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2. Instances have been reported where the Assessing Officers are not following the clarifications so issued and are taking a divergent view even in cases where the clarifications are directly applicable.
3. The undersigned is directed to convey that the field authorities are advised to follow the contents of Circular in letter and spirit. It is also advised that further appeals should not be filed in cases where orders were passed prior to issue of Circular but the issues giving rise to the disputes have been clarified by the Circular.
Facts:
While assessing the total income of the assessee the Assessing Officer (AO) lost sight of the provisions of section 50C of the Act and computed long term capital gains, arising on transfer of property, by adopting agreement value of Rs. 6 lakh to be the sale consideration. The stamp duty value of this property was Rs. 25,89,000.
Subsequently, the AO recorded reasons and reopened the assessment on the ground that income has escaped assessment. In reassessment proceedings, the AO rejected the contentions of the assessee that the property was rented and since the assessee was in need of funds he had to sell the property to its tenants. The AO adopted the stamp duty value to be full value of consideration. He also did not accept cost of construction declared by the assessee at Rs. 6,42,558 for computation of capital gains.
Aggrieved, the assessee filed an appeal to CIT(A) where it challenged the reopening and also the additions on merits. The CIT(A) held that reopening was bad in law since it was based on change of opinion as the AO did not have any tangible material in his possession except the sale deed which has already been produced before the AO at the stage of original assessment proceedings.
Aggrieved, the revenue preferred an appeal to the Tribunal. Held: The Tribunal after considering the ratio of the various decisions of the Apex Court and the High Courts held that it is clear that AO is not justified in reopening the assessment on mere change of opinion. It is admitted fact that there is no material available with the AO to form his opinion that income has escaped assessment. All material evidences were available at the stage of original assessment proceedings and the AO merely following the provisions of section 50C, as was not considered in the original assessment proceedings, reopened the assessment. The assessee has disclosed all the facts which were known all along to the Revenue. Section 50C is not final determination to prove that it is a case of escapement of income. The report of approved valuer may give estimated figure on the basis of facts of each case. Therefore, on mere applicability of section 50C would not disclose any escapement of income in the facts and circumstances of the case. The AO at the original assessment stage considered all the documents and material produced before him and has accepted the cost of property as was declared by the assessee. Therefore, on mere change of opinion, the AO was not justified in reopening the assessment. The CIT(A) on proper appreciation of facts and law correctly quashed the reassessment proceedings.
The appeal filed by the revenue was dismissed.
This circular clarifies that: –
1. Refineries are allowed to import dore up to 15% of their gross average viable quantity based on their license entitlement in the first two months for making this available to the exporters on First in First out (FIFO) basis. Thereafter, the quantum of gold dore to be imported has to be determined lot-wise on the basis of export performance.
2. Before the next import, not more than 80% can be sold domestically.
3. The dore so imported must be refined and must be released on FIFO basis following the 20:80 principle.
4. Subsequent imports will be allowed only up to 5 times the quantum for which proof of export has been submitted and this will be on accrual basis.
An accounting estimate is defined as an approximation of the amount of an item in the absence of a precise means of measurement. There are various items in the Financial Statements that cannot be measured with precision and therefore are required to be estimated. SA 540 describes the auditor’s responsibility with respect to the auditing of accounting estimates and related disclosures made by the management. Read on to know more about SA 540 with respect to the objective of the auditor, procedure to be followed, analysis to be done, approach to be used while auditing accounting estimates with the help of two case studies.
An estimate is made when there is an absence of a precise means to measure. This applies in accounting parlance as well, whereby certain items of financial statements cannot be measured with precision and are therefore required to be estimated based on reliable information and justifiable assumptions available at a point in time.
| Accounting estimates (other than fair value accounting estimates) | Fa ir v alue a c c ounting estimates |
| Allowance for doubtful | Complex financial |
| accounts | instruments, which are not |
| Inventory obsolescence | traded in an active and open |
| Warranty obligations | market |
| Depreciation method or | Share-based payments |
| asset useful life | Property or equipment held |
| Provision against the | for disposal |
| carrying amount of an | Certain assets or liabilities |
| investment where there | acquired in a business |
| exists uncertainty regarding | combination, including |
| its recoverability | goodwill and intangible |
| Outcome of long term | assets |
| contracts | Transactions involving |
| Costs arising from litigation, settlements and judgments. | the exchange of assets or liabilities between independent parties without |
| monetary consideration, for example, a non-monetary exchange of plant facilities in different lines of business. |
An accounting estimate is defined as an approximation of the amount of an item in the absence of a precise means of measurement. An illustrative list of financial statement captions where estimates are used is summarised below:
SA 540 describes the auditor’s responsibility with respect to the auditing of accounting estimates, including fair value accounting estimates, and related disclosures made by the management, wherein the objective of the auditor is to obtain sufficient appropriate audit evidence as to whether in the context of the applicable financial reporting framework:
a) accounting estimates, including fair value accounting estimates, in the financial statements, whether recognised or disclosed, are reasonable; and
b) related disclosures in the financial statements are adequate.
In order to evaluate the reasonableness of recognition of accounting estimates, the auditor shall:
a) obtain an understanding of how management identifies those transactions, events and conditions that may give rise to the need for accounting estimates to be recognised or disclosed in the financial statements and
b) understand how the estimates have been made and what data and assumptions have been used to make such estimates
The understanding so obtained will enable the auditor to assess:
a) for recurring estimates, the historical reliability of the entity’s estimates and the appropriateness of changes, if any, in the existing accounting estimates or in the method or assumptions for making them from the prior period;
b) the completeness and accuracy of key data used in making the estimate;
c) evaluation of management’s use of an expert;
d) the reasonableness of management’s significant assumptions, including any indication of management bias and, where relevant, management’s intent to carry out specific courses of action and its ability to do so;
e) the reasonableness of management’s estimate, including whether the selected measurement basis for the accounting estimate and management’s decision to recognise or not recognise the estimate is in accordance with the require-ments of the applicable financial reporting framework;
f) subsequent events or other subsequent information, if any, that may affect the estimate;
g) the consistency of application of judgments or estimates to similar transactions;
h) business or industry specific factors that may have significant effect on the assumptions
For accounting estimates that give rise to significant risks at the financial statement assertion level, the auditor needs to evaluate how management has considered alternative assumptions and their outcomes on accounting estimates and reasons for their rejection/acceptance. Such examples include estimates pertaining to useful life of tangible assets particularly for entities operating in specialised sectors such as aviation, oil exploration, power generation, infrastructure etc, estimate of useful life of intangible assets such as toll collection rights purchased by a toll operating company, cash flows from a cash generating unit for the purpose of impairment testing, allowances for doubtful debts, inventory obsolescence in technology driven industries, etc.
Sensitivity analysis is one of the methods that can be used to evaluate how an accounting estimate varies with different assumptions. The objective of this evaluation is to obtain sufficient appropriate audit evidence to ensure that management has assessed the effect of estimation uncertainty on accounting estimates. Where management has not considered alternative assumptions or outcomes, the auditor would need to discuss with the man-agement as to how it has addressed the effects of estimation uncertainty and where empirical external evidence is available, evaluate the appropriateness of the estimate considered by the management.
Once the auditor understands the process, there are generally two approaches that the auditor can use:
a) test the process used by management to make the estimate, including testing the reliability of the underlying data, or alternatively
b) develop an independent expectation of the estimate and compare this with the estimate developed by the management.
The choice between these two approaches will depend on the magnitude and complexity of the account balance. An example of the latter ap-proach is the comparison of provision for warranty costs with the estimates made by the management in recent past to determine its reasonableness.
While assessing the methods and assumptions used, the auditor may also need to consider whether management has engaged an expert having specialised knowledge or skills in determining an accounting estimate. Actuarial valuation of employee benefits by an actuary, surveyor’s estimation of the quantum of inventory in certain specialised industries using items such as coal, natural gypsum etc., certification of completion of project work by project engineers to facilitate revenue recognition in construction contracts are some of the elementary examples of involvement of an expert to determine an accounting estimate. The auditor would need to review the appropriateness of estimates made by the expert. For e.g., in case of actuarial valuation of retirement benefits, the auditor would need to evaluate the appropriateness of the estimate of discount rate by reviewing economic reports for interest rates, estimate of salary growth and attrition by reviewing industry reports, estimate of mortality by reviewing annuity/life tables used by insurance companies etc. Similarly for estimation of inventory by surveyors, the auditor would need to assess the estimation methodology used by the surveyor, quantum of inventory holding vis-à-vis consumption pattern, subsequent production of finished goods and other related factors to obtain assurance over the appropriateness of the inventory estimated by the surveyor.
Another pertinent area where estimates are used is for impairment testing for fixed assets. Asset impairment is based either on appraisal of current market value of the asset or based on estimated cash flows from the continuing use of such asset for its remaining useful life. Estimates of future cash flows provided by the management need to be analysed for the reasonableness of the assumptions and consistency with current and predicted future results.
Management may be satisfied that it has adequately addressed the effects of estimation uncertainty in accounting estimates that give rise to significant risks in the preparation of financial statements, however, the auditor may consider this to be inadequate due to non- availability of sufficient appropriate audit evidence or where the auditor believes there exists an indication of management bias in making the estimates. The auditor in such a case may evaluate the reasonableness of the accounting estimate by developing a point estimate or a range. This can be understood with the help of the following example:
Case study 1 (Accounting estimates):
XYZ Ltd (‘XYZ’) is a reputed watch manufacturer and has been in this business for the last 5 years. XYZ commenced its operations during the year ended 31st March 20X0. XYZ formulated a policy of providing free repairs to its customers for a period of 1 year from the date of sale. The sale contract gives the customer, a right to have the watches repaired free of cost for defects that get contracted within a period of one year from the date of purchase of the product. Since inception, XYZ has been providing for warranty costs @ 3% of the value of watches sold during the year.
During the year ended 31st March 20X6, XYZ upgraded its quality testing equipment enabling introduction of certain additional quality checks in the manufacturing process. Management expects that these additional checks would result in more stringent quality clearance of finished products for ultimate sale to customers. Therefore for the year ended 31st March 20X6, management decided to provide for warranty costs at a lower rate of 1% of the value of sales made during the year.
Let us examine the procedures that auditors would need to follow in terms of the requirements of SA 540:
Though the accounting framework does not prescribe a method or model to provide or compute warranty provision, management is required to make a best estimate of the warranty cost based on cumulative experience of the industry, customer base and the likely cost of repairs.
Auditors would need to review the outcome of accounting estimates included in the prior period financial statements and their subsequent re-estimation for the purpose of the current period. Auditors would need to perform a subsequent period testing to deduce actual costs incurred against the provision and effectiveness of controls on accounting of such costs.
Auditors would need to review the trend of actual repair costs incurred over the years and evaluate whether the basis of measurement (as a percentage of sales) needs modification.
Auditor would compare the nature of the earlier warranty claims and how the new machines would take care of these complaints to reduce the warranty costs.
Obtain written representations from management whether they believe significant assumptions used in making accounting estimates are reasonable.
Auditors would need to evaluate whether the management decision to change the estimate basis is indicative of a possible management bias.
Case study 2 (Fair value accounting estimate):
Double Dip Ltd. (DDL) has given 100 options to its employees to receive remuneration in the form of equity settled instruments, for rendering services over a defined vesting period of three years.
The options will vest in three tranches over a period of three years as follows:
Period within which options % of options
will vest to the participant that will vest
|
End of 12 months from the |
|
|
date of grant of options |
34 |
|
End of 24 months from the |
|
|
date of grant of options |
34 |
|
End of 36 months from the |
|
|
date of grant of options |
32 |
DDL measures options granted by reference to the fair value of the instrument at the date of grant. The expense is recognised in the statement of income with a corresponding increase to the share based payment reserve, a component of equity.
The fair value determined at the grant date is ex-pensed over the vesting period of the respective tranches of such grants. The stock compensation expense is determined based on DDL’s estimate of equity instruments that will eventually vest over a period of three years.
The key assumptions used to estimate the fair value of options are given below:
The options were granted on 31st December 20XX and DDL has recognized Rs. 10 crore as fair value cost of options granted.
Analysis
|
Risk-free interest rate |
8% |
|
Expected Life |
3 years |
|
Expected volatility |
46% |
|
Expected dividend yield |
0.02% |
|
Price of the underlying share |
|
|
in market at the time of |
|
|
option grant |
Rs. 250 |
|
Expected forfeiture rate |
3% |
In the given example, the fair value of options as arrived by the management is an estimate and the same has been derived on the basis of various assumptions considered by the management.
The auditors of the Company would need to verify whether the fair value of the options as estimated by the management is reasonable. For this purpose, various assumptions considered by the management would need to be evaluated and assessed independently i.e., completeness and accuracy of data considered for arriving at business and industry specific factors like risk free interest rate etc.
The auditors would also need to consider estimation uncertainty i.e. possible effects of the various alternatives. In the given case, expected volatility is the factor wherein the auditor would need to assess various assumptions and data used to compute the volatility benchmark and what would be the possible effects on the expected volatility if there is a change in the underlying assumptions as well as the overall effect on the fair value of the options because of change in expected volatility.
The auditor needs to ensure that work done by management to mitigate the risk of estimation uncertainty is sufficient enough to support the appropriateness of the estimate. In the event where work done by management is inadequate, the appropriateness of the estimate would have to be assessed independently by the auditors, if required, through point of estimation or range. The auditor may obtain assurance on the expected volatility, based on an analysis of data of entities in similar industry having issued similar options.
Conclusion
An estimate can be significantly affected by management bias and estimation uncertainty. An estimate is a complex process of arriving to an answer where we do not have precise measure of calculating an item of provision. There are accounting estimates as well as as fair value estimates that requires thorough review by an auditor of the process and assumptions used by the management of arriving the same. As such, significant estimates require the exercise of signifi-cant judgment by the auditor and documentation of those judgments is critical to understanding how conclusions were reached. In some cases, even small changes in inputs can result in large changes in value. Hence, an estimate is an estimate; it is not a precise answer.
Following the rapid ushering in of the Companies Act, 2013, MCA has also started issuing draft rules. The author highlights the glaring lacunae in the Draft Rules for Accounting for Demerger, which require the accounting to be undertaken in accordance with the current provisions under Income Tax governing demergers, instead of acceptable accounting principles.
This article deals with the issues relating to accounting for demerger, as a result of the draft rules under the Companies Act 2013. The said rules are not yet final.
As per the draft rules, “demerger” in relation to companies means transfer, pursuant to scheme of arrangement by a ‘demerged company’ of its one or more undertakings to any ‘resulting company’ in such a manner as provided in section 2(19AA) of the Income Tax Act, 1961, subject to fulfilling the conditions stipulated in section 2(19AA) of the Income Tax Act and shares have been allotted by the ‘resulting company’ to the shareholders of the ‘demerged company’ against the transfer of assets and liabilities.
As per section 2 (19AA) of the Income-tax Act, “demerger” in relation to companies, means the transfer, pursuant to a scheme of arrangement under the Companies Act, 1956, by a demerged company of its one or more undertakings to any resulting company in such a manner that—
i. all the property of the undertaking, being transferred by the demerged company, immediately before the demerger, becomes the property of the resulting company by virtue of the demerger;
ii. all the liabilities relatable to the undertaking, being transferred by the demerged company, immediately before the demerger, become the liabilities of the resulting company by virtue of the demerger;
iii. the property and the liabilities of the undertaking or undertakings being transferred by the demerged company are transferred at values appearing in its books of account immediately before the demerger;
iv. the resulting company issues, in consideration of the demerger, its shares to the shareholders of the demerged company on a proportionate basis [except where the resulting company itself is a shareholder of the demerged company];
v. the shareholders holding not less than threefourths in value of the shares in the demerged company (other than shares already held therein immediately before the demerger, or by a nominee for, the resulting company or, its subsidiary) become share-holders of the resulting company or companies by virtue of the demerger, otherwise than as a result of the acquisition of the property or assets of the demerged company or any undertaking thereof by the resulting company;
vi. the transfer of the undertaking is on a going concern basis;
vii. the demerger is in accordance with the conditions, if any, notified u/s.s. (5) of section 72A by the Central Government in this behalf.
Explanation 1—For the purposes of this clause, “undertaking” shall include any part of an undertaking, or a unit or division of an undertaking or a business activity taken as a whole, but does not include individual assets or liabilities or any combination thereof not constituting a business activity.
Explanation 2—For the purposes of this clause, the liabilities referred to in sub-clause (ii), shall include—
(a) the liabilities which arise out of the activities or operations of the undertaking;
(b) the specific loans or borrowings (including debentures) raised, incurred and utilised solely for the activities or operations of the undertaking; and
(c) in cases, other than those referred to in clause (a) or clause (b), so much of the amounts of general or multipurpose borrowings, if any, of the demerged company as stand in the same proportion which the value of the assets transferred in a demerger bears to the total value of the assets of such demerged company immediately before the demerger.
Explanation 3—For determining the value of the property referred to in sub-clause (iii), any change in the value of assets consequent to their revaluation shall be ignored.
Explanation 4—For the purposes of this clause, the splitting up or the reconstruction of any authority or a body constituted or established under a Central, State or Provincial Act, or a local authority or a public sector company, into separate authorities or bodies or local authorities or companies, as the case may be, shall be deemed to be a demerger if such split up or reconstruction fulfils such conditions as may be notified in the Official Gazette, by the Central Government.
Accounting for demerger under the draft rules issued under Companies Act 2013
The draft rules recognise that accounting standards issued under the Companies Accounting Standard Rules do not contain any standard for demergers. Till such time an accounting standard is prescribed for the purpose of ‘demerger’, the accounting treatment shall be in accordance with the conditions stipulated in section 2(19AA) of the Income Tax Act, 1961 and
(i) in the books of the ‘demerged company’:-
(a) assets and liabilities shall be transferred at the same value appearing in the books, without considering any revaluation or writing off of assets carried out during the preceding two financial years; and
(b) the difference between the value of assets and liabilities shall be credited to capital reserve or debited to goodwill.
(ii) in the books of ‘resulting company’:-
(a) assets and liabilities of ‘demerged company’ transferred shall be recorded at the same value appearing in the books of the ‘demerged company’ without considering any revaluation or writing off of assets carried out during the preceding two financial years;
(b) shares issued shall be credited to the share capital account; and
(c) the excess or deficit, if any, remaining after recording the aforesaid entries shall be credited to capital reserve or debited to goodwill as the case may be.
Provided that a certificate from a chartered accountant is submitted to the Tribunal to the effect that both ‘demerged company’ and ‘resulting company’ have complied with conditions as above and accounting treatment prescribed in this rule.
Author’s Analysis
First, the draft rules are designed to ensure compliance with section 2(19AA). In the author’s view, accounting treatment should be governed by Indian GAAP, Ind-AS/IFRS or generally acceptable accounting practices; rather than, the provisions of the Income- tax Act. The requirement to record demergers at book values in accordance with section 2(19AA) may not gel well with the requirements of generally acceptable accounting practices. For example, under IFRS/Ind-AS, distribution to shareholders is recorded at fair value, whereas under the draft rules the same is recorded at book value. This anomaly should be rectified through a collaborative effort of the Institute of Chartered Accountants (ICAI), the Ministry of Corporate Affairs (MCA) and the Central Board of Direct Taxes (CBDT). However it appears that this may not be as easy as it appears. Many issues need to be first resolved, such as, the strategy with respect to, implementation of Ind-AS/ IFRS, continuation of Indian GAAP for some entities, implementation of Tax Accounting Standards, implementation of the IFRS SME standard, etc needs to be finalised. Right now, this whole area is a maelstrom and the Government and the ICAI should provide a clear roadmap, before complicating this space any further.
Second, the draft rules and section 2(19AA) of the Income-tax Act assumes a very simple scenario of demerger. In practice, demerger may involve many structuring complexities. The draft rules therefore are very elementary. They focus on the accounting that is required in a narrow situation where the demerger is in accordance with section 2(19AA) of the Income-tax Act.
Third, the draft rules on accounting of demerger is applicable only when the demerger is in accordance with section 2(19AA) of the Income-tax Act. These accounting rules are not applicable when the demerger is not in accordance with section 2(19AA). For example, a company demerging one of its undertaking may be doing so, to unlock value rather than obtaining tax benefits under section 2(19AA). For such demerger, the prescribed draft accounting rules are not applicable. Thus, as an example, the resulting company could account for the assets and liabilities taken over at fair value rather than on the basis of book values as prescribed in the draft rules.Fourth, in the books of the demerged company when the transfer to a resulting company is a net liability, the draft rules require the corresponding credit to be given to capital reserves. This accounting seems appropriate, as it could be argued that the shareholders are taking over the net liability, and hence this is a contribution by the shareholders to the company. When the transfer to a resulting company is a net asset, the draft rules require the corresponding debit to be given to goodwill. This seems completely ridiculous as distribution of net assets to shareholders cannot under any circumstances result in goodwill for the demerged company. Rather it is a distribution by the demerged company of the net assets to the shareholders, and hence the debit should be made to general reserves. This mistake should be corrected in the final rules. Fifth, in the books of the resulting company, the net assets/liabilities taken over are recorded at book values. This is designed to comply with the requirements of section 2(19AA). As already indicated, the accounting in statutory books should not be guided by the requirements of the Income-tax Act. In practice, the resulting company may want to record the said transfer at fair value, to capture the business valuation. Whilst for tax computation purposes, he net assets may be recorded at book values; it is inappropriate for the Income-tax Act to suggest the accounting to be done in statutory books.Lastly, in the resulting company there is no requirement in respect of how share capital is valued. Thus the securities premium, goodwill and capital reserves can be flexibly determined by ascribing a desired value to the share capital. This is certainly not an appropriate approach from an accounting point of view.
In conclusion, the author believes that some immediate correction is required in the draft accounting rules as suggested in this article. In the long term, accounting should be driven by sound accounting practices and not by income-tax requirements. In this regard, ICAI, CBDT and the MCA should collaborate and establish a clear roadmap for the future.
Effective External Audit, a key pillar for having a good governance structure, is not only a statutory requirement but is also intended to be an unbiased review of the financial statements and the underlying transactions by an independent audit professional to protect the interests of all the stakeholders. In this process, communication by the auditors with those in charge of governance such as audit committees is very crucial. Regulators in various countries are seriously exploring the possibility of introducing a framework for extracting additional information from the auditors. Read on to know more about the items which are typically reported by the auditors to the audit committees based on the practices prevailing in several countries and the emerging trends in this area.
Introduction
Effective External Audit is one of the key pillars for having a good governance structure in any organisational set up especially in the corporate form. The audit process is not only a statutory requirement but is also intended to be an impartial/ unbiased review of the financial statements and the underlying transactions by an independent audit professional, which protects the interests of all the stakeholders. In this process, communication by the auditors with those in charge of governance such as audit committees is very crucial and helps in better understanding of the financial statements and the accounting aspects. Above all, it brings in enormous transparency in sharing the critical information relating to the entity with those who are legally and morally responsible for ensuring good governance. Further, these communications with the audit committee also provide auditors with an exclusive forum separate from the management to discuss matters about the audit and the company’s financial reporting process.
Currently, in addition to the standard audit report on the financial statements and the existing requirement of reporting to those in charge of governance, the regulators in various countries are seriously exploring the possibility of introducing a framework for extracting additional information from the auditors such as Auditors’ Discussion & Analysis on the financial statements similar to that of the Management Discussions & Analysis and enhancing the audit scope/reporting requirements to provide a more detailed and professional analysis to all the readers of the financial statements.
In this context, considering the ever increasing appetite for obtaining more information from the auditor, and the legal/regulatory environment, the auditing standards in general provide for reporting on various matters to those in charge of governance. This article summarises some of the items which are typically reported by the auditors to the audit committees based on the practices prevailing in several countries and the emerging trends in this area.
Reporting Framework in India and in Other Countries
Indian Standard on Auditing SA 260 -“Communication with Those Charged with Governance” deals with the reporting requirements for auditors to those in charge of governance. The SA 260 does not contain any material modifications vis-a-vis ISA 260, which is the equivalent International Auditing Standard. This standard aims at creating a platform to promote effective two-way communication between the auditor and those charged with governance and provides an overall framework for the auditor’s communication with those charged with governance and identifies some specific matters to be communicated to them. However, nothing in this SA precludes the auditor from communicating any other matters to those charged with governance.
Although the auditor is responsible for communicating matters required by this SA, the management also has a responsibility to communicate matters of governance interest to those charged with governance. Communication by the auditor does not relieve the management of this responsibility. Similarly, communication by the management with those charged with governance of matters that the auditor is required to communicate does not relieve the auditor of his responsibility to also communicate to them.
The requirement in India is similar to the reporting requirement in several other geographies where the standard establishes a framework for the auditor to communicate certain matters related to the conduct of an audit to those who have responsibility for oversight of the financial reporting process. For example, in the United States, AU Section 380 – “Communication with Audit Committees” deals with such a reporting requirement for the auditors. Recently, the Public Company Accounting Oversight Board (PCAOB), the auditing regulator in the USA, approved Auditing Standard 16 on communications with the audit committees, which substantially enhances the reporting obligations on the part of the auditors. In Australia, the auditing standard ASA 260 deals with the communication relating to those charged with governance which is very similar to the international reporting framework. The Financial Reporting Council in the UK has recently issued FRC 260, International Standard on Auditing (UK and Ireland) relating to communication with those charged with governance, which puts onerous responsibilities on the external auditors. Singapore Standard on Auditing (SSA 260) is also in line with the reporting requirements of other countries.
Whilst the basic audit committee reporting requirements on the part of the auditors remain the same in many jurisdictions, there is also an emerging trend of mandating auditors to provide more specific information on various aspects relating to the audit process and the financial statements duly considering the country specific requirements and the expectations of the stakeholders.
Matters considered for Reporting The matters which are typically included in the communications to the audit committee can be broadly classified in to two categories, namely;
• Regular Reportable Matters
• Emerging Additional Reporting Requirements
This classification is based on the general practice/ applicability in various jurisdictions and the contents could vary depending on the need/other requirements.
Regular Reportable Matters
The list of items which are included in the regular list of items to be reported would include the following:
• The Auditor’s Responsibility under Generally Accepted Auditing Standards
• Significant Accounting Policies
• Management Judgments and Accounting Estimates
• Composition of the Engagement Team
• A statement that the Engagement Team and others in the firm as appropriate, the firm and, when applicable, network firms have complied with relevant ethical requirements regarding independence
• Planned Scope of Audit
• Overview of the Audit Strategy, Timing of the Audit, and Significant Risks
• Consideration of Fraud in a Financial Statements Audit
• Significant Issues Discussed with the Management prior to retention
• The form, timing, and expected general content of communications
• Disagreements with the Management
• Consultation with other accountants
• Difficulties encountered in performing the audit
• Communication about Control Deficiencies in an audit of Financial Statements
• Financial Statement Presentation
• Alternative Accounting Treatments.
• Significant Audit Adjustments
• Significant Findings from the Audit
• All written representations requested from the Management (where the Management is separate from those charged with governance)
Emerging Additional Reporting Requirements
Items which are increasingly required to be reported in communications by the auditors to the audit commit-tee depending on the various regulatory/other requirements/practices are listed below;
• All relationships and other matters between the firm, network firms and the entity which, in the auditor’s professional judgment, may reasonably be thought to bear on the firm’s independence.
• The related safeguards that have been applied to eliminate identified threats to independence or reduce them to an acceptable level.
• The total fees charged by the audit firm (including network firms) for audit and non-audit services for the period covered by the financial report audit.
• Assessment of the adequacy of the communication process, between the auditor and those charged with governance for the purposes of the audit.
• Illegal Acts
• Going-Concern Matters
• Material Written Communications between the audi-tor and the Management.
• Significant unusual transactions
• Departure from the Auditor’s Standard Report
• Matters that have arisen during the audit which are significant to the oversight of the financial reporting process
• Difficult or contentious matters on which the auditor was consulted
• Specific matters relating to the group audits to be communicated by the parent company auditors
• Auditor’s Judgments about the quality of the entity’s accounting principles and practices
• Auditor’s opinion on other information in any other document which contains the Audited Financial Statements
• New accounting pronouncements and their impact on the entity
Background for the Enhanced Expectations for Additional Reporting Requirements
The emerging regulatory framework is tilted towards enhancing the relevance, timeliness, and quality of the communications between the auditor and the audit committee relative to the annual audit and related in-terim period reviews and fosters constructive dialogue between the auditor and the audit committee about significant audit and financial statement matters. The underlying reasons for enhancing the reporting requirements to the audit committee by the auditors which are emerging in several jurisdictions are explained below.
The audit committee has an important role to play in the relationship between the executive management and the external auditors. The audit committee should always make the external auditor aware of any issues which are of concern to it. Similarly, the external auditor should inform the audit committee of any concerns he has so as to ensure that the financial oversight process is complete and comprehensive. This is absolutely essential since the extent of importance provided to the audit process and the oversight provided by the audit committee is on the rise worldwide. For example, in Belgium, the statute explicitly requires that the audit committee monitors the statutory audit of the annual consolidated accounts, including the follow up of questions raised by the statutory auditor. The French Stock Exchange Authority requires the audit committees to discuss with their statutory auditors specifically and formally, any difficulties they have faced during the course of their audit.
Facing more scrutiny from regulators and investors, audit committees are continuing to challenge their roles and responsibilities. A primary responsibility of the audit committee is to oversee the integrity of the company’s accounting and reporting practices and financial statements. As financial reporting becomes more complex, the audit committee needs to make sure that the financial statements are understandable and transparent. To perform their oversight responsibilities, audit committee members need to understand what information they need, how to analyse it and what questions to ask to gain insights and make informed decisions. In view of the above, the audit committees are expecting enhanced support from the external audi-tors and candid and open communication between the external auditor and the audit committee is imperative in this regard.
The expectations from different stakeholders relating to the compliance aspects of various laws and regulations are also another reason for the enhanced reporting requirements. In some of the jurisdictions, the auditor is now required to inquire if the audit committee is aware of any matters relevant to the audit, including but not limited to violations or possible violations of laws or regulations. Further, the auditor should also assure himself that the audit committee or others with equivalent authority and responsibility is adequately informed with respect to illegal acts that come to the auditor’s attention.
Need for proactive action, understanding the nuances relating to the audit process, managing the subjective assessments, fixing the specific responsibilities have changed the entire dimension of the oversight function. This has also resulted in mandating the auditors to provide information on various significant aspects of the audit such as the planned use of other auditors to audit certain components or subsidiaries, the basis for the auditor’s determination that they can serve as the principal auditor, consultations on difficult or contentious matters outside the engagement team, specialised skill and knowledge to complete the audit, any concerns regarding the management’s anticipated application of accounting pronouncements that are not yet effective.
Audit is no longer an exercise of just ticking the numbers and confirming the mathematical accuracy of the figures provided by the management. It has changed its dimension quite drastically in the recent past and the audit process now requires thorough understanding of the business, external and the internal environments, regulatory framework in which the entity operates business and other risks, internal control framework, computer environment and much more. Currently, there is an expectation to have industry specialists in the audit field so as to bring lot more value to the audit process by demonstrating the immense industry experience. In this background, an auditor is now required to ensure that the audit committee is informed about the methods used to account for significant unusual transaction and the auditor would also be required to communicate about additional aspects of such significant unusual transactions, including the his understanding of the business rationale for them and not just the company’s methods of accounting for them.
Conclusion
Regulators worldwide believe that effective communication between the auditor and the audit committee allows the audit committee to be well-informed about accounting and disclosure matters, including the auditor’s evaluation of matters that are significant to the financial statements and to be better able to carry out its oversight role. Further, the auditor also benefits from a meaningful exchange of information regarding significant risks of material misstatement in the financial statements and other matters that may affect the integrity of the company’s financial reports.
In today’s world, the varying expectations of the stakeholders impose an onerous responsibility on the part of the audit committee and the auditors to discharge their duties properly. One should always remember that the roles of the auditors and the audit committees are critical to the efficiency and integrity of the capital markets and for protecting the interests of the various stakeholders. Considering enhanced regula-tory and legal environment and the investor activism, seamless and timely communication between the au-ditor and the audit committee is absolutely essential. This would pave the way for transparent and focused discussions and would also help in taking well informed decisions and having an effective financial oversight.
In a dynamic environment, the roles and the responsibilities keep changing and the audit profession is not an exception to this ground level reality. Hence, the audit community should rise to the occasion and use this tool of communicating with the audit committee purposefully for not only discharging their professional/ regulatory responsibilities but also for demonstrating their professional expertise and the value created by the services rendered. This would enhance the image of the profession and make the audit process more valuable and reliable.
Land acquisition now has become a crucial driver for development activities undertaken by Government and Private Sector. Central Government has proposed a combined bill on land acquisition and rehabilitation and resettlement which shall now also cover private sector. Hence it is all the more important to analyze various nuances involved in such kind of transactions. There are three types of cost involved in acquisition of land Direct compensation, future subsistence cost for displacement of livelihood of the families and community development and welfare activities in general. The author describes accounting, recognition , measurement treatment and taxation impact on such kind of costs.
Introduction
With the growing need to grow, various industrialists in developing nations like India step forward to invest in new manufacturing facilities. One of the key requisite for this activity is Land, on which the upcoming industries will be set up. Land acquisition is a crucial driver for various infrastructures projects and economic developmental activities undertaken by the Government as well as by Private sector.
Land acquisition refers to the compulsory acquisition of land by the government from the owner of land. In India it is governed under Land Acquisition Act, 1894. Land may be acquired for defence and national security; roads, railways, highways, and ports built by public as well as private sector enterprises; planned development; residential purposes for the poor and landless, etc. This Act did not include any rehabilitation or resettlement scheme or address any Social impact on such acquisition by Government. In 2003, the Central Government formulated the National Rehabilitation and Resettlement Policy, which was last updated in 2007. It provides for minimum rehabilitation and resettlement expenditure that has to be incurred by the Government machinery, though State Governments can provide for additional rehabilitation avenues. In order to facilitate the process of acquisition, many private enterprises have adopted to acquire the land through Government under the provisions of the Act.
Central Government has proposed a combined bill on Land Acquisition and Rehabilitation and Resettlement in the Parliament. The proposed bill requires all Private land acquisitions also to provide rehabilitation and resettlement to displaced people if the area of acquisition is over a certain limit.
As per the existing and proposed guidelines, there are three types of costs incurred while acquiring land:
a. Direct Compensation for the fair value of the piece of land;
b. Future subsistence cost for displacement of the livelihood of the families; and
c. Community development and welfare activities in general.
To take a practical view, following are the objectives and various cost components that are part of Jharkhand Rehabilitation and Resettlement policy – 2008:
Objectives of the Policy
1. to minimise displacement and to promote, as far as possible, non-displacing or least displacing alternatives;
2. to ensure adequate rehabilitation package and expeditious implementation of the rehabilitation process with the active participation of the affected families;
3. to ensure that special care is taken for protecting the rights of the weaker sections of society, especially members of the Scheduled Tribe and Scheduled Castes with concern and sensitivity;
4. to provide a better standard of living, making concerted efforts for providing sustainable income to the affected families;
5. to integrate rehabilitation concerns into the development planning and implementation process; and
6. where displacement is on account of land acquisition, to facilitate harmonious relationship between the requiring body and affected families through mutual cooperation.
Direct Compensation – Family specific
i. Piece of land for constructing house, free of cost
ii. Construct a permanent establishment for the displaced land owner
iii. One time financial assistance in case of the family wishes to relocate.
Future Subsistence – Family specific
i. Allowance for displacement of cattle and Employment to individuals from those family
ii. Employment to family members.
iii. If employment is not given or accepted by land owner, then regular income for sustaining life of the individual for a period of 25 to 30 years depending upon State Governments i.e. Bhatta.
iv. Percentage share in net profits of the company
Community/Infrastructure Development – General
i. Expenses on village infrastructure development such as roads, water and sewerage systems, drainage systems, education, skill development, etc.
ii. Construction of Residential colonies.
Recognition and measurement With respect to compensation cost, there is no ambiguity as it represents direct cost of acquisition based on fair market value of the piece of land.
It is Rehabilitation and Resettlement (R&R) expenditure where various practices have been observed in its recognition and measurement. Some attribute a nexus to acquisition of land and capitalise the entire expected outflow on this account. While some account the R&R cost as revenue expenditure, as and when incurred.
Accounting Policy excerpt from NTPC Limited Consolidated Financial Statements 2009
“Based on the opinions of the Expert Advisory Committee (EAC) of the Institute of Chartered Accountants of India (ICAI) received during the year, in respect of land in possession of the company, provision of Rs. 3,197 million has been made towards expenditure on resettlement & rehabilitation activities including the amount payable to the project affected persons (PAPs) towards land for land option, resettlement grant or other grants, providing community facilities and compensatory afforestation, greenbelt development & loss of environmental value etc. based on the Rehabilitation Action Plan (RAP) of the Company or as per the agreement with/demand letters/directions of the local authorities and the same is included in the cost of land”.
Accounting Policy excerpt from NTPC Limited Consolidated Financial Statements 2012
“Fixed assets: Deposits, payments/liabilities made provisionally towards compensation, rehabilitation and other expenses relatable to land in possession are treated as cost of land.”
Accounting Policy excerpt from Coal India Limited Annual Report 2012
“Land: Value of Land includes cost of acquisition and Cash rehabilitation expenses and resettlement cost incurred for concerned displaced persons. Other expenditure incurred on acquisition of land viz. compensation in lieu of employment, etc are, however, treated as revenue expenditure.”
Looking at the compensation structure in acquisition of land, it seems to be similar to acquisition of Spectrum, which requires initial license fee and regular revenue share to the government with minimum committed every year.
In fact, the analogy also holds good in case of acquisitions of definite life assets such as Mine, Coal or an Oil Block. In these cases, since the assets are not in ready to use condition at the first instance. Government allots them at nominal value with limit on its capital exploration expenditure, as seen in case of Oil& Gas exploration. Once the asset is ready to use, there is a regular fee/royalty/revenue share based on production on an annual basis till the useful resource is depleted.
