Month: January

7.  Capital gains –
Exemption u/s. 54E is available to the depreciable assets which is a long term
capital asset and cannot be denied by referring to the fiction created u/s.50.

CIT vs. V.S. Dempo Company Ltd. (2016) 387 ITR 354 (SC)

In the return filed by the assessee for the Assessment Year
1989-90, the assessee had disclosed that it had sold its loading platform M.V.
Priyadarshni for a sum of Rs.1,37,25,000/- on which it had earned some capital
gains. On the said capital gains the assessee had also claimed that it was
entitled for exemption u/s. 54E of the Income Tax Act. The asset was purchased
in the year 1972 and sold sometime in the year 1989. Thus, the asset was almost
17 years old. Going by the definition of long term capital asset contained in
section 2(29B), it was admittedly a long-term capital asset. The Assessing
Officer however rejected the claim for exemption u/s. 54E on the ground that
the assessee had claimed depreciation on this asset and, therefore, provisions
of section 50 were applicable. Though this was upheld by the Commissioner of
Income Tax (Appeals), the Income Tax Appellate Tribunal allowed the appeal of
the assessee herein holding that the assessee was entitled for exemption under
Section 54E of the Act. The High Court dismissed the appeal of the Revenue.
While doing so the High Court relied upon its own judgment in the case of CIT
vs. ACE Builders Pvt. Ltd. [(2006) 281 ITR 210 [Bom]. The High Court
observed that section 50 of the Act which is a special provision for computing
the capital gains in the case of depreciable assets was not only restricted for
the purposes of section 48 or section 49 of the Act as specifically stated
therein, the said fiction created in sub-section (1) & (2) of section 50
had limited application only in the context of mode of computation of capital
gains contained in sections 48 and 49 and would have nothing to do with the
exemption that is provided in a totally different provision i.e. section 54E.
Section 48 deals with the mode of computation and section 49 relate to cost
with reference to certain mode of acquisition. This aspect was analysed by the
judgment of the Bombay High Court in the case of CIT vs. ACE Builders Pvt.
Ltd. (supra) in the following manner:

“In our opinion, the assessee cannot be denied exemption
u/s. 54E, because, firstly, there is nothing in section 50 to suggest that the
fiction created in section 50 is not only restricted to sections 48 and 49 but
also applies to other provisions. On the contrary, section 50 makes it
explicitly clear that the deemed fiction created in sub-section (1) & (2)
of section 50 is restricted only to the mode of computation of capital gains
contained in Section 48 and 49. Secondly, it is well established in law that a
fiction created by the legislature has to be confined to the purpose for which
it is created. In this connection, we may refer to the decision of the Apex
Court in the case of State Bank of India vs. D. Hanumantha Rao reported in 1998
(6) SCC 183. In that case, the Service Rules framed by the bank provided for
granting extension of service to those appointed prior to 19.07.1969.

The respondent therein who had joined the bank on 1.7.1972
claimed extension of service because he was deemed to be appointed in the bank
with effect from 26.10.1965 for the purpose of seniority, pay and pension on
account of his past service in the army as Short Service Commissioned Officer.
In that context, the Apex Court has held that the legal fiction created for the
limited purpose of seniority, pay and pension cannot be extended for other
purposes. Applying the ratio of the said judgment, we are of the opinion, that
the fiction created u/s. 50 is confined to the computation of capital gains
only and cannot be extended beyond that.

Thirdly, Section 54E does not make any distinction between
depreciable asset and non-depreciable asset and, therefore, the exemption
available to the depreciable asset u/s. 54E cannot be denied by referring to
the fiction created u/s. 50. Section 54E specifically provides that where
capital gain arising on transfer of a long term capital asset is invested or
deposited (whole or any part of the net consideration) in the specified assets,
the assessee shall not be charged to capital gains. Therefore, the exemption
u/s. 54E of the I.T. Act cannot be denied to the assessee on account of the
fiction created in Section 50.”

The Supreme Court held that it was in agreement with the
aforesaid view taken by the High Court.

The Supreme Court noted that the Gujarat High Court as well
as Guahati High Court had also taken the same view in the following cases:

1.  CIT 
vs. Polestar Industries [(2014) 221 Taxman 423 (Guj)];

2.  CIT vs. Tax vs. Assam Petroleum Industries
(P.) Ltd. [(2003) 262 ITR 587 (Guj.)].

The Supreme Court also noted that against the aforesaid
judgments no appeal had been filed.

In view of the foregoing, the Supreme Court did not find any
merit in the instant appeal which was accordingly, dismissed.

8. Business Expenditure – Amortisation of expenditure for
issue of share u/s. 35D – Amortisation allowable over a period of 10 years –
Where benefit is allowed for the first two assessment years, it cannot be denied
in the subsequent balance period.

Shasun Chemicals and Drugs Ltd. V. CIT (2016) 388 ITR 1
(SC)  

Business Expenditure – Bonus – Dispute with workmen – Payment
made to Trust to comply with the requirement of section 43B but the dispute was
settled and the payment was made before the expiry of time permissible u/s. 36
– Deduction was allowable and the provisions of section 40A(9) were not
attracted.

The assessee went in for public issue of shares in order to
raise funds to meet the capital expenditure and other expenditure relating to
expansion of its existing units of production both at Pondicherry and Cuddalore
and for expansion of its Research and Development Activity. The assessee issued
to public 15,10,000 equity shares of Rs.10/- each for cash at a premium of
Rs.30/- per share aggregating to Rs.6,04,00,000/-.

