Subscribe to the Bombay Chartered Accountant Journal Subscribe Now!

Month: January

CHASING FRONT RUNNERS: SEBI GETS BETTER AT THE GAME

Front running is a serious problem in capital
markets. It is very similar to, and as serious as, insider trading. But unlike
insider trading, which has a full-fledged law devoted to it that makes it
easier for SEBI to prosecute wrong-doers, front running has to be established
by a long and arduous procedure. The difficulty was compounded till now because
whether front running was a prohibited practice or not was itself questioned in
law till the Supreme Court ([2017] 144 SCL 5 {SC}) and an
amendment to the law settled it. Fortunately, as a recent case (order dated 4th
December, 2019 in the matter of various entities of Fidelity Group)
demonstrates, SEBI has shown creativity and initiative in the matter to
establish front running by persons and then taken fairly quick action.

 

WHAT IS FRONT RUNNING?

Front running, as the term may indicate, is similar to a person running
in front of you to take unethical and illegal advantage of you; for example,
you ask your assistant to buy 1,00,000 shares of X company for you. Now, it is
known that buying such a large quantity of shares at one stroke could result in
an increase in the price of such shares. So your assistant is tempted to first
buy shares for himself in his own name or in the names of nominees / friends.
Thereafter, he starts buying shares for you while he or his nominees / friends
are selling shares. Thus, he has bought shares at a lower price and he will
sell you shares at the higher ruling price after his purchases. So you
end up in a loss since you paid a higher price for your shares. The same thing
could happen if you wanted to sell a large quantity of shares, except that the
trades would be opposite.

 

Such unethical and dishonest practices could be carried out not just by
one’s office staff, but even by one’s stock brokers. Or, as in the present case
as discussed in detail later, by authorised traders in mutual funds. In such
cases, the investors in such funds end up bearing the loss. SEBI has, even if
by fits and starts, been increasingly taking action against such front runners
and has progressively amended the law.

 

HOW ARE FRONT RUNNING AND INSIDER TRADING SIMILAR?

Both involve some confidential information that a person has and that is
given generally on trust to a deputed person. Such information in both cases is
valuable in the sense that such a person can exploit it for his own illicit /
unethical profit at the expense of the other.

 

An insider, for example, may be a Chief Financial Officer of a company.
He may have access to the latest financial performance of his employer company
that has not yet been made public. If such results are very positive, he may
buy shares before disclosure of the results and then sell when the price rises.
This in a sense causes loss to those people who were deprived of the
information and also leads to loss of credibility of the company and the stock
markets in general.

 

A front runner may well be a stock broker. A client comes to him and
places an order for a significant quantity of shares which will almost
certainly move the price in a particular direction. The stock broker exploits
this order information and places an order for himself first. Then, while he is
executing the client’s order, places a counter order for himself. The client
ends up suffering a loss.

 

HOW ARE FRONT RUNNING AND INSIDER TRADING LAWS DIFFERENT?

Firstly, there is a separate and comprehensive set of regulations
dealing with insider trading. The SEBI Act too has specific provisions dealing
with it. Insider trading and even front running are both notoriously difficult
to establish. However, the Insider Trading Regulations are fairly detailed and
have several deeming provisions to help establish the guilt. These provisions
may result in a whole group of persons to be deemed as insiders. Certain types
of information are deemed to be price-sensitive. Many other presumptions, some
rebuttable, are also made.

 

In comparison, till recently front running was not technically even an
offence, unless it was by intermediaries. Thus, for example, there were two
views on whether an employee of a mutual fund who trades ahead of orders of
mutual funds could be said to have engaged in front running. The Supreme Court,
however, finally held that even that was front running. But front running still
does not have the helpful deeming provisions as do insider trading related
regulations. Hence, the already difficult task of proving such cases is made
even more difficult.

 

So, in this context, the latest order of SEBI is worth a read. The fact
that SEBI used market intelligence and some out-of the-box methods to establish
guilt makes the order even more interesting.

 

BRIEF FACTS OF THE CASE

The discussion here is academic and hence is on the presumption that the
findings of SEBI are correct. It is possible that these prima facie
findings may be wrong as it is only an interim order and the parties may
provide evidence to the contrary which may result in the SEBI order being
modified.

 

The case presents a typical scenario of front running. There were
certain funds belonging to the ‘Fidelity Group’ that dealt in shares. The
relevant dealings were, as expected, in large quantities. And there was this ‘trader’
who placed orders on behalf of the mutual fund with brokerage houses.

 

SEBI has stated that this trader had two relatives
– his mother and his sister – and the three engaged in front running in
concert. How SEBI found out about this relation is an interesting aspect that
is dealt with separately. SEBI found that these relatives made significant
trades that were similar to the orders placed by the fund through the trader.
The trades by these relatives preceded those of the mutual fund and when the fund
itself placed the orders, the relatives reversed their trades. Thus, to
illustrate, if shares of Company A were to be purchased by the fund, the
relatives purchased shares of A before the fund placed its order, and on the
same day. When the orders of purchase for the fund were placed, the relatives
sold the shares they had purchased earlier. In a short span of a few hours, the
relatives made substantial profits. This was repeated over a period of time and
in case of several scrips.

 

It was also found that trading / bank accounts of these relatives were
opened shortly before such trading. Further investigation found that trades
also took place online through IP addresses located in Hong Kong where the
trader was stationed.

 

Thus, by what clearly appears to be intelligent information gathering,
SEBI noticed these transactions. SEBI held that this was front running.

 

USE OF MATRIMONIAL SITES AND INTERNET TO ESTABLISH THE RELATIONS BETWEEN
THE PARTIES

SEBI has in the past, to check for possible
connections, used social media like Facebook. Social media and many
internet-based social sites can provide possible clues to relations between
parties. These may include being ‘friends’ or ‘relatives’ as per the personal
profiles of persons. Even interactions in the form of reactions on posts /
comments could provide some preliminary basis for further investigation.

 

In this case, a question arose about what was the
relation between the employee of the mutual fund who placed the orders and the
two persons who traded apparently ahead of such orders and made substantial
profits. SEBI checked a matrimonial site for the profile of the trader and
found that he had effectively mentioned one of the persons as his mother. The
surname of these three persons was also the same. SEBI further investigated
using PAN card, KYC, bank account and other details of the persons and held
that the two persons were the mother / sister of the trader. SEBI accordingly
concluded for the purposes of its interim order that they were related.

 

This investigative method may be used increasingly
in future. Countless people are on social media and similar sites, and interact
actively there, put up their profiles, etc. Such profiles of course have varying
degrees of ‘privacy’ and particularly ‘public’ profiles (i.e., those that can
be seen by any person) are easy to investigate. The law relating to accessing
private information is developing and can be an interesting study by itself.
But it is clear that this does provide an opportunity for establishing
connections and gathering information. The connection between parties is
relevant not just for front running or insider trading but even for other
matters in securities laws such as price manipulation, takeovers and other
cases where parties are connected in their actions without formal agreements.

 

FINDINGS OF SEBI

SEBI compared the trades of the funds (through the trader) and his two
relatives and their timings, prices and whether they reversed in a synchronised
manner. SEBI held that the trades were connected and there was no explanation
other than that this was on account of front running.

 

It also found other factors which supported this, such as financial
transactions between the parties, the timing of opening of broker / demat accounts by these relatives, etc. SEBI accordingly
held, by its interim order, that this was a case of front running in violation of the relevant regulations.

 

ORDER / DIRECTIONS BY SEBI

SEBI issued several directions through the interim order. It directed
the parties to deposit in an escrow account the profits of Rs. 1.86 crores made
through this alleged front running. Such a direction to deposit the profits is
usually a prelude to a final order of disgorgement – i.e., forfeiting such
profits, usually also asking for interest. SEBI also directed banks and demat
authorities of the parties to not allow any transactions till the amount was
deposited. They have also been debarred from dealing in, or being associated
with, the stock markets.

 

SEBI has given an opportunity to the parties to present their case
before it against these interim directions. If the offence is proved, it is
possible that the parties may face further penal action that could include
debarment, a financial penalty and a final order of disgorgement of the profits
with interest.

 

CONCLUSIONS

This order is a good example of how SEBI has tried to overcome the
problems of gathering information and evidence for difficult-to-establish
offences of front running and thus even insider trading.

 

Use of internet and social media for investigation and evidence is,
however, a double-edged sword. It does give prima facie clues for
further investigation. But social media connections can be misleading. People
may have thousands of ‘friends’ or followers, who are often made by merely
clicking a button once on a webpage. Many of them may be total strangers.
Information uploaded on such pages may be unreliable and even false, and in any
case not authenticated sufficiently to be usable for legal action. However, as
in the present case, it can provide clues to investigate further. The challenge
would be to access private profiles and this would require a careful balance
between the need for privacy and the needs of public interest.

 

Front running arises out of the classic conflict of loyalty / duty and
greed. There are endless opportunities for persons in organisations or for
organisations themselves to illicitly profit from persons who place trust in
them. It would not be surprising if there are numerous such cases. They cause
losses to investors and harm the credibility of both the intermediaries and the
stock markets. If more are being detected and caught, it is good news.

 

However, it is submitted that the law relating to front running should
be made more comprehensive.  

 

 

VIRTUES FOR THE NEW DECADE

Schools
don’t focus enough on the virtues ever since they started ‘educating’. The
world would have been different if children could see and learn more of these
virtues. Rarely are virtues a part of curriculum deep enough and long enough.

 

A
Sajjan – a good human being – is someone who is endowed with Sadgun
– virtues. Most of education lacks grounding values and a long-term view of
life. We are taught how to fit into the economic factory of the world. Our
world is paying the price of this today in every area.

 

I
was told that Japan teaches values for the first 7-8 years of school as a key
subject. Values are the only building blocks for society that will outlast
everything else.

 

As
a civilization India has produced numerous poetic verses called Subhaashit,
good words or counsel for living. Many are epigrams. Each one is pithy,
universal and axiomatic.

 

As
we enter the next decade, this piece walks you through some quintessential verses
on virtues that great persons embody and display. Each of the verses shows a
different facet and carries a nugget of wisdom. None requires commentary or
explanation. But each deserves further contemplation.

 

Considering adversity and prosperity as same

 

Just as the
sun is red when rising as well as when setting, so are great people who remain
even-minded (neutral) in both prosperity and adversity.

 

Living
in present moment

 

The wise do
not ruminate on the past that comprises sad memories, nor the future that
creates apprehension. They live from moment to moment, i.e., in the present
moment.

 

Ability
to have insight

 

What can the scripture do for someone who does not
have intelligence? What good is a mirror for a visually impaired?

 

Seek
the wealth of respect

 

Low-minded
people desire wealth alone.

Common
people desire wealth as well as respect.

However,
great people desire only respect.

Respect
by itself is considered as wealth by great people.

 

When to give answers

 

A wise person should not answer without being asked with
correct intentions (without arrogance, etc.) In the absence of genuine intent
of the questioner, may a wise person even if knowing everything, behave as if
stupid in this world.

 

Traits that mean good conduct

 

 

Civility of the prosperous,

restrained speech of the brave,

calmness of the learned,

humility of the scholar,

wise spending of the wealthy,

non-anger of an austere person,

patience of the powerful,

honesty of a righteous person

–
the basis of all these is good character / conduct.

 

Humility

 

 

Just
as fruit-bearing trees always bend, so do the virtuous ones with humility. But
the fools like dry sticks do not bend (lack humility).

 

Being the cause of happiness of others

 

 

By whatever
means, one should make someone happy. Wise people believe that making other
people happy is the worship of God.

 

These
verses are there to inspire, stir our hearts and to reflect. As we enter 2020,
may more goodness find its way in us and all around us – not in symbolism of
words but in actuality of deeds! In the words of Jnaneshwar Maharaj, these
could lead us to victory over seen and unforeseen, in this world and beyond.
 

 

 

JOINT AND MUTUAL WILLS

INTRODUCTION

Quite
often, during a conversation about Wills the topic veers towards Joint Wills
and / or Mutual Wills. Ironically, this is a subject which finds no official recognition
in the Indian Succession Act, 1925, which is the Act governing Wills by most
people in India. In spite of this, it is a very popular subject! Both these
terms are often used interchangeably, but there is a stark difference between
the two. This month, let us examine the meaning of Mutual Wills and Joint Wills
and their salient features.

 

JOINT WILLS

A
Joint Will, as the name suggests, is a Will which is made jointly by two
persons, say, a husband and his wife. One Will is prepared for the couple in
which the distribution of their joint and even their separate properties is
laid down. It is like two Wills in one. The Will usually provides that on the
death of the husband all properties would go to his wife and vice versa.
It also lays down the distribution of properties once both pass away. The
Supreme Court in Dr. K.S. Palanisami (Dead) vs. Hindu Community in
General and Citizens of Gobichettipalayam and others, 2017 (13) SCC 15
(Palanisami’s case) has defined a Joint Will as follows:

 

‘A
joint will is a will made by two or more testators contained in a single
document, duly executed by each testator, and disposing either of their
separate properties or of their joint property… It is in effect two or more
wills and it operates on the death of each testator as his will disposing of
his own separate property; on the death of the first to die it is admitted to
probate as his own will and on the death of the survivor, if no fresh will has
been made, it is admitted to probate as the disposition of the property of the
survivor. Joint wills are now rarely, if ever, made.’

 

In
Kochu Govindan Kaimal & Others vs. Thayankoot Thekkot Lakshmi Amma
and Others, AIR 1959 SC 71, the Apex Court described Joint Wills as
follows:

‘…in
my judgment it is plain on the authorities that there may be a joint will in
the sense that if two people make a bargain to make a joint will, effect may be
given to that document. On the death of the first of those two persons the will
is admitted to probate as a disposition of the property that he possesses. On
the death of the second person, assuming that no fresh will has been made, the
will is admitted to probate as the disposition of the second person’s
property…’

 

MUTUAL WILLS

A Mutual Will, on the
other hand, is entirely different from a Joint Will (although they appear to be
the same). The Supreme Court in the case of Shiv Nath Prasad vs. State of
West Bengal, (2006) 2 SCC 757 has explained a Mutual Will in detail:

 

‘…we need to
understand the concept of mutual wills, mutual and reciprocal trusts and secret
trusts. A will on its own terms is inherently revocable during the lifetime of
the testator. However, “mutual wills” and “secret trusts”
are doctrines evolved in equity to overcome the problems of revocability of
wills and to prevent frauds. Mutual wills and secret trusts belong to the same
category of cases. The doctrine of mutual wills is to the effect that where
two individuals agree as to the disposal of their assets and execute mutual
wills in pursuance of the agreement, on the death of the first testator (T1),
the property of the survivor testator (T2), the subject matter of the
agreement, is held on an implied trust for the beneficiary named in the
wills. T2 may alter his / her will because a will is inherently revocable,
but if he / she does so, his / her representative will take the assets subject
to the trust. The rationale for imposing a “constructive trust” in
such circumstances is that equity will not allow T2 to commit a fraud by
going back on her agreement with T1. Since the assets received by T2, on
the death of T1, were bequeathed to T2 on the basis of the agreement not to
revoke the will of T1, it would be a fraud for T2 to take the benefit, while
failing to observe the agreement and equity intervenes to prevent this
fraud. In such cases, the instrument itself is the evidence of the agreement
and he, that dies first, does by his act carry the agreement on his part into
execution. If T2 then refuses, he / she is guilty of fraud, can never unbind
himself / herself and becomes a trustee, of course. For no man shall deceive
another to his prejudice. Such a contract to make corresponding wills in many
cases gets established by the instrument itself as the evidence of the
agreement… In the case of mutual wills generally we have an agreement
between the two testators concerning disposal of their respective properties.
Their mutuality and reciprocity depends on several factors…’

 

The Supreme Court in
Palanisami’s case has given another view on what constitutes a Mutual
Will:

 

‘The
term “mutual wills” is used to describe joint or separate wills made as the
result of an agreement between the parties to create irrevocable interests in
favour of ascertainable beneficiaries. The agreement is enforced after the
death of the first to die by means of a constructive trust. There are often
difficulties as to proving the agreement, and as to the nature, scope, and effect of the trust imposed on the estate of the second to die.’

 

Thus, a Mutual Will
prevents a legatee from taking benefit under the Will in any manner contrary to
the provisions of the Will, i.e., such a Mutual Will cannot be revoked
unilaterally. For example, by way of a Mutual Will a husband bequeaths his
estate to his wife and his wife bequeaths her estate to him. Both of them also
provide that if any of them were to predecease the other, they bequeath all
their property to the wife’s brother. The wife dies and the husband revokes his
Mutual Will bequeathing everything to his niece. Such a revocation would not be
allowed since it would constitute a breach of trust upon the husband who
executed the Will on the understanding that after him and his spouse, the
estate would go as they had agreed earlier.

 

Mutual Wills can be
and usually are two separate Wills unlike a Joint Will which is always one
Will.

 

In Dilharshankar
C. Bhachecha vs. The Controller of Estate Duty, Ahmedabad, (1986) 1 SCC 701,
the Court explained the difference between a Joint and a Mutual Will as
follows:

 

‘…Persons may make
joint wills which are, however, revocable at any time by either of them or by
the survivor. A joint will is looked upon as
the will of each testator, and may be proved on the death of one. But the
survivor will be treated in equity as a trustee of the joint property if there
is a contract not to revoke the will; but the mere fact of the execution of a
joint will is not sufficient to establish a contract not to revoke… The term
mutual wills is used to describe separate documents of a testamentary character
made as the result of an agreement between the parties to create irrevocable
interests in favour of ascertainable beneficiaries. The revocable nature of the
wills under which the interests are created is fully recognised by the Court of
Probate; but in certain circumstances the Court of Equity will protect and
enforce the interests created by the agreement despite the revocation of the
will by one party after the death of the other without having revoked his
will… There must be evidence of an agreement to create interests under the
mutual wills which are intended to be irrevocable after the death of the first to
die…’

 

A
Mutual Will can also be a Joint Will, in which case it is termed a Joint and
Mutual Will. Mutual Wills may be made either by a Joint Will or by separate
Wills, in pursuance of an agreement that they are not to be revoked. Such an
agreement could appear either in the Will itself or by a separate agreement.

 

One
of the distinctions between the two terms was explained by the Supreme Court in
Palanisami’s case as follows:

 

‘A
will is mutual when two testators confer upon each other reciprocal benefits,
as by either of them constituting the other his legatee; that is to say, when
the executants fill the roles of both testator and
legatee towards each other. But where the legatees are distinct from the
testators, there can be no question of a mutual will.’

 

Thus,
in a Mutual Will, X as a testator would make Y his legatee and Y as a testator
would make X her legatee. Thus, there would be reciprocal benefits on each
other. It is advisable that Mutual Wills should clearly set out the reciprocal
benefits being given and contain an express clause that neither testator can
revoke it unilaterally. During the lifetime of both the testators, they may
jointly decide to revoke a Mutual Will.

 

ARE SUCH WILLS ADVISABLE?

Personally,
the author prefers that separate Wills are drafted
for couples rather than opting for Joint and / or Mutual Wills. The estate
planning process of a couple could be separate for each partner. There may be
situations such as divorce, remarriage, etc. There may be different interests such
as one may want to bequeath to family while the other may want to donate to
charity. Lastly, obtaining execution of such Wills and obtaining their probate
could be a complicated and sometimes confusing affair. When legal heirs are
anyway grappling with problems on account of the loss of a loved one, why
burden them with one more? That’s why, having a separate Will for each partner
would be the ideal scenario. Even if the Wills are what is popularly known as Mirror
Wills, i.e., each is a reflection of the other.

 

However,
there is one scenario where a Mutual Will is advisable. If the intent is to
bind a couple to a certain pre-determined pattern of disposition without giving
a chance to wriggle out of this after the demise of one of the partners, then a
Mutual Will achieves this objective. For instance, often
a fear is that after remarriage of one of the partners there could be new
claimants to the joint property of the couple. To address this, a Mutual Will
could be executed where during their lifetime each of the partners could enjoy
the property but once both die, the Will would provide the course of succession
to this property. None of the surviving partners would be in a position to
alter this Mutual Will since reciprocal promises have been constituted which
could only have been altered when both
were alive.

 

CONCLUSION

An
analysis of the above cases shows that the intention of the testator is
paramount in construing the nature of the Will. The Court adopts an armchair
construction method where it sits in the chair of the testator. Hence, it
is very important that the Will is drafted in a very clear and unambiguous
manner so as to dispel all doubts in the mind of the Court.  

DCIT-4 vs. M/s Khushbu Industries; Date of order: 19th October, 2016; [ITA. No. 371/Lkw/2016; A.Y.: 2008-09; Lucknow ITAT] Section 151 – Income escaping assessment – Sanction for issue of notice – Section 151(2) mandates that sanction to be taken for issuance of notice u/s 148 in certain cases has to be of Joint Commissioner, reopening of assessment with approval of Commissioner is unsustainable

11.Pr.
CIT-2 vs. M/s Khushbu Industries [Income tax Appeal No. 1035 of 2017] Date
of order: 11th November, 2019 (Bombay
High Court)

 

DCIT-4
vs. M/s Khushbu Industries; Date of order: 19th October, 2016; [ITA.
No. 371/Lkw/2016; A.Y.: 2008-09; Lucknow ITAT]

 

Section
151 – Income escaping assessment – Sanction for issue of notice – Section
151(2) mandates that sanction to be taken for issuance of notice u/s 148 in
certain cases has to be of Joint Commissioner, reopening of assessment with
approval of Commissioner is unsustainable

 

The
assessee filed the return of income u/s 139(1) of the Act on 30th
September, 2008 declaring an income of Rs. 7,120. The notice u/s 148 was issued
by the Income Tax Officer-1(2), Lucknow who did not have jurisdiction over the
assessee. The jurisdiction lay with the Dy. C.I.T., Range-4, Lucknow, who
completed the assessment proceedings u/s 147 read with section 143(3) of the
Act.

 

Being aggrieved by
the order of the AO, the assessee company filed an appeal to the CIT(A). The
CIT(A) held that the AO has not taken approval in accordance with the provisions of section 151(2) before issue of
notice u/s 148 of the Act. In the present case, as per section 151(2) of the
Act, if the case is to be reopened after the expiry of four years the approval
/ satisfaction should be only of the Joint Commissioner of Income Tax. But here
it was reopened and notice u/s 148 issued on the approval of the Commissioner
of Income Tax who is a different authority than the Joint Commissioner of
Income Tax as per section 2 of the Act. For this reason, the notice issued u/s
148 is bad in law and liable to be quashed. The approval granted by the
administrative authorities under whom the said AO worked also did not have
valid jurisdiction over the appellant to grant the said approval u/s 151.
Hence, it was held that the reassessment on the basis of an illegal notice u/s
148 was not sustainable.

 

Aggrieved
by the order of the CIT(A), the Revenue filed an appeal to the Tribunal. The
Tribunal held that the reopening proceedings u/s 148 are bad because the
necessary sanction / approval had not been obtained in terms of section 151 of
the Act. The impugned order of the Tribunal records that the sanction for
issuing the impugned notice had been obtained from the Commissioner of Income
Tax when, in terms of section 151, the sanction had to be obtained from the Joint
Commissioner of Income Tax. Thus, in the absence of sanction / approval from
the appropriate authority as mandated by the Act, the reopening notice itself
was without jurisdiction.

 

Now
aggrieved by the order of the ITAT, the Revenue appealed to the High Court. The
Court observed that the Commissioner of Income Tax is a higher authority;
therefore the sanction obtained from him would meet the requirement of
obtaining sanction from the Joint Commissioner of Income Tax in terms of
section 151 of the Act will no longer survive. This is in view of the decision
of the Court in Ghanshyam K. Khabrani vs. Asst. CIT (2012) 346 ITR 443
(Bom.) which held that where the Act provides for sanction by the Joint
Commissioner of Income Tax in terms of section 151, then the sanction by the
Commissioner of Income Tax would not meet the requirement of the Act and the
reopening notice would be without jurisdiction. In view of the above, the
appeal was dismissed.  

 

M/s Rohan Projects vs. Dy. CIT-2(2); [ITA No. 306/Pun/2015; Date of order: 9th February, 2017; A.Y.: 2012-13; Mum. ITAT] Income accrual – The income accrues only when it becomes due, i.e., it must also be accompanied by corresponding liability of the other party to pay the amount

10.  The Pr. CIT-2 vs. M/s Rohan Projects [Income
tax Appeal No. 1345 of 2017] Date
of order: 18th November, 2019 (Bombay
High Court)

 

M/s
Rohan Projects vs. Dy. CIT-2(2); [ITA No. 306/Pun/2015; Date of order: 9th
February, 2017; A.Y.: 2012-13; Mum. ITAT]

 

Income
accrual – The income accrues only when it becomes due, i.e., it must also be
accompanied by corresponding liability of the other party to pay the amount


The assessee is in
the business of promoter and developer of land. It had sold land to M/s
Symboisis in a transaction that took place in the previous year relevant to the
subject assessment year. The land was sold under a Memorandum of Understanding
(MOU) dated 2nd February, 2012 for a total consideration of Rs. 120
crores. However, the assessee offered only a sum of Rs. 100 crores for tax in
the return for the A.Y. 2012-13. This was because the MOU provided that a sum
of Rs. 20 crores would be paid by the purchaser (M/s Symboisis) on execution of
the sale deed after getting the plan sanctioned and on inclusion of the name of
the purchaser in the 7/12 extract. However, as the assessee was not able to
meet these conditions during the subject assessment year, a sum of Rs. 20
crores, according to the assessee, could not be recognised as income for the
subject assessment year. The AO did not accept the same and held that the
entire sum of Rs. 120 crores was taxable in the subject assessment year.

 

Aggrieved by this
order, the assessee company filed an appeal to the CIT(A). The CIT(A) dismissed
the appeal, upholding the order of the AO. On further appeal, the Tribunal,
after recording the above facts and relying upon the decision of the Supreme
Court in Morvi Industries Ltd. vs. CIT (1971) 82 ITR 835, held
that the income accrues only when it becomes due, i.e., it must also be
accompanied by corresponding liability of the other party to pay the amount. On
the facts of the case it was found that the amount of Rs. 20 crores was not
payable in the previous year relevant to the subject assessment year as the
assessee had not completed its obligation under the MOU entirely. Moreover, it
also found that Rs. 20 crores was offered to tax in the subsequent assessment
year and also taxed. Thus, the appeal of the assessee was allowed.

 

But the Revenue was
aggrieved by this order of the ITAT and filed an appeal to the High Court. The
Court found that the assessee was not able to comply with its obligations under
the MOU in the previous year relevant to the subject assessment year so as to
be entitled to receive Rs. 20 crores is not shown to be perverse. In fact, the
issue is covered by the decision of the Apex Court in CIT vs. Shoorji
Vallabdas & Co. (1962) 46 ITR 144 (SC) wherein it is held that ‘Income
tax is a levy on income. No doubt, the Income-tax Act takes into account two
points of time at which the liability to tax is attracted, viz., the accrual of
the income or its receipt; but the substance of the matter is the income, if
income does not result at all, there cannot be a tax…’


Similarly, in Morvi
Industries Ltd. (Supra) the Supreme Court has held that income accrues
when there is a corresponding liability on the other party. In the present
case, in terms of the MOU there is no liability on the other party to pay the
amount. In any event, the amount of Rs. 20 crores has been offered to tax in
the subsequent assessment year and also taxed. The Bombay High Court in the
case of C.I.T. vs. Nagri Mills Co. Ltd. (1958) 33 ITR 681 (Bom.)
held that the question as to the year in which a deduction is allowable may be
material when the rate of tax chargeable on the assessee in two different years
is different; but in the case of income of a company, tax is attracted at a
uniform rate, and whether the deduction in respect of bonus was granted in the
A.Y. 1952-53 or in the assessment year corresponding to the accounting year
1952, that is, in the A.Y. 1953- 54, should be a matter of no consequence to
the Department; and one should have thought that the Department would not
fritter away its energies in fighting matters of this kind.

 

In the aforesaid
circumstances, the tax on the amount of Rs. 20 crores has been paid in the next
year. Therefore, the appeal is dismissed.

 

 

ACIT-3 vs. Shree Rajlakshmi Textile Park Pvt. Ltd.; Date of order: 18th October, 2016; [ITA No. 4607/Mum/2012; A.Y.: 2008-09; Mum. ITAT] Section 68: Cash credits – Share application money and share premium – Identity, genuineness of transaction and creditworthiness of persons from whom assessee received funds is proved – Addition u/s 68 is not justified

9.  The Pr. CIT-2 vs. Shree Rajlakshmi Textile
Park Pvt. Ltd. [Income tax Appeal No. 991 of 2017] Date of order: 4th
November, 2019 (Bombay High Court)

 

ACIT-3 vs. Shree
Rajlakshmi Textile Park Pvt. Ltd.; Date of order: 18th October,
2016; [ITA No. 4607/Mum/2012; A.Y.: 2008-09; Mum. ITAT]

 

Section
68: Cash credits – Share application money and share premium – Identity,
genuineness of transaction and creditworthiness of persons from whom assessee
received funds is proved – Addition u/s 68 is not justified

 

The
assessee company is in the business of construction of godowns. In the course
of scrutiny, the AO noticed that the assessee had received share application money,
including share premium of Rs. 19.40 crores. The AO added the same to the
assessee’s returned income as cash credit, determining its income at Rs. 19.40
crores.

 

Aggrieved
by this order, the assessee company filed an appeal to the CIT(A). The CIT(A)
deleted the addition of Rs. 19.40 crores after calling for a remand report from
the AO. The remand report indicated that all 20 parties who had subscribed to
the shares of the assessee appeared before the AO and submitted confirmation
letter of purchase of shares, copy of audited balance sheet and profit &
loss account, copy of bank statement along with return of income, as well as
Form 23AC filed with the Registrar of Companies. It also found that Rs. 4.90
crores represented an amount received in the earlier assessment year and from
promoters. Therefore, it could not be added as cash credit for the subject
assessment year. So far as the balance amount of Rs. 14.50 crores is concerned,
the CIT(A) examined the issue and concluded that the shareholders had clearly
established their identity, capacity and genuineness of the transactions on the
basis of the documents submitted.

 

The
Revenue filed an appeal to the Tribunal against the order of the CIT(A). It
stated that during the assessment and also remand proceedings, the letters sent
through RPAD to the companies who invested in the respondent’s company were
returned back with an endorsement ‘No such company exists in the given
address’. This by itself, according to him, establishes the perversity of the
impugned order.

 

The
Tribunal found that the identity and capacity of the shareholders as well as
the genuineness of the transactions stood established. Further, it records that
the Revenue is not able to submit anything in support of its challenge to the
order of the CIT(A), except stating that the order of the AO requires to be
restored.

 

Aggrieved
by the order of the ITAT, the Revenue filed an appeal to the High Court. The
Court observed that in the report the officer indicates that notices sent to
some of the companies came back un-served, yet, thereafter, the companies
appeared before him through a representative and made submissions in support of
their investments. Further, the change of address was given to the AO and yet
it appears that notice was served on an incorrect address. Further, one of the
directors of a company which has subscribed to the shares, has also given an
affidavit stating that the company has paid Rs. 30 lakhs for 30,000 equity
shares of Rs.10 each at a premium of Rs. 90 to the assessee company. Thus, the
amounts received for share subscription is not hit by section 68 of the Act as
the identity and the capacity of the shareholder is proved. Besides, the
genuineness of the transactions also stands established. Accordingly, the appeal
is dismissed.

 

Settlement of cases – Section 145D(1) of ITA, 1961 – Condition precedent – Pendency of assessment proceedings – Assessment proceedings pending till service of assessment order upon assessee

31. M3M India Holdings
Pvt. Ltd. vs. IT Settlement Commission; [2019] 419 ITR 17
(P&H) Date of order: 22nd
October, 2019 A.Y.: 2013-14

 

Settlement of cases –
Section 145D(1) of ITA, 1961 – Condition precedent – Pendency of assessment
proceedings – Assessment proceedings pending till service of assessment order
upon assessee

 

While the assessment proceedings were pending, the assessee sent a mail
to the AO on 26th February, 2018 indicating that the assessment
proceedings should be deferred because it intended to file an application u/s
245D(1) of the Income-tax Act, 1961 before the Settlement Commission. On 27th
December, 2018, the AO finalised the assessment, passed the order and
dispatched it through post. Before it was received or even delivered by the
postal authorities, the assessee filed the application before the Settlement
Commission on 28th February, 2018. The Settlement Commission
accepted the contention of the Department that on the date of the application
the assessment proceedings having been concluded, the application would not lie
and rejected the application.

 

The assessee challenged the order by filing a writ petition and
contended that the assessment proceedings could not have been said to be
concluded till such time as the assessment order was not served upon the
assessee.

 

The Punjab and Haryana High Court allowed the writ petition and held as
under:

 

‘i)   The assessee had communicated
to the Assessing Officer prior to the passing of the assessment order that it
was intending to move an application before the Settlement Commission. The
assessee was entitled to proceed on the basis that till the service of the
assessment order, the case continued to be pending with the Assessing Officer
till the date the assessment order was not served upon it.

 

ii)   Consequently, the order of
the Settlement Commission rejecting the application filed by the assessee u/s
245D(1) was to be set aside.’

 

Settlement of cases – Sections 245C, 245D(2C) and 245D(4) of ITA, 1961 – Settlement Commission – Jurisdiction – Applications filed for settlement of cases for several assessment years allowed to be proceeded with – Order directing that application for years in which nil or no disclosure of additional income or loss was declared not to be proceeded with – Order giving retrospective effect on request of Department – Settlement Commission has no jurisdiction to pre-date its order

30. Pr.
CIT vs. IT Settlement Commission; [2019]
418 ITR 339 (Bom.) Date
of order: 28th February, 2019 A.Ys.:
2008-09 to 2013-14

 

Settlement
of cases – Sections 245C, 245D(2C) and 245D(4) of ITA, 1961 – Settlement Commission
– Jurisdiction – Applications filed for settlement of cases for several
assessment years allowed to be proceeded with – Order directing that
application for years in which nil or no disclosure of additional income or
loss was declared not to be proceeded with – Order giving retrospective effect
on request of Department – Settlement Commission has no jurisdiction to
pre-date its order

 

The assessee applied to the Settlement Commission for
settlement of its cases u/s 245C of the Income-tax Act, 1961 for the A.Ys.
2008-09 to 2013-14 and did not disclose an additional income in some of the
years. The Settlement Commission passed an order dated 29th January,
2015 u/s 245D(2C) wherein it held that the five applicants had made a true and
full disclosure, that there were no technical objections from the Department,
that the five applicants had complied with the basic requirement u/s 245C(1)
and that all the applications were valid and allowed them to be proceeded with.
Thereafter, the Department contended before the Settlement Commission that the
settlement applications for the assessment years in which no additional income
was disclosed by the assessee should be treated as invalid u/s 245D(2C). The
Settlement Commission thereupon passed an order on 31st May, 2016
u/s 245D(4) of the Act excluding from the purview of the settlement those
assessment years where ‘nil’ or ‘no disclosure of additional income’ was made
u/s 245C(1) or where the disclosure was a loss, and directing that the
settlement applications for those assessment years were not to be proceeded
from the stage of section 245D(2C) and that such declaration was effective from
29th January, 2015. The Income Tax Department filed a writ petition
and challenged this order.

 

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

 

‘i)   Once the Settlement Commission had passed an
order u/s 245D(2C), whether legally permissible or not, it had no authority or
jurisdiction to pre-date such an order. While giving retrospective effect to
its order of invalidation it had acted without jurisdiction.

ii)   Under no circumstances could it have made a
declaration of invalidity on 31st May, 2016 giving it a retrospective
effect of 29th January, 2015. The portion of the order giving
retrospective effect to the declaration of invalidity of the settlement
application was severable from the main order of invalidation. While therefore,
striking down the severable portion of the order as illegal, the principal
declaration made by the Commission was not disturbed.

iii)  The direction giving retrospective effect to
the order was set aside and the order passed by the Settlement Commission on 31st
May, 2016 would take effect from such date.’

 

Revision – Section 264 of ITA, 1961 – Delay in filing application – Condonation of delay – Assessee including non-taxable income in return – Assessee acting in time to correct return by filing revised return and rectification application – Revised return rejected on technical ground – Consequent delay in filing application for revision was to be condoned

28 Ramupillai Kuppuraj
vs. ITO; [2019] 418 ITR 458
(Mad.) Date of order: 28th
June, 2018 A.Y.: 2009-10

 

Revision – Section
264 of ITA, 1961 – Delay in filing application – Condonation of delay –
Assessee including non-taxable income in return – Assessee acting in time to
correct return by filing revised return and rectification application – Revised
return rejected on technical ground – Consequent delay in filing application
for revision was to be condoned

 

The assessee, a non-resident seafarer, filed his
return for the A.Y. 2009-10. He then filed, in time, a revised return excluding
an amount of Rs. 19.84 lakhs which was erroneously included in the return
though, according to him, it was income received from abroad and hence not
taxable in India. The revised return was rejected for a technical reason. An
application for rectification was also rejected and a notice of demand was
issued. The assessee filed an application for revision u/s 264 of the
Income-tax Act, 1961 which was rejected solely on the ground of delay. The
assessee filed a writ petition and challenged the order.

 

The Madras High Court allowed the writ petition and
held as under:

 

‘i)   The
Commissioner has powers to condone a delay in the application for revision u/s
264 of the Income-tax Act, 1961. There is no restriction regarding the length
of delay that can be condoned. In case of delay whether sufficient cause has
been made out or not is always a question which depends on the facts and
circumstances of each case and it has to be established based on records of
that case.

 

ii)   The
period of one year for filing an application u/s 264 expires on 22nd
October, 2011, as the order of assessment u/s 143(1) came to be passed on 23rd
October, 2010. Within this one year, i.e., on 5th August, 2011
itself, the assessee had taken the first step to have his Rs. 19.84 lakhs
excluded qua the assessment year by filing a revised return. This
revised return was rejected u/s 139(5) on a technical ground. The assessee
filed a rectification application, on which no orders were passed. Without
passing orders on the application for rectification, a demand notice was issued
triggering a second application for rectification from the assessee which came
to be dismissed. A demand was made on 31st January, 2018, the second
rectification application was filed by the assessee on 2nd July,
2018; the assessee ultimately filed a petition u/s 264.

 

iii)  Therefore,
this was not a case where the assessee had not acted in time. The rejection of
the application for revision solely on the ground of delay was not justified.’

 

 

SUPREME COURT’S LANDMARK DECISION IN ESSAR STEEL CASE

In Committee
of Creditors of Essar Steel India Limited vs. Satish Kumar Gupta1,
the Supreme Court has examined and clarified certain important aspects of the
corporate insolvency resolution process under the Insolvency and Bankruptcy
Code, 2016. The crux of this judgment represented by the main conclusions
reached by the Supreme Court is summarised here.

 

BACKGROUND

Essar Steel was one
of the twelve accounts mandated by the Reserve Bank of India (RBI) for
resolution under the Insolvency and Bankruptcy Code, 2016 (the Code). Essar
Steel owed approximately Rs. 49,000 crores to financial creditors. Its
resolution with payment of Rs. 42,000 to financial creditors in the final
resolution plan makes it among the best resolutions. The Supreme Court decision
has facilitated the biggest resolution under the Code in Indian corporate
history.

 

Essar was admitted
to insolvency in June, 2017. Several bidders showed interest, including
ArcelorMittal which finally won the bid after several legal and procedural
hurdles were cleared. Earlier, the National Company Law Appellate Tribunal
(NCLAT) had cleared the Committee of Creditors’ (COC) plan but tweaked the
financial distribution plan by ordering an equal recovery plan for all
creditors.

 

The challenges
faced during the corporate insolvency resolution process included managing
stakeholders for maximisation of value, improving operations and litigation in
different forums, including by resolution applicants u/s 29A of the Code.
Section 29A was introduced to prevent defaulting promoters from bidding without
paying overdue amounts.

 

ORDER OF APPELLATE TRIBUNAL (NCLAT)

The COC of Essar
Steel had filed an appeal against the July, 2019 order of the NCLAT, mainly
contesting NCLAT’s modification of the distribution of Rs. 42,000 crores in the
resolution plan amongst financial and operational creditors.

 

NCLAT had proposed
an equitable distribution of the bid amount, which meant secured lenders
sacrificing a large portion, approximately 30% of Rs. 42,000 crores. The NCLAT
had also held that the profits of Essar Steel during the pendency of the
insolvency would also be distributed among the creditors on a pro rata
basis.

 

The Supreme Court
observed that the law refers to ‘equitable’ and not ‘equal’ treatment of
operational creditors. Fair and equitable treatment of operational creditors’
rights requires the resolution plan to specify the manner of dealing with the
interests of operational creditors. This is different from saying that
operational creditors must be paid the same amount of their debt
proportionately.

 

The fact that the
operational creditors are given priority in payment over all financial
creditors does not imply that such payment must necessarily be the same
recovery percentage as that of financial creditors.

 

The Supreme Court
recognised the inherent gap in the nature of unsecured lending. The risk was
present at inception. Moreover, all secured creditors too are taking
substantial haircuts.

 

One of the
financial creditors (Standard Chartered Bank) had challenged ArcelorMittal’s
resolution plan before the NCLAT on the ground that the approval process
adopted by the COC was illegal and discriminatory.

 

By virtue of a stay
order in July, 2019 the Supreme Court had ordered status quo of the
resolution process till completion of the adjudication of the issues involved
in the matter. It had assured that it would expeditiously decide on all issues.

 

SUPREME COURT SETS ASIDE NCLAT ORDER

By its order of
November, 2019, the Supreme Court has set aside the order of NCLAT in the Essar
case2 and upheld the claims of the COC.

 

The Supreme Court
has eventually drawn the curtains on a major battle for debt-laden Essar Steel,
paving the entry of the world’s largest steel-maker, ArcelorMittal, into the
second-biggest steel market, India.

 

Its decision
removes all hurdles in the takeover of Essar Steel by ArcelorMittal. It has
been hailed by bankers and lawyers as a landmark judgment which will now speed
up resolution under the Code.

 

In a ruling that
would have a far-reaching impact on litigation under the Code, the Supreme
Court has set aside the NCLAT order that put on par a different class of
creditors – financial vis-à-vis operational creditors, as also secured
and unsecured financial creditors.

 

The judgment has
brought finality to the approval of the resolution plan of ArcelorMittal for
Essar Steel, the largest account under the Code, and opened the doors for its
implementation which would result in inflows of more than Rs. 42,000 crores to
creditors.

 

ISSUES SETTLED BY THE SUPREME COURT

The order was
delivered by a three-judge Bench of the Supreme Court and is binding on all
stakeholders, including the erstwhile promoters. This much-awaited judgment
puts to rest several controversies which were contested in various fora
below. It has settled several contentious issues under the Code as explained
here.

 

1.   Commercial wisdom of
Committee of Creditors – not to be questioned

The Supreme Court
has held that the NCLAT could not have interfered with the decision of the COC,
which is based on its commercial wisdom. It held that the COC will have the
final say in the resolution plans and thereby upheld the primacy of financial
creditors in the distribution of funds received under the corporate insolvency
scheme.

 

Neither the NCLT
nor the NCLAT has the jurisdiction to reverse the commercial wisdom of the
dissenting financial creditors and that, too, on the specious ground that it is
only an opinion of the minority financial creditors.

 

The Supreme Court
accepted the distribution of proceeds as decided by the COC, thereby
establishing the primacy of financial creditors. It will now resolve hundreds
of cases that are pending in the NCLT and the NCLAT.

 

The Court has
crystallised the roles of the COC and the NCLT. It has clarified the limits of
judicial review and left commercial decisions to the COC.

 

According to the
Supreme Court, it was not proper for the NCLAT to have taken up the task of the
COC. The COC has to enter into negotiations with the resolution professional
and the resolution applicant and look at the health of the company and
thereafter make the allocation.

 

2.   Equitable distribution
among creditors

Holding that there
could be no classes of financial creditors on the basis of being secured and
unsecured, the NCLAT had directed that all financial creditors having a claim
amount of over Rs. 100 crores would be entitled to 60.7% of their admitted
claim. It had also awarded around 60% of the admitted claim to certain operational
creditors having claims of more than Rs. 1 crore.

 

The Supreme Court held that under the principle of parity, secured and
unsecured creditors cannot be treated to be equal. It emphasised that equitable
treatment is applicable only to similarly situated creditors and that the
principle of equitable treatment cannot be stretched to equal treatment of
unequals. Equitable treatment may be given to each creditor depending on the
class to which it belongs (that is, secured or unsecured, financial or operational).

 

3.   Deadline for completion
of resolution process – not mandatory

The Supreme Court
relaxed the revised time limit of 330 days for resolving stressed assets by
diluting its mandatory nature and leaving a window open for the NCLT and the
NCLAT to extend the time under certain circumstances.

 

The Court permitted
flexibility by observing that though 330 days is now the outer time limit
within which a corporate resolution plan must be made, exceptions can be made
in deserving cases in which a plan is on the verge of being finalised. It said
that the NCLT and the NCLAT can send the plan back if it falls short of
judicial parameters. If a plan is not approved within time, the liquidation
process must be allowed to start.

 

The Supreme Court
has recognised the need for time-bound resolution even though it has relaxed
the 330 days’ limit by making allowance for exceptional cases to take longer,
if required.

 

4.   Status of personal
guarantees and undecided claims

The Supreme Court
examined the effect of approval of the resolution plan on the claims of
creditors who have not submitted their claims before the resolution
professional within the specified time limit. It held that in terms of section
31(1), once a resolution plan is approved by the COC, it binds all
stakeholders, including guarantors. The Court observed that after the
resolution plan submitted by the resolution professional has been accepted, a
successful resolution applicant cannot be made to face uncertainty in respect
of undecided claims as regards the amounts payable by a successful resolution
applicant who has taken over the business of the corporate debtor. All such
claims may be submitted to the resolution professional so that a resolution
applicant knows precisely the amount payable for taking over and managing the
business of the corporate debtor.

 

The NCLAT had
extinguished the right of creditors against guarantees extended by promoters /
promoter group of the corporate debtor. The Supreme Court set aside the
aforesaid decision on the premise that the same was contrary to section 31(1)
of the Code and the judgment of the Supreme Court in State Bank of India
vs. V. Ramakrishnan3 .

 

Moreover, the
guarantors of the corporate debtor contended that their right of subrogation,
which they may have if they are ordered to pay amounts guaranteed by them in
the pending legal proceedings, could not be extinguished by the resolution
plan. On this aspect, the Supreme Court observed that it was difficult to
accept that the part of the resolution plan which provides extinguishment of
claims of the guarantor on account of subrogation cannot be applied to the
guarantees furnished by the erstwhile directors of the corporate debtor.
Indeed, the Supreme Court added a caveat that it was not stating anything that may
affect the pending litigation pursuant to invocation of such guarantee.

 

5.   Scope of jurisdiction
of NCLT and NCLAT

The Supreme Court
has clarified that the scope of judicial review to be exercised by the
Adjudicating Authority (NCLT) must be within the parameters of section 30(2) of
the Code while the review by the NCLAT must be confined to the grounds provided
in section 32 read with section 61(3) of the Code.

 

The NCLT cannot
exercise discretionary or equity jurisdiction outside section 30(2) of the Code
in respect of adjudication of a resolution plan. The Court emphasised that the
discretion to decide the amount payable to each class or sub-class of creditors
is vested in the COC. This, however, is subject to three caveats. Firstly,
the decision of the COC must show that it has considered the need of the
corporate debtor to continue as a going concern during the insolvency
resolution process. Secondly, the resolution plan has considered the
need to maximise the value of the assets of the corporate debtor. Thirdly,
the interests of all stakeholders, including operational creditors, have been
taken into account.

 

It was observed by the Supreme Court that if nothing is payable to the
operational creditors, the minimum, being liquidation value – which may be nil
after secured creditors have been paid – would not balance the interest of all
stakeholders or maximise the value of assets of a corporate debtor if it
becomes impossible to continue its business as a going concern. Moreover, the
review by the NCLT must consider whether the resolution plan as approved by the
COC has met the requirements of section 30(2) and section 30(2)(e) [viz., that
the resolution plan does not contravene any of the provisions of the law for
the time being in force, as the provisions of the Code are also provisions of
law for the time being in force]. If the NCLT finds that there is any such
contravention, it may send the resolution plan back to the COC to re-submit the
same after complying with the requirements of the said two provisions.

 

6.   Delegation of powers to
sub-committee

As regards the
exercise of powers of the COC pertaining to managing the business of the
corporate debtor, the Supreme Court held that such powers cannot be delegated
to any other person in terms of section 28(1)(h). At the time of approving a
resolution plan u/s 30(4), such power cannot be delegated to any other body as
it is only the COC that is vested with this important power. The Court observed
that sub-committees may be appointed for negotiations with resolution
applicants, or for performing other ministerial or administrative acts,
provided such acts are ratified by the COC.

 

7.   Profits
of the corporate debtor during the resolution process

Whether
available to pay off creditors

The NCLAT had held
that the profits of the corporate debtor during corporate insolvency resolution
process must be used to pay off creditors of the corporate debtor. The Supreme
Court set aside the aforesaid decision by observing that the request for
proposal issued and consented to by ArcelorMittal and the COC had provided that
distribution of profits made during the corporate insolvency process will not
go towards payment of debts of any creditor.

 

8.   Treatment of disputed
claims submitted to resolution professional

In this case, the
claim of certain creditors was admitted by the resolution professional
notionally at Re. 1 on the premise that disputes were pending before various
authorities in respect of such claims. However, NCLT directed the resolution
professional to register their entire claim and the same was upheld by NCLAT.
But the Supreme Court set aside the decision of NCLAT on the ground that the
resolution professional was right in admitting the claim only at a notional
value of Re. 1 due to the pendency of disputes regarding such claims.

 

9.   Constitutional validity
of 2019 amendments

The Constitutional
validity of sections 4 and 6 of the Insolvency and Bankruptcy (Amendment)
Act, 2019 (2019 Amendment Act) was challenged before the Supreme Court.

 

Section 4 of the
2019 Amendment Act sought to introduce the mandatory time limit of 330 days for
completion of the corporate insolvency resolution process, failing which the
corporate debtor would face liquidation. On the other hand, section 6 of the
2019 Amendment Act provided the minimum amount payable to the operational
creditors and dissenting financial creditors as per the resolution plan.

 

The Supreme Court
observed that the time taken in legal proceedings should not prejudice the
litigant if, without any fault of the litigant, the litigant’s case cannot be
taken up within the specified period. Thus, the mandatory deadline
without any exception would violate Articles 14 and 19(1)(g) of the
Constitution. With such observations, while retaining section 4 of the
2019 Amendment Act, the Supreme Court struck down the word ‘mandatorily’
as being manifestly arbitrary under Article 14 of the Constitution and as being
an excessive and unreasonable restriction on the litigant’s right to carry on
business under Article 19(1)(g) of the Constitution.

 

It was clarified
that ordinarily, the corporate insolvency resolution process must be completed
within the extended limit of 330 days from the insolvency commencement date,
including extensions and the time taken in legal proceedings. However, in a
particular case, if it is found that the period left for completion of
corporate insolvency resolution process beyond 330 days is inadequate, and that
it would be in the interest of all stakeholders that the corporate debtor
deserves to be revived and not liquidated, and that the time taken in legal
proceedings is largely due to factors for which the litigant cannot be faulted,
the delay or a large part thereof being attributable to the tardy adjudication
and appellate process, then the NCLT or NCLAT may extend the time limit beyond
330 days. Likewise, even under the new proviso to section 12, where due
to the aforesaid factors the grace period of 90 days from the date of
commencement of the 2019 Amendment Act is exceeded, the NCLT or NCLAT may give
further extension after taking into account the aforesaid factors. Indeed, such
extension is to be given only in such exceptional cases.

 

The Supreme Court
held that section 6 of the 2019 Amendment Act was a provision beneficial to
operational creditors and dissentient financial creditors inasmuch as they
would now receive minimum amount and the computation of such minimum amount was
more favourable to operational creditors, while in the case of dissentient
financial creditors the minimum amount provided was a sum that was earlier not
payable.

 

The constitutional validity of section 6(b) of the 2019 Amendment Act was
upheld by the Supreme Court by observing that the same was merely a guideline
for the COC which may be followed by it for accepting or rejecting a resolution
plan. It also clarified that the COC does not act in any fiduciary capacity to
any group of creditors. The COC is bound to take its decision by majority after
weighing the ground realities. Such a decision would be binding on all
stakeholders, including dissentient creditors.

 

THE WAY FORWARD

The Supreme Court’s
decision should significantly narrow down the chances of long-drawn litigations
under the Code and eventually lead to faster resolutions of stressed assets.

 

This landmark
decision will result in a large-scale disposal of pending appeals before NCLAT
and disposals at NCLT. On similar questions of law, even the High Courts will
now be in a position to direct their registrars to locate such cases and place
them before the judges / courts for disposal in accordance with this landmark
judgment.  

 

Article 25 of India-USA DTAA, Article 23 of India-Canada DTAA and similar provisions in various other DTAAs – If a DTAA provides for credit of foreign tax paid even in respect of income on which tax was not paid in India, tax credit u/s 90(1)(a)(ii) would be available – However, if a DTAA provides for credit u/s 90(1)(a)(i) it would be available only if tax is also paid in India

15 [2019] 111 taxmann.com 42 (Mum.) Tata Consultancy Services Ltd. vs. ACIT [IT Appeal No. 5713 of 2016 & IT (TP)
Appeal No. 5823 (Mum.) of 2016] A.Y.: 2009-10 Date of order: 30th October, 2019

 

Article 25 of India-USA DTAA, Article 23 of
India-Canada DTAA and similar provisions in various other DTAAs – If a DTAA
provides for credit of foreign tax paid even in respect of income on which tax
was not paid in India, tax credit u/s 90(1)(a)(ii) would be available –
However, if a DTAA provides for credit u/s 90(1)(a)(i) it would be available
only if tax is also paid in India

 

FACTS

The assessee was an
Indian company engaged in the business of export of software and providing
consultancy services. It had branches in various tax jurisdictions in which it
had paid tax on profits of branches. Under sections 90 and 91 of the Act, the assessee
claimed credit for tax paid in these jurisdictions. To support its claim, the
assessee furnished statements of tax paid in each jurisdiction. The assessee
contended that the tax paid in those jurisdictions was eligible for deduction
from tax payable in India in terms of the applicable DTAAs as well as u/s 91 of
the Act.

 

After examining the
claim of the assessee and verifying the details, the AO allowed tax credit in
respect of tax paid on income which was taxed abroad and also in India but
restricted the credit to the rate of tax payable in India. However, where
income was taxed abroad but was exempted in India, he did not grant credit,
either u/s 90 or u/s 91.

 

In appeal, relying
on the decision in Wipro Ltd. vs. DCIT [2015] 62 taxmann.com 26 (Kar.),
CIT(A) trifurcated foreign tax credit into three parts, namely, tax paid in
USA, tax paid in other DTAA countries and tax paid in non-DTAA countries. He
directed the AO to allow tax credit in respect of tax paid in USA even on
income which was exempt from tax in India u/s 10A/10AA. In respect of tax paid
in other DTAA and non-DTAA countries, he held that no tax credit will be
available in respect of income which was exempt from tax in India u/s 10A/10AA.

 

HELD

  •     Relying on
    the decision in Wipro Ltd. vs. DCIT [2015] 62 taxmann.com 26 (Kar.),
    CIT(A) restricted foreign tax credit only in respect of tax paid in USA even
    though income was exempt u/s 10A/10AA on the premise that the decision granted
    benefit only in case of India-USA DTAA.
  •     However, the Karnataka High Court had held
    that section 90(1)(a)(ii) applies where the income is chargeable1  to tax under the Act and also in the other
    country. Though tax is chargeable under the Act, the Parliament may exempt the
    income from payment of tax to incentivise the assessee.
  •     In the context of the India-USA DTAA2
    , the Court held that it did not require that to claim credit the assessee must
    have paid tax in India on such income. The Court also mentioned that the
    India-Canada DTAA3  allows
    credit for tax paid in Canada only if income is subjected to tax in India.
  •     A careful reading of the said decision shows
    that if a DTAA provides credit for foreign tax paid even in respect of income
    on which the assessee has not paid tax in India, it would qualify for tax credit
    u/s 90. DTAAs between India and Denmark, Hungary, Norway, Oman, US, Saudi
    Arabia, Taiwan have provisions similar to Article 25 of the India-USA DTAA
    providing for credit of foreign tax even in respect of income not subjected to
    tax in India.
  •     However, DTAAs with Canada and Finland
    provide for credit of foreign tax only if income is subjected to tax in both
    the countries.
  •  Therefore, the assessee was
    entitled to credit for tax paid in case of all countries other than tax paid in
    Finland and Canada.

 

____________________________________________________________________________________

1   Section 90(1)(a)(i) of the Act requires that
tax should have been paid in both the jurisdictions

2   Article 25(2)(a) of India-USA DTAA

3    Article 23(3)(a) of India-Canada DTAA

 

 

 

Article 13 of India-Netherlands DTAA – Section 160(1)(iv) of the Act – Benefit under DTAA is available to an assessee acting as trustee (i.e., a representative assessee) of a tax transparent entity, if beneficiaries or constituents of tax transparent entity are entitled to benefit under DTAA

14 [2019] 112
taxmann.com 21 (Mum.) ING Bewaar
Maatschappij I BV vs. DCIT [IT Appeal No.
7119 (Mum.) of 2014] A.Y.: 2007-08 Date of order:
27th November, 2019

 

Article 13 of
India-Netherlands DTAA – Section 160(1)(iv) of the Act – Benefit under DTAA is
available to an assessee acting as trustee (i.e., a representative assessee) of
a tax transparent entity, if beneficiaries or constituents of tax transparent
entity are entitled to benefit under DTAA

 

FACTS

The assessee was a tax transparent
entity established in the Netherlands. It was registered with SEBI as a
sub-account of a SEBI-registered FII. As trustee, it was the legal owner of the
assets held by a fund which, under the Dutch law, was structured as a legal
entity known as FGR (i.e. fonds voor gemene rekening, which means funds
for joint account). The fund had three investors.

The assessee contended as follows.

  •     The fund was a tax transparent
    entity, fiscally domiciled in the Netherlands, and the income earned by it was
    taxable in the hands of its beneficiaries.
  •     All beneficiaries under the
    fund were taxable in respect of their shares of income in the Netherlands and,
    hence, were entitled to benefits under the India-Netherlands DTAA.
  •     The assessee was the trustee
    of the fund and also the legal owner of the assets owned by the fund.
  •     Under
    the Act, the status of the assessee was AOP. Hence, it was taxable in the
    capacity of representative assessee. As the beneficiaries were taxable entities
    in the Netherlands, which were entitled to benefits under the India-Netherlands
    DTAA, the assessee was also entitled to the same benefits.

Following is a diagrammatic presentation of the structure:

 

The AO, however, held that since the fund had earned capital gain in
India as an AOP, it should be assessed as an AOP. As the said AOP was not a tax
resident entity of Netherlands, benefits under the India-Netherlands DTAA and
particularly that under Article 13 cannot be extended to it.

 

CIT(A) confirmed the order of the AO.

 

HELD

  •     The role of the assessee was that of
    custodian of investments. The AO has nowhere mentioned that profits had accrued
    to the assessee in its own right. The AO had framed the assessment order in the
    name of the assessee mentioning its capacity as trustee of the fund and
    describing its business as ‘sub-account of foreign institutional investor’.
    Thus, there was no doubt that the assessment was made in the representative
    capacity of the assessee.
  •     The fund was organised as an FGR in the
    Netherlands (i.e., funds for joint account). Under the Dutch law, FGR is in the
    nature of a contractual arrangement between the investors, fund manager and its
    custodian. Since an FGR is not a legal entity, it does not hold any assets on
    its own and the assets are held by a custodian (in this case, the assessee).
    The clarifications issued by the Government of Netherlands also noted that the
    fund was a tax transparent entity.
  •     The
    question that was to be addressed was who was the actual beneficiary of the
    trust, in whose representative capacity the assessee was to be taxed, and
    whether those beneficiaries were fiscally domiciled in the Netherlands (i.e.,
    ‘liable to taxation by reasons of his domicile, residence, place of management
    or any other criterion of similar nature’). There are two reasons for following
    this approach.
  •     First, the fund was not a legal entity.
    Hence, it was to be seen as to which legal entities the income belonged to. The
    income belonged to the three investors in the fund, who were tax residents of
    the Netherlands. Hence, benefits under the India-Netherlands DTAA could not be
    denied.
  •     Second, even if one accepts that it is a tax
    transparent entity simpliciter, following the principles laid down in Linklaters
    LLP vs. Income Tax Officer [(2010) 9 ITR (Trib.) 217 (Mum.)],     what is
    important is the fact that income should be taxable in the Netherlands and not
    the manner in which it is taxable. In such an asymmetrical taxation situation,
    as long as income is liable to tax in the Netherlands, whether in the hands of the
    assessee or in the hands of its beneficiaries (since it is a tax transparent
    entity), benefits under DTAA should be granted in India.
  •     According to the approach adopted by the AO,
    for claiming benefit under DTAA it was essential that income should have
    accrued to the taxable entities in the Netherlands. Since the beneficiaries
    were the three investors all of which were taxable entities in the Netherlands
    and not the fund, the assessee was wrongly denied benefit under DTAA.
  •     On facts, Article 13(1), (2) and (3) of the
    India-Netherlands DTAA are not applicable. Gains on the sale of shares is
    covered under Article 13(4) if the shares are unlisted and their value is
    principally derived from immovable properties. However, the AO has not brought
    out any such facts. Thus, Article 13(5) being the residuary provision would
    apply. As Article 13(5) allocates taxing rights to the Netherlands, capital
    gain would not be chargeable to tax in India.

 

Section 9 of the Act – Indian subsidiary hired facility of Indian parent to develop technology and transferred it to BVI sister subsidiary at nominal cost – BVI subsidiary transferred it to USA sister subsidiary in consideration of shares of USA subsidiary – Price of shares was determined at the time when agreement for transfer of technology was made but was substantially higher when shares were issued, resulting in huge profit to BVI subsidiary – On facts, Indian subsidiary not owning infrastructure was not relevant; BVI subsidiary was not paper company since it owned IPRs and had pharma registrations; the transaction could not be regarded as colourable device merely because there was no tax liability in hands of parent company – Other than section 92, no other provision permits taxing of international transactions and since AO had not invoked transfer pricing provisions, sale consideration received by BVI subsidiary could not be taxed in hands of Indian parent

13 [2019] 111 taxmann.com 218 (Ahm.) Sun Pharmaceuticals Industries Ltd. vs. ACIT [ITA No. 1659, 1689 (Ahm.) of 2015] A.Y.: 2008-09 Date of order: 20th June, 2019

 

Section 9 of the Act – Indian subsidiary
hired facility of Indian parent to develop technology and transferred it to BVI
sister subsidiary at nominal cost – BVI subsidiary transferred it to USA sister
subsidiary in consideration of shares of USA subsidiary – Price of shares was
determined at the time when agreement for transfer of technology was made but
was substantially higher when shares were issued, resulting in huge profit to
BVI subsidiary – On facts, Indian subsidiary not owning infrastructure was not
relevant; BVI subsidiary was not paper company since it owned IPRs and had
pharma registrations; the transaction could not be regarded as colourable
device merely because there was no tax liability in hands of parent company –
Other than section 92, no other provision permits taxing of international
transactions and since AO had not invoked transfer pricing provisions, sale
consideration received by BVI subsidiary could not be taxed in hands of Indian
parent

 

FACTS

The assessee was an
Indian company engaged in the pharmaceuticals business. In the course of
survey, the tax authority found various documents indicating that BVI
subsidiary of the assessee (‘BVI Co’) had transferred certain technology to the
American subsidiary of the assessee (‘USA Co’). BVI Co had acquired the said
technology from another Indian subsidiary of the assessee (‘Tech Co’) which had
allegedly acquired the same from the assessee. The AO noted that the cost of
acquisition of technology for BVI Co was quite nominal as compared to the value
at which BVI Co transferred the same to USA Co and earned substantial gain. As
BVI did not charge tax on income of BVI Co, it did not pay any tax on the gain.

 

The following is a
diagrammatic presentation of the transaction:

The tax authority
recorded the statements of two directors of the assessee admitting that the
assessee had developed the said technology for use of the USA Co. Hence, the AO
issued notice to the assessee to show cause why the profit of BVI on transfer
of technology to the USA Co should not be taxed in its hands.

The assessee explained that:

  •     it had allowed Tech Co to use its R&D
    facility;
  •     factually, the said technology had been
    developed by Tech Co;
  •     Tech Co had paid charges for use of R&D
    facility of the assessee;
  •     the user charges were duly recorded in its
    own books of accounts as well as those of Tech Co;
  •     the AO had ignored various relevant
    documents, such as agreement between BVI Co and Tech Co, agreement between Tech
    Co and assessee, transactions recorded in the books of all parties;
  •     the AO had not found any defect in those
    documents;
  •     accordingly, it was mere presumption on the
    part of the AO that Tech Co had acquired the said technology from the assessee
    and the transaction was routed through Tech Co to evade tax.

 

Concluding that technology was developed by the assessee for transfer to
the USA Co but was routed through Tech Co and BVI Co only to evade tax in
India, the AO taxed the gain from transfer to the USA Co in the hands of the
assessee. The CIT(A) confirmed the addition made by the AO.

 

HELD

The Tribunal considered the following questions:

  •     Whether Tech Co was a
    name-lender in the impugned transactions?
  •     Whether the statements of
    directors recorded u/s 131 were valid?
  •     Whether BVI Co was a paper
    company?
  •     Whether transfer of technology
    was a colourable device?
  •     Whether the sale consideration
    received by BVI Co belonged to the assessee?

 

  1.     Whether Tech Co had merely lent name
    for transfer of technology?
  •     The AO held that Tech Co had
    not developed the technology because it did not own infrastructure for
    development of technology.
  •     The assessee had furnished all
    the necessary documents (including agreements pertaining to use of the R&D
    facility and transfer of the technology) and details of persons who visited the
    infrastructure facility of the assessee for development of the technology. The
    AO had not pointed out any defect in the same.
  •     Based on details about Tech Co
    which were furnished by the assessee to the AO, the AO could have exercised his
    powers to issue notice u/s 133(6) to verify the facts from Tech Co. However, he
    failed to do so.
  •     The observations of the AO
    indicated that Tech Co was     engaged in the development
    of the technology but indirectly as a job worker. Thus, the role of Tech Co in
    the development of the technology could not be ruled out completely as alleged
    by the Revenue.
  •     In the given facts and circumstances,
    whether Tech Co owned infrastructure for development was not relevant. What
    mattered was whether Tech Co or the assessee had developed the technology.
  •     The assessee had also submitted that Tech Co
    was not an associated party in terms of section 40A(2)(b) of the Act.
  •     Tech Co had developed the technology
    pursuant to the agreement with BVI Co. Hence, the assessee had discharged its
    onus.

 

  2.   Whether the
statements of directors recorded u/s 131 were valid?

  •     A statement recorded on oath u/s 131 cannot
    be the basis of any disallowance / addition until and unless it is supported on
    the basis of some tangible material. The CBDT has discouraged its officers from
    making additions on the basis of statements without bringing any tangible
    materials for any addition / disallowance.
  •     Except the statement, the lower authorities
    had not collected any evidence to prove that the transaction was bogus.

 

3.     Whether BVI Co was a paper
company?

  •        Several transactions
    between the assessee and BVI Co were the subject matter of transfer pricing
    adjustments.
  •        Income of BVI Co could be
    taxed in India only if, in terms of section 6(3), it was resident of India
    which was never alleged.
  •     If transaction of sale of
    technology is treated as international transaction between the AEs in terms of
    section 92C, it should be determined on arm’s length basis. However, the AO had
    not invoked the said provision.
  •    BVI Co had various purchase
    and sales transactions with the assessee, which had led to dispute under
    transfer pricing regulations. Further, BVI Co owns IPR and also has
    registrations with USFDA. Merely because BVI Co did not own infrastructure, it
    could not be treated as a paper company.
  •     In the absence of DTAA between
    BVI and India, the transactions between the assessee and BVI Co were subject to
    the provisions of the Act. However, there is no provision under which income of
    BVI Co could be taxed in India.

4.    Whether the impugned
transaction is a colourable device?

  •     If the AO treats sale of technology by Tech
    Co to BVI Co as a colourable device, then it cannot treat one part of the
    transaction as genuine and another part as non-genuine. While the AO treated
    the sale of technology by Tech Co to BVI Co as a colourable device, he accepted
    rent for using facility for development of technology as genuine business
    income.
  •     Merely because there was no tax liability could
    not be the reason for regarding any transaction as a colourable device.

5.  Whether the sale
consideration received by BVI Co belonged to the assessee?

  •     Consideration for supply of technology was
    to be discharged by issue of shares of USA Co to BVI Co.
  •     Share price of USA Co was lower at the time
    when the agreement between BVI Co and USA Co was made, whereas it had increased
    when the technology was delivered to USA Co. As one cannot predict future price
    of shares, increase in price of shares could not be treated as a colourable
    device. Further, since shares of USA Co were listed on the stock exchange, the
    assessee could not have any role in such increase.
  •     Share price at the time of delivery could
    also have been lower. In such case, the AO would not have allowed the loss.
  •     Even if it was assumed that the technology
    was developed by the assessee, income could be taxed in the hands of the
    assessee by treating BVI Co as an AE and determining arm’s length price u/s 92.
    However, the AO did not invoke section 92. Other than section 92, there is no
    provision under the Act to tax international transactions between AEs.
  •     Despite having power to refer the matter to
    the TPO, the AO did not do so. Since it was not referred, normal provisions of
    the Act would apply under which purchase and sale prices between AEs cannot be
    disturbed even if they are not at arm’s length price.
  •     Even if it was assumed that the purpose of
    BVI Co was to divert income of the assessee, then the transaction should be
    treated as between the assessee and USA Co. Such a transaction should be
    subject to section 92C for determining arm’s length price. But the AO failed to
    invoke the provisions of the transfer pricing.

 

By holding the
transaction between the assessee, Tech Co and BVI Co as a colourable device but
charging rent from Tech Co as income of the assessee, the Revenue had taken
contradictory stands. Once a transaction is treated as a colourable device, the
assessee should not have suffered tax on rent. Hence, the AO was directed to delete
the addition made by him.

 

Section 271(1)(c) – Assessee cannot be accused of either furnishing inaccurate particulars of income or concealing income in a case where facts are on record and all necessary information relating to expenditure has been fully disclosed in the financial statements and there is only a difference of opinion between the assessee and the AO with regard to the nature of the expenditure

9 DCIT vs. Akruti Kailash Construction (Mum.) Members: Saktijit Dey (J.M.) and Manoj Kumar
Aggarwal (A.M.) ITA No. 1978/Mum/2018 A.Y.: 2012-13 Date of order: 11th October, 2019

Counsel for Revenue / Assessee: Manoj Kumar
/ Pavan Ved

 

Section
271(1)(c) – Assessee cannot be accused of either furnishing inaccurate
particulars of income or concealing income in a case where facts are on record
and all necessary information relating to expenditure has been fully disclosed
in the financial statements and there is only a difference of opinion between
the assessee and the AO with regard to the nature of the expenditure

 

FACTS

The assessee firm, engaged in the business of property development,
filed its return of income for A.Y. 2012-13 on 31st July, 2012
declaring a loss of Rs. 3,36,32,538. The AO, in the course of assessment
proceedings, noted that the assessee has offered interest income of Rs. 70,492
under the head ‘Income from Other Sources’, whereas it has shown a loss of Rs.
3,43,45,900 under the head ‘Income from Business’. He noticed that the loss was
mainly due to various expenses such as administrative, employee costs, etc.,
which have been debited to the P&L account.

 

The AO held that
since the assessee has undertaken a single development project during the year,
the expenditure should have been capitalised and transferred to
work-in-progress and should not have been debited to the P&L account. The
AO, accordingly, disallowed the loss claimed which resulted in determination of
income at Rs. 5,70,840. The assessee did not contest the decision.

 

The AO initiated
proceedings for imposition of penalty u/s 271(1)(c) alleging furnishing of
inaccurate particulars of income and concealment of income. Rejecting the
explanation of the assessee, he imposed a penalty of Rs. 1,06,12,880 u/s
271(1)(c).

 

Aggrieved, the
assessee preferred an appeal to CIT(A) who allowed the appeal holding that
merely because the expenditure was required to be capitalised would not lead to
either concealment of income or furnishing of inaccurate particulars of income.
He observed that treating the expenditure as WIP is mere deferral of income and
that there was no taxable income and tax payable even after assessment and
thus, there cannot be a motive on the part of the assessee to evade tax. The
CIT(A) deleted the penalty levied by the AO.

 

Aggrieved, the
Revenue preferred an appeal to the Tribunal.

 

HELD

The Tribunal
observed that the AO has neither doubted nor disputed the genuineness of
expenditure incurred by the assessee. In the AO’s opinion, since the
development of the project undertaken by the assessee is in progress, instead
of debiting the expenditure to the P&L account the assessee should have
capitalised it by transferring it to WIP. Thus, it held that there is only a
difference of opinion between the assessee and the AO with regard to the nature
of expenditure. It observed that it is also a fact on record that all the
necessary information relating to the expenditure has been fully disclosed by
the assessee in the financial statements. In such circumstances, the assessee
cannot be accused of either furnishing inaccurate particulars of income or
concealing income. It held that the CIT(A) has rightly held that there is no
dispute with regard to the development of the project by the assessee and
treating the expenses as work-in-progress is merely deferral of expenses.

 

The Tribunal upheld the decision of the CIT(A) in deleting the penalty
and dismissed the appeal filed by the Revenue.

Section 80AC – The condition imposed u/s 80AC of the Act is mandatory – Accordingly, upon non-fulfilment of condition of section 80AC, the assessee would be ineligible to claim deduction u/s 80IB(10) of the Act

8 Uma Developers vs.
ITO (Mum.) Members: Saktijit
Dey (J.M.) and N.K. Pradhan (A.M.) ITA No.
2164/Mum/2016 A.Y.: 2012-13 Date of order: 11th
October, 2019

Counsel for Assessee
/ Revenue: Rajesh S. Shah / Chaudhary Arun Kumar Singh

 

Section 80AC – The condition imposed u/s 80AC of the Act is mandatory –
Accordingly, upon non-fulfilment of condition of section 80AC, the assessee would be ineligible to
claim deduction u/s 80IB(10) of the Act

 

FACTS

The assessee, a partnership firm, in its business as builders and
developers undertook construction of a housing project at Akash Ganga Complex,
Ghodbunder Road, Thane. For the assessment year under dispute (2012-13), the
assessee filed its return of income on 31st March, 2013 declaring
nil income after claiming deduction u/s 80IB(10) of the Act. In the course of
assessment proceedings, the AO while examining the assessee’s claim of
deduction u/s 80IB(10) found that conditions of section 80AC have been
violated, issued show-cause notice requiring the assessee to show cause as to
why the deduction claimed u/s 80IB(10) should not be disallowed. In the said
notice, the AO also alleged several violations of various other conditions prescribed
u/s 80IB(10). The AO also conducted independent inquiry with the Thane
Municipal Corporation. In response, the assessee filed its reply justifying the
claim of deduction u/s 80IB(10). As regards non-compliance with the provisions
of section 80AC, the assessee submitted that the said provision is directory
and not mandatory.

 

The AO was of the
view that as per section 80AC, for claiming deduction u/s 80IB(10) the assessee
must file its return of income within the due date of filing return of income u/s
139(1). He held that since the assessee had not filed its return within such
due date, as per section 80AC the assessee would not be eligible to claim
deduction u/s 80IB(10). The AO also held that certain conditions of section
80IB(10) have also not been fulfilled by the assessee. The AO rejected the
assessee’s claim of deduction u/s 80IB(10).

 

Aggrieved, the
assessee preferred an appeal to the CIT(A) who was of the view that due to
non-compliance with the provisions of section 80AC, the assessee is not eligible
to claim deduction u/s 80IB(10). Since he upheld the disallowance, he did not
venture into other issues relating to non-fulfilment of conditions of section
80IB(10) itself.

 

Aggrieved, the
assessee preferred an appeal to the Tribunal.

 

HELD

The Tribunal
observed that the issue before it lies in a very narrow compass, viz., whether
the condition imposed u/s 80AC is mandatory and, if so, whether on
non-fulfilment of the said condition, the assessee would be ineligible to claim
deduction u/s 80IB(10).

 

It held that on a
reading of section 80AC of the Act, the impression one gets is that the
language used is plain and simple and leaves no room for any doubt or
ambiguity. Therefore, the provision has to be interpreted on the touchstone of
the ratio laid down in the Constitution Bench decision of the Hon’ble
Supreme Court in the case of Commissioner of Customs (Import) vs. Dilip
Kumar & Co. & Ors., C.A. No. 3327/2007, dated 30th July,
2018.

 

Having discussed
the ratio of this decision (Supra), the Tribunal held that
applying the principle laid down in the aforesaid decision of the Supreme Court
to the facts of the present case, it is quite clear that as per the provision
of section 80AC, which is very clear and unambiguous in its expression, for
claiming deduction u/s 80IB(10) it is a mandatory requirement that the assessee
must file its return of income within the due date prescribed u/s 139(1),
notwithstanding the fact whether or not the assessee has actually claimed
deduction in the said return of income. Once the return of income is filed
within the due date prescribed u/s 139(1), even without claiming deduction
under the specified provisions, the assessee can claim it subsequently either
in a revised return filed u/s 139(5) or by filing a revised computation during
the assessment proceeding. In that situation, the condition of section 80AC
would stand complied. The words used in section 80AC of the Act being plain and
simple, leave no room for a different interpretation.

 

Therefore, as per
the ratio laid down by the Supreme Court in the decision cited (Supra),
the provision contained in section 80AC has to be construed strictly as per the
language used therein. Otherwise, the very purpose of enacting the provision
would be defeated and the provision would be rendered otiose.

 

The Tribunal noted
that –

(i)    The Pune Bench of the Tribunal in the case of
Anand Shelters and Developers supports the
condition of the AR that the provision of section 80AC is directory. It
observed that the foundation of this decision is the decision of the Andhra
Pradesh High Court in ITO vs. S. Venkataiah, ITA No. 114/2013, dated 26th
June, 2013, as well as some other decisions of the Tribunal;

(ii)    The Calcutta High Court in the case of CIT
vs. Shelcon Properties Private Limited [(2015) 370 ITR 305 (Cal.)] and
the Uttarakhand High Court in Umeshchandra Dalakot [ITA No. 07/2012,
dated 27th August, 2012 (Uttarakhand HC)] have clearly and
categorically held that the provision contained in section 80AC is mandatory;

(iii)   The Special Bench of the Tribunal in Saffire
Garments [(2013) 140 ITD 6] while considering pari material
provision contained under the proviso to section 10A(1A) of the Act, has
held that the condition imposed requiring furnishing of return of income within
the due date prescribed u/s 139(1) for availing deduction is mandatory.

 

The Tribunal
observed that the Delhi High Court in CIT vs. Unitech Ltd., ITA No.
236/2015, dated 5th October, 2015 while considering a
somewhat similar issue relating to the interpretation of section 80AC has
observed that while the decisions of the Calcutta High Court in Shelcon
Properties Pvt. Ltd. (Supra) and of Uttarakhand High Court in Umeshchandra
Dalakot (Supra) are directly on the issue and support the case of the
Revenue that section 80AC is mandatory, but the Court observed that the
decision of the Andhra Pradesh High Court in S. Venkataiah (Supra) was
one declining to frame a question of law thereby affirming the order of the
Tribunal. Thus, ultimately the Delhi High Court left open the issue whether the
provision of section 80AC is directory or mandatory.

 

The Tribunal also
held that:

(a)   after the decision of the Supreme Court in Dilip
Kumar & Co. & Ors. (Supra) the legal position has materially
changed and the provisions providing for exemption / deduction have to be
construed strictly in terms of the language used therein, and if there is any
doubt, the benefit should go in favour of the Revenue;

(b)   the Pune Bench of the Tribunal, while deciding
the issue on the basis that if there are two conflicting views on a particular
issue, the view favourable to the assessee has to be taken, did not have the
benefit of the aforesaid judgment of the Supreme Court while rendering its
decision;

(c)   the condition imposed u/s 80AC has to be
fulfilled for claiming deduction u/s 80IB(10). Since the assessee has not
fulfilled the aforesaid condition, the deduction claimed u/s 80IB(10) has been
rightly denied by the Department.

 

The Tribunal upheld
the order passed by the CIT(A) and dismissed the appeal filed by the assessee.

 

Section 45 – Capital gains arise in the hands of owners and not in the hands of general power of attorney holder

15 [2019] 72 ITR (Trib.) 578 (Hyd.) Veerannagiri Gopal Reddy vs. ITO ITA No. 988/Hyd/2018 A.Y.: 2008-2009 Date of order: 24th May, 2019

 

Section 45 – Capital gains arise in the
hands of owners and not in the hands of general power of attorney holder

 

FACTS

The assessee, an individual, did not file
return of income for A.Y. 2008-09. The AO, however, received information that
the assessee is holding GPA for certain persons and had sold the immovable
property belonging to them for a consideration of Rs. 8,40,000 against a market
value of Rs. 38,08,000 as per the registration authority. Based on this
information, the assessee’s case was reopened u/s 147.

 

In response to the notice u/s 148, the
assessee did not file return of income. Therefore, the AO issued a notice u/s
142(1) along with a questionnaire requiring the assessee to furnish the details
in connection with the assessment proceedings. In response, the assessee filed
a copy of the sale deed and contended that he has executed the sale deed as a
GPA holder only and has not received any amount under the transaction.

 

The AO observed that the assessee had not
filed any evidence in support of his contention but has filed a reply on 29th
February, 2016 in which he has justified the sale of plot for a sum of Rs.
8,40,000 as against a market value of Rs. 38,08,000. Therefore, the AO held
that the assessee sold the plot to his daughter not only as a GPA holder, but
also as owner of the property and has earned capital gain therefrom. The AO
brought the capital gains to tax.

 

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

 

Aggrieved, the assessee filed an appeal to
the Tribunal.

 

HELD

The Tribunal observed that in the year 1994
the assessee was given a registered irrevocable GPA by landowners and it was
stated therein that the possession was also given to the assessee to enable him
to handover possession to the purchaser. The GPA did not mention about the
receipt of consideration from whomsoever. It was 13 years later that the
assessee executed the sale deed in favour of his daughter and in the sale deed
it was mentioned that a sum of Rs. 8,40,000 was received by the vendors from
the vendee in the year 1994 and the vendor has handed over possession to the
vendee. The Tribunal agreed with the Revenue authorities that it is not
understandable as to why GPA was executed in favour of the assessee when the
entire consideration was received in 1994 and even possession handed over.

 

The Tribunal also noted that the recitals in
the GPA stated that the assessee is not the owner of the property but has only
been granted authority to convey the property to a third party. Therefore, the
Tribunal held that it cannot be considered that the assessee became owner of
the property by virtue of an irrevocable GPA.

 

It held that in the relevant previous year,
the assessee has executed the sale deed in favour of his daughter and in the
sale deed it has been mentioned that the total sale consideration was paid in
the year 1994. This fact also cannot be accepted, because if the entire sale
consideration was paid in the year 1994, then the vendors or even the GPA
holder could have executed the sale deed in favour of the vendee in that year
itself. Therefore, the sale is only in the year 2007 but capital gain would
arise in the hands of the owners of the property and not the GPA holder.

 

It observed that the Hon’ble Supreme Court
in the case of Suraj Lamps & Industries Pvt. Ltd. vs.
State of Haryana (2012) 340 ITR 2 has held that GPA is not a deed of
conveyance and hence cannot be construed as an instrument of transfer in regard
to any right, title or interest in the immovable property. It also considered
the judgment in Wipro Ltd. vs. DCIT 382 ITR 179 (Kar.), which has
considered the above judgment as well as the judgment in the case of State
of Rajasthan vs. Basant Nahata (2005) 12 SCC 77 to hold that a power of
attorney is not an instrument of transfer in regard to any right, title or
interest in an immovable property.