This analogy is drawn on following counts:
i. Both, the assets, ie Spectrum in specific, as well as Land, have indefinite useful life.
ii. The compensation for both types of asset acquisition is split into 3 categories
– The utilisation of natural resource also requires certain rehabilitation expenditure such as mine rehabilitation, maintenance of flaura & fauna of the place and other environmental obligations on sustaining basis.
Let us understand the facets of concerns and issues involved in measurement and recognition for accounting of various components of such rehabilitation and resettlement cost.
Recognition and Measurement:
From the accounting perspective, the following two issues arise with regard to the R&R expenditure:
i) The timing of the creation of the provision for R&R expenditure; and
ii) The corresponding debit in respect of the provision, i.e., whether the same should be capitalised or recognised as an expense in the statement of profit and loss.
There is no specific literature for the given case except from the Technical guide on Accounting for Special Economic Zones (SEZs) Development Activities.
It states that “in accordance with the above principles of recognition of provision as enunciated in AS 29, the provision for R & R expenditure should be created and accounted for as follows:
(i) In respect of the R&R expenditure which arises on the acquisition of land as the lump-sum or annuity payment to be made by a Developer to the land seller, provision should be created at the time of the acquisition of the land itself. This is because the Developer has present obligation in this regard at the time of the acquisition of the land itself and the other two criteria for recognition are normally met at that point of time. The amount in respect of the provision should be capitalised as a part of the cost of the land. Similarly, provision should be created at the time of acquisition of land in respect of the other R&R expenditure with regard to which the Developer has a present obligation which cannot be avoided by the Developer by a future action.
Such expenditure should also be capitalised as part of the cost of land.
(ii) Where a provision is not related to any asset, to be recognised as the asset of the Developer, for example, R&R incurred with respect to those assets which will not be recognised by the Developer because he would not be the owner of these assets as these will be transferred to the local area administrators, for example, village panchayats, the same should be recognised in the statement of profit and loss when the provision in this regard is made.
(iii)The R&R expenses, which are revenue in nature, e.g., revenue expenditure in respect of Education and Health Programmes, should be recognised in the statement of profit and loss for the period in which the criteria for making the provision in this regard are met.
The Acquirer has present obligation in this regard at the time of the acquisition of the land itself, there is high probability of outflow of resources to settle the obligation and a reliable estimate can be made at that point of time. These are essentially the three criteria with regard to the timing of the creation of the provision, Accounting Standard (AS) 29, Provisions, Contingent Liabilities and Contingent Assets.”
The Technical guide as referred above, requires all direct and indirect expenditure i.e. Compensation as well as subsistence cost, to be capitalised with the Cost of Land. For Community related expenditure, it however suggests to recognise a separate asset if the expenditure is incurred for creation of a capital asset ie roads, hospitals, buildings, etc and charge to income statement if the expenditure is for health programs and other such Corporate social responsibility measures, as and when incurred.
It is to note that all the three types of expenditure (ie direct compensation of fair value, subsistence cost and community development) is incurred only for acquiring the Land and hence there is direct nexus of such expenditure with the asset in balance sheet. It is within the direct framework of AS 10 Fixed assets to capitalise direct compensation cost to Cost of land, however, capitalising future subsistence expenditure to cost of Land seems to be little unreasonable.
Expert advisory Opinion:
Provision towards resettlement and rehabilitation schemes (Compendium of Opinions — Vol. XXVIII)
The querist had sought an opinion on recognition and measurement of expenditure incurred/to be incurred while acquiring land of project purposes.
The Committee opined as follows:
(a)In respect of the estimated amount payable to the land oustees in respect of ‘Land for Land’, re-habilitation/ resettlement grants, subsistence grant/ self-resettlement grant, a provision, on the basis of best estimate of the expenditure required to settle the obligation, should be made on the acquisition of land from the project affected persons.
(b) In respect of infrastructural measures, a provision on the basis of best estimate of the expenditure re-quired to settle the obligation, should be made on the acquisition of land from the project affected persons.
The recognition criteria for provision is dependent on an Obligating event. The committee has considered the acquisition of Land as the obligating event for recognising a provision for future subsistence cost as well as Community development/Infrastructure related cost.
Looking at the larger picture, following aspect may be evaluated for considering the substance, while applying the recognition and measurement principles for R&R expenditure:
In a growing economy which has natural resources and tribal population residing in interior rural India, setting up a manufacturing plant requires following five major partners:
1. Businessmen, i.e., Promoter with equity and vi-sion;
2. Banks to support the additional capital;
3. Government to allow use of the country’s re-sources (some having definite and some indefi-nite life)
4. People who own a perpetual/indefinite life asset, i.e., Land; and last but not the least
5. Environment/nature itself.
Establishment of any project in backward rural areas is possible only if it benefits all. Government Policy plays a crucial role in combining and serving the interest of all parties and executing the project.
While Promoters with equity investment earn profits from an ongoing business, Lenders earn their share of profit in terms of fixed service cost since they part their money only for short period.
Government initially recovers a fair value of the natural resource but since some of them have in-definite life, it also charges on-going basis, a share in its profits as in case of spectrum usage in Telecom i.e. Revenue Share, Revenue share in Oil & Gas and Royalty in case of mines.
Similar to Government, people who have been living and earning their livelihood also possess and own an asset with indefinite life. In order to obtain their consent, a similar policy is followed wherein they initially get the fair value of their asset and continue to earn the share of business profits for their balance life.
Their contribution to the business is more than Lenders as they have a right to share the profits in a fixed form like “Bhatta” or Share in profits till plant operation, in perpetuity as per the regulations promulgated by the State Governments. This partnership with people promises a regular income to the owner of land which is similar to the revenue share in case of Spectrum Usage, Revenue share and Royalty.
In the above presented partnership, the cost of acquisition as well as future expenditure obligations is known, but then there is no need to create a provision/capitalisation on Day 1 for the Promoter for his future share of profits, for the lender/banker for its committed interest service, Government for its future estimated royalties based on estimated business cashflows, then why should there be a provision and capitalization (in land) of future subsistence cost in case of displaced landowners !!.
Excerpts from AS 29: Provisions, Contingent Liabili-ties and Contingent assets
14. A provision should be recognised when:
(a) an enterprise has a present obligation as a result of a past event;
(b) it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and
(c) a reliable estimate can be made of the amount of the obligation.
Analysing the above requirement of the standard, all the components of R&R costs arise on account of signing an agreement with the land owners for acquiring their land and hence at any subsequent reporting date, an enterprise has obligation on account of the past event i.e. signing the land acquisition contract. However, some of the expenses are arguably not the present obligation but are future obligations.
It is probable that the obligation will lead to out-flow of resources but reliable estimate may not be done for cases that require sharing of future profits. The future estimates are though available with the Company as they are shared with various analysts, it may not be completely reliable, though contrary view exists.
Further, the future obligations under Indian GAAP are recorded at its full value instead of using dis-counted approach. In any case, if such costs are considered as part of capital costs, the actual share in profit for every year will lead to adjustment to the cost of land, which the entity will have to keep a tab till the life of asset. It is more cumbersome under IFRS, which requires use of present value principles for making a provision.
As we have broadly categorised various expenditure components of R&R cost into Compensation, Future subsistence and Community Development.
The first category that includes viz..cost of piece of land for constructing house, free of cost, construct a permanent establishment for the displaced land owner, one time financial assistance in case of the family wishes to relocate, satisfy all the three criteria for provision under AS 29 and also has a direct established nexus for acquisition of land. Thus a provision is made and amount is capitalised with the cost of Land in case of payments to landowners.
Commitments for schools, hospitals, etc. be owned by the Company but for the benefit of people are recognised as fixed assets as and when constructed, CSR activities are expensed as and when incurred. Unfinished work forms part of Commitments disclosure in Balance Sheet.
It is the cost that is in the nature of future subsis-tence that needs to be recognised and measured with its substance rather than form.
Taxation impact
Any cost capitalised as part of land is a capital cost. There is no depreciation benefit available to the Company, though the cost of land increases and the company can avail higher cost at the time of sale of such land. However, it is to note that the Company has not acquired the land for disposal, hence the cost incurred on land is essentially a sunk cost which yields no tax benefit.
Considering the tax perspective, the company sharing percentage profit every year with land owners, will not be allowed to consider as a revenue expenditure if the Company had to provide for and capitalise the entire future profits along with the cost of land.
No depreciation benefit and no direct allowable ex-pense benefit is available in income tax computation for such cost. Thus entities will have to carefully determine its accounting policy.
Points of relevance
a. The Land is for a specific usage as per the policy of the State Government.
b. It can be observed that the Future subsistence costs are in the nature of Corporate Social Responsibility (CSR) which are incurred by the Company and moreso governed by Statute.
c. Some costs are not compensation for land but for future subsistence of displaced people till the plant is in operation and have direct nexus with Operations of the plant. For example, if the company is shut down, there will be no employment, if there is not profit, there is no share of profit.
d. Some are in the nature of regular taxes levied by stature such as property taxes. In case of R&R these are regular income to land owners in the form of Bhatta.
e. If the landowner agrees for employment, the amount of salary is charged to the income statement, but if he agrees for fixed income without employment, then it gets linked towards cost of land and not for future right to use on annual basis like property taxes.
f. Payments made on account of future subsistence, if capitalised with the cost of land, then it may not be allowed as expenditure in income statement which is not the case with “Revenue share” and “Royalty”.
g. Acquiring the land is in substance similar to a Purchase order issued by a company for future subsistence cost. Thus the obligating event is de-ferred to respective future period for provisioning.
Views that emerge
Immediate cost that is compensating the landowners immediate needs to be capitalised with cost of land.
Subsistence allowance which is committed by the Company at the time of acquisition of land is a binding commitment towards land owners. The Obligating event ie acquisition of land only gives rise to a commitment for future and should be viewed as a period cost charged to operations. Especially for clauses such as share of profits, where even determination of profit may not be a reliable estimate, though alternate view exists.
Similar to telecom and hydrocarbon businesses, land acquisition also is regulated for specific usage and regular subsistence cost based on earning. Hence recognising the future subsistence cost component in substance to be considered as part of income state-ment, as one of the charges for the usage of asset. This would to be more in line with comparative asset acquisitions (ie Spectrum, Mine, Oil & Gas) followed by enterprises and also justifies its core substance. Unrecognised commitment can be disclosed as off-balance sheet item under ‘Contractual Commitments’.
Developers other than those opting for Composition Scheme are given one more month after due date to file MVAT audit report in Form 704. Thus, if audit report is filed on or before 15th February, 2014 then penalty u/s. 61 shall not be imposed.
India’s GDP growth has halved from over 9% in 2010-11 to just 4.5% in the current year. Many economists, industrialists, investment analysts and business observers & advisors are demanding more economic reforms from the Government. Recently, the Union Cabinet has cleared projects worth more than Rs. 3 lakh crore. Yet, industrial growth remains below 2%, and the index of industrial production has actually fallen.
One really wonders: why so much effort is producing so little result? There are many shades of opinions, answers & suggestions. One of the important reasons is that though economic reforms at Central Level are essential they have stagnated. In a Federal Structure, we also need additional economic reforms at the State Level.
Gone are the days when an industrial licence was the key hurdle. Today, not just Union Government but the State Governments too have, in their worthy search for inclusiveness, created voluminous laws and regulations regarding conservation of environment, forests, tribal areas and land acquisition etc.
Even central regulations have to be implemented by officials in the State Secretariats and at district levels. The states themselves have to approve / grant many clearances / licenses/ permits/ NOCs relating to forests, tribal areas, environment, mining rights, pollution and land acquisition, power / water supply etc. Thus, hundreds of projects do not move forward.
The States need to rethink their approach towards economic growth. They have limited technical and bureaucratic capacity, and cannot easily handle even public law & order and task of providing various basic services to the public. The Doing Business 2013 report of the World Bank ranks India at only 134th of 189 countries in ease of doing business. India comes only 179th in ease of starting a business, 182nd in ease of getting a construction permit, 111th in getting an electric connection, 158th in paying taxes, 92nd in ease of registering property and 186th in enforcing contracts.
Most hurdles to doing business in India require state-level reforms, not just the central level. State governments are important actors in granting permissions / approvals / clearances to commence a business (particularly an Industrial Project), notably in the conversion of agricultural land into an industrial land.
Businessmen pay both central and state taxes, several times a year. They pay Corporate tax, Service tax, Excise Duty, Customs duty, Octroi, Municipal taxes, Sales tax / VAT, Entry tax and a host of other minor imposts, each entailing hours of paperwork. It is ridiculous that India is 158th in this respect despite having some of the best software companies in the world, which can surely devise simplified, quick tax payments.
One rarely hears a Chief Minister or a state level Finance Minister, Law Minister, Industries Minister, Revenue Minister or Urban Development Minister ever talking about State Level Economic Reforms or laying Road-map for the same. Therefore, we need to stop focusing on just macroeconomic or central government reforms. The most urgent reforms in many fields are needed at the state level and the time has come for voters to demand similar economic reforms in various arenas in their state.
Mr. Kunte came from a small town of Alibag in Raigad district. He came from a very humble background and stayed with his elder sister while doing his articleship in Mumbai. He started his firm around 1956 in Mumbai. During the first decade of his practice, he did not have too much work. He spent these years reading and gathering knowledge. He would tell us that this helped him a great deal when work started pouring in.
Around 1966-67, he started acquiring bigger clients like Aptes in Mumbai and Chowgules in Goa. These were followed by many more in the next few years – from Hero Group in Ludhiana, Kirloskar and Kalyani in Pune, Ghatge Patil in Kolhapur, Alfa Laval, WIMCO in Mumbai and so on. By mid-seventies, he had set up offices in as many as seven – eight cities across India and one at Dubai. At a time when most of the prominent firms were operating only out of Mumbai, he set up offices in smaller cities to cater to the local clients. Till mid-eighties, he would travel for more than 20 days in a month and work for 12 to 14 hours a day.
Mr. Kunte had many exceptional aptitudes. He had a deep knowledge of almost all the relevant Civil laws of the land. His speciality was to interconnect the provisions of different laws. He was brilliant in tax planning and used novel ideas which were his own. For example, in the early seventies, he created capital structure of two types of equity shares with different rights for private companies of his clients which helped to reduce wealth tax liability. For a few clients, he set up trusts in which creditors of the settlor were the primary beneficiaries and receipt by these creditors from the trusts were repayment of their dues and hence not an income. One important rule followed by Mr. Kunte was to read the relevant provisions of applicable laws before giving answer to any query. He would say that when you read the section from the angle of the problem, it gives you a new perspective. He would urge us to first read the sections, form our opinion and only then read the commentary and case laws. He never believed in giving off-the-cuff replies.
Mr. Kunte followed a strict regime of a very ethical practice. As a strict rule, neither he nor any of the partners or employees were allowed to acquire shares of companies that were clients of the firm. In 1985, he was a director in an MNC and was offered 50,000 shares at par whose market price on listing was expected to be much higher. He, however, refused the offer. His view was that a consultant should have absolutely no conflict of interest which would affect the fairness of his advice. This was at a time when there were no Insider Trading Regulations.
Mr. Kunte was a humble and simple man. Though he was advisor to many big industrialists, his personal ideology was of a socialist. He was philanthropic and would urge all of us to spend a portion of the income on charity. He himself set up a number of charitable trusts. One of the trusts ran a blind girls’ institution at Goregaon. He also helped many charitable organisations but strictly on anonymous basis. In the late seventies, he even donated his office at Hamam Street to Bombay Chartered Accountants’ Society. Through trusts on which he was a trustee, he helped BCA to set up a research fund and a library fund.
Finally, the biggest and lasting contribution of Mr. Kunte to the profession is the army of juniors that he trained. The training he imparted to all of us was exceptional. He would throw the problems at us and urge us to form our opinion and then discuss with him. During his professional career, he may have trained more than 20 highly successful juniors all of whom owe their success to him. He was the Guru to them in a truly “Gurukul” tradition where the juniors would stay at his house for many days and get trained. Although, his body has ceased to exist in this world, his soul would continue to live through all of us juniors whom he had trained.
Article 124 of the Constitution says that the President of India, in consultation with the Chief Justice of the Supreme Court, would appoint the judges. The Supreme Court took this to mean that neither the executive nor the legislature could have a say in the appointment and transfers of judges. The convention in respect of this is laid down very firmly indeed in the S. P. Gupta case in 1981, when memories of what the government had done to the judiciary during the Emergency were still very fresh and strong. The government has been grumbling since then. In 1993, the Supreme Court instituted a collegium system, which apparently diluted the power of the Chief Justice but did not abridge the judiciary’s right to appoint its own. In 1998, then President K. R. Narayanan made a Presidential reference questioning the collegium system. While this resulted in more guidelines for appointments and transfers, the core power remained with the judiciary. Since then, the executive has tried hard to put a different appointment system in place. The JAC is the final result.
The JAC will be headed by the Chief Justice of India. The other members are the law minister, two of the senior-most judges of the Supreme Court, the law secretary and – in an idea that has been borrowed from the United Kingdom – two “eminent” persons, to be chosen by the prime minister, the Chief Justice of India and leaders of the Opposition in the Lok Sabha and the Rajya Sabha. It would seem that in the ordinary course of things, there are now enough checks and balances. The criteria for becoming a member of the JAC should now be spelt out clearly. One niggling question remains, however: will this system abridge the independence of the judiciary in some unforeseen way? By its very nature, the unforeseen cannot be anticipated. However, it is possible that – just as it happens in any selection done by committees – there will still be some room for bargaining, which leads to the best judges not being appointed. Such outcomes could be minimized by ensuring open hearings, which limit the scope of such backroom deals. In any case, a simple application of a brute majority decision rule does not always lead to the best results; at the very least, such voting should also be embedded in an open and transparent exchange of reasons.
On appeal by the assessee, the CIT(A) observed that though the NHAI remained the legal owner of the site with full powers to hold, dispose of and deal with the site consistent with the provisions of the agreement, the assessee had been granted not merely possession but also right to enjoyment of the site and NHAI was obliged to defend this right and the assessee has the power to exclude others. In view thereof and relying on certain decisions he held that the assessee was entitled for depreciation. Against this, the Revenue went in appeal before the tribunal.
Held:
The tribunal referred to the decision of the Apex court in the case of Mysore Minerals Ltd. vs. CIT (239 ITR 775) wherein the meaning of word “owner” was explained. In the said case, the Court had allowed the assessee’s claim for depreciation where the title deeds were not executed and possession was given. Further, the tribunal referred to the case of CIT v. Podar Cement (P.) Ltd. (226 ITR 625) (S.C.) where the Court considered the meaning of the word “owner” in section 22 and held that the owner is a person, who is entitled to receive income from the property in his own right. Further, relying on the decision of the Apex Court in the case of R.B. Jodha Mal Kuthiala vs. CIT (82 ITR 570), the Allahabad High Court in the case of CIT vs. Noida Toll Bridge Co. Ltd. (213 Taxman 333) and of the Hyderabad tribunal in the case of M/s. PVR Industries Ltd. (ITA No. 1171, 1175/Hyd/07 and 1176, 1196/Hyd/08 dated 08-06- 2011), dismissed the appeal filed by the revenue.
This Article explores the difference in law between the terms “sale” and “exchange” which are both a mode of transferring property. Various Supreme Court and Other decisions have analysed this difference. The difference also has a bearing on the tax treatment of a sale and an exchange. Recently, the issue has gained importance because of the question of taxation of a slump exchange as compared to a slump sale.
Introduction
“A Rose by Any Other Name Smells As Sweet”— Shakespeare, Romeo and Juliet
While Shakespeare may be right in several cases, when it comes to the transfer of property, there is a difference between ‘Sale’ and ‘Exchange’. Property, whether movable or immovable, can be transferred in a variety of ways, such as, sale, gift, lease, mortgage, exchange, etc. Each of these terms has a different meaning and are not synonyms for one another. What is a sale and what is an exchange has often been the subject-matter of discussion under Tax and other Laws since the consequences of the same vary. Recently, the issue has come into sharp focus because of various decisions under the Income-tax Act dealing with the concept of Slump Exchange. Let us examine the meaning associated with these terms in law.
Meaning of Sale The Transfer of Property Act, 1882 defines sale (in respect of immovable property) to mean a transfer of ownership in exchange for a price paid or promise or part-paid and part-promised. In Samaratmal vs. Govind, (1901) ILB 25 Bom 696. The word ‘ price’ as used in the sections relating to sales in the Transfer of Property Act was held to be in the sense of money.
The Sale of Goods Act, 1930 which deals with the law relating to sale of goods is also relevant. It defines a contract of sale to mean a contract whereby the seller transfers property in goods to the buyer for a price. Where under such a contract, the goods are transferred by the seller, then the contract is called a sale. Thus, price is an essential element under both the Acts. This Act defines the term price to mean money consideration for a sale of goods. Thus, the Sale of Goods Act is very specific in respect of the definition of ‘price’.
Meaning of Exchange An exchange on the other hand, is defined by the same Act to mean a mutual transfer of the ownership of one thing for the ownership of another thing and neither thing nor both thing being money only. The definition of exchange covers both immovable property as well as novable property/goods. Thus, the absence of money is the hallmark of an exchange. A part of the consideration may be in the form of money but there must be something more which must be in kind. E.g., Mr. A lives on a 3 bedroom flat on the 1st floor of a building and he also owns a 2 bedroom flat on the 5th floor of the same building. His neighbour Mr. X lives in a 2 bedroom flat on the 1st floor of the same building. Mr. A and Mr. X agree to swap their 2 bedroom flats, by which Mr. A becomes the owner of both the flats on the 1st floor while Mr. X now owns a flat on the 5th floor. This is a transaction of exchange. In case the properties are of different values, then some money consideration may be paid to neutralise the exchange. However, the transaction yet remains one of an exchange – Fathe Singh vs. Prith Singh AIR 1930 All 426.
Difference As opposed to a sale transaction, the fundamental difference is the absence of money as consideration. However, a sale can also take place where instead of the buyer paying the seller, some debt owed by the seller to the buyer is set-off. That does not make the transaction one of an exchange. For instance in Panchanan Mondal vs. Tarapada Mondal, 1961 (1) I.L.R.(Cal) 619, the seller agreed to sell a property to the buyer for a certain price by one document and by a second document he also agreed to buy another property of the buyer for the same amount. Instead of the buyer paying the seller and vice-versa, they agreed to set-off the two amounts. It was held that the transactions were for execution of two Sale Agreements and not for a Deed of Exchange.
The distinction between a sale and an exchange transaction has been very succinctly brought out by three Supreme Court decisions under the Income-tax Act:
(a) CIT vs. Ramakrishna Pillai (R.R.), 66 ITR 725 (SC)
The Court explained the distinction between an exchange and a sale by an illustration of a person selling his business to a company in exchange for its shares and a person selling his business for money and using that money for subscribing to the shares of that company. The Court held,
“……….. Where the person carrying on the business transfers the assets to a company in consideration of allotment of shares, it would be a case of exchange and not of sale,..”
(b) CIT vs. Motors and General Stores (P.) Ltd., 66 ITR 692 (SC)
This was also a case of a sale of business to a company in exchange for shares of that company. The board of directors of a company executed a deed styled “exchange deed” whereby the company transferred all the assets of its cinema house for a consideration in the shape of certain preference shares in a sugar company. The question was whether the transaction was a sale? The Supreme Court held:
“………..that in essence the transaction …….was one of exchange and there was no sale of the assets of the cinema house for any money consideration …………
Sale is a transfer of property in goods ………… for a money consideration. But in exchange there is a reciprocal transfer of interest in immovable property, a corresponding transfer of interest in movable property being denoted by the word “barter”. The difference between a sale and an exchange is this, that in the former the price is paid in money, whilst in the latter it is paid in goods by way of barter .The presence of money consideration is an essential element in a transaction of sale. If the consideration is not money but some other valuable consideration it may be an exchange or barter but not a sale.”
(c) CIT vs. B. M. Kharwar 72 ITR 603 (SC) ” Where the person carrying on the business transfers the assets to a company in consideration of allotment of shares, it would be a case of exchange, and not of sale, ……. ”
These decisions have very clearly laid down that the difference between a sale and an exchange is that in a sale the price is always paid in money, whilst in an exchange it is always paid in goods by way of barter. The presence of money consideration is an essential element in a transaction of sale. If the consideration is not money but some other valuable consideration it may be an exchange or barter but not a sale.
Each of the parties to an exchange are both a buyer and a seller of property and hence, each of them has the rights which a seller has and is subjected to the liabilities and obligations of a buyer. This is an unique feature of an exchange since a person plays a dual role of a seller as well as a buyer. The decision in the case of Kama Sahu vs. Krishna Sahu, 1954 AIR(Ori) 105 also throws light on this issue:
“…..It appears from this definition that a sale should always be for a price, but in the case of exchange the transfer of the ownership of one thing is not for any price paid or promised, but for transfer of another thing in return….. If in case a transfer of ownership of an immovable property is exchanged for money, then the transaction cannot be an exchange, but a sale. It being so, unless the properties of both parties are simultaneously transferred in favour of each other, the title to the property cannot pass in favour of the one when the other party does not execute any such document in favour of the other. Exchange can be effected either by one document or by different documents. The consideration for the one document executed in pursuance of an agreement for exchange is the execution of a document by the other party. Unless it is so done, the party who has taken the deed from the other party without himself executing any document in favour of that other party, cannot claim to have got a valid title to the property until and unless he executes a similar document transferring his interest in favour of that other party. …… In the case of an exchange, the intention of parties cannot but be that there should be a reciprocal transfer of two things at the same time and that until such a thing is done, the passing of title under the one document executed in pursuance of the contract, should always be postponed till after the execution of the another document by the other party…”
There cannot be an exchange if the parties to the transaction are not the same. In the case of Than Singh and Ors. vs. Nandu Kirpa Jat and Ors., 1978 AIR(P&H) 94, a Deed of Exchange was executed for two immovable properties between two persons. On the very same day, one of the persons to the Deed of Exchange executed a Sale Deed in respect of the property which she received under the Deed of Exchange. It was contended that the exchange was actually a sale. The Court considered the definition of the terms and held:
“….The deed in question fully complies with the requisites of exchange in terms of S. 118 of the Transfer of Property Act and it admits of no other interpretation except that of exchange. The subsequent transaction may be on the same day but it is not between the same parties. Hence it cannot be said that the deed in fact is a cloak on sale and is not an exchange…”
In Sardara Singh vs. Harbhajan Singh, 1974 AIR(P&H) 345, the Court held that Chapter III of the Transfer of Property Act deals with sales of immovable prop-erty, Chapter IV deals with mortgages of immovable property and charges, Chapter V deals with leases of immovable property, and Chapter VI deals with exchanges. Hence, the very scheme of the Act clearly shows that the sales, mortgages, leases and exchanges of the immovable property are dealt with on totally different footings and it is futile to urge that one takes colour from the other.
Tax Consequences of an Exchange
An exchange is a transfer u/s. 2(47) of the Income-tax Act. Hence, an exchange would give rise to capital gains in the hands of the transferor. If the property is immovable property then the provisions of section 50C / section 43CA of deemed sale consideration would also apply. The transferor would be taxed with reference to the fair market value of the property received by him in exchange for the property given up by him. Thus, it becomes important to arrive at a valuation of the property received as well as the property transferred. Unlike in the case of a sale, where the full value of consideration is to be taxed (except in case of deeming fictions, such as, section 50C) , in the case of an exchange one taxes the fair market value of the property received in exchange. This is a very important distinction between the two.
Stamp Duty is payable on an Deed of Exchange. The higher of the values of the two properties would form the basis for levying stamp duty. The rate of stamp duty is the same as applicable on a conveyance.
Taxation of a Slump Exchange
While on the subject of Sale vs. Exchange, we may also consider the position of a ‘slump exchange’. In the case of a slump exchange, all the assets and li-abilities relating to an undertaking is transferred to a buyer company and in consideration for the same, the buyer company issues its equity shares to the seller entity. Section 2(42C) of the Income-tax Act, defines a slump sale as transfer of one or more undertaking for lump sum consideration without values being assigned to individual assets and liabilities in such a sale. The capital gain arising on a slump sale is computed as per the provisions of section 50B of the Income-tax Act.
However, how does one compute capital gains in the case of a slump exchange? As discussed above, a sale requires that the consideration be in the form of money, whereas in case of a slump exchange, the consideration is shares of the buyer company.
The Mumbai Tribunal in the case of Bharat Bijilee Ltd, TS-96-ITAT-2011 (Mum), has examined the issue of tax-ability of a slump exchange. It held that in order to constitute a “slump sale” u/s. 2(42C), the transfer must be as a result of a “sale” i.e., for a money consideration and not by way of an “Exchange”. In that case, it was held that as the undertaking was transferred in consideration of shares and bonds, it was a case of “exchange” and not of “sale” and so section 2(42C) and section 50B would not apply. As regards taxability u/ss. 45 and 48, it was held that the “capital asset” which was transferred was the “entire undertaking” and not individual assets and liabilities forming part of the undertaking. In the absence of a cost/date of acquisition of the undertaking, the computation and charging provisions of section 45 fail and the transaction cannot be assessed. Hence, there was no tax on the transaction.
A similar view has been taken in the recent decision of Zinger Investments (P.) Ltd (2013) 38 taxmann. com 388 (Hyd).
In Avaya Global Connect Ltd., 26 SOT 397(Mum), the Tribunal held that section 2(42C) only deals with a transfer as a result of sale that can be construed as a slump sale. Therefore, any transfer of an undertaking otherwise than as a result of sale would not qualify as a ‘slump sale’. It was further held that if the transfer is as a result of a Court-approved Scheme of Arrangement under which no monetary consideration is paid, then it is not a sale of an undertaking by the assessee.
However, in Virtual Software and Training (P), (2008) 116 TTJ 920 (Delhi) , there was a transfer of an undertaking as a going concern in consideration for an issue of equity shares of the buyer company. The Delhi Tribunal held that such a transaction would also be covered under the definition of slump sale under the Income-tax Act. Even if the trans-action did not constitute a sale under the Sale of Goods Act or Transfer of Property Act, it would still constitute a transfer u/s. 2(47) of the Income-tax Act.
The Delhi High Court in the case of SREI Infrastructure Finance Ltd, TS-237-HC-2012 (Del) had an occasion to consider a case where a sale of an undertaking was carried out by way of a Court-approved Scheme of Arrangement for consideration in cash. The Court held that the definition of slump sale was wide enough to cover sales which took place under Court Schemes also. It may be noted that this was not a case of a slump exchange but was actually a sale by virtue of a Court Scheme.
Conclusion
The way in which a transaction is structured and its documentation drafted would determine its tax and other consequences. Unintended consequences could follow if proper care is not taken while structuring and drafting.
Exercise of due care and caution is required and we need to remember that sale and exchange are as apart as chalk and cheese and never the twain shall meet!
On 9th January 2014, SEBI has notified the final Regulations for settlement of violations of various securities laws. A better set of provisions have replaced the earlier ones which have stronger base in law, but are complex. These new settlement terms are more certain now and leave lesser discretion for the authorities. The author discusses the importance of settlement route, the scheme of the Regulations and also, highlights some issues relating to the same.
Background
SEBI has notified, after consultations, trials and errors, on 9th January 2014, the final Regulations for settlement of violations of various securities laws. This culminates a long journey since 2007 when the first Guidelines were issued, then revised in 2011 and then, after certain changes to SEBI Act and other statutes, finally made formal and detailed Regulations.
Importance of settlement route to cure violations The importance of settlement proceedings lies in the fact that, on the one hand, the securities laws have become exceedingly elaborate and complex. On the other hand, the powers of SEBI to punish in various ways violations have only increased. A Supreme Court decision in Shriram Mutual Fund’s case (AIR 2006 SC 2287) is regularly relied on, mistakenly to some extent in my view, to take a view that penalty has to follow any violation. This mens rea, intention, etc. do not have to be established. For most persons associated with securities markets, the punishment is not just the penalty but the prolonged and legal costly proceedings. In comparison, the procedure of settlement is quick, relatively cheap and generally taint-free. Indeed, the settlement mechanism of SEBI compares quite favorably in many ways with corresponding settlement mechanism under other laws. However, with the passage of time the simple mechanism of the original 2007 Guidelines have inevitably become complex.
While the Regulations are largely an improved version of the Guidelines of 2011, which have been briefly discussed earlier in this column, it would be necessary to summarise the scheme of the Regulations here and highlight some issues.
At the outset, however, it is important to mention the reason why formal Regulations had to be issued and why the Guidelines were not found sufficient. A public interest litigation has been filed in Delhi High Court questioning the power of SEBI to settle violations under the Guidelines. The concern that exists is that the cases settled from 2007 till date may get affected if the Court gives any adverse decision. To alleviate this concern, the SEBI Act and other statutes were amended by a recent ordinance to empower SEBI to formulate regulations permitting settlement of cases.
Scheme of the Regulations The procedure remains broadly the same as under the original Guidelines of 2007. Any person who faces or could face charges for having violated any of the specified securities laws can apply to SEBI for settlement. An independent high power advisory committee (HPAC) would consider the application and clear the same for acceptance and the settled amount paid. In such case, no further proceedings would be taken in respect of such violations. If rejected, the proceedings may be initiated or continued.
However, there are several changes from the 2007 Guidelines and there are other aspects that need discussion too.
There is a three-step formal procedure for consent now. The application would be first placed before an internal committee of SEBI which will examine it in light of the Regulations, ask for further documents and call for personal appearance by the applicant (personally and/or through authorised representative). If the settlement can be finalised at this stage, the application would be forwarded to the HPAC which will then examine it and if required remit it back to the internal committee for reconsideration. Once the settlement is finalised and recommended by the HPAC, it goes to a Panel of two Whole-time Members of SEBI. Here again, if the Panel disagrees with the settlement, it may send the matter back to the Internal Committee where it starts all over again. Or, it may simply reject the application. However, if it finds the settlement to be in order, the applicant would be informed within seven days. Thereafter, the applicant would have to pay the amount of settlement and a final and formal order would be issued.
It may appear that considerable to and fro may arise between the three authorities set up to consider the application. However, it is likely, as seen from past experience, that, except where the matter involved is sensitive/serious or some other important factors/ complexities are involved, the process ought to be smooth and fast. It is likely that the recommendation of the internal committee would be accepted by the HPAC and similarly also accepted by the Panel. Alternatively, it may be rejected by the HPAC and that would be the end of the matter. This is even more likely considering, as also discussed later herein, that the settlement terms are more certain now and have considerably less discretion.
Which violations can be settled? Generally, any violation of the securities laws can be settled. However, a few violations have been stated as generally not capable of being settled. For example, insider trading violations as a rule cannot be settled. Serious cases of market manipulation, frauds, front running, etc. also generally cannot be settled. Non-settling of investor grievances, non compliance of SEBI notices/summons, etc. are some such others. However, the applicant can still apply in such a case where it feels there are reasons enough to make an exception and in case the reasons are found to be adequate, the case may be settled.
Settlement through monetary and non-monetary means Normally, the settlement is by offering a sum in money. However, depending upon the violation and circumstances involved, the settlement may also be through a monetary and/or settlement in kind. Thus, the applicant may offer (or may be asked to offer) settlement some another manner. For example, he may agree not to close his business for a specified period of time and/or remove a certain person from management, profits unjustly made may be disgorged. If accepted these would become part of the settlement terms.
However, unlike the monetary settlement amount, which has detailed formula for calculation that reduces discretion and arbitrariness, the settlement non-monetary settlement has no such formula.
Considerations for settlement
Stage at which settlement is applied for
One of the fundamental principles of settlement is that the more the applicant saves SEBI time and efforts in the actual proceedings, the better the terms of settlement he would be eligible to. Thus, the formula for determination of settlement amount provides for two important qualitative fac-tors. Firstly, how early the applicant comes forward for settlement. For example, a person who waits till the last moment till a formal adverse order is passed against him for settlement has made SEBI go through the whole process. On the other hand is a person as soon as he becomes aware of the violation, comes forward on his own and makes an application for settlement. Considering this, the Regulations lay down factors that would decrease or increase the amount of settlement based on at which stage of the proceedings that the applicant comes forward.
Another factor is past orders against the applicant, for which also a multiplying factor is provided, for determination of the settlement amount.
Repetitive settlements
Repetitive applications for settlements are not al-lowed. The settlement process is not to encourage/ condone frequent violators because otherwise, the sanctity and respect of the law may be disregarded. Thus, an applicant cannot make another application for settlement within 24 months of an earlier settlement. Further, if, in the 36 months preceding the application, two settlement orders have been passed for the applicant, the application cannot be made.
Strangely, this bar is applicable even for non-similar violations. For example, a violation of a disclosure requirement and a violation of a more serious nature are both treated the same. Ideally, repetitive violations of the same type ought to have been barred.
Rejected application
The information submitted or representation sub-mitted by an applicant in an application cannot be used as evidence before any Court/Tribunal, in case the application is rejected. However, this does not apply where the settlement order is revoked or withdrawn in specified cases. In any case, it appears that information independently collected may still be evidence.
Time limit for making of application
The application for settlement has to be made within sixty days of the receipt of a show cause notice.
Retrospective application
A clause that may sound like a transitional one but is intended to resolve a nagging problem is Regula-tion 1(2) . It provides that the Regulations shall be deemed to have come into force from 20th April 2007. It appears that it aims at giving legitimacy to settlement orders and proceedings prior to the notification of these Regulations. As stated earlier, a matter is pending before the Delhi High Court as to whether SEBI has powers to settle proceedings through Guidelines issued on 20th April 2007 (revised in 2011). An Ordinance was recently notified which inserted a new section 15JB in the SEBI Act, also with retrospective effect from 20th April 2007, stating that cases may be settled in accordance with Regulations issued in this behalf. The present Regulations are thus issued in this context. The retrospective effect of these provisions/Regulations is, in my view, legally uncertain. One will have to see, however, how the Delhi High Court views the matter, considering also the fact that hundreds of settlements have already taken places and proceedings closed.
