future and will result in situation change. Includes infrastructure, investments, and the like that are like sowing seeds, building today that will bring enduring benefit and transform the landscape of living and doing business.

1 and 3 only aim to bring as many people into the middle class: the oil and wheel of the economy. Yet, Madhyodaya is often ignored, although the middle class should become as big as it can, where most populace should ideally be. Balance of these results in Sarvodaya – the RISE of ALL.

For Madhyodaya to occur, amongst other things, we need an entire system purged of a lot of dross by Arresting absurdities, undoing unFAIRNESS, and reducing REVENUE BLINDNESS . UNDOING these is equally important as DOING so many other things, and they are mutually exclusive. The Union Budget could have looked more closely at these.

__________________________________________________________________

1 Coined by Shri Deen Dayal Upadhyay, one of the founding fathers of the BJP.
2
Perpetual endemic that affects tax officers, and doesn’t allow them to
apply the law fairly due to blindness caused by collection targets.

Take STT, as an example: It was introduced when the tax on capital gains was abolished, and a more efficient source-based mechanism was brought in 2004. However, this government brought tax back, but ‘forgot’ or ‘ignored’ or ‘winked’ at the STT’s reversal, I guess. So today, you pay STT and tax on CG. Although it is tax, you cannot adjust it against tax on capital gains. It is an irrecoverable tax (unlike TDS or TCS) on loss where you still pay even when you incur loss – an unheard of structure in the tax world. For 2022-23 STT is estimated 60% higher at Rs. 20,000 Cr (collection of STT in 2019-20 was Rs. 6,000 Cr and Rs.12,500 Cr in September 2021 compared to an estimate of Rs. 12,500 Cr for the year 2021-22).

Crypto tax seems to suggest such a line of thinking to tax it without set off amongst other things when several crore people are reported to hold crypto. Since it is not currency – it can have GST implications. It is imperative that north block understands that the middle class is constantly trying to grow their tax paid savings to beat insidious inflation and taxes to stay afloat. On a lighter note, a wise man commented: the plausible cause of no tinkering of personal taxes and procedures could be the debilitated Rs. 4,000 crore tax portal!

While we congratulate FM for doing away with 1,486 union laws from GOI’s attic, the point is this: let’s do the same in tax laws and eradicate the absurd, unfair, arbitrary, outdated, complex, litigative and all that with the potential for abuse by administrators!

Raman Jokhakar
Editor

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RAMPRASAD BISMIL

We are in the platinum jubilee year of our independence. Therefore, through this column, I am making a small attempt to introduce to the readers those martyrs and patriots who sacrificed everything for our independence; and about whom most of us may not be aware of the inspiring details. It is our sacred duty to offer our Namaskaars to them. I wrote on Lokmanya Tilak (BCAJ issue of August, 2021) and Madanlal Dhingra (BCAJ issue of December, 2021).

Today, I am writing about a not very commonly known martyr – Ramprasad Bismil. He was hanged by the Britishers at Gorakhpur on 19th December, 1927. He was born in 1897 to a very poor family at Shahjahanpur in Uttar Pradesh. His father Murlidhar left his job in the municipality and became a small trader. Income was very meagre.

Ramprasad learnt Hindi and Urdu. Since, his father, who was not very educated, refused to give money for buying books, Ramprasad started ‘stealing’ the money from his house. His father stopped it. Ramprasad went into bad company and took up habits of smoking and other drugs. As a result, he ducked the 5th standard twice. At his mother’s request, he was admitted to an English School. There was a priest in a nearby temple who influenced Ramprasad. He then became rather religious. Thanks to a good friend called Sushilchandra Sen, he gave up all bad habits. A gentleman named Munshi Indrajit introduced him to Arya Samaj, founded by Swami Dayanand Saraswati. Ram got inspiration by reading good books. His father drove him out of the house. While wandering in the jungle, he came across Guru Somdev. Under his guidance, Ram learnt yoga, religion and political science. He studied upto 9th standard.

Bhai Paramanand, another revolutionary involved in Lahore conspiracy had written a book ‘Tavarikh-e-Hind’ which greatly influenced Ram and he vowed to dedicate his life to the struggle for India’s freedom. He met Lokmanya Tilak at the Lucknow Congress. Ram joined the revolutionary group. The revolutionary movement needed funds. Ram borrowed Rs. 400 from his mother and sold literature about revolutions. He wrote and published a book ‘How America secured freedom’. Also, a small booklet titled ‘My message to my countrymen’. Both these things were banned by the British Government. Ram earned Rs. 600 and repaid his mother’s loan. He helped the revolutionaries in procuring knives, rifles, pistols and other weaponry. He gained knowledge about the weapons and their prices. He secured a revolver from a Superintendent who was about to retire. The Superintendent was afraid; but Ram ‘created’ a document that he was the son of a resourceful landowner, and ‘obtained’ signatures of three persons to convince the Superintendent! Then he sold some banned revolutionary publications under the ‘guise’ of an ambulance service group in the Congress session.

There was an occasion when his three pseudo revolutionary friends attempted to kill him by betrayal. Ram escaped very luckily. The police were hunting for Ram. His mother who was always supportive, advised him to escape to Gwalior.

There, he started farming and animal husbandry; but never gave up his revolutionary movement. He wrote many books – like Bolshevic revolution, Man ki Tarang, Catherin, Swadeshi Rang; and also translated a few books – like Yogic Sadhana written by Maharshi Aurobindo. He is still recognised as a good writer in Hindi literature.

Then he again started paying attention to his very poor family. His publication business was not very successful. So, he took up a job as a manager in a factory. Then he collected some capital and started a factory of silk clothes. It was running well. From the money earned, he got his sister married. He entrusted the factory to a trusted friend and again turned to freedom struggle. He was focused on raising funds for the revolutionary movement, including looking after their families.

Once he was travelling from Shahjahanpur to Lucknow by train. He observed that on every station, the station master used to handover a money-bag to the guard of the train. There was not much security arrangement. So Ram planned an attack on a train at Kakori Station. He did it on 9th August, 1925 on the train ‘8 down’. The British Government was stunned! All the people involved in this attack except Chandrashekhar Azad were arrested. The trial continued for about 18 months; and 4 persons – Ramprasad, Ashfakulla, Roshansingh and Rajendra Lahiri were sentenced to death. Ram went to the gallows with a smiling face, chanting mantras from Sanskrit scriptures. His mother met him on the previous day and expressed her pride for his supreme sacrifice. Ram pledged that he would like to be born 1000 times of the same mother and sacrifice everything for the country.

While in jail, he had at least two good opportunities to escape. However, he avoided it on one occasion since Roshansingh’s brother who was a clerk in that jail would have come into serious trouble. On another occasion, a policeman expressed his trust in Ram and avoided tying him by a chain. Ram honoured the trust reposed in him and did not run away!

He secretly wrote his autobiography “Bismil ki Atmakatha” while in jail. It was published in 1929 but immediately banned. Finally, it was again published when India became free.

Friends, for want of space, I have avoided many details which reveal the calibre and character of this great son of our country! It is important to note that Ramprasad did all this within a short life of just 30 years! I feel, our country’s present plight is because we forgot them!

Namaskaars to Ramprasad Bismil.

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THE FIRST ‘VIRTUAL’ RRC! IS IT HERE TO STAY? A REPORT ON THE 54TH BCAS RRC

THE FIRST ‘VIRTUAL’ RRC! IS IT HERE TO STAY?

A REPORT ON THE 54^TH BCAS RRC

Greater attendance from more cities, the first-ever virtually hosted ‘refresher’ programme and a puppeteer-ventriloquist to boot! These are some of the highlights of the annual Gyan Ganga, also known as the Annual Residential Refresher Course (RRC) of the Bombay Chartered Accountants’ Society (BCAS), that was organised in the midst of the Covid-19 pandemic from the 7th to the 10th of January, 2021.

This was the 54th edition of the flagship event and it was attended by more than 160 participants from 39 cities and towns apart from Mumbai.

The organisers treated the difficulties, restraints and restrictions posed by the pandemic as opportunities to seek out the best in terms of the Chief Guest, the panellists, faculty, thought providers and so on. Overlapping and sometimes clashing engagements, physical locations and distances were no longer a limitation. Acknowledging the need to ‘admit rather than to restrict’, the doors of the RRC were virtually thrown open to non-members, a few of whom attended and took benefit of the landmark annual event.

From left: Uday Sathaye, Suhas Paranjpe, Narayan Pasari

Countless calls and virtual meetings resulted in drawing up a programme that promised to provoke and trigger fresh thought, debate and conversation. Of course, the time-tested mix of panel discussions, paper presentations, group discussions and talks was not neglected.

As members are aware, one of the main attractions of an RRC is the opportunity to interact with a melange of like-minded professionals and experts from diverse fields, practices and regions.

Any misgivings about the ability to attract an audience in the pandemic were washed away with the early registration of one of our senior-most Past Presidents, Pradyumna Shah, under whose aegis and Presidentship the very first RRC was held in the year 1968-69.

Invigorated by this vote of confidence, the days leading up to D-Day were spent in smoothening out technical issues, preparing videos and notes on how to log in, mock trials with panellists, paper presenters and so on to check the reception quality and also to test their bandwidths!

The first morning (7th January) was earmarked for young delegates to participate in the ice-breaking event, the ‘40s under 40’ programme led by our own youth, or Yuva Shakti, Anand Bathiya and Chirag Doshi.

President Suhas Paranjpe then went on to start the inaugural session by welcoming the participants and briefing them about the BCAS. Seminar, Public Relations and Membership Development Committee Chairman Narayan Pasari spoke about the RRC and gave details of the schedule.

Clockwise from top left: Adv Ajay Singh, Prof. Sunil Sharma, CA Sumit Seth, CA Vikram Pandya, CA Abhay Desai, CA Abhitan Mehta

In acknowledgement of the stellar contribution of our Past President under whose leadership the seed of the RRC was planted half a century ago, the BCAS felicitated Pradyumna Shah who, at the young age of 91, leads by example, proving that learning never stops. Vice-President Abhay Mehta read out the citation that was presented to him.

This was followed by the release of a book authored by another Past President, Uday Sathaye. BCAS also launched its ‘Gift A Membership Scheme’ under the benign gaze of the esteemed Guest of Honour, Mr. Dilip Piramal, Chairman, VIP Industries. In his address, Mr. Piramal spoke candidly on the subject ‘The New Normal – Doing Business in India’. An interactive session, deftly moderated by Joint Secretary Mihir Sheth and the SPRMD Committee Member Dr. Sangeeta Pandit followed.

Mr. Dilip Piramal reflected upon his life experiences and motivated the online audience with his frankness, simplicity and humility on a number of contemporary issues posed to him by the moderators.

Treasurer Chirag Doshi proposed the vote of thanks to the Chief Guest. Also present at the opening session were the Conveners of the Committee, Kinjal Bhuta, Mrinal Mehta and Preeti Cherian.

The inaugural session was followed by the much anticipated curtain-raiser Panel Discussion which saw Jayesh Sheth, Raj Mullick, Vishal Gada and Rutvik Sanghvi lay threadbare the intricacies relating to ‘Business in Digital Economy – An Overall Perspective from Direct Tax, Indirect Taxes, Accounting & FEMA’. The panel was moderated and deftly steered by Past President Chetan Shah and Treasurer Chirag Doshi.

On the second morning, 8th January, Abhitan Mehta started the Group Discussion on ‘Revenue Recognition Accounting – Direct Taxes & Indirect Taxes Aspects’. For each Group Discussion Paper, the participants were divided into four online groups with a Group Leader and an Observer in each for interactive deliberations and discussions on the subject.

Later, the participants took active interest in the Paper Presentation by Sumit Sheth on the subject ‘CARO Reporting & Other Recent Company Law Issues’. This session was chaired by Past President Ashok Dhere. In the evening, Abhitan Mehta returned in a lengthy session in which he presented his replies to the paper that had been discussed in the morning. This session was chaired by Vice-President Abhay Mehta.

Day 3 commenced with the Group Discussion on ‘Case Studies in Direct Taxes (Special Emphasis on Corporate Taxation Schemes & Issues, Penalties & Prosecutions & COVID Impact)’ by Advocate Ajay Singh. In-depth discussions took place among all the four groups. This was followed by the Paper Presentation by Abhay Desai on ‘Intricate Issues in GST, Special Emphasis on Input Tax Credit, Place of Supply, Point of Taxation & Valuation’. This session was chaired by Past President Govind Goyal.

Glimpses of the 54th BCAS RRC

The array of speakers, paper-writers, moderators and others who enriched the
proceedings of the RRC

Yet another stimulating Paper Presentation followed. This one was by Vikram Pandya on the ‘Use & Impact of Artificial Intelligence & Data Analytics for Professionals’. Dr. Sangeeta Pandit chaired this session.

And then it was time to release the much-awaited BCAS App. This was formally done by President Suhas Paranjpe and other office-bearers with much fanfare. The contribution of Joint Secretary Mihir Sheth in the making of the App was hailed and recognised.

The evening ended with a unique entertainment programme by Satyajit Padhaye, a CA and also an ace puppeteer and ventriloquist, which was enjoyed by all the participants and their families. This programme was chaired by Past President Pranay Marfatia.
Day 4 started with replies by Advocate Ajay Singh on his paper ‘Case Studies in Direct Taxes (Special Emphasis on Corporate Taxation Schemes & Issues, Penalties & Prosecutions & COVID Impact)’. This session was chaired by Past President Anil Sathe.

The pièce de résistance of the 54th RRC was the talk by Prof. Sunil Sharma, Faculty, IIM-Ahmedabad, on ‘Strategic Thinking & Organisational Alignment’ which was chaired by Past President Rajesh Muni. The occasion also marked the e-release of the e-book‘Gita for Professionals’ authored by Chetan Dalal.

The virtual RRC concluded with acknowledgements and thanksgiving to all those who had worked towards delivering a successful RRC, especially the ‘Tech Team’ comprising Anand Kothari, Gaurav Save, Mehul Gada, Rimple Dedhia and Ronak Rambhia who had worked tirelessly to deliver a seamless experience.

Till we meet again in 2022 at the 55th RRC!

PREFACE

‘Dear Esteemed Readers,

In the words of our dear Father of the Nation, Mahatma Gandhi, “Be the change you wish to see in the world”. This phrase aptly describes our respected vadil, our Past President, Shri Pradyumnabhai N Shah.

The seeds of the Bombay Chartered Accountants’ Society’s Residential Refresher Course (RRC) were planted under his Presidentship in the year 1968-69. Over the past five decades, countless members, nay generations, have reaped the fruits of this bountiful tree, while sheltering and prospering under its benevolent reach.

One of the early registrations at the 54th edition of the RRC this year, the first one in virtual mode, was none other than our dear Shri Pradyumnabhai himself. All of 92 years of age, his hunger for learning and his commitment to the Society and profession are truly inspirational.

The Seminar, Public Relations & Membership Development Committee (SPR&MD Committee) of the BCAS, which organises the RRC every year, was privileged to honour the contributions of our dear Shri Pradyumnabhai with a citation presented at the hands of the esteemed Chief Guest, Shri Dilip Piramal, Chairman, VIP Industries.

Pradyumnabhai, thank you for showing us the path, for being the torchbearer for the RRC. We, at the BCAS, will be eternally grateful for the legacy you have bestowed on all – the past, the current and the future generations of members – all part of this vibrant Society.’

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Section 44AD – Eligible assessee engaged in an eligible business – Partner of firm – Not carrying on business independently – Not applicable

6. Anandkumar vs. Asst. CIT Tax, Circle-2, Salem [Tax Case Appeal No. 388 of 2019; 23rd December, 2020; Madras High Court] [‘A’ Bench, Chennai in I.T.A. No. 573/CHNY/2018; A.Y.: 2012-13; ITAT order dated 30th January, 2019]

Section 44AD – Eligible assessee engaged in an eligible business – Partner of firm – Not carrying on business independently – Not applicable

The assessee is an individual, a partner in M/s Kumbakonam Jewellers, M/s ANS Gupta & Sons and M/s ANS Gupta Jewellers. The assessee filed his return of income for the A.Y. under consideration admitting a total income of Rs. 43,53,066. The assessment was finalised u/s 143(3) by an order dated 3rd March, 2015 disallowing the claim made by the assessee u/s 44AD. While filing the return, the assessee had applied the presumptive rate of tax at 8% u/s 44AD and returned Rs. 4,68,240 as income from the remuneration and interest received from the partnership firm. The A.O. did not agree with the assessee and opined that section 44AD is available only for an eligible assessee engaged in an eligible business and that the assessee was not carrying on business independently but was only a partner in the firm. Further, the assessee did not have any turnover and receipts of account of remuneration and interest from the firms cannot be construed as gross receipts mentioned in section 44AD.

On appeal, the CIT (Appeals), Salem dismissed the same by order dated 22nd December, 2017. The Tribunal also dismissed the assessee’s appeal.

The Hon. High Court observed that section 44AD is a special provision for computing profits and gains of business on presumptive basis which was introduced in the Act with effect from 1993. At the outset, it needs to be noted that section 44AD is a special provision and it carves out an exception in respect of certain businesses, and from clause (b)(ii) of the Explanation u/s 44AD which prescribes the limit of Rs. 2 crores as total turnover or gross receipts, it is a clear indication that this provision is meant for small businesses. Further, section 44AD(1) commences with a non-obstante clause and states that notwithstanding anything to the contrary contained in sections 28 to 43C in the case of an eligible assessee engaged in an eligible business, a presumptive rate of tax at 8% can be adopted. One more important aspect is that 8% is computed on the basis of the total turnover or gross receipts of the assessee. Therefore, four important aspects to be noted in section 44AD are that the assessee who claims such a benefit of the presumptive rate of tax should an eligible assessee as defined in clause (a) of the Explanation to section 44AD, he should be engaged in an eligible business as defined in clause (b) of section 44AD and 8% of the presumptive rate of tax is computed on the total turnover or gross receipts. Therefore, to avail the benefit of such provision, the assessee has to necessarily satisfy the A.O. that he comes within the framework of section 44AD.

The assessee’s case is that he has received the remuneration and interest from the partnership firm and according to him this remuneration and interest received are gross receipts, and they being less than Rs. 1 crore arising from an eligible business, he is entitled to claim the benefit of the presumptive rate of tax. Further, the assessee’s contention is that he is an eligible assessee and the remuneration and interest received from the partnership firm being gross receipts from an eligible business, the A.O. ought to have allowed the benefit u/s 44AD.

The Revenue submitted that the assessee is not doing any business, but the firm is carrying on business in which the assessee is a partner and therefore the condition that it should arise from an eligible business is not satisfied. In the Statement issued by the ICAI, it has been stated that the word ‘turnover’ for the purpose of the clause may be interpreted to mean the aggregate amount for which sales are effected or services rendered by an enterprise, whereas in the case of the assessee neither has he performed any sales nor rendered any services but merely received remuneration and interest from the firm and the partnership firm has already debited the remuneration and interest in their profit and loss account, and therefore it cannot be taken as turnover or gross receipts.

The assessee should be able to satisfy the four main criteria mentioned in sub-section (1) of section 44AD r/w Explanations (a) and (b) in the said provision. Therefore, the assessee should establish that he is an eligible assessee engaged in an eligible business and such business should have a total turnover or a gross receipt. Admittedly, the assessee who is an individual in the instant case, is not carrying on any business. Therefore, the remuneration and interest received by the assessee from the partnership firm cannot be termed to be the turnover of the assessee (individual). Similarly, it will also not qualify for gross receipts.

Admittedly, the assessee has not done any sales nor rendered any services but has been receiving remuneration and interest from the partnership firms which amount has already been debited in the profit and loss account of the firms. Therefore, the Revenue was right in the contention that remuneration and interest cannot be treated as gross receipts.

The Court noted that the Tribunal observed that the intention of section 40(b) is that the partner should not be disentitled from claiming reasonable remuneration where he is a working partner and should not be denied reasonable interest on the capital invested by him in a firm and these changes if not made in the accounts of the firm, then the pro-rata profits of the firm would be higher resulting in higher tax for the firm. Therefore, the payments have to be construed indirectly as a type of distribution of profits of a firm or otherwise the firm would have been taxed. Therefore, the Tribunal observed that the Legislature in its wisdom chose such remuneration and interest to be a part of profits from business or profession and that can never translate into gross receipts or turnover of a business of being a partner in a firm. The Tribunal took note of the position prior to the substitution of section 44AD by the Finance (No. 2) Act, 2009 with effect from 1st April, 2011. Prior to the said substitution, this provision allowed the application of presumptive tax rate only for the business of civil construction or supply of labour for civil construction. By virtue of the substitution, the applicability of presumptive rate of tax was expanded to include any business which had turnover or gross receipts of less than Rs. 1 crore. The Tribunal noted the Explanatory notes to the provisions of the Finance (No. 2) Act, 2009 vide Circular No. 5/2010 dated 3rd June, 2010 wherein the CBDT had explained why the scope of the said provision was enlarged.

The Court observed that section 44ADA is a special provision for computing profits and gains of profession on presumptive basis and uses the expression ‘Total gross receipts’. As already seen in section 44AD, the words used are ‘total turnover’ or ‘gross receipts’ and it pre-supposes that it pertains to a sales turnover and no other meaning can be given to the said words and if so done, the purpose of introducing section 44AD would stand defeated. That apart, the position becomes much clearer if we take note of sub-section (2) of section 44AD which states that any deduction allowable under the provisions of sections 30 to 38 for the purpose of sub-section (1) be deemed to have been already given full effect to and no further deduction under those sections shall be allowed. Thus, conspicuously section 28(v) has not been included in sub-section (2) of section 44AD which deals with any interest, salary, bonus, commission or remuneration, by whatever name called, due to or received by a partner of a firm from such firm.

Thus, the Tribunal rightly rejected the plea raised by the assessee and confirmed the order passed by the CIT(A) and the A.O. The appeal filed by the assessee was accordingly dismissed.

It is my great hope someday, to see science and decision makers rediscover what the ancients have always known. Namely that our highest currency is respect

– Nassim Nicholas Taleb

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Income from undisclosed sources – Bogus purchases – A.O. disallowing entire purchases – Estimation by Commissioner (Appeals) of profit element embedded in purchases at 17.5% affirmed by Tribunal based on facts – Justified

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Housing project – Special deduction – Sections 80-IB(10) and 80-IB(10)(c) – Eligibility for deduction – Condition precedent – Single approval from local authority for development and construction of residential units more than and less than 1,500 sq. ft. in area – Development permission which includes residential units more than 1,500 sq. ft. irrelevant for deciding eligibility for deduction – Assessee entitled to deduction

39. Principal CIT vs. Pratham Developers [2020] 429 ITR 114 (Guj.) Date of order: 2nd March, 2020 A.Y.: 2010-11

Housing project – Special deduction – Sections 80-IB(10) and 80-IB(10)(c) – Eligibility for deduction – Condition precedent – Single approval from local authority for development and construction of residential units more than and less than 1,500 sq. ft. in area – Development permission which includes residential units more than 1,500 sq. ft. irrelevant for deciding eligibility for deduction – Assessee entitled to deduction

The assessee developed housing projects. It claimed deduction u/s 80-IB(10) in respect of five projects. The A.O. found that one of the projects was undertaken
on land introduced by the partners. He held that the assessee was not the sole owner of the land on which the housing project was constructed and disallowed the deduction. In respect of another project PV, the A.O. held that out of the layout plan for 158 residential units, 55 residential units were of built-up areas of 2,199 sq. ft. which exceeded the prescribed built-up area of 1,500 sq. ft. as envisaged u/s 80-IB(10)(c). Accordingly, the A.O. disallowed the deduction claimed by the assessee u/s 80-IB(10).

The Commissioner (Appeals) found that all the residential units developed by the assessee under the scheme PV were below the prescribed built-up area of 1,500 sq. ft., that as regards the 55 residential units the development agreement entered into between the land owners and its associate concern showed that the scheme was developed by its associate concern and that they did not form part of the housing project developed by the assessee. The Commissioner (Appeals) held, on the facts that the assessee was a separate concern which fulfilled the conditions prescribed u/s 80-IB(10), that the project which consisted of the 55 residential units was a separate project developed by another assessee, and that the assessee was entitled to deduction u/s 80-IB(10) in respect of the 103 residential units in the project which fulfilled the criteria prescribed as to the size of the plot, and the built-up area of each residential unit being of less than 1,500 sq. ft. The Tribunal affirmed the order passed by the Commissioner (Appeals).

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

‘i) The condition laid down u/s 80-IB(10)(c) was fulfilled when the assessee claimed the deduction with respect to the residential units, which had built-up area less than 1,500 sq. ft. Under section 80-IB(10) there was no provision requiring the assessee to obtain a commencement certificate from the local authority for development and construction of the residential units having more than 1,500 sq. ft. area. Therefore, whether such development permission included the area for the residential units which were more than 1,500 sq. ft. would not be relevant for deciding the eligibility for deduction u/s 80-IB(10).

ii) In view of the concurrent findings of fact arrived at by the Commissioner (Appeals) and the Tribunal, there was no legal infirmity in their orders allowing the deduction u/s 80-IB(10).’

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Export – Exemption u/s 10A – Effect of section 10A and notification of CBDT issued u/s 10A – Assessee providing human resources services – Entitled to deduction u/s 10A

38. CIT vs. NTT Data Global Advisory Services Pvt. Ltd. [2020] 429 ITR 546 (Karn.) Date of order: 12th November, 2020 A.Y.: 2007-08

Export – Exemption u/s 10A – Effect of section 10A and notification of CBDT issued u/s 10A – Assessee providing human resources services – Entitled to deduction u/s 10A

The assessee is a private limited company and is in the business of software development and professional services. For the A.Y. 2007-08 the assessee claimed deduction u/s 10A. The A.O. recomputed the deduction u/s 10A by reducing the recruitment fee from the export turnover.

The Commissioner held that income from human resource services is not eligible for deduction u/s 10A and accepted the alternative plea to tax only net income from the business of manpower supply. The Tribunal held that transmitting the data of qualified information technology personnel is human resource services and information technology-enabled services. Accordingly, the appeal preferred by the assessee was allowed.

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

‘i) The expression “computer software” has been defined in Explanation 2 to section 10A and means even any customised electronic data or any product or service of a similar nature as may be notified by the Board. Thus, the Legislature has empowered the Board to notify the products or services of similar nature which would be covered under clause (b) and treated as “customised electronic data” and also, “any product or service of similar nature”. The Board has issued a notification dated 26th September, 2000 which admittedly contains human resources as well as information technology-enabled products or services.

ii) The role of the assessee company was to create an electronic database of qualified personnel and transmit data through electronic means to the client. The Commissioner (Appeals) had found that the assessee was in the business of supply of manpower from India to its foreign clients after their recruitment in India. Thus, irrespective of whether or not the assessee provided training to its employees or to the employees who were recruited by its clients, since the assessee was engaged in providing human resource services, its case was squarely covered by notification dated 26th September, 2000. Therefore, the assessee was entitled to the benefit of deduction u/s 10A.’

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Export – Exemption u/s 10A – (i) Conditions precedent for claiming exemption u/s 10A – Separate accounts need not be maintained – Undertaking starting manufacture on or after 1st April, 1995 must have 75% of sales attributed to export; (ii) Sub-contractors giving software support to assessee on basis of foreign inward remittance – Claim by sub-contractors would not affect assessee’s claim u/s 10A

37. CIT (LTU) vs. V. IBM Global Services India Pvt. Ltd. [2020] 429 ITR 386 (Karn.) Date of order: 3rd November, 2020 A.Y.: 2000-01

Export – Exemption u/s 10A – (i) Conditions precedent for claiming exemption u/s 10A – Separate accounts need not be maintained – Undertaking starting manufacture on or after 1st April, 1995 must have 75% of sales attributed to export; (ii) Sub-contractors giving software support to assessee on basis of foreign inward remittance – Claim by sub-contractors would not affect assessee’s claim u/s 10A

The assessee was in the business of export of software solutions and maintenance services. For the A.Y. 2000-01, the assessee claimed exemption u/s 10A. The A.O., inter alia, held that the assessee had a software technology park unit as well as other units and all overhead expenses had been charged in relation to the other unit and no expenditure was claimed in respect of the software technology park unit for which exemption u/s 10A had been claimed. He also held that the assessee had not fulfilled the stipulations laid down in the Software Technology Parks of India Scheme or the conditions laid down by the Reserve Bank of India regarding maintenance of separate accounts and other conditions and, therefore, the assessee was not entitled to exemption u/s 10A. He further held that the audit report did not exclude payment made to sub-contractors or other expenses incurred abroad. He held that the turnover brought into the country was 56.056% which was below 75% as stipulated u/s 10A. Accordingly, he disallowed the exemption u/s 10A.

The Commissioner (Appeals) allowed the appeal partly. The Tribunal dismissed the appeal preferred by the Revenue and allowed the appeal preferred by the assessee in part.

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

‘i) Section 10A is a special provision in respect of newly-established undertakings in free trade zones. The exemption is dependent on fulfilment of the conditions mentioned in sub-section (2). Sub-section (2) does not contain any requirement with regard to maintenance of separate accounts. Wherever the Legislature intended to incorporate the requirement of maintenance of either separate accounts or separate books of accounts, it has expressly said so. The requirement of maintenance of separate accounts has been provided in the STPI registration scheme and no consequences for non-compliance therewith have been prescribed. Therefore, the requirement is directory.

ii) From a perusal of section 10A(2)(ia) it is evident that it applies to an undertaking which begins to manufacture or produce any article or thing on or after 1st April, 1995 and whose exports of such articles or things are not less than 75% of the total sales thereof during the previous year. Thus, the total export has to be not less than 75% of the total sales.

iii) The A.O. in his remand report to the Commissioner (Appeals) had stated that the assessee had been able to bifurcate the software technology park receipts, section 80HHE receipts and domestic receipts. The direct expenses relating to domestic receipts and export receipts had also been segregated and direct expenses of export turnover were apportioned on the basis of the percentage of turnover of the software technology park unit and section 80HHE receipts.

iv) The Commissioner (Appeals) had concluded that since the assessee had identified the turnover relating to the software technology park units and there was a reasonable basis for quantifying direct and indirect expenses pertaining to the software technology park units, the income pertaining to the software technology park units and therefore, exemption u/s 10A could be worked out. The Tribunal had held that the assessee had units spread over various parts of the country and even abroad, and hence the only plausible method of reasonably allocating the overhead expenses was by relating them to the turnover. The Tribunal had upheld the order to the extent of Rs. 68,72,88,748 holding this to be a reasonable figure. These concurrent findings of fact were based on meticulous appreciation of evidence on record. The Tribunal had rightly held that the allocation of the overhead expenses had to be made on the basis of the turnover.

v) The Commissioner (Appeals) had held that the sub-contractors had given software support activity to the assessee and not to the customers of the assessee. The employees of the sub-contractors operated from the software technology park unit itself and the sub-contractors had claimed exemption u/s 10A on the basis of the foreign inward remittance certificate, which had no bearing with regard to the assessee’s claim to exemption u/s 10A. The question of double deduction did not arise.

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Disallowance of expenditure relating to exempt income – Section 14A r/w/r 8D of ITR, 1962 – Condition precedent for disallowance – Proximate relationship between expenditure and exempt income – Onus to establish such proximity on Department – A.O. must give a clear finding with reference to the assessee’s accounts how expenditure related to exempt income

36. CIT vs. Sociedade De Fomento Industrial Pvt. Ltd. (No. 2) [2020] 429 ITR 358 (Bom.) Date of order: 6th November, 2020

Disallowance of expenditure relating to exempt income – Section 14A r/w/r 8D of ITR, 1962 – Condition precedent for disallowance – Proximate relationship between expenditure and exempt income – Onus to establish such proximity on Department – A.O. must give a clear finding with reference to the assessee’s accounts how expenditure related to exempt income

The assessee was a miner and exporter of mineral ores. For the A.Y. 2009-10 the A.O. computed disallowance u/s 14A read with rule 8D at 0.5% on the average investment. He rejected the assessee’s claim that it did not incur any expenditure to earn the dividend income, that it invested the surplus funds through bankers and other financial institutions and all the forms were filled up by them, and that it only issued cheques. He was of the view that without devoting time and without analysing the nature of the investment, the assessee could not have invested in the mutual funds.

The Commissioner (Appeals) partly allowed the appeal. The Tribunal allowed the assessee’s appeal and deleted the disallowances.

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

‘i) Section 14A inserted by the Finance Act, 2001 with retrospective effect from 1st April, 1962 aims to disallow expenditure incurred in relation to income which did not form part of the total income and has to be read with Rule 8D of the Income-tax Rules, 1962 which provides the method of calculation of the disallowance. Section 14A statutorily recognises the principle that tax is leviable only on the net income. The profits and gains of business or profession are taxed after deducting expenditure from income. In that regard, there is no need for the assessee to establish a one-to-one correlation between income and expenditure. Rule 8D provides the methods for determining the amount of expenditure in relation to income not includible in the total income and comes into play once an expenditure falls within the mischief of section 14A.

ii) The onus is on the Revenue to establish that there is a proximate relationship between the expenditure and the exempt income. The application of section 14A and rule 8D is not automatic in each and every case, where there is income not forming part of the total income. Though the expenditure u/s 14A includes both direct and indirect expenditure, that expenditure must have a proximate relationship with the exempted income. Before rejecting the disallowance computed by the assessee, the A.O. must give a clear finding with reference to the assessee’s accounts as to how the other expenditure claimed by the assessee out of the non-exempt income is related to the exempt income. There must be a proximate relationship between the expenditure and the exempt income and only then would a disallowance have to be effected.

iii) The Tribunal was right in deleting the additions made by the A.O. u/s 14A read with rule 8D. The Tribunal had found that the A.O. had only discussed the provisions of section 14A(1) but had not justified how the expenditure incurred by the assessee during the relevant year related to the income not forming part of its total income and had straightaway applied Rule 8D. There must be a proximate relationship between the expenditure and the exempt income and only then would a disallowance have to be effected. There was no valid reason to interfere with the Tribunal’s well-reasoned order.’

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Capital gains – Sections 2(14), (42A), (47) and 45 – (i) Capital asset – Stock option is a capital asset – Gains on exercising option – Capital gains; (ii) Salary – Stock option given to consultant – No relationship of employer and employee – Gains on exercising stock option – Assessable as capital gains

35. Chittharanjan A. Dasannacharya vs. CIT [2020] 429 ITR 570 (Karn.) Date of order: 23rd October, 2020 A.Y.: 2006-07

Capital gains – Sections 2(14), (42A), (47) and 45 – (i) Capital asset – Stock option is a capital asset – Gains on exercising option – Capital gains; (ii) Salary – Stock option given to consultant – No relationship of employer and employee – Gains on exercising stock option – Assessable as capital gains

The assessee was a software engineer who was employed with a company registered in India from 1995 to 1998. He was deputed to a U.S. company in 1995 as an independent consultant. The assessee served in the US from 1995 to 1998 as an independent consultant and later as an employee of the US company from 2001 to 2004. The assessee thereafter returned to India and was employed in the Indian subsidiary. While on deputation to the US, the assessee was granted stock option by the US company whereunder he was given the right to purchase 30,000 shares at an exercise price of US $0.08 per share. The assessee also had an option of cashless exercise of stock options which was an irrevocable direction to the broker to sell the underlying shares and deliver the proceeds of the sale of the shares after deducting the exercise / option price which was to be delivered to the US company. In the cashless exercise, the underlying shares were not allotted to the assessee and he was only entitled to receive the sale proceeds less the exercise price.

The assessee in the A.Y. 2006-07 exercised his right under the stock option plan by way of cashless exercise and received a net consideration of US $283,606 and offered this as long-term capital gains as the stock options were held for nearly ten years. The A.O. by an order u/s 143(3) split the transaction into two and brought to tax the difference between the market value of the shares on the date of exercise and the exercise price as ‘income from salary’ and the difference between the sale price of shares and market value of shares on the date of exercise of ‘income from short-term capital gains’.

The Tribunal held that the assessee was to be regarded as an employee for the purposes of the plan and the benefits arising therefrom were to be treated as income in the nature of salary in the hands of the assessee.

The Karnataka High Court allowed the appeal filed by the assessee and held as under:

‘i) The Supreme Court in Dhun Dadabhoy Kapadia and Hari Brothers (P) Ltd. held that the right to subscribe to shares of a company was treated to be a capital asset u/s 2(14). The stock option being a right to purchase the shares underlying the options is a capital asset in the hands of the assessee u/s 2(14) which is also evident from Explanation 1(e) to section 2(42A) which uses the expression “in case of a capital asset being a right to subscribe any financial asset”. The cashless exercise of option therefore is a transfer of capital asset by way of a relinquishment or extinguishment of the right in the capital asset in terms of section 2(47).

ii) From a perusal of the communication dated 3rd August, 2006 sent by the US company to the assessee, it was evident that the assessee was an independent consultant and not an employee of the US company at the relevant time. Thus, there was no relationship of employer and employee between it and the assessee. The assessee never received the shares in the stock options. At the time of grant of options to the assessee in the year 1996, section 17(2)(iia) was not there in the statute. The difference between the option / exercise price of the stock option and the fair market value of the shares on the date of exercise of the stock option was assessable as capital gains.

iii) The Revenue in case of several other assessees had accepted the fact that on cashless exercise of option there arises income in the nature of capital gains. However, in the case of the assessee the aforesaid stand was not taken. The Revenue could not be permitted to take a different view.’

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TDS UNDER SECTION 195 IN POST-MLI SCENARIO

In our earlier articles of June, August and September, 2018, we had covered the various facets of TDS under section 195 of the Income-tax Act, 1961 (the Act), including some practical issues on the same. With the increase in global trade, TDS on payments to non-residents has gained importance in recent years. The year 2020 was unforgettable for various reasons – the ongoing pandemic and the lockdown that followed being one of them. However, the international tax landscape in India also underwent a significant change in 2020 with the Multilateral Instrument (MLI) coming into effect on 1st April, 2020. The MLI has modified various DTAAs. Further, the return to the classical system of taxing dividends and the abolishment of the Dividend Distribution Tax regime in the Finance Act, 2020 also extended the scope of TDS u/s 195 as dividend payments hitherto were not subject to such TDS by virtue of the exemption u/s 10(34).

Given the host of changes that the world, particularly the tax world, has undergone in 2020, this article attempts to analyse the impact of these changes on compliance u/s 195 especially for a practitioner who is certifying the taxability of foreign remittances in Form 15CB.

1. BACKGROUND

Section 195 requires tax to be deducted at the ‘rates in force’ in respect of interest or ‘other sum chargeable under the provisions of this Act’ in respect of payment to a non-resident. Further, section 2(37A), defining the term ‘rates in force’ in respect of income subject to TDS u/s 195 refers to the rate specified in the Finance Act of the relevant year, or the rate as per the respective DTAA in accordance with section 90. Therefore, TDS u/s 195 in theory results in the finality of the tax deducted on the income chargeable to tax in India in respect of a non-resident recipient as against the TDS under the other provisions of the Act, wherein TDS is only a form of collection of tax in advance and does not signify the final amount of tax payable in the hands of the deductee. This finality of the tax places a higher responsibility on a professional certifying the taxability u/s 195(6) in Form 15CB. Further, given the penal provisions for furnishing inaccurate information u/s 195, it is extremely important for a practitioner issuing Form 15CB to keep himself updated on the various changes in the international tax world. The ensuing paragraphs seek to address the practical issues arising on account of the recent changes in the international tax arena.

2. UNDERTAKING TDS COMPLIANCE BEFORE MLI

Before evaluating the impact of MLI on undertaking TDS compliances u/s 195, it may be worthwhile to briefly evaluate some of the best practices a professional would follow to avail the benefit under the DTAA before the MLI was effective.

While our earlier articles have covered most of these practices, in order to get a holistic view of the matter the same have been briefly covered below.

i. Tax Residency Certificate (TRC)
Section 90(4) provides that the benefit of a DTAA shall be available to a non-resident only in case such non-resident obtains a TRC from the tax authorities of the relevant country in which such person is a resident.

While the provision seeks to deny benefits of a DTAA to a non-resident who does not provide a valid TRC, the Ahmedabad Tribunal in the case of Skaps Industries India (P) Ltd. vs. ITO [2018] 94 taxmann.com 448 (Ahmedabad – Trib.) held that section 90(4) does not override the DTAA and, therefore, if the taxpayer can substantiate through any other document his eligibility to claim the benefit under the DTAA, the said benefit should be granted to him. One may refer to our article in the August, 2018 issue of this Journal for a detailed discussion on the ruling. In a recent decision, the Hyderabad Tribunal in the case of Sreenivasa Reddy Cheemalamarri vs. ITO [2020] TS-158-ITAT-2020 (Hyd.) has also followed the ruling of the Ahmedabad Tribunal in Skaps (Supra).

However, from the perspective of deduction u/s 195, it is always advisable to follow a conservative approach and therefore in a scenario where the recipient has not provided a valid TRC, the benefit under the DTAA may not be granted. The recipient would always have the option of filing a return of income and claiming refund and substantiating the eligibility to claim the benefit of the DTAA before the tax authorities, if required.

Further, if the TRC does not contain all the information as required in Rule 21AB of the Income-tax Rules, 1962 (Rules), one needs to also obtain a self-declaration from the recipient in Form 10F.

As TRC generally contains the residential status of the recipient as on the date of certificate or for a particular period, it is important that one obtains the TRC and Form 10F which is applicable for the period in which the transaction is undertaken.

ii. Declarations
In addition to the TRC, one generally also obtains the following declarations before certifying the taxability of the transaction u/s 195:
a.    Declaration that the recipient does not have a PE in India and if a PE exists, the income from the transaction is not attributable to such PE;
b.    Declaration that the main purpose of the transaction is not tax avoidance. However, one also needs to evaluate the transaction in detail and not merely rely on the declaration under GAAR as one needs to be fairly certain of the taxability before certifying the same;
c.    Declaration in respect of specific items of income that the recipient is the beneficial owner of the income and that it is not contractually or legally obligated to pass on the said income to any other person;
d.    Declaration that the Limitation of Benefits (LOB) clause, if any, in the DTAA has been met. Similar to the above declarations, one needs to evaluate the transaction in detail to ensure that the transaction or the recipient, as the case may be, satisfies the conditions mentioned in the LOB clause and not merely rely on the declaration.

3. IMPACT ON ACCOUNT OF MLI

i. Background of the MLI
Following the recommendations in the Base Erosion and Profit Shifting (BEPS) Project of the OECD in which discussion more than 100 countries participated, the MLI, a document which seeks to modify more than 3,000 bilateral tax treaties (modified tax treaties are called Covered Tax Agreements or CTAs), was released for ratification. India is one of the nearly 100 countries which are signatories to the MLI.

India signed the MLI on 7th June, 2017 and deposited the ratified document along with a list of its Reservations and Options on 25th June, 2019. Article 34(2) of the MLI provides that the MLI shall enter into force for a signatory on the first day of the month following the expiration of a period of three calendar months from the date of deposit of the ratified instrument. In the case of India, therefore, the MLI entered into force on 1st October, 2019.

Further, Article 35(1)(a) of the MLI provides that the MLI shall come into effect in respect of withholding taxes on the first day of the calendar year (or financial year in the case of India) that begins after the latest date on which the MLI enters into force for each of the Contracting Jurisdictions to the CTA. In other words, the MLI shall have an effect of modifying a particular DTAA on the first day of a calendar year (or financial year) beginning after the MLI has entered into force for both the countries which are signatory to the DTAA.

As the MLI has entered into force for India in October, 2019, it has come into effect and would result in the modification to the DTAA from 1st April, 2020 where the MLI has entered into force for the other signatory to the DTAA prior to 1st April, 2020 as well. The MLI had entered into force for many Indian treaty partners in 2019 or earlier and therefore the MLI has come into effect for those DTAAs from 1st April, 2020.

India has listed 93 of its existing DTAAs to be modified by the MLI. However, as the MLI works on a matching concept, the respective DTAA would be modified only if both the countries, signatories to the DTAA, have included the said DTAA in their final list of treaties to be modified. For example, while India has included the India-Germany DTAA in its final list, Germany has not and therefore the India-Germany DTAA will not be modified by the MLI. Some of the other notable Indian DTAAs which are not modified by the MLI are those with the USA, Brazil and Mauritius. Similarly, out of the 95 signatories to the MLI, as on date 59 countries have deposited the ratified document. Moreover, out of the 59 countries which have deposited the document, some of them have done so only recently and therefore it is important at the time of undertaking compliance of section 195 and dealing with a DTAA to verify whether the DTAA has been modified by the MLI and, if so, from which date. One can use the MLI Matching Database on the OECD website to know whether a particular DTAA has been modified and from which date.

Treaty Partner	Whether modified by MLI	Effective date for withholding taxes from when MLI modifies DTAA ¹
Albania	Yes	1^st April, 2021
Armenia	No	NA
Australia	Yes	1^stApril, 2020
Austria	Yes	1^st April, 2020
Bangladesh	No	NA
Belarus	No	NA
Belgium	Yes	1^st April, 2020
Bhutan	No	NA
Botswana	No	NA
Brazil	No	NA
Bulgaria	No	NA
Canada	Yes	1^st April, 2020
China (People’s Republic of)	No	NA
Colombia	No	NA
Croatia	No	NA
Cyprus	Yes	1^st April, 2021
Czech Republic	Yes	1^st April, 2021
Denmark	Yes	1^st April, 2020
Egypt	Yes	1^st April, 2021
Estonia	Yes	1^st April, 2022
Ethiopia	No	NA
Fiji	No	NA
Finland	Yes	1^st April, 2020
France	Yes	1^st April, 2020
Georgia	Yes	1^st April, 2020
Germany	No	NA
Greece	No	NA
Hong Kong (China)	No	NA
Hungary	No	NA
Iceland	Yes	1^st April, 2020
Indonesia	Yes	1^st April, 2021
Iran	No	NA
Ireland	Yes	1^st April, 2020
Israel	Yes	1^st April, 2020
Italy	No	NA
Japan	Yes	1^st April, 2020
Jordan	Yes	1^st April, 2021
Kazakhstan	Yes	1^st April, 2021
Kenya	No	NA
Korea	Yes	1^st April, 2021
Kuwait	No	NA
Kyrgyz Republic	No	NA
Latvia	Yes	1^st April, 2020
Libya	No	NA
Lithuania	Yes	1^st April, 2020
Luxembourg	Yes	1^st April, 2020
Macedonia	No	NA
Malaysia	No	NA
Malta	Yes	1^stApril, 2020
Mauritius	No	NA
Mexico	No	NA
Mongolia	No	NA
Montenegro	No	NA
Morocco	No	NA
Mozambique	No	NA
Myanmar	No	NA
Namibia	No	NA
Nepal	No	NA
Netherlands	Yes	1^st April, 2020
New Zealand	Yes	1^st April, 2020
Norway	Yes	1^st April, 2020
Oman	Yes	1^st April, 2021
Philippines	No	NA
Poland	Yes	1^st April, 2020
Portugal	Yes	1^st April, 2021
Qatar	Yes	1^st April, 2020
Romania	No	NA
Russian Federation	Yes	1^st April, 2020
Saudi Arabia	Yes	1^st April, 2021
Serbia	Yes	1^st April, 2020
Singapore	Yes	1^st April, 2020
Slovak Republic	Yes	1^st April, 2020
Slovenia	Yes	1^st April, 2020
South Africa	No	NA
Spain	No	NA
Sri Lanka	No	NA
Sudan	No	NA
Sweden	Yes	1^st April, 2020
Switzerland	Yes	1^st April, 2020
Syria	No	NA
Tajikistan	No	NA
Tanzania	No	NA
Thailand	No	NA
Trinidad & Tobago	No	NA
Turkey	No	NA
Turkmenistan	No	NA
Uganda	No	NA
Ukraine	Yes	1^st April, 2020
United Arab Emirates	Yes	1^st April, 2020
United Kingdom	Yes	1^st April, 2020
Uruguay	Yes	1^st April, 2021
USA	No	NA
Uzbekistan	No	NA
Vietnam	No	NA
Zambia	No	NA

Treaty
Partner

Whether
modified by MLI

Effective
date for withholding taxes from when MLI modifies DTAA ¹

Albania

Yes

1^st April, 2021

Armenia

Australia

Yes

1^stApril, 2020

Austria

Yes

1^st April, 2020

Bangladesh

Belarus

Belgium

Yes

1^st April, 2020

Bhutan

Botswana

Brazil

Bulgaria

Canada

Yes

1^st April, 2020

China (People’s Republic of)

Colombia

Croatia

Cyprus

Yes

1^st April, 2021

Czech Republic

Yes

1^st April, 2021

Denmark

Yes

1^st April, 2020

Egypt

Yes

1^st April, 2021

Estonia

Yes

1^st April, 2022

Ethiopia

Fiji

Finland

Yes

1^st April, 2020

France

Yes

1^st April, 2020

Georgia

Yes

1^st April, 2020

Germany

Greece

Hong Kong (China)

Hungary

Iceland

Yes

1^st April, 2020

Indonesia

Yes

1^st April, 2021

Iran

Ireland

Yes

1^st April, 2020

Israel

Yes

1^st April, 2020

Italy

Japan

Yes

1^st April, 2020

Jordan

Yes

1^st April, 2021

Kazakhstan

Yes

1^st April, 2021

Kenya

Korea

Yes

1^st April, 2021

Kuwait

Kyrgyz Republic

Latvia

Yes

1^st April, 2020

Libya

Lithuania

Yes

1^st April, 2020

Luxembourg

Yes

1^st April, 2020

Macedonia

Malaysia

Malta

Yes

1^stApril, 2020

Mauritius

Mexico

Mongolia

Montenegro

Morocco

Mozambique

Myanmar

Namibia

Nepal

Netherlands

Yes

1^st April, 2020

New Zealand

Yes

1^st April, 2020

Norway

Yes

1^st April, 2020

Oman

Yes

1^st April, 2021

Philippines

Poland

Yes

1^st April, 2020

Portugal

Yes

1^st April, 2021

Qatar

Yes

1^st April, 2020

Romania

Russian Federation

Yes

1^st April, 2020

Saudi Arabia

Yes

1^st April, 2021

Serbia

Yes

1^st April, 2020

Singapore

Yes

1^st April, 2020

Slovak Republic

Yes

1^st April, 2020

Slovenia

Yes

1^st April, 2020

South Africa

Spain

Sri Lanka

Sudan

Sweden

Yes

1^st April, 2020

Switzerland

Yes

1^st April, 2020

Syria

Tajikistan

Tanzania

Thailand

Trinidad & Tobago

Turkey

Turkmenistan

Uganda

Ukraine

Yes

1^st April, 2020

United Arab Emirates

Yes

1^st April, 2020

United Kingdom

Yes

1^st April, 2020

Uruguay

Yes

1^st April, 2021

USA

Uzbekistan

Vietnam

Zambia

As highlighted earlier, the above list of DTAAs modified is only as on 15th January, 2021, therefore it is advisable to review the latest list and positions as on the date of the transaction.

The MLI has introduced various measures to combat tax avoidance in DTAAs. While some of the measures are objective, there are certain subjective measures as well and can lead to some ambiguity for a payer who is required to deduct TDS as one needs to evaluate various factual aspects of the income as well as the recipient, which may not always be available with the payer to conclude on the applicability of such measures to a particular payment.

While MLI is a vast subject, the ensuing paragraphs seek to evaluate the impact of the MLI on undertaking compliance u/s 195 and the challenges thereof. Accordingly, there may be some provisions of the MLI, for example, the clause relating to method to be employed for elimination of double taxation, which would not have an impact on TDS u/s 195 and therefore have not been covered in this article. Another similar example is the modification relating to dual resident entities (other than individuals), wherein the provisions of section 195 would not apply as payment to such a dual resident entity (thereby meaning a resident of India under the Act as well as the other country under its domestic tax law) would be considered as payment to a resident and not to a non-resident under the Act.

ii. Principal Purpose Test (PPT)
Article 7 of the MLI provides that ‘Notwithstanding any provisions of a Covered Tax Agreement, a benefit under the Covered Tax Agreement shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the Covered Tax Agreement.’

Therefore, the PPT test acts as an anti-avoidance provision in a treaty scenario and seeks to deny a benefit under a DTAA if it is reasonable to conclude that obtaining the said benefit was one of the principal purposes of the arrangement or transaction. However, it may be highlighted that the PPT and GAAR, although having similar objectives, operate differently. Further, the PPT has a wider coverage as compared to GAAR and therefore a transaction which satisfies GAAR may not satisfy the PPT, resulting in denial of the benefit under the DTAA.

a. Issue 1: How does the PPT impact the compliance u/s 195
The first issue one needs to address is whether the PPT has any impact on the TDS u/s 195. As the PPT seeks to address the issue of eligibility of a taxpayer to obtain the benefit of a CTA, it would impact the tax to be deducted in cases where the DTAA benefit is claimed at the time of deduction.

In other words, if one is applying a DTAA (which has been modified by the MLI, thereby making it a CTA) on account of the beneficial provision under the DTAA at the time of undertaking TDS, one would need to ensure that the PPT test is satisfied to claim the benefit of the DTAA / CTA.

The second aspect that needs to be addressed in this issue is whether the payer needs to evaluate the applicability of the PPT at the time of deduction of tax u/s 195 or can one argue that the PPT needs to only be applied by the tax authorities at the time of assessment of the recipient of the income.

In order to address this aspect, one would need to refer to section 163(1)(c) which makes the payer an agent of the non-resident recipient. Moreover, as highlighted earlier, unlike the other TDS provisions in the Act, in most cases section 195 in theory results in the finality of the tax being paid to the government in the case of payment to a non-resident.

Therefore, the Act places a significant onerous responsibility on the payer to ensure that the due tax is duly deducted u/s 195 in the case of payments to a non-resident. Keeping this in mind, it is therefore necessary for the payer to apply the PPT while granting treaty benefits at the time of deduction of tax u/s 195.

b. Issue 2: How can one apply the PPT while undertaking compliances u/s 195
Once it is determined that the PPT needs to be evaluated at the time of application of section 195, the main issue which arises is that the PPT being a subjective intention-based test to determine treaty eligibility, how can one apply the same while undertaking compliance u/s 195 and what documentation should one obtain while certifying the taxability of the said transaction? As highlighted earlier, the major challenge in application of a subjective test at the time of withholding is that the payer and the professional certifying the taxability of the transaction u/s 195 are not aware of all the facts to conclude one way or another.

There are three views to address this issue.

View 1: Given the onerous responsibility tasked on the payer to collect the tax due on the transaction in the hands of the non-resident recipient and the subjective nature of the PPT, one can consider following a conservative approach by not providing any benefit under the DTAA at the time of deducting tax u/s 195 and asking the recipient to claim a refund of the excess tax deducted by filing a return of income. This would ensure that if any benefit under the DTAA is eventually claimed (by way of the recipient seeking a refund), the payer and the professional certifying the taxability are not responsible and the tax authorities can verify the subjective PPT in the hands of the recipient, who can provide the necessary information to satisfy the PPT directly to the tax authorities.

While this view is a conservative view, it may not always be practically possible as in many cases the recipient may not be willing to undertake additional compliance of filing a return of income, especially in a scenario where there is no tax payable under the DTAA.

View 2: Another conservative view is to approach the tax authorities to adjudicate on the issue by following the provisions of section 195(2) or section 197. This would eliminate any risk that the payer or the professional may undertake. However, this may not always be practically possible as there would be a delay in the remittance and this process is time-consuming, especially in scenarios where the payer makes many remittances to various parties during the year as this would entail approaching the tax authorities before every remittance.

View 3: Alternatively, as is the case with other declarations such as a ‘No PE declaration’ or a beneficial ownership declaration, one can take a declaration that obtaining the benefit under the DTAA is not one of the principal purposes of the arrangement or the transaction.

As per this view, the question arises whether such a declaration is to be obtained from the payer or from the recipient. The PPT needs to be tested qua the transaction as well as qua the arrangement. While the payer would in most cases be aware whether the principal purpose of a transaction is to avail DTAA benefits, an arrangement being a wider term may not entail the payer in necessarily being aware of all the details. Therefore, one must ensure that the declaration is to be obtained from the recipient of the income which is claiming the DTAA benefits.

This view is a practical one and follows the doctrine of impossibility, whereby in the absence of facts to the contrary it is not possible for a professional to certify that the transaction is designed to avoid tax and, therefore, the benefit of the DTAA should not be granted. While the payer would be aware whether the principal purpose of the transaction (not necessarily the arrangement) is to obtain benefit of the DTAA, in the absence of any facts provided to the professional, it is not possible for a professional to suspect otherwise.

Further, the Supreme Court in the case of GE India Technology Centre (P) Ltd. vs. CIT [2010] 193 Taxman 234 (SC) held, ‘(7)….where a person responsible for deduction is fairly certain then he can make his own determination as to whether the tax was deductible at source and, if so, what should be the amount thereof.’

Therefore, where the payer is ‘fairly certain’ having regard to the facts and circumstances about the taxability of a particular transaction, one need not approach the tax authorities.

However, it is advisable for a professional certifying the taxability of the transaction to question the nature of the transaction from an anti-avoidance perspective before taking the declaration or management representation. For example, if the transaction is towards payment of dividend by an Indian company to a Mauritian company, if such Mauritian company was set up at the time when the DDT regime was applicable, it may give credence to the fact that the investment through Mauritius was not made with the principal purpose of obtaining the DTAA rate on dividends paid.

In other words, the professional would need to question and evaluate, to the extent practically possible, as to why a particular transaction was undertaken in a particular manner and with adequate documentation to substantiate such reasoning. Such an evaluation may be required as unlike an audit report, where one provides an ‘opinion’ on a particular aspect, Form 15CB requires a professional to ‘certify’ the taxability after examination of relevant documents and books of accounts.

iii. Holding period for dividends
Article 8(1) of the MLI provides that, ‘Provisions of a Covered Tax Agreement that exempt dividends paid by a company which is a resident of a Contracting Jurisdiction from tax or that limit the rate at which such dividends may be taxed, provided that the beneficial owner or the recipient is a company which is a resident of the other Contracting Jurisdiction and which owns, holds or controls more than a certain amount of the capital, shares, stock, voting power, voting rights or similar ownership interests of the company paying the dividend, shall apply only if the ownership conditions described in those provisions are met throughout a 365-day period that includes the day of the payment of the dividends….’

Accordingly, Article 8(1) of the MLI restricts the participation exemption or benefit granted to a holding company receiving dividends to cases where the shares have been held by the holding company for at least 365 days, including the date of payment of dividends. Such provision, therefore, denies the benefit of the lower tax rate to a company shareholder who has acquired the shares for a short period only to meet the minimum holding requirement for availing such benefit.

This provision, being an objective factual test to avail the benefit of lower tax rate on dividends under the DTAA, can be examined by the professional certifying the tax u/s 195 as this information, being information regarding the shareholding of the Indian payer company, is readily available with the payer company.

However, it may be highlighted that the provision requires the holding period to be maintained for any period which includes the date on which the dividend is paid and not necessarily the period preceding the date of payment of dividend.

For example, Sing Co acquires 50% of the shares of I Co on 1st January, 2021. The dividend is declared by I Co on 30th June, 2021. In this case, while the 365-day holding period has not been met on the day of payment or declaration of dividend, the holding period requirement under Article 8(1) of the MLI would still be satisfied if Sing Co continued holding the said shares till 31st December, 2021 and would still be eligible for the lower rate of tax.

This gives rise to an issue to be addressed as to whether the lower rate of tax under Article 10(2)(a) of the India-Singapore DTAA should be considered at the time of undertaking the TDS compliance at the time of payment of dividend.

In our view, as on the date of the dividend payment the number of days threshold has not been met, the benefit of the lower rate of tax under Article 10(2)(a) of the DTAA should not be granted and TDS should be deducted in accordance with Article 10(2)(b) of the DTAA. In such a scenario, Sing Co can always file its return of income claiming a refund of the excess tax deducted once it satisfies the holding period criterion.

iv. Permanent Establishment (PE)
The MLI has extended the scope of the definition of a PE under a DTAA to include the following:
a.     A dependent agent who does not conclude contracts on behalf of the non-resident will still constitute a PE of the non-resident if such agent habitually plays a principal role in the conclusion of contracts of the non-resident.
b.     The exemption from the constitution of a PE provided to certain activities undertaken in a Source State through a fixed place of business would not be available if the activities along with activities undertaken by a closely-related enterprise in the Source State are not preparatory or auxiliary in nature.
c.     In the case of a construction or installation PE, the number of days threshold that needs to be met will include connected activities undertaken by closely-related enterprises as well.

Now the question arises, how does a professional identify the applicability of the extended scope of the definition of PE in remittances to non-residents and whether a mere declaration that a PE is not constituted would be sufficient.

With regard to point (a) above, for the extended scope of PE in respect of the transaction itself, one should be able to identify the facts of the said transaction before certifying the taxability thereof and a mere declaration on this aspect may not be sufficient.

Similarly, with regard to points (b) and (c) above, one may be able to analyse the applicability of the MLI in case of transactions undertaken by the non-resident recipient himself in India as they would relate to the transaction the taxability of which is to be certified. However, with regard to the activities undertaken by the closely-related enterprises, one may be able to follow the doctrine of impossibility and obtain a declaration from the recipient provided one has gone through all the relevant documents related to the transaction itself.

4. STEP-BY-STEP EVALUATION
Having understood the impact of the MLI on the compliances to be undertaken u/s 195, the table below provides a brief guidance on the step-by-step process that a professional needs to follow before certifying
the transaction in Form 15CB once it is determined that the DTAA is more beneficial than the taxability under the Act:

Step
number

Particulars

Obtain TRC from recipient (check whether TRC is a valid TRC for
the period in which the transaction is undertaken)

Obtain Form 10F if TRC does not contain information as required
in Rule 21AB of the Rules (check whether Form 10F is for the period in which
the transaction is undertaken)

Check whether GAAR provisions apply to the said transaction and
obtain suitable declaration

Check whether any specific LOB clause in the DTAA applies. If
so, whether the conditions for LOB have been met and obtain suitable
declaration

Check whether DTAA modified by MLI as on date of transaction
(follow steps 6 to 7 if MLI modifies DTAA)

Check whether the conditions of PPT are satisfied and obtain
suitable declaration

In case of dividend income earned by a company, verify if the
holding period for the shares is met as on date of transaction

Check if the transaction constitutes a PE for the recipient in
India or if income from the transaction can be attributable to the profits of
any PE of the recipient in India and obtain suitable declaration (in case MLI
modifies DTAA, the declaration should include the modified definition of PE)

In case of dividend, interest, royalty or income from fees for
technical services, check if the recipient is the beneficial owner or if the
beneficial owner is a resident of the same country in which the recipient is
a resident and obtain suitable declaration

5. CONCLUSION
The introduction of the MLI has added complexities to the process of undertaking compliance u/s 195. A professional who is certifying the taxability would now need to evaluate various other aspects in relation to the transaction to satisfy himself, with documentary evidence, that the various provisions of the MLI have been duly complied with. Further, merely obtaining declarations may not be sufficient as one needs to be fairly certain, after going through the relevant documents, of the taxability of the transaction u/s 195 before certifying the same.

1 The effective date for withholding taxes has been provided
from an Indian
perspective and may vary in the other jurisdiction

shailesh.kwebmaker

TAXABILITY OF MESNE PROFITS

ISSUE FOR CONSIDERATION

The term ‘mesne profits’ relates to the damages or compensation recoverable from a person who has been in wrongful possession of immovable property. It has been defined in section 2(12) of the Code of Civil Procedure, 1908 as under:

‘(12) “mesne profits” of property means those profits which the person in wrongful possession of such property actually received or might with ordinary diligence have received therefrom, together with interest on such profits, but shall not include profits due to improvements made by the person in wrongful possession.’

At times, the tenant or lessee continues to use and occupy the premises even after the termination of the lease agreement either due to efflux of time or for some other reasons. In such cases, the courts may direct the occupant of the premises to pay the mesne profits to the owner for the period for which the premises were wrongfully occupied. The taxability of the amounts received as mesne profits in the hands of the owner of the premises has become a subject matter of controversy. While the Calcutta High Court has taken the view that mesne profit is in the nature of damages for deprivation of use and occupation of the property and, therefore, it is a capital receipt not chargeable to tax, the High Courts of Madras and Delhi have taken the view that it is a recompense for deprivation of income which the owner would have enjoyed but for the interference of the persons in wrongful possession of the property and, consequently, it is a revenue receipt chargeable to tax.

LILA GHOSH’S CASE

The issue had earlier come up for consideration of the Calcutta High Court in the case of CIT vs. Smt. Lila Ghosh (1993) 205 ITR 9.

In that case, the assessee was the owner of the premises in question which were given on lease. The lease expired in 1970. However, the lessee did not give possession to the assessee. The assessee filed a suit for eviction and mesne profits. The decree was passed in favour of the assessee by the trial court and it was affirmed by the High Court as well as by the Supreme Court. The assessee then applied for the execution of the decree. The Court appointed a Commissioner to determine the claim of quantum of mesne profits. While the execution of the said decree and the determination of the quantum of the mesne profits were pending, the Government of West Bengal requisitioned the demised property on 24th December, 1979. The said requisition order was challenged by the assessee before the High Court through a writ application filed under Article 226 of the Constitution of India.

During its pendency, a settlement was arrived at between the assessee and the State of West Bengal which was recorded by the Court in its order dated 28th February, 1980. Under the terms of the settlement, the property in question was to be acquired by the State under the Land Acquisition Act, 1894 and compensation of Rs. 11 lakhs for the acquisition was to be paid to the assessee. There was no dispute relating to this compensation received. Apart from the compensation, the assessee also received a sum of Rs. 2 lakhs from the State of West Bengal against the assignment of the decree for mesne profits obtained and to be passed as a final decree against the tenant.

While making the assessment for the assessment year 1980-81, the A.O. assessed the said sum of Rs. 2 lakhs representing mesne profits as revenue receipt in the hands of the assessee under the head ‘Income from Other Sources’. It was taxed as income of the assessment year 1980-81 since it had arisen to the assessee in terms of an order of the Court dated 28th February, 1980. On appeal by the assessee before the CIT(A), it was submitted that the mesne profits were nothing but damages and, therefore, capital receipt not chargeable to tax. It was also contended that in case the assessee’s contention in this respect was to be rejected and the mesne profits of Rs. 2 lakhs be held to be revenue receipts, the same could not be taxed in one year since it related to the period from 19th May, 1970 to 24th December, 1979. However, the CIT(A) rejected all the contentions of the assessee and held that the mesne profits of Rs. 2 lakhs were revenue receipts and assessable under the head ‘Income from Other Sources’ in the A.Y. 1980-81.

On further appeal by the assessee, the Tribunal held that the mesne profits of Rs. 2 lakhs had arisen as a result of the transfer of the capital asset and the same was assessable under the head ‘capital gains’. According to the Tribunal, the assessee had received the sum of Rs. 2 lakhs for transferring her right to receive the mesne profits which was her capital asset. The contention of the assessee that no capital gain was chargeable inasmuch as no cost of acquisition was incurred for the so-called capital asset was rejected by the Tribunal. The Tribunal held that it was possible to determine the cost of acquisition of the asset in question which, according to the Tribunal, consisted of the amount spent by the assessee towards stamp duty and other legal expenses incurred for obtaining the decree. From the decision of the Tribunal, both the assessee as well as the Revenue had sought reference to the High Court.

After referring to the definition of ‘mesne profits’ as per the Code of Civil Procedure, 1908, the High Court referred to the observations of the Judicial Committee of the Privy Council in Girish Chunder Lahiri vs. Shashi Shikhareswar Roy [1900] 27 IA 110 in which it was stated that the mesne profits were in the nature of damages which the court may mould according to the justice of the case. Further, the Supreme Court’s observations in the case of Lucy Kochuvareed vs. P. Mariappa Gounder AIR [1979] SC 1214 were also referred to, which were as under:

‘Mesne profits being in the nature of damages, no invariable rule governing their award and assessment in every case can be laid down and “the Court may mould it according to the Justice of the case”.’

Accordingly, the High Court held that the mesne profits were nothing but damages for loss of property or goods. The Court further held that such damages were not in the nature of revenue receipts but in the nature of capital receipt. While holding so, the High Court relied upon the decisions in the case of CIT vs. Rani Prayag Kumari Debi [1940] 8 ITR 25 (Pat.); CIT vs. Periyar & Pareekanni Rubbers Ltd. [1973] 87 ITR 666 (Ker.); CIT vs. J.D. Italia [1983] 141 ITR 948 (AP); and CIT vs. Ashoka Marketing Ltd. [1987] 164 ITR 664 (Cal.).

The Court disagreed with the views expressed by the Madras High Court in CIT vs. P. Mariappa Gounder [1984] 147 ITR 676 wherein it was held that mesne profits awarded by the Court for wrongful possession were revenue receipts and, therefore, liable to be assessed as income. The Calcutta High Court observed that neither the decision of the Privy Council in Girish Chunder Lahiri (Supra) nor the decision of the Supreme Court in Lucy Kochuvareed (Supra) was either cited or noticed by the learned Judges of the Madras High Court. It was also observed that even the decisions of the Patna High Court in Rani Prayag Kumari Debi (Supra) and that of the Kerala High Court in Periyar & Pareekanni Rubbers Ltd. (Supra), wherein it was held that damages or compensation awarded for wrongful detention of the properties of the assessee was not a revenue receipt, were neither noticed nor considered by the Madras High Court.

As far as the Tribunal’s direction to tax the amount received as capital gains was concerned, the High Court held that there was no assignment of the decree for mesne profits. No final decree in respect of mesne profits was passed in favour of the assessee and the State Government had reserved the right to itself for getting an assignment from the assessee in respect of the final decree for mesne profits, if any, passed against the tenant for its use and occupation of the said property. Therefore, the High Court held that the assessee had not earned any capital gains on the transfer of a capital asset.

The High Court held that the mesne profits received was a capital receipt and, hence, not liable to tax.

THE SKYLAND BUILDERS (P) LTD. CASE
The issue thereafter came up for consideration before the Delhi High Court in the case of Skyland Builders (P) Ltd. vs. ITO (2020) 121 taxmann.com 251.

In this case, the assessee company had let out the property in the year 1980 for five years to Indian Overseas Bank. The parties had agreed to increase the rent by 20% after the expiry of the first three years. The lessee bank did not comply with the terms and increased the rent by 10% only. Therefore, the assessee terminated the lease agreement w.e.f. 31st January, 1990 by serving notice upon the lessee. Since the lessee failed to vacate the premises, the assessee filed a suit for damages / mesne profit and restoration of the premises to the owner. The suit of the assessee was decreed vide judgment / decree issued dated 27th July, 1998 for mesne profit and damages, including interest. In compliance with the Court’s order, the lessee Indian Overseas Bank paid Rs. 77,87,303 to the assessee company. In the original return for the A.Y. 1999-2000, mesne profits of Rs. 77,87,303 was declared as taxable income, whereas in the revised return the assessee claimed it as a capital receipt and excluded it from its taxable income.

The A.O. did not accept the contention of the assessee that it was a capital receipt and relied upon the decision of the Madras High Court in P. Mariappa Gounder (Supra) in which it was held that mesne profits were also a species of taxable income. The A.O. taxed it as ‘Income from other sources’ and allowed a deduction of legal expenses incurred in securing the mesne profits.

Before the CIT(A), apart from claiming that the mesne profits were not taxable, the assessee raised an alternative plea that even if it was treated as income in the nature of arrears of rent, even then it could not have been taxed in the year under consideration merely based on its realisation during the year and, rather, should have been taxed in the respective years to which it pertained. It was claimed that the enabling provision to tax the arrears of rent in the year of its receipt was inserted in section 25B with effect from the A.Y. 2001-02 and it was not applicable for the year under consideration. However, the CIT(A) did not accept the contentions of the assessee and held it to be a revenue receipt liable to be taxed as income. Insofar as section 25B was concerned, the CIT(A) observed that it did not bring about any change in law and it only set at rest doubts regarding taxability of income relating to earlier years in the previous year concerned in which the arrears of rent were received.

The Tribunal also rejected the assessee’s claim with regard to the non-taxability of mesne profits as income under the Act on the ground that it was a capital receipt. It followed the decisions of the Madras High Court in the cases of P. Mariappa Gounder (Supra) and S. Kempadevamma vs. CIT [2001] 251 ITR 87. It did not follow the decision of the Calcutta High Court in the case of Smt. Lila Ghosh (Supra) on the ground that the decision of the Madras High Court in the case of S. Kempadevamma (Supra) was rendered after that and it was binding in nature, being a later decision. The Tribunal also held that the sum which was granted by the Civil Court as mesne profit in respect of the tenanted property could be presumed to be a reasonably expected sum for which property could be let from year to year, and the same value could have been taken as annual letting value of the property in dispute as per section 23(1). With regard to the alternate plea of the assessee concerning the provisions of section 25B introduced subsequently, the Tribunal relied upon the decision in the case of P. Mariappa Gounder in which it was held that the mesne profit is to be taxed in the assessment year in which it was finally determined. The Tribunal’s decision has been reported at 91 ITD 392.

In further appeal before the High Court, the following arguments were made on behalf of the assessee:
•   The income falling under the specific heads enumerated in the Act as being taxable income alone was liable to tax and the income which did not fall within the specific heads was not liable to be taxed under the Act.
•   By its definition, ‘mesne profits’ were a kind of damages which the owner of the property, which was a capital asset, was entitled to receive on account of deprivation of the opportunity to use that capital asset on account of the wrongful possession thereof by another. Therefore, such damages which were awarded for deprivation of the right to use the capital asset constituted a capital receipt.
•   Section 25B introduced w.e.f. 1st April, 2001 could not be applied to bring the mesne profits and interest thereon to tax in the A.Y. 1999-2000 even though they pertained to the earlier financial years. Further, the amount received from the erstwhile tenant could not be regarded as rent under the rent agreement which ceased to exist. The assessee had received damages and not rent since there was no subsisting relationship of landlord and tenant between the assessee and the bank post the termination of their tenancy.
•   Reliance was placed on the decision of the Supreme Court in the case of CIT vs. Saurashtra Cement Ltd. 325 ITR 422 wherein it was held that the amount received towards compensation for sterilisation of the profit-earning source, not in the ordinary course of business, was a capital receipt in the hands of the assessee. In this case, the liquidated damages received from the supplier on account of the delay caused in delivery of the machinery was held to be a capital receipt not liable to tax.
•   The facts before the Madras High Court in the case of P. Mariappa Gounder were different from the facts of the present case. In that case, the assessee had entered into an agreement to purchase a property which was not conveyed by the vendor to the assessee as it was sold to another person who was put in possession. The Court decreed specific performance of the assessee’s agreement with the original owner and the assessee’s claim for mesne profits against the other purchaser who was in possession was also accepted. Thus, it was not a case of grant of mesne profits against the erstwhile tenant who continued to occupy the premises despite termination of the tenancy. But it was a case where another purchaser of the same property held on to the possession of the property and the mesne profits were awarded against him.
•   The decision of the Madras High Court in the case of P. Mariappa Gounder was not followed by the Calcutta High Court in a subsequent decision in the case of Smt. Lila Ghosh (Supra). It was the view of the Calcutta High Court which was the correct view and should be followed.
•   Reliance was also placed on the Special Bench decision of the Mumbai Bench of the Tribunal in the case of Narang Overseas (P) Ltd. vs. ACIT (2008) 111 ITD 1 wherein the view favourable to the assessee was adopted, in view of conflicting decisions of the High Courts, and mesne profits were held to be capital receipts.

The Revenue pleaded that the decision of the Madras High Court in P. Mariappa Gounder had been affirmed by the Supreme Court (232 ITR 2). It was submitted that the decision of the Calcutta High Court in Smt. Lila Ghosh was a decision rendered before the Supreme Court decided the appeal in the case of P. Mariappa Gounder. Further, the view taken by the Madras High Court in P. Mariappa Gounder was reiterated by it in the case of S. Kempadevamma (Supra). The Revenue also placed reliance on the decision of the Delhi High Court in the case of CIT vs. Uberoi Sons (Machines) Ltd. 211 Taxman 123, wherein it was held that the arrears of rent received as mesne profits are taxable in the year of receipt, and that section 25B of the Act which was introduced vide amendment in 2000 with effect from A.Y. 2001-02 was only clarificatory in nature.

In reply, the assessee submitted that the real issue in the case before the Delhi High Court in Uberoi Sons (Machines) Ltd. (Supra), was in which previous year the arrears of rent received by the assesse (as mesne profits) could be brought to tax and the issue was not whether mesne profits received by the landlord / assesse from the erstwhile tenant constituted revenue receipt or capital receipt.

The Delhi High Court held that if the test laid down by the Supreme Court in the case of Saurashtra Cement Ltd. (Supra) had been applied to the facts of the case, then the only conclusion that could be drawn was that the receipt of mesne profits and interest thereon was a revenue receipt. This was because the capital asset of the assessee had remained intact, and even the title of the assessee in respect of the capital asset had remained intact. The damages were not received for harm and injury to the capital asset, or on account of its diminution, but were received in lieu of the rent which the appellant would have otherwise derived from the tenant. Had it been a case where the capital asset would have been subjected to physical damage, or of diminution of the title to the capital asset, and damages would have been awarded for that, there would have been merit in the appellant’s claim that damages were capital receipt.

The High Court held that the issue was no longer res integra as it stood concluded not only by the decision of the Supreme Court in P. Mariappa Gounder but also by the co-ordinate Bench of the Delhi High Court itself in Uberoi Sons (Machines) Ltd. In that case, the Court not only held that section 25B was clarificatory and applied to the assessment year in question, but also held that the receipt of mesne profits constituted revenue receipt. The Court also held that the issue of invocation of section 25B was intimately linked to the issue of whether the said receipts were revenue receipts, or capital receipts, and had it not been so there would be no question of the Court upholding the applicability of section 25B. Therefore, the submission of the assessee that the ratio of the decision in Uberoi Sons (Machines) Ltd. was not that income by way of mesne profits constituted revenue receipts, was found to be misplaced by the Court.

The Delhi High Court in this case did not follow the decision of the Calcutta High Court in the case of Smt. Lila Ghosh for two reasons: due to the subsequent decision of the Supreme Court in P. Mariappa Gounder approving the Madras High Court’s view, and due to the decision of the co-ordinate Bench of the Delhi High Court in the case of Uberoi Sons (Machines) Ltd. following the Madras High Court’s view and taking note of its approval by the Supreme Court. The ratio of the decision of the Special Bench in the Narang Overseas case (Supra) of the Tribunal was also not approved by the High Court for the same reason that the jurisdictional High Court’s decision prevailed over it.

Accordingly, the High Court held that mesne profits and interest on mesne profits received under the direction of the Civil Court for unauthorised occupation of the immovable property of the assessee by Indian Overseas Bank, the erstwhile tenant of the appellant, constituted revenue receipts and were liable to tax u/s 23(1) of the Act.

OBSERVATIONS

In order to determine the tax treatment of mesne profits, it is necessary to first understand the meaning of the term ‘mesne profits’ and the reason for which the owner of the property becomes entitled to receive it. Though the term ‘mesne profits’ is not defined under the Income-tax Act, it is defined under section 2(12) of the Civil Procedure Code. (Please see the first paragraph.)