 

The Tribunal held that since the assessee is
not the owner of the property, capital gains cannot be brought to tax in his
hands.

Sections 37, 263 – Foreign exchange loss arising out of foreign currency fluctuations in respect of loan in foreign currency used for acquiring fixed assets should be allowed as revenue expenditure

14 [2019] 111 taxmann.com 189 (Trib.)(Coch.) Baby Memorial Hospital Ltd. vs. ACIT (CPC –
TDS) ITA No. 420/Coch/2019 A.Y.: 2014-15 Date of order: 8th November, 2019

 

Sections 37,
263 – Foreign exchange loss arising out of foreign currency fluctuations in
respect of loan in foreign currency used for acquiring fixed assets should be
allowed as revenue expenditure

 

FACTS

For assessment
year 2014-15, the assessment of total income of the assessee was completed u/s
143(3) of the Act by accepting the income returned. The Pr. CIT, on
verification of records, noticed that the assessment order passed by the AO was
prima facie erroneous insofar as it was prejudicial to the interest of
the Revenue.

 

The Pr. CIT
found that the assessee had claimed an amount of Rs. 2,08,09,140 being foreign
exchange loss which was allowed by the AO. According to the Pr. CIT, the
foreign exchange loss was on account of foreign currency loan taken for the
construction of new building and additional equipment and the loss was
recognised translating the liabilities at the exchange rate in effect at the
balance sheet date. The Pr. CIT said that the loss on devaluation of rupee on
account of loan utilised for fixed capital was not deductible u/s 37(1) since
the expenditure is capital in nature. Therefore, he held that the foreign
exchange loss claimed as revenue expenditure is to be disallowed in the
assessment. The Pr. CIT set aside the assessment and invoked the provision of
section 263 of the I.T. Act inter alia for the limited purpose of
verifying whether the foreign exchange loss qualifies for being a revenue
expenditure.

 

Aggrieved, the
assessee preferred an appeal to the Tribunal where it contended that the case
of an assessee was a limited scrutiny case and in a limited scrutiny case the
details specific to CASS reasons were furnished and were verified. Therefore,
the order of CIT is invalid.

 

HELD

As regards the
challenge of the assessee to the jurisdiction of CIT, the Tribunal held that
even in a case of limited
scrutiny assessment, the AO is duty-bound to make a prima facie inquiry
as to whether there is any other item which requires examination and in the
assessment, the potential escapement of income thereof exceeded Rs. 10 lakhs.
The AO ought to have sought the permission of CIT / DIT to convert the ‘limited
scrutiny assessment’ into a ‘complete scrutiny assessment’. If there is no
escapement of income, which would have been more than Rs. 10 lakhs, the Pr. CIT
could not exercise jurisdiction u/s 263 of the I.T. Act. In the present case,
the assessee itself agreed that the Pr. CIT is justified in giving direction to
rework MAT income after adding back the provision for doubtful debts. Now, the
argument of the learned AR that in case of limited scrutiny assessment, the Pr.
CIT could not exercise jurisdiction u/s 263 is devoid of merit. Accordingly,
the Tribunal rejected the ground relating to challenging of the exercise of
jurisdiction by the Pr. CIT u/s 263.

 

The Tribunal
observed that the question for its consideration is whether gain on account of
foreign exchange fluctuation can be reduced from the cost of assets as per the
provisions of section 43(1). It held that as per the provisions of section
43(1), actual cost means actual cost of the capital assets of the assessee
reduced by that portion of the cost of the capital assets as has been met
directly or indirectly by any other person or authority. The section also has
Explanations. However, the section nowhere specifies that any gain or loss on
foreign currency loans acquired for purchase of indigenous assets will have to
be reduced or added to the cost of assets.

 

After having
considered the ratio of various judicial pronouncements and the
provisions of Schedule VI and AS-11, the Tribunal observed that in view of the
revision made in AS-11 in 2003, it can be said that treatment of foreign
exchange loss arising out of foreign currency fluctuations in respect of fixed
assets acquired through loan in foreign currency shall be required to be given
in profit and loss account. The said exchange loss should be allowed as revenue
expenditure in view of amended AS-11 (2003). The Tribunal observed that the
Apex Court had followed treatment of exchange loss or gain as per AS-11 (1994).
It held that in view of revision made in AS-11, now treatment shall be as per
the revised AS-11 (2003). Exchange gain or loss on foreign currency
fluctuations in respect of foreign currency loan acquired for acquisition of
fixed asset should be allowed as revenue expenditure.

The Tribunal held that –

(a)   in its opinion, section 43A is only relating
to the foreign exchange rate fluctuation in respect of assets acquired from a
country outside India by using foreign currency loans which is not applicable
to the indigenous assets acquired out of foreign currency loans;

(b) foreign exchange loss arising out of foreign
currency fluctuations in respect of loans in foreign currency used for
acquiring fixed assets should be allowed as revenue expenditure by charging the
same into the profit and loss account and not as capital expenditure by
deducting the same from the cost of the respective fixed assets. Hence, in its
opinion, there is no potential escapement of income on the issue relating to
allowability of foreign exchange loan taken for the construction of new
building and additional equipment. Accordingly, this ground of appeal filed by
the assessee is allowed.

 

Section 37 – Lease rent paid for taking on lease infrastructure assets under a finance lease, which lease deed provided that the assessee would purchase them upon expiry of the lease period, was allowable as a deduction since the assets were used exclusively for the purpose of the business of the assessee

13 [2019] 112 taxmann.com 66 (Trib.)(Del.) NIIT Ltd. vs. DCIT (CPC – TDS) ITA No. 376/Del/2014 A.Y.: 2009-10 Date of order: 1st November, 2019

 

Section 37 – Lease rent paid for taking on
lease infrastructure assets under a finance lease, which lease deed provided
that the assessee would purchase them upon expiry of the lease period, was
allowable as a deduction since the assets were used exclusively for the purpose
of the business of the assessee

 

FACTS

The assessee, a public limited company
engaged in the business of Information Technology Education and Knowledge
Solutions, filed its return of income on 29th September, 2009
declaring Rs. 25.81 crores, which was processed u/s 143(1) of the I.T. Act,
1961. The assessee had taken certain infrastructure / movable assets on lease
which were located at three places, i.e., Malleswaram Centre, Bangalore;
Mehdipatnam Centre, Hyderabad; and Mylapore Centre, Chennai. The said lease, in
accordance with the mandatory prescription of AS-19, was recognised as a
finance lease. Accordingly, in the books of accounts, the present value of
future lease rentals was recognised as capital asset with a liability of
corresponding amount.

 

Lease rents payable over the period of the
lease were divided into two parts, i.e., (a) principal payment of its cost of
asset, which was reduced from the liability recognised in the books, and (b)
finance charges, which was recognised as expense and debited to the P&L
account. Accordingly, in the books of accounts, out of the total lease rent of
Rs. 56,73,765 paid by the assessee during the relevant previous year, an amount
of Rs. 50,09,835 was adjusted against the principal repayments towards the cost
of asset and the balance amount of Rs. 6,63,930 was recognised as interest and
debited to P&L account.

 

The AO noticed that in the return of income,
the assessee has claimed deduction of Rs. 50,09,835 in respect of payment of
principal amount of finance lease. The AO asked the assessee to explain as to
how this amount is allowable as revenue expenditure. After considering the
reply filed by the assessee, the AO held that though the interest on such
finance lease is allowable as revenue expenditure, payment of principal amount
cannot be allowed as revenue expenditure because it is capital expenditure in
nature in respect of the value of leased assets. The AO, following the order of
ITAT, Delhi Bench in the case of Rio Tinto India (P) Ltd. vs. Asstt. CIT
[2012] 24 taxmann.com 124/52 SOT 629 disallowed the deduction claimed
by the assessee on account of principal amount of finance lease.

 

Aggrieved, the assessee preferred an appeal
to the CIT(A) who dismissed the appeal by relying on the decision of the
Tribunal in the case of Rio Tinto India (P) Ltd. (Supra).

 

Aggrieved, the assessee preferred an appeal
to the Tribunal.

 

HELD

The Tribunal noted that it is pursuant to
lease agreements dated 1st September, 2006, 1st April,
2008 and 1st June, 2009 that the assessee was provided
infrastructure assets on lease. The assets provided on lease and also the terms
and conditions for granting lease have been recorded in these agreements. The
agreements provided that after termination, the assessee would buy the
infrastructure assets. It observed that the infrastructure assets are required
for the purpose of business of the assessee. Therefore, the assessee paid finance
lease rentals to the lessor for the purpose of business. Thus, the assessee is
not the owner of these infrastructure facilities provided on rent.

 

It also noted that a similar claim of the
assessee on the basis of the same agreements have been allowed in favour of the
assessee in preceding A.Ys. 2007-08 and 2008-09 in the scrutiny assessments u/s
143(3) of the I.T. Act, 1961. In A.Ys.
2012-13 and 2014-15 also, the Tribunal has allowed the claim of the assessee of
a similar nature vide order dated 26th July, 2019.

 

The Tribunal held that –

(i)   it is a well-settled law that rule of
consistency does apply to the income tax proceedings. Therefore, the AO should
not have taken a different view in the assessment year under appeal, when
similar claims of the assessee have been allowed as revenue expenditure in
earlier years;

(ii) since the assessee used these items wholly and
exclusively for the purpose of business and was not the owner of the same,
therefore, the assessee rightly claimed the same as revenue expenditure and
rightly claimed the deduction of the same;

(iii) it is also well settled law that the liability
under the Act is governed by the provisions of the Act and is not dependent on
the treatment followed for the same in the books of accounts;

(iv)        Further, it is also well settled that
whether the assessee was entitled to a particular deduction or not would depend
upon the provisions of law relating thereto, and not on the view which the
assessee might take of his right, nor could the existence or absence of entries
in the books of accounts be decisive or conclusive in the matter.

The Tribunal set aside the orders of the
authorities below and deleted the entire addition. The appeal filed by the
assessee was allowed.

 

Search and seizure – Assessment of third person – Section 153C of ITA, 1961 – Law applicable – Amendment to section 153C w.e.f. 1st June, 2015 – Amendment expands scope of section 153C and affects substantive rights – Amendment not retrospective – Starting point for action u/s 153C is search – Search prior to 1st June, 2015 – Section 153C as amended not applicable

29. Anilkumar Gopikishan
Agrawal vs. ACIT; [2019] 418 ITR 25
(Guj.) Date of order: 2nd
April, 2019 A.Ys.: 2008-09 to
2014-15

 

Search and seizure –
Assessment of third person – Section 153C of ITA, 1961 – Law applicable –
Amendment to section 153C w.e.f. 1st June, 2015 – Amendment expands
scope of section 153C and affects substantive rights – Amendment not
retrospective – Starting point for action u/s 153C is search – Search prior to
1st June, 2015 – Section 153C as amended not applicable


A search u/s 132 of the Income-tax Act, 1961 came to be conducted on
various premises of H.N. Safal group on 4th September, 2013, wherein
a panchnama was prepared on 7th September, 2013. On the basis
of the seized material, the AO initiated the proceedings against the petitioner
u/s 153C of the Act by issuing a notice dated 8th February, 2018. In
response to the notice the petitioner filed return of income on 1st
May, 2018. On 14th May, 2018, the AO furnished the satisfaction note
recorded by him and also attached therewith the satisfaction of the searched
person. From the satisfaction recorded, it was found that no document belonging
to the petitioner was found during the course of search.

 

However, a hard disc was seized and in the Excel sheet data taken from
the computer of the searched person, where there was reference to the
petitioner’s name. The petitioner raised objections to the proceedings u/s 153C
of the Act, inter alia contending that on the basis of the Excel sheet
data of the computer of the searched person wherein there was only reference to
the petitioner’s name, the AO could not have initiated proceedings against the
petitioner u/s 153C of the Act inasmuch as the conditions precedent for
invoking section 153C of the Act as it stood on the date of the search was not
satisfied. By an order dated 23rd July, 2018, the AO rejected the
objections filed by the petitioner. Being aggrieved, the petitioner filed a
writ petition and challenged the order.

 

The Gujarat High Court allowed the writ petition and held as under:

 

‘i)   Section 153C of the
Income-tax Act, 1961 was amended w.e.f. 1st June, 2015 by virtue of
which the scope of the section was widened. By the amendment, a new class of
assessees are sought to be brought within the sweep of section 153C, which
affects the substantive rights of the assessees and cannot be said to be a mere
change in the procedure. The amendment expands the scope of section 153C by
bringing an assessee, if books of account or documents pertaining to him or
containing information relating to him have been seized during the course of
search, within the fold of that section.

 

ii)   The trigger for initiating
action whether u/s 153A or 153C is the search u/s 132 and the statutory
provisions as existing on the date of the search would be applicable. The mere
fact that there is no limitation for the Assessing Officer of the person in
respect of whom the search was conducted to record satisfaction will not change
the trigger point, namely, the date of search. The satisfaction of the
Assessing Officer of the person in respect of whom the search was conducted
would be based on the material seized during the course of search and not the
assessment made in the case of the person in respect of whom the search was
conducted, though he may notice such fact during the course of assessment
proceedings. Therefore, whether the satisfaction is recorded immediately after
the search, after initiation of proceedings u/s 153A, or after assessment u/s
153A in the case of the person in respect of whom the search was conducted, the
trigger point remains the same, viz., the search and, therefore, the statutory
provision as prevailing on that day would be applicable. While it is true that
sections 153A and 153C are machinery provisions, they cannot be made applicable
retrospectively, when the amendment has expressly been given prospective
effect.

 

iii)  The search was conducted in
all the cases on a date prior to 1st June, 2015. Therefore, on the
date of the search, the Assessing Officer of the person in respect of whom the
search was conducted could only have recorded satisfaction to the effect that
the seized material belongs or belong to the person. The hard disc containing
the information relating to the assessee admittedly did not belong to them,
therefore, as on the date of the search, the essential jurisdictional
requirement to justify assumption of jurisdiction u/s 153C in the case of the
assessees, did not exist. The notices u/s 153C were not valid.’

 

 

INDIAN BANKING: HOW BAD ASSETS WERE CREATED AND WHAT THE FUTURE HOLDS

The CEOs of
India’s debt-laden state-owned banks probably celebrated Christmas ahead of its
arrival in December – after an extremely stressful year, relentlessly chasing
rogue corporate borrowers for recovery of the monies lent. Finance Minister
Arun Jaitley played Santa Claus for them by seeking Parliament’s approval for Rs.
410 billion capital infusion in these banks.

 

The government
had budgeted for Rs. 650 billion fund infusion during the current year, of
which Rs. 420 billion is still to be allotted. This means, Rs. 830 billion will
flow into the public sector banks (PSBs), taking the total sum to Rs. 1.06
trillion by March, 2019.

 

In October,
2017, the government had announced a staggering Rs. 2.11 trillion capital
infusion in phases into PSBs that have little less than 70% share of the assets
of the Indian banking industry. The new package, for which Parliament’s nod has
been sought, is part of that.

 

Incidentally,
between 1985-86 and 2016-17, in little over a decade, the government had
injected Rs. 1.5 trillion into these banks; the bulk of this flowed in since
the global financial crisis of 2008, triggered by the collapse of the iconic US
investment bank Lehman Brothers Holding Inc.

 

To ward off the
impact of the crisis, the Reserve Bank of India (RBI) flooded the banking
system with money and brought down the policy rate to a historic low, less than
the savings bank rate which was regulated then. With too much money, coupled
with pressure from various quarters to lift consumption, banks lent recklessly
and that led to the creation of bad assets.

 

IS THE SCENE GETTING BETTER?

 

In September,
2018, after the annual ritual of a review meeting with the chiefs of PSBs,
Jaitley said that non-performing assets (NPAs) with these banks were on the
decline and Rs.1.8 trillion worth of recovery of bad loans could happen during
fiscal year 2019.

 

According to
him, in the first quarter of the year (April-June, 2018), the lenders recovered
Rs. 365.5 billion. This is 49% higher than the corresponding quarter of the previous
year. During the entire 2018 fiscal year, banks recovered Rs. 745.6 billion.
“It’s still early days of the IBC (Insolvency and Bankruptcy Code), but already
the impact is clearly visible,” Jaitley said.

 

He also said
that the NPAs with the PSBs were declining.
“The last quarter saw PSU banks with a net profit. On the basis of the
last quarter and what their expectations are looking ahead, the good news is
that NPAs are on the decline because recoveries have picked up.”

 

Indeed, the
recovery of bad loans at PSBs gained momentum in the June, 2018 quarter; their
operating profits rose and the overall asset quality improved. Besides, the
provision coverage ratio of these banks has gone up to 63.8%, he pointed out.

 

The listed
banks’ kitty of gross NPAs dropped marginally—a little more than 2% from
Rs.10.25 trillion in March to Rs. 10.03 trillion in June. For PSBs, the drop is
2.5%, from Rs. 8.97 trillion to Rs. 8.74 trillion. In September, it dropped
further – Rs. 8.69 trillion.

 

Clearly, the
pace of fresh slippage has slowed. Aided by provision and aggressive
write-offs, the net NPAs of all listed banks have dropped a little over 6%,
from Rs. 5.18 trillion to Rs. 4.85 trillion in June and Rs. 4.83 trillion in
September.

 

Incidentally,
the PSBs’ share in bad loans is far higher than their share in banking assets.

 

All these data
say that things are getting better, but a closer look at some of the banks’ bad
loan pile-ups clearly signal that the party time has not arrived as yet.

 

Let us take a
look at some individual banks. Twelve of the 21 PSBs were in losses in
September, 2018. Among them, IDBI Bank posted loss in 10 of the past 12
quarters, since December, 2015 (when the NPAs of the banking system started
rising following the RBI intervention), to the tune of Rs. 236 billion. The
trio of Indian Overseas Bank, Central Bank of India and Uco Bank have made losses in all 12
quarters (collectively, Rs. 375 billion). Dena Bank and Bank of Maharashtra
seem better off – they have recorded losses in 11 quarters (Rs. 94 billion).

 

Overall, during
this period, the PSBs recorded Rs. 1.84 trillion losses, around 1.2% of India’s
GDP. This also exceeds the total capital infusion in 31 years between 1986 and
2017, one-third of which — Rs. 500 billion — flowed in 2016 and 2017. By the
December quarter, the losses will probably exceed the big bang recap of Rs. 2.1
trillion.

 

Four PSBs’
advance portfolios declined in the September quarter compared with June and, if
we compare them with a year-ago period, as many as 11 of them have shrunk their
loan books. For two of them, the drop is as much as 10% or more. Similarly for
PSBs, the deposit kitties shrank in the September quarter compared with June;
if we compare them with the year-ago period, then seven banks have shrunk their
deposit portfolios. The RBI restrictions do not impact deposit mobilisation.

 

Finally, six
banks’ gross NPAs surged in September from the June level. Ditto about five
banks’ net NPAs. In September, at least one bank (IDBI Bank) had more than 30%
gross NPAs and another five (Uco
Bank, Indian Overseas Bank, Dena Bank, United Bank, Central Bank) more than 20%
but less than 25%, even as six banks had more than 15% gross NPAs. When it
comes to net NPAs, nine of them had more than 10% and up to 17.3%; for a few of
them the asset quality deteriorated further in September.

 

THE NPA SAGA

 

The NPA saga
started in 2014 but gained momentum in 2016 after the Reserve Bank of India
(RBI), under former Governor Raghuram Rajan, instituted an asset quality review
(AQR) whereby the inspectors of the Central bank audited the banks’ loan books
and identified bad assets. The exercise was completed in October, 2015 and the
banks were directed to come clean in six quarters between December, 2015 and
March, 2017.

 

In a detailed presentation
to a Parliamentary Committee, Rajan has explained what went wrong in the Indian
banking system.

 

According to
him, a larger number of bad loans originated in 2006-2008 when the Indian
economy grew at over 9% for three years in a row. “This is the historic
phenomenon of irrational exuberance, common across countries at such a phase in
the cycle.”

 

In the
aftermath of the collapse of Lehman Brothers, the world witnessed an
unprecedented liquidity crisis and India too could not escape the fallout. The
strong demand projections for various projects started looking increasingly
unrealistic as domestic demand slowed down.

 

Around the same
time, a variety of governance problems, such as the suspect allocation of coal
mines coupled with the fear of investigation, slowed down the government
decision-making. As a result of this, cost overruns escalated for stalled
projects and they became increasingly unable to service debt.

 

And, once the
projects got delayed to the extent that the promoters had little equity left in
the project, they lost interest. “Ideally, projects should be restructured at
such times, with banks writing down bad debt that is uncollectable, and
promoters bringing in more equity, under the threat that they would otherwise
lose their project. Unfortunately, until the Bankruptcy Code was enacted,
bankers had little ability to threaten promoters, even incompetent or
unscrupulous ones,” Rajan has said.

 

He has also
mentioned that unscrupulous promoters who had inflated the cost of capital equipment
through over-invoicing were rarely checked and the PSBs continued financing
promoters even as the private sector banks were getting out. Finally, too many
loans were made to well-connected promoters who had a history of defaulting on
their loans.

 

What Rajan has
not mentioned is that most Indian banks do not have the expertise for project
financing. Till the late 1990s when RBI pulled down the walls between
commercial banks and development financial institutions (DFIs) and the DFIs
were allowed to die while the commercial banks turned themselves into universal
banks, these banks were primarily into financing the working capital needs of
corporations. They got into term lending after the demise of DFIs but never
acquired the expertise to do so.

 

Do all these
banks know how to lend? Had they known, they would not be in such a mess.
Typically, the PSB bosses blame the state of the economy for the rise in bad
loans but this is not convincing as the private banks too
operate in the same milieu and many of them have far better asset quality.

 

 

BANK RECAPITALISATION

 

Officially, the
government does not want to treat this as a dole. Both the government and the
RBI seem to be keen that banking reforms and recapitalisation must go
hand-in-hand. In other words, the taxpayers’ money will not be continuously
pumped in just to keep PSBs alive.

 

To put the
story of bank recapitalisation in context, capital is core to banks for
expanding credit, earning interest and growing their balance sheets so that
they can drive economic activities. The government is the majority owner of
PSBs in India. The statutory requirement in the Banking Companies (Acquisition
and Transfer of Undertakings) Act, 1970/1980, and the State Bank of India Act,
1955, ensure that the Indian government shall, at all times, hold not less than
51% of the paid-up capital in such banks.

 

In 2010, the
Cabinet Committee on Economic Affairs (CCEA), after taking into account the
trends of the economy, had decided to raise government holding in all PSBs to
58%. The objective was to create a headroom and enable PSBs to raise capital
from the market when they need it, without compromising their public sector
character.

 

Subsequently,
in December, 2014, the CCEA decided to allow PSBs to raise capital from the public
markets through instruments such as follow-on public offer or qualified
institutional placement by diluting the government holding up to 52%, in a
phased manner.

 

The regulatory
requirements of capital adequacy and credit growth are the two main drivers for
bank capitalisation. The regulatory architecture is globally framed by the
Basel Committee on Banking Supervision — a committee of bank supervisors
consisting of members from representative countries. Its mandate is to
strengthen the regulation, supervision and practices of banks and enhance
financial stability.

 

So far, three
sets of Basel norms have been issued. The Basel I norms were issued in 1988 to
provide, for the first time, a global standard on the regulatory capital
requirements for banks. The Basel II norms, introduced in 2004, further
strengthened the guidelines for risk management and disclosure requirements.

 

This called for
a minimum capital adequacy ratio (CAR) — or, capital to risk-weighted assets
ratio (CRAR) as it is the ratio of regulatory capital funds to risk-weighted
assets — which all banks with an international presence are to maintain. These
norms were revisited again in 2010 — known as Basel III norms — in the wake of
the sub-prime crisis and large-scale bank failures in the US and Europe. Basel
III emphasised on capital adequacy to protect shareholders’ and customers’
risks and set norms for Tier I and Tier II capital.

 

The capital can
come either from their dominant shareholder (the government of India) or the
capital market. The PSBs’ underperformance and the pile of bad loans leading to
low book value come in the way of accessing the capital market. There is a
significant gap between the book value and market value of PSB shares, with
most PSBs having a lower market value, compared with their book values. Hence,
the government as the majority stakeholder needs to step in to rescue PSBs.

 

THE FUTURE TRAJECTORY

 

How long will
it take for the Indian banks to bring down their NPAs? The December, 2017
Financial Stability Report of the RBI, a bi-annual reality check of the Indian
financial system, had suggested that the gross NPAs in the Indian banking
system may rise from 10.2% in September, 2017 to 10.8% in March, 2018, and an
even higher 11.1% by September, 2018. The actual bad loan figure of March, 2018
was higher than the estimate.

 

And the June,
2018 Financial Stability Report said the gross NPAs may rise from 11.6 % in
March, 2018 to 12.2% by March, 2019. Besides, the system-level
capital-to-risk-weighted assets ratio (CRAR) may come down from 13.5% to 12.8%
during the period; 11 public sector banks under prompt corrective action
framework may experience a worsening of their gross NPA ratio from 21% in March
2018 to 22.3% with six PSBs likely experiencing capital shortfall relative to
the required minimum CRAR of 9%.

 

The AQR is just
the beginning of the RBI actions to unearth the mound of NPAs. At the next
stage, the Central bank took a series of steps to force the banks to chase the
defaulters for recovery as well as punish the banks for not doing enough to
clean up their balance sheets.

 

MORE DISCLOSURES

 

In April, 2017, an RBI notification
said, “There have been instances of material divergences in banks’ asset
classification and provisioning from the RBI norms, thereby leading to the
published financial statements not depicting a true and fair view of the
financial position of the bank.” The regulator advised the banks to make
adequate disclosures of such divergences in the notes to accounts in their
annual financial statements.

 

RBI inspectors
found these when they took a close look at the loan books of all banks while
carrying out the asset quality review in 2015.

 

Under the
regulatory norms, when a borrower is not able to service a loan for three
months, it becomes an NPA and the lender needs to set aside money or provide
for it. However, there could be divergence as under certain circumstances, one
can take a “view” on whether a particular loan is good or bad. For instance,
when the principal or interest payment for a particular loan is overdue between
61 and 90 days (and not exceeding 90 days), this becomes a special mention
account-2 ( SMA-2). If a loan exposure continues to be in this category for
months, a prudent banker would prefer to classify it as an NPA even though
technically it can continue to be treated as a standard asset.

 

Then, there are complexities for some of the
restructured infrastructure loans. There have been cases where banks have given
the borrowers more time, depending on the date of commencement of commercial
operations. Many such loans have been restructured twice and continue to be
tagged as standard assets in banks’ books. Often, the date of commencement of
commercial operations is subject to interpretation and the RBI may not be
comfortable with such cases.

 

While
conducting the AQR, RBI inspectors had found many instances of the same loan
exposure being classified as bad by one bank but good by another.

 

The annual
reports of quite a few banks in the past two years showed “divergence” or a
difference – which in some cases was quite huge – between the lender’s
assessment of bad loans and that of the RBI. As a result of this divergence,
the difference in provisioning is also stark and banks have shown lesser NPAs
than what the RBI assessment had suggested. In other words, had there been no
divergence, these banks would have shown lesser profit and higher NPAs.

 

Subsequently,
in May, 2017, the RBI was empowered through an Ordinance to issue directions to
banks to initiate insolvency proceedings against borrowers for resolution of
stressed assets. The Banking Regulation (Amendment) Ordinance, 2017 was
promulgated on 4th May, 2017. This Ordinance empowered the RBI to
direct banking companies to initiate insolvency proceedings in respect of a
default under the provisions of the Insolvency and Bankruptcy Code, 2016 (IBC).
It also enabled the RBI to constitute committee/s to advise banking companies
on resolution of stressed assets.

 

Armed with the
Ordinance, the Central bank in June, 2017 asked banks to initiate insolvency
proceedings against 12 large bank defaulters with a total debt of over Rs. 2
trillion, around 25% of the banking system’s bad assets at that time.

 

It followed
this up in August, 2017 by sending a second list of 28 defaulters to the
lenders to initiate debt resolution before December 13, failing which these
cases would have to be sent to the National Company Law Tribunal (NCLT) before
December, 2017. Between them, these 40 loan accounts have roughly 40% share of
the Rs. 10 trillion bad assets in the Indian banking system.

 

THE FEBRUARY 2018 CIRCULAR

 

Finally, in February,
2018, the RBI tightened its rules on bank loan defaults, sought to push more
large defaulters towards bankruptcy courts and abolished all existing
loan-restructuring platforms. The objective was to speed up the process of
resolution of the bad loans.

 

The recovery
drive for the banking industry started with the Debts Recovery Tribunals
(DRTs), set up under the Recovery of Debts Due to Banks and Financial
Institutions (RDDBFI) Act, 1993. Almost a decade later, the Securitisation and
Reconstruction of Financial Assets and Enforcement of Security Interests
(SARFAESI) Act, 2002 came into force to help banks and financial institutions
enforce their security interests and recover dues. Still, the recovery did not
get momentum. For instance, in 2013-14 recovery under DRTs was Rs. 305.9
billion while the outstanding value of debt sought to be recovered was close to
Rs. 2.37 trillion.

 

The platforms
such as corporate debt restructuring (CDR), strategic debt restructuring (SDR)
and the scheme for sustainable structuring of stressed assets (S4A) which were
used to clean up the bank balance sheets were all abolished late night on 12th
February, 2018.

 

SDR, introduced
in June, 2015, gave banks the power to convert a part of their debt in stressed
companies into majority equity, but it didn’t work because promoters delayed
the restructuring, dangling the promise of bringing in new investors. Before
that, in February, 2014, RBI had allowed a change in management of stressed
companies. The principle of the restructuring exercise was that the
shareholders must bear the first loss and not the lenders; and the promoters
must have more skin in the game.

 

This was done
after the regulator realised that the CDR mechanism, put in place in August,
2001, could not do much to alleviate the pain of the lenders. Any loan exposure
of Rs. 10 crore and more (including non-fund limits) and involving at least two
lenders could have been tackled on this platform.

 

The S4A scheme
allowed the banks to convert up to half the loans of stressed companies into
equity or equity-like securities. Meant for restructuring companies with an
overall exposure of at least Rs. 500 crore, this scheme could come into play
only when the bankers were convinced that the cash flows of the stressed
companies were enough to service at least half of the funded liabilities or
“sustainable debt”. Not much, however, could get resolved under this scheme
either.

 

After ushering
in a new bankruptcy regime in 2016, the RBI got more powers in 2017 to force
the lenders to deal with 40 biggest corporate loan defaulters. The February,
2018 norms took the story forward.

The rules,
released on 12th February, stipulate that starting 1st
March, lenders must implement a resolution plan within 180 days for defaulted
loan accounts above Rs. 2,000 crore. Failing to do so, the account must be
referred to insolvency courts. They also mandate banks to report defaults
weekly to RBI, even if loan payments are delayed by a day. These norms replaced
earlier schemes such as strategic debt restructuring, 5/25 refinancing, the
Corporate Debt Restructuring Scheme, and the Scheme for Sustainable Structuring
of Stressed Assets, among others, with immediate effect. “All accounts,
including such accounts where any of the schemes have been invoked but not yet
implemented, shall be governed by the revised framework,” the RBI said.

 

It warned that
any failure on the part of banks to meet the prescribed timelines, or any
actions they take to conceal the actual status of accounts or evergreen
stressed accounts, will expose banks to stringent actions, including monetary
penalties.

 

The rules
around resolution plans were also tightened and restructuring of large accounts
with loans of Rs.100 crore or more would need independent credit evaluation by
credit rating agencies authorised by the Central bank. Loans of Rs. 500 crore
or more would need two such independent evaluators.

 

NO LONGER IN A DENIAL MODE

 

As a result of
the series of steps taken by the regulator, Indian banks are no longer in
denial mode. Indeed, in the past, they were slow in recognising bad assets as
such recognition hits their profitability since they need to provide for or set
aside money for NPAs. Which is why, traditionally, bankers try hard not to
allow any loan to slip into NPAs through various ways. But the relentless
pressure of the banking regulator has changed the scene. The bankers are not
taking any chances for any loan account any more. Once it’s gone bad, they are
swift in classifying it as an NPA and providing for it.

 

Once shy in
recognition and resolution of NPAs for fear of being hit on profitability and a
backlash from investors, bankers are now bold and walking the extra mile to
settle with loan defaulters. They don’t care much about the depth of the
haircut and impact on their balance sheets.

 

However, this
detoxification exercise has its own challenges through early recognition of
stressed assets and increased provisioning. To add to the banker’s woes,
frequent involvement by investigative agencies, arrests of a few bankers and
stripping the powers of a few others have created a fear psychosis. Bankers are
tending to opt for a relatively safer and optically transparent path, even at
the cost of recovery maximisation.

Today, the
impact of major economic reforms such as Demonetisation, GST, RERA has
stabilised and recognition of the bad loans has largely been done. We are
probably at the final stage of detoxification.

 

Though this
period has been mired by quite a few litigations, which were expected, IBC
being a new legislation, the message has been conveyed aptly to the corporate
world. The IBC has not only provided a legal framework to systematically
address the NPAs of the banking system with a strong armoury to lenders, but
also put borrowers who were looking for an easy escape route from the situation
on the back foot.

 

Japan, which
introduced the bankruptcy law in 2004, takes six months to settle a case and
the recovery rate is close to 93%. For UK, which introduced it in 2002, the
recovery rate is 88.6% and settlement within a year, while US, where insolvency
law is 40 years old, it takes 18 months to settle a case at a recovery rate of
80.4%. It’s still early days in India but the IBC has made a new beginning for
the banking system. With the recovery picking up, albeit slowly, the banks are
being encouraged to lend and support economic growth. The first signs of this
are already visible – the credit growth in India is at a four-year high.

 

 

Section 50C – Proviso to section 50C inserted by Finance Act, 2016 w.e.f. 1.4.2017 being curative in nature is retrospective.

19.  [2018] 100 taxmann.com 334 (Delhi-Trib.) Amit Bansal vs.
ACIT ITA No.:
3974/Delhi/2018 A.Y: 2012-13 Dated: 22nd November, 2018

 

Section
50C – Proviso to section 50C inserted by Finance Act, 2016 w.e.f. 1.4.2017
being curative in nature is retrospective.

 

FACTS


For
the assessment year under consideration, the assessee, an individual filed his
return of income declaring total income of Rs.10,20,270/-. During the year
under consideration, the assessee has shown net profit from sale/purchase of
properties under the head ‘Income from other sources’ at Rs.1,33,200/-. 

 

In
the course of assessment proceedings, the Assessing Officer (AO) asked the
assessee to provide the details of sale and purchase of property as well as to
justify why the income from sale of property is not to be assessed as ‘Capital
gain’ as against the ‘Income from other sources’ treated by the assessee. He
also asked the assessee to justify the impact of section 50C on the said
transaction.

 

The assessee submitted that he has sold the property held
by him jointly with Vikas Bansal on 22nd July, 2011 with net
consideration of Rs. 42 lakh which was purchased by him on 28th
July, 2010 for the sale value of Rs.39,33,600/- and has declared one half share
of profit on sale/purchase of property at Rs1,33,200/-. The assessee further
submitted that he has entered into an agreement to sell the property on 25th
March, 2011 with buyer Phool Pati and taken a part payment of Rs.10 lakh and no
possession was taken on that date. Thereafter, the assessee entered into an
agreement dated 22nd July, 2011 with buyer Phool Pati for final sale
and gave possession of the property in continuation of earlier agreement dated
25th March, 2011 in which the terms of payment were also specified.

 

It
was submitted that there is no registered conveyance deed and the transaction
was entered into just to earn profit from this venture of sale/purchase.
Alternatively, it was argued that the same may be treated as business income as
against ‘Income from other sources’ and not the ‘Capital gains’ in the hands of
the assessee. So far as the application of provisions of section 50C is
concerned, it was submitted that since the transaction is not in the nature of
capital gains, the provisions of section 50C are not applicable.

 

The
AO held that since the agreement of purchase as well as sale of plot involved
the possession of sale of property to be taken or retained in part performance
of a contract of the nature referred to in section 53A of Transfer of Property
Act, 1982, the property was a capital asset as prescribed in section 2(47)(v).
Therefore, it had to be treated as a capital asset and the asset was a
short-term capital asset in the hands of the assessee. The Assessing Officer
further noted that the circle rate of the property as on 22-7-2011 was Rs.
16,000/- per sq. yard as against the circle rate of Rs. 11,000/- as on
25-3-2011. Applying the provisions of section 50C, he determined the full value
of consideration at Rs. 57,21,600/- as against the actual sale consideration of
Rs. 42 lakh. Accordingly, the Assessing Officer determined the short-term
capital gain and made addition.

 

Aggrieved,
the assessee preferred an appeal to the Commissioner (Appeals) who confirmed
the action of the AO including the action of taking the circle rate of Rs.
16,000/- per sq. yard as on 22-7-2011.

 

Aggrieved
the assessee preferred an appeal to the Tribunal where, on behalf of the
assessee, relying on the ratio of the following decisions

(i)  Rahul G. Patel vs. Dy. CIT [(2018) 173 ITD 1
(Ahd. – Trib.)];

(ii) Smt. Chalasani Naga Ratna Kumaris vs. ITO
[(2017) 79 taxmann.com 104 (Vishakhapatnam – Trib.)];

(iii)       Hansaben Bhaulabhai Prajapati vs. ITO,
ITA No.2412/Ahd/2016 (ITAT, Ahmedabad).

 

it
was submitted that in view of the proviso to section 50C(1), where the date of
the agreement fixing the amount of consideration and the date of registration
for the transfer of the capital asset are not the same, the value adopted or
assessed or assessable by the stamp valuation authority on the date of
agreement may be taken and, thus, it had correctly adopted the rates applicable
on the date of the agreement as against the date of actual sale.

 

HELD


The
Tribunal noted that the proviso to section 50C was inserted by the Finance Act,
2016 with effect from 1-4-2017. It observed that the question that has to be
decided is as to whether the above amendment is prospective in nature i.e.,
will be applicable from assessment year 2017-18 or is retrospective in nature being
curative in nature.

 

The
Tribunal noted that identical issue had come up before the Ahmedabad Bench of
the Tribunal in the case of Dharamshibhai Sonani [2016] 75 taxmann.com
141/161 ITD 627 (Ahd. – Trib.) where it has been held that amendment to
section 50C introduced by the Finance Act, 2016 for determining full value of
consideration in the case of involved property is curative in nature and will
apply retrospectively. It then proceeded to observe that various other
decisions relied on by the Ld. counsel for the assessee also support the case
of the assessee that where the date of the agreement fixing the amount of
consideration and the date of registration regarding the transfer of the
capital asset in question are not the same, the value adopted or assessed or
assessable by the stamp valuation authority on the date of the agreement is to
be taken for the purpose of full value of consideration.

The
Tribunal accepted the argument made on behalf of the assessee in principle and
restored the issue to the file of the AO with a direction to verify necessary
facts and decide the issue in the light of the above observations directing to
adopt the circle rate on the date of agreement to sell in order to compute the
consequential capital gain.

 

The
appeal filed by the assessee was allowed.

 

SEBI HOLDS AUDITORS LIABLE FOR NEGLIGENCE/ CONNIVANCE IN FRAUD – DEBARS THEM FOR 5 YEARS

BACKGROUND


Auditors have been the focus of several
regulators, each of whom seek independent and wide powers to take action
against them when they perceive that auditors have not discharged their duties
properly. SEBI has taken action against several auditors of listed companies
where SEBI felt that auditors were negligent, did not discharge duties mandated
by law and / or where there is connivance with the management in fraud, etc.

 

However,
whether and to what extent SEBI has powers to act directly against the
auditors has been controversial. There are several SEBI orders, a report of
consultation committee of SEBI, a detailed decision of the Bombay High Court,
etc., that have differing views. Some of the decisions of SEBI/SAT are under
appeal. SEBI has recently proposed amendments to regulations to prescribe
duties of auditors and the action SEBI can take in the event the prescribed
duties are not discharged. The powers SEBI is seeking may be questioned before
courts particularly on the issue whether the provisions SEBI Act are wide
enough to provide for powers merely by amending the Regulations. Thus, the
coming years will see several developments before a clearer picture emerges.

 

In the meantime, SEBI has passed yet another
order debarring a firm of auditors for 5 years from carrying out any
certification work for any listed company or any intermediary associated with
the capital markets. In the case of C. V. Pabari & Co., (“the Auditors”)
SEBI has passed order No : WTM/MPB/ISD-FAC/57/2018, dated 31st
October 2018 relating to audit of Parekh Aluminex Limited. There are several
findings of erroneous accounting and presentation in financial statements, in
addition to diversion of funds, over valuation, etc., and violations of
provisions of the Companies Act.

The Order also debars for 5 years the
Wholetime Executive Director, who was also earlier the Chairman of Audit
Committee. However, this article focuses on the action taken against the
auditors, on the facts and the reasons provided by SEBI for debarring the
auditors for five years.

 

BROAD BACKGROUND AND SUMMARY OF THE ORDER.


Parekh Aluminex Limited was a company listed
on Bombay stock exchanges. During the period under question (FY 2009-10 to
2010-12), it was alleged that there was wrongful accounting and disclosure in
financial statements, diversion of funds, over valuation of certain assets,
etc. Some time after this period, the main promoter and Chairman/Managing
Director of the Company also passed away. The share price of the Company
plunged from some Rs. 300 to Rs. 10 and the shares were eventually delisted
from the Bombay Stock Exchange.

 

The Auditors who conducted audit of the
accounts during this period resigned. Other firms of auditors were appointed
who too resigned giving reasons such as non-availability of information. It
appears, however, they did submit some reports. A firm was also appointed to
conduct a forensic audit. Based on the interim forensic audit report and other
preliminary findings, SEBI passed an interim order and also served a show cause
notice to the Whole time Director and the Auditors. They were given a hearing
before passing the final order.

 

Let us consider some of the major
allegations made, the defenses given by the Auditors and the order of SEBI and
its reasons.

 

WHETHER SEBI HAS JURISDICTION TO ACT AGAINST THE AUDITORS?

 

An oft made defense by the auditors is that
SEBI does not have any jurisdiction to act against them in respect of their
services to a listed company. However, SEBI rightly cited the decision of the
Bombay High Court in case of Price Waterhouse & Co. vs. SEBI ((2010) 103
SCL 96 (Bom.)). The Court had held, under certain circumstances
particularly where it can be held that the auditors had connived with the
management in fraud, SEBI could take action against the auditors.

 

However, interestingly, SEBI observed that
even if the financial statements have not been drawn up in accordance with the
mandated accounting standards, SEBI could act against the auditors. It
observed, “…if the financial statements have been drawn up without following
the norms and standards of accounting, SEBI has jurisdiction to take regulatory
measures for protecting the investors interest by taking appropriate steps
against the Auditor.”. I submit that this view is not supported by the
decision of the Bombay High Court.

 

ALLEGATION – LOANS / ADVANCES WERE NETTED OFF AGAINST BORROWINGS

 

It was alleged that loans/advances given to
several persons were adjusted against bank loans in the financial statements.
This resulted in loans given and borrowings both being shown lower by more than
Rs. 1000 crores.

 

SEBI sought explanation from the Auditors as
to why such a disclosure was made and whether this was in consonance with
applicable accounting standards.

 

The answer of the Auditors was that the
adjustment and disclosure was made in the financial statements presented to the
Audit Committee and the Board and the final statements were approved by both
without any objections. The Auditor also pointed out that independent audits
were conducted by banks who had not objected to this adjustment. Further, the
banks extended additional loans. It appears, however, they could not provide
any explanation regarding compliance with accounting standards.

 

SEBI rejected the explanations. It stated
that auditors were expected to conduct an independent audit and could not rely
merely on approvals by Audit Committee/Board and ‘rubber stamp’ the accounts.
SEBI, reiterated that the Auditors could also not rely on bank audits as they
are mandated to conduct audit independent of other agencies. Further Auditors
failure to explain how such a practice was in compliance with accounting
standards was also noted.

 

DIVERSION OF FUNDS TO NON- CORE ACTIVITIES

 

The next allegation was that funds of the
company were diverted for non-core activities. It has been alleged that loans
and advances were given for the purposes of real estate which “…is a non-core
activity of the company”. Similarly, it was alleged that “…the company had
transferred money to companies trading in bullion which is diversion of fund as
the company is engaged in the manufacture of aluminum foil related products.”
Other similar diversion of funds was also alleged. In view of this, SEBI
concluded :

u    that the company has
misrepresented its business operations to its shareholders and to the public in
general.”.

u    that PAL has misstated its
accounts in respect of set off of such loans/advances and “diversion” of funds.
?

?

OBSERVATIONS OF SEBI ON ROLE OF AUDITORS

 

While dealing with the defenses offered by
the auditors and generally examining what had happened in the present case,
SEBI made several observations on role of auditors and what acts or omissions
can be held to be actionable:

 

(a)   Auditors are experts in the field of accounts
and finance and should rely on their own expertise and judgment instead of
relying on and accepting accounting treatment by the management. Else, the
whole purpose of certification by them is defeated.

 

(b)  The auditors could not present a due paper
trail for the work they claim to have done in respect of verifying the loan
documents. Hence, their defense on this aspect was rejected.

 

(c)   Auditors should not merely be “rubber
stamping the accounts” and in doing this failed to follow the “minimum
standards of diligence and care as expected of a statutory auditor”.
Auditors thus showed “lack of professional skepticism in auditing the accounts
of the company”.

 

(d)  Considering that in case of listed companies,
public at large, financial institutions (government and private), etc., rely on
report of auditors, “..the duty and obligation of being absolutely diligent
is multiplied manifold and the auditor cannot take such an obligation
casually”.

 

(e)   The investing public relies on the financial
results to make informed decisions. False accounts have direct impact on
securities markets.

(f)   Such alleged large-scale falsification,
following dubious accounting practices for manipulating financial results,
etc., could not happen without “…its statutory Auditor being part of the
manipulative and deceptive device. Even otherwise, by making representations in
a reckless and careless manner whether it is true or false, tantamount to
fraud”. ?

 

Making such observations, SEBI held that
there have been violations of the provisions of the Act and the Regulations
relating to fraud, manipulation etc., and accordingly gave various directions
as mentioned earlier against the auditors.

 

CONCLUSION AND WAY FORWARD

This is just one of several orders passed
against auditors for their alleged participation or connivance in fraud. Most
of the cases are about fraud, the observations and basis for passing of orders
vary and cover a wide area. It needs to be noted that where the auditors have
participated in or ignored fraud/falsification, the provisions in the SEBI
Act/Regulations relating to fraud would get attracted. This area is sought to
be extended to cover cases of negligence, failure to follow accounting
standards, or proper procedures of audit, and lack of professional skepticism.

 

The proposed Regulations by SEBI seeking to
prescribe extend the duties of auditors (and other specified professionals)
discussed earlier will thus need closer attention. These proposed amendments
require auditors to observe the proposed prescribed duties while rendering
services to listed companies and other specified entities associated with the
capital markets. Failure to do so would result in adverse action against them
by SEBI. Thus, SEBI would be able to, if these proposed amendments are made
law, take action against auditors even under situations even where there is no
fraud but there is lack of care, diligence, etc. The issue is : should auditors
face proceedings before multiple regulators and be subject to multiple and
overlapping consequences. It is time that a holistic assessment of the whole
issue is made and action against the auditors is through a single regulator,
under clear pre-defined and rational guidelines.   

 

 

WE CHOOSE

‘Choice, not chance determines your destiny’

Aristotle

 

These words
mean a lot. There is substance in these words and the substance is Commitment.
We must reckon that choice and challenge are twins more like Siamese
twins not capable of being separated.

 

Every choice
comes with an opportunity and appended risks. Hence, every choice is a risk.
There is no success unless we choose. However, action based on choice backed by
commitment and effort achieves success, for example : Tilak and Gandhi’s call
for Swaraj backed by commitment and effort gave us Independence and John
Kennedy’s call to get man to moon in 1962 was not mere words or rhetoric but
was backed by national resources and national effort.

 

Let us consider
a few instances of choice :

  •    As a nation we chose independence. We chose
    partition. We chose secularism and then we chose Mandal which has led to the
    division of society – instead of having a cohesive outlook we have divided
    ourselves by caste, colour and creed. Ironically, this is not what the framers
    of our Constitution and seekers of independence dreamt of. Their aim was to
    create a cohesive society – whereas today we have a fractured society.
    The present state is the result of what our leaders chose. Virtually every
    section of society is seeking reservation for government jobs and educational
    opportunities. There are protests; quite a few are violent which damage public
    property. The issue is : can society choose to accept violence!
  •    One’s choice to have harmony in a family is
    to choose to sublimate individual ambition for achieving progress and happiness
    of the family.
  •   Business and organisation though based on an
    individual’s (CEO or owners) vision is created through team work hence the
    visionary chooses to create an institution which is guided by the visionary but
    is not individual centred.
  •    Prime Minister Modi’s vision of India based
    on ?Sabka Saath Sabka Vikas’ is based on the choice of co-operation with
    dissenting political parties.
  •    One’s choice to become a chartered accountant
    was based on one’s commitment to hard work, go through a period of training and
    pass one of the toughest exams.
  •    We chose to be chartered accountants because
    we choose to serve stakeholders and provide the stakeholders with true and fair
    financial statements. We have chosen to accept a social responsibility.

 

There are
choices we make in every aspect of our life. Every decision in our life is a
choice. The issue is : what is the base of our choice. In my view choice
should be based on discrimination, detachment and discussion. Decision based on
emotion can be wrong but decisions based on the three Ds are rational
and yield the desired results. Discussion could be with yourself, your mentor,
friend, relative or your team. I believe before discussing with others
discussion with one’s oneself or one’s own self is very relevant.

 

The issue is
: can we live – nay
exist without choice – I perceive that two times an individual does not have a
choice – is the time of birth and death. Choice is an integral part of our
existence. Metaphorically speaking it is rightly said : one can choose friends
but has no choice as to parents and siblings. It is one’s choice to enjoy them
or suffer them. Further, one has the choice of learning from one’s mistakes
rather than crib and wail over them. Above all one has the choice of
complaining and being dissatisfied or accepting the environment and being
satisfied and happy.

 

I would
conclude by quoting Byron Grant,

            ‘Being a man or woman is a matter
of birth.

            Being a man or woman who makes a
difference

            is a matter of choice‘

In short, it is only a happy person who can make a
difference.  

FAMILY SETTLEMENTS – PART I

INTRODUCTION

Maximum disputes
take place within family members rather than among strangers! Family fights have been popular in India right from the times of
“the Mahabharata”. The fight between the Kauravas and the Pandavas is something
which several Indian families witness on a regular basis. As family businesses
grow, new generations join the business, new lines of thinking originate,
disputes originate between family members and gradually it gives rise to a
family settlement / arrangement.

 

Corporate India has
witnessed a spate of family feuds in almost all major corporate houses.   A family arrangement is one of the oldest
alternative dispute resolution mechanisms which is known. The scope of a family
arrangement is extremely wide and is recognised even in ancient English Law.
This is because the world over, Courts lean in favour of peace and amity within
the family rather than family disputes. 
In the last about 60 years, a good part of the law relating to Family
Arrangement / Settlement is well settled through numerous court decisions
including several decisions of the Supreme Court. It is ironic that in a
country where a substantial part of businesses are run and owned by joint
families, there is no legislation which governs or regulates such family
settlements or arrangements. Hence, the entire law in this respect is case-law
made. 

       

WHAT IS A FAMILY SETTLEMENT / ARRANGEMENT? 

It is important to
analyse the basic principles governing family settlement involving properties
held mainly by individuals. Various Courts, including the Supreme Court of
India, have laid down the basic principles relating to family arrangements. Halsbury’s
Laws of England also lays down some important principles in this respect:

 

“The agreement
may be implied from a long course of dealing, but it is more usual to embody or
to effectuate the agreement in a deed to which the term “family
arrangement” is applied. Family arrangements are governed by principles
which are not applicable to dealings between strangers.

 

When deciding
the rights of parties under a family arrangement or a claim to upset such an
arrangement the court considers what in the broadest view of the matter is most
in the interest of the family, and has regard to considerations which, in
dealing with transactions between persons not members of the same family, would
not be taken into account. Matters which would be fatal to the validity of
similar transactions between strangers are not objections to the binding effect
of family arrangements. …………”

 

CONCEPTS AND PRINCIPLES OF FAMILY ARRANGEMENTS / SETTLEMENT

From the analysis
of the numerous judgments, such as Maturi Pullaiah vs. Maturi Narasimham,
AIR 1966 SC 1836; Sahu Madho Das vs. Mukand Ram, AIR 1955 SC 481; Kale vs. Dy.
Director of Consolidation, (1976) AIR SC, 807; Hiran Bibi vs. Sohan Bibi, AIR
1914 PC 44; Hari Shankar Singhania vs. Gaur Hari Singhania (2006) 4 SCC 658,
etc., the concepts and principles of family arrangement are summarised
below :

 

(a)   A
family arrangement is an agreement between members of the same family intended
to be generally and reasonably for the benefit of the family either by
compromising doubtful or disputed rights or by preserving the family property
or the peace and security of the family by avoiding litigation or by saving its
honour.

(b)    If the arrangement of compromise is one
under which a person, having an absolute title to the property, transfers his
title in some of the items thereof to the others, the formalities presented by
law have to be complied with since, the transferees derive their respective
title through the transferor. If, on the other hand, the parties set up
competing titles and differences are resolved by the compromise, there is no
question of one deriving title from the other and, therefore, the arrangement
does not fall within the mischief of section 17 read with section 49 of the
Registration Act, as no interest in property is created or declared by the
document for the first time. It is assumed that the title had always resided in
him or her, so far as the property falling to his or her share is concerned,
and therefore, no conveyance is necessary.

(c)    A
compromise or family arrangement is based on the assumption that there is an
antecedent title of some sort in the parties and the agreement acknowledges and
defines what that title is, each party relinquishing all claims to property
other than that falling to his share and recognising the right of the others,
as they had previously asserted it, to the portions allotted to them
respectively. That explains why no conveyance is required in these cases to
pass the title from one in whom it resides to the person receiving it under the
family arrangement. It is assumed that the title claimed by the person
receiving the property under the arrangement had always resided in him or her
so far as the property falling to his or her share is concerned and therefore
no conveyance is necessary.

 

It does not mean
that some title must exist as a fact in the persons entering into a family
arrangement. It simply means that it is to be assumed that the parties to the
arrangement had an antecedent title of some sort and that the agreement
clinches and defines what that title is.

(d)    A compromise by way of family settlement is
in no sense an alienation by a limited owner of family property. Once it is
held that the transaction being a family settlement is not an alienation, it
cannot amount to the creation of an interest. For, in a family settlement each
party takes a share in the property by virtue of the independent title which is
admitted to that extent by the other parties. 

(e)    In the usual type of family arrangement,
unless any item of property which is admitted by all the parties to belong to
one of them is allotted to another, there is no ‘exchange’ or other transfer of
ownership.

(f)     By virtue of a family settlement or
arrangement members of a family descending from a common ancestor or a near
relation seek to sink their differences and disputes, settle and resolve their
conflicting claims or disputed titles once for all in order to buy peace of
mind and bring about complete harmony and goodwill in the family. Family
arrangements are governed by a special equity peculiar to themselves, and will
be enforced if honestly made.          

           

The object of the
arrangement is to protect the family from long-drawn out  litigations or perpetual strifes which mar
the unity and solidarity of the family and create hatred and bad blood between
the various members of the family.

 

A family settlement
is a pious arrangement by all those who are concerned. A family settlement is
not within the exclusive purview of Hindus, but applies equally to various
other communities also, such as Parsis, Christians, Muslims, etc.

(g)    The term “family” has to be
understood in a wider sense so as to include within its fold not only close
relations or legal heirs but even those persons who may have some sort of
antecedent title, a semblance of a claim.

 

It is not necessary
that the parties to the compromise should all belong to one family. The word
‘family’ in the context of a family arrangement is not to be understood in a narrow
sense of being a group or a group of persons who are recognised in law as
having a right of succession or having a claim to a share in the property in
dispute. If the dispute which is settled is one between near relations then the
settlement of such a dispute can be considered as a family arrangement.

 

Even illegitimate
and adopted children would be covered within the broader definition of the term
“family”. Thus, a settlement arrived at in relation to a dispute between
legitimate and illegitimate children would also be covered within the ambit of
a family settlement. Children yet to be born may also be covered.

(h)    Courts have made every attempt to sustain a
family arrangement rather than to avoid it, having regard to the broadest
considerations of family peace and security. It is not necessary that every
party taking benefit under a family settlement must necessarily be shown to
have, under the law, a claim to a share in the property. All that is necessary
is that the parties must be related to one another in some way and have a
possible claim to the property or a claim or even a semblance of a claim on
some other ground as, say, affection.

(i)     The said settlement must be voluntary and
should not be induced by fraud, coercion or undue influence.

(j)     The family settlement must be a bona
fide one so as to resolve family disputes and rival claims by a fair and
equitable division or allotment of properties between the various members of
the family. The bona fides and propriety of a family arrangement have to
be judged by the circumstances prevailing at the time when such settlement was
made.

(k)    Even if bona fide disputes, present
or possible, which may not involve legal claims are settled by a bona fide
family arrangement which is fair and equitable the family arrangement is final
and binding on the parties to the settlement. 

 (l)    It
is not necessary that there must exist a dispute, actual or possible in the
future, in respect of each and every item of property and amongst all members
arrayed one against the other. It would be sufficient if it is shown that there
were actual or possible claims and counter-claims by parties in settlement
whereof the arrangement as a whole had been arrived at, thereby acknowledging
title in one to whom a particular property falls on the assumption (not actual
existence in law) that he had an anterior title therein. 

(m)   The consideration for such a settlement, if
one may put it that way, is the expectation that such a settlement will result
in establishing or ensuring amity and goodwill amongst persons bearing
relationship with one another.

(n)    The family arrangement may be even oral.

(o)    A family arrangement might be such as the
Court would uphold although there were no rights in dispute, and if sufficient
motive for the arrangement was proved, the Court would not consider the
adequacy of consideration.

(p)    If in the interest of the family properties
or family peace the close relations settle their disputes amicably, the Court
will be reluctant to disturb the same. The Courts lean strongly in favour of
family arrangements that bring about harmony in a family and do justice to its
various members and avoid, in anticipation, future disputes which might ruin
them all.

(q)    The essence of a family arrangement is an
agreement on some areas of dispute by the family members. The agreement is for
the benefit of all the members. The ultimate aim of the agreement is to
preserve amity and goodwill within the family and avoid bad blood. However,
every document cannot be styled as a family arrangement. For example, if the
patriarch of a family makes a will under which he divides his personal shares
in various businesses and family properties among his family members, then the
same cannot be called a family arrangement as it is merely a distribution of
the deceased’s estate as per his will. One of the key requirements for a family
arrangement is the existence of a dispute or a possible dispute. Under a will,
there is no consideration for the acceptance of arrangement.

(r)     A family settlement is different from an
HUF partition. While an HUF partition must involve a joint Hindu family which
has been partitioned in accordance with the Hindu Law, a family arrangement is
a dispute resolution mechanism involving personal property of the members of a
family who are parties to the arrangement. A partition does not require the
existence of disputes which is the substratum for a valid family arrangement.
An HUF partition must always be a full partition unlike in a family settlement.         

(s)    The question of whether a Muslim family can
undergo a family settlement has been the subject matter of various judicial
decisions. All of these have upheld the validity of the same.

(t)     If one of the family members voluntarily
gives up his share in the joint family property, i.e., he styles a gift deed as
a deed of family settlement, then it is not a case of a valid family
arrangement. Any settlement which does not envisage a dispute cannot be a
settlement. 

(u)    If the terms of the settlement are clear and
unambiguous and are not impossible to perform, then the plea of practical
inconvenience cannot be raised at the stage of implementation. That factor must
be considered at the stage of entering into the settlement and not later.

(v)    Principles governing a family settlement are
different from commercial settlement. These are governed by a special equity
principle where the terms are fair and bona fide taking into
consideration the well-being of the family. Technical considerations like the
law of limitation should give way to peace and harmony in the enforcement of
settlements. The duty of the court is that such an arrangement and the terms
should be given effect to in letter and spirit. 

(w)    Consideration is one of the important
aspects of any contract. Under the Indian Contract Act, any contract without
consideration is null and void. In the case of a family settlement, the
consideration is the giving up of mutual claims and rights and love and
affection. In India, the Courts do not enquire into the adequacy of consideration
as in the case of USA. 

 

EXAMPLES OF A VALID / INVALID FAMILY SETTLEMENT.

(a)    A father has started a
business in which he is later on joined by his two sons. All the assets and
business interests are jointly owned by the family. After several years,
disputes arise between the two sons as to who is in command and who owns which
property. This leads to a lot of bad blood and ill-will within the family. In
order to buy peace and avoid unnecessary litigation, the father, the two sons
and their families effectuate a family settlement under which all the
businesses and properties are equally divided between the two brothers’
families. This is a valid family settlement and would be recognised in a court
of law.

(b)    A father and son are joint in business. The
son has played an active role in the business and in creating the wealth. After
many years, the two develop a bitter dispute over various issues with the
result that the son wants to opt out of the business. The son gives up all his
rights and interest in the family properties and in return for the same the
father pays him some money. This is a valid family settlement.

(c)    A family settlement is purported to have
been executed by all the family members of a particular family. However, the married
daughter has not signed the family settlement MOU. In such a case, it cannot be
said that the family settlement would bind the daughter – Sneh Gupta vs.
Devi Sawarup(2009) 6 SCC 194.    

 

WHAT PROPERTIES CAN BE COVERED? 

From the various
principles laid down regarding valid family arrangements, it is clear that
valid family arrangements can relate to self-acquired properties, or other
properties of the family. It is neither a pre-requisite nor even a necessary
condition that a valid family arrangement must relate to ancestral property
only. An analysis of the various Case Laws, such as, H. H. Vijayaba,
Dowager Maharani Saheb, 117 ITR, 784 (SC); Narayandas Gattani, 138 ITR 670
(Bom); Ziauddin Ahmed, 102 ITR 253 (Gau); Shanti Chandran, 241 ITR 371 (Mad),
etc., reveals that even where the property involved in the family settlement
was other than an ancestral property, and the family arrangements were held to
be valid:

 

(a)    The property involved was that of the
relatives of the partners of a firm, which firm had mounting creditors.  These relatives conveyed their properties for
the benefit of the creditors of the firm to discharge debts incurred by the
firm. It was held that the conveyance amounted to a valid family arrangement
and hence was not exigible to gift tax.

(b)    An oral family arrangement, made by father,
during his lifetime, under which he directed a larger share to one son out of
his self-acquired non-ancestral property was held to be a valid family
arrangement.

(c)    The property involved was certain joint
family land.  Major part of the property
was apportioned to the sons of the Karta. It was held that the transaction was
a family settlement.

(d)    Payments promised under a family arrangement
to be made to the assessee’s son out of the assessee’s private property, was
held to be a valid family arrangement.

 

(to be continued…..)

GLOBAL TAX DEVELOPMENTS – AN UPDATE

In recent years,
there has been a flurry of developments in the International Taxation field in
the arena of taxation of Digital Economy, Preventing Base Erosion & Profit
Shifting (BEPS), particularly after publication of BEPS Reports in October 2015
and signature of Multilateral Instruments by various Tax Jurisdictions.
Investigations are being conducted by various affected Tax Jurisdictions
particularly into tax evasion and tax avoidance through the use of Offshore UK
Jurisdictions and other Tax Havens. In this issue, we have attempted to capture
such major developments of particular interest to Indian Tax payers and their
tax Advisors.

 

1.  GOOGLE, APPLE, FACEBOOK AND AMAZON (GAFA) TAX- FRANCE’S NEW DIGITAL TAX ON TECH GIANTS

The French
government’s GAFA tax is being introduced to combat attempts by the firms to
avoid paying what is considered a “fair share” of taxes in the
country, by taking advantage of European tax laws.

 

With efforts to
reform a European Union (EU) tax law not bringing the desired results, France
is going to introduce from 1st January 2019 a digital tax on
technology giants such as Google, Facebook, Apple and Amazon. The new tax
regime is expected to bring in an estimated 500 million euro ($570 million) to
the country’s coffers for 2019. Major technology companies have come under the
scrutiny of lawmakers in countries like France and Britain for allegedly
routing profits through operations in countries with extremely low tax rates or
other arrangements. Earlier this year, the European Commission published
proposals for a three per cent tax on the revenues of major tech companies with
global revenues above 750 million euro a year and taxable EU revenue above 50
million euro.


But to become law, EU tax reforms need the support of all member states. And
some countries, including Ireland, the Czech Republic, Sweden and Finland are
yet to come on board to bring the reforms.

 

2.  EU’S EXPANDED TAX HAVEN BLACKLIST COULD APPLY TO US.

2.1  Black List

The European Union
plans to update its year-old blacklist of tax havens to include new criteria
and an expanded geographic reach—possibly all the way to the U.S. The bloc has
previously threatened that the U.S. could end up on the blacklist, along with
the likes of Guam and Trinidad and Tobago, unless it adopts stricter financial
reporting standards and agrees to share that information with other tax
authorities.

 

The 2019 blacklist
of tax havens will include those that haven’t adopted the Organisation for
Economic Cooperation and Development’s Common Reporting Standard, like the U.S.
The standard calls on countries to obtain information from their financial
institutions and automatically exchange it with other countries every year.

The EU’s goal is to
flag jurisdictions that have failed to make sufficient commitments to
increasing tax transparency and reducing preferential tax measures. Its overall
goal is to eliminate tax avoidance and fraud. Countries on the blacklist could
face sanctions—measures the EU has discussed include imposing withholding taxes
on any funds moved from the EU to a country on the list.

 

What started out as
a list of 17 countries in December 2017 is down to six. Besides the U.S. Virgin
Islands, the others, including Samoa, American Samoa, Guam and Trinidad and
Tobago have insignificant financial centers.

The new criteria
for the blacklist adopted for 2019 will require countries to apply the OECD’s
base erosion and profit shifting minimum standard—requiring companies with a
$750 million global turnover to report country-by-country tax and profits to
national tax authorities. The EU is also negotiating new rules to require
countries or independent territories to apply transparency standards to publish
the beneficial owners of companies. Most EU officials, tax experts and advocacy
groups expect 2019 to be crucial because the bloc must decide how to deal with
the U.S. There were several other tension points between the EU and the U.S. in
2018. The bloc accused the U.S. of violating trade rules through some of its
international tax reform provisions, and the U.S. opposed the bloc’s proposal
to tax digital companies.

 

Some EU politicians
and tax advocacy groups insist that the EU gets either a failing grade or an
“I” for incomplete in its tax haven blacklisting process. For others, the first
year of the EU tax haven process has made a mark as part of an overall trend
away from the use of offshore financing centers in places like the Channel
Islands or the Caribbean. There is a general pressure on companies using
offshore financial centers, driven by politics, popular media and multinational
organisations such as the OECD.

So far, the process
has been an overall failure because the process has been unfair or
inconsistent. When there are tax havens within the EU and they are not on the
list it makes, it hard to go after others outside the EU.

 

The EU Code of
Conduct Group for Business Taxation, made up of officials from EU member
nations, has the final say on which countries end up on the EU list. It
excludes members of the European Parliament. There is a situation where the
United States does not meet the transparency criteria but the EU member states
have decided to ignore that. This goes to show that the process is political.

 

2.2  Grey list

Although the
current EU tax haven blacklist only contains six countries and jurisdictions,
the EU member states agreed a year ago to establish a grey list. This is a
roster of countries, which include more than 50 countries, that currently don’t
comply with EU transparency and fair corporation criteria but made commitments
to do so by the end of 2018. EU member nations are due to decide by March 2019
whether the gray list countries have either met their commitments or should be
placed on the blacklist.

 

The gray list has
been positive in pushing countries to reform harmful tax practices and has for
the first time addressed the issue of zero tax regimes. Indeed one of the most
critical issues the EU must decide in the coming months is whether countries or
jurisdictions with zero corporate tax rates have substantial “economic
substance” on the ground to justify the multinational corporations using their
territory as a headquarters. The goal is to clamp down on letterbox companies.

 

2.3 Economic
Substance Requirements

The EU is
succeeding in the Channel Islands and in other territories as of 1st January
2019. Guernsey and Jersey are introducing substance requirements for tax
resident companies carrying out relevant activities.

 

The Cayman Islands,
one of the world’s largest offshore centers for fund management, is another
territory on the EU gray list. It has also recently adopted “economic substance”
requirements for any company that uses its territory for its headquarters.

 

2.4   The Isle of Man (IOM)

The IOM Parliament
has approved tax legislation that will allow the jurisdiction to avoid being
put on the European Union’s blacklist. This means that from January 2019,
companies engaging in “relevant activities” will have to demonstrate
that they meet specific substance requirements, to avoid sanctions.

Its focus will be
on business sectors identified by the EU including banking, insurance, shipping,
fund management, finance and leasing, headquartering, holding companies,
distribution and service centres and intangible property.

 

This Order follows
a comprehensive review that was carried out by the EU Code of Conduct Group on
Business Taxation (COCG) in order to assess over 90 jurisdictions, including
the IOM against standards of tax transparency, fair taxation and compliance
with anti-BEPS Reports.

 

The review process
took place in 2017 and although the COCG were satisfied that the IOM met the standards
for tax transparency and compliance with anti-BEPS measures, the COCG raised
concerns that the IOM, and other Crown Dependencies did not have “a legal
substance requirement for entities doing business in or through the
jurisdiction.”

 

The IOM is currently
on the EU’s greylist of jurisdictions that have committed to undertake specific
reforms to their tax practices before the end of the year. Without this Order
it would have been placed on a blacklist and faced sanctions as well as
reputational damage.

 

The legislation
will require companies that are tax resident in the IOM and which operate in
these business sectors to demonstrate a minimum level of substance here.
Substance requirements are set out in the legislation and some of the
requirements vary according to the business sector.

 

2.5  Economic Substance Legislation in Jersey

Jersey has tabled
new laws to address the EU’s concerns over ‘economic substance’, the degree of
real business activity carried out by companies registered in the Island.

The new proposed requirements for an economic substance test for Jersey
tax-resident entities have been published and are set to come into force on 1st
January 2019 subject to States approval. The reforms include establish
new tests for certain tax resident companies carrying on “relevant activities”
in respect of demonstrating that they are “directed and managed” in Jersey, and
that their “core income generating activities” are undertaken here.

 

Last year the
Island avoided being placed on a new ‘blacklist’ of non-cooperative
jurisdictions drawn up by the EU Code of Conduct Group on business taxation,
but was among more than 40 regimes asked to reform their tax structures to
ensure compliance with standards, which was dubbed a ‘grey-list’ by some
commentators.

 

The EU wants Jersey
to show it has economic substance by ensuring the taxes it collects within the
financial services sector were generated through real economic activity in the
territory. In other words, proof that an offshore company is paying taxes in
Jersey because it largely does its work and earns its profits in/from Jersey.

The EU list, first
published in December 2017, was divided into three sections: i) cooperative
jurisdictions ii) non-cooperative jurisdictions and iii) jurisdictions that had
undertaken to modify their tax regimes to comply with the rules set by COCG.

 

Many of these ‘grey-listed’ jurisdictions operate tax transparency
regimes that are at least as good as the white-listed ‘cooperative’
jurisdictions, but fell foul of the COCG’s additional criterion that businesses
should only be granted tax residence in a jurisdiction once they demonstrate
they have adequate economic substance there.

 

The blacklist is to
be revised at the end of this year, and grey-listed jurisdictions such as Jersey
are at risk of being moved onto it if they do not act soon. Jurisdictions which
are blacklisted could face sanctions and risk reputational damage.

The other Crown
Dependencies, Guernsey and the Isle of Man, were also consulted and are due to
table similar draft laws soon. Affected companies should review outsourcing
arrangements (where relevant) in respect of Jersey tax-resident companies that
fall within the scope of the new law and whether the third-party service
provider agreements in place meet the tests set out therein.

 

3.  OFFSHORE UK JURISDICTIONS REACT TO LATEST TAX AVOIDANCE INQUIRY

Officials from
Britain’s overseas territories and Crown Dependencies said they were prepared
to cooperate with the latest UK government investigation into tax evasion and
avoidance, but some expressed surprise that it was felt necessary. They pointed
to a raft of new regulations, including the Common Reporting Standard – an
automatic information exchange regime currently coming into force globally –
new and pending additional rules on beneficial ownership registers, and the
UK’s Retail Distribution Review, which they argue have transformed the
so-called offshore financial services industry over the last few years.

 

The UK Parliament’s
Treasury Sub-Committee has announced a “Tax Avoidance and Evasion inquiry” into
“what progress has been made in reducing the amount of tax lost to avoidance
and offshore evasion”, and whether HM Revenue & Customs (HMRC) currently
“has the resources, skills and powers needed to bring about real change in the
behaviour of tax dodgers, and those who profit by helping them”.

 

In his piece for The Guardian, John Mann, a Labour Party MP who
is Chairman of the Sub Committee overseeing it, noted that the British Virgin
Islands, Jersey, Guernsey, the Isle of Man, Bermuda and the Cayman “are on the
EU greylist of uncooperative tax jurisdictions”, and added: “We should regard
it as a matter of national shame that the crown dependencies and overseas
territories that fly our flag give shelter to the wealth of the world’s
financial elite.”

 

In a document
posted on Parliament’s website, the Sub-Committee investigating the tax haven
matters invites comment on six questions as follows:

 

i)     To what extent has there been a shift in
tax avoidance and offshore evasion since 2010? Have HMRC efforts to reduce
avoidance and evasion been successful?

ii)    Is HMRC adequately resourced and
sufficiently skilled to identify, challenge and counteract existing and new
avoidance schemes and ways of evading tax? What progress has it made since 2010
in promoting compliance in this area and preventing and responding to
non-compliance?

iii)    What types of avoidance and evasion have
been stopped, and where do threats to the UK tax base remain?

iv)   What part do the UK’s Crown Dependencies and
Overseas Territories play in the avoidance or evasion of tax? What more needs
to be done to address their use in tax avoidance or tax evasion?

v)    How has the tax profession responded to
concerns about its role in aiding tax avoidance and evasion?

vi)   Where does it [the tax profession] see the
boundary between acceptable and unacceptable practice lie?

 

3.1 Guernsey

The States of Guernsey’s
Policy & Resources Committee, noted in a statement that the EU Council of
Finance Ministers (ECOFIN) had reaffirmed that Guernsey “was a cooperative
jurisdiction in respect of taxation, following a screening against principles
of tax transparency, fair taxation and anti-base erosion and profit shifting”
and that it had also formally “committed to the OECD anti-BEPS initiative, and
in 2017 signed the multilateral convention”.

Guernsey had
committed to address certain outstanding ECOFIN concerns relating to “economic
substance requirements in respect of the analysis of fair taxation” this year,
but the OECD’s Global Forum had assessed the jurisdiction’s tax transparency
standards generally, and found them to “exceed the required standard”, the statement
added.

 

It is also claimed
that Guernsey also meets international standards in respect of the sharing of
beneficial ownership information…and in 2017 went further by establishing a
register of beneficial ownership and putting in place arrangements to share
this information with UK law enforcement authorities.

 

3.2 Jersey – No safe harbour for rogue operators

A spokesperson for
the States of Jersey said: “Jersey is not a safe harbour for rogue operators.
We run a professional, well-regulated international finance centre that expects
companies using our services to pay the tax that is due in the jurisdictions
where it is owed. Jersey does not want abusive tax avoidance schemes operating
in the island. Jersey is not on the EU Code Group’s blacklist, and was
confirmed as a cooperative jurisdiction. The Code Group is now working with the
island, to ensure that this position is maintained.

The government of
Jersey regularly engages with parliamentarians from across the House [of
Commons], including the Treasury Sub-Committee. We are happy to provide
information to the Sub-Committee on the island’s robust financial regulation
and cooperation with HMRC and the European Union.

 

3.3 British Virgin Islands (BVI) sets out measures
to counter EU tax ‘greylist’ concerns

BVI has outlined
its action plan detailing key steps the jurisdiction pledges to undertake in
order to allay EU concerns of harmful tax competition with the bloc. In the
EU’s assessment, a range of factors were taken into account including tax
transparency, fair taxation and a commitment to combat BEPS.

 

Any jurisdiction
judged by EU to be deficient within one or more of these areas is placed on
either a blacklist or an intermediary “greylist”. The EU classifies the
greylist as being for those countries where there is one area where concerns
remain but a commitment to address it has clearly been set out.

 

The BVI said that
it now meets its requirements relating to tax transparency and those in
relation to BEPS. However, the area which the EU has highlighted for the BVI is
referred to as “economic substance”, in other words the existence of a tax
regime without any real economic activity underpinning it.

 

The UK Overseas
Territories with financial centres, as well as Crown Dependencies, have all
been advised that they need to address this issue. The Premier is leading a
team to chart a way forward, and has committed to pass appropriate legislation
ahead of the December 2018 deadline set by the EU.

 

4.  UNITED STATES – NEW BASE EROSION ANTI-ABUSE TAX (BEAT) REGULATIONS

US IRS and Treasury
officials on 14th December 2018 discussed the proposed Base Erosion
Anti-Abuse Tax (BEAT) regulations at a Washington DC tax conference, explaining
the reasoning behind many positions taken by the government in the regulations.

 

A literal reading of the statutory language of the BEAT would result in
many payments that Congress intended to be base erosion payments to fall
outside the statute. To make the statute work as intended, the government
decided that, for purposes of defining applicable taxpayers, the regulations
should provide that the aggregate group is limited to domestic corporations
plus all foreign related parties that are subject to US net
basis tax.

 

4.1 Effectively Connected Income (eci) exception

Consistent with
this new aggregate group concept, the regulations add an exception to the
definition of a base erosion payment for amounts paid or accrued to a foreign
related party that are treated as ECI.

 

Kevin Nichols, Senior Counsel, (ITC) at the US Department of Treasury
said that, “When we define the aggregate group, we sort of draw a box around
all the US corporations as well as the foreign entities to the extent they are
subject to net US taxation. So, those transactions are all disregarded for
purposes of determining the base erosion percentage and determining if you are
an applicable taxpayer. And, once you are an applicable taxpayer, then that
same payment would technically meet the definition of a base erosion payment.
In order to create symmetry between the aggregate group concept and what a base
erosion payment is we linked those two so that there is this exception . . .
which says that payments subject to net taxation are an exception from the base
erosion payment definition”.

 

4.2   Non-cash payments, reorganisations, cost
sharing

The regulations make it clear that base erosion payments
do not need to be made in cash and can occur in the context of a tax-favoured
transaction. There is no logical basis to exclude non-cash consideration,
including payments of stock, from the defintion of base erosion payments or to
exclude a situation where the delivery of the noncash consideration is in
connection with a transaction that has special status under the code, such as a
reorganisation or a section 351 transaction. This rule, coupled with the Global
Intangible Low Taxed Income (GILTI) regulations, will make it more difficult
for taxpayers to move intellectual property from lower tax structures to the US
or to other jurisdictions. Base eroding payments from US participants to a
foreign related party can also be made in the context of a cost-sharing
arrangement.

 

4.3  Services Cost Method Mark-Up Exception

The proposed
regulations take the position that if you meet all the requirements of the
services cost method exclusion from the definition of base erosion payments,
the exclusion is available to the extent of the cost but not the to extent of
any markup.

 

While it has been
clear the exclusion would apply to US corporations that reimburse a foreign
related taxpayer for costs of services provided by the foreign party, there had
been controversy regarding whether and how the exclusion would apply if a
markup is added to the payment.

The regulations
clarification is welcome as companies have wondered if they need to forgo the
markup component to take advantage of services cost method exception and, if
they did forgo the markup, how the foreign jurisdiction would react.

 

4.4 Cost of Goods
Sold  (cogs)
exception

Companies have been
spending significant resources trying to determine what costs can be properly
capitalised and thus considered reductions to gross receipts for purposes of
Cost Of Goods Sold (COGS) rather than as deductible payments subject to BEAT.
Companies that realise they have been deducting items that should have been
included in COGS now want to apply for a change in accounting method but are
concerned that the government may disregard a method change even if it is from
an improper method. Unlike the section 965 transition tax, the BEAT provisions
do not include a special anti-abuse rule aimed at changes in accounting
methods.

 

4.5  Banks, securities dealers, section 989 losses

 

The regulations add
taxpayer-favorable de minimis rules providing that if a small percentage
of a group’s activities include banking and securities dealer activities the
lower, 2 percent base erosion threshold applicable to banks will not apply.

 

Instead, the
general 3 percent threshold applies making it less likely that the group will
be subject to BEAT. The de minimus rule applies when the group’s gross receipts
from banking or securities dealer activities are 2 percent or less of total
receipts.

 

The regulations
clarify that that term “securities dealers” does not include brokers, as some
taxpayers had feared. The government decided to define the term by looking to
securities law.

 

The government,
after a lot of thought, decided to apply a neutral rule for section 988 losses,
noting that such payments can be very common. These losses are not treated as
base erosion payments and are also excluded from the denominator when computing
the base erosion percentage.

 

Note: The reader may visit the websites of the Revenue Authorities of
the concerned Tax Jurisdictions and download various draft reports / Tax
Legislations etc. referred to in this article for his study before rendering
any tax advice or undertaking any further action. If required, the taxpayers
and their tax advisors may consult tax specialists in the aforesaid tax
jurisdictions.  

 

 

USEFUL LIFE UNDER IND AS 16 PROPERTY, PLANT AND EQUIPMENT AND LEASE TERM UNDER IND AS 116 LEASES

QUERY

A lessee enters into a lease for an office
property. The lease has a non-cancellable term of 5 years and contains an
option for the lessee to extend the lease for a further 5 years. The rentals
for the period under the extension option (i.e., years 6-10) are at market
rates. Upon commencement of the lease term, the lessee incurs cost constructing
immoveable leasehold improvements specific to the property. The useful life of
the leasehold improvement is 7 years. At the commencement date of the lease,
the lessee expects, but is not reasonably certain, to exercise the extension
option. The economic penalty of abandoning the leasehold improvement at the end
of the non-cancellable term of the lease is not so significant as to make
exercise of the renewal option reasonably certain. Over what period does the
lessee depreciate leasehold improvements?

 

RESPONSE

View 1 – The
useful life of the leasehold improvements is 5 years

 

Appendix A to Ind
AS 116 defines lease term as: “The non-cancellable period for which a lessee
has the right to use an underlying asset, together with both:

u    (a) periods covered by an
option to extend the lease if the lessee is reasonably certain to exercise that
option; and…”

 

In this case, since
the lessee is not reasonably certain to exercise the option to extend the
lease, the lease term is 5 years for the purpose of Ind AS 116. 

 

Ind AS 16 (56)
states that:

“…all the following
factors are considered in determining the useful life of an asset:

u    (a) expected usage of the
asset. Usage is assessed by reference to the asset’s expected capacity or
physical output.

u    (b) expected physical wear
and tear, which depends on operational factors such as the number of shifts for
which the asset is to be used and the repair and maintenance programme, and the
care and maintenance of the asset while idle.

u    (c) technical or commercial
obsolescence arising from changes or improvements in production, or from a
change in the market demand for the product or service output of the asset…

u    (d) legal or similar limits
on the use of the asset, such as the expiry dates of related leases.” (emphasis
added.)

Keeping in mind the
legal limits, the useful life of the leasehold improvements is 5 years.

 

View 2 – The
useful life of the leasehold improvements is 7 years

 

The useful life of
the leasehold improvement is based on its expected utility to the entity [Ind
AS 16(57)]. To determine the expected utility, the lessee would consider all
the factors in paragraph 56 of Ind AS 16. While paragraph 56(d) of 16 should be
considered, the factor regarding “expected usage of the asset” in paragraph
56(a) of Ind AS 16 is equally relevant in determining the useful life. The
condition contained in paragraph 56(d) of Ind AS 16 reflects the necessity to
consider the existence of legal or other externally imposed limitations on an
asset’s useful life. The ability to extend the lease term is within the control
of the lessee and is at market rates so there are no significant costs or
impediments to renewal.   The term
“expected usage of the asset” for the determination of useful life of an asset
indicates a lower threshold than the “reasonably certain” threshold for
including the extension period in the lease term for Ind AS 116 purposes.