Conclusion
The settlement procedure now is speedy but com-plicated. Serious violations are unlikely to be settled though in some cases may be settled if the circumstances demand with perhaps higher settlement amount. The revised formulae provides for higher settlement amounts as compared to earlier settle-ment amounts seen in practice. This discourages the assumption that violations would be settled as easily. The certainty of amounts is helpful as the party can weigh carefully whether the proceedings ought to be settled. The fact that the party continues to have the option not to admit the violation also helps considering also the fact that often settlements are carried out to buy peace and reduce the efforts involved in settlement. All in all, a better set of provisions have replaced the earlier ones with stronger base in law, certainty though at the cost of being complex.
Members of our profession are being increasingly subjected to disciplinary cases for misconduct. The complainants are often not aware of the grave consequences on the member concerned; or sometimes they knowingly do so to harass the CA with an ulterior motive to exert pressure on a rival party. CA being a soft target is often victimised. Our Council is realising this; but is helpless due to the system.
It is observed that many a time, an altogether stranger to the dispute files a case and makes the life of our member miserable.
Consequences of a complaint:
For items specified in First Schedule to our CA Act, the prescribed punishments are any one or more of – (a) reprimand, (b) fine upto Rs. 1 lakh and (c) suspension of membership for a period up to 3 months.
For items in Second Schedule, any one or more of – (a) reprimand, (b) Fine upto Rs. 5 lakhs and (c) suspension for any length of time, including forever.
However, it is to be noted that the process of disposal of complaint is likely to cause more stress than these prescribed consequences.
Firstly, it takes at least 3 years from initiation of complaint to its disposal (if not contested in appeal). One has to carry the sword hanging on one’s head. It is a great mental agony. It involves expenditure – on paper work, counsel’s fees, traveling (at times to Delhi) to the place of hearing and so on. Most importantly, if one is held prima facie guilty, one is deprived of bank audits, Government audits ( C & AG), etc. This is a great monetary loss.
After all, it is a stigma on one’s professional career.
Locus Standi: For information of the readers, I wish to clarify the distinction between the items of First and Second Schedule. First Schedule contains offences within the members’ community while Second Schedule contains items affecting the outsiders. The latter is considered more serious.
The proceedings are considered as quasi criminal proceedings. Any person can file a complaint. If complaint is not validly made, the Disciplinary Directorate can initiate suo moto action based on ‘information’.
I have come across many cases where the complainant was strictly not concerned with the type of misconduct alleged. Particularly, in First Schedule, the items affect the rights of other members.
For example:
In one case, a company did not appoint its first auditor in the board meeting. (Section 224 (5) of Companies Act, 1956) It was advised to appoint auditor in EGM – section 224 (5)(b). They issued appointment letter which unfortunately did not mention them to be the first auditors. It was implied and understood. Auditors filed form 23 B to ROC. Later on there was a dispute between two groups of management. The Indian group, both the directors being CAs, fabricated the records so as to ‘create’ one more auditor before the EGM! They closed the accounts out of the way – contrary to a different accounting year stated in articles, and filed a frivolous complaint that the auditors (innocent, appointed in EGM) did not communicate with previous auditor! And the alleged ‘previous auditor’ did not even turn up during the proceedings. Complainants admitted that they had manipulated the records. The proceedings stretched over a period of 5 years and a very senior, reputed firm was the victim.
In the second case, there was a change-over in management. The old management, proved to be unscrupulous, created an ‘auditor’ in similar manner and filed similar complaint. The new auditor (genuine) communicated with previous auditor on record (he who signed last audit, and who according to the new management was the previous auditor). The innocent new auditor had no clue whatsoever to indicate the existence of any such ‘previous auditor’.
The third case is more serious. There was a split in management. Two brothers who were directors separated from each other. The outgoing auditor supplied information to an outside lawyer. He was staying in Rajasthan while the company had all its operations in Mumbai. The outsider was not a shareholder, director, employee, supplier, customer and had no connection with the company at all! He filed a case of negligence (Schedule 2) against the auditor ‘claiming himself to be a responsible citizen’ of our country. He found a few minor arithmetic errors in stock valuation sheets which contained hundreds of items (in 12 sheets). Those were human, inadvertent errors, having no material impact. Again the proceedings stretched over 5 years!
During the hearing, he never appeared and it transpired that he was a professional blackmailer.
Conclusion:
Unfortunately, the normal principle of a complainant coming with clean hands is not followed in disciplinary proceedings. Council claims to be concerned (rightly so) only with the members’ conduct and not that of an outsider. Therefore, complaints even from a criminal who is behind bars are entertained. So also, for First Schedule cases, like previous auditors communication, non-payment of undisputed fees, solicitors, advertisement, sharing with non-members, charging fees on percentage basis, etc. a stranger is no way concerned. When previous auditor is not complaining, how is a stranger concerned? This results in lot of burden on Disciplinary Directorate and on the respective committees of the Council as well.
It is suggested that locus standi, materiality and the like concepts be given due weightage in the proceedings.
There were four writ petitions before the court.
In these petitions, the issue involved was whether the copies of office notings recorded on the file of Union Public Service Commission (UPSC) and the correspondence exchanged between UPSC and the Department seeking its advice can be accessed in the RTI Act or not by the person to whom such advice relates.
When one G.S. Sandhu sought information from UPSC to furnish him in respect of departmental proceedings against him, information sought was denied by PIO & FAA. However the Central Information Commission directed the UPSC to disclose the nothings relating to the matter in hand to the respondent, with liberty to the petitioner-UPSC to obliterate the name and designation of the officer who made the said notings.
Before the H.C.of Delhi, UPSC assailed the Commission on four different grounds as under:
(I)There is a fiduciary relationship between UPSC and the department which seeks its advice and the information provided by the Department is held by UPSC in trust for it. The said information, therefore, is exempted from disclosure u/s. 8(1) (e) of the Act, (ii) the file notings and the correspondences exchanged between UPSC and the department seeking its advice may contain information relating not only to the information seeker but also to other persons and departments and institutions, which, being personal information, is exempt from disclosure u/s. 8(1) (j) of the Act, (iii) the officers who record the notings on the file of UPSC are mainly drawn on deputation from various departments. If their identity is disclosed, they may be subjected to violence, intimidation and harassment by the persons against whom an adverse note is recorded and if the said officer of UPSC, on repatriation to his parent department, happens to be posted under the person against whom an adverse noting was recorded by him, such an officer may be targeted and harassed by the person against whom the note was recorded. Such an information, therefore, is exempt from disclosure u/s. 8(1) (g) of the Act and (iv) the notings recorded by UPSC officer on the file are only inputs given to the Commission to enable it to render an appropriate advice to the concerned department and are not binding upon the Commission. Therefore, such information is not really necessary for the employee who is facing departmental inquiry, since he is concerned only with the advice ultimately rendered by UPSC to his department and not the noting meant for consideration of the Commission.
After detailed discussion & analysis of two Supreme Court decisions in (i) Central Board of Secondary Education and Another vs. Aditya Bandopadhyay & Ors. (ii) Bihar Public Service Commission vs. Saiyed Hessian Abbas Rizvi & Another, the High Court of Delhi issued the following directions:
(i) The copies of office notings recorded in the file of UPSC as well as the copies of the correspondence exchanged between UPSC and the Department by which its advice was sought, to the extent it was sought, shall be provided to the respondent after removing from the notings and correspondence, (a) the date of the noting and the letter, as the case may be; (b) the name and designation of the person recording the noting and writing the letter and; (c) any other indication in the noting and/or correspondence which may reveal or tend to reveal the identity of author of the noting/letter, as the case may be;
(II) If the notings and /or correspondence referred in (i) above contains personal information relating to a third party, such information will be excluded while providing the information sought by the respondent;
[Union Public Service Commission vs. G.S. Sandhu & Ors: Decided on 10.10.2013; RTIR IV (2013)216 (Delhi)]
Section 6 (1) of the RTI Act, 2005:
K.K. Mishra, the appellant through his RTI application dated 16.01.2012 sought certified copies in respect of M/s. Nandi Infrastructure Corridor Enterprises Ltd., Bangalore showing composition of Board of Directors and Members/Shareholders of the Company as filed by the Company from time to time with ROC, Karnataka Bangalore from 1.1.2000 onwards.
The CPIO responded by citing one earlier decision of the Commission wherein it was held as under:
“The Registrar of Companies has already put in place system for disclosure of information including the procedure for payment of cost for providing the information. There is no denial of information to the applicant. There is, therefore, no reason why the procedure of the Registrar of Companies in respect of disclosure of information should not be adhered to and followed. As the working of the Office of Registrar of Companies is transparent in so far as public activities are concerned, there is no justification for invoking the cost and fee rules as prescribed under the RTI Act. In case, however, there is any hindrance in providing access to the documents which are expected to be in the public domain, the provisions of the RTI Act could be invoked. In view of this, there is no justification for not respecting the fee and cost rules of the Registrar of Companies as per the relevant provisions under Section 610 of the Companies Act”.
Before the Commission, the appellant stated that for getting the information, he has to first register himself before he can access the information and thereafter pay Rs. 50/- for viewing the information for three hours. Whereas, under RTI Rules, the inspection of documents is free for first hour and thereafter the charges are Rs. 5/- for every 15 minutes. The appellant states that he paid Rs. 50/- through internet banking, but thereafter there were no instructions on the website as to how to access the information on net, the fee payable is Rs. 25/- per page as against Rs. 2/- per page prescribed under RTI Rules. The appellant contested that it would not be appropriate for the CIC to allow ROC to charge such exorbitant rates for information which is in direct conflict with the provisions of the RTI Act and rules. The appellant stated during that hearing that in the above said order specifically mentioned that in case of hindrance in providing access to the documents, the provisions of the RTI Act could be invoked. The respondent CPIO on the other hand stated that in case the appellant is not able to access the information from the website of the ROC, he can approach the help Desk which is placed In their Office to assist the people to access information on the website.
The Commission then quoted from one order of the High Court of Delhi (in the matter of Registrar of Companies & Ors. vs. Dharmendra Kumar Garg & Another) as under:
34. “The mere prescription of a higher charge in the other statutory mechanism (in this case section 610 of the Companies Act), than that prescribed under the RTI Act does not make any difference whatsoever. The right available to any person to seek inspection/copies of documents under sec-tion 610 of the Companies Act is governed by the Companies (Central Government) General Rules & Forms, 1956, which are statutory rules and prescribe the fees for inspection of documents etc. in Rule 21A. The said rules being statutory in nature and specific in their application do not get overridden by the rules framed under the RTI Act with regard to prescription of fee for supply of information, which is general in nature, and apply to all kinds of applications made under the RTI Act to seek information. It would also be complete waste of funds to require the creation and maintenance of two parallel machineries by the ROC – one u/s. 610 of the Companies Act, and the other under the RTI Act to provide the same information to an applicant. It would lead to unnecessary and avoidable duplication of work and consequent expenditure.”
35. “The right to information is required to be balanced with the need to optimize use of limited fiscal resources. In this context I may refer to the relevant extract of preamble to the RTI Act which, inter alia, provides……………………………………………..”
41. “Firstly, I may notice that I do not find anything inconsistent between the schemes provided u/s. 610 of the Companies Act and the provisions of the RTI Act. Merely because a different charge is collected for providing information under Section 610 of the Companies Act than that prescribed as the fee for providing information under the RTI Act does not lead to an inconsistency in the pro-visions of these two enactments. Even otherwise, the provisions of the RTI Act would not override the provision contained in Section 610 of the Com-panies Act. Section 610 of the Companies Act is an earlier piece of legislation. The said provision was introduced in the Companies Act, 1956 at the time of its enactment in the year 1956 itself. On the other hand, the RTI Act is a much later enactment, enacted in the year 2005. The RTI Act is a general law/enactment which deals with the right of a citizen to access information available with a public authority, subject to the conditions and limitation prescribed in the said Act. On the other hand Section 610 of the Companies Act is a piece of special legislation, which deals specifically with the right of any person to inspect and obtain records i.e. information from the ROC. Therefore, the later general law cannot be read or understood to have abrogated the earlier special law.”
In view of above Order, the Commission found no reason to disagree with the reply of office of the Register of companies, Karnataka, Bangalore
[K.K. Mishra vs. office of the ROC, Karnataka, Ban-galore decided on 20.09.2013 in CIC/SS/A/2012/2005: RTIR IV (2013)181(CIC)]
Section 6 of the RTI Act, 2005
In a short order of CIC, it is decided that paying application fees through money order is as good as paying cash and hence the RTI application cannot be rejected on the ground that mode of paying fees is not as per rules. Also in the Order, the Commission referred to the full bench decision reported in BCAJ of January 2014.
In the light of above the Commission decided that the CPIO should have accepted the RTI application and dealt with the same as per the provisions of the RTI Act
[S. Viswanatha Rao vs. Department of Posts, Secunderabad: decided on 27.09.2013: CIC/ BS/C/2012/000279/3569: RTIR IV (2013) 163 (CIC)]
”
More worrying, from the point of view of an incoming regime, is the logjam that the country has witnessed between the haves and the have-nots—breaking this gridlock is a necessary condition for the Indian economy to regain its momentum. While the haves define policy change, the politically empowered have-nots can stall its implementation.
Both anecdotally and empirically—captured so well in the jobless growth phenomenon of the first decade of the new millennium and growing inequality—it is a fact that few have gained from India’s remarkable economic turnaround over the last three decades.
No matter where we look—whether it be about targeting of subsidies, mining for precious resources, people-centric urbanization, developing new infrastructure like roads/highways (more recently the Navi Mumbai airport project, or setting up of the Kudankulam nuclear power plant in Tamil Nadu)—there is an unresolved face-off. And this gulf is only widening. More often than not, these disputes are now ending up in courts and the judiciary is forced to be the referee.
This is a less than optimal situation because differences of such nature mirror the political pulls and pressures in society and hence, should ideally be resolved by elected politicians. So far, politicians have struggled to come up with a template to resolve such vexing face-offs where there can never be a winner. Whether it is environment versus development, paying subsidies in cash or in kind, tariffs for electricity or water, there is no black and white answer. This is because there are far more stakeholders in the economy today than ever before, with varying degrees of economic capacity (or the lack of it).
This is what makes the 2014 general election so significant.
The country is on a cusp. Not since it gained independence has the country needed a visionary— who will have the political courage to attempt out-of-the-box solutions to end this deadlock— at the helm more than it does now. It will not be about strong or weak leadership, secular or communal leaders. Instead, it will be the ability to throw up a person who has the vision to redefine the “grammar of governance” in sync with contemporary India. So think hard before you vote this summer.
According to experts, the newest party is providing an attractive platform for professionals to realise their ambition of entering mainstream politics. There is a general perception that people with non-political lineage find it very difficult to join a traditional political party, let alone contest elections. With faces such as Bala on-board along with AAP’s success in Delhi is expected to prompt more professionals to join the party. Moreover, the trend is also expected to influence the national parties to become more open while choosing their candidates.
N. C. Saxena, member of the National Advisory Council, said it is believed the route to political power is only “via caste, criminal record or through money”, but AAP has put forward a different kind of values and idealism. The question is not just of whether it is easy or difficult to join the party, it is about the values it projects which people can relate to, Saxena added.
AAP, which has made anti-corruption as its prime agenda, has attracted people from multiple fields. While some have quit their day jobs to join the party, others have supported the movement by lending their expertise and through donations.
Raman Roy, one of the pioneers of the Indian business process outsourcing (BPO) industry, said AAP has demonstrated there can be a professional way to do politics in the country. “The perception is that entering politics is very messy and even if somebody wanted to enter it actively, it will be impossible to get a ticket from a leading political party.” However, AAP has given professionals an opportunity to get their hands dirty. “Professionalizing of politics will be a game-changer for India.”
As societies evolve, individuals take over the responsibility of social progress. Monarchs, governments and other authority figures are required only till such time as citizens take over the running of their lives. Sadly, Indian society hasn’t yet reached that point. The Indian tendency to rail against authority is evident in the Devyani Khobragade incident as much as in blaming the police alone for the rise in crimes against women.
It is time to look inwards, where there is a lot that is wrong. Our sense of entitlement, as well as the wretched, fatalistic attitude we have inherited, blinds us to personal shortcomings—our biases and prejudices, our inability to follow reasonable civic rules, or do something about our abysmal creativity and productivity levels. We pride ourselves on being tolerant but are blatantly racist, with each other and with people from other nations who have a different color of skin or a different way of speaking English. We believe the Taj Mahal is the greatest architectural marvel ever created, not because we have compared it with others, but merely because we don’t, and don’t want to, understand or appreciate the architecture of other nations. That xenophobia blinds us. So the only alternative to Hindi movies is Hollywood pulp, to the utter disregard of masterpieces from Kerala or Iran. We wallow in the mediocrity of our film music, insulting not just a glorious tradition but also the universality that it should bring. So no wedding in the vast Hindi heartland, encompassing some eight states, ever resonates to the soothing notes of Carnatic music.
The insularity is compounded by our preference for jugaad over original invention and discovery. For the former, we credit our ability to cut corners, get the job done, no matter what the ecological or social cost. For the latter, we blame the government.
Nor is this lack of creativity in India stemming from an overt focus on hard work. No one will accuse us of high levels of productivity though the sheer number of hours we spend at our workplace should raise hopes of it. According to the Asian Productivity Organization’s Databook 2013, India’s per capita gross domestic product (GDP), an index of its labour productivity, was 7.5% of that in the US in 2011, lower even than that of countries like Fiji, Mongolia and the Philippines. The fate of nations like Italy and Greece shows the ill effects of chronically low productivity levels. Indeed, there is empirical evidence to suggest that productivity growth is a major factor in pushing economic growth as well as the standard of living of a nation, as seen in the case of both Germany and Singapore. Higher productivity leads to increased profitability as costs fall. The sharp recovery in the US despite the financial meltdown shows how higher productivity can lead a nation out of economic gloom.
Nations that are driven by the vim and the vigor of their people exude a soft power that far exceeds mere economic or military might. Germany, Monocle magazine’s leader of the year in its annual ranking of countries by soft power, receives 30.4 million tourists a year. India by contrast gets 6.5 million though its 28 UNESCO World Heritage Sites compares well with Germany’s 38.
The world lauds individual initiative and talent, which is why Scandinavian countries are routinely at the top of any ranking of most respected countries. Creativity and productivity are virtues that need little support from the state. It is about time we turned our attention to our poor performance on both counts.
This is the fourth in a series of essays in which Mint’s editors take stock of 2013 and look at what the new year holds for India.
Two figures are often bandied around . First, only 35 million people pay income tax. Second, only 42,800 people have annual income more than Rs. 1 crore. Both involve minor misstatements : 35 million is the number of people who submit income-tax returns. In a pedantic sense, they may or may not pay income tax. Even if they do, tax paid could be marginal.
And that 1-crore figure for 42,800 is taxable income. There are 78.9 million urban households in India. Half of them can be expected to be below the threshold. Indeed, there is some multiplicity: in a single urban household, there can be more than one individual who submits income-tax returns.
But the illustrative point remains . Since rural households are outside the ambit of income taxes, 35-40 million is the maximum income tax base we can get. Why are we so shocked that just 3% of the population pays personal income tax?
Since 2006-07,Budgets have had a tax revenue foregone statement. For direct taxes, this is divided into corporates, non-corporate firms and individual taxpayers. Notice that all tax exemptions are implicit subsidies to preferred categories of taxpayers. In individual taxpayer category, around half are salaried. Salaried taxpayers are entitled to limited deductions. That’s not true of non-salaried taxpayers. They are entitled to several profit-linked deductions too. And there are many deductions for non-corporate firms too.
Depending on what GDP figure you take, all those exemptions, direct as well as indirect, amount to anything between 5% and 5.5% of GDP. That 12% figure doesn’t include all state level or local-body taxes. If you include those too, the tax/GDP ratio would be around 17%. However, if all exemptions were to go, tax/GDP ratio would be in excess of 22%.
Also, if all subsidies, Centre as well as state, explicit as well as implicit , are included, subsidies amount to 14% of GDP. Before considering abolition of a tax, we, therefore, need to ask questions. Where will the revenue come from? Which expenditure item will be slashed on a continuing basis, not as a one-shot revenue realization from asset sales (such as privatization)?
When figures like 35 million are cited, there is an impression there’s tax evasion. There certainly is evasion . But there’s an important difference between evasion and tax avoidance . When arguments are made about middle class — not all middle class people are salaried or urban — suffering from income tax, it’s really an argument about limited tax avoidance options being available to salaried people.
Second, as long as there are exemptions , compliance costs cannot be reduced significantly. One needs to pin down the expression compliance costs. Does it mean administrative costs of collection? Does it mean costs to taxpayers, including harassment and bribes? And does it include other social costs?
For income tax, administrative costs aren’t actually that high. For every Rs. 100 collected, it’s around 60 paise . Through the large taxpayer unit, it’s around 4.50 paise. That’s today. Studies done 10 years ago suggest if all compliance costs are included, compliance costs are 49% of personal income-tax collections and the system is regressive. Of course, there’s an argument for simplification . DTC was meant to do that, but has deviated from original intent. And, yes, one should simplify the appellate and refund process.
If income tax is scrapped, what will replace it? Every economist should argue direct taxes are superior. If income tax is scrapped, it can’t be scrapped only for personal income, retaining it for corporate taxation. So, there will be a transition from direct to indirect taxation.
While actual revenue numbers depend on elasticities, we need a rough doubling of indirect tax rates, which are inherently regressive. The only argument in favour of indirect taxation is that it’s easier to enforce . Since we can’t or won’t tax rural income, let’s do it via the indirect route. This isn’t a new idea either.
For those who are advocating an abolition of income tax, there also seems a presumption that compliance costs will be zero under the new framework, whatever that new framework is. The argument that there are countries with no personal income taxation won’t wash either. Those are either tax havens or those with large natural resource bases. Besides, precedence is no argument . Just because Peter the Great taxed beards, should we?
And with that unbundling, the traditional credential is rapidly losing relevance. The value of paper degrees lies in a common agreement to accept them as a proxy for competence and status, and that agreement to accept them as a proxy for competence and status, and that agreement is less rock solid than the higher education establishment would like to believe.
The value of paper degrees will inevitably decline when employers or other evaluators avail themselves of more efficient and holistic ways for applicants to demonstrate aptitude and skill. Evaluative information like work samples, personal representations, peer and manager reviews, shared content, and scores and badges are creating new signals of aptitude and different types of credentials.
Lack of understanding of cross-border business operations is another root cause of agony for MNCs, as has been witnessed in the spate of transfer pricing litigation relating to marketing intangibles. In this backdrop, there is an urgent need for the Tax Administration Reform Commission, headed by Parthasarathi Shome, to look into the tax administration of large corporate taxpayers.
One may have thought the Large Taxpayer Unit (LTU) system, a single-window tax facilitation centre, would have been welcomed by India Inc. Under the LTU system, each large taxpayer who has opted to be covered is assigned a senior tax official as a single-point contact. Taxpayers engaged in the manufacture or service sector that have paid excise or service tax dues of more than Rs 5 crore or advance corporate tax of Rs 10 crore or more can opt to be covered by an LTU. In addition, the option to transfer any excess Cenvat credit – of central excise duty or service tax – accumulated in one unit to any other eligible unit is a big advantage for taxpayers having pan- India manufacturing units.
On paper, the LTU system is designed to reduce tax compliance costs and delays for large taxpayers. In turn, it also facilitates tax administration to ensure tax compliance: data mining, for instance is easier. Large corporate taxpayers anywhere in the world place a premium on the ability to finalize their tax positions in real time, which helps them minimize unpredictability in business operations.
LTUs are used by governments to create mutual trust, usher transparency and resolve issues in a time-bound manner, resulting in effective tax administration and collection. It is important for officials manning LTUs to understand business perspectives – an improved economic and com- mercial understanding is vital. Unfortunately, in India, LTUs are perceived as hunting grounds for tax administrators.
The Large Business Service (LBS) system in the UK currently covers 770 companies. It is structured on sectoral lines that aids in understanding the dynamic commercial environment in which different businesses operate. The sector leader also supports client relationship managers (CRMs) who are allocated to each taxpayer.
Following discussions with each taxpayer and consultation with tax and sector specialists, CRMs compile a report of perceived tax risks and tax positions and share this with the large corporate taxpayer. Any differences in view are identified and resolved, and the way forward is agreed. To deal with the complexities of transfer pricing, an internal board has been set up, which results in speedy resolutions in a time-bound manner.
Most importantly, LBS officials also recommend changes to legislation when it finds there are gaps or defects in law. Recently, the large corporate forum, comprising of nominated members of large corporate taxpayers and LBS officials, was relaunched. Periodic meetings help in better understanding of business needs and compliance burdens.
LTUs in India first need to adopt such tax-friendly measures, only later can mandatory coverage be contemplated.
Now, these files accumulated with Natarajan – 180 of them unsigned, 169 signed but still withheld – for reasons that the former minister has not chosen to share with the public. It is tempting to accept the charge, made by Narendra Modi, that the files piled up because of non-payment of a “Jayanthi tax”, unless Natarajan comes up with a credible explanation for this strange hoarding of vital clearances. Regardless of the explanation, the conduct has been inexcusable. The development further strengthens the case for transferring the job of according environmental clearances to an independent authority with expertise and the requisite staff strength. The environment ministry’s job should be to formulate policy and the norms that the regulator would use to accord or deny clearance, or suggest compensatory measures.
This circular contains the amended the instructions issued to Authorised Money Changers (AMC) with respect to establishment of business relationships by corporates. The revised guidelines are as under: –
This circular clarifies that a foreign investor is free to remit funds on cash/TOM/spot basis through any bank of its choice for any permitted transaction. The funds so remitted must be transferred to the designated custodian bank through the banking channel. KYC in respect of the remitter, wherever required, will be the joint responsibility of the bank that has received the remittance as well as the bank that ultimately receives the proceeds of the remittance. The remittance receiving bank is required to issue a FIRC to the bank receiving the proceeds to establish the fact the funds had been remitted in foreign currency.
Presently, an Indian company can issue equity shares against its liability in respect of External Commercial Borrowings (ECB), import of capital goods, lump sum fees/royalties, etc.
This circular clarifies that the rate of exchange prevailing on the date of the agreement between the parties concerned has to be applied at the time of conversion of foreign currency liability in respect of External Commercial Borrowings (ECB), import of capital goods, lump sum fees/royalties, etc. into Indian rupees, for the purpose of issue of equity shares/other securities, as the case may be, against the same. However, the Indian company is free to issue equity shares for a rupee amount less than that arrived at based on the rate of exchange prevailing on the date of the agreement by a mutual agreement with the lender/supplier.
Clarification- Establishment of Liaison Office/ Branch Office/Project Office in India by Foreign Entities- General Permission
Presently, no entity or person, being a citizen of Pakistan, Bangladesh, Sri Lanka, Afghanistan, Iran or China is permitted to establish in India, a branch office or a liaison office or a project office or any other place of business by whatever name called, without obtaining prior permission of RBI.
This circular clarifies that the said restrictions also apply to entities from Hong Kong and Macau. As a result, prior permission of RBI is required to be obtained by entities from Hong Kong and Macau to setup, in India, a Liaison/Branch/Project Offices or any other place of business by whatever name.
Presently, residents (other than exporters and importers) cannot cancel and rebook forward contracts, involving Rupee as one of the currencies, booked by them to hedge current and capital account transactions. Exporters are allowed to cancel and rebook forward contracts to the extent of 50% of the contracts booked in a financial year for hedging their contracted export exposures and importers are allowed to cancel and rebook forward contracts to the extent of 25% of the contracts booked in a financial year for hedging their contracted import exposures.
This circular now permits everyone with a contracted exposure to freely cancel and rebook forward contracts in respect of all current account transactions as well as capital account transactions with a residual maturity of one year or less. In the case of FII/QFI/other portfolio investors, forward contracts booked by them, once cancelled, can be rebooked up to the extent of 10% of the value of the contracts cancelled. However, forward contracts booked by them can be rolled over on or before maturity.
Section 6 (4) of FEMA, 1999 permits a person resident in India to hold, own, transfer or invest in foreign currency, foreign security or any immovable property situated outside India if such currency, security or property was acquired, held or owned by such person when he was resident outside India or inherited from a person who was resident outside India.
This circular clarifies that the following transactions are covered u/s. 6(4) of FEMA, 1999: –
(i) Foreign currency accounts opened and maintained by such a person when he was resident outside India.
(ii) Income earned through employment or business or vocation outside India taken up or commenced while such person was resident outside India, or from investments made while such person was resident outside India, or from gift or inheritance received while such a person was resident outside India.
(iii) Foreign exchange including any income arising therefrom, and conversion or replacement or accrual to the same, held outside India by a person resident in India acquired by way of inheritance from a person resident outside India.
(iv) Persons resident in India can freely utilise all their eligible assets abroad as well as income on such assets or sale proceeds thereof received after their return to India for making any payments or to make any fresh investments abroad without RBI approval if the cost of such investments and/or any subsequent payments are met exclusively out of funds forming part of eligible assets held by them and the transaction is not in contravention of the provisions of FEMA.
This circular has expanded the scope of the Rupee Drawing Arrangements (RDA) by including the following items under the list of Permitted Transactions: –
1. Payments to utility service providers in India, for services such as water supply, electricity supply, telephone (except for mobile top-ups), internet, television etc.
2. Tax payments in India.
3. EMI payments in India to Banks and Non- Banking Financial Companies (NBFCs) for repayment of loans.
The detailed list under Part (B) of Annex-I is annexed to the circular.
Presently, individuals resident in India can include Non-Resident Indian (NRI) close relative(s) as defined in Section 6 of the Companies Act, 1956 as a joint holder(s) in their resident savings bank accounts on “former or survivor” basis. However, such NRI close relatives cannot operate the said account during the life time of the resident account holder.
This circular provides that individuals resident in India can now include NRI close relative(s) as defined in Section 6 of the Companies Act, 1956 as a joint holder(s) in their new/existing resident savings bank accounts/other bank accounts on “either or survivor” basis. The NRI has to give a declaration in the prescribed format stating that he/she will not use the proceeds lying in the above account for any transaction in contravention of FEMA and in case of any violation he/she will be responsible for the same.
The above liberalisation is subject to the following: –
a) The said account will be treated as resident bank account for all purposes and all regulations applicable to a resident bank account will be applicable.
b) Cheques, instruments, remittances, cash, card or any other proceeds belonging to the NRI close relative cannot be credited to the said account.
c) The NRI close relative can operate the said account only for and on behalf of the resident for domestic payment and not for creating any beneficial interest for himself.
d) Where the NRI close relative becomes a joint holder with more than one resident in the said account, such NRI close relative must be the close relative of all the resident bank account holders.
e) Where due to any eventuality, the non-resident account holder becomes the survivor of the said account the same must be categorised as Non- Resident Ordinary Rupee (NRO) account and all such regulations as applicable to NRO account shall be applicable. Onus will be on the NRI account holder to inform the Bank to get the account categorised as NRO account.
This circular permits the issue of equity shares and compulsorily and mandatorily convertible preference shares/debentures under FDI Scheme to a person resident outside with an “optionality clause”. Under this clause, after a minimum lockin period of one year or a minimum lock-in period as prescribed under FDI Regulations, whichever is higher (e.g. defence and construction development sector where the lock-in period of three years has been prescribed), the non-resident investor exercising option/right of buy-back will be eligible to exit without any assured return at the price prevailing/ value determined at the time of exercise of the option. The lock-in period will be effective from the date of allotment of such shares or convertible debentures unless otherwise prescribed.
Valuation will be as under: –
(i) In case of a listed company, the market price prevailing at the recognised stock exchanges.
(ii) In case of unlisted company, price not exceeding that arrived at on the basis of Return on Equity (i.e. Profit After Tax/Net Worth – where Net Worth would include all free reserves and paid up capital) as per the latest audited balance sheet.
(iii) Compulsorily Convertible Debentures (CCD) and Compulsorily Convertible Preference Shares (CCPS) are to be transferred at a price worked out as per any internationally accepted pricing methodology at the time of exit and which is to be duly certified by a Chartered Accountant or a SEBI registered Merchant Banker.
All existing contracts will also have to comply with the above conditions to qualify as FDI compliant.
This circular provides that ‘Maintenance, Repairs and Overhaul’ (MRO) will also be treated as a part of airport infrastructure for the purposes of ECB. As a result, MRO will be considered as part of the sub-sector of Airport in the Transport Sector of Infrastructure.
Facts:
Assessee-company, a Foreign Institutional Investor, was engaged in business of share trading.
The assessee received shares in ratio of 1 : 16 shares held by it in a company. This resulted in long term capital loss. AO disallowed the assessee’s claim of long term capital loss, on swap transaction. When the matter was referred to DRP, it was held that no sound reason was furnished by the assessee to explain as to why it entered in an exchange transaction that resulted in huge loss, that no prudent businessman would enter in to such a transaction, that swap ratio of shares transacted was not done by the competent authority i.e. a merchant banker.
Held:
Swapping of shares was approved by an agency of Govt. of India i.e. FIPB and it had approved the ratio of shares to be swapped. In these circumstances to challenge the prudence of the transaction was not proper. Even if the transaction was not approved by the Sovereign and it was carried out by the assessee in normal course of its business, the Ld AO/DRP could not question the prudence of the transaction. Genuiuness of a transaction can be definitely a subject of scrutiny by revenue authorities, but to decide the prudence of a transaction is prerogative of the assessee. A decision as to whether to do / not to do business or to carry out/not to carry out a certain transaction is to be taken by a businessman. If it is proved that a transaction had taken place, then resultant profit or loss has to be assessed as per the tax statutes. Therefore by casting doubt about the prudence of the transaction, members of the DRP had stepped in to an exclusive discretionary zone of a businessman and it is not permissible.
ii. Set off of short term capital loss subject to STT allowed against short term capital gain not subjected to STT
Facts:
Assessee has claimed set off of short-term capital loss subjected to Securities Transaction Tax(STT) against the short-term capital gains that was not subjected to STT. The AO held that as both the transactions were subject to different rates of tax, the set off of loss is not correct. He held that in order to set off the short term capital loss, there should be short term capital loss and short term capital gain on computation made u/s. 48 to 55. The assessee was entitled to have the amount of such short term capital loss set off against the short term capital gain, if any, as arrived under a similar computation made for the assessment year under consideration.
Held:
The phrase “under similar computation made” refers to computation of income, the provisions for which are contained u/ss. 45 to 55A of the Act. The matter of computation of income was a subject which came anterior to the application of rate of tax which are contained in section 110 to 115BBC. Therefore, merely because the two sets of transactions are liable for different rate of tax, it cannot be said that income from these transactions does not arise from similar computation made as computation in both the cases has to be made in similar manner under the same provisions. The Tribunal therefore, held that short term capital loss arising from STT paid transactions can be set off against short term capital gain arising from non SIT transactions.
Note: Readers may also read following decisions of Mumbai Tribunal:
• DWS India Equity Fund [IT Appeal No. 5055 (Mum.) of 2010]
• First State Investments (Hong Kong) Ltd. vs. ADIT [2009] 33 SOT 26 (Mum)
The Appellant had filed a complaint against the Respondents. Subsequently, the charges were framed against the Respondents u/s. 498A, 304B read with section 34 and Section 302 of the Indian Penal Code by Shri. Prithvi Raj, learned Additional District & Sessions Judge dated 15-05-1995. Thereafter, the case was listed before Shri. S.N. Dhingra, Additional Sessions Judge for the trial, however, the learned Judge had recused from hearing the matter for personal reasons vide Order dated 25-09-2000.
Accordingly, the case was withdrawn from the Court of Shri. S.N. Dhingra, Additional Sessions Judge and transferred to the Court of Shri. S.M. Chopra, Additional Sessions Judge vide the Order dated 29-09- 2000 of the Sessions Judge. Eventually the accused Respondents were tried and acquitted vide judgment and Order dated 22-03-2003 passed by Ms. Manju Goel, Additional Sessions Judge. Being aggrieved by the judgment and Order, the Appellant preferred a revision petition before the High Court. The same was dismissed vide impugned final judgment and Order dated 01-09-2010 passed by learned Judge, Shri. Justice S.N. Dhingra.
The Court observed that it is apparent that the fact of earlier recusal of the case at the trial by learned Shri Justice S.N. Dhingra himself, was not brought to his notice in the revision petition before the High Court by either of the parties to the case. Therefore, Shri Justice S.N. Dhingra, owing to inadvertence regarding his earlier recusal, has dismissed the revision petition by the impugned judgment. In our opinion, the impugned judgment, passed by Shri Justice S.N. Dhigra subsequent to his recusal at trial stage for personal reasons, is against the principle of natural justice and fair trial. It is well settled law that a person who tries a cause should be able to deal with the matter placed before him objectively, fairly and impartially. No one can act in a judicial capacity if his previous conduct gives ground for believing that he cannot act with an open mind or impartially. The broad principle evolved by this Court is that a person, trying a cause, must not only act fairly but must be able to act above suspicion of unfairness and bias.
Facts:
The assessee was engaged in the business of Micro Financial Lending Services through small joint liability groups and direct micro loans. The assessee entered into memorandum of understanding (MOU) with ‘S’, another company which was also engaged in the business of micro finance and acquired the entire business of ‘S’. This also included the acquisition of rights over more than 1.10 lakhs existing clients of ‘S’. The assessee claimed depreciation on the amount contending that the consideration paid to ‘S’ towards transfer of clients was for an intangible asset eligible for depreciation. It was contended that the customers were a source of assured economic benefits over the next 5 years and in that process, the assessee capitalised the cost in the books and amortised the cost over a period of 5 years.