The definition makes it very clear that mesne profits represent the damages that emanate from the property, the true owner of which has been deprived of its possession by a trespasser. It is not rent for use of the property. The Supreme Court in the case of Lucy Kochuvareed vs. P. Mariappa Gounder AIR 1979 SC 1214 has considered mesne profits to be damages. The relevant observations of the Supreme Court are reproduced below:

‘Mesne profits being in the nature of damages, no invariable rule governing their award and assessment in every case can be laid down and “the Court may mould it according to the justice of the case”. Even so, one broad basic principle governing the liability for mesne profits is discernible from section 2(12) of the CPC which defines “mesne profits” to mean “those profits which the person in wrongful possession of property actually received or might with ordinary diligence have received therefrom together with interest on such profits, but shall not include profits due to improvements made by the person in wrongful possession”. From a plain reading of this definition, it is clear that wrongful possession of the defendant is the very essence of a claim for mesne profits and the very foundation of the defendant’s liability therefor. As a rule, therefore, liability to pay mesne profits goes with actual possession of the land. That is to say, generally, the person in wrongful possession and enjoyment of the immovable property is liable for mesne profits.’

The basis for quantification of mesne profits is the gain that the person in wrongful possession of the property made or might have made from his wrongful occupation and not what the owner of the property has lost on account of deprivation from the possession of the property. This aspect of the nature of the receipt has been explained by the Delhi High Court in the case of Phiraya Lal alias Piara Lal vs. Jia Rani AIR 1973 Del 18 as follows:

‘When damages are claimed in respect of wrongful occupation of immovable property on the basis of the loss caused by the wrongful possession of the trespasser to the person entitled to the possession of the immovable property, these damages are called “mesne profits”. The measure of mesne profits according to the definition in section 2(12) of the Code of Civil Procedure is “those profits which the person in wrongful possession of such property actually received or might with ordinary diligence have received there from, together with interest on such profits”. It is to be noted that though mesne profits are awarded because the rightful claimant is excluded from possession of immovable property by a trespasser, it is not what the original claimant loses by such exclusion but what the person in wrongful possession gets or ought to have got out of the property which is the measure of calculation of the mesne profits. (Rattan Lal vs. Girdhari Lal, AIR 1972 Delhi ll). This basis of damages for use and occupation of immovable property which are equivalent to mesne profits is different from that of damages for tort or breach of contract unconnected with possession of immovable property. Section 2(12) and order Xx rule 12 of the Code of Civil Procedure apply only to the claims in respect of mesne profits but not to claims for damages not connected with wrongful occupation of immovable property. The measure for the determination of the damages for use and occupation payable by the appellants to the respondent Jia Rani is, therefore, the profits which the appellants actually received or might with ordinary diligence have received from the property together with interest on such profits.’

The mesne profit cannot be viewed as compensation for the loss of income which the owner of the property would have earned but for deprivation of its possession, or as compensation for the loss of the source of income. It will be more appropriate to consider the mesne profit as compensation or damages for the loss of enjoyment of the property instead of the loss of income arising from the property. Mesne profits is for the injury or damages caused to the owner of the property due to deprivation of the possession of the property. Mesne profits become payable due to wrongful possession of the property with the trespasser, irrespective of whether or not that property before deprivation was earning any income for its owner. It might be possible that the property concerned might not be a let-out property and, therefore, yielding no income for its owner. Even in a case where the property was self-occupied by the owner which is not resulting in any income, the mesne profits become payable if that property has come in wrongful possession of the trespasser. Therefore, it is inappropriate to consider the mesne profits as compensation for loss of income which the owner would have earned otherwise. Any such compensation received due to the injury or damages caused to the assessee is required to be considered as a capital receipt not chargeable to tax, unless it is received in the ordinary course of business as held by the Supreme Court in the case of Saurashtra Cement Ltd. (Supra).

Mesne profits cannot be brought to tax as income under the head ‘Income from House Property’ as it cannot be said to be representing the annual value and that it will not come within the purview of taxation at all. Section 22 creates a charge of tax over the ‘annual value’ of the property. The ‘annual value’ is required to be determined in accordance with the provisions of section 23. As per section 23, the annual value is the sum which the property might reasonably be expected to get from year to year or the actual rent received or receivable in case of let-out property, if it is higher than that sum. The sum of mesne profits per se, which may pertain to a period of more than one year, cannot be considered as an ‘annual value’ of the property concerned for the year in which it accrued to the assessee by virtue of court order or received by the assessee. Therefore, the mesne profits cannot be held to be an annual value of the property u/s 23(1). For this reason and for the reasons stated in the next paragraph, it is respectfully submitted that part of the Delhi High Court’s decision in Skyland Builders (Supra) requires reconsideration where it held that the mesne profits were taxable u/s 23(1).

The erstwhile provisions of section 25B dealing with the taxability of arrears of rent or the corresponding provisions of section 25A, as substituted with effect from 1st April, 2017, can be pressed into play only if the receipt is in the nature of ‘rent’ in the first place. The Supreme Court in the case of UOI vs. M/s Banwari Lal & Sons (P) Ltd. AIR 2004 SC 198 has referred to the Law of Damages & Compensation by Kameshwara Rao (5th Ed., Vol. I, Page 528) and approved the learned author’s statement that right to mesne profits presupposes a wrong, whereas a right to rent proceeds on the basis that there is a contract. Therefore, the rent is the consideration for letting out of the property under a contract and there is no question of any wrongful possession of the property by the tenant. In a manner, the mesne profits and the rent are mutually exclusive.

Furthermore, the erstwhile sections 25AA and 25B and the present section 25A provide for taxation of an arrear of rent received from a tenant or unrealised rent realised subsequently, in the year of receipt under the head ‘Income from House Property’, irrespective of the ownership of the property in the year of taxation. The objective behind these provisions is to overcome the difficulties that used to arise in the past on account of the year of taxation and also in relation to the recipient not being the owner in the year of receipt. All of these provisions, for the purposes of activating the charge, require that the amount received represented (a) rent and (b) such rent was in arrears or unrealised and which rent was (c) subsequently realised. These three conditions are cumulative in nature for applying the deeming fiction of these provisions. Applying these cumulative conditions to the receipt of ‘mesne profits’, it is apparent that none of the conditions could be said to have been satisfied when a person receives damages for deprivation of the use of the property. The receipt in his case is neither for letting out the property nor does it represent the rent, whether in arrears or unrealised. It is possible that for measuring the quantum of damages and the amount of mesne profits the amount of prevailing rent is taken as a benchmark but such benchmarking cannot be a factor that has the effect of converting the damages into rent for the purposes of taxation of the receipt under the head ‘Income from House Property’. In fact, the right to receive mesne profits starts from the time where the relationship of the owner and tenant terminates and the right to receive rent ends.

The next question is whether the receipt of mesne profits could be considered as income under the head ‘Income from Other Sources’, importantly, u/s 56(2)(x). Apparently, the case of the receipt is to be tested vis-à-vis sub-clause (a) of clause (x) which brings to tax the receipt of any sum of money in excess of Rs. 50,000. Obviously, the receipt of mesne profits is on account of damages and cannot be considered to be without consideration and for this reason alone section 56(2)(x) cannot be invoked to tax such a receipt under the head ‘Income from Other Sources’. It is possible that the head is activated for charging the part of the receipt where such part represents the interest on the amount of damages for delay in payment thereof. But then that is an issue by itself.

It is, therefore, correct to hold that the Income-tax Act does not contain a specific provision to tax mesne profits under a specific head of income listed u/s 14. It is a settled position in law that for a receipt to be taxed as an income it should be fitted into a pigeon-hole of a particular head of income or the residual head and in the absence of a possibility thereof, a receipt cannot be taxed.

The next thing to assess is whether the receipt of mesne profits is an income at all or is in the nature of an income. Maybe not. For a receipt to qualify as income it perhaps is necessary that it represents the fruits of the efforts or labour made, or the risks and rewards assumed, or the funds employed. None of the above could be said to be present in the case of mesne profits where the receipt is for deprivation of the use of property. Such a receipt is not even for transfer of any property or right therein and cannot fit into the head capital gains. The receipt is for the unlawful action of the erstwhile tenant and is certainly not payment for the use of the property by him. No efforts are made by the recipient nor have any services been rendered by him. He has not employed any funds nor has he assumed any risks and the question of him being rewarded for the risks does not arise at all.

Lastly, as regards the decision of the Supreme Court in P. Mariappa Gounder confirming the ratio of the decision of the Madras High Court in the same case and the following of the said decision by the Delhi High Court in Skyland Builders (P) Ltd., it is respectfully stated that the Delhi High Court in the latter case did not concur with the view of the Calcutta High Court in the case of Smt. Lila Ghosh only for the reason that the Court noted that the Madras High Court’s view in the case of P. Mariappa Gounder that the mesne profits were revenue receipts was approved by the Supreme Court. With respect, in that case there was a complete failure on the part of the assessee to highlight the fact that the Supreme Court in deciding the case before it had considered only a limited issue concerning the year in which the mesne profits were taxable which arose from the Madras High Court’s decision. The Apex Court in that case had not considered whether the mesne profits was a capital receipt or revenue receipt and this fact of the non-consideration of the main issue by the Court was not pointed out to the Delhi High Court. Had that been highlighted, we are sure that the decision of the Delhi High Court would have been otherwise. This limited aspect of the Supreme Court’s decision becomes very clear on a perusal of the decisions of the High Court and the Supreme Court in P. Mariappa Gounder. The relevant part of both the decisions is reproduced as under:

Madras High Court – Two controversies arise in these references under the Income-tax Act, 1961 (‘the Act’). One is whether mesne profits decreed by a court of law can be held to be taxable income in the hands of the decree holder? The other question is about the relevant year in which mesne profits are to be charged to income-tax.

Supreme Court – The question which arises for consideration in this appeal is as to in which assessment year the appellant is liable to be assessed in respect of mesne profits which were awarded in his favour.

Further, the Mumbai Special Bench in the case of Narang Overseas (P) Ltd. (Supra) has extensively dealt with this aspect of the limited application of the Supreme Court’s decision at paragraphs 6 to 23 and concluded as follows:

‘The above discussion clearly reveals that the judgment of the Hon’ble Supreme Court in the case of P. Mariappa Gounder (Supra) only decides the issue regarding the year of taxability of the mesne profits. That judgment, therefore, cannot be said to be an authority for the proposition that the nature of mesne profits is revenue receipts chargeable to tax. Accordingly, the contention of Revenue that the issue regarding the nature of mesne profits is covered by the aforesaid decision of the Hon’ble Supreme Court cannot be accepted.’

This decision of the Special Bench has remained unchallenged by the Income-tax Department in an appeal before the High Court as is noted by the Bombay High Court in the case of Goodwill Theatres Pvt. Ltd. [2016] 241 Taxman 352. The appeal filed by the Income-tax Department against the decision of the Special Bench was dismissed for non-removal of the office objections.

Insofar as the reliance placed by the Delhi High Court on its earlier decision in the case of Uberoi Sons (Machines) Ltd. (Supra) is concerned, it is worth noting that the following questions of law were framed for consideration of the High Court in that case:
(i) Whether the ITAT was, in the facts and circumstances of the case, correct in law in quashing the re-assessment order passed by the Assessing Officer under section 147(1) of the Income Tax Act, 1961?
(ii) Whether the ITAT was correct in law in holding that the excess amount payable to the assessee towards mesne profits / compensation for unauthorised use and occupation of the premises accrued to the assessee only upon the passing of the decree by the Civil Court on 14th October, 1998?

It can be noticed that the question about the nature of mesne profits, whether revenue or capital, was not raised before the Delhi High Court even in the Uberoi case. Therefore, in our considered opinion the decision of the Supreme Court cannot be a precedent on the subject of the taxability or otherwise of mesne profits. The Court in that simply confirmed that the year of taxation would be the year of the order of the civil court as was decided by the Madras High Court. Any High Court decision not touching the issue of taxability of the receipt cannot be pressed into service for deciding the issue of taxability or otherwise of the receipt.

It may be noted that the question whether mesne profits were capital receipts or revenue receipts had also arisen before the Bombay High Court in the case of CIT vs. Goodwill Theatres Pvt. Ltd. [2016] 241 Taxman 352. The High Court had dismissed the appeal of the Revenue on the ground that the decision of the Special Bench in the case of Narang Overseas (P) Ltd. (Supra) had remained unchallenged, as the appeal filed against that decision before the High Court was dismissed for non-removal of office objections. The Supreme Court, however, on an appeal by the Income-tax Department challenging the order of the High Court has remanded the issue back to the High Court for its adjudication on merits which is reported at [2018] 400 ITR 566.

It is very difficult to persuade ourselves to believe that the decision of the Supreme Court in the case of Saurashtra Cement Ltd. (Supra) could be applied to the facts of the case to hold that the mesne profits was revenue receipts taxable under the Act. The Supreme Court in the said case was concerned with the facts unrelated to mesne profits. In that case, the capital asset was subjected to physical damage leading to the diminution of the title to the capital asset, and damages had been awarded for that, which damages were found to be capital receipt. It was the assessee who had relied upon the decision to contend that the mesne profits was not taxable. Instead, the Court applied the decision in holding against the assessee that applying the ratio therein the receipt could be exempted from taxation only where there was a damage or destruction to the property and diminution to title. Nothing can be stranger than this. The said decision nowhere stated that any receipt unrelated to damage to the capital asset would never be a capital receipt not liable to tax. The Supreme Court in that case of Saurashtra Cement Ltd. held that the amount received towards compensation for sterilization of the profit-earning source, not in the ordinary course of business, was a capital receipt in the hands of the assessee. In that case, the liquidated damages received from the supplier on account of delay caused in delivery of the machinery were held to be a capital receipt not liable to tax.

The facts in Skyland Builders were better than the facts in P. Mariappa Gounder where the receipt of mesne profits was from a person who was never a tenant of the assessee while in the first case the receipt was from an erstwhile tenant who deprived the owner of the possession, meaning there was a prior letting of the premises to the payer of the mesne profits and the receipt from such a person could have been better classified as mesne profits not taxable under the head ‘Income from House Property’.

The better view, in our considered opinion, therefore, is the view expressed by the Calcutta High Court that mesne profits are in the nature of capital receipts not chargeable to tax.

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Business expenditure – Section 37(1) – Capital or revenue expenditure – Payment made by assessee under agreement to an entity for additional infrastructure for augmenting continuous supply of electricity – No asset acquired – Expenditure revenue in nature and allowable

34. CIT vs. Hanon Automotive Systems India Private Ltd. [2020] 429 ITR 244 (Mad.) Date of order: 16th October, 2020 A.Y.: 2010-11

Business expenditure – Section 37(1) – Capital or revenue expenditure – Payment made by assessee under agreement to an entity for additional infrastructure for augmenting continuous supply of electricity – No asset acquired – Expenditure revenue in nature and allowable

Under an agreement to establish additional infrastructure facility to ensure uninterrupted power supply to it, the assessee made a lump sum payment to a company. The A.O. held that the amount paid by the assessee was to improve its asset and was non-refundable and even if the assessee received ‘services’ from the company in future, it would be separately governed by a ‘separate shared services agreement’ and hence the amount paid was not ‘wholly and exclusively’ for the assessee’s business and that it was spent towards the acquisition of a capital asset. The A.O. disallowed the expenditure claimed u/s 37(1) and also rejected the assessee’s alternate claim to depreciation.

The Commissioner (Appeals) held that the expenditure was capital expenditure, but allowed depreciation. The Tribunal held that the expenditure was revenue in nature and allowed the assessee’s claim for deduction.

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

‘i) The Tribunal had rightly examined the nature of the transaction and held that the lump sum payment made by the assessee for the development of infrastructure for uninterrupted power supply to it was revenue expenditure u/s 37(1).

ii) Though the assessee had parted with substantial funds to the company, the capital asset continued to remain the property of the company.’

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Appeal to High Court – Territorial jurisdiction – Section 260A of ITA, 1961 and Article 226 of Constitution of India – Company located in Karnataka and assessed in Karnataka – Appeal to Appellate Tribunal in Bombay – Appeal from order of Tribunal – Bombay High Court had no jurisdiction to consider appeal

33. CIT vs. M.D. Waddar and Co. [2020] 429 ITR 451 (Bom.) Date of order: 27th October, 2020 A.Y.: 2008-09

Appeal to High Court – Territorial jurisdiction – Section 260A of ITA, 1961 and Article 226 of Constitution of India – Company located in Karnataka and assessed in Karnataka – Appeal to Appellate Tribunal in Bombay – Appeal from order of Tribunal – Bombay High Court had no jurisdiction to consider appeal

The assessee company was located in Raichur District, Karnataka. Its registered office, too, was in Karnataka. For Income-tax purposes, the assessee fell within the jurisdiction of the Assistant Commissioner, Belgaum, Karnataka. For the A.Y. 2008-09, the A.O., Belgaum reopened the assessment u/s 147, issued a notice u/s 148 and completed the reassessment in March, 2013.

Assailing that assessment order, the assessee appealed to the Commissioner (Appeals), Bangalore. Eventually, both the assessee and the Revenue further appealed to the Appellate Tribunal, Panaji Bench. The Tribunal held in the assessee’s favour.

The Revenue then filed an appeal before the Bombay High Court. The question before the High Court was as under:

‘An Income-tax Appellate Tribunal exercises its jurisdiction over more than one State, though it is located in one of those States. Its order is sought to be challenged. Which High Court should have the jurisdiction to rule on the Tribunal’s order? Is it the High Court in whose territorial jurisdiction the Tribunal is located? Or is it the High Court in whose territorial jurisdiction the authority that passed the preliminary order operates?’

The High Court held as under:

‘i) In the Ambica Industries case the Supreme Court has held that in terms of Article 227 as also clause (2) of Article 226 of the Constitution of India, the High Court will exercise its discretionary jurisdiction and also issue writs of certiorari over orders passed by the subordinate courts within its territorial jurisdiction. Besides, if any cause of action arises within its territorial limits, it will exercise its jurisdiction. According to Ambica Industries, when the appellate court exercises jurisdiction over a Tribunal situated in more than one State, the High Court located in the State where the first court is located should be considered to be the appropriate appellate authority. The mere physical location of an inter-State Tribunal cannot be determinative of the High Court’s jurisdiction for an aggrieved party to challenge that Tribunal’s order.

ii) The assessee was located in Karnataka and so were the Income-tax authorities. The primary order, too, emanated from Karnataka; so did the first appellate order. All challenges, including the appeal before the Tribunal were in continuation of that primary adjudication or consideration before the Assessing Officer at Belgaum, Karnataka. The Bombay High Court had no jurisdiction to entertain the appeal.’

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Article 15, India-UAE DTAA – Section 5, section 17(2)(vi) of the Act – ESOP benefit had accrued at the stage of grant when assessee was resident – Section 17(2)(vi) provides time when ESOP is to be taxed – Hence ESOP benefit will be taxable notwithstanding that assessee is non-resident on exercise date – ESOP benefit is taxable in country where services are rendered – Residential status at the time of exercise of ESOP is not relevant

10. [2021] 123 taxmann.com 238 (Mum.)(Trib.) Unnikrishnan V.S. vs. ITO ITA Nos.: 1200 & 1201 (Mum) of 2018 A.Ys.: 2013-14 and 2014-15 Date of order: 13th January, 2021

Article 15, India-UAE DTAA – Section 5, section 17(2)(vi) of the Act – ESOP benefit had accrued at the stage of grant when assessee was resident – Section 17(2)(vi) provides time when ESOP is to be taxed – Hence ESOP benefit will be taxable notwithstanding that assessee is non-resident on exercise date – ESOP benefit is taxable in country where services are rendered – Residential status at the time of exercise of ESOP is not relevant

FACTS

The assessee was an employee of an Indian bank. He was deputed to the UAE Representative Office (RO) from 1st October, 2007. Since deputation, the assessee was a non-resident, including in the years in dispute. During the relevant years, the assessee was granted stock options by the Indian bank in June, 2007 which vested equally in June, 2008 and June, 2009. The assessee exercised the vested options in F.Ys. 2012-13 and 2013-14 when he was a non-resident. On exercise of options, the employer had withheld tax which the assessee claimed as refund in his tax return. According to the assessee, he was granted ESOP benefit in consideration of services rendered to the RO outside India and hence the income neither accrued nor arose in India, nor was it deemed to accrue or to arise in India or received in India. Alternatively, it was not taxable in India as per Article 15(1) of the India-UAE treaty since the employment was not exercised in India.

But as per the A.O., ESOP benefit was granted in consideration of services rendered in India in 2007 when the assessee was a resident. Accordingly, the A.O. held that ESOP benefit was taxable in India under the Act as also under the DTAA.

The CIT(A) upheld the order of the A.O. Being aggrieved, the assessee filed an appeal before the Tribunal.

HELD

Taxability under Act

• While ESOP income had arisen to the assessee in the year of exercise, admittedly the related rights were granted to the assessee in 2007 and in consideration of the services which were rendered by the assessee prior to the rights being granted – which were rendered in India all along.

• At the stage when the ESOP benefit was granted in 2007, the income may have been inchoate, yet it had accrued or arisen in India in the year of exercise.

• Section 17(2)(vi) decides the timing of taxation of the ESOP in the year of exercise but does not dilute the fact that ESOP benefit had arisen at the time when the ESOP rights were granted when the assessee was a resident. Section 17(2)(vi) merely deferred its taxability to the year of exercise. Accordingly, income was taxable in the year of exercise notwithstanding that the assessee was a non-resident during those years.

• Reference to the UN Model Convention 2017 Commentary also makes it clear that ESOP benefit relates back to the point of time, and even periods prior thereto, when the benefit is granted. Hence, it cannot be considered as accruing or arising at the point of exercise.

Taxability under Article 15 of DTAA

• ESOP benefit could be taxed as ‘other similar remuneration’ appearing alongside salaries and wages in Article 15 of the India-UAE DTAA.

• Article 15(1) provides that other remuneration (which includes ESOP benefit) can be taxed in the state where employment is exercised. Accordingly, ESOP benefit in respect of employment in the UAE was taxable in the UAE even if the ESOP was exercised after returning to India and on cessation of non-resident status. Similarly, ESOP benefit in respect of service rendered in India was taxable in India notwithstanding that ESOP benefit was exercised when the assessee was a non-resident.

• The decisions such as in ACIT vs. Robert Arthur Kultz [(2013) 59 SOT 203 (Del.)] and Anil Bhansali vs. ITO [(2015) 53 taxmann.com 367 (Hyd.)] relied upon by the taxpayer, in fact, favour the Revenue since they lay down the proposition that if ESOP benefit is received for rendering services partly in India and partly outside India, only the pro-rata portion relatable to services rendered in India is taxable in India.

Note: The Tribunal seems to have premised its decision on the fact that ESOP benefit in the present case was granted in lieu of services rendered in India prior to the date of grant. Hence, the Tribunal did not consider employment exercised in the UAE (October, 2007 to June, 2009) during substantial part of grant to vest period (June, 2007 to June, 2009) as diluting accrual of the salary income in India. Incidentally, during the erstwhile Fringe Benefits Tax (FBT) regime, FAQs 3 to 5 of CBDT Circular No. 9/2007 dated 20th December, 2007 clarified that FBT on ESOPs will trigger on pro-rata basis for employment exercised in India during grant to vest period. This Circular is not referred to in the Tribunal decision.

I begin to speak only when I’m certain what I’ll say isn’t better left unsaid

– Cato

I attribute my success to this: I never gave or took any excuse

– Florence Nightingale

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Article 12(4), Article 14, Article 23(2) of India-Japan DTAA – The words ‘tax deducted in accordance with the provisions’ of Article 23 of DTAA mean taxes withheld by source state which are in harmony, or in conformity, with provisions of DTAA – Article 12(4), read with Article 14, of DTAA as exclusion of FTS in Article 12(4) is attracted only if services were covered under Article 14, scope of which is limited to individuals – Income earned by partnership firm was plausibly taxable under Article 12 and bona fide view adopted by a source country is binding on country of residence while evaluating tax credit claim

9. [2020] 122 taxmann.com 248 (Mum.)(Trib.) Amarchand & Mangaldas & Suresh A. Shroff & Co. vs. ACIT ITA No.: 2613/Mum/2019 A.Y.: 2014-15 Date of order: 18th December, 2020

Article 12(4), Article 14, Article 23(2) of India-Japan DTAA – The words ‘tax deducted in accordance with the provisions’ of Article 23 of DTAA mean taxes withheld by source state which are in harmony, or in conformity, with provisions of DTAA – Article 12(4), read with Article 14, of DTAA as exclusion of FTS in Article 12(4) is attracted only if services were covered under Article 14, scope of which is limited to individuals – Income earned by partnership firm was plausibly taxable under Article 12 and bona fide view adopted by a source country is binding on country of residence while evaluating tax credit claim

FACTS
The assessee was a law firm assessed as a partnership firm in India. It had received fee from Japanese clients after withholding tax @10% under Article 12 of the India-Japan DTAA.

The A.O. denied Foreign Tax Credit (FTC) on the ground that the income was covered under Article 14 – Independent Personal Service (IPS) Article. In terms of Article 14, income from professional services can be taxed in Japan only if the assessee has a fixed base in Japan. Since the assessee did not have a fixed base in Japan, the A.O. held that withholding of tax was not in accordance with the DTAA provisions.

On appeal, the CIT(A) upheld the order of the A.O. Being aggrieved, the assessee appealed before the Tribunal.

HELD
•       Article 23(2)(a) of the India-Japan DTAA requires India to grant credit for tax deducted in Japan in accordance with the provisions of the DTAA. The words ‘in accordance with the provisions’ would mean taxes withheld in the source state which could be reasonably said to be in harmony, or in conformity, with provisions of the DTAA.
•       While interpreting the above words, one is required to take a judicious call as to whether the view adopted by the source jurisdiction was reasonable and bona fide, though such a view may be or may not be the same as the legal position in the residence jurisdiction.
•       Article 12 and Article 14 overlap as regards coverage of professional service. However, Article 12(4) excludes payment made to an individual for independent personal services mentioned in Article 14.
•       Since the income was received by a partnership firm, exclusion in Article 12(4) was not applicable. Therefore, income was rightly subjected to tax in Japan. Accordingly, the assessee was qualified to claim FTC under the India-Japan DTAA.

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Third proviso to section 50C(1) – Insertion of the proviso and subsequent enhancement in its limit to 10% is curative in nature to take care of unintended consequences of the scheme of section 50C, hence relate back to the date when the statutory provision of section 50C was enacted, i.e., 1st April, 2003

13. Maria Fernandes Cheryl vs. ITO (Mumbai) Pramod Kumar (V.P.) and Saktijit Dey (J.M.) ITA No. 4850/Mum/2019 A.Y.: 2011-12 Date of order: 15th January, 2021 Counsel for Assessee / Revenue: None / Vijaykumar G. Subramanyam

Third proviso to section 50C(1) – Insertion of the proviso and subsequent enhancement in its limit to 10% is curative in nature to take care of unintended consequences of the scheme of section 50C, hence relate back to the date when the statutory provision of section 50C was enacted, i.e., 1st April, 2003

FACTS

During the year under appeal, the assesse had sold her flat for a consideration of Rs. 75 lakhs. The valuation of the property for the purpose of charging stamp duty was Rs. 79.91 lakhs. She computed capital gains based on the sale consideration of Rs. 75 lakhs. But according to the A.O., the assessee had to adopt the Stamp Duty Valuation (SDV) which was Rs. 79.91 lakhs for the purpose of computing the capital gains. The CIT(A), on appeal, confirmed the A.O.’s order.

On appeal by the assessee, the Tribunal noted that the variation in the sale consideration as disclosed by the assessee vis-à-vis the valuation adopted by the SDV authority was only 6.55%. The Tribunal then queried the Departmental Representative (DR) as to why the assessee not be allowed the benefit of the third proviso to section 50C(1) as the variation was much less than the prescribed permissible variation of up to 10%.

In reply, the DR contended that the said provision is applicable by virtue of the Finance Act, 2018 with effect from 1st April, 2019. And for the permissible variation of 10%, as against variation of 5% as per the originally enacted third proviso to section 50C, it was contended that the enhancement is effective only from 1st April, 2021. Reference was also made to the Explanatory Notes to the Finance Act, 2020 with regard to increase in the safe harbour limit of 5% under sections 43CA, 50C and 56 to 10%. According to the DR, the insertion of the third proviso to section 50C could not be treated as retrospective in nature.

In conclusion, the DR also submitted that in case the Tribunal was in favour of granting relief to the assessee, then the relief may be provided as a special case and it may be clarified that this decision should not be considered as a precedent.

HELD

According to the Tribunal if the rationale behind the insertion of the third proviso to section 50C(1) was to provide a remedy for unintended consequences of the main provision, then the insertion of the third proviso should be considered as effective from the same date on which the main provision, i.e., section 50C, was brought into effect.

The Tribunal noted that the CBDT itself, in Circular No. 8 of 2018, has accepted that there could be various bona fide reasons explaining the small variations between the sale consideration of immovable property as disclosed by the assessee vis-à-vis the SDV. Further, it also noted that the Tribunals as well as the High Courts in the following cases have held that a curative amendment to avoid unintended consequences is to be treated as retrospective in nature even though it may not state so specifically:
•   Agra Bench of the Tribunal in the case of Rajeev Kumar Agarwal vs. ACIT (45 taxmann.com 555);
•   Delhi High Court in CIT vs. Ansal Landmark Township Pvt. Ltd. (61 taxmann.com 45);
•   Ahmedabad Tribunal in the case of Dharmashibhai Sonani vs. ACIT (161 ITD 627); and
•   Madras High Court in CIT vs. Vummudi Amarendran (429 ITR 97).

According to the Tribunal, the insertion of the third proviso to section 50C(1) was in the nature of a remedial measure to address a bona fide situation, where there was little justification for invoking an anti-avoidance provision – a curative amendment to take care of unintended consequences of the scheme of section 50C.

As for the enhancement of the tolerance band to 10% by the Finance Act, 2020, the Tribunal noted that the CBDT Circular itself acknowledges that it was done in response to the representations of the stakeholders for enhancement in the tolerance band. According to the Tribunal, once the Government acknowledged this genuine hardship of the taxpayer and addressed the issue by a suitable amendment in law, there was no reason to justify any particular time frame for implementing this enhancement of the tolerance band or safe harbour provision.

Therefore, the Tribunal held that the insertion of the third proviso to section 50C and the enhancement of the tolerance band to 10% were curative in nature and, therefore, the same relate back to the date when the related statutory provision of section 50C, i.e., 1st April, 2003, was enacted.

The Tribunal did not agree with the DR’s submission to mention in the order that ‘relief is being provided as a special case and this decision may not be considered as a precedent’. According to the Tribunal, ‘Nothing can be farther from a judicious approach to the process of dispensation of justice, and such an approach, as is prayed for, is an antithesis of the principle of “equality before the law,” which is one of our most cherished constitutional values. Our judicial functioning has to be even-handed, transparent, and predictable, and what we decide for one litigant must hold good for all other similarly placed litigants as well. We, therefore, decline to entertain this plea…’

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Section 56(2)(vii) – Prize money received in recognition of services to Indian Cricket from BCCI is exempt

12. Maninder Singh vs. ACIT (Delhi) N.K. Billaiya (A.M.) and Sudhanshu Srivastava (J.M.) ITA No. 6954/Del/2019 A.Y.: 2013-14 Date of order: 6th January, 2021 Counsel for Assessee / Revenue: G.S. Grewal and Simran Grewal / Rakhi Vimal

Section 56(2)(vii) – Prize money received in recognition of services to Indian Cricket from BCCI is exempt

FACTS

The assessee is a former Indian cricketer. During the year under appeal, he received an award of Rs. 75.09 lakhs from the BCCI in recognition of his services to Indian Cricket. Placing reliance on the CBDT Circular No. 447 dated 22nd January, 1986, the assessee did not include this amount in his return of income. But, according to the A.O., CBDT Circular No. 2 of 2014 supersedes Circular No. 447 relied upon by the assessee. Therefore, he added the amount of Rs. 75.09 lakhs to the total income of the assessee. The CIT(A), on appeal, confirmed the order of the A.O.

HELD

The Tribunal referred to the second proviso to section 56(2)(vii). As per the said provisions, section 56(2)(vii) does not apply to any sum of money or any property received from any trust or institution registered u/s 12AA. The Tribunal noted that the BCCI is registered u/s 12AA. Therefore, it did not find any merit in the impugned addition made by the A.O. Accordingly, the Tribunal directed the A.O. to delete the addition of Rs. 75.09 lakhs made by him.

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Section 115JB – Where additional revenue was not shown by assessee in books of accounts, the A.O. could not tinker with book profit by adding additional revenue on account of subsequent realisation of export while computing book profit u/s 115JB

26. [2020] 80 ITR (Trib.) 528 (Bang.)(Trib.) DCIT vs. Yahoo Software Development (P) Ltd. ITA No.: 2510 (Bang.) of 2017 A.Y.: 2009-10 Date of order: 27th April, 2020

Section 115JB – Where additional revenue was not shown by assessee in books of accounts, the A.O. could not tinker with book profit by adding additional revenue on account of subsequent realisation of export while computing book profit u/s 115JB

FACTS

The assessee filed a revised return of income by including certain additional revenue in the total income (and claimed deduction u/s 10A in respect of the additional revenue).

But it did not modify the books of accounts, nor did it modify the calculation of book profit u/s 115JB.

However, the A.O. increased the book profit by adding the additional revenue on account of subsequent realisation of export. The CIT(A) sustained the addition made by the A.O. Aggrieved, the assessee preferred an appeal before the ITAT.

HELD

The ITAT, following the ratio of the Supreme Court decision in Apollo Tyres Ltd. vs. CIT [2002] 122 Taxman 562/255 ITR 273, allowed the assessee’s appeal.

In the said decision, the Court was concerned with the issue of the power of the A.O. to question the correctness of the profit and loss account prepared by the assessee in accordance with the requirements of Parts II and III of Schedule VI to the Companies Act (in the context of section 115J as then applicable).

In Apollo Tyres (Supra), the Court observed that it was not open to the A.O. to re-scrutinise the accounts and satisfy himself that these accounts had been maintained in accordance with the provisions of the Companies Act. Sub-section (1A) of section 115J did not empower the A.O. to embark upon a fresh inquiry in regard to the entries made in the books of accounts of the company and to probe into the accounts accepted by the authorities under the Companies Act. If the statute mandates that income prepared in accordance with the Companies Act shall be deemed income for the purpose of section 115J, then it should be that income which is acceptable to the authorities. If the Legislature intended the A.O. to reassess the company’s income, then it would have stated in section 115J that ‘income of the company as accepted by the A.O. Thus, according to the Apex Court, the A.O. did not have the jurisdiction to go behind the net profit shown in the profit and loss account except to the extent provided in the Explanation to section 115J.’

Thus, applying the ratio of the abovementioned judgment, the ITAT took the view that the A.O. cannot tinker with / re-compute book profit arrived at on the basis of books maintained in accordance with the Companies Act.

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Section 54F – Where possession of flat was taken within period of two years from date of transfer of original asset, assessee was entitled to benefit of section 54F irrespective of the date of agreement

25. [2020] 80 ITR(T) 427 (Del.)(Trib.) Rajiv Madhok vs. ACIT ITA No.: 2291 (Del.) of 2017 A.Y.: 2012-13 Date of order: 29th May, 2020

Section 54F – Where possession of flat was taken within period of two years from date of transfer of original asset, assessee was entitled to benefit of section 54F irrespective of the date of agreement

FACTS

The assessee offered to tax long-term capital gain (LTCG) on sale of shares effected on 2nd September, 2011. He also claimed deduction u/s 54F on purchase of a new residential house, on the premise that the property was constructed within the time allowed u/s 54F. However, according to the A.O. the residential house was purchased prior to the time period provided in section 54F. The CIT(A) upheld the addition. Consequently, the assessee filed an appeal before ITAT.

HELD

The only dispute arising in this case was pertaining to the date of purchase of the new residential property as contemplated u/s 54F – whether the date of agreement with the builder was to be considered as the date of purchase of the new asset or the date of payment in entirety and the date of possession received subsequently was to be considered as the date of purchase of the new asset. The stand taken by the Department was that the date of agreement with the builder was to be considered as the date of purchase of the new asset, while that of the assessee was that the date of payment in entirety and the date of possession received subsequently was to be considered as the date of purchase of the new asset.

In the instant case, the assessee sold shares on 17th August, 2011 and entered into an agreement with the builder on 29th September, 2009. However, the final amount of consideration was paid to the builder in April, 2012 and possession of the flat received in July, 2012.

The ITAT took into consideration the relevant clause in the deed for purchase of the new house which read as under:

‘46.0 The allottee understands and confirms that the execution of this agreement shall not be construed as sale or transfer under any applicable law and the title to the allottee hereby allotted shall be conveyed and transferred to the allottee only upon his fully discharging all the obligations undertaken by the allottee, including payment of the entire sale price and other applicable charges / dues, as mentioned herein and only upon the registration of the conveyance / sale deed in his favour. Prior to such conveyance, the allottee shall have no right or title in the apartment.’

The ITAT observed that in the backdrop of the aforesaid clause the date of possession of the flat was the date of actual purchase for the purpose of claiming exemption u/s 54F. In arriving at the decision, the ITAT analysed the decision rendered by the Bombay High Court in the case of CIT vs. Smt. Beena K. Jain [1994] 75 Taxman 145 [1996] 217 ITR 363, upholding the decision of the ITAT. In the said decision, the High Court observed that: ‘the Tribunal has looked at the substance of the transaction and come to the conclusion that the purchase was substantially effected when the agreement of purchase was carried out or completed by payment of full consideration on 29th July, 1988 and handing over of possession of the flat on the next day.’

The ITAT also observed that clause 46.0 of the buyer’s agreement in the assessee’s case was identical to clause 12 of the deed of agreement between the assessee and the builder as noted in the case of Ayushi Patni vs. DCIT [2020] 117 taxmann.com 231 (Pune-Trib.) ITA No. 1424 & 1707 (Pune) of 2016 and held that in view of identical facts and circumstances, the ratio of the above decision in the case of Ayushi Patni (Supra) was squarely applicable to the facts of the instant case.

Thus, the ITAT concluded that the new asset was purchased within two years from the date of transfer of the original asset, i.e., shares, and thus the assessee was entitled to benefit of section 54F.

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Section 54 – Exemption from capital gains cannot be denied where the assessee sold more than two residential properties and made reinvestment in one residential property

FACTS
The assessee, an individual deriving income from various heads of income, had submitted his return of income for the year under consideration. The return was duly processed u/s 143(1). Subsequently, the assessment was sought to be reopened based on information about the sale of immovable property and the assessee was asked to reconcile the same. The assessee filed a reply stating that he had not made any transaction for the year concerned and the transaction might have been wrongly reflected using his PAN. The assessee further requested the A.O. to recheck with the sub-registrar. Accordingly, the A.O. issued notice u/s 133(6) to the Sub-Registrar and received information that the assessee had effected sale of an immovable property being a residential flat for which no capital gains tax had been offered. The assessee furnished a capital gains working, submitting that the amount had been reinvested in purchasing another residential property. The A.O. contented that since the claim of capital gains and reinvestment thereof was not made in the return of income, the same was to be rejected and made an addition of Rs. 35 lakhs.

The A.O. also received information from the ITO that during the assessment proceedings of the assessee’s wife, it was found that a property jointly owned by the two had been sold during the year and the proceeds were reinvested in acquiring the same property for which exemption was claimed in the assessee’s case.

On appeal before the CIT(A), the CIT(A) accepted the capital gains workings submitted by the assessee and held that the assessee is eligible for exemption, even though the same was not claimed in the return of income. The A.O. had relied on the Supreme Court decision in the case of Goetze (India) Ltd. vs. CIT to deny the claim for exemption. The CIT(A) held that the decision had categorically held that the appellate authorities could accept such a claim.

As far as the jointly owned property was concerned, the CIT(A) observed that since the capital gains on the same had been reinvested, the assessee would be eligible for capital gains exemption. Thus, the CIT(A) held that the assessee would be eligible for exemption u/s 54 on the sale of the second property also.

Aggrieved, the Revenue filed an appeal before the Tribunal.

HELD
The Tribunal held that exemption u/s 54 is granted to the assessee for reinvestment made in the residential house. The section nowhere restricts that the assessee should have sold only one property and claimed the exemption u/s 54 for only one property. In the instant case, the assessee has sold two residential properties and reinvested in one residential property. The entire conditions of section 54, both pre and post the amendment to section 54 [vide Finance Act (No. 2) of 2014, w.e.f. A.Y. 2015-16] had been satisfied. Thus, the order of the CIT(A) was upheld and Revenue’s appeal was dismissed.

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Section 56(2) – The A.O. was erroneous in mechanically applying the provisions of section 56(2) to the difference between the stamp duty value and the actual sale consideration – The addition made by the A.O. without making a reference to the DVO despite the assessee submitting valuation report was unjustified

23. [2020] 208 TTJ 835 (Mum.)(Trib.) Mohd. Ilyad Ansari vs. ITO A.Y.: 2014-15 Date of order: 6th November, 2020

Section 56(2) – The A.O. was erroneous in mechanically applying the provisions of section 56(2) to the difference between the stamp duty value and the actual sale consideration – The addition made by the A.O. without making a reference to the DVO despite the assessee submitting valuation report was unjustified

FACTS

The assessee was engaged in the business of readymade garments. During the year under consideration, he purchased a flat jointly with his wife for a total consideration of Rs. 40,00,000 which was part of an SRA project. The builder, unable to complete the project, decided to exit from it at the half-way stage. An attempt to revive the project also failed, leading to the flat being sold at a distress price of Rs. 40,00,000 to the assessee. The sale was registered and thereafter the builder disappeared without completing the project. The agreement was made by the builder for a flat admeasuring 1,360 sq. feet. However, when the assessee got the possession, he found that it had been sold to two persons. The actual area of the flat, too, was only 784 sq. feet against the agreement area of 1,360 sq. feet. During the course of assessment proceedings, the A.O. noticed that the stamp duty valuation of the flat is Rs. 2,20,49,999 but the assessee had purchased it only for Rs. 40,00,000.

The assessee was required to explain why the difference is not to be treated as income u/s 56(2)(vii). The assessee filed a valuation report of Perfect Valuation & Consultants, a Government registered valuer, who valued the flat at Rs. 82.60 lakhs. During the assessment proceedings, the assessee filed this valuation report disputing the valuation made by the Stamp Valuation Authority (SVA). However, the A.O. did not refer the matter of valuation to the District Valuation Officer, though the valuation of the SVA was disputed by the assessee by way of the valuation report. The A.O. made an addition of Rs. 1,80,49,999 u/s 56(2)(vii)(b) in the hands of the assessee. The assessee filed an appeal before the CIT(A) against this order. But the CIT(A) also did not consider the valuation report submitted by the assessee, holding that the assessee had not disputed the valuation made by the SVA and confirmed the addition. Aggrieved, the assessee filed an appeal before the Tribunal.

HELD

The A.O. ignored the valuation report of the Government registered valuer submitted by the assessee. The provisions of section 56(2) had been mechanically applied without making any effort to determine the actual cost of the property. It ought to have been done since the property was acquired in semi-construction stage and later abandoned due to disputes amongst the builders. Besides, there was a dispute as regards the area acquired by the assessee as the same flat had been sold to two parties. In view of these circumstances, it was even more necessary for the A.O. to refer it to the valuation officer. Even at the stage of appellate proceedings when the assessee produced the valuation officer’s report that valued other flats in the very same building at Rs. 1,00,76,000, the CIT(A) should have called for remand report and in turn the valuation officer’s report which the CIT(A) had failed to do.

Thus, it was held that the addition made by the A.O. was totally unjustified and the assessee’s appeal was allowed.

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Section 36(1)(iii) – Interest on funds borrowed for acquisition of land held as inventory is allowable u/s 36(1)(iii) – The provisions of Accounting Standards and the provisions of the Act are two different sets of regulations. It is well settled that if there is a contradiction between the two, the provisions of the Act shall prevail – There is no restriction in the provisions of section 36(1)(iii) that the interest can be disallowed if incurred for the purpose of inventory as provided in AS 16

22. [2020] 118 taxmann.com 541 (Bang.)(Trib.) DCIT vs. Cornerstone Property Investment (P) Ltd. A.Ys.: 2013-14 and 2014-15 Date of order: 14th August, 2020

Section 36(1)(iii) – Interest on funds borrowed for acquisition of land held as inventory is allowable u/s 36(1)(iii) – The provisions of Accounting Standards and the provisions of the Act are two different sets of regulations. It is well settled that if there is a contradiction between the two, the provisions of the Act shall prevail – There is no restriction in the provisions of section 36(1)(iii) that the interest can be disallowed if incurred for the purpose of inventory as provided in AS 16

FACTS

The facts as observed by the A.O. in the assessment order were that the assessee held land as inventory. It utilised the proceeds from the issue of debentures for acquiring lands and for making advances for purchase of lands and repayment of loans borrowed earlier. The A.O. also observed that in the earlier year, too, the borrowed funds were utilised for purchase of lands. The total interest expenditure of Rs. 16,39,35,373 being interest on ICDs, interest on NCDs and other ancillary borrowings was directly attributable to purchase of lands. There was no dispute about the use of borrowed funds for which the entire interest expenditure of Rs. 16,39,35,373 was incurred.

Of this total interest expenditure, the assessee claimed deduction for only a part, i.e., Rs. 6,81,01,384, which was disallowed by the A.O.

The CIT(A) deleted the amount of interest disallowed by the A.O. relying on various judgments.

Aggrieved, the Revenue preferred an appeal to the Tribunal where the assessee contended that the facts of the present case are squarely covered by the order of the Tribunal rendered in the case of DLF Ltd. vs. Addl. CIT [IT Appeal No. 2677 (Delhi) of 2011, order dated 11th March, 2016].

HELD

Inventory is a qualifying asset as it is held for more than 12 months and therefore interest attributable to it is required to be capitalised in the books of accounts as per AS 16. The Tribunal rejected the argument of the authorised representative of the assessee that AS 16 does not apply to inventory. It held that the provisions of Accounting Standards are the provisions which are applicable for the maintenance of the accounts of the company and interest is allowable according to section 36(1)(iii). The provisions of Accounting Standards and the provisions of the Act are two different sets of regulations and it is well settled that if there is a contradiction between the two, the provisions of the Act shall prevail. Since in the present case the interest is paid not for the purpose of acquisition of any capital asset but for inventory, the Tribunal did not find any restriction in provisions contained in section 36(1)(iii) which provide that the interest can be disallowed if incurred for the purpose of inventory as provided in AS 16. The Tribunal noted that there is not even an allegation that the interest is not paid on capital borrowed for the purpose of business. The Tribunal noted the observations in the case of DLF Ltd. (Supra) and also the ratio of various benches of the Tribunal where deduction of interest has been allowed u/s 36(1)(iii) even where the assessee has followed project completion method.

The Tribunal, following the decision of the Bombay High Court and also of various co-ordinate benches of the Tribunal, declined to interfere with the order of the CIT(A).

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‘PROCEEDS OF CRIME’ – PMLA DEFINITION UNDERGOES RETROSPECTIVE SEA CHANGE

The concept of ‘proceeds of crime’ is most vital and pervades the entire fabric of The Prevention of Money-Laundering Act, 2002 (PMLA). Previously, it was an exhaustive definition and consisted of only the following three constituents:

•   Any property derived or obtained, directly or indirectly, by any person as a result of criminal activity relating to a scheduled offence;
•   The value of any such property;
•   The property equivalent in value held within the country or abroad (where property considered proceeds of crime is taken or held outside the country).

The erstwhile definition was found narrow and inadequate to deal with the ever-growing menace of money-laundering. Therefore, the Enforcement Directorate had consistently represented to the Government that the definition of ‘proceeds of crime’ was ambiguous. The ambiguity adversely impacted three important aspects, viz., the ability of the Directorate to investigate the money trail, the adjudication of attachments by the PMLA Adjudicating Authority and Tribunal, and also the trial of the offence of money-laundering under PMLA. Accordingly, amendment in the definition of ‘proceeds of crime’ was long called for.

RETROSPECTIVE AMENDMENT

The erstwhile definition was eventually amended by the Finance (No. 2) Act, 2019 by adding the Explanation to the definition w.e.f. 1st August, 2019. The definition of ‘proceeds of crime’ in section 2(1)(u) after such amendment reads as under:

‘Proceeds of crime’ means any property derived or obtained, directly or indirectly, by any person as a result of criminal activity relating to a scheduled offence, or the value of any such property, or where such property is taken or held outside the country, then the property equivalent in value held within the country or abroad.
Explanation – For the removal of doubts, it is hereby clarified that ‘proceeds of crime’ include property not only derived or obtained from the scheduled offence but also any property which may directly or indirectly be derived or obtained as a result of any criminal activity relatable to the scheduled offence.

A review of the Explanation shows that the purpose of inserting it was to expand the parameters of ‘proceeds of crime’. The Explanation seeks to widen the scope of the definition by bifurcating the same into the following two properties as stand-alone constituents of the ‘proceeds of crime’:
• Property derived or obtained from a scheduled offence;
• Property which is directly or indirectly derived or obtained as a result of any criminal activity relatable to the scheduled offence.

From the initial words in the Explanation, ‘For the removal of doubts, it is hereby clarified that’, it is evident that the Explanation is intended to apply retrospectively.

The Supreme Court has held1 that an Explanation may be added in declaratory form to retrospectively clarify a doubtful point of law and to serve as proviso to the main section.

1 Y.P. Chawla vs. M.P. Tiwari AIR 1992 SC 1360,
1362

INGREDIENTS OF ‘PROCEEDS OF CRIME’

A review of the definition of ‘proceeds of crime’ in section 2(1)(u) as expanded by the new Explanation calls for a detailed examination of the following terms and expressions:
•   property [section 2(1)(v)]
•   person [section 2(1)(s)]
•   derived or obtained
•   directly or indirectly
•   as a result of criminal activity relating to
•   scheduled offence [section 2(1)(y)]
•   value (of property) [section 2(1)(zb)]

‘property’ is defined in section 2(1)(v). Its specific constituents: corporeal, incorporeal, movable, immovable, tangible and intangible are self-explanatory;
‘person’ is defined in section 2(1)(s). Its constituents are largely similar to its definition in the Income-tax Act with which all of us are familiar;
‘derived’ is a term that has been interpreted in the context of the expression ‘attributable to’ in a number or tax cases. The word ‘derived’ means ‘derived from a source’, or means ‘arise from or originate in’2.
Black’s Law Dictionary (Sixth Edition) defines ‘obtain’ as ‘to get hold of by effort; to get possession of; to procure; to acquire in any way.’
‘indirect’ has been defined in Black’s Law Dictionary (Sixth Edition) as follows:
‘Not direct in relation or connection; not having an immediate bearing or application; not related in natural way. Circuitous, not leading to aim or result by plainest course or method or obvious means, roundabout, not resulting directly from an act or cause but more or less remotely connected with or growing out of it’.
The expression ‘as a result of criminal activity relatable to’ is connected with ‘scheduled offence’. The expression ‘as a result of criminal activity relatable to’ is wider in scope than the expression ‘as a result of the scheduled offence’. A property may be derived or obtained from commission of a scheduled offence. Alternatively, it may be directly / indirectly derived or obtained as a result of criminal activity relatable to a scheduled offence. Both types of properties are now clarified to be considered ‘proceeds of crime’ on a stand-alone basis.

Accordingly, it stands to reason that property and receipts arising from any and every crime are not covered in this definition. Only the following kinds of receipt and property would be covered in the definition of ‘proceeds of crime’:
• Property / receipts which are derived or obtained from the scheduled offence;
• Property / receipts which are the result of criminal activity relatable to a scheduled offence.

‘scheduled offence’ is defined in section 2(1)(y). This definition consists of Part A, Part B and Part C with a clear mention of the statutes and matters covered therein. These do not call for any interpretation.
‘value’ (of property) is defined in section 2(1)(zb) to mean the fair market value of any property on the date of its acquisition.

In view of the expanded definition of ‘proceeds of crime’, a few important aspects are reviewed as follows:

2 CIT vs. Jameel Leathers and Uppers 246 ITR 97

CONSTITUTIONAL VALIDITY OF DEFINITION OF ‘PROCEEDS OF
CRIME’

The Constitutional validity of the definition of ‘proceeds of crime’ has been examined by courts in several cases.

Thus, in B. Rama Raju vs. Union of India (2011) 12 taxmann.com 181 (AP), the vires of the definition of ‘proceeds of crime’ in section 2(1)(u) was called in question on the following ground:

‘Section 2(u) of the Act defines “proceeds of crime” expansively to include property or the value thereof, derived or obtained, directly or indirectly, as a result of criminal activity relating to scheduled offence even if in the hands of a person who has no knowledge or nexus with such criminal activity allegedly committed by others. The expansive definition thus inflicts grossly unreasonable consequences on innocent persons and is, therefore, unconstitutional offending Articles 14, 20, 21 and 300A of the Constitution’. [Emphasis supplied.]

After examining various aspects, the Andhra Pradesh High Court held that section 2(1)(u) which defines the expression ‘proceeds of crime’ is not unconstitutional.

Similarly, in Alive Hospitality & Foods vs. Union of India (MANU/GJ/1313/0013), it was contended before the Gujarat High Court that the definition of ‘proceeds of crime’ was too broad and, therefore, arbitrary and invalid. While rejecting this contention, the High Court made the following observations:

‘The contention that the definition of “proceeds of crime” [section 2(u)] is too broad and is therefore arbitrary and invalid since it subjects even property acquired, derived or in the possession of a person not accused, connected or associated in any manner with a crime and thus places innocent persons in jeopardy, is a contention that also does not merit acceptance’. [Emphasis supplied]

Likewise, in Usha Agarwal vs. Union of India (MANU/SIK/0040/2013), the High Court of Sikkim held that the definition of ‘proceeds of crime’ has the object of preventing and stemming criminal activities related to money-laundering at its very inception and could not be considered arbitrary.

TAINTED PROPERTIES HELD OUTSIDE INDIA – DEEMED
‘PROCEEDS OF CRIME’

In several cases, it is found that properties derived or obtained by committing a scheduled offence are taken away and held outside India. In such situations, the question arises whether the Enforcement Directorate can initiate proceeding against any property of the accused which is held in India to the extent of the value of the proceeds of crime held overseas. This question was addressed by the Delhi High Court in Abdullah Ali Balsharaf vs. Directorate Enforcement (2019) 101 taxmann.com 466 (Delhi). The High Court held that the Enforcement Directorate would be entitled to initiate proceedings against any property held in India to the extent of the value of the ‘proceeds of crime’ held overseas.

It may be noted that the definition of ‘proceeds of crime’ was amended by the Finance Act, 2015 w.e.f. 14th May, 2015 which inserted the words ‘or where such property is taken or held outside the country, then the property equivalent in value held within the country’. Thus, the conclusion of the Delhi High Court is consistent with the said amendment.

In Deputy Director vs. Axis Bank (2019) 104 taxmann.com 49 (Delhi), the Delhi High Court considered a similar situation and came to the same conclusion by making observations to the following effect:

‘The empowered enforcement officer has the authority of law in PMLA to attach not only a “tainted property” – that is to say a property acquired or obtained, directly or indirectly, from proceeds of criminal activity constituting a scheduled offence – but also any other asset or property of equivalent value of the offender of money-laundering, the latter not bearing any taint but being alternative attachable property (or deemed tainted property) on account of its link or nexus with the offence (or offender) of money-laundering’. [Emphasis supplied.]

CLAIM OF BANK – A VICTIM OF FRAUD – CANNOT BE
DEFEATED EVEN IF PROPERTY REPRESENTS ‘PROCEEDS OF CRIME’

In Indian Bank vs. Government of India (2012) 24 taxmann.com 217 (Madras), the question before the Madras High Court was whether the claim of a bank that was a victim of fraud committed by its borrower can be defeated on the ground that the property represented ‘proceeds of crime’?

While answering this question in the negative, the High Court explained the material facts and rationale underlying its conclusion as follows:
•   Nationalised banks are the victims of a fraud committed by the company and its officers. It is the banks’ money which has actually been made use of by the company and its directors to buy properties in their names. Where do these victims stand vis-a-vis the accused in such cases?
•   The PMLA, thus, not only seeks to punish the offenders, but also seeks to punish the victims of such offences.
•   Section 8(6) and section 9, which seek to punish the victims of crime along with the accused, appear to be a disincentive for the victims.
•   For the victims of crime, there would virtually be no difference between the accused and the Central Government, as in any case they would have to lose their property to either of the two.
•   If the order of adjudication made by the Adjudicating Authority becomes final, after the conviction of the company and its directors by the criminal Court, the Central Government would confiscate such property in terms of section 8(6). Thereafter, the property would vest in the Central Government free of all encumbrances u/s 9. In other words, the banks, who were the victims of fraud, may have to lose the property to the Central Government for no fault of theirs except that they were defrauded by the company.
•   If a property is proved to be involved in money laundering, the Adjudicating Authority has only one choice, viz., to make the attachment absolute, wait for the final adjudication by the criminal Court and either release the property to the accused if he is acquitted in the criminal Court, or confiscate the property to the Central Government if the accused is convicted by the criminal Court. Therefore, section 8 in its entirety is accused-centric and Central Government-centric. It does not take into account the plight of the victims of crime.
•   In view of the inherent lacuna in the Act, I think the banks cannot be left high and dry.
•   The Statement of Objects and Reasons of the Act would show that the primary object for which the Act came into existence was for prevention of laundering of proceeds of drug crimes committed by global criminals / terrorists, involved in illicit trafficking of narcotic drugs and psychotropic substances. The more the Act is used for tackling normal offences punishable under the Indian Penal Code, committed within the territories of India, the more the result would be disastrous for the victims of crime. Therefore, sections 5, 8 and 9 cannot be used by the respondents to inflict injury upon the victims of the crime.

PROPERTIES REGARDED AS NOT ‘PROCEEDS OF CRIME’

In a number of cases, Courts and Tribunals have rejected the claim of the Enforcement Directorate that a particular property is ‘proceeds of crime’. A few illustrative cases may be reviewed as follows:

(i) Mortgaged properties acquired prior to fraud – not ‘proceeds of crime’
Often, circumstances show that mortgaged properties were acquired by owners much before the alleged fraud was committed by the accused persons. In such a situation, a question that needs to be addressed is whether such properties were purchased out of the ‘proceeds of crime’ as defined in section 2(1)(u). This question was addressed in Bank of Baroda vs. Deputy Director (2019) 103 taxmann.com 30 (PMLA-AT). In that case, it was held that mortgaged properties which were acquired by owners much before the alleged fraud was committed by the accused person cannot be considered ‘proceeds of crime’.

(ii) Amount of loan received against mortgage of property – not ‘proceeds of crime’
Obtaining loan on mortgage of property is a common business transaction. Often, the allegation is made that the property mortgaged for the loan is acquired from the ‘proceeds of crime’. However, in Branch Manager, Central Bank of India vs. Deputy Director (2019) 107 taxmann.com 102 (PMLA-AT), it was held that where property was mortgaged with the bank much prior to the date of commission of the offence of money-laundering, the property so mortgaged cannot be regarded as acquired out of the ‘proceeds of crime’.

(iii) Amount of loan obtained by misrepresentation – not ‘proceeds of crime’
In Smt. Nasreen Taj vs. Deputy Director (2017) 88 taxmann.com 287 (PMLA-AT), a loan was taken for purchase of land. It was found that the land was purchased before the grant of loan. It was also found that the loan was obtained by misrepresentation in collusion with a bank employee. It was held that the amount of such loan could not be regarded as ‘proceeds of crime’. While reaching this conclusion, the High Court explained the material facts and rationale underlying its conclusion as follows:
•   The complainant in the criminal case is the bank who is the victim. Had the bank not filed a criminal complaint, perhaps the conspiracy might not have been discovered.
•   In a case like the present one if the security of the bank is treated as ‘proceeds of crime’ and is confiscated under the Act, in future no bank in such circumstances would make a complaint to the authorities.
•   The trial in the prosecution complaint would take a number of years. The victim cannot wait for such a long period of time, although after trial and final determination the victim is entitled to recover the amount by selling immovable properties u/s 8(8).
•   The intention of the Act could not have been to affect a third person or an innocent person as is sought to be done in the instant case.
•   If the impugned order is correct, it would be a patently absurd situation that not only substantial securities of the Bank are not available for the benefit of the bank but are vested in the Central Government as ‘proceeds of crime’. Such a result does not advance the objects of the Act.

CONCLUSION

The recent amendment to the definition of ‘proceeds of crime’ has expanded the list of properties considered as involved in the offence of money-laundering or in a scheduled offence. Consequent to the amendment, the area of scrutiny of substantive transactions by a Chartered Accountant while reporting compliance of statutory laws, applicable to transactions involving properties, is widened substantially.

The said amendment makes it incumbent upon a Chartered Accountant to modify his checklist of forensic audit of substantive transactions to ensure that he fully complies with his reporting obligations.

Intaxication: Euphoria at getting a refund from the IRS, which lasts until you realise it was your money to start with
– From a Washington Post word contest

shailesh.kwebmaker

INITIATIVES DURING PANDEMIC – PERSONAL EXPERIENCES

INTRODUCTION

The pandemic was / is unprecedented, a time of extraordinary change for everyone in every facet of life. It has affected people in most parts of the world directly or indirectly. People have lost their near and dear ones, their occupation / livelihood, or limited their lifestyle with the focus only on basic needs. It has changed drastically how we think and behave. It has bought most families nearer (in some cases even caused strife). Life used to be very mechanical in metros while we were chasing our materialistic / professional dreams. It was challenging irrespective of our educational qualifications, the profession or occupation in which we were engaged. The fear of contracting the virus and uncertainty thereafter created a tremendous scare in all of us. However, for us professionals commitment to clients is paramount and in their time of need we need to support them even more.

At our firm we went back to the basics – our purpose, vision and mission. We took a month to understand that this is a long haul and saw how we could support the clients as our first job and then looked at support to all other stakeholders; we also got what we call our knowledge edge initiatives. We started immediately as most of the staff and partners were suddenly free. Many of the measures taken by us in this period have been adverted to in this article which had a positive impact on the entire eco-system of stakeholders. In retrospect, however, there was much more that we could have done.

ASSESSING THE SITUATION

The first thing to be done in such uncertain times is to take stock of the things on hand, understand how the lockdown would impact everyone. Some of the areas we chose to concentrate on were as follows:

* Ensuring the safety of the employees. Some might have been stuck on outstation assignments. Arrangement of the basic needs, stay and travel was essential for them.

* Assessing the work in progress and completing the services possible for clients.

* Getting each and every employee in the firm updated and given in-depth knowledge – level wise.

* Suo motu reducing the fees of the first quarter work as a signal of support to the clients on 1st April, 2020.

* Looking at what value-added service to provide to all clients without visiting them. This was focused more on specific training / knowledge dissemination.

* Improving the connect of the team leaders with their teams and also with the partners. Understanding their needs and seeing how we could fill the gap.

* Restricting the drawals and deferral of salaries for a period of five months. Once the situation was in control, adding the deferral month-wise.

* Investing in automation for office use as well as for clients’ use.

* Faster geographical as well as size expansion was possible. Virtual opening / puja done.

Assessment of possible support to clients in the difficult situation

We believed that once a client engaged us, it was our moral responsibility to provide all possible value-addition during the difficult time. When a firm has been retained for regular advice or periodic audit, even a small value addition would make a big difference. The CA profession is based on trust and these measures would build / enhance trust. We voluntarily reduced the fee to the extent of 25% for three months and gave other support of value-added services based on information already with us without charging any fee.

Assessment of the possible inflow of information from the client

As a CA firm, we need to get the relevant information on time from our clients for delivery of quality service. Whatever problems we had faced in terms of manpower, infrastructure, etc., the same or even more has been the case with our clients, too. Further, the clients had many other priorities and therefore follow-up on calls and recording of the conversations on email was encouraged. Based on the correct assessment of the possible reduced inflow of cash from the clients, the working capital was planned and even a loan was taken.

Assessment of jobs which can be done and which can be deferred

The statutory compliances did get postponed. It was important for us as well as for our clients to assess what jobs could be done during the lockdown and what jobs could be deferred. Some parts of the jobs could be completed and the rest would have to await the opening up for completion.

Assessment of jobs nearing due dates and action plan

Since the lockdown was announced suddenly, the work stopped abruptly. There were many time-bound assignments / compliances. It was certain that the due dates of all the compliances would be extended, but there could have been other implications. In business many things are inter-related. If one task gets delayed, then another one also gets delayed, and so on, and at the end the impact is on the financials and the cashflow. All jobs like review of ledgers, reconciliations, online verifications, even examination of documents / agreements where available, were taken up. Advice on best practices in the lockdown was also shared with every client.

Assessment of manpower availability and action plan

Just before the complete lockdown, or immediately after the announcement, many employees and workers left for their hometowns by whatever means they could find. The trade / industry employer had to assess how many employees were available for working from their homes during the lockdown and what infrastructure they had in their place of stay. For us, articles / assistants from rural areas somehow reached their hometown but of them some are still (even after nine months) to get back to office.

Assessment of the IT infrastructure availability and action plan

The CA firms can use technology to some extent but the profession cannot be fully automatised. The CA profession is intellect-driven and not machine-driven. Our firm has been using office management software and servers for many years for data management, albeit partially. We were able to catch up on that. We were able to adapt partially to the work-from-home philosophy. We quickly prepared a policy for that and a standard operating programme for the same. As we were maintaining most of the data in the cloud, the employees could get the same and helped us to continue with quite a few of the jobs on hand. However, we had some issues where data was in servers.

Assessment of the working infrastructure at the homes of the employees

Work-from-home has its own challenges, especially in metros where houses are generally small. If everyone works from home, there has to be a proper place to sit and work. Continuous working in uncomfortable positions leads to health issues and reduces productivity. Normally, internet bandwidth is not very high at homes. The internet speed available on cell phones is not sufficient for office work, making conference calls, etc. Further, even to make simple calls there could be a challenge when someone else in the home is talking.

We informed our employees to go for best possible internet connection and also for a basic working table and chair. However, those employees who had gone to their villages where internet facilities are not available, just couldn’t work from home.

PLANNING AND THE EXECUTION OF THE JOB

Having assessed the available resources, the infrastructure and the jobs to be done, proper planning had to be done to execute the same. Since the situation was unusual, the execution of the regular jobs was also a challenge. Further, as a CA firm we have to maintain the quality of the deliverables. The quality was to be achieved through more involved monitoring. In the work-from-home situation, the monitoring also needs extra planning and efforts. The seniors in the firms made the plan for the effective monitoring of the execution and the deliverables through regular conference calls, video calls, etc. The use of office management software like Windows Office 365, iFirm and such other software has been of great use. Sharing the data and monitoring have been both convenient and effective. The hands-off approach (delegation) was given up and micro-management with daily calls and follow-up was taken up till the employees started coming back to office.

MANAGING THE CASHFLOW

One of the most challenging aspects has been managing the cashflow. Where the clients have cashflow issues, the CA firm cannot expect timely payments from them. The biggest expense in a CA firm is the employee payouts. A cut in the salary was inevitable for not only the employees but also for drawings of the partners. However, a cut in the salary should not result in an employee leaving the firm. An efficient employee is an asset to the firm. Retaining an efficient employee is very important for its growth. The salary cut was based on the ‘Manu Principle’, i.e., more cut in case of an employee earning more and less cut in case of an employee earning less. Striking the balance between cashflow and keeping the morale of the employees high has been very important. We brought down the targets to ensure that bonus would be possible for most based on performance. However, we did defer the increments this year.

KNOWLEDGE ENHANCEMENT INITIATIVES

As a CA firm, knowledge / skill across the firm was a key to our success. However, in the normal course the knowledge acquired tended to be on the need-to-have basis. This pandemic gave us an opportunity due to the availability of time. The explosion of online education, most of it freely available, supported this endeavour.

HEALTH ADVISORY TO THE EMPLOYEES AND MENTORING

An abrupt change in lifestyle affects health, especially in the case of senior citizens at home. The employees were advised to be very health-conscious, maintaining hygiene, social distancing, using face masks, avoiding crowded places, etc. This pandemic has created huge mental pressure due to a lack of knowledge about its spread and its impact. We believed that moral support by the employer to the personal health of the employees and their family members would boost their morale. Getting an adequate insurance cover for all for Covid-19 was done to provide some succour.

Regular mentoring of the employees during such times is very important. Not only does it enhance the capability of the employee, but it also improves the productivity and loyalty to the firm. Though mentoring was an irregular activity in our firm earlier, its importance was felt even more during this pandemic. Confidence-building, personality development, knowledge enhancement have been achieved to a reasonable extent through training and mentoring. Many took on longer period commitment to paid coaching to enhance themselves.

Daily discussion on the clause-by-clause analysis of the tax laws

Every day, two hours (for two months intermittently) of discussion through video call among the employees on clause-by-clause analysis of the tax laws has enhanced the knowledge of the employees tremendously. A lot of clarity emerged on the provisions of the laws. Such discussions helped us, in spite of our presence in multiple locations, to have a uniform view on the provisions of the laws.

Deliberation on the landmark decisions

The regular deliberation on landmark case laws among the core group in the advisory and litigation team of the firm was very useful. Such discussions helped us in the interpretation of the ratio of the judgment and its effective use in the given situation.

Preparation or updating of the audit programme, checklist and process document

We used the available time for updating the audit programme, the checklist and standard operating procedure in all streams of operations, such as audit, advisory, dispute resolution, etc. We also looked at various operations like human resources management, client engagement, deliverables, data management, accounts administration, all of which are a must for efficient management and growth of the firm and to deliver quality service. These had been on the backburner for years.

Office re-organisation

In normal times, everyone in the firm would be busy. Once the deliverables are delivered, the file is closed. There will be no time to re-look at the file except when there is a requirement subsequently. This added up to the quantity of paper in the office and data in the hard disc / server. Such unwanted accumulation of data would make it difficult to retrieve the relevant data in the future. During the pandemic, the spare time was used for cleaning of the unwanted papers / files in the office, unwanted data in the hard disc / server and proper organisation of the relevant data and audit papers / documents in some of our offices.

Training the employees of the client

Efficient service to the clients sometimes depends on the quality of data provided by the employees of the client. Where the employee of the clients is properly trained about the compliance required, the form in which the data is to be provided would certainly help the CA firm. During the pandemic, time was utilised for training either all the employees of our clients, or through tailor-made training programmes. Such knowledge enhancement of the employees of the clients has been a value-added activity.

Webinar – Knowledge sharing

Continuous education is a must for every chartered accountant. Sharing knowledge is a good way of learning. A well-structured webinar delivered by an expert would always be well attended. However, it should be as per the Code of Conduct of the ICAI. We conducted several webinars on various subjects inviting our clients and known CAs. We also ensured that we took the opportunity to accept any invitation to speak, especially if it was a challenging subject.

Certificate courses

Since time was available and employees of companies / professionals were available at home, we conducted a number of GST certificate courses. We allowed / mandated / encouraged the employees to attend such courses. Many senior employees were allowed to teach in internal learning sessions and then joined the seniors for public seminars.

Book-writing, revisions and writing, updating the articles

During the pandemic, we could reconsider updating our old books and take on some planned books. We were able to write more than 70 articles and update several existing articles on the website. The updation of the website to some extent has also been done.

Self-empowerment initiatives

The pandemic has provided a great opportunity to introspect and take self-empowerment initiatives. Many great institutions all over the world have been offering online courses in various subjects. Some of them are free and others are for a fee. It was time to set goals and make positive choices and take control of our own lives. It was time to understand our strengths and weaknesses and to develop the belief within. It is true that every challenge is an opportunity to grow. Some of us have participated in a few such self-empowerment programmes.

Expansion

As we were able to spare some time, we started a branch in a metro city (on 10th August, 2020). Mentoring was possible because of the slack and now we are ready to open offices in three Tier II cities before March, 2021. We also decided to have smaller offices due to the focus on online training and seminars.

CONCLUSION

It is a fact that we could choose to react to this dreadful epidemic by focusing on professionalising the firm, empowering ourselves and our employees. The future might not be the same as was the past. The future appears to be more virtual. We believe that it is better to invest in technology, adapt to the change and go digital. The flip side of the pandemic was that it provided a lot of time to introspect and look at the issues on the backburner. The familiar ‘I am too busy’ trope was not available and professionals like us did much more to strengthen the depth of knowledge, catching up with training, took up updating books and articles and, importantly, the one-to-one interpersonal activities increased significantly.

On the whole, we got better prepared for the delivery of services remotely as well as attracting clients due to higher visibility and sharing. Our multi-locational presence has helped us to leverage and support each other because the situation was not so bad in a few locations. Thanks to all these foundation-strengthening activities, we are poised for major growth in F.Y. 2021-22 even though the pandemic is still affecting some locations.

Money is like a sixth sense – and you can’t make use of the other five without it

– William Somerset Maugham

shailesh.kwebmaker

DIGITAL MARKETING? NAAH, IT’S DIGITAL BRANDING

A practising Chartered Accountant is bound by the Code of Ethics (‘CoE’) and is not permitted to advertise herself or her services. Honestly, a CA’s service holds dignity and doesn’t require any kind of solicitation. However, it must be noted that many other entities hire CAs and can brand for more or less all services that a Chartered Accountant offers and market and brand them. From that perspective, a Chartered Accountant is at a disadvantage as she is not on a level playing field. Therefore, we cannot ignore the fact that building a brand for oneself is equally important in today’s world.

I’m sure all of you have come across the following kinds of questions:
•       I am not sure if my firm or I can be on social media or digital platforms because our Code of Ethics does not allow that;
•       CA, as a profession, runs purely on referrals and social or digital media may not help;
•       I know few people who are on these platforms but I’m not sure how effective that is;
•       I feel it’s a waste of time and I have better technical things to concentrate on.

Let us now quickly look at answering these questions by simply understanding the basics of Digital Branding.

WHAT IS DIGITAL
BRANDING?

Today, for everything we search on Google, but do you know Google is merely a search engine and it does not create most of the content? All it does is smartly present to you content which is created by millions of users and subject matter experts like us.

Digital Branding is a process of creating an online identity and brand story of your firm or of yourself. It involves using online channels like websites, social media, SEOs, etc., so that when someone is in need of answers she can get them via Google search or other social media.

To put it simply, Digital Marketing is like pulling customers to you by advertising which is restricted and against the code of ethics, whereas Digital Branding is like creating a digital presence so that those who are in need of advice / service get contact details to approach you.

In the current professional services era, you can think of your brand as the visibility of your digital reputation.

WHY IS DIGITAL
BRANDING IMPORTANT?

Technology is something that disrupts every industry every now and then and firms that do not adjust with technology may cease to exist. We have so many examples of mobile giants like Blackberry, Nokia, etc. However, being professionals we are assured that our knowledge and expertise will not be replaced just like Kodak paper was replaced with Digital Photography. But does that mean technology will not disrupt how CAs are working or getting new clients?

Let us take a look at just the last six months. How many of us had earlier heard about Zoom (a company that was set up in 2011)? But today we will hardly find any professionals who have not heard of or used Zoom. Yes, the pandemic was unprecedented and the entire world was under lockdown so we were all forced to switch to the Digital World. And everyone co-operated in the switch. However, does every change follow the same process? What if, after a few years of working, we suddenly realise that something else has changed slowly but certainly and that we are now the odd person out?

Do we need to wait for a pandemic to teach us the next lesson or do we start blending in with a five-year plan? It’s high time to envisage the importance of digital branding. Agreed, that our profession runs on a referral model, but imagine someone referring you to a potential client and they do not find any digital presence while Googling (searching your firm’s name on Google). There are high chances they may not even approach you. Secondly, the belief that ICAI COE doesn’t allow us to be on digital / social media platforms, or that it’s a risky thing to do, isn’t true.

Currently, there are around 1.5 lakh practising CAs but the real competition is online companies which place advertisements and many other semi-qualified CAs or other professionals offering to do the same work as CAs. Not that all users are interested in hiring those online companies or the semi-qualified individuals – but their ability to approach professionals is limited to Google and other social media, but we are virtually not present there.

WHY HAVING A DIGITAL BRAND WILL
WORK FOR US

Digital Media has its own set of advantages and we have already witnessed one of its major advantages in the pandemic. It was a Eureka! moment for a lot of people who realised that we may not need to travel all the way to just speak face-to-face. We can just do a video call, have negotiations, meetings and discussions and close the deal. Let us try and understand the various advantages that the Digital Platform offers us:

• Cost-effective – Unlike other traditional modes of branding, it is cost-effective. About 90% of the digital media platforms are free to use. The cost, most of the time, is the ‘TIME’ that you invest in using the Digital Platform;
• Global market – With the www revolution, we are not bound by physical boundaries. Anything we post on social media can be accessed by anyone in the world. Connecting has become seamless. For example, a website of a person working in a remote village can be accessed by a person sitting in the US or Europe, vs. the physical billboard outside our office;
• Flexibility – A user can access the details while travelling or early in the morning, or late night, whether on laptop or mobile; digital platforms give flexibility to users to read, watch or listen at a time and place of their choice, as well as it gives us the flexibility to post or just simply schedule the posting as well;
• Interactive – All digital platforms are much more interactive than traditional modes. Websites offer chatbox option, social media provide Direct Message Option and hence when the interaction is quick, there are high chances that users with queries can turn into clients with consultancy;
• Tracking results and analytics – A majority of the digital platforms provide analytics which can help track the results of each post.

Clause (6) of the First Schedule, Code of Ethics, says that a ‘Chartered Accountant in practice shall be deemed to be guilty of professional misconduct, if he solicits clients or professional work either directly or indirectly by circular, advertisement, personal communication or interview or by any other means’.

Often, a practising CA is reluctant to use digital or social media believing it to be a push mode and an indirect way of soliciting. This is where Digital Branding wins over Digital Marketing. Before we look at different modes of digital branding, let us understand the difference with some quick examples:

Digital Marketing / Push Mode	Digital Branding / Pull Mode
Updating status on various social media or sending direct messages to your connects asking them for collaboration or direct work	Regularly updating status on various notifications which show your expertise to readers which may ultimately (in the long run) help win a client
Yourself writing client reviews or attaching screenshots which may brag about your work	Your clients tagging you or giving you a review on ‘Google My Business’ page of how happy they were with your services
Replying to comments on your posts with ‘Reach out to us to avail services’	Replying to comments with your knowledge and leaving an ‘In case you have further queries, you may feel free to reach out to us’

When we talk about having a digital presence, we are nowhere soliciting or advertising our services but just building a brand on digital platforms by generating rich and useful content.

WHAT ARE THE VARIOUS MODES OF
DIGITAL BRANDING?

In this section of the article, we will sketchily look at the modes of Digital Branding and how it may help to build your brand to eventually help you / your firm grow.

Mode I: Search Engine Optimisation
Search engine optimisation (SEO) is the process of growing the quality and quantity of website traffic by increasing the visibility of a website or a web page to users of a web search engine like Google Search or other Social Media Search. In short, SEO is utilising specific goal-oriented strategies to ensure that we rank higher up in search results pages. Firms using SEOs to optimise their content (whether websites or Google My Business) will be the ones clients get their answers from when they first Google and eventually land up assigning their work to the firms. The broad channel categories of SEO Branding include these modes:

A) Website:
Your firm’s website should be optimised with words that show your niche. A good website should ideally be mobile-friendly as well as optimised for computer screens. Your website is your first digital impression; a poorly designed one is like having an office in an area where no one prefers to travel. Websites should be easy to navigate and should answer basic questions like what’s your specialisation, your location and what information and tools you provide and, most importantly, the call to action button, i.e., where a visitor can contact you in case she has a query. If words in a website are used wisely, it can enrich the SEO and provide better search results.

B) Google My Business Account:
The fact is that around 65% of the CA firms do not have their own Google My Business (‘GMB’) account. A GMB account basically is Google’s way of verifying small businesses. So when someone searches exactly about your business, Google shows details about the business on the right-hand side of the search result. If a GMB account is not created, it may show other firms’ results instead. Besides, a verified GMB account means your official website appears first in search results when someone searches your firm’s name instead of some random online aggregator websites.