 

In accordance with
Ind AS 16 (51), if the assessment of useful life changes (for example, the
lessee no longer expects to exercise the lease renewal option) the change shall
be accounted for as a change in an accounting estimate. In such circumstances,
the entity may also need consider whether there is an impairment.

 

AUTHOR’S VIEW

The author believes
that there is greater merit in View 1, because it  results in harmony between the way lease term
and useful life of the leasehold improvements are determined.  

 

 

 

Section 194H – TDS – Commission – Definition – Manufacture and sale of woolen articles – Trade discounts allowed to agents who procured orders and sold goods on behalf of assessee – Not commission – Consistent trade practice followed by assessee – Concurrent finding by appellate authorities – No liability to deduct tax at source

40. CIT vs. OCM India Ltd.; 408 ITR 369
(P&H): Date of order: 9th May, 2018 A. Y. 2008-09

 

Section 194H – TDS – Commission –
Definition – Manufacture and sale of woolen articles – Trade discounts allowed
to agents who procured orders and sold goods on behalf of assessee – Not
commission – Consistent trade practice followed by assessee – Concurrent
finding by appellate authorities – No liability to deduct tax at source

 

The assessee
manufactured and sold woolen articles. During inspection of the office records
of the assesee it was found that the assessee debited an amount of Rs.
4,57,52,494, to the account of trade turnover discounts which had been netted
out from the gross turnover and did not appear as an item of expense in the
profit and loss account. The assessee submitted before the Assessing Officer
that the commission or brokerage arose on account of agency transactions which
did not attract deduction of tax at source for the services rendered by the
third party. The Assessing officer held that the amount being turnover discount
was directly or indirectly for the services rendered according to the inclusive
definition of the Explanation to section 194H of the Act and that the assessee
was liable to deduct the tax at source. A demand of Rs. 47,12,507 on account of
TDS and a further amount of Rs. 6,59,751 on account of interest charged u/s.
201(1A) was raised.

 

The Commissioner
(Appeals) held that the assessee had been debiting commission which amounted to
Rs. 1.84 crore to its commission agents appointed territory-wise who acted and procured
orders or effected sales of the assessee’s products for and on its behalf and
got commission which varied from place to place and quality of the product to
product and therefore, the Assessing officer was not justified in invoking the
provisions of section 194H read with its Explanation to the trade discount
allowed by the assessee to its buyers, customers and direct trade dealers
without involvement of any intermediator or commission agents. Accordingly, he
held that the assessee was not liable under the provisions of section 194H read
with its Explanation and deleted the demand of Rs. 53,72,258. The findings were
affirmed by the Tribunal which held that there was no material on record before
the Assessing officer that such discount offer was a commission within the
meaning of section 194H.

 

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

 

“i)    On a plain reading of section 194H, it is
clear that tax at source is to be deducted by a person responsible for paying
any income by way of “commission or brokerage”. The expression “commission or
brokerage” referred to in this section derives its meaning from the explanation
appended thereto. According to it, “commission or brokerage” includes any
payment received or receivable directly or indirectly by a person acting on
behalf of another person (a) for services rendered (not being professional
services), or (b) for any services in the course of buying or selling of goods,
or (c) in relation to any transaction relating to any asset, valuable article
or thing, not being securities. In order to examine whether Explanation (i) to
section 194H of the Act is attracted, necessarily, it is to be seen whether the
assessee has made any payment and, in case it is so, whether it is for services
rendered by the payee to the assessee.


ii)    Since concurrent findings had been recorded
by the Commissioner (Appeals) and the Tribunal that the assessee had been
debiting trade discount allowed to its commission agents who were acting and
procuring orders or effecting sales of its products for and on its behalf, the
Assessing Officer was not justified to have invoked the provisions of the
Explanation to section 194H. The Department had not been able to show any error
or illegality therein.”

Section 45: Capital gains –Business income- Investment in shares- A company can have two portfolio – investor and a trader at the same time- Investment was held to be assessable as short term capital gains. [Section 28i)]

10. The Pr. CIT-12 vs. Business Match Services (I)
Pvt. Ltd [ Income tax Appeal no 699 of 2016  Dated: 27th November, 2018 (Bombay High Court)].

 

 [Business Match Services (I) Pvt. Ltd vs.
DCIT; dated 19/08/2015 ; ITA. No 7267/M/2010, AY: 2007-08 and 2008-09, Bench B,
Mum. ITAT ]

 

Section
45: Capital gains –Business income- Investment in shares- A company can have
two portfolio – investor and a trader at the same time- Investment was held to
be assessable as short term capital gains. [Section 28i)]


The assessee company is engaged in the business of providing
consultancy services in the field of private placement of shares to foreign
institutional investors, financial institutions.


During the two years under consideration, the assessee also dealt in
purchase and sale of shares. It declared a portion of profits arising on sale
of shares as Short term Capital Gain (STCG) and the remaining portion was offered
as its business income, i.e. the assessee has maintained separate portfolios
for investment and trading assets. In both the years under consideration, the
AO did not agree with the claim of STCG declared by the assessee and
accordingly assessed the same as business income. 


The CIT(A) confirmed the view of the A.O, upon which, the issue
reached the Tribunal at the hands of the Assessee.


Being aggrieved with the order of the CIT(A), the assessee filed the
Appeal before ITAT. The Tribunal find that the AO has considered all the shares
together to take the view that the assessee has indulged in trading in shares.
However, the fact remains that the assessee itself has offered gains arising on
shares held as trading stock as its business income. The assessee has claimed
the gains arising on sale of Adani Enterprises Limited only as Short Term
Capital Gain with the claim that it has held the same as its investment. It is
now well settled proposition that a person is entitled to maintain two separate
portfolios, one for its investment and another one for its trading assets. For
this proposition, it relied on to the Circular No.4/2007 dated 15/06/2007
issued by the CBDT and also the decision rendered by Hon’ble High Court
in the case of Gopal Purohit (2010) (228 CTR 582). In the instant case,
the A.O has not disproved the claim of the assessee that it has maintained two
different portfolios as discussed above. Even though the Ld. CIT(A) has
observed that the question whether transactions were in the nature of trade or
otherwise is largely dependent upon the facts of each case, yet we are of the
view that the Ld CIT(A) has not properly appreciated the facts prevailing in
the instant case. The Tribunal held that the intention of the assessee at the
time of purchase of shares of Adani Enterprises Limited was to hold it as its
investments. The A.O has not brought any material on record to show the
contrary, which means that the AO has arrived at the adverse conclusion only on
surmises. Accordingly, the gains arising on its sale should be assessed as
Short term capital gains only. Accordingly, the gains arising on sale of shares
of Adani Enterprises Limited under the head “Income from Capital gains.” In the
earlier year also, Assessee had claimed capital gain out of its sale of shares.
Same was accepted by the A.O.


Being aggrieved with the order of the ITAT, the Revenue filed the
Appeal before High Court. The Court observed that the dispute pertains only to
one scrip namely the shares of M/s. Adani Enterprise Ltd., Assessee had
purchased the shares in installments and after holding them for some time, sold
them also in installments. Thus, there were no instances of repetitive purchase
and sale of shares. From the balance sheet, it could be gathered that the
Assessee had used its own funds or interest free funds, borrowed from the
Directors of the Company in order to purchase the shares. The Assessee had
taken physical delivery of the shares and in the books of account, treated the
same as an investment. Inter alia, on said grounds, Tribunal had ruled in
favour of the Assessee. Whether the purchase and sale of shares is in the
nature of investment or business venture, would depend on facts and
circumstances of each case. There are judicially laid down guidelines and parameters
to judge whether in a case, the sale of shares would give rise to business
income or capital gain. In the present case, the Tribunal has applied the
correct parameters to the facts, emerging from the record. The revenue appeal
was dismissed.

 

DECODING GST – CLAUSE BY CLAUSE ANALYSIS OF GST FORM 9C

This article is oriented towards performing a clause by clause analysis
of GST Form-9C. GSTR-9C has been titled as a reconciliation statement driven
towards reconciliation of data as per books of accounts with the data reported
in the GSTR 9. Therefore, preparation of GSTR-9 has to be treated as being a
pre-cursor to the reconciliation statement to be prepared for GSTR-9C.

 

Foreword

 

We have all experienced multiple course corrections in the country-wide
GST implementation including the course correction in reporting front. For
instance, in April 2017, the ambitious plan of item level reporting (at output/
input level) in the form of GSTR-1/2/3 with GSTR-1A/2A was introduced. However,
in July 2017 GSTR-1/2/3 and its compliments have been suspended and replaced
with a surrogate return in the form of GSTR-3B condensed the information
requirement. The said form was meant to collect taxes and tide over the IT
preparedness in implementing this nation-wide law. There was a temporary shift
from item level reporting to aggregated level reporting in the returns.
Entities hence prepared internal workings (at item level) and only reported the
aggregate number in GSTR-3B. Then came October 2017 wherein the requirement to
file GSTR 1 was introduced.

 

The flip-flop in reporting formats and ambiguity in
law could have given scope for errors creeping into reporting or taxability.
The law permitted tax payers to rectify both these errors during the course of
the tax period with additional time granted until September 2018. Yet there
could be instances where errors remain unrectified. For such instances, GSTR-9
and 9C assume a higher significance for FY 2017-18. The Auditee should view the
exercise of GSTR 9 as an opportunity to review and rectify the ‘errors in
reporting’ and GSTR-9C as an opportunity to get an external view to taxability
and rectify ‘errors in taxability’.

 

Structure of Form 9C

 

Traditionally, scope of taxation under VAT/ Service tax/ Excise was
limited to business turnover. With advent of GST the gamut of taxation has
widened unimaginably – from financial / recorded transactions to
non-financial/unrecorded activities; from contractual events (written/ oral) to
non-contractual activities; from external transactions to internal events; from
revenue to capital / non-recurring items. The law has encompassed almost
everything one can imagine. We have in some sense transgressed from a
‘transaction based law’ to an ‘event based law’. The law drills deep into the
information mine of an organisation touching internal actions, behaviors and
movements. It is for this reason that 9C attempts to capture whole lot of
information which is beyond the trial balance/ balance sheet of an
organisation. The form has been structured as follows:

 

 

Part-I contains the basic details of registration. Part II, III, IV and
V are the reconciliation tables which are discussed below. It is pertinent to
note that any reconciliation is an examination of the presence/ absence of a
particular number in two comparatives. Therefore, prior to performing any
reconciliation, one needs to be clearly conscious of the composition of
starting point since all adjustments to be made to reach the other end are
based on the presence/ absence of that particular figure in the starting point.
All the clauses of Form-9C should be understood on the basis of this comparative.

 

Part II: Point No. 5: Reconciliation of turnover declared in audited
annual financial statements with turnover declared in Annual Return (GSTR-9)

 

This part reconciles the turnover level differences between audited data
and returned data. Conceptually, audited turnover would vary from returned
turnover on account of certain variances. While this part performs a two-way
reconciliation between audited accounts and GSTR-9, one would also have to
factor the background workings of GSTR-3B and make this a triangular
reconciliation to conclude on the tax level differences. The picture below
depicts the journey from BOA to GSTR-9 to GSTR-3B and back to BOA:

 

 

 

i.      Timing variance
(TV): GST follows a monthly tax period and permits transactions to spill
over multiple months/ financial years but audited accounts freeze numbers
between two dates i.e. 01/04/XX to 31/03/XX. This spill-over effect creates
temporary differences in Y1 and reversing difference in a subsequent year (say
Y2). There could also be cases where the revenue recognition policy uses
different parameters in comparison to the GST time of supply provisions (eg. a
developer following percentage completion method of revenue recognition whereas
GST follows invoice/ receipt basis). Similarly, GST law requires the taxable
person to pay tax on advances received during the year though not recognised as
revenue, thus resulting in a timing difference between the BOA and returns.

 

ii.  Accounting variance (Permanent variance) (AV): As mentioned
earlier, GST encompasses events which may not be reflected in the entity level
books of accounts (say internal stock transfers, internal cross charges, etc)
and thus creates a permanent variance between two numbers.

 

iii.  Value variance
(Permanent variance) (VV): This represents variances arising on account
of difference in commercial value and GST value (section 15).

 

PART 5 & 6 – RECONCILIATION OF GROSS TURNOVER

 

This part reconciles the accounting turnover with the turnover reported
in GSTR-9. The GST turnover would be mapped from GSTR-9 (compilation of all
GSTR-1 returns) with subsequent year adjustments during the period April 2018
to September 2018 (such as rectification in errors in the amendment table,
etc.)

 

Clause Description

Intricacies

Auditor responsibility/ working Papers

Adjustments/ Illustrations

5A. Turnover as per audited financial statements
for the State/UT (for multi-GSTIN units under same PAN the turnover shall be
derived from the audited financial statement) – Starting Point

Report the revenue from operations of the entity
in the P&L for the financial year April 2017 to March 2018 (incl. the
non-GST period)
  •  Financial year 2017-18 numbers are to be
    adopted.  For entities having multiple
    registrations, the instruction of the form suggests that a GSTIN level
    turnover should be extracted from the audited turnover at entity level.
  •  Auditor should obtain the signed financial
    statements.  In case of multiple
    registrations, auditor should obtain GSTIN level data which aggregates to the
    audited figure under a representation letter.

Revenue excluding GST component should be adopted
from financial statements

 

No adjustment should be made to the financial
number and it should be directly planted into this clause. Any adjustments to
this number should be made only via form 9C.

 
  • This clause does not require a ‘State level
    Trial Balance’ and the auditor can rely on any suitable methodology in the
    company which extracts the registration level turnover from the revenue GL
    (such as cost centre, location codes, etc).
  •  Other income streams in separate schedules
    should not be included here. Only those having GST implications should be
    added as a separate line item.
  •   All
    subsequent clauses should also be applied at the GSTIN level only.
  •  The auditor should check if the audit
    adjustments on account of transfer pricing / IND-AS / provisions, etc., are
    accounted for in the books at registration level / consolidated level and
    accordingly, the registration level revenue should be arrived at.
  •  Auditor may consider documenting/ reporting the
    broad composition of the starting point as an observation in Part-B since all
    subsequent adjustments are dependent on this composition. 

 

5B. Unbilled revenue (UBR) at the beginning of the financial year(+)

5H. UBR at the end of the financial year (-)

UBR as reported in the Asset GL as on
01-04-2017and 31-03-2018 (+/-) to be taken at state level
  •  The objective of this clause is to adjust
    opening UBR which is billed during the GST period and eliminate fresh
    recognition of UBR by reducing it from the audited revenue
  •  It may be advisable to map the opening
    composition of UBR with billing under Service tax/ GST period
  • Auditor to document the revenue recognition
    policy and management’s view for its variance with the Time of Supply
    provisions
  • Delay in billing beyond the contractual due
    date may need to be analysed considering the provision of Time of Supply
    under GST.
  •  A MRL may be obtained with regards to details
    of Unbilled Revenue provision of earlier period reversed during the period
    under audit and fresh unbilled revenue provision created during the period of
    audit
  • Some entities have taken a conservative stand
    and considered UBR as their taxable turnover under Service tax (especially
    export entities).  In such case, a note
    that UBR has not been reported since there is no timing variance between
    revenue recognition and time of supply provisions could be provided.

5C. Unadjusted advances (UADV) at the beginning of the financial year
(-)

5I. UADV at the end of the financial year (+)

Report the UADV as on 31-03-2018 and 01-04-2017
as per BS/ location level accounts
  • Only taxable advances need to be included in
    the opening/ closing values i.e. advances on which tax has been paid
  • In case of decentralised billing/ accounting
    practiced during the service tax regime, it would be easy for the assessee to
    ascertain the state level opening UADV
  •  In case of service entities having centralised
    registration under service tax, the adjustments towards opening UADV and the
    service tax turnover may be recorded only in the Form 9C of the centralised
    office of the tax payer
  • Verify opening UADV with the state level
    billing in subsequent period to ensure accuracy of the data provided by the
    assessee and ensure there is no cross adjustments between branches
  •  If assessee has not offered advances to
    taxation during the service tax/ GST period, this clause would become
    redundant and an observation should be made in the certificate
  • Auditor to verify that tax has been paid and
    turnover has been reported in GSTR-9 at the time of receipt of advances which
    are comprised in the year end UADV
  •  In certain cases tax payers have paid the tax
    on advances based on an incorrect place of supply (i.e. IGST instead of
    CGST+SGST), necessary adjustments may need to be made at the tax level if not
    already adjusted in the returns. Refund of the incorrect tax may be sought by
    the assessee through a separate process (refer tax level reconciliation)

5D. Deemed Supply under Schedule I

Transactions without considerations are to be
captured here such as Branch transfers/ intra-entity cross-charges; principal
agent supplies, etc
  • This should include activities which are deemed
    to be supply under the GST law, i.e., covered under schedule I of the CGST
    Act but not included in the financial statements/ state level turnover.
  • Auditor should identify all such cases which
    might be covered under Schedule I of the CGST Act.
  •  Auditor may consider reconciling the delivery
    challans/ e-way bills generation data for completeness of the reporting.

 

 
  •  Some entities have practiced departmental
    accounting for state level registration and made consolidation adjustments at
    the time of preparation of financial statements.  One may verify whether the turnover in 5A
    already includes this figure
  • In case where state level data has been
    extracted from cost centres/ location codes, adjustments to the accounting
    turnover becomes necessary.
  • Fixed asset and other inventory registers may
    be examined to ascertain whether there are disposals/ write-off of business
    assets on which input tax credit has been availed
  •  For instance, branch transfer of goods can be
    identified based on the examination of the inventory registers for
    identification of inter-state stock movements and its reporting in GSTR-3B/1.
    Similarly, deemed supply of service between distinct persons can be
    identified by doing a revenue cost analysis for each registration and reviewing
    the documented policy in this regard.
  • Auditor should conduct a review of all assets
    and seek representation on the physical location/ presence within the
    respective States to determine whether there is any permanent transfer/
    disposal of assets
  • Auditors may consider caveating their report to
    the extent that auditing methodologies only facilitate review of identified
    branch transfers and that the certificate should not be construed as a
    comprehensive identification of all such deemed supplies
  • In case of supply of goods, tax payers have
    been exempted from payment of taxes at the time of receipt of advances.  In such cases, closing unadjusted advances
    for supply of goods would only comprise of receipts during July 2017 to Nov
    2017.

5E. Credit notes issued after the end of the financial year but
reflected in the annual return (+) : apparent error in signage

Credit notes u/s. 35 are issued for cases
involving change in taxable value or on account of goods return or deficient
supplies

  • Credit notes raised by an entity could be those
    which have a GST impact, i.e., satisfy the conditions prescribed u/s. 35 and
    those which do not have a GST impact (for example, account settlement credit
    notes or bad debts and so on).  This
    clause is meant to captures the former and that also only to the extent such
    credit notes are issued during the subsequent financial year in relation to
    supply made during the period under audit are reflected in the Annual return
    filed for the period under audit
  • The auditor will have to review the GSTR 1
    filed for the period from April to September of the next financial year and
    determine credit notes which are issued in relation to supply made during the
    period under audit and further analyse whether the same have been disclosed
    in the Annual return or not.
  • There is lack of clarity on this clause and we
    have to await an amendment to this clause.
    Credit notes raised during 18-19 are logically not required to be
    reported as part of the 17-18 reconciliation.
    It is highly probable that this clause might be amended

5J. Credit Notes accounted for in the audited
financial statement but are not permissible under GST (-): apparent error in
signage

Credit notes u/s. 35 are issued for reduction of
taxable turnover (such as price re-negotiation, short shipment, incorrect tax
rate, etc)
  • This clause would capture all such credit
    notes, where reduction in GST is not allowed u/s. 35 as discussed for the
    earlier clause.
  •  Identification of credit notes and reasons for
    reduction sought in the taxable turnover should be documented as working
    papers
  • Management may seek confirmations on reversal
    of credit on the recipient end

5F. Trade Discounts accounted for in the audited
financial statements but not permissible under GST

Trade discounts u/s. 15(3) could be those granted
at the time of supply or post supply
  • Trade discount here should be understood to
    include cash discounts, target discounts, incentives, etc. which do not
    satisfy the conditions prescribed u/s. 15(3) for non-inclusion in the value
    of taxable supply.
  • Auditor may consider conducting a sample
    analysis of major contracts to identify whether discounts given during the
    year on which section 15 (3) benefit has been claimed satisfy the parameters
    prescribed therein

Gratuitous discount given by a company on 100th
year celebration to its all India distributors may not be permissible under
this clause

5G. Turnover during April 2017-June 2017 (-)

Audited financial turnover at the location level
for the said period is to be reduced
  • The accounting turnover (net of all credit
    notes/ debit notes and accounting adjustments) which was used to arrive at
    the opening figure should be reduced to nullify the effect of pre-GST period
    revenue during the FY.

  • Turnover in excise/ service tax/ VAT returns are irrelevant for reporting
    here.
  •  Auditor would need to understand the process of
    ascertaining locational level turnover for April-June’17 especially under
    service tax regime since many assessee might have opted for centralised
    registration under service tax and would not have identified a turnover to a
    specific location
  •  A view with adequate disclosure may be given
    that consolidated turnover for April-June’17 is to be tagged to the state
    where service tax jurisdiction applies and the disclosure is not having any
    adverse tax consequences

5K. Adjustments on account of supply of goods by
SEZ units to DTA units (-)

Report DTA sales by SEZ unit
  •  ‘Removals’ from SEZ units are liable to custom
    duties as any other imported stock in the hands of the person who declares
    himself as an importer on record (generally the DTA buyer).  Since buyer discharges the customs duties
    on the basis of bill of entry for home consumption, it is not considered as a
    taxable supply by the SEZ unit even-though it is a turnover in the accounts
  •  Where the SEZ unit declares itself as an importer on record, pays
    the custom duties and also charges IGST on the stock transfer invoice to the
    DTA unit, this would form part of the turnover of the SEZ unit and no
    adjustments are required in this clause
  •  The auditor may obtain a list of all DTA sales by the SEZ unit and
    also obtain a copy of Bill of Entry filed by the customer as importer to
    satisfy that the onus of discharging tax was not on the SEZ unit but on the
    DTA unit buying the goods

 
  •  DTA clearances of capital goods by SEZ
    developers are not covered in this clause though principally similar implications
    would apply  (Section 30 of the SEZ Act
    operates only for SEZ Unit)

5L. Turnover for the period under Composition (-)

Accounting turnover during the period under
Composition Scheme to be excluded
  •  GSTR-4 data to be reconciled with accounting
    turnover under the composition schemeand then excluded under this clause.
  •  NIL
  •  NIL

5M. Adjustments in turnover u/s. 15 and rules
made thereunder  (+/-)

Variances in commercial value and GST value to be
aggregated and reported here
  • Section 15 and rules may require upward/
    downward adjustment to taxable value (such as air travel agent invoices/
    money-changer transactions, trading of used goods, admitted undervaluation in
    related party transactions, admitted Free-of cost supplies with external
    parties, etc)
  •  Auditor can ascertain this figure by a invoice-wise comparison of
    revenue GL and GST register (value column)
  • Auditor may study the upward/downward variance at a conceptual
    level and aggregate the same but is not required to attest the said
    quantification

 
  •  Certain value exemption notifications (such as
    sale of flats, sale of second hand pre-GST motor vehicles , etc) may also be
    included here eventhough they are not part of section 15

5N. Adjustments in turnover due to foreign
exchange fluctuations (+/-)

Difference in valuation due to forex rates
adopted for revenue recognition / GST valuation
  •  In respect of export of goods, the law requires
    the customs notified rates to be adopted but commercially agreed currency/
    forex rates may vary. Therefore, there will always be a difference in the
    value of export of goods reported in the Annual Return vis-à-vis books of
    accounts which will have to be reported here.
  • Auditor to examine the internal accounting policy in respect of
    adoption of foreign exchange rates. 
  • In addition, the auditors should obtain a statement of export of
    goods during the year with both, the figures as per books of accounts as well
    as the shipping bill plotted for verification and record purposes.
  • Certain accounting practices for companies who have hedged their
    foreign exchange exposures on export revenue may be examined

 
  •  Any variance in turnover due to difference in
    foreign exchange rates at the time of receipt of advance and time of its
    adjustments may need some reporting

5O. Adjustments in turnover due to reasons not
listed above (+/-)

Residual entry for all other adjustments

  •  All case-specific adjustments may be carried
    out here.  If the web-portal does not
    permit multiple sub-items, it may be advisable to maintain a internal working
    and upload a scanned copy if permitted by the web-portal

 Auditor to seek representation on this residual
adjustments and maintain working papers on the reasons for the adjustments
and its impact at the tax level. Missed reporting of outward supply should
not be reported here but reported as unreconciled difference

 Expense recoveries which are debited to the
profit and loss account

  •  High-sea sales/ drop shipments which are
    excluded from GST
  • Sale of fixed assets, residual value of
    destroyed goods, etc.

 

5R = 5Q-5P : Unreconciled difference between the Accounting
turnover (with adjustments) and the GSTR-9 turnover

Reasons for non-reconciliation to be provided
here

• It is absolutely essential to reconcile the two
turnovers to the last rupee to eliminate the possibility of compensating
reconciling items
  • Auditor cannot adopt a materiality test for this
    unreconciled difference (eg. a Re 10 +ve and Re 9 –ve may result in Re 1
    +ve).  Auditor to identify every
    difference
  •  It is also essential to comment whether tax is
    due on this difference and if yes, whether tax has been discharged and the
    relevant tax period. If tax has not been discharged, auditor may consider
    reporting the same as additional liability

 

 

PART 7& 8 – RECONCILIATION OF TAXABLE TURNOVER

 

This part aims at moving
from the reconciled total turnover as per accounts to the taxable turnover as
reported in GSTR-9.  By this stage, the
accounting turnover has been brought to the level of total turnover as per
GSTR-9. Any difference arising in this reconciliation table would primarily
be on account of: (a) short-reporting of non-taxable turnover in GSTR-1 (say
interest income); or (b) short reporting of taxable turnover; (c) incorrect
reporting head.  In the author’s view,
it may be advisable to rectify any short reporting of non-taxable turnover
and reporting errors of GSTR-1 in GSTR-9 itself so one is left only with
items having a final impact on the tax liability.

 

 

 

 

 

 

Clause Description

Intricacies

Auditor responsibility/ working Papers

Adjustments/ Illustrations

7A. Annual Turnover after (+/-) adjustments above

Turnover as per accounts with the +/- adjustments
  •  This is an auto-filled data field

NIL

NIL

7B. Value of Exempted, Nil rates, Non-GST
supplies, No-Supply turnover (-)

Non taxable items comprised in GSTR-9 are
reported there
  •  Exempted refers to supplies arising from
    Notifications (Goods/ Services) u/s. 11 of the respective acts i.e. N-02/2017
    and 12/2017
  •  Documentation of the list of exemptions availed
    and compliance of exemption conditions may be examined on sample basis

This turnover should be reported net of debit
notes/ credit notes as available from the books of accounts

 
  • Turnover having partial exemption such as rate
    reduction of 18% to 5% or 0.1% or value reduction (in case of
    developers)  would not be reported here
  •  Non-GST supplies imply supply of Non-GST
    products (such as petroleum)
  •  No-Supply implies turnover covered under
    Schedule III i.e. sale of land, etc
  •   Documentation
    of the reasons provided by the assessee for treating the turnover as Non-GST/
    No-Supply, etc.

 

7C. Zero-rated supplies without payment of tax
(-)

Export Supplies and Supplies to SEZ units/
developers
  •  Export supplies of goods and services including
    to SEZ units / developers from accounts is to be extracted and reported here

 
  •  Auditor needs to maintain the LUT as part of
    its working papers and broad parameters on which the assessee has treat the
    transaction as export – a sampling may be undertaken for verification

Same as above

 
  • Tax type would be IGST even for same state SEZs
  • Sample verification of SEZ status of customers
    may be carried out on the GSTN portal

 

7D. Supplies on which tax is to be paid on
reverse charge basis (-)

Turnover of suppliers under RCM
  •  Supplies where the supplier records the
    turnover but does not pay the tax  are
    to be reported here
  •  Auditor needs to maintain the notification
    under which the assessee has taken the stand that RCM is being discharged by
    recipient
  •  Sample invoices for RCM declaration may be
    examined
  •  Same as above

7G = 7F – 7E : Taxable turnover as computed above
and compared with the Turnover as per GSTR-9

There could be +ve/ -ve result
  •  If everything has been captured above, 7G
    should ideally be NIL
  •  +ve implies GSTR-9 taxable turnover is greater
    than accounting taxable turnover indicating tax refund
  •  -ve implies GSTR-9 taxable turnover is lesser
    than accounting taxable turnover resulting in indicating tax payable
  •  Credible explanation should be provided at item
    level for the difference
  •  Auditor needs to ascertain all those cases
    where there is admittedly a tax liability which is payable but the same has
    not been considered by the assessee in its GST workings
  •  Where the tax payer represents to have
    discharged the tax liability in subsequent year GSTR-3B, a categorical
    representation is important on this point.

There should not be any un-explainable difference
at this stage.

 

 

PART 9, 10 & 11 – RECONCILIATION OF RATE WISE LIABILITY AND AMOUNT
PAYABLE THEREON

This part aims at
reconciling the above adjusted taxable turnover at the rate level (as per
accounts) with the tax liability reported in GSTR-3B.  Since the accounting turnover has undergone
changes prior to this level, one would have to perform a rate classification
(exempt, 6%, 12%, etc) even for the adjustments made until this point.  Therefore, workings for the adjustments
should be maintained at an item level.
This part is also important to examine whether there is any excess
collection of taxes by the tax payer.
The tax GL of the tax payer is the primary source of data for this
clause.

 

Clause Description

Intricacies

Auditor responsibility/ working Papers

Adjustments/ Illustrations

9. Reconciliation of rate wise liability and amount payable thereon

Rate wise liability as per accounts to be
reported here
  •  Account extracts computing the rate
    wise liability at the CGST/SGST and IGST level would have to be aggregated
    and reported here (Tax GL)
  •  This should also include rate wise RCM
    liability on inwards supplies of goods/ services
  •  Back-up workings of GSTR-3B would have
    to be examined with GSTR-9 to ascertain the differences at the tax level
  •  Errors due to using incorrect rates
    from HSN schedule could be reported here
  •  Auditor to maintain working papers of
    rate wise liability as per accounts vs. rate wise liability as per GSTR-9
  •  To the extent the variance is because
    of turnover level un-reconciled differences, as a consequence they may form
    part of the un-reconciled tax amounts
  •  Auditor can recommend any additional
    liability under this clause

 

GSTR-3B is primary document for discharge
of tax liability and the back-up workings would provide insights into the
tax level differences beyond those arising due to turnover level

 

 PART 12 & 13 – INPUT TAX CREDIT RECONCILIATION

This part performs an
analysis of the input tax credit availed as per accounts and that reported in
GSTR-3B.  The tax administration
expects that accounts are the sole basis for credit availment and hence
difference in accounting and receipt of goods/ services could be the primary
reason for any variance in credits. Practically, multiple errors have been
performed during the GST implementation.
This exercise is a good opportunity to rectify clerical errors (such
as claiming excess credit in a particular head) as well as eligibility errors
(such as blocked credits, year-end mandatory credit reversals, etc).  Importantly, this form should not be viewed
as a document to avail/ reclaim any missed credit or even adjust the same
with any output liability.

 

12A. ITC availed as per
audited financial statements for the state at GSTIN level

ITC ledger extracts for each GSTIN to be reported
here
  •  Account extracts computing the aggregate of ITC as recorded in
    accounts would be reported here. This figure should be net of any reversals
    made in accounts on the input tax credit front.
  •  Internal working should be made at the tax type level (CGST/ SGST or
    IGST) though the reporting is required to be done at the aggregate level.
  • GSTR-2A reconciliation summary of the tax payer could be examined for
    completeness.

 
  •  Working papers of rate wise input tax credit as per accounts vs.
    rate wise input tax credit used for GSTR-3B workings to be maintained.
  •  Auditor to ascertain if input tax credit availed in a particular
    state is mapped to another state in accounting systems.

 

ITC availed in accounts but not claimed in any of the transition/GST
returns may be written off/ ignored.

 

ISD credit availed in GSTR-3B but availed at a different location in
accounts may come up here.

 

 

12B. ITC booked in the earlier financial years
and claimed in current financial year (+)

Transition Credit of earlier financial years to
be reported here
  •   Transition return workings
    and the accounting treatment would have to be examined and reported here.
  •  Cases of capital goods claiming credit in accounts during FY16-17
    but reported in transition returns would also be covered.

 
  •  Auditor to document basis of claim of
    transition credit and the eligible duties/ taxes claimed u/s. 140.

Centralised Cenvat credit which is distributed
during transition may be adjusted appropriately.

12C. ITC booked in current financial year and
claimed in subsequent financial year (-)

ITC booked in accounts but availed in subsequent
financial year in returns
  •  GSTR-3B workings and the ITC register as per accounts may be
    reconciled on a line-item basis and the difference may be reported here.
  •  This ITC register data may also be compared with
    the ITC reported in GSTR-2A (Table 9 of GSTR-9).
  • Auditor need not propose any disallowance of
    input tax credit availed in GSTR-3B merely on the ground of non-reporting of
    invoice in GSTR-2A.

  • Auditor need not particularly verify conditions of section 16(2) for
    reporting this figure.

All figures reported here should be net of any
reversals or vendor credit notes.

14. Reconciliation of ITC at description level

Ledger level break-up of ITC credit
  •  This table appears to be a ledger-wise breakup
    of the expenses and the corresponding ITC reported in 12A/12B/12C.
  •  Auditor would need to obtain ledger level data
    and extract the expenses under each ledger on which ITC has been availed.

Column 4 : Amount of eligible ITC availed represents
the actual ITC availed in accounts net of the adjustments in 12B/C at the
ledger level.

 
  •  ITC from internal stock transfers which do not
    appear at a GL level may also be reported as a separate line item
  •  Prima facie examination of ledger
    nomenclature / narrations may be adopted for checking eligibility

 

13 & 15. Reconciliation of ITC at ledger
level

Reasons for non-reconciliation to be provided
here
  •  It is absolutely essential to reconcile the two
    turnovers to the last rupee to eliminate the possibility of compensating
    reconciling items
  •  Auditor cannot adopt a materiality test for
    this unreconciled difference (eg. a Re 10 +ve and Re 9 –ve may result in Re 1
    +ve).  Auditor to identify every
    difference

Eg. Admitted reversals of input tax credit not
reversed in GSTR-3B; availment of credit without receipt/ accounting of
goods/ services; credit availed at the wrong GSTIN location

 

 

 

Reporting horizon of GSTR-9C

Books of accounts have an annual time horizon and the GST-1/3B work on
monthly periodicity with hard close only in September following the respective
financial year.  This variance in period
poses a peculiar problem because of a lack of a revision option in GSTR-1/3B
and GSTN storing data based on reporting period rather than the document
date.  Let’s take similar yet
contradictory examples (i) debit note raised in FY17-18 delayed reporting in GSTR-3B/1
of 18-19 (ii) debit notes raised in FY17-18 and delayed reporting only in
GSTR-1 in 18-19 (iii) debit notes raised in FY18-19 for enhancement of a price
agreed in FY 17-18 and reported in GSTR-3B/1 if 18-19?  Let’s compare these example based on following
parameters

 

Parameter

Case – 1 : Delayed
reporting in 3B  & 1

Case – 2 : Delay in
reporting only in 1

Case – 3 : delay in
recognition

Original Invoice date

01-01-2018

01-01-2018

01-01-2018

Accrual of liability

January 2018

January 2018

January 2018 (*)

Debit note date/
Accounting entry

31-03-2018

31-03-2018

30-09-2018

Date of Reporting
additional turnover  in GSTR-9

Clause 10 certainly
capture this amendment

Clause 10 would capture
this amendment only at turnover level

Clause 10 would not
capture this and treated as 18-19 transaction

Date of Reporting
additional turnover  in GSTR-1

This would be a
reconciliation item at turnover and tax level for both 17-18 & 18-19

This will be a
reconciliation item only at turnover level for both 17-18 and 18-19

Transaction of purely
18-19 though accrual of liability in 17-18

 

 

Whether reporting in 9C is anchored to tax liability accrued in FY 17-18
or anchored to accounting and/or reporting the base document?  Section 9 r/w 12/13  provide the time of supply for the
‘transaction value’.  Legally speaking,
all liabilities accrued in 17-18 (either through current year/ subsequent year
adjustments) should be reported as part of Form-9C irrespective of the date of
accounting and reporting in GSTR-3B/1.
Procedurally, section 35(4) and rule 59 require reporting based on date
of issuance of base document.  Going by
this analogy, transactions accounted in 17-18 would form the basis and those
accounted subsequently (for any reasons) should not form part of 17-18.  The author believes that this second approach
should be adopted keeping in mind the true spirit of reconciliation i.e.
balance two values based on its composition.

 

Part – B : General points for Audit observations/
Comments

Part-B is the Auditor’s report over the correctness of contents of the
reconciliation statement.  The report
places an onus that the reconciling items are accurate having credible
reasoning.  This said report could have
two forms – (a) where the certification is by the person who has also conducted
the statutory audit; and (b) where the certification is placing reliance on the
audited books of accounts examined by another statutory auditor.  The prescribed format provides certain areas
where observations/ comment may be provided by the person certifying the
report.  Other general points for
consideration during this exercise are:

  •  GSTR-9 is a management document and auditor is not certifying the
    contents of GSTR-9.  Effectively implying
    that auditor is not expected to certify the legal aspects such as
    classification, place of supply, time of supply, eligibility of exemption/
    zero-rated conditions, valuation. etc.
  •           Compensating tax
    adjustments cannot be netted off.  Excess
    payment can only be refunded by way of a refund application.
  •           Observations should
    emphasise that audit methodologies are expected to give a reasonable and NOT an
    absolute assurance over the correctness of books of accounts and data reported
    in the form.
  •           Auditor’s recommendation
    of the liability would generally be resorted for admitted tax liabilities,
    numerical errors in reporting/ accounting, patent errors in taxability.   In matters having multiple view points,
    auditor may consider the management’s view under a representation.

 

Conclusion

From tax administration perspective, GSTR-9C is like an ‘appetizer’ in a
full course meal of assessments.  In
other words, it addresses the limited question prior to any assessment ie. are
reported values are correct when compared to the accounting records.  It gives a headstart of items included/
excluded from the returns and hence enables the officer to perform a Top-Down
analysis of the records of the entity.
Once this picture is laid out, the officer is equipped in examining the
nuts and bolts of each transaction (such as time of supply, place of supply,
valuation, rate of tax, eligibility/ ineligibility of credits, etc).   Auditor is merely a facilitator and is not
expected to be a judge over the auditee’s decision.  

 

 

 

 

 

 

BOOK PROFIT – WHETHER ADJUSTMENT REQUIRED FOR SHARE OF LOSS FROM PARTNERSHIP FIRM?

 Issue for consideration


U/s. 115JB
of the Income Tax Act, 1961, a company is required to computateits book profits
and pay the Minimum Alternate Tax at 18.5% of such book profits. Explanation 1
to section 115JB provides that the term “book profit” means the ‘profit’ as
shown in the statement of profit and loss for the relevant previous year
prepared under s/s. (2), as increased or reduced by certain items specified
therein. One of the items of reduction contained in clause (ii) is –

 

(ii) – the
amount of income to which any of the provisions of section 10 (other than the
provisions contained in clause (38) thereof) or section 11 or section 12 apply,
if any such amount is credited to the statement of profit and loss.

 

There is
also a corresponding item of addition contained in clause (f) of the
explanation, which reads as under –

 

(f) the
amount or amounts of expenditure relatable to any income to which section 10
(other than the provisions contained in clause (38) thereof) or section 11 or
section 12 apply;

 

Section
10(2A) provides for an exemption in the case of a partner of a firm which is
separately assessed as such. The exemption is as under:

 

“in the
case of a person being a partner of firm which is separately assessed as such,
his share in the total income of the firm.

 

Explanation:
For the purposes of this clause, the share of a partner in the total income of
a firm separately assessed as such shall, notwithstanding anything contained in
any other law, be an amount which bears to the total income of the firm the
same proportion as the amount of share in the profits of the firm in accordance
with the partnership deed bears to such profits;

 

Therefore,
where a company is a partner in a partnership firm, which is taxed separately
as a partnership firm, and the company is entitled to a share of profits of the
partnership firm, such share of profit that the company is entitled to, is not
only exempt u/s. 10(2A) from income tax, but is also to be excluded from the
book profit, by reducing such share of profit credited to the statement of
profit and loss under Explanation 1(ii) of section 115JB and in so computing
any expenditure, incurred for earning such share of profit, is required to be
added back while computing the book profit.

 

The issue
has arisen before the Income tax Appellate Tribunal as to whether, in a case
where the share of the company in the income of the firm is a ‘loss’ which has
been debited to the statement of profit and loss of the company, whether such
loss is required to be added to the book profit of the company , in the same
manner as the share of profit is reduced from the profit as per the statement
of profit and loss. While the Chennai bench of the Tribunal has taken a view
that such share of loss from the partnership firm is to be added back while computing
the book profit, the Mumbai and Kolkata benches have taken the view that such
share of loss is not required to be added back while computing the book profit.

 

Metro Exporters Ltd’s case


The issue
first came up before the Mumbai bench of the tribunal in the case of DCIT
vs. Metro Exporters Ltd 10
SOT 647.

 

In this
case, relating to assessment year 1997-98, the provision then applicable was
section 115JA, which was almost identical to section 115JB in respect of the
issue under consideration. It provided for a reduction from the net profit as
shown in the profit and loss account for the relevant previous year of the
amount of income to which any of the provisions of Chapter III applied, if any
such amount was credited to the profit and loss account.

 

The assessee had debited its share of loss of Rs. 46.94 lakh from a
partnership firm to its profit and loss account. In the initial assessment, the
assessee’s computation of book profits, wherein it had not added back such
share of loss to the book profits, was accepted by the AO. However,
subsequently, reassessment proceedings were initiated u/s. 148 on the ground
that the income chargeable to tax was under assessed by way of omission to
increase the book profit by the share of loss in the partnership firm amounting
to Rs. 46.94 lakh debited to profit and loss account while computing the book
profit as per provisions of section
115 JA. Such share of loss was added to book profits by the AO in the
reassessment proceedings.

 

In first
appeal, the Commissioner(Appeals) deleted the addition made in the reassessment
proceedings, holding the reassessment proceedings as not being in accordance
with law, besides holding that the addition of Rs. 46.94 lakh of share of loss
from partnership firm could not be made to the book profits.

 

Before the
Tribunal, the Department contested both aspects – the decision against validity
of the reassessment proceedings, as well as the merits of the addition made to
book profits. Before the Tribunal, it was argued on behalf of the Department
that sub-clause (f) of the Explanation to section 115 JA, provided that for the
purposes of the section, the profit meant the net profit as shown in the profit
and loss account for the relevant previous year prepared under s/s. (2) as
increased by the amount or amounts of expenditure relatable to any income to
which any of the provisions of Chapter III applied and that the sub-clause
applied in the case of the assessee. It was further argued that the word
‘income’ included ‘loss’ also, and therefore sub-clause (ii) to Explanation to
section 115JA applied to the assessee.

 

On behalf
of the assessee, it was submitted that the addition was wrongly made as Chapter
XII-B was a special provision relating to certain companies, and therefore had
to be strictly construed. It was submitted that the proposition that the word
‘income’ included ‘loss’ was not applicable to assessment framed under Chapter
XII-B of the Act. Further, it was argued that the ‘loss’ was not an
‘expenditure’, and therefore did not fall within the purview of sub-clause (f)
to Explanation to section 115 JA. It was further submitted that sub-clause (ii)
to the Explanation to section 115 JA applied only “if any such amount is
credited to the profit and loss account”. In the case of the assessee, the
share of loss from the partnership firm was not credited to the profit and loss
account, but was debited to the profit and loss account, and therefore
sub-clause (ii) also did not apply to the case of the assessee.

 

The
Tribunal noted that the assessee had debited its share of loss from the
partnership firm to its profit and loss account. It observed that the
provisions of Chapter XII-B were special provisions relating to assessment of
certain companies, whereby the income of certain companies chargeable to tax
for the relevant previous year was deemed to be an amount equal to 30% of such
book profit. Being special provisions applicable to certain companies,
according to the Tribunal, they had to be strictly applied. The income of the
assessee had to be computed in accordance with book profit of the assessee, and
the working of the book profit had to be made as per the provisions of Chapter
XII-B.

 

The
Tribunal held that the proposition that the word “income” included “loss” was
not applicable while computing the profit in accordance with the provisions of
Chapter XII-B. The Tribunal further found that the provisions of sub-clause (f)
of the Explanation to section 115 JA applied to the amounts of “expenditure”
relatable to any income to which any of the provisions of Chapter III applied.
According to the Tribunal, the share of loss from a partnership firm was not
synonymous with the word “expenditure” used in that sub-clause.

 

The
Tribunal further noted that sub-clause (ii) of the Explanation to section 115
JA applied to income to which chapter III applied, if such amount was credited
to the profit and loss account of the assessee. In the case before it, the
tribunal noted that the share of the assessee from the partnership firm was
loss, and was therefore debited to the profit and loss account of the assessee,
and could not have been credited to the profit and loss account of the
assessee. Since it was not a case of share of profit from a firm credited to
the profit and loss account of the assessee, the tribunal held that no addition
for the purpose of computation of the book profit under section 115 JA could be
made with regard to share of loss of the assessee from a partnership firm.

The ratio
of this decision of the Mumbai bench of the Tribunal has been appllied by the
Kolkata bench of the Tribunal in the case of CD Equifinance Pvt Ltd vs.
DCIT, ITA No 577/Kol/2016 dated 9.2.2018 in the context of section 115JB
for Assessment Year 2012-13.

 

Fixit (P) Ltd’s case


The issue
again came up before the Chennai bench of the Tribunal in the case of DCIT
vs. Fixit (P) Ltd 95 taxmann.com 188.

 

In this
case,the assessee was a partner in two partnership firms, and its share of loss
from the two firms was Rs. 2,11,346 and Rs. 68,564, respectively. Such share of
loss was debited to the profit &loss account of the assessee, but was not
added back by the assessee to the net profit while computing book profit u/s.
115JB.

 

The
Assessing Officer was of the opinion that share income from a firm being exempt
under Chapter III, even if such share was a loss, it had to be added back for
computing the profit u/s. 115 JB. He therefore added the share of loss of the
two firms to the profits as per the profit & loss account and computed the
book profit for the purpose of levying tax u/s. 115 JB accordingly.

 

The
Commissioner (Appeals) decided the first appeal in favour of the assessee, on
the ground that the Explanation to section 115 JB spelt out the additions that
could be made to the profits shown in the audited profit & loss account.
Share of loss from a partnership firm could not be considered as an expenditure
relatable to exempt income, and therefore though such share of loss was debited
to the profit &loss account, such share of loss could not be added back
while computing the book profit u/s. 115 JB.

 

Before the
Tribunal, on behalf of the Department, it was argued that clause (ii) of the
Explanation to section
115JB clearly mandated deduction of any income to which any of the provisions
of section 10 applied, if such amount was credited to the profit & loss
account. It was argued that loss incurred by a firm was carried forward in the
hands of such firm. When share of profits from firms were to be reduced, loss,
being a negative income, had to be added back to profits shown in the profit
&loss account. That would be equivalent to an addition.

 

The
Tribunal analysed the provisions of section115 JB, in particular the
Explanation to that section. It also analysed the provisions of section 10
(2A). According to the Tribunal, what was excluded from the total income by
section 10 (2A) was the share of the partner in the total income of the firm.
Since share of loss in the firm was not an expenditure relatable to any exempt
income, in the opinion of the Tribunal, clause (f) of the explanation did not
apply.

 

However,
according to the Tribunal, it was clause (ii) of the Explanation which was
applicable. That was on account of the fact that in the opinion of the
Tribunal, share of loss was nothing but share of negative income. Clause (ii)
of the Explanation mandated reduction of income to which section 10 applied, if
such income was credited in the profit & loss account. According to the
Tribunal, when share of income from a firm was exempt and required to be
excluded u/s. 10 (2A), necessarily the share of loss was also to be excluded.
In the view of the Tribunal, what the assessing officer had done was that by
adding the loss from the two firms to the profits, he was effectively reducing
the negative profit, since loss was nothing but negative profit.

 

The
Tribunal therefore upheld the addition made by the assessing officer of share
of loss from the partnership firms to the book profit of the assessee.

 

Observations


The
controversy surrounds adjudicating upon two important facets; whether a ‘loss’
could be termed as an ‘expenditure’ and be added back to the book profit and
whether the right to reduce an ‘income’ from the book profit would oblige a
company to add back its losses. In effect, both the Mumbai and the Chennai
benches of the Tribunal have accepted the position that the provisions of
clause (f) to section 115 JB, providing for add back of the expenditure, do not
apply to the share of loss from a partnership firm, since such loss is not an expenditure
in relation to exempt income. Therefore, there is no dispute on the first
aspect of the controversy.

 

The
dispute is only as to whether clause (ii) of the Explanation to section 115JB
applies so as to require the company to exclude the loss in computing the book
profit or add back the loss, otherwise debited to the profit & loss
account, to the book profit. That Explanation applies to “amount of income
to which any of the provisions of section 10 apply”. The issue therefore
revolves around whether the proposition that “income” includes loss would apply
in this case i.

The
provisions of Chapter XII-B are special provisions that carry a fiction for
taxing an artificially computed income termed as book profit which is far
detached from the income or the real income on which tax is payable under the
original scheme of taxation of the Act. Computing the book profit is a
convoluted exercise that is removed from the concept of income and seeks to tax
an income that can in no sense be termed as an income. In the circumstances, it
is a futile exercise to apply the understanding otherwise derived in
interpreting the main provisions of the Act that deal with the income or the
real income.In the context of the income taxation, which seeks to tax the real
income of a person, It is true that the term ‘income’ includes ‘loss’ but it is
equally true to restrict the application of such an understanding to such an
income and not extend it to artificial income or fictional income. The Supreme
Court in J.H. Gotla’s case, 156 ITR 323 laid down the law while
explaining the ordinary concept of income to hold that it includes loss, as
well. Application of this analogy to an artificially conceived income should be
avoided at all costs.

 

There are
however two more arguments in favour of the proposition that such share of loss
is not to be added back in computing the book profits. The first is that the
share of loss is not credited to the profit and loss account, as required by
clause (ii), but is debited to the profit and loss account. Besides clause (ii)
falls under the items to be deducted while computing book profits, and not
under the additions to be made while computing book profits.

 

Secondly,
one may draw support from the decision of the Mumbai bench of the Tribunal in
the case of Raptakos Brett & Co Ltd 69 SOT 383 in the context
of exemption of capital losses on sale of listed shares u/s. 10(38). In that
case, while holding that only gains arising from the transfer of a long term
listed equity share was exempt, and not loss, the Tribunal interpreted the term
“income arising from the transfer of a long term capital asset”. It drew a
distinction between a situation where an entire source of income was exempt,
and a situation where only certain types of income from a source were exempt.
According to the Tribunal, if the entire source is exempt or is considered as
not to be included while computing the total income, then, in such a case, the
profit or loss resulting from such a source does not enter into the computation
at all. However, if a part of the source is exempt by virtue of particular
provision of the Act for providing benefit to the assessee, it cannot be held
that the entire source will not enter into the computation of total income.
According to the Tribunal, the concept of income including loss applies only
when the entire source is exempt, and not in the cases, where only one
particular stream of income falling within a source is falling within the
exemption provisions.

 

In the
case of a partner of a partnership firm, the partnership firm is the source of
income. Remuneration and interest from the partnership firm are taxable, with
only share of profit from the partnership firm being exempt from tax.
Therefore, only one stream of income from the source is exempt. That being the
case, following the rationale of Raptakos Brett’s decision, “income”
would not include loss, and share of profit would not include share of loss.
Therefore, the share of loss from a partnership firm, though may be covered by
section 10(2A), is not an income for the purposes of clause(ii) of section
115JB , and is further not credited to the profit and loss account. That being
the case, it is not required to be added back while computing book profits.

 

The better
view seems to be that no adjustment to the net profit is required to be made in
respect of the amount of share in loss debited to the statement of profit &
loss  of the company while computing book
profit u/s. 115JB.  

 

 

How to Sell a Mirror in a place full of Masks

As we cross into the New Year, we take a few days off to refresh,
rejuvenate and revive our mind, body and spirit. The day after 31st
December seems so new and yet so much of it is still the same as it has been
for long. Taking time off allows us to reflect on all that is going on around
us and all that we are becoming as individuals and as a society.

 

 

Our founding fathers must have dreamt of this when we chose to be a
Republic. We are celebrating our 70th Republic Day this month. Most
constitutions came from the divine rights theory based on an Anglo-Saxon system
where God who had all powers also gave all rights – to life, of speech etc. God
was substituted by the State for giving these rights through a constitution.
The caveat was: the State required the consent of its people. While God can do
no wrong, the State can. Therefore, the responsibility of people is even more.
This model asks us to own up what is happening, to discharge our responsibility
and then claim our rights. Often, people understand it in reverse order – claim
rights and hardly discharge duties. 

 

The constitutional framework stands for and on the rule of law with a
dedicated judiciary to deal with conflict. We have come to a point where justice
is beyond the reach of most people. Can most citizens read or comprehend our
laws? Can a lay citizen knock at the door of the highest court and afford a
lawyer there? Are large parts of the judicial system impartial? Take an example
of ‘tribunals’–where although the judiciary is meant to be out of control of
the government, most tribunals are under direct control of the ministry which
is generally a party in the dispute before that very tribunal! And the time it
takes to close out a court case?  

Such clear and visible problems limit the operation of law and impair
the Constitution of the State. In fact, many times the government is in
conflict with citizens for all the wrong reasons. At a recent tax hearing, an
officer mentioned that professionals are responsible for litigation. I asked
him then why does the department lose in most cases and at all levels? He just
said we could talk about this at length at another time!

 

India, like most oriental societies, is based on relationships, not on
individualism. Individual-based societies require more and more contracts for
everything. My roommate, a professor at UC Berkley, when I first went to the US
told me that all relationships in America were either contractual, functional
or legal. That is not so in our society. Therefore, more thrust on values,
rather than just (poorly drafted) laws, is critical.

 

Back then Dr. Ambedkar had said: “However good a Constitution may be,
if those who are implementing it are not good, it will prove to be bad. However
bad a Constitution may be, if those implementing it are good, it will prove to
be good.”

 

These days, many people make it sound as if all good emanates from the
Constitution alone. However, if you read Dr. Ambedkar’s words carefully –
culture, values and ethics are more important – for they make a person and then
whatever she handles will be driven by those values. We need as much or more of
manufacturing of this internal compass pointing towards true north in our
people, as we do for the creation of jobs.

 

At another proceeding, a tax officer was asking for every single
dividend counterfoil of a senior citizen. The assessee had no email and some
counterfoils were not received in the post. The officer said he would be
questioned and even considered corrupt for not taking every supporting evidence
although the bank statements in his possession mentioned the name of the payer
and amounts were rather small. Such kind of out-of-context excessive
technicalities in respect of an eighty-year-old homemaker assessee leads
nowhere; perhaps encourages some people to evade laws rather than struggle to
prove themselves to be on the right side.

 

A relationship-based society like India has survived and thrived on
values. I hope we can put much more thrust on building society and creating
social capital than focus on infrastructure, roads, economics alone. No doubt,
it is easier said than done – just as farm loan waiver does not correct the
root causes of the farmer problems, economics and laws without values won’t
solve a societal problem.

 

Friends, the word of the year declared by two prominent dictionaries
recently gives it away: Toxic1 and Misinformation2. Both
words articulate the stark realities of our times and what we need to fight and
overcome. I leave you with the deep thought that a poet articulates poignantly:

 

   

 

 

 

 

When there is so much falsehood in the world, how does one understand
what is true? How can one sell a mirror, in a marketplace full of (people
wearing) masks?

___________________________________

 

1   Oxford Dictionary for 2017

2       Dictionary.com for
2018

 

 

Happy New Year 2019!

 

 

 

Raman Jokhakar

Editor

APPLICABILITY OF SECTION 14A – RELEVANCE OF ‘DOMINANT PURPOSE’ OF ACQUISITION OF SHARES/ SECURITIES – PART – I

INTRODUCTION


1.1     The Finance Act, 2001 introduced the
provisions of section 14A in Chapter IV of the Income Tax Act,1961[the Act]
with retrospective effect from 1/4/1962 to provide restriction on deduction,
while computing the Total Income under the Act, of any expenditure incurred in
relation to income which does not form part of the Total Income [such
income is hereinafter referred to as Exempt Income]. Effectively, the section
provides for disallowance of expenditure incurred in relation to Exempt Income.

 

1.1.1   For the purpose of determining the quantum of
disallowance u/s. 14A, the Finance Act, 2006 introduced section 14A (2)/(3)
with effect from 1/4/2007. Section 14A (2) provides that the Assessing Officer
[AO] shall determine the amount of expenditure incurred in relation to Exempt
Income in accordance with the prescribed method, if the AO, having regards to
the accounts of the assessee, is not satisfied with the correctness of the
claim of the assessee in respect of such expenditure. section 14A (3) further
provides that the provisions of section 14A (2) shall also apply in cases where
the assessee has claimed that no such expenditure is incurred [i.e. such
expenditure is NIL]. The method of determining such expenditure is prescribed
under Rule 8D which was introduced with effect from 24/3/2008 and the same was
subsequently amended with effect from 2/6/2016

 

1.2     In the context of the provisions of section
14A, large number of issues have come-up for debate such as: applicability of
section 14A in cases where the shares [having potential of yielding Exempt
Income] are acquired /retained not for the purpose of earning dividend income
but for acquiring/retaining controlling interest; such shares are for trading
purpose and held as ‘stock-in trade’ where the dividend is incidentally earned;
whether section 14A can apply to cases where no Exempt Income [dividend] is
earned during the relevant previous year; etc. The issues have also come-up
with regard to quantification of amount of disallowance u/s. 14A under
different circumstances; whether the amount of disallowance should be limited
to the amount of Exempt Income earned during the year and also, whether for
this purpose, the application of Rule 8D is mandatory in all cases irrespective
of the fact that the assessee himself has determined the proper amount of such
disallowance while furnishing the Return of Income or has made a claim that no
such expenditure is incurred; etc. Large scale litigation is continued on
number of such issues in the context of the implications of section 14A.

 

1.3     Recently, the Apex Court, in MaxOpp
Investments Ltd and other cases, had an occasion to consider the major/main
issue of applicability of the provisions of section 14A under the circumstances
where the shares were purchased of a company for the purpose of gaining control
over the said company or were purchased as ‘stock-in-trade’. Since this
judgment settles this major issue and in the process,deals with some other
issues in the context of these provisions, it is thought fit to consider the
same in this column.

 

MAXOPP INVESTMENTS LTD Vs. CIT (2018) 402 ITR
640 (SC)

 

Background


2.1 In the above
case, various appeals [preferred by the assessees as well as the Revenue] had
come-up before the Apex Court involving the implications of section 14A.
Initially, the Court noted that, in these appeals, the question has arisen
under varied circumstances where the shares/stocks were purchased of a company
for the purpose of gaining control over the said company or as
‘stock-in-trade’. However, incidentally income was also generated in the form
of dividends as well which was exempt. On this basis, the Assessees contend
that the dominant intention for purchasing the share was not to earn dividends
income but control of the business in the company in whose shares investment
was made or for the purpose of trading in the shares as a business activity and
the shares are held as stock-in-trade. In this backdrop, the issue is as to
whether the expenditure incurred can be treated as expenditure ‘in relation to
income’ i.e. dividend income which does not form part of the total income. To
put it differently, is the dominant or main object would be a relevant
consideration in determining as to whether expenditure incurred is ‘in relation
to’ the dividend income. In most of the appeals, including in Civil Appeal Nos.
104-109 of 2015 [MaxOpp Investment Ltd], aforesaid is the scenario. Though, in
some other cases, there may be little difference in fact situation. However,
all these cases pertain to dividend income, where the investment was made in
order to retain controlling interest in a company or in group of companies or
the dominant purpose was to have it as stock-in-trade.

 

2.2   In the above context, the Court noted that
the Delhi High Court in MaxOpp Investments Ltd had taken a view that the
provisions of section 14A would apply regardless of the purpose behind making
the investment and consequently, proportionate disallowance of the expenditure
incurred by the assessee will be justified if the expenditure is incurred in
relation to Exempt Income. In this case, after deciding this major common
issues, the Delhi High Court also separately decided some other appeals on
their individual facts with which we are not concerned in this write-up. On the
other hand, the Court noted that the Punjab & Haryana High Court in State
Bank of Patiala has taken a view which runs contrary to the view taken by the
Delhi High Court.

 

2.3   For the purpose of deciding above referred
major issue, the Court preferred to deal with the findings given by the Delhi
High Court in the case of MaxOpp Investment ltd vs. CIT (2012) -347 ITR 272
[MaxOpp Investment Ltd’s case] and by the Punjab & Haryana High Court
in the case of  Principal CIT vs.
State Bank of Patiala (2017) – 391 ITR 218 [State Bank of Patiala’s case]
in the context of facts of these cases.

 

MAXOPP INVESTMENT LTD’S CASE


3.1   In the background given in para 2 above, the
Court decided to briefly note the facts in the above case of Delhi High Court
(arising from Civil Nos104-109 of 2015) for better understanding of the issues
involved and relevant findings given by the High Court in that case.

 

3.2   In the above case, the Appellant company
[MaxOpp Investment Ltd- one of the appellants in set of appeals before Apex
Court] was engaged, inter alia, in the business of finance, investments
and dealing in shares and securities. The Appellant holds shares/securities in
two portfolios, viz. (a) as investment on capital account and (b) as trading
assets for the purpose of acquiring and retaining control over investee group
companies, particularly Max India Ltd., a widely held quoted public limited
company. Any profit/loss arising on sale of shares/securities held as
‘investment’ is returned as income under the head ‘capital gains’, whereas
profit/loss arising on sale of shares/securities held as ‘trading assets’ (i.e.
held, inter alia, with the intention of acquiring, exercising and
retaining control over investee group companies) has been regularly offered and
assessed to tax as business income under the head ‘profits and gains of
business or profession’ [Business Income].

 

3.2.1 Consistent
with the aforesaid treatment regularly followed, the Appellant filed return of
income for the previous year relevant to the Assessment Year 2002-03, declaring
income of Rs. 78,90,430/-. No part of the interest expenditure of Rs.
1,16,21,168/- debited to the profit and loss account, to the extent relatable
to investment in shares of Max India Limited, yielding tax free dividend
income, was considered disallowable u/s. 14A of the Act on the ground that
shares in the said company were acquired for the purposes of retaining
controlling interest and not with the motive of earning dividend. According to
the Appellant, the dominant purpose/intention of investment in shares of Max
India Ltd. was acquiring/retaining controlling interest therein and not earning
dividend and, therefore, dividend of Rs. 49,90,860/- earned on shares of Max
India Ltd. during the relevant previous year was only incidental to the holding
of such shares. The AO, while passing the assessment order dated August 27th,
2004 u/s 143(3), worked out disallowance u/s. 14A at Rs. 67,74,175/- by
apportioning the interest expenditure of Rs. 1,16,21,168/- in the ratio of
investment in shares of Max India Ltd. (on which dividend was received) to the
total amount of unsecured loan. The AO, however, restricted disallowance under
that section to Rs. 49,90,860/-, being the amount of dividend received and
claimed exempt.

 

3.2.2   In appeal, the Commissioner of Income Tax
(Appeals) [CIT (A)] vide order dated January 12th, 2005 upheld the
order of the AO. The Appellant herein carried the matter in further appeal to
the Income Tax Appellate Tribunal, New Delhi (ITAT). In view of the conflicting
decisions of various Benches by the ITAT with respect to the interpretation of
section 14A of the Act, a Special Bench was constituted in the matter of ITO
vs. Daga Capital Management (Private) Ltd. 312 ITR (AT) 1 [Daga Capital’s case].
The appeal of the Appellant was also tagged and heard by the aforesaid Special
Bench.

 

3.2.3 The Special
Bench of the ITAT in Daga Capital’s case, dismissing the appeal of the
Appellant, inter alia, held that investment in shares representing
controlling interest did not amount to carrying on of business and, therefore,
interest expenditure incurred for acquiring shares in group companies was hit
by the provisions of section14A of the Act. The Special Bench further held that
holding of shares with the intention of acquiring/retaining controlling
interest would normally be on capital account, i.e. as investment and not as
‘trading assets’. For that reason too, the Special Bench held that there
existed dominant connection between interest paid on loan utilized for
acquiring the aforesaid shares and earning of dividend income. Consequently,
the provisions of section 14A of the Act were held to be attracted on the facts
of the case.

 

3.2.4 On the
interpretation of the expression ‘in relation to’, the majority opinion of the
Special Bench was that the requirement of there being direct and proximate
connection between the expenditure incurred and Exempt Income earned could not
be read into the provision. According to the majority view, ‘what is relevant
is to work out the expenditure in relation to the Exempt Income and not to
examine whether the expenditure incurred by the Assessee has resulted into
Exempt Income or taxable income’. As per the minority view, however, the
existence of dominant and immediate connection between the expenditure incurred
and dividend income was a condition precedent for invoking the provisions of
section 14A of the Act. It was accordingly held, as per the minority, that mere
receipt of dividend income, incidental to the holding of shares, in the case of
a dealer in shares, would not be sufficient for invoking provisions of section
14A of the Act.

 

3.2.5 Against the
aforesaid order of the Special Bench, the Appellant preferred appeal u/s. 260A
of the Act to the High Court. The High Court of Delhi has, vide impugned
judgment dated November 18th, 2011, held that the expression ‘in
relation to’ appearing in section 14A was synonymous with ‘in connection with’
or ‘pertaining to’, and, that the provisions of that section apply regardless
of the intention/motive behind making the investment. As a consequence,
proportionate disallowance of the expenditure incurred by the Assessee is
maintained.

 

3.2.6   While coming to the above conclusion, the
High Court also took into the account the law prevailing prior to insertion of
section 14A (Prior Law) and the object of insertion of section 14A. The Prior
Law was that when an assessee has a composite and indivisible business which
has elements of both taxable and non-taxable income, the entire business
expenditure was deductible and in such a case the principle of apportionment of
such expenditure relating to non-taxable income did not apply. However, where
the business was divisible, such principle of apportionment was applicable and
the expenditure apportioned to the Exempt Income was not eligible for deduction
[ref CIT vs. Indian Bank Ltd (1965)56 ITR 77 (SC), CIT vs. Maharashtra Sugar
Mills Ltd (1971)82 ITR 452(SC) and Rajasthan State Warehousing Cooperation vs.
CIT (2000) 242 ITR 452 (SC)]

 

3.3    The Apex Court considered the above
judgment and, inter alia, noted the following observations and findings
of the High Court:

 

a.  The object behind the insertion of section 14A
in the said Act is apparent from the Memorandum explaining the provisions of
the Finance Bill, 2001 which is to the following effect:

 

‘Certain incomes
are not includable while computing the total income as these are exempt under
various provisions of the Act. There have been cases where deductions have been
claimed in respect of such Exempt Income. This in effect means that the tax
incentive given by way of exemptions to certain categories of income is being
used to reduce also the tax payable on the non-exempt income by debiting the
expenses incurred to earn the Exempt Income against taxable income. This is
against the basic principles of taxation whereby only the net income, i.e.,
gross income minus the expenditure is taxed. On the same analogy, the exemption
is also in respect of the net income. Expenses incurred can be allowed only to
the extent they are relatable to the earning of taxable income.

 

It is proposed to
insert a new Section 14A so as to clarify the intention of the Legislature
since the inception of the Income-tax Act, 1961,that no deduction shall be made
in respect of any expenditure incurred by the Assessee in relation to income
which does not form part of the total income under the Income-tax Act.

 

The proposed
amendment will take effect retrospectively from April 1, 1962 and will
accordingly, apply in relation to the assessment year 1962-63 and subsequent
assessment years.’

 

b. As observed by the Apex Court in the case of CIT
vs. Walfort Share and Stock Brokers P. Ltd. (2010) 326 ITR 1 (SC) [Walfort’s
case], the insertion of section 14A with retrospective effect reflects the
serious attempt on the part of Parliament not to allow deduction in respect of
any expenditure incurred by the assessee in relation Exempt Income against the
taxable income. The Apex Court in Walfort’s case further observed as under:

 

“…In other words,
Section 14A clarifies that expenses incurred can be allowed only to the extent
that they are relatable to the earning of taxable income. In many cases the
nature of expenses incurred by the Assessee may be relatable partly to the
exempt income and partly to the taxable income. In the absence of Section 14A,
the expenditure incurred in respect of exempt income was being claimed against
taxable income. The mandate of Section 14A is clear. It desires to curb the
practice to claim deduction of expenses incurred in relation to exempt income
against taxable income and at the same time avail of the tax incentive by way
of an exemption of exempt income without making any apportionment of expenses
incurred in relation to exempt income….

 

…Expenses allowed
can only be in respect of earning taxable income. This is the purport of
Section 14A. In Section 14A, the first phrase is “for the purposes of
computing the total income under this Chapter” which makes it clear that
various heads of income as prescribed in the Chapter IV would fall within
Section 14A. The next phrase is, “in relation to income which does not
form part of total income under the Act”. It means that if an income does
not form part of total income, then the related expenditure is outside the
ambit of the applicability of Section 14….”

 

The Apex Court in
Walfort’s case also clearly held that in the case of an income like dividend
income which does not form part of the total income, any expenditure/deduction
relatable to such (exempt or non-taxable) income, even if it is of the nature
specified in sections 15 to 59 of the Act, cannot be allowed against any other
income which is includable in the Total Income. The exact words used by the
Apex Court in that case are as under:

 

“Further, Section
14 specifies five heads of income which are chargeable to tax. In order to be
chargeable, an income has to be brought under one of the five heads. Sections
15 to 59 lay down the Rules for computing income for the purpose of
chargeability to tax under those heads. Sections 15 to 59 quantify the total
income chargeable to tax. The permissible deductions enumerated in Sections 15 to
59 are now to be allowed only with reference to income which is brought under
one of the above heads and is chargeable to tax. If an income like dividend
income is not a part of the total income, the expenditure/deduction though of
the nature specified in Sections 15 to 59 but related to the income not forming
part of the total income could not be allowed against other income includable
in the total income for the purpose of chargeability to tax. The theory of
apportionment of expenditure between taxable and non-taxable has, in principle,
been now widened Under Section 14A.”

 

c.  Likewise, explaining the meaning of
‘expenditure incurred’, the High Court agreed that this expression would mean
incurring of actual expenditure and not to some imagined expenditure. At the
same time, observed the High Court, the ‘actual’ expenditure that is in
contemplation u/s. 14A (1) is the ‘actual’ expenditure in relation to or in
connection with or pertaining to Exempt Income. The corollary to this is that
if no expenditure is incurred in relation to the Exempt Income, no disallowance
can be made u/s. 14A.

 

STATE BANK OF PATIALA’S CASE.


4.1    In the above case, the Punjab and Haryana
High Court has taken a view which runs contrary to the aforesaid view taken by
the Delhi High Court. The Punjab and Haryana High Court followed the judgment
of the High Court of Karnataka in CCI Ltd. vs. Joint Commissioner of Income
Tax, (2012) 206 Taxman 563 [CCI Ltd’s case]. The Revenue has filed appeals
challenging the correctness of the said decision.

 

4.2     The Apex Court noted the brief facts of
this case and further noted that this case arose in the context where Exempt
Income  was earned by the Bank from
securities held by it as its stock in trade. The Assessee filed its return
declaring an income of about Rs. 670 crores which was selected for scrutiny.
The return for the assessment year 2008-09 showed dividend income exempt u/s.
10(34) and (35) and net interest income exempt u/s. 10(15)(iv) (h). The total
Exempt Income claimed in the return of income was, Rs. 12,20 crore. The
Assessee while claiming the exemption contended that the investment in shares,
bonds, etc. constituted its stock-in-trade; that the investment had not been
made for earning tax free income; that the tax free income was only incidental
to the Assessee’s main business of sale and purchase of securities and,
therefore, no expenditure had been incurred for earning such Exempt Income; the
expenditure would have remained the same even if no dividend or interest income
had been earned by the Assessee from the said securities and that no
expenditure on proportionate basis could be allocated against Exempt Income.
The Assessee also contended that in any event it had acquired the securities
from its own funds and, therefore, section 14A was not applicable. The AO
restricted the disallowance to the amount of Rs. 12.20 crore which was claimed
as Exempt Income as against the expenditure of Rs. 40.72 crore allocated
towards Exempt Income by applying the formula contained in Rule 8D holding that
section 14A would be applicable. The CIT(A) issued notice of enhancement u/s.
251 of the Act and held that in view of section 14A, the Assessee was not to be
allowed any deduction in respect of expenditure incurred in relation to Exempt
Income. Therefore, he disallowed the entire expenditure of Rs. 40.72 crore
instead of restricting the disallowance to the amount which was claimed as
Exempt Income as done by the AO. The ITAT set aside the order of the AO as well
as CIT (A). It referred to a CBDT Circular No. 18/2015 dated 02.11.2015 which
states that income arising from such investment of a banking concern is
attributable to the business of banking which falls under the head
“Profits and gains of business and profession”. The circular states
that shares and stock held by the bank are ‘stock-in-trade’ and not
‘investment’. Referring to certain judgments and the earlier orders of the
Tribunal, it was held that if shares are held as stock-in-trade and not as
investment even the disallowance under Rule 8D would be nil as Rule 8D(2)(i)
would be confined to direct expenses for earning the tax Exempt Income. In this
factual backdrop, in appeal filed by the Revenue, the High Court noted that
following substantial question of law arose for consideration:

 

“Whether in the
facts and circumstances of the case, the Hon’ble ITAT is right in law in
deleting the addition made on account of disallowance Under Section 14A of the
Income Tax Act, 1961?”


4.3     The Apex Court then considered the above
judgment and, inter-alia, noted the following observations and findings
of the High Court:

 

(a) In its analysis, the High Court accepted the
contention of the counsel for the Assessee that the Assessee is engaged in the
purchase and sale of shares as a trader with the object of earning profit and
not with a view to earn interest or dividend. The Assessee does not have an
investment portfolio. The securities constitute the Assessee’s stock-in-trade.
The Department, in fact, rightly accepted, as a matter of fact, that the
dividend and interest earned was from the securities that constituted the
Assessee’s stock-in-trade. The same is, in any event, established. The Assessee
carried on the business of sale and purchase of securities. It was supported by
Circular No. 18, dated November 2th, 2015, issued by the CBDT, which
reads as under:

 

“Subject: Interest
from Non-SLR securities of Banks – Reg.

 

It has been brought
to the notice of the Board that in the case of Banks, field officers are taking
a view that, “expenses relatable to investment in non-SLR securities need
to be disallowed Under Section 57(i) of the Act as interest on non-SLR
securities is income from other sources.

 

2. Clause (id) of
Sub-section (1) of Section 56 of the Act provides that income by way of
interest on securities shall be chargeable to income-tax under the head
“Income from Other Sources”, if, the income is not chargeable to
income-tax under the head “Profits and Gains of Business and
Profession”.

 

3. The matter has
been examined in light of the judicial decisions on this issue. In the case of CIT
vs. Nawanshahar Central Cooperative Bank Ltd. [2007] 160 TAXMAN 48 (SC),
the Apex Court held that the investments made by a banking concern are part of
the business of banking. Therefore, the income arising from such investments is
attributable to the business of banking falling under the head “Profits
and Gains of Business and Profession”.

 

3.2 Even though the
abovementioned decision was in the context of co-operative societies/Banks
claiming deduction u/s. 80P(2)(a)(i) of the Act, the principle is equally
applicable to all banks/commercial banks, to which Banking Regulation Act, 1949
applies.

 

4. In the light of
the Supreme Court’s decision in the matter, the issue is well settled.
Accordingly, the Board has decided that no appeals may henceforth be filed on
this ground by the officers of the Department and appeals already filed, if
any, on this ground before Courts/Tribunals may be withdrawn/not pressed upon.
This may be brought to the notice of all concerned.”


(b) The High Court pointed out that the Circular
carves out a distinction between stock-in-trade and investment and provides
that if the motive behind purchase and sale of shares is to earn profit then
the same would be treated as trading profit and if the object is to derive
income by way of dividend then the profit would be said to have accrued from
the investment. If the Assessee is found to have treated the shares and
securities as stock-in-trade, the income arising therefrom would be business
income. A loss would be a business loss. Thus, an Assessee may have two
portfolios, namely, investment portfolio and a trading portfolio. In the case
of the former, the securities are to be treated as capital assets and in the
latter as trading assets.


(c) Further, as a banking institution, the Assessee
was also statutorily required to place a part of its funds in approved
securities, as held in CIT vs. Nawanshahar Central Co-operative Bank Ltd.
MANU/SC/2707/2005 : (2007) 289 ITR 6 (SC) [Nawan shahar’s case]. Since, the
shares, bonds, debentures purchased by the Assessee constituted its
stock-in-trade, the provisions of section 14A were not applicable. Here, the
High Court noted distinction between stock-in-trade and investment and stated
that the object of earning profit from trading in securities is different from
the object of earning income, such as, dividend and interest arising therefrom.
The object of trading in securities does not constitute the activity of
investment where the object is to earn dividend or interest.


(d) The High Court then discussed in detail the
judgment of the Apex Court in Walfort’s case (supra) which related to
dividend stripping. After explaining the objective behind section 14A, the Apex
Court, in the facts of that case, had held that a payback does not constitute
an ‘expenditure incurred’ in terms of section 14A as it does not impact the
profit and loss account. This expenditure, in fact, is a payout.


(e) According to the High Court, what is to be
disallowed is the expenditure incurred to “earn” Exempt Income. The
words ‘in relation to’ in section 14A must be construed accordingly. Applying
that principle to the facts at hand, the High Court concluded as under:

 

“Now, the dividend
and interest are income. The question then is whether the Assessee can be said
to have incurred any expenditure at all or any part of the said expenditure in
respect of the exempt income viz. dividend and interest that arose out of the
securities that constituted the Assessee’s stock-in-trade. The answer must be in
the negative. The purpose of the purchase of the said securities was not to
earn income arising therefrom, namely, dividend and interest, but to earn
profits from trading in i.e. purchasing and selling the same. It is axiomatic,
therefore, that the entire expenditure including administrative costs was
incurred for the purchase and sale of the stock-in-trade and, therefore,
towards earning the business income from the trading activity of purchasing and
selling the securities. Irrespective of whether the securities yielded any
income arising therefrom, such as, dividend or interest, no expenditure was
incurred in relation to the same.”

 

4.4     The Court also noted that the Punjab and
Haryana High Court in the above case referred and concurred with the judgment
of Karnataka High Court in CCI Ltd’s case and considered the same. Apart from
this, the Court also felt it useful to refer and consider the judgment of
Calcutta High Court in the case of G.K. K. Capital Markets (P) Ltd [ (2017)
373 ITR 196 ] [G.K.K. Capital’s case] which had also agreed with the view
of the Karnataka High Court in CCI Ltd’s case. In this context, the Court also
mentioned that the earlier judgment of the Calcutta High Court in the case of Danuka
& Sons vs. CIT [(2011) 339 ITR 319} [Danuka & Sons’ case] was cited
by the Revenue in G.K.K. Capital’s case but that judgment was distinguished on
the ground that, in that case, there was no dispute that part of the income of
the assessee from its business was from dividend and the assessee was unable to
produce any material before the authorities below showing the source from which
the relevant shares were acquired.

 

[ to be
concluded]


Note: The judgment of the Apex Court in the
case of Rajasthan State Warehousing Corporation referred to in para 3.2.6
above dealing with the Prior Law was analysed in this column in the April, 2000
issue of this journal.  

Section 147 : Reassessment – Beyond period of 4 years –Findings in case of another assessee – No failure to disclose material facts – Reassessment was held to be not valid. [Sections 80IB(10) ,148]

12.  Pr.CIT
vs. Vaman Estate [ Income tax Appeal no 678 of 2016, Dated: 27th November, 2018 (Bombay
High Court)]. 

 

[ACIT-21(2) vs. Vaman Estate; dated 15/07/2015 ;
ITA. No 5584/Mum/2012, AY: 2004-05 , Bench: F, Mum.  ITAT ]

 

Section
147 : Reassessment – Beyond period of 4 years –Findings in case of another
assessee – No failure to disclose material facts – Reassessment was held to be
not valid. [Sections 80IB(10) ,148]

 

The assessee filed on 31.10.2004 declaring total income at Rs. Nil.
In the return of income filed by the assessee for the said assessment year, the
principal claim was of deduction u/s. 80IB(10) of the Act arising out of income
from development of a housing project. In the assessment carried out by the
A.O, he disallowed a part of the claim after detailed scrutiny. Such assessment
was reopened by the A.O by issuance of notice, which was done beyond the period
of four years from the end of relevant assessment year. In order to issue such
notice, the A.O had recorded the detailed reasons. The gist of his reason was
that a similar claim was lodged by one 
Abode Builders for the same housing project. In the course of
examination of such claim of the said assessee, the A.O had detected certain
defects. The A.O had rejected the claim inter alia on the ground that
the development and construction of housing project had commenced prior to
01.10.1998 (which was the crucial date for claiming the benefits u/s. 80IB(10)
of the Act). The A.O of the present assessee, therefore, found that the
assessee was not entitled to the deduction since one of the essential
requirements of the provision was breached. He noted that these facts were not
disclosed by the assessee and not brought to the notice of the A.O during the
assessment. Therefore, there was failure on the part of the assessee to
disclose truly and fully all material facts necessary for assessment.


The CIT(A) observed that during the scrutiny assessment, there was
no failure on the part of the assessee to disclose truly and fully all material
facts. Even on merits, he was of the opinion that there was no evidence to
suggest that the development and construction of the housing project commenced
prior to 01.10.1998. On such grounds, the assessee’s appeal was allowed.

 

The Revenue carried the matter in further appeal before the
Tribunal. The Tribunal held that in absence of any failure on the part of the
assessee to disclose true facts, the reopening of assessment beyond the period
of four years was not permissible. It is undisputed that in the original
assessment, the A.O had examined the assessee’s claim of deduction u/s.
80IB(10) of the Act at some length. To the extent he was dissatisfied, the
claim was disallowed. Such assessment was sought to be reopened only on the
ground that in case of Abode Builders where similar claim was raised in
connection with the same housing project, the A. O had detected certain
breaches which disqualified the assessee from claiming deduction. Essentially,
according to the A.O, the development and construction of the housing project
had commenced prior to 01.10.1998. The CIT(A) in a detailed consideration of
all the relevant aspects of the matter came to the conclusion that there was no
material to suggest that the development and construction of the housing
project had commenced prior to 01.10.1998.


Being aggrieved with the order of the ITAT, the Revenue filed the
Appeal before High Court. The Court find that the assessee had made full
disclosure of all relevant facts during the original scrutiny assessment. As
noticed by the CIT(A), all necessary facts were before the A.O while deciding
the original assessment. During such assessment, the assessee’s claim of
deduction was also minutely examined by the A.O. Reopening of assessment beyond
the period of four years was, therefore, correctly disallowed by the CIT(A) and
the Tribunal. As noted, the only source available with the A.O to contend that
relevant material was not brought on record by the assessee was assessment in
case of Abode Builders. Here also, there is one vital defect in the logic
adopted by the A.O. We do not find any where any material to suggest that the
development and construction of the housing project commenced before
01.10.1998. Even in the reasons recorded, the A.O has not linked any material
in order to make this observation. He has mainly relied on the findings of the
A.O of Abode Builders. This conclusion was reversed by the CIT(A) noting that
in fact all along there was evidence suggesting that the commencement of
construction of the housing project was some time in the year 2002. It was
pointed out that the assessment order in case of M/s. Abode Builders was set
aside by the CIT(A) and the same was confirmed by the Tribunal. There was no
failure on the part of the assessee to disclose truly and fully all relevant
facts as correctly held by the CIT(A) and the Tribunal pursuant to the detailed
discussion. Therefore, no question of law arises. The appeal was dismissed
accordingly.  