The AO disallowed depreciation holding that the intangible asset claimed to have been acquired by the assessee does not come under any of the identified assets appearing in the depreciation schedule (intangible asset) i.e. know-how, patents, copy rights, trade marks, licenses, franchises or any other business or commercial rights of similar nature. The AO held that as the assessee had acquired part of the already existing business of ‘S’, the said asset had not been created during the course of business of the assessee and hence cannot be considered to be a business or commercial rights of similar nature.
The CIT (A) held that the customer base acquired by the assessee cannot be considered a licence or business or commercial right of similar nature as it does not relate to any intellectual property whereas section 32(1)(ii) contemplate depreciation in respect of those licenses or rights which relate to intellectual property.CIT(A) relied on decision of the Hon’ble Bombay High Court in case of CIT vs. Techno Shares & Stocks Ltd. [2009] 184 Taxman 103.
Held:
The customer base acquired by the assessee has provided an impetus to the business of the assessee as the customers acquired are with proven track record since they have already been trained, motivated, credit checked and risk filtered. They are source of assured economic benefit to the assessee and certainly are tools of the trade which facilitates the assessee to carry on the business smoothly and effectively. Therefore, by acquiring the customer base the assessee has acquired business and commercial rights of similar nature.
The Hon’ble Delhi High Court in the case of Areva T & D India Ltd. ([2012] 345 ITR 421) while interpreting the term “business or commercial rights of similar nature” has held that the fact that after the specified intangible assets the words “business or commercial rights of similar nature” have been additionally used, clearly demonstrates that the Legislature did not intend to provide for depreciation only in respect of specified intangible assets but also to other categories of intangible assets. In the circumstances, the nature of “business or commercial rights” cannot be restricted to only know-how, patents, trade marks, copyrights, licences or franchisees. All these fall in the genus of intangible assets that form part of the tool of trade of an assessee facilitating smooth carrying on of the business.
The CIT(A) while coming to his conclusion had relied upon the decision of the Bombay High Court in case of CIT vs. Techno Shares & Stock Ltd. wherein the High Court while considering the issue of transfer of membership card of Bombay Stock Exchange has held that it does not Constitute an intangible asset. However, this decision of the High Court has been reversed by the Supreme Court in the case of Techno Shares and Stocks Ltd. vs. CIT [2010] 327 ITR 323. The SC has held that intangible assets owned by the assessee and used for the business purpose which enables the assessee to access the market and has an economic and money value is a “licence” or “akin to a licence” which is one of the items falling in section 32(1) (ii) of the Act.
Based on all the above decisions, it was held that the specified intangible assets acquired under slump sale agreement were in the nature of “business or commercial rights of similar nature” specified in section 32(1)(ii) of the Act and were accordingly eligible for depreciation under that section.
Readers may also read Mumbai Tribunal decision in case of India Capital Markets (P.) Ltd. vs. Dy. CIT [2013] 29 taxmann.com 304/56 SOT 32 (Mum.)
Income does not accrue on a day to day or year to year basis on Optionally Fully Convertible Premium Notes where the terms of the issue provide that the holder of OFCPN could only in the last quarter of the 5th year decide to convert or not to convert the OFCPN into equity shares and in the event of his deciding not to convert the OFCPN into equity shares becomes entitled to Face value being a sum greater than issue price.
Facts I:
On 18-03-2002, the assessee sold 330 Deep Discount Bonds (DDBs) Series A of Nirma Ltd. of Rs. 330 lakh for a consideration of Rs. 4,02,92,630. The DDBs were allotted to the assessee vide letter of allotment dated 28-07-2000. The debenture trust deed was dated 27-04-2001 and certificate of holding to the assessee was issued on 10-05-2001. These DDBs were made available for dematerialisation on 24-09- 2001 and were listed in NSE on 20-09-2001.
The surplus arising on sale of DDBs was returned by the assessee as long term capital gain and benefit of section 54EC was claimed.
The Assessing Officer held that for deciding whether the DDBs are long term capital asset or short term capital asset the holding period should commence from the date of listing of the DDBs on NSE and not from the date of allotment as was the case of the assessee. He, accordingly, considered the gain to be short term capital gain and denied the benefit of section 54EC of the Act.
Aggrieved, the assessee preferred an appeal to CIT(A) who upheld the action of the AO.
Aggrieved, the assessee preferred an appeal to the Tribunal.
Held I :
The Tribunal observed that in the case of Karsanbhai K. Patel (HUF) (ITA No. 1042/Ahd/2006 dated 09-10- 2009; assessment year 2002-03) the Tribunal was considering an identical issue on identical facts. In the said case, the Tribunal held that the period of holding has to be counted from the date of allotment. Following the ratio of the said decision, the Tribunal held that the holding period be counted from the date of allotment. If the holding period was counted from the date of allotment, in the present case, the gain arising on transfer of DDBs would be long term capital gain and the assessee would be entitled to claim benefit of section 54EC. The Tribunal decided the issue in favor of the assessee.
Fact II:
The assessee held Optionally Fully Convertible Preference Notes (OFCPN) of Nirma Industries Ltd. which were acquired by the assessee on 25- 03-2002 i.e. after the date of issue of CBDT Circular No. 2 dated 15-02-2002. The assessee was following mercantile system of accounting.
The OFCPN were of the face value of Rs. 33,750 and were issued for Rs. 25,000. The Tenure was five years from the date of allotment. The terms of the issue provided that the investor had an option to put the OFCPN in the last quarter of 5th year. The investor also had an option to convert each of the OFCPN at the end of 5th year from the date of allotment into 2,500 equity shares of Rs. 10 each at par but no interest would be payable till maturity. If the assessee opts for conversion, it would get 2,500 equity shares of Rs. 10 each at par in lieu of one OFCPN of issue price of Rs. 25,000 and the assessee will not get any monetary gain in the form of interest or otherwise and only if the assessee does not exercise this option then the assessee will get Rs. 33,750 after the expiry of the period of 5 years from the date of allotment.
In view of the terms of the issue, the assessee was of the view that no interest accrued on day to day basis or on year to year basis. However, the Assessing Officer (AO) made an addition of Rs. 47,812 to the total income of the assessee on account of notional accrued interest on OFCPN.
This issue was raised as an additional ground and was admitted. The Tribunal observed that since this issue was not raised before the lower authorities normally it would be restored to the file of the CIT(A) or the AO but since a legal issue had to be decided as to whether as per the terms of the OFCPN of Nirma Industries Ltd., it can be said that any income is accruing on year to year basis or not and since the terms of the issue were before the Tribunal and also before the authorities below the Tribunal decided to decide the issue rather than restore it back to the file of the lower authorities.
Held II:
The Tribunal noted that, as per the terms of issue, in the initial 4 years, the assessee is not eligible to decide as to whether he is going to exercise the option of convertibility or not and such option is to be exercised only in the last quarter of the 5th year and the assessee will get shares at the end of the period of 5 years and no interest as such is payable till maturity even if the assessee does not opt for conversion. If the assessee does not opt for conversion into equity shares he will get Rs. 33,750 for each OFCPN after the expiry of period of 5 years from the date of allotment. The debentures are transferable during the period of 5 years and company is also eligible to purchase debentures at discount, at par or at premium in the open market or otherwise. Hence, in the earlier period also, if the assessee is not opting for conversion in the equity shares, the assessee can sell the debentures in the open market or to the issuer company and it is quite natural that in the open market, such debentures will command such price which will include offer price plus proportionate accretion on account of difference in the issue price and the face value which can be considered as interest although no such nomenclature is given for accretion in the issue details.
The Tribunal held that the issue details suggest that no income is guaranteed to the assessee even after 5 years period from the date of allotment if the assessee opts for conversion and the assessee will get the income being difference between the face value and the issue price only if such option of conversion is not exercised by the assessee which he can exercise only in the last quarter of 5th year. There was an argument forwarded by the learned DR that before the last quarter of the 5th year, the assessee has an option to sell these OFCPNs because these OFCPNs are transferable and in that situation, the assessee will get at least issue price plus proportionate accretion till date of transfer over and above the issue price. This may be correct but in our considered opinion, even in the light of these facts, it cannot be said that any income is accruing to the assessee on day to day or year to year basis. The OFCPN may be held by the assessee as investment or trading item. If the assessee is holding OFCPN as a trading item and till the same is sold by the assessee, it has to be considered by the assessee as closing stock which has to be valued at the cost or market price whichever is lower and in that situation, even if the market price is more than the cost price i.e. issue price, then also this income is not taxed till the sale takes place. Although, if the market price goes down below the cost price i.e. issue price then in that situation, the assessee can claim loss to that extent by valuing the closing stock of OFCPN at market price but in case the market price is more than the cost price, no income is accruing to the assessee till the same is sold.
We have already discussed that the nature of OFCPN is not that of a fixed deposit and it is also not of the nature of DDB because of convertibility option and uncertainty about receipt of any extra amount over and above the issue price. Even on conversion, shares are to be allotted at par and not at premium i.e. face value.
Considering all these facts, we hold that in the facts of the present case, it cannot be said that any income has accrued to the assessee on account of these OFCPNs of Nirma Industries Ltd. because no sale has taken place and there is no guaranteed income to the assessee even after 5 years in case the assessee opts for conversion into shares at par.
The Tribunal allowed this ground of appeal of the assessee.
Facts:
For assessment year 2007-08 the assessee claimed total credit for TDS of Rs. 21,51,63,912 – claim of Rs 16,52,09,344 was made in the original return and further claim of Rs 1,42,71,296 was made in revised return filed on 13-04-2009 and a claim of Rs. 3,56,83,272 was made vide letter, dated 28-12-2010, filed in the assessment proceedings. The Assessing Officer (AO) granted credit of TDS only to the tune of Rs. 11,89,60,393. The AO did not grant credit claimed because of discrepancy with respect to credit shown in Form No. 26AS.
Aggrieved, the assessee preferred an appeal to CIT(A) who directed the assessee to furnish all TDS certificates in original before the AO and directed the AO to verify the claim of credit of TDS and to allow TDS as per original challans available on record or as per details of such TDS available on computer system of the department.
Aggrieved, the assessee preferred an appeal to the Tribunal where it was contended that credit of TDS has to be given on the basis of TDS certificates and in case TDS certificates are not available, on the basis of details and evidence furnished by the assessee regarding deduction of tax at source. Reliance was placed on the decision of Bombay High Court in the case of Yashpal Sawhney vs. ACIT (293 ITR 593). Reference was also made to the decision of the Delhi High Court in the case of Court on its own Motion vs. CIT (352 ITR 273).
Held:
The Tribunal noted that the credit of TDS has been denied to the assessee on the ground that the claim for TDS was not reflected in computer generated Form No. 26AS. It observed that the difficulty faced by the tax payer in the matter of credit of TDS had been considered by the Hon’ble High Court of Bombay in the case of Yashpal Sawhney vs. DCIT (supra) in which it has been held that even if the deductor had not issued TDS certificate, the claim of the assessee has to be considered on the basis of evidence produced for deduction of tax at source as the revenue was empowered to recover the tax from the person responsible if he had not deducted tax at source or after deducting failed to deposit with Central Government. The Hon’ble High Court of Delhi in case of Court on its Own Motion v. CIT (supra) have also directed the department to ensure that credit is given to the assessee, where deductor had failed to upload the correct details in Form 26AS on the basis of evidence produced before the department. Therefore, the department is required to give credit for TDS once valid TDS certificate had been produced or even where the deductor had not issued TDS certificates on the basis of evidence produced by the assessee regarding deduction of tax at source and on the basis of indemnity bond.
The Tribunal modified the order passed by the CIT(A) on this issue and directed the AO to proceed in the manner discussed above to give credit of tax deducted at source to the assessee.
This ground of appeal filed by the assessee was allowed.
Facts:
For the assessment year 2004-05, the assessee filed a return declaring income of 31-08-2004. The return was processed u/s. 143(1) of the Act. Subsequently a notice was issued u/s. 148 of the Act. In response to this notice, the assessee filed a letter asking the Assessing Officer (AO) to treat the return filed u/s. 139 to be a return in response to the said notice. In an order passed u/s. 143(3) r.w.s. 147 of the Act, the AO made an addition of Rs. 10 lakh u/s. 68. In the order passed u/s. 143(3) r.w.s. 147 the AO mentioned that no notice u/s. 143(2) of the Act was served to the assessee within the statutory time limit during the original assessment proceedings. In the reassessment proceedings, the AO had mentioned that as a matter of precaution permission of CIT was obtained.
Aggrieved, the assessee preferred an appeal to CIT(A) who held that the reassessment to be null and void, since it was not in accordance with the provisions of the Act.
Aggrieved, the revenue preferred an appeal to the Tribunal.
Held:
The Tribunal noted that the Delhi High Court has in the case of CIT vs. SPL’s Siddhartha Ltd. (345 ITR 223)(Del) held that u/s. 151 of the Act it was only the Joint Commissioner or the Additional Commissioner who could grant the approval of the issue of notice u/s. 148 of the Act. The court has further held that if the approval was not granted by the Joint Commissioner or the Additional Commissioner and instead taken from Commissioner of Income-tax, then the same was not an irregularity curable u/s. 292B of the Act and consequently notice issued u/s. 148 was not valid.
Following this decision of the Delhi High Court, the Tribunal decided the issue in favor of the assessee and held that the reopening of assessment was not in accordance with law and was liable to be quashed.
The appeal filed by revenue was dismissed.
The assessee is a charitable trust which enjoyed exemption u/s. 11 of the Income-tax Act, 1961. For the A. Y. 2010-11 exemption u/s. 11 was denied by an order u/s. 143(3) of the Act and a demand of Rs. 1,41,07,755/- was raised. A period of seven days was granted instead of statutory period of 30 days from the date of service of the notice as prescribed u/s. 220 of the Act. Assessee preferred an appeal and also filed stay application before Commissioner(Appeals). In the mean time, the Assessing Officer recovered a sum of Rs. 1,39,70,275/- from the bank account of the assessee on 28th March, 2013.
The Gujarat High Court allowed the writ petition filed by the assessee, set aside the demand notice dated 13/03/2013, with a formal direction to the Revenue to refund the amount of Rs. 1,39,70,275/- by way of a cheque to be issued in favour of the assessee within two weeks and held as under:
“i) S/s. (1) of section 220 of the Income-tax Act, 1961, any amount otherwise than by way of advance tax, specified as payable in a notice of demand to be issued u/s. 156 of the Act, needs to be paid within 30 days of the service of the notice. However, the proviso to section 220(1) of the Act gives discretionary powers to the Assessing officer to reduce such period.
ii) Two conditions are required to be fulfilled before the Assessing officer resorts to this exception of the statutory period of 30 days. Firstly, he must have a reason to believe that the grant of the full period of 30 days would be detrimental to the interest of the Revenue and, secondly, prior permission of the Joint Commissioner requires to be obtained. The words “reason to believe” must have the same flavor as one finds in the case of exercise of powers by a reasonable man acting in good faith, with objectivity and neutrality based on material on record or exhibited in the order itself. The prior permission of the superior officer is to ensure that the powers are not exercised arbitrarily and there is a safeguard of a higher officer applying his mind independently to the issue in question when such belief is communicated by the Assessing Officer.
iii) If the demand is not likely to be defeated by any “abuse of process by the assessee”, belief cannot be sustained on the ground that availing of the full period would be detrimental to the interest of the Revenue.
iv) The reason given for reduction of the period for payment of taxes was that in the assessee’s place of assessment there was a budget deficit in the Income-tax Department. It was the budget deficit which was the very basis for making such a formation of belief. Another reason given was that the assessee had a rich cash flow and if the period of 30 days was reduced, the budget deficit would be met and the target set by the Department would be achieved.
v) The reasoning was contrary to the very object of introducing the proviso for giving discretion to the Assessing Officer. It clearly and unequivocally indicated that the Assessing Officer had completely misread the provision and his belief was neither of a reasonable man nor at all based on a rational connection with the conclusion of reduction of the period on account of it being detrimental to the Revenue.
vi) While issuing notice to the bank u/s. 226(3) of the Act for making payment, a notice has also to be given to the assessee which in this case was on the very day when the notice was issued to the bank. No opportunity had been given to the assessee for meeting such a notice issued to the bank. The sizeable amount of Rs. 1.39 crore had been withdrawn and deposited in the account of the Revenue on the very same day. Notice was an illusory and empty formality. This arbitrary exercise of withdrawal of amount from bank also required interference.
vii) Moreover, when the very action of the Assessing Officer was held to be contrary to the provisions of the law, the assessee’s not resorting to note (3) of the demand notice u/s. 156 of the Act or its having resorted to an alternative remedy was not bar to the court exercising the writ jurisdiction.”
For the A. Y. 1989-90 the assessee could not satisfactorily explain cash entry to the tune of Rs. 15,17,060/-. The Assessing Officer was of the opinion that even the profits returned were not truly disclosed as were other sources of income. He, therefore, proceeded to reject the accounts and complete the assessment on an estimate basis. Accordingly, the Assessing Officer made an addition of Rs. 25 lakh over and above the specific amount of Rs. 15,17,060/-. The Commissioner (Appeals) reduced the estimation to Rs. 17 lakh. This was upheld by the Tribunal.
The Delhi High Court allowed the assessee’s appeal and held as under:
“i) In the case of section 68 of the Income-tax Act, 1961, there cannot be any estimate even if for the rest of the accounts, such an exercise is validly undertaken. This is for the simple reason that the expression “any sum” refers to any specific amount and nothing more.
ii) U/s. 68 any amount other than one found credited in the account books of the assessee could not be estimated and charged to tax.”
218 Taxman 316 (Bom): The assessee was engaged in the business of investments and also dealing in shares and securities. In the A. Y. 2006-07, the assessee declared income under the heads ‘profits and gains of profession’ and also under the head ‘capital gains’. The Assessing Officer noted that a part of the capital gains declared was in respect of transfer of shares/securities which were held by the assessee originally as stock-intrade as a dealer in shares/securities which were converted into investment by the assessee on 1st April, 2002 and 1st October, 2004. He held that the short term and long term gains arising out of the sale of shares which were held originally as stock in trade and converted into investments was to be treated as business income. The CIT(A) and the Tribunal allowed the assessee’s claim. The Tribunal held that it is not in dispute that the conversion of its stock in trade into investment was accepted by the Department in A. Ys. 2003-04 and 2005-06. It is also not in dispute that the shares which were sold and gains from such sales were offered under the head capital gains from the date of conversion from stock in trade into investments and prior thereto as business profits. Further in its books of account the assessee showed the shares on which tax is levied under the head capital gain as investments. Further the fact that the assessee was trading in the shares would not estop the assessee from dealing in shares as investment and offer the gain for tax under the head capital gains. Thus, it is open to the trader to hold shares as stock in trade as well as investments.
On appeal by the Revenue, the Bombay High Court upheld the decision of the Tribunal and held as under:
“i) Once the finding of fact is recorded that the shares sold were held by assessee as investments, the gains arising out of the sale of investment were to be assessed under the head capital gains and not under the head business profits.
ii) In view of the above, we see no question of law arises for our consideration. Accordingly, the appeal is dismissed.”
The assessee, an individual, had sold shares and thereafter the sale proceeds of Rs. 54,86,965/- were invested in construction of house property. Exemption was claimed u/s. 54F of the Income Tax Act, 1961. The Assessing Officer rejected the claim on the ground that the construction of the house had commenced before the date of sale of shares. The Tribunal allowed the claim of the assessee.
On appeal by the Revenue, the Delhi High Court upheld the decision of the Tribunal and held as under:
“i) Section 54F(1) if read carefully states that the assessee being an individual or Hindu Undivided Family, who had earned capital gains from transfer of any long-term capital asset not being a residential house could claim benefit under the said section provided, any one of the following three conditions were satisfied; (i) the assessee had within a period of one year before the sale, purchased a residential house; (ii) within two years after the date of transfer of the original capital asset, purchased a residential house and (iii) within a period of three years after the date of sale of the original asset, constructed a residential house.
ii) For the satisfaction of the third condition, it is not stipulated or indicated in the section that the construction must begin after the date of sale of the original/old asset. There is no condition or reason for ambiguity and confusion which requires moderation or reading the words of the said s/s. in a different manner.
iii) Section 54F is a beneficial provision and is applicable to an assessee when the old capital asset is replaced by a new capital asset in form of a residential house. Once an assessee falls within the ambit of a beneficial provision, then the said provision should be liberally interpreted.
iv) In view of the aforesaid position, we do not find any merit in the present appeal and the same is dismissed.”
The assessee is a person carrying on business in the purchase and sale of Telugu films. For the A. Y. 2009-10, the Assessing Officer, made a disallowance of Rs.7,16,15,000/- for non-deduction of TDS u/s. 194J of the Income-tax Act,1961 by invoking section 40(a) (ia) of the Act on the ground that the purchase of film rights fell under the term “Royalty” and that the agreement entered into between the assessee with respect to purchase of film rights was termed as an assignment agreement and the assignee of the satellite rights and the person who transferred such rights was the assignor and such rights were given for a period of 99 years. Therefore, the Assessing Officer held that it is not a sale but a mere grant of satellite right in the movie produced by the assignor and the payments made for transfer of such rights fall within the meaning of “Royalty”. The CIT(A) allowed the assessee’s appeal and held that the payments made by the assessee could not be termed as ‘Royalty’ as they are not covered by Explanation 2 to Clause (vi) of section 9(1) of the Act and the payment were covered by section 28 of the Act as trading expenses and there was no scope for invoking section 40(a)(ia) of the Act and therefore the CIT(A) held that the payments for acquiring of the film rights were not exigible for deduction of Tax at Source u/s. 194J of the Act as they did not qualify as ‘Royalty’. The Tribunal reversed the decision of the CIT(A) and upheld the disallowance.
On appeal by the assessee, the Madras High Court reversed the decision of the Tribunal and held as under:
“i) We have seen the various conditions contained in the sample transfer deed and there is a transfer of copy right in favour of the assessee. Though the agreement speaks of perpetual transfer for a period of 99 years, in terms of section 26 of the Copy Right Act, 1957, in the case of cinematographic film, copy right shall subsist until 60 years from the beginning of the calendar year next following the year in which the film is published. Therefore, the agreement in the case on hand, is beyond the period of 60 years, for which the copy right would be valid, the document could only be treated as one of sale.
ii) We have no hesitation to hold that the findings of the First Appellate Authority was perfectly justified in holding that the transfer in favour of the assessee as sale and therefore, excluded from the definition of “Royalty” as defined under clause (v) to Explanation (2) of section 9(1) of the Act.
iii) In the result, the order of the Income Tax Appellate Tribunal shall stand set aside and the Tax Case(Appeal) is allowed.”
The Appellant company is a subsidiary of Oracle Corporation USA. The Appellant company entered into a licence agreement with its parent/holding company under which the Appellant was granted non-exclusive non-assignable right and authority to duplicate on appropriate carrier media software products or other products and sub-licence the same to third parties in India. The holding company retained the ownership of the copyright. For the relevant years the Assessing Officer disallowed the claim for deduction of the royalty paid to the holding company treating the same as capital expenditure. The Tribunal upheld the disallowance.
The Delhi Court reversed the decision of the Tribunal, allowed the assessee’s appeal and held that the expenditure was of revenue nature and as such an allowable deduction.
The assessee company was engaged in manufacture and sale of certain consumer products. Under its sales promotion scheme the purchasers were entitled to prizes as indicated on the coupons inserted in the packs/containers of their products. The prizes were Santro car, Maruti car, gold chains, gold coins, gold tablas, silver coins, emblems etc. The total amount of prizes distributed valued at Rs. 6,51,238/- for A. Y. 2001-02 and Rs. 54,73,643 for A. Y. 2002- 03. The Assessing Officer held that what has been paid by the assessee as prize in kind is a lottery on which tax was deductible u/s. 194B of the Income-tax Act, 1961 and treated the assessee as an assessee in default on the ground that the assessee neither deducted the tax nor ensured payment thereof before the winnings were released. Accordingly, the Assessing Officer raised a demand of Rs. 3,78, 550/- for the A. Y. 2001-02 and Rs. 17,73,902/- for A. Y. 2002-03 u/ss. 201(1) and 201(1A). The Tribunal cancelled the demand and held that there was no obligation on the assessee to deduct tax at source in respect of prizes paid in kind and in absence of any such obligation no proceedings u/s. 201 could be taken against the assessee.
On appeal by the Revenue, the Karnataka High Court upheld the decision of the Tribunal and held as under:
“i) From the plain reading of the proviso to section 194B, it is clear that it does not provide for deduction of tax at source where the winnings are wholly in kind and it simply puts a responsibility to ensure payment of tax, where winnings are wholly in kind. In the present case, admittedly the winnings were wholly in kind.
ii) The combined reading of sections 194B and 201 would show that if any such person fails to “deduct” the whole or any part of the tax or after deducting, fails to pay the tax as required by or under this Act, without prejudice to any other consequences, which he may incur, be deemed to be an assessee in default in respect of the tax. In other words, the provisions contained in these sections do not cast any duty/responsibility to deduct the tax at source where the winnings are wholly in kind. If the winnings are wholly in kind, as a matter of fact, there cannot be any deduction of tax at source.
iii) The proceedings against the person u/s. 201, such as the assessee in the present case, who fails to ensure payment of tax, as contemplated by proviso to section 194B, before releasing the winnings, are not maintainable or the proceedings against such person are without jurisdiction.”
Assessee believed that conveyance allowance is exempt and accordingly computed TDS u/s. 192 excluding conveyance allowance. The Assessing Officer treated the assessee as assessee in default and raised demand u/s. 201(1) and also levied interest u/s. 201(1A). The Tribunal allowed the assessee’s appeal and cancelled the demand.
On appeal by the Revenue, the Allahabad High Court upheld the decision of the Tribunal and held as under:
“Assessee was under bona fide belief that the conveyance allowance was exempt u/s. 10(14) and tax was not deductible at source and therefore assessee could not be treated as assessee in default for charging interest u/s. 201(1A) of the Act.”
The assessee approached the Commissioner of Income Tax (Appeals), who confirmed the decision of the Assessing Officer, holding that the entire amount received by the assessee towards consideration on transfer of the DEPB credits would be covered u/s. 28(iiid) of the Act. Ninety per cent of the such amount, therefore, had to be excluded for the purpose of working out of the deduction u/s. 80HHC of the Act. The Commissioner of Income Tax (Appeals) observed that the treatment to the DEPB amount should be the same as that of duty draw back. In other words, the entire amount of the DEPB credit would be covered under section 28(iiid) of the Act. The Commissioner of Income Tax (Appeals) was of the opinion that the cost of acquiring the DEPB credit to the assessee was nil.
The assessee carried the issue in appeal before the Tribunal. The Tribunal in the detailed judgment considered various aspects including the interpretation of various clauses of section 28, and in particular, clause (iiid) of section 28 and its co-relation to section 80HHC of the Act. The Tribunal was of the opinion that the face value of the DEPB would be the cost of its acquisition by the assessee. If the assessee sold such DEPB credit at a price higher than the face value, the difference would be the profit of the assessee which would be covered u/s. 28(iiid) of the Act. It is only this element which to the extent of 90 per cent be excluded for the purpose of working out section 80HHC deduction. The Tribunal also referred to Explanation (baa) to section 80HHC, by virtue of which, 90 % of the income referred to in section 28(iiid) of the Act is to be excluded from the total turnover of the assessee for the purpose of working out section 80HHC deduction.
The Revenue carried the matter to the High Court, which on combined reading of the Government of India policy providing for the DEPB benefits, the decision of the Bombay High Court in Kalpataru Colours and Chemicals (2010) 328 ITR 451 (Bom.) and the apex court, in Liberty India vs. CIT (2009) 317 ITR 218 (SC) concluded that the face value of the DEPB credit cannot be taken to be its cost of acquision in the hands of the assessee-exporter.
According to the High Court, the Tribunal committed an error in coming to the conclusion that on transfer of the DEPB credit by an assessee only the amount in excess of the face value therefore would form part of profit as envisaged in clause (iiid) of section 28.
Before the Supreme Court, the learned Additional Solicitor General for the Revenue, fairly submited that in view of the decision of the Supreme Court in Topman Exports vs. CIT [2012] 342 ITR 49 (SC), the civil appeal deserved to be allowed and the matter should be sent back to the Assessing Officer.
The Supreme Court for the reasons given in Topman Exports (supra) set aside the judgement and order of the Gujarat High Court and directed the Assessing Officer to compute the deduction u/s. 80HHC of the Income-tax Act, 1961, in the light of the observations made by it in Topman Exports.
Note: A similar decision was delivered by the Supreme Court in the case of Global Agra Products vs. ITO (2014) 360 ITR 117 (SC)
Minimum Alternate Tax (‘MAT’) was introduced as an alternative mode of tax with an intent to maintain minimum quantum of tax to be paid by the assessee – company which made profits but offered little or negligible income to tax by virtue of various deductions. While the methodology for computing MAT appears simple , the same has been under the subject matter of controversy due to interpretation of terms contained in section 115JB.
In the following article, the authors have analysed the treatment of a provision for the purposes of MAT and brought out the various dimensions of the issue.
1. Introduction
The era of MAT began as an ‘alternative mode’ of tax. With the efflux of time, the MAT regime has actually left us with no ‘alternative’ but to ‘tax’. Its objective is well known; although the text and content is vexed which often keeps the tax doyens perplexed. This complex provision has thrown out innumerable issues from its Pandora box. In this article, we have attempted to address one such issue through a case study.
2. Case Study
X Limited is an Indian company which acquired 1,00,000 equity shares of Y Limited for a consideration of Rs. 60 crore. In Year 1, X Limited created a “Provision for investment loss” amounting to Rs. 16 crore [by debiting the profit and loss account]. Cost of investment in the balance sheet was reduced to the extent of the provision (ie, Rs. 16 crore). The net loss as per the profit and loss account was Rs. 17 crore.
While computing the book profit under the provisions of section 115JB of the Income-tax Act, 1961 (“the Act”), the Provision for investment loss (i.e. Rs 16 crore) was “added back” to net the loss as per the profit and loss account. The book loss (u/s. 115JB) for Year 1 was accordingly computed at Rs. 1 crore. The loss computed under the regular provisions of the Act was Rs. 50 lakh. The loss computed under regular provisions being lower than the book loss, the return of income for Year 1 was filed with the loss of Rs. 50 lakh.
Subsequently, in Year 2, X Limited sold the 100,000 equity shares in Y Limited for Rs. 68 crore. The sale resulted in a gain of Rs. 8 crore. X Limited recognised this gain as “Profit on sale of investment” in the Profit and loss account along with reversal of Provision for investment loss (pertaining to shares sold during the year) amounting to Rs. 16 crore. Cumulatively, profit on sale of investment recognised in financial statements added up to Rs. 24 crore [ie, 8 crore + 16 crore]. The company paid tax under the provisions of MAT (section 115JB) amounting to Rs. 2 crore [after reducing Rs. 16 crore from the net profit].
In this background, the write-up discusses the appropriateness of the MAT computation carried out by X Limited.
3. Case Analysis
MAT – General principles
Minimum Alternate Tax (“MAT”) computed u/s. 115JB is an alternative regime of taxation. The section provides for an alternate, nay an additional mechanism, of ‘computing the tax liability’ of an assessee apart from the normal computation. A comparison is made between tax payable under the normal provisions of the Act and the tax payable on “book profit”. The higher of the tax payable from out of the two computations would have to be discharged by the assessee company.
S/s. (1) to section 115JB requires a tax (at 18.5%) on book-profit to be compared with income-tax payable on the total income as computed under the Act. Section 115JB is an alternative tax mechanism. This is evident from the section heading which reads – “Special provision for payment of tax by certain companies”. It is thus a special provision for payment of tax. The intent of section 115JB is to maintain the minimum quantum of tax (at 18.5% on book profit) that an assessee-company should be liable to pay. If the tax u/s. 115JB is higher, the “book-profit” is deemed to constitute the total income of the Company.
‘Book Profit’ is defined in Explanation 1 to section 115JB. It is defined to mean the net profit as shown in the profit and loss account prepared as per s/s. (2) to section 115JB as reduced or increased by certain sums specified in the section. S/s. (2) requires the profit and loss account to be prepared in accordance with Parts II & III of Schedule VI of the Companies Act, 1956. In arriving at the net profit, therefore, the principles outlined in Parts II & III of schedule VI of the Companies Act, 1956, shall be followed [Apollo Tyres Ltd (2002) 255 ITR 273(SC) and CIT vs. HCL Comnet Systems & Services Ltd. (2008) 305 ITR 409 (SC)].
Explanation 1 outlines a process of additions and deletions of certain sums to the ‘net profit’ disclosed in the Profit and loss account. Judicial precedents indicate that these adjustments are exhaustive. No other adjustments apart from those outlined in the explanation can be made to the ‘net profit’ to arrive at the “book profit”.
Characteristics of book-profit
S/s. (1) to section 115JB envisages a comparison of taxes. If the tax on book profit is higher than the tax payable under the normal provisions of the Act, then, (i) such book-profit would be deemed to be the total income and (ii) the tax payable shall be the tax on book profit (at 18.5%). A two-fold deeming fiction is envisaged. The total income under the normal provisions is replaced with book profit and the tax payable under the normal provisions paves way for ‘tax on book-profit’. Thus, s/s. (1) visualises a 3 step-approach:
(i) The book profit should be an outcome of the computation envisaged in Explanation 1 wherein, net profit as per the profit and loss account is adjusted by the adjustments specified therein;
(ii) Tax on such book profit should exceed the tax on income under the normal provisions; and
(iii) On satisfaction of the twin characteristics above, the book profit is deemed as the total income and the tax on book profit shall be the tax payable by the assessee.
Step ‘(iii)’ is a natural consequence of steps ‘(i)’ & ‘(ii)’. S/s. (1) of section 115JB is operative only when steps (i) and (ii) result in step (iii). In other words, in the absence of book profit or if tax on income under the normal provisions exceeds or is equal to the tax on the book profit, the deeming fiction in step (iii) is not to be invoked. If step (i) and (ii) do not culminate in step (iii), the computation in step (i) [book profit computation] becomes relevant only for step (ii) [comparison] and not step (iii). This is because, the computation of total income under normal provisions is sustained and the occasion of its replacement by book profit does not occur/ arise.
In case the computation [of book profit] under step (i) results in a negative number (or book loss, step (ii) becomes inapplicable or irrelevant. The comparison envisaged in step (ii) is between ‘tax on total income’ and ‘18.5% on book profit’. A negative book profit will invariably result in tax on total income under the normal provisions not being lower than tax on book profits. This can be explained by looking at the twin possibilities below:
Case 1 – Positive total income and book loss
In the above case, tax on total income under the normal provisions (being a positive number) exceeds the “tax payable” on the negative book profit (or book loss) and consequently results in tax on total income under the normal provisions being higher than 18.5% of book profit. Accordingly, section 115JB(1) is not satisfied.
Case 2 – Nil total income and book loss
|
Particulars |
Amount (Rs) |
|
|
|
|
Total income under the normal provisions |
Nil |
|
|
|
|
Tax on total income (@ 30%) – (A) |
0 |
|
|
|
|
Book loss |
(20) |
|
|
|
|
18.5% on book loss – (B) |
(3) |
|
|
|
|
Tax payable by the |
0 |
|
|
|
In the above case, tax on total income (being nil) exceeds the negative tax on the book profit (or book loss) and consequently results in tax on total income being higher than 18.5% of book profit. Accordingly, section 115JB(1) is not satisfied.
In both the situations, “tax” on total income un-der the normal provisions would exceed 18.5% on book loss (or negative book profit). It is a trite to state that ‘total income ’ could either be ‘positive’ or ‘nil’.There cannot be negative total income. Consequently, there cannot be a ‘tax in negative’. For section 115JB to operate, ‘18.5% of book profit’ should be higher than such tax. Even if ‘18.5% on book loss’ is taken to be ‘nil’ in both the aforesaid examples, tax on total income under the normal provisions would not be lower which is the primary condition for section 115JB to be invoked.
Creation of provision for investment loss
In the given case study, X Limited created ‘Provi-sion for investment loss’ which was added back (or adjusted) while computing the book profit u/s. 115JB. The company had filed its return of income in Year 1 with loss (computed under normal provisions of the Act) amounting to Rs. 50 lakh. This loss was lower than the book loss (u/s. 115JB) for Year 1 which was Rs. 1 crore.
Being a book loss, there was no occasion to compute ‘tax on book profit’. Comparison of taxes u/s/s. (1) was not possible. The total income and tax payable could not be deemed as ‘book profit’ and ‘tax on book profit’ respectively for Year 1. Accordingly, operation of section 115JB was not triggered. For Year 1, the ‘Provision for investment loss’ was added back (or adjusted) while computing the “book profit” u/s. 115JB. The net result of the computation was a loss.
The appropriateness of this treatment (i.e, adding back of the provision) can be examined by traversing through the various adjustments housed in Explanation 1. These adjustments can be bisected into ‘upward adjustments’ and ‘downward adjustments’ which increase and decrease the net profit respectively. The opening portion of the Explanation 1 reads – “For the purposes of this section, “book profit” means the net profit as shown in the profit and loss account for the relevant previous year prepared u/s/s. (2), as increased by…”.
The phrase used is ‘net profit’. The expression ‘net profit’ and ‘net loss’ are not synonymous and can-not be used interchangeably. One could argue that the Explanation 1 visualises only a ‘net profit’ and not a ‘net loss’. In other words, the adjustments contemplated under Explanation 1 are not operative where the net result of operation is a loss. This is because the threshold condition to ignite section 115JB, viz. ‘net profit’, is not satisfied.