Having a GMB account builds your brand in multiple ways – it improves SEO for a professional web page, helps you build reputation by taking reviews from clients and colleagues for your page and all of this is absolutely without charge. To summarise, a GMB account is a ‘should have’ and not a ‘good to have’.

Mode II: Social Media Branding
Social Media (‘SM’) Branding is the use of social media platforms to connect with your audience. This involves publishing great and engaging content with your SM profiles, listening to and engaging your followers and analysing your results. Co-reading this with paragraph 2.14.1.7(vii) & (x) of Clause 7, First Schedule of COE, it is to be noted that though one can use the prefix ‘CA’ on SM profiles and have a firm page on SM accounts, utmost care should be taken that no exaggerated claims are made (such as, Best CA for GST, Best CA in Mumbai and so on). Hence, the perception that as a practising CA one may / should not have an SM presence doesn’t really hold true. Let’s quickly look at the channels of SM and how these may help in branding:

(a) LinkedIn / Twitter / Facebook / Instagram:
It is a known fact that the number of users on the above SM in India (including professionals, too, considering LinkedIn and Twitter) are in their billions and not having a presence on these SM won’t really help. These platforms work in an easy way: Every time you publish a post or share an update which the readers find useful, they tend to share the same and the reach increases. The more content you generate on SM, the more people will know you and the better brand you will build for yourself. Firms regularly sharing relevant updates build a reputation which in the long run will get them more clients. (Think about it like this – Since childhood you have seen ads and hoardings of Activa two-wheelers and as a first-time user when you plan to buy a two-wheeler, Activa would be the first brand that will come to your mind. The same happens with clients who look for services the first time.) So, if you have regularly maintained your brand on SM, they will be inclined towards you.

(b) Quora:
This is my personal favourite SM platform. Quora has a competitive edge as only about 500 practising CAs are currently using it. What makes it unique is the purpose of the user visiting it. It’s neither search nor social media but somewhere in between. The content posted here is easy to find even months and years later, unlike other SM where it gets buried or disappears. If any potential clients using Quora find an answer posted by you / your firm, there are 85% chances of them connecting with you when they look for any formal consultancy. This is primarily because of the satisfaction they received with your simple answers. Practising professionals who are active on Quora create an avenue to get new clients for themselves simply by answering questions. Needless to add, the brand is also worth cultivating because the platform has a global reach.

Mode III: Content Branding
Content branding is a strategic approach focused on creating and distributing valuable, relevant and consistent content to attract and retain a clearly defined audience. In our profession, content branding entails writing books, articles, blogs or any kind of write-ups (collectively defined as write-up). Paragraph 2.14.1.6(iv)D of Clause (6), First Schedule of COE countenances using the designation CA in the write-ups. So, every time a person reads your write-up which shows your specialisation, they are building an image of you and next time they wish to have a consultancy on that topic, they may be inclined to approach you because you created a reputation on the topic with your content.

Mode IV: Audio / Visual Branding
If truth be told, the modern generation prefers audio / visual stimulus that is easily accessible and gets to the point over the idea of having to read something, and hence audio / visual branding these days becomes imperative. It’s really simple – a random user (who may be a potential client) wanting to learn how to log-in to the GST portal will prefer to watch a video on the same or attend a webinar rather than reading about it. So, when it’s about technical substance, people prefer reading write-ups, but when it comes to practical stuff, a webinar or an educational video will have the upper hand. And this is what audio / visual branding is all about – creating a marquee for yourself / your firm.

And this definitely works, given the following motives:
•       Hosting a webinar or uploading a video gives you an opportunity to position yourself as an expert in the topic;
•       It is an indirect way of soft sales;
•       The level of interaction it provides gives comfort to the audience; and
•       Lastly, it’s the new trend and we do not want to stay out of sync with it.

While we have delved into how audio / visual branding helps strengthen our Digital Presence, it is also to be noted that there is no violation of the code of ethics here provided we are cautious about not mentioning the firm’s name in the videos [ruled by Paragraph 2.14.1.6(iv) – Q of Clause 6, First Schedule of COE]. However, sharing videos on your own SM profile still does the work.

To summarise, while the COE does restrict direct ways of advertising, we should avoid Digital Marketing but definitely cannot avoid having a Digital Brand for ourselves or our firm. The modes of digital branding discussed here, when used with the correct strategies for each digital / SM platform, can work wonders for us even without soliciting work.

As a first step, this is what should be done:
•       Creating, reviewing and revamping your individual and your firm’s digital / SM channels (redesigning website to enrich the SEO, having a GMB account, initiating and start using Quora, review each of the SM profiles);
•       Plan your first webinar / YouTube video which can showcase your expertise and make it reach more people;
•       Stop hard-selling, rather work on building a reputation on these channels; and
•       Connect with relevant professionals on LinkedIn / Twitter and follow them.

For, it goes without saying that
NETWORK = NET WORTH

Do you think you’re sitting still right now?
– You’re on a planet orbiting a star at 30 km/s
– That star is orbiting the centre of a galaxy at 230 km/s
– That galaxy is moving through the universe at 600 km/s
Since you started reading this, you have travelled about 3,000 km

If your hate could be turned into electricity,
it would light up the whole world
– Nikola Tesla

shailesh.kwebmaker

THE LONG FORM AUDIT REPORT FOR BANKS GETS EVEN LONGER

INTRODUCTION

The Long Form Audit Report (LFAR) has for long been used as a tool by the RBI through the Statutory Auditors to identify and assess gaps and vulnerable areas in the working of banks. According to the RBI, the objective of the LFAR is to identify and assess the gaps and vulnerable areas in the business operations, risk management, compliance and efficacy of internal audit and provide an independent opinion on the same to the Board of the bank.

As recently as on 5th September, 2020, RBI notified a revised format of the LFAR, applicable from the financial year 2020-21, which repeals the earlier format and other instructions issued on 17th April, 2002. Whilst almost all the earlier requirements have been retained, there have been several specific matters which have been included for reporting keeping in mind the large-scale changes in the size, complexities, risks and business models related to banking operations in the last two decades.

The LFAR is an integral part of the statutory audit of banks which needs to be factored right from the planning to the reporting stage of the audit process. In designing the audit strategy and plan, the auditor should consider the LFAR requirements and conduct need-based limited transaction testing.

The following are the main sources of information for the purpose of compiling the information for LFAR reporting:
a) Audited financial statements and the related groupings, trial balances and account analysis / schedules;
b) Minutes of the meetings of the Board and the various committees;
c) Internal and concurrent and other audit reports;
d) RBI inspection reports;
e) Other supporting MIS data / information produced by the entity which should be verified for accuracy /completeness as per the normally accepted audit procedures in terms of the SAs;
f) Policies and procedures laid down by the management.

This article attempts to provide an overview of the major changes in the reporting so as to sensitise both the Central Statutory Auditors and the Branch Auditors.

COVERAGE

As was the case with the earlier format, the indicative areas of coverage are separately indicated for the Central Statutory Auditors and the Branch Auditors. However, in cases where there is only one Statutory Auditor, which is generally the case with private sector banks or the branches of foreign banks, the auditors should ensure that the contents under both the sections are read harmoniously such that nothing significant is missed out. Since the areas to be covered are only indicative, the RBI in its Circular has made it clear that any material additions / changes in the scope may be done by giving specific justification and with prior intimation to the Audit Committee. Accordingly, the auditors should not adopt a boilerplate approach.

Major changes in the indicative content are discussed and analysed in the subsequent sections.

FOR CENTRAL STATUTORY AUDITORS

Credit Risk areas
Credit Risk in the context of banking refers to the risk of default or non-payment or non-adherence to contractual obligations by a borrower. The revenue of banks comes primarily from interest on loans and thus loans form a major source of credit risk. Whilst the basic reporting requirements are the same as before, there are several additional areas which need to be reported / commented upon and which can be broadly categorised as under:

Area	Additional areas to be commented / reported upon be commented / reported upon
*Loan policy*	Specific observations are required regarding the business model / business strategy as per the policy as against the actual business / income flow of the bank
*Review / monitoring / post-sanction follow-up / supervision*	The following are some of the additional matters requiring specific comments / reporting: • Comments on the overall effectiveness of credit monitoring system covering both on-balance sheet and off-balance sheet exposures, along with the quality of reporting both within the bank and to outside agencies (like RBI, CRILC, CIBIL), etc. • Comments on the functioning and effectiveness of the system of identifying and reporting of Red-Flagged Accounts based on Early Warning System (EWS) indicators for which reference should be made to the Master Directions on Frauds-Classification and Reporting dated 1^st July, 2016 issued by the RBI *(also applicable to Branch Auditors)*
*Restructuring / resolution of stressed accounts*	This is an entirely new section which has been introduced keeping in mind the emphasis on restructuring in the backdrop of the enhanced level of stressed assets in the banking system. The specific matters on which comments are required are summarised hereunder: • Deviations observed in restructured accounts / stressed accounts under resolution with reference to internal / RBI guidelines • Special emphasis should be given on the stance of the bank with respect to the following matters: a) formulation of board-approved policies including timelines for resolution; b) the manner in which decisions are taken during review period; c) board-approved policies regarding recovery, compromise settlements, exit of exposure through sale of stressed assets, mechanism of deciding whether a concession granted to a borrower would have to be treated as restructuring or not, implementation of resolution in accordance with the laid-down conditions, among others; Special attention would have to be paid in the current financial year regarding the relaxations and concessions provided as a result of COVID-19
*Asset quality (also applicable to branch auditors)*	This is also an entirely new section given the emphasis on asset classification and the consequential provisioning and attempts by banks and borrowers to subvert the same. The specific matters on which comments are required are summarised as below: • Continuous monitoring of classification of accounts into Standard, SMA, Sub-standard, Doubtful or Loss as per the Income Recognition and Asset Classification Norms by the system, preferably without manual intervention, determining the effectiveness of identifying the consequential NPAs and the appropriate income recognition and provisioning thereof;
*Asset quality (continued)*	• Procedure followed by the bank in upgradation of NPAs, updation of the value of securities with reference to RBI regulations and compliance by the bank with divergences observed during earlier RBI inspection(s) with requisite examples of deviations, if any It is imperative for the auditors to thoroughly review the latest RBI Guidelines and Circulars and also read the latest RBI inspection reports since greater granularity in reporting is now expected *vis-a-vis* the earlier reporting requirements
*Recovery policy (also applicable to branch auditors)*	The following are some of the additional matters requiring specific comments / reporting dealing with the Insolvency and Bankruptcy Resolution Process: • System of monitoring accounts under Insolvency and Bankruptcy Code, 2016 (IBC) • Verifying the list of accounts where insolvency proceedings had been initiated under IBC, but subsequently were taken out of insolvency u/s 12A of the IBC by the Adjudicating Authority based on the approval of 90% of the creditors. The auditors may satisfy themselves regarding the reasons of the creditors, especially the bank concerned, to agree to exiting the insolvency resolution process, and may comment upon deficiencies observed, if any
*Large advances*	The Guidelines now specifically require comments on adverse features considered significant in top 50 standard large advances and the accounts which need management’s attention. In respect of advances below the threshold, the process needs to be checked and commented upon, based on a sample testing. This is a very onerous responsibility which has been cast on the auditors and needs to be factored in whilst selecting their sample for testing. Earlier there was no specific quantitative threshold laid down for reporting. Care should be taken to ensure that the sample which is selected also covers cases beyond the top 50 standard accounts. Further, it appears that this threshold is for the bank as a whole (Attention is also invited to the reporting requirements for Branch Auditors discussed subsequently wherein different quantitative thresholds are specified for individual branches)
*Audit reports*	Major adverse features observed in the reports of all audits / inspections, internal or external, carried out at the credit department during the financial year should be suitably incorporated in the LFAR, if found persisting

Area

Additional areas to be
commented / reported upon

be commented / reported
upon

Loan policy

Specific observations are required regarding the business model /
business strategy as per the policy as against the actual business / income
flow of the bank

Review / monitoring / post-sanction follow-up / supervision

The following are some of the additional matters requiring
specific comments / reporting:

• Comments on the overall effectiveness of
credit monitoring system covering both on-balance sheet and off-balance
sheet exposures, along with the quality of reporting both within the bank and
to outside agencies (like RBI, CRILC,
CIBIL), etc.

•
Comments on the functioning and effectiveness of the system of
identifying and reporting of Red-Flagged Accounts based on Early
Warning System (EWS) indicators for which reference should be made to the
Master Directions on Frauds-Classification and Reporting dated 1^st
July, 2016 issued by the RBI (also applicable to Branch Auditors)

Restructuring / resolution of stressed accounts

This is an entirely new section which has been introduced
keeping in mind the emphasis on restructuring in the backdrop of the enhanced
level of stressed assets in the banking system. The specific matters on which
comments are required are summarised hereunder:

•
Deviations observed in restructured accounts / stressed accounts under
resolution with reference to internal / RBI guidelines

•
Special emphasis should be given on the stance of the bank with
respect to the following matters:

a)
formulation of board-approved policies including timelines for resolution;

b) the
manner in which decisions are taken during review period;

c)
board-approved policies regarding recovery, compromise settlements,
exit of exposure through sale of stressed assets, mechanism of deciding
whether a concession granted to a borrower would have to be treated as
restructuring or not, implementation of resolution in accordance with the
laid-down conditions, among others;

Special attention would have to be paid in the current financial
year regarding the relaxations and concessions provided as a result of
COVID-19

Asset quality (also applicable to branch auditors)

This is also an entirely new section given the emphasis
on asset classification and the consequential provisioning and attempts by banks
and borrowers to subvert the same. The specific matters on which comments are
required are summarised as below:

•
Continuous monitoring of classification of accounts into Standard,
SMA, Sub-standard, Doubtful or Loss as per the Income Recognition and Asset
Classification Norms by the system, preferably without manual intervention,
determining the effectiveness of identifying the consequential NPAs and the
appropriate income recognition and provisioning thereof;

Asset quality (continued)

• Procedure followed by the bank in
upgradation of NPAs, updation of the value of securities with reference to
RBI regulations and compliance by the bank with divergences observed during
earlier RBI inspection(s) with requisite examples of deviations, if any

It is imperative for the auditors to thoroughly review the
latest RBI Guidelines and Circulars and also read the latest RBI inspection
reports since greater granularity in reporting is now expected vis-a-vis
the earlier reporting requirements

Recovery policy (also applicable to branch auditors)

The following are some of the additional matters requiring
specific comments / reporting dealing with the Insolvency and Bankruptcy
Resolution Process:

•
System of monitoring accounts under Insolvency and Bankruptcy Code,
2016 (IBC)

•
Verifying the list of accounts where insolvency proceedings had been
initiated under IBC, but subsequently were taken out of insolvency u/s 12A of
the
IBC by the Adjudicating Authority based
on the approval of 90% of the creditors.
The auditors may satisfy themselves regarding the reasons of the creditors,
especially the bank concerned, to agree to exiting the insolvency resolution
process, and may comment upon deficiencies observed, if any

Large advances

The Guidelines now specifically require comments on adverse
features considered significant in top 50 standard large advances and the
accounts which need management’s attention. In respect of advances below
the threshold, the process needs to be checked and commented upon, based on a
sample testing. This is a very onerous responsibility which has been
cast on the auditors and needs to be factored in whilst selecting their
sample for testing. Earlier there was no specific quantitative threshold laid
down for reporting. Care should be taken to ensure that the sample which is
selected also covers cases beyond the top 50 standard accounts. Further, it
appears that this threshold is for the bank as a whole

(Attention is also invited to the reporting requirements for
Branch Auditors discussed subsequently wherein different quantitative
thresholds are specified for individual branches)

Audit reports

Major adverse features observed in the reports of all audits / inspections,
internal or external, carried out at the credit department during the
financial year should be suitably incorporated in the LFAR, if found
persisting

Market risk areas
Market risk mostly occurs from a bank’s activities in capital markets, commodities markets and dealings in foreign currencies. This is due to the unpredictability of equity markets, movement of exchange and interest rates, commodity prices and credit spreads. The major components of a bank’s market risk include interest rate risk, equity risk, commodity price risk and foreign exchange risk.

This section covers reporting on investments and derivatives (the latter being specifically added) apart from CRR / SLR and ALM reporting requirements. Some of the specific additional areas requiring comments / reporting are as under:

•    Merit of investment policy and adherence to the RBI guidelines.
•    Deviations from the RBI directives and guidelines issued by FIMMDA / FIBIL / FEDAI which primarily deal with valuation of investments and foreign exchange exposures should be suitably highlighted.
•    With respect to the RBI directives, special focus should be placed on compliance with exposure norms, classification of investments into HTM / AFS / HFT category and inter-category shifting of securities.
•    Veracity of liquidity characteristics of different investments in the books, as claimed by the bank in different regulatory / statutory statements.
•    The internal control system, including all audits and inspections, IT and software being used by the bank for investment operations should be examined in detail.

Since there is a lot of emphasis on compliance with the RBI guidelines, it is important for auditors to be aware of the relevant guidelines dealing with investments and derivatives, the important ones being as under:

•    Master Circular – Prudential Norms for Classification, Valuation and Operation of Investment Portfolio by Banks dated 1st July, 2015 and other related matters.
•    General Guidelines for Derivative Transactions vide RBI Circulars dated 20th April, 2007, 2nd August, 2011 and 2nd November, 2011 together with specific operational guidelines for Currency Option, Exchange Traded Interest Rate Futures, Interest Rate Options and Commodity Hedging vide separate Master Directions.
•    Guidelines for Inter-Bank Foreign Exchange Dealings vide Master Directions on Risk Management and Inter-Bank Dealings dated 5th July, 2016.

Governance, assurance functions and operational risk areas
This is a new section introduced in place of the existing section on Internal Controls. Whilst the basic reporting requirements are the same as before, there are several additional areas which need to be reported / commented upon and which can be broadly categorised as under:

Area	Additional areas to be commented / reported upon
*Governance and assurance functions*	This is an entirely new section given the emphasis on proper and robust governance and risk management keeping in mind the large-scale changes in the business model of banks. The specific matters on which comments are required are summarised hereunder: • Observations on governance, policy and implementation of business strategy and its adequacy *vis-à-vis* the risk appetite statement of the bank • Comments on the effectiveness of assurance functions (risk management, compliance and internal audit) • Comments on the adequacy of risk-awareness, risk-taking and risk-management, risk and compliance culture The following are some of the specific matters which are relevant for an effective governance, assurance and risk management system in a bank: a) Oversight and involvement in the control process by the Board, Audit Committee and Those Charged With Governance, some of which are specifically mandated by the RBI, like framing of policies on specific areas, constitution of specific Board Level Committees and undertaking calendar of reviews. b) Mandatory Risk Based Internal Audit vide RBI Circular Ref: DBS.CO.PP.BC. 10/11.01.005/2002-03, 27^th December, 2002. c) Mandatory Concurrent Audit vide RBI Circular Ref: DBS.CO.ARS. No. BC. 2/08.91.021/2015-16 dated 16^th July, 2015
Balancing of books / Reconciliation of control and subsidiary records	Item-wise details of system-generated transitory accounts not nullified at the year-end should be given separately with ageing of such items
Inter-branch reconciliation, suspense accounts, sundry deposits, etc.	The following are some of the additional matters requiring specific comments / reporting: • Sufficiency of audit trail with respect to entries in such accounts • Age-wise analysis of unreconciled entries for each type of entry as on balance sheet date along with subsequent clearance thereof, if any, should be provided
*Frauds / vigilance (also applicable to branch auditors)*	Special focus should be given to the potential risk areas which might lead to perpetuation of fraud. For this purpose, reference should be made to Early Warning System (EWS) indicators as per the Master Directions on Frauds-Classification and Reporting dated 1^st July, 2016 issued by the RBI
*KYC / AML requirements (also applicable to branch auditors)*	This is also an entirely new section given the need and importance for banks to comply with various AML regulations and also regulations countering the financing of terrorism and to prevent them from becoming involved with criminal or terrorist activity. The specific matters on which comments are required are summarised hereunder: • Whether the bank has duly updated and approved KYC and AML policies in synchronisation with RBI circulars / guidelines. • Whether the said policies are effectively implemented by the bank. • Assessment of the effectiveness of provisions for preventing money laundering and terrorist financing. The KYC and AML Guidelines are prescribed in the Master Directions on KYC dated 8^th December, 2016 as amended from time to time issued by the RBI. As per the directions, all banks are required to frame a KYC policy which must contain at least the following key elements as laid down in the Master Directions: a) Customer Acceptance Policy. b) Risk Management. c) Customer Identification Procedures. d) Monitoring of Transactions. e) Maintenance of Records under the PML Act. f) Reporting Requirements to Financial Intelligence Unit – India and sharing of information.
*Para-banking activities*	There is now a separate section which has been included in respect of such activities which are specifically permitted to be undertaken by the RBI, either departmentally or through subsidiaries. These activities are generally non-fund based and are a major source of revenue for banks. The specific matters on which comments are required are summarised hereunder: • Whether the bank has an effective internal control system with respect to para-banking activities undertaken by it. • A list of such para-banking activities undertaken by the bank should also be provided. The RBI has issued a Master Circular dated 1^st July, 2015 as amended from time to time on such activities. Some of the main para-banking activities which banks are permitted to undertake either departmentally or through subsidiaries in terms of the aforesaid Circular are Equipment Leasing, Hire Purchase and Factoring, Primary
*Para-banking activities (continued)*	Dealership Business, Mutual Fund Business, Insurance Business, etc.

Area

Additional areas to be commented /
reported upon

Governance and assurance functions

This is an entirely new section given the emphasis on
proper and robust governance and risk management keeping in mind the large-scale
changes in the business model of banks. The specific matters on which
comments are required are summarised hereunder:

•
Observations on governance, policy and implementation of
business strategy and its adequacy vis-à-vis the risk
appetite statement of the bank

•
Comments on the effectiveness of assurance functions (risk management,
compliance and internal audit)

•
Comments on the adequacy of risk-awareness, risk-taking and
risk-management, risk and compliance culture

The following are some of the specific matters which are
relevant for an effective governance, assurance and risk management system in
a bank:

a) Oversight
and involvement in the control process by the Board, Audit Committee and
Those Charged With Governance, some of which are specifically mandated
by the RBI, like framing of policies on specific areas,
constitution of specific Board Level Committees and undertaking calendar of
reviews.

b) Mandatory
Risk Based Internal Audit vide RBI Circular Ref: DBS.CO.PP.BC.
10/11.01.005/2002-03, 27^th December, 2002.

c) Mandatory
Concurrent Audit vide RBI Circular Ref: DBS.CO.ARS. No. BC.
2/08.91.021/2015-16 dated 16^th July, 2015

Balancing of books / Reconciliation of control and subsidiary
records

Item-wise details of system-generated transitory accounts not
nullified at the year-end should be given separately with ageing of such
items

Inter-branch reconciliation, suspense accounts, sundry deposits,
etc.

The following are some of the additional matters requiring
specific comments / reporting:

•
Sufficiency of audit trail with respect to entries in such accounts

•
Age-wise analysis of unreconciled entries for each type of entry as on
balance sheet date along with subsequent clearance thereof, if any, should be
provided

Frauds / vigilance (also applicable to branch auditors)

Special focus should be given to the potential risk areas which
might lead to perpetuation of fraud. For this purpose, reference should be
made to Early Warning System (EWS) indicators as per the Master Directions
on Frauds-Classification and Reporting dated 1^st July, 2016 issued
by the RBI

KYC / AML requirements (also applicable to branch auditors)

This is also an entirely new section given the need and
importance for banks to comply with various AML regulations and also
regulations countering the financing of terrorism and to prevent them from
becoming involved with criminal or terrorist activity. The specific matters on
which comments are required are summarised hereunder:

•
Whether the bank has duly updated and approved KYC and AML policies in
synchronisation with RBI circulars / guidelines.

•
Whether the said policies are effectively implemented by the bank.

•
Assessment of the effectiveness of provisions for preventing money
laundering and terrorist financing.

The KYC and AML Guidelines are prescribed in the Master
Directions on KYC dated 8^th December, 2016 as amended from time to
time issued by the RBI.

As per the directions, all banks are required to frame a KYC
policy which must contain at least the following key elements as laid down in
the Master Directions:

a)
Customer Acceptance Policy.

b) Risk
Management.

c) Customer Identification Procedures.

d)
Monitoring of Transactions.

e)
Maintenance of Records under the PML Act.

f)
Reporting Requirements to Financial Intelligence Unit – India and
sharing of information.

Para-banking activities

There is now a separate section which has been included in
respect of such activities which are specifically permitted to be undertaken
by the RBI, either departmentally or through subsidiaries. These activities
are generally non-fund based and are a major source of revenue for banks. The
specific matters on which comments are required are summarised hereunder:

•
Whether the bank has an effective internal control system with respect
to para-banking activities undertaken by it.

• A
list of such para-banking activities undertaken by the bank should also be
provided.

The RBI has issued a Master Circular dated 1^st July,
2015 as amended from time to time on such activities. Some of the main
para-banking activities which banks are permitted to undertake either
departmentally or through subsidiaries in terms of the aforesaid Circular are
Equipment Leasing, Hire Purchase and Factoring, Primary

Para-banking activities (continued)

Dealership Business, Mutual Fund Business, Insurance Business,
etc.

CAPITAL ADEQUACY

Whilst the existing requirement of attaching the Capital Adequacy computation certificate in accordance with the BASEL III guidelines along with the comments on the effectiveness of the system of calculating the same and reporting of any concerns relating thereto are retained, there is now an additional requirement to give certain comments with regard to the International Capital Adequacy Assessment Process (ICAAP) Document, which is briefly discussed hereunder.

ICAAP Document
ICAAP is a process which needs to be undertaken by banks in terms of BASEL III under Pillar 2 Supervisory Review Process (SRP), which envisages the establishment of suitable risk management systems in banks and their review by the RBI. One of the principles under SRP envisages that the RBI would review and evaluate banks’ internal capital adequacy assessments and strategies, as well as their ability to monitor and ensure their compliance with the regulatory capital ratios which gets reflected in the ICAAP document, which is required to be submitted to the Board of Directors for review and then forwarded to the RBI based on which it would take appropriate supervisory action if they are not satisfied with the result of this process. In this context, the following matters are required to be specifically commented upon:
•    Whether stress test is done as per RBI Guidelines;
•    Whether assumptions made in the document are realistic, encompassing all relevant risks;
•    Whether the banks’ strategies are aligned with their Board-approved Risk Appetite Statement.

The ICAAP requirements are part of the BASEL III Guidelines as prescribed in the Master Circular dated 1st July, 2015 as amended from time to time issued by the RBI.

GOING CONCERN AND LIQUIDITY RISK ASSESSMENT

Going concern assessment
This is an entirely new section which has been introduced keeping in mind the specific reporting responsibilities and considerations under the SAs. The matters which need to be commented upon are as under:
•    Whether the going concern basis of preparation of financial statements is appropriate;
•    Evaluation of the bank’s assessment of its ability to continue to meet its obligations for the foreseeable future (for at least 12 months after the date of the financial statements) with reasonable assurance for the same;
•    Any material uncertainties relating to going concern.

For considering the above matters the auditors should consider the guidance in SA-570 (Revised), Going Concern, issued by the ICAI. Further, an important indicator to assess the Going Concern assumption is whether the bank has been placed under the Prompt Corrective Action (PCA) framework as laid down under the RBI guidelines vide RBI Circular Ref: RBI/2016-17/276 DBS.CO.PPD.BC. No. 8/11.01.005/2016-17 dated 13th April, 2017 which gets triggered on breach of certain thresholds on Capital Adequacy, Profitability and Leverage Ratio. The auditors should verify the correspondence with the RBI and other documentary evidence to ensure / identify the status of the supervisory actions indicated / initiated by the RBI, as per the above-referred Circular.

Liquidity assessment
This is also an entirely new section which has been introduced considering its linkage with the going concern assessment and the recent guidelines framed by the RBI relating to Liquidity Coverage Ratio (LCR) and Net Stability Funding Ratio (NSFR). The matters which need to be commented upon are as under:
•    As a part of the assessment of the bank on going concern basis, the auditor should consider the robustness of the bank’s liquidity risk management systems and controls for managing liquidity;
•    Identifying any external indicators that reveal liquidity or funding concerns;
•    Availability of short-term liquidity support;
•    Compliance with norms relating to LCR and NSFR (as and when applicable).

The RBI has issued Guidelines for Maintenance of LCR vide RBI Circular Ref: RBI/2013-14/635 DBOD.BP.BC. No. 120 / 21.04.098/2013-14 dated 9th June, 2014 and related Circulars in terms of which banks are required to maintain an LCR, computed as the ratio of HIGH QUALITY LIQUID ASSETS TO THE NET CASH OUTFLOW OVER THE NEXT 30 DAYS which should be >= 100% effective 1st January, 2019.

INFORMATION SYSTEMS

The reporting under this section has been modified to include comments and reporting on certain specific matters, in addition to the existing requirements. These are briefly indicated hereunder:

Robustness of IT Systems:
•    Whether the software used by the bank were subjected to Information System & Security Audit, Application Function testing and any other audit mandated by RBI.
•    Adequacy of IS Audit, migration audit (as and where applicable) and any other audit relating to IT and the cyber security system.
•    Compliance with the findings of the above audits.

The following are the main RBI Circulars which are relevant in the context of the above reporting:
•    RBI Circular Ref: DBS.CO.OS MOS.BC. /11/33.01.029 / 2003-04 dated 30th April, 2004 on Information System Audit;
•    RBI Circular Ref: DBS.CO.ITC.BC. No. 6/31.02.008/2010-11 dated 29th April, 2011 Guidelines for IS Audit.

IT Security Policy (Including Cyber Security Policy)
• Whether the bank has a duly updated and approved IT Security and IS Policy;
• Whether the bank has complied with the RBI advisory / directives relating to IS environment / cyber security issued from time to time.

The following are the main RBI Circulars which are relevant in the context of the above reporting:
• RBI Circular Ref: DBS.CO.ITC.BC. No. 6/31.02.008/2010-11 dated 29th April, 2011 (covering the IT Security Framework);
• RBI Circular Ref: RBI/2015-16/418 DBS.CO/CSITE/BC. 11/33.01.001/2015-16 dated 2nd June, 2016 (covering the Cyber Security Framework).

Critical systems / processes
•    Whether there is an effective system of inter-linkage including seamless flow of data under Straight Through Process (STP) amongst various software / packages deployed.
•    Outsourced activities – Special emphasis has been placed on outsourced activities and bank’s control over them, including bank’s own internal policy for outsourced activities. In determining the reporting obligations in respect of outsourcing activities, the auditors should refer to the RBI Circular Ref: RBI/2006/167 DBOD.NO.BP. 40/ 21.04.158/ 2006-07 dated 3rd November, 2006. The said Circular requires the bank to put in place a comprehensive outsourcing policy, duly approved by the Board, which needs to cover the following aspects:
    a) Selection of activities;
b) To ensure that core management functions including Internal Audit, Compliance function and decision-making functions like determining compliance with KYC norms for opening deposit accounts, according sanction for loans (including retail loans) and management of investment portfolio are not outsourced;
    c) Selection of service providers;
    d) Parameters for defining material outsourcing;
    e) Delegation of authority depending on risks and materiality;
    f) Systems to monitor and review the operations.

OTHER MATTERS
The specific additional areas requiring comments / reporting are as under:
Depositor Education and Awareness Fund (DEAF) Scheme 2014
Specific comments are required on the system related to compliance with the DEAF norms, which are laid down in the RBI Circular Ref: DBOD. DEAF Cell. BC. No. 101/ 30.01.002/2013-14 dated 21st March, 2014 the salient features of which are as under:
(a) Under the provisions of section 26A of the Banking Regulation Act, 1949 the amount to the credit of any account in India with any bank which has not been operated upon for a period of ten years or any deposit or any amount remaining unclaimed for more than ten years shall be credited to the Fund, within a period of three months from the expiry of the said period of ten years;
(b) The Fund shall be utilised for promotion of depositors’ interests and for such other purposes which may be necessary for the promotion of depositors’ interests as specified by RBI from time to time;
(c) The depositor would, however, be entitled to claim from the bank the deposit or any other unclaimed amount or operate the account after the expiry of ten years, even after such amount has been transferred to the Fund;
(d) The bank would be liable to pay the amount to the depositor / claimant and claim refund of such amount from the Fund.

Customer Services
Specific comments are required on business conduct including customer service by the bank describing instances, if any, of wrong debit of charges from customer accounts (also applicable to Branch Auditors), mis-selling, ineffective complaint disposal mechanism, etc. In this context, reference should be made to the RBI Master Circular on Customer Service in Banks dated 1st July, 2015 in terms of which banks are required to have a proper Customer Services Governance Framework coupled with Board Approved Customer Service Policies on specific aspects like Deposits, Cheque Collection, Customer Compensation, Grievance Redressal, amongst others.

In respect of all the above matters, involving compliance with the specific RBI guidelines, it is imperative for the auditors to thoroughly review the latest RBI Guidelines and Master Circulars / Directions and also read the latest RBI Inspection reports since greater granularity in reporting is now expected vis-a-vis the earlier reporting requirements.

FOR BRANCH AUDITORS

Whilst the basic reporting requirements are similar to those before, there are several additional areas which need to be reported / commented upon which can be broadly categorised as under:

Area	Additional areas to be commented / reported upon
*Cash, balances with the RBI, SBI and other banks*	• Reconciliation of the balance in the branch books in respect of cash with its ATMs with the respective ATMs, based on the year-end scrolls generated and differences, if any • Bank Reconciliation entries remaining unresponded for more than 15 days • Unresponded entries with respect to currency chest operations
*Large advances*	• Details in the specified format for all outstanding advances in excess of 10% (earlier 5%) of outstanding aggregate balance of fund-based and non-fund-based advances of the branch or Rs. 10 crores (earlier Rs. 2 crores), whichever is less • Comment on adverse features considered significant in top 5 standard large advances and which need management’s attention
*Credit appraisal*	• Cases of quick mortality in accounts, where the facility became non-performing within a period of 12 months from the date of first sanction; • Whether the applicable rate of interest is correctly fed into the system;
*Credit appraisal (continued)*	• Whether the interest rate is reviewed periodically as per the guidelines applicable to floating rate loans linked to MCLR / EBLR (External Benchmark Lending Rate). [Refer to RBI Circular Ref: RBI /2019-20/53 DBR. DIR. BC. No. 14/13.03.00/2019-20 dated 4^th September, 2019 for Benchmark-Based Lending]. • Whether correct and valid credit rating, if available, of the credit facilities of bank’s borrowers from RBI accredited Credit Rating Agencies has been fed into the system
*Deposits*	• Whether the scheme of automatic renewal of deposits applies to FCNR(B) deposits; • Where such deposits have been renewed, whether the branch has satisfied itself as to the ‘non-resident status’ of the depositor and whether the renewal is made as per the applicable regulatory guidelines and the original receipts / soft copy have been dispatched
*Gold / bullion*	• Does the system ensure that gold / bullion is in effective joint custody of two or more officials, as per the instructions of the controlling authorities;
*Gold / bullion (continued)*	• Does the branch maintain adequate and regular records for receipts, issues and balances of gold / bullion. • Does the periodic verification reveal any excess / shortage of stocks as compared to book records which have been promptly reported to the controlling authorities
*Books and records*	• Details of any software / systems (manual or otherwise) used at the branch which are not integrated with the CBS; • Any adverse feature in the IS audit having an impact on the branch accounts; • Prompt generation and expeditious clearance of entries in the exception reports generated

Area

Additional areas to be commented /
reported upon

Cash, balances with the RBI, SBI and other banks

•
Reconciliation of the balance in the branch books in respect of cash
with its ATMs with the respective ATMs, based on the year-end scrolls
generated and differences, if any

•
Bank Reconciliation entries remaining unresponded for more than 15
days

•
Unresponded entries with respect to currency chest operations

Large advances

•
Details in the specified format for all outstanding advances in
excess of 10% (earlier 5%) of outstanding aggregate balance of fund-based
and non-fund-based advances of the branch or Rs. 10 crores (earlier Rs. 2
crores), whichever is less

•
Comment on adverse features considered significant in top 5
standard large advances and which need management’s attention

Credit appraisal

•
Cases of quick mortality in accounts, where the facility became
non-performing within a period of 12 months from the date of first sanction;

•
Whether the applicable rate of interest is correctly fed into the
system;

Credit appraisal (continued)

•
Whether the interest rate is reviewed periodically as per the
guidelines applicable to floating rate loans linked to MCLR / EBLR

(External Benchmark Lending Rate). [Refer to RBI Circular Ref: RBI
/2019-20/53 DBR. DIR. BC. No. 14/13.03.00/2019-20 dated 4^th September,
2019 for Benchmark-Based Lending].

•
Whether correct and valid credit rating,
if available, of the credit facilities of
bank’s borrowers from RBI accredited Credit Rating Agencies has been fed into
the system

Deposits

•
Whether the scheme of automatic renewal of deposits applies to FCNR(B)
deposits;

•
Where such deposits have been renewed, whether the branch has
satisfied itself as to the ‘non-resident status’ of the depositor and whether
the renewal is made as per the applicable regulatory guidelines and the
original receipts / soft copy have been dispatched

Gold / bullion

• Does
the system ensure that gold / bullion is in effective joint custody of two or
more officials, as per the instructions of the controlling authorities;

Gold / bullion (continued)

• Does
the branch maintain adequate and regular records for receipts, issues and
balances of gold / bullion.

• Does
the periodic verification reveal
any excess / shortage of stocks as
compared to book records which have been promptly reported to the controlling
authorities

Books and records

•
Details of any software / systems (manual or otherwise) used at the branch which are not
integrated with the CBS;

• Any
adverse feature in the IS audit having an impact on the branch accounts;

•
Prompt generation and expeditious
clearance of entries in the exception reports generated

CONCLUSION

The amendments / additional reporting requirements seem to reflect the mindset of the regulators to place enhanced responsibilities and expectations on the auditors in the already existing long list of reporting requirements in the LFAR which has become longer and more onerous with correspondingly longer sleepless nights!

Neediness: The need to be approved by others highlights the
fact that you do not approve of yourself
– Strategic Revolt

We don’t control our body, property, reputation, position,
and, in a word, everything not of our own doing
– Epictetus

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TAXABILITY OF PRIVATE TRUST’S INCOME – SOME ISSUES

Taxability as to the income of the trustees of a private trust is something which at times eludes answers. This is despite the fact that most of the taxation law in this regard is contained in just a few sections, viz., sections 160 to 167.

SPECIFIC TRUST VS. DISCRETIONARY TRUST

Section 161 provides inter alia that tax shall be levied upon and recovered from the representative assessee in the like manner and to the same extent as it would be leviable upon the person represented. This phrase, ‘in like manner and to the same extent’, came to be interpreted by the Hon’ble Supreme Court in the case of C.W.T. Trustees of H.E.H. Nizam’s Family (Remainder Wealth) Trust, 108 ITR 555, page 595 in which the Court explained the three-fold consequences:

a) There must be as many assessments on the trustees as there are beneficiaries with determinate and known shares, though for the sake of convenience there may be one assessment order specifying separately the tax due in respect of the income of each of the beneficiaries;
b) The assessment of the trustees must be made in the same status as that of the particular beneficiary whose income is sought to be taxed in the hands of the trustee; and
c) The amount of tax payable by the trustees must be the same as that payable by each beneficiary in respect of the share of his income, if he were to be assessed directly.

Thus, it is clear that income in case of specific trust cannot be taxed in the hands of the trustees as one unit u/s 161(1) and tax on the share of each beneficiary shall be computed separately as if it formed part of the beneficiaries’ income. It is because of this reason that the Madras High Court in the case of A.K.A.S. Trust vs. State of Tamil Nadu, 113 ITR 66, held that a single assessment on the trustees by clubbing the income of all beneficiaries whose shares were defined and determined was not valid.

As opposed to specific trust there is a discretionary trust which means that the trustees have absolute discretion to apply the income and capital of the trust and where no right is given to the beneficiary to any part of the income of the trust property. Section 164 of the Act itself provides that a discretionary trust is a trust whose income is not specifically receivable on behalf of or for the benefit of any one person, or wherein the individual shares of the beneficiaries are indeterminate or unknown.

Therefore, section 161(1) can apply only where income is specifically received or receivable by the representative assessee on behalf of or for the benefit of the single beneficiary, or where there are more than one, the individual shares of the beneficiaries are defined and known. Tax in such a case would be levied on the representative assessee on the portion of the income to which any particular beneficiary is entitled and that, too, in respect of such portion of income. On the other hand, if income is not receivable or received by the representative assessee specifically on behalf of or for the benefit of the single beneficiary, or where the beneficiaries being more than one, their shares are indeterminate or unknown, the assessment on the representative assessee qua such income would be in accordance with the provision of section 164.

APPLICABILITY OF MAXIMUM MARGINAL RATE

The next issue is that relating to the interpretation of sub-section (1A) of section 161 which provides that in case of a specific trust where income includes profits and gains of business, tax shall be charged on the whole of the income in respect of which such person is so liable at the maximum marginal rate. Therefore, whenever there is any income of profits and gains of business in the case of specific trust, the whole income would suffer the tax at the maximum marginal rate irrespective of the tax which could have been levied upon the beneficiary as per the plain text of that section. But it has been held in CIT vs. T.A.V. Trust 264 ITR 52, 60 (Kerala) that where there are business income as well as other income in case of specific trust, then, too, income from the business earned by the trust alone shall be taxed at the maximum marginal rate and the other income has to be assessed in the hands of the trustees in the manner provided in section 161(1), i.e., in the hands of the beneficiaries. It would be appropriate if the observations of the High Court are extracted:

‘Now reverting to section 161(1A) of the Act it must be noted the sub-section (1A) only says, “notwithstanding anything contained in sub-section (1)”: in other words, it does not say “notwithstanding anything contained in this Act”. Thus, though the provisions of sub-section (1A) override the provisions of sub-section (1) of section 161, it does not have the effect of overriding the provisions of section 26 of the Act and consequently computation of the income from house property has to be made under sections 22 to 25 of the Act since the Tribunal had entered a categorical finding that the shares of the beneficiaries are definite. As already noted, as per sub-section (1A), where any income in respect of which a representative assessee is liable consists of, or includes, income by way of profits or gains of business, tax shall be charged on the whole of the income in respect of which such person is so liable at the maximum rate. The income so liable referred to in the said sub-section is only the business income of the trust and not any other income. It is only the income by way of profits and gains of business that can be charged at the maximum marginal rate. Any other interpretation, according to us, is against the very scheme of the Act and further such an interpretation will make the provisions of sub-section (1A) of section 161 unconstitutional. It is a well settled position that if two constructions of a statute are possible, one of which would make it intra vires and the other ultra vires, the Court must lean to that construction which would make the operation of the section intra vires (Johri Mal vs. Director of Consolidation of Holdings, AIR 1967 SC 1568).

This was an important interpretation placed by the Kerala High Court which is available to the taxpayers and can be pressed in appropriate cases.

According to section 164(1), income of the discretionary trust shall suffer tax at the maximum marginal rate, meaning that there would not be any basic exemption available except in situations provided under the provisos appended thereto. However, the Gujarat High Court in Niti Trust vs. CIT 221 ITR 435 (Guj.) has held that if there is a long-term capital gain, the maximum marginal rate applicable is 20% and such income would suffer the tax @ 20%. A similar position has been explained and taken by the Mumbai Bench of the Income-tax Appellate Tribunal in the case of Jamshetji Tata Trust vs. JDIT (Exemption) 148 ITD 388 (Mum.) and in Mahindra & Mahindra Employees’ Stock Option Trust vs. Additional CIT 155 ITD 1046 (Mum).

It may, however, be noted that the maximum marginal rate (MMR) as per the existing tax structure otherwise would work out to approximately 42.74%. Therefore, it can be taken in case of discretionary trust that if income includes any income on which special tax rate is applicable, that special rate being MMR for that income would be applicable qua such income and the rest of the income would suffer the tax rate (MMR) of 42.74% approximately.

‘ON BEHALF OF’ ‘FOR THE BENEFIT OF’

Private trust in itself is not a ‘person’ under the Act. Trustees who receive or are entitled to receive income ‘on behalf of’ or ‘for the benefit of any person’ are assessed to tax as taxable entities. Although section 160(1) uses the twin expressions ‘on behalf of’ and ‘for the benefit of’, but section 5(1)(a) which prescribes the scope of total income, uses the expression ‘by or on behalf of’ and therefore the question arises as to whether the implications of both the expressions are similar or are different.

The Supreme Court in the case of W.O. Holdswords & Ors. vs. State of Uttar Pradesh, 33 ITR 472, had occasion to examine both the phrases in the context of the position of trustees. The Court held that trustees do not hold the land from which agricultural income is derived on behalf of the beneficiary but they hold it in their own right though for the benefit of the beneficiary. Besides, a trust is defined in the English Law as ‘A trust in the modern and confined sense of the word is the confidence reposed in a person with respect to property of which he has possession or over which he can exercise a power to the intent that he may hold the property or exercise the power for the benefit of some other person or objects’ (vide Halsbury’s Laws of England, Hailsham Edition, Volume 33, page 87, para 140).

Thus, it is more than evident that legal estate is vested in the trustees who hold it for the benefit of the beneficiary. Section 3 of the Indian Trust Act, 1882 is also clear and categorical on this point to the effect that the trustees hold the trust property for the benefit of the beneficiaries but not ‘on their behalf’.

Section 56(2)(x) introduced by the Finance Act, 2017 provides inter alia that any sum of money and / or property received by a person without consideration, or property received by a person without adequate consideration, would constitute income. There is some threshold limit in certain situations given under that section but that is not relevant for the purpose of the present discussion. Exceptions given in the proviso to section 56(2)(x) provide inter alia that money or property received from an individual by a trust created or established solely for the benefit of a relative of an individual would not be hit by clause (x) of section 56(2). Thus, if the settlor is an individual and the beneficiary is a relative of such individual, receipt of money and / or property by the trustees for the benefit of the relative would not be hit by the provisions of section 56(2)(x).

But whether the property settled by the individual settlor for the benefit of a non-relative would become taxable income u/s 56(2)(x) is a question which would engage all of us.

Section 4, which is the charging section, provides inter alia that income tax shall be charged for any assessment year in accordance with and subject to the provisions of the Act in respect of total income of the previous year of every person. Section 5 provides inter alia that total income of any previous year of a person includes all income from whatever source derived which is received or deemed to be received in India in such year by or on behalf of such person. Therefore, any income which is not received by the person or on behalf of such person cannot be brought within the scope of total income. In other words, income received for the benefit of such person is not contemplated to be covered u/s 5 and cannot be brought to tax in the hands of such person. Therefore, when the trustees receive the property for the benefit of the beneficiary, such receipt falls outside the scope of total income even if the beneficiary is a non-relative qua the settlor as the receipt of the property by the trustees cannot be said to be received by the beneficiary or received on behalf of the beneficiary. Therefore, the applicability of section 56(2)(x) even in the case of a non-relative beneficiary in the light of the above interpretation may not be easy for the Revenue. However, such interpretation is liable to be fraught with strong possibility of litigation.

In sum, taxability of private trust has been saddled with lots of controversies many of which have been sought to be given quietus with amendments made from time to time, but such controversies are never-ending.

The point of modern propaganda isn’t only to misinform or push an agenda. It is to exhaust your critical thinking, to annihilate truth
– Gary Kasparov

Teachers should prepare the student for the student’s future, not for the teacher’s past
– Richard Hamming

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BURDEN OF DEALING WITH GOVERNMENT AND LESSONS FOR PROFESSIONALS

The recent compliance season of FYE 2019-20 in Covid’s shadow was another instance in the uninterrupted tradition of inciting difficulty in dealing with the government BY the government. The late announcement of extension for the due date of 31st October when the FM had earlier postponed dates except this tax audit date much in advance, appeared to display deep and vehement disregard for income-tax payers by the CBDT in spite of announcements such as ‘honouring the honest taxpayer’.

The unceasing inefficiencies, digital dysfunctionalities and lack of service require no summary. The point here is to nudge those vested with exclusive power, responsibility and obligation to make amends.

Let’s also look in the mirror and relearn some lessons. I have divided them under three groups:

REMEMBER:

1. Our job often is to report and help compliance.

2. Beyond a point, we need not call for extensions as much as we like to uphold what we believe is right.

3. The client is the primary owner of the compliance responsibility.

4. Signing off with a client doesn’t mean ‘delivering anyhow’ or ‘delivering no matter what’. That happens only in super-hero movies.

5. Promises and rhetoric are for optics. The final test of one’s word is the resultant experience. (GST, for example – great idea, terrible implementation!)

6. We ‘suffer’ when something goes wrong; but government cannot ‘suffer’ or ‘feel’.

7. Government has low commitment. Its words are need-based and breaches have no consequence1.You and I have a personal honour to keep our word, unlike the government.

8. Vote banks are more important than taxpayer banks. The taxpayers and tax professionals are at the bottom of their priority list.

1 Remember the FM adding
LTCG on STT-paid securities sale or MAT on SEZ profits that were tax-free

NEVER:

9. Carry the burden of clients. Few understand the pain that professionals go through.

10. Breach the ‘respectable distance’ we must keep from clients.

11. Emotionally identify (like doctors) with client problems, rather, identify their problems, give solutions and offer assistance.

12. Compromise on health. Your health is of paramount importance. Health once damaged can be irreparable and even(tually) fatal.

13. Feel that a contract of service by a Chartered Accountant is a contract of guarantee or insurance.

14. Work without an engagement letter defining scope and fees, timelines, deliverables and client readiness as a precondition. Never.

ALWAYS:

15. Explain the rules of services – Compliance is a sub-set of client preparedness and provision of useable data well in time.

16. Let clients sense that you cannot be taken for granted, especially for those perennial late-comers, shabby record-keepers, and low quality hirers.

17. Remind clients of their responsibilities, timelines to supply data and the consequences of not doing so.

18. Keep educating clients on the difference between products and services – products can be delivered off the shelf, not services.

19. Let clients know that delays have a ripple effect. Delay or breaking the tempo impacts other assignments. Have a start date and an end date.

20. Know the difference between material and immaterial for both amounts and issues in an assignment.

21. Consider variable fees – benefits for early birds.

Till we don’t do enough of the above, compliance professionals will be sinking deeper into a hole – health-wise and money-wise. Increasing compliances may seem lucrative and remunerative but will be taken over by machine. The role of CAs in our mind must be re-imagined and recalibrated constantly. This is not a guess, estimate or premonition. It is written on the wall!

Raman Jokhakar

Editor

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ARE YOU CHASING THE GOLDEN DEER?

The pandemic brought us on our knees. In the name of growth, development and progress, mankind has gotten itself to a juncture where we are made to ponder – Are we chasing a golden deer? A few words about the legendary golden deer shall be in place.

Fulfilling the wish of Kaikeyi, King Dashrath sent Ram to forest exile for 14 years. Travelling through the woods, Ram, accompanied by his wife Sita and brother Laxman, reached the banks of the river Godavari and built an ashram there.

Ravana, to fulfil the wish of his sister Surpanakha who wanted Sita to be abducted to avenge the humiliation of her nose being cut off, was ready to do as desired by her. He requested Maricha, his uncle, to turn into a golden deer and graze around Ram’s ashram. Reluctantly, Maricha agreed to disguise himself and turn into a golden deer. As the golden deer grazed near Ram’s ashram, Sita noticed the enchanting beauty of the deer. The ‘Aranyakanda’ from Valmiki’s Ramayana describes the deer thus:

‘A beautiful golden deer with silver spots.
A deer that glowed as it moved with the sparkle of a hundred gems.
Sapphires, moonstones, black jets and amethysts,
studded on its lithe, golden body’.

Lured by its beauty, Sita insisted on having the deer and convinced Ram to chase it and bring it to her. Much against the wishes of Laxman, Ram chased the deer. After a long chase away from the ashram, Ram shot the deer, at which point of time it took the original form of Maricha and cried out for help in Ram’s voice. The rest of the narrative is history. However, for the purpose of the present contemplation I think we as professionals need to do some soul-searching in answer to this question at an individual level.

Our endeavour or life-long pursuit is seeking a state of everlasting happiness for ourselves and our near and dear ones. In this pursuit, we set out to achieve our degrees, get ourselves on a career path, slog our backs out without respite from dawn to dusk, making huge sacrifices in the process, bring up our families though finding it difficult to spend time with them, make money (the limits of which are never set) – but by the time we start feeling that we have ‘arrived’, it is time to ‘depart’!

The following lines are deeply entrenched in my mind’s eye right from the days when I commenced my career as a Chartered Accountant –

‘You’re counted among the best in your profession.
Because you’ve got talent, you’ve used it.
But have you been using yourself up in the process?
You slogged and made sacrifices –
Remember all those late nights at the office
And those hectic afternoons when you almost went mad with the tension?
Those skipped lunches, those fried snacks,
Those endless cups of coffee to keep the adrenalin flowing? Cigarettes? Booze?
Success has its price. You’ve paid it.
That’s why you are where you are.
Fair enough. But what lies ahead?
A long roll downhill? Hypertension? Heart disease? Ulcers? Diabetes?
A fragile old age, brought about prematurely’?

Does it sound like a rollercoaster ride bereft of all thrills, leaving you tired and exhausted? Do you think you have been successful but have no sense of accomplishment? Is it a futile attempt to reach the horizon?

What are you consumed by in your daily grind?
Is there a sense of accomplishment in what you do?
What gives meaning to what you do?
Does your success bring you fulfilment?
Are your goals aligned to a higher purpose?

At whatever stage of life you may be at, it’s never too late to answer the question, Are You Chasing The Golden Deer? because an unexamined life is not worth living.

shailesh.kwebmaker

USHERING IN UTOPIA

Your Editorial, EPIC SPEECH ON ‘BABUCRACY’ (BCAJ, December, 2020), is really an eye-opener. If such conditions are ushered in, we will be in UTOPIA. You have wonderfully brought out the quintessence of the Minister’s lamentations. Standards of general honesty are very low in our country. One Nitin Gadkari cannot bring in sweeping changes. People should raise their levels of integrity. Rama Rajyam cannot be established overnight. So many years of Independence have not made any marked change of attitude… You have done well, Editor, and let us hope for a transformation.

– R. Krishnan

shailesh.kwebmaker

WHO OR WHAT’S A CAP?

Mr. Thinkeshwar was a senior Chartered Accountant in practice for many years. His real name was Ishwar. However, he used to think so much that people started calling him ‘Thinkeshwar’. He was very sensitive and quite aware of social issues. He had genuine sympathy for the pains and miseries of the people, was a social activist and a good writer, too.

In the months of June and July, 2020 when Covid-19 was at its peak, he read a news item about how ‘Corona Afflicted People’ (CAP) were treated in society. One person tested Corona positive while he was in his office. Immediately, the boss asked him to leave. The CAP said there was no conveyance available. He was working in an essential service office – in a bank. But the boss ordered him to quit immediately and refused to even meet him. The driver refused to take him home in the car. The poor fellow walked about six km. to reach home. The security person was surprised to see him back so early. The news had already reached all the occupants of the society and the watchman was instructed not to let him enter the building. His family members were watching from their balcony. They threw his clothes and personal things down and asked him to go and stay in some hotel or any other place. He pleaded with each one of them – boss, colleagues, bank customers, driver, watchman, family members – about how he had done good things for them. But no one was in a mood to listen.

Thinkeshwar was moved by such true stories and started writing a very emotional article.

Suddenly, a thought occurred to him which gave him the shivers – what would happen if he himself became a CAP! He imagined certain scenes and dialogues:

With partners: ‘I slogged for the development of the firm with utmost good faith and sacrificed my personal life.’

Partners: ‘See, our agreement is to share only the profits of the firm, not each other’s personal difficulties’.

With articles: ‘I was generous to you – granting leaves, giving concessions in timings, imparting good training’.
Articles: ‘That’s nothing. It was your duty and our right.’

With staff: ‘I treated you so nicely and affectionately. Never did any bossing, paid salaries and bonus on time.’
Staff: ‘So what? We worked on lower salary. We would have earned much more outside (although everybody had tried outside). On the contrary, we obliged you by working with you.’

To clients: ‘I sacrificed my personal life to provide better service to you, carried all your anxieties on my head and remained in stress always. I helped you in many difficult situations on low fees, which were never received promptly, and undertook so much risk in certifying your accounts.’
Clients: ‘Sorry. That was your professional duty. We could have hired some other CA at a much cheaper cost but due to our “relations” we kept on obliging you. And we believe there is some law that prohibits prompt and regular payment of fees to CA’s!’

To family members: ‘I slogged at the cost of my health and sacrificed all personal pleasures. I committed so many sins to provide you a happy life.’
Family: ‘What’s great about that? It is the fate of all CAs. It’s your destiny. We are not going to share your sins and pains.’

Many similar scenes took place in Mr. Thinkeshwar’s vivid imagination – with Revenue Officers, friends, relatives and neighbours, but everybody disowned him.

Poor CAP’s, he thought to himself. He remembered the story of ‘Valya the dacoit’ who became Valmiki to write the Ramayan. And then suddenly he trembled as he realised that CAP also stands for CA’s in Practice.

He smiled to himself and happily started writing ‘Light Elements’ for BCAJ with a heavy heart.

shailesh.kwebmaker

SEBI: REVISING ITS OWN ORDERS AND ENHANCING PENALTIES

BACKGROUND

One of the many penal powers that SEBI has under the SEBI Act, 1992 (‘the Act’) is to levy fairly hefty penalties on those who have violated the provisions of various securities laws. The penalty is often up to three times the gains or Rs. 25 crores, whichever is higher. A person on whom a penalty has been levied can appeal to the Securities Appellate Tribunal (‘SAT’) and, if he does not succeed, further to the Supreme Court.

However, the question is, can SEBI review and revise its own orders?

The penalty is levied by an Adjudicating Officer (‘AO’) who, though subordinate to SEBI, is expected to act independently. It may happen that the ‘AO’ has, in the eyes of SEBI, made an error and thus the alleged wrongdoer escapes with a lower or even no penalty. Can this error be corrected? An incorrect order not only lets a wrongdoer escape but also creates a precedent for related matters in similar context and future cases.

The Act provides for a review and revision of the orders passed by the ‘AOs’. The Act was amended in 2014 with effect from 28th March, 2014 and sub-section (3) was introduced to section 15-I to permit such revision. Broadly stated, SEBI can initiate proceedings to revise an adjudication order and enhance the penalty if the order is found erroneous and not in the interests of the securities markets. The review proceedings have to be initiated within three months of the original order, or disposal of appeal by SAT against such order, whichever is earlier.

SEBI has passed several review orders under this provision. In fact, it recently enhanced the penalty on credit rating agencies in the matter of IL&FS from Rs. 25 lakhs as per the original order to Rs. 1 crore. Let us analyse the provision in more detail and consider briefly some pertinent cases.

SECTION 15-I(3) ANALYSED

Section 15-I of the SEBI Act lays down the procedure for adjudication by an ‘AO’ under various provisions that prescribe the penalty for specific wrongs. Section 15-I(3) lays down the provisions relating to revising orders passed by the ‘AO’ and reads as under (emphasis supplied):

Power to adjudicate
…
(3) The Board may call for and examine the record of any proceedings under this section and if it considers that the order passed by the adjudicating officer is erroneous to the extent it is not in the interests of the securities market, it may, after making or causing to be made such inquiry as it deems necessary, pass an order enhancing the quantum of penalty, if the circumstances of the case so justify:

Provided that no such order shall be passed unless the person concerned has been given an opportunity of being heard in the matter:

Provided further that nothing contained in this sub-section shall be applicable after expiry of a period of three months from the date of the order passed by the adjudicating officer or disposal of the appeal under section 15T, whichever is earlier.

Specific aspects of this provision are discussed in the following paragraphs.

ORDER SHOULD BE ‘ERRONEOUS’

This is the basic and most important prerequisite for enabling SEBI to take up revision of such orders. There has to be a manifest error in the order. The error may be of fact or of law. The error may be of not levying a penalty where the law requires it, or levying a lower penalty. An error must also be distinguished from taking a different view from amongst two or more views plausible. It is submitted that the view taken by the ‘AO’ has to be erroneous in the sense that such view could not possibly be taken. An error may not be very difficult to identify and demonstrate. However, in case of law there may be some subtleties. If two views are possible on reading the relevant provision of law, merely because the ‘AO’ took one of the plausible views does not mean that the order is erroneous. However, if the view in law is not possible to be taken, then the order is erroneous.

The other issue is, when can the amount of penalty levied be said to be erroneous? Certain provisions levy a minimum penalty and thus if the ‘AO’ levies penalty below this statutory minimum, the order is obviously erroneous. There can be other similar errors. The interesting question is that if the ‘AO’ levies penalty within a certain range permissible under law, can the order be held to be erroneous and a higher penalty be levied? As we shall see later, SEBI has levied higher penalty, albeit on facts, in certain orders.

THE ORDER IS ‘NOT IN THE INTEREST OF SECURITIES MARKETS’

The error should be of such a nature that it is not in the interests of securities markets. This provision is obviously very broad in nature and gives a wide brush for the SEBI to paint with. The securities markets consist of investors, companies, various intermediaries, exchanges, etc. There is also generally the credibility of the securities markets. Further, and more importantly (as also pointed out in orders under this provision), an error whereby a wrongdoer escapes with lower or no penalty creates an unhealthy precedent for others and indirectly serves as a disincentive for those who scrupulously follow the law.

The two conditions are simultaneous
The order should be erroneous and such error should be one that is not in the interests of the securities markets. Both these conditions have to be shown by SEBI before it can take up review of such an order and pass a revised one.

Opportunity of being heard
This is a basic principle of natural justice and is inbuilt in the provision. The party should be given a fair opportunity of being heard since the revision may result in enhancement of the penalty.

Enhancement of the quantum of penalty
The order can be revised and the amount of penalty can be increased. An interesting contention was raised in a couple of cases that enhancement means that the earlier order should have levied at least some penalty. And, therefore, if there was no penalty levied, there is no question of enhancement! SEBI has rejected this technical argument and has held that a penalty can be levied even if no penalty was levied earlier.

Interestingly, SEBI has even taken a view in some orders that the revision need not necessarily be for enhancing the penalty. It may even be for correcting a wrong interpretation of law by the ‘AO’.

Time limit
The provision shall not apply after a period of three months from the date of the original order or disposal of the appeal by SAT in relation to such order, whichever is earlier. While the wording is not wholly clear on this point, SEBI has taken a view that the time limit applies to initiation of the proceedings and the final revised order may be passed in due course even after such time.

Whether appeal to SAT against original order would bar such revision till appeal is disposed of?
SAT has refused to bar the continuation of such proceedings for revision even when the original order was under appeal before it (in the case of India Ratings and Research Private Limited vs. SEBI, order dated 1st July, 2020). However, it also ordered in that case that the revised order should not be given effect to.

Whether the provisions relating to revision under the Income-tax Act, 1961 are pari materia with the provisions under the Act?
A stand often raised by parties when faced with such revision proceedings is that the provision under the Act should be interpreted and applied in the same strict manner as the provision for revision of orders under the Income-tax Act for which there are numerous precedents laying down principles. However, SEBI has rejected this stand generally. It has taken a view that the scheme, object and even wording of the provision under the Income-tax Act are sharply different. Hence, section 15-I(3) of the (SEBI) Act has to be viewed independently and broadly.

SOME ORDERS PASSED UNDER THIS PROVISION

Over the years, SEBI has passed several orders revising the original order. Some of those orders are worth reviewing briefly.

In an order dated 13th November, 2014 in the case of Crosseas Capital Services Private Limited, no penalty was levied in a certain case of self-trades through automated trading. On facts, SEBI reviewed this order and held that a penalty was leviable and also directed the party to review its systems to ensure that such acts are not repeated. SEBI also rejected the argument that ‘enhancement’ can be only where the earlier order had levied at least some penalty. Orders of similar nature were passed against a stock-broker and his client in two other cases –

a) In the case of broker Adroit Financial Services Private Limited and its client AKG Securities and Consultancy Limited, vide order dated 13th January, 2015, and
b) In the case of broker Marwadi Shares and Finance Limited and its client Chandarana Intermediaries Brokers Private Limited, vide order dated 13th October, 2015.

Vide order dated 11th January, 2017, in the matter of Saradha Realty India Limited, SEBI passed an interesting direction. The original order of the ‘AO’ had let off certain directors of the company who had resigned although they were directors at the time when the violations took place. The penalty was thus levied, jointly and severally, only on the existing directors. SEBI passed a revised order levying such penalty on all the persons who were directors at the time when the violations took place. The amount of penalty itself was not enhanced.

In a recent order (dated 20th November, 2020 in the matter of Oxyzo Financial Services Private Limited), SEBI held that the ‘AO’ had made a wrong interpretation of the applicable provision and thus revised it as per the correct interpretation. However, since even otherwise there was no violation by the party of the applicable law, no penalty was levied even in the revised order.

In three recent orders, all dated 22nd September, 2020, SEBI enhanced the penalty levied from Rs. 25 lakhs to Rs. 1 crore in each case. These were the cases of credit rating agencies in respect of credit rating in the matter of IL&FS. SEBI held that, especially in view of the significant amounts involved and the impact on investors, a higher penalty was deserved.

CONCLUSION

Often, adjudication proceedings are initiated many years after an alleged violation. These proceedings themselves may take a long time to conclude. The revision proceedings would then add yet another layer to the time and proceedings. Thankfully, there is a short time limit of a maximum of three months of the original order to initiate such proceedings.

However, the wordings of the provision for revision are broad and even vague at places. The scope ought to be narrow particularly considering that the original order has to be ‘erroneous’. Merely because SEBI holds another, different view should not result in invocation of this provision if the view in the original order is also an alternate and acceptable one. Further, merely because a higher penalty was leviable by itself should not result in invocation of this provision. One hopes that, in appeal, clearer principles would be laid down.

shailesh.kwebmaker

SUPREMACY OF THE DOMESTIC VIOLENCE ACT

INTRODUCTION

The Protection of Women from Domestic Violence Act, 2005 (‘the DV Act’) is a beneficial Act and one which asserts the rights of women who are subject to domestic violence. Various Supreme Court and High Court judgments have upheld the supremacy of this Act over other laws and asserted from time to time that this is a law which cannot be defenestrated.

In the words of the Supreme Court (in Satish Chander Ahuja vs. Sneha Ahuja, CA No. 2483/2020), domestic violence in this country is rampant and several women encounter violence in some form or other or almost every day; however, it is the least reported form of cruel behaviour. The enactment of this Act of 2005 is a milestone for protection of women in the country. The purpose of its enactment, as explained in Kunapareddy Alias Nookala Shankar Balaji vs. Kunapareddy Swarna Kumari and Anr. (2016) 11 SCC 774 was to protect women against violence of any kind, especially that occurring within the family, as the civil law does not address this phenomenon in its entirety. In Manmohan Attavar vs. Neelam Manmohan Attavar (2017) 8 SCC 550, the Supreme Court noticed that the DV Act has been enacted to create an entitlement in favour of the woman of the right of residence. Considering the importance accorded to this law, let us understand its important facets.

WHO IS COVERED?

It is an Act to provide for more effective protection of the rights, guaranteed under the Constitution of India, of those women who are victims of violence of any kind occurring within the family.

It provides that if any act of domestic violence has been committed against a woman, then she can approach the designated Protection Officers to protect her. In V.D. Bhanot vs. Savita Bhanot (2012) 3 SCC 183, it was held that the Act applied even to cases of domestic violence which have taken place before the Act came into force. The same view has been expressed in Saraswathy vs. Babu (2014) 3 SCC 712.

Hence, it becomes essential to find out who can claim shelter under this Act. An aggrieved woman under the DV Act is one who is, or has been, in a domestic relationship with an adult male and who alleges having been subjected to any act of domestic violence by him. A domestic relationship means a relationship between two persons who live or have, at any point of time, lived together in a shared household, when they are related by marriage, or through a relationship in the nature of marriage, or are family members living together as a joint family.

WHAT IS DOMESTIC VIOLENCE?

The concept of domestic violence is very important and section 3 of the DV Act defines the same as an act committed against the woman which:
(a) harms or injures or endangers the health, safety, or well-being, whether mental or physical, of the woman and includes causing abuse of any nature, physical, verbal, economic abuse, etc.; or
(b) harasses or endangers the woman with a view to coerce her or any other person related to her to meet any unlawful demand for any dowry or other property or valuable security; or
(c) otherwise injures or causes harm, whether physical or mental, to the aggrieved person.

Thus, economic abuse is also considered to be an act of domestic violence under the DV Act. This term is defined in a wide manner and includes deprivation of all or any economic or financial resources to which a woman is entitled under any law or custom or which she requires out of necessity, including household necessities, stridhan property, etc.

SHARED HOUSEHOLD

Under the Act, the concept of a ‘shared household’ is very important and means a household where the aggrieved lives, or at any stage has lived, in a domestic relationship with the accused male and includes a household which may belong to the joint family of which the respondent is a member, irrespective of whether the respondent or the aggrieved person has any right, title or interest in the shared household. Section 17 of the DV Act provides that notwithstanding anything contained in any other law, every woman in a domestic relationship shall have the right to reside in the shared household, whether or not she has any right, title or beneficial interest in the same. Further, the Court can pass a relief order preventing her from being evicted from the shared household, against others entering / staying in it, against it being sold or alienated, etc. The Court can also pass a monetary relief order for maintenance of the aggrieved person and her children. This relief shall be adequate, fair and reasonable and consistent with her accustomed standard of living.

In S.R. Batra and Anr. vs. Taruna Batra (2007) 3 SCC 169 a two-Judge Bench of the Apex Court held that the wife is entitled only to claim a right u/s 17(1) to residence in a shared household and a shared household would only mean the house belonging to or taken on rent by the husband, or the house which belongs to the joint family of which the husband is a member.

Recently, a three-Judge Bench of the Supreme Court had an occasion to again consider this very issue in Satish Chander Ahuja vs. Sneha Ahuja, CA No. 2483/2020 and it overruled the above two-Judge decision. The Court had to decide whether a flat belonging to the father-in-law could be restrained from alienation under a plea filed by the daughter-in-law under the DV Act. The question posed for determination was whether a shared household has to be read to mean that household which is the household of a joint family / one in which the husband of the aggrieved woman has a share. It held that shared household is the shared household of the aggrieved person where she was living at the time when the application was filed or in the recent past had been excluded from its use, or she is temporarily absent. The words ‘lives or at any stage has lived in a domestic relationship’ had to be given its normal and purposeful meaning. The living of a woman in a household has to refer to a living which has some permanency. Mere fleeting or casual living at different places shall not make a shared household. The intention of the parties and the nature of living, including the nature of household, have to be looked into to find out as to whether the parties intended to treat the premises as a shared household or not. It held that the definition of shared household as noticed in section 2(s) did not indicate that a shared household shall be one which belongs to or (has been) taken on rent by the husband. If the shared household belongs to any relative of the husband with whom the woman has lived in a domestic relationship, then the conditions mentioned in the DV Act were satisfied and the said house will become a shared household.

The Supreme Court also noted with approval the decisions of the Delhi Court in Preeti Satija vs. Raj Kumari and Anr., 2014 SCC Online Del 188, which held that the mother-in-law (or a father-in-law, or for that matter ‘a relative of the husband’) can also be a respondent in the proceedings under the DV Act and remedies available under the same Act would necessarily need to be enforced against them; and in Navneet Arora vs. Surender Kaur and Ors., 2014 SCC Online Del 7617, which held that the broad and inclusive definition of the term ‘shared household’ in the DV Act was in consonance with the family patterns in India where married couples continued to live with their parents in homes owned by the parents. However, the Supreme Court also sounded a note of caution. It held that there was a need to observe that the right to residence u/s 19 of the DV Act was not an indefeasible right of residence in a shared household, especially when the daughter-in-law was pitted against an aged father-in-law and mother-in-law. Senior citizens in the evening of their lives were also entitled to live peacefully and not be haunted by marital discord between their sons and daughters-in-law. While granting relief the Court had to balance the rights of both the parties.

LIVE-IN RELATIONSHIPS

A live-in relationship is also considered as a domestic relationship. In D. Velusamy vs. D. Patchaiammal (2010) 10 SCC 469 it was held that in the DV Act Parliament has taken notice of a new social phenomenon which has emerged in India, known as live-in relationship. According to the Court, a relationship in the nature of marriage was akin to a common law marriage and must satisfy the following conditions:
(i)   The couple must hold themselves out to society as being akin to spouses;
(ii)    They must be of a legal age to marry;
(iii)   They must be otherwise qualified to enter into a legal marriage, including being unmarried;
(iv) They must have voluntarily cohabited and held themselves out to the world as being akin to spouses for a significant period of time; and
(v) The parties must have lived together in a ‘shared household’.

SEPARATED COUPLES

The Supreme Court had an interesting issue to consider in the case of Krishna Bhattacharjee vs. Sarathi Choudhury, Cr. Appeal No. 1545/2015 ~ whether once a decree of judicial separation has been issued, could the woman claim relief under the DV Act. The Supreme Court held after considering various earlier decisions in the cases of Jeet Singh vs. State of U.P. (1993) 1 SCC 325; Hirachand Srinivas Managaonkar vs. Sunanda (2001) 4 SCC 125; Bai Mani vs. Jayantilal Dahyabhai, AIR 1979 209; Soundarammal vs. Sundara Mahalinga Nadar, AIR 1980 Mad 294, that there was a distinction between a decree for divorce and a decree of judicial separation; in divorce there was a severance of the status and the parties did not remain as husband and wife, whereas in judicial separation the relationship between husband and wife continued and the legal relationship continued as it had not been snapped. Accordingly, the Supreme Court held that the decree of judicial separation did not act as a deterrent for the woman from claiming relief under the DV Act since the relationship of marriage was still subsisting.

SENIOR CITIZENS ACT

Just as the DV Act is a beneficial statute meant for protecting the rights of women, so also the ‘Maintenance and Welfare of Parents and Senior Citizens Act, 2007’ is a Central Act enacted to provide for more effective provisions for the maintenance and welfare of parents and senior citizens. More often than not, there arises a divergence between the DV Act and the Senior Citizens Act and hence it is essential to understand this law also.

The Senior Citizens Act provides for the setting up of a Maintenance Tribunal in every State which shall adjudicate all matters for their maintenance, including provision for food, clothing, residence and medical attendance and treatment. Section 22(2) of this Act mandates that the State Government shall prescribe a comprehensive action plan for providing protection of the life and property of senior citizens. To enable this, section 32 empowers it to frame Rules under the Act. Accordingly, the Maharashtra Government has notified the Maharashtra Maintenance and Welfare of Parents and Senior Citizens Rules, 2010. Rule 20, which has been framed in this regard, provides that the Police Commissioner of a city shall take all necessary steps for the protection of the life and property of senior citizens.

Section 23 covers a situation where property has been transferred by a senior citizen (by gift or otherwise) subject to the condition that the transferee must provide the basic amenities and physical needs to the transferor. In such cases, if the transferee fails to provide the maintenance and physical needs, the transfer of the property is deemed to have been vitiated by fraud, coercion or under undue influence and can be held to be voidable at the option of the transferor.

Eviction from house under Senior Citizens Act
One of the most contentious and interesting facets of the Act has been whether the senior citizen / parent can make an application to the Tribunal seeking eviction from his house of the relative who is harassing him. Can the senior citizen / parent get his son / relative evicted on the grounds that he has not been allowing him to live peacefully? Different High Courts have taken contrary views in this respect. The Kerala High Court in C.K. Vasu vs. The Circle Inspector of Police, WP(C) 20850/2011 has taken the view that the Tribunal can only pass a maintenance order and the Act does not empower the Tribunal to grant eviction reliefs. A single Judge of the Delhi High Court in Sanjay Walia vs. Sneha Walia, 204 (2013) DLT 618 has held that for an eviction application the appropriate forum would be a Court and not the Maintenance Tribunal.

However, another single Judge of the Delhi High Court in Nasir vs. Govt. of NCT of Delhi & Ors., 2015 (153) DRJ 259 has held that the object of the Act had to be kept in mind and which was to provide simple, inexpensive and speedy remedy to the parents and senior citizens who were in distress by a summary procedure. The provisions had to be liberally construed as the primary object was to give social justice to parents and senior citizens. Accordingly, it upheld the eviction order by the Tribunal. It held that directions to remove the children from the property were necessary in certain cases to ensure a normal life for the senior citizens. The direction of eviction was a necessary consequential relief or a corollary to which a senior citizen would be entitled and it accordingly directed the police station to evict the son.

A similar view was taken in Jayantram Vallabhdas Meswania vs. Vallabhdas Govindram Meswania, AIR 2013 Guj. 160. The Division Bench of the Punjab & Haryana High Court in J. Shanti Sarup Dewan vs. Union Territory, Chandigarh, LPA No. 1007/2013 held that there had to be an enforcement mechanism set in place, especially qua the protection of property as envisaged under the said Act, and that the son was thus required to move out of the premises of his parents to permit them to live in peace and civil proceedings could be only qua a claim thereafter if the son so chose to make one, but that, too, without any interim injunction.

Senior Citizens Act or D.V. Act – Which reigns supreme?

What happens when a woman claims a right under the DV Act to a shared household belonging to her in-laws in which she and her husband resided and at the same time the in-laws seek to evict her by resorting to the Senior Citizens Act? We have already seen that the Supreme Court in the case of Satish Chander (Supra) has categorically established that a shared household would even include a house owned by and belonging to the in-laws. In such a scenario, which Act would reign supreme? A three-Judge Bench of the Supreme Court had an occasion to consider this very singular issue in Smt. S. Vanitha vs. The Deputy Commissioner, Bengaluru Urban District & Ors., CA 3822/2020 Order dated 15th December, 2020. The facts were that the in-laws sought to evict their estranged daughter-in-law from their house by resorting to the Senior Citizens Act. The Tribunal issued an eviction order. The woman claimed that as the lawfully-wedded spouse she could not be evicted from her shared household in view of the protection offered by section 17 of the DV Act. By relying on the decision in Satish Chander (Supra) she claimed that the authorities constituted under the Senior Citizens Act had no jurisdiction to order her eviction.

J. Dr. Chandrachud, speaking on behalf of the Bench, observed that the Maintenance Tribunal under the Senior Citizens Act may have the authority to order an eviction, if it is necessary and expedient to ensure the maintenance and protection of the senior citizen or parent. Eviction, in other words, would be an incident of the enforcement of the right to maintenance and protection. However, this remedy could be granted only after adverting to the competing claims in the dispute.

The Bench observed that section 36 of the DV Act contained a non-obstante clause to ensure that the remedies provided were in addition to other remedies and did not displace them. The Senior Citizens Act was undoubtedly a later Act and also stipulated that its provisions would have effect, notwithstanding anything inconsistent contained in any other enactment. However, the Court held that the provisions of the Senior Citizens Act giving it overriding force and effect would not by themselves be conclusive of the intent to deprive a woman who claimed a right in a shared household under the DV Act. It held that the principles of statutory interpretation dictated that in the event of two special acts containing non-obstante clauses, the later law typically prevailed and here the Senior Citizens Act, 2007 was the later statute. However, interestingly, the Apex Court held that in the event of a conflict between two special acts, the dominant purpose of both statutes would have to be analysed to ascertain which one should prevail over the other. In this case, both pieces of legislation were intended to deal with salutary aspects of public welfare and interest.

It held that a significant object of the DV Act was to provide for and recognise the rights of women to secure housing and to recognise the right of a woman to reside in a matrimonial home or a shared household, whether or not she has any title or right in the shared household. Allowing the Senior Citizens Act to have an overriding force and effect in all situations, irrespective of competing entitlements of a woman to a right in a shared household within the meaning of the DV Act, 2005, would defeat the object and purpose which the Parliament sought to achieve in enacting the latter legislation. The law protecting the interest of senior citizens was intended to ensure that they are not left destitute, or at the mercy of their children or relatives. Equally, the purpose of the DV Act could not be ignored by a sleight of statutory interpretation. Both sets of legislations had to be harmoniously construed.