 

Section 194L and 194LA – TDS – State Metropolitan Development Authority – Acquisition of land for projects paying sums to illegal squatters for their rehabilitation – Not a case of compulsory acquisition from owners of land for which compensation paid – No liability to deduct tax at source on payments to illegal squatters

39. 
CIT vs. MMRDA; 408 ITR 111(Bom):  Date of order: 6th September,
2018 A. Ys. 2000-01 to 2009-10

 

Section 194L and  194LA – TDS – State Metropolitan Development
Authority – Acquisition of land for projects paying sums to illegal squatters
for their rehabilitation – Not a case of compulsory acquisition from owners of
land for which compensation paid – No liability to deduct tax at source on
payments to illegal squatters

 

For the purpose of
implementing the scheme of the Government relating to road widening near the
railway track, the assessee, the Mumbai Metropolitan Regional Development
Authority, evacuated illegal and unauthorised persons who were squatters and
hutment dwellers. The Assessing Officer was of the opinion that there was
acquisition of immovable property for various projects by the assessee, for
which the project affected persons were compensated under the Land Acquisition
Act, 1894, He treated the assessee as the assessee-in-default u/s. 201(1) of
the Act and liable to pay interest u/s. 201(1A) since the assessee had not
deducted tax at source u/s. 194L/194LA. Accordingly, he computed the payment of
tax u/s. 201(1) and interest u/s. 201(1A)

 

The Commissioner
(Appeals) allowed the appeal and deleted the demand. The Tribunal upheld the
order of the Commissioner (Appeals).

 

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

 

“i)    The possession of those persons was
unauthorized and illegal and they were not the owners of the land on which they
had squatted or built their illegal hutments and were trespassers. Therefore,
there was no question of the land being acquired by the assessee.


ii)    The Tribunal correctly came to the
conclusion that the land had always belonged to the State and it was encroached
upon, which encroachment was removed by the assessee and the encroaching
squatters or hutment dwellers were rehabilitated. There was no question of
there being any compulsory acquisition from them under any law either under the
1894 Act or any other enactments which permitted compulsory acquisition of
land. Hence section 194L or section 194LA had no application.”

 

Sections 115JB and 254 Rectification of mistake – Tribunal accepting that assessee’s book profits to be computed after giving effect to deduction u/s. 54EC – AO passing order giving effect to directions issued by Tribunal – Notice of rectification issued thereafter on ground that deduction u/s. 54EC wrongly allowed – Not permissible Notice quashed

38. 
Meteor Satellite Pvt. Ltd. vs. ITO; 408 ITR 99 (Guj): Date of order: 16th April, 2018 A. Y. 2010-11

 

Sections 115JB and 254 Rectification of
mistake – Tribunal accepting that assessee’s book profits to be computed after
giving effect to deduction u/s. 54EC – AO passing order giving effect to
directions issued by Tribunal – Notice of rectification issued thereafter on
ground that deduction u/s. 54EC wrongly allowed – Not permissible Notice
quashed

 

For the A. Y.
2010-11, the Tribunal accepted the assessee’s contention and held that the
assessee’s profits ought to be computed u/s. 115JB of the Act after carrying
out deduction u/s. 54EC. The Assessing Officer gave effect to the order and
recomputed the assessee’s book profits according to the directions of the
Tribunal and passed an order. Subsequently, he issued a notice u/s. 154 of the Act
to rectify the order passed by him for giving effect to the order of the
Tribunal on the ground that the book profits of the assessee had been wrongly
computed by allowing deduction u/s. 54EC in contravention of the law for
determining the book profits and that rectification of the order was to be
carried out.

 

The assessee filed
a writ petition and challenged the validity of the notice. The Gujarat High
Court allowed the writ petition and held as under:

 

“i)    There was no error in the Assessing
Officer’s order implementing the Tribunal’s directions. The Tribunal had
directed the Assessing Officer to compute the assessee’s book profits in a
particular manner which was correctly understood and given effect by him.


ii)    He had proposed to rectify his order giving
effect to the Tribunal’s decision on the ground that there had been  an apparent error. However, as long as the
order of the Tribunal stood, the assessment order was required to be
implemented. Further, having implemented the order, it was not open for him to
exercise power of rectification which was meant for correcting any error
apparent on record.”

 

Section 4 – Income – Chargeable as (Compensation) – Compensation awarded under Motor Vehicles Act or Employees’ Compensation Act in lieu of death of a person or bodily injury suffered in a vehicular accident, is a damage and not an income and cannot be treated as taxable income

37. 
National Insurance Company Ltd. vs. Indra Devi; [2018] 100 taxmann.com
60 (HP): Date of order: 25th October, 2018

 

Section 4 – Income – Chargeable as
(Compensation) – Compensation awarded under Motor Vehicles Act or Employees’
Compensation Act in lieu of death of a person or bodily injury suffered in a
vehicular accident, is a damage and not an income and cannot be treated as
taxable income

 

The respondent Nos.
1 and 2 had filed a claim petition being u/s. 3 of the Workmen Compensation Act
for compensation on account of death of ‘R’, who, while working as a
cleaner/conductor, died in an accident. The Commissioner allowed the petition
by awarding a sum of Rs. 3,94,135 along with 12 per cent interest. In pursuance
to the award, the petitioner-insurance company deposited a sum of Rs. 5,32,007,
in the Court of the Commissioner after deducting TDS on interest component
payable on the compensation amount, which was deducted by the
petitioner-insurance company in compliance of section 194A. The tax was
deposited with the respondent No. 3- ITO (TDS). In execution petition preferred
by the claimants/respondents for payment of balance amount of compensation, the
Commissioner, directed to attach movable property of petitioner-insurance
company herein for realisation of balance amount. The petitioner insurance
company filed a writ petition and challenged the said order. The Himachal
Pradesh High Court held as under:

 

“i)    Section 194A clearly provides
that any person, not being an individual or a Hindu Undivided Family,
responsible for paying to a ‘resident’ any income by way of interest, other
than income by way of interest on securities, shall deduct tax on such income
at the time of payment thereof in cash or by issue of cheque or by any other
mode. Compensation awarded under Motor Vehicles Act or Employees’ Compensation
Act in lieu of death of a person or bodily injury suffered in a vehicular
accident, is a damage and not an income and cannot be treated as taxable
income.


ii)    It is well settled that
interest awarded by the Motor Accident Claims Tribunal on a compensation is
also a part of compensation upon which tax is not chargeable.


iii)    Therefore, in view of abovesaid
decision, deduction of tax by petitioner/Insurance Company on the awarded
compensation and interest accrued thereon is illegal and is contrary to the law
of land.


iv)   In view of above discussion,
this petition is disposed of directing respondent No. 3 to refund the TDS to
the petitioner/Insurance Company.


v)    The amount deposited with the
department after deduction at source is Rs. 34,468, whereas the impugned order
of realization passed by the Commissioner is Rs. 66,900. Therefore, it is made
clear that for payment of balance amount claimed in the execution petition
filed by the respondents No. 1 and 2, the petitioner/Insurance Company has to
satisfy the Court of Commissioner and in case any amount beyond Rs. 34,468 is
found payable to the D.H./Claimants/respondents, the Commissioner/Executing
Court shall be entitled to pass any order in accordance with law for failure of
the petitioner company to satisfy the award.”


Section 9 of the Act w.r.t. Article 12 of DTAA between India and Austria – Income – Deemed to accrue or arise in India (Royalty/Fees for technical services) – Assessee-company entered into a technical assistance agreement with a non-resident company in Austria for design of new 75CC, 3-valve cylinder head for moped application – Assessing Officer treated payment to Austrian company as royalty – Since engine had already been developed by assessee and scope of technical services agreement was only to design a new 3-valve cylinder head with a specified combustion system for considerable improvement of fuel efficiency, performance and meeting Indian emission standards and moreover all products, design of engines and vehicles were supplied by assessee, payment did not constitute royalty

36. 
DIT vs. TVS Motors Co. Ltd.; [2018] 99 taxmann.com 40 (Mad): Date of the order: 24th October,
2018 A. Y. 2002-03

 

Section 9 of
the Act w.r.t. Article 12 of DTAA between India and Austria – Income – Deemed to accrue or
arise in India (Royalty/Fees for technical services) – Assessee-company entered
into a technical assistance agreement with a non-resident company in Austria
for design of new 75CC, 3-valve cylinder head for moped application – Assessing
Officer treated payment to Austrian company as royalty – Since engine had
already been developed by assessee and scope of technical services agreement
was only to design a new 3-valve cylinder head with a specified combustion
system for considerable improvement of fuel efficiency, performance and meeting
Indian emission standards and moreover all products, design of engines and
vehicles were supplied by assessee, payment did not constitute royalty

 

The assessee
entered into a technical assistance agreement with a non-resident company in
Austria for design of new 75CC, 3-valve Cylinder head, the project which
commenced in January 2001 and was completed in October 2001. The assessee
during the assessment proceedings contended that the fees paid by them to the
Austrian company was only for technical services, as the entire work was done
in Austria and no part of the work was done in India and the entire income was
taxable only in Austria in terms of provision of the DTAA with Austria. The
Assessing Officer, on going through the technical assistance agreement held
that the Austrian company was providing the design of newly developed engine
for being used by the assessee and thus payment was taxable as ‘royalty’.

 

The Commissioner
(Appeals) allowed the assessee’s appeal and held that the payment did not
constitute royalty. The Tribunal dismissed the appeal filed by the revenue.

 

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

 

“i)    The scope of the work was for design of a
new 3-valve cylinder head with AVL CCBR combustion system. This would have
considerable improvement of fuel efficiency, improved performance and Meeting
India 2004 Emission Limits under IDC test conditions. The agreement states that
the assessee has recently developed a new 75CC 4-stroke 2-valve air cooled
engine with single speed transmission for moped application. As the local
market, (India), is asking for better fuel economy, the Austrian company was
asked to design a new 3-valve cylinder head with a lean burn combustion system
with charge motion for rapid combustion. The whole work under the said
agreement was to be carried out in Austria. The assessee was to supply the
material with all design documentation, engines and components as required for
the project. The total price for the project work deliverables and services was
agreed at EURO 349.522.


ii)    The engine has already been developed by the
assessee and scope of the technical services agreement was only to design a new
3-valve cylinder head with a specified combustion system for considerable
improvement of fuel efficiency, performance and meeting the Indian emission
standards. All products, design of the engines and vehicles are supplied by the
assessee. On completion all the drawings are also delivered by the Austrian
company to the assessee. The entire project was carried out in Austria and no
part of the project was performed in India. Thus, the Commissioner (Appeals)
rightly held that the payment does not constitute royalty.”

Section 10B – Export oriented undertaking – 10B(9)/(9A)) – Assessee firm was engaged in production and export of iron ore – It claimed deduction u/s. 10B – Assessing officer rejected assessee’s claim on ground that assessee’s sister concern got merged with assessee – assessee’s sister concern was also an EOU – Impugned order rejecting assessee’s claim was to be set aside

35. 
CIT vs. Trident Minerals; [2018] 100 taxmann.com 161 (Karn): Date of order: 10th October, 2018 A Y. 2009-10

 

Section 10B – Export oriented undertaking –
10B(9)/(9A)) – Assessee firm was engaged in production and export of iron ore –
It claimed deduction u/s. 10B – Assessing officer rejected assessee’s claim on
ground that assessee’s sister concern got merged with assessee – assessee’s
sister concern was also an EOU – Impugned order rejecting assessee’s claim was
to be set aside

 

The assessee-firm
was engaged in business of production, manufacture and export of iron ore. On
02/05/2008 the assessee’s sister concern namely KMMI Exports merged with
assessee. On 22/09/2009, return of income was filed u/s. 139(1) of the Act and
deduction u/s. 10B was claimed in respect of export income. The Assessing
Officer held that deduction u/s. 10B was not allowable on the ground that two
partnership firms had been merged and that assets of KMMI Exports had been
taken over by assessee.

 

The Commissioner
(Appeals) allowed the claim of the assessee.

 

The Tribunal upheld
the decision of the Commissioner (Appeals).

 

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

 

“i)    The Commissioner (Appeals) recorded a
finding that the Circular of the Board issued u/s. 84 was not withdrawn and was
still in force. It is the Rule and also the practice of the Board to withdraw
the Circular once it is not relevant. Therefore, the Circular No. 15/5/63-IT(A1),
dated 13/12/1962 is in force and relevant in the present context, when the
clauses u/s. 80J and 10B are similar. It was also recorded by the appellate
authority that the observation made by the Assessing Officer, as per section
10B(7), only Indian company is eligible for amalgamation is not appropriate.


ii)    As mentioned by the assessee in the written
submission that ‘the sub-sections (9) and (9A) which were omitted with effect
from 01/04/2004 clearly suggests that the transfer by any means will not entitle
the deduction under this section only up to 31/03/2003. In other words, the
transfer by any means is allowed with effect from 01/04/2004 by implication,
moreover, the firms merged are family concerns with same partners, with the
same sharing ratio and doing the same business and two firms are having 100 per
cent EOU recognised by the SEZ Authorities. Hence, the Commissioner held that
the claim of the assessee was justifiable and the same was allowed.


iii)    On appeal filed by the revenue, Tribunal
recorded a finding that the unit of the assessee firm is a 100 per cent EOU
unit entitled for deduction u/s. 10B of the Act. It is also seen that Assessing
Officer has not disputed the EOU status of the unit KMMI Exports also. The
issue for consideration is after the merger of the firm KMMI exports with the
assessee-firm, whether the assessee-firm is entitled for deduction u/s. 10B of
the Act. Earlier, there was sub-section (9) to section 10B, which specifically
provided that the deduction cannot be allowed, if there was a transfer of
ownership or beneficial interest in the undertaking. The sub-section (9A) of
section 10B was omitted with effect from 01/04/2004. In this view of the
matter, the inevitable and appropriate conclusion is that the limitations
specified in sub-sections (9) and (9A) of section 10B Act do not exist from
01/04/2004 and, therefore, the conclusion of the Assessing Officer that
deduction u/s. 10B cannot be granted on the merger of firms is not correct.


iv)   The Tribunal after considering a finding that
in view of the CBDT Circular No. 1 of 2013, dated 17/01/2013, it is clear that
deduction is granted to the undertaking. Therefore, it follows as long as the
undertakings remain eligible for deduction u/s. 10B, the deduction cannot be
denied merely on the ground that there has been a merger of the firms which own
the undertakings. The Assessing Officer has not rendered any finding that
either on the units, belonging to the assessee and the other belonging to the
firm that got merged, i.e., KMMI Exports, is not eligible for deduction u/s.
10B of the Act. The only reason adduced is that due to the merger of the two
units, the assessee is deploying assets already put to use by the merged firm
and hence the assessee cannot claim deduction u/s. 10B of the Act.


v)    The Tribunal further recorded a finding that
both the units/undertakings of the assessee-firm and KMMI Exports are otherwise
eligible for deduction u/s. 10B and the deduction is towards undertaking as
long as undertakings are agreeable that section 10B which is not been disputed
by the Assessing Officer merger of the firm and KMMI Exports which is not
undertaking. In view of the above, the Tribunal upheld the order passed by the
Appellate Court allowing the deduction u/s. 10B.


vii)   It is undisputed fact that the claim made by
the assessee for deduction u/s. 10B for the assessment year 2009-10 after the
merger of two firms with effect from 26/12/2011. It is also undisputed that in
view of the deletion of the provision of sub-section (9) of section 10B from
the statute with effect from 01/04/2004 the impugned order passed by the
Tribunal allowing the assessee’s claim for deduction u/s. 10B was to be
upheld.”


Section 10(23C)(iiiad) – Educational institution – Exemption u/s. 10(23C)(iiiad) – Assessee-trust was established predominantly with an object of providing education to all sections of society – Mere fact that it spent a meagre amount of its total income on some allied charitable activities such as providing food and clothing to relatives of poor students, would not stand in way of AO to deny benefit to it u/s. 10(23C)(iiiad)

34. 
Sri Sai Educational Trust vs. CIT; [2018] 100 taxmann.com 50 (Mad): Date of order: 10th October, 2018 A. Y. 2014-15

 

Section 10(23C)(iiiad) – Educational
institution – Exemption u/s. 10(23C)(iiiad) – Assessee-trust was established
predominantly with an object of providing education to all sections of society
– Mere fact that it spent a meagre amount of its total income on some allied
charitable activities such as providing food and clothing to relatives of poor
students, would not stand in way of AO to deny benefit to it u/s.
10(23C)(iiiad)

 

The assessee trust
was established predominantly with an object of providing school education to
all sections of society. The only activity of the assessee-trust was running of
an educational institution. The assessee-trust was granted registration u/s.
12A on 30/05/2016. The assessee filed its return for relevant year i.e. A. Y.
2014-15 claiming exemption of income. The assessee’s claim was based on plea
that in view of the registration granted u/s. 12AA of the Act, with effect from
01/04/2015 and in view of the first proviso to section 12A(2), effect of such
registration had to be applied retrospectively in respect of the subject year
i.e. A. Y. 2014-15 also and consequently, the Assessing Officer ought not to
have assessed the income to tax. The assessee’s alternative plea was that if
the exemption was not allowed with retrospective application of the
registration as contemplated u/s. 12A(2), it should have been granted the
benefit of exemption by applying section 10(23C)(iiiad). The Assessing Officer
rejected assessee’s claim of granting benefit of section 12A with retrospective
effect. He further held that since assessee was not existing solely for
educational purpose as it was carrying on some other charitable activities
also, exemption u/s. 10(23C)(iiiad) was also not allowable.

 

The assesee filed a
writ petition and challenged the order of the Assessing Officer. The Madras
High Court upheld the order of the Assessing Officer as regards section 12A.
The High Court allowed the writ petition and held that the assessee is entitled
to exemption u/s. 10(23C)(iiiad) and held as under:

 

“i)    Perusal of the provision of section
10(23C)(iiiad) would show that any income received by any University or
educational institution existing solely for educational purposes and not for
purposes of profit, shall not be included in total income. In other words, such
income is not taxable and on the other hand, gets exempted from levy of tax. It
is the contention of the assessee that since the trust is existing solely for
educational purposes without having any purpose of profit, the respondent is
not entitled to bring the disputed income to tax.


ii)    There is no dispute to the fact that the
assessee trust is running an educational institution for providing elementary
school education without distinction of caste and creed, from 1997. Though the
Trust Deed refers few other charitable activities such as providing medical
relief to the poor, relief to orphans, etc., the predominant object of the
trust is evidently seen as administering, establishing and maintaining schools
and other educational institutions to impart education to poor students without
any restriction as to caste, community or religion. This noble object of the
assessee trust cannot be looked into with magnifying glass to find out as to
whether any meagre expenditure spent by them on any allied charitable purpose,
so as to project, as though by doing such activity, the assessee-trust is not
existing solely for educational purposes. In this case, the objection of the
revenue relates to a sum of Rs.54,300/- spent by the petitioner for providing
sarees to mothers and grandmothers of the children studying in the school. This
free distribution of clothes to the mothers and grandmothers of the children is
considered by the revenue as the one not related to educational purposes.


iii)    On the other hand, it is contended by the
assessee that such distribution was made only to encourage those mothers and
grandmothers to send their ward to the school without discontinuation. This
purpose is not doubted by the Revenue. Nor any contra material is available
before the Assessing Officer to draw adverse inference. Therefore, the main
object behind the distribution of the sarees to those persons is evidently for
ensuring the continuance of study at the petitioner School and not solely for
providing clothes to needy persons totally unconnected with the school.


iv)   At this juncture, it is better to understand
the scope of Section 10(23C)(iiiad). The term “any university or
educational institution existing solely for educational purpose” used
under the above provision is heavily relied on by the Revenue to deny the
benefit of exemption to the petitioner on the sole ground that a portion of the
income spent on other charitable purpose, viz., distribution of sarees to the
mothers and grandmothers of the children studying in the school was not for
educational purpose. There is no dispute to the fact that the sum spent on such
purpose is very minimal, compared to the total income.


v)    While the nature of existence of the
institution is to be derived only by considering the predominant activity of
the institution, the nature of spending the money so received by such
institution to its various activities, has to be ascertained and adjudged going
by the ultimate purpose for which it was spent. If the event of spending and
the purpose for which such event took place, have some nexus to achieve the
main object viz., the predominant activity of the institution, then such
spending on an allied activity cannot be looked in isolation from the main
object.


vi)   An institution solely existing for
educational purposes, if indulges in certain allied charitable activities, such
as feeding and clothing poor, giving some medical aid to those people, etc.,
certainly, such activities cannot alter the predominant object of such
institution. While ‘the imparting education’ is like the water flowing in the
main channel, certain incidental other charitable activities done by such
institution, here and there, cannot be considered as major breach of the
channel, but as the reach of the ‘over flown’ water from the main channel to
the adjacent lands. So long as the desired destination of the channel (the
institution) is evidently existing and being achieved to reach the predominant
object and not disputed, the nature or character of the institution run by the
trust cannot be doubted, as it will always fit into the above term
“institution existing solely for educational purposes” and consequently,
is entitled to protection u/s. 10(23C)(iiiad).


vii)   Further, strictly speaking, Section 10(23C)
contemplates and excludes any income “received by” and not “the
spending” of such money received u/s. 10(23C). At the same time, if the
spending is totally on a deviated object or an object, which is totally
opposite or opposed to the main object for which the trust is created,
certainly such spending cannot have any protection u/s.10(23C)(iiiad). Thus, the sole purpose of existence is to be gathered, derived
and construed based on overall predominant activity and not from certain
isolated activity, especially when such activity also happens to be charitable
in nature, more particularly, when a meagre sum is spent on such activity. At
the same time, proportionality of the money spent on such activity, other than
the predominant activity, also plays a major role in deciding the nature of
existence of the institution. If major portions of the money received by the
trust is spent on certain objects other than the predominant object, certainly
the sole purpose of the Trust for which it was created, can be doubted. On the
other hand, if such spending is meagre and does not shake the conscience of the
Assessing Officer, being the quasi judicial authority, is at liberty to bring
such expenditure also under the exemption clause.


viii)  It is not established by the revenue that the
assessee is carrying on any other activities for profit other than running the
school. Therefore, when the only predominant activity is being carried on by
the assessee-trust, viz., the running of the school mere spending a meagre
amount, out of the total income derived by the trust, towards the distribution
of sarees to mothers and grandmothers of children studying in the school, could
not stand in the way of the Assessing Officer to deny the benefit u/s.
10(23C)(iiiad). Thus the respondents are not justified in rejecting the claim
of the petitioner u/s. 10(23C)(iiiad) of the Act.


ix)   Accordingly, the writ petition is allowed and
the impugned order is set aside.”

Section 12A – Charitable or religious trust – Registration of (Cancellation of) – Where assessee educational society, set up with various aims and objects including improvement in standard of education of backward students of rural areas, was running a school and Commissioner had not doubted genuineness of aims and objects of assessee, application u/s. 12A could not be rejected merely on ground that secretary of society was getting lease rent for land given to society for running school or his wife who had requisite qualification was teaching in school and was being paid salary

33. 
CIT (Exemption) vs. Ambala Public Educational Society; [2018] 100
taxmann.com 131 (P&H): Date of order: 29th October, 2018

 

Section 12A – Charitable or religious trust
– Registration of (Cancellation of) – Where assessee educational society, set
up with various aims and objects including improvement in standard of education
of backward students of rural areas, was running a school and Commissioner had
not doubted genuineness of aims and objects of assessee, application u/s. 12A
could not be rejected merely on ground that secretary of society was getting
lease rent for land given to society for running school or his wife who had
requisite qualification was teaching in school and was being paid salary

 

The
assessee-society was a trust registered with the Registrar of Societies,
Haryana. The assessee-society was set up with various aims and objects
including improvement in the standard of education of the backward students of
rural areas. The assessee-society was running a school. It made an application
for registration u/s. 12A of the Act. During the proceedings, the Commissioner
was swayed by the fact that the secretary of the assessee-society was getting
lease rent of certain amount per annum for land given to society for running
school and wife of the secretary was teaching in school and getting salary from
the school. It was further stated that the assessee-society was not registered
under the New Haryana Registration & Regulation of Societies Registration
Act, 2012. Accordingly, the application was rejected.

 

On appeal, the
Tribunal ordered granting registration u/s. 12A to the society.

 

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

 

“i)    The contentions raised by the revenue lacks
merit. There is no requirement u/s. 12A that the assessee-society is required
to be registered under the 2012 Act. Moreover, the assessee-society explained
before Tribunal that it had applied for registration under the 2012 Act but due
to back log, grant of registration was delayed. The certificate regarding
registration under 2012 Act was produced before the Tribunal.


ii)    The application u/s. 12A cannot be rejected
merely on the ground that the secretary of the society was getting lease rent
for the land given to the society for running the school or his wife who had
requisite qualification was teaching in the school and was being paid the
salary. It is not the case set up by the revenue that the exorbitant amounts
had been paid by the assessee-society to the secretary or to his wife. No
dispute has been raised to the fact that the assessee-society is running a
school as per its aims and objects.


iii)    The Commissioner while rejecting the
application has not doubted the genuineness of aims and objectives of the
assessee-society. On the other hand the Assessing Officer while finalising the
assessment for A. Y. 2010-11 u/s. 143(3) has specifically recorded the finding
that the income earned by the society has been utilised for educational
purposes.


iv)   The order of the ITAT warrants no
interference. No error has been pointed out in the findings recorded by the
ITAT much less shown to be perverse. No substantial question of law arises. The
appeal is, accordingly, dismissed.”

Sections 40(a)(ia) and 194J – Business expenditure – Disallowance u/s. 40(a)(ia) – Payments liable to TDS – Third party administrator for insurance companies – Payments merely routed through assessee – Disallowance u/s. 40(a)(ia) not warranted

32. 
CIT vs. Dedicated Healthcare Services (TPA) India Pvt. Ltd.; 408 ITR 36
(Bom): Date of order: 17th September,
2018 A. Y. 2008-09

 

Sections
40(a)(ia) and 194J – Business expenditure – Disallowance u/s. 40(a)(ia) –
Payments liable to TDS – Third party administrator for insurance companies –
Payments merely routed through assessee – Disallowance u/s. 40(a)(ia) not
warranted




The assessee
carried on business as a third party administrator for insurance companies.
According to the Department, the insurance companies issued policies that were
serviced by the third party administrator who acted as a facilitator and
charged fees, provided services, such as hospitalisation, cashless access,
billing and call centre services, and all the claims payable by the insurance
companies for these services were routed through the third party administrator.

 

It was further
stated, that the receipts and disbursements were routed the bank account of the
assessee for which the assessee passed certain book entries, that on receipt of
the amount, the bank account was debited and the account of the insurance
company was credited and that on payment of claims to the hospital/insured, the
account of the insurance company was debited and the bank account was credited.

 

For the A. Y.
2008-09 it was found that the assessee had made payments to various hospitals
during the year without deducting the tax at source u/s. 194J of the Income-tax
Act, 1961 (hereinafter for the sake of brevity referred to as the
“Act”) which called for disallowance u/s. 40(a)(ia) of the Act.
Relying on the CBDT circular No. 8 of 2009, dated 24/11/2009, the Assessing
Officer held that the third party administrator was required to deduct tax at
source u/s. 194J from all such payments made to hospitals, etc.

 

The Commissioner
(Appeals) allowed the appeal filed by the assessee. The Tribunal upheld the
decision of the Commissioner (Appeals).

 

The Bombay High
Court upheld the decision of the Tribunal and held as under:

 

“i)    The Tribunal had found that the assessee
only facilitated the payments by the insurer to the insured for availing of the
medical facilities. The assessee did not render any professional services to
the insurer or the insured and only collected the amount from the insurer and
passed it on to various hospitals which provided medical services to the
insured. It had found that for transactions there was no claim of expenses by
the assessee which was disallowed.


ii)    The Department could not be permitted to
raise the same questions as had been earlier dealt with in the Division Bench
judgments and orders of the Court.”

EXTERNAL AUTHORITY FOR DISCIPLINARY ACTION AGAINST AUDITORS

1.  Introduction 

 

At present the Council of the Institute of
Chartered Accountants of India (ICAI) has power to ensure that its members
maintain discipline while discharging their professional and other duties.
Sections 21, 21A to 21D of the Chartered Accounts Act (CA Act) provide for
mechanism for conducting Disciplinary proceedings and for awarding punishment
to erring members of ICAI. Sections 22,22A to 22G of CA Act provide for filing
appeals before the Appellate Authority appointed u/s. 22. The First schedule to
the CA Act gives a list of Professional Misconduct by members in their dealings
with other members of ICAI or with the Institute. The Second Schedule to the
Act gives a list of Professional Misconduct by members in practice in their
dealings with their clients.  Section 132
of the Companies Act, 2013 (Act), which has now come into force provides for
constitution of a “National Financial Reporting Authority” (NFRA). By a
Notification dated 21.03.2018 the Central Government has notified the
constitution of NFRA. U/s. 132 of the Act, NFRA is authorised to recommend to
the Central Government to notify Accounting and Auditing Standards as well as
to take disciplinary action against Auditors of some specified companies and
bodies corporate. This action can be taken against the Firms of Auditors as
well as against partners of the Firm. Thus an External Authority is now set up
to take disciplinary action against Auditors of specified entities.  The existing powers of the Council of ICAI to
take disciplinary action against such Auditors is now taken away and entrusted
to the NFRA.  However, ICAI will continue
to have powers regarding disciplinary matters in cases of Auditors of entities
other than specified entities.

 

The National Financial Reporting Authority Rules,
2018, have been notified on 13th November, 2018. These Rules have
come into force on 14th November, 2018.  Significant changes have been made by section
132 of the Companies Act, 2013 and the above Rules in the matter of
disciplinary action against Auditors. In this article some of the important
provisions relating to disciplinary action that can be taken against Auditors
of specified entities by NFRA are discussed.

 

 

 

2.   CONSTITUTION
OF NFRA

 

(i)    Section
132(3) of the Act provides that NFRA shall consist of a  Chairperson, who shall be a person of
eminence and having expertise in accountancy, auditing, finance or law and such
other members, not exceeding 15, consisting of part-time and full-time members
as may be prescribed.

 

(ii)    NFRA
(Manner of Appointment and other Terms and Conditions of Service of Chairperson
and Members) Rules, 2018 notified on 21.03.2018 provide for various matters
relating to appointment, service conditions of Members of NFRA and other
matters. According to these Rules the Central Government has to appoint a
Chairperson, Three Full-Time Members and Nine Part-Time Members of NFRA. The
Rules provide for their qualifications, service conditions and other matters.

 

3.   THE
POWERS OF NFRA

 

The powers which NFRA can exercise are listed in
section 132(4) as under:-

 

(i)    Power
to investigate, either on its own or on a reference  made by the Central Government, in case of
such class of  bodies  corporate or persons, as may be prescribed,
into the matters  of professional or
other misconduct committed by a  Chartered
Accountant or a Firm of Chartered Accountants. Once NFRA initiates this
investigation, ICAI or any other body will have no authority to initiate or
continue any proceedings in such matters of misconduct.

 

(ii)    NFRA
shall have the same powers as vested in a Civil Court under Code of Civil
Procedure, 1908. In other words, it can issue summons, enforce attendance,
inspect books and other records, examine witnesses etc.

 

(iii)   If
any professional or other misconduct is proved, NFRA can impose penalty as
under:

u
In the case of an individual CA, minimum penalty of Rs.1 lakh which may extend
to 5 times of the fees received by the individual.

u
In the case of a C.A. Firm, minimum penalty of Rs. 5 lakh which may extend to
10 times the fees received by the Firm.

u
NFRA can debar any Chartered Accountant or a CA Firm from practice for a
minimum period of six months or for such higher period not exceeding 10 years.

 

(iv)   Any
person / firm aggrieved by any order of NFRA can file appeal before the
National Company Law Appellate Tribunal. This appeal can be made in such manner
and on payment of such fees as may be prescribed.

 

(v)   The
above provisions of section 132 will override any provisions contained in any
other statute. This will mean that the Council of ICAI will not be able to
exercise its powers relating to disciplinary action against auditors of
specified entities. Even powers to formulate accounting and auditing standards,
ensure quality of audit etc., are now vested in NFRA.  To this extent the autonomy conferred on ICAI
under the C.A.  Act, 1949, is partially
taken away.

 

(vi)   By a
Notification dated 13th November, 2018, the Central Government has
issued the “National Financial Reporting Authority Rules, 2018” (NFRA Rules).
These Rules specify the class of companies and bodies corporate governed by
NFRA for taking disciplinary action against Auditors of these entities, the
functions and duties of NFRA and other related matters. The provisions of these
Rules are discussed below.

 

4.   CLASS OF
ENTITIES GOVERNED BY NFRA – (RULE 3)

 

(i)    Rule 3
of NFRA Rules gives power to NFRA to (a) monitor and enforce compliance with
the  Accounting and Auditing Standards,
(b) Oversee the quality of Service of the Auditor u/s. 132 (2), and (c)
Undertake investigation u/s. 132 (4) of Auditors of the following class of
Companies and Bodies Corporate (Specified Entities).

 

(a)   All
Companies which are listed on Stock Exchanges in India or outside India.

 

(b)   Unlisted
Public Companies having (i) paid-up capital of Rs. 500 crore or more, (ii)  Turnover of Rs.1,000 crore, or more, or (iii)
Aggregate outstanding Loans, Debentures and Deposits of Rs. 500 crore or more
as at 31st March of the immediately preceding Financial Year.

 

(c)   Insurance
Companies, Banking Companies, Companies engaged in Generation or Supply of
Electricity and Companies Governed by any Special Act or Bodies Corporate
incorporated by any Act in accordance with the provisions of section 1(4)(b) to
(f) of the Act.

 

(d)   Any
Body Corporate or Company or person or any class of Bodies Corporate or
Companies or persons, on reference made to NFRA by the Central Government in
Public Interest. It may be noted that section 3 of the Limited Liability
Partnership Act, 2008 provides that an LLP registered under that Act is a Body
Corporate. Therefore, it appears that Auditors of any LLP, irrespective of its
capital, turnover or borrowings, will now be governed by the NFRA Rules if such
a case is referred to NFRA by the Government. Apparently, this does not appear
to be the intention of these Rules. We will have to wait for some clarification
from the Central Government in respect of this matter.

 

(e)   A Body
Corporate incorporated or registered outside India which is a Subsidiary or
Associate Company of an Indian Company or a Body Corporate referred to in (a)
to (d) above, if the income or net worth of such subsidiary or Associate
Company exceeds 20% of the consolidated income or net worth of such Indian Company
or Body Corporate referred to in (a) to (d) above.

 

(ii)    Auditors
of the above companies and bodies corporate have to file a return in the
prescribed form with NFRA on or before 30th April of every year
under Rule 5.

 

(iii)   A
Company or a Body Corporate, other than a Company Governed under this  Rule, shall continue to be governed by NFRA
for a period  of 3 years after it ceases
to be listed or its paid-up capital, turnover, or aggregate borrowing falls
below the limits stated in (i) (b) above.

 

5.   REPORTING
OF AUDITORS APPOINTMENT

 

The above Rule provides for reporting about
Auditors’ particulars by a Body Corporate as under:

 

(i)    Every
existing Body Corporate, other than a Company Governed by this Rule, has to
inform NFRA, within 30 days (i.e. on or before 14th December, 2018),
particulars of Auditor holding office on 14th November, 2018 in Form
NFRA-1.

 

(ii)    Every
Body Corporate, other than a Company governed by this Rule shall, within 15
days of the appointment of its Auditor u/s. 139(1), inform NFRA about the
particulars of its Auditor in Form NFRA-1.

 

(iii)   Every
Body Corporate incorporated or registered outside India (as referred to in Para
4(i) (e) above) has also to file the particulars of its Auditors in Form NFRA
-1 within the above time limit.

 

It may be noted that if the NFRA Rules apply to an
LLP, irrespective of its capital, turnover or borrowings, all small and big
LLPs will have to file particulars of their existing Auditors on or before
14.12.2018 in Form NFRA-1.  This is going
to be a difficult task for an LLP.
Similarly, a Foreign Body Corporate to which Rule 3 is applicable will
have to file Form NFRA-1 within the above time limit. The above Rule states
that particulars of Auditors appointed u/s. 139(1) of the Act are to be given.
It may be noted that section 139(1) refers to appointment of Auditors of
Companies registered under the Companies Act, 2013. It does not refer to
appointment of Auditors by a Body Corporate.
Further, Form NFRA-1 requires the Body Corporate to state whether the
Auditor’s appointment is within the limit of 20 Audits provided in section
141(3)(g) of the Act. This limit applies to 20 Audits of Companies and not to
Bodies Corporate. To this extent, compliance with the reporting requirements of
Rule 3(3) will become difficult. It is difficult to understand why such onerous
duty is cast on all Bodies Corporate including LLP and Foreign Bodies
Corporate.  Further, the time limit of
one month from the publication of Rules is too short as most of the bodies
corporate may not be aware of this requirement. It is not understood as to what
public interest is going to be served by bringing the Auditors of all LLPs
under NFRA when Auditors of all Private Companies and most of the Public
Unlisted Companies are kept outside the purview of NFRA.

 

6.   FUNCTIONS
AND DUTIES OF NFRA (RULE 4)

 

Section 132 (2) of the Act read with Rule 4 of
NFRA Rules provides for functions and duties of NFRA as under:

 

(i)    NFRA
shall protect the public interest and interest of investors, creditors and
others associated with Companies and Bodies Corporate, listed under Para 4(i)
(a) to (f) above, by establishing high quality standards of accounting and
auditing.

 

(ii)    NFRA
will exercise effective oversight of accounting functions performed by the
above companies and bodies corporate and auditing functions performed by the
Auditors of the above entities.

 

(iii)   Maintain
particulars of Auditors appointed by the above companies and bodies corporate.

 

(iv)   Recommend
Accounting Standards and Auditing Standards for approval by the Central
Government.  For this purpose NFRA shall
receive from ICAI recommendations for modification of existing accounting and
auditing standards or for issue of new standards before making recommendations
to the Central Government.

 

(v)   Monitor
and enforce compliance with the Accounting and Auditing Standards notified by
the Central Government.

 

(vi)   Oversee
the quality of service of Auditors associated with ensuring compliance with the
above standards and suggest measures for improvement in the quality of service.

 

(vii)  Promote
awareness in relation to the compliance of the Accounting and Auditing   standards. For this purpose it may
co-operate with National and International Organisations of Independent Audit
Regulators to establish and oversee adherence to these standards.

 

(viii) Perform
such other functions and duties as may be necessary or incidental to the above
functions and duties.

 

(ix)   Discharge
such functions as may be entrusted by the Central Government by Notification.

 

7.   MONITORING
AND ENFORCING COMPLIANCE WITH ACCOUNTING STANDARD (RULE 7)

 

For discharging this function, NFRA has the
following powers:

 

(i)    It may
review the Financial Statements of the above specified entities and may issue a
notice to such Entity or its Auditor to provide further information or
explanation.  It may also call for
production of the relevant documents for inspection.

 

(ii)    It
may require personal presence of the officers of the Entity or its Auditor for
seeking additional information or explanation.

 

(iii)   It
shall publish its findings relating to non-compliance by any such entity on its
website or in such other manner as it considers fit.

 

(iv)   If, in
a particular case, NFRA finds that any Accounting Standard is not followed, it
can decide on the further course of investigation.

 

 

 

8.   MONITORING
AND ENFORCING COMPLIANCE WITH AUDITING STANDARDS (RULE 8)

 

For discharging the above function, NFRA has the
following powers relating to the Auditors of the specified entitie:

 

(i)    To
review the working papers of Auditors, including the Audit Plan and other Audit
Documents as well as any communication relating to the Audit.

 

(ii)    To
evaluate the sufficiency of the quality control system of the Auditor and the
manner of documentation of the system by the Auditor.

 

(iii)   To
perform such other testing of the audit, supervisory and quality control
procedures of the Auditor as may be considered necessary or appropriate.

 

(iv)   It may
require the Auditor to report on its governance practices and internal
processes designed to promote audit quality, protect its reputation and reduce
risks, including risk of failure of the Auditor.  It may take such action on this report as may
be necessary.

 

(v)   NFRA
can require the Auditor to appear before it personally and obtain from him
additional information or explanation in connection with the conduct of the
Audit.

 

(vi)   NFRA
shall publish its findings relating to non-compliance with the Auditing
Standards on its website or in such manner as it considers fit.  In respect of proprietary or confidential
information, such publication will not be made but the same may be reported to
the Central Government.

 

(vii)  In a
case where NFRA finds that any law or professional or other standard has been
violated by the Auditor, it may decide to conduct further investigation and
take action against the Auditor.

 

9.   OVERSEEING
THE QUALITY OF SERVICE BY THE AUDITOR (RULE 9)

 

(i)    On the
basis of the review made by NFRA, as stated above, it can direct the Auditor to
take measures for improvement of audit quality. This may include suggestions to
change the audit process, quality control and audit reports.  It may also specify a detailed plan with time
limits.

 

(ii)    It
shall be the duty of the Auditor to make the required improvements and send a
report to NFRA explaining as to how he has complied with the directions of
NFRA.

 

(iii)   NFRA
shall monitor the improvements made by the Auditor and take such further
action, depending on the progress made by the Auditor, as it thinks fit.

 

(iv)   NFRA
may refer, with regard to overseeing the quality of Auditors of the specified
entities, to the Quality Review Board (QRB) of ICAI and call for a report or
information in respect of such Auditors from QRB as it may deem appropriate.

 

10. INVESTIGATION
ABOUT PROFESSIONAL OR OTHER MISCONDUCT (RULE 10)

 

(i)    NFRA
has power to investigate in the following circumstances.

 

(a)   Where
any reference is received from the Central Government for investigation into
any matter of professional or other misconduct u/s. 132(4) as stated in Para 3
above.

 

(b)   Where
NFRA decides to undertake investigation into any matter on the basis of its
compliance or oversight activities.

 

(c)   Where
NFRA decides to undertake investigation suo motu in any matter of
professional or other misconduct by the Auditor of the specified entities

 

(ii)    If
during the investigation, NFRA finds that any of the specified entities has not
complied with the Act or the Rules or which involves fraud amounting to Rs. 1
crore or more, it shall repot its finding to the Central Government.

 

(iii)   On or
after 14th November, 2018, the action in respect of cases of
professional or other misconduct against the Auditors of specified entities
shall be initiated by NFRA only.  No
other Institute or Body can initiate such action against the Auditor. Further,
no other Institute or Body shall initiate or continue any proceedings in such
cases where NFRA has initiated an investigation as stated above. This will mean
that if any case against the Auditor of a specified entity is pending before
ICAI on  14.11.2018, the same will have
to be transferred to NFRA if NFRA decides to investigate in the same matter.

 

(iv)   The
action in respect of cases of professional or other misconduct against Auditors
of companies and other entities (other than the specified entities) shall
continue to be investigated by ICAI as provided in the CA  Act.

 

(v)   For the
above purpose Explanation below section 132(4) provides that the expression
“Professional or other Misconduct” shall have the same meaning as assigned to
it u/s. 22 of the Chartered Accountants Act. Therefore, NFRA will have to
decide  such cases of misconduct as
provided in section 22 and the First and Second Schedules of the C.A. Act.

 

(vi)   It may
be noted that Rule 10 provides that NFRA shall initiate investigation against
the Auditors of specified entities u/s. 132(4) on a reference being made by the
Central Government.  There is no provision
for investigation by NRFA on the basis of a compliant by a shareholder,
creditor or any other person who has a grievance against Auditors of the
specified entities.  It is, therefore,
presumed that such complaints by shareholders, creditors etc., will have to be
investigated by ICAI under its Disciplinary Jurisdiction.

 

11. DISCIPLINARY
PROCEEDINGS (RULES 11 AND 12)

 

The procedure for conducting Disciplinary
Proceedings by NFRA against Auditors of specified entities is given in Rule 11
and 12.  Briefly stated, this procedure
is as under:

 

(i)    NFRA
can start disciplinary proceedings against Auditors of specified entities on
the basis of (a) a reference received from the Central Government, (b) finding
of its Monitoring, enforcement or oversight activities, or (c) material
otherwise available on record. If NFRA believes that sufficient cause exists to
take action against the Auditors u/s. 132(4), it shall refer the matter to its
concerned Division dealing with Disciplinary matters. This Division will then
issue show-cause notice to the Auditors.

 

(ii)    Rule
11(2) and 11(3) specifies the various matters which will be stated in the
show-cause notice. Copies of documents relied upon by NFRA and extracts of
relevant portions from the Report of the Investigation and other records are to
be enclosed with the show-cause notice.
The procedure for service of show-cause notice is given in Rule 11(4).

 

(iii)   Rule
11(5) states that the concerned Division shall dispose of the show-cause notice
within 90 days of the assignment through a summary procedure as may be
specified by NFRA. The concerned Division will pass a reasoned order in
adherence to the principles of natural justice.
For this purpose, where necessary or appropriate, opportunity of being
heard in person will be given. The concerned Division will also take into
consideration the submissions made by the Auditors and the relevant facts and
circumstances and material on record before passing the order. There is no
clarity whether the hearing will be given by a Bench of the members of NFRA and
whether the above order will be passed by such Bench. Again, it is not clear as
to how many members of NFRA will constitute such Bench.

 

(iv)   The
above order passed by the concerned Division of NFRA shall specify that (a) No
further action is to be taken against the Auditors, (b) Caution the Auditors,
or (c) Punishment by levy of penalty and/or debarring the Auditors from
practice is awarded as specified in section 132(4). Such Penalty may be as
stated in Para 3(iii) above.  The above
order shall not become effective for a period of 30 days from the date of issue
or for such other period as the order may specify for the reasons given in the
order.

 

v)    The
above order has to be served on the Auditors and copies of the order have to be
sent by NFRA to (a) the Central
Government, (b) ICAI, (c) C & AG (if the case relates to Auditors of
a  Government Company), (d) SEBI (if the
case relates to Auditors of a listed Company), (e) RBI (if the case relates to
Auditors of a Bank or NBFC), (f) IRDA (if the case relates to Auditors of an
Insurance Company), (g) Concerned regulator in
a foreign country (if the case relates to  a Non-Resident Auditor).  Further this order is to be published on the
Website of NFRA.

 

(vi)   If the
above order imposes a monetary penalty on the Auditors the same is to be
deposited within 30 days of the date of the order. If appeal is filed against
the above order by the Auditor, he has to deposit 10% of the amount of the
penalty with the Appellate Tribunal. If within 30 days of the above order the
Auditor does not pay the penalty nor file appeal against the order, NFRA,
without prejudice to any other action, will inform the Company / Body Corporate
of which he was the Auditor. Upon receipt of such intimation the Company / Body
Corporate shall remove such Auditor in default and appoint any other Auditor in
accordance with the provisions of the Act.

 

(vii)  If the
order imposes a penalty on the Auditor or debars the Auditor from practice,
NFRA will send copies of such order to all Companies / Bodies Corporate in
which the Auditor is functioning as Auditor. On receipt of such information,
all such Companies / Bodies Corporate shall remove that Auditor from his
position as Auditor and appoint another Auditor in accordance with the
provisions of the Act.

 

(viii) In all
the above cases where the order of NFRA is stayed or where penalty is to be
paid, the time limit of 30 days is from the date of the order. Since the time
given u/s. 421 for filing appeal to the Appellate Tribunal is 45 days from the
date of service of the order, Rule 11 and 12 should have given time to the
Auditor of 45 days for payment of penalty from the date of service of the order
of NFRA. Further, as stated in  (vi) and
(vii) above, Rule 12 provides for intimation to be given to the specified
companies or bodies corporate about the order of NFRA awarding punishment by
way penalty or debarring  the Auditor
from practice so that he is removed from his office as auditor in that company
/ body corporate. In the interest of justice, such intimation should not be
given by NFRA if the appeal filed by the Auditor before judicial authorities is
pending. Again, it may so happen that the action is taken by NFRA for
professional or other misconduct by an Individual who is one of the partners of
a Firm of Chartered Accountants. In such a case if the penalty is levied in the
case of that Individual or he is debarred from practice, the Firm of Chartered
Accounts which is the Auditor of the company / body Corporate should not be removed
from its office as Auditor of that company / body corporate. The provision in
Rule 12 to remove the Auditor from his position as Auditor of a company / body
corporate in a case where only penalty is levied by NFRA is very harsh and
needs to be modified.

 

 

12. OTHER
MATTERS

 

(i)    Rule
13 provides that if any company or any officer of the company or an Auditor or
any other person contravenes any of the provisions of these Rules, such
company, its officer, Auditor or other person in default shall be punishable
under the provisions of section 450 of the Act. This section provides for levy
of Fine on the defaulting company, officer, Auditor or other person of an
amount upto Rs.10,000 and in case of continuing default, of a further Fine
which may extend to Rs.1,000 per day when the default continues. 

 

(ii)    Rules
14 to 19 provide for various matters such as (a) Role of the Chairperson and
full-time members of NFRA, (b) Constitution of advisory committees, study
groups, task force, (c) Measures to be taken for the promotion of awareness and
significance of Accounting and Auditing Standards, Auditor’s Responsibilities,
Audit Quality and such other matters through education, training, seminars,
workshops, conferences, publicity etc., (d) Maintenance of   confidentiality  and security of information, (e) Avoidance of
conflict of interest and (f) Association with International Associations and
securing International Assistance.

 

13. TO SUM UP

 

(i)    NFRA
is established as an External Authority for taking Disciplinary Action against
Auditors by section 132 of the Companies Act, 2013. There was some resistance
by the CA profession and, therefore, this section was not brought into force
when the Companies Act, 2013 came into force on 1.4.2014. Section 132(3) and
(11) was brought into force on 21.03.2018. Section 132(1) and (12) came into
force on 01.10.2018 and section 132(2), (4), (5), (10) (13) (14) and (15) came
into force on 24.10.2018.  S/s. (6) to
(9) were deleted w.e.f.  9.2.2018.

 

(ii)    The
justification for creating such External Authority (NFRA) is given by the
Committee of Experts, appointed by the Ministry of Corporate Affairs, in their
Report dated 25.10.2018. In this Report they have stated as under:



“In the aftermath of Enron, the U.S. enacted
the Sarbanes Oxley Act, 2002. The Supreme Court in its judgment dated February
23, 2018 has referred to this statute to examine the need of an oversight
mechanism for the audit profession. This law inter alia provided for the
setting up of the Public Company Accounting Oversight Board (PCAOB) as an
independent audit regulator to oversee the audits of public companies.
Similarly, U.K. also has a two-tier structure, where the Financial Reporting
Council (FRC) is the independent regulator for the audit profession.

 

In the Indian context, the Satyam incident has
been a wake-up call for policy-makers. Pursuant to the global trend of shift
from Self-Regulatory Organisation (SRO) model to an independent regulatory
model for the audit profession, the Companies Act, 2013 provided for the setting
up of the National Financial Report Authority (NFRA).

 

However, the continued opposition to the
establishment of NFRA has delayed the implementation of this critical reform.
Consequently, although the Companies Act, 2013 was enacted in August 2013, the
section establishing NFRA was notified
only on March 21, 2018 along with the NFRA Chairperson and Members’
Appointment Rules, 2018. Once NFRA becomes fully operational, it will be
adequately equipped to handle the contemporary challenges in relation to
auditors, audit firms and networks operating in India.”

 

(iii)   Reading
the provisions of section 132 of the Act and the above NFRA Rules framed by the
Central Government, it is evident that the autonomy of ICAI to issue Accounting
and Auditing Standards and taking disciplinary action in cases of erring
members is now curtailed. The function of ICAI will be restricted to only
recommending changes in the existing Accounting and Auditing Standards or
Suggesting new Standards. Whether to issue such Standards or not or in which
form they should be issued will be decided by NFRA and the Central Government.
Even the function of monitoring, enforcing, compliance, overseeing quality of
service  rendered by the CA profession,
suggesting measures for improvement in quality of professional service,
promoting awareness in relation to the compliance of Accounting and Auditing
Standards which was hitherto in the domain of ICAI, has been transferred to
NFRA.  Disciplinary jurisdiction which
was hitherto within the domain of ICAI has now been curtailed because NFRA is
now entrusted with the task of taking disciplinary action against the Auditors
of all listed companies, large unlisted Public Companies, Banks, Insurance
Companies Electricity Companies and Bodies Corporate. These provisions will
reduce the importance of ICAI as it is now left with the task of giving
education to students of CA Courses, conducting examinations and awarding
membership and Certificate of Practice to those who have passed the
examinations.  Even the measures to be
taken for the promotion of awareness and significance of Accounting and
Auditing Standards, Auditors Responsibilities, Audit Quality and  such other matters through education,
training, Seminars, Workshops, Conferences and Publicity which were in the
exclusive  domain of ICAI, its Regional
Councils and Branches will now come under the domain of NFRA under Rule 16.

 

(iv)   From
the above analysis of the provisions of section
132 of the Act and NFRA Rules it is evident that Auditors of the specified  companies and bodies corporate will have to
be more vigilant  while rendering their
professional services to these entities. Some questions of interpretations will
arise during the course of implementation of these Rules.  Therefore, it is necessary that a strong
representation is made for modification of these Rules in respect of the
following matters:

 

(a)   In Rule
3 it should be clarified that the expression “Body Corporate” shall not include
LLP. In fact no public interest is involved in the case of an LLP and,
therefore, Auditor of LLP should not be brought within the supervision of NFRA.

 

b)    In Rule
3(2) it is provided that every existing body corporate should file Form NFRA-1
giving details of its Auditors within 30 days of publication of these Rules.
This time limit is too short and it should be extended up to 90 days from the
date of publication of the Rules (i.e. up to 14.02.2019).

 

(c)   In Rule
10 it is necessary to clarify that the Investigation by NFRA about the
misconduct of the Auditors of any specified entity shall be only in respect of
their conduct relating to statutory audit of the entity. In this Rule the
expression used is “Professional or Other Misconduct”, which is very wide. It
includes conduct of an Auditor in his personal life as well as  his conduct while rendering professional
services other than the Audit Service.

 

(d)   In Rule
10 it is stated that the NFRA will start investigation against the Auditor of
specified entities on a reference being made by the Central Government or on its
own on the basis of the available records. It is essential that this Rule
should provide that any shareholder of a specified company or its creditor or
any other person can approach NFRA if there is a complaint against the Auditor
of a specified entity.

 

(e)   In
Rules 11 and 12, for the reasons stated in Para 11 (viii) above, the period of
30 days should be increased to 45 days. Further, information about the order
passed by NFRA should not be given to specified entities if the Auditor has
filed appeal against the order of NFRA and the judicial proceedings are
pending.

 

(f)    As
stated in Para 11(viii) above, if the order passed by NFRA is against the
conduct of an Individual who is a Partner of the Audit Firm and no punishment
is awarded to the Firm, the disqualification as auditor of the specified entity
should not extend to the Firm.

 

(g)   Rule 11
deals with Disciplinary Proceedings to be followed by NFRA or making inquiry
against the Auditor of a specified entity. There is no clarity as to who will
give hearing to such Auditor. It is necessary to clarify that such hearing will
be given by a Bench of two or three Members of NFRA.  It is also necessary to clarify that any
Authorised person or Advocate will be allowed to assist such Auditor at the
time of hearing.

 

(v)          Establishment of NFRA with such wide
powers is a new experiment in India. As these provisions will have retroactive
application, in as much as matters relating to earlier years may also be
referred to NFRA, let us hope that NFRA takes into consideration the
limitations within which the Auditors have to discharge their Audit function
and adopts a sympathetic view while dealing with the disciplinary cases against
such Auditors.

INSOLVENCY RESOLUTION PROFESSIONAL – JOURNEY AND ACCOUNTING AND TAX ASPECTS

1.     INTRODUCTION


1.1.  The introduction of the Insolvency and
Bankruptcy Code, 2016 (“Code”) ushered in a new era in the distressed asset landscape
and was undoubtedly a significant reform. Prior to introduction of the Code,
multiple regulations, at times not in congruence, were leading to disputes and
defaults thus invariably delaying the entire process. The laws addressing the
revival and financial reconstruction were provided for under different Acts.
These different laws were implemented in different judicial forums, namely (i)
Provincial Insolvency Act, 1920 (ii) Presidential Towns Insolvency Act, 1909
(iii) Winding up provisions of the Companies Act, 1956 (iv) Sick Industrial
Companies (Special Provisions) Act, 1985 (v) Recovery of Debts Due to Banks and
Financial Institutions Act, 1993 and the (vi) Securitisation &
Reconstruction of Financial Assets, Enforcement of Security Interests Act, 2002
which often led to delay in achieving the end objective of
resolution/reconstruction.

 

1.2.  The defining aspect of the Code is the strict
adherence to timelines, an aspect which was relatively absent in previous
legislations. The Code explicitly provides for a 180-day period of resolution
of the corporate debtor with an extension of 90 days. The lapse of 180/270 days
leads to the compulsory liquidation of the corporate debtor. The Code has
ushered in a change from the existing situation of “debtor in possession” to
“creditor in control”. This overhaul has empowered the creditors to take
decisions for the benefit of the corporate debtor and the creditors with
relatively less opposition from the promoters or the erstwhile directors of the
corporate debtor whose powers have been suspended during the period of
moratorium, which lasts during the period of the Corporate Insolvency
Resolution Process.

 

1.3.  The Code has given significant headroom to
indebted companies reeling under pressure to meet their obligations and has
facilitated the lenders to expedite recovery and resolution of stressed assets.
The Code stipulates a strict 180-day window (extendable to 270 days) for
running and completing the Corporate Insolvency Resolution Process (CIRP). The
time-bound nature of the process is a unique feature that provides confidence
to the creditors and the appointment of an Independent Resolution Professional
to manage the process makes the entire ecosystem of resolution more sacrosanct.

 

2.     IMPORTANCE OF INFORMATION 


2.1.  As an Interim Resolution
Professional/Resolution Professional (IRP/RP), one assumes the management
responsibilities of the company since the board of directors of the corporate
debtor stands suspended u/s. 17 of the Code.

 

2.2.  While the IRP/RP is entrusted with the duty of
managing the company as a going concern during the CIRP and steer it towards a
successful resolution, he is required to comply with the provisions of various
regulations which govern the company undergoing CIRP.

 

2.3.  As a process, the IRP/RP assumes the control
of the company once the CIRP is initiated and takes charge of the books of
accounts, financial information and records, assets and operations of the
company.

 

2.4.  Various provisions of the Code require the
IRP/RP to take on record the financial information relating to the company for
present and past time period. For example, section 18 of the Code requires that
the IRP on assuming charge of the company has to collect all information
relating to the assets, finances and operations of the corporate debtor for
determining the financial position of the corporate debtor, including
information relating to, inter alia, financial and operational payments
for the previous two years and list of assets and liabilities as on the initiation
date.

 

2.5.  In order to ensure a time-bound and speedy
mechanism, due care with appropriate safeguards needs to be incorporated so as
to ensure that the scales are balanced with regard to the speed, accuracy and
authenticity of the information, accompanied by its legality. In view thereof,
the Code has envisaged four pillars of institutional infrastructure. These
pillars include a new competitive industry of Information Utilities (IUs),
which has probably no parallel in India or abroad. These have been envisioned
with a view that they would store authentic and verified financial information
such as debt and default, assets and liabilities of corporates, partnerships
and individuals. Further, they shall hold a collection of information about all
corporate and individual entities at all times. Thus, when the Insolvency
Resolution Process would commence under the Code, within less than a day,
undisputed and complete information would become available to all stakeholders
involved in the process and thus address the source of delay in dissemination
of information.[1]
However, till date the IU pillar of the IBC has not been optimally developed
and is still in its nascent stage

 

2.6.  Further, Regulation 36 of the Code requires
the Resolution Professional to prepare and submit an information memorandum
including, inter alia, the latest financial statements, the audited
financial statements of the corporate debtor for the last two financial years
and provisional financial statements for the current financial year made up to
a date not earlier than 14 days from the date of the application to CIRP.

 

2.7.  Apart from this, the RP while undertaking his
duties under the Code requires that all the information pertaining to the
accounts of the company is kept up-to-date in order to ensure adequate
disclosures with respect to compliances, CIRP costs etc., during the CIRP as
and when required by IBBI.

 

2.8.  Regular updating of accounting statements and
financial records is also required since the Code provides rights to the
Committee of Creditors of the Company to ask the RP for providing them with any
particular financial information during the process. Apart from this, the
Resolution Professional while dealing with prospective investors is also often
required to provide latest financial information which is required by the
investors for submission of the resolution plan.



2.9.  The IBBI vide Circular dated 3rd January
2018 has directed all Insolvency Professionals to exercise reasonable care and
diligence and take all necessary steps to ensure that corporate persons
undergoing Insolvency Resolution Process, fast-track Insolvency Resolution
Process, liquidation process or voluntary liquidation process under the
Insolvency and Bankruptcy Code, 2016 comply with provisions of the applicable
laws (Acts, Rules and Regulations, Circulars, Guidelines, Orders, Directions,
etc.) during such process. For example, a corporate person undergoing
Insolvency Resolution Process, if listed on a stock exchange, needs to comply
with every provision of the Securities and Exchange Board of India (Listing
Obligations and Disclosure Requirements) Regulations, 2015, unless the provision
is specifically exempted by the competent authority or becomes inapplicable by
operation of law for the corporate person. This implies that it is the RP’s
responsibility to ensure that all the financial statements falling during the
CIRP are duly prepared and published as required under applicable laws and
regulations.

 

2.10.     This aspect regarding compliance of various
laws during the CIRP process was also touched upon by the Mumbai NCLT Bench in
the case of Roofit Industries, where it noted that companies are governed by
various enactments, they have to run in compliance with the laws of this
country and it can’t be said that companies running under CIRP are free to
flout all other laws.

 

2.11.     It is also to be noted that requirements
pertaining to their payment of tax or filing of returns during the CIRP would
be primarily the responsibility of the IRP/RP.

 

3.     THE CHALLENGE


3.1.  More often than not it is observed that the
IRP/RP’s face challenges in terms of availability of financial information,
various legacy non-compliances spilling over into the CIRP period, ongoing tax
appeals/litigations, lack of required data to finalise the books of accounts
and so on.

 

3.2.  There are instances where it is found that
inadequate accounting procedures are followed by a company under CIRP and the
company may not have contemporaneous records pertaining to previous periods
maintained with it. This usually stems from the fact that there is usually a
brain-drain of key executives of the company undergoing CIRP, a possible case
of mismanagement in the past resulting in loss of records, loss of data during
handover by employees who have left the company, possible IT
infrastructure-related issues like server crashes, as also the various existing
non-compliances resulting in levy of penalties and interest.

 

3.3.  Thus, the IRP/RP usually finds himself with a
myriad of challenges in meeting the ongoing compliances during the CIRP.
Although the Code u/s. 19 stipulates that the personnel of the corporate debtor
have to extend help to the Interim Resolution Professional in terms of running
the process and provide the necessary information, the primary responsibility
of compliance remains with the IRP/RP.

 

3.4.  It is possible that the accounts of the
company for the year preceding the year in which the CIRP was initiated have
not been finalised and published as on the date of CIRP and with the board of
directors of the company now suspended, the RP has a task cut for him to ensure
the compliance of finalising the accounts. In such circumstances which are
usually also caused by lack of necessary co-operation from the previous
management of the company and lack of necessary information, the RP finds
himself in a challenging situation where he has to completely re-do the
financial statements to ensure their correctness and completeness.

 

3.5.  This, in addition to possible non-availability
of past records, absence of adequate man-power within the company undergoing
CIRP and a legacy of past non-compliances poses a real challenge for the IRP/RP
in meeting the ongoing compliance.

 

3.6.  As the auditor of the company is also required
to comment regarding the going concern status of the company in its audit
report, it becomes very difficult to harmonise the idea of going concern for a
company under CIRP to express an opinion.

 

3.7.  The Resolution Professional is also required
to carry out a liquidation and fair valuation of the assets of the company
under CIRP. This also gives rise to various difficulties in integrating the
finding of the valuer appointed by the Resolution Professional which carries
out the liquidation and fair valuation within certain assumptions and a
framework, with the requirement to restate the financial statements as per the
applicable accounting standards for the company undergoing CIRP.

 

3.8.  The matters pertaining to taxation also need
to be dealt with caution as there could be several ongoing cases that may
result into demands and penalties during the CIRP period. This requires the
IRP/RP to understand all the ongoing litigations to ensure that necessary steps
are taken to address the same. It is not quite possible to imagine a situation
where the bank accounts of the company under CIRP are attached u/s. 226 of the
Income Tax Act, 1961 for non-compliances before the CIRP. This leaves the
IRP/RP with a challenging situation where on the  one hand he is duty-bound to maintain the
going concern status of the company, while on the other, the company’s bank
accounts are frozen affecting its ability to conduct day-to-day operations
smoothly.

 

3.9.  This brings to the fore an important aspect of
overriding of legislations. Although section 238 of the Code is an over-riding
provision, it has been tested on various occasions as to its applicability and
operability given the evolving jurisprudence of the Code.

 

3.10.     The problem of inadequate past financial
data bears an impact during the ongoing tax assessments as well. The company
usually reeling under financial stress finds itself in a difficult position to
meet the requirement for paying the appeal deposit or representing before the
tax authorities. This, however, does not absolve the RP of any compliances and
requires that he has to ensure that appropriate actions, be it appeal or
otherwise, are taken.

 

3.11.     Section 80 of the Income Tax Act, 1961
provides that in the event a taxpayer fails to file return in accordance with
the provisions of section 139(3) of the Act, the carry-forward losses computed
in accordance with the sections specified therein would lapse. The RP often faces
some practical predicaments relating to filing of timely income tax returns
with inadequate available data, requirement of filing with respect to digital
signatures, changing of signatories for filing returns without support from the
previous signatories, etc. The direct implication of such non-compliance would
be to lose the benefit of carrying forward losses of the year.

 

3.12.     Another set of challenges which may have an
implication on compliances is the mandatory applicability of Indian Accounting
Standards applicable to certain class of companies. Ind AS 8 deals with
Accounting Policies, Changes in Accounting Estimates and Errors. The said
standard mandates that any material prior period error is to be set right by
restating the financial statements of that year. A tax complication may arise
as to whether such error impacting the profit/loss of earlier years would be
allowed as an expenditure in the year of resolution or should be claimed for
the year when such error occured. Such claim would be possible only if the
timeline for revised return permits the same. In a nutshell, the claim in
respect of such error may not be available if one were to take the provision of
law and jurisprudence on the subject.

 

3.13.     One other aspect of taxation is the claims
admission process, wherein the IRP/RP is required to deal with various claims
by the tax authorities including claims arising out of ongoing cases or cases
under appeal. The law is still evolving on the subject of determining the
amount of claim in case of liabilities which are not crystallised on the date
of submission of claim or are contingent on the happening/non-happening of
certain events in future.

 

3.14.     Like the IBC, another reform that is still
in its sapling stages is GST. It is possible that the company under CIRP often
does not have adequate resources and manpower to ensure various GST compliances
including registration, transition from previous indirect tax regime to GST
regime or necessary infrastructure to implement GST.

 

3.15.     A few other aspects that remain to be
tested are the possibility of waiver of existing tax demand on approval of a
Resolution Plan, tax liability of the period up to the date of approval of
Resolution Plan but crystallised afterwards, and waiver of tax liability arising
on implementation of the Resolution Plan given that a Resolution Plan may often
involve certain write-backs resulting in notional income for the company. The
order in the matter of J.R. Agro Industries Pvt. Limited vs. Swadisht Oils
Pvt. Limited, (Company Application No. 59 of 2018 in CP No. (IB) 13/ALD/2017)
may be referred to, wherein a company application was filed before the AA
(Allahabad Bench) by the RP u/s. 30(6) of the IBC for approval of the
resolution plan as approved by the Committee of Creditors. The AA observed that
“we cannot allow exemption of any liability arising in respect of income tax”.
The NCLT further noted that any statutory liability of the transferor company
shall be the liability of the transferee company and since the income tax
department was not a party to the proceedings, the resolution plan cannot be
approved without giving the department a hearing at this stage. Accordingly,
the resolution professional was asked to modify its resolution plan with a
direction that the same may be re-submitted after getting the plan approved
from the CoC. In this regard, numerous orders of the AA state that a waiver of
statutory dues, if any, can only be done by the appropriate authority by moving
an appropriate application before the statutory authorities.

 

3.16.     IP is expected to
maintain robust documentation during the period he had acted in his role. This
would be more relevant because if there are certain challenges post his
completion of role, he would be expected to demonstrate that he acted in good
faith and with due diligence.

 

3.17.     With the few relaxations and certain
decisions of the Hon’ble Supreme Court, it appears that the battle is only half
won with the complexities outpacing the challenges faced. The IBC has been a
landmark legislation and it will continue to evolve.

 

3.18.     While some of the areas
listed above may need more thought and consideration, the issue that IBC deals
with is such that there will always be other unforeseen challenges.

 

4.     ACCOUNTING CONSIDERATIONS


4.1.  To begin with, when a company is under the
Resolution Process, if there is a reporting date and the company has to issue
its financial statements, the company will have to consider the following
issues:

 

4.1.1.    Going Concern Assessment: Indian Accounting
Standard (“Ind AS”) 1 Presentation of Financial Statements, requires the
management to make an assessment of going concern while preparing the financial
statements. The company being admitted under the Code is an indicator of
accumulated losses and inability to pay its operational and/or its financial
creditors. Hence, the management of the company will have to carry out a going
concern assessment taking into consideration the stage of the Resolution
Process and its future prospects and decide on the accounting treatment
accordingly.

 

In cases where it
is likely that the company will be sent under liquidation or it has already
been referred for liquidation before the financial statements have been
approved for issue, the financial statements cannot be prepared using the going
concern assumption. Ind AS 1 does not prescribe the accounting treatment to be
followed in case financial statements are to be prepared on a basis other than
going concern basis. The management will have to decide on appropriate accounting
policies for preparing the accounts depending on the facts and circumstances
and provide detailed disclosures for the basis of preparation of the financial
statements and judgements made in selecting the accounting policies. There will
be a similar requirement under Accounting Standard (“AS”) 1 Disclosure of
Accounting Policies.

 

4.1.2.    Impairment of Assets: AS 28 / Ind AS 36 Impairment
of Assets requires the management to test its tangible and intangible
assets for impairment in case any indicators are identified. When the company
is admitted under a Resolution Process under the Code, it is an indicator for
the management to calculate the recoverable amount for its tangible and
intangible assets and if it is below the carrying amount, an impairment loss will
have to be recognised in the profit and loss.

 

4.1.3.    Additional Disclosures:
There may be several claims made by the creditors on the company which may or
may not match with the liabilities recognised in the financial statements.
Depending on the stage of the Resolution Process, the company will have to
provide detailed disclosures about such claims and also give the expected
financial effect of the same on the financial statement.

 

4.2.  Once the Resolution Process has been approved,
the company under the Code will have to evaluate the following accounting
considerations:

 

4.2.1.    Debt restructuring: There are several ways
in which the existing debt of the company may be restructured with the lenders
as part of the resolution. The accounting will be driven by the terms and
conditions of the agreed restructuring. In case of any full or partial waiver
of principal or interest amount by the lender, the gain on the reduction of the
liability for the company will be recognised in profit and loss as per Ind AS
109 Financial Instruments. There are some exceptions to this rule
provided under Appendix D to Ind AS 109 which the company may have to evaluate.

 

In case of novation
of the loan to the acquirer or a special purpose vehicle (SPV) formed for the
Resolution Process, the company will have to evaluate whether the same will
qualify for extinguishment of liability from original lender under Ind AS 109.

 

Ind AS 109 requires
that a substantial modification of the terms of an existing financial
liability, or a part of it, should be accounted for as an extinguishment of the
original financial liability and the recognition of a new financial liability.
A change in lender could significantly alter the future economic risk exposure
of the liability and could be regarded as representing a substantial change
which would lead to derecognition of the original liability.

 

In that case, the
company will derecognise the existing loan and recognise a new obligation to
the acquirer or the SPV at fair value of the loan with the revised term and the
difference between the carrying value of the extinguished liability and the
fair value of the new loan will have to be recognised in profit and loss.

 

This credit taken
to the profit and loss may have significant implications on the computation of
MAT.

 

4.2.2.    Other aspects in the Resolution Process:
Depending on the other steps agreed as part of the resolution process, the
company may have to account for any additional equity / debt issued to the
acquirer. If a part of the business is being demerged, the company may have to
evaluate implications under Ind AS 105 non-current assets held for sale and
discontinued operations.

 

4.3.  Depending on the structure finalised under the
Resolution Process, the acquirer will have to evaluate the following possible
accounting implications:

 

4.3.1.    The acquirer will have to apply Ind AS 103 Business
Combinations and give effect to acquisition accounting at fair values of
the net assets acquired depending on the structure agreed – merger, demerger or
reverse merger. For the acquisition accounting, the company will also have to
undertake purchase price allocation of the net assets. This may entail several
accounting complexities as under, depending on the structure of the
transaction:

 

a.     Are there any contingent liabilities of the
company which need to be fair valued?

b.    While comparing the net assets acquired and
consideration transferred, normally there should not be a goodwill considering
the circumstances in which the transaction has taken place.

c.     If there is a merger of the entities, the
acquirer to evaluate whether the values to be merged will be those appearing in
the standalone financial statements or consolidated financial statements of the
acquiree. There is guidance provided pertaining to this in the Ind AS Transition
Facilitation Group (ITFG) which the company will have to evaluate.

d.    Due to fair valuation of
assets and liabilities, there will be changes in the book base and the company
will have to evaluate the consequent impacts on deferred tax balances.

In case the company
is following Indian GAAP, the acquirer will have to evaluate the accounting
treatment as per AS 14 Accounting for Amalgamations, whether pooling of
interest or purchase method will be used to account for the transaction.

 

4.3.2     Another important consideration is the
year in which this acquisition accounting needs to be done. Based on the
process under IBC and application of Ind AS 103, the same will be done in the
year in which the final approvals for the Resolution Plan have been received
from the NCLT. In case such approval is received after the reporting date, but
before the financial statements are approved for issue, appropriate disclosures
as per Ind AS 10 Events after the Reporting Date will have to be given.

Even after the Resolution Plan has been implemented, the acquirer
and the company will have to be mindful of some of the challenges as mentioned
hereunder:



a.     In case the company becomes a subsidiary of
the acquirer, it will have to include the company’s financial statements in its
consolidated financial statements.

b.    The acquirer will have to harmonise the
accounting policies, judgements and estimates of the company with its own
policies.

c.     The acquirer will also have to evaluate the
Internal Controls over Financial Reporting (ICFR) for the company.

d.    Finance function readiness will have to be
evaluated for quarterly and annual reporting, as applicable and compliance with
requirements of Accounting Standards, SEBI requirements and Companies Act.

e.     A detailed investor communication will have
to be issued to manage the investor expectations.



Thus, it becomes
critical for both the acquirer and the company under the IBC to be mindful of
the various accounting implications while deciding the overall structure to
arrive at an effective resolution to revive the struggling company.

 

5.     TAX CONSIDERATIONS


5.1.  Prior to introduction of IBC,
the Sick Industrial Companies Act (SICA) was enacted to identify sick and
potentially sick companies owning industrial undertakings and for
implementation of suitable measures to revive such companies. Section 32 of the
SICA provided that the scheme made under the SICA would have overriding effect
over other laws in force and basis this provision, it was also possible for a
sick company to obtain customised tax concessions with the consent of the
income tax department through the BIFR scheme approved under SICA. However,
there is no similar provision in the Code. This led to recommendations from the
industry bodies and professional chambers for providing tax concessions under
the Income Tax Act, 1961 (ITA), for companies undergoing Resolution Process.

 

In deference to the
recommendations and to facilitate the effective implementation of IBC,
amendments were made in the ITA vide Finance Act, 2018 (FA 2018) to facilitate
the rehabilitation of companies undergoing Insolvency Resolution Process.

 

The following is a
snapshot of the amendments made by FA 2018:

 

1.     Amendment of MAT provisions to provide for
deduction of aggregate of brought-forward book losses and unabsorbed
depreciation.

 

Provisions of section 115JB of ITA as they existed prior to amendment
by FA 2018 provided for deduction of an amount which is lower than
brought-forward loss and unabsorbed depreciation as per books in computing the
book profits for MAT purposes. FA 2018 inserted Clause (iih) in Explanation 1
to section 115JB(2) to provide a deduction of aggregate of
brought-forward losses and unabsorbed depreciation in case of a company against
whom an application for insolvency proceedings has been admitted under IBC.

 

2.     Carry forward of losses of IBC companies
not to be impacted in case of change in shareholding pursuant to implementation
of Resolution Plan.

 

Section 79 of the ITA provides that carry forward and set-off of losses
in a closely-held company shall be allowed only if there is a continuity in the
beneficial owner of the shares carrying not less than 51% of the voting power,
on the last day of the year or years in which the loss was incurred.
Implementation of Resolution Plan under IBC for the revival of the insolvent
companies may involve restructuring in the form of mergers, acquisitions,
buy-outs, etc., thus resulting in a change in shareholding of the insolvent
company. Noting that application of section 79 in such cases may act as a
hurdle for the revival of the insolvent companies, FA 2018 amended section 79
to provide that the rigours of section 79 will not apply to change in
shareholding resulting from the implementation of the Resolution Plan under IBC[2].

3.     Resolution professional authorised to
verify the return of income during the Resolution Process.

 

The return of income filed under the ITA is required to be verified
by the managing director/director of the company. Once an application for
insolvency resolution has been accepted under IBC, the powers of the board of
directors are suspended and the management of the affairs of the company is
handed over to the Resolution Professional. Section 140 of ITA was thus amended
to authorise the Resolution Professional to verify the return of income filed
by the company, in respect of whom an application for corporate insolvency
process has been admitted under IBC.



4.     Section 178 – In addition, section 178 of
ITA dealing with responsibilities of a liquidator was amended by IBC (Section
247 of IBC read with the third schedule) to provide that the provisions of
section 178 will apply subject to the other provisions of IBC.

 

5.2.  While the above amendments are welcome, the
following are certain aspects that need consideration/ suitable amendments to
truly enable the revival of insolvent companies.

 

1.     The insertion of clause (iih) is intended
to provide relief to companies undergoing Insolvency Resolution Process by
allowing them full set-off of loss and depreciation instead of the lower of the
two. However, the interpretation of clause (iih) in conjunction with existing
clause (iii) raises number of interpretational issues:

u      Which is the first year
in the lifecycle of corporate insolvency process in which clause (iih) will
become applicable?

u      Once clause (iih) becomes
applicable, which is the year in which it shall cease to apply? This issue
becomes more crucial in cases where the Resolution Process extends beyond the
270 – day period prescribed under IBC due to litigations.

u      If the amount of losses
and unabsorbed depreciation quantified under clause (iih) remains unutilised,
how would such losses and depreciation be carried forward and set off u/s.
115JB? Can both clause (iih) and clause (iii) be applied for a single year?

u      A related issue that
arises is whether in case of the merger of an IBC company with another company
pursuant to a Resolution Plan, the amalgamated company can claim benefit of
clause (iih)?


2.     MAT relief in respect of sick companies
covered under SICA was governed by clause (vii) of of Explanation 1 to section
115JB. Clause (vii) provides that any profits of a sick industrial company for
the period beginning from the assessment year in which the company qualifies as
a sick industrial company and ending with the assessment year in which the net
worth of the company becomes equal to or exceeds the accumulated losses, needs
to be reduced from ‘book profit’. In other words, profits of a company for the
period during which it qualifies as a sick industrial company under the SICA is
not to be considered for MAT purposes. Clause (vii) is now redundant with the
repeal of SICA.

 

It is very common for creditors of companies undergoing IBC to take
a haircut (waiver). Such waiver when credited to the profit and loss account is
likely to have a huge MAT impact for the IBC companies. This acts as a hurdle
for the revival of IBC companies. Clause (iih) providing relief to IBC
companies is not as wide in scope as clause (vii) and may not be able to
relieve the MAT impact of such waiver, especially in case of IBC who have
nominal or nil brought-forward losses. Clause (iih) may thus be of no help in
revival of such IBC companies.



3.     Whether the benefit of
exclusion from section 79 applies only to change in shareholding of the IBC
company or whether it can apply even to the change in shareholding of
subsidiaries of the IBC company?



4.     Whether the Resolution Professional who
verifies the return of income be visited with the consequences of a principal
officer under the Income Tax Act, such as penal consequences for failure in
withholding and payment of tax deducted at source (TDS), filing of TDS return,
etc.?

 

6.     CONCLUSION


While it is
heartening to see that the government is keen to facilitate the implementation
of IBC, there are still many aspects as discussed above, which may need policy
consideration for the IBC to be effective in its true spirit.

 

Tax is and
continues to be a major factor that will impact and influence various
stakeholders in the IBC process. Despite IBC being hailed as an important
legislative reform to resolve the burgeoning NPA problem in the Indian economy,
if the tax laws are not amended appropriately, it may hinder the growth of the
Indian economy.

 

 


[1] BLRC Report

[2] This is subject to
affording a reasonable opportunity of being heard to the jurisdictional
principal commissioner or commissioner.

THE INSOLVENCY & BANKRUPTCY CODE, 2016

Two years ago,
India was accorded number 130 in the World Bank’s Ease of Doing Business 2017
rankings[1],
with the average time for resolution standing at 4.3 years. Low recovery rates
had led to a dip in the number of high-risk high-return ventures, as investment
returns could not be guaranteed to investors’ satisfaction. However, with the
onset of the Insolvency and Bankruptcy Code, 2016 (“IBC”), there has been a sea
change in the restructuring space, leading to an increasingly diligent business
environment and a quicker turnaround on account of resolution plans being
completed within a year of the commencement of the IBC in several cases. India
displayed rapid progress as per the Ease of Doing Business 2018 rankings,[2]
 as it rose thirty ranks, and has
proceeded to further improve by twenty three ranks and jumped to number 77 in
the recently published Ease of Doing Business 2019 Rankings.[3]

 

LEGAL CHANGES


Committee of Creditors


The IBC has undergone
a substantial amount of changes from its inception, evolving gradually based on
the needs of all the stakeholders involved. The commercial wisdom of the
committee of creditors (“CoC”) comprising of financial creditors has
been given utmost weightage, which can be deduced in a number of cases. The
voting threshold for major decisions to be undertaken by the CoC has been
reduced from 75 % to 66 %, whilst routine decisions can now be taken with the
approval of 51 % of the CoC, which was 75 % prior to the latest amendment.
Further, withdrawal of an application is now only permitted if 90 % of the CoC
approve the same.

 

Section 29A of the IBC


Section 29A of the IBC, which pertains to the eligibility criteria of
resolution applicants, has inspired intense debate from its inception. The
section has now been substantially amended in order to widen the scope of
ineligible resolution applicants, so as to protect the interests of the company
as a going concern and ensuring maximisation of the value of the assets. The
most notable case in this regard has been the ongoing resolution process of
Essar Steel Limited, wherein ArcelorMittal and Numetal Limited have been
engaged in a competitive bid process in order to acquire Essar Steel Limited.
This case has been instrumental in setting out the eligibility criteria
applicable to resolution applicants under the IBC.

 

Subsequent amendments have resulted in increasingly stringent conditions
being applied to defaulting promoters and their connected parties in order to
prevent them from finding loopholes to regain their companies after leading
them to financial distress. The exception to this rule is the MSME industry,
whose promoters are currently exempt from the restrictions applicable u/s. 29A
of the IBC.