Further, the opening portion of the Explanation 1 deals with ‘increase’ of ‘net profit’ by certain adjustments. The second portion which deals with downward adjustments deals with reduction of the net profit by certain adjustments. The phrase used therein is “reduced by”. Thus, the law envisages an ‘increase’ and ‘decrease’ of net profits. The legislature has not employed the phrase “adjusted by”. The phrases used in the Explanation 1 have specific connotations. They cannot be understood in any modified manner. This aspect is important because an adjustment which ‘increases’ a ‘net profit’ would arithmetically ‘decrease’ if the start point were to be a ‘net loss’. This opposite numerical consequence indicates that the adjustments in the first portion have to necessarily result in an increase in the base figure and the ones in the latter portion should cause a reduction. Accordingly, the law visualises only ‘net profit’ to be the start point or base figure [and not ‘net loss’].
In the present case study, the net loss as per Profit and loss account in the Year 1 was Rs. 17 crore. Existence of net loss thus excludes X Limited from the clutches of section 115JB. Accordingly, it could be argued that there was no need to carry out any computation u/s. 115JB.
Alternative view
If one were to adopt the aforesaid position [that MAT is operative only on ‘net profit’], then all loss making companies would be excluded from the gamut of MAT computation. Such interpretation, although may be literally correct, would defy the objective of MAT computation. This could encourage the practice of ‘skewing of profits’ or ‘window dressing’ of financial statements.
Having accepted that loss making companies are also subject to MAT provisions (like in the present case), one needs to understand whether the book profit computation carried out by X Limited for Year 1 is in accordance with Explanation 1.
Two adjustments which could be relevant in the present context are clause (c) and (i) of the first part of the Explanation 1. These clauses read as under:
(c) the amount or amounts set aside to provisions made for meeting liabilities, other than ascertained liabilities
……
(i) the amount or amounts set aside as provision for diminution in the value of any asset
As per clause (c) of Explanation 1, any provision for liability other than ‘ascertained liability’ is to be added to the net profit in order to arrive at the book profit for the purpose of section 115JB. A liability may be capable of being estimated with reasonable certainty though the actual quantification may not be possible. Even though estimation is involved, it would amount to a provision for ascertained liability. The intention of the legislature in inserting clause (c) is to possibly prohibit provision for contingent liability helping in reduction of the book profit. A provision for loss on investment should not be regarded as provision for meeting unascertained liability.
Prior to insertion of clause (i), there was no express provision which dealt with provision for diminution in the value of asset. It amply clarified by the Apex Court in the case of CIT vs. HCL Comnet Systems & Services Ltd. (2008) 305 ITR 409 (SC) that clause
(c) does not deal with diminution in value of as-sets. The Court observed (although the decision was in the context of provision for doubtful debts) that a provision for doubtful debts is to cover up the probable diminution in value of asset (debtors) and is not provision for a liability. Thus, provision for diminution in value of assets cannot be equated with provision for liabilities. Consequently, clause (c) in Explanation 1 cannot be applied in cases where a diminution in value of investments is contemplated.
Subsequently, clause (i) in second part under Explanation 1 was inserted by the Finance (No. 2) Act, 2009, with retrospective effect from 01-04-2001. Acknowledging that clause (c) was not suitable to rope in provision for loss in the value of assets, clause (i) was inserted to achieve this objective. Clause (i) statutorily affirms the Apex Court decision that provision for diminution in value of assets is different from provision for liabilities.
Clause (i) employs the expression “provision for diminution in the value of any asset”. Both clause (c) and
(i) use the term ‘provision’. This is possibly because a provision need not necessarily be for a liability and it could also be for diminution in the value of assets or for loss of an asset. This is discernible from the definitions/ description given in the ICAI literature and Company Law provisions. The word “provision” has not been defined in the Act. The Guidance Note on “Terms Used in Financial Statements” issued by the Institute of Chartered Accountants of India defines the term ‘provision’ as under:
“an amount written off or retained by way of providing for depreciation or diminution in value of assets or retained by way of providing for any known liability, the amount of which can-not be determined with substantial accuracy.”
Paragraph 7(1) of Part III of old Schedule VI to the Companies Act, 1956 defines the term ‘provision’ as under:
“the expression ‘provision’ shall, subject to sub-clause (2) of this clause, mean any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets or retained by way of providing for any known liability of which the amount cannot be determined with substantial accuracy.”
From the above, one can discern that a provision need not necessarily be for a liability. It can also be provision for depreciation or diminution in value of assets. The Mumbai Tribunal in the case of ITO vs. TCFC Finance Limited (ITA No.1299/Mum/2009) held that provision for diminution in the value of investment has to be added for computing book profit, regardless of the fact whether or not any balance value of the asset remains. The Tribunal also defined the meaning of the term “diminution” in the following manner:
“In common parlance the word “diminution” indicates the state of reduction. The Shorter Oxford Dictionary gives the meaning of the word “diminution” as “the action of making or becoming less; reduction “. Accordingly, any provision made for diminution in the value of any asset, is to be added for computing book profit under the provisions of section 115JB”
In the present case-study, the provision was created against loss due to decrease in the realisable value of investment (i.e, shares in Y Limited). It signifies preparedness for a dip in the value of the asset (Y Limited shares). The provision for investment loss after the amendment to the statute would be covered within the precincts of clause (i).
Reversal of provision for investment loss in Year 2
In the present case study, X Limited sold 100,000 equity shares in Y Limited in Year 2 for a gain of Rs. 8 crore. The company reversed the provision for investment loss amounting to Rs. 16 crore. Conse-quently, Rs. 16 crore was included in net profits while computing the MAT liability. After reducing Rs. 16 crore from the net profit, the company discharged its tax liability under MAT.
There is no dispute around inclusion of Rs. 8 crore in the book profit [being gain from the sale of shares]. The question is whether while computing book prof-its under MAT, reversal of “Provision for investment loss” was to be ‘retained’ or ‘reduced’ from the net profits in ascertaining tax on book profit.
As already detailed, Explanation 1 outlines the computation of book profit involving certain additions and deletions (or adjustments) to the ‘net profit’. The start point of such computation is ‘Net Profit as shown in the Profit & Loss Account’. The adjustments contemplated in the definition include ones which increase such net profit (‘Upward Adjustments’) and items which reduce the net profit (‘Downward Adjustments’). One such ‘Downward Adjustment’ is amount withdrawn from any Reserve or Provision, if any such amount is credited to the Profit & Loss Account and had been instrumental in increasing the book profit for any earlier year. Clause (i) of the second part of Explanation 1 which houses this adjustment, reads as under:
(i) the amount withdrawn from any reserve or provision (excluding a reserve created before the 1st day of April, 1997 otherwise than by way of a debit to the profit and loss account), if any such amount is credited to the profit and loss account:
Provided that where this section is applicable to an assessee in any previous year, the amount withdrawn from reserves created or provisions made in a previous year relevant to the assessment year commencing on or after the 1st day of April, 1997 shall not be reduced from the book profit unless the book profit of such year has been increased by those reserves or provisions (out of which the said amount was withdrawn) under this Explanation or Explanation below the second proviso to section 115JA, as the case may be;
Clause (i) read with the proviso appended to it mandates reduction of net profits by the amount withdrawn from any reserves/provisions if – (a) it is credited to the profit and loss account and (b) the book profit u/s. 115JA / 115JB for year in which such provision was created had been increased by the amount of such provision. In other words, reduction as per Clause (i) is permissible only on satisfaction of twin conditions. Firstly, the amount withdrawn is credited to profit and loss account and secondly at the time of ‘creation’ of reserve, the ‘Book Profit’ had been increased by the amount of the said with-drawal. This was the mandate of the Apex Court in the case of Indo Rama Synthetics (I) Limited vs. CIT (2011) 330 ITR 363 (SC). The ruling advocates a strict reading of the downward adjustment for withdrawal from reserve. The Supreme Court held that if the reserves created are not referable to the profit and loss account and the amount had not gone to increase the book value at the time of creation of the reserve; the question of deducting the amount (transferred from such reserve) from the net profit does not arise at all. The Apex Court held that the objective of clauses (i) to (vii) is to find out the true and real working result of the assessee company.
In the present case, X Limited had credited the re-versal of provision for investment loss to its profit and loss account in Year 2. The reversal of the pro-vision to the profit and loss account satisfies the first condition referred to above. On this, there is no dispute. The doubt is regarding the compliance of the second condition. X Limited has excluded such reversal while computing the MAT liability. To enable such exclusion, the said reversal (of provi-sion) should have ‘decreased’ the book losses in the year of its creation (i.e, Year 1). A reduction of book loss has the same effect as increase in book profit. Accordingly, the second condition is satisfied. The question is whether the said treatment is tenable? Can increase in book profits (in the year of creation) to the extent of provision created by itself, satisfy the stipulated condition? Does such increase necessarily have to culminate in tax being payable under the MAT regime? Should an increase in book profit (on creation of provision) necessarily be accompanied with a tax liability u/s. 115JB?
The answer to this issue has both ‘for’ as well as ‘against’ view points. The analysis would not be complete, unless both the possible views are captured. The following paragraphs discuss these viewpoints:
View I – Increase in book profits should result in payment of tax under MAT
As per this view -point, the increase in book profit should result in tax liability under the MAT provisions. If such increase does not culminate in tax being payable u/s. 115JB, then the reversal of such provision should not be reduced while computing the book profit.
In this regard, it may be relevant to peruse circular no.550 issued by the Central Board of Direct Taxes explaining amendments to Income-tax Act vide Finance Act, 1989. The relevant portion of the same is as under:
“Amendment of the provisions relating to levy of minimum tax on ‘book profits’ of certain companies
24.4 Further, under the existing provisions certain adjustments are made to the net profit as shown in the profit and loss account. One such adjustment stipulates that the net profit is to be reduced by the amount withdrawn from reserves or provisions, if any, such amount is credited to the profit and loss account. Some companies have taken advantage of this provision by reducing their net profit by the amount withdrawn from the reserve created or provision made in the same year itself, though the reserve when created had not gone to increase the book profits. Such adjustments lead to unintended lowering of profits and consequently the quantum of tax payable gets reduced. By amending section 115J with a view to counteract such a tax avoidance device, it has been provided that the “book prof-its” will be allowed to be reduced by the amount withdrawn from reserves or provisions only in two situations, namely :—
(i) if the reserves have been created or provisions have been made in a previous year relevant to the assessment year commencing before 1st April, 1988; or
(ii) if the reserves have been created or provisions have been made in a previous year relevant to the assessment year commencing on or after 1st April, 1988 and have gone to increase the book profits in any year when the provisions of section 115J of the Income-tax Act were applicable.” (emphasis supplied)
The Circular clarifies that clause (i) is an anti-abuse provision. It was introduced to prohibit unintended lowering of profits and consequent reduction of tax payable. The intent was to induce parity in tax treatment in the year of creation and withdrawal of reserves. The objective is to plug-in tax leakage. The emphasis is on the payment of correct quantum of tax. The amendment seeks to impact the tax liability under MAT and not the mere arithmetic adjustment of book profit. In this background, it may be pertinent to observe the closing portion of the above quoted circular. It is clarified that the amount withdrawn from reserves or provisions is deductible in MAT computation only if (a) the reserves have been created or provisions have been made for the year on or after 1st April, 1988 and (b) have gone to increase the book profits in any year when the provisions of section 115J of the Income-tax Act were applicable. Twin conditions are visualised by the circular. The first relates to year of creation being on or after 01-04-1998 and the second mandates that the book profits should have been increased in the year in which section 115J is applicable. The latter condition thus requires not only enhancement of book profit but such increment has to occur in the year in which section 115J is applicable. MAT is “applicable” when the final discharge of tax happens under the regime of section 115J. The phrase “is applicable” has to be read in such context. Otherwise, it would have no meaning, as section 115J being a part of the statute would in any way be “applicable” to any company. The circular issued in the context of section 115J should also be applicable to section 115JB purposes, as in substance, the provisions are the same (More on ‘applicability’ of section 115JB later).
The latter condition of book profit enhancement accordingly has to occur in the year in which section 115JB is applicable. Section 115JB is an alternate tax regime. It is applicable only when the tax on book profits exceeds the tax on total income. If the tax on book profits does not ‘exceed’ tax on total income, section 115JB is not applicable.
To conclude, amount withdrawn from reserves or provisions is deductible in MAT computation only if (a) provisions have been made for the year on or after 01-04-1988; (b) such amount has gone to increase the book profit in the year in which taxes were payable under MAT regime (or section 115JB).
This view is supported by the Hyderabad tribunal in Vista Pharmaceuticals Ltd vs. DCIT (2012) 6 TaxCorp (A.T.) 27449 (Hyd). The issue before the tribunal was with regard to direction of the CIT to consider the interest waived to be included in the computation of book profit under section 115JB. The facts of the case were that the assessee computed its book profit u/s. 115JB at ‘nil’ after reducing the amount of interest waived by bank on the ground that it is the amount withdrawn from provision for interest to financial institutions debited to Profit and Loss account in earlier year now credited. The tribunal held as under:
“In the case of the present assessee, the amount withdrawn from reserve or provision i.e., waiver of interest cannot be considered as part of book profit since it was never allowed in the computation of book profit of the company in any of the earlier years since the company never had any book profit being sick industrial undertaking…….
It is also an admitted fact that in the earlier years there is no computation of book profit ex con-sequentia, there was no assessment with regard to computation of book profit u/s. 115JB of the Act. It was held in the case of Narayanan Chettiar Industries vs. ITO (277 ITR 426) that in respect of remission of liability no addition can be made un-less an allowance or deduction is allowed to the assessee in the previous year. Further in the case of Rayala Corporation Pvt. Ltd. vs. ACIT, 33 DTR 249, wherein it was held that returns for earlier years have been found defective by the Assessing Officer and declared to be nonest, as the assessee had failed to rectify the defect in spite of notice issued u/s. 139(9) of the Act, deduction of interest claimed in such returns cannot be deemed to have been allowed and, therefore, interest waived by bank cannot be charged u/s. 41(1) of the Act.
6. Taking the clue from the above judgments, similarly, unless the provision created by the assessee towards interest liability is allowed as a deduction while computing the book profit u/s. 115JB, when the assessee writes back the same to the Profit and Loss A/c, then it should be considered for determining the book profit. It is nobody’s case that interest liability has been allowed as deduction in earlier years. In other words, an allowance or deduction has been made in earlier years in respect of interest liability while computing the book profit and writing back the same could be added to the book profit. A reading of clause (i) to Explanation 1 to section 115JB(2) gives the above meaning.” (emphasis supplied)
The Hyderabad Tribunal ruled that unless the provision increased the “book profit” in an earlier year, the write back of such provision should continue to be considered for determining the “book profit”. The Tribunal departed from the literal reading of clause (i) and the proviso therein. The clause (and the proviso) stipulates the increase in book profit in the year of creation of provision/reserve. The “increase” is not an exercise in vacuum but one which results in attraction and enhancement of book profit tax. The Tribunal opted to place reliance on the rationale in circular no.550.
In the present case, while computing book profit u/s. 115JB for Year 1, X Limited had decreased the net loss by the provision of Rs. 16 crore made for diminution in the value of investment. In Year 2, the company reversed Rs. 16 crore out of the above referred provision for investment loss.
The provision for investment loss was “added back” while computing book profit (in Year 1). However, there was no net profit as per Profit and loss account in that year. As already explained, in the absence of net profit, it could be argued that section 115JB is not applicable. Tax was also not discharged in that year u/s. 115JB. In effect, there is no addition of provision for diminution in value of investment allowance. Applying the principles of the circular and the Hyderabad Tribunal, X Limited has not suffered tax under MAT on creation of provision for investment loss. Consequently, reversal of such provision would continue to be included in book profits computation. Once section 115JB is not applicable in the year of creation of reserve, reversal of such provision cannot be excluded from book profit computation.
Further, the provision for diminution in value of investments did not result in any additional tax liability under the MAT computation. On the contrary, such provision has decreased/reduced income while computing the total income under the normal provisions of the Act. It is an ‘erosion of capital’ which resulted in a loss. Such loss was claimed as a charge against income chargeable to tax. Subsequently, these investments were sold at a price over and above the original cost of investments/ shares. To clarify:
Accordingly, one possible view is that reversal of provision for diminution in value of investment cannot be excluded under Clause (i) of the second part of Explanation 1 while computing book profits.
View II – Increase in book profits need not result in payment of tax under MAT
Literal interpretation
Clause (i) is permissible only on satisfaction of twin conditions – (i) amount withdrawn is credited to profit and loss account and (ii) at the time of ‘creation’ of reserve, the ‘Book Profit’ was increased by the amount of the said withdrawal. The mandate of the law is clear and unambiguous. Modern judicial approach to interpretation of statutes is often driven by literal rule. Laws and regulations are the intentions of legislators captured in words. Every statute must be read according to the natural construction of its words. The words of a statute are to be understood in their natural and ordinary grammatical sense. The aspect of allowance or deduction discussed by the Hyderabad Tribunal is deviation from the literal reading of the law. Nothing prevented the legislature to lay down law to this effect.
View-I could result in absurd results Even otherwise, View I appears to revolve around whether the adjustment of provision for investment loss in the year of creation results in a positive book profits. It could never be the intent of the law to discriminate between companies which have only a nominal value of book profits (post set-off of provision for investment loss) with those companies where the net loss is not completely wiped off by the provision for investment loss in the computation. This can be understood through the below explained illustration:
|
Particulars |
Company A |
Company B |
|
|
|
|
|
Net loss as per Profit and loss |
(10,000) |
(10,000) |
|
account for Year 1 |
|
|
|
|
|
|
|
Add: Provision for investment |
10,100 |
9,900 |
|
loss |
|
|
|
|
|
|
|
Book |
100 |
(100) |
If the aforesaid provision was reversed in Year 2, Company B would not be able to claim reduction in that year (if View I were to be followed). On the contrary, Company A which has a nominal book profit of Rs. 100 may be allowed reduction of pro-vision reversal in Year 2 (although one could argue that only proportionate reduction will be allowed). Such interpretation would result in unintended consequence.
View I results in tax on capital
In the present case study, consideration received on sale of shares (by X Limited) was over and above the historical or original cost of such shares. The differential between such sale consideration and original cost is a gain and has to be necessarily offered to tax. There is no dispute on this aspect. One could argue that consideration to the extent of reversal of provision is ‘capital’ in nature. This is because, such consideration (i.e, to the extent of reversal of provision) refills the vacuum created by provision. Levying a tax on such consideration would amount to a ‘tax on capital’. In essence, it would culminate in higher effective rate of tax on capital gains. The philosophy of MAT taxation was to provide for an alternate tax regime and not double taxation. A denial of reduction from book profit would compel the taxpayer to pay taxes on income which he never earned.
Section 115JB – wider applicability
Circular no. 550 clarified that the amount withdrawn from reserves or provisions is deductible in MAT computation only if (a) the reserves have been created or provisions have been made for the year on or after 1st April, 1988 and (b) have gone to increase the book profits in any year when the provisions of section 115J of the Income-tax Act were applicable. The latter condition thus requires not only enhancement of book profits but such increment has to occur in the year in which section 115J is applicable.
S/s. (1) to section 115JB deals with the ‘applicability’ of the provision. It is applicable to every “company”. If 18.5% of book profit of such company exceeds tax on its total income then, such amount (i.e, 18.5%) would be the tax payable and book profit would be the total income. Thus, section 115JB is applicable to every company but the liability to pay tax is only in case of certain companies. The ‘certain companies’ are those which are liable to tax under MAT. This is supported by the section heading which reads – “Special provision for payment of tax by certain companies”. Section 115JB deals thus deals with payment of tax ‘by certain companies’. In other words, section 115JB is ap-plicable to all companies but renders only ‘certain companies’[whose tax under MAT exceeds normal tax computation] as liable to tax u/s. 115JB.
Applying this proposition in the present case, section 115JB was applicable to X Limited in Year 1 [although there was a book loss]. The provision for investment loss was “added back” while computing book profits for that year. The adjustment resulted in a reduction of loss. A “reduction of loss” is effectively the same as “increase in profits”. Accordingly, reversal of such provision in Year 2 should be excluded from while computing book profits for the year.
One may, in this connection, refer to the decision of the Kolkata Tribunal in the case of Stone India Limited vs. Department of Income-tax [ITA Nos. 1254/ Kol/2010]. The Tribunal in this case had an occasion to deal with treatment of “Provision for diminution in value of investment” for the purposes of book profits u/s. 115JB. In this case, the assessee debited its Profit and Loss A/c for the year ended 31.03.2001 with certain provision for diminution in the value of investment. In computation of book profit u/s. 115JB of the Act the said provision for diminution in the value of investment was not added back to the book profit. Subsequently, out of the said provision, the assessee wrote back certain amount in the accounts for the year ended 31-03-2006. The question was whether the reversal of provision for diminution in the value of investment was deductible in computation of book profit for AY 2006-07. The Court observed –
“It is also observed that clause (i) of Explanation to section 115JB of the Act says that the amount withdrawn from any reserves or provisions created on or after 01- 04-1997, which are credited to the profit and loss account, shall not be reduced from the book profits, unless the books profits were increased by the amount transferred to such reserves or provisions in the year of creation of such reserves (out of which the said amount was withdrawn). In this case, provision for diminution in the value of investment Rs. 7,05,73,000/ – was created in the financial year 2000-01 relevant to assessment year 2001-02 but book loss of the said year was not appreciated by the said amount in the computation filed u/s. 115JB along with the return. As there is a loss of Rs. 30,008/- prior to providing of prior year adjustment and diminution in the value of investment, no addition has been made u/s. 115JB by the assessee in the assessment year 2001-02 on account of diminution in the value of investment….. and the
exceptional item on account of diminution in the value of investment has not been adjusted while computing the book profit u/s. 115JB. Therefore, we are of the considered opinion that the observation of the Ld. CIT(A)was not justified in directing the assessee…” (emphasis supplied)
In the aforesaid case, provision for investment loss was not added back to the net loss while computing the book profits. The same had been reversed in subsequent year. In the year of provision, there was a net loss. The assessee did not carry out any adjustment. The Tribunal therefore ruled that reversal cannot be reduced from the book profits. The basis or rationale for such decision is that the book profits were not adjusted or appreciated by the provision created.
The Tribunal appears to have laid emphasis on the ‘adjustment or appreciation’ of book profits. The conclusion of the tribunal was driven by the non-adjustment of book profits in the initial year. Applying the ratio of the Tribunal ruling, it appears that if an adjustment of “book profit” had been made in the year of creation of the reserve, it would suffice to exclude the reversal of provisions while computing book profit for a subsequent year.
4. To conclude
X Limited had a net loss as per Profit and loss ac-count for Year 1. A view could be taken that MAT computation is not applicable in the year of loss and no adjustment contemplated u/s. 115JB is required. A better view would be that MAT provisions are applicable even in the year of loss and accordingly, adjustment of adding back provision for diminution in the value of investment in the Year 1 was appropriate.
As regards, exclusion of reversal of provision from book profit computation in Year 2, there are two views possible. View II appears to be appropriate and therefore reversal of provision should be excluded while computing book profits for Year 2.
5. Fall out of view-ii
In the present case, there was a provision created for diminution in investment amounting to Rs. 16 crore in Year 1. Such provision reduced the profits (or increased the losses) for the year. Subsequently, in Year 2, such provision was reversed and credited to Profit and loss account. Such credit ‘enhanced’ the profits for the year. While computing book profit for MAT purposes, X Limited reduced such reversal of provision. Thereby ‘enhancement of profit’ was nullified. By this, MAT liability was reduced.
Due to the provision entry in Year 1, the brought forward loss of Year 2 was increased. This enhanced loss translated into an ‘(increased) deduction’ from book profits while computing MAT liability for Year 2.
This is due to a ‘downward’ adjustment as per clause
(iii) of Explanation 1 to section 115JB which reads –
“the amount of loss brought forward or unabsorbed depreciation, whichever is less as per books of ac-count.” In this adjustment, the amount of brought forward losses (or business loss) is compared with unabsorbed depreciation loss; lower of the two is reduced in the book profits computation. The brought forward losses are to be adopted from the books of account. Consequently, an expense/ charge in the earlier years enhances the brought forward losses of the current year.
To sum-up, if View-II were to be adopted, X Lim-ited would avail dual benefit by – (i) reducing the book profits by amount of reversal in provision for diminution in value of investment and (ii) availing accelerated losses (depreciation or business loss whichever is less).
Unfortunately, most people ignore spirituality in their day to day living. In their opinion, whatever little charity or worship they do, is also a thing to be kept separate from their material life. The separation of the spirituality from our daily life is the root cause of diminishing values and erosion of ethical standards in society. Anarchy, corruption, war, disharmony, absence of law and order, tyranny, materialism, selfishness and consumerism are rampant today and due to our failure to synthesise the material life with spirituality. The world and the society is nothing but a group of individuals. When an individual lives his or her life bereft of spirituality, many vices like anger, violence, fear, hatred, greed, selfishness, envy, and enmity breed in him. Individual vices collectively surface on the stage called society and becomes the cause of society’s downfall. If we want to transform the world, establish high standards of ethics and remove vices from society, then we shall have to start with the inner transformation of the individual and only spirituality has the power of transforming that an individual.
Man is by nature self-centered and is interested in only those acts which benefit him. Even from this angle spirituality should be adopted by every individual because it is in the self interest and of immense benefit to persons who adopt it.
Every person is in pursuit of happiness and tries to find it in material wealth, fame and power. This erroneous pursuit for happiness ultimately robs him of peace and happiness and gives restlessness and pain. Many times, these material possessions become the cause of unhappiness.
This physical world is governed by some subtle universal and natural laws established by the Supreme Power whom we call God. Not having the awareness and understanding of these laws, man tries to seek happiness in their breach. These subtle laws are unchanging and autonomous. These laws are:-
1. As you sow, so you reap.
2. You receive what you give.
3. The fruit of the action is according to the intention behind it.
4. What you do unto others shall be done unto you.
5. Every action has a reaction.
6. Every sin shall be punished and every good deed shall be rewarded.
Everyone has heard of the simple laws described above. However, what is important is living these laws. Our universe is governed by these laws but we do not understand this due to our shortsightedness and impatience. Today, we find many persons achieving material success by unethical and dishonest ways. This results in our not believing in the importance of purity of means for material success.
In fact, one gets peace and joy only by living in harmony with these laws. Every material success can be attained by living according to these subtle laws. Spiritual living means practicing ethics and values and living in harmony with the voice of our conscience.
A question naturally arises to us – what about our life hitherto lived in disharmony with these laws? Let us accept that man is imperfect. It is natural for him to commit mistakes. The issue is, is there no respite for the mistakes committed? The answer is “better late than never”. These laws are meant for aspiring us to move towards perfection from imperfection and not to punish us.
I would like to end by quoting Swami Vivekananda, who always advocated practice more than theory. He has said, “Hindu religion does not consist in struggles and attempts to believe in certain doctrine or dogma, but in realising; not in believing, but in being and becoming.”
Penalty – Concealment of Income – The Assessing Officer during the assessment proceedings, is not required to record his satisfaction for initiation of penalty proceeding in a particular manner.
The appellant-assessee filed his return of income for the assessement year 2004-05 on 27th October, 2004, declaring an income of Rs. 16,17,040 along with tax audit report. The case was selected for scrutiny and notices were issued u/s. 143(2) and 142(1) of the Income-tax Act, 1961.
During the course of the assessment proceedings, it was noticed by the Assessing Officer that certain documents comprising share application forms, bank statements, memorandum of association of companies, affidavits, copies of income-tax returns and assessment orders and blank share transfer deeds duly signed had been impounded. These documents had been found in the course of survey proceedings u/s. 133A conducted on 16th December, 2003, in the case of M/s. Marketing Services (a sister concern of the assessee). The Assessing Officer then proceeded to seek information from the assessee and issued a show-cause notice dated 26th October, 2006. By the showcause notice, the Assessing Officer sought specific information regarding the documents pertaining to share applications found in the course of survey, particularly, blank transfer deeds signed by persons, who has applied for the shares. Reply to the show-cause notice was filed on 22nd November, 2006, in which the assessee made an offer to surrender a sum of Rs. 40.74 lakh with a view to avoid litigation and buy peace and to make an amicable settlement of the dispute. Following were the words used by the assessee :
“The offer of surrender is by way of voluntary disclosure and without admitting any concealment whatsoever or any intention to conceal, and subject to non-initiation of penalty proceedings and prosecution”
The Assessing Officer after verifying the details and calculation of the share application money accepted by the company completed the assessment on 29th December, 2006 and a sum of Rs. 40,74,000 was brought to tax, as “income from other sources” and the total income was assessed at Rs. 57,56,700.
The Department initiated penalty proceedings for concealment of income and not furnishing true particulars of its income u/s. 271(1)(c) of the Income-tax Act. During the course of the hearing, the assessee contended that penalty proceedings are not maintainable on the ground that the Assessing Officer has not recorded his satisfaction to the effect that there has been concealment of income/furnishing of inaccurate particulars of income by the assessee and that the surrender of income was a conditional surrender before any investigation in the matter. The Assessing Officer did not accept those contentions and imposed a penalty of Rs. 14,61,547 u/s. 271(1)(c) of the Act. The assessee challenged that the order before the Commissioner of Income-tax (Appeals), which was dismissed.
The assessee filed as appeal before the Income-tax Appellant Tribunal, Delhi. The Tribunal recorded the following findings:
“The assessee’s letter dated November 22, 2006, clearly mentions that the offer of the surrender is without admitting any concealment whatsoever or any intention to conceal.”
The Tribunal took the view that the amount of Rs. 40,74,000 was surrendered to settle the dispute with the Department and since the assessee, for one reason or the other, agreed or surrendered certain amounts for assessment, the imposition of penalty solely on the basis of the assessee’s surrender could not be sustained. The Tribunal, therefore, allowed the appeal and set aside the penalty order.
The Revenue took up the matter in appeal before the High Court. The High Court accepted the plea of the Revenue that there was absolutely no explanation by the assessee for the concealed income of Rs. 40,74,000. The High Court took the view that in the absence of any explanation in respect of the surrendered income, the first part of clause (A) of Explanation 1 was attracted.
On appeal to the Supreme Court by the assessee, the Supreme Court fully concurred with the view of the High Court that the Tribunal has not properly understood or appreciated the scope of Explanation 1 to section 271(1)(c) of the Act.
According to the Supreme Court, the Assessing Officer should not be carried away by the plea of the assessee like “voluntary disclosure”, “buy peace”, “avoid litigation”, “amicable settlement”, etc., to explain away its conduct. The question is whether the assessee has offered any explanation for concealment of particulars of income or furnishing inaccurate particulars of income. The Explanation to section 271(1) raises a presumption of concealment, when a difference is noticed by the Assessing Officer, between reported and assessed income. The burden is then on the assessee to show otherwise, by cogent and reliable evidence., that income was not concealed or inaccurate particulars were not furnished. When the initial onus placed by the explanation, has been discharged by him, the onus shifts on the Revenue to show that the amount in question constituted the income and not otherwise.
The assessee has only stated that he had surrendered the additional sum of Rs. 40,74,000 with a view to avoid litigation, buy peace and to channelise the energy and resources towards productive work and to make amicable settlement with the Income-tax Department. The statute does not recognise those types of defences under Explanation 1 to section 271(1)(c) of the Act. It is a trite law that the voluntary disclosures do not release the appellant assessee from the mischief of penal proceedings. The law does not provide that when an assessee makes a voluntary disclosure of his concealed income, he had to be absolved from penalty.
The Supreme Court was of the view that the surrender of income in this case was not voluntary in the sense that the offer of surrender was made in view of detection made by the Assessing Officer in a survey conducted 0n the sister concern of the assessee. In that situation, it could not be said that the surrender of income was voluntary. The Assessing Officer during the course of assessment proceedings has noticed that certain documents comprising share application, forms, bank statements, memorandum of association of companies, affidavits, copies of income-tax returns and assessment orders and blank share transfer deeds duly signed, had been impounded in the course of survey proceedings u/s. 133A conducted on 16th December, 2003, in the case of a sister concern of the assessee. The survey was conducted more than 10 months before the assessee filed its return of income. Had it been the intention of the assessee to make full and true disclosure of its income, it would have filed return declaring an income inclusive of the amount which was surrendered later during the course of the assessment proceedings. Consequently, it was clear that the assessee had no intention to declare its true income. It is the statutory duty of the assessee to record all its transactions in the books of account, to explain the source of payments made by it and to declare its true income in the return of income filed by it from year to year. In the opinion of the Supreme Court, the Assessing Officer, had recorded a categorical finding that he was satisfied that the assessee had concealed true particulars of income and was liable for penalty proceedings u/s. 271 read with section 274 of the Income-tax Act, 1961.
According to the Supreme Court, the Assessing Officer has to satisfy whether the penalty proceedings be initiated or not during the course of the assessment proceedings and the Assessing Officer is not required to record his satisfaction in a particular manner or reduce it into writing.
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This circular provides that renewal/rollover of an existing/original guarantee, which is part of the total financial commitment of the Indian Party will not be not to treated/reckoned as a fresh financial commitment, if: –
(a) The existing/original guarantee was issued in terms of the then extant/prevailing FEMA guidelines.
(b) There is no change in the end use of the guarantee, i.e. the facilities availed by the JV/WOS/Step Down Subsidiary.
(c) There is no change in any of the terms & conditions, including the amount of the guarantee except the validity period. The rolled over guarantee has to be reported as fresh financial commitment in Part II of Form ODI. If the Indian party is under investigation by any investigation/enforcement agency or regulatory body, the concerned agency/body must be kept informed about the rollover.
If the above conditions are not met, the Indian party has to obtain, through the designated AD bank, prior approval of RBI for rollover/renewal of the existing guarantee.
Facts:
The Assessing Officer disallowed the claim of certain expenditure u/s. 40(a)(ia) on the ground that the tax has not been deducted at source. Aggrieved, the assessee preferred an appeal to the Commissioner of Income-tax (Appeals) who allowed the appeal by stating that the amounts `payable’ only attract disallowance u/s. 40(a)(ia) and the amounts already paid would not attract the provisions of section 40(a) (ia).
Aggrieved, the Revenue preferred an appeal to the Tribunal where it relied on three decisions of Calcutta High Court and Gujarat High Court which have held that the law stated by the Special Bench in Merilyn Shipping & Transports vs. Addl CIT is not acceptable.
Held:
The Tribunal noted that the judgment of the Allahabad High Court is in favour of the assessee but the orders of the Calcutta High Court and the Gujarat High Court are against the assessee. It held that in such circumstances, the rule of judicial precedence demands that the view favourable to the assessee must be adopted, as held by the Hon’ble Supreme Court in the case of CIT vs. Vegetable Products Ltd. 88 ITR 192 (SC). In view of the fundamental rule declared by the Hon’ble Supreme Court, the Tribunal following the judgment of the Allahabad High Court, which is in favor of the assessee, held that the disallowance u/s. 40(a)(ia) applies only to those amounts which are `payable’ and not to those amounts which are `paid’.
The appeal filed by the revenue was dismissed.
The anticipated growth of XBRL use and its potential to replace traditional financial statements and electronic version of such financial statements in HTML or PDF format raises important assurance issues related to the information in ‘XBRL Instance Documents.’ Many companies that are currently providing their information using XBRL are doing so with limited quality assurance due to a lack of guidance on the best practices and limited auditor involvement. This poses a significant threat to the reliability and quality of XBRL-tagged financial data.
Auditors currently attest to the material accuracy of the financial statements using generally accepted principles of accounting (GAAP) as the criteria against which the financial statements prepared by the management are evaluated. Attestation on the financial statements does not apply to the current process of creating XBRL Instances, and it is not clear what criteria would be used by the auditors or others as they provide assurance services in XBRL environment. In contrast to a traditional financial audit, the subject-matter in an XBRL assurance engagement would be on the XBRL ‘documents,’ which are computer-readable files created in the tagging process.
There is a misconception that tagging of information in XBRL is similar to converting a Word document into PDF file and that tagged XBRL data is as accurate as the underlying information in the source documents from which it has been created and hence Assurance on XBRL Instance is like the original to a zerox copy being certified. This is an inappropriate analogy, because the process of tagging involves judgment and there is potential for intentional or unintentional errors that could result in inaccurate, incomplete, and/or misleading information. This is a problem because it is the XBRL-tagged data that will ultimately be consumed and used for decision-making purpose. Therefore, completeness, accuracy or consistency of the XBRL-tagged data is of paramount importance.
Potential risk in XBRL instances
Open taxonomy risks mainly relate to creation of a new taxonomy element (taxonomy extension). The filer could create a duplicate element for a concept that already has an element in the base taxonomy or could create an inappropriate or misleading taxonomy element. The taxonomy extension may not comply with the rules of XML and XBRL. The filer could use prohibited name in taxonomy extension.
Evaluating the quality of XBRL formatted information
Completeness
All required information and data as defined by the entity’s reporting environment is formatted in the XBRL Instance document and is complete in all respect.
Mapping
The elements viz. line items, domain members and axis selected in the XBRL file are consistent with the associated concepts in the source documents.
Accuracy
The amount, date and other attributes e.g., monetary units are consistent with the source documents.
Structure
XBRL files are structured in accordance with the requirements of the entity’s reporting requirements.
Approach to XBRL assurance
Srivastava & Kogan had presented a conceptual framework of assertion for XBRL instance documents for XBRL filings at SEC.
Control Tests and Substantive Tests
Control Tests and Substantive Tests need to be designed and applied to mitigate the risks in XBRL instance documents.
The Auditors are familiar with internal controls over the accounting processes. However, in the case of assurance over XBRL instance document, internal controls over XBRL tagging process need to be checked. The control tests need to be applied on:
(i) the effectiveness of the XBRL tool that has been used to generate XBRL instance document; and
(ii) the effectiveness of the validation tool
Substantive tests
In traditional audit sampling, the auditor is expected to specify either tolerable error or tolerable deviation rate and a desired reliability in order to determine a sample size sufficient to meet the audit objectives. However, in the case of audit of an XBRL instance document, since the objective of sampling is to determine whether tagging process has resulted in a material misstatement; an attribute sampling approach would not be appropriate. One can imagine a situation where a single wrong tagging results in a material misstatement or where numerous wrong tagging aggregates to an immaterial amount of error.