The aforesaid issue was opened for public subscription during
the financial year ending 31.03.1995 relevant to the Assessment Year 1995-96.
The assessee had, in the prospectus issued, clearly stated under the column
projects that the production capacity of its existing products, more
particularly Ibuprofen and Ranitidine was proposed to be increased.

The assessee incurred a sum of Rs.45,51,890/- towards the
aforesaid share issue expenses and claimed 1/10th of the aforesaid share issue
expenses each year u/s. 35D of the Act from the Assessment Years 1995-96 to
2004-05. The Assessing Officer on the same set of facts allowed the claim of
the assessee (1/10th of the share issue expenses u/s. 35D of the Act) for the
initial Assessment Year being the Assessment Year 1995-96 after examining the
materials produced. However, the Assessing Officer disallowed the expenses for
the Assessment Year 1996-97 on the ground that the share issue expenses were
not eligible for deduction in view of the decision of the Supreme Court in the
case of Brooke Bond India Ltd. vs. CIT [(1997) 225 ITR 798 (SC)],
stating that the expenditure incurred was capital in nature and hence not
allowable for computing the business profits.

Aggrieved against the aforesaid disallowance made by the
Assessing Officer for the Assessment Year 1996-97, the assessee filed an appeal
before the Commissioner of Income Tax (Appeals), [hereinafter referred to as
CIT(A)] who vide his order directed the Assessing Officer to verify
physically the factory premises of the assessee and find out, whether there
were any additions to the plant and machinery at the factory and whether there
were any additions to the buildings at the factory whereby any expansion has
been made to the existing industrial undertaking to justify the claim made by
the assessee.

In furtherance to the aforesaid direction, the Assessing
Officer after making due physical verification of the factory premises and on
being satisfied with the expansion of the facilities to the industrial
undertaking duly allowed the claim of share issue expenses. While doing so, the
Assessing Officer, for the assessment year 1996-97, passed a detailed and
elaborate order after scrutinising all the materials made available to him and
recorded a positive finding of fact that there was an expansion to the existing
units of the industrial undertaking and after being satisfied of the same duly
allowed the claim of share issue expenses u/s. 35D.

In the return by the assessee for the assessment year
2001-02, it was mentioned by the assessee that it had paid bonus to its
employees to the tune of Rs.96,08,002/- in the said Financial Year and,
therefore, it claimed deduction. However, invoking the provisions of section
40A(9), the said expenditure was disallowed on the ground that it was not paid
in cash to the concerned employees. CIT(A) allowed the expenditure and the same
view was taken by the ITAT but the High Court has reversed the view of ITAT on
this ground also.

In the aforesaid backdrop, two questions were raised before
the Supreme Court by the assessee.

As regards to the issue amortisation u/s. 35D of the
expenditure incurred on issue of shares, the Supreme Court noted that in the
Income Tax Return which was filed for the Assessment Year 1995-96, the assessee
had claimed that it had incurred a sum of Rs.45,51,890/- towards the share
issue expenses and had claimed 1/10th of the aforesaid share issue expenses
u/s. 35D of the Act from the Assessment Year 1995-96. This claim of the
assessee was found to be justified and allowable under the aforesaid provisions
and on that basis 1/10th share issue expenses was allowed u/s. 35D of the Act.
When it was again claimed for the Assessment Year 1996-97, though it was
disallowed and on directions of the Appellate Authority, the Assessing Officer
made physical verification of the factory premises. He was satisfied that there
was expansion of the facilities to the industrial undertaking of the assessee.
It was on this satisfaction that for the Assessment Year 1996-97 also the
expenses were allowed. The Supreme Court held that once this position is
accepted and the clock had started running in favour of the assessee, it had to
complete the entire period of 10 years and benefit granted in first two years
could not have been denied in the subsequent years as the block period was 10
years starting from the Assessment Year 1995-96 to Assessment Year 2004-05. The
Supreme Court observed that the High Court, however, disallowed the same
following the judgment of the Supreme Court in the case of Brooke Bond India
Ltd (supra). In the said case it was held that the expenditure incurred on
public issue for the purpose of expansion of the company is a capital
expenditure. However, in spite of the argument raised to the effect that the
aforesaid judgment was rendered when section 35D was not on the statute book
and this provision had altered the legal position, the High Court still chose
to follow the said judgment. According to the Supreme Court it was here where
the High Court went wrong as the instant case was to be decided keeping in view
the provisions of section 35D. The Supreme Court held that in any case, it
warrants repetition that in the instant case under the very same provisions
benefit was allowed for the first two Assessment Years and, therefore, it could
not have been denied in the subsequent block period. The Supreme Court thus,
answered the question in favour of the assessee holding that the assessee was
entitled to the benefit of section 35D for the Assessments Years in question.