 

Cross-Border Insolvency
Laws


With a number of creditors and assets located across the globe,
regulating the recovery and involvement of foreign assets and creditors has
gained an increasing urgency in order to address the interests of all
stakeholders. This has led to lawmakers initiating the process of aligning
domestic cross-border insolvency laws with existing international laws under
UNCITRAL. While the draft chapter, which is currently undergoing an extensive
review, deals with the laws pertaining to corporate debtors only, eventually
the focus will also include personal cross-border insolvency laws.

 

Impact of IBC across
all spheres of law


In order to
facilitate the smooth implementation of the IBC, a number of significant
changes have been introduced across several spheres of law, in the form of
amendments to the Income Tax Act, 1961, the Companies Act, 2013, multiple
Securities and Exchange Board of India (“SEBI”) regulations and the Real
Estate Regulations and Developments Act, 2016 (“RERA”). 



a)     Relaxations under Income Tax Act


With regard to
income tax, there have been two relevant changes in the form of amendments to
the Finance Act, 2018. Section 79 of the Finance Act, 2018 has been amended to
provide that business losses shall not lapse in respect of a company, whose
resolution plan has already been approved by the National Company Law Tribunal
(“NCLT”). However, the amendment has a caveat in the form of an
opportunity to appeal to higher authorities.

Moreover, section 115JB has been amended to provide that in the case of
companies whose application is admitted by the NCLT under the IBC, the amount
of total loss brought forward (which is inclusive of unabsorbed depreciation)
would be allowed to be reduced from the book profit for the purpose of levying
minimum alternate tax.

 

Additionally, a
reference could also be made to the Monnet Ispat & Energy Limited judgment,
which has rendered further clarity on the priority of the ranking provided to
the Income Tax Department under the waterfall mechanism provided u/s. 53 of the
IBC.

 

b)    Exemptions under Companies Act, 2013


Under the Companies
Act, 2013, if a resolution plan has already been approved by the NCLT, then the
consent of shareholders of the corporate debtor (which is generally required
for significant corporate actions such as reduction of capital, disposal of
material assets and preferential allotment of shares), is not necessary for the
resolution plan to take effect.

 

c)     SEBI
(Delisting of Equity Shares) Regulations, 2009


Delisting of
securities from stock exchanges generally requires compliance with stringent
pricing norms and appropriate shareholder consent. However, if delisting is
proposed under a resolution plan under the IBC, then exemptions from the
elaborate delisting requirements are available, provided, the resolution plan
under the IBC grants an exit option to the existing public shareholders at a
price not less than their liquidation value and the price provided to promoters
and/or other shareholders. Further, an application for listing of shares
delisted pursuant to a resolution plan under the IBC can now be made without
adhering to the cooling-off period prescribed under the delisting regulations.

 

d)    Exemptions under SEBI (Listing Obligations
and Disclosure Requirements) Regulations, 2015


Shareholder consent
is no longer required if certain actions are undertaken pursuant to an approved
resolution plan under the IBC. These include undertaking material related party
transactions, divesting control in a material subsidiary and selling more than
20 % of the assets of a material subsidiary. Relaxations have also been
provided for undertaking the actions listed herewith pursuant to an approved
resolution plan under the IBC such as change of promoter, a company procuring
professional management, and a reclassification of promoter(s) or promoter
group as public shareholder.

 

e)     Exemptions under SEBI (Substantial
Acquisition of Shares and Takeovers) Regulations, 2011


Companies which
have an approved plan under the IBC have also been exempted from the
requirement of making an open offer. Further, successful acquirers under a
resolution plan are now permitted to hold more than
75 % of the shares in a listed company, which would have otherwise breached the
requirement for a minimum public shareholding of 25 %.

 

f)     Exemptions under SEBI (Issue of Capital and
Disclosure Requirement) Regulations, 2011


Preferential
allotment of shares can be made by companies if the preferential allotment
takes place as the result of a resolution plan under the IBC. Further
exemptions include relaxation from the multiple pricing requirements and
requirement of shareholder consents for allotment of equity shares and
convertible securities.

 

g)    Real Estate Regulations and Developments
Act, 2016


With the Jaiprakash Associates Limited  – Jaypee Infractech Limited case gaining
an exceptional amount of traction, it became essential to address the concerns
of home buyers as significant financial creditors. With the ordinance on 6th
June, 2018 and subsequently the amendment of 17th August, 2018
coming into effect, allottees under the Real Estate Regulations and
Developments Act, 2016 are now included as financial creditor(s) in keeping
with the amendment to the definition of financial debt.

 

The amendment and the outcome of the Jaypee Infratech Limited
matter has shown the efforts made by lawmakers to secure and protect the
interests of homebuyers who did not have any representation in the CoC despite
their substantial investment.

 

STRUCTURAL AND CULTURAL
CHANGES


The architects of
the IBC drafted the law with an endeavour to ensure that the company remains a
going concern. The IBC has provided the economy a medium to ensure commercial
stability. The IBC has now gained traction as a means of ensuring the
maximisation of the value of assets in a time-bound manner and preventing the
obliteration of the value of the assets of the company on account of corporate
distress.

 

In the course of
the last two years, a system comprising of experienced professionals and
organisations such as Insolvency Professionals (“IP”), Information
Utility (“IU”), Insolvency Professional Entities (“IPE”),
Insolvency and Bankruptcy Board of India (“IBBI”) in collation with the
adjudicatory authorities has managed to create an efficient ecosystem. The
combined efforts and experience of the aforementioned parties in dealing with
stressed assets can be credited for the significant turnaround the market has
undergone.

 

The IBBI has taken
up the mantle of regulating the aforementioned parties with multiple
regulations, guidelines and circulars, in order to help these parties to
smoothly navigate through these problematic situations. The adjudicatory
authorities have provided further clarity with regard to the laws applicable
and have adopted alternate approaches occasionally to ensure that the interests
of all stakeholders are not compromised.

 

The culture of
creditors consistently having to pursue debtors to ensure recovery has
gradually evolved into a culture wherein the promoters are viewing debt
repayment as an obligation, and not as an option, leading to speedier
resolution and recovery for the creditors. With promoters being held
accountable under the IBC, promoters have begun to take proactive steps to
ensure that defaults do not occur or are engaged in offering out-of-court
settlements for existing debts to their creditors.

 

The change has
percolated beyond debtors and creditors, and has led to a significant and
expedited improvement in the overall economic culture prevalent in the market,
with corporates opting to take quicker action with regard to deployment of
resources and smoother functioning in terms of timely payments in order to
reduce any possibilities of being involved in insolvency proceedings.

 

RBI Circular dated 12th
February, 2018 on Stressed Assets


Reporting
requirements have become increasingly stringent especially on account of the
RBI 12th February, 2018 circular (“Circular”), which in addition to
the multiple amendments to the law, has led to significant improvements in the
prevalent debt culture, with lenders exercising more caution by using
feasibility and viability as the determinants for future projects.

 

The IBC has
increasingly become more inclusive and creditor-friendly by providing for
mitigation of risk not only for financial creditors but also for operational
creditors. With regard to financial creditors, home buyers are also considered
as a class of financial creditors, a step which has provided substantial relief
to the common population in addition to corporate organisations.

 

The circular has also led to an improvement in ensuring post-credit
disbursement discipline, in addition to future lenders increasing their
diligence and prudence while determining the viability of a project which they
intend to fund. 

 

It must be noted,
however, that the ensuing litigation filed by a number of power companies has
led to a halt to the ongoing process of bringing to task a number of defaulting
companies as banks refrain from reporting them as non-performing assets.

 

Project Sashakt


In addition to the
Circular, Project Sashakt has also been largely responsible for introducing a
structural change in the business environment by increasing transparency and
investor confidence with regard to the financials of a bank. Early resolution
is key to the preservation of organisational capital and to ensuring a quicker
turnaround with regard to the resolution process.

 

The committee
headed by Mr. Sunil Mehta suggested a five-pronged approach, which would result
in bad loans amounting to up to Rs. 50 crore being managed at the bank level,
within a stipulated deadline of 90 days, whilst bad loans between Rs. 50 crore
to Rs. 500 crore would require banks to enter into an intercreditor agreement,
which would authorise the elected lead bank to implement a resolution plan in
180 days or make reference of the asset to the NCLT. As a part of Project
Sashakt, the government is currently looking into instituting an Asset
Reconstruction Company (“ARC”) and an Asset Management Company (“AMC”)
and is on the lookout for possible investors who would be willing to fund the
AMC.

 

A collation of the
ideas and implementation respectively for Project Sashakt and the Circular is
expected to bring in substantial improvement with regard to debt recovery in
compliance with expedited timelines.

 

 

 

 

CASES WHICH HAVE MADE
AN IMPACT


a)     Bhushan Steel Limited


Bhushan Steel Limited (the company has been renamed as Tata Steel BSL
Limited) and Bhushan Power and Steel Limited have been a significant part of
the resolution process under the IBC. Bhushan Steel Limited was one of the
first major companies to achieve resolution and was acquired by Tata Steel
Limited. Bhushan Power and Steel Limited is currently undergoing the resolution
process, with its three bidders – Tata Steel Limited, JSW Steel Limited and
Liberty House. Bhushan Power and Steel Limited has undergone two rounds of
bidding. In the first round of bidding, Liberty House submitted its bid after
the proposed deadline, and filed before NCLT an application seeking consideration
of its bid. The NCLT subsequently directed the CoC to consider Liberty House’s
bid, resulting in Tata Steel Limited appealing before the NCLAT to discount
Liberty House’s bid from being considered on account of non-adherence to the
procedure.

 

The NCLAT, however,
asked the CoC to reconsider Liberty House’s bid. With a number of appeals filed
by both Liberty House and Tata Steel Limited based on several issues,
eventually the NCLAT asked lenders to consider the three bids submitted by Tata
Steel Limited, Liberty House and JSW Steel Limited in a second round of
bidding. Reports state that currently JSW Steel Limited is the H1 bidder for
Bhushan Power and Steel Limited after Tata Steel Limited refrained from
revising its bid.

 

b)    Essar Steel Limited


The ongoing
resolution process of Essar Steel Limited has significantly led to the
developments which have taken place in section 29A which sets out the
ineligibility criteria of resolution applicants. ArcelorMittal and Numetal
Limited have been engaged in a competitive bidding process for more than a year
in order to procure one of the largest steel companies in India.

 

This led to the
eligibility of both the companies to be re-examined in light of the amendment,
with the Resolution Professional declaring both the prospective resolution
applicants as ineligible. A number of applications were filed by both the
companies pertaining to the ineligibility of the other company on account of
their association with non-performing assets. The orders passed by the courts
in this matter have dealt in detail with issues concerning management and
control in addition to lifting of the corporate and several other aspects of
section 29A.  Subsequently, both
companies were asked to clear their non-performing assets (“NPA”) within
two weeks from the order passed by the Supreme Court on 4th
October,2018.

 

ArcelorMittal has offered to pay Rs. 42,000 crore for Essar Steel
Limited. ArcelorMittal has already made a payment of Rs. 7,469 crore in order
to clear the outstanding liabilities on account of NPAs, Uttam Galva Steels
Limited and KSS Petron Limited in keeping with the order of the Supreme Court.
However, in a last attempt to save their flagship company, the promoters of
Essar have offered to pay back all dues, amounting to Rs. 54,000 crores. Even
though ArcelorMittal has been declared as the H1 bidder, a number of creditors
have challenged the decision before the adjudicatory authorities claiming that
the plan does not address the interest of all stakeholders sufficiently. The
outcome of this case will play a significant role in determining the future of
a number of NPAs.

 

c)     Jaypee Infratech Limited – Jaiprakash
Associates Limited


The case concerning Jaypee Infratech Limited – Jaiprakash Associates
Limited has been instrumental in helping home buyers to secure their rights as
financial creditors in the CoC, and participate in the resolution process.

 

The courts have
gone out of their way to ensure that the rights of home-buyers are not
compromised as far as possible and have accorded home-buyers the status of
financial creditors in order to render them a voice with regard to major
decisions to be undertaken by the CoC. 

 

Jaypee Infratech
Limited provided an upstream guarantee to its parent company, Jaiprakash
Associates Limited. However, subsequently both companies have become NPAs.
During the first attempt for resolution, the CoC for Jaypee Infratech Limited
had decided to liquidate the asset on account of unviable proposals. However,
the liquidation proceedings were stayed by the Supreme Court, whilst NCLT asked
Jaiprakash Associates Limited to return 760 acres of land to Jaypee Infratech
Limited on account of the transaction being deemed undervalued and fraudulent.
Through subsequent court hearings, the Supreme Court asked Jaiprakash
Associates Limited to pay Rs. 1,000 crore, which was subsequently reduced to
Rs. 650 crore.Since liquidation would not
serve the purpose of recovering the dues of the creditors, the Supreme Court
opted to restart the resolution process and included home buyers as a class of
financial creditors in the CoC. The insolvency process for Jaypee Infratech
Limited has commenced, with the home-buyers voicing their opinions with regard
to the selection of the resolution professional already.

 

CONCLUSION


In a short span of two years, the IBC has managed to stabilise the
economy to a considerable extent. By establishing an efficient ecosystem of
dedicated organisations and individuals with experience in the field of
insolvency and bankruptcy, the market has witnessed a turnaround with regard to
NPAs in multiple sectors. Credit must be given to the lawmakers and
adjudicatory authorities for the efforts they have made to address the best
interests of all stakeholders to the best of their capacities.

 

It must also be
duly noted that with defaulters being held accountable for their financial
irresponsibility under the IBC, the managements responsible for companies, such
as promoters, are proactively engaged in ensuring that their companies do not
convert into NPAs.

 

In cases where
companies have defaulted, attempts are being made to convince their creditors
to accept out-of-court settlements. Alternatively, by means of IBC, distressed
asset fund investors are being provided with multiple opportunities for
investment and to ensure the turnaround of NPAs. This is gradually reflecting
positively on the fiscal health of the economy. In the course of another year,
the impact that IBC has made as a path-breaking law will be clearly evident as
a number of approved resolution plans will be implemented to a substantial
extent.

 


[1] Ease of Doing
Business 2017, World Bank http://www.doingbusiness.org/en/rankings

[2] http://www.worldbank.org/en/news/press-release/2017/10/31/india-jumpsdoing-business-rankings-with-sustained-reform-focus

[3] Ease of Doing
Business 2019, World Bank http://www.doingbusiness.org/en/rankings

Section 9 of the Act; Articles 7, 5 and 12 of India-Philippines DTAA – In absence of FTS Article in DTAA, and in absence of PE in India, receipt of Philippines company from Indian company, being in the nature of business profit, were not chargeable to tax in India.

 17.  [2018] 100 taxmann.com 230 (Bangalore –
Trib.) DCIT vs. IBM India
(P.) Ltd IT (IT)ANos.: 1288,
1291, 1294, 1297, 1300, 1303 & 1306 (Bang.) of 2017 A.Ys.: 2009-10 to
2015-16 Date of Order: 16th
November, 2011

 

Section
9 of the Act; Articles 7, 5 and 12 of India-Philippines DTAA – In absence of
FTS Article in DTAA, and in absence of PE in India, receipt of Philippines
company from Indian company, being in the nature of business profit, were not
chargeable to tax in India. 

 

FACTS


The Taxpayer was an Indian
member-company of a global group. The Taxpayer was engaged in the business of
selling computers, software and lease financing of its products. The group had
a policy of deputing employees of one group company to another group company,
as may be required for certain business projects. For this purpose, the two
respective group companies entered into a standard expatriate agreement. During
this period, the employer of the deputed employee paid salary of deputed
employee in the home country. Thus, Philippines Group Company, (“FCo”) of the
Taxpayer had deputed its employee to the Taxpayer in India. The Taxpayer
reimbursed the amount equivalent to the salary to FCo. Further, the Taxpayer
had withheld tax on the salary of the employee and deposited the same with
Government of India. The Taxpayer did not withhold tax from the reimbursed
amount.

 

According to the tax authority,
FCo continued to be the employer of the deputed employees and also paid their
salaries. The Taxpayer only reimbursed salary to FCo but did not directly pay
salary to deputed employee. Therefore, the reimbursed amount was covered within
the definition of FTS under the Act as well as under India-Philippines DTAA.
Since the Taxpayer had not withheld tax from reimbursed amount, it was held
‘assessee-in-default’.

 

In appeal before CIT(A) the
Taxpayer also contended that in absence of FTS article in India-Philippines
DTAA, the receipt was ‘business profit’ and since FCo did not have a PE in
India, the receipt could not be chargeable to tax in India. CIT(A) held that
even if reimbursement by the Taxpayer to FCo was regarded as FTS, the payment
would not be chargeable to tax in India in absence of FTS article in
India-Philippines DTAA.  

______________________________________________________

2. Apparently,
the disallowance was u/s. 40(a)(i) of the Act though the decision does not
mention the relevant provision

 

 

HELD


  • In
    an earlier decision in the case of the Taxpayer, the Tribunal has held that
    when India-Philippines DTAA does not provide for taxing of FTS, it is not
    chargeable to tax.
  • There
    is no specific clause in India-Philippines DTAA regarding income in the nature
    of FTS. Article 23 does not apply to items of income which can be classified
    under any other article, whether or not the income is taxable. A payment would
    be covered by Article 23(1) [‘Other Income’ Article] if the payment was not
    covered within any other Article.
  • FCo
    received payment in the course of its business. FCo did not have any PE in
    India. Hence, the receipt, though business profit, cannot be brought to tax
    under Article 7. Therefore, it was not chargeable to tax in India.      

 

 

 

Section 9 of the Act; Article 12 of India-Japan DTAA – payments received by Japanese company in respect of deputation of high-level technical executives to Indian subsidiary were FTS, particularly because technical knowledge was made available; in absence of reconciliation of receipts with actual payments, the receipts could not be treated as reimbursement of cost.

16.  [2018] 99 taxmann.com 183 (Chennai – Trib.) Panasonic
Corporation vs. DCIT ITA No.: 1483
(Chny) of 2017 A.Y. 2013-14 Date of Order: 2nd
August, 2018

 

Section
9 of the Act; Article 12 of India-Japan DTAA – payments received by Japanese
company in respect of deputation of high-level technical executives to Indian
subsidiary were FTS, particularly because technical knowledge was made
available; in absence of reconciliation of receipts with actual payments, the
receipts could not be treated as reimbursement of cost.

 

FACTS


The Taxpayer was a company
incorporated in Japan. (“FCo”). FCo was engaged in the business of electrical
and electronic products and systems. FCo had a subsidiary in India (“ICo”). In
the course of its business, FCo deputed certain high-level technical executives
to ICo for providing highly technical services to ICo. ICo reimbursed the
salaries of the deputed employees to FCo.

 

According to ICo, since it was a
case of mere reimbursement of expenses, the receipts by FCo could not be construed
as income of FCo. Further, the objective of secondment was to support ICo and
there was no economic benefit to FCo.

 

According to the AO, ICo was
required to withhold tax from the payment. Since ICo had not withheld the tax,
the AO disallowed2  the
deduction while passing draft assessment order. The DRP directed FCo to
reconcile receipts from ICo with actual payments. FCo could not reconcile the
same. DRP observed that routing salary through FCo was with the twin objectives
of having absolute control over seconded employees and not letting the customer
know about the margin retained by FCo over the actual salary. DRP further
observed that services rendered by employees of FCo made technology available
to ICo which was apparent since subsequently there was no requirement for
deputation of employees again.

 

Relying on decision in Food
World Supermarkets Ltd vs. DDIT [2015] 63 taxmann.com 43, DRP conducted
that irrespective of whether amount was received with mark-up or on
cost-to-cost basis, it had to be considered as FTS. Since FCo could not
reconcile the receipts with actual payments, it could not be treated as
reimbursement of expenses. 

 

HELD


  • The
    AO disallowed claim of FCo on the ground that it received FTS. The AO and DRP
    also found that the technical knowledge was made available to ICo. FCo also
    could not reconcile the receipts and the actual payments, before DRP as well as
    the Tribunal.
  • The
    deputed personal were all holding senior technical/managerial positions with
    ICo and reported to the top management of FCo. They were working under
    direction, control and supervision of FCo.
  • The
    deputed personal were rendering highly technical services. Further, the
    services resulted in technology being made available to ICo, which obviated the
    necessity of employees to be deputed again. Accordingly, order of the AO and
    DRP was confirmed. 

Section 5 of the Act – salary for services rendered outside India but received in India is not taxable in India in absence of TRC if the Taxpayer furnishes evidence in support of accrual of salary outside India.

15.  IT A No.:2407/Bang/2018 Maya C. Nair vs.
ITO A.Y.: 2013-14 Date of Order: 31st
October, 2018

 

Section 5 of the Act – salary for services rendered
outside India but received in India is not taxable in India in absence of TRC
if the Taxpayer furnishes evidence in support of accrual of salary outside
India.

 

FACTS


The Taxpayer
was an individual employed in India. During the relevant year, she was deputed
by her employer to USA. During the deputation period, her entire remuneration
was credited by her employer to her bank account in India. As her stay in India
was less than one hundred and eighty-two days, she qualified as non-resident in
terms of section 6(1) of the Act. In her return of income, the Taxpayer
disclosed remuneration for services rendered in India as taxable and claimed
remuneration for the deputation period outside India as exempt. For the period
of her deputation in USA, the Taxpayer had furnished return of income in USA
and had also duly paid taxes in USA.

 

However, for the following reasons,
the AO concluded that the Taxpayer was not entitled to exemption of income
earned on deputation in USA and accordingly charged tax thereon.

(i) The Taxpayer had not provided confirmation of her employer in India
or in USA to establish that she was working in USA.

(ii)        The receipt of salary in India by the Taxpayer suggested that
she had rendered services in India, unless the Taxpayer proved otherwise1.

 

(iii)       To claim benefit in terms of India-USA DTAA, the Taxpayer was
required to provide Tax Residency Certificate (“TRC”), which she had failed to
provide.

The Taxpayer preferred an appeal
before CIT(A)-12. By her order dated 31-10-2017, and relying on certain
judicial decisions, CIT(A)-12 deleted the addition made by the AO in respect of
the exempt income. Subsequently, by a departmental administrative order, CCIT
transferred the appeal for that particular year to CIT (A)-10. Hence, CIT(A)-10
passed ex-parte order dated 28-02-2018. In his order, CIT(A)-10 upheld
the order of the AO treating income that had accrued in USA as taxable in
India.

 

__________________________________________

1. It may be
noted that section 5(2) of the Act provides that income received in India by a
non-resident is chargeable to tax in India.

 

 

HELD


  • When
    CIT(A)-10 passed the order, order of CIT(A)-12 was in existence. It was solely
    the mistake of the department, for which, the Taxpayer should not be made to
    suffer hardship and harassment.
  • CIT(A)-12
    could not have invalidated her order as ‘rectification’ u/s. 154 of the Act. Section
    154 merely provides for correction of mistake apparent from the records but
    does not confer power to recall or invalidate an order.

  • As
    there cannot be two appellate orders of two different CIT(A)s for the same
    assessment year, order of CIT(A)-10, being later, was not a valid order under
    law and was liable to be quashed as non-maintainable.
  • It
    is not the case of revenue that the order of CIT(A)-12 was perverse or was made
    on wrong factual or legal premise. CIT(A)-12 had passed a reasoned order and
    had relied on decisions of jurisdictional High Court and the Tribunal.
    Therefore, remanding the matter to CIT(A)-10 would, rather than serving a
    useful purpose, will cause hardship to the Taxpayer.
  • In
    ITO vs. Bholanath Pal [2012] 23 taxmann.com 177 (Bangalore), it was held
    that salary accrues where the services under the employment are rendered. The
    facts of the Taxpayer are similar to the facts in the said decision. Absence of
    TRC cannot be a ground for denying DTAA benefit. A taxpayer is required to
    provide evidence in support of exemption claimed. The Taxpayer had furnished
    evidence of her stay outside India and since the salary for services rendered
    outside India did not accrue in India, it was not taxable in India.

Article 12 of India-USA DTAA; Explanation 2 to section 9(1)(vi), payment made towards web hosting charges not taxable as royalty under the Act as well as the DTAA

14.  TS-623-ITAT-2018 (Pune) EPRSS Prepaid
Recharge Services India P. Ltd. vs. ITO Date of Order: 24th
October, 2018 A.Y.: 2010-11

 

Article
12 of India-USA DTAA; Explanation 2 to section 9(1)(vi), payment made towards
web hosting charges not taxable as royalty under the Act as well as the DTAA

 

Facts

The Taxpayer is a private Indian
company engaged in distribution and sale of recharge pens of various DTH
providers via online network. In order to run its business, the Taxpayer required
access to servers. Instead of purchasing servers and incurring expenditure on
its maintenance, Taxpayer hired server space under a web hosting agreement from
a foreign company (“FCo”).

 

The Taxpayer did not withhold
taxes while making payment to FCo for such services on the contention that
payment for web hosting services did not qualify as royalty or FTS.

AO, however, held that the
payments were made for the use of servers which amounted to use of commercial
equipment. Hence, they qualified as royalty u/s.9(1)(vi) of the Act. Aggrieved,
the Taxpayer appealed before CIT(A), who upheld the order of AO.

 

The Taxpayer appealed before the
Tribunal.

 

HELD

  • As
    per the terms of the agreement, the Taxpayer had made payments for use of
    technology driven services of FCo and not for use of any IPR or rights owned by
    FCo. The fact that payments made to FCo varied with the use of technology also
    supported the fact that the payments were for availing services. Accordingly,
    the payments made for web hosting services did not qualify as royalty.
  • Further
    while using the technology services provided by FCo, the Taxpayer did not use
    or acquire any right to use any industrial, commercial or scientific equipment.
    Hence, the payments made by Taxpayer cannot be said to be covered under clause
    (iva) to Explanation 2 of section 9(1)(vi) of the Act. Reliance was placed on
    the decision of Madras HC in Skycell Communications Ltd. & Anr
    (TS-18-HC-2001).
  • Thus,
    the Taxpayer was not liable to withhold taxes on web hosting charges paid to
    FCo.
  • Without
    prejudice, the definition of royalty, which was retrospectively amended to
    include use of, or right to use, an equipment cannot be applied in respect of
    the tax years which have elapsed before the amendment came into force.
  •  In
    any case, since payments were made by the Taxpayer to FCo before the
    retrospective amendment came into force, the Taxpayer cannot be held to be in
    default for failure to withhold taxes on the basis of retrospective amendment.
  •  Also, retrospective
    amendment to the Act cannot amend the DTAA. Thus, amended definition of
    ‘royalty’ under the Act cannot be read into the DTAA. Since the Taxpayer had no
    control over the servers of FCo, payment for such services did not qualify as
    royalty under the DTAA as well.

Section 2(47) – Reduction of share capital, even where there is no change in the face value of the share or the shareholding pattern, results in extinguishment of right in the shares amounting to transfer of shares.

8.  Jupiter Capital Pvt. Ltd. vs. Assistant
Commissioner of Income Tax (Bangalore) Members:  Sunil Kumar Yadav (J. M.) and Arun Kumar
Garodia (A. M.) ITA
No.:445/Bang/2018 A.Y.: 2014-15. Dated: 29th
November, 2018 Counsel for
Assessee / Revenue:  S. Parthasarathi /
D. Sudhakara Rao

 

Section
2(47) – Reduction of share capital, even where there is no change in the face
value of the share or the shareholding pattern, 
results in extinguishment of right in the shares amounting to transfer
of shares.

 

FACTS

The
assessee had invested in 15,33,40,900 equity shares at face value of Rs. 10 on
different dates in its subsidiary company, Asianet News Network Private Limited
(‘ANNPL’). The total number of shares of ANNPL was 15,35,05,750 out of which
the assessee’s share was 99.89%. As a result of the Order of High Court of
Bombay, there was a reduction in share capital of ANNPL to 10,000 nos., and
consequently the share of the assessee was reduced proportionately to 9,988
nos. The Court also ordered for payment of Rs. 3.18 crore as a consideration
for reduction in share capital. The face value of the shares remained the same
at Rs. 10 after the reduction. 

 

The assessee claimed Rs. 164.49 crore as Long Term
Capital loss. According to the assesse, this loss had accrued on account of
reduction in share capital of ANNPL. According to the AO, the reduction in
shares of ANNPL did not result in transfer of capital asset as envisaged u/s.
2(47). The AO came to this conclusion, in light of the finding that, even though
the number of shares had reduced, the face value of Rs. 10 as well as the
percentage of assessee’s share at 99.89% remained at the same level as it was
before the reduction of share capital. He didn’t agree with the assessee that
there was real transfer of asset, as the scheme resulted in
extinguishment/relinquishment of part of the assessee’s rights in the shares of
ANNPL and therefore, the transaction fell within the purview of section
2(47).  The AO held that the decision of
the Supreme court in the case of Kartikeya V. Sarabhai vs. CIT  (228 ITR 163) relied on by the assessee
cannot be applied as the facts of the case are contrary to the case as there
was no reduction in the face value of the shares in the case of the
assessee.  On appeal, the CIT(A) agreed
with the AO and upheld her order.

 

HELD


The Tribunal noted
that in the case of the assessee, on account of reduction in number of shares
in ANNPL, the assessee extinguished its right of 15,33,40,900 shares and in
lieu thereof, it received 9,988 shares at Rs. 10/- each along with an amount of
Rs. 3.18 crore.  According to the
tribunal, the basis adopted by the CIT(A) to hold that the judgment of the
Supreme Court in the case of Kartikeya V. Sarabhai was not applicable in
the present case was not proper as the Supreme court had not made any reference
to the percentage of shareholding prior to reduction of share capital and after
reduction of share capital.  According to
the tribunal, the judgment of the Apex Court was squarely applicable to the
case of the assessee, therefore, following the same the Tribunal held that the
assessee’s claim for capital loss on account of reduction in share capital in
ANNPL was allowable.

Section 194-1A – Four persons who purchased immovable property of Rs. 1.5 crore jointly not liable to deduct tax at source since purchase consideration for each person was Rs. 37.5 lakh which was less than the threshold limit of Rs. 50 lakh prescribed in the provisions.

7.  Vinod Soni vs. ITO (Delhi) Members:  H.S. Sidhu (J. M.) Ando.P. Kant (A. M.) ITA
No. 2736/Del/2015 A.Y.:
2014-15.  Dated:
10th December, 2018 Counsel
for Assessee / Revenue:  Raj Kumar / B.S.
Rajpurohit

 

Section
194-1A – Four persons who purchased immovable property of Rs. 1.5 crore jointly
not liable to deduct tax at source since purchase consideration for each person
was Rs. 37.5 lakh which was less than the threshold limit of Rs. 50 lakh
prescribed in the provisions.

 

FACTS


The
assesse and three of his family members each purchased 1/4th
undivided equal shares in an immovable property vide single sale deed for Rs.
1.5 crore. The purchase consideration for each person was Rs. 37.5 lakh.
According to the AO, since the value of the property purchased under single
sale deed exceeded Rs. 50 lakh, as per section 194 IA(2), the assessee was
required to deduct tax at source @1%. For his failure, the AO held the assessee
as defaulter u/s. 201(1) and levied a penalty of Rs. 1.5 lakh. The levy was
confirmed by the CIT(A). 

 

HELD


The
Tribunal noted that as per the purchase deed each of the vendees had become the
absolute and undisputed owner of the said plot in equal share.  It also noted from details of party wise
payment furnished that each of the vendee had made payment from their own bank
account / loan account.  Further, the
tribunal also noted that the provisions of section 194-IA do not apply where
the consideration for transfer of immovable property was less than Rs. 50 lakh.
According to the Tribunal, since the said provisions apply to a person being a
transferee, the provision would apply only w.r.t. the amount related to each transferee
and not with reference to the amount as per a sale deed.  In the instant case, there were four separate
transferees and the sale consideration w.r.t. each transferee was Rs. 37.5
lakh, i.e. less than Rs. 50 lakh each. Each transferee was a separate income
tax entity therefore, it observed that the law has to be applied with reference
to each transferee as an individual transferee/person. Accordingly, it was held
that the provisions of section 194-IA were not applicable and allowed the
appeal of the assesse.

Sections 28, 40A(2)(b) – If the assessee derives income from developing properties and leasing them out, income is chargeable to tax as ‘business income’ following the concept of consistency. No disallowance u/s. 40A(2)(b) can be sustained if the AO fails to specifically bring the actual fair market value on record on basis of corroborative evidences.

25.  (2018) 66 ITR (Trib.) 116 (Mumbai) ACIT vs. Grew
Industries Pvt. Ltd. ITA No.:
5427/Mum/2016 A.Y.: 2011-12 Dated: 9th May, 2018

 

Sections
28, 40A(2)(b) – If the assessee derives income from developing properties and
leasing them out, income is chargeable to tax as ‘business income’ following
the concept of consistency.

 

No
disallowance u/s. 40A(2)(b) can be sustained if the AO fails to specifically
bring the actual fair market value on record on basis of corroborative
evidences.

 

FACTS


Briefly,
facts were that the assessee – a company, was engaged in the business of
development of commercial properties including I.T. Parks, offices etc., and
given them on lease. The Assessing Officer (AO) intended to treat the lease
rent as ‘Income from house property’ as against ‘Business income’ as offered by
the assessee. Upon this, the assessee explained that the I.T. Park was
developed by Salarpuria Properties Pvt Ltd (SPPL) on the land belonging to the
assessee. That the assessee developed the property to be used as I.T. Park in
Bangalore keeping the need of I.T Sector in Bangalore and office premises of
several I.T Companies were located in the I.T. Park. Also, the development and
maintenance of I.T. Park was a very complex commercial activity, which required
continuous and considerable efforts so as to provide services round the clock.
It was submitted, as per section 80 IA of the Act, development and maintenance
of I.T. Park was regarded as a business activity. It was submitted by the
assessee that in A.Y. 2006-07 to A.Y.2010-11, the income received from I.T.
Park was offered as ‘Business income’ and the department had also accepted it.
Therefore, it was submitted that the income offered by the assessee should not
be assessed as ‘Income from House Property’. Disregarding the assessee’s
submissions, the AO held the income to be ‘Income from house property’. This
was later reversed by the first appellate authority.

 

During
the course of assessment proceedings, the Assessing Officer noticed that the
assessee had claimed deduction on account of payment of salaries of Rs.
1,11,000/- and Directors remuneration of Rs. 2,20,00,000/. The AO found that no
such remuneration was paid in the earlier assessment years. He, therefore,
called upon the assessee to justify the reasonableness of payment made to them.
The assessee justified the payment made to the Directors, however, the
Assessing Officer was of the view that there was no justification of payment to
the Directors and also observed that the assessee failed to establish the
reasonableness of commission paid to the Directors. Accordingly, he disallowed
the payment made u/s. 40A(2)(b) of the Act. The CIT(A) after considering the
submissions of the assessee, allowed assessee’s claim. The CIT(A) appealed to
the ITAT.

 

HELD


The
learned DR relying on the observations of the Assessing Officer submitted that
the lease rentals were received by the assessee merely as an owner of the property.
Therefore, the income derived from lease rental had to be assessed as ‘Income
from House Property’. The learned AR submitted that the assessee had also
demonstrated with documentary evidence that it was operating and maintaining
the I.T. Park. The learned AR submitted that the assessee was in the business
of developing and leasing out commercial properties, I.T. Parks etc. Therefore,
the income derived from such activities had to be treated as ‘Business income’.

 

The
Tribunal pointed out that the Assessing Officer himself had accepted the fact
that the assessee owns number of properties and had leased them out. Though
principle of res judicata is not strictly applicable to income tax
proceedings, each assessment year being an independent unit, rule of
consistency cannot also be ignored. Considering all the facts on record, the
ITAT held that the object of the assessee was to derive income from developing
properties and leasing them out. Further following the principle of
consistency, as per earlier years the income of the concerned year should also
be considered to be ‘business income’.

 

As
regards the payment made to the Directors, the Assessing Officer had disallowed
them primarily for two reasons – firstly, the assessee had not carried out any
business activities and secondly, the payment made was unreasonable. The first
reasoning of the Assessing Officer had lost its force considering the fact that
the income derived by the assessee had been held to be business income. Even
otherwise also, besides leasing out of properties, the assessee had other
business activities also. That being the case, the disallowance of expenditure
on the ground of no business activity was totally wrong. As regards the
applicability of section 40A(2)(b) of the Act is concerned, the ITAT observed
that the Assessing Officer had not established on record what was the fair
market value of the services rendered by the assessee. The Assessing Officer
merely made a vague statement that the remuneration paid by the assessee to the
Directors was unreasonable, without bringing any corroborative evidence on
record. Neither did he establish the actual fair market value of the services
rendered. Hence, the ITAT held that the disallowance was merely on the basis of
conjectures and surmises and could not be sustained.

 

 

Section 234E – Assessing Officer cannot make any adjustment by levying fee u/s. 234E prior to 01.06.2015

24.  [2018] 66 ITR (Trib.) 69 (Chennai) A.R.R. Charitable
Trust vs. ACIT ITA No.:
1307/Chny/2017 & 238, 239, 240 & 241/Chny/2018 A.Y.s: 2013-14 to
2015-16 Dated: 24th July, 2018

 

Section
234E – Assessing Officer cannot make any adjustment by levying fee u/s. 234E
prior to 01.06.2015

 

FACTS


Prior
to 01.06.2015, there was no enabling provision in section 200A of the Act for
making adjustment in respect of the statement filed by the assessee with regard
to tax deducted at source by levying fee u/s. 234E of the Act. The Parliament
for the first time enabled the Assessing Officer to make adjustment by levying
fee u/s.234E of the Act with effect from 01.06.2015. Therefore while processing
statement u/s. 200A of the Act, the Assessing Officer cannot make any
adjustment by levying fee u/s. 234E prior to 01.06.2015.

 

Thus
the legal position prior to 01.06.2015, as per various precedents was that, the
Assessing Officer had no authority to levy fee while issuing intimation u/s.
200A of the Act. In the present case, the Ld. CIT(A) in his order, stated that
intimation u/s. 200A of the Act was issued on 31.07.2015. However the Ld. AR
pointed out referring to the intimations issued u/s. 200A of the Act, that all
the intimations u/s. 200A of the Act were issued before 01.06.2015, therefore,
the CIT(Appeals) was not justified in confirming the levy of fee.

 

HELD


The Tribunal on careful examination of facts held that the
intimations were issued for all the years before 01.06.2015. Therefore, the
CIT(Appeals) was not correct in saying that the intimations were issued on
31.07.2015. When the intimations were issued before 01.06.2015, this Tribunal
was of the considered opinion that the Assessing Officer had no jurisdiction to
levy fee u/s. 234E of the Act. The amendment to section 200(3) of the Act was
made only with effect from 01.06.2015.

 

Relying
on its own decision in Smt. G. Indhirani the Tribunal in I.T.A. Nos.238 to
241/Chny/18, held that while processing statement u/s. 200A of the Act, the
Assessing Officer cannot make any adjustment by levying fee u/s. 234E prior to
01.06.2015. Thus the fee levied u/s. 234E of the Act was deleted.

Sections 11, 12 – Tax exemption u/s. 11/12 cannot be denied merely for receiving sponsorship from a corporate business entity.

23.  (2018) 66 ITR (Trib.) 82 (Delhi) D.C.I.T. vs. India
Olympic Association ITA No.:
1130/DEL/2016 A.Y.: 2011-12 Dated: 19th July, 2018

 

Sections
11, 12 – Tax exemption u/s. 11/12 cannot be denied merely for receiving
sponsorship from a corporate business entity.

 

FACTS 


The
assessee-society was an Apex sports body for selecting athletes to represent
India at Olympic Games, Asian Games and other international athlete meets at
these events. It was registered u/s. 12A of the Act. The assessee received an
income from sponsorship amounting to Rs. 86 lakh received from Samsung India
Electronics Pvt. Ltd for 2010 Asian Games and 2010 Youth Olympic Games.
Therefore, the Assessing Officer (AO) formed an opinion that the assessee had carried
out the activities for the purposes of general public utility in the nature of
trade, commerce or business. The AO further formed a belief that this
transaction of the assessee was in the nature of rendering services in relation
to business of Samsung in lieu of consideration from Samsung India Electronics
Pvt. Ltd.  The AO was convinced that
proviso to section 2(15) of the Act squarely applies and hence the assessee
does not fall within the category of ‘charitable organisation’. Accordingly,
benefit u/s. 11/12 of the Act was denied to the assessee. Being aggrieved, the
assessee carried the matter before the first appellate authority and reiterated
that the proviso to section 2(15) of the Act does not apply in the case of the
assessee and the AO had wrongly denied claim of exemption u/s. 11/12 of the
Act.

 

HELD


The
Tribunal allowed the assessee’s appeal and held as under:

 

1.  On drawing support from the speech of the Finance Minister and
subsequent clarification issued by the CBDT within the framework of amended
provisions of section 2(15) of the Act, the Tribunal was of the view that an
object of public utility need not be an object in which the whole of the public
is interested. It is sufficient if well defined section of the public benefits
by the objects which means that the expression “object of general public
utility” is not restricted to objects beneficial to the whole mankind.


2.  Receiving sponsorship is not a part of any business carried out by
the appellant. Merely receiving sponsorship from a business entity cannot
tantamount to a conclusion that the assessee has entered into a business
activity with such sponsorer.


3.  The Hon’ble ITAT relied on the following decisions:


(a) CIT vs. Swastik Trading Co. Ltd. (113 ITR 852) wherein it was
held that establishing and maintaining Gaushalas and Panjrapole constitutes
charitable purpose.


(b) ICAI vs. Director General of Income Tax (Exem) (347 ITR 99)
where ICAI which was denied exemption u/s. 10(23C)(iv) of the Act because in
the opinion of the DGIT (Exem.) the institute was holding coaching classes and
therefore was not an educational institution. The Hon’ble Delhi High Court held
that the order denying the exemption was not valid.

 

Thus, in the Tribunal’s opinion, there was no material
which may suggest that the assessee association was conducting its affairs
solely on commercial lines with the motive to earn profit. There was also no
material which could suggest that the assessee association had deviated from
its objects which it had been pursuing since past many decades. The proviso to
section 2(15) of the Act was not applicable to the facts of the case and the
assessee-association deserved benefit u/s. 11/12 of the Act.

 

Section 234A – When the taxes have been deposited before the original due date of filing of return of income even though the return has been filed within the extended due date so notified by the CBDT, there would not be any levy of interest u/s. 234A where the returned income has been accepted or where the taxes deposited are higher than the taxes finally determined by the AO.

22.  [2018] 196 TTJ 768 (JP – Trib.) Rajasthan State
Mines & Minerals Ltd vs. ACIT ITA No.:  47/Jp/2018 
A.Y.:  2014-15.Dated: 24th October, 2018

                                  

Section
234A – When the taxes have been deposited before the original due date of
filing of return of income even though the return has been filed within the
extended due date so notified by the CBDT, there would not be any levy of
interest u/s. 234A where the returned income has been accepted or where the
taxes deposited are higher than the taxes finally determined by the AO.

 

FACTS


The
due date of filing of return of income for A.Y.2014-15 was extended by the CBDT
vide its order u/s. 119 from 30.9.2014 to 30.11.2014. The assessee filed the
return on 28.11.2014. The assessee had paid self-assessment tax well before the
original due date of filing return of income. The AO while working out the
interest u/s. 234A had not given credit of self-assessment tax paid by the assessee.
Aggrieved by the assessment order, the assessee preferred an appeal to the
CIT(A). The CIT(A) confirmed the same.

 

HELD


The
Tribunal followed the ratio of the Hon’ble Supreme Court decision in the case
of CIT vs. Pranoy Roy & Anr. (2009) 222 CTR (SC) 6 wherein it was
held that the interest u/s. 234A of the Act on default in furnishing return of
income shall be payable only on the amount of tax that has not been deposited
before the due date of filing of the IT return for the relevant assessment
year. The Tribunal relying upon the judgement of Hon’ble Supreme Court, held
that where the taxes deposited before filing the return of income were more
than the taxes finally determined on regular assessment, the interest u/s. 234A
was held not leviable.

Section 271AAA r.w.s 132 and 153C – Where no search and seizure operation u/s. 132(1) was carried out in assessee’s case, initiation of penalty proceeding u/s. 271AAA by Assessing Officer was invalid.

21.  [2018] 196 TTJ 812 (Mumbai – Trib.) DCIT vs. Velji
Rupshi Faria ITA No.:
1849/Mum/2017 A.Y.:  2008-09 Dated: 31st August, 2018

           

Section
271AAA r.w.s 132 and 153C – Where no search and seizure operation u/s. 132(1)
was carried out in assessee’s case, initiation of penalty proceeding u/s.
271AAA by Assessing Officer was invalid.

 

FACTS



The assessee was
an individual and stated to be the key person pursuant to a search and seizure
operation u/s. 132(1) of the Act in certain business concerns. The Assessing
Officer (AO) initiated proceedings u/s. 153C of the Act against the assessee.
Pursuant to the notice issued u/s. 153C of the Act, the assessee filed its
return of income. During the assessment proceedings, the AO referring to the
incriminating material found in course of search and seizure operation made a
number of additions. While completing the assessment, the AO also initiated
proceedings for imposition of penalty u/s. 271AAA of the Act. And then passed
an order on 13th March 2014.



Aggrieved
by the assessment order, the assessee preferred an appeal to the CIT(A). The
CIT(A) after considering the submissions of the assessee and having found that
search and seizure operation u/s. 132(1) of the Act was not carried out in case
of the assessee, followed the decision of the Tribunal, Ahmedabad Bench, in
case of Dy. CIT vs. K.G. Developers, ITA No.1139/Ahd./ 2012, dated 13th
September 2013, and deleted the penalty imposed.

 

Being
aggrieved by the CIT(A) order, the Revenue filed an appeal before the Tribunal.

 

HELD


The
Tribunal held that only in case of a person in whose case search and seizure
operation u/s. 132(1) of the Act was carried out on or after 1st Day
of 2007 but before the 1st Day of July 2010, penalty proceedings
u/s. 271AAA of the Act could be initiated. The primary condition for initiating
penalty proceeding was, a person concerned must have been subjected to a search
and seizure operation u/s. 132(1) of the Act. In present case, no search and
seizure operation u/s. 132(1) of the Act was carried out. Thus, the primary
condition of section 271AAA of the Act remained unsatisfied. Even otherwise
also, if penalty proceedings u/s. 271AAA of the Act was initiated against a
person who was not subjected to search action u/s. 132(1) of the Act, the
provision itself became unworkable as no declaration u/s. 132(4) of the Act was
possible from any person other than the person against whom the search and
seizure u/s. 132(1) was carried out. In the end, the Tribunal upheld CIT(A)
order.

 

NOTE:
Section 271AAA was applicable for searches u/s. 132(1) initiated prior to the 1st
day of July, 2012. For searches initiated on or after the 1st day of
July, 2012, section 271AAB shall be applicable.

Section 68 – Additions made to income of assessee, who was a non-resident since 25 years, were unjustified since no material was brought on record to show that funds were diverted by assessee from India to source deposits found in foreign bank account.

20.  [2018] 100 taxmann.com 280 (Mumbai-Trib) DCIT(IT) vs. Hemant
Mansukhlal Pandya ITA Nos.: 4679
& 4680 (Mum) of 2016  and C.O. 58
& 159 of 2018 A.Y.s: 2006-07
& 2007-08 Dated: 16th November, 2018

 

Section
68 – Additions made to income of assessee, who was a non-resident since 25
years, were unjustified since no material was brought on record to show that
funds were diverted by assessee from India to source deposits found in foreign
bank account.

 

FACTS


The
assessee, a non-resident since financial year 1995-96, is a director in a
company in Japan and living in Japan on business visa since 1990.  He got permanent residency certificate from
Japan in 2001.  The assessee has filed
his return of income for AY 2006-07 declaring total income of Rs.
5,51,667.  Subsequent to processing of
the return, the assessment was reopened u/s. 147 of the Act for the reasons
recorded as per which information was received by Government of India from the
French Government under DTAA that some Indian nationals and residents have
foreign bank accounts in HSBC Private Bank (Swisse SA, Geneva) which were
undisclosed to the Indian Income-tax department. This information was received
in the form of a document (hereinafter referred to as ‘base note’) was processed
with that of the assessee’s Indian income-tax return and found that the details
contained in base note were matching with the information provided by the
assessee in his income-tax return. Accordingly, the DDIT(Inv), Unit VII(4),
Mumbai sent information to the concerned AO for further action. The AO, after
recording reasons, issued notice u/s. 148 of the Act for reopening of the
assessment.

 

In
the course of assessment proceedings the AO called for various details
including details of bank accounts maintained in HSBC, Geneva in original CD
and other details. In response to notice, the assessee, stated that he is a
non-resident for more than 25 years and being a non-resident, he is not under
obligation to declare his foreign assets and foreign income to the Indian
Income-tax Authorities; hence, the question of submitting the CD of the HSBC
Bank account or the consent waiver form does not arise.  The AO, issued notice and asked the assessee
to file necessary details in support of HSBC Bank account maintained in Geneva
and also show cause as to why assessment shall not be framed u/s. 144 of the
Act, based on material available on record.

 

In
response, the assessee filed an affidavit and stated that his foreign bank
accounts and foreign assets have no connection with India or any Indian
business. No amounts from India have been transferred to any of his foreign
accounts directly or indirectly.  The assessee
challenged the authenticity and correctness of the base note and contended that
no addition can be made merely on assumptions or presumptions. The assessee
further submitted that the bank account maintained in HSBC, Geneva is having no
connection with India and accordingly question of furnishing details of bank
accounts and foreign assets does not arise. He further stated that he has filed
his income-tax return regularly in India in the status of Non-resident
declaring whatever income accrued or deemed to accrue in India and such returns
have been accepted by the department. In the absence of any provisions to
declare foreign bank accounts and assets by non-residents to Indian Income-tax
department, the question of disclosing those accounts to Indian Income-tax
department does not arise and consequently, the amount lying in HSBC Geneva
account cannot be taxed in India.

 

The
AO added the peak balance in HSBC account, amounting to Rs. 48,95,304 (Rs.
45.52 per USD) by holding that since the assessee had not produced any
evidences to prove that the money deposited in his foreign bank account does
not have any source from India.  He held
that since the assessee did not produce any documentary evidence to prove that
prior to 2001 he was permitted to have business/profession or work in Japan or
any other country the only conclusion that can be drawn is that prior to this
date, the assessee cannot be engaged in any business, profession or employment
in Japan.  He also held that there is a prima
facie presumption of amounts in the said account being undisclosed and
sourced from India. The circumstances of the case point to only one thing with
regard to source of deposits in HSBC, Geneva accounts; that the deposits were
made by the assessee in his HSBC, Geneva account from sources in India which
have not been disclosed in his return of income.

 

Aggrieved,
the assessee preferred an appeal to CIT(A) who deleted the addition made by the
AO.

 

Aggrieved,
the revenue preferred an appeal to the Tribunal. 

 

HELD


The
Tribunal noted that the assessee had only one bank account in India of which
the bank statements from 1998 to 2008 were furnished by the assessee. On
perusal of the said bank statements it could be seen that no amounts have been
transferred by the assessee from this bank account in India to any of the other
bank accounts including HSBC Geneva.  It
also noted that the balance maintained in this Indian Bank Account is so less
that it cannot fund an amount of Rs. 4.28 crore which has been added by the AO
to assessee’s income.  The Tribunal
observed that the AO sought to put the onus of proving a negative that the
deposits in foreign bank accounts are not sourced from India, on the
assessee.  It held that the AO is not
justified in placing the onus of proving a negative on the assessee.  In fact, only a positive assertion can be
proved and not a negative one.  The onus
of proving that an amount false within the taxing ambit is on the department
and it is incorrect to place the onus of proving negative on the assessee. The
Tribunal held that when the AO found that the assessee is a non-resident
Indian, he was incorrect in making addition towards deposits found in foreign
bank account maintained with HSBC Bank, Geneva without establishing the fact
that the said deposit is sourced out of income derived in India, when the
assessee has filed necessary evidence to prove that he is a non-resident since
25 years and his foreign bank account and assets did not have any connection
with India and that the same have been acquired/sourced out of foreign income
which has not accrued/arisen in India.

 

The Tribunal then proceeded to examine whether the government/
legislature intended to tax foreign accounts of non-residents.  Having noted the clarifications of Minister
of State for Finance on the floor of the Loksabha and also the provisions of
the Black Money Act and the FAQs issued to the Black Money Act it held that the
AO, without understanding these facts and also without answering the
jurisdictional issue of whether the non-resident assessee was liable to tax in
India in respect of deposits in his foreign bank account, when he had proved
that the source of deposit was not from India, went on to make addition on
wrong footing only on the basis of information in the form of base note which
is unverified and unauthenticated.  It
held that no material was brought on record to show that the funds were
diverted by the assessee from India to source the deposits found in foreign
bank account.  The suspicion, however
strong, cannot take place of proof and no addition could be made on presumption
and assumption.  The Tribunal held that
the AO had not proved that impugned addition could be made within the ambit of
section 5(2) r.w.s. 68/69 of the Act.



The
Tribunal also noted that the co-ordinate Bench of ITAT has in the case of Dy.
CIT vs. Dipendu Bapalal Shah [(2018) 171 ITD 602 (Mum.-Trib.)] decided an
identical issue in respect of foreign bank accounts and held that when the AO
failed to prove the nexus between deposits found in foreign bank accounts and
source of income derived from India, erred in making addition towards deposit
u/s. 68/69 of the Act. 

 

As
regards reliance of the revenue on the decision of the Mumbai Bench of ITAT in
the case of Rahul Rajnikant Parikh [IT Appeal No. 5889 (Mum) 2016] the
Tribunal held that the said case has no application to the facts of the case as
in the said case, the Tribunal has not laid down any ratio.  The matter was set aside to the file of the
AO.  It is settled law that a
judgment/order delivered by consent has no precedential value. 

 

The
Tribunal held that the AO erred in making addition towards deposit found in
HSBC Bank Account, Geneva u/s. 69 of the Act. 
It held that the CIT(A) has rightly deleted the addition made by the AO.
The appeal filed by the revenue was dismissed.

 

Section 153A: Assessment – Search- Approval to the assessment order granted by the Addl. CIT in a casual and mechanical manner and without application of mind renders the assessment order void. [Section 153D].

11.  Pr CIT
vs. Smt. Shreelekha Damani [ ITA no 668 of 2016 Dated: 27th November, 2018 (Bombay High
Court)]. 

 

[Shreelekha
Damani vs. DCIT(OSD-1)CR-7; dated 19/08/2015; ITA. No 4061/Mum/2012, AY:
2007-08 Bench: F Mum. ITAT ]

 

Section
153A: Assessment – Search- Approval to the assessment order granted by the
Addl. CIT in a casual and mechanical manner and without application of mind
renders the assessment order void. [Section 153D].

 

A search and seizure action u/s. 132 of the Act was carried out on
16.10.2008 on Simplex Group of Companies and its Associates. The
Office/residential premises of the company and its Directors/connected persons
were also covered. Simplex Group is engaged in the business of Reality, paper,
Textile and Finance. On the basis of the incriminating documents/books of
account found during the course of search and seizure operation, assessment was
made u/s. 143(3) of the Act r.w.s 153A and as per the endorsement on page-11 of
the assessment order this order is passed with the prior approval of the ACIT,
Central Range-7, Mumbai.

 

The assessee before the Tribunal raised a additional ground against
the assessment order that the A.O has not complied with the provisions of
section 153D and hence the assessment made u/s. 153A of the Act is bad in law.

 

The Revenue furnished the copy of the approval given by Addl. CIT,
Central Range-7, Mumbai which is also filed by the assessee in the paper book .
The assessee vehemently submitted that the so called approval brought on record
cannot be considered as an approval within the frame work of the provisions of
Sec. 153D of the Act. The approval granted by the Addl CIT is devoid of
application of mind and by any stretch of imagination the order made u/s.
143(3) r.w.s 153A of the Act cannot be said to be made after receiving the
approval as per the provisions of section 153D of the Act.

 

The Tribunal held that the contents of this approval are “res
ipsa Loquiter” in as much as the language is speaking for itself. The Addl
CIT says that the draft order was placed before him on 31.12.2010. He further
says that there was no much time left to analyse the issue of draft order on
merit, therefore, the said order is approved as it is.

 

The legislature wanted the assessments/reassessments of search and
seizure cases should be made with the prior approval of superior authorities
which also means that the superior authorities should apply their minds on the
materials on the basis of which the officer is making the assessment and after
due application of mind and on the basis of seized materials, the superior
authorities have to approve the assessment order.

 

The approval granted by the Addl. Commissioner is devoid of any
application of mind, is mechanical and without considering the materials on
record. In our considered opinion, the power vested in the Joint
Commissioner/Addl Commissioner to grant or not to grant approval is coupled
with a duty. The Addl Commissioner/Joint Commissioner is required to apply his
mind to the proposals put up to him for approval in the light of the material
relied upon by the AO. The said power cannot be exercised casually and in a
routine manner. The Tribunal observed that in the present case, there has been
no application of mind by the Addl. Commissioner before granting the approval.
Therefore, the assessment order made u/s. 143(3) of the Act r.w.s. 153A of the
Act is bad in law and deserves to be annulled.

 

Being aggrieved with the order of the ITAT, the Revenue filed the
Appeal before High Court. The Court observed 
that in plain terms, the Additional CIT recorded that the draft order
for approval u/s. 153D of the Act was submitted only on 31st
December, 2010. Hence, there was not enough time left to analyse the issues of
draft order on merit. Therefore, the order was approved as it was submitted.
Clearly, therefore, the Additional CIT for want of time could not examine the
issues arising out of the draft order. His action of granting the approval was
thus, a mere mechanical exercise accepting the draft order as it is without any
independent application of mind on his part. The Tribunal is, therefore,
perfectly justified in coming to the conclusion that the approval was invalid
in eye of law. We are conscious that the statute does not provide for any
format in which the approval must be granted or the approval granted must be
recorded. Nevertheless, when the Additional CIT while granting the approval
recorded that he did not have enough time to analyse the issues arising out of
the draft order, clearly this was a case in which the higher Authority had
granted the approval without consideration of relevant issues. Question of
validity of the approval goes to the root of the matter and could have been
raised at any time. In the result, no question of law arises. Accordingly, the
Reveune Appeal was dismissed.

Sale Vis-À-Vis Service Qua Treatment In Hospital

Introduction

In pre GST era, whether a particular
transaction is sale or service has always remained debatable issue. There are a
number of judgements involving the above controversy. Recently, in Maharashtra,
there arose a controversy about nature of transaction in treatment of in-house
patients in a hospital. In hospital, when the patient is admitted, he is given
medical treatment. The treatment includes services of doctors as well as giving
medicines as may be required. In this transparent era, normally, hospitals show
charges towards medicines separately and other charges like bed charges, room
charges etc., separately. Although, this entire in-house treatment is
generally considered as single transaction of service, thus not liable for VAT.
But, in case of Saifee Hospital, while deciding first appeal, the
first appellate authority took a view that the receipts toward medicines are
liable to tax under MVAT Act. Similarly, estimations were made towards food
supply out of composite charges for room. There were also receipts towards
special beds and mattresses. These charges were also held to be liable to VAT
under ‘Transfer of right to use goods’.

 

Against the above first appeal order, second
appeal was filed before Hon. M.S.T. Tribunal. Hon. Tribunal has recently delivered
judgment in case of Saifee Hospital (Second Appeal No.190 of 2016 dated
8.12.2017).

 

Issues raised by
first appeal order

 The
Hon. Tribunal has noted that the following issues are raised by the first
appellate authority and after giving hearing, the first appellate authority
held them as liable to tax under MVAT Act.

 

“According to the first appellate authority,
the following transactions were liable to tax,

 

1) The supply of drugs and
medicines and other surgical goods effected by pharmacy/drugstore to indoor
admitted patients, is a sale liable to VAT.

2)  Provision of food in hospital to admitted patients received in
the composite charges received from patients for the bed charges is a sale of
food and liable to VAT.

3) Supply of dental materials/implants
by dental Department is a sale liable to VAT.      

4)  Hire charges for mattresses
are liable to VAT.

5)  Provisions of goods like
special beds and equipments where hire charges have been received from patients
is deemed sale in the nature of transfer of right to use any goods.”

 

Arguments on
behalf of the appellant

The Hon. Tribunal has noted the submissions
made by the appellant in detail. The indicative grounds of appeal are as under:

 

1. On introduction of VAT,
specific query was made with the Commissioner of Sales Tax about liability of
tax on medicines administered to in-patients for treatment.

     The Commissioner of Sales
Tax, vide letter dated 26.12.2007, has clearly stated that the dominant
intention in administering medicines to in-patients is treatment of diseases
and not supply/sale of medicines consumables or implants.

2.  The department has further
issued circular no.7A of 2008 dated 13.3.2008, wherein also, following BSNL,
same position is reiterated.

3.  Even if pharmacy from where
medicines are supplied is owned by hospital, so far as supply of medicines for
treatment to in-patients is concerned it is not sale. So far as sale by
pharmacy over counter to outpatients or general public is concerned, it is
considered as sale under MVAT Act and due VAT has been discharged.        

4.  Various judgements on very
same issue were cited like:

(a) Dr. Hemendra Surana (90 STC
251) wherein it is held that taking x-ray and giving report is not a works
contract activity. 

(b) Bharat Sanchar Nigam Ltd. (145 STC 91)(SC), where it is observed
that medicines provided by doctor/hospital is not sale.

(c) International Hospital Pvt.
Ltd. (Writ Tax No. 68 of 2014 decided on 6.2.2014) in which use of stents for
treatment of patient is held as not amounting to sale.

(d) Tata Main Hospital (2208
NTN Vol-36 149) and Fortis Healthcare (CWP 1922 to 1924 of 2012 dated
23.1.2015).

 

In the above judgements, the respective High
Courts have held that treatment of in-house patients is not amounting to
sale.  

 

5.  Even the extended meaning
of ‘sale’ under Article 366 (29A) does not cover such services. Various
judgements were cited in support of the same.

 

6.  In relation to charging the
medicines at MRP used for in-patient, it was contended that there is no tax
collection. Reliance was placed on the judgement of Hon. Supreme Court in case
of Hindustan Lever Ltd. (93 VST 452).

 

Arguments on
behalf of Department

Supporting the order of the first appellate
authority, the department made elaborative arguments. Indicative arguments are
noted as under:

 

(1) In pharmacy, there is common stock and there is no difference
between supplying medicines over the counter and supplied for treatment of
in-patient.

 

(2) To show sales of goods,
Department also cited instances that the patients take away unused medicines
with them while taking discharge.

 

(3) Judgements cited, including
BSNL were tried to be distinguished on ground that they relate to composite
transaction sand not the one where sale is discernible.

 

(4) The judgments relating to
medicine services were also tried to be distinguished on ground that the facts
were different, mainly that there was no sale from pharmacy owned by very same
hospital.

 

(5) Judgements of Kerala High
Court in case of Malankara Orthodox Syrian Church (135 STC 224)(Ker) and
PRS Hospital vs. State of Kerala, 2003 (11) KTR 176 were relied
upon. In those judgements, based on facts and legal position under respective
Act, the activity of Hospital was held as covered by Sales Tax Acts.

 

(6) The arguments were also
made to treat these transactions as deemed sales by Works Contract or transaction
of hotel service on ground there is transfer of medicines/food for human
consumption.

 

(7) The provisions of MRP/Drug
Price Control Order relied upon to suggest that the prices are inclusive of
tax. It was contended that tax is collected which cannot be allowed to be
retained by hospital.     

 

The Hon. Tribunal has analysed arguments
from both sides in elaborate manner.

 

The Hon. Tribunal held that the basic nature
of transaction is of rendition of services. The intention of parties is not to
sell/purchase medicines, but to be administered by doctors in course of
treatment.

 

The Hon. Tribunal examined position whether
there is discernible sale or not, in following words.

     

“44. The next question is whether the supply
of medicine in the course of treatment are discernible sale so as to attract
the main definition of sale i.e. sale as per the Sales of Goods Act. The
Appellant Officer in para 116 of his order remarks that intention of private
hospital is to sell the medicine and earn profit. This may be so, but whether
the patient intends to purchase medicine when admitted to hospital? Even in a
composite contract, for a sale to be discernible, it must satisfy all the
criteria for sale as per sale of goods Act. In Gannon Dunkerley (8 STC) the concept
of sale has been discussed.

 

In para 16 the Court has said :

 

“.. In order to constitute a sale, it is
necessary that there should be an agreement between the parties for the purpose
of transferring goods which of course presupposes capacity to contract, that it
must be supported by money consideration and that as a result of the
transaction property must actually pass in goods. Unless all these elements are
present, there can be no sale.”

 

“We are accordingly of the opinion that on
true interpretation of expression ‘sale of goods’ there must be an agreement
between the parties for the sale of very goods in which property eventually
passes.”

 

45.Thus, when a patient is admitted to
hospital, his intention is not to buy medicines, nor the medicines identified
or agreed to be delivered to patient before administering the same during
course of the treatment. It is not correct to say that as soon as bills are
prepared by pharmacy, the goods are ascertained and delivered to the patients.
These bills to inpatient according to appellate authority himself, are as per
requirement of DCPO and for the purpose of books to be maintained according to
DCPO. In large organisations, which to an outsider is single entity, there may
be internal divisions incorporating the concept of profit centre for each
division. Such divisions do not make them a separate entity from the single
whole for transaction with outside person. Internal dynamism may allow pharmacy
to operate as a profit Centre, treating everything issued from it same as any
other sale, but that does not make it a sale same as over the counter sale to
customer. The fact that billing from over the counter and to a patient in same
and same price is charged also does not make it different. In a restaurant,
there may be sale from counter as well as service. The billing may be same and
even  price may be same for the both
types of sales, yet first is sale simplicitor and second is a deemed sale.”

The Tribunal refuted each and every argument
of department by giving elaborate explanation.

 

The argument that it can be deemed sale
under clauses 366(29A) is also rejected.

 

It is held that the circular issued by
Commissioner of Sales Tax is binding. It is also held that though charges for
medicines are at MRP, there is no collection of tax but it is price.

 

The Hon. Tribunal thus concurred with
appellant hospital and set aside the order of first appellate authority.

 

In respect of argument about charges for
special bed etc. also the Tribunal held that there is no lease
transaction. The patient cannot take such goods outside. Therefore, there is no
lease sale in respect of such goods also.

 

Similarly, there cannot be tax on food
included in room rent as it is not separable nor provided for in Rules. Rule 59
of MVAT Rules is meant for hotels and not for hospitals. Tribunal deleted such
levy also.

 

Finally, the Hon. Tribunal allowed appeal in
favour of appellant in all respects.      

 

Conclusion     

The judgement will definitely give respite
to worried hospitals. The Hon. Tribunal has set guidelines for levying tax
under MVAT Act. This judgement will be useful in various other situations. _

 

13 Section 12A(2) – First proviso to section 12A(2) inserted by the Finance Act, 2014, with effect from 1.10.2014, being a beneficial provision intended to mitigate hardships in case of genuine charitable institutions, has to be applied retrospectively.

[2017] 87
taxmann.com 113 (Amritsar – Tribunal.)

Punjab
Educational Society vs. ITO

ITA No. :
459/Asr/2016

A.Y. : 2011-12                                                                    
Date of Order:  20th  November, 2017


FACTS 

The assessee, an educational institution,
filed its return of income for AY 2011-12 on 29.09.2011, declaring total income
at Rs. Nil. During the course of assessment proceedings the Assessing Officer
(AO) observed that the assessee society during the year under consideration had
shown excess of income over expenditure of Rs. 34,31,521 which was transferred
to its Reserves and Surplus account. Since the gross receipts of the assessee
society, which was neither registered u/s. 12A nor approved u/s. 10(23C)(vi) of
the Act had during the previous year relevant to assessment year 2011-12
exceeded Rs. One crore, the AO called upon the assessee to explain why the same
may not be brought to tax in his hands. 

 

The assessee submitted that it was
registered u/s. 12AA(1)(b)(i) of the Act with the competent authority with
effect from AY 2012-13, therefore, it being a charitable society which was
running an educational institution, could not be denied exemption for the
reason that its gross receipts had exceeded Rs. One crore. It also submitted
that it had applied its income purely for accomplishment of its objects as per
section 11(5), therefore, its income could not be subjected to tax.

 

The AO taxed the sum of Rs. 34,31,521 as the
assessee society had not applied for the grant of registration u/s. 12AA with
the prescribed authority nor was approved u/s. 10(23C)(vi) or (via) for AY
2011-12.

 

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

 

HELD

The Tribunal observed that the issue
involved in the present appeal lies in a narrow compass viz. as to whether the
CIT(A) was right in concluding that the first proviso of section 12A(2) would
be applicable to the facts of the present assessee or not. It noted that the
first proviso of section 12A(2) had been made available on the statute vide
the Finance (No. 2) Act, 2014, with effect from 01.10.2014. It also observed
that a perusal of the Explanatory notes of the Memorandum to Finance (No. 2)
bill, 2014 explaining the objects and reasons for making available the first
proviso to section 12A(2) on the statute reveals that it was in order to
mitigate the hardships caused to charitable institutions, which despite having
satisfied the substantive conditions rendering them eligible for claim of
exemption, however, for technical reasons were saddled with tax liability in
the prior years, due to absence of registration u/s. 12AA.

 

It noted that the issue as to whether the
beneficial provisions made available on the statute by the legislature in all
its wisdom, vide the Finance (No. 2) ‘Act’, 2014 with effect from
01.10.2014 were to be given a retrospective effect, or not, had already
deliberated upon and adjudicated by this Tribunal in bunch matters of St.
Judes Convent School vs. Asstt. CIT [2017] 164 ITD 594/77 taxmann.com 173
(Asr.).

 

The Tribunal, having given a thoughtful
consideration to the aforesaid observations of the Tribunal, found itself to be
in agreement with the view taken therein. The Tribunal held that the first
proviso of section 12A(2) as had been made available on the statute vide
the Finance (No. 2) ‘Act’. 2014, with effect from 01.10.2014, being a
beneficial provision intended to mitigate the hardships in case of genuine
charitable institutions, would be applicable to the case of the present
assessee. It set aside the order of the CIT(A) and consequently deleted the
addition of Rs.34,31,521/- sustained by her.

 

The appeal filed by the assessee was
allowed.

12 Sections 115JAA, 234B – For the purposes of calculating the levy of interest u/s. 234B of the Act, amount of “assessed tax” is to be determined after reducing the entire MAT credit (including surcharge and cess) u/s. 115JAA.

2017] 88 taxmann.com 28 (Kolkata – Trib.)

Bhagwati Oxygen Ltd. vs. ACIT

ITA No. : 240(Kol) of 2016

A.Y.: 2011-12     
Date of Order:  15th November,
2017


FACTS

The assessee, a private limited company,
electronically filed its return of income for the assessment year 2011-12
disclosing total income of Rs. 1,41,26,460/. The assessee computed the tax
liability at Rs. 46,92,789/- including surcharge and cess under the normal
provisions of the Act.  The assessee
computed the book profit u/s. 115JB of the Act at Rs. 92,42,889/- and
determined the tax payable thereon at Rs. 17,13,632/- including surcharge and
cess. The assessee computed the MAT credit u/s. 115JAA of the Act to be
adjusted in future years at Rs. 29,79,157/- ( 46,92,789 – 17,13,632).

 

This return was processed u/s. 143(1) by
Centralized Processing Centre, Bangalore (in short “CPC”) wherein the
total income under normal provisions of the Act was determined at Rs.
1,41,27,460/- and tax @ 30% thereon was determined at Rs. 42,38,238/-. In the
said intimation u/s. 143(1) the book profit u/s. 115JB of the Act was
determined at Rs. 92,42,889/- and tax @ 18% was determined at Rs. 16,63,720/-.
Accordingly, the CPC in the intimation u/s. 143(1) of the Act determined the
MAT credit u/s. 115JAA of the Act at Rs. 25,74,518/- (4238238 – 1663720). While
determining the MAT credit u/s. 115JAA CPC completely ignored the surcharge
portion and cess portion computed by the assessee, both under normal provisions
of the Act as well as under computing the tax liability u/s. 115JB of the Act.
In view of this, the assessee was fastened with a demand payable.

 

Aggrieved, the assessee preferred an appeal
to CIT(A). In the course of appellate proceedings the assessee placing reliance
on the decision of the Hon’ble Supreme Court in the case of CIT vs. K.
Srinivasan [1972] 83 ITR 346, among other decisions, pleaded that surcharge
and cess are nothing but a component of tax. The CIT (A) however, was not
convinced with the argument of the assessee and upheld the demand raised by the
CPC in the intimation u/s. 143(1).

 

Aggrieved, the assessee preferred an appeal
to the Tribunal.

 

HELD 

The Tribunal observed that –

 

(i)   the issue under dispute
has been addressed against the assessee by the decision of Delhi Tribunal in
the case of Richa Global Exports (P.) Ltd. vs. Asstt. CIT [2012] 25
taxmann.com 1/54 SOT 185;

(ii)  the issue under dispute
is covered in favour of the assessee by the Co-ordinate Bench of Hyderabad
Tribunal in the case of Virtusa (India) (P.) Ltd. vs. Dy. CIT [2016] 67
taxmann.com 65/157 ITD 1160;  

(iii)  the Hyderabad Tribunal
after considering the decision of Delhi Tribunal (supra) and after
considering the decision of the Apex Court in the case of K. Srinivasan
(supra) had held that tax includes surcharge and cess and accordingly the
entire component of taxes including surcharge and cess shall have to be
reckoned for calculating the MAT credit u/s. 115JAA of the Act;  

(iv) the Hon’ble Apex Court had
in the case referred to supra, had held that meaning of word ‘surcharge’
is nothing but an ‘additional tax’.

 

It held that this understanding of surcharge
and cess being included as part of the tax gets further sanctified by the
amendment which has been brought in section 234B of the Act in Explanation 1
Clause 5, while defining the expression ‘assessed tax’. Having considered the
language of Explanation 1 to section 234B of the Act it observed that from the
said provisions it could be inferred that the legislature wanted to treat the
payment of entire taxes (including surcharge and cess) eligible for MAT credit
u/s. 115JAA while calculating the interest on ‘assessed tax’ u/s. 234B of the
Act, meaning thereby, the assessed tax shall be determined after reducing the
entire MAT credit u/s. 115JAA of the Act for the purpose of calculating
interest u/s. 234B of the Act. It observed that this is clinching evidence of
the intention of the legislature not to deprive any credit of any payment of
surcharge and cess made by the assessee either in the MAT or under the normal
provisions of the Act. It noted that it is not in dispute that the surcharge
and cess portion was not paid by the assessee along with the tax portion. The
bifurcation of the total payment of taxes by way of tax, surcharge and cess is
only for the administrative convenience of the Union of India in order to know
the purpose for which the said portion of amounts are to be utilised for their
intended purposes. Hence, the bifurcation is only for utilisation aspect and
does not change the character of payment in the form of taxes from the angle of
the assessee. As far as assessee is concerned, it had simply discharged the
statutory dues comprising of tax, surcharge and cess to the Union of India and
hence if paid in excess, would be eligible for either refund or adjustment as
contemplated u/s. 115JAA of the Act. It observed that if the version of the
CIT(A) is to be accepted, then it would result in an situation wherein if the
assessee is entitled for refund, he would not be entitled for refund on the
surcharge and cess portion. This cannot be the intention of the legislature and
it is already well settled that the tax is to be collected only to the extent
as authorised by law in terms of Article 265 of the Constitution and the
department cannot be unjustly enriched with the surcharge and cess portion of
the amounts actually paid by the assessee. It held that the reliance placed on
behalf of the assessee on the decision of Hyderabad Tribunal is well founded
and squarely applies to resolve the dispute in the present case.

 

The Tribunal allowed this ground of appeal
filed by the assessee.

11 Section 201(1A) – Interest u/s. 201(1A), on delay in deposit of TDS, is to be calculated for the period from the date on which tax was deducted till the date on which the tax was deposited.

[2017] 88 taxmann.com 103 (Ahmedabad)

Bank of Baroda vs. DCIT

ITA No. : 1503/Ahd./2015

A.Y.: 2014-15                     
Date of Order:  30th November,
2017


FACTS 

The assessee, a branch of a nationalised
bank, deposited tax deducted at source, u/s. 194A of the Act, for the month of
September 2014 on 8th October, 2014. While processing the TDS return
u/s. 200A, a sum of Rs. 2,78,607 was charged as interest for delay in
depositing the tax at source, for a period of two months, i.e. September and
October 2014. This interest amount of Rs.2,78,607/- was sought to be recovered
by the Assessing Officer.

 

Aggrieved, by the action of levying interest
for a period of two months, assessee carried the matter in appeal before the
CIT(A) who observed that the issue in dispute is whether the day on which tax
was deducted is to be excluded or not. Relying on the decision of the Hon’ble
Apex Court in Criminal Appeal No.1079 of 2006 in case of Econ Antri Ltd. vs.
Ron Industries Ltd. & Anr, in order dated 26-03-2013 he held that for
the purpose of calculating period of one month, the period has to be reckoned
by excluding the date on which the cause of action arose. He held that the
assessee was liable to pay interest for a period of one month.

 

Aggrieved, the assessee preferred an appeal
to the Tribunal.

 

HELD  

The Tribunal observed that the time limit
for depositing the tax deducted at source u/s. 194A, as set out in rule
30(2)(b) – which applies in the present context, is “on or before seven
days from the end of the month in which the deduction is made”. It noted
that since the TDS was deposited on 8th of October 2014, admittedly
there was clearly a delay in depositing tax at source. It noted that the
contention on behalf of the assessee is that the levy of interest should be
reduced to actual period of delay in depositing the tax at source, i.e. from
the date on which tax was deducted and till the date on which tax was
deposited. It is only if such a period exceeds one month, then the question of
levy of interest will arise. It observed that what has been done in the present
case is that the interest has been charged for two calendar months, i.e.
September and October. It held that the question of levy of interest for the
second month can arise only if the period of time between the date on which tax
was deducted and the date on which tax was paid to the Government exceeds one
month. The Tribunal directed the Assessing Officer to re-compute the levy of
interest u/s. 201(1A) accordingly.

 

10 Section 201(1)/201(1A) r.w.s 191- Before treating the payer as an assessee in default u/s. 201(1), since the ITO(TDS) did not requisition information from the recipients of income to ascertain whether or not taxes have been paid by them, there is violation of mandate of explanation to section 191 and thus invocation of jurisdiction u/s. 201(1)/(1A) is void.

Aligarh Muslim University vs. ITO

(2017) 158 DTR (Agra) (Trib) 19

ITA No: 191/Agra/2016

A.Y.:2015-16
Date of Order: 15th May, 2017

FACTS

The assessee/deductor university paid salary
to its employees after deducting tax u/s. 192. The ITO (TDS) noticed that the
assessee was allowing exemption u/s. 10(10AA)(i) on the payment of leave salary
at the time of retirement/superannuation to its employees, considering them as
employees of Central Government. The Assessing Officer treated the assessee as
an assessee in default u/s. 201/201(1A) for short deduction of tax due to
allowing the exemption u/s. 10(10AA)(i) beyond the maximum limit of Rs. 3 lakh.

 

On appeal to the CIT(A), the CIT(A) directed
the ITO(TDS) to allow the assessee to adduce evidence that the deductees had
themselves paid due tax on their leave salary and then, to recompute the
amounts in respect of which the assessee would be an assessee in default u/s. 201(1).

 

The assessee preferred an appeal to the
Tribunal and argued that in order to declare the assessee as assessee in default,
the condition precedent is that the payee had failed to pay tax directly and it
is only after the finding that the payee had failed to pay tax directly, that
the assessee could be deemed to be an assessee in default in respect of such
tax.

 

HELD

A bare perusal of the Explanation to section
191 itself makes it clear that it is only when the employer fails to deduct the
tax and the employee has also failed to pay tax directly, that the employer can
be deemed to be an assessee in default. In other words, in order to treat the
employer as an assessee in default, it is a pre-requisite that it be
ascertained that employee has also not paid the tax due.

 

The CIT (A) has stated that before him, no
evidence was produced to show as to which of the employees of the University
had paid due taxes in respect of leave salary income on which TDS was not made
properly and that it was therefore, that he was unable to quantify the relief
that can be allowed in respect of such employees.

 

The Tribunal held that it was not within the
purview of the CIT(A) to fill in the lacuna of the ITO (TDS). In fact,
it was for the ITO (TDS) to ascertain the position, as prescribed by the
Explanation to section 191, that is, as to whether the deductee had failed to
pay the due tax directly, and only thereafter to initiate proceedings to deem
the assessee as an assessee in default u/s. 201(1) of the Act. As observed by
the Allahabad High Court in the case of Jagran Prakashan Ltd vs. DCIT
reported in 345 ITR 288, this is a foundational and jurisdictional matter
and therefore, the Appellate Authorities cannot place themselves in the
position of the ITO (TDS) to ratify a jurisdiction wrongly assumed.

 

The only prerequisite was that the details
of the persons to whom payments were made, should be available on record. And
once that is so, i.e., the assessee has submitted the requisite details to the
ITO (TDS), it is for the ITO (TDS), to ascertain, prior to invoking section
201(1) of the Act, as to whether or not the due taxes have been paid by the
recipient of the income.

 

The show cause notice issued to the
University contains the names of 237 persons with full details of payments made
to them by the University. Therefore, it is amply clear that at the time of
issuance of notice dated 02.03.2015, u/s. 201/201(1A) to the University, the
ITO (TDS) was in possession of the requisite details of the recipients of the
income. As such, the legislative mandate of the Explanation to section 191 of
the Act was violated by the ITO (TDS), by not requisitioning, before issuing
the show cause notice to the University, information from the recipients of the
income, as to whether or not the taxes had been paid by them, nor seeking such
information from the concerned Income-tax Authorities.

 

As observed, this is a foundational
jurisdictional defect going to the root of the matter. Violation of the mandate
of the Explanation to section 191 is prejudicial to the invocation of the
jurisdiction of the ITO (TDS) under sections 201/201(1A). In absence of such
compliance, the invocation of the jurisdiction is null and void ab initio.

 

As a consequence, the order under appeal no
longer survives and it is cancelled.

 

8. Depreciation – trial production – even if final production is not started – as the expenses incurred thereafter will have to be treated as incurred in the course of business and on the same basis the depreciation is admissible.: Section 32

The Pr.CIT-4
vs. Larsen and Toubro Ltd. [Income tax Appeal no 421 of 2015 dt : 06/11/2017
(Bombay High Court)].

[Larsen and
Toubro Ltd. vs. The Pr.CIT-4. [ITA No. 4771 & 4459/Mum/2005; Bench : J ;
dated 27/08/2014 ; AY 1997-98 Mum. ITAT ]

 

The assessee
had claimed depreciation in respect of the machineries which were stated to
have been installed and put to use in the production of clinker which is
intermediates stage for production of cement. The AO observed that even if the
assessee had produced 100 MT of clinker it was only a trial run for one day and
this quantity was minuscule compared to the intended production capacity and
that the assessee was not able to prove that after the trial run, commercial
production of clinker was initiated within reasonable time. The AO pointed out
that the trial runs continued till October 1997 before the reasonable quantity
of clinker was produced. The AO held that use of machinery for trial production
cannot be deemed to be user for the purpose of business and therefore
depreciation on plant and machinery used in production of clinker cannot be
allowed. The AO disallowed the claim of depreciation of Rs. 34,79,40,576/-.

 

The CIT(A) confirmed the disallowance by
observing that as per section 32 the depreciation can be allowed, only if the
assets have been used for the purpose of business carried on during the year.
The expression ‘used for the purpose of business or profession means that the
assets were capable of being put to use and were used for the purpose of
enabling the owner to carry on the business or profession. The user of assets
during the year should be actual, effective and real user in the commercial
sense. In the case of the appellant as has been pointed out by the AO, even if
it is accepted that plant and machinery used for production of intermediate
stages are eligible for depreciation, is accepted, the trial production took
place only for one day. It appears that some technical snag developed in the
plant and, therefore, immediately the trial run was stopped. The AO has stated
that the trial run continued at least till October, 1997.