Hence, it laid down a very important principle, that the right of a woman to secure a residence order in respect of a shared household could not be defeated by the simple expedient of securing an order of eviction by adopting the summary procedure under the Senior Citizens Act! It accordingly directed that, in deference to the dominant purpose of both the legislations, it would be appropriate for a Maintenance Tribunal under the Senior Citizens Act to grant only such remedies of maintenance that do not result in obviating competing remedies under other special statutes such as the DV Act. The Senior Citizens Act could not be deployed to override and nullify other protections in law, particularly that of a woman’s right to a shared household u/s 17 of the DV Act.

CONCLUSION

It is evident that the DV Act is a very important enactment and a step towards women’s empowerment. Courts are not hesitant to uphold its superiority over other laws and under various scenarios.

shailesh.kwebmaker

DEPARTMENT AUDIT

INTRODUCTION

For long taxes in India and the world over have worked on the principle of self-assessment, meaning a registered taxpayer (RTP) would himself assess his liability and discharge the same as per the provisions applicable under the respective statute by filing the prescribed returns. Once the self-assessment process is concluded, the tax authorities initiate the process of verifying the correctness of the taxes paid by the RTP under the self-assessment scheme which involved interaction with the RTPs / their consultants.

Under the pre-GST regime, with the presence of multiple taxes, there were multiple assessments in different forms that an RTP had to undergo. The VAT law provided for a concept of assessment which was done on a year-on-year basis requiring the RTP to visit the tax department with box-loads of files to demonstrate various claims and positions taken by him, while the Central Excise / Service tax followed a detailed Audit structure, which was commonly known as EA-2000 Audit, and in respect of which a detailed manual for the tax officials on how an Audit on taxpayer records should be carried out was also issued.

Apart from these, there were provisions for investigation, special audits, etc., under the respective statutes which empowered the tax authorities to undertake further verification. The same practice has also been followed under the GST regime with the law providing for different methods of assessment such as Provisional Assessment (section 60), Scrutiny in different scenarios (sections 61 to 64), Audit by Tax Authorities (section 65), Special Audit (section 66) and investigation (section 66).

ASSESSMENT VS. SCRUTINY VS. AUDIT VS. INVESTIGATION

The term assessment has been defined u/s 2(11) to mean determination of tax liability under this Act and includes self-assessment, re-assessment, provisional assessment, summary assessment and best judgment assessment. The above definition demonstrates that while there can be different forms of assessments, their purpose is to determine the tax liability of a person, whether or not such person is registered.

But while the term ‘scrutiny’ has not been specifically defined, the way the provisions u/s 61 have been worded indicate that scrutiny is to be seen vis-à-vis the correctness of the particulars furnished in the returns. Therefore, the scope of scrutiny would generally cover cases where there is a mismatch between GSTR1 and GSTR3B or non-disclosure of certain information in the returns, etc. In other words, the basis for scrutiny proceedings should only be the returns filed and nothing else. In that sense, this is similar to intimation issued u/s 143 (1) of the Income-tax Act.

The term ‘audit’, on the other hand, has been defined u/s 2(13) to mean the examination of records, returns and other documents maintained or furnished by the registered person under this Act or the rules made thereunder or under any other law for the time being in force to verify the correctness of turnover declared, taxes paid, refund claimed and input tax credit availed, and to assess his compliance with the provisions of this Act or the rules made thereunder.

Lastly, the term investigation, which generally encompasses ‘inspection, search, seizure and arrest’, is undertaken by the tax authorities when they have reason to suspect suppression by an RTP whether of liability on supply of goods / services or claim of input tax credit. Any proceedings under this category can be initiated only after approval by the competent authority and empowers the tax authorities to confiscate the records of the RTP.

A plain reading of the above clearly indicates the distinction in the concept behind each of the steps and the very distinction needs to be respected. The same can be summarised as under:

•   Assessment – determination of tax liability,
•   Scrutiny – to verify the correctness of the returns filed,
•   Audit – to verify the overall compliance with the provisions of GST, including returns filed, credits / refunds claimed, etc.,
•   Investigation – to undertake verification based on specific information received relating to suppression by an RTP– either in respect of liability or input tax credit.

A primary question which generally arises and is also experienced in daily proceedings is whether there can be parallel proceedings. For example, can scrutiny of an RTP be undertaken when the audit for the same period is already going on? Or can an RTP be subjected to parallel proceedings – audit by one wing and investigation by another? In a recent decision in the case of Suresh Kumar PP vs. Dy. DGGI, Thiruvananthapuram [2020 (41) GSTL 308 (Ker.)], the single-member Bench had refused to intervene when parallel proceedings, audit u/s 65 and investigation were initiated. In fact, the HC held that interferences in process issued for auditing of books as well as order of seizure of the documents would help the Department in correlating the entries in document and at the time of auditing of the account.

When appealed before the Division Bench [reported in 2020 (41) GSTL 17 (Ker.)], while the High Court held that there was no infirmity in the audit and investigation proceedings being continued simultaneously, the Revenue itself submitted that once the investigation proceedings are initiated, the audit proceedings shall stand vacated. This is an important takeaway from this judgment (although in favour of Revenue) for RTPs who are facing parallel proceedings at the same time for the same period. The RTP can always contend that since the Department has taken a stand in one case that once investigation commences audit proceedings shall be discontinued, the same should be followed in other cases as well. However, it remains to be seen whether or not the Revenue follows this stand in all the cases.

In this background, we shall now discuss the provisions relating to audit u/s 65 for which many RTPs have already started receiving notices and some important aspects which revolve around the same.

SCOPE OF AUDIT

The term ‘audit’ has been defined u/s 2(13) and reproduced above. On going through the same, it is apparent that the scope of audit is to be restricted to ‘examination of records, returns and other documents maintained or furnished by the registered person’.

While the term ‘record’ has not been defined, the term ‘document’ has been defined u/s 2(41) to include written or printed record of any sort and electronic record as defined in clause (t) of section 2 of the Information Technology Act, 2000 (21 of 2000). Section 145 further provides that any document, which is maintained in a microfilm or reproduced as image embodied in a microfilm or a facsimile copy of a document or statement contained in a document and included in printed material produced by a computer or any information stored electronically in any device or media including hard copies made of such information, shall be deemed to be a document for the purposes of this Act. It is, therefore apparent that all documents which are stored in a scanned copy should be sufficient during the audit purpose. This should apply also for copies of purchase invoices, sales invoices, etc., which, during the audit, tax authorities generally insist upon for physical verification.

The second important takeaway from the definition of ‘audit’ which to some extent also defines the scope of ‘audit’, is that the examination is to be of the documents maintained or furnished by the registered person, i.e., things which are within the reach of the RTP being audited. Therefore, what can be the subject matter of audit is only such documents / records which are maintained / furnished by the RTP and are within his control. Therefore, the audit team cannot insist on a reconciliation based on figures appearing in form 26AS and demand tax on the mismatch since the form 26AS is not maintained / furnished by the RTP, but prepared by the Government based on disclosures made by the RTPs’ clients / suppliers. This view finds support from the decision of the Tribunal in the case of Sharma Fabricators & Erectors Private Limited vs. CCE, Allahabad [2017 (5) GSTL 96 (Tri. All.)] where the Tribunal had set aside the demand raised based on TDS certificates issued by the clients and not the books of accounts of the RTP.

A similar issue is likely to arise in case of mismatch between GSTR3B and GSTR2A. GSTR3B is the monthly return wherein an RTP also lodges a claim for input tax credit while GSTR2A is the document wherein the supplies disclosed by the supplier in GSTR1 are disclosed and auto-populated and made available to the recipient. A strong view can be taken that GSTR3B and GSTR2A are not comparable documents as GSTR2A is not maintained / furnished by the recipient. However, such a stand may not be accepted by the Department after the introduction of Rule 36(4) as the scope of audit is to look at the overall correctness of the returns furnished by the RTP and compliance with the various provisions of the Act and Rules framed therein.

In fact, on the issue of whether an audit can be conducted when there is apprehension that certain amounts were kept outside of the accounts, the Supreme Court has, while admitting the appeal in the case of Commissioner vs. Ranka Wires Private Limited [2006 (197) ELT A83 (SC)], sought an affidavit from the Revenue as to why the audit was conducted when the show cause notice alleged that certain amounts were kept out of the accounts. This indicates that even the Supreme Court is of the view that in a case where the dispute revolves around transactions outside the books of accounts of the RTP, the same is a fit case for investigation and not audit.

LEGAL VALIDITY

Under the Service Tax regime, the power to conduct audit was derived from Rule 5A of the Service Tax Rules, 1994. However, there were no enabling powers under the Finance Act, 1994 empowering the Central Government to frame rules relating to Department Audit. For this reason, the Delhi High Court has, in the case of Mega Cabs Private Limited vs. UoI [2016 (43) STR 67 (Del. HC)] held Rule 5A as ultra vires the provisions of the Finance Act, 1994. This dispute continued even after the introduction of GST where the notice for conducting audits was challenged on the grounds that the savings clause under the CGST Act, 2017 did not save the right of the Revenue to conduct audit u/r 5A of the Service Tax Rules, 1994. There have been conflicting decisions of the High Courts in this regard and therefore the dispute will reach finality only with a judgment of the Apex Court.

However, the above decision may not continue to apply under GST. The basis for the conclusion in the case of Mega Cabs (Supra) was that there was no enabling provision under the Finance Act, 1994 which empowered the Central Government to make Rules relating to audit. However, under the GST regime there are specific provisions which empower the Government to undertake Department Audit and frame rules in regard to the same.

AUDIT U/S 65 – PROCEDURAL ASPECTS

The detailed procedure to be followed while conducting audit has been provided for u/s 65 of the CGST Act, 2017. In addition, the CBIC has also issued a detailed Manual for steps to be followed before, during and after the audit.

Selection of registered person for audit

This is the first step of the audit process. This requires following of the risk-assessment method for selection of the RTP who shall undergo audit. The entire process would be facilitated based on the available registered person-wise data, the availability of which would be ensured by the Audit Commissionerate. Based on the process of risk assessment undertaken, the list of RTPs selected for the audit would be shared with the Audit Commissionerate, along with the risk indicators, i.e., area of focus for the Audit Team. The Audit Commissionerate would also be at liberty to select RTPs at random for undertaking of audit based on local risk perception in each category of small, medium and large units as well as those registered u/s 51 and 52 to verify compliance thereof.

The Manual also speaks of accrediting such RTPs, who have a proven track record of compliance with tax laws, though the procedure for such accreditation is yet to be provided. RTPs who have received accreditation shall not be subjected to audit up to three years after the date of the last audit.

Authorisation for conducting audit

The first formal step after selection of the RTP liable to be audited is authorisation u/s 65(1) to conduct the said audit, either by the Commissioner or any officer authorised by a general or specific order. U/r 101 it has been provided that the period of audit shall be a financial year or part thereof, or multiples thereof. This is the enabling provision for initiating the audit process and unless a valid authorisation has been obtained, the entire proceedings would be treated as null and void.

One may refer to the decision of the Karnataka High Court in the case of Devilog Systems India vs. Collector of Customs, Bangalore [1995 (76) ELT 520 (Kar.)] where a notice not issued by a ‘proper officer’ was held to be invalid. On the other hand, recently the Delhi High Court has, in the case of RCI Industries & Technologies Limited vs. Commissioner, DGST [2021-VIL-31-Del.], held that if an officer of the Central GST initiates intelligence-based enforcement action against an RTP administratively assigned to a State GST, the officers of the former would not transfer the said case to their counterparts in the latter Department and they would themselves take the case to its logical conclusion.

A question might arise as to whether or not the auditee should be given an opportunity of being heard before his name is selected for the purpose of conducting audit u/s 65(1). This aspect has been dealt with by the High Court in the case of Paharpur Cooling Towers Limited vs. Senior Joint Commissioner [2017 (7) GSTL 282 (Cal.)] wherein, in the context of VAT, the Court held that subjecting an assessee to audit does not result in adverse civil consequence and therefore the question of giving a hearing before selection does not arise.

However, while selecting an RTP for special audit, the Delhi High Court has held in the case of Larsen & Toubro Ltd. [2017 (52) STR 116 (Del.)] that since an order for special audit is likely to cause prejudice, hardship and displacement to the assessee, the requirement of issuance of a show cause notice ought to be read into section 58A of the Delhi Value Added Tax Act, 2004 so as to grant reasonable opportunity for representation.

Pre-Audit preparation

This is where the actual audit process concerning an RTP commences. The first step is to prepare the Registered Person Master Profile (RPMF) which contains details that can be extracted from the Registration Certificate, such as application for registration, registration documents and returns filed by the registered person as well as from his annual return, E-way Bills, reports / returns submitted to regulatory authorities or other agencies, Income-tax returns, contracts with his clients, audit reports of earlier periods as well as audits conducted by other agencies, like office of the C&AG, etc., most of which will be available in the GSTN.

The Manual speaks about a utility ‘RTPs at a Glance’ made available to the Audit Team which would contain a comprehensive data base about an RTP. It appears primarily to be a facility exclusively for the Audit Team and not for the auditee. The Manual also requires that before the start of each audit the RPMF should be updated based on the details available or sourced from the auditee and the same should be updated periodically after completion of audit. Various documents gathered during the audit, such as audit working papers, audit report duly approved during Monitoring Meeting, etc., along with the latest documents should also form part of the RPMF.

AUTHORS’ VIEWS

The Audit Manual speaks about RPMF which needs to be collated and updated by the Jurisdictional Audit Commissionerate. This is a novel concept aimed at improving the quality of the process and would also help the Audit Team become aware about the auditee. However, maintenance of records in the specified format prescribed in the Audit Manual is not something new but one that was also used during the EA 2000 Audit. Past experience indicates that the Audit Teams generally shift the onus to compile and collect the basic details which is cast on them on to the auditees and such an exercise is started only when the audit nears completion and the file is to be put before the monitoring committee for review.

In fact, in the notices currently received it is seen that even the RPMF is being sent to the auditee for submission along with intimation in Form GST ADT 01 and the list of documents required for the audit. Therefore, perhaps to this extent, the process laid down by the Manual appears to have failed to achieve the stated objective. This is because only after the profiling activity is undertaken is the audit allocated to the audit parties.

Audit intimation

The next step, after undertaking profiling of the RTP / auditee, is to allocate the audit to the audit parties. The audit parties are expected to issue intimation in Form GST ADT 01 giving the auditee at least 15 days to provide the details required for the audit as provided for u/s 65(3). An indicative list of information to be requisitioned by the audit party has been provided in Annexure III of the Audit Manual.

Section 65 clearly requires that a general / specific order be issued by the Commissioner / an officer authorised by him stating that the RTP has been selected for Department Audit for the period specified therein. Such a list has already been released by the Maharashtra State authorities where the audit will be conducted by the respective State Audit Team. Any RTP receiving intimation for audit should check:

• Whether the notice has been received from his jurisdiction, i.e., an RTP allotted to State cannot be audited by Central authorities and vice versa;
• The second point to check is whether the general order specifically mentions the RTP. If not, a request for a specific order should be made in writing to the Audit Team as absence of the same would render the entire proceedings being without the authority of law and any proceedings emanating from such an exercise might not survive the test of law.

Vide Explanation to section 65, it has been clarified that the term ‘commencement of audit’ shall be the date on which the records and other documents called for by the tax authorities are made available by the registered person, or the actual institution of audit at the place of business, whichever is later. This is important because section 65 provides that once the audit process commences, the same must be concluded within three months which period can be extended by the Commissioner for a further period of up to six months for reasons to be recorded in writing.

It is therefore of utmost importance that the RTP under audit maintain proper communication regarding submission of documents and once all the documents sought by the Audit Team are submitted, a formal letter intimating them about the same should be filed. This is important because under the service tax regime, while dealing with the issue of what constitutes commencement of audit, the Tribunal has in the case of Surya Enterprises vs. CCE & ST, Chennai II [2020 (37) GSTL 320 (Tri. Che.)] held that mere issuance of a letter requesting for submission of documents could not be considered as initiation of audit. The Department had to demonstrate that the audit was commenced by producing its register of audit visit.

Desk Review

On the basis of the response of the auditee, the Audit Party is expected to undertake a Desk Review to understand the operations, business practice and identify potential audit issues. The Desk Review proposed in the Manual is an exhaustive process to be undertaken by the Audit Party for the preparation of the audit plan, which includes:

•   Referring to RPMF which would throw up various points meriting inclusion in the audit plan;
•   Analysis of exports turnover, turnover of non-taxable / exempted goods and service to obtain a clear picture of the transactions not considered for tax payment and arrive at a prima facie opinion on the correctness of such claims;
•   Determine the various mismatches, such as GSTR1 vs. GSTR3B, credits as per 3B vs. 2A, etc., which should be discussed in the Audit Plan for verification at the time of audit;
•   Undertake ratio analysis, trend analysis and revenue risk analysis based on the documents obtained up to that stage and reconciling the same with the Third Party Information, such as Form 26AS, ITR, etc., and analysing the variances;
•   Prepare a checklist (different checklists have been prescribed for traders and composite dealers)

Audit plan

The next activity is to prepare the audit plan based on the above activities undertaken by the Audit Team. The Manual specifically highlights the importance of the Audit Plan and the steps preceding its preparation. It also specifies the preferable format in which the Audit Plan is to be prepared and requires that the same should be discussed with the Assistant / Deputy Commissioner and finalised after approval of the Commissioner / Joint or Additional / Deputy or Assistant, as the case may be.

Audit verification

The next step is to undertake audit verification. Section 65(2) provides that the audit ‘may’ be conducted at the POB of the RTP or in their office. The purpose of audit verification, as per the Manual, is to perform verification activities and obtain audit evidence by undertaking verification of data / documents submitted at the time of desk review and verification of points mentioned in the Audit Plan.

The primary activity to be carried out during Audit Verification is evaluation of internal controls which has been dealt with extensively in the Manual as it lays down different techniques to be followed for this process, including walk-through, ABC analysis, etc., and requires the various findings to be recorded in the working papers, the formats of which have also been specified in Annexure VIII of the Manual.

Additionally, the auditor is also required to undertake verification of all the points mentioned in the Audit Plan. The primary point to verify is whether any weakness in internal control of the auditee has resulted in loss of revenue to the Government. The Audit Team is also expected to verify various documents submitted to Government Departments which can be used for cross-verification of information filed for the assessment of GST.

Audit observations

The next step as per the Manual is to communicate the various audit observations to the auditee and obtain his feedback on the same. The Manual categorically states that an audit observation is not a show cause notice but only an exercise for understanding the perspective of the auditee on a particular issue and clearly states that wherever a suitable reply is provided by the auditee, the same may be removed from the findings and excluded from the draft audit report after approval of the seniors.

However, the Manual further states that where the response of the auditee is not forthcoming, the observation should be included in the draft audit para specifically stating the non-submission of response by the auditee.

This is an important step in the Manual. Even under the EA 2000 Audit it has been seen that whenever an observation letter is shared with the auditee, it is more in the nature of a show cause notice, rather than seeking the viewpoint of the auditee on a particular issue and in the observation para itself there is a statement saying that the payment of the tax amount, along with interest and penalty, be made and compliance be reported to the Audit Team. This contrasts with the purpose of the concept of communication of observation as it takes the shape of a recovery notice rather than a routine communication.

Unless the Audit Team is sensitised about this aspect, the Audit Manual will lose its purpose as it is unlikely the approach of the Audit Team would change even after issuance of this Manual. It has also been seen that the Team expects a reply to the observation para, at times in one to two days. The Audit Team needs to be sensitised to the fact that the auditee resources must also carry out their regular activity and they can, at no point of time, be fully dedicated only to the Department Audit process. Even otherwise, certain observation paras may involve legal issues that may need more time, including the auditee obtaining legal advice for drafting a reply to the same in which case a reply at such a short notice may not be feasible. Therefore, it is essential that a standardised format for sharing of audit observation and sufficient time to the auditee for replying to the same be prescribed.

Preparation of audit report

Once the above exercise is concluded, the Audit Team is expected to prepare a draft audit report for onward submission to senior officers and should be placed before the Monitoring Cell Meeting (MCM) for discussion on various points raised therein. It is during the MCM that the decisions of issuing notices, including invocation of extended period of limitations, are taken or issuance of a show cause notice can be waived.

Based on the decisions taken during the MCM, a Final Audit Report (FAR) has to be prepared which will also be conveyed to the auditee. Section 65(6) provides that on conclusion the ‘Proper Officer’ shall within 30 days inform the auditee about the findings, the reasons for such findings and his rights and obligations. The same shall be intimated in form GST ADT 02 as notified vide Rule 101(5). It is only after the issuance of the final audit report u/s 65(6) that recovery proceedings u/s 73 or 74 can be initiated.

It is imperative to note that generally the recovery proceedings are initiated before the issuance of the FAR. At the time of receipt of a show cause notice, the auditee needs to ensure whether the same is received prior to the issuance and receipt of the FAR or afterwards. It is imperative to note that even under the pre-GST regime, (recently) in Sheelpa Enterprises Private Limited vs. Union of India [2019 (367) ELT A17 (Guj.)] the High Court has admitted a writ petition challenging the validity of a show cause notice issued prior to the issuance of the FAR.

The Final Audit Report shall comprise of the decision taken on the audit paras, including cases where the show cause notice is issued / to be issued and cases where a decision to not initiate proceedings has been taken.

Respecting timelines

Section 65, Rule 101 of the CGST Rules, 2017 and the Audit Manual issued by the CBIC strongly reiterate the importance of adhering to timelines, both for initiation of audit as well as conclusion. The fact that this aspect has been specifically included in the statute demonstrates the intention of the Legislature to ensure timely compliance of the proceedings. This is a positive aspect because under the EA 2000 there were no strict timelines prescribed, but rather only guidelines which meant that the EA 2000 audit in many cases kept going on for a long stretch of time.

While this is a positive move on the part of the Legislature to include the timelines in the statute itself, it will also cast an onerous responsibility on the auditees to ensure that they have submitted all the information sought by the Audit Team within the prescribed time. Besides, proper documentation and acknowledgement of submission of documents would also be important since it is possible that the Audit Team might dispute the date of ‘commencement of audit’ itself citing receipt of incomplete data. It is therefore advisable that the fact of non-availability of certain details (for instance, state-wise trial balance) be intimated to the Audit Team at the initial stage itself.

The RTP should also note that in case of delay in submission, there might be adverse action taken on account of non-submission. For example, if an RTP has claimed certain exemption and the supporting documents for which are not submitted within the timelines prescribed by the Audit Team, it is possible that they may end up with an observation letter which would result in unnecessary initiation of a protracted litigation since the experience suggests that an observation para generally culminates in issuance of a show cause notice.

Therefore it is imperative that an RTP who has already received audit notice or is likely to receive one, prepares basic documentation which can be shared immediately with the Audit Team as and when asked, such as state-wise trial balances, details of exports along with FIRC details, basis for claim of exemption, reconciliation of earnings / expenditure in foreign currency with GST filings, etc. Perhaps a lot of the information sought by the Audit Team is generally required during the audit u/s 35. It would therefore be prudent that the RTP / consultants prepare the supporting file during the audit u/s 35 itself so that not only is there no duplication of work, but they also become aware of any specific issues.

An assessee, who was also registered under service tax, will agree that a lot of litigations under that tax were on account of non-submission of the above information. Of course, the Courts have time and again held that demand cannot be based merely on account of a difference in two figures and should be supported with proper evidence. One may refer to the decision of the Tribunal in the case of Go Bindas Entertainment Private Limited vs. CST, Noida [2019 (27) GSTL 397 (Tri. All.)].

Other points to note

An audit process involves substantial human element and therefore needs to be handled carefully on all fronts, be it sharing of information or interacting with the Audit Team owing to the subjectiveness of the auditor. The auditee / their consultants must bear this aspect in mind while interacting. It is important that at no point of time should they antagonise the Audit Team. This is important because if such a situation arises, it is likely that the Audit Team might raise meritless observations which would culminate in the issuance of show cause notices and the initiation of unnecessary protracted litigations.

One important aspect which needs to be noted by the readers, although out of context but arising from the Department Audit process, is that whenever a notice is issued by the Audit Team it is generally issued invoking the extended period of limitation alleging fraud, wilful misstatement, etc., with the intention to evade payment of tax. Such audit notices generally allege that ‘had the audit not been conducted, the fact of the said contravention, which can be either non-payment of tax / excess claim of input tax credit and so on, would have gone unnoticed’. It is imperative to note that merely making such a statement is not sufficient for invocation of extended period of limitation. There must be some demonstration that there prevailed an intention to evade payment of tax and the allegation of fraud, wilful misstatement, etc., should be demonstrated with supporting documentation by the Audit Team. The Mumbai Bench of the Tribunal has, in the case of Popular Caterers vs. Commissioner, CGST, Mumbai West [2019 (27) GSTL 545 (Tri. Mum.)], held that suppression can’t be alleged merely because the Audit Team found certain credits inadmissible.

The High Court has, in the case of Haiko Logistics Private Limited vs. UoI [2017 (6) GSTL 235 (Del.)] raised serious questions on the act of seizure of documents undertaken during the audit process.

Similarly, no summons can be issued in pursuance of the audit process. The Tribunal in the case of Manak Textiles vs. Collector of Central Excise [1989 (42) ELT 593 (Tri. Del.)] held that a statement made to an audit party is not valid as the Audit Party has no authority to record any statement. This principle should apply under GST also as audit is conducted u/s 65 while powers to record statements are governed u/s 70.

CONCLUSION

While the Audit Manual indicates the intention of the CBIC to make the entire process smooth and systematic, it remains to be seen how the same is implemented. Past experience shows that the Department Audit is generally an exhausting process resulting in unwarranted litigation, which in India is protracted and costly. It is therefore important that the RTP prepare for audit on an annual basis, irrespective of whether a notice for the same is received or not, and keep the documentation ready to the extent possible.

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ACCOUNTING FOR CROSS HOLDING

INTRODUCTION

There is no existing guidance under Ind AS for the accounting of cross holdings. This article provides guidance on the accounting of cross holdings between two associate companies. Consider the following fact pattern:

Entity Ze has an associate Ve (20% of Entity Ve and significant influence).

Entity Ve has an associate Ze (20% of Entity Ze and significant influence).

Both Entity Ze’s and Entity Ve’s share capital is 200,000 shares at 1 unit each.

Entity Ze’s profit excluding its share in Ve = INR 1000; Entity Ve’s profit excluding its share in Ze = INR 1000.

ISSUES

• How does an entity account for cross holdings in associates in accordance with paragraph 27 of Ind AS 28 Investments in Associates and Joint Ventures in the Consolidated Financial Statements?

• Does an entity adjust EPS calculation for the cross holdings?

RESPONSE

References to Ind AS

Paragraph 26 of Ind AS 28 applies consolidation procedures to equity method of accounting as follows:

‘Many of the procedures that are appropriate for the application of the equity method are similar to the consolidation procedures described in Ind AS 110. Furthermore, the concepts underlying the procedures used in accounting for the acquisition of a subsidiary are also adopted in accounting for the acquisition of an investment in an associate or a joint venture.’

Paragraph 27 of Ind AS 28 states:

‘A group’s share in an associate or a joint venture is the aggregate of the holdings in that associate or joint venture by the parent and its subsidiaries. The holdings of the group’s other associates or joint ventures are ignored for this purpose. When an associate or a joint venture has subsidiaries, associates or joint ventures, the profit or loss, other comprehensive income and net assets taken into account in applying the equity method are those recognised in the associate’s or joint venture’s financial statements (including the associate’s or joint venture’s share of the profit or loss, other comprehensive income and net assets of its associates and joint ventures), after any adjustments necessary to give effect to uniform accounting policies (see paragraphs 35 and 36A).’

Paragraph B86 of Ind AS 110 Consolidated Financial Statements states:

‘Consolidated financial statements:… (c) eliminate in full intragroup assets and liabilities, equity, income, expenses and cash flows relating to transactions between entities of the group (profits or losses resulting from intragroup transactions that are recognised in assets, such as inventory and fixed assets, are eliminated in full).’

Paragraph 33 of Ind AS 32 Financial Instruments: Presentation states:

‘If an entity re-acquires its own equity instruments, those instruments (“treasury shares”) shall be deducted from equity. No gain or loss shall be recognised in profit or loss on the purchase, sale, issue or cancellation of an entity’s own equity instruments. Such treasury shares may be acquired and held by the entity or by other members of the consolidated group. Consideration paid or received shall be recognised directly in equity.’

GROSS APPROACH

Entity Ze’s profit and Entity Ve’s profit are dependent on each other, which can be expressed by simultaneous equations as follows:

a = INR 1000 + 0.2b
b = INR 1000 + 0.2a

Solving the simultaneous equation results in:

a = INR 1250 and b = INR 1250

Therefore, Entity Ze’s profit is INR 1250, and Entity Ve’s profit is INR 1250.

NET APPROACH

This approach ignores the cross holding and simply takes up the investor’s share of the associate’s profit, excluding the equity income arising on the cross shareholding. Thus, the additional profit in the financial statements of both Entity Ze and Entity Ve is limited to INR 200 each (1000*20%).

A literal view of paragraph 27 of Ind AS 28 is that Entity Ze recognises its share of Entity Ve’s profits, including Entity Ve’s equity accounted profits. However, in the case of cross holdings this approach results in a portion of Ze’s profits being double counted. Consequently, the net approach, which only accounts for 20% of the associate’s profit, is more appropriate. In this fact pattern, the net approach results in Entity Ze and Entity Ve both recognising profit of INR 1200 (rather than INR 1250 as per the gross approach). The difference of INR 50 represents the equity effect of the cross holdings and therefore is not recognised in profit. In other words, the INR 50 represents (with respect to the associate that is preparing its consolidated accounts) a portion of its own profit being double counted.

Additionally, the equity method of accounting employs consolidation-type procedures such as the elimination of unrealised profits. Income arising on an investment held by a subsidiary in a parent is eliminated under paragraph B86(c) of Ind AS 110 Consolidated Financial Statements. Consequently, in applying consolidation procedures in equity accounting, income arising from associate’s investment in the investor should also be eliminated.

Consequently, the net approach is the only acceptable method.

EPS CALCULATION

The number of ordinary shares on issue is adjusted using the net approach. Consequently, an adjustment reduces the entity’s equity balance and its investment in the associate by its effective 4% interest (20*20%) in its own shares. The result is similar to the treatment of treasury shares that are eliminated from equity and, accordingly, excluded in determining the EPS. In calculating earnings per share, the weighted average number of ordinary shares is reduced by the amount of the effective cross holding. Therefore, Entity Ze’s and Entity Ve’s ordinary shares are reduced to 192,000 (200,000*[100-4]; i.e. 96%) for the purpose of the earnings per share calculation.

Some may argue that the associate is not part of the group and therefore the shares held in the investor are not ‘treasury shares’ as defined in Ind AS 32. However, it may be noted that the view in the preceding paragraph does not rely on viewing the associate’s holding as treasury shares. Rather, it relies on the fact that Ind AS 28.26 states that many of the procedures that are appropriate for the application of the equity method are similar to the consolidation procedures described in Ind AS 110. If a subsidiary holds shares in a parent, these are eliminated under paragraph B86(c) of Ind AS 110. The same procedure should therefore apply to equity accounting.

Though this issue is discussed in the context of cross holdings between associates, it will apply equally to jointly controlled entities that are equity accounted.

shailesh.kwebmaker

Search and seizure – Sections 132, 143(2) and 158BC of ITA, 1961 – Block assessment u/s 158BC – Issue and service of notice u/s 143(2) is mandatory – Non-issuance of notice – Assessment vitiated

39. CIT vs.
Sodder Builder and Developers (P) Ltd.; [2019] 419 ITR
436 (Bom.) Date of order:
16^th July, 2019

Search and
seizure – Sections 132, 143(2) and 158BC of ITA, 1961 – Block assessment u/s
158BC – Issue and service of notice u/s 143(2) is mandatory – Non-issuance of
notice – Assessment vitiated

A search and seizure operation u/s 132 of the Income-tax Act, 1961 was
conducted in the assessee’s premises. A notice was issued u/s 158BC to assess
the undisclosed income. The Assistant Commissioner passed an assessment order
u/s 158BC. The records indicated that no notice u/s 143(2) was issued to the
assessee.

The assessee contended that non-issuance of such a notice vitiated the
assessment made under the special procedure under Chapter XIV-B. The Tribunal
accepted the assessee’s claim and allowed the appeal filed by the assessee.

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

‘i) In the present case,
admittedly, no notice u/s 143(2) of the said Act was ever issued to the
assessee. By applying the law laid down by the Hon’ble Apex Court in Asst.
CIT vs. Hotel Blue Moon (210) 321 ITR 362 (SC), we will have to hold
that the assessment made in the present case stands vitiated.

ii) Therefore, even if we were to
hold in favour of the Revenue with regard to the other substantial questions of
law framed at the time of admission of this appeal, the assessment made in the
present matter would nevertheless stand vitiated for want of mandatory notice
u/s 143(2) of the said Act.

iii) The assessment made by the
Assistant Commissioner pursuant to the notice issued u/s 158BC was vitiated for
want of the mandatory notice u/s 143(2).’

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Search and seizure – Sections 68, 132, 153A and 153C of ITA, 1961 – Assessment of third person – Jurisdiction of AO – Addition made u/s 68 not based on material seized during search – Not sustainable

38. Principal
CIT vs. Ankush Saluja; [2019] 419 ITR
431 (Del.) Date of order:
14^th November, 2019 A.Y.: 2007-08

Search and
seizure – Sections 68, 132, 153A and 153C of ITA, 1961 – Assessment of third
person – Jurisdiction of AO – Addition made u/s 68 not based on material seized
during search – Not sustainable

A search and seizure operation u/s 132 of the Income-tax Act, 1961 was
conducted in the S group. Cash and jewellery which belonged to the assessee
were found and seized from the residence of the assessee’s father in whose name
the search warrant of authorisation was issued. The satisfaction note was
recorded by the AO in this regard and a notice u/s 153C read with section 153A
was issued against the assessee. In response thereto, the assessee filed his
return of income. The AO treated the unsecured loans as unexplained cash credit
u/s 68 of the Act and made an addition to that effect.

The Commissioner (Appeals) held that the addition u/s 68 was not based
on any incriminating document found and seized during the search and,
therefore, the addition could not be sustained. The Tribunal upheld the order
of the Commissioner (Appeals).

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

‘i) There were concurrent
findings of fact to the effect that the additions made by the Assessing Officer
u/s 68 were not based on any incriminating document found or seized during the
search action u/s 132. In this view of the matter, the assumption of
jurisdiction u/s 153C by the Assessing Officer was not justified and
accordingly the additions made u/s 68 could not be sustained.

ii) No question of law arose.’

shailesh.kwebmaker

Reassessment – Sections 147 and 148 of ITA, 1961 – Condition precedent for notice – Tangible material to show escapement of income from taxation – Agricultural income disclosed in return and accepted – Subsequent advisory by IT Department that claims of agricultural income should be investigated – Notice based solely on advisory – Not valid

37. Ravindra
Kumar (HUF) vs. CIT; [2019] 419 ITR
308 (Patna) Date of order:
6^thAugust, 2019 A.Y.: 2011-12

Reassessment –
Sections 147 and 148 of ITA, 1961 – Condition precedent for notice – Tangible
material to show escapement of income from taxation – Agricultural income
disclosed in return and accepted – Subsequent advisory by IT Department that
claims of agricultural income should be investigated – Notice based solely on
advisory – Not valid

For the A.Y. 2011-12, the assessee had filed return of income which
included agricultural income. On 22^ndMarch, 2018, the AO issued
notice u/s 133(6) of the Income-tax Act, 1961 requiring the assessee to furnish
the information relating to the agricultural income disclosed in his return.
The assessee did not respond to this notice. The notice was followed by a
notice u/s 148. The reassessment notice was based on an advisory issued by the
Income-tax Department. The advisory directed the AO to verify whether there was
any data entry error in the returns filed, to provide feedback where assessment
was complete and in cases where assessment was pending, to thoroughly verify
the claims on agricultural income. The assessee filed a writ petition and
challenged the notice.

The Patna High Court allowed the writ petition and held as under:

‘i) A power to reopen an
assessment would vest in the Assessing Officer only if there is tangible material
in his possession for coming to a conclusion that there was escapement of
income chargeable to tax, from assessment, and the reasons with the Assessing
Officer must have a live link with the formation of belief.

ii) The Assessing Officer
mentioned in the “reasons” supplied that the assessee had not
produced certain evidence in support of agricultural income and in the absence
of which the claim towards agricultural income could not be substantiated. The
admission by the Assessing Officer regarding absence of material could not lead
to the formation of belief that the disclosure was incorrect and chargeable to
tax u/s 147 of the Act. The reason was firstly that such opportunity was very
much available to the Assessing Officer at the stage of filing of the returns
when in exercise of powers u/s 142/143 such directions could have been issued
for production of records and a failure of the assessee to satisfy the
Assessing Officer on such count could have led to a best judgment assessment
u/s 144 at the stage of original assessment; but having not done so, such
recourse could not be adopted by relying upon the statutory provisions of
section 147 of the Act.

iii) Secondly such enabling powers
were only to be exercised where there was tangible material available with the
Assessing Officer and not in the absence thereof. In view of the clear fact
situation available on the record where such reopening was simply founded on
the advisory dated 10^th March, 2016 issued by the Department and
where the reasons so present for the formation of belief was not resting on any
tangible material in possession of the Assessing Officer, the entire exercise
was illegal and de hors the provisions of section 147 / 148’.

shailesh.kwebmaker

Article 7 of India-US DTAA – Explanation (a) to section 9(1)(v)(c) of the Act – Interest paid by an Indian branch of a foreign bank to its head office / overseas branches was not taxable under the Act – Explanation (a) to section 9(1)(v)(c) deeming such interest as income is prospective in nature

19. JP Morgan Chase Bank N.A. vs. DCIT
ITA No. 3747/Mum/2018 & 363/Mum/2019
A.Ys.: 2011-12 and 2012-13

Date of order: 30th December, 2019

Article 7 of India-US DTAA – Explanation (a) to section 9(1)(v)(c) of the Act – Interest paid by an Indian branch of a foreign bank to its head office / overseas branches was not taxable under the Act – Explanation (a) to section 9(1)(v)(c) deeming such interest as income is prospective in nature

FACTS

The assessee, an Indian branch (BO) of a US banking company, paid interest to its head office (HO) and sister branches abroad. The HO contended that the payment by the BO to the HO was payment to self and was covered under the principle of mutuality. Hence, interest received by it was not taxable in India. The AO accepted the contention of the assessee and completed the assessment on that basis.

Administrative CIT exercises power u/s 263 of the Act. According to the CIT, under the India-USA DTAA, interest is taxable in the source country. Since the assessee had its PE in India (i.e., the BO), interest was taxable in India. He further held that since the assessee had opted to be governed under beneficial provisions of the DTAA, the single entity approach under the Act gave way to the distinct and independent entity or separate entity approach under the DTAA. Hence, the BO and the HO were two separate entities. The CIT further referred to Explanation (a) to section 9(1)(v)(c) of the Act which was effective from 1st April, 2016 and mentioned that since the amendment was clarificatory in nature, it applied retrospectively. He also referred to the CBDT Circular No. 740 dated 17th April, 1996 mentioning that a branch of a foreign company in India is a separate entity for taxation under the Act. The CIT distinguished the Tribunal Special Bench decision in Sumitomo Mitsui Banking Corporation vs. DDIT [2012] 19 taxmann. com 364 (Mum.) on the ground that the Tribunal had no occasion to consider the reasoning mentioned by him in the context of the DTAA. The CIT concluded that interest received by the HO and other branches abroad was taxable in India.

Aggrieved, the assessee filed an appeal with the Tribunal.

HELD

The Special Bench of the Tribunal in the case of Sumitomo Mitsui Banking Corporation vs. DCIT1 held that since the interest paid by the BO to the HO is in the nature of payment made to self, it will be governed by the principle of mutuality. Hence, it was not taxable under the Act. Applying the same principle, interest received by the HO (and other branches) from the BO was not taxable in India.

Explanation (a) to section 9(1)(v)(c) of the Act, which deems that interest paid by the BO of a bank to its HO is taxable in India, applies prospectively from 1st April, 2016 and cannot be invoked to tax interest of any earlier financial year.

shailesh.kwebmaker

Article 12 of India-Singapore DTAA – Receipt from Indian group companies towards information technology and business support services did not qualify as royalty / FTS under India- Singapore DTAA

18. ACIT vs. M/s FCI Asia Pte. Ltd.
ITA Nos. 2588 & 2589/Del/2015
A.Ys.: 2009-10 and 2010-11

Date of order: 6th January, 2020

Article 12 of India-Singapore DTAA – Receipt from Indian group companies towards information technology and business support services did not qualify as royalty / FTS under India- Singapore DTAA

FACTS

The assessee, a Singapore company, was engaged in providing IT support services as well as business support services to its affiliates in India. The IT support services included services such as centralised data centre, disaster recovery management and backup storage. The business support services included common services towards purchasing, communications and international relationship matters, legal and insurance
support services.

The assessee contended that the services rendered by it were standardised IT-related services. Although the affiliates were provided access to IT infrastructure, they were not conferred with any use or right to use the equipment which remained under the control of the assessee. Thus, payment for such services did not amount to royalty under the Act as well as the India- Singapore DTAA. Besides, the IT support services as well as business support services did not enable the affiliates to apply technical knowledge independently or to perform such services independently without any recourse to the assessee. Hence, in the absence of a ‘make available’ clause under the India-Singapore DTAA being satisfied, such services did not qualify as Fees for Technical services under the India-Singapore DTAA.

However, the AO contended that in the course of rendering services, the assessee granted a right to its affiliates to access the data centre / storage capacity maintained by
it. Thus, payments made by the affiliates were towards the use of, or the right to use, industrial, commercial and scientific equipment. Hence, the payments were in the nature of royalty under the Act as well as under Article 12 of the India-Singapore DTAA.

Aggrieved, the assessee appealed before CIT(A) who ruled in his favour. The aggrieved AO preferred an appeal before the Tribunal.

HELD

The services rendered by the assessee in relation to the centralised data centre, WAN bandwidth management, disaster recovery management, backup and offsite storage management and security management merely involved provision of a ‘facility’ and not a right to use the equipment. Hence, the payment received for such services did not qualify as royalty.

Support services such as purchasing, communications and international relationship matters, legal and insurance support services did not enable the service recipient to make use of the said technical or managerial services independently. Further, there was no training involved under the agreement. Thus, consideration for such services did not qualify as FTS.

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Article 12 of India-Finland DTAA – Consideration for distribution, updation and maintenance of software, without right of exploitation of intellectual property, was not in nature of royaltyunder India-Finland DTAA

17. TS-810-ITAT-2019 (Mum.)
Trimble Solutions Corporation vs. DCIT
ITA No. 6481/Mum/2017; 6482/Mum/2017
A.Y.: 2011-12

Date of order: 16th December, 2019

Article 12 of India-Finland DTAA – Consideration for distribution, updation and maintenance of software, without right of exploitation of intellectual property, was not in nature of royaltyunder India-Finland DTAA

FACTS

The assessee, a company incorporated in Finland, was engaged in the business of developing and marketing specialised off-the-shelf software products. The assessee appointed non-exclusive distributors for the distribution of the software to end-customers in India. In addition, the assessee also provided software upgrades, maintenance and support services with regard to such software.

During the year under consideration, the assessee received income from the sale of software as well as payments for maintenance and support services from the distributors in India. The assessee contended that the software was provided to its distributors for the purpose of resale / distribution to the end-customers for use as copyrighted article but no right was granted to use copyright in software. Further, the payments received for software upgrades, maintenance and support services with regard to software were also not for transfer of any right in copyright of a copyrighted article. Thus, payments received from distributors cannot be characterised as royalty under the India-Finland DTAA.

The AO, however, was of the view that distribution of software to end-customers through distributors resulted in transfer or use of copyright in software. In any case, postinsertion of Explanations 4 and 5 to section 9(1)(vi), grant of a license was also ‘royalty’. The AO read the definition of royalty under the Act into the India-Finland DTAA and held that payments received from distributors would qualify as royalty even under the India-Finland DTAA. The AO further held that payments received for maintenance and support services (including upgrades) were part of, and inextricably linked to, supply and use of software. Hence, payment for such services was also in the nature of royalty.

Aggrieved, the assessee approached the Dispute Resolution Panel (DRP), which rejected the objections of the assessee.

Aggrieved, the assessee filed an appeal before the Tribunal.

HELD

Article 12 of the India-Finland DTAA envisages consideration for the use of, or the right to use, certain specific works which could include intellectual properties (such as copyright, patents, etc.) by the owner of such intellectual properties from any other person.

The Tribunal noted the following factors from the agreement entered into between the assessee and the distributors:

• Distributors were granted non-exclusive license to market and distribute software products developed by the assessee;

• Distributors did not have the right to use the source code of such software products;

• Distributors were not permitted to modify, translate or recompile, add to, or in any way alter software products (including its documentation);

• Distributors were not permitted to create source code of software products supplied under the agreements;

• Distributors were not expressly permitted to reproduce or make copies of software products under the agreements (except backup copy as required by the customer);

• Distributors were not vested with rights of any nature in intellectual property developed and owned by the assessee in software products;

• All trademarks and trade names which distributors used in connection with products supplied, remained the exclusive property of the assessee. At all times, the assessee had title to all rights to intellectual property, software and proprietary information, including all components, additions, modifications and updates.

The assessee had granted only the right to distribute software products and not the right to reproduce or make copies of software. Thus, in the absence of vesting of any right of commercial exploitation of intellectual property contained in copyrighted article (i.e., software product), the amount received by the assessee from its distributors was in the nature of business income.

In terms of Article 3(2) of the India-Finland DTAA, the definition of a term under domestic law can be applied only if it is not defined in the DTAA. Royalty is defined in the India-Finland DTAA. Hence, amendment of its definition under domestic law had no bearing on the definition under the DTAA. Therefore, the contention of the AO / DRP that the definition of ‘royalty’ under the Act was to be read into the DTAA was incorrect.

Accordingly, payments received by the assessee from distributors were not in the nature of royalty under Article 12 of the DTAA.

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Article 15 of India-Korea DTAA – Technical advisory services provided by non-resident individual to Indian company were in nature of IPS under Article 15 of India-Korea DTAA which, in absence of fixed base in India, were not taxable in India

16. TS-803-ITAT-2019 (Ahm.)
J. Korin Spinning Pvt. Ltd. vs. ITO
ITA No. 2734/Ahm/2016
A.Y.: 2015-16

Date of order: 13th December, 2019

Article 15 of India-Korea DTAA – Technical advisory services provided by non-resident individual to Indian company were in nature of IPS under Article 15 of India-Korea DTAA which, in absence of fixed base in India, were not taxable in India

FACTS

The assessee, an Indian company, entered into an agreement with Mr. L, a resident of South Korea, under which he was required to act as technical adviser and provide technical advice in relation to certain aspects of the production process of the assessee. The assessee paid a consideration to Mr. L for the said services.

According to the assessee, the services provided by Mr. L were in the nature of Independent Personal Services (IPS) in terms of Article 15 of the India-Korea DTAA. Since Mr. L did not have a fixed base available to him in India, consideration for the services was not taxable in India. Hence, the assessee did not withhold tax u/s 195 from the payments made to him.

The AO, however, contended that the services rendered by Mr. L were industrial in ature since they related to setting up of the assessee’s factory and cannot be categorised as IPS. Hence, they qualified as fee for technical services (FTS) u/s 9(1)(vii) as well as Article 13 (Royalties and FTS) of the DTAA.

The CIT(A) dismissed the assessee’s appeal. Aggrieved, the assessee filed an appeal before the Tribunal.

HELD

Mr. L was a technical expert in certain fields of textiles. He was engaged by the assessee to provide technical advice on some aspects of the assessee’s production process.

Mr. L was an individual and resident of Korea.

The agreement was between the assessee and Mr. L individually and not with any ‘firm’ or ‘company’.

The agreement mentioned Mr. L as ‘Technical Adviser’ to the assessee. Hence, the services rendered by him qualified as IPS.

Mr. L and his technical team were required to fly to India on need basis for rendering services to the assessee. This indicated that Mr. L did not have a fixed base in India.

Since Mr. L did not have a fixed base in India, the consideration received by him was not taxable in India as per Article 15 of the India-Korea DTAA.

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Section 56(2)(viib) – When there was no case of unaccounted money being brought in the garb of share premium, the provisions not attracted

11. Clearview Healthcare Pvt. Ltd. vs. ITO
(Delhi) Member: H.S. Sidhu (J.M.) ITA No. 2222/Del/2019 A.Y.: 2014-15 Date of order: 3^rd January, 2020 Counsel for Assessee / Revenue: Kapil Goel /
Pradeep Singh Gautam

Section 56(2)(viib) – When there was no
case of unaccounted money being brought in the garb of share premium, the
provisions not attracted

FACTS

The issue before the Tribunal was about taxability or otherwise of share
premium received on shares issued by the assessee company u/s 56(2)(viib). The
assessee was incorporated on 29^th January, 2010. During the year
under appeal, the company had issued shares at premium. According to the AO,
the difference between the share premium received and the share valuation
determined under Rule 11UA amounting to Rs. 9.20 lakhs was the income of the
assessee as per the provisions of section 56(2)(viib). On appeal, the CIT(A)
confirmed the AO’s order.

Before the Tribunal, the assessee referred to the Explanatory Memorandum
to the Finance Act, 2012 and contended that the legislative intent was to apply
the said provisions only where, in the garb of share premium, money was
received which was not clean and was unaccounted. According to the assessee,
the lower authorities have applied the provisions of section 56(2)(viib)
without any finding that the money was not clean money. It was also pointed out
that in the subsequent year, on 1^st December, 2014, the company’s
shares were sold by one of its shareholders to a non-resident at a price which
was higher than the price at which the shares were issued by the company. And
the said price was accepted by the tax authorities in the shareholder’s tax
assessment.

HELD

The Tribunal agreed with the assessee that the provisions of section
56(2)(viib) would apply only when money received was not clean and was
unaccounted money, received in the garb of share premium as mentioned in the
Explanatory Memorandum to the Finance Act, 2012.

According to the
Tribunal, a subsequent transaction with a foreign buyer which was at a higher
amount and on the basis of detailed due diligence, also justified that the
share premium received by the assessee was not excessive and was fair.

Keeping in view the facts and circumstances of the case and by applying
the principles from the decision of the Chennai Tribunal in the case of Lalithaa
Jewellery Mart Pvt. Ltd. (ITA Nos. 663, 664 and 665/Chennai/2019
decided on 14^th June, 2019) and legislative intent behind
the insertion of section 56(2)(viib), the Tribunal held that the addition made
by the AO on account of alleged excess share premium was unjustified when those
very shares were sold in the next financial year at a much higher amount after
proper due diligence to a non-resident buyer; and further there was no case of
unaccounted money being brought in in the garb of the stated share premium,
hence the addition made u/s 56(2)(vii) was deleted.

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Proviso to section 2(15) r/w/s 11 and 12 – As part of running an educational institution and imparting training to the students, the assessee had undertaken research projects for the industry and earned consultancy fees from them – Since the dominant object was to impart education, the proviso to section 2(15) does not apply

10. Institute of Chemical Technology vs. ITO
(Mum.) Members: Saktijit Dey (J.M.) and Rifaur Rahman
(A.M.) I.T.A. Nos. 6111 and 6922/Mum/2016 A.Ys: 2011-12 and 2012-13 Date of order: 15^th January, 2020 Counsel for Revenue / Assessee: Nishant Thakkar
and Jasmine Amalsadwala / Kumar Padmapani Bora

Proviso to
section 2(15) r/w/s 11 and 12 – As part of running an educational institution
and imparting training to the students, the assessee had undertaken research
projects for the industry and earned consultancy fees from them – Since the
dominant object was to impart education, the proviso to section 2(15)
does not apply

FACTS

The assessee was
established as the Department of Chemical Technology by the University of
Bombay on 1^stOctober, 1933. With the passage of time, the assessee
was granted autonomy and subsequently got converted into an independent
institution in January, 2002. In September, 2008 the assessee was granted
deemed university status. When the assessee was a part of Mumbai (earlier
Bombay) University, the income earned by it formed part of the income of Mumbai
University and was exempt u/s 10(23C). For the impugned assessment years, the
assessee in its return of income declared nil income after claiming exemption
u/s 11.

During the year
under consideration the assessee had received consultancy fees. Applying the
provisions of section 2(15) read with
sections 11 and 12, the AO disallowed its claim of exemption with regard
to the consultancy fee received. The assessee’s claim of exemption u/s 11 in
respect of other income was allowed by the AO.

The assessee explained that as a part of the curriculum and with a view that the students / fellows of the Institution gain
actual working experience, the assessee had undertaken research projects for
the industry and earned consultancy fees from the industry clients. Out of the
fees received, only 1/3^rd amount was retained by the assessee and
the balance amount was paid to the faculty who undertook the research projects.
The amount retained by the assessee was mainly to cover the cost of
infrastructure / laboratory facilities provided for undertaking the research
and administrative expenditure. Thus, it was submitted, the activities undertaken
by the assessee were not in the nature of business but only for research and
training purposes and therefore were part of its main activity of imparting
education on the latest technical developments in the field of chemical
technology. However, the AO didn’t agree with the explanation offered by the
assessee.

Relying on the
decision of the Tribunal in the assessee’s own case for the assessment year
2010-11, the Commissioner (Appeals) upheld the disallowance / addition made by
the AO.

Before the Tribunal,
the assessee submitted that in respect of the aforesaid decision of the
Tribunal relied on by the CIT(A), the Tribunal had no occasion to consider the
assessee’s argument that the proviso to section 2(15) was not
applicable. According to the assessee, the proviso to section 2(15)
would be applicable only when the activity was for ‘advancement of any other
object of general public utility’. The assessee contended that the
consultancy service provided was part of its educational activity, therefore ancillary
and incidental to its main object of providing education. Therefore, even
though the assessee had received consultancy fee, the same was received in
furtherance of its object of educational activity, hence it cannot be treated
as an activity in the nature of trade, commerce or business and thereby treat
the same as for a non-charitable purpose.

HELD

The Tribunal agreed
with the assessee that applicability or otherwise of the proviso to
section 2(15) in the case of the assessee was not examined or dealt with by the
Tribunal in A.Y. 2010–11. According to it, the contention of the assessee
regarding applicability of the proviso to section 2(15) does require
examination keeping in view the decision of the Bombay High Court in DIT(E.)
vs. Lala Lajpatrai [2016] 383 ITR 345, wherein the Court held that the
test to determine as to what would be a charitable purpose within the meaning
of section 2(15) was to ascertain what was the dominant object / activity.
According to the Court, if the dominant object was the activity of providing
education, it will be charitable purpose under section 2(15) even though some
profit arose from such activity. Since the aforesaid claim of the assessee was
not examined by the Departmental authorities, the Tribunal restored the matter
to the file of the AO for re-examination and directed him to adjudicate the
issue keeping in view the additional evidence filed by the assessee and the
decisions cited before him.

Note: Before the Tribunal, the assessee had also alternatively claimed
exemption under sections 10(23C)(iiiab) and / or 10(23C)(vi) and furnished
additional evidence. The Tribunal directed the AO to also consider the same.

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Section 80P(4): Provisions of section 80P(4) exclude only co-operative banks and the same cannot be extended to co-operative credit societies

20. [2019] 107 taxmann.com 53
(Trib.)(Ahd.)(SB) ACIT vs. People’s Co-op. Credit Society Ltd. ITA Nos. 1311, 2668 to 2670, 2865, 2866,
2871 & 2905 (Ahd.) of 2012 A.Ys.: 2007-08 to 2009-10 Date of order: 18^th April, 2019

Section 80P(4):
Provisions of section 80P(4) exclude only co-operative banks and the same
cannot be extended to co-operative credit societies

FACTS

The assessee, a
co-operative credit society, providing credit facilities to its members and
carrying on banking business, claimed deduction u/s 80P(2)(a)(i). The AO
disallowed the same holding that provisions of section 80P(4) are applicable to
the assessee.

Aggrieved, the
assessee preferred an appeal to the CIT(A) who allowed the appeal.

The Revenue then
preferred an appeal to the Tribunal.

HELD

In view of the
contrary decisions by various benches of the Tribunal, a Special Bench (SB) was
constituted by the President to consider the question whether a co-operative
credit society is to be considered as a co-operative bank and whether by virtue
of the provisions of section 80P(4), a co-operative credit society shall be
disentitled to claim deduction u/s 80P(2)(a)(i).

At the time of
hearing before the Tribunal, the learned representatives agreed that the issues
before the SB of the Tribunal are now covered in favour of the assessee by
various decisions of the Hon’ble Jurisdictional High Court – including in the
cases of Pr. CIT vs. Ekta Co-operative Credit Society Ltd. [2018] 91
taxmann.com 42/254, Taxman 33/402 ITR 85
and CIT vs. Jafari Momin Vikas Co-operative Credit Society
Ltd. [2014] 49 taxmann.com 571/227, Taxman 59 (Mag.) 362 ITR 331 (Guj.).

The Tribunal, having considered the ratio of the decisions of the
Jurisdictional High Court in the cases of Pr. CIT vs. Ekta Co-operative
Credit Society Ltd. (Supra) and CIT vs. Jafari Momin Vikas
Co-operative Credit Society Ltd. (Supra), held that the legal position
is quite clear and unambiguous. As held by the Jurisdictional High Court, the
benefit of section 80P(2)(a)(i) cannot be denied in the case of co-operative
credit societies in view of their function of providing credit facilities to
the members and the same are not hit by the provisions of section 80P(4).

The appeals filed
by the Revenue were dismissed.

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Rule 37BA(3) r/w/s 199: Credit for Tax Deducted at Source has to be allowed in the year in which the corresponding income is assessed even though the tax is deposited by the deductor in the subsequent assessment year

19. [2019] 112 taxmann.com 354 (Trib.)(Pune) Mahesh Software Systems (P) Ltd. vs. ACIT ITA No. 1288/Pune/2017 A.Y.: 2011-12 Date of order: 20th September, 2019

Rule 37BA(3) r/w/s 199: Credit for Tax Deducted at Source has to be allowed in the year in which the corresponding income is assessed even though the tax is deposited by the deductor in the subsequent assessment year

FACTS
The assessee raised an invoice and offered to tax income arising therefrom in March, 2011. The assessee claimed credit for tax deducted thereon. However, the deductor deposited TDS only in April, 2011, i.e., in the succeeding financial year. Consequently, the TDS claimed by the assessee did not appear in Form 26AS for the year in which the income was booked. The AO, relying on sub-rule (1) of Rule 37BA, did not allow the credit in A.Y. 2011-12.

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

The assessee then filed an appeal to the Tribunal.

HELD
The Tribunal observed that the AO had relied on sub-rule (1) of Rule 37BA for denying the benefit of TDS during the year under consideration. It provides that credit for TDS shall be given to the person to whom payment has been made or credit has been given on the basis of information furnished by the deductor. Thus, what is material for sub-rule (1) is the beneficiary of credit and not the time when credit ought to be allowed. The CIT(A), in addition, had relied on sub-rule (4) of Rule 37BA which again provides that credit for TDS shall be granted on the basis of information relating to TDS furnished by the deductor.

The Tribunal observed that the point of time at which the benefit of TDS is to be given is governed by sub-rule (3) of Rule 37BA which very clearly provides that – ‘credit for tax deducted at source and paid to the Central Government, shall be given for the assessment year for which such income is assessable.’

In view of the above, the Tribunal held that the credit of TDS had to be allowed in the year under consideration even though the TDS was deposited by the deductor in the subsequent assessment year.

The Tribunal allowed the appeal filed by the assessee.

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Section 142A(6): It is mandatory for the Valuation Officer to submit the Valuation Report within six months from the date of receipt of the reference – Delay in filing the report cannot be condoned

18. [2019] 75 ITR (Trib.) 219 (Hyd.) Shri Zulfi Revdjee vs. ACIT ITA No. 2415/Hyd/2018 A.Y.: 2013-14 Date of order: 5^thSeptember,
2019

Section 142A(6): It is mandatory for the
Valuation Officer to submit the Valuation Report within six months from the date
of receipt of the reference – Delay in filing the report cannot be condoned

FACTS

The assessee sold a
property during F.Y. 2012-13. He filed the return of income disclosing capital
gains arising from the sale of the said property. The AO sought to make an
addition u/s 50C of the Act. However, since the assessee objected to it, he
referred the file to the Departmental Valuation Officer (DVO) for valuation of
the property. The DVO submitted the report after the expiry of the period
stipulated u/s 142A(6). Further, he also considered the value of the house as
on the date of registration of agreement. The assessee, inter alia,
raised an objection that the report submitted by the DVO is beyond the
stipulated time limit of six months, as specified u/s 142A(6), and consequently
the assessment is barred by limitation.

The assessee
preferred an appeal to the CIT(A) who dismissed the appeal. Aggrieved, the
assessee filed an appeal to the Tribunal.

HELD

The Tribunal
observed that u/s 142A the valuation report by the DVO has to be submitted
within six months from the date of receipt of the reference. However, the DVO
submitted his report after 15 months from the end of the month in which
reference was made to him. The Tribunal considered whether the time limit for
submission of report could be enlarged or condoned. It noted that the word used
in sub-section (6) of section 142A is ‘shall’, while in other sub-sections it
is ‘may’. In B.K. Khanna & Co. vs. Union of India and others, the
Delhi High Court [156 ITR 796 (Del.)] has held that where the words
‘may’ and ‘shall’ are used in various provisions of the same section, then both
of them contain different meanings and the word ‘shall’ shall mean ‘mandatory’.
In sub-section (6), since the word ‘shall’ is used, the time limit specified
therein is mandatory and, thus, delay cannot be condoned. The Tribunal held
that the report of the DVO had to be filed within the time limit prescribed
under section 142A(6) and, thus, the Assessment Order passed on the basis of
the DVO’s report is not sustainable.

The Tribunal
allowed this ground of appeal filed by the assessee.

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Section 10(13A), Rule 2(h) of Fourth Schedule – For the purpose of computing qualifying amount u/s 10(13A) of the Act, the amount received as performance bonus does not assume character of salary

17. [2020] 113
taxmann.com 295 (Trib.)(Kol.) Sudip Rungta vs.
DCIT ITA No.
2370/Kol/2017 A.Y.: 2011-12 Date of order: 10^th
January, 2020

Section 10(13A), Rule 2(h) of Fourth Schedule – For the purpose of
computing qualifying amount u/s 10(13A) of the Act, the amount received as
performance bonus does not assume character of salary

FACTS

The assessee was a salaried employee who, for the year under
consideration, filed his return of income declaring total income of Rs. 2,61,97,296. During the year under
consideration, he had received a basic salary of Rs. 30,00,000 and performance
bonus of Rs. 1,50,00,000. In the return he had claimed exemption of HRA of Rs.
8,47,742. The AO called for details of the rent paid and calculation of the
amount of exemption. In response, the assessee submitted that the total rent
paid during the year was Rs. 8,20,000 and for the purposes of computing
exemption, only the basic salary had been regarded as ‘salary’.

The AO held that
‘performance bonus’ is covered under the term ‘salary’ as per the meaning
assigned to the definition of ‘salary’ for the purpose of calculating exemption
u/s 10(13A). ‘Performance bonus’ cannot be comprehended as an allowance or
perquisite as defined in Rule 2(h) of the Fourth Schedule to be excluded from
the purview of ‘salary’. Thus, the assessee’s total salary for computation of
exemption u/s 10(13A) for the year under assessment comes to Rs. 30,00,000 plus
Rs. 1,50,00,000, which totals Rs. 1,80,00,000; and 10% of this comes to Rs.
18,00,000. Since the assessee has paid rent of Rs. 8,20,000 which is much less
than the amount of Rs. 18,00,000, the assessee is not entitled to any benefit u/s
10(13A) of the Act. Thus, the AO denied the benefit u/s 10(13A) of the Act.

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

The assessee then
preferred an appeal to the Tribunal where it was submitted that clause (h) of
Rule 2A specifically provides that
‘salary’ includes dearness allowance if the terms of employment so provide, but
excludes all other allowances and perquisites. Accordingly, the performance bonus
received by the appellant did not form part of ‘salary’ for the purposes of
computing exemption u/s 10(13A) of the Act.

HELD

The Tribunal noted
that the decision of the Hon’ble Kerala High Court in the case of CIT vs.
B. Ghosal (125 ITR 444) is on identical facts wherein on the same set
of facts, the Court had held that ‘performance bonus’ does not form part of
‘salary’ as defined in clause (h) of Rule 2A for the purposes of section
10(13A) of the Income tax Act, 1961.

Considering the facts narrated above, the Tribunal noted that total rent
paid by the assessee during the year is Rs. 8,20,000. The basic salary for the
purpose of computation of house rent disallowance is Rs. 3,00,000 (10% of Rs.
30,00,000 being basic salary). Therefore, excess of rent paid over 10% of
salary is Rs. 5,20,000 (Rs. 8,20,000 minus Rs. 3,00,000). Therefore, the
assessee is entitled for house rent allowance at Rs. 5,20,000 u/s 10(13A) of
the Act. The AO is directed to allow the exemption of HRA at Rs. 5,20,000.

The Tribunal
allowed the appeal filed by the assessee.

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ITP-3(1)(4) vs. M/s Everlon Synthetics Pvt. Ltd. [ITA No. 6965/Mum/2013; Date of order: 23rd May, 2016; A.Y.: 2006-07; Mum. ITAT] Section 147: Reassessment – Within four years – Regular assessment u/s 143(3) – Issue of one-time settlement with bank and consequential relief granted by the bank was discussed and deliberated by the AO – Reopening notice issued on same ground is bad in law

12. The Pr.
CIT-3 vs. M/s Everlon Synthetics Pvt. Ltd. [Income tax Appeal No. 1039 of 2017] Date of order:
4^th November, 2019 (Bombay High
Court)

ITP-3(1)(4) vs.
M/s Everlon Synthetics Pvt. Ltd. [ITA No. 6965/Mum/2013; Date of order: 23^rd
May, 2016; A.Y.: 2006-07; Mum. ITAT]

Section 147:
Reassessment – Within four years – Regular assessment u/s 143(3) – Issue of
one-time settlement with bank and consequential relief granted by the bank was
discussed and deliberated by the AO – Reopening notice issued on same ground is
bad in law

The assessee is
engaged in the business of manufacture of polyester and texturised / twisted
yarn and management consultancy. The assessee filed its return of income on 29^th
November, 2006. The AO completed the assessment on 24^th November,
2008 u/s 143(3) of the Act, accepting ‘Nil’ return of income as filed by the
assessee. Thereafter, on 28^th March, 2011, a notice was issued u/s
148 of the Act to the assessee, seeking to re-open the assessment. The reason
in support of the re-opening notice was in regards to cessation of liability
u/s 41 of the Act.

The assessee
objected to the re-opening notice on the ground that it was based on ‘change of
opinion’ and, therefore, without jurisdiction. However, this contention was not
accepted by the AO. This resulted in the assessment order dated 30^th
August, 2011 u/s 143(3) r/w/s 147 of the Act, adding the sum of Rs. 1.37 lakhs
to the income of the assessee by holding it to be a revenue receipt.

Aggrieved by
this order, the assessee company filed an appeal to the CIT(A). The CIT(A)
recorded a finding of fact that during the course of regular scrutiny
proceedings u/s 143(3), the issue of the assessee’s one-time settlement with
the bank and consequential relief granted by the bank was discussed and
deliberated by the AO. In fact, queries were raised by the AO with regard to
the one-time settlement; the assessee, by its communication dated 11^th
November, 2008, responded with complete details of the one-time settlement with
its bankers, including the details of relief / waiver obtained. The CIT(A) held
the settlements to the extent of Rs. 2.06 crores as revenue receipt, as
reflected in the Profit and Loss Account, and the fact that the amount of Rs.
1.37 crores was transferred to the capital account was deliberated upon by the
AO before passing an order u/s 143(3) of the Act. Thus, the CIT(A) held that
the re-opening notice was without jurisdiction as it was based on a mere change
of opinion.

Being aggrieved
by the order of the CIT(A), the Revenue filed an appeal to the Tribunal. The
Tribunal held that the issue of one-time settlement with the bank and the
treatment being given to the benefit received on account of settlement, was a
subject matter of consideration by the AO. It found on facts that during the
regular assessment proceedings, the issue of one-time settlement was inquired
into by the AO and the appellant had furnished all details in its letter dated
11^th November, 2008. It also records the fact that the impugned
notice was only on the basis of audit objection and the AO had not applied his
mind before issuing a re-opening notice and merely acted on the dictate of the
audit party. In the circumstances, the Tribunal upheld the view of the CIT(A)
that the re-opening notice is without jurisdiction.

Aggrieved by
the order of the ITAT, the Revenue filed an Appeal to the High Court. The
Revenue submitted that the issue of one-time settlement found no mention in the
assessment order passed u/s 143(3). Thus, no opinion was formed by the AO while
passing the regular assessment order. Therefore, there was no bar on him on
issuing the re-opening notice. It was, thus, submitted that the issue requires
consideration and the appeal be admitted.

The Court
observed that during the scrutiny assessment proceedings, queries were raised
and the petitioner filed a detailed response on 11^th November, 2008
giving complete details to the AO of the one-time settlement and the manner in
which it was treated. This finding of fact was not shown to be perverse in any
manner. The re-opening notice is not based on any fresh tangible material but
proceeds on the material already on record with the AO and also considered before
passing the order u/s 143(3). The submission
of Revenue that consideration of an issue by the AO must be reflected in the
assessment order, is in the face of the decision of the Court in GKN
Sinter Metals Ltd. vs. Ms Ramapriya Raghavan 371 ITR 225 which approved
the view of the Hon’ble Gujarat High Court in CIT vs. Nirma Chemicals
Ltd., 305 ITR 607, to the effect that an assessment order cannot deal
with all queries which the AO had raised during the assessment proceedings. The
AO restricts himself only to dealing with those issues where he does not agree
with the assessee’s submission and gives reasons for it. Otherwise, it would be
impossible to complete all the assessments within the time limit available.

Thus, the Court held that once a query is raised during assessment
proceedings and the assessee has responded to the query to the satisfaction of
the AO, then there has been due consideration of the same. Therefore, issuing
of the re-opening notice on the same facts which were considered earlier,
clearly amounts to a change of opinion and is, thus, without jurisdiction.
Accordingly, the Revenue appeal is dismissed.

shailesh.kwebmaker

Reassessment – Sections 147 and 148 of ITA, 1961 – Notice after four years – Failure to disclose material facts necessary for assessment – No duty to disclose investments – Notice for failure to disclose investment – Not valid

36. Bhavik
Bharatbhai Padia vs. ITO; [2019] 419 ITR
149 (Guj.) Date of order:
19^th August, 2019 A.Y.: 2011-12

Reassessment –
Sections 147 and 148 of ITA, 1961 – Notice after four years – Failure to disclose
material facts necessary for assessment – No duty to disclose investments –
Notice for failure to disclose investment – Not valid

For the A.Y. 2011-12, the assessee-petitioner received a notice u/s 148
of the Income-tax Act, 1961 dated 30^th March, 2018. The reasons
assigned by the AO for reopening are as under:

‘As per information available with this office during the year under
consideration the assessee had made investment of Rs. 50,00,000 in the pension
policies of LIC of India. The assessee has filed his return of income for the
A.Y. 2011-12 declaring total income at Rs. 72.78 lakhs. The information was
received from the Income-tax Officer (I & CI)-1, Ahmedabad on 27^th
March, 2018. On a perusal of the information, it is found that the assessee has
made investment of Rs. 50,00,000 in the pension policies of LIC of India during
the F.Y. 2010-11 relevant to the A.Y. 2011-12. During the inquiries conducted
by the Income-tax Officer (I & CI), the investment of Rs. 50,00,000 made by
the assessee remains unexplained. Thus, there is an escapement of Rs. 50,00,000
and the case requires to be reopened u/s 147 of the Act.’

The assessee filed his objections to the notice
issued u/s 148 of the Act pointing out that he had disclosed all the income
liable to be offered and to be brought to tax in its return of income. The
assessee further pointed out in his objections that as the assessee did not
have any business income during the A.Y. 2011-12, he was not obliged to
disclose his investment of Rs. 50,00,000 in the pension policies of the LIC of
India in his return of income. The assessee further pointed out that he had
salary, income from other sources and capital gains and in such circumstances,
he was required to file form ITR-2 for the A.Y. 2011-12. It was also pointed
out that the Form ITR-2 does not include the column for the disclosure of
investments. In such circumstances, the assessee could not have been expected
to disclose his investments in his return of income. The assessee further
pointed out that his total income for the A.Y. 2011-12 was Rs. 71.50 lakhs. He
had sufficient past savings and the current year’s income to make an investment
of Rs. 50,00,000 in the LIC policies. He also pointed out to the respondent
that just because he had made an investment of Rs. 50,00,000 his case should
not be reopened, as he could be said to have made full and true disclosure of
his income. By an order dated 8^th October, 2018, the AO rejected the
objections. The assessee filed a writ petition and challenged the order.

The Gujarat High Court allowed the writ petition and held as under:

‘The notice for reassessment had been issued after four years on the
ground that the assessee had failed to disclose investments. It was not in
dispute that the form of return of income, i.e., ITR-2, then in force had no
separate column for the disclosure of any investment. The notice was not
valid.’

shailesh.kwebmaker

Income Declaration Scheme, 2016 – Scope of – Amount paid as advance tax can be adjusted towards amount due under Scheme

35. Alluri
Purnachandra Rao vs. Pr. CIT; [2019] 419 ITR
462 (Tel.) Date of order:
18^th September, 2019 A.Ys.: 2010-11
to 2015-16

Income
Declaration Scheme, 2016 – Scope of – Amount paid as advance tax can be adjusted
towards amount due under Scheme

The petitioner filed the subject declaration under the Income
Declaration Scheme, 2016 in Form 1 on 30^th June, 2016 for the A.Ys.
2010-11 to 2015-16 declaring undisclosed income of Rs. 40,98,706. In terms of
the Income Declaration Scheme, the petitioner was liable to pay a sum of Rs.
18,44,418 towards tax, surcharge and penalty on this undisclosed income. In
that regard, the petitioner claimed credit of a sum of Rs. 12,11,611 being his
tax deducted at source (TDS). He also claimed credit of a sum of Rs. 1,10,000,
being the advance tax / prepaid tax paid by him for the assessment year
2013-14. After adjusting the aforesaid credits, he paid the balance sum of Rs.
5,22,807 in three instalments as required.

The Principal Commissioner of Income Tax-6, Hyderabad, rejected the
declaration filed by the petitioner on the ground that he had failed to pay the
tax, surcharge and penalty on the undisclosed income declared by him before the
due date, i.e., 30^th September, 2017. This was because he did not
give credit to the advance tax of Rs. 1,10,000 paid by the petitioner for the
A.Y. 2013-14. The petitioner filed a writ petition and challenged the order of
the Principal Commissioner.

The Telangana High Court allowed the writ petition and held as under:

‘i) The Income Declaration
Scheme, 2016, was promulgated under sections 184 and 185 of the Finance Act,
2016 enabling an assessee to pay tax at 30% on undisclosed income along with
surcharge and penalty at 25% on the tax payable. Under section 187 of the Act,
read with Notification No. S. O. 2476(E) dated 20^th July, 2016
([2016] 386 ITR [ST] 5), the tax, surcharge and penalty were to be paid in
three instalments between 30^th November, 2016 and 30^th
September, 2017.

ii) The Central Board of Direct
Taxes issued Circular No. 25 of 2016, dated 30^th June, 2016 ([2016]
385 ITR [ST] 22), furnishing clarifications on the Income Declaration Scheme;
question No. 4 thereunder was whether credit for tax deducted at source, if
any, in respect of the income declared should be allowed. The answer to this
was in the affirmative and to the effect that credit for tax deducted at source
should be allowed in those cases where the related income was declared under the
Scheme and credit for the tax had not already been claimed in the return of
income filed for any assessment year. Once the tax deducted at source relevant
for the period covered by the declaration filed under the Income Declaration
Scheme is given credit in accordance with the clarification of the Central
Board of Direct Taxes itself, there is no reason why advance tax paid for the
very same period, which has not been given credit to earlier, should not be
adjusted against the amount payable under the Scheme.

iii) The assessee’s declaration
pertained to the A.Ys. 2010-11 to 2015-16. Advance tax of Rs. 1,10,000 had been
paid by him for the A.Y. 2013-14. Admittedly, there was no regular assessment
for that year, whereby the advance tax could have been adjusted. Therefore,
there was no rationale in denying the assessee credit of this amount while
computing the amount payable by him under the Income Declaration Scheme. If the
amount paid by the assessee for the A.Y. 2013-14, being a sum of Rs. 1,10,000,
were adjusted, the payments made by him on 21^stNovember, 2016 (Rs.
1,50,000), 28^th March, 2017 (Rs. 1,50,000) and 27^th
September, 2017 (Rs. 2,22,807) would be sufficient to discharge his liability
in respect of the tax, surcharge and penalty payable by him towards his
undisclosed income declared under the Income Declaration Scheme. Hence the
rejection of the declaration was not valid.

iv) The writ petition is
accordingly allowed setting aside the impugned proceedings dated 6^th
February, 2018 passed by the Principal Commissioner of Income Tax-6, Hyderabad,
rejecting the declaration filed by the petitioner under the Income Declaration
Scheme, 2016. The said declaration shall be considered afresh by the Principal
Commissioner of Income Tax-6, Hyderabad, duly giving credit not only to the tax
deducted at source but also to the advance tax paid by the petitioner for the
A.Y. 2013-14. This exercise shall be completed expeditiously and, in any event,
not later than four weeks from the date of receipt of a copy of the order, be
it from whatever source.’

shailesh.kwebmaker

Exemption u/s 10(10AA) of ITA, 1961 – Leave salary (government employees) – Government employees enjoy protection and privileges under Constitution and other laws which are not available to other employees and government employees form a distinct class; they are governed by different terms and conditions of employment – Consequently, retired employees of PSUs and nationalised bank cannot be treated as government employees and, thus, they are not entitled to get full tax exemption on leave encashment after retirement / superannuation u/s 10(10AA)

34. Kamal Kumar
Kalia vs. UOI; [2019] 111
taxmann.com 409 (Delhi) Date of order:
8^th November, 2019

Exemption u/s
10(10AA) of ITA, 1961 – Leave salary (government employees) – Government
employees enjoy protection and privileges under Constitution and other laws
which are not available to other employees and government employees form a
distinct class; they are governed by different terms and conditions of
employment – Consequently, retired employees of PSUs and nationalised bank
cannot be treated as government employees and, thus, they are not entitled to
get full tax exemption on leave encashment after retirement / superannuation
u/s 10(10AA)

The petitioners, who were employees of Public Sector Undertakings and
nationalised banks, filed a writ contending that although they were Central and
State Government employees, they were discriminated against. They were granted
complete exemption in respect of the cash equivalent of leave salary for the
period of earned leave standing to their credit at the time of their
retirement, whether on superannuation or otherwise. However, all others,
including the employees of PSUs and nationalised banks, are granted exemption
only in respect of the amount of leave salary payable for a period of ten
months, subject to the limit prescribed.