So far as the other question regarding deduction on account
of payment of bonus to the employees of the assessee was concerned, the Supreme
Court noted that in the Assessment Years in question the workers of the
assessee had raised a dispute of quantum of bonus which had led to the labour
unrest as well. Because of this the workers had finally refused to accept the
bonus offered to them. Faced with this situation, the assessee had made the
payment to the Trust to comply with the requirement of section 43B, as the said
provision makes it clear that deduction in respect of bonus would be allowed
only if actual payment was made. Pertinently, the dispute could be settled with
the workers well in time and for that reason payment of bonus was made to the
workers on the very next day of deposit of the said amount in the Trust by the
assessee. This happened before the expiry of due date by which such payment was
supposed to be made in order to claim deduction u/s. 36 of the Act. However,
since the payment was made from the Trust, the Assessing Officer took the view
that as the payment was not made by the assessee to the employees directly in
cash, it was not allowable in view of the provisions of section 40A(9). Though
this view was not accepted by the CIT(A) as well as ITAT, the High Court had
found justification in the stand taken by the Assessing Officer. According to
the Supreme Court, here also the High Court had gone wrong in relying upon the
provisions of section 40A(9) of the Act.

The provisions of section 36 which enumerate various kinds of
expenses which are allowable as deduction while computing the business income
u/s. 28. The amount paid by way of bonus is one such expenditure which is
allowable under clause (ii) of sub-section (1) of section 36. According to the
Supreme Court there was no dispute that this amount was paid by the assessee to
its employees within the stipulated time. Embargo specified u/s. 43B or
40A(9)  did not come in the way of the
assessee. Therefore, the High Court was wrong in disallowing this expenditure
as deduction while computing the business income of the assessee and the
decision of the ITAT was correct.

On both counts, the order of the High Court was set aside by
the Supreme Court and the appeals were allowed.

Note: In the above case, in the context of the second
issue relating to deductibility of bonus payment, some of the observations of
the apex court relating to sections 40A(9) and 43B lack clarity and do not seem
to be in line with the provisions and hence, they are ignored.

9  Appeal to the High
Court – High Court must frame the substantial question(s) of law arising in the
appeal before answering the same.

Jai Hind Cycle Company Ltd. vs. CIT (2016) 388 ITR 482
(SC)

The only point canvassed at the hearing before the Supreme
Court was that the income tax appeal u/s. 260A 
had been decided by the High Court without framing any substantial
question of law. This, according to the Appellant was impermissible on the
basis of several decisions of the Supreme Court including the one in M.
Janardhana Rao vs. Joint CIT reported in [(2005) 273 ITR 50 (SC)].

The Supreme Court after perusing the said order of the Court,
was of the view that the High Court ought to have framed the substantial
question(s) of law arising in the appeal before answering the same. The High
Court having not done that, the Supreme Court set aside the order passed by the
High Court and remanded the matter to the High Court for a de novo
consideration after formulating the substantial question(s) of law arising, if
any.

BCAJ Admin

10.  Co-operative Society – Deduction u/s. 80P –
If the income of a society is falling within any one head of exemption, it has
to be exempted from tax notwithstanding that the condition of other heads of
exemption are not satisfied – A deduction would however not be admissible to a
co-operative bank – Also, where the activities of the society are in violation
of the Co-operative Societies Act, deduction cannot be allowed.

The Citizen
Co-operative Society Limited vs. ACIT (2017) 397 ITR 1 (SC)

The Assessee as
Co-operative Society had filed return of income for the Assessment Year
2009-10, for the year ending March 31, 2009 on September 30, 2009 declaring NIL
income. In the return filed, the Assessee claimed a sum of Rs. 4,26,37,081/- as
deduction u/s. 80P of the Act.

The Assessing
Officer held that deduction in respect of income of co-operative societies u/s.
80P of the Act was not admissible to the Appellant as the benefit of deduction,
as contemplated under the said provision was, inter alia, admissible to
those co-operative societies which carried on business of banking or providing
credit facilities to its members. On the contrary, the Appellant society was
carrying on the banking business for public at large and for all practical
purposes, it was acting like a co-operative bank governed by the Banking
Regulation Act, 1949, and its operation was not confined to its members but
outsiders as well.

Insofar as
disallowance of deduction claimed u/s. 80P of the Act was concerned, the CIT
(A) rejected the claim for deduction thereby upheld the order of the Assessing
Officer. While doing so, the CIT (A) followed the order of the Income Tax
Appellate Tribunal (ITAT) in the case of the Appellant itself in respect of
Assessment Years 2007-08 and 2008-09.

Further, appeal
to the ITAT met the same fate as ITAT also referred to its aforesaid order and
dismissed the appeal of the Appellant.

Undeterred, the
Appellant approached the High Court in the form of appeal u/s. 260A of the Act.
This appeal was dismissed by the High Court with the observations that there
was no illegality or infirmity in the order passed by the ITAT.

The Supreme
Court noted that section 80P of the Act provides for certain deduction in
respect of incomes of the co-operative societies. A co-operative society is
defined by section 2(19) of the Act. Where the gross total income of such
co-operative societies includes any income referred to in sub-section (2) of
section 80P, the sums specified in s/s. (2) are allowed as deduction in
accordance with and subject to the provisions of the said section, while
computing the total income of the Assessee. The profit exempted is the net
profit included in the total income and not the gross profit of the business.
Sub-section (2) enlists those sums which are allowed as deductions. Clause (a)
of s/s. (2) includes seven kinds of co-operative societies which are entitled
to this benefit, and in respect of the co-operative societies engaged in the
activities mentioned in those seven classes, the whole of the amount of profits
and gains of business attributable to anyone or more of such activities is
exempted from income by allowing the said income as deduction.

The Supreme
Court observed that in the present petition it was concerned with sub-clause
(i) of Clause (a) of sub-section (2) of section 80P, which enlisted a
co-operative society engaged in carrying on the business of banking or
providing credit facilities to its members.