 

The appellant has not produced any evidence
to show as to when exactly the commercial production started. In the present
case, the trial production by the assessee cannot be considered as the date of
user by the assessee. One cannot ignore the facts that there was substantial
gap between the first trial run and subsequent trial runs and commercial
production. From the long gap between the first trial run and subsequent trial
runs it can be said that the installation of plant and machinery even for
production of clinkers was not satisfactorily completed and was still in installation
stage. The CIT(A) confirmed the action of the AO.

 

The assessee
filed appeal before ITAT. The Tribunal observed that there is no merit in the
action of the lower authorities for denial of claim of depreciation in respect
of plant and machinery which has been put to use even for trial production,
which is also for the purpose of assessee’s business of manufacture of clinker.
The Hon’ble Gujarat High Court in the case of ACIT vs. Ashima Syntex, 251
ITR 133 (Guj) held that even trial production of a machinery would fall
within the ambit of “used for the purpose of business” .Further, it
was held that as the statute does not prescribe a minimum time limit for
“use” of the machinery, the assessee cannot be denied the benefit of
depreciation on the ground that the machinery was used for a very short
duration for trial run. Furthermore, the Hon’ble Bombay High Court in the case
of CIT vs. Industrial Solvents & Chemicals Pvt. Ltd., (Mumbai) (119
ITR 615) held that once the plant commences operation and reasonable
quantity of product is produced, the business is set up. This is so even if the
product is sub-standard and not marketable.

 

Industrial
Solvents & Chemicals Pvt. Ltd. was entirely a new company. The Court held
that once the business is set up, the expenses incurred thereafter will have to
be treated as incurred in the course of business and on the same basis, the
depreciation and development rebate admissible to the assessee company would
have to be determined. Even use of machine for one day will entitled the
assessee for claim of depreciation. Since it is not clear from the record as to
the period for which machinery was actually used by assessee, we direct the AO
to verify the period of used and restrict the claim of depreciation to 50%, if
he finds that machinery was used for less than 180 days during the year under
consideration.

 

The Revenue filed appeal before High Court. The Court observed that the issue is no longer res integra in view of the decision of Industrial Solvents & Chemicals (P) Ltd. (supra). The court observed that the Order of the Tribunal cannot be faulted inasmuch as the jurisdictional High Court has already held that once plant commences operation and even if product is substantial and not marketable, the business can said to have been set up. Mere breakdown of machinery or technical snags that may have developed after the trial run which had interrupted the continuation of further production for a period of time cannot be held ground to deprive the assessee of the benefit of depreciation claimed. In the above view, the appeal was dismissed. _

7. Revision – Difference of view – it is not open to CIT to revise it – Further CIT has considered wrong facts – revision not permissible : Section 263

Commissioner
of Income Tax-III, Pune vs. V. Raj Enterprises. [Income tax Appeal no 1335 of
2014 dt : 31/01/2017 (Bombay High Court)].

 

[V. Raj
Enterprises vs. Commissioner of Income Tax, [dated 30/09/2013 ; A Y: 2007-08
.Pune   ITAT ]

 

The Assessee is
engaged in the business of arbitrage and jobbing through various share broking
firms. For the subject AY in its ROI, assessee returned an income of Rs.2.10
crore. The AO by an order dated 30/11/2009 u/s. 143(3) of the Act, determined
the income at Rs.2.11 crore.

 

Thereafter, the
CIT in exercise of its powers u/s. 263 of the Act, by order dated 30/3/2012
revised the assessment order. The CIT held that the Assessee was not entitled
to rebate u/s. 88E of the Act in respect of STT (Security Transaction Tax) paid
as it was a share broker. Moreover, it helds that this aspect was not examined
by the AO while passing the Assessment Order.

 

Being aggrieved,
the Assessee carried the issue in appeal to the Tribunal. The Tribunal held
that the AO while passing the Assessment Order u/s. 143(3) of the Act had
verified and examined the Contract Notes, Bills of respective brokers etc.,
before granting the rebate of STT paid u/s. 88E of the Act as claimed by the
Assessee. Further, on same set of facts, the Assessee’s claim for rebate u/s.
88E of the Act had been allowed by the Revenue in the earlier Assessment Years.
Further, the order also notes that the CIT while revising the order of
Assessment proceeded on an incorrect assumption of fact that the Assessee is a
share broker. This is contrary to the facts on record as the Assessee was doing
the work of jobbing through different share brokerage firm. Thus, for the above
reasons, the Tribunal allowed the appeal and set aside the CIT order dated
30/3/2012 , passed in exercise his powers u/s. 263 of the Act. 

 

The grievance
of the Revenue in appeal before High Court was that the Assessee is not
entitled to the benefit of rebate of STT u/s. 88E of the Act. The High Court
noted that the issue arising in the appeal was a jurisdictional issue of the
powers of the CIT to exercise his powers of Revision u/s. 263 of the Act in the
present facts. The grievance of Revenue on merits of the dispute would merit
examination only if the exercise of jurisdiction u/s. 263 of the Act, is
proper. As noted by the Tribunal, the entire basis of exercising jurisdiction
u/s. 263 of the Act is on the basis of assumption of incorrect fact that the
Assessee is a share broker. This, in fact, is not so. Where the basic facts
have been misunderstood by the CIT, the exercise of powers of Revision is not
sustainable.

 

Moreover, the
same issue also arose for the earlier AYs i.e. 2005-06 and 2006-07. The Revenue
had accepted the Assessee’s claim for rebate u/s. 88E of the Act to the extent
STT is paid. Last but not the least, Revenue is not able to dispute the fact
that the AO while passing the Assessment Order dated 30th November,
2009 had granted the claim of the Petitioner for benefit u/s. 88E of the Act on
examination and verification of the Contract Notes, Bills of respective brokers
etc. Thus, on the basis of the records available and examination by the
AO, a view has been taken by the AO and it is not open to CIT to revise it
merely because his view on the same facts, is different, as held by the Apex
Court in Malbar Industrial Co. Ltd., vs. CIT 243 ITR 83 (SC).

 

In view of the
above, the revenue Appeal was dismissed.

36. Section 144C and CBDT Circulars No. 5 of 2010 dated 03/06/2010 and Circular No. 9 of 2013 dated 19/11/2013- International transactions – A. Y. 2009-10 – Transfer pricing – Arm’s length price – Assessment order – Procedure to be followed – Issuance of draft assessment orders by AO mandatory – Failure to do so – Not mere procedural error – Failure makes assessment order invalid – Circular clarifying that requirement u/s. 144C applies to all orders passed after 01/10/2009 irrespective of A. Y. – Department not entitled to rely on earlier circular saying provision applicable for A. Y. 2010-11 onwards

CIT vs. C-Sam (India) Pvt. Ltd.; 398 ITR 182 (Guj):

 

For the A. Y. 2009-10, upon a scrutiny
assessment and applying transfer pricing on account of assessee’s international
transactions with associated persons against the nil returned income, the
Assessing Officer computed the assessee’s income at Rs. 2.86 crores making
various additions and deletions according to the order of the Transfer Pricing
Officer (TPO). In appeal before the Commissioner (Appeals) the assessee
challenged the validity of the assessment order and the additions on the ground
that the procedure laid down u/s. 144C of the Income-tax Act, 1961, was not
followed by the Assessing Officer. The Commissioner (Appeal) allowed the
assessee’s claim and quashed the assessment order passed u/s. 143(3) of the Act
without complying with the requirement of section 144C(1) of the Act. The
Tribunal dismissed the Department’s appeal and confirmed the order of the
Commissioner (Appeal).

 

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

 

“i)   The
procedure laid down in section 144C of the Act, is mandatory. Before the
Assessing Officer can make variations in the returned income of an eligible
assessee, section 144C(1) lays down the procedure to be followed
notwithstanding anything to the contrary contained in the Act. This non
obstante clause thus gives an overriding effect to the procedure. When an
Assessing Officer proposes to make variations in the returned income declared
by an eligible assessee he has to first pass a draft order, provide a copy
thereof to the assessee and only thereupon the assessee could exercise his
valuable right to raise objections before the Dispute Resolution Panel (DRP) on
any of the proposed variations. In addition to giving such opportunity to an
assessee, the decision of the DRP is made binding on the Assessing Officer. It
is therefore not possible to say that such requirement is merely procedural.
The requirement is mandatory and gives substantive rights to the assessee to
object to any additions before they are made and such objections have to be
considered not by the Assessing Officer but by the DRP. The legislative desire
is to give an important opportunity to an assessee who is likely to be
subjected to upward revision of income on the basis of transfer pricing
mechanism. Such opportunity cannot be taken away by treating it purely
procedural in nature.

ii)   Circular dated June 3,
2010 was an explanatory circular issued by the Finance Ministry in which it was
provided that the amendments (which include section 144C of the Act) are made
applicable w.e.f. October 1, 2009 and will accordingly apply in relation to A.
Y. 2010-11 and subsequent years. In the clarificatory circular dated November
19, 2013, it was provided that section 144C would apply to any order which is
being passed after October 1, 2009 irrespective of the assessment year. The
latter circular clarified what all along was the correct position in law.
Section 144C(1) itself in no uncertain terms provides that the Assessing
Officer shall forward a draft order to the eligible assessee, if he proposes to
make any variation in the income or loss which is prejudicial to the interest
of the assessee on or after October 1, 2009. The statute was thus clear,
permitted no ambiguity and required a procedure to be followed in case of any
variation which the Assessing Officer proposed to make after October 1, 2009.
The earlier circular dated June 3, 2010 did not lay down the correct criteria
in this regard.

iii)   The upward revision was
made in the income of the assessee on the basis of the order of the TPO and was
done without following the mandatory procedure laid down u/s. 144C. When the
statute permitted no ambiguity and required the procedure to be followed in
case of any variation which the Assessing Officer proposed to make after
October 1, 2009 the assessee could not be made to suffer on account of any
inadvertent error which ran contrary to the statutory provisions.

iv)  No question of law arises.
Tax appeal is therefore dismissed.”

 

35. Sections 144C(1), 156 and 271(1)(c) – International transactions – A. Ys. 2007-08 and 2008-09 – Transfer pricing – Arm’s length price – Scope of section 144C(1) – Issuance of draft assessment orders by AO mandatory – Condition not fulfilled – Assessment orders, consequent demand notices and penalty proceedings invalid

Turner International India Pvt. Ltd. vs.
Dy. CIT; 398 ITR 177 (Del):

 

The assessee was a wholly owned subsidiary
of T engaged in the business of sub-distribution of distribution rights and
sale of advertisement inventory on satellite delivered channels. For A. Ys.
2007-08 and 2008-09, the Assessing Officer made a reference u/s. 92CA of the
Act, to the Transfer Pricing Officer (TPO) who passed separate orders in
respect of the distribution activity segment. On that basis, the Assessing
Officer passed orders. The Dispute Resolution Panel (DRP) concurred with the
orders of the TPO and the final orders were passed by the Assessing Officer.
The Tribunal held that neither the assessee nor the TPO had considered the
appropriate comparables and therefore, the determination of the arm’s length
price (ALP) was not justifiable. It set aside the orders of the DRP and
remanded the matter to the Assessing Officer for undertaking a transfer pricing
study afresh and accordingly make the assessments. The TPO issued fresh notices
u/s. 92CA(2) and passed separate orders proposing upward adjustments.
Subsequently, the Assessing Officer passed orders in respect of both assessment
years confirming the additions proposed by the TPO. He also issued demand
notices u/s. 156 and notices u/s. 271(1)(c) initiating penalty proceedings.

 

The assessee filed writ petitions and
challenged the assessment orders, demand notices u/s. 156 and the notices u/s.
271(1)(c). The assessee contended that there was non-compliance with the
provisions of section 144C(1) which required the Assessing Officer to first
issue draft assessment orders.

 

The Delhi High Court allowed the writ
petitions and held as under:

“i)   The legal position is
unambiguous. The failure by the Assessing Officer to adhere to the mandatory
requirement of section 144C(1) and first pass draft assessment orders would
result in invalidation of the final assessment orders and the consequent demand
notices and penalty proceedings.

ii)   The final assessment
orders dated 31/03/2015 passed by the Assessing Officer for the A. Ys. 2007-08
and 2008-09, the consequent demand notices issued by the Assessing Officer and
the initiation of penalty proceedings are hereby set aside.”

GST – Case Studies On Valuation (Part-2)

This feature of the article
contains certain case studies where the valuation principles discussed in the
first part are given a practical perspective. 

 

Case
Study 1 : Barter/ Exchange Transactions (say Redevelopment Projects)

 

In a typical redevelopment
project, the developer agrees to deliver redeveloped flats to the existing
occupants in exchange for land/development rights. A diagrammatic presentation
of the arrangement is as follows:

 


 

 

The developer provides
construction services to two categories of customers (a) existing
occupants/land owner; and (b) new occupants/customers. As regards the former,
the developer delivers newly constructed flats of similar or larger areas (S1);
provides alternative accommodation until delivery of the new flat and also
provides some monetary payment (especially where the value of the land rights
given up is substantially high in comparison to the construction cost: S3
should be understood as excess of C1 over S1 & S2). These are in exchange
for undivided rights over the land as well as entitlement for additional flat
construction over the existing superstructure for sale to new occupants. As
regards the latter, the developer constructs the new flats and allots the same
to its customers for monetary consideration (C2). For the purpose of examining
the valuation provisions, the said transactions are assumed to be taxable in
terms of section 7 r/w Schedule II of the CGST Act.

 

Developer-Land Owner Arrangement

Section 15 of the CGST Act
states that the transaction value (being the price) would be the taxable value
of this transaction. In this transaction set-up, the developer receives
development rights as the consideration for the construction services. There is
no price (money consideration) which is agreed between the developer and the
land owner and therefore, reference would have to be made to the valuation
rules as per section 15(4) of the said Act. Valuation norms under Rule 27 may
be applied as follows:

 

(a)    OMV
of such supply (identical value of S1 and S2): Under this
clause, the money value of an identical supply at the same time at which the
supply being made to land owners would have to be ascertained. The subject
matter of valuation is the supply (ie. value of developed flats (S1)
and not the non monetary consideration/development rights (C1). The
flats which are sold to external customers may not qualify as identical flats
since the valuation of those flats includes a host of other costs (such as land
value, etc.) which are not present in the value of flats delivered to
the existing occupants. Further, the risks undertaken by the external customers
are distinct from the risks taken by the existing occupants. At times, the
amenities are also different. Therefore, the OMV rule fails to provide a
reliable basis of valuation.

 

(b)    Monetary
value of non-monetary consideration (C1): Unlike its
predecessor, this clause attempts to identify the monetary value of the
consideration rather than its supply i.e. value of the development rights
should be ascertained and not the value of the developed flats. It is
practically impossible to identify the monetary value of the development rights
associated with a particularly property as there is no open market for such
rights. However, in most of the cases, the development agreements attract
payment of stamp duty and hence, there is a ready reckoner valuation of the
development rights on the basis of which the stamp duty is calculated. It can
be argued that this valuation which is endorsed by the stamp duty authorities
can be the basis for identification of the monetary value of non-monetary
consideration.

 

(c)    Value
of like kind or quality (comparable value): If the above clause fails, then
we need to proceed to this clause. This clause attempts to ascertain the value
of similar supplies i.e. value of similar flats in the same society. While the
flats can be said to be similar on parameters such as quality, materials,
reputation, etc., the value of such flats also includes the value of
land, etc. which does not form part of the bargain between the developer
and the existing occupant. The general practice of using the guideline value of
land and extracting this value does not have legal force under this rule (refer
2016 (43) S.T.R. 3 (Del.) Suresh Kumar Bansal vs. Union Of India).
Therefore, resorting to this practice at the first instance without testing
other rules may not be advisable (until Rule 31 is invoked). Hence this rule
also fails to provide a reliable basis of valuation.

 

(d)    Cost
of non-monetary component: This clause invokes Rule 30 which requires that
the cost of provision of the service with a 10% markup can be adopted as the
value of construction service. In the absence of clear costing guidelines on
‘provision of service’, principles issued by autonomous professional bodies
could be relied upon. For example, as per the revised AS7 – Construction
Contracts issued by ICAI, contract cost is defined to comprise the following:

–    Costs directly relatable to the contract;

–    Costs attributable to contract activity in
general; and

–   Such other Costs as are specifically
chargeable to the customer under the terms of the contract.

 

The developer can ascertain
the cost of construction of a project and allocate the costs to the respective
flats using the accounting/costing principles and load such value with the 10%
markup. In effect, cost of S1 and S2 would be the value of the development
rights in terms of section 15 of the GST law. S3 cannot be adopted as the cost
of the developed flats since it is a payment towards value of land/development
rights (excess of land value over construction value). Though this rule is
optional for service providers, it may be beneficial to opt for this rule in
projects (say Mumbai CBD) where land value is substantially high in comparison
to the construction costs. Moreover, with the advent of Real Estate Regulatory
Authority Act being legislated, project wise bank accounts would give
additional information to the builders to identify the cost of construction.

 

(e)    Residual
Rule: Rule 31 can be invoked only when it is established that all preceding
rules have failed to provide a value in such exchange transaction. Moreover,
the option of skipping Rule 30 vests in the hands of the tax payer and not the
Revenue. Therefore, unless the revenue authorities categorically conclude that
Rule 30 is not providing a reliable basis of valuation in such arrangements,
the residual rule cannot be invoked.

 

Comparison with Service Tax Valuation
Rules

The valuation scheme under
the Service tax regime was not as comprehensive as present in the GST Law.
Section 67 followed a pattern of first identifying the money value of the
non-monetary component (C1); else, obtaining the value of similar services (C2)
and if both these mechanisms failed, it permitted the assessee to arrive at a
value not below the cost of services.

 

However, the CBEC vide
its Circular No. 151/2/2012-S.T., dated 10-2-2012 had stated that in
such cases, value of similar flats to the new occupants (C2 excluding the land
value) would form the basis of valuation for flats delivered to the existing
occupants, in a way bypassing the statutory scheme of valuation and directly looking
for an external value. On the contrary, the CBEC education guide (which was
subsequently withdrawn by a High level Committee report dated 20-1-2016) stated
that the value of land would form the basis of valuation in such scenarios.
Under the GST law, Q17 of a FAQ issued for builders has toed the line of its
earlier CBEC circular and stated that value of similar flats should be adopted
for the purpose of valuation. The said FAQ has deviated from the structured
valuation mechanism in Rule 27 and consequently gives contradictory results. In
view of the author, either the value of development rights or the cost of
construction can be adopted as the basis of valuation for land owner’s share of
flats.

 

Case
Study 2 – Exclusion on account of Pure Agency (say CHA services/ Advertising
Agency services)

 

Rule 33 provides a specific
exclusion for recoveries towards expenditure or costs incurred by a supplier as
a pure agent of the recipient. The said rule provides multiple conditions in
order to be termed as a pure agent.

But prior to examining the
issue of exclusion from the point of pure agency, one should first examine
whether the said amount is includible in taxable value in the first place.
‘Price’ is considered narrower than the phrase ‘gross amount charged’. Price
refers to the money consideration for supply and the term ‘consideration’ has
been defined in a very concise manner to mean such payments/acts (i.e.
monetary/ non-monetary) which are in respect of or in response to
or as an inducement of the supply (refer discussion on nexus theory in
earlier article). These phrases suggest that there has to be direct nexus
between the payment and the supply for the said payment to be termed as
consideration and cannot include extraneous recoveries by the supplier. Thus,
where an expense recovery is excludible from price itself and not part of any
other inclusion under valuation, the pure agency tests have no application at
all.

 

Further, the tests of pure
agency are relatively liberal in comparison to the erstwhile service tax
regime. A comparative chart of these tests under both regimes has been
provided:

 

Service Tax Law

GST Law

Implications

Section
67 used the words “gross amount charged”

Section
15(1) uses the word “price”

The
word ‘price’ is narrower than gross amount charged

Rule
5(1) specifically included all costs incurred during the course of provision
of service

No
similar inclusion. Section 15(2)(c) is restricted to pre-supply expenses
recovered which are incidental in nature

Extraneous
expense recoveries (including post delivery expense recoveries) are
excludible from valuation

Rule
5(2) exclusion subject to 12 (8+4) conditions as under:

Rule
33 exclusion subject to 7 (3+4) conditions as under:

 

(i)
    the service provider acts as a pure
agent of the recipient of service when he makes payment to third party for
the goods or services procured;

the
supplier acts as a pure agent of the recipient of the supply, when he makes
the payment to the third party on authorisation by such recipient;

Refer
discussion on pure agent below

(ii)
   the recipient of service receives and
uses the goods or services so procured by the service provider in his
capacity as pure agent of the recipient of service;

 Deleted

Supplier
need not establish receipt and use by recipient

(iii)
   the recipient of service is liable to
make payment to the third party;

Deleted

Supplier
can claim deduction even if the invoice is not directly addressed to the
recipient

(iv)
  the recipient of service authorises
the service provider to make payment on his behalf;

 Deleted, can be inferred from clause (i)

Similar
provisions

(v)
   the recipient of service knows that
the         goods and services for which
payment has been made by the service provider shall be provided by the third
party;

Deleted,
can be inferred from clause (i)

Similar
provisions

(vi)
  the payment made by the service
provider on behalf of the recipient of service has been separately indicated
in the invoice issued by the service provider to the recipient of service;

the
payment made by the pure agent on behalf of the recipient of supply has been
separately indicated in the invoice issued by the pure agent to the recipient
of service

No
change

(vii)
  the service provider recovers from the
recipient of service only such amount as has been paid by him to the third
party; and

Deleted,
Can be inferred from Clause (d) – One can argue on difference between
incurred and paid

No
substantial change

(viii)
the goods or services procured by the
service provider from the third party as a pure agent of the recipient of
service are in addition to the services he provides on his own account.

the
supplies procured by the pure agent from the third party as a pure agent of
the recipient of supply are in addition to the services he supplies on his
own account.

No
change

Explanation 1. – For the purposes of sub-rule (2), “pure agent” means a
person who –

Explanation  – For the purposes of
this rule, “pure agent” means a person who –

 

(a)
   enters into a contractual agreement
with the recipient of service to act as his pure agent to incur expenditure
or costs in the course of providing taxable service;

enters
into a contractual agreement with the recipient of supply to act as his pure
agent to incur expenditure or costs in the course of supply of goods or
services or both;

No
change

(b)    neither intends to hold nor holds any title
to the goods or services so procured or provided as pure agent of the
recipient of service;

neither
intends to hold nor holds any title to the goods or services or both so
procured or supplied as pure agent of the recipient of supply;

No
change

(c)
   does not use such goods or services
so procured; and

does
not use for his own interest such
goods or services so procured

Permits
use of the services by the supplier though chargeable to the account of the
recipient (eg. lodging in a hotel during an audit of a client)

(d)    receives only the actual amount incurred
to procure such goods or services.

receives
only the actual amount incurred to procure such goods or services in addition
to the amount received for supply he provides on his own account.

No
change

 

As is evident from the
above table, the pure agency test has been substantially borrowed from the
service tax law. Unlike the GST law, valuation under the service tax law is
focused on the ‘Gross Amount Charged’ which is definitely wider than the term
‘price/ consideration’. This is also evident from the Explanation to section 67
which stated that all amounts payable for services provided would be includible
as ‘consideration’. Moreover, by Finance Act, 2015 the service tax law
specifically included reimbursements as part of the Gross Amount Charged.
However, the GST law is narrower to the extent it focuses on the ‘price’ agreed
between the contracting parties – the intention emerging from the contract
plays a pivotal role in drawing the line between price and other amounts
charged. Further, section 15(2)(c) only includes expenses which are incidental
to the supply and incurred prior to the delivery/ completion of the supply.
Therefore, an assessee is definitely in a better position to claim the benefit
of pure agency vis-à-vis the earlier service tax law.

 

Case Study
2A : Travel/ Lodging Costs during Audit

 

An auditor during the
course of audit incurs certain expenses which are to the account of the auditee
(such as travel/lodging costs, reprography costs, etc.) and reimbursable
to an auditor. The auditor claims these expenses are part of the Out of Pocket
Expenses (OPE) while invoicing its client for the audit services. These expense
recoveries do not fall within the scope of the term ‘price’ of the audit
services. But, such expenses can be considered as incidental expenses which are
incurred prior to supply of services and hence included by virtue of section
15(2)(c) of the GST law. Now, by applying the pure agency tests, an auditor can
claim such expense recoveries as an exclusion on account of the following:

 

–   Though the Travel and lodging services are
used by the auditor, they are incurred during the course of and for the
purposes of the audit assignment and not for the auditor’s own account.

–   Audit engagement letters contain an
authorisation to incur OPEs for the purpose of conduction of an audit which
stand recoverable from the auditee.

–   The auditor does not hold any title or claim
ownership over the said services.

–   The auditor recovers only the actual expense
from the supplier.

 

Thus, OPE expenses are
excludible from taxable value in view of the pure agency rule. This is a clear
departure from the service tax regime where the practice of applying service
tax even on the OPE component was prevalent on account of the fairly stringent
pure agency tests provided under that law.

 

Case Study
2B : Custom House Agency Services

 

Typically, the role of a
CHA is to clear the goods at the customs port and place the goods on a
conveyance for delivery to the factory premises. In the process, a CHA agent
incurs many expenses on behalf of the importer for clearance of the goods and
delivery upto the factory /premises of the importer. The CHA directly interacts
with multiple agencies in view of their proximity with such agencies such as
Port Trust, Steamer Agents, Cargo Handlers, Warehouse keepers, Packers, Goods Transport Agents.

 

The service tax law was
plagued with disputes over inclusion of many costs incurred by such an agent.
The CBEC Circular No. 119/13/2009-S.T dated 21-12-2009 had in substance
clarified that the pure agency tests would have to be complied with in order to
claim exclusion of any expense incurred by the CHA. However, Tribunals (relying
on the Delhi High Court in case of Intercontinental Consultants &
Technocrats Pvt. Ltd.) have consistently held that as long as the expenses
were in the nature of reimbursements, they are excludible from the value of the
CHA services itself. The Tribunals have not resorted to the pure agency tests
to reach such a conclusion.

 

In the context of GST, a
question arises with respect to inclusion of expense recoveries u/s. 15(2) (b)
or (c). Clause (b) is applicable only in reverse scenarios i.e. where the
primary responsibility of incurring the costs is on the supplier but is
eventually borne by the recipient, whereas in a CHA’s case, the expenses are
primarily required to be incurred by the recipient, but incurred by the CHA.
Clause (c) applies to all incidental expenses which are charged in respect of
and until supply of services.

 

The role of a typical CHA
is to perform the customs clearance formalities. Services are said to be
completed once all custom clearance formalities are completed and the goods are
available for dispatch to the relevant destination. Expenses incurred until
customs clearance would definitely be included under this clause (such as
customs duty, port charges, steamer agent charges, DO charges, etc.).
But, post customs clearance expenses may technically not fall within this
clause, even if it is said to be incidental in nature to the CHA services.

 

Thus, an expense recovery
should be tested on two grounds i.e. firstly, whether it is incidental in
nature and secondly, whether the same is until completion. In cases of
pre-supply incidental expenses, pure agency tests become relevant since they
are includible by virtue of section 15(2)(c). However, post supply expense
recoveries need not comply with the pure agency tests as long as they are
claimed as reimbursements – such expense recoveries are neither forming part of
price nor includible u/s. 15(2)(c).

 

Case Study
2C : Advertisement Agencies

Advertisement Agencies
provide a bundle of both creation and production work for their clients.
Typically, once the creative work is completed, the advertisement is required
to be posted on a particular media (such as newspaper, television, radio, etc.).
Where the contracts entered into by Advertisement agencies are lumpsum
contracts inclusive of the cost of production, the said services would be taxed
at the gross value including the production work. In contracts where the
production work is separately chargeable, it is important to apply the pure
agency test and ascertain the includibility of such incidental recoveries.

 

In such contracts, the
appropriate media is mutually decided between the advertisement agency and the
customer. The invoice raised by the media agency is addressed to the customer
with reference of the advertisement agency through which the advertisement is
placed. The media agency collects the invoice from the advertisement agency and
recovers the costs from the customer by way of a reimbursement. The
advertisement agency also earns a sales commission from the media agency as an
incentive.

 

In such cases, the question
which arises is whether the advertisement agencies can claim the media costs as
a reimbursement under pure agency rules inspite of the fact that it makes a
profit on an overall basis. If we are to dissect the transaction, there are two
distinct transactions in this arrangement – the first pertains to the media
agency recovering the costs of the advertisement from the customer and the
second pertains to payment of commission to the advertisement agency as an
incentive. In the first leg, the advertisement agency acts as a pass through
and recovers the actual media cost. The invoice is addressed to the end
customer with the payment being routed through the advertisement agency. The
second leg is an independent leg wherein the advertisement agency claims its
commission/ incentive from the media agency. Thus, there is a good case to take
a stand that the commission generated does alter the character of reimbursement
by the advertisement agency and hence such reimbursement satisfies the pure
agency tests under Rule 33.

 

The CBEC has issued a press
release on the point of inclusion of advertisement costs in print media as
follows:

a.   Where
an advertisement agency works on a principal to principal basis (i.e. profit
model), it would be liable to tax on the entire value of such transaction but
at the rate applicable to sale of advertisement space.

b.   Where
an advertisement agency works as an agent (i.e. commission model), it would be
liable to tax only on the commission generated from such business.

 

This press release can
certainly be resorted to contend that the production costs are excludible even
if commission is generated from the media agency. More importantly, the press
release has not specifically resorted to the pure agency tests to conclude that
the advertisement costs with the media are excludible and GST is limited to
commission earned from the media.

 

Case
Study 3 – Grossing up of TDS, esp. on foreign exchange payments

 

Income tax law requires the
assessee making foreign exchange payments to gross-up the TDS component for
calculation of TDS, particularly in contracts where the agreed price is net of
Indian taxes (section 195A of the Income-tax Act, 1961). In such cases, a
question arises is whether the gross up component is includible in calculation
of taxable value for discharging the GST on reverse charge basis. Section
15(2)(b) of GST law requires that the taxable value should include all costs/
expenses which are liable to be incurred by the supplier but incurred by the
recipient.

 

Income tax law collects
taxes in three ways: direct levy (advance tax/ self-assessment tax), tax
deduction at source (TDS) and tax collected at source (TCS). Direct levy
implies imposition of tax on the person earning the taxable income. TDS/ TCS
are part of machinery provisions where the obligation to remit the taxes is
placed on the payer/ seller but subject to a final assessment in the hands of
the person earning the income.

 

Section 191 of the Income
Tax Act, 1961 provides that even in cases where TDS / TCS is not deducted, the
assessee earning the income is liable to pay the income tax on such income.
This is a clear indication that the primary liability of payment of income tax
always rests on the person earning the income. TDS/TCS provisions are purely
mechanisms to collect the income at source from the income earner. Section
195A, which is part of the TDS provisions, is also based on this principle that
the income chargeable to tax in the hands of the foreign recipient is the
grossed up value (TDS being a mechanism of collection) and not just the
contractual price agreed between the parties.

 

Applying the above
understanding, the TDS component borne by the remitter should ideally stand
included in the taxable value in terms of section 15(2)(b) of the GST law, in
other words the income tax liability (payable as TDS) of the supplier is borne
by the recipient (as a remitter). Reverse charge tax should hence be computed
on the grossed up value of the remittance in such cases.

 

 

Comparison with Service Tax Valuation
Rules

This issue fell under
debate before the Tribunal in Magarpatta Township Dev. & Construction
Co. Ltd. vs. C.C.E., PUNE-III1,  wherein it was held by reference to the
earlier Rule 7 of the Service Tax Valuation Rules, 2006 that such TDS cannot be
included in the taxable value. Rule 7 refers to actual consideration ‘charged’
for the purpose of determination of taxable value which is unlike the GST law
wherein all costs incurred by the recipient on behalf of the supplier fall
within the ambit of taxation. Hence, in view of the author, TDS gross up is
includible in the taxable value of import of service transactions.

________________________________________________

1   2016
(43) S.T.R. 132 (Tri. – Mumbai)

 

 

Case
Study 4 – Valuation in case of notified Valuation schemes (say Air Travel
Agents)

 

The valuation scheme for
air travel agents can be understood as follows:

 

–  This scheme is applicable to services in
relation to book of air tickets by an air travel agent

–   The term ‘air travel agent’ has not been
defined, but if understood as per industry norms, refers to the persons who
perform the service of booking of air tickets on behalf of the airline (as per
International Air Travel Association (IATA) policy)

–   Air travel agents charge a commission from
the airline, receive a booking fee from customers and in many cases make a
profit on the booking fee (especially in inventory models where ATAs hold
inventory of seats in specific sectors)

–   The scheme overrides the other valuation
provisions and requires tax to be computed only 5%/ 10% of the base fare.

 

The primary question that
arises is whether all the three sources of income of an ATA are includible in
the said valuation scheme. If yes, the ATA has to merely charge GST on 5%/10%
of the base fare as applicable and need not separately charge/ collect GST. The
ambiguity arises since the provision does not refer to any particular service/
HSN category, rather states that services ‘in relation to’ booking of tickets
are covered under the said scheme. It must be appreciated that the phrase ‘in
relation to’ is much wider than ‘in respect of’ and a broader scope should be
attributed to it. In the view of the author, all the three categories of income
stand included in the scope of the valuation scheme as all the three sources of
income arise from the booking of air tickets. The phrase ‘in relation to
booking’ certainly widens the scope of the subject matter, of valuation and
hence such a stand can be taken by ATAs on their booking services.

 

Case
Study 5 – Discount Policy variants

 

Companies have
innovative/peculiar methods of passing on benefits of discounts through the
supply chain. Though there is no exhaustive list, the general terminology used
are – trade/ invoice discount; discount on list price, cash discount,
turnover/off-take/target discount, seasonal discounts, gold/ silver incentive,
price protection/support, free/ promotion items etc. The GST law
classifies discounts given by supplier into two broad categories – pre-supply
discounts and post supply discounts. As stated in the earlier article,
pre-supply discounts are eligible on the invoice value itself and post supply
discounts are eligible for deduction by issuance of credit notes with
corresponding matching and input tax credit reversal by the recipient. While
trade/invoice discounts fall within the ambit of pre-supply discounts, the rest
would generally fall within the scope of post supply discounts, since they are
provided after the transaction of supply.

 

In the case of post supply
discount, can a supplier issue a credit note without any GST impact and
overcome the rigours of Credit note matching? The answer is a definite ‘Yes’.
The GST law prescribes the issuance of a credit note (with GST reversal) only
if the supplier wishes to avail a reduction from his taxable turnover. This
does not prohibit a supplier from issuing a commercial/accounting document for
settlement of transactions/accounts in respect of a particular sale/purchase
transaction. It is not necessary that a supplier should always link an
accounting/ commercial credit note with its original supply invoice for
commercial purposes. In contract law terminology, it is merely an alteration of
the original contract price (section 62 of the Indian Contract Act, 1872). GST
law cannot override the contract/commercial terms and make it mandatory for the
supplier to raise a credit note with a GST reversal.

 

Even speaking from a
practical perspective, a tax officer cannot recover any additional tax from the
supplier since no tax benefit has been claimed by the supplier in this case.
From a recipient’s perspective, as long as the conditions of section 16 are
complied with, input tax credit cannot be denied merely on account of an
additional discount given by the supplier. The additional discount is a
mechanism of settlement of accounts between the parties and the proviso of
non-payment cannot be invoked against the recipient. Moreover, since this
transaction is revenue neutral without any revenue loss to the exchequer, it is
definitely permissible for suppliers to issue credit notes without any GST
reversal to their customers.

 

Summary

In the context of
valuation, the biggest challenge that anyone would face is to reconcile certain
elements of a duty based law (such as excise/customs) with certain elements of
a transaction based law (such as sales tax/ service tax). Both are distinct
fields of taxation and GST being a composition of both would certainly create
confusion over the interpretation of the law. The litigation on this front
would also depend on the background of the assessing authority. An erstwhile
excise/customs official would certainly lean towards applying legacy duty based
principles and an erstwhile VAT official may follow the contractual terms.
There is bound to be some disparity in administration of tax laws itself and
the Government(s) should take proactive steps to issue appropriate circulars
clarifying legal position in order to maintain uniformity in administration.

 

From an economic perspective,
transaction value approach ensures that economy drives tax collection and not
the other way around. The revenue has to appreciate that in a multi-point tax
system where credit flow is robust, it is only the last leg of the value chain
which would generate revenues for the government. The purpose of introduction
of GST was to facilitate market forces to operate independent of tax
structures. It is in light of this principle, the rigours of valuation as
existed in the First and the Revised Model GST law have been diluted and the
discretion granted to revenue authorities on the point of valuation is fairly
limited. Unless the revenue authorities appreciate the larger picture, disputes
around valuation would ultimately burden the industry with onerous taxes. _

34. Section 37- Income – Charge of tax – Commission – Business expenditure – A. Ys. 1997-98 and 1998-99 – Assessee receiving 95% of payments against invoices after deduction of commission of 5%. – Finding of fact by Tribunal – Liability to tax only actual receipts

CIT vs. Olam Exports (India) Ltd.; 398 ITR 397 (Ker):

 

For the A. Ys.
1997-98 and 1998-99, the assessee claimed dediction u/s. 37 of the Act, of the
amounts payed towards commission to a concern, LE, for consignment sales. The
Assessing Officer disallowed the claim on the ground that the existence of such
an agent itself was in doubt. The Tribunal found that the evidence indicated
that the assessee had received only 95% of the invoice price and held that the
assessee could not have been taxed for the income which the assessee had not
received.

 

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

 

“i)   The assessee could only
be taxed for the income that it had derived. There were transactions between
the assessee and LE and the invoices which were raised by the assessee in the
name of the agent contained the gross sale prices and the net amount payable
after recovery of 5% towards commission and other expenses due. Based on such
transactions, the amounts were realised by the assessee through banks and the F
form under the Central Sales Tax Act, 1956 were also obtained from the agent.

ii)   Those admitted facts,
therefore, showed that the assessee had received only 95% of the gross price
and the Department had no material before it to show that the assessee had
received anything in excess thereof, either directly or otherwise. If that was
so, despite the contentions raised by the Department regarding the doubtful
existence of the agent, the assessee having received only 95% of the gross
value, it could have been taxed only for what it had actually received.

iii)   Therefore, the Tribunal
was justified in coming to the factual conclusion that the assessee could not
have been taxed for anything more than what it had received. No question of law
arose.”

Building The Firm Of The Future

We live in
an era of profound change. While change is inevitable, the continued success of
individual accounting firms is not. To cope with an increasingly turbulent
environment, firms need to develop new strategies that are better adapted to a
modern marketplace.

Change is
arriving from many sources, and its pace is accelerating. One way to measure
this acceleration is to examine the half-life of knowledge — how long it takes
for half of humanity’s knowledge to be supplanted by new information.

For much of human history, this
half-life could be measured in hundreds of years. By the 1920s, the
half-life of knowledge was 35 years. In the 1960s, it was 10 years. By 2000, it
was down to 5 years. Today, it is estimated to be about 2.5 years, and experts
expect it to continue dropping.

Change can come from many
directions, as well. For instance, a simple change in the threshold that
triggers mandatory audits can decimate demand. And international competition,
deregulation and new business models can dramatically impact entire industries.
The winds of political change are often unpredictable.

Technology, of course, is a primary
agent of change. It has already made real-time communications inexpensive and
almost universal. Artificial intelligence can do your taxes and keep the books.
There is even speculation that block-chain transactions may replace the need
for required audits.

Demographics also drive change. The
workplace is steadily being taken over by individuals who have grown up with
digital technology. These digital natives have different life experiences and
expectations than the generation they are replacing in the workforce.

In this article, we will identify
emerging global marketplace trends that are most likely to impact Chartered
Accountancy practices. We will then identify specific strategies and tactics
that are effective today — and should continue to work for the foreseeable
future — at accelerating the growth and profitability of accounting firms
around the world. We believe that these proven strategies provide a practical
template for the firm of the future.

Market
Trends Shaping the Future of Accounting

While many forces are shaping
accounting’s future market environment, some carry more weight than the others.
We’ve identified five emerging market trends likely to have the biggest impact
on the industry.

1.    The
commoditization of routine professional services

There was a time when Chartered
Accountants were rare. Fees were stable and relatively high, even for widely
used services such as tax and audit.

But over time, many of these
services became widely available as accounting practices proliferated. In
addition, lower-cost alternatives, such as tax filing software, entered the
marketplace.

These innovations exerted downward
pressure on fees. Today, services are increasingly viewed as commodities and
providers as interchangeable. In this scenario, the only selection criteria of
significance are cost and payment terms.

How do we remedy this race to the
bottom? The answer is expertise. Figure 1
shows the relationship between the level of perceived expertise and the billing
rates clients are willing to pay. It is anchored at US$100 for a professional
of “average” expertise. The results show that the higher the level of
expertise, the more clients are willing to pay.

Figure 1. Relative hourly rates buyers will
pay, by Visible Expert level1

________________________________________________________________________________________________________________________________________________________________

1.    Source: The Visible Expert,
2014, p. 42, https://hingemarketing.com/library/article/the-visible-expert


2.    The
expectation of full transparency

Today’s consumers expect complete
transparency, a trend that is driven by people’s daily experiences online. An
individual can go online and find ratings and reviews for everything from
restaurants and movies to cameras and cars, and — for better or for worse —
this crowd-sourced phenomenon is now being applied to professional services.
Buyers have begun to expect that they will be able to use websites, online
tools and social media to understand a firm’s services and approach, as well as
assess its strengths and weaknesses. If buyers aren’t able to find information
on a firm relatively quickly, they often move on.

In fact, a recent study of referrals
showed that over half (52%) of the prospects receiving referrals ruled out a
firm they were referred to before even talking with them. The most
common reason cited for ruling out a firm was that its website or online
presence did not adequately demonstrate how the firm could help the buyer.2

____________________________________________________________________________________________________

2.    Source: Referral Marketing
for Professional Services Firms Research Report, 2015, p. 14,
https://hingemarketing.com/library/article/referral-marketing-for-professional-services-firms

3.    Specialized
expertise is assumed

Today’s sophisticated buyers have
come to expect that for any given problem they have they will be able to find a
specialized solution — and more often than not this solution can be found
online. From personalized services to downloadable apps, these solutions come
in many guises.

The same should apply to
professional services. If a company has a business challenge, it should easily
be able to find a firm that specializes in solving that specific problem.This
tilt towards specialists is already happening in the marketplace. In our recent
study of accounting firms, we found that specialists grew twice as fast as
generalists (see Figure 2).3

Figure 2. Median growth of generalist and
specialized accounting & financial services firms


_______________________________________________________________________________________________________

3     Source: Accounting & Financial
Services Research, 2017, p. 10,
https://hingemarketing.com/library/article/2017-accounting-financial-services-research-summary-marketing-growth-insights

4.    Expert
advice is freely available

Have a question? Want to research a
business issue?  Free advice from a
knowledgeable expert is only a few clicks away — whether it is a blog post,
webinar, video or whitepaper.

We live in an age when professional
services buyers expect to be able to educate themselves for free on any
business issue they encounter. If a firm fails to meet this expectation, one
of its competitors will. A firm’s ability to develop and promote educational
content is important because when buyers are ready to hire a new firm, they
often will think first of the experts they have come to rely upon for the
information they need. Feeding prospective clients’ ongoing need for
information is a new and powerful way of building competitive advantage.

The power of this approach is nicely
demonstrated by a recent study of referrals. This study compared several of the
most common approaches to generating more referrals.

Figure 3 shows the probability of
receiving a referral based on each technique.4 Note that visible
expertise (i.e, sharing your expertise in an educational context) was the most
powerful approach — far more powerful than a referral from a client or a
friend.

_______________________________________________________________________

4.             Source: Referral
Marketing Study, 2016, p.9, https://hingemarketing.com/library/article/referral-marketing-study

Figure 3. Factors that increase the
probability of referrals


Figure 4 shows how referral sources
learn about a firm’s expertise5. Note how many of the activities in
this figure are ways of sharing knowledge and educational content.

 Figure 4. How referral sources discover experts


_________________________________________________________________________

5 Source: Referral
Marketing for Professional Services, 2016, p.11,
https://hingemarketing.com/library/article/referral-marketing-for-professionalservices-firms

5.    A
time-pressured marketplace moves online

“I want what I want and I want it
now” could well be the rallying cry of today’s overworked business
professional. Psychological studies have shown that managerial and professional
positions are among the most stressful and time pressured. And in many (perhaps
most) cases, these are your potential clients. No wonder they value getting
fast answers to their business questions.

Of course, there is no better medium
to satisfy this need for speed than the internet. Social media is faster than
face-to-face networking. And online search takes only a few seconds. “Faster”
and “easier” are very appealing concepts to prospective clients. As a result,
the business advantage of having a robust online presence is clear.

So what is the likely result of
these changing marketplace expectations?

Winners
and Losers in the Emerging Marketplace

If there is one clear consequence of
these emerging trends, it is this: there will be winners and losers. Some firms
will adapt to the changing marketplace and settle into market niches in which
they can grow and prosper. Other firms will ignore the changes around them.
Many firm principals believe (or hope) that these market forces will not affect
their clients, and they continue to rely on “tried-and-true” business
development techniques that have worked for them in the past.These firms are
not likely to thrive much longer.

This sorting into winners and losers
is not just a theoretical possibility. It is already well under way. Almost 10
years ago, my agency identified a group of firms that consistently outperformed
their peers on almost every measure of financial performance. We call them High
Growth firms.

High Growth firms grow five to ten
times faster than their average-growth peers, and this growth does not come at
the expense of profitability. According to our most recent study, High Growth
firms are twice as profitable as their peers. And they achieve this performance
while spending no more on marketing than their slower-growing competitors.6

___________________________________________________________________________________________

6.    Source: 2017 High Growth
Study, p. 10-11,
https://hingemarketing.com/library/article/2017-high-growth-research-study-research-summary

Far more often than not, firms that
achieve these levels of growth and profitability have a clear strategy that
gives them a competitive advantage. They also tend to receive much higher
valuations when they are acquired or merge with another firm.

One study of firm value showed that
High Growth firms receive valuations of multiples up to 10 times higher than
average.7

How are these firms able to
accomplish this impressive growth in the face of a turbulent, highly
competitive global business environment?

___________________________________________________________________________

7.    Source:
Top Dollar: How to Achieve a Premium Valuation for Your Professional Services
Firm, 2008, p. 8,
https://hingemarketing.com/library/article/high_growth_professional_services_firm_how_some_firms_grow_in_any_market

In our attempt to answer this
question, we have learned that there are certain principles and practices that
allow these firms to adapt quickly to emerging marketplace changes. While every
firm faces different business and market challenges, there are some practical
approaches that seem to cut across industries, markets and cultures. We explore
these approaches in the next section.

Becoming
the Firm of the Future

There is no single technique or
business strategy that guarantees future success. But our research has
uncovered several practices that significantly improve a firm’s ability to
align its business approach with the needs and expectations of an evolving
marketplace. Below are six strategies that a firm can begin using today to
prepare for the uncertainties of tomorrow.

1. Create a Culture of Learning and
Change

The biggest barrier to building the
firm of the future often lies between our ears. Fear of change and a desire to
minimize risk by avoiding the new and untested can blind us to the implications
of an evolving world. Instead of seeking to understand the change around us and
embracing it, many firms look to others in the accounting industry for
leadership and inspiration. They model their approach to business development,
marketing and operations after competitors whom they admire.

While such apparent caution may seem
less risky, it is in fact very dangerous. It will erode any competitive
advantage a firm has developed, stifle innovation and prevent a firm from
recognizing and serving emerging client needs.

A far safer course is to be
proactive and monitor the evolving marketplace. Equipped with this knowledge, a
firm can develop services and strategies that address emerging client needs
long before competitors catch on. In the next section, we will explore how to
achieve this level of market insight.

Before firms retool their marketing,
however, they must develop a firm culture that supports learning and change. One
way a firm can make learning an integral part of its culture is to implement a
training schedule. For example, one of our clients — an international law
firm based in Mumbai — devotes one hour each workday morning to formal
training. While this level of training may sound excessive (and it probably
isn’t necessary at most firms), it sends a powerful message to potential
clients and employees.

Another way firms can foster a
culture of ongoing change is to adopt a practice of continually introducing and
testing new services. We call this the Test–Measure–Learn cycle. When they assume this mindset, employees realise that innovations and
improvements are inherently uncertain and must be tested and refined.

Figure 5. The Test–Measure–Learn cycle

 

 For example, suppose you have an
idea for a new service that helps clients use financial information to improve
operational efficiencies. You start the cycle by testing the idea and measuring
the results. Did it work as expected?

What were the unanticipated results?
Over time, your accumulated insights allow you to learn from that experience
and apply that learning to your next test. Each successive iteration should add
value or reduce cost.

While some individuals may follow
this pattern instinctively, we find that most do not. Introducing a
Test–Measure–Learn policy makes learning and continual improvement a part of
the culture. Firms that institute this kind of process find that uncertainty is
less daunting and their approach to the marketplace becomes more flexible and
adaptable.

2.    Research
Based Marketplace Insights

Perhaps the biggest challenge in
becoming a firm of the future is finding a way to discover clients’ changing
needs and business priorities. Their industries, after all, are facing their
own risks and opportunities. So you should try to understand those first. The
problem is that most professionals feel as though they already know their
clients and their business challenges. However, this belief is an illusion.

As humans, we have blind spots. We
think we understand something when we, in fact, do not. Our clients don’t
always communicate their true feelings or concerns to us. And we bring our own
histories and motivations to every interaction. The net result is that almost
every firm operates with dangerously flawed assumptions about what clients want
and how they think about critical business issues.

The antidote for this problem is
research. Firms that conduct systematic research on their target client group
have a more objective view of their challenges and priorities. They are able to
base their decisions on empirical evidence rather than assumptions or
instincts. It equips them to anticipate trends and offer highly relevant new
services. In short, research reduces risk.

This effect is powerful: firms
that conduct formal research on their target client group grow faster and are
more profitable. In a recent study we found that 34% of High Growth firms carry
out systematic client group research at least each business quarter. None
of their slow-growth peers did similar research.8

_______________________________________________________________________________________________________________

8     Source: 2017 High Growth
Study, p. 17, https://hingemarketing.com/library/article/2017-high-growth-research-study-research-summary

Figure 6. Percent of firms, by type, that
conduct frequent research (quarterly or more often)


3.    A
Focused Strategy

The firm of the future will benefit
from a narrowly focused strategy. In a turbulent environment, the firm that
tries to be everything to everyone is likely to discover that it is nothing
special to anyone.

We’ve already seen this effect in
play — buyers favour specialists over generalists. While it may seem intuitive
that offering more services to more audiences creates greater opportunity for
growth, the opposite is true. The more a firm broadens its appeal, the bigger
its pool of competitors grows and the more difficult it becomes to stand out to
prospective buyers.

So how do firms establish
competitive advantage? By offering superior client service? In fact, this is a
very popular strategy, used by two thirds of firms today. Unfortunately, it
doesn’t work. Firms that attempt to differentiate themselves on superior
client service actually grow 250% slower than firms that employ other
differentiators.

Keeping in mind that every firm
operates in its own competitive environment and needs its own strategy, there
are a few differentiators that consistently work better than others. One approach
is to offer a niche service. Firms that take this approach are 25% more likely
to be High Growth firms. Another proven differentiation approach is to
specialize in an industry. These businesses are 89% more likely to become High
Growth firms.

Why are these niche approaches so
effective? We’ve identified three reasons:

First, having a niche allows a firm
to be more visible to its target audience. When an audience is smaller, it is
easier and less expensive to reach them.

Second, firms that specialize are
more likely to be perceived as top experts in their field. Top experts are able
to close business more quickly, are less likely to offer commoditized services
and can charge premium fees.

Third,a niche firm’s smaller,
well-defined market makes it easier to understand and monitor its market. As a
result, these firms are well positioned to introduce innovative solutions as
their clients’ needs evolve.

4.    An
Expertise Centered Brand

Perceived expertise is critical to
the future success of accounting firms. According to our research, expertise is
the number one selection criteria when prospective clients seek out a firm to
hire. Even more impressive, in nearly three out of four searches (72%)
expertise is the factor that tips the scale in favour of the final choice.

As evolving technology and
increasing global competition push more traditional accounting services into
the commodity category, expertise will become the primary way that the firm of
the future will compete.

But there is a problem with
competing on expertise. Expertise is invisible. A buyer cannot assess
expertise by looking at or meeting a person. To address this problem, firms
have to find ways to make their expertise broadly visible to their target
client groups. The most effective way to build this visibility is to bring
their expertise directly to their audience, even before they are ready to buy —
by speaking at events, publishing educational articles and blog posts and
putting on free webinars, to name just a few common tactics.

Centering a firm’s brand on
expertise is not only effective today, it is a strategy that will contribute to
the firm’s future relevance and competitive advantage.

5. A Balanced Approach to Practice
Development

When reviewing Figure 4 above, you
may have noticed that referral sources learn about expertise in many ways. They
gather their information from a variety of offline (e.g., speaking engagements)
and online (e.g., blogging or social media) sources. In fact, firms that generate
leads from both online and traditional sources tend to grow faster and are more
profitable than those that solely rely on traditional sources. Our research
tells us that these firms can grow up to four times faster and be more than
twice as profitable than firms that follow an unbalanced approach.9
These firms are also better prepared for an increasingly digital future than
those that rely heavily on traditional business development techniques.

__________________________________________________________________

9.    Source: Online Marketing for
Professional Services, 2012, p. 58,
https://hingemarketing.com/library/article/online_marketing_for_professional_services

6.    A
Magnet for Top Talent

Professional services firms are only
as good as their talent. After all, it is their professionals’ expertise that
firms are selling. But many firms struggle
to attract and retain top talent. A lack of qualified job candidates can
severely limit a firm’s future prospects and put a ceiling on growth

For this reason, a firm would be
wise to invest in its employer brand: What is the firm’s reputation as a place
to work? Does the employer brand attract top talent or keep them away? Is it
consistent with the firm’s client-facing brand?

When building its employer brand, a
firm must first understand what job candidates are looking for in a firm. A
recent study on employer brands provides a few helpful clues. When asked what
they care about most, employees’ top response was to work with a growing firm.
Their next most common response was having the ability to work remotely or
telecommute. Interestingly, obtaining the highest available salary came in
third place.10

__________________________________________________________________________________________________

10.  Source: Employer Brand Study,
p. 18, https://hingemarketing.com/library/article/employer-brand-study.


Firms must also understand that
generational differences will play a growing role in the war for talent. While
many of today’s leaders lament the changing expectations and priorities of the
rising generation (those born after 1980 and sometimes referred to as
Millennials), these young professionals open up many opportunities for the firm
of the future.

For example, Millennials are eager
to build personal brands in their industry. This ambition is completely
consistent with a firm’s goal to make its expertise more visible. And firms
that encourage the development of their experts’ personal brands may have a
recruiting edge when competing for this demographic.

Millennials are also adept at
representing the firm on social media, an advantage in a world that is tilting
steadily towards online communication. Characteristics that may be an
uncomfortable fit in today’s firm are likely to become valuable assets to the
firm of tomorrow.

A Final Thought

Building the firm of the future may
seem like an impossible task. The future is always uncertain, after all, and
the pace of change has never been faster. But there are compensating factors.
Times of great change can also produce great opportunities.

We can see some of these
opportunities already in the extraordinary growth enjoyed by firms that have
embraced emerging market realities and are leveraging new business strategies
and tactics. There will be winners and there will be losers in this race to the
future. Which path will your firm choose to take? _

Supreme Court Freezes Assets Of Independent Directors – A Thankless Job Made Worse

Background

 

In a recent ruling, the Supreme Court has
directed a freeze on assets of all the directors, including independent
directors, owing to certain defaults by the Company. They have also been
required to be personally present at hearings of the Court. At this stage,
there does not appear to be any conclusive finding about the guilt of the
independent directors and the matter is still sub judice. But this order
does raise concerns about the liabilities and inconveniences that independent
directors can be subjected to. As will be discussed later herein, being an
independent director is in a sense a thankless job. Their remuneration is
subject to statutory limits while their liability is enormous. There have
already been several orders by SEBI, that has taken different types of actions
against them. The defences available in law owing to recent changes appear to
have been diluted. Let us consider this decision (Chitra Sharma vs. UOI,
dated 22nd November 2017) generally in the light some existing
provisions.

 

Needless to emphasise, Chartered
Accountants, Company Secretaries, lawyers, etc. are sought after persons
to fill in the posts of independent directors in listed companies and also
committees like Audit Committee. They too will warily see the developments in
law and court rulings.

 

Role of independent directors

 

Independent directors are a major pillar of
good corporate governance. They are meant to balance against the control of
Promoters, and directly or indirectly protect the interests of minority/public
shareholders and even other stakeholders. Committees like Audit Committee or
Nomination and Remuneration Committee are to have majority or at least half of
the number of members as independent directors.

 

The Companies Act, 2013 (“the Act”) lays
down in Schedule IV a very detailed code for independent directors. Their role
and obligations are laid down broadly and generally as well as specifically.

 

Apart from the specific code for independent
directors, there is a very detailed role under the SEBI (Listing Obligations
and Disclosure Requirements) Regulations, 2015 (“the Regulations”) for the
Board generally.

 

Powers of independent directors

 

The powers of independent directors are, in
comparison, relatively scanty. They do have powers as part of the Board generally.
They have right of information as part of the Board/Committee. However, these
are available few times a year when the Board/ Committee meets. Between these
meetings, they do not have direct substantive powers, either individually or
collectively. In meetings too, they individually do not have powers except to
participate and vote and perhaps require that their dissenting views be
recorded.

 

Remuneration

 

Independent directors are in a peculiar
position. They cannot be paid too much simply because they would lose their
independence since they would become dependent on the Company. Paying them too
less means that they do not have enough compensation and incentive to do
justice to their efforts and the risks that the position carries, of action by
regulators.

 

Typically, independent directors are paid by
way of sitting fees and, where the Company is profitable and if the Company so
decides, payment by way of commission as a percentage of profits. Sitting fees
are, however, limited to Rs. 1,00,000 per meeting (in practice, often a lesser
amount). Such level of remuneration in many cases would not be adequate for
many competent directors to accept the responsibilities and liabilities that
law imposes.

 

Kotak Committee appointed by SEBI has
recently recommended certain minimum remuneration for independent and
non-executive directors and though it still does not appear to be adequate in
proportion to liability, it is clear that attention is being given to this
area.

 

Liability of independent directors generally

 

Non-executive directors usually do not have
specific and direct liability under the Act/Regulations. Generally, executive
directors, key managerial personnel, etc. are taken to task first, for their
respective general or specific role in defaults. Non-executive directors who
are promoters may of course face action under certain circumstance. But
generally, non-executive directors can ensure that due role is formally
apportioned to competent persons so that they do not face actions on matters so
delegated. However, under the Act and even the Regulations, this has changed to
an extent. Under section 149(12) of the Act and the Regulations, some further
relief is sought to be given. Essentially, an independent director will be
liable, only if the default is with his knowledge through board proceedings.
This does help him because, unless the matter is brought before and part of
board proceedings, he may not be held liable. However, this is subject to the
condition that he should have acted diligently. This provision has not been
tested well and it will have to be seen how much it helps.

 

Orders/actions against independent directors

 

SEBI has general and special powers by which
it can pass adverse orders against independent directors. And it has passed
such orders. SEBI can, of course, take action for violation of specific
provisions of the Regulations applicable to them. However, depending on their
role, SEBI can use its general powers to pass orders against them. This may
include debarring them from acting as independent directors of listed
companies.

 

The Order in case of Zenith Infotech as
originally passed is particularly noteworthy. (Order No. WTM/RKA/ISD/11/2013
dated 25th March 2013). In this case, SEBI had alleged diversion of
funds of Zenith. SEBI ordered the whole Board, including the independent
directors, to provide personal bank guarantee to the extent of $33.93
million for the losses suffered by Zenith. The guarantee was to be provided
without use of the assets of Zenith. Needless to emphasise that, independent
directors, particularly professionals, would usually not be able to provide
such guarantees. Professional directors would then face further adverse
directions for not complying with orders which may include prosecution.

 

Order of the Supreme Court

 

The Company concerned here is facing
insolvency proceedings. Numerous persons have booked flats and it appears that
the buyers are looking at loss of advances paid for purchase of flats. The
Supreme Court had earlier required the promoters to infuse funds in the
company. However, this apparently was not done to the extent ordered. The
Supreme Court has thus ordered that, inter alia, the independent directors
and their dependents will not transfer any of their assets till further notice.
The Court ordered:-

 

(d) Neither the independent
directors nor the promoter directors shall alienate their personal properties
or assets in any manner, and if they do so, they will not only be liable for
criminal prosecution but contempt of the Court.

 

(e) That apart, we also direct
that the properties and assets of their immediate and dependent family members
should also not be transferred in any manner, whatsoever.

            …

      Matters be listed on 10.1.2018. On that day, all the independent
directors and promoter directors of Jaiprakash Associates Limited, shall remain
present.

     

Thus, the directions are (i) the assets of
the independent directors and their immediate and dependent family
members are frozen (ii) the independent directors are required to be personally
present before the Court at the hearing of the case.

 

The broad based order means that independent
directors’ business/professional and even personal activities are seriously
affected.

At this stage, there does not appear to be
any final ruling of the guilt of the independent directors. It is also not
clear whether there is any finding of complicity or even negligence of their
duties as independent directors. Even if such a direction is reversed in the
future, in the interim, the independent directors face serious difficulties.

 

As stated earlier, there are some defences
available to independent directors in case of wrong doings by the company. If
they have taken due safeguards and carried out their role with diligence, they
may not ultimately be held liable. But in the interim, such orders are
effectively a punishment.

 

Recent order of SEBI exonerating
independent directors where they exercised diligence.

 

In the case of Zylog Systems Limited (Order
dated 20th June 2017), there was a finding that the Company declared
dividends but did not pay it. The question arose as to the role of the Board
generally and also of the independent directors in particular. SEBI issued show
cause notices to, inter alia, the independent directors, alleging
violations and seeking to pass adverse directions. The independent directors
explained in detail their role as independent directors generally and as
members of the Audit Committee. They explained how they brought to notice such
non payment of dividends to the Board of Directors of the company. When the
Board of Directors did not still take steps to pay the dividends, the said directors resigned. SEBI dropped the
proceedings against them and observed.

 

I have considered the charges alleged in
the SCN and replies filed by the noticees. I note that the Independent
Directors do have an important role to play in guiding the management so that
the interest of the Company and the minority shareholders are protected.
Further, the Independent directors will also have to ensure that the
functioning of the Company is in full compliance with the applicable laws. In
this case, I have noted that noticees after noticing the violation of non-payment
of dividend have taken strong stands to convince the Company’s Board about the
necessity of ensuring that the statutory dues and the dividends are paid
without any delay, in the Board meeting held on November 14, 2012. As the
company failed to comply, the two noticees resigned from the Company ’s Board.

 

Considering the above facts and
circumstances of the case, I am of the view that since both the noticees did
not have any role in the day-to-day management of the company and have
discharged their responsibility as Independent Directors putting in their best
efforts, I do not deem it fit to pass any directions under section 11 and 11B
of the SEBI Act, 1992 against Mr. S. Rajagopal and Mr. V. K. Ramani. The SCN is
disposed of accordingly.

 

Conclusion

 

Many of the cases till now where independent
directors have faced adverse actions are fairly glaring cases of serious
alleged violations causing losses to shareholders/others. Clearly, if
independent directors are complicit with such violations, adverse action
against them is expected and inevitable. However, adverse directions before
such allegations are proved can cause losses. Even otherwise, proving their
innocence or that they exercised diligence in their duties can itself be an
expensive affair. It is submitted that specific and general guidelines should
be framed both by Ministry of Corporate Affairs and SEBI. There should be
guidance as to the specific steps an independent director should take to
discharge his duties with diligence on one hand and clear examples where they
can be held liable. Else, there will be increasing disillusionment amongst
existing and potential independent directors. In the absence of clarity, the
intention of the lawmakers to have good corporate governance may fall flat. _

Insolvency And Bankruptcy Code: An Inordinate Ordinance?

Introduction

The first batch of the Insolvency and
Bankruptcy Code, 2016 (“the Code”) has been enforced with effect from 1st
December 2016 and has met with mixed success. Attention of the readers is
invited to the columns which appeared in this Feature in the months of October
and November where the Code was analysed in detail. While the Code has been
successful in transforming corporate debtors from being debtor driven to
creditor driven, at the same time there have been certain gaps which needed to
be addressed on an urgent basis.

 

Background for the Ordinance

One of the key concerns under the Code was
whether a promoter of a corporate debtor could be a bidder for the very same
debtor under the resolution process? There had been several instances under the
Code where promoters had bid for the very same companies which they were
earlier running. India is one of the only nations where the powers of the Board
of Directors is superseded by the resolution professional (“RP”) during
the resolution process. Further, in other nations, there is no bar on promoters
bidding for their own stressed assets. 

 

Interestingly, the Insolvency and Bankruptcy
Board of India (“IBBI”) had in November 2017 amended the Insolvency and
Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons)
Regulations, 2017 to provide for enhanced disclosures with respect to all
corporate resolution applicants. It provided that a resolution plan shall
contain details of the resolution applicant and other connected persons to
enable the Committee of Creditors (“CoC”) to assess the credibility of
such applicant and other connected persons to take a prudent decision while
considering the resolution plan for its approval. The details to be given in the plan are as follows:

(a)   identity of the applicant
and connected persons;

 

(b)   conviction for any
offence, if any, during the preceding five years;

 

(c)   criminal proceedings
pending, if any;

 

(d)   disqualification, if any,
under the Companies Act, 2013, to act as a director;

 

(e)   identification as a
wilful defaulter, if any, by any bank or financial institution or consortium
thereof in accordance with the guidelines of the RBI;

 

(f)   debarment, if any, from
accessing to, or trading in, securities markets under any order or directions
of the SEBI; and

 

(g)   transactions, if any,
with the corporate debtor in the preceding two years.

 

Thus, the IBBI put the onus on the CoC to
take an informed decision after due regard to the credibility of the bidder for
the corporate debtor. It also put a great deal of responsibility on the
shoulders of the RP.

 

It was in this backdrop that a burning question
cropped up – should the promoter who was in charge of the downfall in the first
place be given a second chance – and this was both a legal and an ethical
issue! While there are no easy answers to the ethical dilemma, the Government
has tried to address the first question, i.e., the legal question. It has done
so through the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2017 (“the
Ordinance”) which was promulgated by the President on 23rd November,
2017 (nearly a year after the Code was enforced). Let us examine this Ordinance
and also whether it suffers from the vices of extremity or is it a necessary
evil?

Interesting Preamble

The Ordinance states that it has been
enacted to strengthen further the insolvency resolution process since it has been
considered necessary to provide for prohibition of certain persons from
submitting a resolution plan who, on account of their antecedents, may
adversely impact the credibility of the processes under the Code. Thus, it
seeks to prohibit certain persons who have questionable antecedents as these antecedents
may adversely impact the credibility of the resolution process.
The Ordinance enlists these antecedents.

 

Criteria for the Resolution Applicant

The Code earlier described a resolution
applicant as any person who submits a resolution plan to the RP. Thus, he would
be the person interested in bidding for the corporate debtor or its assets. The
Ordinance now defines this term to mean a person, who individually or jointly
with any other person, submits a resolution plan to the resolution professional
pursuant to the invitation made by the RP. One of the key duties of the RP,
earlier included inviting prospective lenders, investors and other persons to
put forth resolution plans for the corporate debtor.

 

This duty has now been significantly
amplified by the Ordinance to provide that it would include inviting
prospective resolution applicants, who fulfil such criteria as may be laid down
by the RP with the approval of the CoC, having regard to the complexity and
scale of operations of the business of the corporate debtor and such other
conditions as may be specified by the IBBI, to submit a resolution plan.

 

Thus, the CoC and the RP would jointly lay
down the criteria for all resolution applicants. This criteria would be fixed
after considering the regulations issued by the IBBI in this respect and the
complexity and scale of operations of the business of the corporate debtor.
Hence, again a very onerous duty is cast on both the CoC and the RP to fix the
criteria after considering various subjective and qualitative conditions. 

 

Ineligible Applicants

While the Ordinance seeks to formulate
certain subjective criteria for barring prospective bidders, it also lays down
objective conditions under which any person would not be eligible to submit a
resolution plan under the Code. What is interesting to note is that the bar
operates not just in respect of the plan for the corporate debtor under
question but also for any other resolution plan under the Code. Hence, there is
a total embargo on such debarred persons from acting as a resolution applicant
applying under the Code.

 

A person ineligible to submit a resolution
plan/act as a resolution applicant under the Code, is anyone who, whether alone
or jointly with anyone else:

 

(a)   is an undischarged
insolvent;

 

(b)   has been identified as a
wilful defaulter under the RBI Guidelines. The RBI’s Master Circular on Wilful
Defaulters dated 1st July 2015 states that a ‘wilful default’ would
be deemed to have occurred if any of the following events is noted:

(i)    The unit has defaulted
in meeting its payment / repayment obligations to the lender even when it has
the capacity to honour the said obligations.

(ii)   The unit has defaulted
in meeting its payment /repayment obligations to the lender and has not
utilised the finance from the lender for the specific purposes for which
finance was availed of but has diverted the funds for other purposes.

(iii)   The unit has defaulted
in meeting its payment /repayment obligations to the lender and has siphoned
off the funds so that the funds have not been utilised for the specific purpose
for which finance was availed of, nor are the funds available with the unit in
the form of other assets.

(iv)  The unit has defaulted in
meeting its payment /repayment obligations to the lender and has also disposed
off or removed the movable fixed assets or immovable property given for the
purpose of securing a term loan without the knowledge of the bank/lender.

 

(c)   whose account is
classified as an NPA (non-performing asset) under the RBI Guidelines and a
period of 1 year or more has lapsed from the date of such classification and
who has failed to make the payment of all overdue amounts with interest thereon
and charges relating to non-performing asset before submission of the
resolution plan – this is the only case where a promoter though barred can
become eligible once again to bid. As long as the promoter makes his NPA account
a standard account by paying up all overdue amounts along with
interest/charges, he can submit a resolution plan. However, this is easier said
than done. The account became an NPA because the promoter was unable to pay up.
Now that it has become an NPA, it would be a herculean task for him to find a
financier who would lend him so that the NPA becomes a standard account!

 

(d)   has been convicted for
any offence punishable with imprisonment
for 2 years or more – this is a very harsh condition, since any conviction for
2 years or more would disentitle the applicant. Consider the case of a person
who has been implicated in a case which is actually a civil dispute, but
converted into a criminal case of forgery and he is convicted by a lower Court
for 2 years or more. Ultimately, his case may be overturned and he may be
acquitted by a Higher Court. In the absence of an express provision, it is
possible that such a person, although acquitted, would be ineligible. Hence,
the amendment should provide that once conviction is set aside, he would again
become eligible.

 

(e)   has been disqualified to
act as a director under the Companies Act, 2013 – this would impact several
directors who have been recently disqualified as directors u/s. 164(2) of the
Companies Act, 2013 on account of failure of the companies to file Annual
Returns and other documents. Several independent directors have also been
disqualified by virtue of the Ministry of Corporate Affair’s drive against
supposed shell companies. All such directors would also become ineligible to
submit applications. 

 

(f)   has been prohibited by
the SEBI from trading in securities or accessing the securities markets – this
embargo is quite severe. The SEBI has been known to prohibit several persons
from trading in securities or accessing the securities markets. Many of the
SEBI’s Orders in this respect have been overturned by the Securities Appellate
Tribunal. What happens in such a case? 

 

(g)   has indulged in
preferential transaction or undervalued transaction or fraudulent transaction
in respect of which an order has been made by the Adjudicating Authority under
the Code – this is to prevent promoters who have entered into fraudulent
transactions with the corporate debtor or transactions to defraud creditors.

 

(h)   has executed an
enforceable guarantee in favour of a creditor, in respect of a corporate debtor
under the insolvency resolution process or liquidation under the Code – this
again ranks as a surprising exclusion. Merely because a person has provided a
guarantee for a company which is undergoing a corporate resolution process, he
is being penalised. Not all cases of insolvency are because of fraud or
misfeasance. Some are genuine cases because of changes in market circumstances
or spiralling of raw materials/oil prices, etc. In such cases, why
should a person who was not even in charge of the debtor be debarred. In fact,
he had provided a guarantee in favour of the creditors which could have been
enforced and some dues could be recovered. Many persons may now think twice
before standing as corporate guarantors.

(i)    Is a connected person in
respect of a person who meets any of the criteria specified in clauses (a) to
(h) would also be ineligible. A connected person is defined to mean

 

(1)   any person who is the promoter
or in management/control of the resolution applicant.

 

(2)   any person who is the
promoter or in management/control of the business of the corporate debtor
during the implementation of the resolution plan.

 

(3)   the
holding/subsidiary/associate company or related party of the above two persons.
The term related party is defined u/s. 5(24) of the Code and includes a long
list of 13 persons. Thus, all of these would also be disqualified if a promoter
becomes ineligible and none of these could ever submit a resolution application
for any company/LLP under the Code.             

 

(j)    has been subject to any
disability, corresponding to the above clauses under any law in a jurisdiction
outside India –thus, even if a person has acted as a guarantor for a small
foreign company which is undergoing bankruptcy proceedings abroad, then he
would be ineligible from participating in the bidding process. This is indeed a
strange provision.      

 

A related provision is that the CoC cannot
approve a resolution plan which was submitted before the commencement of the
Ordinance in a case where the applicant became disqualified by virtue of the
amendments carried out by the Ordinance. Moreover, if no other resolution plan
is available before the CoC other than the one presented by the now
disqualified bidder, then the CoC would be required to ask the RP to invite a
fresh plan. Clearly, this is a very tough task to follow in practice. An actual
case of this nature has occurred in Gujarat NRE Coke Ltd. where, other than the
promoters, there were no other bidders and the promoters have now been
disqualified under the Ordinance. It would be interesting to see what happens
next in this case. However, it is clear that there would be several more such
cases.

 

Conclusion

As it is, RPs are finding it tough to get
resolution applicants. The problem is even more severe in the case of SME
corporate debtors undergoing insolvency resolution. This is now going to get
worse with a whole slate of applicants becoming disqualified by virtue of the
Ordinance. It has painted all applicants by the same brush and even their
related parties and associate companies. If one were to try and plot a tree of
disqualified bidders, one could end up with a forest! This Ordinance while
laudable in its objective of keeping out unscrupulous promoters from gaining a
backdoor re-entry, may in practice become a pain point for RPs.

 

Considering that the IBBI had amended its
Regulations to provide full disclosure about applicants and asked the CoC and
the RP to take more responsibility about applicants, the Ordinance may appear
excessive in its outreach. In fact, this may further lower the value which the
stressed assets could fetch! One only hopes that the Ordinance does not cause
inordinate harm to the already overburdened bad loans’ market. _

ICDS – Post Delhi High Court Decision

The Central Government (CG)
has notified 10 Income Computation and Disclosure Standards (ICDS) u/s. 145(2)
of the Income-tax Act (ITA). Section 145 of the ITA provides that the taxable
income of a taxpayer falling under the heads “Profits and Gains from Business
and Profession” (PGBP) or “Income from Other Sources” (IFOS) shall be computed
in accordance with either the cash or mercantile system of accounting,
whichever is regularly employed by the taxpayer. Section145(2) grants power to
the CG to prescribe the ICDS to be followed by any class of taxpayers or in
respect of any class of income. The notified ICDS are applicable from 1st
April, 2016, (financial year 2016-17) to taxpayers following the mercantile
system of accounting and for the computation of income chargeable under the
heads PGBP or IFOS. They do not apply to taxpayers who are individuals or Hindu
Undivided Families, which are not liable for tax audit under the provisions of
the ITA.

 

A writ petition was filed
by The Chamber of Tax Consultants (Chamber) on the constitutional validity of
section 145(2) as also the validity of notified ICDS, to the extent they are in
conflict with the principles laid down in binding judicial precedents rendered
prior to ICDS. The Chamber urged that while section 145(2) of the ITA permits
the CG, as a delegate of the Legislature, to notify ICDS, it cannot be read as
granting unfettered powers to the CG, in the guise of delegated legislation, to
notify ICDS modifying the basis of taxation which can, if at all, be done only
by the Parliament by amending the ITA. The notified ICDS, to the extent they
seek to unsettle binding judicial precedents and modify the basis of
chargeability and computation of taxable income, are ultra vires the ITA
and the Constitution of India.

 

The Chamber further argued
that “the accounting standards (AS) issued by the ICAI were applicable to all
corporate entities and non-corporate entities following the mercantile system
of accounting. ICDS was applicable only to taxpayers following mercantile
system of accounting (i.e. to all assesses except individuals and HUFs whose
accounts are not required to be audited u/s. 44B of the Act). There was no
reasonable basis on which such differentiation or classification can be made
for the applicability of the ICDS, since the Assessee following the cash system
of accounting would escape from the implications and compliance requirements of
the ICDS. This is violative of Article 14 of the Constitution.”

 

The Delhi High Court (HC)
upheld the constitutional validity of section145(2), but struck down several
contentious provisions of individual ICDS. In a landmark ruling, the HC held
that ICDS cannot override binding judicial precedents or statutory provisions.
It held that the force of judicial precedents can be overridden only by a valid
law passed by the Parliament. Such power cannot be exercised by the Executive.
The provisions of ICDS, being a delegated legislation, have to be so read down
such that they do not modify the basis for computation of taxable income as
recognised by the provisions of the ITA or the binding judicial precedents laid
down by the Supreme Court (SC) or High Courts.

 

In the following
paragraphs, we discuss the provisions of individual ICDS that are struck down
by the HC.

 

ICDS I on Accounting Policies

–  ICDS I provides that expected or mark to
market (MTM) losses are not to be allowed as deduction, unless specifically
permitted by any other ICDS and, thus, does away with the concept of
“prudence”, which was present in the earlier Tax Accounting Standard (TAS) I.

–  The provision of ICDS I is contrary to the
settled judicial position. Many High Court rulings have recognised the
principle of ”prudence” by allowing deduction for provision for expected losses
on contracts recognised in the books of account by the taxpayer in compliance
with GAAP.

–  The ITA also grants deduction for revenue
expenses “laid out” or “expended” for the purpose of business in which the
concept of “prudence” is inherent.

–   The removal of the concept of prudence is
also not consistent with the prudence principles inherent in other ICDSs. A few
examples are given below.

•    Inventory
valuation at lower of cost and market price (ICDS II).

•    Provision
for expected losses on contracts in ICDS III, with the only modification that
the said loss will be allowed in proportion of completion of the contract,
rather than allowing the same for the unfinished portion of the contract. This
was primarily for bringing horizontal equity of treating the contract profit
and contract loss on the same principle.

•    The
principle of reasonable certainty is adopted for recognising revenue in ICDS
IV.

•    Provision
for the losses on forward cover transactions in the nature of hedging (except
to the extent the same pertains to highly probable transactions or firm
commitment) in ICDS VI.

•    Valuation
of inventory (of investments) under ICDS VIII at lower of cost and market price

•    Recognising
provisions for present obligation of future liabilities in ICDS X.

–  Accepting the above contentions, the HC held
that non-acceptance of the “prudence” concept is contrary to the ITA and,
hence, ICDS I is unsustainable to that extent.

–   It may be noted that the CBDT Circular (No 10
dated 23rd March, 2017) provides horizontal equity by not taxing MTM
gains.

 

ICDS II on Valuation of Inventory

–   As per the settled judicial position, if the
business of a partnership firm continues after dissolution of the firm, then
the inventory has to be valued at lower of the cost and the market price. On
the other hand, if the business is discontinued on dissolution of the firm,
then the inventory has to be valued at market price.

–   ICDS II requires that inventory, as on the
date of dissolution of the firm, is to be valued at market price, irrespective
of continuance or discontinuance of the business. This leads to notional
taxation of income contrary to the judicial position.

–   Furthermore, there is a specific provision of
the ITA [section 145A], which provides that the inventory shall be valued as
per the method of accounting regularly employed by the taxpayer.

–   The HC held that: (a.) It is not permissible
for ICDS II to override the settled judicial position. (b.) Where the taxpayer
follows a certain method of accounting for valuation of inventory, the same
shall override ICDS II by virtue of the specific provision in the ITA. Thus,
the HC held that ICDS II is ultra vires the ITA and, to that extent, it
is struck down.

 

ICDS III on Construction Contracts –
Retention money

–  ICDS III provides that retention money should
form part of the contract revenue and taxed on the basis of percentage of
completion method (POCM). The CBDT Circular reiterates this position.

–  However, as per the settled judicial
position, retention money accrues to the taxpayer only when the defect
liability period is over and the Engineer-in-Charge certifies that no liability
is attached to the tax payer. Retention money cannot form part of the revenue
unless the same has accrued as “income” as per the charging provisions of the
ITA.

–   The HC held that taxation of retention money
would need to be seen on a case-to-case basis depending upon the contractual
terms, conditions attached to such amount and keeping in mind the settled tax
principles of accrual of income. ICDS III, to the extent it seeks to bring
retention money to tax at the earliest stage even when the receipt is uncertain
or conditional, is contrary to the settled position. Therefore, to that extent
ICDS III was struck down.

–   Whilst as per law, retention money is taxable
on completion of defect liability period, in practice, many companies prefer to
offer it for tax on its recognition in the accounts, which is much earlier than
completion of the defect liability period. This is done predominantly because
it is the method of accounting regularly followed by the tax payer (section
145) and to avoid any possible litigation. Since the item involves mere timing
difference, tax payers find it convenient to offer retention money for tax as
per accounts, and thereby avoid cumbersome offline calculation for tax
purposes. It also meets the Tax Officers’ intent of taxing it at the earliest
point of time. Therefore, the risks and consequences to the tax payer of
continuing with its existing practice is very limited.

 

ICDS III on Construction Contracts –
Incidental income

 

–   The SC, in the case of CIT vs. Bokaro
Steel Ltd., held that receipts which are inextricably linked to the setting
up of plant or machinery can be reduced from the cost of asset.

–   However,
ICDS III, read with the provisions of ICDS IX on Borrowing Cost, provides that
incidental income earned cannot be reduced from the borrowing cost forming part
of the cost of the asset.

–   The
HC held that, to the extent the provisions of ICDS III are contrary to the settled
judicial position, they are not sustainable.

 

ICDS IV on Revenue Recognition – Export
incentives

 

–   As
per the SC ruling in the case of CIT vs. Excel Industries Ltd., export
incentives are taxable only in the year in which the claim is accepted by the
Government, as the right to receive the payment accrues in favour of the
taxpayer when the corresponding obligation to pay arises for the Government.

–   However,
ICDS IV requires recognition of such income in the year of making claim if
there is a reasonable certainty of ultimate collection.

–   ICDS
IV, being contrary to the SC ruling, is ultra vires the ITA provisions
and, hence, struck down to that extent.

–  In
the case of Excel Industries, exports were made in Year 1, which
entitled the tax payer to duty free imports. The benefit arising to the tax
payer on exports was recognised in the books in Year 1 and duty free imports
were made in Year 2. In other words, from an accounting parlance, the incentive
was earned in Year 1 and utilised in Year 2. Taxpayer claimed that for tax
purposes, the benefit is taxable in Year 2 when there is corresponding
liability on Government to pay which was upheld by the SC. In more complicated
export incentives or Government grants, the taxability will depend upon facts
and circumstances and may not be straight-forward. As already explained in the
context of retention monies, most tax payers may be offering these incentives
for tax in the year in which it is accrued in the accounts.

 

ICDS IV on Revenue Recognition –
Completed contract method (CCM)

–   Accounting
principles (AS-9) permit the taxpayer with respect to service related contracts
to follow either CCM or POCM for revenue recognition. As per AS-9, the choice between CCM and POCM is
dependent on whether there is only a single act in performance of service
contract or more than one act. It may be noted that the AS are not binding on
all categories of assesses, firms, etc. Such assessees are free to
follow any method of accounting.

–   Judicial
precedents have recognised both methods as valid for tax purposes under the
mercantile system of accounting.

–   ICDS
IV, which only permits POCM, is contrary to the above judicial position and,
hence, liable to be struck down to that extent.