Materiality
The current auditing processes for examining and reporting on financial statements are designed to ascertain that, ‘taken as a whole’, the financial statements are free from any material misstatement and present a ‘true and fair view’ of the state of affairs of any company. The concept of materiality in the context of traditional audit of financial statements refers to the probable impact on the judgment of a reasonable person of an omission or misstatement in financial statement. In conjunction with auditors risk assessment, materiality’s role in planning a financial statement audit is to determine the allocation of audit efforts and in the opinion formation phase of the audit to evaluate the implications of the audit evidence on the financial statements ‘taken as a whole’. However, in case of XBRL, where a single inappropriate or mis-leading tag could result in the XBRL document ‘taken as a whole’ being materially misstated, the concept of materiality can’t be applied the way it is being applied to the audit of traditional financial statements.
In audit of XBRL instance document, two kinds of materiality need to be considered:
(i) Materiality for the entire financial statement; and
(ii) Materiality for each line item in the XBRL instance document.
Since the materiality concept used in the audit of financial statement is at the aggregate level, the implied materiality in the XBRL instance document is also at the aggregate level. However, since users of XBRL data are going to use each line item separately in their decisions, they will perceive each line item to be accurate in isolation. This would lead to erroneous decisions.
Conclusion
The focal point of XBRL assurance is the evaluation of the accuracy and validity of the XBRL tags applied to the line items in the financial statement of the company. In order to perform these evaluation, the auditors need to have the knowledge of what constitutes an error in XBRL instance document, what is the potential risk in XBRL instance document, how control tests and substantive tests should be applied in XBRL environment, and how materiality should be conceived and applied to XBRL instance document.
References
1. Bovee, M., A. Kogan, K. Nelson, R. Srivastava, M. Vasarhelyi. 2005. Financial Reporting and Auditing Agent with Net Knowl-edge (FRAANK) and extensible Business Reporting Language (XBRL) Journal of Information Systems, Vol. 19. No. 1
2. Boritz, J. E. and W. G. No. 2007. Auditing an XBRL Instance Document: The Case of United Technologies Corporation
3. Plumee & Plumee (2008) Assurance on XBRL for Financial Reporting
4. AICPA — Proposed Principles & Criteria for XBRL Formatted Information
5. Rajendra P. Srivastava & Alexander Kogan (2008) — Assur-ance on XBRL Instance Document: A Conceptual Framework of Assertions
6. AICPA — Performing Agreed Upon Procedures Engagements That Address The Completeness, Accuracy or Consistency of XBRL Tagged Data
7. ICAEW — Draft Technical Release for Performing Agreed Upon Procedures Engagements That Address XBRL Tagged Data Included Within Financial Statements Prepared in An iXBRL Format.
The ‘profit neutrality’ theory on account of arm’s-length remuneration to a dependent agent PE (DAPE) may not always hold good as the dependent agent (DA) may not be compensated for entrepreneurial risks that may arise to the principal.
Facts:
Taxpayer, a French company (FCO), is engaged in the business of operation of ships in international traffic.
FCO carried on operations in India through agents who handled the work at most of the Indian ports. The agents were responsible for all clearances from Government departments.
The Tax Department held that as business of FCO was carried out through a fixed place by an agent in India, wherein the agent was to maintain the office for the principal duly equipped, it could be said that FCO had PE in India. The Tax Department attributed 10% of the gross receipts from India to agency PE.
FCO contended that it did not have a PE in India under the DTAA, hence its business profits could not be taxed in India. In any case, due to arm’slength principal, there was no attribution of profit.
Held:
As the Dispute Resolution Panel (DRP) upheld the AO’s contention, appeal was preferred to ITAT. ITAT accepted contentions of FCO and held that FCO did neither have basic rule PE, nor agency PE. On Basic PE rule
The Agency PE rule specifically overrides the Basic PE rule.
The very business model of business of FCO being carried out through an agent is such that it does not ordinarily admit the possibility of a PE under the Basic PE rule.
In case of Airlines Rotables Ltd.2, UK it was observed that the following three criteria are embedded in the definition of the Basic PE rule:
In the agency business model, the above three parameters are not satisfied. Under such a model, the business of the foreign enterprise is carried out by the agent, and the principal does not have the powers, as a matter of right to use the agent’s place for carrying out its business, nor does it have the right of disposal of that place.
On DAPE
The France DTAA in Article 5(5) and Article 5(6) contains the scope of the DAPE. Article 5(5) provides the situations in which business being carried on through a DA creates a PE.
Under Article 5(6) of India-France DTAA even when an agent is wholly or almost wholly dependent on the foreign enterprise, it would still be treated as an independent agent, if the transactions are at arm’s length.
The sine qua non for constituting a DAPE under the France DTAA is the finding that the transaction is not carried out at arm’s length. No such finding was given by the Tax Department.
In absence of findings by the Tax Department or the DRP, FCO does not have a PE in India.
On profit attribution
One of the issues raised was about tax neutrality for the taxpayer even assuming there is emergence of PE. The ITAT ruled that the issue is academic in the facts of the case as DAPE did not exist. ITAT did however caution that the tax neutrality theory (i.e., once the agent is paid at arm’s length no further attribution can be made to PE) on account of existence of DAPE may not always hold good, as the DA may not be compensated for the risks that may arise to the principal.
Pendency of a proceeding u/s.195 or 197 of the Act, or even a final order under any of these sections, cannot invalidate an application for advance ruling being entertained.
Facts:
Applicant, a tax resident of China (FCO), entered into an offshore supply contract with an Indian company (ICO) in 2006.
FCO filed an application before the AAR on 18 November 2010 on the issue of taxability of the amounts received/receivable by it under the offshore supply contract.
As on the date of filing the application, status in respect of the years covered by the application was as under:
The Tax Department raised a preliminary objection regarding the admissibility of the application u/s.245R(2) on the ground that for each of the years proceedings are pending.
FCO contended that the application was maintainable and mere filing return before approaching the AAR would not mean that the question raised in the application is already pending before the Tax Department. Reliance was also placed on the ‘Hand Book’ on Advance Rulings.
Mere pendency of a proceeding u/s.195 or 197 of the Act, or even an order under any of the sections, would not invalidate an application for advance ruling being entertained. However, where a return of income is furnished and the proceedings for assessment are going on, all the claims raised by the taxpayer are before the tax authority for consideration and decision.
It cannot be said that the issue of taxability of one of the items of income returned has not arisen or not pending before the Tax Authority merely because the same has not been raised in general or specific questionnaire issued by the Tax Authority to the applicant. There is no restriction on the power of the Tax Authority to inquire.
Proviso to section 245R(2) of the Act creates a specific bar on the jurisdiction of the AAR to give a ruling once it is found that there subsists pendency of proceedings. In the circumstances, the application is liable to be rejected.
The ‘Hand Book’ on Advance ruling relied on by FCO itself provides that it should not be construed as an exhaustive statement of law. Even otherwise, what is stated in the ‘Hand Book’ cannot control the rendering of a decision with reference to the relevant provisions under the ITA.
Business income of foreign company not taxable in absence of a PE in India.
Agency PE cannot be created by an Indian company acting independently.
Facts
Taxpayer, a non-resident company (FCO) of USA, is engaged in production and distribution of films.
FCO entered into an agreement with an Indian company (ICO) to grant exclusive rights of distribution of cinematographic films to ICO. The agreements were signed outside India. ICO had no right to broadcast films on TV or radio and it was an admitted fact that the consideration was for distribution of films. The payment was also made to FCO outside India.
According to FCO, the income was not taxable in India, as the payment was specifically excluded from royalty definition of ITA and once income was not taxable in terms of specific source rule of royalty taxation, the amount was not chargeable u/s.9(1)(i) of the Act.
The contentions were rejected by the Tax Department. Aggrieved by the order of CIT(A), Tax Department further appealed to ITAT.
Held:
ITAT accepted FCO’s contentions and concurred with the CIT(A)’s order for the following reasons:
The definition of royalty u/s.9(1)(vi) excludes payment received for sale, distribution and exhibition of cinematographic films. Hence amount received by FCO cannot be considered as royalty under ITA.
When there is a special source rule dealing with a specific type of income, such provision would exclude applicability of general provision dealing with the income accruing or arising out of any business connection in India.
Consideration received by FCO is also not taxable as business income, as FCO does not have business connection in India. Even if FCO has business connection, profits only to the extent attributable to PE can be taxed in India. However, since FCO does not have PE in India, such income will not be liable to tax in India.
ICO, to whom the licence was granted by virtue of agreement, cannot be considered as Agency PE as it is not exclusively dealing for FCO, but also for other non-residents.
Determination of payee’s taxability is a primary question and not incidental while determining withholding obligation of payer u/s.195.
Facts:
The applicant, an Indian public sector company (ICO), entered into various offshore supply and service contracts with a company incorporated in Russia (FCO), for setting up a power plant in India.
In terms of the contract between ICO and FCO, it was agreed that FCO had primary obligation to pay taxes in India and ICO was required to reimburse the same. Effectively, tax obligation in respect of FCO’s income was on ICO.
For the purpose of TDS obligation, ICo had contended that the income from onshore service contract alone was taxable in India and the income from offshore supply contract was not taxable in India.
The AAR, before considering ICO’s application, raised primary question of whether the application filed by ICO was maintainable having regard to the bar imposed u/s.245R(2) (i), wherein AAR is precluded from ruling on a question, which is already pending before any Income-tax Authority, Appellate Tribunal or any Court.
Held:
AAR rejected ICO’s contention and held:
AAR ruling is binding not only on the applicant (payer), but also for the transaction for which the ruling is sought.
An AAR ruling is sought by ICO in relation to a transaction between resident and non-resident and not in terms of the other provisions of ITA which could have entitled ICO to claim tax implications of its own. This ruling is in relation to ‘transaction’ and, hence, pendency of proceedings in the case of any party to the transaction would operate as a bar against the other in approaching AAR.
Reliance was placed on Foster’s ruling1 wherein it was held that if a proceeding in respect of a transaction to which the applicant (as a payee) was a party, was pending before the Tax Authority in the case of the other party (payer) to the transaction, the application would be barred for the reason that the question posed before the Tax Authority and the AAR would be the same.
Withholding tax provisions under ITA obligate a payer to withhold tax on every payment to a non-resident, provided the same is chargeable to tax in India. Thus, the liability of the payee to pay tax on the payment received is not a question that is incidental to the issue of whether the payer is bound to withhold tax; this question is primary and not incidental.
As the issue of whether the payment made under the transaction was taxable under the ITA was already pending before the Tax Authority in the case of FCO before ICO approached the AAR, the application was not maintainable.
The activities of liaisoning per se should not result in any tax implication in India. However, when such activities cross the threshold of liaisoning, they would constitute Permanent Establishment and proportionate profits attributable to its activities in India may be subjected to tax. Several cases by Tribunals, Courts and AAR have been decided and in this Article, various aspects concerning taxability of liaison offices have been dealt with.
1.0 Introduction
1.1 Meaning of the term ‘Liaison’
A ‘Liaison Office’ (LO) is a representative office set up primarily to explore and understand the business and investment climate. Such office is not permitted to undertake any commercial/trading/industrial activity, directly or indirectly, and is required to maintain itself out of inward remittances received from the parent company through normal banking channels.
1.2 Meaning of the term ‘Liaison Office’ as per FEMA
Clause 2(e) of the Notification No. FEMA 22/2000-RB, dated 3rd May 2000 pertaining to Foreign Exchange Management (Establishment in India of Branch or Office or other Place of Business) Regulations, 2000 defines ‘Liaison Office’ as under:
“ ‘Liaison Office’ means a place of business to act as a channel of communication between the Principal place of business or Head Office by whatever name called and entities in India but which does not undertake any commercial/trading/industrial activity, directly or indirectly, and maintains itself out of inward remittances received from abroad through normal banking channel.”
Schedule II of the said Notification lists activities which are permitted to a Liaison Office in India as follows:
(i) Representing in India the parent company/group companies;
(ii) Promoting export import from/to India;
(iii) Promoting technical/financial collaborations between parent/group companies and companies in India;
(iv) Acting as a communication channel between the parent company and Indian companies.
Thus, in essence, a ‘Liaison Office’ (LO) is nothing but a representative office of the non-resident entity in India, whose activities are confined to dissemination of information, facilitate/promote trade and/or to act as a communication channel between group companies and Indian companies. A liaison office is not supposed to undertake activities which cross the threshold of doing business in India, such as raising invoice, effecting delivery of goods, conclusion of contracts, etc. But when such activities are carried on, they may result in tax incidence.
2.0 Taxability of Liaison Office under the provisions of the Income-tax Act, 1961
The ambit of clause (i) of section 9(1) is wide enough to cover “all income accruing or arising, whether directly or indirectly, through or from any business connection in India or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India”.
Of all the different incidences of income covered by section 9(1)(i) above, the following are most relevant for our discussion:
— Income arising through “business connection in India”; and
— Income arising through any source of income in India.
Certain activities of an LO would not attract any tax liability in view of the specific exemptions provided u/s.9, which are as follows:
9(1)(i) Expl. 1. (b) : Activities which are confined to the purchase of goods in India for the purpose of export; Expl. 2 : Activities which do not qualify the test of ‘Business Connection’ (This explanation defines ‘Business Connection’ on the lines of ‘Agency PE’ under Tax Treaty Provisions).
2.1 Business Connection (BC)
(a) Maintaining a branch office in India for the purchase or sale of goods or transacting other business.
(b) Appointing an agent in India for the systematic and regular purchase of raw materials or other commodities, or for sale of the non-resident’s goods, or for other business purposes.
(c) Erecting a factory in India where the raw produce purchased locally is worked into a form suitable for export abroad.
(d) Forming a local subsidiary company to sell the products of the non-resident parent company.
(e) Having financial association between a resident and a non-resident company.”
The Circular further states that wherever the transactions are on a principal-to-principal basis, as well as on arm’s-length basis, between a subsidiary and a parent company, the same cannot result into BC. In other words, the concept of BC carves out an exception in respect of transactions between the principal and independent agent.
The Apex Court in the case of R. D. Aggarwal and Co. held that the expression ‘Business Connection’ means something more than a business, that it pre-supposes an element of continuity between the business of the non-resident and the activity in the taxable territory, though a sporadic or isolated transaction may not be construed as such, for the connection may take several forms, like carrying on a part of the main business or activity incidental to the non-resident through an agent or it may merely be a relation between the business of the non-resident and the activity in the taxable territory which facilitates or assists in the carrying on of that business. Applying this test in the case of Western Union Financial Services Inc., (2007) 291 ITR (A.T.) 176, wherein the assessee (Western Union) was engaged in the business of transfer of monies in India from abroad through various agents (including Department of Post, NBFCs, banks, travel agents, etc.), the Delhi Tribunal held that there exists BC in India.
The Supreme Court in the case of Anglo-French Textile Co. Ltd. v. CIT, (1953) 23 ITR 101 (SC), held that where there was a continuity of business relationship between the person in India, who helps to make the profits and the person outside India who receives the profits, BC exists.
In the case of GVK Industries Ltd. v. CIT, (1997) 228 ITR 564 (AP), the Andhra Pradesh High Court enumerated the following principles in respect of BC after examining various case laws:
(i) “Whether there is a business connection between an Indian company and a non-resident (company) is a mixed question of fact and law which has to be determined on the facts and circumstances of each case;
(ii) the expression ‘business connection’ is too wide to admit any precise definition; however, it has some well-known attributes;
(iii) the essence of ‘business connection’ is the existence of close, real, intimate relationship and commonness of interest between the Non-Resident Company (NRC) and the Indian person;
(iv) where there is control of management or finances or substantial holding of equity shares or sharing of profits by the NRC with the Indian person, the requirement of principle (iii) is ful-filled;
(v) to constitute ‘business connection’, there must be continuity of activity or operation of the NRC with the Indian party and a stray or isolated transaction is not enough to establish a business connection.”
From the above legal analysis it is clear that if the activities of an LO are such that they constitute BC, there would be incidence of tax in India. However, if the activities of the LO are confined to purchase of goods in India for the purpose of export [as per section 9(1) (i) Expl. 1(b)], then there will be no tax incidence in India. Let us examine, under what circumstances, activities of the LOs were held to be covered by the exclusion of section 9.
2.2 Activities confined to purchases from India for the purpose of exports
Cases in favour of assessee
2.2.1 In a number of decisions, viz. Angel Garments Ltd., [287 ITR 341 AAR; (2006) 157 Taxman 195 (AAR)], Gutal Trading Est., [278 ITR 63 (AAR)], Ikea Trading (Hong Kong) Ltd., [2008 TIOL 23 (AAR); (2009) 308 ITR 0422 (AAR)], and DDIT v. Nike Inc., [2009 TIOL 143 (Bang. ITAT)], ADIT (IT) v. Fabrikant & Sons Ltd., (2011 TII 46 ITAT-Mum.-Intl.), it has been held that where the activities of the Liaison Office in India are confined to purchase of goods in India for the purpose of export, the income therefrom cannot be brought to tax in India.
Cases against assessee
2.2.2 The Delhi Tribunal made interesting observations in case of Linmark International (Hong Kong) Ltd., [2011 TII 05 ITAT-Del-Intl], wherein it held that the purchase exclusion [section 9(1)(i) Expl. 1(b)] only scales down the extent of incomes that are deemed to accrue or arise in India. Such a limitation cannot be read into the provision which deals with income that accrues or arises in India. In this case it was found that the Indian LO was doing substantial business activities on behalf of a BVI company which was a non-functional entity. The Tribunal placed reliance on the Supreme Court decision in the case of Performing Rights Society Ltd. & Another v. CIT & Others wherein it was held that, where income has actually accrued in India, there is no requirement to further examine whether the income is covered by the provision that deems income to accrue or arise in India.
2.2.3 In case of Columbia Sportswear Company, (2011) 337 ITR 0407 (AAR) (applicant), on the facts of the case, the AAR held that there was a Business Connection, observing that “in the matter of manufacturing of products as per design, quality and in implementing policy, the liaison office is actually doing the work of the applicant. The activities of the liaison office are not confined to India. It also facilitates the doing of business by the applicant with entities in Egypt and Bangladesh. A person in the business of designing, manufacturing and selling cannot be taken to earn a profit only by sale of goods”.
Two interesting observations made by AAR in the case of Columbia Sportswear are:
(i) All activities (including purchase) other than actual sale cannot be divorced from the business of manufacture; and
(ii) If the activities of the Indian LO supports businesses in other countries as well (in the present case it was Egypt and Bangladesh), then it cannot be stated that the operations of the applicant in India are confined to the purchase of goods in India for the purpose of export.
2.2.4 Nokia Networks OY, Finland (NOY), [No. 2005 TIOL 103 ITAT Del-SB; 95 ITD 269 (SB) (Del. Tribunal)], is a tax resident of Finland. NOY had a liaison office (‘LO’) in India. Further, NOY had a 100% subsidiary in India by name Nokia India (P) Ltd. (NPL). NOY entered into an agreement with an Indian Company for supply of telecom equipment (hardware with software embedded therein). NPL, the Indian subsidiary of NOY, entered into an agreement for installation of the said equipment supplied by NOY.
It was held that NOY had a Business Connection under the Act, not because NOY had liaison office in India, but because it had its own subsidiary (NPL) in India and there was intimate business connection based on facts. There was a service agreement and a technical support agreement between NOY and NPL and other Indian Cos. which support the NOY’s activity of supplying telecom equipments. NPL having a live link with NOY, was held to be the business connection in India.
2.3 Activities in addition to or incidental to purchases
Many a time, activities of LOs extend beyond merely purchases. In such a scenario, can the assessee take shelter under the exclusion of section 9(1)(i) Expl. 1(b)? By and large, the Tribunals/AAR/Courts have held that if other activities are incidental to the activity of purchases for the purpose of exports, then there will not be any incidence of deemed income u/s.9 of the Act.
The table below shows what kind of activities were held to be incidental to purchases and which were not so:
|
Sr. |
Nature of activities |
Whether held as deemed income u/s.9(1) of |
Case Law |
|
No. |
|
Act? |
|
|
|
|
|
|
|
1 |
Training of the employees of |
No |
DDI |
|
|
the manufacturers (to ensure |
|
(Indian |
|
|
quality) who supplied goods |
|
2009 TIOL 143 ITAT-Bang. |
|
|
to the affiliates of the LO. |
|
|
|
|
|
|
|
|
2 |
Negotiation of prices, assort- |
|
ADIT |
|
|
ment of diamonds. |
No |
(2011 TII 46 ITAT-Mum.-Intl) |
|
|
|
|
|
|
3 |
Material management, mer- |
Yes. It was held that in the matter of |
Columbia |
|
|
chandising, production man- |
turing of products as per design, quality |
Company |
|
|
agement, quality control and |
implementing policy, the liaison office is |
(2011) 337 ITR 0407 (AAR) |
|
|
administration support consti- |
doing the work of the applicant. |
|
|
|
tuting teams from finance, |
|
|
|
|
human resources and infor- |
|
|
|
|
mation systems. |
|
|
|
|
|
|
|
|
4 |
Facilitation by the liaison of- |
Yes. As activities were not confined to India, |
Columbia |
|
|
fice in doing business with |
exclusion provided in section 9(1)(i) Expl. |
Company |
|
|
entities in Egypt and Bangla- |
not be applicable. |
(2011) 337 ITR 0407 (AAR) |
|
|
desh. |
|
|
|
|
|
|
|
|
5 |
Indian office rendering sup- |
Yes & No |
Aramco |
|
|
port services to the non- |
The AAR held that to the extent Indian |
(AAR No. 825 of 2009) |
|
|
resident parent company and |
engaged in purchases for its non-resident |
2010 TIOL 14 ARA-IT |
|
|
its group company. |
there is no income u/s.9(1). But income is |
|
|
|
|
able to the activities of the Indian Office |
|
|
|
|
group company as the applicant failed to |
|
|
|
|
that the Indian Office worked as an agent of |
|
|
|
|
group company. |
|
|
|
|
|
|
3.0 Taxability of Liaison Office under the provisions of DTAA
Under Article 5 of the DTAA if the activities of an LO are considered to be PE in India, then under Article 7, the income of the non-resident attributable to such PE in India would be liable to tax in India.
Article 5 of the UN and OECD Model Conventions deals with the definition of a Permanent Establishment (PE). Paragraph 4 of Article 5 contains a list of exclusions i.e., activities, which will not constitute a PE.
The following activities are not regarded as PE:
(a) the use of facilities solely for the purpose of storage, display, of goods or merchandise belonging to the enterprise;
(b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display;
(c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise;
(d) the maintenance of a fixed place of business solely for the purpose of purchasing good or merchandise or of collecting information, for the enterprise;
(e) the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary nature;
(f) the maintenance of a fixed place of business solely for any combination of activities, men-tioned in sub-paragraphs (a) to (e), provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary nature.
It may be noted that in respect of activities mentioned in paragraph (a) and (b) above, the scope of the OECD Model Convention is wider than UN MC in that “the use of facilities or the maintenance of stock of goods or merchandise for the purpose of delivery” would not constitute a PE. In the case of UN MC, delivery of goods or merchandise would constitute PE.
The OECD Model Commentary makes it clear that a fundamental feature of these activities is that they are all of a preparatory or auxiliary nature.
3.1 Meaning of preparatory or auxiliary services
Paragraph 4 of Article 5 on PE, in both the MCs, list activities which are excluded from the definition of PE. Besides specific exclusions (e.g., maintenance of stock of goods, facilities used for storage, display, fixed place of business solely for the purpose of purchasing goods or collecting information, etc.), clauses (e) and (f) of the said paragraph provide that the maintenance of a fixed place of business would not result in PE, if the activities of the enterprise are of a preparatory or auxiliary in nature. However, which of the activities would constitute of preparatory or auxiliary in nature and which would not, is difficult to determine at times for the reason that it would also depend upon the facts and circumstances of each case.
The main and indeed, the decisive criterion would be whether or not the activity of the fixed place of business by itself forms an essential and significant part of the activity of the enterprise, as a whole. If the activities of the fixed place are identical with the general purpose and object of its parent, then such activities cannot be regarded as preparatory or auxiliary in nature, e.g., the parent company is engaged in the business of supply of auto components and its fixed base, too, is the engaged in supply of auto components, then such activity of PE cannot be regarded as of auxiliary or preparatory in nature.
It would be worth noting that preparatory or auxiliary activities, which are exclusively for the enterprise by itself, would not result in PE. “If the same are rendered for a consideration and for third parties, then they may constitute the enterprise’s main object and the corresponding facilities may well be PE.” (Klaus Vogel on Double Taxation Conventions — M. No. 116 a — page 321)
The AAR in the case of UAE Exchange ascertained the nature of activities carried on by Indian liaison office by interpreting the term ‘auxiliary’ as used in common English usage, meaning, “helping, assisting or supporting the main activity.”
The Special Bench of the Delhi Tribunal in case of Motorola Inc. v. DCIT, Non-Resident Circle, 95 ITD 269 (Delhi Tribunal), held that the activities carried on by the employees of Motorola, Sweden, through the office of its Indian subsidiary were of preparatory or auxiliary in nature. These activities were carried on prior to commencement of business in India. Activities included such as market survey, industry analysis, economy evaluation, furnishing of product information, ensuring distributorship and their warranty obligations, ensuring technical presentations to potential users, development of market opportunities, providing services and support information, procurement of raw materials for Motorola, accounting and finance services, etc. for a period of one year.
If the activities of the LO are confined to preparatory or auxiliary, then it would not result in PE. Fundamentally, as per FEMA provisions LOs are not supposed to cross the threshold of preparatory or auxiliary activities as they are barred from carrying on any activities of commercial or industrial in nature. They are supposed to restrict themselves to the activities of liaisoning, dissemination of information, export promotion, etc. etc. However, in actual practice when it is found that LOs have crossed this limit, they have been held to be PE in India.
3.2 Can LO be regarded as PE?
Let us examine the various case laws on this aspect:
Cases where it was held not to be PE
3.2.1 In IAC v. Mitsui and Co. Ltd., (1991) 39 ITD 59, Special Bench, ITAT Delhi, has held that the LO cannot be regarded as a PE and a similar view was taken by the Delhi Bench in BKI/Ham V. O. F. v. Additional CIT, (2001) 70 TTJ 480.
3.2.2 In the case of Western Union Financial Services Inc. the Delhi Tribunal held that since the assessee did not have an outlet of its own in India, there was no fixed place of business and therefore there is no PE. It further held that installation of software, use of credit cards or display of names of the Principal by its agents in India does not give rise to a PE.
3.2.3 In the case of K. T. Corporation v. DIT, [23 DTR 361 (AAR) (2009) 180 Taxman 395 (Bom.)], the AAR held that as per provisions of Article 5(4)(d) [Article 5(4)(d) of the India-Korea Tax Treaty reported at 165 ITR (St). 191], collecting information for an enterprise by an LO located abroad is considered an auxiliary activity, unless the collecting of information is the primary purpose of the enterprise. Accordingly, preparation of reports dealing with India’s market scenario in mobile as well as broadband segments, etc., which were in the nature of ‘aid’ or ‘support’ of the main activities, were held to be preparatory and auxiliary activities. While holding on to the facts stated by the applicant that there is no PE, the AAR added a caveat that if the activities of the LO are enlarged beyond the parameters fixed by RBI or if the Department lays its hands on any concrete materials which substantially impact on the veracity of the applicant’s version of facts, it is open for the Department to take appropriate steps under law. Even though the last observations by the AAR were not warranted, it shows that activities of LO are always under close radar of the Income-tax Department.
Cases where it was held to be a PE
3.2.4 In the case of Nokia Networks OY (NOY) (supra) its subsidiary was held to be a PE in India because Nokia virtually projected itself in India through Nokia India Private Ltd. (NPL), as NOY was able to monitor its activities in India through NPL.
3.2.5 The AAR in the UAE Exchange Centre LLC, (2004) 268 ITR 09, held that the Indian LO is the PE of the UAE Enterprise. On the facts of the case, the AAR held that an activity of printing cheques/drafts in India and dispatching the same to the addresses of the beneficiaries by the Indian LO could not be said to be of an auxiliary nature.
3.2.6 In case of Columbia Sportswear Company, (2011) 337 ITR 0407 (AAR), the AAR held that “if an establishment satisfies provisions of Article 5.1 of a DTAA which defines a PE to mean a fixed place of business through which the business of an enterprise is wholly or partly carried on, there is no need to go into the question whether the establishment cannot be brought within the inclusive part of the definition in sub-article 2. Once the definition in Article 5.1 is satisfied, the only inquiry to be undertaken is to see whether it is one of those establishments excluded by sub-article 3”. The AAR held that the LO constituted a fixed place of business within the meaning of Article 5.1 of the India-US DTAA and considering the nature of activities of the LO, it held that the LO would constitute PE in India. The AAR observed that the LO was practically involved in all the activities connected with the business of the applicant, except the actual sale of the products outside the country.
3.2.7 The Karnataka High Court in case of Jebon Corporation India, [2011 TII 15 HC-Kar-Intl], on the facts of the case held that the LO was carrying on the commercial activities of procuring purchase orders, identifying the buyers, negotiating and agreeing on the price, ensuring material dispatch to the customers, following up payments from customers and also offering after sales support. Consequently, the High Court held that the Indian LO is a PE under Article 5 of the India-Korea tax treaty. Some of the interesting observations made by the High Court are as follows :
(i) The mere fact that buyers placed orders and made payments directly to HO and the HO directly sent goods to the buyers is not sufficient to establish that there is no PE;
(ii) When the facts clearly showed that the LO was engaged in trading activity and therefore entering into business transactions/contracts, the mere fact of them being not signed by the LO would not absolve it of liability;
(iii) Just because RBI did not take any action against the LO for carrying on the alleged commercial activities, would not render the findings, recorded by the Income-tax Authorities under the Act, as erroneous or illegal.
4.0 Conclusion
The activities of LOs are under Income-tax Department’s scanner for quite some time now. Even though RBI permits restricted activities for the LO, in actual practice, it has been found that some LOs are crossing the threshold of liaisoning and carries on full-fledged business activities in India.
RBI generally, relies on the CA certificate about the nature of activities carried on by LOs in India. Thus, a CA certifying that LO’s activities are confined to what is permitted by RBI assumes colossal responsibility. In case of Jebon Corporation (where it was found that the LO was engaged in the trading activity), the Karnataka High Court observed that the facts revealed on investigation will be forwarded to the RBI for appropriate action in accordance with law. In the light of these developments, we, CAs, need to be more vigilant and careful in issuing certificates about the activities of LOs. The clients should be advised to convert their LO in to a branch/subsidiary, if so warranted, as undertaking non-permitted activities would result in penal consequences, in a addition to tax implications, in India.
The exemption shall be claimed either on the basis of rates specified in the Schedule to the Notification or on the basis of documents. The procedure for claiming refund under both the options has been prescribed.
The exemption by way of refund shall be available only where no CENVAT credit of service tax paid on the specified taxable services used for export of the said goods has been taken under the CENVAT Credit Rules, 2004.
The exemption shall not be available to a Unit or Developer of a Special Economic Zone.
Where any refund of service tax paid on specified taxable service utilised for export of said goods has been allowed to an exporter, but the sale proceeds in respect of export of goods are not received by or on behalf of the exporter, in India, within the period allowed by the RBI including any extension of such period, such refund shall be deemed never to have been allowed and recovered, as if it is a recovery of service tax erroneously refunded.
(a) If the movie is exhibited by the theatre-owner or exhibitor on his account — i.e., the copyrights are temporarily transferred — Service tax would be levied under copyright service to be provided by distributor or sub-distributor or area distributor or producer, etc., as the case may be.
(b) If the movie is exhibited on behalf of distributor or sub-distributor or area distributor or producer, etc. i.e., no copyrights are temporarily transferred — Service tax would be levied under business support service/renting of immovable property service, as the case may be, to be provided by theatre owner or exhibitor.
2. Where the arrangement between the distributor/ sub-distributor/area distributor and the movie exhibitor/theatre-owner is on unincorporated partnership/ joint collaboration basis, services provided by each of the persons i.e., the ‘new entity’/theatreowner or exhibitor/distributor or sub-distributor or area distributor or producer, etc. as the case may be, would be liable to service tax based on the nature of transaction under applicable service head.
It is further clarified that the arrangements mentioned in this Circular will apply mutatis mutandis to similar situations across all the services taxable under the Finance Act, 1994.
(i) Deemed dealer
Deemed dealers whose tax liability during the previous year was Rs.1 crore or less subject to permission of joint commissioner were filing yearly return. Now they will be required to upload returns on six-monthly basis within 30 days from the end of the six-monthly period and required to furnish details for the entire year in Annexure J1, J2 that is party-wise sales & purchases and Annexure C & D that is TDS Certificates received and issued, within 90 days from the end of the financial year along with 2nd half-yearly return.
(ii) Dealers not covered under Mvat Audit
Dealers not covered under Mvat audit are now required to furnish annual details in Annexure JI & J2 that is party-wise sales & purchase and Annexure G, H & I that is for declaration forms received and not received along with last monthly, quarterly or six-monthly returns within 90 days from the end of the financial year. These details are also required to be furnished for the first year of registration and last year, that is, year in which RC is cancelled where Mvat audit is not applicable.
All the dealers covered under these amendments will be required to make payment of tax within 21 days in case of monthly or quarterly returns and within 30 days in case dealers are required to file returns on half-yearly basis.
From 1st January, 2012 Professional Tax Registration certificate holder and professional tax enrolment certificate holder can make the payment of professional tax electronically, at their option. For making payment on website of the Department PTRC holder should first get enrolled for professional tax e-services, no such requirement for PTEC payment. Detailed instructions are given in the Circular.
Facts
Force India Ltd. (FIL) is a public company having two divisions:
(a) Manufacturing Division where high-tech products are manufactured for the IT sector. This division has two plants employing more than 500 employees. Exports constitute more than 50% earnings for this division. Most of the manufacturing equipment required for the two plants are imported;
(b) ITES Division where medical transcription and medical billing services are rendered. This division is spread over three locations and employs more than 700 employees. The entire billing of this division (on monthly basis) is to customers located outside India and in most cases, there are long-term contracts entered into with these customers.
Transactions of imports/exports of the manufacturing division are predominantly denominated in USD, whereas for the ITES division entirely denominated in Euros.
In view of the multi-currency exposure, the recent volatility in the exchange rates and since the CFO of FIL had a deep understanding of the forex markets, FIL has entered into the following contracts:
(i) Forward contracts for USD for the net exposure of the manufacturing division for the next 18 months. These contracts mature on a monthly basis and have no co-relation to the payments to be made for imports or export realisations.
(ii) Forward contracts for Euros for the receivables of the ITES division (including projected receivables for future billings). These contracts mature on a monthly basis.
(iii) Contracts at the MCX for USD.
FIL closes its financial statements on 31st December every year. As at 31st December 2011, the following information is available:
(a) Net realised and unrealised loss on forward contracts in USD Rs.15 lakh and Rs.160 lakh respectively;
(b) Net realised and unrealised loss of forward contracts in Euros Rs.5 lakh and Rs.75 lakh, respectively;
(c) MTM loss on open contracts at the MCX Rs.20 lakh.
Discuss the treatment of the aforesaid losses as well as the foreign currency exposures for receivables/ payables of FIL in the financial statements for the year 2011.
Discussion and solution
1. An entity can have exposure to foreign currency fluctuations in the following situations:
(a) Long-term or short-term forex loans taken for acquisition of fixed assets — whether from India or outside India;
(b) For sales/purchases in forex;
(c) On forward contracts entered into by the entity for hedging its exposure to forex fluctuations;
(d) On forward contracts entered into for speculative purposes.
2. In the given case, the company has exposure to foreign currency fluctuations on account of the following:
(a) Sales from manufacturing division and services rendered from ITES division;
(b) Imports of equipment for the manufacturing division;
(c) Forward contracts entered into in USD for the manufacturing division;
(d) Forward contracts entered into in Euros for the ITES division;
(e) Contracts entered into at MCX.
3. In each of the above cases, the company has realised gains/losses during the year 2011 as well as unrealised or mark-to-market (MTM) losses as at 31st December 2011.
4. Accounting treatment of forex exposures is primarily determined by the following:
(a) Accounting Standard (AS) 11 ‘The Effects of Changes in Foreign Exchange Rates’ as notified by the Companies (Accounting Standards) Rules, 2006;
(b) Amendments thereto by Notifications issued in March 2009, May 2011 and December 2011;
(c) Announcement by ICAI in March 2008 on ‘Accounting for Derivatives’.
(d) Accounting Standard 30 ‘Financial Instruments: Recognition and Measurement’ issued by ICAI. Though AS-30 is not yet notified under the Companies (Accounting Standards) Rules, 2006, the same can be voluntarily adopted so far as it does not conflict with any other notified accounting standard or any existing regulatory and statutory requirement.
5. The amendments to AS-11 as referred to in 4(b) above relate to accounting for forex fluctuations for loans (other than short-term) in foreign currency for acquisition fixed assets. In the given case study, there are no such loans obtained by FIL and hence these amendments are not applicable.
6. Monetary items are defined by para 7.11 of AS-11 as ‘money held and assets and liabilities to be received or paid in fixed or determinable amounts of money’. In the given case, debtors arising from export sales as well as rendering of services and creditors arising from imports would be monetary items since they would be received or paid in fixed or determinable amounts of money.
7. As per para 13 of AS-11, ‘exchange differences arising on the settlement of monetary items or on reporting an enterprise’s monetary items at rates different from those at which they were initially recorded during the period, or reported in previous financial statements, should be recognised as income or as expenses in the period in which they arise’.