The Supreme
Court observed that there could not be any dispute to the proposition that
section 80P of the Act was a benevolent provision which was enacted by the
Parliament in order to encourage and promote growth of co-operative sector in
the economic life of the country. It was done pursuant to declared policy of
the Government. Therefore, such a provision had to be read liberally,
reasonably and in favour of the Assessee (See-Bajaj Tempo Limited, Bombay
vs. Commissioner of Income Tax, Bombay City-III, Bombay (1992) 3 SCC 78).
It was also trite that such a provision had to be construed as to effectuate
the object of the Legislature and not to defeat it (See-Commissioner of
Income Tax, Bombay and Ors. vs. Mahindra and Mahindra Limited and Ors.
(1983) 4 SCC 392). Therefore, all those co-operative societies which fall
within the purview of section 80P of the Act are entitled to deduction in
respect of any income referred to in s/s. (2) thereof. Clause (a) of s/s. (2)
gives exemption of whole of the amount of profits and gains of business
attributable to anyone or more of such activities which are mentioned in s/s.
(2).

The Supreme
Court held that sub-section (i) of Clause (a) of sub-section (2), with which it
was concerned, recognised two kinds of co-operative societies, namely: (i)
those carrying on the business of banking and; (ii) those providing credit
facilities to its members.

The Supreme
Court referring to its decisions in the case of Kerala State Cooperative
Marketing Federation Limited and Ors. vs. Commissioner of Income Tax (1998)
5 SCC 48, and of the Punjab and Haryana High Court in the case of Commissioner
of Income Tax vs. Punjab State Co-operative Bank Ltd. (2008) 300 ITR 24
(Punjab & Haryana H.C.), observed that if the income of a society is
falling within any one head of exemption, it has to be exempted from tax
notwithstanding that the condition of other heads of exemption are not
satisfied.

The Supreme
Court noted that with the insertion of s/s. (4) by the Finance Act, 2006, which
was in the nature of a proviso to the aforesaid provision, it was made clear
that such a deduction would not be admissible to a co-operative bank. However,
if it was a primary agriculture credit society or a primary co-operative
agriculture and rural development bank, the deduction would still be provided.
Thus, co-operative banks were specifically excluded from the ambit of section
80P of the Act.

According to
the Supreme Court, if one had to go by the aforesaid definition of
‘co-operative bank’, the Appellant did not get covered thereby. It was also a
matter of common knowledge that in order to do the business of a co-operative
bank, it was imperative to have a licence from the Reserve Bank of India, which
the Appellant did not possess. The Reserve Bank of India itself had clarified
that the business of the Appellant did not amount to that of a co-operative
bank. The Appellant, therefore, would not come within the mischief of
sub-section (4) of section 80P.

However,
according to the Supreme Court, the main reason for disentitling the Appellant
from getting the deduction provided u/s. 80P of the Act was not s/s. (4)
thereof. What has been noticed by the Assessing Officer, after discussing in
detail the activities of the Appellant, was that the activities of the
Appellant were in violations of the provisions of the Mutually Aided Co-op
Societies Act, 1995 (MACSA) under which it is registered. It was pointed out by
the Assessing Officer that the Assessee was catering to two distinct categories
of people. The first category was that of resident members or ordinary members.
In the opinion of the Supreme Court, there may not be any difficulty as far as
this category was concerned. However, the Assessee had carved out another
category of ‘nominal members’. These were those members who were making
deposits with the Assessee for the purpose of obtaining loans, etc. and,
in fact, they are not members in real sense. Most of the business of the
Appellant was with this second category of persons who had given deposits which
were kept in Fixed Deposits with a motive to earn maximum returns. A portion of
these deposits was utilised to advance gold loans, etc. to the members
of the first category. It was found, as a matter of fact, that the depositors
and borrowers were quiet distinct. In reality, such activity of the Appellant
was that of finance business and could not be termed as co-operative society.
It was also found that the Appellant was engaged in the activity of granting
loans to general public as well. All this was done without any approval from
the Registrar of the Societies. With indulgence in such kind of activity by the
Appellant, it was remarked by the Assessing Officer that the activity of the
Appellant was in violation of the Co-operative Societies Act. Moreover, it was
a co-operative credit society which was not entitled to deduction u/s. 80P
(2)(a)(i) of the Act.

The Supreme
Court noted that a specific finding was also rendered that the principle of
mutuality was missing in the instant case.

According to
the Supreme Court, these were the findings of fact which had remained unshaken
till the stage of the High Court. Once the aforesaid aspects were taken into
consideration, the conclusion was obvious, namely, the Appellant could not be
treated as a co-operative society meant only for its members and providing
credit facilities to its members.

The Supreme
Court held that such a society could not claim the benefit of section 80P of
the Act. The appeal, therefore, was dismissed with costs.

11.  Offences and Prosecution – If there is an
attempt to evade tax of the amount less than the monetary limit prescribed in
the Circular, no prosecution should be launched.

Suresh
Sholapurmath and Ors. vs. Income Tax Department and Ors. (2017) 397 ITR 145
(SC)

The assessee
was liable to pay Rs.1465. Rs. 465 was paid but, the document was tampered with
by showing it as Rs.1465.