–   It
may be noted that with respect to construction contracts (not service contracts,
covered under AS-9), AS-7, permits only POCM. ICDS III on Construction
Contracts also allows only POCM. The HC did not strike down ICDS III, on this
account, probably because the POCM method is the only acceptable method
provided under AS-7 for construction contracts.

 

ICDS IV on Revenue Recognition – Interest
Income

–   The
Chamber contended that under ICDS IV, interest income on non-performing assets
(NPAs) of Non-banking Financial Companies (NBFCs) would become taxable on time
basis even though such interest is not recoverable.

–  The
HC noted that the CBDT Circular clarifies that while interest income is to be
taxed on time basis alone, bad debt deduction, if any, can be claimed under the
provisions of the ITA. Furthermore, the Parliament has inserted a specific
provision in the ITA to grant bad debt deduction for incomes recognised under
ICDS (without recognition in the books) in the year in which they become
irrecoverable.

–  The
HC held that this provision of ICDS IV cannot be held to be ultra vires
since a corresponding bad debt deduction can be claimed by the taxpayer if the
amount of interest is irrecoverable. Also, the Chamber has not demonstrated
that ICDS IV is contrary to any ruling of the SC or any other Court.

–  The
HC further observed that once interest income is offered to tax on time basis
by claiming corresponding bad debt deduction, if the amount is not recoverable,
ICDS creates a mechanism to track unrecognised interest amounts for future
taxability, if so accrued.

 

ICDS VI on Foreign Exchange Fluctuations

–   The
SC held, in the case of Sutlej Cotton Mills Ltd .vs. CIT, that exchange
fluctuation gain/loss in relation to loan utilised for acquiring a capital item
would be capital in nature.

–   ICDS
VI provides that exchange fluctuation loss/gain in case of foreign currency
derivatives held for trading or speculation purposes shall be allowed on actual
settlement, and not on MTM basis. The HC held that this is not consonant with
the ratio laid down by the SC in the Sutlej Cotton Mills ruling and,
therefore, struck it down.

–   The
CBDT Circular clarifies that the opening balance of Foreign Currency
Translation Reserve Account as on 1 April 2016 (i.e., on the date ICDS first
became applicable), which comprises of accumulated balance of exchange
fluctuation gains/losses in relation to non-integral foreign operations, is
taxable to the extent it relates to monetary items.

–   In
line with the SC decision in the case of Godhra Electric Supply Company Ltd
vs. CIT, the HC held that valuation of monetary assets and liabilities of
the foreign operations as at the end of the year cannot be treated as real
income as it is only in the nature of notional or hypothetical income which
cannot be subjected to tax.

 

ICDS VII on Government Grants

–   ICDS
VII provides that recognition of government grants cannot be postponed beyond
the date of actual receipt. This is in conflict with the accrual system of
accounting since, many times, conditions are attached to the receipt of
government grant which need to be fulfilled in the future. In such instance, it
cannot be said that there is any accrual of income although the money has been
received in advance.

–   Therefore,
the HC struck down ICDS VII to that extent.

 

ICDS VIII on Securities held as Inventory

–   ICDS
VIII provides for valuation of securities held as inventory and is divided into
two parts.

–   Part
B of ICDS VIII, which applies to banks and public financial institutions,
provides that recognition of securities should be in accordance with the RBI guidelines.

–   Part
A applies to taxpayers other than banks and public financial institutions. It
requires valuation of inventory on “bucket approach” i.e., category-wise
application of lower of cost and market instead of individual valuation of each
security. However, this is different from the normal accounting principles and,
thus, taxpayers will need to maintain separate records for tax purposes every
year.

–  The
HC held that Part A of ICDS VIII, which prescribes “bucket approach”, differs
from ICDS II on valuation of inventory which, under similar circumstances, does
not prescribe the ”bucket approach”. This shows that ICDS has adopted separate
approaches at different places for valuation of inventory. This change is not
possible without a corresponding amendment in the ITA. Hence, to that extent,
Part A of ICDS VIII is ultra vires the ITA.

 

Comparison between Indian GAAP, ICDS and Delhi HC Decision

Point  of Difference

Indian GAAP

ICDS

Delhi HC Decision/Judicial pronouncements

Revenue
during early stage of construction, when outcome cannot be estimated
reliably.

Revenue
recognised to the extent costs are recoverable. No threshold is prescribed
for early stage.

Same
as Indian GAAP. However, the early stage shall not extend beyond 25%
completion. (ICDS III – Construction Contracts).

No
change.

Retention
money.

Forms
part of contract revenue and POCM is applied to entire contract revenue.

Same
as Indian GAAP (ICDS III – Construction Contracts).

Retention
money accrues to the taxpayer only when the related performance conditions
are fulfilled, for eg. when the defect liability period is over and the
Engineer-in-Charge certifies that no liability is attached to the tax payer.
Retention money cannot form part of the revenue unless the same has accrued.

Export
incentive.

When
it is reasonably certain that all conditions will be fulfilled and the
ultimate collection will be made.

In
the year of making claim, if there is a reasonable certainty of ultimate
collection. (ICDS VII – Government Grants).

Income
will not accrue, till the time conditions attached to it are fulfilled and
there is corresponding liability on Government to pay the benefit. (SC in Excel
Industries case).

Revenue
from construction contracts.

POCM

POCM

Not
discussed.

Revenue
from service contracts.

POCM
or CCM

u  Only POCM for long duration contracts (>
90 days).

u   CCM permitted for short duration contracts (< 90 days) (ICDS
IV – Revenue Recognition).

Accounting
principles and Judicial precedents permit, both POCM and CCM.

Real
estate developers.

As
per Guidance Note on Accounting for Real Estate Transactions, only
POCM is allowed.

No
ICDS for real estate developers. 
Judicial precedents will apply. 
Therefore, POCM or CCM will be allowed per the method of accounting
regularly employed by the taxpayer. 
The acceptance of CCM by the tax authorities for real estate
developers is a contentious issue and generally resisted by the Tax
Department. There are also cases where CCM has been disallowed by courts.
Currently, if taxpayer is following POCM in books, it would be bound u/s.145,
which requires income to be computed as per method of accounting regularly
followed by the taxpayers in its books. Most corporate real estate developers
follow POCM. A few corporates and non-corporates that followed CCM had to
face severe litigations and an audit qualification from the auditor on the
financial statements.

Not
discussed.

Onerous
Contract.

Expected
losses are recognised as an expense immediately.

Losses
incurred on a contract will be allowed only in proportion to the stage of
completion (ICDS III – Construction Contracts).

Prudence
is inherent in section 37(1) and hence expected losses allowable as per
judicial precedents.

Borrowing
Cost capitalisation – whether substantial period of time is required.

Applies
only when assets require substantial period of time for completion.

No
condition w.r.t substantial period of time except for inventory and general
borrowing costs ( 12 months) (ICDS IX – Borrowing Costs).

No
change.

Capitalisation
of specific borrowing cost.

Actual
borrowing cost.

Actual
borrowing cost.

No
change.

Capitalisation
of general borrowing cost.

Weighted
average cost of borrowing is applied on funds that are borrowed generally and
used for obtaining a qualifying assets.

Allocation
is based on average cost of qualifying asset to average total assets (ICDS IX
– Borrowing Costs).

No
change.

Borrowings
– Income on temporary investments.

Reduced
from the borrowing costs eligible for capitalisation.

Not
to be reduced from the borrowing costs eligible for capitalisation. Thus, it
will be taxable income (ICDS IX – Borrowing Costs).

Accounting
principles and Judicial precedents permit reduction of incidental income
where it has close nexus with construction activity. (SC in Bokaro Steel).

Contingent
Assets.

Recognition
is based on virtual certainty.

Recognition
is based on reasonable certainty (ICDS X – Provisions, Contingent Liabilities
and Contingent Assets).

Test
of ‘reasonable certain’ is not in accordance with S. 4/5 of ITA. Hypothetical
income not creating enforceable right cannot be taxed.

Government
Grant
classification.

u   Income related grant

u   Assets related grant

u   Grant in the nature of promoter’s contribution (credited to
capital reserve).

u     Income related grant

u     Assets related grant

     (ICDS VII – Government Grant).

 

No
change.

Government
Grant – recognition.

Not
recognised until there is a reasonable assurance that the entity shall comply
with the conditions attached to them and the grants will be received.

Similar
to Indian GAAP, except recognition is not postponed beyond the date of actual
receipt. (ICDS VII – Government Grant).

Taxable
when conditions attached to the receipt of government grant are fulfilled
and, there is corresponding liability on Government to pay.

Capitalisation
of exchange differences on long term foreign currency monetary item for
acquisition of fixed assets
(AS 11.46A).

Paragraph
46/ 46A of AS 11 provides option for capitalisation.

u   On imported assets S43A allows capitalisation

u   On local assets S43A does not apply.

u     With respect to local assets, all MTM exchange differences are included
in taxable income (ICDS VI – Foreign Exchange)

Distinguish
between capital and revenue nature of exchange fluctuation (Sutlej Cotton Mills).  Thus, exchange
differences on local capital assets, are not revenue in nature; nor, are
capitalisable under 43A.

Forward
contracts under AS 11 for hedging purpose.

Premium/
discount to be amortised over the contract period. Spot-to-spot gains/ losses
are recognised in P&L.

Same
as Indian GAAP. (ICDS VI – Foreign Exchange).

No
change.

Foreign
currency risk of a firm commitment or a highly probable forecast transaction.

As
per Guidance Note on Accounting for Derivative Contracts (GN)
derivatives are measured at fair value through P&L, if hedge accounting
is not applied.

Premium,
discount or exchange difference, shall be recognised at the time of
settlement. (ICDS VI – Foreign Exchange).

ICDS
cannot override judicial precedents (which will implicitly include SC ruling
in Woodward Governor’s case (312 ITR 254) which upheld MTM treatment
as per accounting principles). Thus MTM losses/gains are deductible/taxable.

Foreign
currency risk on contract for trading or speculative purposes.

As
per GN, derivatives are measured at fair value through P&L.

Premium,
discount or exchange difference shall be recognised at the time of
settlement. (ICDS VI – Foreign Exchange).

MTM
losses are tax deductible

[SC
in Sutlej Cotton Mills].

MTM
gains – No clarity but on principles, it is taxable.

MTM
losses on commodity derivatives.

As
per GN, derivatives are measured at fair value through P&L, if hedge
accounting is not applied.

u   MTM losses are not tax deductible. (ICDS I – Disclosure of
Accounting Policies)

u     CBDT Circular – MTM Gains are not taxable.

u     Consequently, tax will apply on settlement.

ICDS
cannot override judicial precedents (which will implicitly include SC ruling
in Woodward Governor’s case (312 ITR 254) which
permitted MTM treatment as per accounting principles).  Thus MTM losses/gains are
deductible/taxable.

 

The Road Ahead

The ICDS has far-reaching implications on tax
liability of assessees, which are debilitating. The introduction of Ind AS
should have been tax neutral, with minimal or no impact on tax liability. It is
unfortunate that Ind AS was used as an excuse to introduce ICDS that had severe
tax consequences on tax payers, which were mostly negative. The standards were
framed by a part time committee and that too in a great hurry. The ICDS
standards appear to be one sided, determined to maximise tax collection, rather
than routed in sound accounting principles. Such a backhanded and concealed
manner of bringing in an important piece of legislation, many of the provisions
of which were in conflict with the ITA or judicial precedents was deservedly
struck down by the HC. To the extent, the provisions were in conflict with the
ITA, the ICDS itself provided that those would prevail over ICDS. However,
there was no such exemption for ICDS provisions that were in conflict with
judicial precedents. The CBDT’s clarification in the Circular that ICDS shall
prevail over judicial precedents on ‘transactional issues’ was also highly
unsatisfactory.

 

There were also many interpretative
challenges that could have created a very litigious environment. Consider this;
the preamble of the ICDS states that where there is conflict between the
provisions of the ITA and ICDS, the provisions of the ITA shall prevail to that
extent. If a company has claimed mark-to-market losses on derivatives as
deductible expenditure u/s. 37(1) of the ITA – Can the company argue that this
is a deductible expenditure under the ITA (though the matter may be sub
judice) and hence should prevail over ICDS which prohibits mark-to-market
losses to be considered as deductible expenditure?

 

Some of the transitional provisions in ICDS
had significant unanticipated effect. For example, the ICDS requires contingent
assets to be recognised based on reasonable certainty as compared to the
existing norm of virtual certainty. Consider a company has filed several
claims, where there is reasonable certainty that it would be awarded
compensation. However, it has never recognised such claims as income, since it
did not meet the virtual certainty test under AS 29 Provisions, Contingent
Liabilities and Contingent Assets. Under the transitional provision, it
will recognise all such claims in the first transition year 2016-17. If the
claim amounts are significant, the tax outflow could be devastating. This could
negatively impact companies that have these claims. The interpretation of “reasonable
certainty” and “virtual certainty” would also come under huge stress and
debate.  This may well be another
potential area of uncertainty and litigation.

 

The struck down ones of some contentious
provisions of ICDS by the HC is a huge relief to tax payers. It will not only
bring fairness and tax neutrality but will also avoid a litigious environment,
provided the HC decision is upheld by the SC and not contested by the
Government.

 

Taxpayers which have already filed returns
for tax year 2016-17 can explore revising their returns on the basis of the law
laid down by the present ruling. While there may be no difficulty in case of
the SC ruling which is binding on all lower Courts in India, there could be
difficulties in the case of a High Court ruling. A High Court ruling would be
binding on a lower judicial authority in the jurisdictional area of the High
Court. Whether a High Court ruling would bind lower judicial authority in other
jurisdictional areas is a highly contentious and debatable matter.

 

In this respect, different High Courts have
taken different views. If other High Courts step into this issue, the situation
can get very muddy and complicated, particularly if they take a conflicting
position from that taken by the Delhi HC. Therefore, it is natural to expect
that the CG may intervene, either by filing a special leave petition with the
SC for stay of the HC decision or alternatively, incorporating the ICDS as part
of the Act. _

17 Section 9 of the Act; Articles 12, 23 of India-UK DTAA – Guarantee fee received by UK company from its Indian subsidiaries is not in the nature of ‘Interest’, business income or FTS; such income qualifies as ‘Other Income’.

[2017] 88 taxmann.com 127 (Delhi – Trib.)

Johnson Matthey Plc v. DCIT

A.Y.: 2011-12, Dated: 06thDecember,
2017


Facts

The Taxpayer was a company incorporated in,
and resident of, the UK. ICo 1 and ICo 2 were two Indian subsidiary companies
of the Taxpayer. The Taxpayer, inter alia, provided guarantees for
credit facilities provided by foreign banks to ICo1 and ICo 2. The Taxpayer
offered the guarantee fees received from ICo 1 and ICo 2 as ‘Interest’ taxable
at the rate of 15%, under Article 12 of India-UK DTAA.

 

The AO concluded that the guarantee fee was
‘Other Income’ under Article 23 of India-UK DTAA and accordingly, was subject
to tax at the rate of  40%.

 

The Taxpayer contended that the guarantee
fee was in the nature of business income and such fee was not taxable in India,
in absence of a PE. The Taxpayer further contended that it offered the fee to
tax as ‘Interest’ out of abundant caution.

 

Held

–    The term “interest” in Article
12(5) of DTAA and section 2(28A) of the Act is to be understood in the context
of the other words and phrases used in the definition. The term “interest”, in
its widest connotation, will indicate the payments made by the receiver of some
amount, pursuant to a loan transaction. Even the expressions “claims of
any kind” or “service fee or other charge” as appearing in the
DTAA or in the Act, are to be understood in relation to the transaction or
contract of loan.

 

–    A payment can be treated as interest only in
the context and privity of loan contract. though no creditor-debtor
relationship may exist. Payments made to strangers cannot be treated as
interest, even where such payments are incidental to a loan.

 

–    The Taxpayer was a stranger to the privity
of loan transactions as the contract of loan was different from the contract of
guarantee.

 

–    Accordingly,
scope of the expressions “debt claims of any kind” or “the
service fee or other charge in respect of moneys borrowed or debt
incurred” cannot be extended to payment of guarantee commission as the
Taxpayer was a stranger to the privity of contract of loan.

 

–    The Taxpayer was manufacturing
technologically advanced chemicals and was not in the business of providing
corporate/bank guarantee to earn guarantee commission. It had provided
guarantee only to secure finance for its subsidiaries and not to earn fee.
Hence, the fee cannot be considered ‘business profit’ under Article 7 of
India-UK DTAA.

 

–    Such fee was neither for rendering any
technical or consultancy service nor for making available any knowledge,
experience, skill know-how or process, nor was it for any development or
transfer of a technical plan or a technical design. Further, it was also not
covered within Explanation to section 9(1)(vii) of the Act. Hence, it could not
not be considered Fee for technical service (FTS).

 

–    Accordingly, guarantee fee was taxable as
‘Other Income’ in terms of Article 23(3) of India-UK DTAA. _

16 Section 9 of the Act; Article 5 of India-USA DTAA – Income of US company could not be taxed in India since non-exclusive advertising and sales agent for canvassing channel airtime sales did not constitute PE of US company in India

[2017] 87 taxmann.com 345 (Mumbai – Trib.)

SPE Networks India Inc. vs. DCIT

A.Ys: 2005-06 to 2010-11,

Date of Order: 08th November,
2017


Facts

The Taxpayer was a company incorporated in,
and a resident of, USA. It was engaged in the business of operating, marketing
and distribution of the television channels and related activities. For
marketing two of its channels the Taxpayer had appointed its group company in
India (“ICo”) as a non-exclusive advertising and sales agent for canvassing
airtime for its channel. The Taxpayer was to receive substantial portion of the
share of revenue collected by ICo from distribution of channels. The Taxpayer
claimed that since it did not have PE in India, in terms of Article 7 of
India-USA DTAA, its income was not taxable in India.

 

For the following reasons, AO contended that
ICo was a dependent agent of the Taxpayer and hence, the Taxpayer had a
business connection and Dependent Agency PE in India.

 

(i)   The Taxpayer carried on
the telecasting business in India by extensively utilising the services of ICo
for sale of advertisements and distribution of channels.

(ii)  Activities of both the
Taxpayer and ICo were interlaced, interconnected, inter dependent and interlinked.

(iii)  The agreement was a
revenue sharing arrangement which depended upon the gross advertisement airtime
revenue and not purchase and sale of advertisement airtime.

(iv) ICo had an authority to
conclude contracts on behalf of the Taxpayer in India .

 

     Accordingly, AO held that
15% of the net revenue received by the Taxpayer from ICo was taxable in India.

 

Held

?   Taxpayer had entered into two agreements
with ICo, which gave rise to two revenue streams for the Taxpayer i.e
advertisement revenue and distribution revenue. Advertisement revenue was
generated from advertisement broadcasted on the channel and distribution
revenue was generated by distributing the viewership rights to the customers
through cable operators.

 

?   Perusal of the agreements clearly showed
that: (a) the Taxpayer was carrying on its operations from USA and not from
India; (b) both sale of advertisement and distribution of channels were not
carried out in India; (c) the Taxpayer did not have any office premises or a
fixed place of business in India at its disposal; and (d) none of its employees
were based in India through whom it could render the services in India. Thus,
there was neither fixed base PE nor service PE in India.

 

?    Though CIT(A) endorsed the view of the AO
that the Taxpayer had Agency PE, nothing was brought on record to prove that
the agreements between the Taxpayer and ICo were not on Principal-to-Principal
basis. Tribunal noted that: (i) ICo had no authority to conclude contract on
behalf of the Taxpayer; (ii) while selling the airtime and distributing
channels, ICo was acting in its own right and not on behalf of the Taxpayer:
(iii) ICo was not dependent on the Taxpayer economically or legally; and (iv)
ICo also carried out significant marketing activities for other channels.
Hence, it was an independent entity carrying on its own business. 

 

?  ICo
purchased airtime from the Taxpayer and sold in its own right and the Taxpayer
had no control over it. The revenue earned by ICo was not on behalf of the
Taxpayer. ICo made payment to the Taxpayer for the purchases. ICo was not
subject to any control of the Taxpayer for conducting business in India. Its
activities were not devoted wholly or almost wholly for the Taxpayer.
Similarly, revenue of the Taxpayer was not entirely dependent on the earning of
ICo. Thus, it cannot be treated as a dependent agent, of the Taxpayer.

 

?   The AO had not alleged that the transactions
between the Taxpayer and ICo were not at arm’s length. The TPOs had held that
no TP adjustments were required to be made to the income of the Taxpayer on
account of advertisement revenue or distribution revenue.

 

?  Accordingly, the Taxpayer did not have any
business connection or agency PE or fixed base PE in India and ICo was not an
agent of the Taxpayer. Hence, the AO had wrongly invoked Rule 10.

15 Articles 4, 8, 29 of India-UAE DTAA – Since India-Germany DTAA also provided benefits similar to India-UAE DTAA, it could not be said that incorporation of the company in UAE was for availing DTAA benefits merely because it was owned by German shareholders.

[2017] 88 taxmann.com 102 (Rajkot – Trib.)

ITO vs. Martrade Gulf Logistics FZCO-UAE

A.Y. 2008-09, Date of Order: 28th
November, 2017

Facts       

The Taxpayer was a company incorporated in
UAE engaged in the business of shipping. It had filed return u/s. 172(4) of the
Act. The Taxpayer was held by German shareholders. The Taxpayer claimed that
the income earned out of the operations of ships in international waters was
not taxable in India by virtue of India-UAE DTAA.

 

The AO noted that: (i) the meeting of its
shareholders was held outside UAE; (ii) its directors were not residents of
UAE; (iii) its shareholders were not residents of UAE; (iv) the Taxpayer was
not liable to tax in UAE; and (v) the Taxpayer only had its registered office
in UAE with some senior employees. Hence, the AO concluded that effective
control and management of the Taxpayer was not situated in UAE and denied
India-UAE DTAA benefit. Further, the AO contended that the Taxpayer was merely
registered in UAE for doing the business of the German entities. Thus, owing to
Article 29 of India-UAE DTAA, benefit of Article 8 cannot be granted to the
Taxpayer.

 

However, the Taxpayer contended that despite
the fact that its shareholders and directors are non-UAE residents, it was managed
and controlled wholly from UAE, and the business was also carried on from UAE.
Hence, it was eligible for India-UAE DTAA benefits.

 

On appeal, the CIT(A) observed that the
place of effective management of the Taxpayer was UAE. Further, UAE had also issued
Residency Certificate, Incorporation Certificate, Trading License and other
documents. Hence, the CIT(A) concluded that the Taxpayer was a resident of UAE
and consequently, eligible for treaty benefit.

 

The CIT(A) further referred to explanation
u/s. 115VC of the Act which defines the place of effective management in case
of a ship operating company and stated that since all the board meetings were
regularly conducted in UAE, the control and management was situated in UAE.
Accordingly, he held that the AO had wrongly determined the residential status
of the Taxpayer by considering the nationality of the directors. Therefore,
having regard to Article 8, read with Article 4, of India-UAE DTAA, profits
from operations of ship in international waters was not taxable in India.

 

Held

?  On account of its incorporation in UAE, the
Taxpayer was liable to tax in UAE. Therefore, it was “resident of Contracting
State” under Article 4(1) of the India-UAE DTAA.

 

?    Tribunal further relied on its earlier
decision in ITO vs. MUR shipping DMC Co. (ITA No. 405/RJT/2013) and
observed that:

•    All that is necessary for
the purpose of being treated as resident of a Contracting States under
India-UAE DTAA is that the person should be liable to tax in that Contracting
State by reason of domicile, residence, place of management, place of
incorporation. Reliance in this regard was placed on the decision of ADIT
vs. Green Emirate Shipping and Travels, (2006) 100 ITD 203 (Mum).

 

•    Being ‘liable to tax’ in
the Contracting State does not necessarily imply that the person should
actually be liable to tax in that Contracting State by virtue of an existing
legal provision but would also cover the cases where that other Contracting
State has the right to tax such persons, irrespective of whether or not such a
right is exercised by the Contracting State.

 

•    Since the Taxpayer was not
a resident of India, the question of applying the POEM test under the
tie-breaker rule in Article 4(4), which the AO had emphasised, was irrelevant.

 

•    For invoking Article 29,
it should be established that if the Taxpayer was not to be incorporated in
UAE, it would not have been entitled for such benefits. However, India-Germany
DTAA also provided such benefit. Hence, even if the Taxpayer was incorporated
in UAE but its entire share capital was held by German entities shall not
affect the taxability of shipping income. This is for the reason that  similar benefit with regard to taxability of
shipping profits is available even under India-Germany treaty. Therefore, the
requisite condition for invoking Article 29 was not fulfilled.

 

14 Articles 8, 24 of India-Singapore DTAA – Distinction between ‘liable to tax’ and ‘subject to tax’; expression ‘exempt from tax’ implies, treaty benefit of non-taxation in source state depends on taxability in residence state; remanded to CIT(A) for proper deliberation on whether treaty benefits can be granted in source state, where such benefit results in double non-taxation.

TS-556-ITAT-2017(Rjt)

BP Singapore Pte Ltd. vs. ITO

A.Y.: 2015-16,

Date of Order: 28th November,
2017


Facts

A Singapore Company (“the Taxpayer”) was
engaged in the business of operation of ships in international waters. The
Taxpayer had claimed exemption under Article 8 of the DTAA in respect of the
freight income.

 

The Assessing Officer (“AO”) contended that
Article 24 of the India-Singapore treaty grants benefits of an exemption or
lower rate of taxation under the treaty only where income was taxed in
Singapore and since there was no evidence indicating that the freight income
was taxed in Singapore, AO applied Article 24 and denied the treaty benefits to
the Taxpayer.

 

The Taxpayer contended that as per Article
8, India has no right to tax shipping income. Hence, the income cannot be said
to be “exempt from tax in India”. Therefore, Article 24 was not applicable to
the facts of the case. Further, since the income was taxable in Singapore on
accrual basis1 , even for this reason, Article 24 could not be
applied.

_________________________________________________________

1   Though
the Taxpayer had claimed that the income was taxed in Singapore on accrual
basis, during the proceedings before Tribunal, it mentioned that because of
applicability of an incentive provision, such freight income was not taxed in
Singapore.

 

 

Held

?    The income was liable to tax in Singapore as
the fiscal domicile of the Taxpayer was in Singapore. However, it was not
actually taxed because of the incentive provision. In other words, though it
was “liable to tax”, the income was not “subjected to tax”

?    On the issue of whether income was “exempt
from tax in India”, Tribunal held as follows:

 

•    Article 3(2) requires
contextual interpretation of the undefined terms. Even where there is a
domestic law meaning to the undefined term, the contextual meaning will have
precedence.

 

•    The expression ‘exempt
from tax’ in Article 24, essentially implies that the treaty benefit of
non-taxation of an income, or its being taxed at a lower rate in a contracting
state (in this case, India), depends on the status of taxability in other
contracting state (in this case, Singapore).

 

•    Irrespective of whether
the treaty grants taxing rights exclusively to resident state (like the
language used in Article 8) or exempts the income in the source state the
impact on source state taxation remains the same, especially if seen in the context
of the provisions of the treaty where a benefit being granted is dependent
on the taxation in resident state.

 

?    Thus, technically, Article 24 was applicable
to the facts of the case.

 

?    However, noting that granting of treaty
benefits in the facts of the case, would lead to double non-taxation of income,
the matter was remanded back to CIT(A) for adjudication de novo on the issue of
whether, having regard to the underlying objective of the treaty to avoid
double non-taxation, treaty benefits in the source state (i.e India) can be
granted in respect of an income which is exempt from tax in resident state.

 

?    The Tribunal noted that this issue would
impact a large number of Singapore companies and may be difficult to adjudicate
without proper deliberation, backed by the submissions of the parties. Hence,
the Tribunal remanded the matter to the CIT(A) to consider the issue and
directed both the parties to provide detailed arguments before CIT(A).

Impact Of Multilateral Instrument On India’s Tax Treaties From An Anti-Abuse Rules Perspective

BACKGROUND

On 7th June 2017, representatives
of 68 jurisdictions met at the OECD headquarters in Paris to sign the
multilateral instrument[1]
(MLI). The MLI is an outcome of the Base Erosion and Profit Sharing (BEPS)
Action 15, which specifically addresses the issue of how to modify existing
bilateral tax treaties in order to implement BEPS tax treaty measures. The
MLI is an innovative and swift way of modifying bilateral tax treaties without
getting caught in the time-consuming process of re-negotiating each tax treaty.
The implementation of the MLI is expected to have a far-reaching impact on the
existing bilateral tax treaties. The OECD estimates that potentially 1,100
existing bilateral tax treaties are set to be modified. This is a turning
point in the history of international taxation.

 

SCOPE OF MLI FROM INDIA’S PERSPECTIVE

As of now, the MLI is signed but not yet
effective. The MLI will enter into force on the first date of the month after
three calendar months from the date when at least five countries deposit the
instrument of ratification, acceptance or approval; detailed provisions are
also there for entry into effect of the MLI.

 

Once the MLI is effective, it will modify an
existing bilateral tax treaty only if both the countries have notified the tax
treaty for the purposes of MLI. Under the MLI framework, such a tax treaty is
referred to as the covered tax agreement (CTA). India has notified all its tax
treaties (such as tax treaties with USA, UK, Singapore, Netherlands, Japan,
Luxembourg, etc.) as CTAs for the purposes of MLI. However, there are
some countries such as Mauritius, Germany and China who have chosen not to
notify their tax treaty with India – accordingly, the MLI will not apply to
India’s tax treaties with Mauritius, Germany and China. Further, USA and Brazil
are not signatories to the MLI itself. Accordingly, apart from tax treaties
with a few countries, most of India’s tax treaties will stand modified when the
MLI becomes effective.

 

It may be noted that all tax treaties will
not stand modified at the same time. The effective date of MLI for each
signatory country will vary depending upon when that country signed the MLI.
The MLI provisions will apply only after the MLI has become effective for both
countries.

 

MINIMUM STANDARDS OF BEPS ACTION 6
IMPLEMENTED THROUGH MLI

The MLI implements two minimum BEPS
standards relating to prevention of tax treaty abuse (BEPS Action 6) and
improvement of dispute resolution (BEPS Action 14). In this article, we are
discussing the impact of MLI on India’s tax treaties with respect to BEPS
Action 6.

 

The BEPS Action
6 identified treaty abuse, and in particular treaty shopping, as one of the
most important sources of BEPS concerns.Taxpayers engaged in treaty shopping
and other treaty strategies claim treaty benefits in situations where these
benefits are not intended to be granted, thereby depriving countries of tax
revenues. Therefore, countries have come together to include anti-abuse
provisions in their tax treaties, including a minimum standard to counter
treaty shopping. The BEPS Action 6 includes three alternative rules to address
tax treaty abuse:

 

1.  Principal purpose test
(PPT) rule (a general anti-abuse rule based on the principal purpose of
transactions or arrangements)

 

2.  PPT rule, supplemented with
either simplified or detailed limitation of benefits (LOB) rule (a specific
anti-abuse rule which limits the availability of treaty benefits to persons
that meet certain conditions)

 

3.  Detailed LOB rule,
supplemented by a mechanism that would deal with conduit arrangements not
already dealt with in tax treaties.

PPT rule

The MLI presents the PPT rule as the
default option (as the PPT rule meets the minimum standard recommended under
BEPS Action 6 on a standalone basis). Being a
minimum standard, these are mandatory provisions of the MLI and therefore, the
countries who have signed the MLI cannot typically opt out of these provisions.
As an exception, the countries can opt out if a tax treaty already meets the
minimum standards or if it is intended to adopt a combination of a detailed LOB
provision and either rules to address conduit financing structures or a PPT.
Accordingly, generally speaking, PPT rule of the MLI will replace the existing
anti-abuse provision in the tax treaty, or will be inserted in the absence of
anti-abuse provision in the tax treaty. For example, India’s tax treaties with
Canada, Denmark, France, Ireland, Japan, Netherlands, and Sweden do not have an
anti-abuse provision and therefore, the PPT rule of the MLI will be inserted
into those tax treaties.

 

The PPT rule of the MLI provides that a
benefit under a tax treaty shall not be granted if it is reasonable to
conclude, having regard to all relevant facts and circumstances, that obtaining
the benefit was one of the principal purposes of any arrangement or transaction
that resulted directly or indirectly in that benefit. A classic example is
where the PPT rule addresses treaty shopping by multinational companies who set
up ‘letterbox’ or ‘conduit’ companies which do not have substance in reality
and exist only to take advantage of the tax treaty. With the operation of the
PPT rule, the tax treaty benefits would be denied to such ‘letterbox’ or
‘conduit’ companies which are set up primarily with the intention to take
advantage of a favourable tax treaty. However, such benefit may be granted if
it is established that granting that benefit in these circumstances would be in
accordance with the object and purpose of the relevant provisions of the tax treaty.

 

The explanatory statement to the MLI
clarifies that the PPT rule of the MLI will not only replace the existing PPT
rules that deny all tax benefits under a particular tax treaty (a general
anti-abuse rule) but also those existing rules that deny tax benefits under
specific articles such as dividends, royalties, interest, income from
employment, other income and elimination of double taxation. This will ensure
that narrower provisions are replaced by the broader PPT rule of the MLI. In
case of a tax treaty that does not already contain a PPT rule, the PPT rule of
the MLI will be added. All these changes to the tax treaty are going to make
treaty shopping difficult. The amendments to the tax treaty arising from
operation of MLI will be prospective. Further, there is no grandfathering
clause available under the MLI provisions for the existing structures. The taxpayers
may have to evaluate how to align their structures with the amended tax
treaties.

 

The PPT rule of the MLI refers to “one of
the principal purpose” as opposed to “principal purpose” or “main purpose” or
“primary purpose”. Thus, the PPT rule of the MLI is broader than some of the
existing PPT rules contained in tax treaties which only refer to main or
principal or primary purpose. Therefore, the PPT rule of the MLI, once
incorporated into the tax treaties may broaden the scope of anti-abuse provision.
Existing structures which have been put in place simply to take advantage of
the tax treaties and which do not have any substance would be adversely hit by
the amended tax treaties.

 

Simplified LOB rule

In addition to the PPT rule under the MLI, a
country may also opt to apply a simplified or detailed LOB rule. Under the MLI,
an optional provision will be applicable to a tax treaty only if both the
countries have opted for such provision. If one of the countries has not opted
for it, the optional provision will not be applicable to the CTA. Thus, the
simplified LOB rule (an optional provision) will be applicable to a particular
tax treaty only if both the countries to the tax treaty have exercised the
choice to opt for it. While India has chosen to apply the simplified LOB, very
few other countries[2]
have made a similar choice. Practically, simplified LOB will not get
incorporated into India’s tax treaties, except where the other country has also
opted for such rule (such as, Bulgaria, Colombia, Indonesia, Russia, Slovak
Republic and Uruguay). Though the inclusion of PPT rule and simplified LOB rule
makes the anti-abuse provisions in the tax treaty stronger, from an India tax
treaty perspective, the PPT rule is going to be relevant as very few countries
have opted for simplified LOB rule.

 

Detailed LOB

The detailed LOB is out of the ambit of the
MLI and does not provide for the text of the detailed LOB as it requires
substantial bilateral customisation. Instead, countries that prefer to address
treaty abuse by adopting a detailed LOB provision are permitted to opt out of
the PPT and agree instead to endeavour to reach a bilateral agreement that
satisfies the minimum standard.

 

IMPACT ON SELECT INDIA’S TAX TREATIES

 

India-UK

 

Article 28C of the India-UK tax treaty,
which is a general anti-abuse provision, will stand replaced by the PPT rule of
the MLI as India and UK both have notified Article 28C for the purposes of MLI.
The PPT rule of the MLI provides for a carve-out in case where the tax benefits
are in accordance with the purpose and object of the tax treaty whereas Article
28C of India-UK tax treaty does not have such a carve-out. Therefore, the
replacement of the PPT rule in place of Article 28C of the India-UK tax treaty
may lead to relaxation of the general anti-abuse provision in the tax treaty.

 

The UK has also notified anti-abuse
provisions contained in Articles 11(6), 12(11) and 13(9) of the India-UK tax
treaty for the purposes of application of MLI; however, India has not notified
these provisions leading to notification mismatch. Based on the step-by-step
process outlined by the OECD, the PPT rule of the MLI will supersede these
articles to the extent they are incompatible with the PPT rule. India and UK
are not on the same page in case of Articles 11(6), 12(11) and 13(9) of the
India-UK tax treaty.

 

India-Singapore

 

The India-Singapore tax treaty contains
specific anti-abuse provisions which deny tax treaty benefits in relation to
capital gains. These provisions are in the nature of a specific anti-avoidance
rule (SAAR) and will not be impacted by the PPT rule. The PPT rule will
accordingly co-exist with the capital gains SAAR. At this stage, it is unclear
as to how this will play out. It will suffice to say that MLI will make this
treaty one of the most complicated.

 

India-Mauritius

 

Mauritius has not notified the
India-Mauritius tax treaty as a CTA, and accordingly, the PPT rules will not be
included as part of the tax treaty.

 

India-Luxembourg

 

The general anti-abuse provision contained
under Articles 29(2) and (3) of the India-Luxembourg tax treaty can be regarded
as broader in scope than the PPT under the MLI. As India and Luxembourg have
notified the Articles 29(2) and (3), the PPT under the MLI will replace the
aforementioned articles of the India-Luxembourg tax treaty. Thus, there is a
relaxation of the threshold.

 

India’s tax treaties with Canada, Denmark,
France, Ireland, Japan, Netherlands, Sweden

 

These tax treaties do not have an anti-abuse
provision and therefore, the PPT rule of the MLI will be inserted into the tax
treaty.

 

INTERPLAY BETWEEN PPT RULE OF THE MLI AND
GENERAL ANTI-AVOIDANCE RULE (GAAR) UNDER THE INCOME-TAX ACT, 1961

 

Scope of PPT rule of the MLI and GAAR

 

The scope of operation of the PPT rule of
the MLI and GAAR are different; whereas the PPT rule applies only to tax treaty
abuse, the GAAR applies to all kinds of abuse of the tax provisions (including
tax treaty abuse). The PPT rule of the MLI is different than GAAR when it comes
to the use of the terms “one of the principal purposes” as opposed to “main
purpose” under the GAAR. An arrangement which has more than one principal/main
purpose (of which obtaining tax benefit is one, but is not the main purpose)
may get covered under the PPT rule of the MLI, but may not attract GAAR.
Moreover, for GAAR to apply, the transaction should also not be at arm’s
length/ result in abuse of provisions of law/lack or deem to lack commercial
substance/is not bona fide. In contrast, the PPT rule of the MLI
provides a carve-out in terms of which the tax benefits will not be adversely
impacted by the PPT rule of the MLI, if such tax benefits are in line with the
purpose and objects of the tax treaty. Therefore, it cannot be generalised
whether PPT rule of the MLI or GAAR is broader in scope.

 

Interaction between PPT rule and GAAR

 

Let’s consider a situation where if the PPT
rule were applied, the tax treaty benefits would be denied; however, if the
GAAR were invoked, the tax treaty benefits would not be denied. The Income-tax
Act, 1961 (ITA) broadly provides that a taxpayer can apply the provisions of
the ITA or the tax treaty, whichever is beneficial. Relying on this provision,
can a taxpayer contend that it wants to be governed by the provisions of the
GAAR under the ITA and not the PPT rule under the tax treaty? This seems a
difficult proposition, as once the taxpayer elects to claim the benefits of a
tax treaty (say, reduced withholding tax on technical service fees), the entire
treaty (including the PPT rule) has to be considered, leading to the benefit
not being available.

 

To summarise, once a taxpayer seeks to claim
a tax treaty benefit, the PPT rule is to be examined to see whether the benefit
is to be granted or not. Thereafter, even if the PPT rule is not triggered, it
may be open to the tax authorities to deny the tax treaty benefit by invoking
the GAAR.

 

Implementation and administration of GAAR

 

The Indian tax authorities have the right
to deny tax treaty benefits if the GAAR is invoked in a particular case. It all boils down to how the Indian tax authorities will administer
the GAAR. In the context of the LOB rule, the Indian tax authorities have
clarified that GAAR will be invoked in cases where they believe that anti-abuse
rules under the tax treaty have fallen short of preventing the mischief of tax
treaty abuse. There are checks and balances provided under the GAAR in order to
prevent an overzealous tax officer from involving GAAR in every case. Any
proposal to invoke GAAR will be vetted by senior tax authorities at the first
stage and by another panel at the second stage that will be headed by a High
Court Judge. However, time will be the best judge of how Indian tax authorities
implement and administer the GAAR.

 

It is pertinent to note that these processes
and safeguards for invoking GAAR are strictly not applicable to the PPT rule. We will need to see whether these processes and safeguards are
extended for applying the PPT rule as well – clarifications on this are awaited
from the Indian tax authorities.

 

CONCLUSION

India is at the forefront in the fight
against tax avoidance and black money. The BEPS project and its implementation
through the MLI is an important opportunity available to the Indian and foreign
governments to strengthen their tax treaties to tackle the issue of tax treaty
shopping. _


[1] Multilateral Convention to Implement Tax Related Measures to
Prevent Base Erosion and Profit Shifting

[2] Argentina, Armenia, Bulgaria, Chile, Colombia, Indonesia, Mexico,
Russia, Senegal, the Slovak Republic and Ururguay.

33. U/s. 80HHC – Export Business – Deduction – A. Y. 1996-97 – Supporting manufacturer – Application by exporter for renewal of trading house certificate pending before concerned authorities – Does not disentitle supporting manufacturer to the deduction u/s. 80HHC – Exporter gave disclaimer certificate with details of export – Supporting manufacturer entitled to benefit of deduction u/s. 80HHC(1A)

CIT vs. Arya Exports and Industries; 398 ITR 327 (Del):

 

The assessee was a supporting manufacturer
of an export trading house, R. In its return for the A. Y. 1996 97, the assessee claimed deduction u/s. 80HHC(1) on the net profit
shown in the profit and loss account. It had dispatched the supplies prior to
31/03/1995 and on various dates between 01/04/1995 to 05/06/1995 and the goods
were exported by R which had issued a disclaimer certificate on 29/08/1996. It
submitted the certificate in form 10CCAB, which was issued by the export
trading house R, confirming that no deduction u/s. 80HHC(1) had been claimed by
R in respect of the export turnover shown by the assessee. The certificate
contained the particulars which related to the supporting manufacturers and the
export trading house, also included the invoice numbers, dates of invoice,
shipping bill numbers, nature of goods with quantities, etc. R had a
trading house certificate, valid up to 31/03/1995 and had filed an application
for renewal of its trading house certificate by a receipt dated 16/10/1995, and
had not received any communication to indicate that its application for renewal
was rejecetd. The Assessing Officer held that it was obligatory on the part of
R, the export trading house, to obtain a certificate from the concerned
Government authorities and that without the renewal certificate, the claim for
deduction u/s. 80HHC by the assessee, a supporting manufacturer, was not valid
and that therefore, the exports done after 01/04/1995 were not entitled to
deduction u/s. 80HHC. The Commissioner (Appeals) and the Tribunal allowed the
assessee’s claim for deduction.

 

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

 

“i)   The assessee was entitled
to the deduction u/s. 80HHC(1A) for the A. Y. 1996-97. The legislative scheme
which emanated from sub-section (1A) of section 80HHC was to treat the
supporting manufacturer and its entitlement to deduction separately from that
of the exporter. The words “assessee” used throughout s/s. (1) referred only to
the exporter whereas the same word used throughout s/s. (1A) referred to the
supporting manufacturer. There was a discernible distinction, in the
legislative scheme of section 80HHC between, the deduction that could be
claimed by an exporter and the deduction that could be claimed by a supporting
manufacturer. While the supporting manufacturer has to fulfil the condition of
a certificate having been issued by the exporter/export trading house to avail
the benefit of a deduction from the turnover that had been made available to
the supporting manufacturer, expressly u/s. 80HHC(1A), the deduction did not
hinge upon the eligibility of the exporter for the deduction u/s. 80HHC(1).
Further, a perusal of form 10CCAB showed that there was a separate certificate
to be issued in favour of the supporting manufacturer where the exporter made a
declaration that it had not claimed a deduction u/s. 80HHC(1) and there was a
counter verification by the chartered accountant of such a certificate. It was,
therefore, clear that there was no double deduction claimed in respect of the
export, which was consistent with the legislative intent of extending the
benefit u/s. 80HHC either to the exporter or to the supporting manufacturer and
not to both.

 

ii)   Even
after the period for which the renewal of the trading house certificate was
sought, R continued to be treated as an export house according to the facts
that had emerged before the Commissioner (Appeals) and the Tribunal. R filed an
application for renewal of its trading house certificate, which was pending
before the relevant authorities for four years and was pending even on the date
of the assessment order.

 

iii)   The export import policy
for the relevant period expressly stated that during the interim period the
export trading house would be eligible to claim all the facilities and benefits
of the exporter and, therefore, the further benefit of the supporting
manufacturer as well. The benefit u/s. 80HHC was, therefore, available to R for
the exports made during the period in question. However, R having issued the
disclaimer, did not, in fact, claim the deduction. The mere non-grant of the
renewal of the trading house certificate by the Director General of Foreign
Trade could not deprive the assessee as a supporting manufacturer of the
deduction it was entitled to u/s. 80HHC(1A).”

32. Sections 2(15) and 12AA – Charitable Trust – Registration – A. Y. 2012-13 – Meaning of charitable purpose – Institution for training Government officials in water and land management – Direct connection with preservation of environment – Institution entitled to registration

CIT vs. Water and Land Management
Training and Research Institute; 398 ITR 283 (T&AP):

 

The assessee is an institution established
in the year 1983, under the control of the Irrigation Department of the
Government of Andhra Pradesh. The assessee applied for registration u/s. 12AA
of the Act. The Director of Income Tax (Exemptions) observed that though the
institute was mainly functioning as a training institute for the purpose of
training Government officials in the field of water and land management, the
institute was also providing guidance to farmers and rendering consultancy
services to various organisations for a fee. With this view, the Director of
Income-tax (Exemptions) rejected the application for registration. The Tribunal
allowed the appeal and directed registration u/s. 12AA. 

 

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

 

“i)   A careful reading of the
definition of the expression “charitable purpose” appearing in section 2(15) of
the Act, 1961 would show that it is an inclusive definition. This is clear from
the usage of the word “includes”. The definition “includes” within its ambit,
(a) relief of the poor, (b) education, (c) yoga, (d) medical relief, (e)
preservation of environment including waterheads, forests and wildlife, (f)
preservation of monuments or places or objects of artistic or historic interest
and (g) the advancement of any other object of general public utility.
Interestingly, the first proviso does not deal with anyone of the first six
items. The first proviso as it stood before April 1, 2016 or even as it stands
after April 1, 2016 deals only with one of the seven items covered by the
substantive part of the definition, namely, “advancement of any other object of
general public utility”. The second proviso takes away from the ambit of the
first proviso, even an activity relating to the advancement of any other object
of general public utility, if the aggregate value of the receipts from the
activities referred to in the first proviso is 
Rs. 25 lakhs or less in the previous year.

 

ii)   It is only after an
institution is granted registration u/s. 12AA of the Act; that the examination
of the gross receipts year after year for the purpose of finding out the
eligibility for exemption would arise. This has also been clarified by the CBDT
Circular No. 21 of 2016, dated May 27, 2016.

 

iii)   Charitable purpose
includes preservation of environment including waterheads, forests and
wildlife. The activity carried out by the assessee had a direct casual
connection to the activity of preservation of environment. The Tribunal was
correct and the assessee was entitled to registration.”

31. Section 2(47) – Capital gain – Computation – Transfer – A. Y. 1995-96 – Transfer of land to developer – 44% of land transferred in exchange for 56% of built-up area – Consideration for transfer of land was cost of construction of 56% of built up area – Cost of acquisition of land was its market value on 01/04/1981 – Land and development charges deductible from sale consideration

CIT vs. Vasavi Pratap Chand; 398 ITR 316 (Del):

 

A piece of land
was owned by co-owners. They entered into an agreement with A on 02/05/1984. In
terms of the agreement, the building on the land was to be demolished and an
apartment complex was to be constructed thereon. It was agreed that the
co-owners would get built up area of 89,136 sq. ft. which constituted 56% of
the total built up area. 44% of the built-up area would belong to A. The entire
cost of construction was to be met by A. The co-owners entered into agreements
with various flat buyers and ultimately sold constructed flats during the
assessment years 1993-94 to 1995-96. In the A. Y. 1995-96, the three co-owners
sold 18,636 sq. ft. of built up area for a total consideration of Rs.
4,72,98,075. Each co-owner disclosed a loss of Rs. 31,30,663 under the head
“capital gains” in his individual return. The Assessing Officer held that the
cost of acquisition of property (one-third share) would be only Rs. 2,03,334.
In other words, the Assessing Officer adopted the computation of cost of
acquisition in the manner indicated in section 49(1)(i) of the Wealth-tax Act,
1957. The Tribunal held that the figure indicated in the wealth-tax return
filed by the assessee could not be taken to be the basis for determining
capital gains. It held that the agreement of sale clearly showed that 56% of
the built-up area including the land would be retained by the assessee and 44%
by the builder. There was simultaneous transfer of possession of 44% of land by
the assessee to the builders and possession of 56% of the built-up area by the
builder to the assesses in the financial year 1991-92 in terms of section 2(47)
of the Income-tax Act, 1961 read with section 53A of the Transfer of Property
Act. The Tribunal further held that the cost of acquisition of land had to be
its market value as on 01/04/1981. It did not reduce the land and development
charges from the sale consideration.

 

On appeal, the Delhi High Court held as under:

 

“i)   There was transfer of
title to the land by the assessee in favour of A. What was transferred under
the collaboration agreement was only 44% of the land owned by them in exchange
for 56% of the built-up area and not the entire land. Further, the assesee not
only transferred the flats to the buyers but the proportionate right in the
appurtenant land as well. There was transfer of possession of 44% of the land
by the assesee to the builder and possession of 56% of the built-up area by the
builder to the assessee in terms of section 2(47) of the 1961 Act read with
section 53A of the Transfer of Property Act.

 

ii)   The consideration for the
transfer of 44% land was the cost of construction of the 56% built-up area. The
land and development charges had to be reduced from the sale consideration.

 

iii)   The value declared in
the tax return filed by the assessee under the Wealth-tax Act could not be
taken to be the cost of acquisition in the hands of the assessee. The cost of
acquisition of land had to be the market value of land as on 01/04/1981.”

30. Section 153 – Assessment – Limitation – Computation of period – Exclusion of time during which assessment proceedings stayed by Court – Expl. 1 – A. Y. 2006-07 – Effect of section 153 – Period between vacation of stay and receipt of order by Income Tax Department not excluded – Vacation of stay on 09/11/2016 – Order of reassessment passed on 30/01/2017 – Barred by limitation

Saheb Ram Omprakash Marketing P. Ltd. vs.
CIT; 398 ITR 292 (Del):

 

In the case of the assessee, a notice u/s.
148 of the Act, was issued on 27/03/2012 for reopening the assessment for the
A. Y. 2006-07. The assessee filed a writ petition and challenged the validity
of the notice and the reassessment proceedings. The High Court granted stay of
the reassessment proceedings by an order dated 18/03/2013. The stay was vacated
by an order dated 09/11/2016. According to the assessee, on the date of the
stay order being vacated i.e., on 09/11/2016, there were only 13 days left for
passing the reassessment order where period is extended to 60 days by
Explanation 1 to section 153. Therefore, the assessee claimed that a valid reassessment
order could have been passed only up to 08/01/2017, i.e. within 60 days from
09/11/2016; the date on which the stay was vacated by the Court. The Department
rejected the assessee’s claim. It was the claim of the Department that the said
order of the Court dated 09/11/20016 was received by the Department on
02/12/2016 and therefore, the Department would have 60 days from 02/12/2016 to
pass the order of reassessment. Accordingly, the Assessing Officer passed the
reassessment order on 30/01/2017. 

 

The assessee filed a writ petition and
challenged the validity of the reassessment order on the ground of limitation.
The Delhi High Court allowed the writ petition and held as under:

 

“i)   In terms of explanation 1
to section 153 of the Act, in computing the period of limitation “the period
during which the assessment proceedings are stayed by an order or injunction by
the court” shall be excluded. In terms of the first proviso to Explanation 1,
where, after the vacation of stay, the period available to the Assessing
officer to complete the reassessment proceedings is less than 60 days, then
such remaining period shall be extended to 60 days and the period of limitation
shall be deemed to be extended accordingly.

 

ii)   Clause (ii) of
Explanation 1 only excludes from the computation of limitation, “the period
during which the assessment proceeding is stayed by an order or an injunction
of any court”. It does not exclude the period between the date of the order of
vacation of stay by court and the date of receipt of such order by the
Department.

 

iii)   Circular No. 621 dated
19/12/1991, issued by the CBDT, while explaining the reason for introduction of
the proviso to Explanation 1, acknowledged that the time remaining after
vacation of stay in terms of section 153(2) of the Act may not be sufficient to
complete the reassessment proceedings which is why the language used in the
first proviso is that the period “shall be extended to 60 days” for passing the
assessment order in terms of section 153(2) of the Act, if the period remaining
within limitation after the excluded period has elapsed, is less than 60 days.

 

iv)  The Revenue could not take
advantage of the fact that it received the copy of the order dated 09/11/2016
of the Court only on 02/12/2016 to contend that the assessment order having
been passed on 30/01/2017 within 60 days of the date of receipt of the order of
the High Court, was not issued (passed) beyond the period stipulated u/s.
153(2) of the Act read with the proviso to Explanation 1 thereof.

 

v)   Even otherwise, the
assertion that the Revenue was aware of the order only on 02/12/2016 was not
correct. The Revenue had been unable to dispute the fact that, on 30/11/2016, a
notice was issued by the Assessing Officer u/s. 142(1) of the Act and this was
pursuant to the order passed by this Court on 09/11/2016. Clearly, therefore,
on the date such notice was issued, the Assessing Officer was aware of the
order dated 09/11/2016 of the Court. Also, the order dated 09/11/2016 was
passed in the presence of counsel of the Revenue and, therefore, the Revenue
clearly was aware of the order on that date itself.

 

vi)  The order dated 30/01/2017
was time-barred.”

29. Section 254 –Appellate Tribunal – Power and duties as final fact finding authority –A. Y. 2009-10 and 2010-11 – Must reappraise and reappreciate all factual materials – Failure by Tribunal to render complete decision in terms of powers conferred on it – Matter remanded to Tribunal

Thyrocare Technologies Ltd. vs. ITO(TDS);
398 ITR 443 (Bom):

 

The assessee
is a sample testing laboratory. The Assessing Officer was of the view that the
sample collectors were not independent persons but were agents of the assessee
which was the principal and that it was an arrangement with the sample
collectors to avoid the obligation to deduct tax at source. The assessee
submitted before the Commissioner (Appeals) that the samples were not collected
directly by it from the patients, but by the sample collectors who visited the
patients and thereafter, brought the samples to it for testing. It was also
submitted that there was no privity of contract between it and the patients and
that the sample collectors did not collect the samples exclusively for it, but
were free to send the samples collected by them for testing to any other
laboratories and therefore it was a principal to principal relationship. The
order of the Assessing Officer was set aside by the Commissioner (Appeals). The
Tribunal held that the payments made by the assessee to the sample collectors
were in the nature of commission or brokerage which was evident from the
affidavit-cum-undertaking executed by the sample collectors and their
application forms for appointment as sample collectors and also from the
statements recorded during the survey u/s. 133A of the Income-tax Act, 1961
(Hereinafter  for the sake of
brevity  referred to as the “Act”).
It also held that the assessee did not satisfactorily explain the queries
raised. It further held that the Commissioner (Appeals) erred in not correctly
appreciating the nature of the payments made to the sample collectors, that
there was a principal and agent relationship between the assessee and the
sample collectors and deleting the interest levied u/s. 201(1A).

 

In appeal before the High Court, the
assessee raised the issue whether the findings of the Tribunal that the
assessee had not “satisfactorily explained the queries”, “not produced any
documents to substantiate the contention” and “not discharged the burden”, were
perverse, contrary to the facts on record and that it never indicated during
the hearing that it was not satisfied with the evidence. The Bombay High Court
remanded the matter back to the Tribunal and held as under:

“i)   The order of the Tribunal
was vitiated not only by non-application of mind but also by misdirection in
law. The Tribunal as the last fact finding authority, failed to make any
reference to the observations, findings and conclusions in the order of the
Assessing Officer and that of the first appellate authority.

 

ii)   It termed certain facts
as undisputed, whereas, they were very much disputed such as the non-admission
by the assessee that the service providers were its agents or that they were
allowed to collect the necessary charges from its clients for collecting the
sample and delivering the reports. There was no reference to any communication
or any document which indicated that the Tribunal’s queries had not been
satisfactorily answered by the assessee.

 

iii)   The
Tribunal should, independent of the statements recorded during the survey u/s.
133A, have referred to such of the materials on record which disclose that the
assessee had entered into such arrangements so as to have avoided the
obligation to deduct tax at source. If the arrangements were sham, bogus or
dubious, then such a finding should have been rendered.

 

iv)  The Tribunal was obliged,
in terms of the statutory powers conferred on it, to examine the matter,
reappraise and reappreciate all the factual materials satisfactorily. It had
not rendered a complete decision and its order was to be set aside.

 

v)   We direct the Tribunal to
hear the appeals afresh on the merits and in accordance with law after giving
complete opportunity to both sides to place their versions and arguments. The
Tribunal shall frame proper points for its determination and consideration and
render specific findings on each of them.”

28 Sections 253 and 254 –Appeal to Appellate Tribunal – Condonation of delay – A. Ys. 1994-95 and 1996-97 – Delay of 2984 days in filing appeal – Request for condonation of delay not to be refused unless delay is shown to be deliberate and intentional – Orders of Tribunal rejecting condonation of delay based on irrelevant factors – erroneous – delay condoned – Appeals filed by assessee to be restored for adjudication by Tribunal

Vijay Vishin Meghani vs. Dy. CIT; 398 ITR
250 (Bom):

 

For the A. Ys. 1994-95 and 1996-97, the
assessee filed appeals before the Appellate Tribunal against the orders of the
Commissioner (Appeals) with a delay of 2,984 days. The assessee made applications
for condonation of delay. The assessee submitted an affidavit stating that he
followed the advice given by his chartered accountant not to file further
appeals before the Tribunal for the A. Ys. 1994-95 and 1996-97, as the issue
involved was    identical to the appeal
filed before the Tribunal for the A. Y. 1993-94, which was then pending before
the Tribunal, to avoid multiplicity of litigation and that after the
adjudication of appeal for the A. Y. 1993-94 by the Tribunal, he could move a
rectification application before the Assessing Officer to bring the assessment
order in conformity with the decision of the Tribunal. In support of the
averments made in the affidavit, the assessee also filed an affidavit by one of
the partners of the firm of chartered accountants.

 

The Tribunal dismissed the appeal in limine
and observed that a chartered accountant could not have given an absurd advice.
The affidavit filed by the firm of chartered accountants was rejected. The
affidavit filed by the assessee was also rejected on the ground that it gained
strength only from the affidavit filed by the firm of chartered accountants.
The Tribunal held that the assessee had failed to show the reasons for the
entire period of delay, i.e., no reason was given for the delay that occurred
between periods and therefore, the delay in filing the two appeals could not be
condoned. In a miscellaneous application u/s. 254(2).

 

The Bombay High Court allowed the appeals
filed by the assessee against the said orders of the Tribunal dismissing the
appeals as barred by limitation and held as under:

 

“i)   None should be deprived
of an adjudication on the merits unless the Court or the Tribunal or appellate
authority found that the litigant had deliberately and intentionally delayed filing
of the appeal, that he was careless, negligent and his conduct lacked
bonafides. Those were the relevant factors.

 

ii)   The Tribunal’s order did
not meet the requirement set out in law. It had misdirected itself and had
taken into account factors, tests and considerations which had no nexus to the
issues at hand. The Tribunal, therefore, had erred in law and on the facts in
refusing to condone the delay. The explanation placed on affidavit was not
contested nor could it have been concluded that the assessee was at fault, that
he had intentionally and deliberately delayed the matter and had no bona
fide or reasonable explanation for the delay in filing the proceedings. The
position was quite otherwise.

 

iii)   In the light of the
above discussion, we allow both the appeals. We condone the delay of 2,984 days
in filing the appeals but on the condition of payment of costs, quantified
totally at Rs. 50,000. Meaning thereby,  
Rs. 25,000 plus 25,000 in both appeals. The cost to be paid in one set
to the respondents within a period of eight weeks from today. On proof of
payment of costs, the Tribunal shall restore the appeals of the assessee to its
file for adjudication and disposal on the merits.”

 

Analysis Of Decisions Taken At The 22ND & 23RD Meetings Of The GST Council

This article provides an analysis of the
changes made or proposed in the 22nd and 23rd GST Council
meetings. A wide range of changes have been brought about in these Council
meetings which seem to aim at reducing the tax and compliance burden. One gets
a feeling that GST is turning out to be another law entangled in a complex web
of notifications which is perceived to be more dynamic than the stock exchange.
Some attribute the dynamics to a premature introduction of the law.

There were lots of speculations around the
outcome of the 23rd Council meeting after the Hon’ble Prime Minister
had promised relief. The top most highlight of all proposals was the relocating
of almost 178 items from the 28% slab to 18% slab. On one hand, it appears that
the rate change was purely to please the aam aadmi, while on the other hand it
seems the move is aimed at discouraging tax evasion on fast moving consumer
goods. If we consider this as a move to discourage tax evasion, it may lead to
tax buoyancy with more transactions in these goods coming into the system. In
the subsequent paragraphs, the major changes brought about by the 22nd
and the 23rd Council meetings are analysed.

 

1.  REDUCTION IN TAX RATES

     The reduction of GST rate
on almost 178 items from 28% to 18% is a major move by the Government. Most of
the daily use items like chocolates, custard powder, polishes, sanitary ware,
etc. are the goods where the rate reduction is done. However, luxury and sin
goods like pan masala, aerated water and beverages, cigars and cigarettes,
tobacco products, cement, paints, perfumes, ACs, dish washing machines, washing
machines, refrigerators, vacuum cleaners, cars and two-wheelers, aircraft and
yacht continue to be in the highest tax bracket of 28%.

 

     The rates were reduced
with effect from 15th November 2017; however, the goods bearing the
original MRP were in stock with the distributors and retailers. Most of the big
players have announced that they will ask their logistical partners to ensure
that the rates that get charged to consumers are below the MRP affixed on the
package to take care of the rate reduction.  

 

2.  5% GST RATE FOR RESTAURANTS

     As a consequence of
recommendations of the GST Council, another major move affecting the restaurant
industry was notifying 5% GST for restaurants. Prior to this change in rate of
tax, airconditioned       restaurants and
restaurants serving liquor had to bear GST @ 18% and other restaurants had to
bear 12% GST. As per the amended rate notification, the rate of GST on certain
restaurants, eating joints including canteen or mess has been notified @ 5%
(with no Input Tax Credit). It is felt that this change seems like a mandatory
scheme for eateries. Prior to introducing this change, the Hon’ble Finance
Minister had stated that all members of the Council felt that restaurants were
not passing on the benefit of ITC to consumers and GST was being levied on
existing card rates. There is no doubt in the fact that we all must have felt
our restaurant bills going up post implementation of GST. The million dollar
question that comes up here is whether this change is going to actually reduce
our restaurant bills.

 

     Few questions that arise
in this regard are enumerated hereunder:

 

     Is the amendment against
the objective of GST

     GST as we all know is a
value added tax and the objective of this tax is to allow seamless flow of
credit. Such a move of restricting the ITC in the hands of eateries may go
directly against the stated objective.

 

     The terms ‘restaurant’
& ‘eating joint’ is not defined

     The rate notification (5%)
covers within its ambit restaurants, eating house including mess or canteen.
This implies that this rate applies only in case where the activity of supply
of food is undertaken by a restaurant, eating joint including a mess or
canteen. This also means that when the food is supplied by a retail outlet like
a banya shop or a super market, 5% rate shall not apply. There is no clarity on
status of bakeries located in hotels (run by third parties), standalone ice
cream parlours. These tax payers are nothing but re-sellers of ready to eat
food and in most cases there is no preparation or serving done at the store or
retail outlet. There is an urgent need for the Government to clarify the
coverage of this entry, else the basic objective for which the GST rates were
reduced may not get fulfilled. Rather, there is always a possibility that end
consumer prices may increase to cover the increase in cost of supply due to denial of ITC.     

 

     Whether charging 5% is
mandatory

     On a perusal of the
notification it is apparent that the rate of 5% prescribed in the notification
at Entry no. 7(i) is subject to the condition that no ITC on inward supplies of
goods or services that are used for providing the service is claimed. A
residuary entry at serial no. 7(ix) which prescribes 18% rate for all
accommodation, food and beverage services that are not covered by other entries
excludes restaurants and eating joints covered by entry no 7(i). Further, an
explanation in entry 7(ix) specifically excludes restaurants covered by entry
at serial no. 7(i). A question that arises here is whether 5% is a mandatory
rate or a rate that is conditional to not claiming ITC. On a strict and
conservative interpretation, 5% seems to be mandatory rate for those covered by
entry 7(i) of the above notification.

 

     Another school of thought
is that 5% rate attaches a condition to it and hence is applicable only where
the condition is satisfied. Hence, it cannot be read to be mandatory. Then in
such a case where should such cases get classified. Can they be classified
under entry 35 as “Other miscellaneous services not covered elsewhere” is a
question which needs immediate attention of the government. 

 

     Would the move lead to a
reduction in restaurant bills?

 

     Every business activity is
run with an intention to earn profit and it is a simple math that profit is
sales – cost. Tax is charged on sales value. Hence, there is no doubt that 5%
should be charged on the base sale price. So let’s go back to base sales price.
Base sale price would be decided based on a certain mark up over the cost. With
the denial of ITC under the 5% scheme the operating costs are bound to go up
(especially across the counter sale of ready food). The logical outcome would
be increase in base sale price. Most of the restaurants operate in leased
premises and the lease rentals are liable for payment of GST. This would
constitute a huge ITC loss for the restaurants. The amount of ITC that shall
hit the Profit and Loss account debit side would vary from restaurant to
restaurant and only restaurants that operate on a low ITC may perhaps be in a
position to reduce the base sale price along with the reduction in the rate of
tax. 

 

3.  CHANGES IN COMPOSITION
SCHEME

     (A)   Changes already implemented

 

    The 22nd GST
Council meeting proposed an increase in the threshold limits for composition.
Section 10 of the CGST Act, 2017 empowers the Government to raise the maximum
threshold as under:

Rs. in lakhs

States

Old Threshold

New Threshold

Special Category

50

75

Other States

75

100

 

 

    Subsequent to the above
change an order1 was issued to clarify certain aspects relating to
composition scheme. This order was issued in terms of powers of the Government
to remove difficulties arising in giving effect to any provisions of the Act.
The following was clarified in the above order:

 

a)  A tax payer engaged in
supplying restaurant and other services specified in Para 6(b) of Schedule II
to the Act and also supplying exempt services (including interest income) shall
be allowed to go for composition u/s. 10 if all other conditions are satisfied.

 

b)  Further, it was clarified
that while computing his aggregate turnover for determining eligibility for
opting for composition, the value of these exempt services shall not be
included.

 

     As per the Press Release
dated 06-10-2017, it was also decided to constitute a Group of Ministers who
shall work towards making composition scheme even more attractive.

[1] Order No. 01/2017-CT, dated 13-10-2017 issued
under section 172 of the CGST Act, 2017.

(B) Changes proposed at 23rd
GST Council meeting to be implemented after making legislative changes

 

(i)  It has been proposed to
enhance the current threshold to 200 Lakhs. However, this proposal can come
into effect only after making changes to the law       

 

(ii) Uniform composition rate
of 1% to be made applicable to manufacturers and traders. However, no change is
proposed to composition rate applicable to restaurants.

 

(iii) Supply of services up to
Rs. 5 lakh per annum will be allowed by exempting the same

 

The notifications relating to (ii) and (iii)
above are still awaited. It may be noted that the changes as per 22nd Council
meeting and proposals by 23rd Council meeting would imply the
following:

 

(i)  Rule 3(3A) has been
inserted in the CGST Rules,2017 allowing entry into composition scheme any time
till 31-03-2018.

 

(ii) The option for composition
shall be applicable only in the month succeeding the month in which the option
opting for composition is exercised by filing Form GST CMP-02.

 

(iii) Such persons shall also
have to intimate details of inputs and capital goods in stock and pay ITC
attributable to such stock as per section 18(4) and computed in the manner
prescribed in Rule 44 of the CGST Rules. The intimation has to be given in Form
GST ITC-03.

 

The question here is whether introducing
such changes in the scheme of composition would really make it attractive at a
time when we are approaching the end of the financial year. 

 

4.  RELIEF IN COMPLIANCE
PROCEDURES PROPOSED AT THE 22nd AND 23rd GST COUNCIL MEETINGS

 

A.  Filing of GSTR-2, 3
suspended:

 

     Inspite of the glitches
and the OOPS! on the GSTN portal tax payers did manage to file returns in Form
GSTR-3B and GSTR-1. However, when it came to furnishing details of inward
supplies, it seemed to be a task on hand for matching various elements (with
the biggest challenge being Invoice number and date). It was highly unfair for
a genuine tax payer where his credit claim is made depended on the timely
furnishing of outward supplies by his vendor. Considering the hardships faced
by tax payers, the Government has suspended filing of GSTR-2 which is viewed as
a very practical and bold step.

 

     It
may be noted here that filing of GSTR-2 has been suspended for the time being
but at some point in time this compliance has to be faced.The press release
dated 10-11-2017 states that a committee of officers would work out the time period for filing of GSTR-2 and
3.

 

From an industry perspective, what seems to
be the most desirable is:

 

a)  Invoice number level and
date matching should be done away with and only the tax element be matched.

b)  Alternatively the matching
of ITC may be done after the end of the financial year or on a quarterly basis
instead of monthly basis.

c)  If the ITC matching is done
on an annual or quarterly basis Forms GSTR-1, 2 and 3 should be consolidated
and a single return containing details of outward and inward supplies and the
tax computation for each period should be filed at the end of the month or
quarter, as the case may be.

 

B.  Quarterly returns for SME
sector

     Another welcome move
relates to reduced periodicity of filing of returns by small and medium sized
businesses with annual aggregate turnover up to Rs. 1.5 crore, and  it was proposed at the 22nd
council meeting to allow such SME businesses to file GSTR-1, 2 and 3 and
also pay taxes on quarterly basis. Consequent to the 22nd
council meeting, the notification giving effect to this proposal was long
awaited.

 

     However, the above
decision was tweaked at the 23rd council meeting where filing of
GSTR-2 and 3 was suspended for the time being for all tax payers and quarterly
filing due dates and eligibility for the SME sector were notified as under:

 

Quarter for
which details to be furnished in Form GSTR-1

Due Date

Jul-Sep,
2017

31-12-2017

Oct-Dec,
2017

15-02-2018

Jan-Mar,
2018

30-04-2018

 

     Form 3B and payment of
taxes continue to be a monthly affair

     It may be noted here that
even though periodicity has been changed for filing Form GSTR-1, the
periodicity for payment of taxes and filing of Form GSTR-3B is still a monthly
affair for all tax payers (unlike what was the original proposal at the 22nd
Council Meeting).

 

     The efforts that are
required for computing the tax liability for a month and preparing Form 3B are
no less than filing of Form GSTR-1. In such a situation, would just changing
periodicity of filing GSTR-1 to quarterly really help the SME sector?

 

     Clarity on applicability

     The eligibility of a tax
payer for filing quarterly returns as notified2 is reproduced here
under:

 

     “The registered persons
having aggregate turnover of up to 1.5 Crore rupees in the preceding financial
year or the current financial year,
as the class of registered persons who shall follow the special procedure as
detailed below for furnishing the details of outward supply of goods or
services or both

 

     The confusion that is created
here is the reading of the word “or” used in the notification. Whether a tax
payer whose turnover in the preceding year was below the 1.5 crore mark but who
has crossed this threshold already in the current year can still avail the
benefit of quarterly filing. The same question arises in a vice versa
situation. However, if we go by the intention, it seems that the word “or”
should be read literally and not as “and”. Hence, even if the aggregate
turnover is above 1.5 crore in the current year, the benefit should be
available.

 

5.  NO GST PAYABLE ON ADVANCES
RECEIVED FOR SUPPLY OF GOODS

     The liability to pay tax
arises when the time of supply gets triggered. The provisions relating to time
of supply state that the liability shall arise on the earlier of the date of
invoice or date of receipt of payment. This implies that GST becomes payable on
advances received prior to making of the supply. While the service tax law
already contained provisions for taxing advances, similar provisions were not
present under the VAT laws and central excise law. The concept of taxing
advances relating to supply of goods was fairly new to suppliers of goods under
the GST law and had its own inherent issues, especially when it is difficult to
determine the classification of the goods to be supplied at the time when the
advance is received. Further, at times, it was also difficult to determine the
location of the supplier where advances were centrally received at the head
office.

 

     As proposed by the council
at its 22nd Council Meeting, the requirement for making payment of
GST on advance was exempted only in cases of tax payers (not being under
composition) whose preceding year turnover did not exceed Rs. 1.5 crore or
current year turnover is not likely to exceed the above threshold3.
At the 23rd Council Meeting, this relaxation was extended to all
suppliers of goods4. It may be noted that in case of supplier
of services the tax shall be payable on advances received.  

[2] Notification No. 57/2017-CT, dated 15-11-2017  

 

6.  CLARIFICATION IN CASE OF
INTER-STATE MOVEMENT OF RIGS, TOOLS, ETC.

     It has been clarified5
that inter-state movement of various modes of conveyances between distinct
persons carrying passengers, goods or for repairs and maintenance shall neither
be treated as a supply of goods or services and hence, no IGST shall be
payable.

 

     A similar issue was faced
in case of inter-state movement of rigs, tools and spares, and all goods on
wheels like cranes. These goods may move to various locations for providing
services. The press release states that no IGST shall be payable in case these
goods move for the purpose of providing services to customers or for the
purpose of getting these goods repaired. The press release further states that
applicable tax shall be payable on services that are provided using such goods.

 

     Consequent to the Council
decision, a clarification6 in this regard was issued which simply
states that circular 1/2017 shall mutatis mutandis apply to inter-state
movement of such goods, and except in cases where movement of such goods is for
further supply of the same goods, such inter-state movement shall be treated
‘neither as a supply of goods or supply of service,’ and consequently, no IGST
would be applicable on such movements. It further states that the applicable
GST shall be payable on repairs of such goods. There seems to be a disconnect
between the press release and the Circular to the extent that there is no
specific mention that no GST shall be payable even when these goods are used
for providing services to customers located in other States.

 

     Further, it is not clear whether the clarification would hold good where
the distinct person is registered in the other State and the billing location
is from that State.

 

[3] Notification No. 40/2017-CT, dated 13-10-2017

[4] Notification No. 57/2017-CT, dated 15-11-2017 

[5] Circular No. 1/1/2017-IGST, dated 07-07-2017

[6] Circular No. 21/21/2017-GST, dated 22-11-2017

7.  Other
changes

a)  Tax payers who have paid
late fees for July, August and September, 2017 shall be re-credited to their
Cash ledger under the “Tax” head.

 

b)  Late fees for return in Form
3B for the period Oct-2017 onwards have been reduced7 as
provided in the table below. It may be noted that the waiver applies only
for Form 3B and not other returns.

 

Particulars

Original Late Fees per day

Reduced Late Fee per day

 

CGST

SGST

CGST

SGST

Cases where tax payable is NIL

100

100

10

10

Other Cases

100

100

25

25

 

 

[7] Notification No. 64/2017-CT, dated 15-11-2017

c)  A facility for manual
filing of advance ruling applications has been introduced. Rule 97A has been
inserted in the CGST Rules8.        

 

d)  Exemption from registration
in case of small service providers (having aggregate turnover less than Rs. 20
lakh making inter-state or intra state supply of services through an E-Commerce
operator)9.

 

e)  Input Tax Credit has been
allowed10 in respect of supply of services to Nepal and Bhutan
despite the said services being treated as exempted services.

 

f)   Date for filing Form
TRAN-1 extended to 27-12-201711.

 

g)  Date for furnishing details
of goods sent to job worker in Form ITC-04 extended12 to 31-12-2017
for the period Jul. to Sept., 2017. _

______________________________________________________________________

8      Notification No. 55/2017-CT, dated 15-11-2017
9      Notification No. 65/2017-CT, dated 15-11-2017  issued under section 23(2) of the CGST Act, 2017
10    Explanation inserted in Rule 43 of the CGST Rules, 2017 vide Notification No. 55/2017-CT, dated 15-11-2017
11    Order No. 9/2017-GST, dated 15-11-2017
12    Notification No. 63/2017-CT, dated 15-11-2017

Can There Be A Levy Of IGST On Actual Imports?

Introduction

1.  It is common knowledge that
the levy of additional duty of customs, commonly known as CVD and special
additional duty, commonly known as SAD, have been replaced for many products
with the IGST, also known as integrated tax on imports of goods. In this
article, we examine whether there can be a levy of such integrated tax on the
activity of actual imports into the country using the present wordings in the
statute.

 

Legal Analysis

 

IGST or the integrated tax is a tax which is
levied on inter-State supplies of goods or services. The levy is under an
enactment called Integrated Goods and Services Tax Act, 2017.

 

2.  The charging provision is
section 5 which levies a tax on all inter-State supplies of goods or services.
Proviso to section 5(1) of the IGST Act reads as under:

 

     “Provided that the
integrated tax on goods imported into India
shall be levied and collected in accordance with the provisions of section 3 of
the Customs Tariff Act, 1975 on the value as determined under the said Act at
the point when duties of customs are levied on the said goods under section 12
of the Customs Act, 1962.”

 

3.  Section 7 of the IGST Act,
2017 would talk of determination of what is inter-State supply. For our
purposes, section 7(2) of the IGST Act states that “Supply of goods imported into the territory of India, till they
cross the customs frontiers of India, shall be treated to be a
supply of goods in the course of inter-State trade or commerce”.

 

4.  If one compares the
language used in section 7(2) and proviso to section 5(1), the events
considered are different. Section 7(2) talks about “imported into territory
of India, till they cross the customs frontiers of India….” Proviso to
section 5(1) talks about “goods imported into India”. While the former
deals only with determining what is inter-State supply and states that till
goods cross the customs frontiers, they are treated as supply in the course of
import or export of goods, the latter is the charging section which states that
the charge on goods imported is determined by the Customs Tariff Act.
Therefore, the two seem to operate in two different fields. While one talks of
“in the course of imports or exports”, the other talks of “goods imported into
India”. The former would probably cover instances such as high sea sales, while
the latter deals with actual imports into the country.

 

5.  The net effect of this
would be that u/s. 7, transaction in high seas, would be termed as in the
course of imports or exports and would be treated as inter-State supply of
goods or services. Though the proviso to section 5(1) states that integrated
tax on goods imported into India would be levied and collected in accordance
with the provisions of section 3 of the Customs Tariff Act, there is no fiction
created to stipulate that goods imported into India would be treated as supply
in the course of inter-State trade or commerce. The fiction created in
section 7(2), it seems to the authors, is not sufficient to take care of direct
imports because of inappropriate language used in section 7(2). If this
position is true, then the charge of integrated tax on direct imports is on
precarious grounds. We could read it this way too – the charge under IGST Act
is restricted to tax only on transactions at the high seas or before customs
clearances and cannot be fastened on goods actually imported.

 

6.  We now have to look at the
Constitution of India. The Constitution 101st Amendment Act has
already created a fiction as to what kind of supply vis-à-vis imports is
deemed to be in the course of inter-State trade or commerce. The Explanation to
Article 269A(1) reads as under:

 

     “For the purposes of this
clause, supply of goods, or of services, or both in the course of import
into the territory of India shall be deemed to be supply of goods, or of
services, or both in the course of inter-State trade or commerce.”

 

7.  The above would show that
extent to which fiction can be created by Parliament to treat any supply vis-à-vis
import is already specified in the Constitution. Only supply in the course of
import into the territory of India alone is deemed to be supply in the course
of inter-State trade or commerce. Direct imports are not covered. This is quite
clearly the case as direct imports were already covered under the customs
legislation.

 

8.  Such being the case,
Parliament cannot create any fiction vis-à-vis imports to treat them as
supply in the course of inter-State trade or commerce except to the extent
provided in the Explanation to Article 269A(1). No fiction can be created by
the Parliament to treat direct imports as supply in the course of inter-State
trade or commerce because the scope of fiction is already defined in the
Constitution i.e., Explanation to Article 269A(1). Article 269A(5) confers
power on the Parliament to formulate the principles for determining the place
of supply, and when a supply of goods, or of services, or both takes place in
the course of inter-State trade or commerce. Section 7 of the IGST Act has been
enacted pursuant to the powers granted by Article 269A(5). The powers given by
Article 269A(5) should be read along with section 269(1). While formulating the
provisions regarding place of supply, the Parliament cannot go beyond
Explanation to Article 269A(1) create any fiction with respect to direct
imports as the scope of fiction is already defined in the said Explanation.

 

9.  We can look at this in
another way too – Article 246A which was introduced by the above Amendment Act,
is a special provision with respect to goods and services tax and therefore, to
that extent would override Article 246 in the matter of vesting legislative
powers. Parliament already had powers under Article 246 read with Schedule VII
List 1 entry 83, to levy a duty of customs and therefore, the special
provisions for levy of GST on goods or services supplied can be restricted to
only two things:

 

a.  Tax on goods or services
supplied inside India

b.  Tax on goods or services
supplied in the course of export or import and not on actual imports or exports
which is covered by the customs legislation already.

 

     This reading would clearly
harmonise the two Articles in the Constitution as otherwise, the state
legislatures would have the power to levy import duties which is clearly not
the case.

 

10. As we are dealing
with the subject of imports, it would be relevant to note what is import.
Section 2(10) of the IGST Act, 2017 defines import of goods to mean bringing
goods into India from a place outside India. Section 2(23) of the Customs Act,
1962 has the same definition. Therefore, we have to examine some decisions on
the concept of import. The Hon’ble Supreme Court discussed when import is said
to take place.

 

–   Kiran
Spg. Mills vs. Collector of Customs, (2000) 10 SCC 228

 

     6. Attractive, as the
argument is, we are afraid that we do not find any merit in the same. It has
now been held by this Court in Hyderabad Industries Ltd. v. Union of India
[(1999) 5 SCC 15 : JT (1999) 4 SC 95] that for the purpose of levy of
additional duty Section 3 of the Tariff Act is a charging section. Section 3
sub-section (6) makes the provisions of the Customs Act applicable. This would
bring into play the provisions of Section 15 of the Customs Act which, inter
alia, provides that the rate of duty which will be payable would be (sic the
rate in force) on the day when the goods are removed from the bonded warehouse.
That apart, this Court has held in Sea Customs Act [ Sea Customs Act, S. 20(2),
Re, AIR 1963 SC 1760 : (1964) 3 SCR 787, 803], SCR at p. 803 that in the case
of duty of customs the taxable event is the import of goods within the customs
barriers. In other words, the taxable event occurs when the customs barrier is
crossed. In the case of goods which are in the warehouse the customs barriers
would be crossed when they are sought to be taken out of the customs and
brought to the mass of goods in the country. Admittedly this was done after
4-10-1978. As on that day when the goods were so removed additional duty of
excise under the said Ordinance was payable on goods manufactured after
4-10-1978. We are unable to accept the contention of Mr. Ramachandran that what
has to be seen is whether additional duty of excise was payable at the time
when the goods landed in India or, as he strenuously contended, they had
crossed into the territorial waters. Import being complete when the goods
entered the territorial waters is the contention which has already been
rejected by this Court in Union of India v. Apar (P) Ltd. [(1999) 6 SCC 117]
decided on 22-7-1999. The import would be completed only when the goods are to
cross the customs barriers and that is the time when the import duty has to be
paid and that is what has been termed by this Court in Sea Customs case [ Sea
Customs Act, S. 20(2), Re, AIR 1963 SC 1760 : (1964) 3 SCR 787, 803] (SCR at p.
823) as being the taxable event. The taxable event, therefore, being the day of
crossing of customs barrier, and not on the date when the goods had landed in
India or had entered the territorial waters, we find that on the date of the
taxable event the additional duty of excise was leviable under the said
Ordinance and, therefore, additional duty under Section 3 of the Tariff Act was
rightly demanded from the appellants.”