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

‘i) So far as the challenge to
provisions of section 10(10AA) of the Income-tax Act, 1961 on the ground of
discrimination is concerned, there is no merit therein. This is because
employees of the Central Government and the State Government form a distinct
class and the classification is reasonable having nexus with the object sought
to be achieved. The Central Government and State Government employees enjoy a
“status” and they are governed by different terms and conditions of employment.
Thus, Government employees enjoy protection and privileges under the
Constitution and other laws, which are not available to those who are not
employees of the Central and State Governments.

ii) There is no merit in the
submission of the petitioner that the employees of PSUs and nationalised banks
are also rendering services for the government and such organisations are
covered by Article 12 of the Constitution of India as “State”. Merely because
PSUs and nationalised banks are considered as “State” under article 12 of the
Constitution of India for the purpose of entertainment of proceedings under
Article 226 of the Constitution and for enforcement of fundamental rights under
the Constitution, it does not follow that the employees of such public sector
undertakings, nationalised banks or other institutions which are classified as
“State” assume the status of Central Government and State Government employees.

iii) Therefore, the instant
petition is rejected, insofar as the petitioners’ challenge to the provisions
of section 10(10AA) is concerned.’

shailesh.kwebmaker

Charitable purpose – Meaning of – Sections 2(15) and 11 of ITA, 1961 – Preservation of environment is an object of general public utility – Polluting industries setting up company for prevention of pollution – Object not to earn profit – Fact that members of company would benefit is not relevant – Company entitled to exemption u/s 11

33. CIT vs.
Naroda Enviro Projects Ltd.; [2019] 419 ITR
482 (Guj.) Date of order:
29^th July, 2019 A.Ys.: 2009-10

Charitable
purpose – Meaning of – Sections 2(15) and 11 of ITA, 1961 – Preservation of environment
is an object of general public utility – Polluting industries setting up
company for prevention of pollution – Object not to earn profit – Fact that
members of company would benefit is not relevant – Company entitled to
exemption u/s 11

The assessee company was incorporated on 19^th October, 1995
and was later converted into a company limited by shares incorporated u/s 25 of
the Companies Act, 1956. The assessee company was engaged in the activity of
preservation of environment by providing pollution control treatment for
disposal of liquid and solid industrial waste. The assessee company was
registered u/s 12AA of the Income-tax Act, 1961 as a charitable institution.
For the A.Y. 2009-10 the assessee had filed its return of income declaring total
income (loss) of Rs. 258 (Rupees two hundred and fifty eight only) along with
the auditor’s report u/s 12A(b) of the Act in Form 10B claiming exemption u/s
11 of the Act. The AO took the view that the assessee company is not entitled
to seek exemption u/s 11 and held as under:

‘i) The assessee is carrying on
business activity under the pretext of charitable activity. The incidental
profit cannot be for all the years and not to the extent reflected in the table
given in the order.

ii) The objects specified in the
memorandum of association are important but the same have to be considered with
reference to the real practice adopted for running the activity, i.e., whether
it is charitable or for the purpose of making profit. The object included in
definition of “charitable purpose” as defined in section 2(15) should be
evidenced by charity; otherwise even environment consultant will also claim
exemption u/s 11 being a trust or a company u/s 25.

iii) The action is carried out for
the benefit of members to discharge their onus of treatment of chemicals, etc.
with substantial charge with intention to earn profit under the shelter of
section 25 of the Companies Act.

iv) Hence it is held that the assessee is rendering service of pollution
control as per the norms laid down by the Gujarat State Pollution Control Board
or any other authority responsible for the regulation of pollution in relation
to any trade, commerce or business carried out by the industries located in the
industrial area of Naroda, Vatva and Odhav for a uniform cess or fee or any
other consideration, irrespective of the nature of use or application, or
retention, of the income of such activity. Since the aggregate value of
receipts are more than Rs. 10,00,000 both the provisos to section 2(15)
are applicable to the assessee company and it is not entitled for exemption.’

The Commissioner (Appeals) and the Tribunal held that taking an overall
view, the dominant objects of the assessee were charitable as the dominant
object was not only preservation of the environment, but one of general public
utility and, therefore, the assessee was entitled to seek exemption u/s 11 of
the Act.

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

‘i) The assessee was a company
engaged in the activity of preservation of the environment by providing
pollution control treatment for disposal of liquid and solid industrial waste.
The benefit accrued to the members of the company. The members were none other
than the owners of the polluting industries. These members were obliged in law
to maintain the parameters as prescribed by the Gujarat Pollution Control Board
and in law for the purpose of discharge of their trade effluents, in other
words, discharge of solid and liquid waste. If they did not do so, they would
be liable to be prosecuted and their units would also be liable to be closed.

ii) However, this, by itself, was
not sufficient to take the view that the company had not been set up for a
charitable purpose. The birth of this company also needed to be looked into
closely. The fact that the members of the assessee company were benefited was
merely incidental to the carrying out of the main or primary purpose and if the
primary purpose was charitable, the fact that the members of the assessee
benefited would not militate against its charitable character nor would it make
the purpose any less charitable.

iii) Prior to the introduction of
the proviso to section 2(15) of the Act, the assessee company was
granted registration u/s 12A of the Act. From this it was clear that prior to
the introduction of the proviso to section 2(15) of the Act, the
authority, upon due consideration of all the relevant aspects, had arrived at
the satisfaction that the assessee company was established for charitable
purposes. The company continued to be recognised as a charitable institution.
The certificate issued u/s 12A, after due inquiry, was still in force.

iv) The driving force was not the
desire to earn profit, but the object was to promote, aid, foster and engage in
the area of environment protection, abatement of pollution of various kinds
such as water, air, solid, noise, vehicular, etc., without limiting its scope.
In short, the main object was preservation and protection of the environment.

v) The Commissioner (Appeals) and
the Appellate Tribunal had concurrently held that taking an overall view, the
dominant objects of the assessee were charitable as the dominant object was not
only preservation of the environment, but one of general public utility and,
therefore, the assessee was entitled to seek exemption under section 11 of the
Act. The Tribunal was the last fact-finding body. As a principle, this court
should not disturb the findings of fact in an appeal under section 260A of the
Act unless the findings of fact are perverse.’

shailesh.kwebmaker

Capital gains – Exemption u/s 54 of ITA, 1961 – Scope – Additional cost of construction incurred within stipulated time though not deposited in capital gains account – Entitled to deduction

32. Venkata Dilip Kumar vs. CIT; [2019] 419 ITR 298 (Mad.) [2019] 111 taxmann.com 180 (Mad.) Date of order: 5^th November, 2019

Capital gains – Exemption u/s 54 of ITA, 1961 – Scope – Additional cost
of construction incurred within stipulated time though not deposited in capital
gains account – Entitled to deduction

The assessee had long-term capital gain on transfer of a residential
house and invested the same in a new residential house. The assessee claimed
deduction u/s 54 of the Income-tax Act, 1961, an amount of Rs. 1.5 crores being
paid to the builder for the new house. This was allowed by the AO. The assessee
had also claimed further deduction of Rs. 57.25 lakhs u/s 54 contending that
though such sum was not deposited in the capital gains deposit account, it was
utilised for the purpose of additional expenditure towards the construction
cost and that the sum was drawn out of the capital gains deposited in the same
bank branch, although in a savings bank account. The AO refused to grant
deduction u/s 54. This was confirmed by the Tribunal.

The Madras High Court allowed the appeal filed by the assessee and held
as under:

‘i) Section 54 of the Income-tax
Act, 1961 deals with profits on sale of property used for residence. The
capital gains so arising in the hands of the assessee, instead of being dealt
with as income, will be dealt with by giving deduction to such capital gains,
provided the assessee satisfies the requirement contemplated under the
provision. For seeking benefit of deduction u/s 54, the assessee should have
purchased one residential house either one year before the transfer or two
years after the date of such transfer, or constructed a residential house
within a period of three years after the date of such transfer. Meeting the
expenses towards the cost of construction of the house within a period of three
years entitles an assessee to the deduction u/s 54.

ii) Section 54(2) contemplates
that if the amount of the capital gains is not appropriated by the assessee
towards purchase of the new asset within one year before the date on which the
transfer of the original asset took place, or is not utilised by him for the
purchase of the new asset before the date of furnishing the return of income
u/s 139, he has to deposit the sum in an account in any such bank and utilise
in accordance with any scheme which the Central Government may, by
notification, frame in that behalf. In other words, if the assessee has not
utilised the amount of the capital gains either in full or part, such
unutilised amount should be deposited in a capital gains account to get the
benefit of deduction in the succeeding assessment years. Section 54(2) cannot
be read in isolation and on the other hand, application of section 54(2) should
take place only when the assessee fails to satisfy the requirement u/s 54(1).
While the compliance with the requirement u/s 54(1) is mandatory and if
complied with, has to be construed as substantial compliance to grant the
benefit of deduction, the compliance with the requirement u/s 54(2) could be
treated only as directory in nature. If the assessee with material details and
particulars satisfies that the amount for which deduction is sought u/s 54 is
utilised either for purchasing or constructing the residential house in India
within the time prescribed u/s 54(1), the deduction is bound to be granted
without reference to section 54(2). Mere non-compliance with a procedural
requirement u/s 54(2) itself cannot stand in the way of the assessee getting
the benefit u/s 54, if he is, otherwise, in a position to satisfy that the
mandatory requirement u/s 54(1) is fully complied with within the time limit
prescribed therein.

iii) The
assessee had claimed that it had utilised the disputed sum towards the cost of
the additional construction within the period of three years from the date of
the transfer and therefore, if such contention were factually correct, the
assessee had to be held to have satisfied the mandatory requirement u/s 54(1)
to get the deduction.

iv) Matter remanded to verify
whether the sum was utilised by the assessee within the time stipulated u/s
54(1) for the purpose of construction. If such utilisation was found to have
been made within such time, the Department was bound to grant deduction.’

shailesh.kwebmaker

Reimagining Financial Reporting

The accrual system of accounting was one of the
biggest turning points in financial reporting. Everything changed once it was
adopted and accountants came to be counted upon more than ever before. In a
lighter vein, an accountant is someone most likely to know what is actually
going on in a business!

While we have come a long way indeed, churning out
literally tons of paper on financial reporting – both information and analysis
– with a view that the reader must know what the preparer knows, however, the
semantics of this information hasn’t been more incomprehensible than it is
today from the perspective of a lay investor. The test of understandability is
not yet bridged.

The auditor is also part of this financial
reporting quagmire. Reporting by auditors has expanded in extent and
significance but perhaps not in reaching the minds of the lay reader. There are
facts, definitions, information, laying down of responsibilities, KAM and
auditor’s response, and so on and so forth.

The grapevine has it that a new CARO 2020 is about
to come, and hence this thought process. Today, the auditors’ report (AR) for
most companies contains the independent auditor’s report with two annexures in
the form of the CARO and the report on ICFR. A word count comparison of
Microsoft (2018) and TCS (2019) audit reports shows 75% more words in the
latter (470 vs. 1966) – and this is excluding CARO, KAM and ICFR reports! But
that is just the size of the content.

The general feeling in India is that size will
cover up for shortcomings in quality of content. Or that size reflects
effective content. People are looking for effective, clear, simple, succinct
content. Often, investors complain that auditors word their reports
defensively. Of course, this was called for considering that the profession is
blamed for many things for which it is not even responsible! We need something
better and clearer because everything that needs to be communicated cannot be
written, and what is written is often not understood if it is long and complex.

For all these years, till F.Y. 2017-18, the opinion
came only towards the end. In F.Y. 2018-19, it was upgraded to the top in the
main report (we have to follow the international standards). But the ICFR
report still has opinion at the end. As if this wasn’t enough, we got ‘Other
Information’ recently that adds to the confusion, and even managements had to
be explained what it really meant.

The auditor signs the AR at three places and
financials at four to five. Signature is important, but one wonders if it would
make any difference if an auditor signed just once instead of thrice in the AR.

Considering the many difficult words in use, we
perhaps need a Glossary of Words as a standard part of an Annual Report for lay
readers to try to understand the meaning of these words. Consider ‘Other
Comprehensive Income’. Literally, it means nothing, at least the first two
words. There are also words such as ‘management’ and ‘those charged with
governance’. To a lay reader this is out of bounds, especially in the words of
FMs, 99% companies are SME. Section 134(5) doesn’t even segregate the two.

There is some conflicting verbiage under the
‘responsibility of management…’ – the words used are financial position and
financial performance in the context of the preparation of financial
statements. While these words refer to the same thing referred to elsewhere,
but they confuse a lay reader. We do have a concept of Nature and Function in
accounting, and here both are at play talking about the same financials.

While we have heavier reporting, we need not have
heavier jargonised lingo. We need better naming and a glossary to be a standard
part of an Annual Report to make sense of financial information. After all, the
financial information is for the reader and not the accountant or
administrator. The understanding gap of GAAPs is wide! This gap must be
bridged, and soon!

Raman Jokhakar

Editor

shailesh.kwebmaker

FIRST SIGNS OF EVOLUTION

We are experiencing
the first signs of evolution of the GST law and who would have imagined that
the beginning would be from a property dispute matter! A recent decision of a
single-member bench of the Hon’ble Bombay High Court in Bai Mamubai Trust
vs. Suchitra 2019 (31) GSTL 193 has set the tone for the upcoming years
of GST. This article is an attempt to decode the decision and examine its
application.

ISSUE AT HAND

The Bombay High
Court was hearing a suit between a landlord (plaintiff) and a tenant (defendant)
under the Maharashtra Rent Control Act, 1999 regarding adverse possession of a
commercial property. In view of the strong prima facie case of the
landlord to obtain possession of the property, the Court granted interim
protection by placing a condition of payment of an ad hoc royalty by the
defendant to be deposited with the Court Receiver under an agency agreement.
The Court Receiver was directed to invest the royalty received as a fixed
deposit with a nationalised bank. This direction raised three questions for the
plaintiff and the Court Receiver:

(a) Whether the royalty paid by the defendant was
liable to GST during the period of dispute?

(b) If yes, who was liable to collect the GST from
the tenant and pay the same to the Government – whether the Court Receiver or
the landlord?

The primary issue
before the Court was the applicability of GST on the royalty payment by the
defendant to the Court Receiver during the pendency of the dispute. This
required examination of the following entries:

* Provisions of
section 7 defining the scope of supply for the purpose of GST;

* Schedule III –
Entry 2: Services by any Court or Tribunal established under any law for the
time being in force; and

* Applicability of
reverse charge provisions on receipt of services from the Central Government in
terms of Notification 13/2017-CGST(Rate).

Submissions
of amicus curiae: The Court appointed an amicus curiae to assist it in
resolving the issue on legal principles. The submissions made by him were as
follows:

(i) Any amount paid under a Court’s order / decree
or an out-of-Court settlement is taxable only if it is towards an underlying
taxable supply; where the payment is towards restitution of a loss or damage,
i.e. compensatory in nature, such payment would lack the tenets of supply, i.e.
enforceable reciprocity in actions.

(ii) The method adopted for quantifying the
damages, i.e. equating to the commercial rental value should not be confused
with the underlying purport of the payment {Citing Senairam Doongarmall
vs. Commissioner of Income Tax [(1962) SCR 1 257]}.

(iii) Services provided by the Court Receiver were to
be treated as ‘Services by any Court or Tribunal established under any law for
the time being in force’ within the meaning of paragraph 2 of schedule III to
the CGST Act and is, accordingly, not within the ambit of GST.

(iv) Section 92 of the CGST Act provides for
collection and discharge of tax liability by a Court Receiver from the estate
in its control. The Court Receiver would be a convenient point for the Revenue
to collect its tax being the person who is in direct receipt of the
consideration / royalty, where such payment itself is liable to be taxed under
the provisions of the CGST Act. The Court Receiver can discharge the liability
as an agent of the supplier in terms of section 2(105) of the said Act.

Court
Receiver’s submissions: The Court Receiver also
made its submission on the specific question on taxability of the royalty as
follows:

(1) There is a distinction between fees or
remuneration of the Court Receiver under Rule 591 of the Bombay High Court
(Original Side) Rules, 1980 and the moneys paid by a litigant towards the matter
under litigation.

(2) The Court Receiver is an adjunct of the Court
and a permanent department of the Court and its role is to implement interim
protection to litigants. Therefore, the former is clearly covered under
schedule III and not taxable.

(3) Monies paid in the Court of litigation as part
of interim protection are to be examined based on the underlying relationship
between the litigating parties – taxable event of supply cannot be applied on a
notional contract between either of the parties and the Court Receiver.

(4) For example, during the tenure of permissive
use of a property, what is paid by the occupier to the right owner is the
contractual consideration. If such permissive use or occupation is terminated
or comes to an end and the occupation becomes unlawful, the nature of payment
to be paid to the right owner changes from contractual consideration to
damages or mesne profits for unauthorised use and occupation of the
property. GST is payable on the former contractual consideration, but
not on damages payable for unauthorised use and occupation of the property. The
fact that the measure of damages is to be based on market rent should not
influence the nature of the payment being made, i.e. a payment to compensate
the right owner for violation of his legal right. Royalty is towards
compensation and not a contractual consideration.

(5) The Court Receiver may discharge the GST by
including this obligation in the agency agreement. This may obviate the
requirement of the Court Receiver from having to obtain separate CGST
registration for each matter or transaction in respect of which it is appointed
to act by the Court; (though) it is preferable from an audit and administrative
perspective to obtain separate GST registration for each matter, where the same
is paid for by the Court Receiver.

Submissions
of State Government / Union of India

(I) GST may be
recovered from the Court Receiver u/s 92 only if it is conducting a business of
a taxable person. A binding contract has come into existence under the
directions of the Court (i.e. the defendant has to either accept the offer to
retain possession and pay royalty, or vacate the premises).There is an offer,
its acceptance and consideration for forming a valid contract.

(II) The order
permitting the defendant to remain in possession of the suit premises is
essentially a contract and payment of royalty is ‘consideration’ for this
‘supply’ of premises to the defendant pursuant to an order of
the Court. GST will be liable to be paid under the MGST Act. The Learned
Advocate-General relied on a judgment of the Supreme Court in Assistant
Commissioner, Ernakulam vs. Hindustan Urban Infrastructure Ltd. [(2015) 3 SCC
745] (which considers Rule 54 of the Kerala Sales Tax Rules which is in
pari materia with section 92 of the MGST Act) to contend that akin to an
official liquidator who was termed to be a dealer of company assets even though
the express consent of the Company in Liquidation was not present, the Court
Receiver represents the plaintiff and is a supplier of services.

(III) As per the
decision of the Supreme Court in Humayun Dhanrajgir vs. Ezra Aboody
(2008) Bom C.R. 862, royalty is a compensation payable by the occupier
to the right owner in the property towards the use of his rights in his
property. There is a clear supply of service of providing premises (subject, of
course, to the final determination of the rights of the parties to the suit).
Such letting or providing of premises is clearly covered in the scope of
‘supply’ u/s 7 of the CGST Act as also under the definition of ‘services’ u/s
2(102) of the CGST Act.

(IV) The Court
Receiver wears two hats, one as an agent of the Court and another as an agent
of the plaintiff on whose application he is appointed. Tax is only levied
on the services rendered by the Court Receiver as an agent / on behalf of the
plaintiff u/s 92 of the CGST Act.

The findings of the
Court can be segregated into the following sub-headings:

(A) Status of
the Court Receiver and its Court fee: The
Court cited the decision of Shakti International Private Limited vs.
Excel Metal Processors Private Limited 2018 (4) Arb LR 17 (Bom.) which,
in turn, relied on certain Supreme Court decisions and effectively approved the
submission of the amicus curiae that the Court Receiver is a permanent
department of the Court, implements orders of the Court and functions under the
supervision and direction of the Court, hence to be concluded as a ‘Court’¹.
Accordingly, the fee of the Court Receiver is clearly excludible in terms of
Entry 2 to Schedule III of the GST enactments.

(B) GST
liability on income from estate under control of Court Receiver: The Court held that ‘supply’ being an essential ingredient of
taxability, has to be identified for each case; the present case being royalty
payments for use of commercial premises.

On the aspect
of supply: The royalty payment was held as not
being towards a taxable supply for the following reasons:

(a) It was being paid towards damages or compensation
or towards securing any future determination of compensation or damages for a violation
of the legal rights of the landlord (plaintiff) in the tenanted
premises;

(b) The basis of payment is illegal
possession or trespass and hence lacked necessary reciprocity to make it a
supply;

(c) The plaintiff is not in agreement with
continuing possession and hence seeking damages for loss and such loss closely
resembles in monetary terms the rental value of the property;

(d) In contrast, had there been a money suit for
recovery of unpaid rent, certainly the tax is liable on the unpaid
consideration as it represented an agreed reciprocal obligation where one of
the litigating parties was seeking relief of its rights in the contract;

(e) Damages represent an award in money for a civil
wrong which is in contrast to ‘consideration’. While damages are towards
restitution for loss caused on account of violation, consideration is towards
an identifiable supply;

(f) The law of damages is not restricted to only
unpaid consideration, i.e. what ought to have been paid, but also expands to
compensating the loss to a party which may not even be privy to the agreement
(e.g. in torts);

(g) The decision of the Supreme Court in Hindustan
Urban Infrastructure (Supra) is distinguishable as the said decision
pertained to an official liquidator being termed as a dealer of goods of the
company it represents in the course of liquidation;

(h) Royalty for the demise of a property itself has
many colours and the true character is to be determined from specific facts –
the ratio of the decision of the Supreme Court in Humayun
Dhanrajgir vs. Ezra Aboody (2008) Bom C.R. 862 clearly distinguishes
the rent paid for a tenancy as being in the nature of (a) consideration during
the tenure of the tenant; (b) compensatory after the tenure as a disputed
occupant; and (c) mesne profits as being towards the occupancy in spite
of being declared as illegal by a Court;

(i) The Court also accepted the submission that
the measure for computation cannot be the litmus test for ascertaining the
character of a supply;

(j) Contractual obligations would dominate over
consideration while deciding the character of a supply. Even though business
and supply definitions are inclusive, a positive act of supply is a necessary
concomitant of a supply transaction;

(k) The Court cited an example of a Court Receiver
being deputed to make an inventory of goods, collect rents with respect to
immovable property in dispute, or where the property has to be sealed, or the Receiver
is appointed to call bids for letting out the premises on leave and license,
the fees or charges of the Court Receiver are exempt. In providing these
services, the office of the Court Receiver is acting as a department of the
Court and therefore no GST is payable.

Interestingly, as
an obiter, the Court specifies some instances where GST may be
applicable – it may be observed that each of them has a positive act with
reciprocity and hence includible as supply:

(i) Where the Court Receiver is appointed to run
the business of a partnership firm in dissolution, the business of the firm
under the control of receivership may generate taxable revenues.

(ii) Where the Court authorises the Court Receiver
to let out the suit property on leave and license, the license fees paid may
attract GST.

(iii) Where the Court Receiver collects rents or
profits from occupants of properties under receivership, the same will be
liable to payment of GST.

(iv) Consideration received for assignment, license
or permitted use of intellectual property.

On the aspect
of representative capacity of Court Receiver:

Curiously, having
decided that the said royalty is not towards a supply, the Court need not have
examined the provisions designating the Court Receiver as a representative
assessee. Yet, the Court specifically stated that section 92 would be
applicable where the Court Receiver was in control of the business of the
taxable person, a taxable event of supply takes place with respect to such
business on account of which the estate of the taxable person would be liable
to tax, interest or penalty under the CGST Act. Therefore, in the event the
supply is taxable, the Court Receiver would have to take registration and
discharge the tax liability as an agent of the supplier [Court directed that a
clause in the standard form of the agency agreement to the effect may be
included] – the agent appointed by the Court Receiver must obtain registration
and make such payment on behalf of the Receiver and indemnify the Receiver for any
liability that may fall upon the Receiver u/s 92 of the GST Act concerned.

Ratio Decidendi

The following are
the key takeaways from this decision:

(1) Reciprocal obligations arising from positive
actions are necessary for an arrangement to be a supply;

(2) Consideration should be examined as a
reciprocal of a positive act and distinguished from compensations for
restituting a loss;

(3) Measure cannot fix the character of the
payment, it has to be ascertained from contractual obligations and substance of
the agreement;

(4) Schedule II was not invoked as a starting point
for deciding supply, and naturally so in view of the retrospective amendment
setting the role of schedule II as being classificatory and not directory, in
deciding the scope of supply u/s 7 of the GST enactment;

(5) In case of representative persons, distinguish
the receipt while acting as a representative and those on its own account. In
the present facts, the Court Receiver acted as a representative while
collecting royalty payments but acted on its own account in respect of the fee
as a Court Receiver. The former was not taxable on account of not falling
within the scope of supply u/s 7 itself, while the latter was held as being
exempt on account of schedule III of the GST law.

CAUTION OVER APPLICATION

However, the
following should not be immediately concluded from this decision:

(I) All court-directed payments are not
compensatory and damages are to be identified in their true sense based on
facts of the case;

(II) Scope of the term ‘business’ and whether Court
Receiver is in ‘business’ – the Court directly invoked schedule III to hold
that it was exempt under GST and has not examined section 7 on this aspect;

(III) GST implications if the Court in this civil
suit ultimately holds that tenant has rightful possession under the tenancy and
the royalty previously deposited as a fixed deposit (even partially) is
appropriated towards the rent to the landlord;

(IV) Whether or not
there is a supply inter se between the Court Receiver and the principal
in case of supply of goods, especially in the context of schedule I entry 3
which deems transactions between principal and agent as supplies even in the
absence of consideration.

The Hon’ble High Court has delivered a
well-reasoned order and even if the same is to be challenged before higher
forums, the principles set out in this decision seem to be on a solid
foundation. The Court has certainly placed some boundaries over the seemingly
unfenced scope of supply u/s 7. This decision would have implications on
matters involving liquidated damages, demurrage / detention charges, notice pay
recovery, etc. and the underlying character of the obligation would have to be
minutely studied prior to taking support of this decision.

shailesh.kwebmaker

FAILURE TO CLAIM DEDUCTION IN RETURN OF INCOME AND SECTION 80A(5)

ISSUE FOR CONSIDERATION

Section 80A(5)
provides for denial of deduction under sections 10A, 10AA, 10B, 10BA, or under
any of the provisions of part C of Chapter VIA (‘specified deductions’) of the
Income-tax Act in cases where the assessee fails to make a claim in the return
of income. It is usual to come across cases where assessees have failed to make
a specific claim for deduction in computing the total income and, as a
consequence, in claiming the same in the return of income, or where the
assessees try to cover up the failure by filing a revised return.

This disabling
provision has been introduced by the Finance (No. 2) Act, 2009 with
retrospective effect from 1^st April, 2003. On introduction of the
new provision, an issue has arisen about the eligibility of an assessee to qualify
for the specified deductions in cases where the assessee has staked the claim
for the specified deduction for the first time in the revised return of income
and such return is filed beyond the time permissible in law but before the
completion of assessment. Conflicting decisions of the Tribunal are available
in the context of the new provision of section 80A(5) on the subject. The ratio
of such decisions is discussed here to highlight the difficulty and the
possible steps that may be taken to mitigate the hardship.

THE
OLAVANNA SERVICE CO-OP. BANK CASE

The issue arose in the case of M/s Olavanna Service Co-op. Bank ITA
No. 398/Coch/2014 dated 21^stNovember, 2017 (unreported-Cochin).
The only issue in the appeal for assessment year 2010-11 was with regard to the
denial of deduction u/s 80P by invoking the provisions of section 80A(5). The
assessee, a co-operative bank registered under the Kerala Co-operative
Societies Act, 1969, had failed to file return of income for the A.Y. 2010-11.
The AO had issued notice u/s 142(1) requiring the assessee to file the return
of income but the assessee neither complied with the notice nor filed a return
of income. The AO initiated best judgment proceedings u/s 144 and called for
the details, at which point in time the assessee filed the return of income on
20^th March, 2013 which was beyond the time limit prescribed u/s 139
and the time limit prescribed in notice u/s 142(1) and, therefore, the AO treated
the same as invalid. On the basis of the material gathered during the course of
assessment, the AO worked out the total income of the assesse from business and
in completing the assessment he disallowed the claim of deduction u/s 80P by
invoking the provisions of section 80A(5).

On appeal, the CIT(A) relied on the decision of the ITAT, Cochin Bench in
the case of Kadachira Service Co-op. Bank Ltd. & Ors., 153 TTJ
(Cochin) 129 wherein it was held that
the assessee was not entitled for deduction u/s 80P for the A.Y. 2009-10
if the return of income had not been filed within the prescribed time. The
CIT(A) dismissed the appeal as, in his opinion, the factual matrix was the same
in both the cases. Against this order of the CIT(A), the assessee filed an appeal
before the Tribunal.

It was contended
before the Tribunal on behalf of the assessee that the assessee had filed the
return of income before the assessment proceedings were completed and,
therefore, the return filed should have been considered for the purpose of
making the assessment. It was further submitted that the AO should have
regularised the return of income u/s 148 of the Act, considering the fact that
the proceedings had been initiated on the basis of the reason to believe that
the income had escaped assessment. Further, it was submitted that since the
income had been assessed u/s 144 relying on all the materials, deeds and
documents submitted by the assessee in the course of the assessment proceedings
in response to the directions of the AO, he should have granted the deduction
as provided u/s 80P of the I.T. Act.

It was explained
that the assessee was a co-operative society coming under the classification of
Primary Agricultural Credit Society or Primary Co-operative Agricultural and
Rural Development Bank carrying on the business of banking, providing credit
facility to its members for agricultural purposes and, therefore, the claim of
exemption u/s 80P should have been allowed and that, even if it was held that
the assessee was doing banking business, proportionate exemption should have
been granted in respect of the agricultural credit facilities given to its
members, instead of disallowing the entire claim of deduction u/s 80P of the
Act.

The Tribunal, on
hearing both the sides, noted that a similar issue had come up for
consideration in the case of Kadachira Service Co-op. Bank Ltd. &
Ors., 153 TTJ (Cochin) 129. The relevant portion of the observations in
the said case were referred to by the Tribunal to hold that unless the Central
Government, by a notification in the official gazette, exempted the
co-operative societies from filing the returns, they had to file the return of
income and the co-operative societies could not have been under the impression
that they need not file their returns of income since their income was
exempted; a statutory liability of filing the return under the Income-tax Act
could not be disowned on the ground of a bona fide impression that no
return of income was required to be filed. It was observed that when the language
of the provision was plain and unambiguous, the language employed in the
statute was determinative of the legislative intent.

On examination of
section 80A(5), the Tribunal noted that the intention of the legislature in
introducing the provision was to avoid multiple deductions in respect of the
same profit and for that the legislature had imposed three conditions for
claiming deduction under sections 10A, 10AA, 10B, 10BA, or under any provisions
of part C, Chapter VIA. One of the conditions required that there should be a
claim made in the return of income. The legislature, in its wisdom, thought it
fit that implementation of these three conditions would prevent misuse and
avoid multiple claims of deduction under sections 10A, 10AA, 10B, 10BA, or under
any provisions of part C, Chapter VIA. A plain reading of the language of
sections 80A(4) and 80A(5) made clear the purpose and intent of the legislature
in a manner that did not require any further interpretation.

The Tribunal
examined the other provisions of the Act that provided for a deduction, to
appreciate the provisions of section 80A(5) of the Act, noting that while other
provisions required filing of return u/s 139(1), section 80A(5) did not carry
any such limitation. That being so, even if a return was filed u/s 139(4) it
would not dilute the infraction in not furnishing the return in due time as
prescribed in section 139(1). In section 80A(5) the legislature obviously
omitted to mention the words ‘in due time’. What it says is that where the taxpayer
fails to make a claim in the return of income, no deduction shall be allowed.
It does not say that the return of income shall be furnished in due time. The
return might be filed either u/s 139(1), or 139(4), or in pursuance of a notice
issued u/s 142(1) or 148 of the Act.

On the question of
when there was a failure on the part of the taxpayer to file return of income
within the time limit provided u/s 139(1) or 139(4), or within the time
specified in the notice u/s 142(1) or 148, the Tribunal held that the return of
income filed belatedly could not be treated as return of income.

While dealing with
the contention that when the return was filed before completion of the
assessment proceedings, the AO ought to have issued notice u/s 148 for regularising
the returns, the Tribunal held that the AO had no jurisdiction to issue notice
u/s 148 for assessing the income of the taxpayer. In other words, no income
could be said to have escaped assessment at that point of time. Therefore, the
contention of the assessee that notice ought to have been issued u/s 148 had no
merit at all. It referred to the decision in the case of Sun Engineering
Works (P) Ltd., 198 ITR 297, 320 (SC) to hold that proceedings u/s 147
were for the benefit of the Revenue.

The Tribunal held
that accepting the plea of the assessee that the deduction be allowed even
where no return was filed, would mean that a person who had not filed a return
would get benefit but a person who filed the return but failed to make a claim
either by ignorance or otherwise may not get the benefit at all. The Tribunal
was of the considered opinion that such could certainly not be the legislative
intent.

In conclusion, the
Tribunal held that it was a settled principle of law that in order to avail benefits
under the beneficial provision, the conditions provided by the legislature had
to be complied with, and therefore, the Tribunal was of the considered opinion
that in view of the mandatory provisions contained in section 139(1) r/w/s
80A(5) of the Act, it was mandatory for every co-operative society for claiming
deduction u/s 80P to file the return of income and to make a claim of deduction
u/s 80P in the return itself. If the return was not filed either u/s 139(1) or
139(4), or in pursuance of notice issued u/s 142(1) or 148, the taxpayer was
not entitled for any deduction u/s 80P.

CASE OF KAMDHENU BUILDERS AND DEVELOPERS

A similar issue was
examined in yet another case, of Kamdhenu Builders and Developers vs.
DCIT, ITA No. 7010/Mum/2010 (unreported-Mumbai) for A.Y. 2007-08 dated
27^th January, 2016. The assessee in that case, a partnership firm,
was engaged in the business of building housing projects and doing real estate
development. The original return of income for A.Y. 2007-08 was filed on 18^th
October, 2007 declaring total income from the housing project at Rs.
1,94,12,489. During pendency of assessment proceedings, the assessee had filed
a revised return of income on 31^st August, 2009 declaring Nil
income, as the entire profit of Rs. 1,94,12,489 was claimed to be allowable as
deduction u/s 80IB(10) of the Income-tax Act. The AO had not allowed the claim
of deduction on the ground that revised return of income was furnished on 31^stAugust, 2009, which was beyond the date by which the revised return of
income should have been furnished as per the provisions of law u/s 139(5) of
the Income-tax Act. According to the AO, the claim of deduction u/s 80IB was
also inadmissible on account of the provision of law u/s 80A(5) of the
Income-tax Act.

On appeal, the
CIT(A) allowed the assessee’s claim. The Tribunal, on further appeal by the
Revenue, has largely relied upon the order of the CIT(A) and has reproduced
extensively his observations and findings in its order, some of which were as
under:

‘I have circumspected
the entire spectrum and circumstances of the case and considered finding of the
AO, remand report, written submission of the appellant and counter
representation vis-à-vis provision of
law and various decisions of the Hon’ble
ITAT, High Court and Supreme Court relevant to the issue. It transpires from the
assessment order and remand report of AO dated 7^th June, 2010 that
Ld. AO had denied or is not willing to give deduction u/s 80IB(10) merely on
the ground of provision of law u/s 80A(5) irrespective of fulfilment of all the
conditions prescribed by the appellant to be entitled for legal claim of
deduction u/s 80IB(10) of the Act. This approach and contention of the Ld. AO
is not tenable because of obvious facts of fulfilment of all the conditions by
the appellant. There is no bar of furnishing of revised return of income u/s
80A(5) and the decision of the Hon’ble ITAT, High Courts and Supreme Court over
such issues support the appellant. Under section 80A(5), there is an insertion
of new provision of law with effect from 1^st April, 2003 providing
that where the assessee failed to make claim in his return of income for any deduction u/s 10(A),
or section 10(AA), or section 10(B), or section 10(BA), or under any provision
of Chapter VIA under the head in C – deduction in respect of certain income, no
deduction shall be allowed to him thereunder, means there is no restriction
about the revised return of income but
there is a provision of law for claiming such deduction through return of
income only. This provision of law does not limit the date of filing of return
of income to be either as provided u/s 139(1) or 139(4) or 139(5) of the
Income-tax Act. As such, there is no ambiguity regarding interpretation or
understanding of this provision of law. The provision of section 80A(5) does
not provide that return of income through which the deduction has to be claimed
should be filed on or before the due date specified under these sections, it is
worthwhile to mention that whenever legislature intends to provide a law with
reference to the prescribed date of return of income before any specified date, it has
clearly identified and mentioned in expressed word.’

The CIT(A) cited
the examples of section 80AC where a return of income had to be filed prior to
due date as per section 139(1) and of section 54(2) which referred to the date
of furnishing return as per section 139 and also of section 139(3) where carry
forward of loss was permitted only if such return of loss was filed within the
time limit provided by section 139(1). He noted that for claiming any such
deduction under these sections, return of income had to be filed within the
specified date u/s 139(1), whereas u/s
80A(5) there was no such specific limitation of date; therefore, in absence of
any specific limitation of date, the words ‘return of income’ provided u/s
80A(5) had to be construed to mean any such return of income filed prior to the
completion of assessment or a return of income filed during the assessment
proceedings, provided the original return of income was filed within the time limit prescribed u/s 139(1).

He further held: ‘Obviously,
appellant complies with the provision of section 80AC of the Income-tax Act.
When the original return of income has been filed well within the due date, the
revised return filed thereafter before the completion of assessment proceedings
or assessment order is passed, it is a valid return of income to be considered
by the Assessing Officer, otherwise every purpose of giving such right to such
appellant would be frustrated. The revised return of income is essential for
removal of defects of original return. It obviously corrects shortcomings from
which it suffered. The revised return must therefore be considered as it was
originally filed vide Thakur Dharmapur Sugar Mills Ltd. vs. CIT (1973) 90
ITR 236, 239 & 240 (All.) and Gopaldas Parshottamdas vs. CIT
(1941) 9 ITR 130 (All.). It is important to point out that when a revised return cures the
defects in the original return and does not obliterate the latter, the
assessment means on the basis of original return of income ignoring the revised
return is liable to be set aside vide CIT vs. Chitranjali (1986) 159 ITR 801
(Cal.). Similar view has also been taken in the case of CIT vs.
Bansidhar Dalal and Sons, 207 ITR 494 (Cal.).’

The CIT(A) observed
that an AO’s functions encompassed power as well as duty to be exercised within
the ambit of law. Relying on various court pronouncements, he observed that it
was only the true and correct total income of every person which was assessable
u/s 4 of the Act and, consequently, the tax collector was rather duty-bound to
collect the legitimate tax due on such total income – neither a penny less nor
a penny more, and the determination / assessment of total income would depend
on the relevant provisions of the Act irrespective of the nature of return
filed by any person; and that an income which was not taxable could not be
taxed merely because the assessee forgot to claim the exemption / deduction
under some mistaken belief. Rather, it was the duty of the Assessing Officer to
allow such deduction or exemption to which the assessee was entitled on the
basis of material placed on record. Therefore, the assessee was entitled to
claim deduction if such claim was made by the assessee before the completion of
assessment proceedings. He relied on the findings in the case of Anchor
Pressings (P) Ltd., 161 ITR 159 (SC) in which case the claim for
deduction u/s 80-O was made by the assessee before completion of assessment
proceedings by way of a revised return filed after expiry of period specified
u/s 139(5), it was held that the assessee was entitled to the said deduction in
computing his total income.

The CIT(A) relying
on the cases of Lucknow Public Educational Society, 318 ITR 223 (All.);
Gujarat Oil & Allied Industries, 109 CTR (Guj.) 272, 201 ITR 325 (Guj.); and
Berger Paints (India) Ltd., 174 CTR (Cal.)269: 254 ITR 503 (Cal.)
held that the mistake was procedural in nature. The mistake was a technical
breach and the AO was duty-bound to ask for details before denying the claim.
In the instant case, the AO had not asked any information before denying the
exemption for which the assessee was legally entitled. On the other hand, he
had rejected the second return which enclosed the necessary documents for
claiming the exemption.

The CIT(A) noted
with approval the decision in the case of Emerson Network Power India (P)
Ltd., 122 TTJ/27 SOT/19 DTR where it had been held that any claim made
at the time of assessment but not made in the original return, nor made by way
of valid revised return, could not be denied and the AO was obliged to give due
relief to the assessee or entertain its claim if admissible as per law, even
though the assessee had not filed the revised return, and that the legitimate
claim of the assessee should not be rejected on technical grounds. In the
background of all the decisions and facts of the case, the denial of claim of
deduction of the appellant made through revised return of income during the
course of assessment proceedings and well before the passing of assessment
order, according to the CIT(A), was not tenable in the eye of law.

Against the above
order of the CIT(A), the Revenue filed an appeal to the Tribunal on the
following grounds:

‘(i) On the facts and circumstances of case and in
law, the Ld. CIT(A) erred in holding that the assessee is entitled to deduction
u/s 80IB(10) of Rs. 1,94,12,489 in spite of the fact that the claim for
deduction was not made in the original return and was only made in the return
filed for A.Y. 2007-08 on 31^stAugust, 2009, which is not a valid
return in the eye of law and also cannot be treated as revised return u/s
139(5).

(ii) On the
facts and circumstances of the case and law, the Ld. CIT(A) erred in allowing
the deduction u/s 80IB(10) of Rs. 1,94,12,489 as the same is contrary to the
provisions of section 80A(5), effective from 1^stApril, 2003, which
does not permit allowance of deduction unless the claim for deduction is made
in the return of income.

(iii) On the facts and circumstances of case and in
law, the Ld. CIT(A) erred in allowing the deduction u/s 80IB(10) as the same
only means that deduction can be claimed just by filling revised return u/s
139(5)… has already elapsed, in the course of assessment proceedings, which is
not at all acceptable in the light of amended provisions of section 80A(5),
vide Finance (No. 2) Bill, 2009.’

It was contended by
Revenue that as per the provisions of section 80A(5), effective from A.Y.
2003-04, the assessee was not entitled for deduction unless the claim of
deduction was made in the original return filed by him. On the other hand, the
assessee contended that original return was filed well within the time, and the
revised return was filed to correct the omission in the original return.
Nowhere had the AO alleged that the assessee had not complied with any of the
conditions prescribed for claim of deduction u/s 80IB(10). A legal claim, even
if not made in the original return or even in the revised return, but made by
the assessee before the AO completing the assessment, should be allowed.

The Tribunal in its
considered view noted that section 80A(5) only required filing of return.
Nowhere is it suggested that claim should be made in the original return and
not by way of revised return. It further noted that when the original return of
income had been filed well within the due date, the revised return filed
thereafter, before the completion of assessment proceedings, was a valid return
of income to be considered by the AO; that the assessee had been given
opportunity to file revised return u/s 139(4) for removal of any defect in the
original return; the CIT(A), considering the remand report and the written
submission of the assessee, and after applying various judicial pronouncements,
recorded a finding to the effect that the assessee had filed a revised return
claiming deduction u/s 80IB(10) before completion of assessment, and following
the judicial pronouncements laid down by the Allahabad High Court in the case
of Thakur Dharmapur Sugar Mills Ltd. 90 ITR 236, held that
revised return must be considered as it was originally filed; it was the duty
of the AO to allow legal claim if made before him and provided it fulfilled all
the conditions of the claim; nowhere had the AO alleged that the assessee has
failed to comply with any of the conditions of section 80IB(10); the only
grievance of the AO was that the claim was not made in the return filed u/s
139(1); the CIT(A) recorded a finding to the effect that both the original
return was filed well within the time limit prescribed under the law and the
revised return was filed before the AO completed the assessment, that the
assessee had fulfilled all the conditions u/s 80IB(10) and, therefore was
entitled for deduction in respect of the housing project.

The Tribunal noted
that the findings recorded by the CIT(A) had not been controverted by the
Department by bringing any positive material on record and the Tribunal did not
find any reason to interfere in the order of the CIT(A) in allowing the
assessee’s claim for deduction u/s 80IB(10) of the Act.

OBSERVATIONS

Section 80A(1)
stipulates that in computing the total income of an assessee, there shall be
allowed the deductions specified in sections 80C to 80U of the Act. Section
80A(5) reads as follows: ‘Where the assessee fails to make a claim in his
return of income for any deduction under section 10A or section 10AA or section
10B or section 10BA or under any provision of this Chapter under the heading
“C Deductions in respect of certain
incomes”, no deduction shall be allowed to him thereunder’.

On a plain reading
of the provision it is clear that the disabling provision is activated only in
the case of an ultimate failure to make a claim in the return of income. The claims
though not made in the return of income u/s 139(1), would continue to be valid
as long as the claim for specified deduction is made in any of the returns
filed u/s 139(3), 139(4) and 139(5), or even in response to notices u/s 142(1)
or 148 of the Act, subject to compliance of the independent conditions of the
respective provisions under which a specified deduction is being claimed.

In cases where it
is necessary for the taxpayer to file the return of income within a specified
date, the legislature has inserted the words ‘before the due date specified’ or ‘in due
time’ or ‘within the time limit’. In
section 80A(5), the legislature expressly omitted to include the words ‘within
the time limit’ or ‘before the due date specified’ or ‘in due time’. Therefore,
for the purpose of Chapter VIA the legislature intended not to make compulsory
the filing of return of income within the specified time or in due time as
provided in section 139(1) of the Act. In fact, section 80 r/w/s 139(3) of the
Income-tax Act, which provides for carry forward of losses, requires the
taxpayer to file the return of income within the time allowed u/s 139(1).

While introducing
section 80A(5), the legislature was well aware that not only for carry forward
of losses but also for deductions u/s 10A and 10B, the taxpayer has to file the
return of income within the time limit prescribed u/s 139(1) of the Act. In
spite of that, the legislature omitted to mention the words ‘within due time’
in section 80A(5). Therefore, the return of income filed within the time limit
provided in section 139(1) or 139(4), or the time specified in the notice u/s
142(1) or 148 can be considered as return of income. The issue, therefore, is
limited to the belated return filed beyond the time limit provided u/s 139(1)
or 139(4), or the time specified in notice u/s 142(1) or 148 of the Act.

The challenge
therefore is in respect of a case where no claim at all is made in the return
of income, or a case where such a claim is made in the return of income that is
filed, not under any of the above referred provisions, but before the
assessment. Nonetheless, such a challenge may also be faced in a case where the
assessee for the first time seeks to claim one of the specified deductions
before the appellate authorities. For brevity’s sake, however, the discussion
here is mainly restricted to a case where a deduction has been claimed in the
revised return of income filed beyond the permissible time but before the
assessment is completed; it is this aspect of section 80A(5) that has been
examined under the conflicting decisions discussed above.

The Notes to Clauses and the Explanatory Memorandum issued at the time of
introduction of the provision by the Finance (No. 2) Bill, 2009 are reported in
315 ITR (Stat) 81 and 82. The intention of the legislature in enacting sections
80A(4) and 80A(5) is to avoid multiple deduction in respect of the same profit.
The legislature prescribed three conditions in sections 80A(4) and 80A(5) which
are: (i) If a deduction in respect of any amount was allowed u/s 10A, 10AA
or 10B or 10BA or under provisions of Chapter VIA under the head ‘C – Deductions in respect of certain
incomes’ in any assessment year, then the same deduction in respect of the same
profit & gains shall not be allowed under any other provisions of the Act
for such assessment year; (ii) The aggregate deduction under various provisions
shall not exceed the profit and gains of the undertaking or unit or enterprise
or the business profit, as the case may be; and (iii) There shall be a claim
made in the return of income. The legislature in its wisdom thought that
the above three conditions would avoid multiple deductions in respect of the
same profit. One of the conditions prescribed by the legislature in section
80A(5) is to make a claim in the return of income. The Delhi High Court in the
case of Nath Brothers Exim International Limited, 394 ITR 577
examined and upheld the constitutionality of the provision of section 80A(5).

A reference may also
be made to the Circular No. 37 of 2016 dated 2^nd November, 2016
clarifying that an increased claim for deduction would not be denied in cases
where such increase is on account of the additions or disallowances made in
assessment of the total income. In this context, a useful reference may be made
to the decision in the case of Oracle (OFSS) BPO Services Limited, 307
CTR (Delhi) 97, which, independent of circulars, supports such a claim.
[Also see Influence, 55 taxmann.com 192 (Delhi) and E-Funds
International India (P) Limited, 379 ITR 292 (Delhi).]

In a case where the
assessee cannot claim the deduction for want of positive profits, or where the
electronic return does not permit to record the eligibility to the claim for
deduction, or where a return carries a note, as was in the case of DIC
Fine Chemicals Limited, 202 TTJ (Mum.) 378, highlighting its inability
to claim deduction for want of profits, or the inability to disclose, the
deduction should not be denied; the deduction, in such cases, on assessment,
would be well within the provision of section 80A(5) and would in any case be
saved by the said circular and the said decisions. Such cases cannot be
attributed to the failure of the assessee to claim a deduction in the return of
income.

The issue of the failure to claim a deduction in the return of income has
in fact been examined by the Delhi and the Bombay High Courts in the cases of Nath
Brothers, 394 ITR 577 and EBR Enterprises, 107 taxmann.com 220,
respectively. The Courts, in these cases, have held that not only the provision
of section 80A(5) is constitutional, as it is based on a reasonable
classification, but it also denies the right to claim the specified deduction
in a case where an assessee fails to claim such deduction in the return of income.
The Bombay High Court in the EBR Enterprises case specifically
disapproved the decision of the Mumbai Bench of the Tribunal in the case of Madhav
Constructions (Supra) where the Tribunal had held that the deduction
was not limited by the provisions of section 80A(5). The High Court, however,
in the very same Madhav Constructions case had refused to admit
the appeal of the Revenue against the order of the Tribunal

The case of the
assessee for the claim of deduction is likely to be on a better footing where a
claim is staked before the AO, before completion of assessment, by filing a
return of income, revised or otherwise. Please see Chirakkal Service
Co-op. Bank Ltd., 384 ITR 490 and The Pazhavangadikara Service
Co-op. Bank (Cochin-unreported) ITA No. 200/Coch/2018 dated 9^th
July, 2018. In these cases, a claim made vide a belated return of
income, filed in response to notice u/s 148, was allowed as a deduction.

Outside of section
80A(5), it is a settled position in law that an AO is duty-bound to allow all
those deductions, reliefs and rebates otherwise allowable irrespective of the
claim by the assessee. This position of law articulated by the CBDT in Circular
No. 14(XL-35) of 1955 dated 11^thApril, 1955 has been approved by
several decisions of the courts rendered from time to time.

It is also a settled position in law that an assessee is entitled to
place a fresh claim for deduction or relief or rebate before the appellate
authorities, for the first time. Similarly, there is no bar on the AO to
entertain a claim made outside the return of income during the course of
assessment proceedings. Likewise, no special emphasis is required in stating
that a mere failure to stake a claim at a specific point of time or in a
specified format should not result in the frustration of a valid claim.

In view of the overwhelming position in law
in favour of allowance of a lawful claim, we are of the considered view that
the courts should favour an allowance of a lawful claim, even in the cases
where there is an express stipulation for denial of the benefits on the grounds
of non-compliance of a technical requirement, as long as the assessee has
finally corrected himself by compliance before the authorities. The court, in
such cases, should not only entertain the claim but is also obliged to allow
the reliefs to avoid unjust enrichment of the State.

shailesh.kwebmaker

I.Section 43(6), Explanation 2 – In Explanation 2 to section 43(6), deprecation actually allowed shall not include any unabsorbed depreciation – The WDV in the hands of the amalgamated company is to be calculated without considering the unabsorbed depreciation of the amalgamating companies, for which set-off was never allowed II.When a receipt is held to be capital in nature and not chargeable to tax under the normal provisions of the Act, the same cannot be taxed u/s 115JB of the Act as well III.Section 234B r/w/s 115JB – Interest u/s 234B cannot be levied where liability arises on account of retrospective amendment in the Act

16. [2019] 112
taxmann.com 55 (Trib.)(Mum.) ACIT vs. JSW Steel
Ltd. ITA No.
156/Bang/2011; CO No. 59/Mum/2012 A.Y.: 2006-07 Date of order: 29^thNovember, 2019

I. Section 43(6), Explanation 2 – In Explanation
2 to section 43(6), deprecation actually allowed shall not include any
unabsorbed depreciation – The WDV in the hands of the amalgamated company is to
be calculated without considering the unabsorbed depreciation of the
amalgamating companies, for which set-off was never allowed

II. When a receipt is held to be capital in nature
and not chargeable to tax under the normal provisions of the Act, the same
cannot be taxed u/s 115JB of the Act as well

III. Section 234B r/w/s 115JB – Interest u/s
234B cannot be levied where liability arises on account of retrospective
amendment in the Act

FACTS I

In the return of
income filed by the assessee for the year of amalgamation, i.e., A.Y. 2006-07,
the assessee computed WDV in respect of the assets transferred by the
amalgamating companies by reducing the amount of deprecation (‘actually
allowed’) in A.Y. 2005-06 in accordance with the provisions of Explanation (2)
to section 43(6) of the Act.

The AO observed
that the closing WDV of the amalgamating company becomes the WDV in the hands
of the amalgamated company and accordingly determined the WDV of the assets
acquired on amalgamation after considering normal depreciation allowed on
assets of the two amalgamating companies; consequently, he disallowed excess
depreciation of Rs. 6,81,27,607 (being 15% of the difference in the WDV of Rs.
45,41,84,048).

However, the AO was
of the view that Explanation (3) has to be read into Explanation (2) and
accordingly the WDV of the assets transferred on amalgamation has to be
computed after reducing the total depreciation in the hands of the amalgamated
companies.

Aggrieved, the
assessee preferred an appeal to the CIT(A) who allowed the appeal and directed
the AO to allow depreciation on the increased written down value of the assets.

Being aggrieved,
the Revenue preferred an appeal to the Tribunal.

HELD I

The Tribunal
observed that

(i) the only dispute under consideration is
whether the WDV of the assets transferred on amalgamation was to be computed in
the hands of the amalgamated company considering the unabsorbed depreciation,
i.e., depreciation not given effect to, in the assessment of the amalgamating
companies;

(ii) the provisions of Explanations (2) and (3) to
section 43(6) explains what will be the WDV of assets in the hands of the
amalgamated company in cases of amalgamation. Similarly, section 32(2) provides
for carry forward of unabsorbed depreciation and section 72A provides for carry
forward of business loss and unabsorbed depreciation in the hands of the
amalgamated company in cases of amalgamation;

(iii) on going through Explanation (2) to section
43(6), it is very clear that it speaks about depreciation ‘actually allowed’ in
relation to the said preceding year in case of the amalgamated company.

The Tribunal held
that in view of Explanation (2) to section 43(6) of the Act, the WDV in the
hands of the assessee as on 1^st April, 2005 (the appointed date)
would be the WDV of block of assets as on 31^st March, 2004 as
reduced by the depreciation ‘actually allowed’ during the said preceding year,
i.e., F.Y. 2004-05, in the hands of the amalgamating companies. Accordingly,
the WDV of assets transferred on amalgamation in the hands of the amalgamating
company has to be necessarily computed in terms of Explanation (2) to section
43(6) of the Act. In terms of this Explanation, while computing the WDV on
amalgamation, the depreciation actually allowed has to be reduced.

Since the case of
the AO was that Explanation (3) has to be read into Explanation (2) and,
accordingly, the WDV of assets transferred on amalgamation has to be computed
after reducing the total depreciation in the hands of the amalgamated
companies, the Tribunal found it necessary to read and comprehend as to why the
provision of section (3) to section 43(6) of the Act cannot be applied in the
facts of the present case. It held that Explanation (3) to section 43(6) states
that any depreciation which is carried forward u/s 32(2) shall be deemed to be
depreciation actually allowed. Further, it observed that Explanations (2) and
(3) to section 43(6) of the Act both used the term depreciation actually
allowed. However, as against Explanation (2), Explanation (3) to section 43(6)
of the Act operates as a deeming fiction, wherein depreciation which is carried
forward u/s 32(2) of the Act is deemed to have been actually allowed.

The Tribunal held
that in its view Explanation (3) being a deeming fiction, operates only in
particular conditions and in order to remove an anomaly which otherwise would
have been created under the other provisions of the Act. It held that while
interpreting Explanation (3) one needs to be aware of the intention of the
statute. These provisions, along with their intent, have been explained
elaborately by the Hon’ble Bombay High Court in the case of Hindustan
Petroleum Corporation Limited where it was held that Explanation (3) to
section 43(6) seeks to find certain anomalies which would have otherwise
existed under the Act. The intention of Explanation (3) is not simply to
nullify the provision of Explanation (2) to section 43(6), as has been read by
the AO. This is also evident from the fact that Explanation (2) has been
introduced from 1^stApril, 1988, whereas Explanation (3) was always
on the statute, which clearly implies that Explanation (3), which is a legal /
deeming fiction, was not introduced to nullify the impact of Explanation (2) of
the Act.

Accordingly, in
terms of Explanation (3) to section 43(6), in the present case, unless the
unabsorbed depreciation of the amalgamating companies is carried forward in the
hands of the amalgamated company u/s 32(2), Explanation (3) cannot be read into
Explanation (2) to simply conclude that depreciation ‘actually allowed’ also
includes unabsorbed depreciation.

It observed that in
view of the ratio of the decision of the Supreme Court in the case of CIT
vs. Doom Dooma India Ltd. [2009] 310 ITR 392, the words actually
allowed under Explanation (2) only mean depreciation, which has been given
effect to in the computation of income of the amalgamating companies and will
not include unabsorbed depreciation. This legal proposition, it observed, is
also supported by the decision in the case of Silical Metallurgic Ltd.
where the Hon’ble Court held that the statutory provision makes it clear that
the WDV of the asset would be the actual cost of the assets of the assessee
less depreciation allowed to the company. Any unabsorbed depreciation, which
was not set off for carry forward could not be taken into account.

A similar view was
taken by the Bombay High Court in the case of Hindustan Petroleum Corpn.
Ltd. and a Special Leave Petition filed against the aforesaid High
Court decision has been dismissed by the Hon’ble Supreme Court on merits in SLP
(C) No. 19054 of 2008 (SC). A similar proposition has been laid down by
the Hon’ble Madras High Court in the case of EID Parry India’s vs. CIT
[2012] 209 Taxmann 214. The Courts have, considering the applicability
of provisions of section 72A, held that deprecation actually allowed shall not
include any unabsorbed depreciation.

The Tribunal held
that the WDV in the hands of the amalgamated company was to be calculated
without considering the unabsorbed depreciation of the amalgamating companies,
for which set-off was never allowed. The Tribunal upheld the findings of the
CIT(A) and dismissed this ground of the appeal of the Revenue.

FACTS II

The assessee
received a sales tax subsidy of Rs. 36,15,49,828 from the Karnataka Government
for setting up a new industrial unit in the backward area of the state. The
refund of sales tax subsidy was routed through the profit and loss account and
hence the same was considered as part of the book profits u/s 115JB of the I.T.
Act, 1961. Subsequently, the assessee realised that sales tax subsidy being
capital receipt as held by the CIT(A), the same is not taxable under the MAT
provisions; accordingly, the issue was raised before the Tribunal and this
ground was taken by the assessee in the cross-objections filed by it.

HELD II

The Tribunal noted
that

(i) the Coordinate Bench of the ITAT, Mumbai
Tribunal, in the assessee’s own case for A.Y. 2004-05 in ITA No. 923/Bang/2009,
had considered an identical issue and held that where a receipt is held to be
capital in nature not chargeable to tax under the normal provisions of the Act,
the same cannot be taxed u/s 115JB of the I.T. Act, 1961;

(ii) the Hon’ble Kolkata High Court, in the case of
Pr. CIT vs. Ankit Metal & Power Ltd. [2019] 109 taxmann.com
93 had considered an identical issue and after considering the decision
of the Hon’ble Supreme Court in the case of Apollo Tyres Ltd. (Supra)
held that when a receipt is not in the character of income as defined u/s 2(24)
of the I.T. Act, 1961, then it cannot form part of the book profit u/s 115JB.
The Court further observed that the facts of case before the Hon’ble Supreme
Court in the case of Apollo Tyres Ltd. were altogether different,
where the income in question was taxable but was exempt under a specific
provision of the Act, and as such it was to be included as a part of book
profit; but where the receipt is not in the nature of income at all, it cannot
be included in book profit for the purpose of computation u/s 115JB.

The Tribunal
further noted that to a similar effect was the ratio of the following
decisions:

(a) Sutlej Cotton Mills
Ltd. vs. Asstt. CIT [1993] 45 ITD 22 (Cal. Trib.) (SB);

(b) Shree Cement Ltd. vs.
Addl. CIT (2015) 152 ITD 561 (Jai. Trib.);

(c) Sipca India (P) Ltd.
vs. Dy. CIT [2017] 80 taxmann.com 87 (Kol. Trib.).

As regards the case
laws relied upon, on behalf of the Revenue, the Tribunal held that the Tribunal
or High Court in those cases came to the conclusion that the capital receipt is
in the nature of income, but by a specific provision the same has been exempted
and hence came to the conclusion that once a particular receipt is routed
through the profit and loss account, then it should be part of book profit and
cannot be excluded while arriving at book profit u/s 115JB of the Act, 1961.

The Tribunal held
that when a particular receipt is exempt from tax under the Income tax Law,
then the same cannot be considered for the purpose of computation of book
profit u/s 115JB. It directed the AO to exclude the sales tax subsidy received
by the assessee amounting to Rs. 36,15,49,828 from the book profits computed
u/s 115JB.

The cross-objection
filed by the assessee was allowed.

FACTS III

Section 234B
r/w/s 115JB – Interest u/s 234B cannot be levied where liability arises on
account of retrospective amendment in Act

While completing
the assessment, interest of Rs. 9,84,94,367 was levied on total income computed
u/s 115JB on account of retrospective amendment to section 115JB. In the profit
and loss account for the year ended 31^st March, 2006, the assessee
had debited provision for deferred tax of Rs. 433.61 crores. In the return of
income filed for A.Y. 2006-07, the aforesaid provision was not added back while
computing book profit u/s 115JB. However, subsequently the Finance Act, 2008
made a retrospective amendment to section 115JB by inserting clause (h) in
Explanation 1 to section 115JB according to which book profits are required to
be increased by an amount of deferred tax and provision thereof; the said
amendment was made with retrospective effect from A.Y. 2001-02. Accordingly,
during the course of assessment proceedings while computing book profits u/s
115JB, the AO, in view of the insertion of clause (h) in Explanation 1 to
section 115JB by the Finance Act, 2008 with retrospective effect, added the
provision for deferred tax liability and consequently interest u/s 234B was
levied which interest arose on account of the retrospective amendment to
section 115JB.

Aggrieved, the
assessee preferred an appeal to the CIT(A) who allowed the appeal on the ground
that no liability can be fastened onto the assessee on the basis of
retrospective amendment to the Act.

HELD III

The Tribunal noted
that whether interest us/ 234B can be charged on the basis of a retrospective
amendment on recomputed book profit is no longer res integra. The
Coordinate Bench of the ITAT Bangalore Tribunal, in the assessee’s own case for
A.Y. 2005-06 in ITAT No. 924/Bang/2009, had considered an identical issue and
held that no interest can be levied u/s 234 B where liability arises on account
of retrospective amendment in the Act.

It observed that in the current year as well, the liability for interest
u/s 234B has arisen only on account of a retrospective amendment to the
provision of section 115JB. Accordingly, the assessee would not have
anticipated the retrospective amendment at the time of making the payments for
advance tax, but would have estimated the liability to pay advance tax on the
basis of the then existing provisions. The Tribunal found no error in the
findings recorded by the CIT(A), while deleting the interest liability u/s 234B
of the Act. The Tribunal upheld the findings of CIT(A) and rejected the ground
taken by the Revenue. This ground of appeal of the Revenue was dismissed.

shailesh.kwebmaker

PROSECUTION UNDER THE INCOME TAX ACT, 1961 – LIABILITY OF DIRECTORS

INTRODUCTION

It has been
observed of late that the Income Tax Department has become very aggressive in
initiating prosecution proceedings against assessees for various offences under
the Income-tax Act, 1961. As per a CBDT press release dated 12^th
January, 2018, during F.Y. 2017-18 (up to end-November, 2017) prosecution
complaints increased by 184%, complaints compounded registered a rise of 83%
and convictions marked an increase of 269% compared to the corresponding period
of the previous year. Even the Courts have adopted a proactive approach. In Ramprakash
Biswanath Shroff vs. CIT(TDS) [2018] 259 Taxmann 385 (Bom)(HC), where
the assessee filed a petition contending that Form No. 16 had not been issued
by his employer in time, the Court suggested the Income Tax Department also
invoke section 405 of the Indian Penal Code, 1860 which is a non-cognisable offence.

When the offence is
committed by a company, an artificial juridical person, it is observed that
prosecution is launched against all the directors, including independent
directors, in a mechanical manner. As per section 2(47) r/w/s 149 of the
Companies Act, 2013, independent director means a director other than a
Managing Director, or a whole-time director, or a nominee director. Thus, an
independent director is not responsible for the day-to-day affairs of the
company.

Recently, the Court
of Sessions at Greater Mumbai, in the case of Eckhard Garbers vs. Shri
Shubham Agrawal, Criminal Revision application No. 267 of 2019 dated
16^th December, 2019, quashed prosecution proceedings
launched against Mr. Eckhard Garbers, an independent director and a foreign
national. This decision has received wide publicity in view of several
prosecution proceedings launched against directors who had no role in the
day-to-day affairs of the company. This article looks at the said decision in
addition to analysing section 278B which deals with prosecution against a
person/s in charge of or responsible for the conduct of the business of a
company.

The provisions
regarding the liability of the directors and other persons for offences
committed by the company are enumerated under various Acts such as Industries
(Development and Regulation) Act; Foreign Exchange Regulation Act; MRTP Act;
Securities Contracts (Regulations) Act; Essential Commodities Act; Employees’
Provident Funds and Miscellaneous Provisions Act; Workmen’s Compensation Act;
Payment of Bonus Act; Payment of Wages Act; Environment (Protection) Act; Water
(Prevention and Control of Pollution) Act; Minimum Wages Act; Payment of
Gratuity Act; Apprentices Act; Central Excise and Salt Act; Customs Act, 1961;
Negotiable Instruments Act; etc. The provisions of these Acts are somewhat
identical in nature. Even section 137 of the CGST Act is identical to the
provisions of section 278B of the Income-tax Act, 1961. Hence, when the
provisions qua the directors’ liability are considered under the
Income-tax Act, 1961, or the GST Act, it is also pertinent to note the law as
laid down under other Acts by the Courts.

SCHEME
OF THE INCOME TAX ACT, 1961

PROVISIONS OF
SECTION 278B

As per sub-section
(1) of section 278B, where an offence under this Act has been committed by a
company, every person who, at the time the offence was committed, was in charge
of, and was responsible to, the company for the conduct of the business of the
company as well as the company shall be deemed to be guilty of the offence and
shall be liable to be proceeded against and punished accordingly. The proviso
to sub-section (1) provides that nothing contained in this sub-section shall
render any such person liable to any punishment if he proves that the offence
was committed without his knowledge or that he had exercised all due diligence
to prevent the commission of such offence.

Sub-section (2)
provides that notwithstanding anything contained in sub-section (1), where an
offence under this Act has been committed by a company and it is proved that
the offence has been committed with the consent or connivance of, or is
attributable to any neglect on the part of, any director, manager, secretary or
other officer of the company, such director, manager, secretary or other
officer shall also be deemed to be guilty of that offence and shall be liable
to be proceeded against and punished accordingly.

As per sub-section
(3) where an offence under this Act has been committed by a person, being a
company, and the punishment for such offence is imprisonment and fine, then,
without prejudice to the provisions contained in sub-section (1) or sub-section
(2), such company shall be punished with fine and every person referred to in
sub-section (1), or the director, manager, secretary or other officer of the
company referred to in sub-section (2), shall be liable to be proceeded against
and punished in accordance with the provisions of this Act. The Explanation to
section 278B provides that for the purposes of section 278B, (a) ‘company’
means a body corporate and includes (i) a firm; and (ii) an association of
persons or a body of individuals whether incorporated or not; and (b)
‘director’, in relation to (i) a firm means a partner in the firm; (ii) any
association of persons or body of individuals, means any member controlling the
affairs thereof.

LEGISLATIVE
HISTORY AND ANALYSIS OF THE SECTION

Section 278B was
inserted by the Taxation Laws (Amendment) Act, 1975 reported in [1975]
100 ITR 33 (ST) w.e.f. 1^st October, 1975. The object and
scope of this section was explained by the Board in its Circular No. 179 dated
30^th September, 1975 reported in [1976] 102 ITR 26 (ST).

Under sub-section
(1) the essential ingredient for implicating a person is his being ‘in charge
of’ and ‘responsible to’ the company for the conduct of the business of the
company. The term responsible is defined in the Blacks Law dictionary to mean
accountable. Hence, the initial burden is on the prosecution to prove that the
accused person/s at the time when the offence was committed were ‘in charge of’
and ‘was responsible’ to the company for its business, and only when the same
is proved that the accused persons are required to prove that the offence was
committed without their knowledge, or that they had exercised all due diligence
to prevent the commission of such offence.

Both the
ingredients ‘in charge of’ and ‘was responsible to’ have to be satisfied as the
word used is ‘and’ [Subramanyam vs. ITO (1993) 199 ITR 723 (Mad)(HC)]. Under
sub-section (2) emphasis is on the holding of an offence and consent,
connivance or negligence of such officer irrespective of his being or not being
actually in charge of and responsible to the company in the conduct of the
business. Apart from this, while all the persons under sub-section (1) and
sub-section (2) are liable to be proceeded against, it is only persons covered
under sub-section (1) who, by virtue of the proviso, escape punishment
if they prove that the offence was committed without their knowledge or despite
their due diligence. From the language of both the sub-sections it is also
clear that the complaint must allege that the accused persons were responsible
to the firm / company for the conduct of its business at the time of the
alleged commission of the offence to sustain their prosecution. [Jai
Gopal Mehra vs. ITO (1986) 161 ITR 453 (P&H)(HC)].

Insertion of
sub-section (3) by the Finance (No. 2) Act, 2004 w.e.f. 1^stOctober,
2004 [2006] 269 ITR 101 (ST) was explained by Circular No. 5
dated 15^th July, 2005 reported in [2005] 276 ITR 151 (ST).
The said amendment was brought to resolve a judicial controversy as to whether
a company, being a juristic person, can be punished with imprisonment where the
statute refers to punishment of imprisonment and fine. The Apex Court in Javali
(M.V.) vs. Mahajan Borewell and Co. (1998) 230 ITR 1(SC) held that a
company which cannot be punished with imprisonment can be punished with fine
only. However, in a subsequent majority decision in the case of ACIT vs.
Veliappa Textiles Ltd. (2003) 263 ITR 550 (SC) it was held that where
punishment is by way of imprisonment, then prosecution against the company
would fail. In order to plug loopholes pointed out by the Apex Court in Veliappa
Textiles (Supra), sub-section (3) was introduced whereby the company
would be punished with fine and the person/s in charge of or conniving officers
of the company would be punished with imprisonment and fine. It is also to be
noted that the legal position laid down in the case of Veliappa Textiles
(Supra) was overruled by the Apex Court decision rendered in Standard
Chartered Bank vs. Directorate of Enforcement (2005) 275 ITR 81 (SC).

NATURE
OF LIABILITY

The principal
liability u/s 278B is that of the company. The other persons mentioned in
sub-section (1) and sub-section (2) are vicariously liable, i.e., they could be
held liable only if it is proved that the company is guilty of the offence
alleged.

The Apex Court in Sheoratan
Agarwal vs. State of Madhya Pradesh AIR 1984 SC 1824 while dealing with
the provisions of section 10 of the Essential Commodities Act which are similar
to section 278B, has held that the company alone may be prosecuted. The
person-in-charge only may be prosecuted. The conniving officer may individually
be prosecuted.

The Apex Court in Anil
Hada vs. Indian Acrylic Ltd. A.I.R. 2000 SC 145 while dealing with
section 141 of the Negotiable Instruments Act, held that where the company is
not prosecuted but only persons in charge or conniving officers are prosecuted,
then such prosecution is valid provided the prosecution proves that the company
was guilty of the offence.

The Supreme Court
in Aneeta Hada vs. Godfather Travels and Tours Private Limited (2012) 5
SCC 661 held that the director or any other officer of the company
cannot be prosecuted without impleadment of the company unless there is some legal
impediment and the doctrine of lex non cogit ad impossibilia (the law
does not compel a man to do that which is impossible) gets attracted.

STRICT
CONSTRUCTION

The Supreme Court in the case of Girdharilal Gupta vs. D.N. Mehta,
AIR 1971 SC 2162 has held that since the provision makes a person who
was in charge of and responsible to the company for the conduct of its business vicariously liable for an offence committed by the company, the
provision should be strictly construed.

MENS REA

Section 278B is a
deeming provision and hence it does not require the prosecution to establish mens
rea on the part of the accused. In B. Mohan Krishna vs. UOI 1996
Cri.L.J. 638 AP it is held that exclusion of mens rea as a
necessary ingredient of an offence is not violative of Article 14 of the
Constitution.

DIRECTORS
WHO ARE SIGNATORY TO AUDITED BALANCE SHEET

In Mrs.
Sujatha Venkateshwaran vs. ACIT [2018] 96 taxmann.com 203 (Mad)(HC) it
was held as under: ‘Since assessee had subscribed her signature in profit and
loss account and balance sheet for relevant assessment year which were filed
along with returns, the Assessing Officer was justified in naming her as
principal officer and accordingly she could not be exonerated for offence under
section 277.’

IMPORTANT
JUDICIAL PRECEDENTS

In the case of Girdhari Lal Gupta (Supra),
the Supreme Court construed the expression, ‘person in charge and responsible
for the conduct of the business of the company’ as meaning the person in
overall control of the day-to-day business of the company. In arriving at this
inference, the Supreme Court took into consideration the wordings pertaining to
sub-section (2) and observed:

‘It mentions
director, who may be a party to the policy being followed by a company and yet
not be in charge of the business of the company. Further, it mentions manager,
who usually is in charge of the business but not in overall charge. Similarly,
the other officers may be in charge of only some part of business’.

The Apex Court in State
of Karnataka vs. Pratap Chand & Ors. (1981) 2 SCC 335 has, while
dealing with prosecution of partners of a firm, held that ‘person in charge’
would mean a person in overall control of day-to-day business. A person who is
not in overall control of such business cannot be held liable and convicted for
the act of the firm.

In Monaben
Ketanbhai Shah & Anr. vs. State of Gujarat & Ors. (2004) 7 SCC 15 (SC)
the Apex Court, while dealing with the provisions of sections 138 and 141 of
the Negotiable Instruments Act, 1881, observed that when a complaint is filed
against a firm, it must be alleged in the complaint that the partners were in
active business. Filing of the partnership deed would be of no consequence for
determining this question. Criminal liability can be fastened only on those who
at the time of commission of offence were in charge of and responsible for the
conduct of the business of the firm. The Court proceeded to observe that this
was because of the fact that there may be sleeping partners who were not
required to take any part in the business of the firm, and / or there may be
ladies and others who may not know anything about such business. The primary
responsibility is on the complainant to make necessary averments in the
complaint so as to make the accused vicariously liable. In Krishna Pipe
and Tubes vs. UOI (1998) 99 Taxmann 568 (All) it was held that sleeping
partners cannot be held liable for offence/s.

In Jamshedpur
Engineering & Machine Manufacturing Co. Ltd. & Ors. vs. Union of India
& Ors. (1995) 214 ITR 556 (Pat.)(HC), the High Court of Patna
(Ranchi Bench) held that no vicarious liability can be fastened on all
directors of a company. If there are no averments in the complaint that any
director was ‘in charge of’ or ‘responsible for’ the conduct of business,
prosecution against those directors cannot be sustained.

Justice Mathur,
while dealing with the liability of non-working directors in R.K.
Khandelwal vs. State [(1965) 2 Cri.L.J. 439 (AH)(HC)], very succinctly
stated as under:

‘In companies there can be directors who are not in charge of, and
responsible to the company for the conduct of the business of the company.
There can be directors who merely lay down the policy and are not concerned
with the day-to-day working of the company. Consequently, the mere fact that
the accused person is a director of the company shall not make him criminally
liable for the offences committed by the company unless the other ingredients
are established which make him criminally liable. To put it differently, no
director of a company can be convicted of the offence under section 27 of the
Act [The Drugs Act, 1940] unless it is proved that the sub-standard drug was
sold with his consent or connivance or was attributable to any neglect on his
part, or it is proved that he was a person in charge of and responsible to the
company, for the conduct of the business of the company.’

In Kalanithi
Maran vs. UOI [2018] 405 ITR 356 (Mad)(HC), while dealing with the
liability of the Non-Executive Chairman of the Board of Directors of the
company for the offence of non-deposit of TDS, it was held that merely because
the petitioner is the Non-Executive Chairman, it cannot be stated that he is in
charge of the day-to-day affairs, management and administration of the company.

The Court held in Chanakya
Bhupen Chakravarti and Ors. vs. Rajeshri Karwa and Ors. (4^th
December, 2018) (Del)(HC) Crl. M.C. 3729/2017 that ‘there is some
distinction between being privy to what were the affairs of the company and
being responsible for its day-to-day affairs or conduct of its business.’

In Pooja
Ravinder Devidasani vs. State of Maharashtra & Anr. (2014) 16 SCC 1 (SC),
the Supreme Court ruled thus: ‘17. Non-Executive Director is no doubt a
custodian of the governance of the company but is not involved in the
day-to-day affairs of the running of its business and only monitors the
executive activity.’

In Mahalderam
Team Estate Pvt. Ltd. vs. D.N. Pradhan [(1979) 49 Comp. Cas. 529 (Cal)(HC)],
it was held that a director of a company may be concerned only with the policy
to be followed and might not have any hand in the management of its day-to-day
affairs. Such person must necessarily be immune from such prosecutions.

In the case of Om
Prakash vs. Shree Keshariya Investments Ltd. (1978) 48 Comp. Cas. 85 (Del)(HC),
the Court had held that a distinction has to be made between directors who are
on the board purely by virtue of their technical skill or because they
represented certain special interests, and those who are in effective control
of the management and affairs, and it would be unreasonable to fasten liability
on independent directors for defaults and breaches of the company where such
directors were appointed by virtue of their special skill or expertise but did
not participate in the management. This view has been followed by the Division
Bench of the Bombay High Court in the case of Tri-Sure India Ltd. [(1983)
54 Comp. Cas. 197 (Bom)(HC).

In S.M.S.
Pharmaceuticals Ltd. vs. Neeta Bhalla & Anr. [2005] 148 Taxmann 128 (SC)
the Court, while dealing with provisions of section 141 of the Negotiable
Instruments Act which is similar to section 278B, laid down the following
important law relating to the liability of directors:

(a) It is necessary to specifically aver in a
complaint u/s 141 that at the time the offence was committed, the person
accused was in charge of, and responsible for, the conduct of business of the
company. This averment is an essential requirement of section 141 and has to be
made in a complaint. Without this averment being made in a complaint, the
requirements of section 141 cannot be said to be satisfied.

(b) Merely being a director of a company is not
sufficient to make the person liable u/s 141 of the Act. A director in a
company cannot be deemed to be in charge of and responsible to the company for
the conduct of its business. The requirement of section 141 is that the person
sought to be made liable should be in charge of and responsible for the conduct
of the business of the company at the relevant time. This has to be averred as
a fact as there is no deemed liability of a director in such cases.