The Karnataka
High Court refused to quash the prosecution proceedings against the Appellants.
The High Court declined to follow the Circular which provided that if there is
an attempt to evade tax of less than Rs.25,000, no prosecution could be
launched. According to the High Court, this was not a case of evasion of tax
but of furnishing of false declaration and hence circular would not be of any
assistance to the assessee.

The Supreme
Court noted that the amount involved is small, and was paid with interest long
ago. According to the Supreme Court, the Circular dated February 7, 1992
squarely applied and, therefore, no proceedings should have been filed as the
amount was below Rs. 25,000. In view of this, the Supreme Court set aside the
judgement of the High Court and quashed the proceeding against the appellants.

12.  Interest on Refund – Whether an assessee is
entitled to interest u/s. 244A of the Income-tax Act, 1961 on excess self
assessment tax – The High Court could not have disagreed with the decision of a
co-ordinate Bench – Appropriate course of action would have been to refer the
matter to a larger Bench

Engineers
India Ltd. vs. Commissioner of Income Tax (2017) 397 ITR 16 (SC)

The issue
before the Supreme Court pertained to grant of interest u/s. 244A of the
Income-tax Act, 1961 for the Assessment Year 2006-07.

The impugned
judgment of the High Court revealed that another judgment of the Co-ordinate
Bench of the same High Court in the case of CIT vs. Sutlej Industries Ltd.
[2010] 325 ITR 331 (Delhi) was cited wherein the view taken was that in such
circumstances the Assessee would be entitled to interest u/s. 244A of the Income-tax
Act on the refund of the self-assessment tax. The High Court however did not
agree with the aforesaid view and made the following observation:

“Having
found the position of law as indicated above, we express, with respect, our
inability to subscribe to, or follow, the view taken by the other Division
Bench of this Court in the case of CIT vs. Sutlej Industries Ltd.”

The Supreme
Court held that in the impugned judgment, the Bench had differed with the
earlier view expressed by the Co-ordinate Bench. In the circumstances,
according to the Supreme Court, the appropriate course of action would have
been to refer the matter to the larger Bench.

The Supreme
Court noted that subsequently in the case of Sutlej Industries Ltd. vs. CIT
(I.T.A. Nos. 493 of 2003 and 120 of 2004) [2005] 272 ITR 180 (Delhi) pending
before the High Court, the High Court had referred the matter to a larger
Bench. In these circumstances, the Supreme Court set aside the impugned
judgment of the High Court and remanded the appeal to the High Court for its
decision afresh along with I.T.A. Nos. 493 of 2003 and 120 of 2004 by a larger
Bench.

The appeal was
disposed of accordingly.

13.  Non-resident – Permanent Establishment – No
part of the main business and revenue earning activity of the two American
companies was carried on through a fixed business place in India put at their
disposal – The Indian company only rendered support services which enabled the
assessees in turn to render services to their clients abroad – This outsourcing
of work to India would not give rise to a fixed place or service PE

ADIT vs.
E-Funds IT Solution Inc. (2017) 399 ITR 34 (SC)

The assesses,
e-Funds Corporation, USA [e-Funds Corp] and e-Funds IT Solutions Group Inc.,
USA [e-Funds Inc] were companies incorporated in United States of America [USA]
and were residents of the said country. They were assessed and had paid taxes
on their global income in USA. e-Funds Corp was the holding company having
almost 100% shares in IDLX Corporation, another company incorporated in USA.
IDLX Corporation held almost 100% shares in IDLX International BV, incorporated
in Netherlands and later in turn held almost 100% shares in IDLX Holding BV,
which was a subsidiary again incorporated in Netherlands. IDLX Holding BV was almost
a 100% shareholder of e-Funds International India Private Limited, a company
incorporated and resident of India [e-Funds India] IDLX International BV was
also the parent/holding company having almost 100% shares in e-Funds Inc.,
which, as noticed above, was a company incorporated in USA.

Both e-Funds
Inc. and e-Funds Corp. had entered into international transactions with e-Funds
India. e-Funds India being a domestic company and resident in India was taxed
on the income earned in India as well as its global income in accordance with
the provisions of the Income–tax Act. The international transactions between
the assessees and e-Funds India and the income of e-Funds India, it was
accepted, were made subject matter of arms length pricing adjudication by the
Transfer Pricing Officer [TPO] and the Assessing Officer [AO] in the returns of
income filed by e-Funds India.

The assessing
authority for assessment years 2000-01 to 2002-03 and 2004-05 to 2007- 08 in
the case of e-Funds Corporation, USA and for assessment years 2000-01 to
2002-03 and 2005-06 to 2007- 08 in the case of e-Funds IT Solutions Group Inc.,
USA decided that the assessees had a permanent establishment [PE] as they had a
fixed place where they carried on their own business in Delhi, and that,
consequently, Article 5 of the India U.S. Double Taxation Avoidance Agreement
of 1990 [DTAA] was attracted. Consequently, the assessees were liable to pay
tax in respect of what they earned from the aforesaid fixed place PE in India.

The CIT
(Appeals) dismissed the appeals of the assessees holding that Article 5 was
attracted, not only because there was a fixed place where the assessees carried
on their business, but also because they were having “service PEs” and “agency
PEs” under Article 5.

In an appeal to
the ITAT, the ITAT held that the CIT (Appeals) was right in holding that a case
of “fixed place PE” and “service PE” had been made out under Article 5, but
said nothing about the “agency PE” as that was not argued by the Revenue before
the ITAT. However, the ITAT, on a calculation formula different from that of
the CIT (Appeals), arrived at a nil figure of income for all the relevant
assessment years.