8. The above-referred para 13 of AS-11 would be applicable to foreign currency fluctuations as referred to in para 2(a) and 2(b) in the case above. All exchange differences on settlement of these items or on restatement at the year-end would thus need to be transferred to the statement of profit and loss.
9. Accounting treatment for forward contracts in foreign currency entered into by an entity is to be done as per paras 36 and 37 of AS-11. The said paras are as under:
37. The risks associated with changes in exchange rates may be mitigated by entering into forward exchange contracts. Any premium or discount arising at the inception of a forward exchange contract is accounted for separately from the exchange differences on the forward exchange contract. The premium or discount that arises on entering into the contract is measured by the difference between the exchange rate at the date of the inception of the forward exchange contract and the forward rate specified in the contract. Exchange difference on a forward exchange contract is the difference between (a) the foreign currency amount of the contract translated at the exchange rate at the reporting date, or the settlement date where the transaction is settled during the reporting period, and (b) the same foreign currency amount translated at the latter of the date of inception of the forward exchange contract and the last reporting date.”
11. Paras 38 and 39 of AS-11 further state as under:
“38. A gain or loss on a forward exchange contract to which paragraph 36 does not apply should be computed by multiplying the foreign currency amount of the forward exchange contract by the difference between the forward rate available at the reporting date for the remaining maturity of the contract and the contracted forward rate (or the forward rate last used to measure a gain or loss on that contract for an earlier period). The gain or loss so computed should be recognised in the statement of profit and loss for the period. The premium or discount on the forward exchange contract is not recognised separately.
39. In recording a forward exchange contract intended for trading or speculation purposes, the premium or discount on the contract is ignored and at each balance sheet date, the value of the contract is marked to its current market value and the gain or loss on the contract is recognised.”
12. As can be seen from the above, paras 38 and 39 of AS-11 prescribe the treatment for forward contracts which are intended for trading or speculation purpose. Thus, in all cases where paras 38 and 39 are applicable, the gain/loss computed in terms of these paras would need to be recognised in the statement of profit and loss.
13. Besides contracts covered by paras 36, 37, 38 and 39 of AS-11, there could be other forward con-tracts which a company may enter into to hedge the foreign currency risk of a firm commitment or a highly probable forecast transaction. Accounting treatment for such contracts is not covered by AS-11 since these are neither backed by actual transactions, nor intended for trading or speculation.
14. Accounting of such contracts which are entered into to hedge the foreign currency risk of a firm commitment or a highly probable forecast transaction would be covered by the ICAI announcement of March 2008. The said announcement lays down 2 options which can be followed by a company to account for such contracts. The 2 options are:
(a) The mark-to-market (MTM) loss in case of such transactions should be provided for in the statement of profit and loss following the principle of prudence as enunciated in AS-1 ‘Disclosure of Accounting Policies’ — the gains arising on MTM, however, need not be provided;
(b) Adopt AS-30 on a voluntary basis. Paras 80 to 113 of AS-30 provide for recognition and measurement of forward contracts intended for hedging and which are not covered by AS-11. These paras provide that in case the forward contracts fall within the definition of an ‘effective hedge’ within the meaning of AS-30, the MTM gains/losses on such contracts can be transferred to a ‘Hedging Reserve Account’ and carried forward in the balance sheet rather than recognise them in the statement of profit and loss account. To qualify as an ‘effective hedge’, however, there has to be close relationship between the date of maturity of the forward contract and the realisation of the underlying ‘hedged item’ i.e., the export receivables. There are also stringent documentation requirements laid down by AS-30 to prove the effectiveness of a hedge. On settlement or cancellation of these contracts, the eventual gains/losses would need to be transferred to the statement of profit and loss account.
15. The ICAI announcement also mentions that in case one of the above 2 options is not followed and there is a MTM loss as at the year-end on such contracts, appropriate disclosures should be made by the auditor in his report. Since the announcement only mentions ‘appropriate disclosures’, such disclosures may not amount to a qualification in the report of the auditors.
16. In the given case, in the situation mentioned in para 2(c) above, the company has entered into contracts to cover its exposure in USD for exports of goods and import of equipment. As per the information available, these contracts do not have any co-relation with the receivables/payables, but they are backed by actual transactions of exports/imports since these are entered into in respect of the net exposure of the manufacturing division. In such a case, the accounting treatment would need to be as per paras 36 and 37 of AS-11 (as discussed in paras 9 and 10 above). Thus, the realised as well as unrealised losses on such contracts would need to be accounted for in the statement of profit and loss.
17. In the given case, in the situation mentioned in para 2(d) above, the company has entered into contracts to cover its exposure in Euros for exports of services. As per the information available, some of these contracts are backed by actual export receivables, but the remaining contracts are to cover future exports of services. Since these contracts mature on a monthly basis, there seems to be a co-relation between the receivables (as in most cases of export of ITES services the billings are on regular pre-determined intervals).
18. The accounting treatment for contracts which are backed by receivables would be covered by para 36/37 of AS-11 and would be as discussed in para 16 above. However, in case of contracts which are for future billings, these would be in the nature of hedge for the foreign currency risk of a firm commitment or a highly probable forecast transaction. These would be accounted as per the ICAI announcement (as discussed in paras 14 and 15 above). Thus, FIL would have an option to either provide the MTM loss on such contracts or adopt AS-30 and transfer the loss to a ‘Hedging Reserve’.
19. In the given case, in the situation mentioned in para 2(e) above, the company has entered into contracts at the MCX for USD. These contracts, though apparently, entered into for trading or speculative purposes, in this case, seem to be entered into for hedging the forex exposures of FIL. If the contracts were entered into for trading or specula-tive purposes, the accounting treatment would be as per paras 38/39 of AS-11. However the contracts seem to be backed by actual transactions of exports/imports. In such a case, the accounting treatment would be as per paras 36/37 of AS-11. In either case, the realised as well the unrealised (or MTM) losses would need to be transferred to the statement of profit and loss.
20. The duty of the statutory auditor in the above case would be as under:
(a) For situations in 2(a) and 2(b) above, verification whether appropriate closing rates are considered for determining the forex fluctuations and whether the same are accounted in the statement of profit and loss;
(b) For situation mentioned in 2(c) above, verification of open forward contracts in USD and whether the same are clearly backed by actual transactions of exports/imports on a net basis;
(c) For situation mentioned in 2(d) above:
(i) Verification and adequate documentation whether AS-11 or AS-30 would be applicable to the forward contracts entered into;
(ii) verification of open forward contracts in Euros and whether they constitute an ‘effective hedge’ vis-à-vis the receivables/ future receivables as envisaged by AS-30 and whether the company had adequate internal documentation at the time of entering into these contracts so as to constitute an ‘effective hedge’;
(d) For situation mentioned in 2(e) above, verification of whether the contracts entered into at MCX were towards hedging of open exposures in USD or whether these were for trading or speculation;
(e) Adequate audit documentation for all the above with reasoning and supporting to be kept as part of audit working papers.
Editor’s Note: The case study is based on the case studies presented by the author at the Residential Refresher Course of BCA.
The assessee entered into a technical assistance agreement with a Japanese company. The assessee had filed an application u/s.195(2) and the requisite no objection certificate was granted permitting nondeduction of tax at source. However, the Assessing Officer held that the payments attracted provisions for deduction of tax at source and treated the assessee as assessee in default u/s.201(1) of the Act, for not deducting tax at source. The CIT(A) and the Tribunal allowed the assessee’s claim.
On appeal by the Revenue, the Punjab and Haryana High Court upheld the decision of the Tribunal and held as under:
“(i) The Tribunal has recorded a clear finding that the certificate granted u/s.195(2) was never cancelled u/s.195(4), in absence of which the assessee was not required to deduct tax at source and could not be treated as assessee in default. On the said finding, no question of law has been claimed or referred.
(ii) If the assessee was not required to deduct tax at source and could not be declared as assessee in default, question of whether the payment was in nature of fee for technical services or in nature of reimbursement for expenses incurred or whether DTAA overrides the provisions of the Act, need not be gone into.”
In this case the assessment was reopened u/s.147. The assessee had requested for the reasons recorded, but the same were not furnished till the passing of the reassessment order. Following the judgment in the case of CIT v. Fomento Resorts and Hotels Ltd., (Bom.); ITA No. 71 of 2006, dated 27-11- 2006, the Tribunal held that though the reopening of the assessment is within three years from the end of the relevant assessment year, since the reasons recorded for reopening the assessment were not furnished to the assessee till the completion of the assessment, the reassessment order cannot be upheld.
The Bombay High Court dismissed the appeal filed by the Revenue and observed that the special leave petition filed by the Revenue against the decision of the Bombay High Court in the case of Fomento Resorts and Hotels Ltd. has been dismissed by the Apex Court.
The assessee-club was granted exemption from paying income-tax on the income from its members on the basis of the principle of mutuality. On the same basis the assessee also claimed exemption in respect of income from fixed deposits, dividend, income from Government securities and profit on sale of investment. The Assessing Officer did not allow the claim. The Tribunal allowed the assessee’s claim and held that the principle of mutuality would apply even on these incomes.
On appeal by the Revenue, the Delhi High Court upheld the decision of the Tribunal and held as under:
“We are of the opinion that the aforesaid finding of the Tribunal is correct on facts and in law, which does not call for any interference.”
The Delhi High Court allowed the writ petition filed by the assessee-society and held as under:
“(i) The Supreme Court in the case of Sole Trustee, Loka Sikshana Trust v. CIT, (1975) 101 ITR 234 interpreted the word ‘education’ in section 2(15) and held that the word has been used to denote systematic instruction, schooling or training given to the young in preparation for the work of life and it also connotes the whole course of scholastic instruction which a person has received. It has further been observed that the word also connotes the process of training and development of knowledge, skill, mind and character of students by normal schooling.
(ii) It is seen that the petitioner is being run like any school or educational institution in a systematic manner with regular classes, vacations, attendance requirements, enforcement of discipline and so on. These provisions in the rules and regulations satisfy the condition laid down in the judgment of the Supreme Court in Sole Trustee, Loka Sikshana Trust (supra). It cannot be doubted that having regard to the manner in which the petitioner runs the music school, that there is imparting of systematic instruction, schooling or training given to the students so that they attain proficiency in the field of their choice — vocal or instrumental in western classical music.
(iii) The Calcutta High Court in CIT v. Doon Foundation, (1985) 154 ITR 208/22 Taxman 9 has observed that section 10(22) does not impose a condition that an educational institution to be eligible for exemption thereunder should be affiliated to any university or any board. As per the High Court, so long as the income is derived from an education institution existing solely for educational purposes and not for purposes of profit, such income is entitled to exemption u/s.10(22). This judgment takes care of the objection of the prescribed authority that the petitioner is not affiliated to, or recognised by any university or board in India and that it merely awards certificates or grades which are issued by the Trinity College and Royal School of Music, London. Since section 10(23C)(vi) also uses the same language as section 10(22), the same principle should govern the interpretation of that provision also.
(iv) The Supreme Court in S. Azeez Basha v. Union of India, AIR 1968 SC 662 has considered the nature of an educational institution. It was held by the Supreme Court that there is a good deal in common between educational institutions which are not universities and those which are universities in the sense that both teach students and both have teachers for the purpose. It was further observed by the Supreme Court that what distinguishes a university from any other educational institution is that a university grants degrees of its own, whereas other educational institutions cannot. These observations of the Supreme Court support the stand of the petitioner that the fact that it does not conduct its own examination or awards degrees of its own is not decisive of the question whether it is an educational institution or not. It also lends support to the petitioner’s stand before the prescribed authority that it is not a mere coaching centre preparing students for competitive examinations.
(v) For the above reasons, it is held that the petitioner meets the requirements of an educational institution within the meaning of section 10(23)(c)(vi).
(vi) Accordingly, the impugned order passed by the prescribed authority is quashed. The prescribed authority will now deal with the asses-see’s application for approval afresh in accordance with law. The writ petition is accordingly allowed.”
The assessee had received pure gold supplied by ‘R’ Jewellery, Dubai, and the same after conversion into jewellery was ‘exported’ by the assessee to ‘R’ Jewellery, Dubai. In the meantime ‘R’, Jewellery Dubai continued to remain the legal owner of the gold and had not sold the gold to the assessee. The assessee was paid conversion charges or production/ manufacturing charges for converting the gold into jewellery. The Assessing Officer held that the assessee was not manufacturing ornaments/ jewellery and was not an exporter as he was paid making charges for the job work/services for making ornaments as per specification of third parties. Accordingly, the AO held that the assessee was not entitled to deduction u/s.10A. The Commissioner (Appeals) and the Tribunal allowed the assessee’s claim for deduction.
On appeal by the Revenue, Delhi High Court upheld the decision of the Tribunal and held as under:
“(i) Section 10A/10B is applicable when an undertaking manufactures, or is engaged in production of articles or things. The term ‘production’ has a larger magnitude and is more expansive and liberal than the term ‘manufacture’.
(ii) In the present case, manufacture as well as production of goods, articles or things is covered u/s.10A/10B. The activity for converting gold bricks, biscuit or bars, into jewellery amounts to ‘production or manufacture’ of a new article and, therefore, qualifies for deduction u/s.10A/10B.
(iii) Case of the Revenue is that the assessee had not exported jewellery as the assessee was not owner of the imported gold or the exported jewellery and was paid making charges. Thus, the income earned does not qualify for deduction u/s.10A/10B.
(iv) The expressions/terms, ‘importer’ and ‘exporter’ are wide and not restricted to the owner of the goods at a particular point of time. Owner is treated as the importer/ exporter but a person who holds himself out as an importer or exporter is also an importer or exporter. The activity undertaken i.e., export/import is important and the person involved and associated with the said activity is important/relevant, mere ownership is not the sole criteria to determine whether a person is an importer or exporter. Further the expression ‘exported’ or ‘imported’ goods has reference to the nature of the goods as in the case of expressions ‘import’ or ‘export’ and not a person/owner.
(v) In the present case, the standard gold was imported into India and then converted into jewellery or ornaments and was sent out of India i.e., jewellery and ornaments were exported. When the import was made, the assessee was shown as a consignee and an importer and when the export was made the assessee was shown as a consignor i.e., the exporter. The assessee complied with the various formalities, when the standard gold was imported and then again when the jewellery/ornaments were exported. The assessee was in actual physical possession of the gold when it remained in India and would have been liable in case of loss, etc. The concept of and the term ‘ownership’, has various jurisprudential connotations. For all practical purposes, the assessee was in possession of gold and had a right, dominance and dominion over it. They were liable to pay Customs duty, etc. in case export was not made. Keeping in view the nature of transactions in question, it is not possible to hold that the assessee did not ‘export’ the jewellery/ornaments and that the transactions in question cannot be regarded as export for the purpose of section 10A/10B. Thus, when the assessee had exported the ornaments, it was exporting articles or things. The assessee were exporters or had exported articles/things as understood in common parlance.
(vi) Section 10A does not apply to export income earned by an assessee from merely trading the goods and postulates that the assessee must be an undertaking, which manufactures or produces articles or things, which are exported.
(vii) This condition in the present case is satisfied. Accordingly, the contention raised by the Revenue fails and has to be rejected. Appeals are accordingly dismissed.”
The assessee, a charitable institution transferred development cess to Mandi Parishad and claimed deduction of the said amount. The Assessing Officer disallowed the claim for deduction. The CIT(A) allowed the assessee’s claim and held that the payment treated as expenditure or application by the assessee shall be treated as business receipt by Mandi Parishad and directed the Assessing Officer to make a reference to the Assessing Officer of Mandi Parishad to take remedial measures, if necessary, in the relevant assessment years to tax the relevant receipts in the hands of the Mandi Parishad. The Tribunal held as under:
“The learned CIT(A) while referring to the cases of Mandi Parishads had not afforded any opportunity to the said assessees and it is also noticed that the learned CIT(A) made these observations in spite of the fact that no such material relating to Mandi Parishads was available to him. In our opinion, these observations of the learned CIT(A) are unnecessary, because the facts of the case which is pending for adjudication are only to be considered. However, in the instant case, neither the material relating to other issues was available to the learned CIT(A) nor opportunity of being heard was given to the said assessee whose cases have been referred by the learned CIT(A). We, therefore, modify the order of the learned CIT(A) to this extent that the impugned observations made by him are unwarranted in the case of present assessees.”
On appeal by the Revenue the Allahabad High Court upheld the decision of the Tribunal and held as under:
“(i) It is not open to another quasi-judicial authority of limited jurisdiction, in the matter of lis between the assessee and Revenue before it to proceed to determine the rights or liabilities of the third party, who is not before it, in the assessment of the assessee.
(ii) The CIT(A) had no jurisdiction to direct the Assessing Officer to make a reference to the Assessing Officer of Mandi Parishad, to whom the assessee used to pay cess and claim it as deduction, to take a remedial action and, if necessary, to tax the receipts in the hands of Mandi Parishad.”
The assessee had sold a house property on 13-1-2006 and had purchased another house property on 2-1- 2007. The Assessing Officer disallowed the assessee’s claim for deduction u/s.54 of the Income-tax Act, 1961 holding that the assessee failed to deposit the amount in the capital gains account scheme and also failed to purchase house property before the due date for filing the return of income. The Commissioner (Appeals) allowed the assessee’s claim and held that the assessee had complied with the provisions of section 54 as she had purchased the new residential property on 2-1-2007 i.e., before the due date u/s.139(4) of the Act. The Tribunal affirmed the order of the Commissioner (Appeals).
On appeal by the Revenue, the Punjab and Haryana High Court upheld the decision of the Tribunal and held as under:
“(i) The sale of the asset had taken place on 13- 1-2006, falling in the previous year 2006-07, the return could be filed before the end of the relevant A.Y. 2007-08 i.e., 31-3-2007. Thus, s.s(4) of section 139 provides the extended period of limitation as an exception to s.s(1) of section 139 of the Act.
(ii) S.s (4) was in relation to the time allowed to an assessee u/ss.(1) to file the return. Therefore, such provision is not an independent provision, but relates to the time contemplated u/ss.(1) of section 139. Therefore, s.s(4) had to be read along with s.s(1).
(iii) Therefore, due date for furnishing return of income according to section 139(1) of the Act was subject to the extended period provided u/ss.(4) of section 139 of the Act.”
On appeal by the Revenue, the Delhi High Court upheld the decision of the Tribunal and held as under:
“Since the assessee had been doing other business activity also, namely, ‘trading’, it could not be said that the assessee had closed its business with the suspension of manufacturing soft drinks. The expenditure was deductible.”
In fact the balance amount of Rs.98.46 lakh was added back under different heads, but was not separately indicated and in its objection the assessee did not take this specific plea. It only stated that Rs.1,07,69,936 was added back/credited to the profit and loss account and one item of Rs.9,23,471 was reflected on the credit side of the profit and loss account. As regards, disallowance of expenses incurred for earning tax-free income it was contended that section 14A was introduced in the statute by the Finance Act, 2001, with retrospective effect from April 1, 1962 and the return was filed on 30-11-2000 and therefore it was not obligatory to make a disallowance and there was no failure on the part of the assessee in disclosing fully and truly the material facts in respect of the expenditure incurred for earning the tax-free income. The assessee also relied upon the proviso to section 14A which prohibited reopening of assessment for any assessment year beginning on or before 1-4-2001.
On a writ challenging the notice issued u/s.148 for want of jurisdiction, the Delhi High Court noted that in reply to the notice issued u/s.154 of the Act the assessee had given the full break-up and specific details with regard to credit/adjustment of Rs.98.46 lakh into profit and loss account and hence it found some merit in the contention of the assessee. However, it did not dwell further on this aspect since the notice was sustainable on the ground of section 14A. According to the High Court the proviso to section 14A only barred the reassessment/rectification and not the original assessment on the basis of retrospective amendment. Since the Assessing Officer had failed to apply section 14A when he passed the original assessment order, it had prima facie resulted in escapement of income. According to the High Court there was an omission and failure on the part of the assessee to point out the expenses incurred relatable to tax-free/exempt income which prima facie have been claimed as a deduction in the income and expenditure account and hence there was omission and failure on the part of the petition to disclose fully and truly the material facts.
On an appeal, the Supreme Court held that in its view the reopening of the assessment was fully justified on the facts and circumstances of the case. However, on merits of the case, it would be open to the assessee to raise all contention with regard to the amount of Rs.98.46 lakh being offered for tax as well as its contention on section 14A of the Act.
[Honda Siel Power Products Ltd. v. Dy. CIT and Others, (2012) 340 ITR 53 (SC)]
Section 80I(2)(iv) (effective up to 31-3-1991) of the One finds that similar language and expression has been used under the Act of 1922 and has been continued to be used by the Legislature even under the provisions of the 1961 Act while stipulating one of the conditions for the ‘tax holiday’. For ready reference, the language and expressions as used in different provisions over the period are tabulated below:
Comparison of incentive provisions where employment of workers is mandated.
|
Section |
Language |
|
|
|
|
15C(2)(iii) of the |
Employs ten or more workers in manufacturing process carried on with |
|
1922 Act |
of power, or employs twenty or more workers in a manufacturing |
|
|
without the aid of power. |
|
|
|
|
84(2)(iv) |
It |
|
1961 Act |
aid of power, or employs twenty or more workers in a manufacturing |
|
|
on without the aid of power. |
|
|
|
|
80J(4)(iv) |
In |
|
1961 Act |
undertaking employs ten or more workers in a manufacturing process |
|
|
the of power, or employs twenty or more workers in manufacturing |
|
|
on without the aid of power. |
|
|
|
|
80HH(2)(iv) |
It |
|
1961 Act |
aid of power, or employs twenty or more workers in a manufacturing |
|
|
on without the aid of power. |
|
|
|
|
80I(2)(iv)/ |
In |
|
80IB(2)(iv) of the |
undertaking employs ten or more workers in a manufacturing process |
|
1961 Act |
with the of power, or employs twenty or more workers in manufacturing |
|
|
carried on without the aid of power. |
|
|
|
|
10BA(2)(e) of the |
It employs twenty or more workers during the previous year in the |
|
1961 Act |
manufacture or production. |
|
|
|
Income-tax Act, 1961, analogous to present section 80IB(2)(iv) of the Act, requires employment of certain number of workers by the new industrial undertaking as one of the conditions for the undertaking to qualify for the ‘tax holiday’. The industrial undertaking should employ ten or more workers in a manufacturing process where the manufacture or production of articles or things takes place with the aid of power or employ twenty or more workers in a manufacturing process if manufacture or production is undertaken without the aid of power.
It appears that one of the aims and objects of the Legislature under the scheme of ‘tax holidays’ over the period is to generate employment in the country.
The language and expression as used in the aforesaid sections have been subject of the judicial interpretation by Courts on different counts viz., the determination of period for which the aforesaid condition needs to be satisfied in a financial year, interpretation of the expression ‘employs’, meaning of the word ‘workers’, etc.
The controversy, sought to be discussed here, revolves around the issue whether the contractual workers or the workers supplied by a contractor for manufacture or production of articles or things could be treated as ‘workers’ employed by the assessee undertaking for the purpose of deduction u/s.80IB/u/s.80I of the Act.
The Bombay High Court recently had an occasion to deal with the aforesaid issue under consideration, wherein the High Court held that it was immaterial as to whether the workers were directly employed or employed by hiring them from a contractor. What was relevant was the employment of ten or more workers and not the mode and the manner in which the said workers were employed. In deciding the issue, the Bombay High Court dissented with the findings that were given on the subject by the Allahabad High Court.
Jyoti Plastic’s case The issue came up recently before the Bombay High Court in the case of CIT v. M/s. Jyoti Plastic Works Private Limited, [339ITR 491 (Bom)]
Jyoti Plastic Works Private Limited (‘Jyoti Plastic’) was engaged in the manufacture of plastic parts which were excisable and had claimed deduction u/s.80IB of the Act. In the reassessment proceedings, the AO disallowed the deduction u/s.80IB of the Act for the following two reasons:
(1) Jyoti Plastic was not a manufacturer, as the goods were manufactured at the factory premises of the job worker; and
(2) The total number of permanent employees employed in the factory were less than ten and thereby the condition as required u/s.80IB (2)(iv) was not satisfied.
The first Appellate Authority and the Mumbai Tribunal allowed the claim of Jyoti Plastic and the Revenue, being aggrieved, carried the issue to the Bombay High Court. As regard the first issue, the Court held in favour of Jyoti Plastic. With respect to the second issue, the Court, in the absence of the meaning of the word ‘worker’ under the Act, referred to the following external aids of construction to determine the meaning of the word ‘worker’:
(1) Black Law Dictionary — ‘worker’ means a person employed to do work for another;
The Court further relied on its earlier judgment in the case of CIT v. Sawyer’s Asia Limited (122 ITR 259) (Bom.), wherein the Court while considering the provisions of section 84(2)(iv) of the Act had observed that the word ‘workers’ should also include ‘casual workers’.
The Revenue relied on the following decisions of the Allahabad High Court to submit otherwise :
(1) R and P Exports v. CIT, (279 ITR 536); and
(2) Venus Auto Private Limited v. CIT, 321 ITR 504.
The Bombay High Court distinguished the decision of the Allahabad High Court in the R and P Exports’ case on the ground that the Tribunal in the case before the Bombay High Court had recorded a specific finding of fact that the agreement between Jyoti Plastic and the contractor was a ‘contract of service’ and not ‘contract for service’, whereby the contractual workers were under direct control and supervision of Jyoti Plastic as against the facts which were to the contrary in the case of R and P Exports (supra).
With regard to the decision of Venus Auto Private Limited (supra), the Court acknowledged that the facts in the said case were similar to the facts of the case before the Court; it dissented with the ratio of the decision in the said case and chose to rely on its own decision in the case of Sawyer’s Asia Limited (supra).
The Court finally concluded that since the agreement with the contractor was a ‘contract of service’ i.e., of employer-employee relationship and just because it differed with terms of contract of service with regular employees, that could not be a ground to deny the deduction u/s.80IB of the Act. In other words, so long as the agreement between the parties was a ‘contract of service’ and not ‘contract for service’, it would satisfy the condition prescribed u/s.80IB(2)(iv) of the Act.
Venus Auto’s case
The issue had come up earlier before the Allahabad High Court in the case of Venus Auto Private Limited v. CIT, (321 ITR 504).
Venus Auto Private Limited (‘Venus Auto’) was engaged in the manu-facturing activity of the scooter seat and claimed deduction u/s.80HH and u/s.80I of the Act. In the assessment and appellate proceedings up to the Tribunal stage, Venus Auto’s claim for deduction was rejected on the ground that the condition u/s.80I(2) (iv) of workers employed was not satisfied as the workers employed through the contractor were not to be treated as the workers employed in the industrial undertaking.
On appeal by Venus Auto before the High Court, the Allahabad High Court observed that the word ‘employment’ meant employment of workers by Venus Auto. There should be a relationship of employer and employee between the workers and Venus Auto. The Court observed that with regard to the contractual employees, there was no such employer-employee relationship between Venus Auto and the contractual employees; such relationship existed between the contractor and the contractual employees. The Court on facts and in law distinguished the reliance of Venus Auto on the following decisions:
(1) Aditya V. Birla v. CBDT, (170 ITR 137) (SC);
(2) CIT v. K. G. Yediyurappa, (152 ITR 152) (Kar.);
and
(3) CIT v. V. B. Narania & Co., (252 ITR 884) (Guj.)
Further, the Court observed that vide word ‘it employs’, the Legislature sought to limit the relationship between employer and employee only i.e., between Venus Auto and the workers and therefore, it would not include the workers employed by the contractor.
Observations
‘Tax holidays’ have been provided from time to time vide various sections, viz., section 15C of the Act of 1922 section 84, section 80J, section 80HH, section 80I, section 80IA and section 80IB of the Act of 1961. The intention of the Legislature has been all along to encourage the setting up of new industrial undertakings with a view to expanding industries, employment opportunities and production of goods. The Courts have acknowledged the intention of the Legislature in introducing the said deduction/exemption/relief provisions of the Act and have held that such provisions should be interpreted liberally and reasonably and they should be so construed as to effectuate the object of the Legislature and not to defeat it.
The purpose of ‘tax holiday’ provisions has been apparently to provide tax incentives to stimulate the industry and manufacture of articles, resulting in more employment and economic gain for the country. The element of ‘number of workers to be employed’ being consistently present in all the ‘tax holiday’ provisions justifies the intention of the Legislature to promote and create employment opportunities in the country, thereby reducing unemployment.
In the case of CIT v. P. R. Alagappan, (173 ITR 522) (Mad.), the Court for the purpose of section 80J (4) of the Act explained that a ‘worker’ was a person who worked relying on the definition of ‘worker’ in the Factories Act.
The Court approved of the reference to the definition of ‘worker’ under the Factories Act and also observed that the expression ‘employs’ contemplated ‘contract of service’.
The Karnataka High Court in the case of CIT v. K. G. Yediruppa & Co., (152 ITR 152) in context of section 80HH(2)(iv) of the Act has held that in absence of definition of the word ‘worker’, the ordinary meaning of the word ‘worker’ meant casual, permanent or temporary workers.
Similarly, in the case of CIT v. Sawyer’s Asia Ltd. (supra), the Bombay High Court for the purpose of deduction u/s.84(2)(iv), observed as under:
“………The undertaking is not required to have ten or more regular workers and it may be said to have satisfied that requirement if the aggregate actual number of workers engaged in the manufacturing process, both regular and normal, is ten in number……….If it chooses to have less than 10 regular workers on its muster roll, it runs the risk of not satisfying the requirement on such days on which the necessary number of casual workers is not available.”
The Court also considered even persons employed on casual basis as eligible to be ‘workers’ for the purpose of satisfaction of condition u/s.84(2)(iv) of the Act.
Similarly, in the case of CIT v. V. B. Narania & Co., (252 ITR 884), the Gujarat High Court, in context of provisions of section 80HH(2)(iv) and section 80J(2) (iv), held by relying on the decision of Apex Court in the case of Harish Chandra Bajpai v. Triloki Singh, (AIR 1957 SC 444), that a contract of employment may be in respect of either piece work or time work. It held that the real test of deciding whether the contract was one of employment or not was to find whether the agreement was for the personal labour of the person engaged, and if that was so, the contract was one of employment and the rest of the facts were immaterial like, whether the work was time work or piece work, or whether the employee did the whole of the work himself, or whether he obtained the assistance of other persons also for the work.
In interpretation of the analogous provisions to sec-tion 80IB(2)(iv)/section 80I(2)(iv) the Courts have interpreted the word ‘worker’ to also include ‘casual and temporary workers’ and the expression ‘employ’ has been interpreted to mean a contract of service, where the requirement of personal labour of the person employed is of importance as against whether the employee is in normal employment of the undertaking or otherwise. The stress is upon the substance of the arrangement rather than its legal form.
Looking from the perspective of intention of the Legislature in creating employment and supported by the above-referred decisions, the better view appears to be that the casual and contractual workers employed directly or through the contractor are to be treated as the ‘workers’ for the purposes of the ‘tax holiday’. The decision in the case of Venus Auto (supra) may require reconsideration.
The Tribunal concluded that royalty in respect of computer software has to be decided on the basis of provisions of the Act or relevant DTAA under consideration.
On the other hand, the Delhi High Court recently in the case of Asia Satellite Telecommunications Co. Ltd. v. DIT and vice versa, (332 ITR 340) upheld the reliance on OECD Commentary while interpreting the definition of ‘royalty’ in respect of leasing out transponder capacity on a satellite. The Court held that the technical terms used in DTAA are the same which appear in section 9(1)(vi) and for better understanding of the terms, OECD Commentary can always be relied upon. The Court relied on the decision of the Apex Court in the case of UOI and Anr v. Azadi Bachao Andolan & Anr., (263 ITR 706) and other catena of decisions1 to emphasise that the international accepted meaning and interpretation placed on identical or similar terms employed in various DTAAs should be followed by the Courts in India when it comes to construing similar terms occurring in the Act.
On a combined reading of the findings of the aforesaid decisions, one may reconcile that for better understanding of the terms used in the Act or DTAAs, one may refer to the OECD Commentary provided and subject to:
The true significance however, lies in the practical implementation of the aforesaid principle while interpreting the provisions of the Act and DTAAs, which may be subject to criticisms or limitations similar to reliance on English decisions and other international decisions and/or statutes. In addition, India not as a ‘Member’ of OECD but as ‘Observer’ has expressed its position/views on the Articles of OECD Model Convention and its commentary thereon, which has been published in the OECD Model Tax Convention on Income and on Capital 2010 (version dated 22 July 2010). The position is presented qua the Articles under the Tax Convention as regard to its disagreement with the Text of the Article or disagreement with an interpretation given in the commentary in relation to the Article. It would be further necessary to highlight that while nations like Indonesia and China, (non-OECD economies like India) have expressly clarified that in the course of negotiations with other countries, they will not be bound by their stated positions in the OECD Commentary; India has not expressly clarified as such. Therefore, one may suggest that India may be bound by its stated positions in respect of the OECD Commentary in its course of negotiation and interpretations of DTAAs with other countries.
In the backdrop of the aforesaid discussion, it may then be necessary to consider the legitimacy in relying on OECD Commentary for interpretation of provisions of the Act and DTAAs entered into by India with other countries.
Reliance on OECD Commentary in interpreting provisions of the Act
Reference to English and other International decisions for interpretation and construction of the provisions of the Act have been subject of concern and criticism, time and again by the Courts2 since the provisions of the Act are not in pari materia with the provisions of the other statues, as well as the fundamental concepts and the principles on which the provisions are incorporated under the Act are different vis-à-vis the other statues. The provisions of the Act though may at times appear to be similar to the provisions of OECD Tax Convention, on deeper scrutiny may reveal differences not only in the wording but also in the meaning of a particular expression which has been acquired in the context of the development of law in those countries. Reliance on OECD Commentary in interpreting the provisions of the Act may therefore be subject to similar criticisms and concerns.
OECD is a 31 Member country organisation where the respective governments work together to address the economic, social and environmental challenges of globalisation. The OECD Model Tax Convention on Income and on Capital was designed and developed by the member countries as a means to settle on a uniform basis the most common problems that arise in the field of International juridical double taxation. India while negotiating its tax treaties maintains a balance and follows either OECD Model or UN Model on Tax Convention or a mix of the two. So, the provisions and terms as used in the Act may not confirm to the same language, interpretation and meanings as used in the DTAAs by India with other countries. Observations have been made by various Courts in catena of decisions3 with respect to various provisions of the Act as being wider/narrower in scope to the analogous provisions of DTAAs.
One may therefore say that the provisions of the Act should be construed on their own terms without drawing any analogy of the OECD Commentary, subject to principles as drawn above.
Reliance on OECD Commentary in interpreting provisions of DTAAs
Though, India is not a signatory to Vienna Convention on the Law of Treaties (‘VCLT’), but the judicial forums4 in India have acknowledged its importance in interpreting the provisions of DTAAs and have observed as under:
“The DTAAs are international agreements entered into between States. The conclusion and interpretation of such convention is governed by public international law, and particularly, by the Vienna Convention on the Law of Treaties of 23 May 1969. The rules of interpretation contained in the Vienna Convention, being customary international law also apply to the interpretation of tax treaties. . . . .”
The principles governing the interpretation of tax treaties can be broadly summed up as follows:
(i) A tax treaty is an agreement and not a taxing statute, even though it is an agreement about how taxes are to be imposed.
(ii) The principles adopted in the interpretation of statutory legislation are not applicable in interpretation of treaties.
(iii) A tax treaty is to be interpreted in good faith in accordance with the ordinary meaning given to the treaty in the context and in the light of its objects and purpose.
(iv) A tax treaty is required to be interpreted as a whole, which essentially implies that the provisions of the treaty are required to be construed in harmony with each other.
(v) The words employed in the tax treaties not being those of a regular Parliamentary draughtsman, the words need not examined in precise grammatical sense or in literal sense. Even departure from plain meaning of the language is permissible whenever context so requires, to avoid the absurdities and to interpret the treaty ut res magis valeat quam pereat i.e., in such a manner as to make it workable rather than redundant.
(vii) Words are to be understood with reference to the subject-matter, i.e., verba accopoenda sunt secundum subjectum materiam.
(viii) When a tax treaty does not define a term employed in it, and if the context of the treaty so requires, the terms can be given a meaning different from its meaning in the domestic law. The meaning of the undefined terms in a tax treaty should be determined by reference to all of the relevant information and the context.
The rules of interpretation in VCLT can be found in Article 31 to 33 of the Convention. Article 32 of the Convention provides recourse to supplementary means of interpretation, which in turn should confirm to the broad principles of Article 31 as summarised above. According to Article 32 of VCLT, the ‘supplementary means of interpretation’ include the preparatory work of the treaty and the circumstances of its conclusion. The word ‘include’ indicates that the rule is not exhaustive and there may be other supplementary means of interpretation. One such means is provided by the commentaries appended to the OECD Model Tax Convention. To the extent, the provisions of DTAAs are similar to OECD Model Convention, the OECD commentaries may become relevant to interpretation of DTAAs.