(c) The Managing Director or Joint Managing
Director would be admittedly in charge of the company and responsible to the
company for the conduct of its business. When that is so, holders of such
positions in a company become liable u/s 141 of the Act. By virtue of the
office they hold as Managing Director or Joint Managing Director, these persons
are in charge of and responsible for the conduct of the business of the
company. Therefore, they get covered u/s 141.

In Madhumilan
Syntex Ltd. vs. UOI (2007) 290 ITR 199 (SC) the assessee had deducted
TDS but credited the same to the account of the Central Government after the
expiry of the prescribed time limit, thereby constituting an offence u/s 276B
r/w/s/ 278B. A show-cause notice was issued against the company as well as its
four directors as ‘principal officers’. The accused pleaded the ground of
‘reasonable cause’. However, sanction for prosecution was granted as a
complaint was filed against the appellants on 26^th February, 1992 in the Court of the Additional
Chief Judicial Magistrate (Economic Crime), Indore. The accused filed
applications u/s 245 of the Cr.PC, 1973 (the Code) for discharge from the case
contending that they had not committed any offence and the provisions of the
Act had no application to the case. It was alleged that the proceedings
initiated were mala fide. In several other similar cases, no prosecution
was ordered and the action was arbitrary as also discriminatory. Moreover,
there was ‘reasonable cause’ for delay in making payment and the case was
covered by section 278AA of the Act. The directors further stated that they
could not be treated as ‘principal officers’ u/s 2(35) of the Act and it was
not shown that they were ‘in charge’ of and were ‘responsible for’ the conduct
of the business of the company. No material was placed by the complainant as to
how the directors participated in the conduct of the business of the company
and for that reason, too, they should be discharged.

However the prayers
of the accused were rejected. Against this rejection a revision petition was
filed, which was also rejected. And against this, a criminal petition was filed
before the High Court, which was also dismissed. Hence, the accused approached
the Supreme Court. The following important points of law were laid down by the
Apex Court:

1. Wherever a company is required to deduct tax
at source and to pay it to the account of the Central Government, failure on
the part of the company in deducting or in paying such amount is an offence
under the Act and has been made punishable;

2. From the statutory provisions, it is clear
that to hold a person responsible under the Act it must be shown that he / she
is a ‘principal officer’ u/s 2(35) of the Act or is ‘in charge of’ and
‘responsible for’ the business of the company or firm. Where necessary
averments have been made in the complaint, initiation of criminal proceedings,
issuance of summons or framing of charges cannot be held illegal and the Court
would not inquire into or decide the correctness or otherwise of the
allegations levelled or averments made by the complainant. It is a matter of
evidence and an appropriate order can be passed at the trial;

3. No independent and separate notice that the
directors were to be treated as principal officers under the Act is necessary
and when in the show-cause notice it was stated that the directors were to be
considered as principal officers under the Act and a complaint was filed, such
complaint can be entertained by a Court provided it is otherwise maintainable;

4. Once a statute requires to pay tax and
stipulates the period within which such payment is to be made, the payment must
be made within that period. If the payment is not made within that period,
there is a default and appropriate action can be taken under the Act;

5. It is true that the Act provides for
imposition of penalty for non-payment of tax. That, however, does not take away
the power to prosecute the accused persons if an offence has been committed by
them.

Though the Apex
Court did not go into the merits of the case and decided the issue in respect
of the maintainability of the criminal complaint, the decision has given a
clear warning to corporates and their principal officers on the need for strict
adherence to time schedules in the matter of payment of taxes, especially Tax
Deducted at Source.

Analysis of
recent decision of Court of Sessions at Greater Mumbai in the case of Eckhard
Garbers vs. Shri Shubham Agrawal, criminal revision application No. 267 of 2019
dated 16^th December, 2019

FACTS
OF THE CASE

The facts of the
case as can be culled out from the order are as under:

(i) The Income Tax Department had filed criminal
case bearing C.C. No. 231/SW/2018 against the company, its six directors and
Chief Financial Officer on the ground that the company had deducted income tax
by way of TDS from various parties but the said amount was not immediately
credited to the Central Government; subsequently, after a delay of between one
and eleven months, the said amount was credited to the Government; as such,
offences punishable u/s 276B r/w/s 278B of the Income Tax Act, 1961 were
attracted.

(ii) The learned Additional Chief Metropolitan
Magistrate, 38th Court, Ballard Pier, Mumbai, by order dated 24^thJuly,
2018, issued process against the accused persons for offences punishable u/s
276B r/w/s 278B of the Income Tax Act, 1961.

(iii) Being aggrieved by the said order of issue of
process, the applicant / accused No. 7, i.e., Eckhard Garbers, had preferred
criminal revision application before the Sessions Court. He contended that he
is a foreign national and as such he was just a professional and an independent
director. He has not participated in the day-to-day business of the company and
was not in charge of such day-to-day business; as such, as per section 278B of
the Act, he is not liable for criminal proceedings.

FINDINGS
OF THE SESSIONS COURT

(a) The averments regarding the position and the
liability of the accused persons, especially Mr. Eckhard, are vague in nature.
There is nothing in the complaint showing how each of the accused / directors
were in charge of and responsible for the day-to-day business of the accused
No. 1 / Company. The averment in the complaint is as under:

‘8. It is further
respectfully submitted that the accused are… the directors. The accused are
also liable for the said acts of omission and contravention committed by the
accused and therefore they are also liable to be prosecuted and to be punished
for the act committed by the accused… u/s 276B of the I.T. Act, 1961.’

(b) There must be detailed averment showing how
the particular director / accused was participating in the day-to-day conduct
of the business of the company and that he was in charge of and responsible to
the company for its business and if such averments are missing, the Court
cannot issue process against such director. The Sessions Court, while coming to
the said conclusion, has relied on the following two decisions:

# Hon’ble Supreme
Court in the case of Municipal Corporation of Delhi vs. Ram Kishan
Rohtagi and others reported in AIR 1983 SC 67. In paragraph 15 of the
judgment, it is observed by their Lordships as under:

‘15. So far as the
manager is concerned, we are satisfied that from the very nature of his duties
it can be safely inferred that he would undoubtedly be vicariously liable for
the offence, vicarious liability being an incident of an offence under the Act.
So far as the directors are concerned, there is not even a whisper nor a shred
of evidence nor anything to show, apart from the presumption drawn by the
complainant, that there is any act committed by the directors from which a
reasonable inference can be drawn that they could also be vicariously liable.
In these circumstances, therefore, we find ourselves in complete agreement with
the argument of the High Court that no case against the directors (accused Nos.
4 to 7) has been made out ex facie on the allegations made in the
complaint and the proceedings against them were rightly quashed.’

# In Homi
Phiroze Ranina vs. State of Maharashtra [2003] 263 ITR 6 636 (Bom)(HC)
while dealing with the liability of non-working directors, the Bombay High
Court held as follows:

‘11. Unless the
complaint disclosed a prima facie case against the applicants / accused
of their liability and obligation as principal officers in the day-to-day
affairs of the company as directors of the company u/s 278B, the applicants
cannot be prosecuted for the offences committed by the company. In the absence
of any material in the complaint itself prima facie disclosing
responsibility of the accused for the running of the day-to-day affairs of the
company, process could not have been issued against them. The applicants cannot
be made to undergo the ordeal of a trial unless it could be prima facie
showed that they are legally liable for the failure of the company in paying
the amount deducted to the credit of the company. Otherwise, it would be a
travesty of justice to prosecute them and ask them to prove that the offence is
committed without their knowledge. The Supreme Court in the case of Sham
Sundar vs. State of Haryana AIR 1989 SC 1982 held as follows:

… It would be a
travesty of justice to prosecute all partners and ask them to prove under the proviso
to sub-section (1) that the offence was committed without their knowledge. It
is significant to note that the obligation for the accused to prove under the proviso
that the offence took place without his knowledge or that he exercised all due
diligence to prevent such offence arises only when the prosecution establishes
that the requisite condition mentioned in sub-section (1) is established. The
requisite condition is that the partner was responsible for carrying on the
business and was during the relevant time in charge of the business. In the
absence of any such proof, no partner could be convicted…’ (p. 1984).

(c) The Chief Finance Officer, who
was responsible for the day-to-day finance matters, including recovery of TDS
from the customers and to deposit it in the account of the Central Government,
was prima facie responsible for the criminal prosecution for the alleged
default committed, but certainly the Director, who is not in charge of and not
responsible for the day-to-day business of the company is not liable for
criminal prosecution, unless it is specifically described in the complaint as
to how he is involved in the day-to-day conduct of the business of the company.

CONCLUSION

From the analysis
of the provisions of section 278B it could be seen that the scope and the exact
connotation of the expression ‘every person who at the time the offence was
committed was in charge of, and was responsible to, the company for the conduct
of the business of the company’ assumes a very important role. If a person,
i.e., the director or an executive of the company falls within the purview of
this expression, he would be liable for the offence of the company and may be
punished for the same. If, on the other hand, the person charged with an
offence is not the one who falls within the ambit of that expression, the court
will relieve him of the accusation. Therefore, the essential question that
arises is as to who are the persons in charge of, and responsible to, the
company for the conduct of the business of the company. It should be noted that
the onus of proving that the person accused was in charge of the conduct of the
business of the company at the time the contravention took place lies on the
prosecution.

Another essential
aspect is that the complaint must not only contain a bald averment that the
director is responsible for the offence, but the averment must show how the
director who is treated as accused has participated in the day-to-day affairs
of the company. If such an averment is not found and the Magistrate has issued
process and taken cognisance of the complaint, then the accused director can
file a revision application before the Courts of Session. The director can also
file a Writ Petition before the High Court by invoking the provisions of
section 482 of the Cr.PC. The Bombay High Court in Prescon Realtors and Infrastructure
Pvt. Ltd. and Anr vs. DCIT & Anr WP/59/2019 dated 7^th August,
2019 has stayed the proceedings before the trial court against the
company and its directors as self-assessment taxes were ultimately paid by the
company. Thus, in genuine cases the Bombay High is entertaining the Writ
Petitions challenging the processes issued by the Magistrate.

Where the directors
have resigned, or were not involved in the day-to-day affairs of the company,
the directors can also file discharge application u/s 245 of the Cr.PC before
the Magistrate Court. However, one must note that as per section 280C, offences
punishable with imprisonment extending to two years or fine, or both, will be
tried as summons cases and not warrant cases. There is no provision of discharge
in summons triable cases. Hence, in such cases the process may be challenged by
filing revision before the Sessions Court or by filing a Writ Petition before
the Bombay High Court.

The companies must
clearly cull out the responsibilities of directors, Chief Financial Officers,
accountants, etc. so that tax defaults can be appropriately attributed to the
right person in the company and all the key persons of the company don’t have
to face the brunt of prosecution.

shailesh.kwebmaker

MFN CLAUSE: RELEVANCE OF INTERPRETATION BY FOREIGN COURTS

BACKGROUND

A tax treaty is usually bilateral in nature and is limited to two
countries: Resident country and Source country. When two bilateral treaties are
compared, there ought to be substantial or minor differences on account of the
different strategies and the negotiation power of the competent authorities of
the respective countries. The question is whether the taxpayer can rely on
another bilateral tax treaty, one that is not applicable to him. The answer is
clearly ‘No’.

The taxpayer relies on the tax treaty entered into by his resident
country for the income that has arisen in the source country. For his
taxability, the taxpayer is restricted to the applicable tax treaty only.
However, the tax treaty mechanism is such that, if expressly provided for in
his treaty, the taxpayer is permitted to enforce the beneficial provisions of
another bilateral tax treaty, though subject to conditions. This is widely termed
as the Most Favoured Nation clause (MFN clause). It prevents discrimination
amongst the OECD member states. Its application cannot be implicit but has to
be expressly provided for. If not expressed, a tax treaty cannot oblige another
tax treaty to apply its beneficial provisions (whether in terms of scope or tax
rate).

In the Indian context, the MFN clause is usually found in the Protocol to
its tax treaties, for example, the Protocol to the India-Netherlands TT, the
India-France TT, the India-Sweden TT, etc. For instance, article 12(3)(b) of the India-Sweden Tax Treaty
defines the Fees for Technical Services (FTS) as ‘(b) The term “fees for
technical services” means payment of any kind in consideration for the
rendering of any managerial, technical or consultancy services, including the
provision of services by technical or other personnel but does not include
payment for services mentioned in articles 14 and 15 of this Convention’.

If the Indian taxpayer is making payment for commercial service, the
payment would primarily be covered under this FTS article. It would be interesting to then look into the Protocol
to the India-Sweden DTA that reads as under:

‘In respect of
Articles 10 (Dividends), 11 (Interest) and 12 (Royalties and fees for technical
services) if under any Convention, Agreement or Protocol between India and a
third State which is a member of the OECD, India limits its taxation at source
on dividends, interest, royalties, or fees for technical services to a rate
lower or a scope more restricted than the rate or scope provided for in this
Convention on the said items of income, the same rate or scope as provided for
in that Convention, Agreement or Protocol on the said items of income shall
also apply under this Convention.’

Taking benefit of
the FTS clause (or Fees for Included Services) in the India-USA tax treaty or
the India-UK tax treaty, where USA is the OECD member state, the scope for FTS
in the India-Sweden tax treaty would be reduced to make-available
technical services. Where the FTS is not make-available, the FTS would
be subject to tax only when the taxpayer has a permanent establishment in India
in accordance with Article 7 of that treaty. In other words, if the taxpayer
has no permanent establishment, the FTS income that is not make-available
service would not be taxed in India. This is how the MFN clause would apply and
be beneficial to the taxpayer.

FOREIGN
COURT DECISION

In this context,
the author has discussed a recent foreign court decision on the MFN clause. It
is significant in terms of the manner in which this clause should be applied.
The decision articulates the importance of the phrase ‘limits its taxation at
source’, in respect of interpreting the phrase ‘a rate lower or a scope more
restricted’. It looks into the resultant tax effect, rather than the rate or
scope prescribed in another Tax Treaty (referred to as TT). The decision is
explained in detail below:

South Africa

Tax Court in
Cape Town

ABC Proprietary Limited vs. Commissioner (No.
14287)

Date of Order:
12^th June, 2019

(i) FACTS

The taxpayer is a
South African tax resident company and a shareholder of a Dutch company. The
Dutch company declared dividend to the South African taxpayer in respect of
which it withheld dividend tax at the rate of 5% and paid it to the Dutch Tax
Authorities. The taxpayer subsequently requested a refund of the dividend tax
paid to the Dutch Tax Authorities on account of the MFN clause in the
Netherlands-South Africa Tax Treaty (NL-SA TT). It contended as follows:

(a) NL-SA TT
provides for 5% withholding tax;

(b) MFN of NL-SA TT
referred to the South Africa-Sweden Tax Treaty (SA-SW TT) that also provides
for 10% withholding tax; but the second MFN of the SA-SW TT provides for an
effective withholding tax rate of 0% after referring to the South Africa-Kuwait
Tax Treaty (SA-Kuwait TT).

The peculiarity of
this decision is the extent to which the second MFN influences the effective
withholding tax rate in the NL-SA DTA. Coincidentally, the recent judgment of
the Dutch Supreme Court on 18^th January, 2019 in case number
17/04584 is on similar facts with a similar outcome. Both the decisions are
discussed together.

(ii) TT ANALYSIS

To understand the
importance of this decision, it is equally important to have the extract of the
relevant clauses for our benefit.

NL-SA TT

Article 10 of the
NL-SA TT provides for a 5% dividend withholding tax on distribution of
dividends if the beneficial owner is a company holding at least 10% of the
capital in the company paying the dividends. The MFN clause in article 10(10)
is given as under:

(10) If under
any convention for the avoidance of double taxation concluded after the date of
conclusion of this Convention between the Republic of South Africa and a third
country, South Africa limits its taxation on dividends as contemplated in
sub-paragraph (a) of paragraph 2 of this Article to a rate lower, including
exemption from taxation or taxation on a reduced taxable base, than the rate
provided for in sub-paragraph (a) of paragraph 2 of this Article, the same
rate, the same exemption or the same reduced taxable base as provided for in
the convention with that third State shall automatically apply in both
Contracting States under this Convention as from the date of the entry into
force of the convention with that third State.

It can be observed from the above that the MFN clause of the NL-SA TT
has a time limitation to its applicability. Only the OECD member state DTAs,
that are concluded by South Africa after the signing of the NL-SA TT, would be
looked into. Once applied, the beneficial tax rate or scope for taxation of FTS
in third state TTs would also apply in the NL-SA TT. Accordingly, the SA-SW DTA
satisfied the condition. The analysis of the SA-SW DTA is discussed below.

SA-SW TT

Originally, the
SA-SW TT was concluded prior to the conclusion of the NL-SA TT, however, the
Protocol, wherein the 10% dividend withholding tax rate and the second MFN
clause was provided for, was concluded after the conclusion of the NL-SA TT.
The Court and the tax authority did not think that this would be an issue and
both concluded that since the Protocol was concluded after the date of
conclusion of the NL-SA TT, the SA-SW TT would continue to apply.

Article 10 of the
SA-SW TT read with the Protocol did not provide for any concession in the tax
rate (i.e. 5% withholding tax rate in the NL-SA TT; whereas it was 15% in the
SA-SW TT). However, the Protocol introduced Article 10(6) to the SA-SW TT and
read as follows:

(6) If any
agreement or convention between South Africa and a third state provides that
South Africa shall exempt from tax dividends (either generally or in respect of
specific categories of dividends) arising in South Africa, or limit the tax
charged in South Africa on such dividends (either generally or in respect of
specific categories of dividends) to a rate lower than that provided for in
sub-paragraph (a) of paragraph 2, such exemption or lower rate shall
automatically apply to dividends (either generally or in respect of those
specific categories of dividends) arising in South Africa and beneficially
owned by a resident of Sweden and dividends (either generally or in respect of
those specific categories of dividends) arising in Sweden and beneficially
owned by a resident of South Africa, under the same conditions as if such
exemption or lower rate had been specified in that sub-paragraph.

It can be observed from the above that the time limitation present in
the NL-SA TT is not present in the SA-SW TT. Hence, in the absence of any
limitation, the MFN clause of the SA-SW TT is open to all member states (no
time limitation and no OECD member state limitation). This is where the
SA-Kuwait TT was applied wherein the dividend withholding tax rate is 0% when
dividends arise in South Africa.

SA-Kuwait TT

Article 10(1) of
the SA-Kuwait TT provides that the ‘Dividends paid by a company which is a
resident of a Contracting State to a resident of the other Contracting State
who is the beneficial owner of such dividends shall be taxable only in that
other Contracting State.’ In other words, the dividend paid by the South
African company would be exempt from withholding tax. Kuwait is a non-OECD
member and the SA-Kuwait TT was concluded prior to the date of conclusion of
the NL-SA TT and hence direct reference to this TT was not possible.

(iii) TAX AUTHORITIES’ CONTENTION

The tax authorities
denied the benefit of exemption for various reasons: (a) the benefit of the
SA-Kuwait TT is not available directly to the NL-SA DTA; (b) the purpose of the
MFN clause is to provide additional benefit and bring parity with other OECD
member states. The clause should be read literally and not be open to
interpretation on the basis of another MFN in another DTA, i.e., the SA-SW TT;
and (c) the intention of the MFN clause is to look into the tax rates as
specified in other DTAs, without considering any other MFN clause or other
influence. The MFN clause should be interpreted to bring parity with the
‘specified’ tax rate, rather than the ‘applied’ / ‘effective’ tax rate. The tax
authorities refused to exempt the withholding tax rate.

(iv) ISSUE

Whether the
dividend withholding tax rate is exempt under the NL-SA TT, by virtue of the
MFN clause in that TT and in the SA-SW TT?

(v) DECISION

The Tax Court of
South Africa gave its judgment in favour of the taxpayer that dividends arising
from South Africa would be exempt from withholding tax. It is identical to the
one given by the Hon’ble Supreme Court of the Netherlands. It gave the
following reasons:

(a) The MFN clause to be interpreted based on its
plain meaning. It cannot be contended that the MFN clause is not intended to be
triggered by MFN clauses in treaties concluded thereafter.

(b) The South African tax authorities had in
practice exempted the withholding tax on dividends arising from South Africa;
when the SA-SW TT, read with the SA-Kuwait TT, was applied.

(c) From the perspective of the NL-SA TT, the real
tax effect has to be seen while contemplating the beneficial effects of the MFN
clause.

(d) Accordingly, once it was clear that the SA-SW
TT is a qualified TT, the effective / resultant withholding tax rate would
apply to the NL-SA TT. The indirect effect of the SA-Kuwait TT, that was
concluded prior to the NL-SA TT, is purely coincidental.

IN AN INDIAN CONTEXT

From an Indian perspective, we do not have judgments on any similar
issue. Hence, it becomes imperative to analyse the above decision from the
perspective of Indian tax treaties. Let’s take an example of payments being
made by an Indian resident to a Dutch company in the nature of Fees for
Technical Services. We have considered the India-Netherlands Tax Treaty (Ind-NL
TT), the India-Sweden Tax Treaty (Ind-SW TT) and the India-Greece Tax Treaty
(Ind-Gr TT).

Ind-NL TT

Article 12 of the Ind-NL TT provides for a 20% withholding tax rate and
defines FTS as: The term ‘fees for technical services’ as used in this
Article means payments of any kind to any person, other than payments to an
employee of the person making the payments and to any individual for
independent personal services mentioned in Article 14, in consideration for
services of a managerial, technical or consultancy nature.

The extract of the Protocol to the Ind-NL TT is given below:

If after the signature of this Convention under any
Convention or Agreement between India and a third State, which is a member of
the OECD, India should limit its taxation at source on dividends, interest,
royalties, fees for technical services or payments for the use of equipment to
a rate lower or a scope more restricted than the rate or scope provided for in
this Convention on the said items of income, then, as from the date on which
the relevant India Convention or Agreement enters into force, the same rate or
scope as provided for in that Convention or Agreement on the said items of
income shall also apply under this Convention.

It can be observed that, like the NL-SA TT, the Ind-NL TT provides for a
time limitation and the OECD member-state condition for applicability of the
MFN clause.

Ind-SW TT

The Ind-SW TT
(conclusion date: 24^th June, 1997) was concluded after the date of
conclusion of the Ind-NL TT (conclusion date: 30^th July, 1988);
accordingly, Ind-SW is a qualified TT for application of the MFN clause.

Article 12 of the
Ind-SW TT provides for a 10% withholding tax rate and defines FTS as: The
term ‘fees for technical services’ means payment of any kind in consideration
for the rendering of any managerial, technical or consultancy services,
including the provision of services by technical or other personnel, but does
not include payments for services mentioned in Articles 14 and 15 of this
Convention.

The extract of the Protocol to the Ind-SW TT is given below:

In respect of
Articles 10 (Dividends), 11 (Interest) and 12 (Royalties and fees for technical
services), if under any Convention, Agreement or Protocol between India and a
third State which is a member of the OECD, India limits its taxation at source
on dividends, interest, royalties or fees for technical services to a rate
lower than or a scope more restricted than the rate or scope provided for in
this Convention on the said items of income, the same rate or scope as provided
for in that Convention, Agreement or Protocol on the said items of income shall
also apply under this Convention.

It can be observed that,
like the SA-SW TT, the Ind-SW TT also does not provide for any time limitation,
although it does specify an OECD member-state condition.

Ind-Gr TT

The Ind-Gr TT was concluded on 11^th February, 1965, that is,
prior to the date of conclusion of the Ind-NL TT dated 30^th July,
1988 and hence, like the above decision, direct reference to this TT was not
possible. But Greece is an OECD member state and, thus, satisfied the MFN
clause of the Ind-SW TT. The Ind-Gr TT does not have the FTS article and hence
the income from performance of services would be taxable under Article 3 for
industrial or commercial services, or under Article 14 for professional
services. The threshold requirements in Article 3 and Article 14 would
accordingly apply in the present case. These provide for a reduced scope that
is ‘more restricted’, resulting in limiting India’s right to tax FTS and,
hence, could be read into the Ind-SW TT and thereafter into the Ind-NL TT.

Another argument that can also come up for analysis is whether the ‘scope
more restricted’ in the Ind-SW TT takes into account a complete absence of the
FTS article or takes into account a mere tax effect on FTS? Reliance can be
placed on another foreign court decision by the Supreme Court of Kazakhstan in
the case of The Kazmunai Services (Case No. 3??-77-16), dated 3^rdFebruary, 2016, wherein the taxpayer applied the MFN clause of
the Kazakhstan-India DTA and wanted to benefit from the missing FTS article in
the Kazakhstan-Germany DTA, the Kazakhstan-UK DTA and the Kazakhstan-Russia
DTA. The Supreme Court denied the benefit of the MFN clause without discussing
its applicability and the issue about the absent FTS article.

In response, it could be stated that the MFN clause refers to the nature
of income (FTS), rather than the FTS article in itself. The phrase used in the
MFN clause of the Ind-SW TT is ‘India limits its taxation at source on
dividends, interest, royalties or fees for technical services to a
rate lower or a scope more restricted than the rate or scope provided for in
this Convention [emphasis] on the said items of income’.
Therefore, in the case of complete absence of FTS, the MFN clause could still
apply when the comparative TT provides for a reduced taxing right on FTS, and
thereby affecting the Source State’s right to ‘taxation at source’.

CONCLUSION

The MFN clause, when applied through the Protocol, is assumed to have an
automatic application, i.e., without the need for a formal approval from tax
authorities¹, similar to the MFN clause in the SA-SW TT above. The
past decisions on the MFN clause²
are usually from the perspective of the scope of FTS, wherein, the scope
for FTS is reduced to either ‘make-available’ technical services or removing
managerial service from FTS, or from the perspective of reducing the tax rate
on FTS; all to the extent of the scope or tax rate as ‘specified’ in the
qualifying TT. None of the Indian decisions goes past the ‘specified’ scope or
tax rate in the qualified TT. The objective of this article is to be aware of
its possibility and its planning opportunities.

Observing the similarities between the above foreign decision and the
above example, the MFN clause in the Ind-NL TT refers to two important terms,
‘limits its taxation at source’ and ‘a rate lower or scope more restricted’.
It highlights the resultant scope or resultant rate that limits India’s taxation at source. We
know that the TT merely provides for an allocation of taxing rights between the
resident and the source country. If another TT with another OECD member state
provides for a reduced scope or a lower rate, and thereby limiting India’s
right to ‘taxation at source’, the MFN clause of the Ind-SW TT will get
triggered. India’s right to taxation at
source is determined after taking into account the final tax rate
and provides for an observation to the resulting tax outcome. The scope of the
MFN clause needs to be seen from the perspective of the net result. Whether we
can derive the same result before the Indian judiciary as in the above foreign
decision, only time will tell.

shailesh.kwebmaker

ASSUMPTION OF JURISDICTION U/S 143(2) OF THE INCOME TAX ACT, 1961

Putting one to notice is one of the most
fundamental aspects of law and adjudication. As we are aware, in scrutiny
proceedings the Assessing Officer (AO), in order to ensure that the assessee
has not understated income or not claimed excessive loss, can call the assessee
to produce evidence to support the return of income filed. To assume proper
jurisdiction, the AO has to satisfy two conditions provided in section 143(2)
of the Income Tax Act (the Act). This section states that where a return of
income has been furnished, the AO shall, if he considers it necessary or
expedient to ensure that the assessee has not understated income or has
computed excessive loss, serve on the assessee a notice requiring him to
adduce evidence in support of his return of income. The proviso to
section 143(2) of the Act states that no notice under the sub-section shall
be served on the assessee after the expiry of six months from the end of
the month in which the return is furnished. It is pertinent to note that the
section, including the proviso, has not gone through any material
changes over the years.

It is clear from the above that it is
incumbent upon the AO to serve a notice u/s 143(2) and the proviso puts
a further limit on the AO to serve the notice within six months from the end of
the month in which the return of income was furnished. Now, one does not
require any authority to support the proposition that when the legislature has
used the word ‘shall’, it has not left any discretion with the AO and that it
is mandatory for him to follow such procedure. The issue eventually boils down
to interpretation of the word ‘serve’ and whether mere issuance of notice u/s
143(2) is sufficient compliance.

SECTIONS AND RULES
DEALING WITH SERVICE UNDER THE ACT

At this point it would be useful to go
through section 282 of the Act as it stood prior to the amendment brought in by
the Finance (No. 2) Act, 2009; it stated that ‘a notice or requisition under
this Act may be served on the person therein named either by post or as if it
were a summons issued by a court under the Code of Civil Procedure, 1908’. Therefore,
notice could have been served either through post or as if it were summons
under the Code of Civil Procedure, 1908 (CPC). It would be pertinent to note
that Order 5 of the CPC deals with issue and service of summons. In Order 5 of
the CPC, Rules 9 to 20 are of relevance and Rules 17 and 20 are of some
importance for the discussion herewith.

Rule 17 of Order 5 of the CPC reads as
follows: ‘Where the defendant or his agent or such other person as aforesaid
refuses to sign the acknowledgement… the serving officer shall affix a copy of
the summons on the outer door or some other conspicuous part of the house in
which the defendant ordinarily resides or carries on business or personally
works for gain, and shall then return the original to the Court from which it
was issued, with a report endorsed thereon or annexed thereto stating that he
has so affixed the copy, the circumstances under which he did so, and the name
and address of the person (if any) by whom the house was identified and in
whose presence the copy was affixed.’

The Rule
provides that if the defendant or his agent refuses to sign the
acknowledgement, then the serving officer can affix a copy of the summons on
the outer door or any conspicuous part of the house and shall return the
original to the Court (in our case the AO) with a report saying under what
circumstances he affixed the copy on the outer door.

Rule 20 of Order 5 of the CPC reads as
under: ‘(1) Where the Court is satisfied that there is reason to believe
that the defendant is keeping out of the way for the purpose of avoiding
service, or that for any other reason the summons cannot be served in the
ordinary way, the Court shall order the summons to be served by affixing a copy
thereof in some conspicuous place in the Courthouse, and also upon some
conspicuous part of the house (if any) in which the defendant is known to have
last resided or carried on business or personally worked for gain, or in such
other manner as the Court thinks fit.

(2) Effect of service substituted by
order of the Court shall be as effectual as if it had been made on the defendant personally.’

From a reading of the above Rule it is
evident that if the Court (in our case the AO) is satisfied that there is
reason to believe that the defendant is keeping out of the way for the purpose
of avoiding service, the Court shall order the summons to be served by affixing
a copy thereof in some conspicuous place. The aforesaid provisions are relevant
to appreciate the point that the Act sufficiently provides remedy to a
situation where the assessee is being evasive in receiving notices either in
order to frustrate the attempts of the AO to serve the notices within the time
limit prescribed under the Act and, as a consequence, to vitiate the entire
proceedings, or to stall the assessment proceedings. Further, the aforesaid
position will not change even under the amended provisions of section 282 of
the Act, as I will point out below.

The Act also deals with how the notice has
to be delivered to the person mentioned therein. Under the amended section
282(2) of the Act, the Board has been empowered to make rules providing for the
addresses to which a communication referred to in sub-section (1) may be delivered.
In view of the same, Rule 127 of the Rules was inserted. Further, the first proviso
states that if the assessee specifically intimates to the AO that notice shall
not be served on the addresses mentioned in sub-clauses (i) to (iv) of Rule
127(1) of the Rules (address in PAN database and return of income of the year
in consideration, or previous year, or in the MCA database) where the assessee
furnishes in writing any other address for the purpose of communication. The
second proviso states that if the communication could not be served on
the addresses mentioned in clauses (i) to (iv) of Rule 127(2) of the Rules as
well as the address mentioned in the first proviso as provided by the
assessee, then the AO shall deliver or transmit the document, inter alia,
to the address available with any banking company, or co-operative bank, or
insurance company, or post-master general, or address available in government
records, or with any local authority mentioned in section 10(20) of the Act. As
evident, the Rules have provided enough avenues to the AO to achieve the same.

The question which one would have to
consider is what would be the position when the assessee has not intimated the
AO of the new address and the notice issued on an old address comes back unserved
and, thereafter, the time limit to issue further notice has expired?

In my opinion, considering the sheer avenues
available with the AO in view of Rule 127 of the Rules, it was incumbent upon
the AO to serve or communicate the notice on any of the addresses provided
therein. The argument with respect to passing of time limit and, therefore, the
AO could not serve notice on the assessee, would not exonerate the AO from
making endeavours much before the passing of the time limit. If the assessee has
to be vigilant enough to meet deadlines, compliances and its rights and
contentions, equally, the AO, with all the resources at its disposal in today’s
technologically advanced environment, is expected to serve notices within the
time limit provided under the Act. If the AO issues a notice at the fag end of
the period of limitation and thereafter the service of the notice is called
into question, in my opinion, as stated above, it may not absolve the AO from
his duty to serve it within time for the simple reason that proceedings ought
to have been initiated a bit earlier on a conservative basis. Further, if, at
the same time, the conduct of the assessee is not forthcoming or is evasive,
the Courts, in my opinion, surely would step in to do justice.

Further, instances have come to light with
regard to E-assessment proceedings where the AO, rather than serving the
notices on the email address provided by the assessee, is merely uploading the
notices on the e-filing income tax portal of the assessee; this, in my opinion,
would also not be valid service of notice. The Rules mandate, as discussed
above, that the electronic record has to be communicated to the assessee on his
email address and not merely uploaded.

After dealing with the sections on modes of
service, it would be suitable to deal with sections mandating service of notice
in addition to section 143(2) of the Act. Section 292BB, which states that
where an assessee has appeared in any proceedings relating to an assessment,
then it shall be deemed that any notice which was required to be served upon
the assessee has been duly served upon him in time in accordance with the
provisions of the Act and such assessee shall be precluded from taking any
objection in any proceedings, inter alia, on the ground that the notice
was not served upon him on time. However, nothing contained in the section
would apply where the assessee raises that objection before the completion of
the assessment itself. The provision impliedly, or rather expressly, recognises
the fact that valid service of notice within the time limit prescribed under
the requisite provisions has been given utmost importance under the Act and
failure to service it within the stipulated time limit would vitiate the entire
proceedings.

Reference can also be made to section
153C(2) to demonstrate that the legislature has been emphasising the point of
service of notice u/s 143(2) and recognising a distinction between service and
issuance of notice. The section provides that where the incriminating material
as mentioned in 153(1) has been received by the AO of the assessee after the
due date of filing of return of the assessment year in which search was carried
out and no notice u/s 143(2) has been served and the time limit to serve the notice
has also expired before the date of receiving the incriminating material, then
the AO shall issue notice as per the manner prescribed u/s 153A.

Therefore, what the section provides is, all
other conditions remaining constant, if notice u/s 143(2) has been issued but
not served and the time limit for serving the notice has also expired, then the
AO can proceed as per the procedure provided u/s 153A. Therefore, the
legislature itself has again made a distinction between issue of notice and
service of notice u/s 143(2) and put beyond the pale of doubt that the
requirement as provided u/s 143(2) is of service of notice and not mere
issuance. It would also be relevant to take note of section 156, which also
puts an embargo of service of the notice of demand. Further, as I point out in
paragraph (vii) below, service of notice is a precondition to assume valid
jurisdiction.

A FEW DECISIONS OF THE
SUPREME COURT / THE COURT

The Supreme Court, in the context of section
156, dealt with the issue whether the subsequent recovery proceedings would
stand vitiated when no notice of demand had been served on the assessee. In the
case of Mohan Wahi vs. CIT (248 ITR 799), the Court, following
the decision in the case of ITO vs. Seghu Setty (52 ITR 528)
rendered in the context of the Income-tax Act, 1922 (1922 Act), held that the
use of the term ‘shall’ in section 156 implies that service of demand notice is
mandatory before initiating recovery proceedings and constitutes the foundation
for recovery proceedings and, therefore, failure to serve the notice of demand
would render the subsequent recovery proceedings null and void.

Reference can also be made to the Three-Judge
Bench decision of the Supreme Court in the case of Narayana Chetty
vs. ITO (35 ITR 388) wherein the Court, dealing with section 34
(providing power to reopen an assessment) of the 1922 Act, held that service of
the notice is a precondition and it is not a procedural irregularity. A similar
analogy, in my submission, can be drawn with regard to section 143(2) as well –
that section 143(2) mandates service of notice on the assessee and the said
notice also forms the bedrock of assessment proceedings, therefore, mere
issuance is not sufficient.

Further, I would like to point out the
decision of the Supreme Court in the case of R.K. Upadhyaya vs. Shanabhai
P. Patel (166 ITR 163) where the
Court has made a distinction between issuance of notice and service of notice.
However, prior to dealing with the same it is appropriate to discuss the
decision of the Supreme Court in the case of Bansari Debi vs. ITO (53 ITR
100). The controversy in that is as follows: Section 34(1)(b) of the
1922 Act provided that the AO may, at any time within eight assessment years
from the end of the assessment year of which reopening is sought to be done,
reopen the assessment by serving a notice on the assessee. The aforesaid
section was amended by section 4 of the Indian Income tax (Amendment) Act, 1959
(Amending Act) which, inter alia, provided that no notice issued u/s 34(1)
can be called into challenge before any court of law on the ground that the
time limit for issuing the notice had expired. The assessee raised a plea that
when the notice is issued within a period of eight years but served beyond the
period of eight years, it would not be saved by the Amending Act, as it only
dealt with issuance of notice.

The Court, rejecting the argument of the
assessee, held that the purpose of bringing the Amending Act was to save the
validity of the notice; if a narrow interpretation of ‘issue’ is given, then
the Amending Act would become unworkable as the time limit prescribed in
34(1)(b) of the 1922 Act was only with regard to service of notice. Therefore,
to advance the purpose of the legislature, which was to save the validity of
notices beyond the time prescribed under the 1922 Act, the Court held that the
word ‘issue’ has to be interpreted as the word ‘service’. The Court held that a
wider meaning of the word ‘issue’ would be consistent with the provisions of
the Act as well. In conclusion, the Court in the aforesaid case held that
‘issue’ can be interchangeably used with ‘service’.

Thereafter, in the context of the 1961 Act,
the Supreme Court in the case of R.K. Upadhyaya (Supra)
was again called upon to decide whether service and issue can be used
interchangeably. The controversy before the Court was that the notice u/s 148
was issued by registered post prior to the date of limitation; however, it was
served after the period of limitation. The assessee / respondent before the
Court argued that though section 149 states that the no notice shall be issued
beyond the period of limitation and section 148 provides that reassessment
cannot be done without service of the notice u/s 148, in view of the decision
of Bansari Debi (Supra), ‘issue’ used in section 149 shall be
interpreted to mean ‘serve’; therefore, service beyond the period of limitation
is not valid in law.

The Supreme Court rejected the argument by
holding that the scheme of the 1961 Act is materially different from the 1922
Act. A clear distinction has been made between ‘issue of notice’ and ‘service
of notice’ under the 1961 Act. The Court held that section 148 provides service
of notice as a condition precedent to making the assessment and section 149
provides for issuance of notice before the period of limitation; therefore,
there is a clear distinction between the two. The decision in the case of Bansari Debi (Supra) could not be applied for the purpose of
interpreting the provisions of reopening under the 1961 Act.

In my view of the aforesaid decisions as
well as the provisions of the Act, it can be contended that service of notice
u/s 143(2) is a condition precedent for assuming jurisdiction u/s 143. The
legislature has made a clear distinction between the term ‘issue’ and ‘service’
and it is manifested from sections 148 and 149 of the Act. Therefore, the two
terms cannot be used interchangeably.

CIRCULARS /
INSTRUCTIONS ISSUED BY THE BOARD

Reference can also be made to Instruction
No. 1808 dated 8^th March, 1989 which deals with the then
newly-inserted proviso u/s 143(2). The proviso is identically
worded as the new proviso, the only difference being the time limit for
service of the notice. The instruction which the Board gave to the authorities
is as follows:

‘4. It may be noted that, under the
aforesaid provision, it is essential that a notice under section 143(2) of the
Act is served on the assessee within the statutory time limit, and mere issue
of the notice within the statutory period will not suffice’. The instruction clearly states that mere issuance of notice within
the statutory period will not suffice, it has to be served. Similar
instructions have been given by the Board for selection of cases u/s 143(2)(i)
vide Instruction No. 5 dated 28^th June, 2002. A similar instruction
has been given in the General Direction issued by the Board vide Notification
No. 3265 (E) 62/2019 dated 12^th September, 2019 with regard to the
new scheme of E-assessment, which has been brought with much fanfare.

In view of the aforesaid interpretation
given by the Board through various circulars and instructions that notice u/s
143(2) has to be served, it would not be open to Revenue to contend otherwise
that mere issuance of notice would suffice the requirement of the section. Considering
the aforesaid provisions, the dictum of the Supreme Court in the aforesaid
decisions and the interpretation given by the Board itself, it would be safe to
conclude that issuance of notice u/s 143(2) will not meet the requirement of
assuming valid jurisdiction to initiate proceedings u/s 143.

RECENT DECISION OF THE
SUPREME COURT

However, the Supreme Court recently,
in the case of Pr. CIT vs. M/s I-ven Interactive Ltd. (418 ITR 662),
has apparently altered the aforesaid position. The Court has not only put a
burdensome finding on the assessee but has also given a distinctive
interpretation of law which I would like to discuss.

Facts

The assessee filed its return of income
online on 28^th November, 2006 for 2006-07 and also filed a hard copy
on 5^th December, 2006. In the return of income, the assessee had
mentioned its new address. Thereafter, a notice u/s 143(2) was issued on 5^th
October, 2007 at the old address, picked up from the PAN database of the
assessee. Though it is not coming out very clearly from the facts as narrated
by the Court in its order, the question of law before the Bombay High Court as
well as the grounds of appeal raised before the Tribunal proceeds on the footing
that the notice was indeed served on the associate entity of the assessee
within the time limit prescribed under the proviso to section 143(2).
Another notice u/s 143(2) was issued on 25^th July, 2008 at the
address available in the PAN database. The assessment order was passed u/s
143(3) on 24^th December, 2008.

The assessee challenged the order before the
Commissioner of Income tax (Appeals) (CIT[A]), inter alia, on the ground
that the notice u/s 143(2) issued on 5^th October, 2007 was not
served on the assessee and the subsequent notices were served beyond the time
limit prescribed u/s 143(2). The CIT(A), vide order dated 23^rdDecember,
2010, allowed the appeal holding that the AO passed the order without assuming a valid jurisdiction u/s 143(2).

Revenue challenged the order of the CIT(A)
before the Income tax Appellate Tribunal (the Tribunal) which, vide its order
dated 19^th January, 2015, confirmed the order of the CIT(A). The
Tribunal, affirming the finding of the CIT(A), inter alia, held that the
assessee had, during the course of the assessment proceedings, brought to the
notice of the AO that the notice u/s 143(2) dated 5^thOctober, 2007
was not served on the appellant, therefore, the proceedings u/s 143(3) were bad
in law.

Revenue challenged the order of the Tribunal
before the Bombay High Court in ITA No. 94 of 2016. The Bombay High Court,
dismissing the appeal, noted that the AO had, in fact, served at the new
address the assessment order u/s 143(3) on 30^th November, 2006 for
assessment year 2004-05 which was very much prior to the notice u/s 143(2)
dated 5^th October, 2007 and 25^th July, 2008. The Bombay
High Court noted that the assessee, in the course of the assessment
proceedings, had raised the issue of valid service of notice u/s 143(2) and, therefore,
the Tribunal rightly held that in view of the proviso to section 292BB,
notice not being served within time was invalid.

Arguments before the Supreme Court

It was submitted that as there was no
intimation by the assessee to the AO of change of address, the notice u/s
143(2) was sent to the assessee at the available address as per the PAN
database. In view of these facts, the AO was justified in sending the notice
u/s 143(2) on the old address. Once the notice has been issued and sent to the
available address as per the PAN database, it is sufficient compliance of
provisions u/s 143(2).

The assessee argued that the AO was aware
about the new address and, therefore, the notice u/s 143(2) ought to have been
served at the new address only. But the notice u/s 143(2) was, in fact, served
on the old address and, therefore, the same was never served on the assessee.
Further, the subsequent notice was served beyond the time limit provided u/s
143(2). The assessee further relied on the decision of the Supreme Court in the
case of ACIT vs. Hotel Blue Moon (321 ITR 362) to submit that
notice u/s 143(2) has to be served within the time limit prescribed under the proviso
to section 143(2).

The assessee further argued that the AO was
aware about the change of address, which is evident from the fact that the AO
had sent assessment orders for the assessment years 2004-05 and 2005-06 to the
new address.

Conclusion of the Supreme Court

The Court held that as there was no
intimation of change of address to the AO, the AO was justified in issuing the
notice u/s 143(2) on the address available in the PAN database. The Court
further held that mere mentioning of the new address in the return of income
without specifically intimating the AO with respect to the change of address
and without getting the PAN database changed is not adequate. In the absence of
any specific intimation, the AO was justified in issuing the notice at the
address available in the PAN database, especially in view of the return being
filed under the e-filing scheme. The Court noted that the notices u/s 143(2)
are issued on selection of cases generated under the automated system of the
Department which picks up the address of the assessee from the PAN database.

The Court, thereafter, held that once a notice
is issued within the time limit prescribed as per the proviso to section
143(2), the same can be said to be sufficient compliance of section 143(2).
Actual service of the notice upon the assessee is immaterial. The Court gave
such an interpretation to the proviso because, in its wisdom, it felt
that in a case it may happen that though the notice is sent within the period
prescribed, the assessee may avoid actual service of the notice till the expiry
of the period prescribed. The Court further held that in the decision relied
upon by the assessee in the case of Hotel Blue Moon (Supra) also,
it was observed that issuance of notice u/s 143(2) within the time limit
prescribed under the proviso to section 143(2) is necessary.

With regard to the argument of the assessee
that the AO was aware of the change of address in view of the fact that the AO
himself had issued assessment orders for earlier assessment years, i.e. 2004-05
and 2005-06 on the new address, the Court held that the matter had been
adequately explained by the Revenue. In view of the aforesaid findings, the
Court set aside the order of the Bombay High Court and remanded the matter back
to the file of the CIT(A) to decide the issue on merits.

Analysis of the aforesaid decision

The Court came to the aforesaid conclusion
that issuance of a notice is sufficient and service is immaterial majorly on
the point that an assessee may deliberately avoid service of notice within the
time limit in order to stall the assessment proceedings. The remedy for the situation
envisaged by the Court has been adequately provided under the Act itself as
pointed out in paragraph (ii) above, that if the assessee is evasive then there
are various modes of effecting service which would be considered as valid forms
of service. Further, the Act has made clear the requirement of service of the
notice, and not mere issuance, as discussed in paragraph (vi) above. The Court
in its previous decisions has also opined that service of notice is a
precondition for assuming valid jurisdiction and also brought out distinction
between issue and service of notice and how it has been used distinctively
under the Act, which we have seen in aforesaid paragraph (viii). In fact,
Revenue itself has interpreted that service of notice is the most crucial point
of assuming jurisdiction u/s 143(2) which we have seen in paragraph (ix) above.

In my submission, it was not open to the
Revenue to contend otherwise. Further, reference can also be made to the
decision of the Supreme Court Three-Judge Bench in the case of UCO
Bank vs. CIT (237 ITR 889) in which the Court dealt with a somewhat
similar issue. To a previous Three-Judge Bench of the Supreme Court, a CBDT
Circular was not pointed out which was in consonance with the provisions of the
Act and the concept of income. The Court held that circulars are issued for the
purpose of proper administration of the Act, to mitigate the rigours of the
application of provisions of the statute, in certain situations by applying
interpretation beneficial to the assessee, and circulars are not meant for
contradicting or nullifying any provision of the law. Such circulars are
binding on the Revenue and when one such circular was not put before the
earlier Three-Judge Bench of the Supreme Court in a correct perspective, the
same would be contrary to the ratio laid down by the decision of the Constitutional
Bench in the case of Navnitlal Jhaveri vs. AAC (56 ITR 198). In
my opinion, this can be similarly submitted with regard to the aforesaid
circulars referred to in paragraph (vi) as well.

Obiter vs.
ratio of the decision

One more aspect
which I would like to highlight with regard to the aforesaid decision and that
can be kept in mind is that the notices were served on the associate of the
assessee within the time limit provided under the proviso to section
143(2) and that may have prompted the Court to reach the aforesaid conclusion.
Looking at it from another angle, we can wonder whether the interpretation
given by the Court is the ratio of the judgment or an obiter dictum?
It is well settled that even the obiter of the Court is binding
throughout the country and no authority is required to support that
proposition. The only point of distinction would be that when the obiter of
the Court contradicts the ratio of a previous decision, then the ratio
laid down in the previous decision has to be followed and not the obiter.

In this regard, I would draw attention to
the decision rendered by the Punjab and Haryana High Court in the case
of Sirsa Industries vs. CIT (178 ITR 437). Even there, the High
Court was dealing with a question in which seemingly a Three-Judge Bench
decision of the Supreme Court in the case of Chowringhee Sales
Bureau vs. CIT (87 ITR 542) had taken a view contrary to the decision
of the Division Bench in the case of Kedarnath Jute Mfg. Co. Ltd.
vs. CIT (82 ITR 363). The facts of the case are noteworthy. The
assessee was following the mercantile system of accounting and claimed
deduction of sales tax payable by taking a view that the liability had accrued
and therefore deduction could be claimed. The AO sought to reopen the
assessment to deny deduction claimed on mercantile basis by taking the view
that in the case of Chowringhee Sales (Supra), the Supreme Court
held, even though that party was following the mercantile system of accounting,
that ‘a party would be entitled to claim deduction as and when it passes it
on to the government’. The High Court held that the Supreme Court in the
case of Chowringhee Sales (Supra) was considering a different
issue and not the allowability or non-allowability of sales tax payable and,
therefore, it cannot be said that there is a conflict between the decision of
the Three-Judge Bench in the case of Chowringhee Sales (Supra)
and the decision of the Division Bench in the case of Kedarnath Jute Mfg.
(Supra), which allowed deduction of sales tax liability on the basis of
accrual of liability. In view of the same, the High Court quashed the reopening
notices.

The facts of the case before the Court in
the case of I-ven Interactive, as narrated above, show that the notice was
served on the associate of the assessee within the time limit provided under
the proviso to section 143(2). Therefore, it is possible to argue that
the Court was called upon to decide only on the point as to whether or not
notice u/s 143(2) served on the associate of the assessee on the old address of
the assessee was a valid service u/s 143(2). Consequently, mere issuance of
notice u/s 143(2) was sufficient compliance of the provision of section 143(2)
was merely an observation made by the Court.

Considering the aforesaid provisions of the
Act, the decisions of the Court itself which the Court did not have the
occasion to deal with sufficiently, as well as the CBDT Circulars, in my
opinion it is still an arguable case that mere issuance of notice u/s 143(2) is
not a sufficient compliance of the provisions of section 143(2). Inversely,
whether service of notice should have been read as issuance of notice has not
been foreclosed.

With regard to the second important finding
which the Court had given, that merely mentioning the new address in the return
of income would not suffice, a specific intimation has to be filed with the AO
bringing to his notice the change of address as well as an application for
change of address has to be made in the PAN database. From 2^nd
December, 2015 (the date from which Rule 127 of the Rules was inserted), the
Act has implicitly recognised the fact that once an address is mentioned in the
return of income, the AO is aware about that address and, thereby, notice can
be served on the said address as well in a given scenario. The second proviso,
inserted from 20^thDecember, 2017, sheds some light on the
controversy dealt with by the Court. Therefore, in my view, after insertion of
Rule 127 of the Rules, failure to specifically bring to the AO’s notice would
not enable the AO to shirk his responsibility of serving the notice to the
assessee.

I have tried to comprehensively deal with
the aspect of issue vs. service as well as what would be the consequences of a
notice coming back unserved. In future on account of electronic transmission of
notices as well as e-assessments, service of notice would throw up innumerable
fresh challenges. It would be interesting to see how the Courts deal with the
same.

shailesh.kwebmaker

INCOME-TAX E-ASSESSMENTS – YESTERDAY, TODAY & TOMORROW

INTRODUCTION

The Government of
India has, over the last few years, taken various steps to reduce human
interface between the tax administration and the taxpayers and to bring in
consistency and transparency in various tax administrative matters through the
use of Information Technology. This has been very pronounced in the matter of
scrutinies being conducted by tax officers under the Income-tax Act, 1961 (the
Act). This article traces the history of E-assessments and takes a peep into
what the coming days will bring.

RECENT
HISTORY

When we look at the
recent past, one of the initial impacts of technology in the income tax
scrutiny assessment procedures was the implementation of the Computer-Assisted
Scrutiny Selection (CASS) scheme for selection of cases. The process of
selection of cases based on scrutiny on random basis was gradually dispensed
with and was replaced by a system-based centralised approach. Under CASS, the
selection of income tax returns for the purpose of scrutiny was based on a
detailed analysis of risk parameters and 360-degree data profiling of the
taxpayers.

The CASS
substantially reduced the manual intervention in the selection process of cases
for assessment proceedings. Nonetheless, some cases were manually picked up by
the taxmen on the basis of pre-determined revenue potential-based parameters.

The CASS provided
greater transparency in the selection procedures as the guidelines of selection
were placed in the public domain for wider information of taxpayers. The entire
process was made quite transparent and scientific.

In order to address
the concerns of taxpayers with respect to undue harassment and to ensure proper
tax administration, the Board, by virtue of its powers u/s 119 of the Act and
in supersession of earlier instructions / guidelines that in cases selected for
scrutiny during the Financial Year 2014-15 under CASS, on the basis of either
AIR data or CIB information or for non-reconciliation with Form 26AS data,
ensured that the scope of inquiry should be limited to verification of those
particular aspects only. The Assessing Officers (AOs) were instructed to
confine their questionnaire and subsequent inquiry or verification only to the
specific point(s) on the basis of which the particular return was selected for
scrutiny.

Apart from this,
the reason(s) for selection of cases under CASS were displayed to the AOs in
the Assessment Information System (AST) application and notices for selection
of cases of scrutiny u/s 143(2) of the Act, after generation from AST, were
issued to the taxpayers with the remark ‘Selected under Computer-Aided Scrutiny
Selection (CASS)’.

PILOT
PROJECT

In order to further
improve the assessment procedures and usher in a paperless environment, the
Department rolled out the E-assessment procedures via a pilot project wherein
the AOs conducted their inquiry by sending queries and receiving responses
thereto through e-mails.

The cases covered under the pilot project were initially those which had
been selected for scrutiny on the basis of AIR (Annual Information Return) /
CIB (Central Information Branch) information or non-reconciliation of tax with
Form 26AS data. However, the Department ensured that the consent of the
taxpayers was sought for their scrutiny assessment proceedings to be carried
out under the newly-introduced E-assessment proceedings and only willing
taxpayers were considered under the pilot run.

New Rule 127 was
inserted by the Income Tax (Eighteenth Amendment) Rules, 2015 w.e.f. 2^nd
December, 2015 which gave the framework for issue of notices and other
communication with the assessee. It prescribes the rule for addresses
(including address of electronic mail or electronic mail message) to which
notices or any other communication may be delivered.

Between the years
2016 and 2018, the CBDT progressively amended rules, notified various
procedures and issued the required guidelines to increase the scope of
E-proceedings on the basis of the pilot study. Notification No. 2/2016 dated 3^rd
February, 2016 and Notification No. 4/2017 dated 3^rd April, 2017
were very important and provided the procedures, formats and standards for
ensuring secured transmission of electronic communications.

The Finance Act,
2016 introduced section 2(23C) in the Act to provide that the term ‘hearing’
includes communication of data and documents through electronic mode.
Accordingly, to facilitate the conduct of assessment proceedings
electronically, CBDT issued a revised format of notice(s) u/s 143(2) of the
Act.

The scope of
E-assessment proceedings was extended vide Instruction No. 8/2017 dated 29^th
September, 2017 to cover all the cases which were getting barred by limitation
during the financial year 2017-18 with the option to the assessees to
voluntarily opt out from ‘E-proceedings’.

The CBDT later
issued Instruction No. 1/2018 dated 12^th February, 2018 through
which the proceedings scheme was stretched to cover all the pending scrutiny
assessment cases. However, exceptions were carved out for certain types of
proceedings such as search and seizure cases, re-assessments, etc., where the
assessments were done through the personal hearing process. Further, there
remained an option to object to the conduct of E-assessment.

Thereafter,
Instruction No. 03/2018 dated 20^thAugust, 2018 issued by the Board
carved out the way for all cases where assessment was required to be framed u/s
143(3) during the year 2018-19. It provided that assessment proceedings in all
such cases should mandatorily be through E-assessment

NEW
E-ASSESSMENT SCHEME

In September, 2019
the CBDT notified the ‘E-Assessment Scheme, 2019’ (scheme) laying down the
framework to carry out the ‘E-assessments’. As anticipated, the scheme was
churned out with the intention to bring about a 360-degree change in the way
tax assessments will be carried out in future.

The scheme is in line with the recommendations of the Tax Administration
Reforms Commission (TARC) which was formed with the intention to review the
application of Tax Policies and Tax Laws in the context of global best
practices and to recommend measures for reforms required in tax administration
in order to enhance its effectiveness and efficiency. An extract of the TARC
report is as under:

‘Currently, the
general perception among taxpayers is that the tax administration is focused on
only one dimension – that of revenue generation. This perception gains strength
from the manner in which goals are set at each functional unit of both the
direct and indirect tax departments. These goals, in turn, drive the
performance of individual tax officials. Therefore, the whole system of goal
setting, performance assessment, incentivisation and promotion appears to be
focused on only this dimension. This single-minded revenue focus can never meet
the criteria of the mission and values mentioned above. What is required is a
robust framework that is holistic in its approach to issues of performance
management.’

As the phrase
‘faceless’ suggests, under this scheme a taxpayer will not be made aware of the
AO who would be carrying out the assessment in his case. It could be an officer
located in any part of the country.

The prime objective
of the Government in introducing the E-Assessment Scheme, 2019 has admittedly
been to eliminate the interface between the taxpayers and the tax department
and to impart greater transparency and accountability. The scheme would also
help in optimising the utilisation of resources of the tax department, be it
human or technical, through economies of scale and functional specialisation.
The scheme envisages a team-based assessment with dynamic jurisdiction. It is
also intended to ensure the tax assessments are technically sound and that
consistent tax positions are taken on various issues to avoid prolonged and
unnecessary litigations for both the taxpayer as well as the tax officers.

The then Hon’ble
Finance Minister, the late Mr. Arun Jaitley, said in his Union Budget speech
for the financial year 2018-19:

‘E-assessment

We had
introduced E-assessment in 2016 on a pilot basis and in 2017 extended it to 102
cities with the objective of reducing the interface between the department and
the taxpayers. With the experience gained so far, we are now ready to roll out
the E-assessment across the country which will transform the age-old assessment
procedure of the income tax department and the manner in which they interact
with taxpayers and other stakeholders. Accordingly, I propose to amend the
Income-tax Act to notify a new scheme for assessment where the assessment will
be done in electronic mode which will almost eliminate person to person contact
leading to greater efficiency and transparency.’

In the above
background, two new sub-sections, (3A) and (3B), were introduced in section 143
of the Act enabling the Central Government to come out with a scheme for the
faceless electronic assessments which was finally notified as ‘E-Assessment Scheme, 2019’ vide Notification No. 61/2019
and 62/2019, dated 12^th September, 2019 to conduct
E-assessments with effect from 12^th September, 2019.

The scheme has laid out a functional structure of the E-assessment
centres at the national and the regional levels. The framework also provides
for specialised units in the Regional E-assessment Centre for carrying out
specific functions related to various aspects of an assessment. The proposed
structure is depicted as under:

The functions of
these centres and units set up under the scheme are discussed below:

NATIONAL E-ASSESSMENT CENTRE (NeAC)

NeAC will be an
independent office and a nodal point which would oversee the work of the
E-assessment scheme across the country. All the communications between the
income tax department and the taxpayers would be made through the NeAC, which
will enable the conduct of tax assessment in a centralised manner.

On 7^th
October, 2019 the Revenue Secretary, Mr. Ajay Bhushan Pandey, inaugurated the
NeAC in Delhi. He stated that the setting up of the NeAC of the Income Tax
Department is a momentous step towards the larger objectives of better taxpayer
service, reduction of taxpayer grievances in line with the Prime Minister’s
vision of ‘Digital India’ and promotion of the Ease of Doing Business.

The NeAC in Delhi
will be headed by the Principal Chief Commissioner of Income Tax (Pr.CCIT) and
would coordinate between the different units in the tax department for
gathering information, coordination of assessment, seeking technical inputs on
tax positions, verification and review of the information submitted by
taxpayers, review of draft orders framed by the assessment units, etc.

REGIONAL
E-ASSESSMENT CENTRE

The Regional
E-assessment centre would comprise of (a) Assessment unit, (b) Review unit, (c)
Technical unit, and (d) Verification unit. Eight Regional E-assessment Centres
(ReAC) have already been set up in Delhi, Mumbai, Chennai, Kolkata, Ahmedabad,
Pune, Bengaluru and Hyderabad. Each of these ReACs will be headed by a Chief
Commissioner of Income Tax (CCIT).

(a) Assessment
units

Assessment units
under the E-Assessment Scheme will perform the function of making assessments,
which will include identification of points or issues material for the
determination of any liability (including refund) under the Act, seeking
information or clarification on points or issues so identified, analysis of the
material furnished by the assessee or any other person, and such other
functions as may be required for the purposes of making assessment. In simple
terms, the Assessment units will largely perform the functions of an AO.

(b) Verification
units

Verification units,
as the name suggests, will carry out the function of verification, which
includes inquiry, cross-verification, examination of books of accounts,
examination of witnesses and recording of statements, and such other functions
as may be required for the purposes of verification. This may also include site
visits for examining and verifying facts for carrying out assessments.

Technical units
will play the role of experts by providing technical assistance which includes
any assistance or advice on legal, accounting, forensic, information
technology, valuation, transfer pricing, data analytics, management or any
other technical matter which may be required in a particular case or a class of
cases under this scheme. This apparently will include the functions of a
Transfer Pricing Officer in a transfer pricing assessment.

(d) Review units

The Review units
would perform the function of review of the draft assessment order, which
includes checking whether the relevant and material evidence has been brought
on record, whether the relevant points of fact and law have been duly
incorporated in the draft order, whether the issues on which addition or
disallowance that should be made have been discussed in the draft order,
whether the applicable judicial decisions have been considered and dealt with
in the draft order, checking for arithmetical correctness of modifications
proposed, if any, and such other functions as may be required for the purposes
of review.

As notified in
Notification No. 61/2019, the Assessment units, Verification units, Technical
units and Review units will have the authorities of the rank of Additional /
Joint Commissioner, or Additional / Joint Director, or Assistant / Deputy
Director, or Assistant / Deputy Commissioner, amongst other staff /
consultants.

The CBDT vide
Notification No. 77/2019 has already notified 609 tax officers to play the role
of Assessment, Technical, Verification and Review Units. As per the said
notification, these officers will concurrently exercise the powers and
functions of the AO to facilitate the conduct of E-assessment proceedings in
respect of returns furnished u/s 139 or in response to notice under sub-section
(1) of section 142 of the said Act during any financial year commencing on or
after the 1^st day of April, 2018.

The E-Assessment
Scheme also provides for levy of penalty for non-compliance of any notice,
direction and order issued under the said scheme on any person including the
assessee. Such penalty order after providing adequate opportunity of being
heard to the assessee, will be passed by the NeAC.

After the
completion of assessment proceedings, the NeAC would transfer all the
electronic records of the case to the AO having jurisdiction over such case to
perform all the other functions and proceedings such as imposition of penalty,
collection and recovery of demand, rectification of mistake, giving effect to
appellate orders, submission of remand report, etc. which are otherwise
performed by an AO.

The notification
has also carved out an exception for cases wherein the NeAC may, at any stage
of the assessment, if considered necessary, transfer the case to the AO having
jurisdiction over such case.

DIGITAL
SERVICE OF NOTICE / RECORDS

All notices or records
or any other communication will be delivered to the assessee by electronic
means, viz. by placing it on the E-proceeding tab available on the income-tax
E-filing portal account of the assessee, or by sending it to the e-mail address
of the assessee or his authorised representative, or by uploading on the
assessee’s mobile application.

Notice or any
communication made to any person other than the assessee would be sent to his
registered e-mail address. It also provides that any delivery would also have
to be followed by a real-time alert to the addressee.

The date and time
of service of notice will be determined in accordance with the provisions of
section 13 of the Information Technology Act, 2000. As per the said section,
the time of receipt of an electronic record shall be, if the addressee has
designated a computer resource for the purpose of receiving electronic records,
the time when the electronic record enters the designated computer resource,
otherwise, the time when the electronic record is retrieved by the addressee.

E-RESPONSE
TO NeAC

Under this scheme, the assessee, in response to notice or any other
communication received from the NeAC, shall file his response only through the
E-proceedings tab on his income-tax e-filing portal account. Any other person
can respond to the NeAC using his registered e-mail address.

PERSONAL HEARINGS

Generally, no personal hearings will be required between the assessee /
authorised representative and the income tax department in the course of the
E-assessment proceedings under this scheme. However, in the following cases,
the assessee by himself or through his authorised representative will be
entitled for hearings which will be conducted exclusively through video
conferencing:

(i) Where a modification is proposed in the draft
assessment order, the assessee or his authorised representative in response to
show-cause notice may request a hearing;

(ii) In the case of examination or recording of the
statement of the assessee or any other person (other than statement recorded in
the course of survey u/s 133A of the Act).

APPELLATE
PROCEEDINGS

The E-Assessment
Scheme has clarified regarding the filing of appeals u/s 246A of the Act
against the E-assessment orders passed by NeAC, which shall be filed with the
Commissioner (Appeals) having jurisdiction over the jurisdictional AO in such
case.

ISSUES
IN E-ASSESSMENT SCHEME

The E-Assessment
Scheme, 2019 is not a separate code by itself. It is a part of the existing
statute and therefore the scheme must gel well with the existing statute. Any
conflict there would create legal friction and attract litigation on the
validity of the very assessment.

Provision of the
newly-inserted sub-sections (3A), (3B) and (3C) to section 143 of the Act:

‘(3A) The
Central Government may make a scheme, by notification in the Official Gazette,
for the purposes of making assessment of total income or loss of the assessee
under sub-section (3) so as to impart greater efficiency, transparency and
accountability by

(a) eliminating
the interface between the Assessing Officer and the assessee in the course of
proceedings to the extent technologically feasible;

(b) optimising
utilisation of the resources through economies of scale and functional
specialisation;

(3B) The Central
Government may, for the purpose of giving effect to the scheme made under
sub-section (3A), by notification in the Official Gazette, direct that any of
the provisions of this Act relating to assessment of total income or loss shall
not apply or shall apply with such exceptions, modifications and adaptations as
may be specified in the notification:

Provided that no
direction shall be issued after the 31^stday of March, 2020.

(3C) Every
notification issued under sub-section (3A) and sub-section (3B) shall, as soon
as may be after the notification is issued, be laid before each House of
Parliament.’

The entire
E-Assessment Scheme, 2019 is born out of the provision of sub-section (3A) of
section 143 of the Act which empowers the Government to make a scheme for the
purposes of making assessments under sub-section (3) of section 143(3) of the
Act. Thus, although the assessments u/s 144, section 147 and section 153A etc.
are carried out conjointly u/s 143(3) of the Act, it appears from the scheme
that such assessment originating from the said sections would currently be
outside the ambit of the said scheme.

The E-Assessment
Scheme is based on the concept of dynamic jurisdiction. The Notifications No.
72 and 77 of 2019 have specified various income tax authorities in the NeAC (9)
and ReAC (609) which have been empowered with the concurrent powers and
functions of an AO in respect of returns furnished u/s 139 and section 142(1)
of the Act during the financial year commencing on or after 1^st
April, 2018.

At this point, it is relevant to refer to the provisions of section 120
of the Act which deals with the jurisdiction of income tax authorities.
Sub-section (5) of the said section deals with concurrent jurisdiction. It
empowers the Board to allow concurrent jurisdiction in respect of any area or
persons or class of persons or incomes or classes of income or cases or classes
of cases, if considered necessary or appropriate. Under the scheme, the Board
has already allowed concurrent jurisdiction to over 600 income tax authorities.
Whether this is in line with the provision of section 120(5) of the Act is the
question that perhaps will be answered by the Courts in course of time.

The scheme in its holistic structure, despite having multiple units,
viz. Verification unit, Review unit, NeAC, Technical unit, still leaves the
entire discretion to complete the assessment to the Assessment unit. The
suggestions of the other units like the Technical unit which also appears to be
performing the functions of a Transfer Pricing Officer will not be binding on
the Assessment unit. This deviates from the existing provision of section 92CA
of the Act.

Under sub-section
(3B) of the Act, the Government has also been authorised to come out with such
notifications till 31^st March, 2020 which may be necessary to give
effect to the E-Assessment Scheme by making exceptions, modifications and
adaptations to any provision of the Act. It still remains to be evaluated
whether this would amount to excessive delegation of power as the power to make
law is the jurisdiction of the Parliament. It is only the implementation of
such law that lies with the Government. Vide this provision, the Government is
allowed to make changes in the Act merely by way of notification. Although the
intention behind such provision is to ensure smooth implementation of the
scheme, one cannot deny the fact that there is also a possibility of it being
misused.

Although
sub-section (3C) of section 143 of the Act requires all such the notifications
to be tabled before each House of Parliament, it has not specified any
time-frame. Further, it does not necessitate discussion of such notifications
in the Parliament, which could prompt insightful debates and allow the Houses
to make necessary changes in the notifications. Thus, this provision appears to
be more routine in nature. Also, this arguably endows the power to make law to
the Board.

Section 144A of the
Act allows an assessee to approach the jurisdictional Joint Commissioner of
Income-tax requesting his authority to examine the case and issue necessary
directions to the AO for completion of assessment. With the advent of the
E-Assessment Scheme, this provision will more likely lose its relevance as all
the specified income tax authorities under the scheme, including Joint
Commissioners, will concurrently hold the power and perform the functions of an
AO.

The scheme provides
for review of assessment orders by the Review unit if considered necessary by
the NeAC. The Review unit, upon perusal of the draft assessment order, would
share its suggestions. However, the scheme does not provide that such
suggestions would be mandatory for the Assessment unit to follow while passing
the final draft assessment order.

At present, the
scheme covers only limited scrutiny cases as all the notices issued u/s 143(2)
of the Act in accordance with the scheme must, as mentioned in the Notification
Nos. 61 and 62 of 2019, have to specify the issue/s for selection of cases for
assessment. However, it is seen in some cases that such issues mentioned in
notices u/s 143(2) of the Act have been very general and vague; for example,
‘business expenses’, ‘import and export’,
etc. Thus, it needs to be seen whether such issues can even be termed as
specific if they are not broad and are imprecise.

Further, it does not visualise conversion of limited scrutiny cases to
complete scrutiny cases. However, it allows the NeAC to transfer cases to the
jurisdictional assessing officer at any given point of time during the course
of assessment. Needless to say but upon transfer, the jurisdictional assessing
officer can take necessary recourse under the Act for conversion of a case to
complete scrutiny. Further, it would require compliance of provision of section
127 of the Act for transfer of cases to the jurisdictional assessing officer.

An assessee under the circumstances specified in the scheme will be
allowed to represent his case in person or through his authorised representative
via video conferencing which will be attended by the Verification unit. It will
be interesting to see whether a recording of the discussion is forwarded to the
Assessment unit to avoid any spillage of information in the process.

The scheme provides for the Assessment unit to share with the NeAC, along
with the draft assessment order, details of penalty proceedings to be initiated
therein, if any. NeAC is then authorised to issue show cause on the assessee
for levy of penalty under the Act. It will have to be seen who, under this
scheme, will be considered to record satisfaction for levy of penalty. If such
satisfaction is held to be recorded by the Assessment unit, a show-cause notice
issued by the NeAC will be held as invalid since as per the current settled
position of laws, recording of satisfaction and issue of show cause notice for
levy of penalty have to be carried out by the same AO.

At present, the provision of section 264 empowers the Pr. Commissioner of
Income Tax or the Commissioner of Income Tax to call for and examine the record
of any assessment proceedings carried out by any income tax authority
subordinate to him, other than cases to which the provision of section 263
applies, and pass such order not being prejudicial to the assessee. With the
advent of faceless E-assessments, it would be interesting to see whether such
an order u/s 264 is passed by the Pr. Commissioner of Income Tax or the
Commissioner of Income Tax having jurisdiction over the Assessment unit, or the
one having jurisdiction over the jurisdictional assessing officer. As yet, the
scheme has not visualised such circumstances.

The provision of section 144C requires mandatory passing of a draft
assessment order in the case of foreign companies and cases involving transfer
pricing assessment. In such cases, the assessee has the option to choose to
file an application before the dispute resolution panel and it is only after
the direction of the dispute resolution panel that the final assessment order
is passed by the AO. It is quite clear that the scheme currently does not have
scope for carrying out assessment in these cases.

CONCLUSION

The scheme has been launched by the Government on 7^thOctober,
2019 and 58,322 cases have already been selected for assessment under it in the
first phase by issue of e-notices on taxpayers for the cases related to tax
returns filed u/s 139 of the Act since 1^st April, 2018.

There is no doubt that the scheme has conceptualised a complete paradigm
shift in the way assessments will be carried out in future. The assessments
have been centralised and made faceless. Exchange of communication between
taxpayers and the tax department as well as amongst the income tax authorities
in the tax department has been centralised. The allocation of cases by the NeAC
would be based on the automated allocation system. Thus, it goes without saying
that both the taxpayers and the tax department will need to gear up their
systems to adapt to the scheme.

shailesh.kwebmaker

THINKING CORRECTLY: THE KEY TO PHENOMENAL SUCCESS

Very often, we come across the expression
‘That person is a very good person’. What actually are we referring to? Is it
any physical characteristic? Does the expression refer to his looks, his
height, his weight, or anything specific about his personal appearance? No, the
expression refers to his good thoughts and his good thinking.

How does one cultivate ‘good’ thinking or
thinking correctly? There is no scientific way, but a very good solution is to
constantly bring in an attitude of positivity, helpfulness and consideration
for others at all times and in all circumstances. ‘This life is for others’ is
a good maxim to begin with. If we can gather all our thoughts around this one
thought, our thinking will automatically correct itself for the better. For
example, amongst aging people one common prayer to God is ‘Please give me
strength to look after myself if my son does not look after me when I have
grown old’. However, consider another prayer, ‘Please give me strength to be
able to look after all those whose sons have deserted them’. If God can grant
the first prayer, he can also grant the second one. In the first case the
person will appear to God as a self-centred person thinking only about himself,
whereas the second prayer will appear to Him as one that has been made by a
considerate, helpful and positive person. While the first prayer is not wrong,
the second prayer symbolises good thinking.

Right from a subordinate to the less
privileged people around us, like drivers, liftmen, janitors, etc., even if we
give them a smile, or an occasional chocolate, or a kind word, such acts can
ensure unbelievable good vibes and divine energy around us which has to be experienced
to be believed. However, the real challenge to thinking correctly is during
adverse circumstances.

A jamaai (son-in-law) was visiting
his in-laws and one of the brothers-in-law teased him and even requested him to
take the garbage out. The natural reaction expected in such circumstances would
have been disastrous. The jamaai would feel hurt and insulted, he would
sulk and would probably fight with his wife and his in-laws. In extreme cases,
his future relationship with his in-laws, his wife, children and others around
him would possibly be severely impacted.

However, consider a case where a jamaai
reverses the situation by willingly doing what is asked of him – and even
more. He readily removes the garbage and smilingly even offers to help his
in-laws with things like ironing their clothes. What is really important is his
cheerful attitude when he does this. The good natured act would win over all
the in-laws and they would be full of admiration. Initially, they might have
imagined him to be a ‘stuck-up’ jamaai, but now he becomes very dear to
them; most importantly, his wife is overjoyed and their marriage becomes very
successful and he lives a happy life.

In any situation in life, even if one has
been insulted and treated badly, returning the act with good-natured behaviour
can reverse the situation and such an attitude fosters good thinking. Once good
thinking is regularly practised, thoughts of jealousy, hatred and negative
feelings will reduce to a point where they will automatically be repelled.
Though this is not easy, it comes with practice and with a single theme in your
life: ‘Everyone around me is God’s creation and whether they like me or not, I
have nothing against them and I will gladly help them in every way’.

Once such good thinking is started, friends,
I guarantee you that life will be immensely happy and enjoyable. This attitude
of thinking positively for others also has a miraculous effect of changing the
world around us. It is the key to real success in life and the world will then
become a much better place to live in.

shailesh.kwebmaker

MANDATORY PAYMENT FOR FILING APPEAL AND ESCAPE THEREFROM

INTRODUCTION

Laws are being so drafted nowadays that even for
preferring an appeal against an order passed by Revenue authorities the
aggrieved assessee has to shell out a minimum 10% or maybe even a higher
proportion of the dues.

In other words, the law makes it compulsory that
for filing / entertaining an appeal, the appellant must pay a minimum amount
upfront.

For example, under the MVAT Act payment of 10% of
tax dues has been made compulsory from 15^th April, 2017. Although
litigation on the said issue is on before the Hon. Bombay High Court, but as of
today no appeal is being admitted without payment of minimum 10% of tax dues.

Recently, the above issue has been dealt with by
the Hon. Supreme Court in the case of Tecnimont Pvt. Ltd. vs. State of
Punjab (67 GSTR 193)(SC).

FACTS OF THE CASE

The case arose from an order and judgment of the
Punjab and Haryana High Court. Under the Punjab Value Added Tax Act, 2005 (PVAT
Act), payment of 25% of additional demand was mandatory for entertaining an
appeal. This was challenged before the High Court.

The following questions arose before the Hon.
Punjab & Haryana High Court while deciding the case of Punjab State
Power Corporation Ltd. vs. State of Punjab (90 VST 66)(P&H):

‘(a) Whether the State is empowered to enact
section 62(5) of the PVAT Act?

(b) Whether the condition of 25% pre-deposit for
hearing first appeal is onerous, harsh, unreasonable and, therefore, violative
of Article 14 of the Constitution of India?

(c) Whether the first appellate authority in its
right to hear appeal has inherent powers to grant interim protection against
imposition of such a condition for hearing of appeals on merits?’

The Court decided the first two issues in favour of
the State, i.e., the State is empowered to make the provision as it has done
and that the provision is not in violation of Article 14 of the Constitution.

However, regarding the third issue, i.e., whether
the appellate authority is empowered to use its discretion for a lower amount,
the Hon. Punjab & Haryana High Court held in the affirmative, observing as
under:

‘It is, thus, concluded that even when no express
power has been conferred on the first appellate authority to pass an order of
interim injunction / protection, in our opinion, by necessary implication and
intendment in view of various pronouncements and legal proposition expounded
above, and in the interest of justice, it would essentially be held that the
power to grant interim injunction / protection is embedded in section 62(5) of
the PVAT Act. Instead of rushing to the High Court under Article 226 of the
Constitution of India, the grievance can be remedied at the stage of first
appellate authority. As a sequel, it would follow that the provisions of
section 62(5) of the PVAT Act are directory in nature, meaning thereby that the
first appellate authority is empowered to partially or completely waive the
condition of pre-deposit contained therein in the given facts and
circumstances. It is not to be exercised in a routine way or as a matter of
course in view of the special nature of taxation and revenue laws. Only when a
strong prima facie case is made out will the first appellate authority
consider whether to grant interim protection / injunction or not. Partial or
complete waiver will be granted only in deserving and appropriate cases where
the first appellate authority is satisfied that the entire purpose of the
appeal will be frustrated or rendered nugatory by allowing the condition of
pre-deposit to continue as a condition precedent to the hearing of the appeal
before it.

Therefore, the power to grant interim protection /
injunction by the first appellate authority in appropriate cases in case of
undue hardship is legal and valid. As a result, question (c) posed is answered
accordingly.’