The appeal of
the assessees to the Delhi High Court proved successful [(2014) 364 ITR 256
(Delhi)] and the High Court, by an elaborate judgment, has set aside the
findings of all the authorities referred to above, and further dismissed the
cross-appeals of the Revenue.

Consequently,
the Revenue was in appeal before the Supreme Court.

The Supreme
Court observed that the Income-tax Act, in particular section 90 thereof, does
not speak of the concept of a PE. This is a creation only of the DTAA. By
virtue of Article 7(1) of the DTAA, the business income of companies which are
incorporated in the US will be taxable only in the US, unless it is found that
they were having PEs in India, in which event their business income, to the
extent to which it is attributable to such PEs, would be taxable in India. The
Supreme Court noted that Article 5 of the DTAA provides for three distinct
types of PEs with which it was concerned in the present case: fixed place of
business PE under Articles 5(1) and 5(2); service PE under Article 5(2) (l) and
agency PE under Article 5(4). According to the Supreme Court, specific and
detailed criteria are set out in the aforesaid provisions in order to fulfill
the conditions of these PEs existing in India. The burden of proving the fact
that a foreign assessee has a PE in India and must, therefore, suffer tax from
the business generated from such PE is initially on the Revenue.

In the context
of fixed place PE, on the behalf of the Revenue, it was argued that under
Article 5(1) of the DTAA, on the facts of these cases, a case of fixed place PE
has been made out. In support of this, it was, inter-alia, pointed out
that: Most of the employees are in India (In fact, the High Court records that
40% of the employees of the entire group are in India). e-Funds Corp has call
centers and software development centers only in India. e-Funds Corp is
essentially doing marketing work only and its contracts with clients are
assigned, or sub-contracted to e-Funds India. The master services agreement
between the American and the Indian entity gives complete control to the
American entity in regard to personnel employed by the Indian entity. It is
only through the proprietary database and software of e-Funds Corp, that
e-Funds India carries out its functions for e-Funds Corp. The High Court
records that the software, intangible data etc. is provided free of cost
and then states that this is irrelevant. The Corporate office of e-Funds India
houses an ‘International Division’ comprising the President’s office and a
sales team servicing e-Funds India and eFunds group entities in the United
Kingdom, South East Asia, Australia and Venezuela. The President’s office
primarily oversees operations of e-Funds India and eFunds group entities
overseas. The sales team undertakes marketing efforts for affiliate entities
also. The Transfer Pricing [TP] Report says that e-Funds India provides
management support and marketing support services to eFunds Corp group
companies outside India. Regarding supervision of personnel rendering the
services, the TP Report states that “The President’s office manages the
operations of eFunds India and eFunds group entities in UK and Australia and
accordingly, employees of these entities report to the President. The
President’s overall reporting is to EFC. Though the personnel rendering
marketing services are employees of EFI, they report to overseas group entities
to the extent that they are engaged in rendering services to such entities.”
Heavy reliance was also placed upon the Form 10 K report dtd. 31/3/2003 filed
by the e-Fund Corp for the group with the United States Securities and Exchange
Commission.

The Revenue’s
counsel had further submitted that on these facts, the assessees satisfy the
requirements of fixed place PE. For this, reliance was also placed on the judgment
of the Apex Court in the case of Formula One World Championship Ltd. [(2017)
394 ITR 80 (SC)] [Formula One] and contented that physically located premises
are at the disposal of the assessees with the degree of permanence required,
viz., the entire year. It was also contended that the High Court was not right
in holding that the place of management PE under Article 5(2)(a) was prima
facie made out, but since the said provision had not been invoked and requires
factual determination, the Revenue’s argument is dismissed on this score. Heavy
reliance was also placed on the MAP settlement made for the Asst. Years 2003-04
and 2004-05 by the assessees to contend that the assessees have admitted for
those years that some income is attributable to their Indian PEs and this
admission would continue to bind the assessees in all subsequent years.

On the other
hand, on behalf of the assessees, it was, inter-alia, contended that the
tests for determining the existence of fixed place PE have now been settled by
the Apex Court in the case Formula One (supra). These require that the
fixed place must be at the disposal of assessees, which means that the
assessees must have a right to use the premises for the purpose of his own
business and that has not been made out in the facts of this case. The TPO has
specifically held that whatever is paid under various agreements between the
assessees and the Indian company are at arm’s length pricing and this being the
case, even if fixed place PE is found, once arm’s length price is paid, the US
companies go out of the net of Indian taxation. Referring to Article 5(6) of
the DTAA, it was further contended that mere fact that a 100 per cent
subsidiary is carrying on the business in India does not by itself means that
the holding company would have a PE in India. It was also further pointed out
that ultimately there are four businesses that the assessees are engaged in
viz., ATM Management Services, Electronic Payment Management, Decision Support
and Risk Management and Global Outsourcing and Professional Services. All these
businesses are carried on outside India and the property through they are
carried out viz., ATM networks, software solutions and other hardware networks
and information technology infrastructure were all located outside India. The
activities of e-Funds India are independent business activities on which, as
has been noticed by the High Court, independent profits are made and income is
assessed to tax in India. For this, a specific reference was also made to the report
of Deloitte Haskins and Sells dated 13/3/2009, which was produced before the
CIT (A). It was further contended that MAP settlement made for the Asst Years
2003-04 and 2004-05 cannot be considered as precedent to hold that there is a
PE in subsequent years. In fact, this settlement was without prejudice to the
assessees contention that they have no PE in India and it is also clarified in
the follow-up letters that the same is not binding on subsequent years.