The Kolkata Tribunal in the case of Graphite India Ltd. v. DCIT, (86 ITD 384) while deciding whether the services rendered by an American Consultant to an Indian Company are covered under the Article 15, being in the nature of professional services or under Article 12, being in the nature of Fees for Technical services, observed as under as regard to interpretation of OECD and UN Model Commentaries:
“17. The aforesaid interpretation is clearly in harmony with the OECD and UN Model Conventions’ official commentaries, ………….. Andhra Pradesh High Court has, in the case CIT v. Visakhapatnam Port Trust, (1984) 38 CTR (AP) 1: (1983) 144 ITR 146 (AP), referred to OECD commentaries on the technical expressions and the clauses in the model conventions, and referred to, with approval, Lord Radcliffe’s observations in Ostime v. Australian Mutual Provident Society, (1960) AC 459, 480: (1960) 39 ITR 210, 219 (HL), which have described the language employed in these documents as the ‘international tax language’. In view of the observations of Andhra Pradesh High Court, in Visakhapatnam Port Trust’s case (supra), these model conventions and commentaries thereon constitute international tax language and the meanings assigned by such literature to various technical terms should be given due weightage. In our considered view, the views expressed by these bodies, which have made immense contribution towards development of standardisation of tax treaties between various countries, constitute ‘contemporanea expositio’ inasmuch as the meanings indicated by various expressions in tax treaties can be inferred as the meanings normally understood in, to use the words employed by Lord Radcliffe, ‘international tax language’ developed by bodies like OECD and UN.”
As discussed earlier, India by giving its stance on the text of the Article of OECD Model Tax Convention and commentaries thereon has helped in confirming an interpretation, in resolving ambiguities and obscurities and in displacing interpretation which appears absurd or unreasonable from India’s point of view. India’s position qua the text of the Articles and commentaries thereon as stated in the OECD Model Tax Convention — July 2010 version under the chapter ‘Non -OECD Economies’ positions on the OECD Model Tax Convention’ is tabulated below:
|
Relevant |
|
OECD |
||
|
|
|
Text |
|
Commentary |
|
|
|
|
|
|
|
Article 1 – Persons |
No disagreement5 |
|
Disagreement6 |
|
|
Article 2 – Taxes |
No disagreement |
|
No disagreement |
|
|
Article 3 – General |
Reservations7 |
|
No disagreement |
|
|
Article 4 – Resident |
Reservations |
|
Disagreement |
|
|
Article 5 – Permanent |
Reservations |
|
Disagreement |
|
|
Article 6 – Income |
Reservations |
|
No disagreement |
|
|
Article 7 – Business |
Reservation and |
|
Disagreement |
|
|
|
|
disagreement |
|
|
|
|
|
|
|
|
|
Article 7 – Business |
Reservations |
|
Disagreement |
|
|
Article 8 – Shipping, |
|
|
|
|
|
Air Transport |
Reservations |
|
Reservations |
|
|
Article 9 – |
No disagreement |
|
No disagreement |
|
|
Article 10 – |
Reservations |
|
Disagreement |
|
|
Article 11 – Interest |
Reservations |
|
Disagreement and |
|
|
Article 12 – Royalties |
Reservations |
|
Disagreement and Reservations |
|
|
Article 13 – Capital |
Reservations |
|
No disagreement |
|
|
Article 14 – |
Article and |
|||
|
Article 15 – Income |
Reservations |
|
Disagreement |
|
|
Article 16 – Director’s |
No disagreement |
|
No disagreement |
|
|
Article 17 – Artists |
Reservations |
|
No disagreement |
|
|
Article 18 – Pensions |
No disagreement |
|
No disagreement |
|
|
Article 19 – |
No disagreement |
|
Disagreement |
|
|
Article 20 – Students |
Reservations |
|
No disagreement |
|
|
Article 21 – Other |
Reservations |
|
No disagreement |
|
|
Article 22 – Taxation |
Reservations |
|
No disagreement |
|
|
Article 23A – |
Reservations |
|
No disagreement |
|
|
Article 23B – Credit |
|
|
|
|
|
Article 24 – Non |
Reservations |
|
Reservations |
|
|
Article 25 – Mutual |
No disagreement |
|
Disagreement |
|
|
Article 26 – Exchange |
Reservations |
|
No disagreement |
|
|
Article 27 – |
|
|
|
|
|
Article 28 – Members |
There are no disagreements which India has |
|||
|
Consular Posts |
||||
|
Article 29 – Territorial Extension |
of the Article and |
|||
|
Article 30 – Entry |
|
|
|
|
|
Article 31 – |
|
|
|
|
However, a question that arises is whether the position by India with respect to provisions of OECD Model Tax Convention is binding on taxpayers, tax authorities and more so, on the judicial forums of India.
To begin with, it is necessary to find the statutory force or lack of it, under which India has provided its position to the OECD Model Tax Convention, since its nature will determine the legitimacy of reference to OECD Commentary for interpreting the provisions of DTAAs.
After considering the OECD Commentary — ‘Non-OECD Economies’ Positions on the OECD Model Tax Convention’ Chapter, one understands that these are official statements made by Government of India as regard its interpretation of the Tax Convention. The clarifications or comments provided to OECD are not issued as a rule u/s.295, Circular or order u/s.119 of the provisions of the Income-tax Act, 1961. A pos-sible conclusion which can then be drawn is that even though such clarification may not be binding on taxpayers, they shall have high persuasive value considering contemporary official statements made by the Government of India on the subject of interpretation.
One also needs to consider whether these official statements can be considered as an aid for construction of the DTAAs entered into by India and which are based on OECD Model Tax Convention.
The aforesaid explanations received from the Indian Government could be considered as an aid for construction, which is in accordance with the Latin Maxim Contemporanea expositio. The Indian Courts8 have time and again held that Contemporaneous Exposition by the administrators entrusted with the task of executing the statute is extremely significant in interpretation of the statutory instruments. The rule of contemporanea expositio provides that “administrative construction (i.e., contemporaneous construction placed by administrative or executive officers) generally should be clearly wrong before it is over-turned; such a construction commonly referred to as practical construction, although non-controlling, is nevertheless entitled to considerable weight, it is highly persuasive.” [Crawford on Statutory Construction, 1940 Ed, as in K. P. Varghese (supra)]. However, generally, such expositions from the administrators are subject to the following limitations:
good against such expositions; and
Therefore, based on the aforesaid discussion and doctrine of Contemporanea exposition, one may hold that provisions of DTAAs could be construed based on the explanation as received from the Indian Government on the OECD Model Tax Convention, provided the said exposition adheres to the broad principles of Article 31 of the VCLT, even though the applicability of VCLT to India may be a question in itself.
So, besides, decisions delivered by the various Indian judicial forums interpreting the provisions of DTAAs, one can now rely on India’s position on the Articles of the OECD Model Tax Convention and commentary thereon.
Lastly, the relevant extracts of the decision of the Apex Court in the case of UOI v. Azadi Bachao Andolan and Anr. (supra) as regard to interpretation of DTAAs are reproduced below:
“………… Interpretation of Treaties
96. The principles adopted in interpretation of treaties are not the same as those in interpretation of statutory legislation. While commenting on the interpretation of a treaty imported into a municipal law, Francis Bennion observes:
“With indirect enactment, instead of the substantive legislation taking the well-known form of an Act of Parliament, it has the form of a treaty. In other words the form and language found suitable for embodying an international Agreement become, at the stroke of a pen, also the form and language of a municipal legislative instrument. It is rather like saying that by Act of Parliament, a woman shall be a man. Inconveniences may ensue. One inconvenience is that the interpreter is likely to be required to cope with disorganised composition instead of precision drafting. The drafting of treaties is notoriously sloppy, usually for very good reason. To get Agreement, politic uncertainty is called for.
…… This echoes the optimistic dictum of Lord Widgery CJ that the words “are to be given their general meaning, general to lawyer and layman alike… the meaning of the diplomat rather than the lawyer.” [Francis Bennion, Statutory Interpretation, p. 461 (Butterworths) 1992 (2nd Ed.)]
An important principle which needs to be kept in mind in the interpretation of the provisions of an international treaty, including one for double taxation relief, is that treaties are negotiated and entered into at a political level and have several considerations as their bases. Commenting on this aspect of the matter, David R. Davis in Principles of International Double Taxation Relief, p. 4 (London Sweet & Maxwell, 1985), points out that the main function of a Double Taxation Avoidance Treaty should be seen in the context of aiding commercial relations between treaty partners and as being essentially a bargain between two treaty countries as to the division of tax revenues between them in respect of income falling to be taxed in both jurisdictions”
On a more practical front, one finds that since the publication of India’s position on OECD Model Tax Convention, the Courts have not acknowledged much, the said publication as an aid for construction in interpreting the provisions of DTAAs. The taxpayers could however look forward to taking re-course to the India’s position on OECD Commentary as an aid for construction, for the favourable interpretations with respect to provisions of DTAA.
Strange as it may sound, the Indian commodity markets are older than the securities markets, however, very little is known about these markets to the common man. The various commodity markets in India clocked a turnover of over Rs.92 trillion for the period ended April to December 2011. Commodity markets have various components, such as bullion, metals, grains, energy, oil and oilseeds, petrochemicals, pulses, spices, plantation products, etc. and span over 100 commodities. In the recent past, gold and silver have given excellent returns and that is why now there is a sustained interest in the commodity markets. Let us take a bird’seye view of the regulatory aspect of this market, the types of contracts which can be executed, the tax treatment of these contracts, etc.
Forward Contracts (Regulation) Act
The FCRA regulates the forward contracts in commodities. As the name suggests, it does not apply to spot delivery contracts. It is somewhat similar in nature to Securities Contracts (Regulation) Act, 1956.
Forward Market Commission
(a) Ready Delivery Contracts — Contracts where delivery and payment must take place immediately or within a maximum period of 11 days. These are similar to the spot delivery contracts which one comes across under the SCRA. If a commodity contract is settled by cash or by an offsetting contract and as a result of that the actual tendering of goods is dispensed with, then it is not an Ready Delivery Contract. These contracts are outside the purview of the Forward Markets’ Commission. The Amendment Bill seeks to increase the duration from 11 to 30 days.
(b) Forward Contracts — These are contracts for the delivery of goods and are not a Ready Delivery Contract. The FMC regulates these Contracts. Commodity derivatives are also a type of Forward Contract. Thus, a contract which is settled by cash or by an offsetting contract and as a result the actual tendering of goods is dispensed with becomes a Forward Contract.
Forward Contracts can be of three types:
(a) Specific Delivery Contract — It is a Forward Contract which provides for the actual delivery of specific qualities of goods. The delivery must take place during a specified future period at a price fixed/to be fixed. Further, the names of the buyer and seller must be mentioned in the contract. The Amendment Bill proposes to add that such contracts must also be actually performed by actual delivery.
Specific Delivery Contracts cannot be settled by paying the difference in cash or by an offsetting contract. They can be executed on an off-market basis also. Specific delivery contracts are contracts entered into for actual transactions in the commodity and the terms of contract may be tailored to suit the needs of the parties as against the standardised terms found in futures contracts.
Specific Delivery Contracts, in turn, can be of two types — Non-Transferable (NTSDC) and Transferable (TSDC). Non-transferable are those contracts which are only between a defined buyer and a seller and cannot be transferred by either party, whereas ‘transferable contracts’ may be transferred from one person to another till the actual maturity of the contract or delivery date.
(b) Forward contracts other than specific delivery contracts are what are generally known as ‘Futures Contracts’, though the Act does not specifically define the term futures contracts. Such contracts can be performed either:
Thus, the main difference between Specific Delivery Contracts and Futures is that while Specific Delivery Contracts must be performed by delivery, futures can be cash settled also. Futures contracts are usually standardised contracts where the quantity, quality, date of maturity, place of delivery are all standardised and the parties to the contract only decide on the price and the number of units to be traded. Futures contracts must necessarily be entered into through the Commodity Exchanges.
(c) Option Agreements —
The Amendment Act proposes to add a third category — options in commodities. This would mean an agreement for the purchase or sale of a right to buy and/or sell goods in future and includes a put and call in goods. These must be entered into through the Commodity Exchanges.
Commodity exchanges
Currently, permanent recognition has been granted to three national-level multi-commodity exchanges, Multi-commodity Exchange of India Limited (MCX), National Commodity and Derivatives Exchange Limited (NCDEX), and National Multi-commodity Exchange of India Limited (NMCE) Ahmedabad. These national commodity exchanges have permission for conducting forward/futures trading activities in all commodities, to which section 15 of the FCRA is applicable.
Members of commodity exchanges are commodity brokers.
Trading in forward contracts
Nothing contained in section 15 applies to Specific Delivery Contracts, whether transferable or non-transferable. However, the Central Government is empowered u/s.18(3) to notify such classes of Specific Delivery Contracts to which the provisions of section 15 would also apply.
Regulation of commodity brokers
Commodity brokers cannot provide advisory services to clients for investment in commodities futures contract. Portfolio advisory services, portfolio management services and other services are not permissible in the Commodity Derivative Markets. The FMC has not formulated any guidelines for investment advisory services by any entity and hence, these activities are not permitted to the brokers.
Trading in overseas commodities exchanges and setting up joint ventures/wholly-owned subsidiaries abroad for trading in overseas commodity exchanges is reckoned as financial services activity under the FEMA Regulations and requires prior clearance from the FMC. Any investment in a JV/WOS for such a purpose would have to comply with the requirements for overseas direct investment in a financial service as specified under Rule 7 r.w. Rule 6 of the FEMA Notification No. 120/2004.
FDI in commodity brokerages
Neither the Consolidated FDI Policy issued vide Circular 2/2011, nor the Regulations issued under the FEMA, 1999 contain any specific provision for foreign direct investment in a commodity brokerage. Hence, any FDI in a commodity brokerage would require prior FIPB approval. The FIPB has given approvals to several such FDI proposals.
However, it may be noted that the RBI does not permit foreign banks to invest in commodity brokerages, whether directly or indirectly. Hence, any proposal for FDI by a foreign bank in a commodity broker would not be permissible. It is for this reason that the takeovers of IL&FS Investmart by HSBC and Geojit Securities by BNPI were held up by the RBI till such time as the commodity broking arms were hived-off/restructured. FDI in commodity exchanges is allowed up to 49% (FDI & FII). Investment by Registered FIIs under the Portfolio Investment Scheme (PIS) is limited to 23% and investment under the FDI Scheme is limited to 26%.
Taxation of commodity contracts
Taxation of commodity derivative contracts is one of the issues facing investors and traders in commodities. The first question to be considered is whether the assessee is an investor or a trader and hence, whether his gain is taxable as capital gains or as business income. The various tests, judgments, controversies, etc., which one comes across while dealing with this issue in the case of securities would be applicable even to commodities.
Secondly, in the cases where they constitute a business, the question arises whether they constitute a speculative business. Section 43(5) of the Income-tax Act grants a specific exemption to derivatives traded on stock exchanges. However, there is no specific exemption for contracts traded on commodity exchanges. Hence, one would have to ascertain whether a commodity contract falls under any of the other exemptions specified u/s.43(5).
Further, the losses from speculative commodity businesses can only be set off against speculative commodity businesses. They cannot be set off against profits from delivery based commodity transactions or capital gains or profits from security derivatives transactions.
Stamp duty on contract notes
Stamp Duty on commodity transactions is a State subject and the duty incidence would depend upon the location of the broker’s office which issues the contract note. For instance, under the Bombay Stamp Act, 1958, the State of Maharashtra levies a duty @ 0.005% of the value of the contract for the purchase or sale of any commodity, such as cotton, bullion, spices, oil seeds, spices, etc. Similarly, any electronic or physical contract note issued by a commodity broker, whether delivery based or non-delivery based attracts a duty @ 0.005%.
Maharashtra levies one of the highest incidences of stamp duty on commodity broker notes. Earlier, such contracts were charged with minimum duty of Rs.100 per document.
Section 10B of the Bombay Stamp Act, provides that it is the responsibility of the commodity exchange to collect the stamp duty due on brokers’ notes by deducting the same from the brokers account at the time of settlement of such transactions.
Penalties under FCRA
Any violation of the FCRA is a criminal offence inviting imprisonment and/or a fine. The Bill proposes to make the penalties for violating the FCRA more stringent, for example, violation of some of the provisions would carry imprisonment up to one year and/or a fine ranging from Rs.25000 to Rs.25 lakh. The Bill also seeks to introduce penalties for insider trading similar to what is found under the SEBI Act.
Auditor’s responsibility
Just as a compliance audit of stock brokers requires a knowledge of the securities markets, an audit of commodity brokers requires knowledge of the commodity markets on the part of the auditor. This would include a knowledge of the various applicable Regulations, relevant Exchange Circulars, Compliance Forms, etc.
An auditor of a market intermediary should be well-versed with the important laws in this respect which affect the functioning and the existence of the entity. For instance, in case of the intermediaries, non-compliance with the regulations could result in cancellation of the registration certificate and this would affect the very substratum of the entity.
By broadening his peripheral knowledge, the Auditor can make intelligent enquiries and thereby add value to his services. He can caution the auditee of likely unpleasant consequences which might arise as a result of improperly stamped or unregistered mortgage deeds. It needs to be repeated and noted that the audit is basically under the relevant law applicable to an entity and an auditor is not an expert on all laws relevant to business operations of an entity. All that is required of him is exercise of ‘due care’.
The plaintiff’s version was that he had been in continuous possession of the schedule lands having been put in possession of the same under the private sale deed and has been raising seasonal crops. Thus, he asserts that after his purchase, he has been in possession of the schedule lands and the said fact is known to each and every body in and around the village, including the defendants. He also pleaded that by continuously remaining in possession and upon asserting his title to the knowledge of the defendants he perfected the title to the schedule property by adverse possession.
The defendants No. 3 and 4 alleged that the sale deed are sham and bogus documents and the property was coparcenery property, therefore the defendant No. 1 could not have sold the same.
The issue that arose was whether the plaintiff was entitled to protect his possession under law on the ground that since he remained in possession of the property for more than the period of 12 years and that he had perfected his title by adverse possession.
The Court observed that person who obtained the possession of the property under executory terms of contract of sale, cannot ask for declaration of his title on the ground that he remained in possession of the property for more than 12 years period and contending that his possession is adverse to the real owner. The Apex Court in Achal Reddi v. Ramakrishna Reddiar & Ors., AIR 1990 SC 553 held that possession of a purchaser is under a contract of sale, his possession cannot be adverse and he cannot set up the plea of adverse possession. Therefore, the Trial Court erred in declaring the title of the plaintiff holding that he perfected his title to the schedule mentioned property by adverse possession against the defendants.
However, by virtue of the doctrine of part performance embodied in section 53A of the Transfer of Property Act, the plaintiff can protect his possession from defendants 1 and 2 who sold the property to him under the simple sale deed, so also he can protect his possession from defendants 3 and 4 who had the knowledge of the earlier sale transaction in his favour under a sale deed. Further it is true that section 53A only operates as a bar against the defendants in the present case from enforcing any rights against the plaintiff other than those which were provided under simple sale deed. Although the section does not confer title on the person who took possession of the property in part performance of the contract, the law is now well settled that when all conditions of the section are satisfied as in the present case, the possession of the person must be protected by the Court whether he comes as a plaintiff or defendant. The only embargo is that section 53A cannot be taken in aid by the transferee to establish his right as owner of the property. But the transferee can protect his possession having recourse to section 53A, either by instituting a suit for injunction as a plaintiff or by defending the suit filed by the transferor or subsequent purchasers as a defendant. It is also well settled that the transferee can very well file a suit for injunction to protect his possession even though his remedy to file a suit for specific performance of contract is barred by limitation.
The suit of the plaintiff seeking possession of the suit property had been dismissed. The case of the plaintiff was that the defendants had entered into an agreement to sell dated 13-11-1992 with the father of the plaintiff, namely, Sh. Mangat Ram for the purchase of the aforenoted suit property; total consideration was Rs.2,80,000; a sum of Rs.1,05,000 was paid to Sh. Mangat Ram; the defendants agreed to pay the balance consideration on or before 13-9-1993. The balance amount was not paid. The defendants requested Sh. Mangat Ram to cancel the agreement; the defendants had agreed to vacate the property within three to four months. Sh. Mangat Ram expired on 21-4-1997. In spite of requests of the plaintiff to the defendant to vacate the suit property as also the legal notice dated 22-12-2001, the defendants failed to adhere to the said request. Thereafter the suit seeking possession of the suit shop as also damages at the rate of Rs.5,000 per month was claimed. The defendant took defence of part performance of contract u/s.53.
The Court observed that the conditions necessary for making out the defence of part performance to an action in ejectment by the owner are:
(a) That the transferor has contracted to transfer for consideration any immoveable property by writing signed by him or on his behalf from which the terms necessary to constitute the transfer can be ascertained with reasonable certainty;
(b) That the transferee has in part performance of the contract take possession of the property or any part thereof, or the transferee, being already in possession continues in possession in part performance of the contract;
(c) That the transferee has done some act in furtherance of the contract; and
(d) That the transferee has performed or is willing to perform his part of the contract.
The provision does not confer a title on the transferee in possession; it only imposes a statutory bar on the transferor. In the instant case, it is not in dispute that an agreement to sell dated 13-11-1992 had been executed by Mangat Ram (the father of the plaintiff) qua the disputed shop in favour of the defendant.
The essential ingredients of the doctrine of part performance had been made out entitling the defendant to seek shelter and protection under this statutory provision. Admittedly in terms of the agreement the defendant was put in possession of the suit shop. The defendant had been given possession of the suit shop; it has also been proved on record that a sum of Rs.2,15,000 had been paid by the defendant to the plaintiff in part performance of the contract; he was also ready and willing to perform his part of the contract and in fact his case was that the balance consideration had also been paid by him to the plaintiff. The case of the plaintiff on the other hand was that this amount had been returned back and a sum of Rs.80,000 had been paid. This document was rightly disbelieved; it did not even bear the signatures of Mangat Ram. In view of agreement to which there was no denial the defendanttransferee is entitled to protect his possession over the suit property taken in part performance of the contract even if the period of limitation to bring a suit for specific performance has expired. The Limitation Act does not extinguish the defence; it only bars the remedy.
The dispute in the present case was in regards to refund claim, the relevant date for computing limitation period should be counted from the date of order of the Commissioner (Appeals), which was dispatched on 10-1-2007 and received on 27-1-2007 by the assessee or the limitation period will start from the date of communication of order.
The Commissioner (Appeals) upheld the order of the Asst. Commissioners observing that as per the records, the order had been handed over to the postal authority at GPO on 10-1-2007 and, hence, the same has to be taken as the date of dispatch and the words ‘date of the order’ in clause (ec) of the Explanation (B) to section 11B of Central Excise Act mean the date of dispatch and not the date of communication of the order.
On appeal, the Delhi Tribunal observed that the limitation period prescribed u/s.11B for filing the refund claim is one year from the relevant date. Unlike the judgments of the Courts or Tribunal which are either dictated in the open Court or are pronounced in the open Court and thus the date of the pronouncement and the date of communication to the affected parties are the same, in case of adjudication of any dispute by the Departmental adjudicating authorities or the Commissioner (Appeals), the judgments are not pronounced or dictated in presence of the parties but are sent by post and, thus, there would be a time gap between the date on which the order has been signed, the date of dispatch and the date on which the order is received by the assessee. The point of dispute, thus, in the case was as to whether the words ‘date of such judgment, decree order or direction’ used in clause (ec) of explanation (B) to section 11B refer to the date of signing of the order or date of dispatch order or the date of actual communication of the order to the assessee. It is clear that when some order of Court or an authority affects as assessee, the limitation would start from the date on which the order was communicated to the assessee or the date on which it was pronounced or published so that the party affected by it has reasonable opportunity of knowing the passing of such order and what it contains. The Apex Court in the case of CCE v. M. M. Rubber Co., 1991 (SS) ELT 289 (SC) held that the limitation period would start from the date of the communication of the order and not the date of signing of the order or the date of dispatch and as such with regard to the order passed by the Dept. adjudicating authority or the Commissioner (Appeals) the words ‘date of judgment’ have to be interpreted as the date of communication of the order. Thus, the refund claim was within time and the impugned order rejecting the same as time-barred, was not sustainable.
The appellants’ application for grant of letter of administration had been dismissed on the ground that the Will had not been proved, therefore the same could not be looked into.
On appeal it was observed by the High Court that a will is required to be attested by two witnesses. Section 68 of the Evidence Act lays down the procedure for proof of a document, which is required by law to be attested. Section 68 of the Evidence Act reads as follows:
“Proof of execution of document required by law to be attested. If a document is required by law to be attested, it shall not be used as evidence until one attesting witness at least has been called for the purpose of proving its execution, if there be an attesting witness alive, and subject to the process of the Court and capable of giving evidence.”
Thus in view of the aforesaid provision, if a Will (which is required under the law to be attested by witness) is not proved by adducing evidence of attesting witness, the same cannot be looked into evidence, unless the appellant shows that the said attesting witnesses are not alive and/or not capable to give evidence. In the instant case, both attesting witnesses of the Will were alive. Under the said circumstance, it was held that the Will had not been proved in accordance with law and therefore the same cannot be looked into.
The GN should be applied to all transactions in real estate commencing or entered into on or after 1st April 2012. The GN also gives an early adoption option, provided that it is applied to all transactions commencing on or were entered into on or after the earlier adoption date.
This GN mandates the application of POC method [as defined in Accounting Standard (AS) 7, Construction Contracts] in respect of real estate transactions where the economic substance is similar to construction-type contracts. It gives the following indicators for determining if the economic substance of the transactions is similar to construction type contracts:
(a) The period of such projects is in excess of 12 months and the project commencement date and project completion date fall into different accounting periods.
(b) Most features of the project are common to construction-type contracts, viz., land development, structural engineering, architectural design, construction, etc.
(c) While individual units of the project are contracted to be delivered to different buyers these are interdependent upon or interrelated to completion of a number of common activities and/or provision of common amenities.
(d) The construction or development activities form a significant proportion of the project activity.
The GN also specifies that the POC method is applied only when all the following conditions are fulfilled:
(a) All critical approvals necessary for commencement of the project have been obtained;
(b) When the stage of completion reaches a reasonable level of development. Rebuttable presumption — reasonable level is not achieved if the expenditure incurred on project costs is less than 25% of the construction and development costs;
(c) At least 25% of the estimated project revenues are secured by contracts or agreements with buyers; and
(d) At least 10% of the total revenue as per the agreements of sale or any other legally enforceable documents are realised at the reporting date.
Therefore, companies need to assess the eligibility of individual project based on the above parameters at each reporting period before any revenue can be recognised from them. Unless and until all the above conditions are met, revenue cannot be recognised from a project. In the calculation of stage of completion of 25% for point (b) above, only actual construction costs can be included and other costs (i.e., cost of land and development rights and borrowing costs) are excluded. Hence, the GN focusses on actual physical construction activities rather than costs. However, this calculation of stage of completion is only for determining if the project is an eligible project for revenue recognition. Once it is determined that a particular project is an eligible project, revenue can be recognised based on a POC calculation that is different from the calculation done for deciding eligibility. Put differently, revenue recognition can be based on a higher POC, calculated by taking total actual costs including cost of land and development rights. While this is not explicitly mentioned in the GN it is coming out from the illustration appended to the GN.
The GN also puts an additional overall restriction on recognition of revenue when there are outstanding defaults in payment by customers. It says that the recognition of revenue by reference to POC should not at any point exceed the estimated total revenue from eligible contracts. Eligible contracts for this purpose are those meeting the above four POC criteria plus where there are no outstanding defaults of the payment terms. The GN does not define ‘outstanding default’ and hence, a question arises if the ‘outstanding default’ to be determined as at the period ends only or post balance sheet payments should also be considered? For example, there was a default in payment by a customer before the period end, but the customer has paid and regularised the account post the period end before the financial statements approved. It is not clear from the GN whether this will be considered as an ‘outstanding default’ as at the period end.
Example
ABC Limited is in the business of real estate development and sale. On 1st April 2010, ABC started a project to construct and sell 100 flats of 1,000 sq.ft. each. Cost of construction, including directly attributable costs is Rs.3,000 per sq.ft. Cost of land and development right is Rs.30 crore. Actual figures for the year ended 31st March 2011 are given in Table 1:
|
|
Rs. in crores |
|
Sales — 30 flats at |
21.00 |
|
Collection from |
8.40 |
|
Actual construction |
15.00 |
|
Total revised |
17.00 |
|
POC for determining |
|
|
costs/total estimated |
46.88% |
|
|
|
|
POC for recognition |
|
|
costs/Total revised |
72.58% |
|
|
|
|
|
Rs. in crores |
|
Revenue to be |
|
|
(30 x 7,000 x 1,000 x |
15.24 |
|
|
|
|
Project costs [(30 + |
|
|
sq.ft./100,000 |
13.50 |
|
|
|
|
Work in progress (30 |
31.50 |
|
|
|
In case there were defaults in payment by 10 flat holders out of the total 30, the additional computation shown in Table 3 is to be done to determine if the revenue recognition of Rs.15.24 crore is appropriate.
|
|
Rs. in crores |
|
Revenue to be |
|
|
(as above) |
15.24 |
|
|
|
|
Estimated total |
|
|
eligible contracts |
|
|
(20 flats x 1,000 |
|
|
per sq.ft.) |
14.00 |
|
|
|
|
Work in progress (30 + 15 – 13.50) |
31.50 |
|
|
|
Since the revenue as per the POC workings of Rs.15.24 crore is higher than the estimated total revenue from eligible contracts of Rs.14 crore, revenue recognition should be restricted to Rs.14 crore and correspondingly cost of projects to be recognised in the profit and loss should also be adjusted.
This guidance note will enhance consistency in the accounting practices of real estate developers and in particular the application of the percentage completion method. This however remains a very important ‘carve-out’ and will have a significant impact on companies who wish to prepare and report their financial statements under IFRS.
Editor’s Note: It is understood that the Guidance Note on Recognition of Revenue by Real Estate Developers has been finalised and is expected to be issued shortly.
Depreciation
At erection/project sites: The cost of roads, bridges and culverts is fully amortised over the tenure of the contract, while sheds, railway sidings, electrical installations and other similar enabling works (other than purely temporary erections, wooden structures) are so depreciated after retaining 10% as residual value.
Depreciation
Expenditure on items like electricity transmission lines, railway sidings, roads, culverts, etc. the ownership of which is not with the company are charged off to revenue in the year of incurrence of such expenditure.
Depreciation
The cost of fixed assets, constructed by the company, but ownership of which belongs to government/local authorities, is amortised at the rate of depreciation specified in Schedule XIV to the Companies Act, 1956.
Expenditure on power lines, ownership of which belongs to the State Electricity Boards, is amortised over the period as permitted in the Electricity Supply Act, 1948.
Expenditure on marine structures, ownership of which belongs to the Maritime Boards, is amortised over the period of agreement.
From Significant Accounting Policies
Depreciation
Capital assets whose ownership does not vest in the company have been depreciated over the period of five years.
Depreciation
Capital assets whose ownership does not vest in the company is depreciated over their estimated useful life or five years, whichever is less.
Depreciation
Assets not owned by the company are amortised over a period of five years or the period specified in the agreement.
From Fixed Assets Schedule
Fixed assets includes assets costing Rs.238.63 crores (Previous year Rs.150.94 crores) not owned by the company.
Fixed assets
Depreciation
Capital expenditure referred to in Policy 2.3 is amortised over a period of five years from the year in which the first unit of project concerned comes into commercial operation and thereafter from the year in which the relevant asset becomes available for use.
From Notes to Accounts
During the year the company has received the opinion from the Expert Advisory Committee of the Institute of Chartered Accountants of India (EAC of ICAI) and as per opinion of EAC, expenditure incurred for creation of assets not within the control of company should be charged to Profit & Loss account in the year of incurrence itself. The company has represented to the EAC of ICAI that such expenditure, being essential for setting up of a hydro project, should be allowed to be capitalised. Pending receipt of further opinion/communication from the EAC, the accounting treatment as per existing accounting practices/ policies has been continued.
From Auditor’s Report
Further to our comments in the Annexure referred to in Para 3 above, without qualifying our report, we draw attention to (a) ……., (b) ……. and (c) Note No. 12 (Schedule 24 — Notes to Accounts) regarding having referred the issue of capitalisation of expenditure incurred for creation of assets (enabling assets) not within the control of the company, to Expert Advisory Committee of the Institute of Chartered Accountants of India.
Depreciation
Capital expenditure on assets not owned by the company is amortised over a period of four years from the month in which the first unit of project concerned comes into commercial operation and thereafter from the month in which the relevant asset becomes available for use. However, similar expenditure for community development is charged off to revenue.
From Notes to Accounts
During the year the company has received an opinion from the Expert Advisory Committee of the Institute of Chartered Accountants of India on accounting treatment of capital expenditure on assets not owned by the company wherein it was opined that such expenditure are to the charged to the statement of Profit & Loss Account as and when incurred. The company has represented that such expenditure being essential for setting up of a project, the same be accounted in line with the existing accounting practice and sought a review. Pending receipt of communication regarding the review, existing treatment has been continued as per existing accounting policy.
Facts:
The assessee-company sold shares held in Nalwa Sponge Iron Ltd. (NSIL) to three persons at Rs.12 per share. The book value of shares was estimated to be Rs.254.40 at the time of sale. The AO took the view that the sale of shares was a device to pass on undue monetary benefit to the persons, who according to the AO were related persons. Based on that the AO recomputed capital gain by adopting the fair market value of the shares which was Rs.254.50. He thus made additions of Rs.6,06,27,500 as undisclosed sale consideration. On appeal to the CIT(A) by the assessee, it was held that the AO can’t alter the computation of capital gain without any evidence.
The Department filed appeal against the order of the CIT(A).
Held:
Section 48 contemplates ascertainment of ‘full value of consideration received or accruing as a result of the transfer of capital asset’. The word received means actually received and word accruing means the debt created in favour of the assessee as a result of transfer. In any case, both the terms are used as actual and not estimated amounts. The erstwhile provision does not contain words ‘fair market value’, thus addition made to sale consideration by the AO is not in accordance with the section 48 of the Act.
As regards the objection raised by the AO regarding related party, there was no evidence to prove that transferees were related to the directors of the company. However in any case transferees could not be said to be related to the company as company does not have any corporeal existence.
Hence it was held that the transactions were conducted with independent parties.
Also it is commonly accepted law that the onus to prove otherwise than the fact lies on the person who alleges. In the instant case even though the transaction had taken place at values far less than the arm’s-length price, in absence of any evidence purporting receipt of more consideration than stated, computation of capital gain made by the assessee cannot be altered by the AO.
In order to show that the transaction was colourable device intended to evade tax, the Revenue must prove understatement of consideration. They should have basic material and evidence in its hand. In the instant case, the AO relied upon hypothetical sale price without any evidence, which does not prove that there is more consideration passed than what is disclosed.
Held that as there was no evidence on record that transferees were related to directors of the assessee-company and that the assessee had received amount more than stated consideration, computation of capital gain can be made only on the basis of consideration actually received.
Facts:
The assessee HUF in its return of income declared long-term capital gains on sale of shares. The assessee claimed that it had purchased a flat and therefore LTCG was exempt u/s.54F of the Act. The LTCG arose on sale of 6000 shares of a company known as Poonam Pharmaceuticals Ltd. (P). The shares had been purchased by the assessee on 8-4-2003 for a sum of Rs.14,320 through V. K. Singhania, a stock-broker in Calcutta. The purchase price was claimed to have been paid in cash. The shares were sold in 3 tranches in August, Sept and Nov 2004 for a total consideration of Rs.17,87,450. The shares were claimed to have been sold through Shyamlala Sultania, stock-broker in Calcutta. The delivery of shares was received and given via Demat account of the assessee. In the course of assessment proceedings, the AO with a view to verify the transactions of purchase and sale of shares wrote a letter to P which was returned unserved with a remark ‘Not Known’. The broker through whom the shares were claimed to have been sold stated that the assessee was not his client and during the previous year he had not done any transactions in shares of P. The Calcutta Stock Exchange confirmed that M/s. V. K. Singhania had not done any transaction in scrip P in the physical form in the online trading system of Calcutta Stock Exchange.
The AO, in the course of assessment proceedings, examined the assessee u/s.131 and recorded statement of the Karta of the assessee. In the statement it was stated that the shares were purchased and sold on the advice of one Mr. R who was resident of Mumbai. Upon being confronted with the materials collected by the AO, he stated that he had purchased and sold shares and had nothing more to say. He then sought adjournment and before the next date of hearing filed a letter surrendering the amount of exemption claimed on the ground that due to his age he cannot go to Calcutta to verify the details, he has not concealed any income nor filed wrong particulars, but with a view to buy peace and avoid litigation the surrender was being made by revising return of income (though time for filing revised return u/s.139(5) had expired) and taxes were paid. The AO made a reference to investigation conducted by Investigation Wing of the Department and pointed modus operandi followed by various persons claiming LTCG. The AO held that the assessee had brought into his accounts unaccounted money and paid less tax by claiming the sum brought in the books as LTCG.
Subsequently, the AO levied penalty on the ground that the assessee had concealed particulars of income and only when investigation was carried out the assessee surrendered the amount and offered the sale proceeds of shares as Income from Other Sources.
Aggrieved, the assessee preferred an appeal to the CIT(A) who confirmed the order of the AO.
Aggrieved, the assessee preferred an appeal to the Tribunal.
Held:
The Tribunal noted the sequence of events and observed that the assessee had shown the shares in its balance sheet as on 31-3-2004 and the same was accepted by the Revenue. It also noted that the shares were transferred to the Demat account of the assessee. Sale consideration was received by banking channels. The Tribunal observed that the enquiry by the AO from the Calcutta Stock Exchange that the transaction was not done through the Exchange cannot be taken as basis to conclude that the transactions of sale of shares was not genuine. It observed that denial of Shyamlal Sultania, through whom shares were sold is a circumstance going against the assessee. The Tribunal held that from the sequence of events it cannot be said with certainity that the claim made by the assessee was bogus. It noted that the surrender was made to buy peace and avoid litigation. It was because of his inability to go to Calcutta, due to old age, to collect necessary evidence that the surrender was made. The AO had not brought on record any independent material to show that the assessee was part of any investigation referred to in the assessment order. The Tribunal held that imposition of penalty would depend on facts and circumstances of the case. On the present facts, the Tribunal held that the explanation offered by the assessee was bona fide. The Tribunal directed that the penalty imposed be deleted.
The appeal filed by the assessee was allowed.