The above judgment was challenged by the State on
the issue of the answer to question (c) and by the assessee in respect of the
answers to the first two questions.

The Hon. Supreme Court decided the issue under Tecnimont
Pvt. Ltd. vs. State of Punjab (67 GSTR 193)(SC).

CONSIDERATION BY SUPREME COURT

In its judgment, the Supreme Court referred to
various precedents on the issue. The indicative observations of the Supreme
Court can be noted as under:

‘15. In Har Devi Asnani 11 the
validity of proviso to section 65(1) of the Rajasthan Stamp Act, 1998
came up for consideration in terms of which no revision application could be
entertained unless it was accompanied by a satisfactory proof of the payment of
50% of the recoverable amount. Relying on the earlier decisions of this Court
including in Smt. P. Laxmi Devi the challenge was rejected and
the thought expressed in P. Laxmi Devi 10 was repeated in Har
Devi Asnani 11 as under:

“27. In Govt. of A.P. vs. P. Laxmi Devi 10 this
Court, while upholding the proviso to sub-section (1) of section 47-A of the Stamp Act introduced by the Andhra Pradesh Amendment Act 8
of 1998, observed (SCC p. 737, para 29):

29. In our opinion in this situation it is always
open to a party to file a writ petition challenging the exorbitant demand made
by the registering officer under the proviso to section 47-A alleging
that the determination made is arbitrary and / or based on extraneous
considerations, and in that case it is always open to the High Court, if it is
satisfied that the allegation is correct, to set aside such exorbitant demand
under the proviso to section 47-A of the Stamp Act by declaring the
demand arbitrary. It is well settled that arbitrariness violates Article 14 of
the Constitution (vide Maneka Gandhi vs. Union of India 17). Hence,
the party is not remediless in this situation.

…

28. In our view, therefore, the Learned Single
Judge should have examined the facts of the present case to find out whether
the determination of the value of the property purchased by the appellant and
the demand of additional stamp duty made from the appellant by the Additional
Collector were exorbitant so as to call for interference under Article 226 of
the Constitution.”

16. These decisions show that the following
statements of law in The Anant Mills Co. Ltd. have guided
subsequent decisions of this Court:

The right of appeal is the creature of a statute.
Without a statutory provision creating such a right the person aggrieved is not
entitled to file an appeal… It is permissible to enact a law that no appeal
shall lie against an order relating to an assessment of tax unless the tax had
been paid. It is open to the Legislature to impose an accompanying liability
upon a party upon whom legal right is conferred or to prescribe conditions for
the exercise of the right. Any requirement for the discharge of that liability
or the fulfilment of that condition in case the party concerned seeks to avail
of the said right is a valid piece of legislation…’

Observing as above, the Hon. Supreme Court upheld
the validity of two provisions.

In respect of question (c), that is, in spite of
such provisions, whether the appellate authority has discretion, the Hon.
Supreme Court observed as under:

‘18. It is true that in cases falling in second
category as set out in paragraph 11 hereinabove, where no discretion was
conferred by the Statute upon the appellate authority to grant relief against
requirement of pre-deposit, the challenge to the validity of the concerned
provision in each of those cases was rejected.

But the decision of the Constitution Bench of this
Court in Seth Nand Lal was in the backdrop of what this Court
considered to be meagre rate of the annual land tax payable. The decision in Shyam
Kishore attempted to find a solution and provide some succour in cases
involving extreme hardship but was well aware of the limitation. Same awareness
was expressed in P. Laxmi Devi and in Har
Devi Asnani and it was stated that in cases of extreme hardship a writ
petition could be an appropriate remedy. But in the present case the High Court
has gone a step further and found that the appellate authority would have
implied power to grant such solace, and for arriving at such conclusion,
reliance is placed on the decision of this Court in Kunhi 1.

19. Kunhi 1 undoubtedly laid down
that an express grant of statutory power carries with it, by necessary
implication, the authority to use all reasonable means to make such grant
effective. But can such incidental or implied power be drawn and invoked to
grant relief against requirement of pre-deposit when the statute in clear
mandate says no appeal be entertained unless 25% of the amount in question is
deposited? Would not any such exercise make the mandate of the provision of
pre-deposit nugatory and meaningless?

20. While dealing with the scope and width of
implied powers, the Constitution Bench of this Court in Matajog Dubey vs.
H.C. Bhari also touched upon the issue whether exercise of such power
can permit going against the express statutory provision inhibiting the
exercise of such power. The discussion was as under:

“Where a power is conferred or a duty imposed by
statute or otherwise, and there is nothing said expressly inhibiting the
exercise of the power or the performance of the duty by any limitations or
restrictions, it is reasonable to hold that it carries with it the power of
doing all such acts or employing such means as are reasonably necessary for
such execution. If in the exercise of the power or the performance of the
official duty, improper or unlawful obstruction or resistance is encountered,
there must be the right to use reasonable means to remove the obstruction or
overcome the resistance. This accords with common sense and does not seem
contrary to any principle of law. The true position is neatly stated thus in Broom’s
Legal Maxims, 10th Ed., at page 312: It is a rule that when the law
commands a thing to be done, it authorises the performance of whatever may be
necessary for executing its command.

(Emphasis added)”’

Relying upon the above precedents, the Hon. Supreme
Court held that once there is a specific provision, the appellate authority
cannot have discretion and cannot forgo such condition nor lower the amount.

AN ALTERNATIVE

The Hon. Supreme Court, while deciding the issue,
has also given a solution about cases where such condition cannot be complied
with. The said observations are available at many places and in precedents
reproduced by the Hon. Supreme Court.

In the paragraph reproduced above from the judgment
of Har Devi Asnani it can be seen that in case of exorbitant
demand, or in case of demand based on extraneous considerations, it is open to
approach the High Court under its inherent powers for deletion of such demand
as violative of Article 14.

The High Court can consider such a plea. Even in
the present case, the Hon. Supreme Court concluded as under:

‘25. As stated in P. Laxmi Devi and
Har Devi Asnani, in genuine cases of hardship recourse would
still be open to the concerned person. However, it would be a completely
different thing to say that the appellate authority itself can grant such
relief. As stated in Shyam Kishore, any such exercise would make
the provision itself unworkable and render the statutory intendment nugatory.’

Thus, an inference can be drawn that in case of
arbitrary demand one can approach the High Court by writ petition. It can also
be stated that in case of inability to pay the minimum amount, supported by
necessary documents and reasons, one can approach the High Court by writ
petition to waive the condition.

CONCLUSION

The law is now becoming very clear. Once there is a
condition of minimum payment, the appellate authority has no discretion in
spite of great prejudice to the assessee. However, if the circumstances exist,
the assessee can approach the High Court by way of writ petition to waive the
condition or set aside the demand itself.

As of today, the laws are
becoming mechanical and discretions are being done away with. The only hope for
justice will be from the Hon. High Courts in deserving cases.

shailesh.kwebmaker

SAT RULES: WHETHER PUBLIC CHARITABLE TRUSTS CAN BE RELATED PARTIES

Related parties
and transactions with them are a concern of many laws – the Companies Act,
2013, the SEBI Regulations, the Income-tax Act and so on. The core concern is
that when parties are ‘related’, there is a conflict of interest between such
related parties who are involved in taking a decision regarding these
transactions and the interests of other parties who have no say or even
knowledge about it. For example, a firm owned by the daughter of the MD of a
listed company is sought to be given a contract of services. There is obviously
concern whether the terms would be fair, whether such services were indeed
needed by the company, etc. In a sense, thus, transactions with related parties
are a form of corporate nepotism. However, the definition of related parties,
as we will see a little later, is not narrow to include merely relatives of
controlling / deciding person/s. It includes subsidiaries, parent companies,
group entities of a certain type, etc. Business realities require that certain
activities are carried on by the same group in different entities, and even
otherwise transactions between groups or related entities are inevitable. Yet,
concerns would remain about the conflict of interest and whether the
arrangement is on commercial arm’s length terms.

The Companies
Act, 2013 (the Act) and the SEBI (Listing Obligations and Disclosure
Requirements) Regulations, 2015 (the LODR Regulations) both deal with matters
relating to related parties and transactions with them. There is a detailed
accounting standard, too, dealing with this. Generally, these provide for
certain safeguards. There are requirements of approval of shareholders beyond a
particular threshold of materiality, with related parties generally barred from
voting thereon. The Audit Committee also has to approve all related party
transactions. Besides, there are requirements of disclosure of related parties
and transactions with them in the accounts. All of this serves at least two
purposes. Firstly, parties whose interests could potentially be affected would
get a say. Secondly, there is disclosure irrespective of whether such approval
was required. Hence, readers can review the nature and extent of such transactions.

Considering these varied safeguards and considering that parties may
still try to avoid them, an understanding of the provisions relating to such
transactions is important. A recent decision of the Securities Appellate
Tribunal (SAT) provides such an opportunity. Essentially, it held inter alia
that a public charitable trust whose managing trustee was father / father-in-law of the promoter directors of a listed company was
not a related party. Thus, although there were significant transactions with such
trust, the relevant provisions of law governing related parties would not
apply. The decision of SAT is in the matter of Treehouse Education and
Accessories Limited vs. SEBI [(2019) 112 taxmann.com 349 (SAT), order dated 7^th
November, 2019].

BACKGROUND

The facts of
the case are complicated and may even appear to be sordid, involving alleged
criminal acts. The background of what had transpired, as narrated by the
decision of SAT discussed here, an earlier decision of SAT and two orders of
SEBI, is as follows.

Treehouse
Education and Accessories Limited, a listed company (the Company) is engaged in
the business of education that it carries out through its own schools,
franchisees and along with certain public charitable trusts. It develops the
course and curriculum for the purpose. The franchisees and the trusts had
certain commercial arrangements with the company. It appears that there were
proposals and negotiations to merge the company with a company of the Zee group
for which an exchange ratio was also determined. For certain reasons, details
of which are not relevant here, there were disputes to such an extent that the
matter went to the police and the courts and the share exchange ratio was
revised substantially downwards.

The company
suffered very large losses which had allegedly questionable issues. There were
media reports about the company as per the SEBI orders which led to SEBI
initiating a preliminary inquiry.

Soon
thereafter, after making certain preliminary allegations, SEBI passed an
interim order debarring the company and its directors from accessing the
capital markets and ordered a forensic audit into its affairs. The order of
SEBI was appealed against to SAT which asked SEBI to pass a final order within
a specified time after giving due opportunity to the parties to present their
case. SEBI did so and passed a confirmatory order on 16^thNovember,
2018 imposing the same directions as did the interim order. This order was
appealed again and SAT passed the order which is now discussed here.

Two issues of
contention arose. One was whether SEBI was entitled to initiate such
investigations and pass such harsh orders on the facts (more so when they were
admittedly initiated on the basis of media reports). The second issue, and
which is the subject of more detailed discussion here, is whether the company
and the public charitable trust whose managing trustee is a relative of the
promoter directors, can be said to be related parties? And thus, whether the
provisions of disclosure, approval, etc. under the relevant provisions apply to
transactions with them.

Whether
transactions with public charitable trust where relative of promoter directors
is a managing trustee are related party transactions?

Owing to, as
the company explained to SEBI, certain peculiar circumstances / laws relating
to educational institutions / schools, the company had to enter into a tie-up
arrangement with public charitable educational trusts to run certain schools.
The company would provide its name and backing and curriculum, etc. More
importantly, it would provide funds (returnable over certain years, with
interest for a part of this time) that can be used to set up the schools.

One trust, to which large amounts were provided as security deposit, had
a managing trustee who was the father / father-in-law of the promoter director
couple. Owing to losses by the said trust, security deposits of large amounts
had effectively eroded and hence potentially huge losses were faced. The
question thus arose whether the law relating to related party transactions was
violated. For this purpose the moot question was whether the company and the
trust were related parties as understood in law.

The relevant
provisions for this purpose are contained in the Act and the LODR Regulations.
Section 2(76) of the Act defines the term ‘related party’ exhaustively. On a
plain and literal reading of the definition, it appears that a public
charitable trust would not be covered under the said definition. However, since
the company is a listed company, the provisions of the LODR Regulations would
also be applicable. Hence, if a party with whom the company transacts is a
related party under those Regulations, then the relevant requirements contained
therein would also have to be complied with.

Regulation
2(1)(zb) defines related party as follows (emphasis supplied):

‘”related
party” means a related party as defined under sub-section (76) of section
2 of the Companies Act, 2013 or under the applicable accounting standards:…’

Thus, it
includes, first, a related party as defined under the Act that we have seen
does not include a public charitable trust. However, the definition is wider
and has a second leg and includes a person defined as a related party under the
applicable accounting standards. If we apply the Indian Accounting Standards
(Ind AS 24), the definition therein is fairly wide and indeed worded
differently. It includes categories of persons not included in the definition
under the Act. Thus, for example, it includes entities that are controlled by
the persons who control the company or the ‘close relatives’ of such persons.
There are other categories, too. The relevant question would be whether on the
facts of the case a public charitable trust whose managing trustee is the
father / father-in-law of the director couple said to be in control of the
company is a related party. This would have been an interesting analysis.

Here is a case
where a company has commercial relations with a public charitable trust whose
objective is understood to be public welfare. There is a relative of the
promoter director who is stated to be the managing trustee.

SEBI had in its
interim as well as confirmatory orders made a preliminary allegation that the
said trust was a related party, the transactions with whom were carried out
without complying with the relevant provisions of law. And on this and other
grounds, ordered debarment of the parties and a forensic audit of the affairs
of the company. The appellants challenged this order and asserted that the
trust was not a related party.

SAT observed as
follows while holding that the trust was not a related party (emphasis
supplied):

‘18. Similarly,
we are unable to agree with the contentions of SEBI that a trustee of a public
charitable trust is a related party going by the correct reading of the
definition in the Companies Act as well as in the LODR Regulations, unless
there is evidence to show that those Trusts have been set up or (are) operating
for the benefit of the appellant(s). Moreover, there is nothing on
record to show that Mr. Giridharilal, the trustee, has personally benefited in
any manner not only by virtue of being a trustee or in general by any other
means.’

Making this
legal and factual conclusion, the SAT overturned the order of SEBI insofar as
it debarred the appellants.

Interestingly,
neither SEBI nor SAT made any detailed analysis of the definition of related
party under the Act or under the Regulations. SAT merely says that on a
‘correct reading of the definition’ under the Act / Regulations, a trustee of a
public charitable trust is not a related party. It did not explain what this
reading was and how was it correct. Curiously, it places its own additional
condition about the trust being set up or operating for the benefit of the
appellants.

However, it is
respectfully submitted that such a condition is not part of the law relating to
related party transactions.

It is submitted
that the Order of SAT needs reconsideration. The definitions of related party
would need to be analysed, the facts of the case examined in more detail and
only the conditions specified in the law applied. It appears that the second
leg of the definition in the LODR Regulations was not even examined.

Reliance on media
reports by SEBI in making adverse orders against parties

Another
observation SAT made is that SEBI initiated the examination based on media
reports which resulted in passing of adverse orders against the appellants that
remained in place for a very significant time. It is submitted that taking
hasty action relying on media reports is a dangerous way of reacting. Media,
particularly social media, have a tendency to quickly build outrage which a
patient regulator may consider letting pass, focusing instead on the surer
method of meticulous examination. It was particularly noted by SAT that the
appellants have suffered debarment for quite a long period and the
investigation and even the forensic audit has not yet been completed.

CONCLUSION

The SAT order
is only with reference to the interim / confirmatory order. SEBI is yet to
investigate fully and also yet to receive the forensic report ordered.
Thereafter, it may make formal charges, if any, and pass a final order. This
may happen in the near future. It would be interesting to see how SEBI deals
with the issue of related party in the context of these facts since in the
earlier orders it had made preliminary allegations only. More interesting would
be to see how SEBI deals with the reasoning and ruling of SAT on related
parties, which I submit requires reconsideration.

shailesh.kwebmaker

FOREIGN INVESTMENT REGIME: NEW RULES

INTRODUCTION

The Foreign Exchange Management Act, 1999 (the FEMA) governs the law relating to foreign exchange in India. The Reserve Bank of India is the nodal authority for all matters concerning foreign exchange. Under section 6(2) of the FEMA, the RBI was the authority empowered to notify Regulations pertaining to capital account transactions. Pursuant to the same, the RBI had notified the Foreign Exchange Management (Transfer or Issue of any Security to a Person Resident Outside India) Regulations, 2017 (TISPRO Regulations) for foreign investment in Indian securities and the Foreign Exchange Management (Acquisition and Transfer of Immovable Property in India) Regulations, 2018 (Property Regulations) for foreign investment in Indian immovable property.

However, the Finance Act, 2015 amended FEMA to provide that the RBI would only be empowered to notify Regulations pertaining to Debt Instruments, whereas the Central Government would notify Rules pertaining to the limit and conditions for transactions involving Non-Debt Instruments. While moving the Finance Bill, 2015 the Finance Minister explained the rationale for the same. He stated that capital account controls were more a policy matter rather than a regulatory issue. Accordingly, the power to control capital flows on equity was transferred from the RBI to the Central Government. Hence, a distinction was drawn between Debt Instruments and Non-Debt Instruments. The power to determine what is debt and what is non-debt has also been given to the Central Government.

While this enabling amendment was made in 2015, the actual Rules for the same were only notified on 16^thOctober, 2019 and, thus, the transfer of power took place only recently. Let us analyse some key features of these new Rules.

DISTINCTION

The Department of Economic Affairs, Ministry of Finance is the authority within the Central Government which has been given the above responsibility. The Finance Ministry has, on 16^th October, 2019, determined certain instruments as Debt Instruments and certain others as Non-Debt Instruments as given in Table 1 below:

Debt Instruments	Non-Debt Instruments
Government bonds	Investments in equity in all types of companies
Corporate bonds	Capital participation in LLPs
Securitisation structure other than equity tranches	Investment instruments recognised in the Consolidated FDI Policy, i.e., compulsorily convertible preference shares, compulsorily convertible debentures, warrants, etc.
Loans taken by Indian firms	Investments in units of Investment Vehicles such as Real Estate Investment Trusts (REITs); Alternative Investment Funds (AIFs); Infrastructure Investment Trusts (InVITs)
Depository receipts backed by underlying debt securities	Investment in units of Mutual Funds which invest more than 50% in equity shares
	Junior-most layer of securitisation structure
	Acquisition, sale or dealing directly in immovable property
	Contribution to trusts
	Depository receipts backed by equity instruments, e.g., ADRs / GDRs

Table 1: Classification of Debt vs. Non-Debt Instruments

NOTIFICATION OF RULES AND REGULATIONS

Pursuant to this determination, the Finance Ministry on 17^th October, 2019 notified the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (the NDI Rules) and, correspondingly, the RBI has notified the Foreign Exchange Management (Debt Instruments) Regulations, 2019 (the Debt Regulations). The NDI Rules have superseded the erstwhile TISPRO Regulations and the Property Regulations which were issued by the RBI. While there are no changes in the NDI Rules as compared with the erstwhile Property Regulations, there are several changes in the NDI Rules as compared with the erstwhile TISPRO Regulations which are explained below. The RBI had also notified the Master Direction No. 11/2017-18 on Foreign Investment in India. This was issued pursuant to the TISPRO Regulations. However, section 47(3) of the FEMA states that all Regulations made by the RBI before 15^th October, 2019 shall continue to be valid until rescinded by the Central Government. Now that the TISPRO Regulations have been superseded by the NDI Rules, it stands to reason that this particular Master Direction would also no longer be valid. However, unlike the TISPRO Regulations, this Master Direction has not been expressly rescinded.

The TISPRO Regulations permitted an Indian entity to receive any foreign investment which was not in accordance with the Regulations provided that the RBI gave specific permission for the same. The NDI Rules also contain a similar provision for the RBI to give specific permission but it must do so after consultation with the Central Government. The powers of the RBI to specific pricing guidelines for transfer of shares between residents and persons resident outside India continue under the NDI Rules but they must be made in consultation with the Central Government.

Debt vs. Non-Debt definition: As compared to the TISPRO Regulations, the NDI Rules contain certain changes. Some of the key features of these Rules are explained here. One of the important definitions is the term ‘Non-Debt Instruments’ which has been defined in an exhaustive manner to mean the instruments listed in Table 1 above. Consequently, the term ‘Debt Instruments’ has been defined to mean all instruments other than Non-Debt Instruments.

Equity instruments: The term ‘capital instruments’ has been replaced with the term ‘equity instruments’. It means equity shares, compulsorily convertible debentures (CCDs), compulsorily convertible preference shares (CCPS) and warrants.

FDI: The distinction between foreign direct investment (FDI) and foreign portfolio investment has been continued from the TISPRO Regulations. Accordingly, any foreign investment through equity instruments of less than 10% of the post-issue paid-up capital of a listed company would always be foreign portfolio investment, whereas if it is 10% or more it would always be FDI. Any amount of foreign investment through equity instruments in an unlisted company would always be FDI.

Listed Indian company: The definition of the term ‘listed Indian company’ has undergone a sea change as compared to the TISPRO Regulations. Earlier, it was defined as an Indian company which had its capital instruments listed on a stock exchange in India and, thus, it was restricted only to equity shares which were listed.

The NDI Rules amended this definition to read as an Indian company which has its equity or Debt Instruments listed on a stock exchange in India. This amendment has created several unresolved issues. For example, under the SEBI (Issue and Listing of Debt Security) Regulations, 2008 a private limited company can also list its non-convertible debentures on a recognised stock exchange in India. Now, as per the amended definition under the NDI Rules, such a private company would also have to be treated as a listed Indian company. Accordingly, any foreign investment in such a private company, through equity instruments of less than 10% of the share capital, would now be treated as foreign portfolio investment. Secondly, Rule 21 specifies the pricing guidelines and states that the price of equity instruments issued by a listed Indian company to a person resident outside India would be as per the SEBI Guidelines. Thirdly, in case of a transfer of shares in such a company from a resident to a person resident outside India would have to be as per the SEBI Guidelines. There are no SEBI Guidelines for pricing of unlisted equity shares in case of a company whose debentures are listed. Hence, the Rules require adherence to SEBI pricing Guidelines when, in fact, there are none for private companies whose debt alone is listed! It is submitted that the NDI Rules should be amended to revert to the original position.

Rule 19 of the NDI Rules provides that in case of the merger / demerger of two or more Indian companies, where any of them is a company listed on a stock exchange, the scheme shall be in compliance with the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015. Here Rule 19 does not use the defined phrase of ‘listed Indian company’. Further, while the aforesaid SEBI Regulations apply both to listed equity shares and listed debt, the provisions in Regulation 37 relating to scheme of arrangement apply only to companies which have listed their equity shares. Hence, it stands to reason that this particular provision of Rule 19 only covers companies whose equity shares are listed on a stock exchange.

Separate schedules: Similar to the TISPRO Regulations, the NDI Rules classify the different types of foreign investment which an Indian entity can receive into different schedules. Schedule I deals with FDI in an Indian company; schedule II deals with investment by a Foreign Portfolio Investor; schedule III deals with repatriable investment by NRIs; schedule IV deals with non-repatriable investment by NRIs and other related entities; schedule V deals with investment by other non-resident investors, such as sovereign wealth funds, pension funds, etc.; schedule VI deals with investment in an LLP; schedule VII deals with investment by a Foreign Venture Capital investor; schedule VIII deals with investment in an investment vehicle; schedule IX deals with investment in Foreign Depository Receipts; and schedule X deals with investment in Indian Depository Receipts.

Mutual funds > 50% in equity: One major amendment introduced by the NDI Rules was to classify a mutual fund which invested more than 50% in equity as an investment vehicle along with an REIT, AIF and an InVIT. The implication of this seemingly small amendment is drastic. It would mean that any mutual fund which is owned and / or controlled by non-residents and if it has invested more than 50% in equity, then any investment made by such a fund would be treated as indirect FDI. Thus, any investment by such a fund (even though it is not a strategic investment but a mere portfolio investment) would have to comply with pricing guidelines, reporting, sectoral caps and conditions, etc., specified for indirect FDI. Further, several sectors would be out of bounds for such a fund which are currently off limits for FDI. This move created turmoil within the mutual fund industry since several funds are owned and / or controlled by foreign companies. It also led to a bias against such funds and in favour of purely domestic funds. The SEBI took up this issue with the Finance Ministry and, accordingly, the NDI Rules have been amended on 5^th December, 2019 with retrospective effect to drop such mutual funds which invest more than 50% in equity from the definition of investment vehicle. Accordingly, any investment by such mutual funds would no longer be classified as indirect FDI.

Sectoral caps: The NDI Rules amended the definition of sectoral caps to provide the maximum repatriable investment in equity and Debt Instruments by a person resident outside India. Thus, compared to the TISPRO Regulations, Debt Instruments were also added in the definition of sectoral caps. This definition again created an ambiguity since it was not possible to consider debt investment while reckoning the sectoral caps. Accordingly, the NDI Rules have been amended on 5^th December, 2019 with retrospective effect to drop Debt Instruments from the definition of sectoral caps and revert to the earlier definition.

Pricing of convertible instruments: Unlike the TISPRO Regulations, the NDI Rules did not provide flexibility in determining the issue price of CCDs and CCPS. Now, the NDI Rules have been amended on 5^th December, 2019 with retrospective effect to provide that the price of such convertibles can either be determined upfront or a conversion formula should be determined at the time of their issue. The conversion price should be ≥ the fair market value as at the date of issue of the convertible instruments.

FPI: The NDI Rules have substantially amended the provisions relating to investments by SEBI Registered Foreign Portfolio Investors or FPIs:

(a) Under the TISPRO Regulations, maximum aggregate FPI investment was 24%. This limit could be increased to the sectoral caps by passing a special resolution. Thus, a company in the software sector which has no sectoral caps could increase the FPI limit to 100%.

(b) The NDI Rules now provide that with effect from 1st April, 2020 the FPI limit for all companies shall be the sectoral caps applicable to a company irrespective of whether or not it has increased the limit by passing a special resolution. The only exception is a company operating in a sector where FDI is prohibited – in which case the FPI limit would be capped @ 24%. This is a new feature which was not found in the TISPRO regime. Thus, in the case of a listed company operating in the casino / gambling sector (where FDI is taboo) the FPI limits would be 24%! This is a unique provision since FDI and FPI are and always were separate ways of investing in a company. Now, FPI would be limited in a company simply because it is ineligible to receive FDI.

(c) In case the Indian company desires to reduce the FPI limit then it can peg it to 24% or 49% or 74% provided that it passes a special resolution to this effect before 31^st March, 2020. Thus, if an Indian company is wary of a hostile takeover through the FPI route, then it may reduce the FPI limit. Such a company which has reduced its FPI limit may once again increase it to 49% or 74% or sectoral cap by passing another special resolution. However, once a company increases its FPI limit after first reducing it, then it cannot once again reduce the same.

(d) If an FPI were to inadvertently breach the limit applicable to a company, then it has five trading days to divest the excess shares, failing which its entire shareholding in that company would be classified as FDI.

(e) The Rules originally provided that FPIs could sell / gift shares only to certain non-residents. This provision has been amended with retrospective effect to provide that FPIs can sell in accordance with the terms and conditions provided by the SEBI Regulations. Thus, the original position prevalent under the TISPRO Regulations has been restored.

FVCI: Under the TISPRO Regulations, a SEBI registered Foreign Venture Capital Investor could invest in the securities of a start-up without any sectoral restrictions. As compared to the TISPRO Regulations, instead of the term ‘securities’, the NDI Rules provide a more detailed description permitting investment in the equity or equity-linked instruments or debt instruments issued by a start-up. However, if the investments are in equity instruments then the sectoral caps, entry routes and other conditions would apply.

Sectoral conditions: The NDI Rules have made certain changes in the sectoral conditions for certain sectors which are as follows:

(i) Coal and lignite: 100% FDI through the automatic route is now allowed in sale of coal and coal mining activities, including associated processing infrastructure, subject to the provisions of the Mines and Minerals (Development and Regulation) Act, 1957 and the Coal Mines (Special Provisions) Act, 2015. This includes coal washery, crushing, coal handling and separation (magnetic and non-magnetic).

(ii) Manufacturing: The 100% automatic route FDI is permissible in manufacturing. The definition of the term manufacturing has been amended to include contract manufacturing in India through a legally tenable contract, whether on principal-to-principal or principal-to-agent basis. In this respect, the Commerce Ministry has clarified that the principal entity which has outsourced manufacturing to a contractor would be eligible to sell its products so manufactured through wholesale, retail or e-commerce on the same footing as a self-manufacturer. Further, the onus of compliance with the conditions for FDI would remain with the manufacturing entity.

(iii) Broadcasting: A new entry has been added permitting FDI up to 26% on the Government approval route in uploading / streaming of news and current affairs through digital media.

(iv) E-commerce: Under the TISPRO Regulations, an e-commerce entity was defined to mean an Indian company or a foreign company covered under the Companies Act, 2013 or an office, branch or agency which is owned or controlled by a person resident outside India and which is conducting e-commerce activities. The NDI Rules have truncated the definition to only cover a company incorporated under the Companies Act, 1956 / 2013. Hence, going forward, branches of foreign companies would not be treated as an eligible e-commerce entity. Further, a new condition has been included that an e-commerce marketplace with FDI must obtain and maintain a report from its statutory auditor by the 30^thday of September every year for the preceding financial year confirming compliance with the FDI Guidelines.

(v) Single Brand Product Retail Trading (SBRT): The original NDI Rules contained some variations compared to the TISPRO Regulations which have now been rectified. However, even though 100% automatic route FDI continues to be allowed in SBRT, there are yet some changes compared to the TISPRO Regulations:

(1) SBRT FDI > 51% requires that at least 30% of the value of the goods procured shall be locally sourced from India. The entity can set off this 30% requirement by sourcing goods from India for global operations. For this purpose, the phrase ‘sourcing of goods from India for global operations’ has been defined to mean the value of goods sourced from India for global operations for that single brand (in rupee terms) in a particular financial year directly by the entity undertaking SBRT or its group companies (whether resident or non-resident), or indirectly by them through a third party under a legally tenable agreement.

(2) As before, an SBRT entity operating through brick and mortar stores can also undertake retail trading through e-commerce. However, it is now also possible to undertake retail trading through e-commerce prior to the opening of brick and mortar stores, provided that the entity opens brick and mortar stores within two years from the date of starting the online retail.

The power to govern the mode of payment and reporting of the non-debt instruments still vests with the RBI and, thus, the RBI has also notified the Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019. These lay down the forms to be filed on receipt of various types of foreign investment, the manner of making payment by the foreign investors and the manner of remittance of the sale / maturity proceeds on sale of these foreign investments. These Regulations contain provisions which are the same as those contained in the earlier TISPRO Regulations.

DEBT REGULATIONS

Consequent to the notification of the Debt Rules, the RBI has notified the Foreign Exchange Management (Debt Instruments) Regulations, 2019. These regulate debt investment by a person resident outside India. For instance, the investment by FPIs in corporate bonds / non-convertible debentures is governed by these Regulations. One change in the debt regulations as compared to the TISPRO Regulations is that NRIs are no longer allowed to invest in money market mutual funds on a non-repatriation basis.

CONCLUSION

The FEMA Regulations have been totally revamped in the field of capital instruments. It remains to see whether the Government would amend more FEMA Regulations to transfer power from the RBI to itself. One only wishes that whichever authority is in charge, there is clarity and simplicity in the FEMA Regulations which would lead to a conducive investment climate.

shailesh.kwebmaker

ACCOUNTING FOR OWN EMPLOYEE TRAINING COSTS INCURRED ON CUSTOMER CONTRACTS

This article seeks to provide guidance on
the most appropriate accounting under Ind AS 115 Revenue from Contracts with
Customers to account for own employee training costs incurred on customer
contracts.

FACT PATTERN

Consider the following fact pattern:

1. Ez Co enters
into a contract with a customer, Ti Co, that is within the scope of Ind AS 115.
The contract is for the supply of outsourced services. Ez’s employees take
calls from Ti’s customers and provide them with online assistance for
electronic products purchased from Ti.

2. To be able to
provide the services to Ti, Ez incurs training costs for its employees so that
they understand Ti’s equipments and processes. Applying Ind AS 115, Ez does not
identify the training as a performance obligation.

3. The contract
permits Ez to recharge to Ti the costs of training (i) Ez’s employees at the
beginning of the contract, and (ii) new employees that Ez hires as a result of
any expansion of Ti’s operations. Ez is unable to recharge costs associated
with training replacement employees (i.e., new employees of Ez recruited to
replace those that leave Ez’s employment).

Whether Ez should
recognise an asset for the training costs incurred to fulfil a contract with
the customer (Ti)?

RESPONSE

Training costs
should not be capitalised as a cost to fulfil a contract, regardless of whether
they are explicitly rechargeable in Ez’s contract with its customer.

ANALYSIS

Paragraphs 95-96 of
Ind AS 115 state:

95 If the costs incurred in fulfilling a contract
with a customer are not within the scope of another Standard (for example, Ind
AS 2 Inventories, Ind AS 16 Property, Plant
and Equipment or Ind AS 38 Intangible Assets), an entity shall
recognise an asset from the costs incurred to fulfil a contract only if those
costs meet all of the following criteria:

(a) The costs relate directly to a contract or to an
anticipated contract that the entity can specifically identify (for example,
costs relating to services to be provided under renewal of an existing contract
or costs of designing an asset to be transferred under a specific contract that
has not yet been approved);

(b) the costs generate or enhance resources of the
entity that will be used in satisfying (or in continuing to satisfy)
performance obligations in the future; and

(c) the costs are expected to be recovered.

96 For costs incurred in fulfilling a contract
with a customer that are within the scope of another Standard, an entity shall
account for those costs in accordance with those other Standards.

In this context,
training costs are specifically addressed in Ind AS 38. Ind AS 38.69 requires
that (extract):

‘In some cases,
expenditure is incurred to provide future economic benefits to an entity, but
no intangible asset or other asset is acquired or created that can be
recognised. … Other examples of expenditure that are recognised as an expense
when it is incurred include:

a) …

b) Expenditure on training activities

c) …

d) …’

Paragraph 3 of Ind AS 38 states (extract) – ‘If another Standard
prescribes the accounting for a specific type of intangible asset, an entity applies
that Standard instead of this Standard. For example, this Standard does not
apply to:

(a)….

…….

(i) assets arising from contracts with customers
that are recognised in accordance with Ind AS 115, Revenue
from Contracts with Customers’.

It may be noted
that Ind AS 115 does not apply specifically to training costs. Consequently,
Ind AS 38 will apply. As a result, training costs that are incurred in respect
of a contract with a customer cannot be recognised as an asset and must be
expensed as incurred. A prohibition on capitalising employee training costs is
consistent with the requirement that an asset must be controlled. Since an
employer does not control its employees, it follows that training costs that
enhance the knowledge and performance of employees cannot be capitalised (see
paragraph 15 of Ind AS 38). This is also consistent with the requirements of
paragraph B 37 of Ind AS 103 Business Combinations, which prohibits the
recognition of an asset for an acquired assembled workforce because it is not
an identifiable asset.

The training costs
meet the following requirements of paragraph 95 Ind AS 115:

relate specifically to a
contract that Ez can identify (Ind AS 115.95[a]);

enhance the resources of Ez
that will be used in satisfying performance obligations in the future (Ind AS
115.95[b]); and

are expected to be
recovered (Ind AS 115.95[c]).

A key difference
between Ind AS 115.95 and the criteria in Ind AS 38 is that, under Ind AS
115.95, the entity does not need to control the resource. It is not necessary to demonstrate that the employees are controlled
by Ez; instead, it is sufficient that Ez’s resources (the employees) have been
enhanced by the training.

Paragraph 95 of Ind
AS 115 requires an entity to recognise an asset from the costs incurred to
fulfil a contract with a customer not within the scope of another Ind AS
Standard only if those costs meet all the three criteria specified in paragraph
95. Consequently, before assessing the criteria in paragraph 95, an entity
first considers whether training costs incurred to fulfil a contract are within
the scope of another Standard.

Paragraph 5 of Ind
AS 38 states that ‘this Standard applies to, among other things, expenditure
on advertising, training, start-up, research and development activities’.

Accordingly, in the
fact pattern described, the entity applies Ind AS 38 in accounting for the
training costs incurred to fulfil the contract with the customer. Since an
employer does not control its employees, it follows that training costs that
enhance the knowledge and performance of employees cannot be capitalised.

shailesh.kwebmaker

DCIT (OSD)-8(2) vs. Hotel Leela Venture Ltd.; Date of order: 28th July, 2016; [ITA No. 617/Mum/2014; A.Y.: 2009-10; Mum. ITAT] Section 115JB of the Act – MAT – Forward foreign exchange contract entered into by assessee could not be considered as contingent in nature as it creates a continuing binding obligation on date of contract against assessee

14. The Pr. CIT-10 vs. Hotel Leela Venture Ltd. [Income tax Appeal No.
1097 of 2017] Date of order: 5^th November, 2019 (Bombay High Court)

DCIT (OSD)-8(2) vs. Hotel Leela Venture Ltd.; Date of order: 28^th
July, 2016; [ITA No. 617/Mum/2014; A.Y.: 2009-10; Mum. ITAT]

Section 115JB of the Act – MAT – Forward foreign exchange contract
entered into by assessee could not be considered as contingent in nature as it
creates a continuing binding obligation on date of contract against assessee

The assessee is
a company engaged in the business of five star deluxe hotels. The AO made an
addition of Rs. 10,47,08,044 to the book profit on account of foreign currency
transaction difference.

Being aggrieved
by the order, the assessee filed an appeal to the CIT(A). The CIT(A) partly
allowed the appeal, deleting the addition on the ground that the liability was
not a contingent liability.

Aggrieved by
the order of the CIT(A), the Revenue filed an appeal to the Tribunal. The
Tribunal found that after considering various judicial pronouncements, the
CIT(A) reached the conclusion that the said liability is not contingent. As per
the CIT(A), a contingent liability depends purely on occurrence and
non-occurrence of an event, whereas if an event has already taken place, which
in the present case is of entering into a contract and undertaking of
obligation to meet the liability, and only the consequential effect of the same is to be determined, then it cannot
be said that it is in the nature of a contingent liability.

After applying
the proposition of law laid down by the Hon’ble Supreme Court in the cases of Woodward
Governor India and Bharat Earth Movers, the CIT(A)
recorded a finding to the effect that it was not a contingent liability. Accordingly,
the appeal of the Revenue was dismissed.

Being aggrieved
by the order of the ITAT, the Revenue filed an appeal to the High Court. The
Court held that the Tribunal and the CIT(A) had held that the forward foreign
exchange contract entered into by the assessee to buy or sell foreign currency
at an agreed price at a future date cannot be considered as contingent in
nature as it creates a continuing binding obligation on the date of the
contract against the assessee. The view taken by the Tribunal was correct, that
in the present case where an obligation was undertaken to meet a liability and
only the consequential effect was to be determined, it could not be said that
the amount in question was in the nature of contingent liability.

Further, the
Revenue sought to urge an additional question of law to the effect that the
Tribunal erred in not treating the amount of Rs. 10,47,08,044 as capital
expenditure for computation of book profit u/s 115JB of the Act when this
amount was treated by the AO and accepted by the assessee as a capital
expenditure.

The Court
observed that this point was not urged before the Tribunal nor had it found
reference in the present appeal memo. The appeal was filed before the Tribunal
on the sole ground of the amount in question being a contingent liability. In
view of such a single, focused approach before the Tribunal, the decision of
the Tribunal was restricted only to that ground.

The argument of
Revenue that there was only a mistake in choosing the words, that instead of
capital expenditure, the words contingent liability were used, cannot be
accepted because the reason for the amount being treated as contingent in
nature had also been specified in the said ground, stating that the loss was on
account of foreign exchange fluctuation. It is not permissible for the
appellant to urge the said question for the first time before the Court and
that, too, during the course of the oral arguments.

Accordingly,
the appeal was dismissed.

shailesh.kwebmaker

The Pr. CIT vs. M/s. Realvalue Realtors (P.) Ltd.; [ITA No. 4836/Mum/2011; Date of order: 30th June, 2016; A.Y.: 2007-08; Mum. ITAT] Section 68 – Cash credit (share capital) – Substantial part share application money was received in earlier assessment year and, thus, it could not be added in impugned A.Y. – Addition deleted

13. The Pr. CIT vs. M/s. Realvalue Realtors (P.) Ltd. [Income tax Appeal
No. 957 of 2017] Date of order: 4^th November, 2019 (Bombay High Court)

The Pr. CIT vs. M/s. Realvalue Realtors (P.) Ltd.; [ITA No.
4836/Mum/2011; Date of order: 30^th June, 2016; A.Y.: 2007-08; Mum.
ITAT]

Section 68 – Cash credit (share capital) – Substantial part share
application money was received in earlier assessment year and, thus, it could
not be added in impugned A.Y. – Addition deleted

The assessee company is engaged in the business of dealing in property
and trading in shares and stocks. The AO, during the assessment proceedings,
noted that in the relevant previous year the assessee had received an amount
from one Mr. Mushtaq Ahmed Vakil as share application money. The assessee
company had allotted 24,21,788 shares to him. The AO held that the assessee had
failed to discharge the onus of establishing the genuineness of the transaction
and the creditworthiness of the shareholder and added an amount of Rs.
8,12,44,700 as income from other sources.

The assessee filed an appeal before the CIT(A). The CIT(A) called for a
remand report from the AO. The Commissioner, after going through this remand
report, concluded that out of the total share application money of Rs.
8,12,44,700, an amount of Rs. 5,18,44,700 was received in the A.Y. 2006-07 and
could not be added in the impugned assessment year. Accordingly, the
Commissioner directed the AO to take necessary action if required. In respect
of the remaining amount of Rs. 2.94 crores, the Commissioner observed that
sufficient evidence was produced in respect of the identity and genuineness of
the share application money and of Mr. Vakil and accordingly deleted the said
addition.

Being aggrieved by the order of the CIT(A), the Revenue filed an appeal
to the Tribunal. The Tribunal upheld the order as regards Rs. 5,18,44,700 not
pertaining to the relevant assessment year. As regards the amount of Rs. 2.94
crores, the Tribunal set aside that part of the order of the Commissioner and
remanded the matter to the AO to examine the genuineness of the investment of
Rs. 2.94 crores by Mr. Vakil. Accordingly, the appeal was partly allowed by the
impugned order.

Aggrieved by the order of the ITAT, the Revenue went before the High
Court. The Court found that as far as the amount of Rs. 5,18,44,700 was
concerned, both the Commissioner (Appeals) and the Tribunal had, after
considering the records, categorically held that this amount was relevant for
the A.Y. 2006-07. In fact, the AO in his remand report dated 16^th
September, 2010 had accepted this position. As regards the amount of Rs. 2.94
crores, the Tribunal has sent the same for verification by the AO. The
contentions of the parties regarding this amount about its genuineness, etc.
would be considered on remand. In the circumstances, the appeal was dismissed.

shailesh.kwebmaker

WHAT’S IN A NAME? PREFERENCE SHARE VS. FCCB

Query

Top Co, whose functional
currency is INR, has issued preference shares to a foreign investor. As per the
terms, at the end of 3-years from the issuance date, the holder has the option
to either redeem each preference share for cash payment of USD 10 or to get 10
equity shares of Top Co for each preference share. Whether the equity
conversion option represents an equity instrument or a (derivative) financial
liability of Top Co?

Response

ITFG
responded to a similar issue in Bulletin No. 17 and its view is reproduced
below.

ITFG view

Ind AS 32,
Financial Instruments: Presentation lays down the principles for the
classification of financial instruments as financial assets, financial
liabilities or equity instruments from the issuer’s perspective. As per
paragraph 11 of Ind AS 32, “A financial liability is any liability that is:

(a) a contractual obligation :

(i) to deliver cash or another financial asset
to another entity; or

(ii) to exchange financial assets or financial
liabilities with another entity under conditions that are potentially
unfavourable to the entity; or

(b) a contract that will or may be settled in the
entity’s own equity instruments and is:

(i) a non-derivative for which the entity is or
may be obliged to deliver a variable number of the entity’s own equity
instruments; or

As per the
above definition, as a general principle, a derivative is a financial liability
if it will or may be settled other than by the exchange of a fixed amount of
cash or another financial asset for a fixed number of the entity’s own equity
instruments. The term ‘fixed amount of cash’ refers to an amount of cash fixed
in functional currency of the reporting entity. Since, an amount fixed in a
foreign currency has the potential to vary in terms of functional currency of
the reporting entity due to exchange rate fluctuations, it does not represent
“a fixed amount of cash”. However, as an exception to the above general
principle, Ind AS 32 regards the equity conversion option embedded in a
convertible bond denominated in a foreign currency to acquire a fixed number of
entity’s own equity instruments to be an equity instrument if the exercise
price is fixed in any currency, i.e., whether fixed in functional currency of
the reporting entity or in a foreign currency. [It may be noted that the
corresponding standard under IFRSs (viz., IAS 32) does not contain this
exception].

Ind AS 32
makes the above exception only in the case of an equity conversion option
embedded in a convertible bond denominated in a foreign currency, even though
it explicitly recognises at several places that other instruments can also
contain equity conversion options. Given this position, it does not seem that
the above exception can be extended by analogy to equity conversion options
embedded in other types of financial instruments denominated in a foreign
currency such as preference shares.

In view of
the above, the equity conversion option forming part of terms of issue of
preference shares under discussion would be a (derivative) financial liability.

Authors’ point of view

It appears that the above opinion provides unwarranted emphasis
on the nomenclature of the instrument rather than the terms and conditions of
the instrument. It may be noted that an instrument is classified based on its
terms and conditions under Ind AS, rather than its nomenclature. In other
words, from an Ind AS perspective, there is no difference in how the preference
share or the bond is accounted, if they contain similar terms and conditions.
From that perspective, it appears unreasonable that the exemption of treating
the conversion option fixed in foreign currency as equity is allowed only for
conversion options in bonds and not for conversion options in preference
shares, though both instruments are similarly accounted under Ind AS.

Whilst a preference share and a bond under the Indian Companies
Act have different liquidation rights, from the point of view of RBI
regulations and Ind AS accounting there is no difference. Consequently, all
that an entity has to do is to nomenclate a preference share as a bond or
structure it like a bond. Sometimes debt covenants with existing bond holders
may prohibit an entity from issuing new bonds. In those cases, there will be a
restriction on the entity from raising funds using a bond. On the other hand,
raising foreign funds using a preference share with a conversion option may be
debilitating from an accounting and balance sheet perspective.

The ITFG opinion has not
provided a strong case or basis for making a difference between accounting for
conversion option contained in a bond and that contained in a preference share.
Neither has it defined the term bond and preference share, which may result in
different interpretation. However, common practice will be to use the same
definition contained in the Companies Act. The exemption for a bond and not for
a preference share appears arbitrary and rule based, rather than based on sound
and solid accounting principles.

Final Remarks

The ITFGs main argument is
that the carve-out from IAS 32 was meant to operate more like an exemption
rather than based on a sound principle. In the long run carve-outs is not the
preferred option, particularly if those are not supported by a strong basis of
conclusion or a well-defined principle. In addition to the possibility of
multiple interpretation of the carve-out, it will camouflage gearing in
financial statements and create confusion in the minds of investors. The
International Accounting Standard Board has issued a discussion paper titled Financial
Instruments with Characteristics of Equity (FICE). The objective of the
discussion paper is to clearly set out the principles of debt vs. equity.
Indian standard setters will have an opportunity of participating in this
discussion and eliminating any differences between the IFRS and Ind AS standard
with respect to debt vs equity classification.

At last, I am reminded of a
quote from Shakespeare’s Romeo and Juliet – “What’s in a name? that which we
call a rose by any other name would smell as sweet.” The ITFG has proved
him wrong!!

shailesh.kwebmaker

PERIOD OF LIMITATION PROVIDED IN SECTION 154(7) VIS-À-VIS DOCTRINE OF MERGER

ISSUE FOR CONSIDERATION

Section 154 empowers the income-tax
authority to amend any order passed by it under the provisions of Act with a
view to rectifying any mistake apparent from the record. Sub-section (7) of
section 154 provides for the time limit within which the order can be amended
for this purpose. It provides that no amendment u/s. 154 shall be made after
the expiry of four years from the end of the financial year in which the order
sought to be amended was passed.

Under the Act, many times, more than one
order is framed in the case of the assessee for the same assessment year, . For
instance, the reassessment order is passed u/s. 147 after the assessment order
u/s. 143(3) has already been passed, or the order is passed for giving effect
to the order passed by the appellate authorities while adjudicating the appeal
filed against the order passed by the lower authorities. Quite often, the issue
arises in such cases about the limitation period; whether it should be counted
from the date of the original order or from the date of the subsequent order.

In the case of Hind Wire Industries Ltd.
vs. CIT 212 ITR 639, the Supreme Court has dealt with an issue where an order was sought to be rectified for the
second time, on an issue which was not the subject matter of the first order.
The Supreme Court in the facts of the case held that the word ‘order’ in the
expression ‘from the date of the order sought to be amended’ in section 154(7)
as it stood at the relevant assessment year had not been qualified in any way,
and it did not necessarily mean the original order. It could be any order,
including the amended or rectified order. Accordingly in the facts of the case,
it was held that the time limit as provided in section 154(7) should be
reckoned from the date of rectified order, and not from the date of original
order. This finding of the Supreme Court has been relied upon by the different
high courts to support the conflicting decisions delivered by them.

Section 263 authorising Pr. CIT or CIT to
pass the order of revision also contains an express provision whereby an order
of revision is not allowed to be passed after the expiry of two years from the
end of the financial year in which the order sought to be revised was passed.
In the case of CIT vs. Alagendran Finance Ltd. 293 ITR 1, in the context
of section 263 , the Supreme Court held that the period of limitation provided
for under sub-section (2) of section 263 would begin to run from the date of
the order of original assessment and not from the order of reassessment, if the
issue on which the order was sought to be revised was not the subject matter of
the reassessment. It was held that the doctrine of merger will have no
application in such a case. In deciding the case, the Supreme Court had
referred to its earlier decision in the case of Hind Wire Industries Ltd.
(supra).

In a situation where the order giving effect
to an appellate order has been passed subsequent to the assessment order, and
the Assessing Officer wishes to rectify the mistakes arising from his original
order, the High Courts have given conflicting decisions in so far as the period
of limitation provided in section 154(7) is concerned. The Delhi High Court has
held that the period of limitation would begin from the date of order giving
effect to that appellate order. As against this, the Allahabad High Court has
held that it would begin from the date of original order which contained the
mistake apparent from the record.

Tony Electronics’ case:The issue first came up before the Delhi High Court in the case of CIT
vs. Tony Electronics Ltd. 320 ITR 378 (Delhi).

In this case, the assessment order passed
u/s. 143(3) had been challenged by filing an appeal before the Commissioner
(Appeals). The order was also passed by
the Assessing Officer giving effect to the Commissioner (Appeals)’ directions.
Thereafter, the notice u/s.154 was issued for rectifying the mistake apparent
from record in the latest order. The relevant dates on which different types of
orders and notices issued were as follows:

24-11-1998

Assessment order
u/s. 143(3) was passe.

20-5-1999

Appeal against
assessment order dated 24-11-1998 was disposed of by the
Commissioner(Appeals).

8-5-2003

The appeal effect
order u/s. 143(3)/250 was passed.

28-6-2004

Appeal against the
appeal effect order dated 8-5-2003 was disposed of by the
Commissioner(Appeals).

23-7-2004

Second Order u/s.
143(3)/250 giving effect to the second order of Commissioner(Appeals) dated
28-6-2004 was passed.

30-1-2006

Notice u/s. 154 of
the Act, alleging that there was mistake in the second order dated 23-7-2004
.

26-4-2006

Order u/s. 154 of
the Act was passed.

In this case, while making the assessment
originally, the AO had discussed in the order that the depreciation amounting
to Rs. 6,28,842 claimed by the assessee was to be disallowed however, in the
final computation of assessed income, had under an error failed to reduce the
said amount of disallowed depreciation. The assessee not having any grievance,
had not filed any appeal against the said order proposing for the withdrawal of
depreciation. Therefore, the same was required to be reduced from the total
amount of depreciation of Rs. 54,86,162 and only the balance depreciation of
Rs. 48,57,200 was allowable to the assessee. The lapse of the AO had resulted
into under assessment by Rs. 12,57,688. In short, the mistake was that
disallowed depreciation, instead of being added to the income, was reduced from
the income, resulting in double deduction. The notice issued u/s.154 stated
that the amount of assessed income taken as the basis while passing the latest
order dated 23-7-2004 giving effect to the Commissioner (Appeals)’s order was
mistakenly taken lower by Rs. 12,57,688.

The assessee questioned the jurisdiction of
the Assessing Officer to pass the rectification order u/s. 154 on the ground
that in view of sub-section (7) of section 154, such a rectification order
could be passed within four years “from the end of the financial year in
which the order sought to be amended was passed”. According to the
assessee, since the assessment was framed on 24-11-1998, the period of four
years had lapsed long ago and, therefore, the proposed action on the part of
the Assessing Officer was time-barred. The Assessing Officer did not accept the
plea while passing the order dated 26-4-2006. According to him, the period of four years was to be counted from
23-7-2004 when the Assessing Officer had passed an order for giving appeal
effect.

The Commissioner(Appeals) confirmed the
action of the Assessing Officer and dismissed the appeal filed by the assessee.
However, the Tribunal quashed the Assessing Officer’s order on the ground that
the action of rectification u/s. 154 was barred by limitation. The Revenue
challenged the findings of the Tribunal before the High Court.

Before the High Court, the contentions of
the Revenue were two fold namely:

1. The Assessing Officer had inherent power to
rectify a totalling mistake which crept in computation. For correcting a
totalling mistake, limitation prescribed under sub-section (7) of section 154
was not even applicable. Otherwise, it would frustrate the object and purpose
of determining the taxable income and to collect the tax thereon.

2. Even if it was held that
limitation under sub-section (7) of section 154 was applicable, then also it
would start to run from the last order, i.e. order dated 23-7-2004, and not
from the original order. The revenue sought to invoke the doctrine of Merger
and submitted that since the mistake had occurred at the time of passing order
dated 28-6-2004, while giving effect to the decision of the
Commissioner(Appeals), limitation should start from that date.

The assessee submitted that the appellate
orders dealt with altogether different issues while the impugned mistake sought
to be rectified had crept in the original order dated 24-11-1998 and was not
the subject-matter of appeals. It was not a mistake in the amount of income
taken to be the basis, which had occurred in the order dated 23-7-2004, as
stated in his notice by the Assessing Officer u/s. 154, but it was a mistake
that had taken place in the original order by not reducing the amount of
depreciation disallowed in computing the assesse income. The doctrine of merger
would be applicable
only in respect of those issues that were before the appellate authorities.

The High Court duly noted that both
Commissioner (Appeals) and the Tribunal had recorded a finding that the mistake
was in the original order dated 24-11-1998 and not in the order dated 23-7-2004
but hereafter went on to hold that the doctrine of merger applied to the said
order and the order merged with the latest order.

The High Court relied upon the decision of
the Supreme Court in the case of Hind Wire Industries Ltd. (supra) and
observed that, the Supreme Court, in that case, was of the view that the word
‘order’ used in the expression “from the date of the order sought to be
amended” occurring in sub-section (7) of section 154 had not been
qualified in any way and it did not necessarily mean the original order. The
Court was further of the view that once a reassessment order or rectification
order was passed giving effect to the order of the appellate forum, the
original order ceased to operate.

By relying upon
the understandings of the Courts with regard
to the Doctrine of Merger[1],
the High Court also held that once an appeal against the order passed by an
authority is preferred and is decided by the appellate authority, the original
order merged into the order passes subsequently.With this merger, order of the
original authority ceased to exist and the subsequent order prevailed, in which
the original order merged. For all intent and purposes, it was the subsequent
order that was to be seen.

The High Court noted that the counsel for
the assessee agreed that the order of re-assessment substituted the initial
order that did not survive in any manner or to any extent. The High Court
extended the principle to a case where the assessment order wass challenged in
appeal and the appellate authority passed an order at variance with the order
passed by the Assessing Officer, on the basis of which a fresh order u/s.143(3)
r.w.s 250 was required to be passed by the Assessing Officer giving effect to
the order of the appellate authority.

Accordingly, the High Court upheld invoking
of the provisions of section 154 by the Assessing Officer in this case, on the
ground that the assessment order had merged with the order of
Commissioner(Appeals) passed on 28-6-2004, the limitation for the purpose of
sub-section (7) of section 154 was to be counted from the said date.

SHREE NAV DURGA COLD STORAGE & ICE FACTORY’S CASE

A similar issue recently came up for
consideration before the Allahabad High Court in the case of Shree Nav Durga
Cold Storage & Ice Factory vs. CIT 397 ITR 626 (Allahabad).

In this case,
for Assessment Year 2003-04, various orders were passed as explained below in
the chronological order:

31-3-2006

Assessment order u/s. 143(3) was passed.

27-12-2006

Appeal against assessment order dated 31-3-2006 was disposed
of by the Commissioner(Appeals).

13-6-2008

ITAT passed the order remanding the matter back to the
Assessing Officer for the limited purpose of arriving at the fair market
value on the date of transfer by referring to the Valuation Authority and,
accordingly, recalculate the long-term capital gain.

31-12-2009

The fresh assessment order was passed by the Assessing
Officer but without the benefit of report of Valuation Officer.

25-1-2011

Upon receipt of the report of the Valuation Officer, the
order was passed in exercise of power u/s. 154, 254, 143(3) re-determining
the amount of long-term capital gain.

9-5-2011

The assessee filed the application u/s. 154 for rectification
of mistake stating that long-term capital loss which was brought forward from
earlier years had to be set off against capital gain for the year but the
same had been missed by Assessing Officer

This application made u/s. 154 was rejected
by the Assessing Officer. Both, the Commissioner(Appeals) and ITAT, confirmed
the order of the Assessing Officer rejecting the application of the assessee by
observing that the purpose of section 154, the limitation would commence from
assessment order dated 31.03.2006 and not subsequent orders.

On behalf of the assessee, it was contended
before the High Court that the Assessing Officer was under a statutory
obligation to allow set off of brought forward capital loss and since the last
order was passed by him on 25.01.2011, for the purpose of section 154 (7),
limitation would count from the date of the said order, and in any case, from
the date of the order dated 31.12.2009 which was passed after remand by the Tribunal.
It was argued that the order dated 31.03.2006 merged in the judgment of the
Tribunal dated 13.06.2008 whereby the matter was remanded to the Assessing
Officer. Reliance was placed on the judgment of the Supreme Court in Hind
Wire Industries Ltd. (supra) and Delhi High Court in Tony Electronics
Ltd. (supra).

On the facts, the High Court observed that
the issue of set off of brought forward capital loss had already attained
finality when assessment order dated 31.03.2006 was passed by the Assessing Officer
since in the appeal before Commissioner (Appeals) and the Tribunal, the
Assessee did not raise that plea at all. The order of remand passed by the
Tribunal was only confined to determination of long-term capital gain for the
year and not for any other purpose. It was a limited and partial remand,
confined to a particular purpose.

In the light of these facts, the High Court
observed that the legislature had not thought it fit to apply the general
doctrine of merger, but the doctrine of ‘Partial Merger’ had been adopted. The
High Court drew support from the relevant provision of section 263 which
permitted the Commissioner to exercise revisional power over such matters as
had not been considered and decided in the appeal.

Once the issue of merger was governed by
statutory provisions, then, obviously, it was the statute which shall prevail
over the general doctrine of merger. Accordingly, the High Court rejected the
appellant’s contentions and held that the order in which the amendment was
sought was the original order dated 31-3-2006 and, hence, limitation would
count from the date of that order.

With regard to the Delhi High Court’s
decision in the case of Tony Electronics Ltd.(supra), the Allahabad High
Court held that the inference drawn therein from reading of the judgement in Hind
Wire Industries Ltd. was much more then what had actually been said by the
Supreme Court. The Supreme Court had held as follows in Hind Wire Industries
Ltd.:

“word “order” has not been
qualified in any way and it does not necessarily mean the original order. It
can be any order, including the amended or rectified order.”

The aforesaid word “including”
made it very clear that an amended or rectified order would not result in
nullifying the original order and to say that the original order would cease to
exist. To read it as if, once the rectified order was passed, the original
order would disappear, would result in nullifying the effect of the word
“including” in the observations made by the Supreme Court, while
reading the meaning of the word “order” in section 154(7).
Accordingly, the Allahabad High Court disagreed with the view taken by the
Delhi High Court in the case of Tony Electronics Ltd,(supra) and held that the
rectification was barred by limitation.

OBSERVATIONS

Under the Income tax Act, an assessment
order or an order giving appeal effect
is usually passed by an Assessing officer. This order can be later on;

? rectified by him

? revised by the Commissioner,

? modified by the
Commissioner(Appeals) or other appellate authorities,

? set aside by the
Commissioner or the appellate authorities,

? reopened and reassessed or
specially assessed by him (only assessment order)

? substituted by him by giving
effect to the order of the higher authorities,

? substituted by passing fresh
order when set-aside by the higher authorities.

Unless any of the above happens, the order
passed by the AO attains finality. Once, any one of the above orders are
passed, the original order, till then final, becomes disturbed or vitiated, and
the question arises whether the order originally passed is substituted or
survives or it partially survives. The Act by itself does not provide for an
answer to this question and with that throws open challenging situations in
applying the provisions that stipulate time limits for actions w.r.t the date
of an order.

Ordinarily, where an appeal is provided
against an order passed by an authority, the decision of the appellate
authority, when passed, becomes the operative decision in law. If the appellate
authority modifies or reverses the decision of the authority, it is the
appellate decision that is effective and can be enforced. In law the position
would be just the same even if the appellate decision merely confirms the
decision of the authority. As a result of the confirmation or affirmance of the
decision by the appellate authority the original decision merges in the
appellate decision and it is the appellate decision alone which subsists and is
operative and capable of enforcement. The act of fusion of the one order in to
another is enshrined in ‘doctrine of merger’ which again is neither a doctrine
of constitutional law nor a doctrine statutorily recognised. It is a common law
doctrine founded on principles of propriety in the hierarchy of justice
delivery system. Please see Kunhayammed vs. State of Kerala, 245 ITR 360
(SC) which reiterates the position affirmed by various courts over a period
of time.

The merger doctrine in civil procedure
stands for the proposition that when the court order replaces an order of the authority with that of the
court , it is the order of the court that prevails. The logic underlying the
doctrine of merger is that there cannot be more than one decree or operative
orders governing the same subject-matter at a given point of time. When a
decree or order passed by inferior court, tribunal or authority was subjected
to a remedy available under the law before a superior forum then, its finality
is put in jeopardy. Once the superior court has disposed of the lis before it
either way – whether the decree or order under appeal is set aside or modified
or simply confirmed, it is the decree or order of the superior court, tribunal
or authority which is the final, binding and operative decree or order wherein
merges the decree or order passed by the court, tribunal or the authority
below.

This doctrine
however is not of universal or unlimited application and is not rigid in its
application. The nature of jurisdiction exercised by the superior forum and the
content or subject-matter of challenge laid or which could have been laid shall
have to be kept in view. If the subject matter of the two proceedings is not
identical, there can be no merger. The doctrine of merger does not by default
mean that wherever there are two orders, one by the inferior authority and the
other by a superior authority, passed in an appeal or revision there is a
fusion or merger of two orders irrespective of the subject-matter of the
appellate or revisional order and the scope of the appeal or revision
contemplated by the particular statute. The application of the doctrine depends
on the nature of the appellate or revisional order in each case and the scope
of the statutory provisions conferring the appellate or revisional
jurisdiction.

The Courts are clear that the doctrine of
merger cannot be applied rigidly in all cases. Its application varies from case
to case keeping in mind the subject matter and the nature of jurisdiction
exercised by the authority. It is this flexibility of the doctrine that has
been beautifully explained by the Supreme court in the case of Hind Wires
Industries Ltd. when it stated that “word “order” has not
been qualified in any way and it does not necessarily mean the original order.
It can be any order, including the amended or rectified order.” Both
the courts, Allahabad and Delhi, have heavily relied on these findings of
flexibility to deliver conflicting decisions in some what similar
situations.

The doctrine
may apply differently in each of the situations referred to earlier in this
part; in some cases the original order will survive and the limitation may
apply from its date; in other cases, the limitation may begin from the
substituted order while for some items in some cases, the limitation may apply
from the date of the order and for the rest of the items it may apply form the
date of the later order.

The real issue therefore before both the
courts was whether the original order survived or not. Application of period of
limitation would begin with the date of the order that subsisted. There could
be cases where both the orders survive which happens in cases of a partial
application of doctrine whereunder a part of the order passed in respect of
some items has remained intact and undisturbed by the later events and the
other part has been unsettled by later events. In such cases, the limitation
will apply from the date of the first order in respect of settled or
undisturbed items and would apply w.r.t the date of later order in respect of
the disturbed or unsettled items of the first order. Applying this
understanding , the Allahabad high court in the case of Shree Nav Durga Cold
Storage & Ice Factory (supra) correctly held that the claim for set off
of brought forward losses could not be claimed on application u/s. 154 in as
much as the same was time barred for the reason that the issue of set –off of
losses was not the subject matter of the appeal and had become final on passing
of the first order and in that view of the matter could not have been affected
by the appellate order or the order giving effect to the appellate order.

The Allahabad High Court in the context has
observed that what has been adopted in the Income-tax Act is the doctrine of
partial merger and not the full merger on the basis of the following provisions
of the Act:

? Even in a case where the
order of the lower authority had been the subject matter of the appeal, section
263 permits the Pr. CIT or CIT to pass the order of revision but only in
respect of such matters as had not been considered and decided in such appeal.

? Where the earlier
assessment made has become the subject matter of any appeal, reference or
revision, the Assessing Officer is still permitted to reopen the assessment
u/s. 147 for reassessing the other incomes which are not subject matter of any
such appeal, reference or revision.

? Sub-section (1A) of section
154 inserted w.e.f. 6^th Oct., 1964 by the Direct Taxes (Amendment)
Act, 1964 also embodies the doctrine of partial merger. It lays down that where
any matter had been considered and decided in any proceeding by way of appeal
or revision relating to an order referred to in s/s. (1), the authority passing
such order may, notwithstanding anything contained in any law for the time
being in force, amend the order under that sub-section in relation to any
matter other than the matter which had been so considered and decided.

The decision of the Supreme Court in the
case of Hind Wire Industries Ltd. which has been relied upon by the
Delhi High Court dealt with a case, wherein the original as well as amended
order were passed by the same authority i.e. the Assessing Officer. Further,
the Delhi High Court proceeded on the basis of the principle that when the
reassessment order is passed, the initial order of assessment does not survive
in any manner or to any extent and extended this principle to decide the issue
before it. Had the ratio of the decision of the Supreme Court in the case of
Hind Wire Industries Ltd. been properly explained the Delhi High Court, we are
sure that the decision could have been different in the case of Tony Electronics
wherein it ordered for rectification of a mistake contained in the original
order overlooking the fact that the mistake was not the subject matter of the
appeal and therefore that part of the order containing the mistake had become
final and did not get substituted by the order giving effect to the appellate
order.

In view of the above, the period of
limitation provided in section 154(7) should be reckoned from the date of such
order under which the issue sought to be rectified had become final which could
either be the original assessment order
or the subsequent order. What is important is to figure out the order in which
the mistake has occurred and to find out whether the mistake has been the
subject matter of the orders passed by the higher authorities or even by the AO
himself in some cases. Having said this,
the limitation will have a fresh lease of life from the date of the later order
in all cases where a fresh order is passed under the provisions of the Act or
in pursuance of the set-aside of the entire order by the higher authorities or
where the direction for passing a fresh order is issued. In such a case, if the
mistake sustains in the fresh order, it will be rectified within the time limit
determined w.r.t the date of passing the fresh order.

[1] Gojer Bros. (P.)
Ltd. vs. Ratan Lal Singh [1974] 2 SCC 453 and CIT vs. Amritlal Bhogilal &
Co. [1958] 34 ITR 130 (SC).

shailesh.kwebmaker

Main object is carry out infrastructure projects – Amendment in object clause as do business in futures and options – Amended clause to be considered

15. Pr.CIT-1 vs. Triforce Infrastructure
(India) Pvt. Ltd [ Income tax Appeal no 888 of 2016 Dated: 11^th
December, 2018 (Bombay High Court)].

[DCIT-1(3) vs. Triforce Infrastructure
(India) Pvt. Ltd; dated 12/06/2015 ; ITA. No 1890/Mum/2014, Bench : SMC AY: 2007-08 ,
Mum. ITAT ]

Main object is carry out infrastructure
projects – Amendment in object
clause as do business in futures and
options – Amended clause to be considered

The
assessee had in its return of income declared nil income. During assessment
proceedings, the A.O noted from the Profit & Loss Account that the assessee
was in receipt of speculation gain, dividend income and gain on Options
aggregating to Rs. 6.11 lakh. Against the above, the expenditure claimed was
Rs.42.45 lakh. Out of the above, expenditure claimed as loss on futures was
Rs.42.40 lakh. The A.O in assessment proceedings u/s. 143(3) of the Act
disallowed the loss on account of futures and options on the ground that the
object clause of Memorandum of Association (MOU) did not authorise the company
to do business in futures and options.

Being
aggrieved with the asst order, the
assessee filed an appeal to the CIT(A). The CIT(A) while allowing the appeal
reproduced clauses 21 and clause 68 of the MOU. In fact, clause 68 was
introduced into the MOU w.e.f. 30^th December, 2005. It was further
held that clause 21 could itself permit the assessee to deal with the shares,
futures and options. Nevertheless, on 31^st December, 2005 clause 68
of the MOU specifically enabled the assessee to do business in futures and
options i.e. before starting the business in futures and options. As the
relevant assessment year is 2007-08, the CIT(A) allowed the assessee’s appeal
holding that loss incurred in futures and options as well as trading in shares
is a part of its business loss.

Being
aggrieved with the order of the CIT(A), the Revenue filed an appeal to the
Tribunal. The Tribunal find that the main business of the assessee is to carry
out infrastructure projects for which the assessee company collected share
application money also. As per the assessee, due to unfavourable circumstances,
the assessee did not get any infrastructure contract, therefore, he decided to
deploy the available surplus funds, collected for infrastructure activity, in
the stock exchange market. The assessee furnished all these details to the A.O
regarding the receipt of share application money, loss incurred in future and
options transactions, share business along with the details of business
expenditure incurred by the assessee. The A.O without providing due opportunity
to the assessee, as has been claimed, in the same breath, assess the income
from speculation business of shares and gains in the future options transactions.
The Tribunal dismissed the Revenue’s appeal upholding the order of the CIT(A).

Being
aggrieved with the order of the Tribunal, the Revenue filed an appeal to the
High Court. The Court find that the view taken by the CIT(A) as well as the
Tribunal, cannot be faulted with. The losses on futures and options was
incurred post 30^th December, 2005 i.e. after clause 68 was
introduced in the MOU by an amendment. This appeal is in respect of A.Y.
2007-08 when clause 68 of the MOU was in existence. This entitled the assessee
to do business in Futures and Options. In the above view, the question as
proposed does not give rise to any substantial question of law. The appeal is
dismissed.

shailesh.kwebmaker

Section 37 (1): Business expenditure – books of accounts, and details not produced – being destroyed due to flood – filed evidence indicating the destruction of physical accounts due to heavy rains – Allowable as deduction – ‘best judgment assessment’ should not be made as a ‘best punishment assessment’.

14. Pr CIT-19 vs. Rahul J Jain [ ITA no
857 of 2016 Dated: 11^th December, 2018 (Bombay High Court)].

[Asst CIT 16(3) vs. Rahul J Jain ; dated 28/09/2015 ; ITA. No
5986/Mum/2013, AY : 2009-10, Bench : D
Mum. ITAT ]

Section 37 (1): Business expenditure – books
of accounts, and details not produced – being destroyed due to flood – filed
evidence indicating the destruction of physical accounts due to heavy rains –
Allowable as deduction – ‘best judgment
assessment’ should not be made as a ‘best punishment assessment’.

The
assessee is engaged in the business of trading in ferrous and nonferrous
metals. During the scrutiny proceeding, the assessee was unable to produce its
physical books of accounts, evidences for sales, purchases and expenses claimed
in the view of the same being destroyed due to flood on 8^th July,
2009. The assessee filed necessary evidence indicating the destruction of
physical accounts due to heavy rains on 8^th July, 2009. Besides, it
also filed evidences of its sellers and buyers to support its claim of loss.
However, the A.O assessed the income of the assessee at Rs. 57.95 lakh under
the head ‘business’ as against the loss of Rs.18.74 2 lakh as shown by the
assessee in its return of income.

The
CIT(A) allowed the assessee’s appeal inter alia by noting the fact that the
assessee had produced various documents in support of its claims for expenses,
after recording the fact that various confirmation letters from the parties who
had made purchases were also filed. However, the A.O did not carry out any
further verification in regard to it. The CIT(A) also recorded the fact that
the return as submitted should be accepted keeping in view of the fact that
there was a sharp and continuous fall in nickel prices which is the main
ingredient in stainless steel. Further, the assessee has made more than 90 % of
the sale during the year, out of the opening stock held by it as a carried
forward from the earlier year. Moreover, it also takes cognizance of the fact
that the assessee’s book results were also accepted by the Sales Tax and
Central Excise authorities. For all the above reasons, the appeal of the
assessee was allowed by order of the CIT(A).

Being
aggrieved with the order of the CIT(A), the Revenue filed further appeal to the
Tribunal. The Tribunal find that the documentary evidence to support the
assessee’s claim containing sufficient particulars on the basis of which
requisite verification from the parties mentioned therein could have been done
by the A.O, if he has any doubt in regard to the documents submitted. Further,
the Tribunal notes that the documents submitted in support of their claim were
not disputed by the Revenue before the Tribunal. Further, the impugned order
also records fall in the prices of the steel in the global market which lead to
a loss of the sales made by the assessee. In these circumstances, the appeal of
the Revenue was dismissed.

The Tribunal in its order
observed as under :- “We can very well appreciate that at times, the A.O has no choice but to make a best judgment
assessment.

But in our considered view,
the fairness of justice demands that ‘best judgment assessment’ should not be
made as a ‘best punishment assessment’.

Being aggrieved with the order of the ITAT,
the Revenue filed further appeal to the High Court. The court find that both
the CIT(A) and the Tribunal on examination of the facts have come to the
conclusion that there was material evidence available before the A.O for him to
carry out necessary investigation to determine whether or not the loss suffered
by the assessee was justifiable. The
best judgment assessment can certainly be resorted to by the A.O in the absence
of any record, but it cannot be arbitrary. This is more particularly so when
various supporting documents justifying their loss return was filed before the
A.O and he had completely ignored the same. We find that this appeal
essentially is in respect of question of facts. In the above view, the appeal
was dismissed.

shailesh.kwebmaker

Section 68 : Cash credits – Unsecured loans received – Confirmation, balance sheet and bank accounts of creditor was produced – A.O has not made enquiry in respect of the creditors – Deletion of addition was held to be justified.

13. The Pr. CIT-27 vs. Parth Enterprises [ Income
tax Appeal no 786 of 2016 Dated: 11^th December, 2018 (Bombay High
Court)].

[ITO-22(1)(4) vs.
Parth Enterprises; dated 10/06/2015; ITA. No 976/Mum/2013, Bench : C , AY:
2009-10 Mum. ITAT ]

Section 68 : Cash credits – Unsecured loans
received – Confirmation, balance sheet and bank accounts of creditor was
produced – A.O has not made enquiry in respect of the creditors – Deletion of addition was held to be justified.

The
assessee is engaged in the business of builders and developers. During the
year, the assessee had taken unsecured loans from 90 persons. However,
confirmations were filed only in respect 77 persons. The AO conducted enquiry
from external sources on the basis of information available on record and on
test check basis on 01.12.2011. Enquiries were conducted in a few cases, based
on the statement given by those parties . During a survey action u/s. 133A of the IT Act at the premise of one
Deepak Kapadia CA by the DDIT (investigation), unit IX(3), Mumbai his statement
was also recorded, that in his statement he admitted that he had provided
entries for loans in lieu of cash received from the assessee and also explained
that the modus operandi is of giving cheques and receiving cash back which were
then returned to those parties whose names are appearing as unsecured creditors
in the books of account of the appellant.

This
resulted in the A.O concluding that unsecured loans to the extent of Rs. 3.35
crore were hit by section 68 of the Act. Thus, added to the income of the
assessee.

Being
aggrieved by the assessment order the assessee filed an appeal to the CIT(A).
The CIT(A) found that creditworthiness of the parties were not doubted. On
facts, it came to the conclusion that out of 90 parties, loan reflected in the
names of 13 parties was hit by Section 68 of the Act. Accordingly, an addition
of Rs.36 lakh was confirmed against the addition of Rs. 3.35 crore made by the
A.O. In regard to the balance of Rs. 2.99 crore, the CIT(A) found that the
loans were genuine and therefore not hit by section 68 of the Act resulting in
its deletion.

Being
aggrieved by order, further appeals were filed by the Assessee as well as
Revenue to the Tribunal. The Revenue challenged the deletion of Rs. 2.99 crore
while the assessee challenged the upholding of addition of Rs. 36 lakh.

The
Tribunal find that there were total 90 loan creditors from whom unsecured cash
credit amounting to Rs. 3,35,00,000 had been introduced in the books of accounts
by the assessee, that out of the 90 loan creditors confirmations were submitted
only in the case of 77 parties and for the remaining 13 parties confirmation
were not furnished during the assessment proceedings, that during the course of
appellate proceedings the remaining loan
confirmation were filed along with other supporting documents. The FAA after
considering the remand report and reply of the assessee – decided the matter.
Thus the ITAT decided the effective ground of appeal against the assessee with
regard to the creditors who had advance Rs.36 lakh to it. Further it held that
the FAA had rightly deleted the addition of Rs. 2.99 crore. The AO had made no
effort to verify the details filed by the assessee before him.

Being aggrieved with the order of the ITAT, the Revenue filed the Appeal before
High Court. The Hon. Court find that there are concurrent finding on facts
rendered by the CIT(A) and the Tribunal holding that only Rs. 36 lakh can be
added to the declared income and the balance amount of Rs. 2.99 crore was not
hit by section 68 of the Act. This finding is premised on the fact that no
enquiry was made in respect of 76 creditors out of 77 creditors and the
assessee had provided required documentary evidence in respect of the 76 creditors.
Thus, these are essentially finding of fact and the view taken by the Tribunal
is a possible view on these facts. In view of the above, the question raised
does not give rise to any substantial question of law. Accordingly, appeal was
dismissed.

shailesh.kwebmaker

Time limit for issuing notice u/s. 148 – Amendment to section 149 by Finance Act, 2012, which extended limitation for reopening assessment to sixteen years, could not be resorted for reopening proceedings concluded before amendment became effective

50. Brahm Datt vs. ACIT; [2018] 100 taxmann.com 324
(Delhi) Date of order: 6^th December, 2018 A. Y. 1998-99 Section 149 of ITA and Finance Act, 2012

Time limit for issuing notice u/s. 148 – Amendment to
section 149 by Finance Act, 2012, which extended limitation for reopening
assessment to sixteen years, could not be resorted for reopening proceedings
concluded before amendment became effective

The assessee was a senior citizen aged about 84 years. From A. Ys.
1984-85 to 2003-04, he was a non-resident/not ordinarily resident of India. He
was previously working and residing in foreign countries, viz; Jordan and Iraq
and while so, he derived income primarily from salary and professional
receipts. The assessee during the course of search clarified that he did not
maintain any foreign bank account in his personal capacity, he, however had
contributed an amount of approximately US$ 2-3 million at the time of settling
of the offshore Trust, when he was a non-resident, out of his income earned
from sources outside India. The revenue primarily relying upon his statement,
issued impugned notice dated 24/03/2015 u/s. 148 of the Income-tax Act, 1961
seeking to initiate reassessment proceedings for A. Y. 1998-99, on the
suspicion that the, income of the assessee had escaped assessment. The
Assessing Officer rejected the assessee’s contention that limitation for
re-assessment for A. Y. 1998-99 had expired on 31/03/2005 and therefore, re-assessment
was bared by limitation. The Assessing Officer contended that the proceedings
were initiated within the extended period of 16 years from the end of the
relevant assessment year by relying on section 149(1)(c), introduced by the
Finance Act, 2012, with effect from 01/07/2012.