Since the
Revenue originally relied on fixed place of business PE, the Supreme Court
tackled it first. The Supreme Court observed that under Article 5(1), a PE
means a fixed place of business through which the business of an enterprise is
wholly or partly carried on. According to the Supreme Court, what is a “fixed
place of business” was no longer res integra. In Formula One’s case (supra),
it had after setting out Article 5 of the DTAA, held that the principal test,
in order to ascertain as to whether an establishment has a fixed place of
business or not, is that such physically located premises have to be ‘at the
disposal’ of the enterprise. For this purpose, it is not necessary that the
premises are owned or even rented by the enterprise. It will be sufficient if
the premises are put at the disposal of the enterprise. However, merely giving
access to such a place to the enterprise for the purposes of the project would
not suffice. The place would be treated as ‘at the disposal’ of the enterprise
when the enterprise has right to use the said place and has control thereupon.

Thus, it was
clear that there must exist a fixed place of business in India, which was at
the disposal of the US companies, through which they carry on their own
business. There was, in fact, no specific finding in the assessment order or
the appellate orders that applying the aforesaid tests, any fixed place of
business had been put at the disposal of these companies. The assessing
officer, CIT (Appeals) and the ITAT had essentially adopted a fundamentally
erroneous approach in saying that they were contracting with a 100% subsidiary
and were outsourcing business to such subsidiary, which resulted in the
creation of a PE. The High Court has dealt with this aspect in some detail and
the Supreme Court agreed with the findings of the High Court in this regard.

The Supreme
Court further held that the reliance placed by the Revenue on the United States
Securities and Exchange Commission Form 10K Report, as had been correctly
pointed out by the High Court, is also misplaced. It is clear that this report
evidently speaks of the e- Funds group of companies worldwide as a whole.

According to
the Supreme Court, the Deloitte’s report dated 31/03/2009 [which was produced
before the CIT(Appeals)] showed that no part of the main business and revenue
earning activity of the two American companies was carried on through a fixed
business place in India which had been put at their disposal. It was clear from
the report that the Indian company only rendered support services which enabled
the assessees in turn to render services to their clients abroad. This
outsourcing of work to India would not give rise to a fixed place PE and the
High Court judgment was, therefore, correct on this score.

In the context
of existence of service PE under Article 5(2)(l) of the DTAA, in addition to
some of the facts pointed for fixed place PE [including the fact of TP report
regarding supervision of personnel rendering service], it was, inter-alia,
further pointed out by Revenue’s counsel that: The Master sub-contractor
agreement between e-Funds Corp and e-Funds India discussed in the CIT(A)’s
order provides in clause 1.1(a) that : “Subcontractors personnel assigned to
work with eFunds IT or Customers located in the United States shall be directed
by eFunds IT or by Subcontractors supervisor acting at the direction of eFunds
IT. In the event Subcontractors personnel are assigned to perform such services
in India, the Subcontractor shall supervise such work, acting at the direction
of eFunds IT. eFunds IT shall be the sole judge of performance and capability
of each of subcontractors personnel and may request the removal of one or more
of Subcontractors personnel from a project covered by any statement of work as
follows.” It is submitted that the personnel engaged in providing these
services were ostensibly the employees of e-Funds India but were de facto
working under the control and supervision of eFunds Corp. In this regard,
reference was made to relevant part of the judgement in DIT vs. Morgan
Stanley and Company Inc. [(2007) 292 ITR 416 (SC)]. Furthermore, the AO in
the Assessment Order has observed that e-Funds Corp has seconded two employees
to e-Funds India and these employees worked as Sr. Director Technical Services and Country
Head-Business Development. The activities of the seconded employees go beyond
mere ‘stewardship activities’ in terms of Morgan Stanley’s case [supra].
The term ‘Other Personnel’ has to be seen in the context of the facts of this
case which show that e-Funds India was not an independent subsidiary.

In the context
of service PE, in addition to some of the points made out in connection with
non-existence of fixed place PE,  the
assessee’s counsel, inter alia, further contended that under Article
5(2)(l) of the DTAA, it is necessary that the foreign enterprises must provide
services to customers who are in India, which is not Revenue’s case as all
their customers exist only outside India. It was also pointed out that the
entire personnel engaged only by the Indian company and the facts that the US
companies may indirectly control such employees is only for the purpose of
protecting their own interest. The reliance was also placed on the judgment of
the Supreme Court in Morgan Stanley’s case (supra).

Insofar as a
service PE was concerned, the Supreme Court noted that the requirement of
Article 5(2)(l) of the DTAA was that an enterprise must furnish services
“within India” through employees or other personnel. In this regard, the
Supreme Court referred to its judgment in Morgan Stanley’s case (supra)
and noted that none of the customers of the assessees were located in India or
have received any services in India. This being the case, it was clear that the
very first ingredient contained in Article 5(2)(l) was not satisfied.

However, the
learned Attorney General, relying upon paragraph 42.31 of the OECD Commentary,
had argued that services have to be furnished within India, which does not mean
that they have to be furnished to customers in India. Para 42.31 of the OECD
Commentary states that “Whether or not the relevant services are furnished to a
resident of a state does not matter: what matters is that the services are
performed in the State through an individual present in that State.”