The assessee filed writ petition challenging the notice u/s. 148 on the
ground of limitation. Delhi High Court allowed the writ petition and held as
under:

“i) The revenue had sought to
contend that the amendment (to section 149) is merely procedural and no one has
a vested right to procedure; and that procedural amendments can be given effect
any time, even in ongoing proceedings.

ii) The question of revival of
the period of limitation for reopening assessment for A. Y. 1998-99 by taking
recourse to the subsequent amendment made in section 149 in the year 2012,
i.e., more than 8 years after expiration of limitation on 31/03/2005, has been
dealt with by the Supreme Court in K.M. Sharma v. ITO [2002] 122 Taxman 426/254
ITR 772(SC).

iii) Assessment for A. Y. 1998-99
could not be reopened beyond 31/03/2005 in terms of provisions of section 149
as applicable at the relevant time. The assessees return for A.Y. 1998-99
became barred by limitation on 31/03/2005.

iv) In view of the above
discussion, it is held that the petition has to succeed; the impugned
reassessment notice and all consequent proceedings are hereby quashed and set
aside. The writ petition is allowed.”

shailesh.kwebmaker

TDS – Payment to non-resident – Effect of amendment to section 195 by F. A. 2012 with retrospective effect from 01/04/1962 – No change in condition precedent for application of section 195 – Income arising to non-resident must be taxable in India

49. Principal CIT vs. Motif India Infotech (P) Ltd.; 409
ITR 178 (Guj) Date of order: 16^th October, 2018 A. Y. 2009-10 Sections 9(1) and 195 of ITA 1961

TDS – Payment to non-resident – Effect of amendment to
section 195 by F. A. 2012 with retrospective effect from 01/04/1962 – No change
in condition precedent for application of section 195 – Income arising to
non-resident must be taxable in India

The assessee was a company engaged in software development. It provided
software related services to its overseas clients. In the course of assessment
proceedings for the A. Y. 2009-10, the Assessing Officer found that the assesse
had made payment of Rs. 5.51 crore to a foreign based company towards fees for
technical services without deducting tax at source. The assessee argued that
the payment received by the non-resident was not taxable and that therefore,
there was no requirement for deducting tax at source while making such payment.
However, the Assessing Officer disallowed the expenditure relying on section
40(a)(i) of the Act holding that the tax was deductible at source.

The Commissioner (Appeals) accepted the assessee’s claim and held in
favour of the assessee observing that there was no dispute that the services
were in the nature of technical services, but would be covered under the
Explanation clause contained in section 9(1)(vii)(b) of the Act. He was of the
opinion that the services were utilised outside India in a business or
profession carried outside India, or for the purpose of earning any income
outside India. This was upheld by the Tribunal.

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

“i) In the case of GE India
Technology Centre P. Ltd. Vs. CIT; 327 ITR 456 (SC), the ratio laid down by the
Supreme Court was that mere remittance of money to a non-resident would not
give rise to the requirement of deducting tax at source, unless such remittance
contains wholly or partly taxable income. After the judgment was rendered, the
Legislature amended section 195 by inserting Explanation 2 by the Finance Act,
2012, but with retrospective effect from 01/04/1962. The Explanation provides
that for removal of doubts, it is clarified that the obligation to comply with
sub-section (1) of section 195, and to make deduction as provided therein
applies and shall be deemed to have always applied to all persons, resident or
non-resident, whether or not the non-resident person has a residence or place
of business or business connection in India; or any other presence in any
manner whatsoever in India. Mere requirement of permanent establishment in
India was thus done away with. Nevertheless, the basic principle that
requirement of deduction of tax at source would arise only in a case where the
payment made to a non-resident was taxable, still remains.

ii) The Commissioner (Appeals)
and the Tribunal had accepted the assessee’s factual assertion that the
payments were for technical services provided by a non-resident, for providing
services to be utilised for serving the assessee’s foreign clients. Clearly,
the source of income namely the assessee’s customers were the foreign based
companies.

iii) We are fortified in the view
by a judgment of the Karnataka High Court in the case of CIT Vs. ITC Hotels;
(2015) 233 Taxman 302 (Karn), in which it was held that where the recipient of
income of parent company is not chargeable to tax in India, then the question
of deduction of tax at source by the payer would not arise.

iv) In the result, the tax appeal
is dismissed.”

shailesh.kwebmaker

Settlement of cases – Construction business – Receipt of on money – Additional disclosure of undisclosed income for one assessment year during settlement proceedings – Does not amount to untrue disclosure for other assessment years under settlement proceedings – Commission accepting disclosures made by assessees and passing orders on their settlement applications – Order of Settlement Commission not erroneous

48. Principal CIT vs. Income-Tax Settlement Commission
and another; 409 ITR 495 (Guj) Date of order: 13^th June, 2017 A. Ys. 2012-13 to 2014-15 Sections 245C and 245D of ITA 1961 and Article 226 of
Constitution of India

Settlement of cases – Construction business – Receipt of
on money – Additional disclosure of undisclosed income for one assessment year
during settlement proceedings – Does not amount to untrue disclosure for other
assessment years under settlement proceedings – Commission accepting
disclosures made by assessees and passing orders on their settlement
applications – Order of Settlement Commission not erroneous

For the A. Ys. 2012-13 to 2014-15 the assesse filed applications before
the Settlement Commission for settlement of disputes that arose out of pending
assessments. In the settlement applications the assessees made additional
disclosure of undisclosed income on account of receipt of on money through sale
of constructed properties. The assessees projected 15 % profit on the turnover.
On the basis of the turnover of unaccounted receipts disclosed and 15 % profit
rate claimed by them, the assessees made disclosure of additional income in
their applications for settlements. The Department contended before the
Settlement Commission that further inquiry was necessary and that the rate of
15 % profit was on the lower side as in similar business the rate of return was
much higher. The Settlement Commission accepted the disclosure of the turnover
made by the assesse as the Department did not bring any contrary material on
record in that respect and held that the 15 % rate of profit out of the
turnover was reasonable. The Settlement Commission further recorded that during
the course of the proceedings, each of the assessees made a voluntary
disclosure of an additional sum of Rs. 2 crore, i.e., a sum of Rs. 50 lakh each
for the A. Y. 2014-15 “in a spirit of settlement and to put a quietus to the
issue”. Accordingly, the Settlement Commission passed an order u/s. 245D on
21/01/2016.

The Revenue filed a writ petition and challenged the validity of the
order. The Gujarat High Court dismissed the writ petition and held as under:

“i) It is true that before the
Settlement Commission, the assesses indicated that the additional disclosure of
Rs. 50 lakh each may be accounted for the A. Y. 2014-15. However, we cannot
lose sight of the fact that such disclosures were made in the spirit of
settlement and to put an end to the controversy. The assessees therefore cannot
be pinned down to effect such disclosures in the A. Y. 2014-15 alone.

ii) We cannot fragment a larger
picture and telescope the additional disclosures for a particular year and
taking into account the comparable figures for that year decide whether such
disclosures would shake the initial disclosures and to hold that the initial
disclosures were untrue projecting the additional disclosures for all the
assessment years, the assessees had sought for settlement.

iii) We find the Commission
committed no error in accepting them (additional disclosures) and in proceeding
to pass final order on such settlement applications. In the result, the
petitions are dismissed.”

shailesh.kwebmaker

Recovery of tax – Stay of demand when assessee in appeal before Commissioner (Appeals) – Discretion of AO to grant stay – CBDT Office Memorandum cannot oust jurisdiction of AO to grant stay – Prima facie case showing high pitched assessment and financial burden on assesse – Stay on condition of deposit of 20% of amount demanded – Not justified

47. SAMMS Juke Box
vs. ACIT; 409 ITR 33 (Mad); Date of order: 28^th June, 2018 A. Y. 2015-16

Section 220(6) of ITA 1961 and Article 226 of
Constitution of India

Recovery of tax – Stay of demand when assessee in appeal
before Commissioner (Appeals) – Discretion of AO to grant stay – CBDT Office
Memorandum cannot oust jurisdiction of AO to grant stay – Prima facie
case showing high pitched assessment and financial burden on assesse – Stay on
condition of deposit of 20% of amount demanded – Not justified

For the A. Y. 2015-16, the assessee’s assessment was completed u/s.
143(3) of the Act. The assessee had receipts of Rs. 28,05,852/- from Conde Nast
(India) Limited for the year. However, by mistake, M/s. Conde Nast (India)
Limited had deducted excessive TDS and accordingly in Form 26AS the receipts
were shown to be Rs. 6,62,03,927/. The assessee did not claim the excessive
credit of TDS. The assessee also took steps to make the necessary corrections.
However, in the meanwhile, the Assessing Officer completed the assessment on
the basis of the receipts as shown in Form 26AS resulting in high pitched
assessment. The assesse preferred appeal before the Commissioner (Appeals) and
made an application to the Assessing Officer for stay of the demand u/s. 220(6)
during the pendency of the appeal before the Commissioner (Appeals). The
Assessing Officer passed order and directed the assesse to deposit 20 % of the
demand for grant of the stay as per the CBDT Office Memorandum dated
31/07/2017. The assesse filed writ petition and challenged the said order.

The Madras High Court allowed the writ petition, set aside the said
order and held as under:

“i) Before whatever forum when an
application for interim relief is sought, the authority has to be necessarily
guided by the principles governing the exercise of jurisdiction under Order
XXXIX, rule 1 of the Civil Procedure Code 1908. Thus, the authority while
examining an application for grant of stay should consider whether the
applicant has made out a prima facie case, whether the balance of convenience
is in his favour, and if stay is not granted whether the applicant would be put
to irrepairable hardship.

ii) Thus, when a statutory
authority exercises power to grant interim relief, he cannot be weighed down by
directives, which leave no room for discretion of the authority. Though the
CBDT’ Office Memorandum dated 31/07/2017 appears to fix a percentage of tax to
be paid for being entitled to an order of stay, it carves an exception in the
very same instruction and this is clear from the Office Memorandum dated
29/02/2016, in paragraph 4(B(b)). Thus, CBDT did not completely oust the
jurisdiction of the Officer, while examining a prayer for stay of the demand of
tax pending appeal.

iii) The respondent could not have
passed the order without taking note of the assessee’s case and without
considering whether the assesse had made out a prima facie case for grant of
interim relief. The assesse had specifically pointed out its financial position
and the prejudice that was being caused to it on account of the high pitched
assessment. It had specifically pleaded that its income of the year was one
fourth of the tax assessed. This aspect was not dealt with by the respondent,
while passing the order. The order was not valid.

iv) I find that the information
furnished by the Assessing Officer in the para-wise comments are not contained
in the impugned order. The respondent cannot improve upon the impugned order by
substituting fresh reasons in the form of a counter-affidavit. Thus, the
information furnished to the learned standing counsel for the Revenue would
clearly demonstrate that at the time of passing the impugned order, no such
reasons weighed in the minds of the respondent and therefore, the respondent
cannot justify his order by substituting fresh reasons, after the order is put
to challenge.

v) In the result, the writ
petition is allowed, the impugned order is set aside and the matter is remanded
to the respondent for fresh consideration and to pass an order on merits and in
accordance with law after affording an opportunity of hearing to the assessee.”

shailesh.kwebmaker

Loss – Capital or revenue loss – Investment in shares as stock-in-trade – Loss in sale of portion of shares – Transaction in course of business – Revenue in nature – Not capital loss

46. Calibre
Financial Services Ltd. vs. ACIT; 409 ITR 410 (Mad) Date of the order: 31^st October, 2018 A. Y. 2001-02 Section 45 of ITA 1961

Loss – Capital or revenue loss – Investment in shares as
stock-in-trade – Loss in sale of portion of shares – Transaction in course of
business – Revenue in nature – Not capital loss

The assessee was engaged in financial advisory and syndication services
and the memorandum of association of the company authorised it to deal in
shares and stocks. For the A. Y. 2001-02, the Assessing Officer treated the
loss that arose from the transaction of sale of mutual fund units as capital
loss as against the claim of the assesee that it was revenue loss and passed an
order u/s. 143(3) of the Act accordingly.

The Commissioner (Appeals) allowed the appeal and held that it was a
revenue loss. The Tribunal reversed the order and held that there was no
evidence available to indicate that the intention of the assessee to treat the
holding as stock-in-trade.

The Madras High Court allowed the appeal filed by the assesse and held
as under:

“i) The Tribunal erred in concluding
that there was no evidence available on record to indicate that the intention
of the assessee was to treat the holding as stock-in-trade. The Assessing
Officer had extracted the written submission made by the assesse, in which it
had stated that the assesse was a financial service company which rendered
financial advisory and syndication services and also traded in shares, units of
mutual funds, etc. The memorandum of association of the assessee authorised it
to deal in shares and services. Further, it stated that as authorized, the
assessee had purchased mutual fund units during the financial year 2000-2001
and sold the units during the same year. The trading in such units was done in
the ordinary course of its business and the loss was revenue in nature.

ii) Further, the assessee had
stated that it had treated the transaction as revenue transaction and debited
the loss incurred to the profit and loss account as in the earlier financial
year also, in which it was allowed by the Assessing Officer. Similar
transactions had been held to be revenue in nature. For the A. Y. 2006-07, the
Assessing Officer did not agree with the assessee but the Commissioner
(Appeals), had held that the assessee had acquired equity shares, which it held
as stock-in-trade and out of which, a portion was sold incurring a loss which
was accounted as business expenditure and that the method of accounting and the
principle of accounting for loss or gains from investments or stock-in-trade
had been consistently and regularly followed by the assesse and accordingly,
the claim of the assessee with regard to loss that arose from trading in shares
was to be allowed as a business loss as claimed by the assesse.

iii) Thus, for the above reasons,
we are of the considered view that the Tribunal fell in error in reversing the
order passed by the Commissioner (Appeals). In the result, the appeals filed by
the assessee are allowed and the orders passed by the Tribunal, which are
impugned herein, are set aside. Accordingly, the substantial questions of law
are answered in favour of the assesse and against the Revenue.”

shailesh.kwebmaker

Income Declaration Scheme 2016 – Determination of sum payable and payment of first instalment by assessee – Rejection of application pursuant to issue of notice for assessment – Tax already deposited under scheme to be adjusted by Department

45. Sangeeta
Agrawal vs. Principal CIT; 409 ITR 254 (MP) Date of order: 3^rd August, 2018 A. Y. 2014-15 Section 191 of F. A. 2016 (Income Declaration Scheme,
2016); Article 226 of Constitution of India and section 143(2) of ITA 1961

Income Declaration Scheme 2016 – Determination of sum
payable and payment of first instalment by assessee – Rejection of application
pursuant to issue of notice for assessment – Tax already deposited under scheme
to be adjusted by Department

The assessee made an application under the Income Declaration Scheme,
2016, and offered an amount as undisclosed income for the A. Y. 2014-15. The
total tax payable thereon was determined and she paid the first instalment of
tax. Thereafter, a notice u/s. 143(2) of the Act, was issued and the
application under the Scheme was rejected. Since according to section 191 of
the Finance Act, 2016, any amount paid under the Scheme was not refundable, the
assesse prayed for adjustment of the amount already paid. The Department
rejected the application for adjustment or refund of the amount paid under the
Scheme.

The assesee filed a writ petition and challenged the order of rejection.
The Madhya Pradesh High Court allowed the writ petition and held as under:

“Considering the law laid down by the Supreme Court in the case of
Hemalatha Gargya Vs. CIT; (2003) 259 ITR 1 (SC) as well as the Bombay High
Court in Sajan Enterprises Vs. CIT; (2006) 282 ITR636 (Bom), we quash the
impugned order and direct the respondent-Revenue to adjust the amount of Rs.
3,28,068 which has been deposited by the petitioner in the relevant A. Y.
2014-15.”

shailesh.kwebmaker

Charitable or religious trust – Denial of exemption – Section 13(2)(c) – In order to invoke provisions of section 13(2)(c), it is essential to prove that amount paid to person referred to in sub-section (3) of section 13 is in excess of what may be reasonably paid for services rendered

44. CIT vs. Sri Balaji Society; [2019] 101 taxmann.com 52
(Bom) Date of order: 11^th December, 2018 A. Ys. 2008-09 and 2009-10 Sections 12AA and 13 of ITA, 1961

Charitable or religious trust – Denial of exemption –
Section 13(2)(c) – In order to invoke provisions of section 13(2)(c), it is
essential to prove that amount paid to person referred to in sub-section (3) of
section 13 is in excess of what may be reasonably paid for services rendered

The assessee was a charitable trust and enjoyed the registration u/s.
12AA. During relevant years, the assessee had incurred expenditure, some of
which was paid to one SBC towards advertisements in various magazines and
souvenirs. The Assessing Officer noticed that said SBC was a partnership firm
consisting of three partners who happened to be trustees of the assessee-trust.
The Assessing Officer opined that the firm i.e., SBC was a firm covered u/s.
13(3)(e) vis-a-vis trust. The Assessing Officer thereafter carried out the
analysis of the expenditure in connection with the advertisements with a
special focus on the payments made to the SBC. He thus denied the benefit u/s.
11 relying upon the provisions of section 13(2)(c).

The Commissioner (Appeals) allowed the appeal. He examined the material
on record at length and came to the conclusion that the Assessing Officer had
incorrectly invoked the said provision in making the disallowance. He was of
the opinion that the payments made by assessee were not in excess of what may
be reasonably paid for the services in question. The Tribunal confirmed order
passed by the Commissioner (Appeals).

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

“i) Clause (c) of sub-section (2)
of section 13 can be invoked, if any amount is paid by way of salary, allowance
or otherwise to any person referred to in sub-section (3) out of resources of
the trust for services rendered to the trust and the amount so paid is in
excess of what may be reasonably paid for such services. Thus, essential
requirement for invoking the said provision is that the amount paid was in
excess of what may be reasonably paid for the services.

ii) In the present case, the
Commissioner (Appeals) and the Tribunal had elaborately examined the accounts
of the assessee, the payments made to the SBC, the payments made to other
agencies for similar work, comparative rates of payments and came to the
conclusion that no excess payment was made to the related person.

iii) Essentially, this is a pure
question of fact. No question of law arises.”

shailesh.kwebmaker

Business expenditure – Deduction u/s. 35AD – Specified business – Hotel Business – Commencement of new business not disputed by Department and income offered to tax accepted – Certification of hotel as three-star category hotel in subsequent year – Time taken by competent authority for certification beyond control of assesse – Assessee not to be denied deduction u/s. 35AD on the ground that the certification was in the later year

43. CIT vs.
Ceebros Hotels Pvt. Ltd.; 409 ITR 423 (Mad) Date of order: 13^th November, 2018 A Y. 2011-12 Section 35AD of ITA 1961

Business expenditure – Deduction u/s. 35AD – Specified
business – Hotel Business – Commencement of new business not disputed by
Department and income offered to tax accepted – Certification of hotel as
three-star category hotel in subsequent year – Time taken by competent authority
for certification beyond control of assesse – Assessee not to be denied
deduction u/s. 35AD on the ground that the certification was in the later year

The assessee was in the hotel business running a three-star hotel. The
assessee commenced the business in the A. Y. 2011-12 but the certification of
the three-star was received only in the subsequent year. For the A. Y. 2011-12,
the Assessing Officer denied the benefit of deduction u/s. 35AD(5)(aa) of the
Act on the ground that the assesse obtained classification as three-star
category hotel only during the subsequent year, i.e., A. Y. 2012-13.

The Tribunal allowed the assessee’s claim and held that once the
Department had accepted the income of the assessee offered to tax from the
hotel business, which was newly established and became fully operational in the
year 2010, the assessee was eligible for the investment allowance, that once
the application for star category classification was not rejected and after
inspection no discrepancy was found and the assessee was recommended for
classification under the three-star category the assessee could not be
penalised for the delay on the part of the Hotel and Restaurant Approval and
Classification Committee to inspect the Hotel before the end of the financial
year.

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

“i) The reasons assigned by the
Tribunal for grant of deduction to the assessee u/s. 35AD(5)(aa) were just and
proper and the findings rendered by it were right.

ii) The application filed by the
assesse for classification was made on 19/04/2010 and thereafter certain
procedures were to be followed and an inspection was required to be conducted
for such purpose. The manner in which the inspection was conducted and the time
frame taken by the competent authority were beyond the control of the assessee.
The Department had not disputed the operation of the new hotel from the F. Y.
2010-11 as it had accepted the income, which was offered to tax from the newly
established hotel which became fully operational in the year 2010.

iii) Nowhere in the clause (aa) of
sub-section (5) of section 35AD was it mandated that the date of the
certificate was to be with effect from a particular date. Therefore, the
provision which was to encourage the establishment of hotels of a particular
category, should be read as a beneficial provision and therefore, the
interpretation given by the Tribunal were valid and justified. Therefore, the
Tribunal was right in concluding that the assesse is entitled to claim
deduction u/s. 35AD(5)(aa) for the A. Y. 2011-12.”

shailesh.kwebmaker

Article 13 of DTAAs; Section 9(1)(vii) – Payment made to non-resident LLPs towards professional services qualified as IPS.

21. TS-10-ITAT-2019 (Del) ACIT vs. Grant Thornton Date of Order: 10^th January, 2019 A.Y.: 2010-11

Article 13 of DTAAs; Section 9(1)(vii) –
Payment made to non-resident LLPs towards professional services qualified as
IPS.

FACTS

Taxpayer, an Indian company was engaged in
providing international accountancy and advisory services to various clients in
India and abroad. During the year under consideration, Taxpayer availed
services² of various foreign limited liability partnerships (NR
LLPs) to render services to its clients abroad and paid fees to such NR LLPs
without withholding tax. The taxpayer contended that services obtained from NR
LLPs were in the nature of ‘Independent Personal Services’ (“IPS”) rendered
outside India and in absence of a fixed base of the NR LLPs in India, tax was
not required to be withheld on such payments under the relevant DTAA.

The AO, however contended that services
rendered by NR LLPs were technical services which accrued or arose in India
u/s. 9(1)(vii). Further, the IPS article under the treaty applied only to an
individual (both in his own capacity or as a member of a partnership) and not
to an LLP. Thus, in absence of any withholding, AO disallowed the payments made
to NR LLPs.

Aggrieved, Taxpayer appealed before the
CIT(A) who reversed AO’s order on the ground that income derived by an
individual or a partnership firm by rendering professional services is exempt
from tax in India by virtue of IPS article. Further, as the services rendered
by the NR LLPs did not make available any technical knowledge or skill, it did
not qualify as FIS under the relevant DTAA.

_______________________________

2. Professional services pertaining to the
field of lawyering (giving reviews and opinions) and accounting e.g. SAS70
engagement, review and filing of form number1120, due diligence, review of US
GAAP financials etc

Consequently, AO appealed before the
Tribunal.

HELD

There is no dispute that the
services rendered by NR LLPs were professional services. The IPS article in
some of the DTAAs applied in respect of payments made to “residents”, while in
some other DTAAs, it applied to individual (both in his own capacity or as a member
of a partnership). Thus, there was no infirmity in the order of CIT(A) who had
upheld the applicability of IPS article on payments made to NR LLPs.

Further, in absence of
satisfaction of make available condition, the payment made to NR LLPs did not
qualify as FTS under respective DTAAs.

Thus, in absence of
chargeable income, there was no obligation on Taxpayer to withhold taxes on
payments made to NR LLPs.

shailesh.kwebmaker

Article 12(1) of India-Israel DTAA and India -Russia DTAA – since charge of tax on royalty arises only at the time of payment, tax is not required to be withheld when provisions for payment of royalty is made.

20. TS-676-ITAT-2018(Ahd) Sophos Technologies Pvt. Ltd. vs. DCIT Date of Order: 16^th November,
2018 A.Y: 2012-13

Article 12(1) of India-Israel DTAA and
India -Russia DTAA – since charge of tax on royalty arises only at the time of
payment, tax is not required to be withheld when provisions for payment of
royalty is made.

FACTS

Taxpayer was a private Indian Company
engaged in the business of development of network security software product. As
part of its business, Taxpayer procured anti-virus software and anti-spam
software from suppliers in Russia and Israel respectively and bundled them with
its own software product. This bundled software was sold by the Taxpayer to the
end customers.

In terms of the
understanding with the suppliers, Taxpayer was liable to pay royalty in respect
of such anti-virus and anti-spam software only on activation of the license key
by the end customer (i.e. the ultimate user of the bundled software).
Withholding obligation on such royalty payment was also discharged at the time
of actual payment to the suppliers.
Taxpayer recognised the income at the time of sale of the bundled
software and correspondingly made a provision for payment of the royalty in its
books of accounts. Withholding obligation on such royalty payment was
discharged at the time of actual payment to the suppliers and not at the time
of making provision in the books.

Taxpayer contended that the liability to
withhold taxes arises only on the activation of the key by the actual customer.

The AO, however, was of the view that
Taxpayer was required to withhold taxes at the time of making the provision for
royalty and as Taxpayer had failed to withhold taxes at that time, AO
disallowed the expenses claimed towards such provision. Aggrieved, the Taxpayer appealed before the
CIT (A) who upheld AO’s order.

Aggrieved, the Taxpayer appealed before the
Tribunal.

HELD

Article 12(1) of
India-Russia DTAA and India-Israel DTAA are identically worded and provide that
“royalty arising in a Contracting State and paid to a resident of the other
Contracting State may be taxed in that other State”. Thus, in terms of the
DTAA, royalty is taxable only at the point of time when the royalty is paid to
the resident of the other Contracting State.

The liability to deduct tax at source arises
only when the income embedded in the relevant payment is eligible to tax.

In the present case, royalty
in respect of the bundled product became payable when the product was activated
and not at the point of sale of bundled software. Thus, the taxes were also
required to be withheld only upon activation of license keys.

shailesh.kwebmaker

Article 5(2)(h) of India-UAE DTAA – Grouting activity undertaken in India by UAE Company for a period of 9 months does not result in construction PE under India-UAE DTAA

19.
TS-741-ITAT-2018 (Del) ULO Systems LLC vs. ADIT Date of Order: 29^th December,
2018 A.Y.: 2007-08

Article 5(2)(h) of India-UAE DTAA –
Grouting activity undertaken in India by UAE Company for a period of 9 months
does not result in construction PE under India-UAE DTAA

FACTS

Taxpayer, a UAE company, was engaged in
providing grouting and precast solutions to support and protect subsea
pipelines, cables and structures. As part of grouting activity, a neat mixture
of cement and water (grout) is mixed and pumped into water in certain shapes
and forms, which acts as a support and stabilises the subsea pipelines and
cables. It also helps in preventing the corrosion of the pipelines.

During the year
under consideration, Taxpayer undertook several projects in India for which it
was present in India for an aggregate period of 264 days. Further, presence for
any single project did not exceed the threshold specified in India-UAE DTAA.
Also, the projects were unconnected and were performed for unrelated
third-party customers in India.

Taxpayer believed that the grouting activity
carried out in India was in the nature of construction activity as contemplated
in Article 5(2)(h) of India-UAE DTAA, and as the presence in India did not
exceed 9 months, it did not create its Permanent Establishment (“PE”) in India.
Further, since the contracts were not inter-connected, time spent on such
projects could not be aggregated for calculating the 9-month threshold.

The AO, however, held that that the grouting
activity would create a fixed place PE under Article 5(1) of the DTAA. AO also
alleged that Taxpayer circumvented the 9-month threshold by manipulating the
number of days of presence in India.

Aggrieved, the Taxpayer approached the
Dispute Resolution Panel (DRP) which confirmed AO’s order.

Aggrieved, the Taxpayer appealed before the
Tribunal.

HELD

It is a settled legal
principle that a specific provision would override a general provision. Thus,
Article 5(1) could not be applied where activities are covered under the
specific construction PE article [Article 5(2)(h)] of the DTAA.

Article 5(2)(h) does not
differentiate between a simple/complex construction work. Thus, the fact that
grouting activity is not a simple masonry work and involves complex aspects is
not relevant for determining whether it is covered by construction PE article.

Evaluation of whether there
exists a PE needs to be made on a year to year basis.

While construction PE clause
of some treaties (like India-Australia and India-Thailand) are worded in a
manner to specifically aggregate the time spent on multiple projects, Article
5(2)(h) of India-UAE DTAA is worded differently and uses singular expressions ‘a
building, site or construction or assembly project’. Thus, time spent on
multiple projects in India cannot be aggregated for calculating the threshold
period under India-UAE DTAA.

Since the Taxpayer’s
presence in India in the relevant year for carrying on each of the grouting
project was less than 9 months, there was no construction PE of the Taxpayer
was constituted in India.

shailesh.kwebmaker

Article 2 & Article 12 of India-Japan DTAA; rate prescribed in DTAA is total withholding rate inclusive of surcharge and cess.

18.
TS-721-ITAT-2018 (Ahd) ACIT vs. Panasonic Energy India Co. Ltd. Date of Order: 3^rd December, 2018 A.Y.: 2008-09

Article 2 & Article 12 of India-Japan
DTAA; rate prescribed in DTAA is total withholding rate inclusive of surcharge
and cess.

FACTS

Taxpayer, a private limited company was
engaged in the business of manufacturing, trading, and export of dry Batteries
along with spare parts of dry batteries. During the year under consideration,
the Taxpayer paid brand usage fee and royalty fee to a Japanese company (FCo)
after withholding tax on such sum at the rate of 20%¹ on the gross
amount.

The Assessing Officer (AO), however, was of
the view that the taxes were required to be withheld at the rate of 22.66%
after considering surcharge and education Cess of 2.66% and thus disallowed the
proportionate expenditure on account of short deduction of taxes on such
payments to FCo.

______________________________________

1. India-Japan DTAA provided ceiling of 10%.
However, it is not clear from the decision as to why the Taxpayer withheld tax
@20%.

Taxpayer argued that the scope of Article 2
of the DTAA covered both surcharges and education cess. Even otherwise, as per
the provision of Article 12 of the DTAA, the payment was liable to tax at the
rate not exceeding 10% whereas Taxpayer had withheld tax @20% which was
adequate to cover the amount of surcharge and education cess. However, AO disregarded
the Taxpayer’s contentions and disallowed the proportionate expenses on account
of short withholding of tax.

Aggrieved, the Taxpayer filed an appeal
before the CIT(A) who reversed AO’s order on the ground that disallowance can
be made only if there was either no deduction or after deduction of tax, the
same was not paid on or before due date of filing of return. However, since
Taxpayer had withheld taxes appropriately at the rates prescribed in DTAA and
also paid the same before the due date of filing of return, no disallowance
could be made.

Aggrieved, the AO appealed before the
Tribunal.

HELD

Article 2 of
India-Japan DTAA provides that the term “taxes” referred to in the DTAA for
Indian purposes means the income tax including surcharge thereon. A plain
reading of the provisions of DTAA reveals that the amount of tax includes
surcharge.

Further as
per Article 12, the tax that can be charged on royalty is restricted to 10% of
the gross amount of royalty. Having regard to the definition of “taxes” in
Article 2, the total tax including surcharge is restricted only to 10% under
Article 12. Therefore, Taxpayer was not liable to withhold tax on the payment
made to FCo after including the surcharge over and above the tax rate as
specified under Article 12 of India-Japan DTAA.

Further, as
held in the case of DIC Asia Pacific Pte. Ltd. (18 ITR 358), since
education cess is charged on the income tax, it partakes the character of the
surcharge. Therefore, Taxpayer was not liable to include education cess over
and above the taxes withheld by the Taxpayer.

shailesh.kwebmaker

Sections 28(iv), 68 – The fact that premium is abnormally high as per test of human probabilities is not sufficient. The AO has to lift the corporate veil and determine whether any benefit is passed on to the shareholders/directors.

9.
Bharathi Cement Corporation Pvt. Ltd. vs. ACIT (Hyderabad) Members: P. Madhavidevi, JM and S. Rifaur
Rahman, AM ITA Nos.: 696 & 697/Hyd./2014 A.Y.s: 2009-10 and 2010-11 Dated: 10^th August, 2018 Counsel for assessee / revenue: Nageswar Rao
/ M. Kiranmayee

Sections 28(iv), 68 – The fact that premium
is abnormally high as per test of human probabilities is not sufficient. The AO has to lift the corporate veil and
determine whether any benefit is passed on to the shareholders/directors.

FACTS

During the previous
year relevant to the assessment year under consideration, the assessee company,
filed its return of income declaring total income of Rs. 2,91,01,250. This income comprised of interest on fixed
deposits which was offered for taxation under the head `Income from Other
Sources’. The Company had not commenced its business activity of manufacture
and sale of cement at its manufacturing unit in Andhra Pradesh and did not have
any income chargeable under the head `Profits and Gains of Business or Profession’.

The Assessing
Officer (AO) in the course of assessment proceedings observed that the share
capital of the assessee company was held by Y S Jagmohan Reddy (66.43%) and
Silicon Builders (P.) Ltd. (33.15%), a company was owned and controlled by Y S
Jagmohan Reddy. The directors of the
Company were Y S Jagohan Reddy; Harish C. Kamarthy, J Jagan Mohan Reddy, Ravinder Reddy and V. R.
Vasudevan.

During the
previous year relevant to assessment year 2009-10 the assessee company issued
0% convertible preference shares with a face value of Rs. 10/- per share and a
premium of Rs. 1,440 per share on a private placement to 3 investors viz.
Dalmia Cements Ltd., India Cements Ltd., and Suguni Contructions Pvt. Ltd., a
company belonging to Sri Nimmagadda Prasad.
The aggregate amount received by the company on account of issue of
share capital was Rs. 70.32 crore comprising of
Rs. 48.50 lakh towards face value of shares issued and Rs. 69.84 crore
towards the amount of share premium.

The AO observed
that the investments made by the investors are not technical investments but
are an arrangement between the investors and directors of the assessee company
to pass on the funds through the assessee.
He held that this was a method adopted by the directors, who were influential
persons in the then State Govt. of A.P., to pass on contracts and other
facilities to the beneficiaries. To
investigate the investments made by the subscribers, the AO issued summons u/s.
133(1) of the Act to the investors and senior officers attended but none of
them agreed that they had invested under any sort of influence. The AO brought
on record various incidences in which the investors (in the capital of the
company) were benefitted from the State Government policies and he treated the above
receipt of share premium by the assessee as income u/s. 28(iv) of the Act.

Aggrieved, the
assessee preferred an appeal to the CIT(A) who based on appraisal of evidence
on record as also further evidence held that the investments made by the
investors and the benefits and concessions received by them from Government of
A.P. were part and parcel of one integrated plan for quid pro-quo. He
also made comparison with the investments made in assessee company and shares
available in the market of same industry and not only upheld the action of the
AO but also enhanced the total income to make addition even for the face value
of the share capital issued. However, he
held the amounts to be taxable under the head `Income from Other Sources’.

Aggrieved, the
assessee preferred an appeal to the Tribunal.

HELD

The Tribunal
observed that the assessee had allotted 0% convertible preference shares on
private placement basis to three investors.
The investors were well known companies in the industry. The shares were issued at a huge
premium. While the premium was
determined without any basis, the issue and allotment was within the four
corners of law. It noted that the AO /
CIT(A) have not brought on record any issues with the issue and allotment of
shares since the allotment was in accordance with the provisions of the
Companies Act and the Rules as they existed at the time of issue and
allotment. It observed that while the
determination of premium may not be in accordance with the industry norms, it
was accepted by the investing parties.

The Tribunal
also observed that the arrangement and the circumstances leading to the issue
and allotment of shares may draw some doubts that certain benefits may have
passed on to the directors but the question is whether the directors/shareholders
have really benefitted with this arrangement and the assessee company was used
as an arrangement to pass on the benefit.
It held that the revenue has to prove that the investors have passed on the
benefit to the shareholders/directors through this arrangement by bringing
cogent material. The Tribunal held that since the assessee is artificial person
created by the statute, we cannot trespass the legal entity. It cannot (sic
can) be trespassed provided the authority has evidence to prove that this legal
person was used to pass on the benefit to the interested shareholders by
lifting the corporate veil. In this case, no such evidence was brought on
record rather circumstantial evidence and test of human probabilities were
applied to convert the capital transaction, as per Companies Act, into revenue
transaction under the Income-tax Act.

The Tribunal
held that it cannot presume or apply test of human probabilities, it observed
that it is dealing with the business transaction, it has to based on cogent
material. Considering the whole
situation, the Tribunal observed that the AO/CIT(A) have restricted themselves
tby stopping the investigation based on circumstantial evidence and applying
test of human probabilities. In order to
lift the corporate veil for the purpose of determining whether any benefit is
passed on to the shareholders/directors, they have to bring on record proper
evidence/cogent material.

The Tribunal
directed the AO to redo the assessment keeping in mind that no doubt the
assessee has received this capital receipt and what circumstances which lead to
investment is not important but whether the assessee company was used as a
vehicle to pass on the benefit to shareholders/directors.

shailesh.kwebmaker

Section 194H –Where assessee, engaged in business of providing DTH services, sold set top Box (STB) and recharge coupon vouchers to distributors at a discounted rate, discount so offered could not be considered as commission and, hence, not liable for deduction of tax at source under provisions of section 194H.

30. [2019] 197 TTJ 75 (Mumbai – Trib.) Tata Sky Ltd.
vs. ACIT ITA No.: 6923
to 6926/Mum/2012 A.Y: 2009-10 to
2012-13 Dated: 12^th
October, 2018

Section 194H
–Where assessee, engaged in business of providing DTH services, sold set top
Box (STB) and recharge coupon vouchers to distributors at a discounted rate,
discount so offered could not be considered as commission and, hence, not
liable for deduction of tax at source under provisions of section 194H.

FACTS

The
assessee-company was engaged in business of providing Direct to Home (DTH)
services in the brand name of Tata Sky. The provision of this service required
installation of set top box and dish antenna at the customer’s premises. The
assessee had entered into agreement with distributors for sale/distribution of
settop boxes, prepaid vouchers, recharge vouchers (RCVs) etc. As per the
agreements, STBs and RCVs were sold to distributors at a discounted price. The distributors/dealers
sold these items to customers/subscribers of the assessee-company at a price
not exceeding the MRP mentioned for the product.

The Assessing
Officer held that the assessee was liable to deduct tax at source in respect of
payments made to the distributors as discount for sale of STBs and recharge
coupons as same was ‘commission and brokerage’ and the same was income in the
hands of distributions for service relevant of assessee. He therefore, treated
the assessee to be in default as per the provisions of section 201(1).

Aggrieved by
the assessment order, the assessee preferred an appeal to the CIT(A). The
CIT(A) upheld the order of the Assessing officer.

HELD

The Tribunal
held that the assessee entered into agreement with the distributor for sale of
Set Top Box (STB) and recharge coupon vouchers. As per agreement products are
sold to distributor at discounted price, as agreed. The distributor/dealer
sells these items to customers/subscribers at a price not exceeding MRP on the
product. As per the agreement, payment of each order for the above items was to
be made by distributor either at the time of placing the order or at the time
of delivery. Apart from the above assessee also provided festival/seasonal
discounts to the distributors. For these discounts assessee did not make any
payment rather it issued credit notes and same was subsequently adjusted from
the payment due from the distributor, so in the financial statements the
discount amount was not reflected.

The Tribunal followed the ratio of the Bombay High
Court decisions in the case of CIT vs. Piramal Healthcare Ltd (2015) 230
Taxman 505 and CIT vs. Qatar Airways (2011) 332 ITR 253 wherein it
was held that the assessee should not be visited with the liability to deduct
TDS for non-deduction of tax at source u/s. 194H on the difference between the
discounted price at which it is sold to the distributors and the MRP upto which
they are permitted to sell. The difference between MRP and the price at which
item is sold to the distributor cannot be held to be commission or brokerage.
The distributors are customers of the assessee to whom sales are affected. The
discounts and credit notes credited cannot be considered to be commission
payment u/s. 194H and therefore, the assessee was not liable to deduct the tax at source on the impugned amounts in this case.

shailesh.kwebmaker

Section 69 r.w.s.5 & 6 –Where additions were made to income of assessee, who was a non-resident since 25 years, since, no material was brought on record to show that funds were diverted by assessee from India to source deposits found in foreign bank account, impugned additions were unjustified.

29. [2019] 197 TTJ 161 (Mumbai – Trib.) DCIT (IT) vs.
Hemant Mansukhlal Pandya ITA No.: 4679
& 4680/Mum/2016 A.Y: 2006-07
& 2007-08 Dated: 16^th
November, 2018

Section 69
r.w.s.5 & 6 –Where additions were made to income of assessee, who was a
non-resident since 25 years, since, no material was brought on record to show
that funds were diverted by assessee from India to source deposits found in
foreign bank account, impugned additions were unjustified.

FACTS

The assessee
was a non-resident individual living in Japan on a business visa since 1990. He
had been a director in a company in Japan and had got permanent residency certificate
from Japan since 2001. The assessing officer had made addition towards amount
found credited in HSBC Bank account, Geneva on the ground that the assessee had
failed to explain and prove that deposit was not having any connection to
income derived in India and not sourced from India. The Assessing Officer had
made additions on the basis of a document called ‘base note’ received from
French Government, as per which the assessee was maintaining a bank account in
HSBC Bank, Geneva. Except this, the Assessing Officer had not conducted any
independent enquiry or applied his mind before coming to the conclusion that
whether the information contained in base note was verified or authenticated.

Aggrieved by
the assessment order, the assessee preferred an appeal to the CIT(A). The
CIT(A) deleted the addition of income as made by the Assessing Officer. Being
aggrieved by the CIT(A) order, the Revenue filed an appeal before the Tribunal.

HELD

The Tribunal
held that the Assessing Officer was not justified in placing the onus of
proving a negative that the deposits in foreign bank account were not sourced
from India on the assessee. The onus of proving that an amount falls within the
taxing ambit was on the department and it was incorrect to place the onus of proving
negative on the assessee. No material was brought on record to show that the
funds were diverted by the assessee from India to source the deposits found in
foreign bank account. Therefore, it is viewed that when the Assessing Officer
found that the assessee was a non-resident Indian, was incorrect in making
addition towards deposits found in foreign bank account maintained with HSBC
Bank, Geneva without establishing the fact that the said deposit was sourced
out of income derived in India. Hence, the findings of the CIT(A) were upheld
and the appeal filed by the revenue was dismissed.

shailesh.kwebmaker

Section 68 – Mere non production of Director of Shareholder Company cannot justify adverse inference u/s. 68 of the Act.

28. (2018) 66 ITR (Trib.) 226
(Delhi) Gopal Forex Pvt. Ltd. vs. ITO ITA No.: 902/Del/2018 A.Y: 2008-09 Dated:
26^th June, 2018

Section 68 – Mere non production of Director of Shareholder Company
cannot justify adverse inference u/s. 68 of the Act.

FACTS

The assessee company filed its return of income. Subsequent to the
processing of return of income, information was received from the investigation
wing of Income tax about a search operation carried out in the case of Jain
Brothers who were involved in providing accommodation entries and bogus share
capital. The name of the assessee company was found in a list as one of the
beneficiaries.

Reassessment proceedings were initiated and additions were made by the
AO only on the basis of purported documents seized from the premises of Jain
Brothers. In the assessee’s case addition was sustained merely because the
director of shareholder company did not present himself physically before the
AO.

Important question raised before CIT(A) was whether adverse inference
u/s. 68 could be drawn by AO once assessee placed all the relevant documents in
its possession before AO to establish its burden u/s. 68, without discharging
secondary burden lying on the AO to point out defect in the assessee’s
submission.

HELD

Before the Hon’ble ITAT, heavy reliance was placed by the Hon’ble bench
on Moti Adhesives P. Ltd. ITA No. 3133/Del/2018 where it was held that
once assessee places all the reliable and trustworthy documentary evidences to
support the veracity of transactions u/s. 68, it is the duty of AO to
dispassionately consider the same with objective standards and to not make
additions solely on the basis of investigation wing’s report prepared at the
time of search. This discharges the assessee’s burden u/s. 68 & shifts the
secondary burden to the AO. To discharge his burden, the AO must bring credible
incriminating material on record to displace the detailed evidence filed by the
assessee. But in the present case, it was observed that AO merely reproduced
the investigation wing’s report in the reasons recorded, the show cause notice
issued & the final order passed. If reassessment & additions are based
upon the sole ground of prima facie opinions which are used to reopen
the case, this would frustrate the entire object of law. Besides, additions
made merely on basis of non-production of directors of Share Holder Company
disregarding all the other detailed evidences on record is unjustified.

The Hon’ble ITAT also relied on the following judgements:

i) Softline Creations
Pvt. Ltd. (387 ITR 636) [Delhi HC]

ii) CIT vs. Orissa
Corporation Pvt. Ltd. (Vol. 159 ITR 78) [SC]

iii) Crystal Networks Pvt.
Ltd. vs. CIT (353 ITR 171) [Calcutta HC]

iv) Crystal Networks Pvt.
Ltd. vs. CIT (353 ITR 171) [Calcutta HC]

v) CIT vs. Dataware Pvt.
Ltd. (ITAT No. 263 of 2011) [Calcutta HC]

vi) Rakam Money Matters Pvt.
Ltd. (ITA no. 778/2015) [Delhi HC]

vii) Orchid Industries Pvt.
Ltd. (397 ITR 136) [Bombay HC]

viii) Aksar Wire Products (P)
Ltd. (ITA no. 1167/Del/2015) [Delhi ITAT]

ix) CIT vs. Stellar
Investment Ltd. (Civil No. 7868 of 1996) [SC]

Thus, relying on the views expressed in a plethora of judgements, the
Hon’ble ITAT held that mere non production of Director of share holder company
ipso facto cannot justify straight adverse inference u/s. 68 dehors detailed
documentary evidences filed.

shailesh.kwebmaker

Section 153A, Rule 27 – Any issues other than those relating to undisclosed income which come to the AO’s knowledge while conducting enquiries relating to Search shall not be considered by AO for making assessment u/s. 153A if normal assessment for such relevant assessment years had already been completed earlier. Rule 27 gives liberty to the respondent to raise any ground which had been decided against him by the first appellate authority.

27. (2018) 66 ITR (Trib.) 306 (Delhi) ACIT vs.
Meroform India Pvt Ltd. ITA No.:
4494/Del/2014 A.Y: 2011-12 Dated: 31^st
July, 2018

Section 153A,
Rule 27 – Any issues other than those relating to undisclosed income which come
to the AO’s knowledge while conducting enquiries relating to Search shall not
be considered by AO for making assessment u/s. 153A if normal assessment for
such relevant assessment years had already been completed earlier.

Rule 27 gives
liberty to the respondent to raise any ground which had been decided against
him by the first appellate authority.

FACTS

Assessment for six years was reopened u/s.
153A. Against these, the assessee filed appeals for all the six years. Out of
these, the department preferred appeals to the Hon’ble ITAT for three
assessment years. In these three appeals, the CIT(A) had dismissed the legal
contentions of the assessee but gave relief on merits. Therefore, assessee had
not filed any cross appeal or cross objection, but it raised a legal ground by
invoking Rule 27 of ITAT Rules, challenging the validity of additions made in
the impugned assessment orders on the ground that the same were beyond the
scope of section 153A. CIT(DR) objected to the admission of the petition made
under Rule 27 and submitted that the respondent assessee cannot be permitted to
raise a ground or an issue which was decided against it which could only be
done by filing of appeal.

The second
issue raised in the appeal was whether issues already considered in the
assessments completed earlier, which had attained finality, can be re-examined
u/s. 153A by the assessing officer?

HELD

The tribunal
allowed the ground raised under Rule 27 of the Income Tax Appellate Tribunal
rules, 1963 and held
as under:

Rule 27 gives
the liberty to the respondent to support the first appellate order on any of
the ground decided against him. The issue of scope of addition in assessment
completed u/s. 153A had been decided against the assessee and therefore, as a
respondent it can very well raise the defence in the appeal filed by the
revenue. The only limitation which can be inferred is that the respondent
cannot claim any fresh relief which had been denied to him by the first
appellate authority and also which is not part of the grounds so raised by the
revenue. In the given case, it was not a claim of any fresh relief denied to
the assessee and also it was a part of the ground raised by the revenue. The
respondent assessee got the favourable judgment on merits but there was an
adverse finding on the issue of scope of addition u/s. 153A; and therefore, the
assessee can very well raise such an issue under Rule 27.

In the second
issue, the ITAT held that in the case of assessments which have attained
finality and are non-abated assessments, no additions can be made over and
above the original assessed income unless some incriminating material has been
found during the course of search. This proposition had been well discussed in
the judgment of CIT vs. Kabul Chawla (2016) 380 ITR 573 (Delhi HC).
Further, section 153A does not say that additions should be strictly made on
the basis of evidence found in the course of the search. But this does not mean
that the assessment can be arbitrary or without any relevance or nexus with the
seized material. Thus, an assessment has to be made under this Section only on
the basis of seized material as laid down in Pr.CIT vs. Meeta Gutgutia 395
ITR 526 (Delhi HC).

Thus, in the
opinion of the ITAT all the additions made by the AO in the said three
assessment years were beyond the scope of assessment u/s. 153A, because
assessments for these assessments years had attained finality before the date
of search and no incriminating material was found relating to such additions.

shailesh.kwebmaker

TRANSFER PRICING: WHAT HAS CHANGED IN OECD’S 2017 GUIDELINES? [PART 2]

This article summarises the key
additions/ modifications made in the 2017 Guidelines as compared to the earlier Guidelines. The first part of the
article, published in the December issue of the Journal, discussed about the
general guidance contained in Chapters I to V of the new Transfer Pricing
Guidelines issued in 2017 (2017 Guidelines). This part of the article deals
with guidance relating to specific transactions:

? Chapter VI – Special
Consideration for Intangibles

? Chapter VII – Special
Considerations for Intra-Group
Services,

? Chapter VIII – Cost
Contribution Agreements, and

? Chapter IX – Business
Restructurings

1. Chapter
VI – Special Considerations for Intangibles

The 2017 Guidelines
have broadened the concept of ‘intangibles’ for transfer pricing purposes, and
also provide detailed guidance on intangibles including several aspects of
intangibles not addressed in the earlier guidelines. The key differences are
discussed in this section.

1.1. Definition of
intangibles

The 2017 Guidelines
provide that the word ‘intangible’ is intended to address something which is not
a physical asset or a financial asset, which is capable of being
owned or controlled for use in commercial activities and whose
use or transfer would be compensated had it occurred in a transaction between
independent parties in comparable circumstances.¹ The 2017
Guidelines provide that intangibles that are important to consider for transfer
pricing are not always recognised as intangible assets for accounting purposes
and the accounting or legal definitions solely may not be relevant for transfer
pricing.

___________________________

1 Refer para 6.6 of 2017 Guidelines

The 2017 Guidelines discuss that distinctions are sometimes sought to be
made between (a) trade and marketing intangibles² (b) soft and hard
intangibles (c) routine and non-routine intangibles and between other classes
and categories of intangibles, but the approach to determine arm’s length price
does not depend on such categorisations.³ An illustrative list of
intangibles is also provided in the 2017 Guidelines. The Guidelines also
provide that factors such as group synergies and market specific
characteristics are not intangibles, since they cannot be owned or controlled
by any one entity in the group.

1.2. Framework for transfer
pricing analysis of transactions involving intangibles

Like any other transfer pricing matter, analysis of cases involving
intangibles should be in accordance with principles outlined under Chapter I to
III of the 2017 Guidelines. The Guidelines provide for a similar six-step
framework for analysing transactions involving intangibles.⁴

________________________________________________

2 Marketing Intangible and Trade Intangible
have also been defined in the 2017 Guidelines.

3 Refer para 6.15 of 2017 Guidelines

4 Refer para 6.34 of 2017 Guidelines

1.3. Intangible ownership and
contractual terms relating to intangibles

The 2017 Guidelines
specifically provide that legal ownership does not necessarily confer the right
to returns generated from the intangible. The Guidelines give an example of an
IP Holding Company which does not perform any relevant functions, does not
employ any relevant assets and does not assume any relevant risks. The
Guidelines provide that such party will be entitled to compensation, if any,
only for holding the title to the IP, and not in the returns otherwise
generated from the IP. The returns from the intangible, even though they accrue
initially to the legal owner of the intangible, will need to correspond to the
functions performed, assets employed and risks assumed by the different
entities in the group.

1.4. Functions, Assets and
Risks relating to Intangibles

1.4.1. Functions

The 2017 Guidelines
provide that determining the party controlling and performing functions
relating to DEMPE of intangibles is one of the key considerations in
determining arm’s length conditions for the controlled transactions.

In case some
functions are outsourced, if the legal owner neither performs nor controls the
outsourced functions relating to the DEMPE of intangible, it would not be
entitled to any ongoing benefit attributable to the outsourced functions.
Depending on the facts, the return for entities performing and controlling such
functions may comprise a share of the total return derived from exploitation of
the intangible.

1.4.2. Assets

The 2017 Guidelines
provide for considering important assets and specifically identify intangibles
used in research, development or marketing, physical assets and funding.

Unlike the earlier
guidelines, there is a detailed discussion in the 2017 Guidelines on funding,
and returns corresponding to funding. The Guidelines provide that funding
returns from intangibles would depend on the precise functions performed and
risks undertaken by the funder. An entity providing funding but not controlling
risks or performing functions relating to the funded activity would be entitled
to lesser returns than an entity which also performs and controls important
functions and controls important risks associated with the funded activity.

In the context of
funding, the Guidelines distinguish between financial risks (risks relating to
funding/ investments) and operational risks (risks relating to operational
activities for which the funding is used). If the investor controls the
financial risk associated with the provision of funding, without the assumption
of operational risks, it could generally expect only a risk-adjusted return on
its investments.

1.4.3. Risks

The 2017 Guidelines
specifically identify risks relating to transactions involving intangibles,
such as risks related to development of intangibles, risk of product
obsolescence, infringement risk, product liability risk, and exploitation risk.⁵
A detailed analysis of the assumption of these risks with respect to functions
relating to the DEMPE of intangibles is crucial.

The Guidelines also
provide that generally, the responsibility for the consequences of risks
materialising will have a direct correlation to the assumption of risks by the
parties to the transaction.

1.5. Actual (ex post)
Returns

The 2017 Guidelines
also discusses regarding sharing of profit/losses among group entities in case
of variation between actual (ex post) and anticipated (ex ante)
returns.

The 2017 Guidelines
provide that the entitlement of the group entity to the variation depends on
which party assumes the risks identified while delineating the actual
transaction. The entitlement also depends on performance of important functions
or contributing to control of economically significant risks, and for which an
arm’s length remuneration would include a profit-sharing element.

1.6. Illustration on
application of arm’s length principle in certain specific fact patterns

The 2017 Guidelines
identify specific commonly found fact patterns and provide useful guidance on
those and provide detailed guidance on these situations. These are briefly
discussed in this section.

1.6.1. Marketing intangibles

The 2017 Guidelines
discuss a common situation where a related entity performs marketing or sales
functions that benefit the legal owner of the trademark – through marketing
arrangements or distribution/marketing arrangements.⁶

___________________________

5 Refer para 6.65 of 2017 Guidelines

The Guidelines
provide that such cases require assessment of:

? Obligations
and rights implied by the legal registrations and agreements between the
parties;

? Functions
performed, assets employed and risks assumed by the parties;

? Intangible
value anticipated through the marketer/ distributor’s activities; and

? Compensation
provided to the marketer/distributor.

The Guidelines then
provide that any additional compensation for the marketer/distributor will
arise if it is not already adequately compensated for its functions through the
contractual arrangement.

1.6.2. Research, development and
process improvement arrangements

The 2017 Guidelines
provide that in cases involving contract research and development activities,
compensation on a cost plus modest mark-up basis may not reflect arm’s length
price in all cases. While determining the compensation, the Guidelines give
much weightage to the research team, i.e., including their skills and
experience, risks assumed by them, intangibles used by them, etc. Similarly,
analysis would be required in case of product or process improvements resulting
from the work of a manufacturing service provider.

1.6.3. Payment for use of company name

The 2017 Guidelines
provide that generally, no compensation should be paid to the owner of the
group name for simple recognition of group name, or to reflect the fact of
group membership. A payment would be due only if the use of the group name
provides a financial benefit to the entity using the group name. Similarly,
where an existing successful business is acquired by another business, and the
acquired business begins to use the group name, brand name, trademark, etc., of
the acquirer, there should be no automatic assumption that the acquired
business should start paying for such use of the group name and other
intangibles. In fact, in a case where the acquirer leverages the existing
positioning of the acquired business to expand to new markets, one should
evaluate whether the acquirer should pay a compensation to the acquired
business.

_________________________________

6
Refer para 6.76 of 2017 Guidelines

1.6.4. Other specific cases

The 2017 Guidelines
also provides guidance on various other specific fact patterns involving
intangibles such as transfer of all or limited rights, combination of
intangibles, transfer of intangibles with other business transactions, use of
intangibles in connection with sales of goods/ services.

1.7. Comparability factors

The 2017 Guidelines
provide detailed guidance on comparability factors relating to intangibles.
These factors should be considered in a comparability analysis especially under
the CUP Method (say, benchmarking analysis to find comparable royalty rates for
use of intangibles). The comparability factors specifically mentioned, although
not exhaustive, include exclusivity; extent and duration of legal protection;
geographic scope; useful life; stage of development; rights to enhancements,
revisions and updates; and expectation of future benefit.

Similarly, some key
risks that need to be analysed for a comparability analysis include risks
related to future development of the intangible, product obsolescence and
depreciation, infringement risks, product liability risks, etc.

1.8. Valuation of intangibles

The 2017 Guidelines
tend to favour the CUP Method and the transactional profit split method for
valuing intangibles. The Guidelines also recognise valuation techniques as
useful tools. One-sided methods including RPM and TNMM are generally not
considered reliable for directly valuing intangibles.

Use of cost-based
methods for valuing intangibles have also been largely discouraged, other than
in limited circumstances involving, say, development of intangibles for
internal business operations, especially when such intangibles are not unique
or valuable.

The Guidelines have
provided detailed guidance on the use of Discounted Cash Flow (DCF) Method or
other similar valuation methods for valuing intangibles. Having said that, the
Guidelines also caution that because of the heavy reliance on assumptions and
valuation parameters, all such assumptions and parameters must be appropriately
documented, along with the rationale for using the said assumptions or
parameters. The Guidelines also recommend taxpayers to present a sensitivity
analysis, with alternative assumptions and parameters, as part of their
transfer pricing documentation.

1.8.1. Intangibles having
uncertain valuations

In cases involving
intangibles the valuation of which is highly uncertain at the time of the
transaction, the 2017 Guidelines provide guidance on a much broader concept of
arm’s length behaviour. The Guidelines inter alia provide that in case
the valuation of the intangible is highly uncertain at the time of the
transaction, the parties to the transaction would potentially adopt short-term
agreements, include price-adjustment clauses, adopt a contingent pricing
arrangement, or even renegotiate the terms of the transaction in some cases.

1.8.2. Hard-to-Value Intangibles
(HTVI)

HTVIs include
intangibles for which, at the time of their transfer, (i) no reliable
comparables exist, and (ii) it is difficult to predict their level of success.

The 2017 Guidelines
make an exception regarding the use of ex post results, and provide that
in certain cases involving HTVIs, and subject to certain safeguards and
exemptions, ex post results can be considered as presumptive evidence
about the appropriateness of the ex ante pricing arrangements. The
Guidelines also provide a safe harbour of 20%, within which valuation based on ex
ante circumstances should not be questioned and replaced by valuation based
on ex post results.

2. Chapter
VII – Special Considerations for Intra-Group Services

In the analysis of
transfer pricing for intra-group services, one key issue is whether intra-group
services have in fact been provided, and the other issue is, what is the
intra-group charge for such services under the arm’s length principle. Detailed
guidance has been provided in the 2017 Guidelines on various aspects in the
context of intra-group services such as shareholders’ activities, on call
services, form of remuneration, determination of cost pools, documentation and
reporting, levy on withholding tax on provision of low value-added intra-group
services.

2.1. Low Value Adding
Intra-Group Services

The 2017 Guidelines
recommend an elective, simplified transfer pricing approach relating to
particular category of intra-group services referred to as low value adding
intra-group services. Under this approach, subject to fulfilment of certain
criteria, the arm’s length price of the services would be considered to be
justified without specific benchmarking and detailed documentation of the
benefit test by the recipient.

The guidance
provided in the 2017 Guidelines are summarised below.

3. Chapter
VIII – Cost Contribution Arrangements

The 2017 Guidelines
provide that a Cost Contribution Arrangement (CCA) is a contractual arrangement
among business enterprises to share the contributions and risks involved in the
joint development, production or the obtaining of intangibles, tangible assets
or services, with the understanding that such intangibles, tangible assets or
services are expected to create benefits for the individual businesses of each
of the participants.

Two types of CCAs
are commonly encountered: (1) Joint development, production or the procurement
of intangibles or tangible assets (“Development CCAs”); and (2) Procurement of
services (“services CCAs”).

With regard to
application of arm’s length principle, the general guidance provided in the
2017 Guidelines, including the risk analysis framework, also apply to CCAs. To
apply the arm’s length principle to a CCA, it is therefore a necessary
precondition that all the parties to the arrangement have a reasonable
expectation of benefit. The next step is to calculate the value of each
participant’s contribution to the joint activity, and finally to determine
whether the allocation of CCA contributions (as adjusted for any balancing
payments made among participants) accords with their respective share of
expected benefits.

The Guidelines also
provide that the guidance provided in Chapter VI relating to intangibles and
Chapter VII relating to intra-group services also apply to CCAs, to the extent
relevant.

Further, the
Guidelines provide specific additional guidance in the following areas:

3.1. Participants

A participant must
be assigned an interest or rights in the intangibles, tangible assets or
services that are the subject of the CCA and should have a reasonable
expectation of being able to benefit from that interest or those rights. The
Guidelines discuss in detail regarding determination of participants in CCAs.

3.2. Expected benefits

In determining the
participants’ share of expected benefits, the 2017 Guidelines encourage the use
of relevant allocation keys. The Guidelines also provide that the CCA should
provide for a periodic reassessment of allocation keys. Consequently, the
relevant allocation keys may change over a period of time, and this may lead to
prospective adjustments in the share of expected benefits of the participants.

3.3. Value of Contributions

The 2017 Guidelines
recommend distinguishing between pre-existing contributions and current
contributions for the purpose of valuing them. Any pre-existing contributions
(say, any existing patented technology) should generally be valued at arm’s
length based on the general guidance provided in the 2017 Guidelines, including
the use of valuation techniques. However, any current contributions (say,
ongoing R&D activities) should be valued based on the value of the
functions themselves, rather than the potential value of the future application
of such functions.

3.4. Documentation

The 2017 Guidelines
emphasise that taxpayers should provide detailed documentation relating to CCAs
as a part of the master file. Additionally, the local file should also contain
transactional information including a description of the transactions, amounts
of payments and receipts, identification of the associated enterprises
involved, copies of inter-company agreements, pricing information and
satisfaction of the arm’s length principle. The Guidelines also provide for an
additional disclosure of management and control of CCA activities and the
manner in which any future benefits from the CCA activities are expected to be
exploited.

4. Chapter
IX – Business Restructurings

The 2017 Guidelines
contain an elaborate discussion on transfer pricing aspects of business
restructurings. Business restructuring refers to the cross-border
reorganisation of the commercial or financial relations between associated
enterprises, including the termination or substantial renegotiation of existing
arrangements.

Business
restructurings may often involve the centralisation of intangibles, risks or
functions with profit potential attached to them.

As compared to the
earlier guidelines which included conversion of full-fledged distributors or
manufacturers to low risk ones and also included transfers of intangibles, the
2017 Guidelines also include concentration of functions in a regional or
central entity with corresponding reduction in scope or scale of functions carried
out locally, as a business restructuring transaction.

The Guidelines
address two aspects of a business restructuring – i) arm’s length compensation
for the restructuring itself, and ii) arm’s length pricing of
post-restructuring transactions.

Some key additional
guidance provided in these Guidelines is discussed in this section.

4.1. Arm’s length
compensation for the restructuring itself

4.1.1. Accurate delineation of the
restructuring transaction

The general
guidance relating to arm’s length principle is applicable also for business
restructuring. The 2017 Guidelines recommend performing accurate delineation of
transactions including detailed functional analysis in pre and
post-restructuring scenarios. In doing so, the Guidelines place special emphasis
on the risks transferred as a part of the restructuring, and importantly,
whether such risks are economically significant (i.e., whether they carry
significant profit potential and hence, may explain a significant reallocation
of profit potential).

Like earlier
guidelines, one needs to also analyse the business reasons for and expected
benefits from restructuring, and other options realistically available to the
parties.

4.1.2. Transfer of something of value

The 2017 Guidelines
provide that in case physical assets such as inventories are transferred
between foreign associated enterprises as a part of the restructuring, the
valuation of such assets is likely to be resolved as a part of the overall
terms of the restructuring. In practice, there may also be an inventory rundown
period before the restructuring becomes effective, to mitigate complications
relating to cross-border inventory transfers.

Similarly, in case intangibles
are transferred as a part of the restructuring, the Guidelines provide that the
valuation of such intangibles should be done in line with the guidelines
provided for valuation of intangibles, including guidance provided for valuing
HTVIs (Chapter VI).

In case of transfer
of an activity, the 2017 Guidelines are aligned with the earlier
guidelines and provide that the valuation of such an activity should be done as
a going concern of the entire activity, rather than individual assets.

4.1.3. Indemnification for termination or substantial
renegotiation of existing arrangements

Indemnification
means any type of compensation that may be paid for detriments suffered by the
restructured entity, whether in the form of an up-front payment, of a sharing
in restructuring costs, of lower (or higher) purchase (or sale) prices in the
context of the post-restructuring operations, or in any other form.

The 2017 Guidelines
provide for consideration of the following aspects in this regard:⁷

? Whether,
based on facts, the commercial law supports the right to indemnification for
the restructured entity

? Whether
the indemnification clause, or its absence, is at arm’s length

? Which
party should bear the indemnification costs

Each of the above
aspects has been discussed in detail in the OECD guidelines.

4.1.4. Documentation

The 2017 Guidelines
provide for documenting important business restructuring transactions in the
master file. Further, in the local file, taxpayers are required to indicate
whether the local entity has been involved in, or affected by, business
restructurings occurring in the past year, along with related details.

4.2. Arm’s Length
compensation for post- restructuring transactions

The 2017
Guidelines, like the earlier guidelines, provide that the arm’s length
principle should apply in the same manner to restructured transactions, as they
apply to transactions which were originally structured as such.

______________________________

7 Refer para 9.79 of 2017 Guidelines

Further, there
could be inter-linkages between the restructuring and the business arrangement
post-restructuring. In these situations, the compensation for the restructuring
and for the subsequent controlled transactions could be potentially dependent
on each other, and may need to be evaluated together from an arm’s length
perspective.

5. Concluding
Remarks

The 2017 Guidelines have addressed some key
challenges faced by taxpayers with respect to the specific
transactions/situations covered in this part of the article. In several
situations, the Guidelines provide for arm’s length behaviour in principle,
considering the overall scheme of things, and not merely evaluating the price
of isolated transactions

In the Indian
context, transfer pricing for transactions involving intangibles appears to be
a significant focus area for Indian tax authorities. Analysis of control of
functions and assumption of risks vis-à-vis provision of funding in
transactions relating to intangibles is extremely pertinent in the Indian
context given India’s leading position as a preferred destination for several
MNCs for intangible creation/upgradation in verticals such as technology,
engineering, pharma, etc.; and also given the huge marketing and promotional
spend incurred by many Indian distributors. The guidance also aligns, in
principle, with the approach of valuing intangible transfers using a DCF
approach, albeit with several safeguards relating to the assumptions and
other parameters used for valuations. Overall, the guidance provided in the
2017 Guidelines is largely being implemented by tax authorities, as evidenced
by the nature of queries and depth of discussions during APAs as well as
transfer pricing audits.

Guidance on low
value adding intra-group services has already been largely implemented in the
Indian safe harbour rules.

The 2017 Guidelines also provide several
examples relating to intangibles and CCAs in Annexes to Chapters VI and VIII,
respectively. Readers are encouraged to study the examples for a better understanding
of these concepts.

shailesh.kwebmaker

ARE PROFESSIONAL FIRMS HEADING TOWARDS EXTINCTION?

The Industrial Revolution 200 years back
completely transformed the way businesses were conducted. Work was standardised
into small repetitive steps which increased productivity not by 20% to 30% but
by a factor of hundreds. The technology revolution is today similarly poised to
transform the way in which professional practice is organised.The existing way
of conducting professional practice is undergoing a paradigm shift and
proactively managing these changes is not a matter of choice but a question of
survival. In this article an attempt has been made to articulate some of these
fundamental changes and how we need to respond to the challenges.

THE OLD WAY

Professionals as a class emerged in the
nineteenth century and today they are an indispensable part of society. They
are highly respected for their knowledge and expertise and the apex body (ICAI
in our case) under which they function has the responsibility to ensure that
those who are admitted into their fraternity are not just professionally
competent, but carry the profession with integrity.There is a tacit
understanding that in return for their specialised knowledge, the professionals
would be granted the right of self-governance in their field of expertise.

In 1939 the sociologist T.H. Marshall
remarked; “the professional man, it has been said, does not work in order to
be paid: he is paid in order that he may work.” So the core value of the
profession has been service and not profit. Some of our seniors remember with
nostalgia that we were in the profession of chartered accountancy
and not in the business of chartered accountancy.

The very foundation of the relationship
between a professional and a client is that of trust. Clients who seek the help
of professionals in matters of critical importance themselves lack the
requisite knowledge and expertise and would therefore follow implicitly the
advice of the professional. Similarly, the client would be in no position to
ascertain or even estimate what is the fair remuneration that must be paid for
such services. Indeed, the senior professionals would also reminisce about the
days when it was considered inappropriate to question a professional about his
fees.

The very basis of this relationship is now
under stress. The distinction between profession and business is getting
blurred and the concept that professionals will always put the interest of the
client above their own and act with utmost professional integrity is being
questioned. The very idea that certain tasks should be the exclusive domain of
professionals is also being questioned. Above all, technology is transforming
the manner in which professional services are rendered and professional firms
organised.

PROFESSIONAL AS THE GATEKEEPER

It is under this backdrop that one has to
try and understand the future of professionals, including Chartered
Accountants. The society expects us to be not just gatekeepers but conscious
keepers of the businesses we audit. We are expected to detect and flag off
financial impropriety and frauds; however, we continue to believe that this is
way beyond our scope of work. It has been ingrained in auditors that they are
watchdogs and not bloodhounds. However, this is a distinction that the world at
large does not understand. As John C. Coffee, Jr. asks in his book
Gatekeepers, “why did the watchdog not bark when Enron happened?”

Today, most professionals believe that
this so-called “expectation gap” needs to be bridged and that public awareness
needs to be created on the real role of the professional. However, may be we need to look at this issue from the perspective
of the public and the regulator, who expect us to detect frauds and other
financial misdemeanors. We are expected to raise an alarm well in advance when
the entity is going under. Is it possible to fulfill these expectations by
using technology, artificial intelligence (AI) and data analytics? If not,
there is a possibility that alternatives will emerge as that seems to be the
crying need of the times.

THE FEES MODEL

Also what will come under stress is the
age-old fees model that professionals have employed, where fees are
predominantly charged based on “time spent”. Clients seek professional advice
for solutions to problems that they have not fully comprehended. So
professionals don’t just help solve problems, but often also help in
articulating the problem itself with clarity. If this be the case, how can the
client even estimate the time that is expected to be spent by the professional
on a given assignment? It is hardly surprising that more and more clients want
to know the fees upfront or want a cap on the fees. Their argument is that as
professionals we have a better understanding of the problem and its intricacies
and hence are best placed to estimate the time. In other words, the risk of
time overrun (and conversely the advantage of efficiency) should be borne by
the professional.

Of course, time basis is still the only
effective and preferred fee determinant, but as professionals we must make a
conscious effort to move away from this model wherever possible for the
following reasons:

1. It is in the interest of the professional to
prolong the time, clearly leading to a conflict of interest situation.

2. The client has no means of judging the time
required or actually spent for the job. So there is an inherent reason for
heartburn that the time spent was padded up.

3. The system rewards the inefficient as those
who take more time are paid higher.

4. It stifles innovation and the need to bring
about efficiencies as there is no incentive to reduce time spent on the
assignment.

Fees charged on the basis of time spent
focuses on effort rather than results and professionals should consciously move
towards a fees model based on “value provided”.After all it is in our interest
to communicate to the client the value derived by him rather than time spent by
us.

TECHNOLOGY THE GAME CHANGER

But these are relatively minor challenges
confronting the profession. The elephant in the room is technology and
artificial intelligence that is encroaching upon all spheres of human
enterprise. According to research by Frey and Osborne cited in a 2014 article
by The Economist, Accountants and Auditors were the second highest
vocation that would be affected by technology. One of the jobs that was 10
years back believed to be immune from technology was that of a truck driver. It
was argued that driving required human skills and hence it could not be
automated. Google has now turned that argument on its head. In fact, it is not
inconceivable that children 30 years from now may be amused and amazed that
their parents actually physically drove their vehicles.

The initial efforts of using artificial
intelligence (AI) was based on trying to replicate the way the human mind
functions and these efforts only met with limited success. But today machines
have become much more adept by following a completely different path. As
Patrick Winston, a leading voice in AI stated, “there are lots of ways of
being smart that aren’t smart like us”. Chess for example was considered as
an epitome of human intelligence, intuitiveness and ingenuity. But the
programme “Deep Blue” beat the chess champion Gary Kasparov not by mimicking
the functioning of the human mind, but by applying brute computing power. The
machine lacked creativity or insights, but compensated by its ability to
analyse 200 million possible moves in seconds and winning with brute
number-crunching force.

In the light of these inevitable changes,
professionals will have to bring about transformative changes in the way they
conduct and organise their professional practice. A decade back it was common
to state that only those who will use technology effectively and integrate it
with their practice will survive. This meant the application of technology was
limited to automation and for incremental increase in efficiency and
productivity. This barely touched the tip of the proverbial iceberg in terms of
actual potential to bring about structural changes. The fact is that
technology today is no longer the enabler, it is the driver and it must be used
to bring about transformative changes. As professionals we must be prepared for
the future where judgement may be replaced by Big Data mining, experience by
analytical tools and intuition by computing logic.

BRUTE FORCE OF COMPUTING POWER

Moore’s Law predicted in 1996 that the
processing power of computers would double every two years. This sounded
improbable and certainly not sustainable, but the consensus today is that this
law will hold true for decades. Which means machines will be ever more
versatile and competent.

In the face of this, the argument often put
forth by professionals that however much one uses technology, the final
solution requires judgement and hence professionals will always be
indispensable, needs to be critically examined. The argument goes that routine,
repetitive work can be standardised and transferred to the machines, but tasks
requiring judgement and strategic inputs will still be the domain of humans.
However, the trend seems that machines with intelligent systems are bound to
become more and more sophisticated in making connections, identifying patterns,
forming correlations and finding solutions that may till now have been
considered well beyond human cognitive capabilities.

Already in a lot of areas, machines are
outperforming humans. By using their processing power, they are able to analyse
huge amounts of data to reach conclusions that are more accurate than those
reached by humans. As humans we make decisions emotionally/intuitively and then
justify them rationally. The ways of working of future machines are unlikely to
resemble the human way of working, but they will be effective and perhaps less
fallible. Deep Blue proved that human intuition and analytical capabilities are
no match for the brute computing and processing power of the computer.
Ominously, increasingly capable machines, using Big Data, AI or some other new
technology are poised to encroach upon more and more areas that were the
exclusive domain of human experts.

Audits can no longer be conducted behind the
shelter of test checks. 100% of the transactions can not only be verified, but
organised and analysed from different perspectives and this analysis can be on
real-time basis. Data can be drawn from varied sources, in different and even
unstructured formats. Analysis of this data collected both from within the
company and from other comparable businesses, may give remarkable insights into
the functioning of the auditee. At the core, Big Data is applying math to huge
quantities of data to infer probabilities and make increasingly accurate
predictions.

STANDARDISATION AND DELEGATION

Professionals also believe that their work
cannot be standardised beyond a point. It is highly intellectual and unlike
manufacturing work it cannot be spliced into small repetitive tasks. This
thinking is also under challenge and if one were to really break down the work
of a professional, a large portion can indeed be standardised and systematized.
Once that happens, it can easily be delegated to machines, and what’s more, it
can be digitised and be made available to be downloaded online. So tasks
considered as non-routine will increasingly be routinised and even genuinely
non-routine tasks may also be performed by smart machines of the future.

We have also seen that semi-qualified staff
with the aid of sophisticated technology are often as effective as highly
knowledgeable professionals. Paramedics with minimal training and good
equipment have transformed the health care in rural places. So it is not
difficult to visualise that a semi-qualified person with the help of
appropriate processes and systems will deliver the same end results as qualified
professionals. Technology-based companies could replace a lot of functions
performed by professionals with the help of semi-trained staff equipped with
the right technology support.

Would then professionals only be required to
tackle situations and problems where there are no clear-cut precedents? Without
precedents, the professionals would also be blind guessing and in such a
situation once again the computer would be better equipped to find solutions
through programmed simulation.

EXCLUSIVITY VS. COMPETITION

One big
protection for professionals is that they are insulated from competition. The
rationale is that professionals with intensive training alone can competently
handle complexities involved in a professional task. Opening out professional
tasks to non-professionals would expose the lay person to not just poor quality
of service, but to wrong and potentially damaging advice from quacks.

Surely, in
today’s knowledge world, it would be increasingly difficult to argue that
certain spheres of knowledge should be the exclusive domain of certain
professional bodies. Transparency ensures quality and as professional work is
standardised and streamlined, it is likely that in future customers will rely
more on peer review of fellow clients to decide the quality of the professional
service rather than a self-governing disciplinary mechanism.

So let’s not
be surprised if more and more tasks reserved for professionals are opened out
to others.

TO SUMMARISE

The present
form of professional practice is under threat from multiple forces:

1. AI through
brute computing and processing power is encroaching upon more and more areas of
professional practice and human endeavour.

2. Machines with Big Data
analytics are poised to produce consistently better results than those possible
by the best of professionals in ever-increasing areas.

3. Even intellectual work can be
defragmented into smaller tasks that can be standardised and hence be
machine-programmed.

4. Para professionals with
sophisticated access to databases and technology can do a large amount of work
that till now was the domain of qualified professionals.

5. The exclusivity protection to
professionals from regulators may be under threat and public opinion may compel
changes to allow many more service providers.

So the big
question: are professionals doomed to extinction? Probably not, but
professionals who are unwilling to transform their professional practice
in response to the above challenges may find it difficult to survive. Nobody
can predict the future. Yet, in a technology-driven world that premise is
nuanced as there may not be any future things that may have flourished for
centuries. As Peter Drucker put it, “the only thing we know about the
future for sure is that it will be different”.

Note: Some of the thoughts in this article
are inspired from the book “The Future of the Professions” by Richard Susskind
and Daniel Susskind.

shailesh.kwebmaker

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