Based upon the
said paragraph, it was argued that in assessment year 2005-06, two employees of
the American company were seconded in India and that, therefore, it was clear
that management of the American company through these employees had obviously
taken place. The High Court, in dealing with this contention, had found it was
not known as to what functions they performed and to whom they reported and it
was also not known whether the services were performed related to services
provided to an associated enterprise in which case clause 5(2)(l)(ii) would be
applicable. According to the High Court, whether the seconded employees were
performing stewardship services or were directly involved with the working
operations was relevant. It was the case of the assessee that they were deputed
to look towards development of domestic work in India and cost of such
personnel was fully borne e-Funds India. They were working under the control
and supervision of e-Funds India. This factual assertion was not negated or
questioned by the AO.

The Supreme
Court agreed with the approach of the High Court in this regard. It held that
para 42.31 of the OECD Commentary does not mean that services need not be
rendered by the foreign assessees in India. If any customer is rendered a
service in India, whether resident in India or outside India, a “service PE”
would be established in India. As noticed hereinabove, no customer, resident or
otherwise, received any service in India from the assessees. All its customers
received services only in locations outside India. Only auxiliary operations
that facilitated such services were carried out in India. This being so, it was
not necessary to advert to the other ground namely, that “other personnel”
would cover personnel employed by the Indian company as well, and that the US
companies through such personnel were furnishing services in India. This being
the case, it was clear that as the very first part of Article 5(2)(l) was not
attracted, the question of going to any other part of the said Article did not
arise. It was perhaps for this reason that the AO did not give any finding on
this score.

The Supreme
Court agreed with the assessee’s counsel that the “agency PE” aspect of the
case need not be gone into as it was given up before the ITAT. However, the
Supreme Court was of the view that for the sake of completeness, it was
necessary to agree with the High Court, that it had never been the case of
Revenue that e-Funds India was authorised to or exercised any authority to
conclude contracts on behalf of the US company, nor was any factual foundation
laid to attract any of the said clauses contained in Article 5(4) of the DTAA.

Dealing with
the issue of effect of MAP settlement for the Asst. Years 2003-04 and 2004-05,
the Supreme Court referred to the relevant paras of OECD Manual on MAP and, in
particular, Best Practice No.3, relied on by the Revenue’s counsel and noted
that this would show that a competent authority should engage in discussion
with the other competent authority in a principled, fair and objective manner,
with each case being decided on its own merits. It is also specifically
observed that, where an agreement is not otherwise achievable, then both
parties should look for appropriate opportunities for compromise in order to
eliminate double taxation on the facts of the case, even though a principled
approach is important. The learned Attorney General also relied upon Best
Practice No. 1 of the said OECD Manual, which requires the publication of
mutual agreements reached that may apply to a general category of taxpayers
which would then improve guidance for the future. According to the Supreme
Court, the Best Practice No. 1 has no application on the facts of the present
case, as the agreement reached applies only to the respondent companies, and not
to any general category of taxpayers. It is clear, therefore, that the
assessee’s counsel Shri Ganesh is right in replying upon para 3.6 of the OECD
Manual, which deals with settlements which are often case and time specific and
they are not considered as precedents for the tax-payers or the tax
administration. It is very clear, therefore, that such agreement cannot be
considered as a precedent for subsequent year, and the High Court’s conclusion
on this aspect is also correct.

Note: In the above case, in the context of fixed place PE, the Court has followed internationally accepted tests confirmed by the Supreme Court in the case of Formula One (supra) and applied the same to the facts found by the High Court in this case. The judgement in Formula One’s case is digested in this column in the last month and since this case, in this respect, follows the same, it is thought fit to consider in this column in this month, which is now also reported in ITR. In the context of service PE, primarily it has relied on its earlier judgment in the case of Morgan Stanley (supra), which has been analysed in greater detail by us in this journal in the column Closements in the months of September/October, 2007. The above judgement is also primarily based on the factual findings of the High Court and also based on certain lack of findings of facts at the lower level. As such, this judgement should be read, understood and applied accordingly. For the purpose of deciding the issues raised in this case, the Court has also referred to and considered the relevant part of OECD commentaries on OECD Model as well as by learned authors Klaus Vogel & Arvind A. Skaar (on PE) and also the OECD Manual on MAP etc. _

BCAJ Admin

5. Pr. CIT vs. NRA Iron and Steel Pvt. Ltd. (2019) 418 ITR 449 (SC)

Notice – Service of notice – Application for recall of ex parte
order – Service of notice on authorised representative – Section 2(35) defines
‘principal officer’ which includes agent of the company and the term ‘agent’
would certainly include a power of attorney holder – No ground for recall of
judgment

An application was filed for recall of the judgment for the A.Y. 2009-10
passed by the Supreme Court on the ground that the applicant company was not
served with the notice of the SLP at its registered office, nor was a copy of
the SLP served on the applicant company.

The applicants submitted that the court notices
were sent to the earlier registered office address of the company, i.e., at
310, 3rd Floor, B-Block, International Trade Tower, Nehru Place, New Delhi.
However, on 19^th May, 2014, the company had changed its registered
office to 211, Somdutt Chambers II, 9, Bhikaji Cama Place, New Delhi 110066.