 

One may see with profit the following decisions also:

–   The
Hon’ble Supreme Court in Union of India vs. Apar (P) Ltd., (1999) 6 SCC
117

–   Bharat
Surfactants (P) Ltd. vs. Union of India, (1989) 4 SCC 21

–   Further,
we can see the decision of the Supreme Court in Garden Silk Mills Ltd. vs.
Union of India, (1999) 8 SCC 744

 

     17. It was further
submitted that in the case of Apar (P) Ltd. [(1999) 6 SCC 117: JT (1999) 5 SC
161] this Court was concerned with Sections 14 and 15 but here we have to
construe the word “imported” occurring in Section 12 and this can only mean
that the moment goods have entered the territorial waters the import is
complete. We do not agree with the submission. This Court in its opinion in
Bill to Amend Section 20 of the Sea Customs Act, 1878 and Section 3 of the
Central Excises and Salt Act, 1944, Re [AIR 1963 SC 1760 : (1964) 3 SCR 787 sub
nom Sea Customs Act (1878), S. 20(2), Re] SCR at p. 823 observed as follows:

     “Truly speaking, the
imposition of an import duty, by and large, results in a condition which must
be fulfilled before the goods can be brought inside the customs barriers, i.e.,
before they form part of the mass of goods within the country.”

 

     18. It would appear to
us that the import of goods into India would commence when the same cross into
the territorial waters but continues and is completed when the goods become
part of the mass of goods within the country; the taxable event being reached
at the time when the goods reach the customs barriers and the bill of entry for
home consumption is filed.

 

–   Hotel
Ashoka vs. ACCT 2012(276) E.L.T. 433 (S.C.)

 

     18. It is
an admitted fact that the goods which had been brought from foreign countries
by the appellant had been kept in bonded warehouses and they were transferred
to duty free shops situated at International Airport of Bengaluru as and when
the stock of goods lying at the duty free shops was exhausted. It is also an
admitted fact that the appellant had executed bonds and the goods, which had
been brought from foreign countries, had been kept in bonded warehouses by the
appellant. When the goods are kept in the bonded warehouses, it cannot be said
that the said goods had crossed the customs frontiers. The goods are not
cleared from the customs till they are brought in India by crossing the customs
frontiers. When the goods are lying in the bonded warehouses, they are deemed
to have been kept outside the customs frontiers of the country and as stated by
the learned senior counsel appearing for the appellant, the appellant was
selling the goods from the duty free shops owned by it at Bengaluru
International Airport before the said goods had crossed the customs frontiers.

 

     19. Thus,
before the goods were imported in the country, they had been sold at the duty
free shops of the appellant.

 

     20. In view of the
aforestated factual position and in the light of the legal position stated
hereinabove, it is very clear that no tax on the sale or purchase of goods can
be imposed by any State when the transaction of sale or purchase takes place in
the course of import of goods into or export of the goods out of the territory
of India. Thus, if any transaction of sale or purchase takes place when the
goods are being imported in India or they are being exported from India, no
State can impose any tax thereon.

 

     The legal position
therefore is that only when duty is paid can it be said that the goods are
imported.

11.        But what do we mean
by the terminology “in the course of import or export”?

 

12.        Article 286 of the
Constitution prior to its amendment read as under:

 

     286. (1) No law of a
State shall impose, or authorise the imposition of, a tax on the sale or
purchase of goods where such sale or purchase takes place—

 

(a) outside the State; or

(b) in the course of the import of the goods into, or export of the
goods out of the territory of India.

(2) Parliament may by law formulate principles for determining when
a sale or purchase of goods takes 
place  in   any  
of   the   ways
mentioned in clause (1).

 (3) Any law of a State shall,
in so far as it imposes, or authorises the imposition of,—

(a) a tax on the sale or purchase of goods declared by Parliament by
law to be of special importance in inter-State trade or commerce; or

(b) a tax on the sale or purchase of goods, being a tax of the
nature referred to in sub-clause (b), sub-clause (c) or sub-clause (d) of
clause (29A) of article 366, be subject to such restrictions and conditions in
regard to the system of levy, rates and other incidents of the tax as
Parliament may by law specify.

 

13.  Section 5(2) of the
CST Act was enacted pursuant to Article 286. Section 5(2) read as under:

 

     “(2) A sale or purchase
of goods shall be deemed to take place in the course of the import of the goods
into the territory of India only if the sale or purchase either occasions such
import or is effected by a transfer of documents of title to the goods before
the goods have crossed the customs frontiers of India.”

 

14. The above fiction gives
an idea as to what can be treated as to be in the course of imports. It doesn’t
include direct imports and rightly so. No doubt section 5(2) is a fiction. But
the manner in which it is worded, it essentially encompasses the natural
meaning of the expression “in the course of import”. Section 5(2) of CST Act
doesn’t cover direct imports. It covers only sale which occasions import or
sale by transfer of document of title to goods before the goods have crossed
the customs frontier. It is understandable too as the customs legislation is
the one which should cover it.

 

15. Article 286 has been
amended by the Constitution 101st  Amendment
Act. The amended Article reads as under:

     286. (1) No law of a State
shall impose, or authorise the imposition of, a tax on the supply of goods or
of services or both, where such supply takes place —

     (a) outside the State; or

     (b) in the course of the
import of the goods or services or both into, or export of the goods or
services or both out of, the territory of India.

     (2) Parliament may by law
formulate principles for determining when a supply of goods or of services or
both takes place in any of the ways mentioned in clause (1).

 

–   This
is also best expressed in the words of the Supreme Court in State of
Travancore-Cochin vs. Bombay Co. Ltd., 1952 SCR 1112 : AIR 1952 SC 366 :
(1952) 3 STC 434 [popularly known as First case of Travancore].

 

     10. We are clearly of
opinion that the sales here in question, which occasioned the export in each
case, fall within the scope of the exemption under Article 286(1)(b). Such
sales must of necessity be put through by transporting the goods by rail or
ship or both out of the territory of India, that is to say, by employing the
machinery of export. A sale by export thus involves a series of integrated
activities commencing from the agreement of sale with a foreign buyer and
ending with the delivery of the goods to a common carrier for transport out of
the country by land or sea. Such a sale cannot be dissociated from the export
without which it cannot be effectuated, and the sale and resultant export form
parts of a single transaction. Of these two integrated activities, which
together constitute an export sale, whichever first occurs can well be regarded
as taking place in the course of the other. Assuming without deciding that the
property in the goods in the present cases passed to the foreign buyers and the
sales were thus completed within the State before the goods commenced their
journey as found by the Sales Tax Authorities, the sales must, nevertheless, be
regarded as having taken place in the course of the export and are, therefore,
exempt under Article 286(1)(b). That clause, indeed, assumes that the sale had
taken place within the limits of the State and exempts it if it took place in
the course of the export of the goods concerned.

            ………

 

     12. It was said that,
on the construction we have indicated above, a “sale in the course of export”
would become practically synonymous with “export”, and would reduce clause (b)
to a mere redundancy, because Article 246(1), read with Entry 83 of List I of
the Seventh Schedule, vests legislative power with respect to “duties of
customs including export duties” exclusively in Parliament, and that would be
sufficient to preclude State taxation of such transactions. We see no force in
this suggestion. It might well be argued, in the absence of a provision like
clause (b) prohibiting in terms the levy of tax on the sale or purchase of
goods where such sales and purchases are effected through the machinery of
export and import, that both the powers of taxation, though exclusively vested
in the Union and the States respectively, could be exercised in respect of the
same sale by export or purchase by import, the sales tax and the export duty
being regarded as essentially of a different character. A similar argument
induced the Federal Court to hold in Province of Madras v. Boddu Paidanna and
Sons [1942 FCR 90] that both central excise duty and provincial sales tax could
be validly imposed on the first sale of groundnut oil and cake by the
manufacturer or producer as “the two taxes are economically two separate and
distinct imposts”. Lest similar reasoning should lead to the imposition of such
cumulative burden on the export-import trade of this country which is of great
importance to the nation’s economy, the Constituent Assembly may well have
thought it necessary to exempt in terms sales by export and purchases by import
from sales tax by inserting Article 286(1)(b) in the Constitution.

 

     13. We are not much
impressed with the contention that no sale or purchase can be said to take
place “in the course of” export or import unless the property in the goods is
transferred to the buyer during their actual movement, as for instance, where
the shipping documents are indorsed and delivered within the State by the
seller to a local agent of the foreign buyer after the goods have been actually
shipped, or where such documents are cleared on payment, or on acceptance, by
the Indian buyer before the arrival of the goods within the State. This view,
which lays undue stress on the etymology of the word “course” and formulates a
mechanical test for the application of clause (b), places, in our opinion, too
narrow a construction upon that clause, in so far as it seeks to limit its
operation only to sales and purchases effected during the transit of the goods,
and would, if accepted, rob the exemption of much of its usefulness.

 

     14. We accordingly hold
that whatever else may or may not fall within Article 286(1)(b), sales and
purchases which themselves occasion the export or the import of the goods, as
the case may be, out of or into the territory of India come within the
exemption and that is enough to dispose of these appeals.

 

16. In our view, the above
passage does conclude that the sale and purchase in the course of import should
be widely construed to cover integrated activities. If that be so, it would
become crystal clear that activities covering actual imports and exports would
be taxed under the customs legislations and other activities relating to or in
the course would not suffer any tax under the earlier regime to soften the tax
impact on such transactions. If this proposition was accepted, then the entire
IGST mechanism should be restricted only to transactions that occur in the
course of import or export and not actual imports or exports themselves.

 

17. Now it becomes clear that actual imports are covered by customs
legislation and IGST Act can only cover the supply in the course of imports or
exports. Further, as import of goods is already covered under the customs
legislation, it cannot be termed as a supply under the CGST Act, 2017 itself
which definition applies to the IGST Act also. Having understood this, we may
have to look at whether the customs legislation can impose an integrated tax.

 

18. The expression
‘integrated tax’ has a specific connotation. It is defined by section 2(12) of
IGST Act as means the integrated goods and services tax levied under this
Act;

 

19. Proviso to section
5(1) states that the integrated tax on goods imported into India shall be levied
and collected in accordance with the provisions of section 3 of the Customs
Tariff Act, 1975 on the value as determined under the said Act at the point
when duties of customs are levied on the said goods u/s. 12 of the Customs Act,
1962.

 

20. An Act cannot create
a charge on a particular transaction under some other Act. IGST Act cannot
create a charge under Customs Act in respect of a taxable event. The main
provision of section 5(1) does not cover import [ie., there is no fiction
created in the main provision of section 5(1) that inter-State supplies include
imports]. The proviso to section 5(1) is misplaced. It cannot be read as
proviso to section 5(1). There is no provision similar to section 7(4) of IGST
Act so far as import of goods are concerned. A fiction should have been created
similar to section 7(4) of IGST Act so far as import of goods are concerned. So
howsoever one interprets Explanation to Article 269A(1) or Article 286, there
is no provision in IGST Act to create charge on imports. Therefore, the proviso
to Section 5(1) to the IGST Act is completely superfluous and redundant. It can
be saved only by stating that it was done ex abundanti cautela.

 

21. Section 3(7) of
Customs Tariff Act states that “any article which is imported into India
shall, in addition, be liable to integrated tax at such rate, not
exceeding forty per cent. as is leviable under section 5 of the Integrated
Goods and Services Tax Act, 2017 on a like article on its supply in India, on
the value of the imported article as determined under sub-section (8).”

 

22. Section 3(7) of the
Customs Tariff Act is creating a charge of integrated tax on imports which is
not permitted, as the customs legislation does not define what is an integrated
tax. As stated earlier, integrated tax has specific connotation. It is a levy
under IGST Act. One might compare the language used in section 3(7) with that
used in sections 3(1) and 3(5) of the Customs Tariff Act [Sections 3(1) and
3(5) deal with additional customs duty]. Sections 3(1) and 3(5) read as under:

 

     3. (1) Any article which
is imported into India shall, in addition, be liable to a duty (hereafter in
this section referred to as the additional duty) equal
to the excise duty for the time being leviable on a like article
if produced or manufactured in India and if such excise duty on a like article
is leviable at any percentage of its value, the additional duty to which the
imported article shall be so liable shall be calculated at that percentage of
the value of the imported article:

 

     (5) If the Central
Government is satisfied that it is necessary in the public interest to levy
on any imported article [whether on such article duty is leviable under
subsection ( 1) or, as the case may be, sub-section ( 3) or not] such
additional duty as would counter-balance
the sales tax, value added tax, local tax or any other charges for the time
being leviable on a like article on its sale, purchase or transportation in
India, it may, by notification in the Official Gazette, direct that such
imported article shall, in addition, be liable to an additional duty at a rate
not exceeding four per cent. of the value of the imported article as specified
in that notification.

 

23. A perusal of the
above would show that additional duty equivalent to excise duty and sales tax
is levied. Therefore, the nature of duty remained as customs duty. Only the
rate is equivalent to excise duty or the sales tax rate.

 

24. All along, whenever
any additional duty of customs equivalent to excise duty or special additional
duty equivalent to sales tax were levied on imported goods, the relevant
provisions were made in the Customs Tariff Act. It used the expression
“equivalent to”.

 

25. A perusal of section
3(7) would show that what is leviable u/s. 3(7) is not additional duty
equivalent to rate of integrated tax. Section 3(7) stipulates levy of
integrated tax on imports. Customs Tariff Act cannot levy integrated tax.
Integrated tax is levied under IGST Act which is a law made pursuant to Article
246A read with Article 269A. Article 269A does not empower levy of tax on
direct imports. Integrated tax which takes its power under Article 269A cannot
be levied on imports. So, can one counter this argument to say that the
terminology used should be ignored, as Parliament has power to make laws with
respect to imports as well as inter-State supplies?  

 

26. One cannot read the
words ‘integrated tax’ in section 3(7) of Customs Tariff Act to mean customs
duty. It is also interesting to note section 17 of IGST Act which deals with
apportionment of ‘integrated tax’.Section 17 states that:[relevant extract]

     17. (1) Out of the
integrated tax paid to the Central Government,––

     ……….

 

     (d) in respect of
import of goods or services or both by an unregistered person or by a
registered person paying tax under section 10 of the Central Goods and Services
Tax Act;

 

     (e) in respect of import
of goods or services or both where the registered person is not eligible for
input tax credit;

 

     (f) in respect of import
of goods or services or both made in a financial year by a registered person,
where he does not avail of the said credit within the specified period and thus
remains in the integrated tax account after expiry of the due date for
furnishing of annual return for such year in which the supply was received, the
amount of tax calculated at the rate equivalent to the central tax on similar
intra-State supply shall be apportioned to the Central Government.”

 

27. If integrated tax on
imports is to be read as customs duty, how can section 17 of IGST Act deal with
its apportionment.

 

28.        Section 2(62) of
CGST Act defines ‘input tax’ as under: [relevant extract]

 

     “(62) “input tax” in
relation to a registered person, means the central tax, State tax, integrated
tax or Union territory tax charged on any supply of goods or services or both
made to him and includes—

 

(a) the integrated goods and services tax charged on import
of goods;”

 

29.        Section 42 of CGST Act
reads as under:

 

     42. (1) The details of
every inward supply furnished by a registered person (hereafter in this section
referred to as the “recipient”) for a tax period shall, in such manner and
within such time as may be prescribed, be matched––

     (a) with the
corresponding details of outward supply furnished by the corresponding
registered person (hereafter in this section referred to as the “supplier”) in
his valid return for the same tax period or any preceding tax period;

     (b) with the integrated
goods and services tax paid under section 3 of the Customs Tariff Act, 1975 in
respect of goods imported by him; and

 

     (c) for duplication of
claims of input tax credit.

 

30. If integrated tax in
section 3(7) of Customs Tariff Act were to be understood as customs duty,
section 2(62) and section 42 of CGST Act should not have been so worded. The
use of integrated tax in section 3(7) of Customs Tariff Act has been
consciously taken, which is vindicated from the language in section 17 of IGST
Act and sections 2(62) and 42 of IGST Act.

 

31. Taxable event of
import cannot suffer a levy under IGST Act. Customs Act alone can create charge
on imports. Import is a taxable event under the Customs Act. It is not a
taxable event under IGST Act. The same aspect [i.e., import] cannot be taxed
under two Acts. So howsoever one chooses to interpret Explanation to Article
269A(1) or Article 286, charge on imports cannot be created under IGST. Article
286, even prior to its amendment, did not empower levy of CST on imports. Imports
were not treated as part of inter-State trade or commerce. This is evident from
entry 41 and 42 of List I to Seventh Schedule. So, section 3(7) of Customs
Tariff Act and proviso to section 5(1) of IGST Act fail to create a valid charge of integrated tax on imports.

 

32. Rag-bag legislation
acknowledged by the Hon’ble SC in Ujagar Prints’s case 1989 (38) ELT 535 was vis-à-vis
entries in List I of the Seventh Schedule to the Constitution. It stated that
if one entry doesn’t empower Parliament to make law vis-à-vis a
particular levy, there is no prohibition on relying on the residual entry to
find the source for power to make law in respect of such levy. The Hon’ble SC
did state that Parliament has exclusive power to make laws in respect of those
matters which are not covered either by List II or List III. Would this
principle apply to harmonious interpretation of Article 246, 246A and 269A? If
one were to apply rag-bag legislation principle, one of the fall outs would be
that Parliament is empowered to make law, prescribing two levies in respect of
very same aspect [Factually, Parliament has prescribed only one levy;
Theoretically, it is empowered to prescribe two levies in respect of the same
aspect].  IGST Act has been enacted
pursuant to Article 246A read with Article 269A of the Constitution. Customs
Act has been enacted pursuant to Article 246. Article 269A does not empower levy
of GST on direct imports. Can the Customs Act which is enacted under Article
246 levy integrated tax [though integrated tax is a levy pursuant to Article
269A which doesn’t empower levy of integrated tax on direct imports] on
imports? The Hon’ble SC did not consider a situation where Parliament made
enactment pursuant to two different Articles of the Constitution. If Parliament
is said to be empowered to make a law in respect of a particular levy under
more than one Article, doesn’t it render one of the Articles otiose. Is
it not against the principles of harmonious construction?

  

33. Interestingly, if
one were to interpret that Explanation to Article 269A(1) and Article 286
empower levy on direct imports, not only 3(7) of Customs Tariff Act but even
the main levy on imports i.e., basic customs duty [i.e., section 12 of Customs
Act read with section 2 of Customs Tariff Act] would fail. This is because if
one were to interpret that Explanation to Article 269A(1) and Article 286
empower levy on direct imports, it means that direct imports are deemed to be
inter-State supplies. Levy on inter-State supplies are governed by IGST Act. So
the natural fall out is that direct imports which are deemed to be inter-State
supplies should be liable only to integrated tax and not customs duty.

 

34. It would also be
interesting to note that the recent clarification by the government stating
that customs duty would be levied only on actual imports but would include the
price charged in several high sea sale transactions for the purpose of customs
valuation shows that when actual imports do take place, it is only the customs
legislation which would be relevant.

 

35. Though we have made
passing references to high sea sales while talking about section 7(2) of the
IGST Act at few places in this article, we wish to opine that there is no valid
levy of IGST on high sea sales. The purpose of this article is not to examine
the levy of IGST on high sea sales. Therefore, without going into details, we
would like to mention that the intention of legislators to levy IGST on high
sea sales is not achieved by the manner in which section 7(2) of the IGST Act
is worded. Though the Explanation to Article 269A(1) and Article 286(1)(b) is
intended to empower levy of IGST on high sea sales, the said intention is not
carried out by the legislators. This is because the language used in section
7(2) should have been similar to that in the section 5(2) of CST Act or at the
least, the language similar to Explanation below Article 269A(1) or Article
286(1)(b) should have been replicated in section 7(2). Section 7(2) doesn’t use
the expression “in the course of”. The levy of IGST, therefore, fails
even in case of high sea sales.

 

Though Article 286 has been amended, there
is no provision similar to section 5(2) of CST Act in IGST Act. This argument
would give additional support to the view that high sea sales are not liable to
IGST.

 

Conclusion

The conclusions reached could be summarised as under:

 

a.  Levy of customs duty on
actual imports can arise only under the Customs Act, 1962.

 

b.  Levy of integrated tax on
supplies in the course of import or export excluding actual imports/exports can
be made under the IGST Act, 2017, but the present wordings fall short of what
is used in the Constitution and therefore, the same does not seem to extend to
transactions such as on high sea sales.

 

c.  The present levy u/s. 3(7)
of the Customs Tariff Act which states that there shall be levied an integrated
tax is clearly beyond the legislation itself, as the customs legislation can
only levy a customs duty equivalent to the integrated tax and not an integrated
tax per se. This would now need legislative amendments. _

Loan Or Advance To Specified ‘Concern’ By Closely Held Company Which Is Deemed As Dividend U/S. 2 (22) (E) – Whether Can Be Assessed In The Hands Of The ‘Concern’? – Part II

(Continued
from the last issue)

 

2.6     As stated in para 1.4
of Part I of this write-up, under the New Provisions, loan given to two
categories of persons are covered u/s. 2(22) (e) viz. i) certain shareholders
(first limb of the provisions) and ii) the ‘concern’ in which such shareholder
has substantial interest (second limb of the provisions). As mentioned in para
1.5 of Part I of this write-up, in cases where the requisite conditions of the
second limb of the New Provisions are satisfied, the issue is under debate
that, in such cases where the loan is given to a ‘concern’, whether the amount
of loan is taxable as deemed dividend in the hands of the shareholder or the
‘concern’ which has received the amount of the loan. As also mentioned in that
para, the judicial precedents [including the Special Bench in Bhaumik Colour’s
case reported in (2009) 18 DTR 451] largely, directly or indirectly, showed
that, in such cases, deemed dividend should be taxed in the hands of the
shareholder and on the other hand, in CBDT circular [No. 495 dtd. 22/9/1987], a
view is taken that the same should be taxed in the hands of the ‘concern’. As
further mentioned in para 2.5       read
with para 2.4 of Part I of this write-up, the Delhi High Court decided this
issue in favour of the assessee company on the short ground that the deemed
dividend can not be assessed in the hands of the assessee company which was not
a shareholder of the lending company [i.e. BPOM] as dividend can be assessed
only in the hands of the shareholder of the lending company and can not be
assessed in the hands of a non-shareholder. For this, the Delhi High Court
merely relied on its judgement in the case of Ankitech P. Ltd. [ITA No
462/2009] and passed a short order to this effect (Ref: para 2.4 of Part I of this
write-up). Therefore, it is necessary to analyse, that judgement of the Delhi
High Court also, more so as that has been ultimately approved by the Apex
Court.

 

         CIT vs.
Ankitech[P]Ltd[(2012)40ITR14(Del)-ITA No. 462/2009] & connected Appeals

 

3.1     In the above, the High Court dealt with and simultaneously
disposed of number of appeals relating to different assessees by a common order
by taking the facts of the case of Ankitech P. Ltd. [ITAT No.462/2009] as the
base.

 

3.2     In the above case, the brief facts were that the assessee company
had received advances of Rs. 6,32,72,265 by way of a book entry from M/s
Jackson Generator (P) Ltd. [JGPL]. There was sufficient accumulated profit with
JGPL to cover this amount. So far as the shareholding pattern of the two
companies is concerned, the undisputed facts revealed that the same
shareholders (Guptas) were holding (it seems beneficially) more than 10% of
equity shares carrying voting power in JGPL and the same shareholders were also
holding (it seems beneficially) equity shares carrying voting power in the
assessee company much more than 20% and accordingly, were having substantial
interest therein. As such, the facts would reveal that the conditions of the
second limb of the New Provisions were satisfied. It is also worth noting that
the assessee company itself was neither a registered shareholder nor the
beneficial shareholder in JGPL(i.e. lending company). On these facts, the
Assessing Officer (AO), while completing the assessment for the Asst. Year. 2003-04,
assessed the above referred amount of advances as deemed dividend in the hands
of the assessing company. While doing so, the AO rejected the specific
contention raised by the assessee company that since the assessee company is
not a shareholder in JGPL, the provisions of section 2(22) (e) will not be
attracted as one of the essential conditions for taxing deemed dividend u/s.
2(22) (e) was that such income is to be assessed in the hands of the
shareholder. The view of AO was confirmed by the Commissioner of Income-tax
(Appeals). However, the Tribunal deleted the addition by taking a view that
though the amount received by the assessing company by way of book entry is
deemed dividend u/s. 2(22)(e), the same cannot be assessed in the hands of the
assessee company as it was not a shareholder in JGPL and a dividend cannot be
paid to a non-shareholder.

 

        The Tribunal also took the view that it would
have to be taxed, if at all, in the hands of the shareholders who have
substantial interest in the assessee company and also holding not less than 10%
shares carrying voting power in the lending company. For this, it appears that
the Tribunal had relied on the Special Bench decision in Bhaumik Colour’s case
(supra).

 

3.3     When the issue came-up
before the High Court at the instance of the Revenue with four questions
raised, the Court, in this context, felt that real question is one and stated
as under [pg 16]:

 

          “Though as many as
four questions are framed, it is with singular viz., whether the assessee who
was not the shareholders of M/S. Jackson Generators (P) Ltd. (JGPL) could be
treated as covered by the definition of “dividend“ as contained in section
2(22)(e) of the Income-tax Act (hereinafter referred to as “the Act”).”

  

 3.3.1 To decide the issue,
the Court referred to the relevant provisions of section  2(22) (e) along with the share holding
pattern of both the companies and stated that the payment of advance given by
JGPL to the assessee company (‘concern’) would be treated as deemed dividend u/s.
2(22)(e). With these undisputed facts, the Court, in the context of the issue
on hand, stated as under [pg 19]:

 

          “…….. The dispute
which has arisen, in the scenario is to whether this is to be treated as
dividend income in the form of dividend advance of the shareholders or advance
of the said concern,(i.e. the assessees herein). Whereas the Department has
taken it as income at the hands of the assessee, as per the assessee it cannot
be treated as dividend income to their account. The Tribunal has accepted this
plea of the assessee holding that such dividend income is to be taxed at the
hands of the shareholders.” 

 

3.3.2 The Court then referred to the historical background of the
provisions from 1922 Act to the New Provisions narrated by the Special Bench in
Bhaumik Colour’s case (supra) and observed as under [pg 21]:

 

          “It is clear from the
above that under the 1922 Act, two categories of payments were considered as
dividend viz., (a) any payment by way of advance or loan to a shareholder was
considered as dividend paid to shareholder; or (b) any payment by any such
company on behalf of or for the individual benefit of a shareholder was
considered as dividend. In the 1961 Act, the very same two categories of
payments were considered as dividend but an additional condition that payment
should be to a shareholder being a person who is the beneficial owner of shares
and who has a substantial interest in the company, viz., shareholding which
carries not less than twenty per cent. of voting power, was introduced, By the
1987 amendment with effect from April 1, 1988, the condition that payment
should be to a shareholder who is the beneficial owner of shares (not being
shares entitled to a fixed rate of dividend whether with or without a right to
participate in profits) holding not less than ten per cent. of the voting power
was substituted. Thus, the percentage of voting power was reduced from twenty
per cent. to ten per cent. By the very same amendment, a new category of
payment was also considered as dividend, viz., payment to any concern in which
such shareholder is a member or a partner and in which he has a substantial interest.
Substantial interest has been defined to mean holding shares carrying 20 per
cent. of voting power.”

 

3.3.3  After referring to the
above referred historical background, the Court noted that the controversy in
the present case refers to the second limb of the New Provisions. The Court
then stated that a Special Bench in Bhaumik Colour’s case has analysed the New
provisions and spelt out the conditions [Ref. para 1.4.1. of Part I of this
write-up] which are required to be satisfied for attracting this category of
the New Provisions. These include the view that the expression ‘such
shareholder’ found in the second limb of the New Provisions refers to
registered shareholder [for this, basically reliance was placed on Apex Court’s
judgement in the case of C. P. Sarathy Mudaliar (supra)] and the
beneficial holder of the shareholding carrying 10% voting power. In this
context, the Court also referred to the relevant part of the order of the
Special Bench and noted that the Special Bench held that the intention behind
this provision is to tax dividend in the hands of the shareholders. The Court
then also referred to the judgements of the Bombay High Court in the case of
Universal Medicare (P) Ltd [(2010)324 ITR 263] and Rajasthan High Court in the
case of Hotel Hilltop [(2009) 313 ITR 116] in which also similar view was
taken.

 

 3.4 The Court then noted that
despite the above referred judgements of the High Courts of Bombay and
Rajasthan, the learned counsel appearing on behalf of the Revenue (Ms. Bansal)
made a frantic afford to persuade the Court to take a contrary view. Her
endeavour was to demonstrate on first principle that by this deeming provision
fictionally the ‘concern’ which receives the amount would be treated as
shareholder for the purpose of this provision and the same should be treated as
dividend in the hands of the recipient (i.e. ‘concern’). In this regard, her
contention was that under the New provisions, deeming fiction is specifically
created to tax the amount of such loan given to a ‘concern’ as deemed dividend
and when this legal fiction is created, it was to be taken to its logical
conclusion and as such, the ‘concern’ which had received the amount should be
taxed. For this, she placed reliance on certain judgements including of the Apex
Court dealing with the effects of creation of a legal fiction. According to
her, this is the effect of the second limb of the New Provisions read with Explanation 3. She also relied on the
CBDT Circular No. 495 dtd 22/9/1987 in which such a view is taken (Ref. para
2.6 above)

 

3.4.1  The Court then dealt
with the contentions of the learned counsel for the Revenue and pointed out
that we have already referred to the relevant provisions of section 2(22)(e)
and requisite conditions for invoking the same as well as the historical
background of section 2(22)(e). Considering the intention behind enacting these
provisions, the Court stated as under [pg 35]:

 

          “…… The intention behind the provisions of section 2(22)(e)
of the Act is to tax dividend in the hands of shareholders. The deeming
provisions as it applies to the case of loans or advances by a company to a
concern in which its shareholder has substantial interest, is based on the
presumption that the loans or advances would ultimately be made available to
the shareholders of the company giving the loan or advance. “

 

3.4.2 The Court then proceeded
further to deal with the contention with regard to creation of deeming fiction
and its effects and stated as under [pg 35]:

 

          “Further, it is an
admitted case that under the normal circumstances, such a loan or advance given
to the shareholders or to a concern, would not qualify as dividend. It has been
made so by a legal fiction created u/s. 2(22)(e) of the Act. We have to keep in
mind that this legal provision relates to “dividend”. Thus, by a deeming
provision, it is the definition of dividend which is enlarged. Legal fiction
does not extend to “shareholder”. When we keep in mind this aspect, the
conclusion would be obvious, viz., loan or advance given under the conditions
specified u/s. 2(22) (e) of the Act would also be treated as dividend. The
fiction has to stop here and is not to be extended further for broadening the
concept of shareholders by way of legal fiction. It is common case that any
company is supposed to distribute the profits in the form of dividend to its
shareholders/members and such dividend cannot be given to non members. The
second category specified u/s. 2(22) (e) of the Act, viz., a concern (like the
assessee herein), which is given the loan or advance is admittedly not a
shareholder/member of the payer company. Therefore, under no circumstances, it
could be treated as shareholder/member receiving divided. If the intention of
the Legislature was to tax such loan or advance as deemed dividend at the hands
of “deeming shareholder”, then the Legislature would have inserted a deeming
provision in respect of shareholder as well, that has not happened. Most of the
arguments of the learned counsel for the Revenue would stand answered, once we
look into the matter from this perspective.”

 

3.4.3 Finally, rejecting the argument with regard to creation of
deeming fiction and its logical effect as contented by the learned counsel for
the Revenue, the Court stated as under [pg 36]:

 

          “No doubt, the legal
fiction/deemed provision created by the Legislature has to be taken to “logical
conclusion” as held in Andaleeb Sehgal [2010] 173 DLT 296 (Delhi) [FB].
The revenue wants the deeming provision to be extended which is illogical and
the attempt is to create a real legal fiction, which is not created by the
Legislature. We say at the cost of repetition that the definition of
shareholder is not enlarged by any fiction.”

 

3.4.4 With regard to the view
expressed in the CBDT Circular, the Court stated that it is inclined to agree
with the observations of the Special Bench in Bhaumik Colour’s case (supra)
that the same is not binding on the courts. In this regard, the Court further
observed as under [pg 36]:

 

          “…..Once it is found that such loan or advance cannot be
treated as deemed dividend at the hands of such a concern which is not a
shareholder, and that, according to us, is the correct legal position, such a
circular would be of no avail. ”

 

3.5    Having taken a view
that such deemed dividend cannot be assessed in the hands of the assessee
company which is not the shareholder of JGPL, the Court further concluded as
under [pg 36]:

 

          “Before we part with,
some comments are to be necessarily made by us. As pointed out above, it is not
in dispute that the conditions stipulated in section 2(22)(e) of the Act
treating the loan and advance as deemed dividend are established in these cases
Therefore, it would always be open to the Revenue to take corrective measure by
treating this dividend income at the hands of the shareholders and tax them
accordingly. As otherwise, it would amount to escapement of income at the hands
of those shareholders.”

 

3.6         In the above
judgement, the Court took the view that once the requisite conditions of the
second limb of the New Provisions are satisfied, the amount of loan can be
assessed as deemed dividend in the hands of the shareholder only and not in the
hands of a ‘concern’ (non-shareholder). On this basis, the Court also
simultaneously disposed of all other connected appeals. However, in addition to
this, the Court also passed further orders in respect of four other appeals,
which are based on specific facts of these cases with which we are not
concerned in this write-up. These additional four orders are in the cases of
Timeless Fashions Pvt Ltd. [ITA No. 1588 of 2010], Nandlala Securities Pvt.
Ltd. [ITA No. 211 of 2010], Roxy Investment [ITA No. 2014 of 2010] and Indian
Technocraft Ltd. [ITA No. 352 of 2011].

 

         CIT vs. Madhur Housing
and Development Company (Appeal No. 3961 of 2013-
SC)

 

4.1     As mentioned in para 2.6 above, in the above case, the Delhi High
Court decided the issue of taxation of deemed dividend in the hands of the
assessee company [i.e. ‘concern’] on the short ground that the deemed dividend
cannot be assessed in its hands, as it was not a shareholder of the lending
company (i.e. BPOM) and for that purpose, the Court merely followed its earlier
decision in the case of Ankitech (P) Ltd. [ITA No 462/2009] (supra).

 

4.2   The above judgement of
the Delhi High Court along with number of appeals relating to different
assessees invoking similar issue came-up before the Apex Court and the Apex
Court disposed of all of them, by a common order, by referring to the judgement
and the order of the Delhi High Court in the above case (i.e. Madhur Housing’s
case) by passing the following order: 

 

          “The impugned
judgement and order dated 11.05.2011 has relied upon a judgement of the same
date by a Division Bench of the High Court of Delhi in ITA No. 462 of 2009.
Having perused the judgement and having heard arguments, we are of the view
that the judgement is a detailed judgment going into section 2(22)(e) of the
Income-tax Act which arises at the correct construction of the said Section. We
do not wish to add anything to the judgment except to say that we agree
therewith.

 

         These appeals are
disposed of accordingly. “

 

4.3   
From the above, it would appear that the Apex Court took note of the
fact that the judgment of the Delhi High Court in the case of Ankitech (P) Ltd.
(supra) is a detailed judgement considering this aspect of the
provisions of section 2(22)(e) of the Act and approved the same. It is worth
noting that the Apex Court has approved the judgement of the Delhi High Court
only in the case of Ankitech (P) Ltd. [ITA No 462/2009] which is analysed in
para 3 above. For this purpose, it seems that the Apex Court has not considered
separate orders simultaneously passed by the Delhi High Court in four other
connected appeals [Ref. para 3.6 above].

 

Conclusion

 

5.1    The above judgement of
the Division Bench of the Apex Court directly dealt with and decided the issue
referred to in para 2.6 above [read with para 1.5 of Part I of this write-up]
that in a case where the conditions for invoking the second limb of the New
Provisions of section  2(22) (e) are
satisfied, the amount of loan given to a ‘concern’, which is treated as deemed
dividend, should be assessed only in the hands of the common shareholder with
requisite shareholding in the lending company and who is also having
substantial interest in the ‘concern’ and not in the hands of the ‘concern’
receiving the loan. As such, the issue referred to in para 2.6 above read with
para 1.5 of part I of this write-up now could be treated as settled. Based on
this, the judicial precedents supporting this view, referred to in para 1.5 of
Part I of this write-up, could also be treated as impliedly approved. In this
respect, based on this, the view expressed in the CBDT Circular [No. 495 dtd.
22/9/1987] referred to in para 2.6 above could be treated as incorrect position
in law.

 

5.1.1  In the above case, the
Apex Court has also specifically considered the effect of a legal fiction
created in section 2(22)(e) and its logical effect. In this context, the Court
has emphatically taken a view that the legal fiction created in   section 2(22)(e) only expands the meaning of
the expression ‘dividend’ and it does not, in anyway, enlarge the meaning of
the expression ‘shareholder’ as contemplated in the said provisions. In fact,
this and the general principles that dividend can be paid by the company only
to its shareholders/members and it cannot be given to non-shareholders/members
are the main basis of conclusion arrived by the Apex Court in the above case.

 

5.2     Interestingly, as
mentioned in para 1.6 of part I of this write-up, the Division Bench of the
Apex Court in the case of Gopal and Sons HUF [ (2017) 391 ITR 1] also had an
occasion to indirectly deal with similar issue of the type referred to in para
2.6 above [read with para 1.5 of part I of this write-up] in the context of a
case of a loan given by closely held company to an HUF, which was the
beneficial owner of the shares with requisite shareholding in the lending
company. In that case, there was some debate as to whether the HUF itself was a
registered shareholder or its Karta was the registered shareholder of the
lending company. On these facts, the following question was raised before the
Apex Court:

 

          “Whether in view of the settled principle that
HUF cannot be a registered shareholder in a company and hence, could not have
been both registered and beneficial shareholder, loan/ advances received by HUF
could be deemed as dividend within the meaning of section 2(22)(e) of the
Income-tax Act, 1961 especially in view of the term “concern” as defined in the
Section itself?”

 

5.2.1  Under the above
circumstances, in that case, the Apex Court, on peculiar facts of the case,
took the view that the amount of loan in question should be treated as deemed
dividend under the second limb of the New Provisions and it should be taxable
as such in the hands of the HUF, as the Karta of the HUF is having undisputedly
substantial interest in the HUF. The Court also further concluded that even if
it is presumed that HUF itself is not a registered shareholder of the lending
company, as per the provisions of section 2(22)(e), once the payment is
received by the HUF (which was admittedly beneficial owner of the shares) and
the registered shareholder of the lending company [it’s Karta] is a member of
the said HUF with substantial interest, the payment made to the HUF constitutes
deemed dividend u/s. 2(22) (e) and taxable as such in the hands of HUF.
According to the Court, that is the effect of Explanation 3 to the said
section. According to the Court, the judgment of C.P. Sarathy Mudaliar (supra)
will have no application as that was delivered u/s. 2(6A)(e) of the 1922 Act,
wherein     there was no provision like
Explanation 3. Effectively, the Court concluded that, in view of the
Explanation 3 to section 2(22)(e), the amount of loan constitutes deemed
dividend under the second limb of the New Provisions of section 2(22)(e) in the
hands of the HUF, even if one presumes that HUF itself is not a registered
shareholder of the lending company.

 

5.2.2  From the above, it
would appear that in Gopal and Sons HUF’s case (supra), the Apex Court
impliedly decided the issue referred to in para 2.6 above read with para 1.5 of
Part I of this write-up, by taking a view that the deemed dividend under the
second limb of the New Provisions is taxable in the hands of the ‘concern’
(i.e. HUF). This gives support to the opinion expressed in CBDT circular
referred to in that para. This judgement has been analysed by us in this column
in April and May, 2017 issues of this journal. 

 

5.3    Interestingly, in the above judgement of the Apex Court in the case
of Madhur Housing and Development Company, the Apex Court’s  judgement in Gopal and Sons HUF’s case (supra)
has not been referred to or considered. Apex Court in the above case referred
to the judgement of the Delhi High Court in the case of Ankitech (P) Ltd. (Ref.
para 4.2 above) and approved the same and the judgement of the Apex Court in
the case of Gopal and Sons HUF(supra), which is the recent one, was not
available before the Delhi High Court in that case.

 

5.3.1  It is also worth noting
that in the case of Gopal and Sons HUF (supra), the facts were peculiar
and it was also noted that though the share certificates were issued in the
name of the Karta of the HUF but in the annual returns of the company filed
with the ROC, HUF was also shown as registered shareholder. Whether this
factual position could be regarded as relevant in the context of the issue on
hand (i.e. to determine the taxable person of deemed dividend) to distinguish
the effect of Gopal and Sons HUF’s case (supra) may be a matter of
consideration. However, this would be an uphill task in view of the conclusion
of the Apex court in the case of Gopal and Sons HUF (supra) referred to
in para 3.9 read with para 3.8 of part II of the write-up on that judgement
appeared in May, 2017 issue of this journal.

 

5.4          In
view of the above, an interesting issue is likely to come-up for consideration
as to which judgement of the Apex Court, between the two of the above, would be
relevant, for the purpose of determining the taxable person under the second limb
of the New Provisions in cases where the loan is given to a ‘concern’ and the
other conditions for treating such a loan as deemed dividend under these
provisions are satisfied. _

Allowability Of Interest On Delayed Payment Of Tax Deducted At Source

Issue for Consideration

Chapter XVII of the
Income-tax Act, 1961 contains several provisions for collection and recovery of
tax, by way of Tax Deduction at Source (‘TDS’) and Tax Collection at Source
(‘TCS’), by the payer and the receiver respectively. The payer and receiver are
also tasked with remitting the TDS and TCS to the government, filing periodic
statements and issuing certificates in respect of the same. Interest is levied
u/s. 201(1A), on the payer/receiver, for the period of delay in case of
non-deduction or collection of tax, or for failure to pay the same as required
by the Act.

 

Section 37(1) of the Act
provides for allowance of a deduction in respect of any expenditure, which is
not dealt with in sections 30 to 36 and is not in the nature of capital
expenditure or personal expenses of the assessee, but is laid out or expended
wholly and exclusively for the purposes of the business or profession.

 

Further, Explanation 1 to
section 37(1) declares that, for the removal of doubts, any expenditure
incurred by an assessee for any purpose which is an offence or which is
prohibited by law shall not be deemed to have been incurred for the purpose of
business or profession and no deduction or allowance shall be made in respect
of such expenditure.

 

Four attributes emerge from
the provisions of section 37 as being essential for claiming deduction in respect
of any expenditure in computing the income under the head “Profits and gains of
business or profession” –

 

1)     It
must not be capital in nature;

2)     It
must not be personal in nature;

3)     It
must be laid out or expended wholly and exclusively for the purposes of
business or profession; and

4)     It
must not be incurred for a purpose which is an offence or which is prohibited
by law.

 

        In
claiming the deduction u/s. 37(1) for interest u/s. 201(1A), an issue arises as
to whether such interest can be considered to be incurred wholly and exclusively for the
purpose of business or profession.

 

Conflicting decisions of
the different benches of the Tribunal, delivered in recent times, have
reignited the controversy. The Ahmedabad bench has, in two separate decisions,
taken a view that no deduction can be allowed in respect of such interest and
the Kolkata bench, on the other hand, has upheld the allowability of deduction
of interest in a recent decision.

 

Shree Saras Spices & Food P.
Limited’s case

The issue came up before
the Ahmedabad bench of the Tribunal in the case of Shree Saras Spices &
Food P. Limited vs. DCIT ITA Nos. 2527/Ahd/2010 and 1220/Ahd/2012 for
assessment years 2007-08 and 2009-10.

 

In the said case, the
assessee had claimed deduction in respect of interest on TDS. The A.O.
disallowed the same. The assessee challenged the addition before the CIT(A),
who dismissed the appeal and confirmed the action of the A.O., relying on the
Supreme Court decisions in the case of East India Pharmaceutical Works Ltd.
vs. CIT (1997) 224 ITR 627 (SC) and Bharat Commerce & Industries
Ltd. vs. CIT (198) 230 ITR 733 (SC). The CIT(A) observed that interest was
paid on TDS only upon late payment to the Government treasury, which implied that
the assessee had utilised Government funds and paid interest as a compensation
for enjoyment of the amount due to the Government.

 

On second appeal by the
assessee, the Tribunal also noted that the assessee had used the Government
money for its own purposes and interest on late payment of TDS was not
allowable as was held in East India Pharmaceutical Works Ltd. vs. CIT
(supra) and accordingly, dismissed the appeal.

 

The issue of allowability
of interest on late payment of TDS was also examined by the Ahmedabad bench in
an earlier decision in the case of ITO vs. Royal Packaging ITA No.
1363/Ahd/2010 for assessment year 2005-06.

 

In that case, interest on
TDS was disallowed by the A.O. on the ground that since TDS was not allowable,
interest on same was also not allowable. On appeal before the CIT(A), it was
argued by the assessee that since interest received on tax refund was taxable,
in the same manner, interest on late payment of TDS was an allowable expense.
The CIT(A) accepted the contention of the assessee and deleted the addition
made by the A.O.

 

On further appeal, the
Tribunal relying on the Supreme Court decision in the case of Bharat
Commerce & Industries Ltd. vs. CIT (supra), held that interest on late
payment of TDS is also not allowable and restored the disallowance made by the
A.O.

 

Narayani Ispat Pvt. Ltd.’s case

Recently, the issue had
once again arisen before the Kolkata bench in the case of DCIT vs. Narayani
Ispat Pvt. Ltd. ITA No. 2127/Kol/2014 for assessment year 2010-11.

In that case, interest on
late payment of service tax and TDS was claimed by the assessee as a part of
its interest and finance expenses. However, the A.O., relying on the Supreme
Court decision in the case of Bharat Commerce & Industries Ltd. vs. CIT
(supra), disallowed the claim of interest.

 

The assessee preferred an
appeal against the addition before the CIT(A), wherein it was pointed out that
in the case of Bharat Commerce & Industries Ltd. vs. CIT (supra),
the disallowance was made in respect of interest u/s. 215 of the Act due to
delay in the payment of income tax on the income disclosed under Voluntary
Disclosure of Income and Wealth Act, 1976, which was different from the
interest u/s. 201(1A) on late deposit of service tax and TDS. The assessee
relied on the decision of the Karnataka High Court in the case of CIT vs.
Mysore Electrical Industries Ltd. 196 ITR 884 (Kar), where interest for
failure to pay PF contribution was held deductible, and also on the Supreme
Court decision in the case of Lachmandas Mathura Das vs. CIT 254 ITR 799 (SC),
where interest on sales tax arrears was held deductible. Accepting the
arguments of the assessee, the CIT(A) held that the impugned interest expense
was incurred wholly and exclusively for the purpose of business and was thus,
allowable.

 

The Tribunal, in further
appeal by the Revenue discussed the judgement in the case of Bharat Commerce
& Industries Ltd. vs. CIT (supra) in detail and distinguished its facts
since it dealt with interest on delayed payment of income tax, whereas in the
appeal before the tribunal, interest was paid for delayed payment of service
tax and TDS. The Tribunal observed that interest for delay in making payment of
service tax and TDS was compensatory in nature and not in the nature of
penalty. It also delved upon the decision of the Supreme Court in the case of Lachmandas
Mathura Das vs. CIT (supra), and held that its principles can be applied to
interest on delayed payment of TDS, noting that interest on late payment of TDS
related to expenses claimed by the assessee which were subjected to the TDS
provisions and that TDS did not represent tax of the assessee, but rather the
tax of the payee. The deduction allowed by the CIT(A) in respect of interest on
TDS was thus upheld by the Tribunal.

 

Observations

The issue under
consideration is relevant for a large number of assessees.

 

Section 40(a)(ii) of the
Act expressly provides for disallowance of any sum paid on account of any rate
or tax levied on the profits or gains of any business or profession under the
head ‘Profits and Gains of Business Profession’. The case for disallowance of
income tax levied on the profits and gains of the business or profession is
thus specifically settled by the express provisions of the Act. Similarly
settled by the decisions of the Supreme Court, is the proposition of the law
that any interest paid for delay in payment of income tax on profits and gains
of business or profession is also not deductible in computing the profits and
gains of business. It is also settled that any interest paid on borrowings made
for payment of such income tax is also not deductible in computing such profits
and gains of business.

 

In the case of Bharat
Commerce & Industries Ltd. vs. CIT (supra), the assessee, a
manufacturing company, had claimed deduction in respect of interest on delay in
payment of advance tax u/s. 37(1) of the Act on the ground that delayed payment
of taxes resulted in increase in the assessee’s financial resources, which
became available for its business. The assessee also contended that the
interest paid to the Government represented in effect, the interest on capital
that would have been borrowed by it otherwise and thus, it was an expense
incurred wholly and exclusively for the purpose of its business.

 

The Apex Court observed as under –

“When interest is paid
for committing a default in respect of a statutory liability to pay advance
tax, the amount paid and the expenditure incurred in that connection is in no
way connected with preserving or promoting the business of the assessee. This is
not expenditure which is incurred and which has to be taken into account before
the profits of the business are calculated. The liability in the case of
payment of income- tax and interest for delayed payment of income-tax of
advance tax arises on the computation of the profits and gains of business. The
tax which is payable is on the assessee’s income after the income is
determined. This cannot, therefore, be considered as an expenditure for the
purpose of earning any income or profits.”

 

The Supreme Court, in the
said case, in conclusion, held that the interest levied u/s. 139 and section
215 of the Income-tax Act was not deductible as a business expenditure u/s.
37(1) of the Act. The court in that case held that the income tax was a tax on
profit of the business and was therefore not allowable as a deduction.
Similarly, interest also was not deductible as the same was inextricably
connected with the assessee’s tax liability; if the income tax was not a
permissible deduction u/s. 37, any interest payable for default in payment of
such income tax could not be allowed as a deduction. In arriving at the
conclusion, the court followed its own decision in the cases of East India
Pharmaceutical Works Ltd, 224 ITR 627 and Smt. Padmavati Jaikrishna, 166
ITR 176, where decisions dealt with the issue of deductibility of interest
paid on moneys borrowed for payment of income tax.

 

The principles that emerge
from the observations of the Apex Court in the above decision as well as in the
various decisions cited therein, are that interest on delayed payment of income
tax would take its colour from the principal amount of income tax and thus, it
could not be considered to be incurred wholly and exclusively for the purpose
of business and consequently, such interest cannot be claimed as a deduction.
Where, however, the principal amount is an expenditure for the purpose of
earning any income or profits and is incidental to the business, whether
interest on delayed payment thereof would be allowed as a deduction u/s. 37(1)
is a question that was not addressed by the court.

The Bombay High Court had
the occasion to examine the issue of deductibility u/s. 37(1) of the interest
u/s 201(1A) of the Act. The court, in a brief order, upheld the disallowance of
the deduction u/s. 37 by simply following the decisions in the cases of Aruna
Mills Ltd, 31 ITR 153 (Bom.), Ghatkopar Estate and Finance Corporation Pvt.
Ltd, 177 ITR 222 (Bom.), Bharat Commerce Industries Ltd, 153 ITR 275 (Del.) and
Federal Bank Ltd, 180 ITR 37 (Kerela) after noting that the high courts in
the above referred decisions had taken a similar view.

 

Subsequently, the Madras
High Court in the case of Chennai Properties and Investments (P) Ltd., 239
ITR 435 (Mad) examined the deductibility u/s. 37(1) of the interest u/s.
201(1A) of the Act. The court noted that the interest paid took it’s colour
from the nature of the principal amount remaining unpaid.The principal amount
being income tax, interest thereon was in the nature of a direct tax, and could
not be regarded as a compensatory payment, and was therefore not allowable as
business expenditure. In deciding against the assessee, the court followed the
decision of the Supreme Court in the case of Bharat Commerce and Industries
Ltd, 230 ITR 733 (SC).

 

In spite of the issue of
the deductibility and allowance of interest paid for delay in payment of the
tax deducted at source levied u/s 201(1A) being decided against the assessee by
the high courts, in our considered opinion, it remains open and debatable.
While the Bombay and the Madras High Courts have examined the issue and have
held against the allowability of such interest, the said decisions, in our very
respectful opinion, cannot be taken to have been delivered on due examination
of the law, in as much as the courts, in those cases, have simply relied on the
precedents to arrive at a conclusion without appreciating that the decisions,
referred to as precedents, were concerned with the payment of interest under
sections 139, 215 and 270, levied for delay in payment of income tax on gains
of business. None of them were concerned with the payment of interest on
delayed payment of the tax deducted at source. Neither was this distinction
highlighted before the courts nor did the courts on their own examine the vital
difference between the tax on income and the tax deducted at source. It is
possible that the decisions in question may be reviewed or reconsidered or
dissented or distinguished. The law shall remain debatable till such time as
the same is examined by the highest court of the land.

 

It is significant to note
that usually a tax is deducted at source on payments made by a businessman in
his character as a trader and, in most of the cases, such payments are
expressly or otherwise deductible under the Act, in computing the Profits and
Gains of Business or Profession. In the absence of any specific provisions such
as section 40(a), for expressly disallowing the payments, the tax deducted and
withheld is a part of the expenditure of the payer and in no manner can be construed
as a tax on his profits or gains of business or profession. Therefore,
provisions of section 40(a)(ii) have no application to such payments or
interest thereon. In fact, the entire expenditure representing the payment,
including tax deducted and withheld, is deductible in law without reservation.

 

The
term “tax” is defined u/s. 2(43) to mean income tax chargeable under the
provisions of Income-tax Act and includes the fringe benefit tax. On a bare
reading of this provision, it is clear that the term “tax” in no manner
includes the tax deducted at source which is tax on somebody else’s income and
not on the income of the assessee payer; in any case, the tax deducted at
source is not an income tax ‘chargeable’ under the provisions of the Act.

 

The view of the Kolkata
Tribunal in the case of Narayani Ispat Pvt. Ltd. (supra), thus,
appears reasonable that TDS, by itself, does not represent income tax of the
assessee, but is a deduction from the payment made to a party in respect of
expenses claimed by the assessee, at a certain percentage prescribed in the
Act. So long as the expenses from which tax is deducted, relate to the business
of the assessee, the TDS thereon would also be considered to be relating to the
business of the assessee and therefore, interest on delayed payment of such TDS
would be considered to be incurred wholly and exclusively for the purpose of
business.

 

It may be true that the
interest for delay in payment of the tax deducted at source would not be
considered to be interest on capital borrowed for the purposes of business and
therefore, may not be eligible for deduction u/s. 36(1)(iii) of the Act. The same however, would be eligible for deduction
u/s.37(1) of the Act, being an expenditure wholly and exclusively incurred for
the purposes of business.

 

The better view therefore, is that
interest on delayed payment of the tax deducted at source, payable u/s. 201(1A)
or any other similar provision, is deductible in law in computing the Profits
and Gains of Business or Profession of the payer. _

Will the sweeping sway of technology disrupt the Republic?

A very Happy New Year 2018! 2018 will be the
year when this third millennium becomes an ‘adult’ and so will all those born
at the turn of this century!

 

Most facets of our life are affected at
their root by the sweeping sway of technology. Politics, Religion and law
making appear to have remained comparatively untouched by disruption in spite
of being in dire ‘need’. As we celebrate our Republic Day on 26th January
2018 and with it our constitutional democracy, here are my thoughts on why
large parts of our constitutional democracy should look forward to disruption.

 

As citizens, it is our duty to ask
questions. If there is one duty at the top of the list of a citizen it is to
question the government. Questioning is the price that government should pay
for holding our country in trust. A government has to stand the test of
questioning, which is the price of Trust and Power and obligation for being
elected. Those trusted with the country are answerable – not in elections but
on a regular less frequent basis. I am tempted to pose some questions (Q)
on the three pillars of our constitutional framework to allow you to take a
quick check on where we stand:

 

Q on the
Judiciary:

 

Is legal recourse guaranteed by constitution
available to the citizens considering its prohibitive costs, disproportionate
complexity and procedure and near eternal ‘time to resolution’? (Numerous CJIs
have said this, and therefore no evidence is necessary to prove this).

 

Q on the
Executive:

 

Do you as a citizen feel inclined to seek,
as your first preference, government services in education, health, sanitation,
safety, social welfare, housing, etc.? What are the odds of receiving a timely,
courteous and appropriate service?

 

Q on the
Legislature:

 

Do those who made a commitment to uphold the
spirit of constitution, get carried away by narrow political ideology, and
underperform to deliver their lofty promises, have little accountability and
treat themselves as an entitled class? Do most elected representatives
strengthen rather than fiddle with the rule of law, government institutions and
administrative mechanism to pollute the vital breath of our democracy?

 

The answers to questions such as these tell
us that something very important is still amiss! The spirit of our constitution
and the vision of its makers are yet to blossom.

 

Can Aadhaar disrupt Democracy?

 

Aadhaar, rather than just a tool for
subsidies or policing, could well become the REAL and DIRECT BEDROCK1  of DEMOCRACY for India! Today, we have
few thousand people2 sitting in legislatures representing 1.3
billion people. Their speed, direction and intention have a lot to ask for.
Once mobile and Aadhaar settle down, there is a massive opportunity beyond
economic and social. Here is throwing a few thoughts and questions (and
wishes):

 

a. Can Aadhaar be used to vote
(including preferences, recommendations) directly on critical issues – more
frequently – and bring about direct view points of people without any filters?

 

b.  Can Aadhaar be used as a
participation and oversight tool on those who govern us? Rather than a 5 year
big fights and yearly battles in states, can Aadhaar linked participation bring
agility and stability to elections. Rather than being tracked, ensuring we can
track what the elected are up to.

 

c. Can Aadhaar neutralise
blame game? When people decide directly, there is no one to blame. All the
worthless paid mudslinging will end (and some tv channels will end too). 

 

d. Can Aadhaar be used to test
draft laws before being passed and get direct empirical feedback to measure
perceptions and potential implications directly from citizens/stakeholders?
While we thought we elect ‘representatives’ to do just that, they seem to take
it too lightly.

 

Imagine a problem in your locality –
shouldn’t people living there give preferences, solutions and be directly
involved in arriving at a solution than just having some ward officer or some
councillor decide our fate. Instead of the triad of long debates, bad
decisions, and timid execution; why not have everyone directly concerned, get
involved.

 

Of course, there will be norms and ground
rules to avoid endless debate or pitfalls of group decision. Considering the
state of democracy and ill effects of politicisation of issues; a mandatory
participation of people would allow our country to overcome evils the present
model has thrown up. This participation could be the dawn of real freedom and
real responsibility. Such approach could open the high citadels of power to
those who actually own it and not those who ‘win’ it. Then a minister will not
have to go to a calamity affected area to give government aid and claim credit
for himself / party for giving what belonged to people in the first place.

 

Let us imagine a new level at which direct
participative democracy can transform our country. Let’s ask – Will
DELEGATION undergo disruption where DIRECT is possible? Can this diffuse the
drama of representational election based on political ideology and bring the
ideology of the constitution to the forefront? With growth of technology,
the very idea of Sovereign can undergo disruption. Could some of this be the
eventual fruition of the constitution makers’ dream – Purna Swaraj. Such
disruption in the idea of Republic could make the real winner stand up on the
high pedestal – the Citizen, the Indian, YOU.

________________________________________________________________________

[1] English meaning of Aadhaar

[2] Perhaps 0.002% people

Life Skills (Part 2)

It is Alright to Fail

History is replete with examples that most
successful people did face multiple failures at various stages of their lives
but developed a crucial life skill of accepting it as part of learning
experience of life. When you accept that it is alright to fail and there need
not be any stigma attached to it you are emancipated from the greatest barrier
of fear that holds you back from living life fully. It is only then you can
dream without casting limitations to yourself. Failure also gives you a crucial
understanding that life offers no guarantee that all your wishes have to be
fulfilled. In fact, it is God’s way of pushing you towards options that destiny
may have in store for you to let you succeed.

 

There is No Perfect Decision

It is important to understand that the
choices in life may not be black and white always to help you make a perfect
decision. There could be grey areas with complex implications. In fact, the
decision that you take under such circumstance will always be an amalgam of
facts and intuition. There is no point in lamenting the decision taken then in
hindsight. The choices may not be between better and best always and you may
sometimes need to decide between the worse and worst.


Thus, this life skill teaches you that there
is nothing like a perfect decision but only an appropriate decision under
circumstances then prevailing. This understanding makes you free from the
baggage of the past.

 

Giving is the Best Take-away in Life

One of the most mysterious life skills to
learn is that life is a teaser. The more you pursue material gains the more
they elude you. It is important to understand that somehow it works in reverse
order. When you want something, you need to be prepared to give in selfless
manner. By some strange logic, it comes back to you in abundance. Giving
creates positive ripples in environment around you which then creates a
conducive circumstance to give you in abundance. Giving is to be construed as
what you can give selflessly. It may not always be money. It could be a smile,
an encouragement, love, care, genuine praise, sincere desire to help….
anything which you can give genuinely.

 

Listening

Listening is a life skill which can help you
not only to overcome most difficult situations but can also help you grab an
opportunity. When your child draws a picture of the family and portrays you
with mobile on your ear, perhaps he is telling you to listen that he needs your
time. A good client telling you nicely that he loved your previous year’s work
the best is a message that he has reason to be unhappy this year. Right
listening can save you from some difficult future situations. Similarly, when
you learn to listen to your inner voice, it can lead you towards opportunity
hitherto overlooked. This is God’s way of pushing you towards your destined
path, provided you have learnt to listen.

 

Life skills help you find your bearing with
peace in mind and confidence to live life fullest with rich experience. They
help you find your roots.

 

As Osho says “Once you are rooted in your
own centre, nothing from outside can move you”. _

 

33. Export – 100% export oriented unit – Exemption u/s. 10A – A. Y. 2002-03- Electronic transmission of software developed in India branch to head office outside India at markup 15% over cost – Is export eligible for exemption u/s. 10A-

Dy DIT vs. Virage Logic International; 389
ITR 142 (Del):

The assessee was a 100% export oriented unit
which developed software and electronically transmitted to its head office
located abroad at a markup of 15% over the cost. For the A. Y. 2002-03 the
assessee’s claim for deduction u/s. 10A of the Act was rejected by the
Assessing Officer holding that the transfer of software by the assessee did not
amount to export. The Tribunal allowed the assessee’s claim.

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

“i)   Mere omission of a
provision akin to section 80HHC(2), Explanation 2 or the omission to make a
provision of a similar kind that encompassed Explanation 2(iv) to section 10A
of the Income-tax Act, 1961 by itself did not rule out the possibility of
treatment of transfer or transmission of software from the branch office to the
head office as an export.

ii)   According to section
80IA(8) the transfer of any goods “for the purpose of eligible business” to
“any other business carried on by the assessee” was covered. The incorporation
in its entirety without any change in the provision of section 80IA(8) in
section 10A through sub-section (7) was for the purpose of ensuring that inter
branch transfers involving exports were treated as such, as long as the other
ingredients for a sale were satisfied.

iii)   The absence of a “deemed
export” provision in section 10A similar to the one in section 80HHC did not
logically undercut the amplitude of the expression “transfer of goods” u/s.
80IA(8) which was part of section 10A. Such an interpretation would defeat section
10A(7). The transfer of computer software by the Indian branch to the head
office was entitled to claim benefit of section 10A of the Act.”

32. Co-operative society – Deduction u/s. 80P – A. Ys. 2008-09, 2009-10 and 2011-12 – Effect of amendment w.e.f. 01/04/2007 – Deduction denied to co-operative banks – Difference between co-operative bank and primary agricultural credit society – Primary agricultural credit society is entitled to deduction u/s. 80P

CIT vs. Veerakeralam Primary Agricultural
Co-operative Credit Society; 388 ITR 492 (Mad):

Assessee is a primary agricultural
co-operative credit society. For the A. Ys. 2008-09, 2009-10 and 2011-12, the
Assessing Officer disallowed the assessee’s claim for deduction u/s. 80P on the
ground that assessee is a co-operative bank. The Tribunal allowed the assesee’s
claim.

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

“i)   The benefit of section
80P is excluded for co-operative banks, whereas the primary agricultural credit
societies are entitled to the deduction.

ii)   The primary object of the
assessee-society was to provide financial accommodation to its members to meet
all the agricultural requirements and to provide credit facilities to the
members, as per the bye-laws and as laid down in section 5(cciv) of Banking
Regulation Act, 1949.

iii)   The assessee society was
admittedly not a co-operative bank but a credit co-operative society. It was
entitled to deduction u/s. 80P.”

31. Charitable purpose – Computation of income- Depreciation – Sections 11 and 32 – A.Y. 2009 -10 – Asset whose cost allowed as application of income u/s. 11- Depreciation allowable – Section 11(6) denying depreciation on such assets inserted w.e.f. 01/04/2015 – Amendment not retrospective- Depreciation allowable for A. Y. 2009-10

CIT vs.
Karnataka Reddy Janasangha; 389 ITR 229 (Karn):

Dealing with the amendment inserting section
11(6) of the Income-tax Act, 1961 w.e.f. 01/04/2015, the Karnataka High Court
held as under:

“For assessment years prior to the
introduction of section 11(6) of the Income-tax Act, 1961. i.e. prior to April
1, 2015, depreciation is allowable on assets, where cost of such assets has
already been allowed as application of income in the year of
acquisition/purchase of asset.”

30. Charitable purpose – Computation of Income- Depreciation – Sections 11 and 32(1) – A. Y. 2004-05 – Assets whose cost allowed as application of income to charitable purposes in earlier years – Depreciation is allowable on such assets

CIT vs. Krishi Upaj Mandi Samiti; 388 ITR
605 (Raj):

The assessee was a charitable trust eligible
for exemption u/s. 11. The assessee had availed exemption u/s. 11 in respect of
an asset being building. In the A. Y. 2004-05, the Assessing Officer disallowed
the assessee’s claim for depreciation on the said building on the ground that
exemption has been availed u/s. 11 on investment in the said building. The
Tribunal allowed the assessee’s claim.  

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

“i)   In computing the income
of a charitable institution or trust depreciation of assets owned by such
institution is a necessary deduction in commercial principles, hence the amount
of depreciation has to be deducted to arrive at the income.

ii)   The Appellate Tribunal
rightly allowed depreciation claimed by the assessee on capital assets for
which capital expenditure was already allowed in the year under consideration.

iii)   The income of a
charitable trust derived from the depreciable heads was also liable to be
computed on commercial basis. The assessee was a charitable institution and its
income for tax purposes was required to be determined by considering the
provisions of section 11 of the Act, after extending normal depreciation and
deductions from its gross income.

iv)  In computing the income of
a charitable institution depreciation of assets owned by it was a necessary
deduction on commercial principles, hence, the amount of depreciation had to be
deducted to arrive at the income.”

29. Capital gain – Section 47 – Where no gain or profit arises at time of conversion of partnership firm into a company, in such a situation, notwithstanding non-compliance with clause (d) of proviso to section 47(xiii) by premature transfer of shares, transferee company is not liable to pay capital gains tax

CIT vs. Umicore Finance Luxemborg; [2016]
76 taxmann.com 32 (Bom):

The assessee was a non-resident company
incorporated under the laws of Luxembourg. It purchased entire shareholding of
an Indian company ‘A’. The company ‘A’ was incorporated as a private limited
company succeeding erstwhile firm ‘AZ’. On the date of the conversion, the
partners of the erstwhile firm continued as shareholders having shareholding
identical with profit sharing ratio of the partners. The assessee filed an
application before the AAR seeking a ruling on question as to whether
notwithstanding the non-compliance with clause (d) of proviso to
section 47(xiii), it was liable to pay capital gain tax. The AAR noted
that the assessee had clarified that whilst converting the partnership firm
into a company, there was no revaluation of the assets and the assets and
liabilities of the firm as also the partners, capital and current accounts were
taken at their book value in the accounts of the company. It was in such
circumstances the AAR ruled that notwithstanding premature transfer of shares
as specified in clause (d) of proviso to section 47(xiii),
the assessee-company was not liable to pay capital gain tax.

On a writ petition filed by the Department
challenging the said order of the AAR, the Bombay High Court held
as under:

“i)   The AAR noted that
section 47(xiii) specifically excludes different categories of transfers
from the purview of capital gains taxation but it is subject to fulfilling the
conditions laid down in clauses (a) to (d). The fact that
conditions (a) to (c) are satisfied, is not in dispute but,
however, the question is whether clause (d) requires to be satisfied.
The AAR has rightly pointed out that the first part of clause (d) has
been satisfied but, however, it is noted by the AAR the requirements of second
part of clause (d) i.e. the shareholding of 50 % or more should continue
to be as such for the period of five years from the date of succession, has not
been fulfilled in the instant case by reason of the transfer of shares by the
Indian Company to the assessee before the expiry of five years.

ii)   The AAR has also noted
that the consequences of violation of those conditions have been specifically
laid down in sub-section (3) of section 47A which was also introduced by the
same Finance Act. It is further pointed out that if no profit or gains arose
earlier when the conversion of the firm into a Company took place or if there was no transfer at all of the capital assets of the firm at
the point of time, the deeming provision u/s. 47A(3) cannot be inducted to levy
the capital gain tax.

iii)   The AAR further found
that the shares allotted to the partners of the existing firm consequent upon
the registration of the firm as a Company, did not give rise to any profit or
gains. It is further noted that by such reconstitution of the Company under
part IX of the Companies Act, the assets automatically gets vested in the newly
registered Company as per the statutory mandate contained u/s. 575 of the
Companies Act. It is further found that it cannot be said that the partners
have made any gains or received any profits assuming that there was a transfer
of capital assets. It was also noted that worth of the shares of the company
was not different from the interest of partners in the existing firm.

iv)  On perusal of the said
observations, it is opined that AAR in a very reasoned order, has taken a view
that no capital gains accrued or attracted at the time of conversion of the
partnership firm into a private limited company. In part IX of the Companies
Act, therefore, notwithstanding the non-compliance with clause (d) of
the proviso to section 47(xiii) by premature transfer of shares, the
said Company is not liable to pay capital gains tax. These findings have been
arrived at essentially looking into the fact that there was no revaluation of
assets at the time of conversion of the firm ‘AZ’.

v)   The said finding of fact
has not been disputed by the revenue and, as such, the finding of the AAR that
there was no capital gains in the transaction in question cannot be faulted. It
is also to be noted that even immediately after such conversion in question
from the partnership firm into a private limited company, the assessment with
regard to the income of the new company as well as of the respective partners
were carried out and there was no objection or grievances raised by the
Assessing Officer that any capital gains tax had to be paid on account of the
incorporation of the company in terms of the said provisions.

vi)  The transfer of shares in
favour of the assessee by the erstwhile partners who were shareholders of ‘A’
Ltd. and such partners/shareholders are liable to pay capital gains even if
acceptable, would not affect the decision passed by the AAR whilst coming to
the conclusion that there were no capital gains at the time of incorporation of
the new company by the said partnership firm.

vii)  The contention of the
revenue that in view of the violation of clause (d) of section 47(xiii),
the exemption from capital gains enjoyed by the assessing firm upon conversion
into a private limited company, ceases to be in force cannot be accepted. There
are no capital gains which have accrued on account of such incorporation. In
such circumstances, the said contention of the revenue that in view of the
transfer of the capital assets or intangible assets, there are capital gain tax
payable by the transferee company, cannot be accepted. As pointed out
hereinabove, there was no capital gains payable at the time of the
incorporation of the company from the erstwhile partnership firm.

viii) The next contention of
the revenue is that the application u/s. 245N of the assessee itself was not
maintainable. The main submission on that aspect is that the assessee not being
parties to the transaction, the question of seeking an advance ruling at the
instance of the assessee is not covered under clauses (i), (ii)
and (iii) of section 245N(a). Looking into the question as to whether
capital gains are liable to be paid or not in terms by the transferee company
being a non-resident company, the respondent herein, would be a matter which
would come within the scope of advance ruling.

ix   Considering the aforesaid
observations and taking note of the findings of the AAR, it is held that there
is no case made out for interference by the Court under article 226 of the
Constitution of India. As such, the petition stands rejected.”

Welcome 2017!

Welcome 2017! Wishing you a very happy new year from the
BCAJ! As Indians, we have the privilege to wish Happy New Year many times
throughout a 365 days period! Each new year is an opportunity to wish well to
people around us, to send blessings to so many we don’t even know, take time to
reflect on the days that went by, refresh our hopes and aspirations and renew
our resolve to realize our dreams. While we prefer to look at the past, as
‘what we know’ is embedded only in the past, we cannot benefit from that
completely until we look into the future. In the words of Micheal Chibenko “One
problem with gazing too frequently into the past is that we may turn around to
find the future has run out on us.”  So
best we combine reflecting on the past and look into how we want our future to
be!

Surge since Surgical Strike

The hangover of demonetization lingers on beyond 2016! This
is perhaps one of the longest lasting HOT TOPIC that has caught fascination of
one and all and doesn’t seem like it will die out anytime soon. The so called
surgical strike has caused a SURGE in so many things. In lighter vain, since 9th
November 2016, there has been a spike in lay people talking confidently like
economists on every aspect of demonetization. On a more serious note, I have never
seen such all encompassing SURGE in every facet of citizens’ lives, from
social, economic, political to psychological, covering everyone and everything.
Be it surge in queues, in cash flow of banks, in worries of the black money
hoarders, in the risks of downturn for several businesses, to a surge in blood
pressure of tax evaders and hoarders of illicit cash. There was a surge in
issuance and flip flops of government clarifications, in forwards and debates
on media and chat applications, in digital transactions, in uncertainty for
politicians who anticipated to use those notes to buy votes, in coffers of
local bodies and utility companies and so many areas that no one can list out.
Shall we call this move a bold ‘disruption’ in the sphere of ‘illicit’ economy? 

While the ‘demons’ got demonetized of their ill-gotten money,
the ‘commons’ had to go through pains of this sweeping change. The problem of
tainted money was so widespread that people began to believe it to be
legitimate. Sometimes pervasiveness becomes a cause for people to
wrongly believe it to be legitimate? This was a wakeup call, an alarm
and a siren to push people to make a change at a fundamental level. Let
2017 bring before us a strong and decisive follow through to ‘disrupt’ the
business of the corruption in India.  

Gazing into 2017

As I write we have the news of BHIM1  being unveiled. If I had one wish for the
year I would love to see ‘disruption’ through innovation in the sphere of
governance and law making. There are a thousand problems, but there can be
million solutions to deal with them. All we need is to find SIMPLE, FUNDAMENTAL
and DIRECT ways to deal with them. With power of technology and innovation, we
are no lesser gods, to turn around a massive problem on to our side.

The last three bastions that are embedded in the old mind set
and remain considerably untouched by innovation are organised religions,
politics and legal frameworks. As a professional in practice, I would expect
innovation at least in the Union Budget 2017 as this will be the last one to
make significant changes before the one that will precede the election year. In
the current context, one dream, and perhaps a bit far out, is to see changes in
Sections 13A and 13B.

_______________________________________________________

1   An App that will allow Digital transfers from
mobile handset other than smart phones

When churning takes place, it throws up both desirable and
undesirable. While we see billion commons queue up to get few thousands in new
currency, we also saw many others with new currency worth crores (equivalent to
lacs of people queuing up for months). It only showed how an ‘inside job’ was
still at it.  If the government is
serious, bold and willing to go to the end of the road of weeding out corruption,
a good start can be right in the backyard of its own class. A measure to ban
and regulate cash donations to political parties beyond a certain percentage of
total receipts, investigate cash ‘donations’, and prescribe stringent record
keeping, usage and audit is the need of the hour. A good beginning could be to
appoint a high powered committee with past or present CEC, SC judge/s, CAG
amongst others to suggest ‘surgical’ reform in this area with time bound
implementation.  Here is a big ‘break
point’2 , for the good in the government to ‘walk the talk’ on
corruption by starting from where it needs to start – from those who seek and
wield political power.

Let’s leave that topic aside for a while and look at many
other changes our world is seeing! A big change at a high level is that a
fossil fuel company has lost its top spot which is now taken over by a
technology giant. The top three most valuable companies are tech giants, and
that does tell us where things are headed. The solar power advocates are reaching
new heights and will lead to a new wave at how we look at energy. This could
also result in disruption of oil based middle-east geopolitics. . Electorates
in the west – particularly the US and UK have shown unpredictable and volatile
mood, and Germany and France will tell us what is next in store for EU. We can
look forward to fireworks from the Trump term starting this month. Media power,
fake news and propaganda are areas to watch out for. We will be challenged to
distinguish between misinformation and information; and differentiate and
depend on facts over pouring propaganda. We can look forward to more and more
of Artificial Intelligence (AI) surrounding and hounding us. A White House
report3  predicts massive job
losses in the US, between 9 – 47 percentages, which seems unprecedented and
unstoppable and will impact India too. Imagine all back office and routine
tasks taken over by AI! Winner-take-most will continue to dominate and
therefore competition might shrink more in many important areas, and result in
more wealth inequality.

___________________________________________________

2              In tennis lingo

3              Artificial
Intelligence, Automation, and the Economy, 
December 2016

In the end – Don’t postpone Joy!

Clouding human mind has never been such an important
business. Directing large numbers of people has never been so critical for
control – of their beliefs, habits, preferences and choices. With nearly 3
billion connected to internet the ‘market opportunity’ is humongous for every
selfish goal to find takers. Today we are surrounded, rather ambushed through
‘media’ that is incessantly seeking us.

In this maze, I wish to leave you with a short anecdote
attributed to John Lennon, “When I was five years old my mother always told
me that happiness was the key to life. When I went to school, they asked me
what I wanted to be when I grew up. I wrote down ‘happy’. They told me I didn’t
understand the assignment, and I told them they didn’t understand life.” I
guess that is why we wish a Happy New Year! For all we need is TO BE HAPPY! May
you find that all through 2017!

WEALTH WITHOUT WORK

I was reading Stephen Covey’s Book “Principle – Centered
Leadership.” The Chapter “Seven Deadly Sins” completely took me by surprise.
Stephen was writing about Seven Deadly Sins as listed by Mahatma Gandhi! I knew
nothing about this! My curiosity took me to Gandhi Book Centre from where I was
directed to ‘Mani Bhavan’ Library on Laburnum Road, Gamdevi. They helped me to
discover the original writing of Gandhiji which had appeared in “Young India”
in the year 1925 as under:

Seven Social Sins

The same fair friend wants readers of Young India to know, if
they do not already, the following social sins:

1. Wealth Without Work

2. Pleasure Without Conscience

3. Knowledge Without Character

4. Business (Commerce) Without Morality (Ethics)

5. Science Without Humanity

6. Religion Without Sacrifice

7. Politics Without Principles

Naturally, the friend does not want the readers to know these
things merely through intellect but to know them through the heart so as to
avoid them.

Mohandas Karamchand
Gandhi

(October 22, 1925, Page 360 Young India 1925)

As I look around, I find that of the seven, “Wealth Without
Work’ is the most deadly, most rampant and one which has a terrible impact on
the society today. For that matter, it is not only wealth without work, but
also income without work, position and power without work which has a
devastating effect on the human being.

These are the days of ‘Getting Rich Quickly’. People who have
done nothing, but held on to inherited wealth have made fortunes in
investments. People having immovable properties and particularly land, have
seen their wealth sky rocketing to unbelievable dizzy heights. Kids in their
teens spend at a pub or a club more money than what may be the take home pay of
a peon or a clerk. Experience teaches us that hard earned money gives a
different flavour to our lives, and makes us happier.  As someone has very aptly put it, “The
Greatest Waste in the World is the difference between what we are and what we
are capable of becoming.”

It is the duty of all us of to ensure that our future
generations are not crippled by excessive provision made for them and their
talents are not stifled. Let us all then see that we provide sufficiently for
our children’s needs, but at the same time ensure that they learn the value of
work.

“It is not enough to have lived. Be determined to live for
something.

It should be creating joy for
others, Working for the betterment of the society, Sharing what we have,
Bringing hope to the lost.  And giving
love to the loners.”

“William
Arthur Ward”

There are several wealthy persons like Azim Premji and Bill
& Melinda Gates who have either during their life time or by making their
wills have ensured that a substantial portion of the massive wealth is utilised
for philanthropic purposes, for the welfare of the poor and needy, and for
making our world a better place to live in. We can emulate their examples.

We must remember that there are two things that
which are certain. We are all going to die some day. Secondly whatever wealth
we have gathered in our lifetime, we will have to leave behind. Let us then
teach our children the concept of trusteeship. They should understand that
whatever they inherit in excess of their genuine needs, that they are getting
and holding as trustees, are for people who are poor and needy who are less
fortunate than them. If they adopt this principle of trusteeship, they will be
saved from the sin of “wealth without work.”

12. Penalty – Year of taxability of income – u/s.271 (1) (c)

The CIT, vs. M/s. Otis Elevator Co.(I) Ltd. [ Income tax
Appeal no 758 of 2014, dt : 15/11/2016 (Bombay High Court)].

[DCIT, vs. M/s. M/s. Otis Elevator Co.(I)
Ltd,. [ITA No. 4509/MUM/2012,; Bench : C ; dated 21/08/2013 ; 2007-2008 . Mum.
ITAT ]

The assessee is engaged in manufacturing and
sale of elevators / lifts. In the subject AY, the assessee had declared an
income of Rs.89.04 crore. The AO added a sum of Rs. 7.35 crore on account of
advances received on dormant contracts prior to 2004. Finally, the AO
determined the taxable income of the assessee at Rs.156.05 crore in his order in quantum proceedings and also initiated
penalty proceedings u/s. 271(1)(c) of the Act.

In the penalty proceedings, the assessee
explained that the amounts of Rs.7.35 crore shown as advances in respect of
dormant contracts were in fact offered to tax in the subsequent AYs 2008-09 and
2009-10. Consequently, the assessee contended that no penalty u/s. 271(1)(c) of
the Act is imposable. However, the AO did not accept the above contention and
imposed a penalty of Rs. 2.47 crore u/s. 271(1)(c) of the Act upon the assessee
for concealing income by filing inaccurate particulars.

Being aggrieved, the assessee preferred an
appeal to CIT(A). By order the CIT(A) held that the amounts received as
advances in respect of dormant contracts and shown as current liability were in
fact offered to tax during the subsequent AYs i.e. Assessment Years 2008-09 and
2009-10 even before the proceedings for assessment of the subject AY i.e. AY
2007-08 were initiated in November, 2010. The CIT(A) in his order records the
fact that the return of income for AY’s 2008-09 and 2009-10 were filed on 29th
September, 2008 and 30th September, 2009 that is much before
November, 2010. In these circumstances, the CIT(A) allowed the appeal of the
assessee and deleted the penalty of Rs.2.47 crore u/s. 271(1)(c) of the Act
imposed by the AO.

Being aggrieved, the Revenue carried the
issue of penalty in appeal to the Tribunal. On consideration of the facts, the
Tribunal held that the advances relating to the dormant contracts were offered
to tax in the subsequent assessment years even before any inquiry was initiated
by the AO to complete the assessment for the subject AY. Consequently, the
Tribunal held that it was not a case of concealment of income but rather the
dispute was only with regard to in which year the income was taxable. The
Tribunal dismissed the Revenue’s appeal.

In Revenue appeal, the High court note that
the basis for imposition of penalty is non payment of tax on the amount
received on dormant accounts in the subject assessment year. Both the CIT(A)
and the Tribunal have rendered a finding of fact that these amounts / advances
relating to dormant contracts have already been offered to tax for the
subsequent AY’s i.e. Assessment Years 2008-09 and 2009-10. In the present
facts, undisputedly the income has been declared in the subsequent assessment
years before the assessment proceedings for the subject AY 2007-08 was
initiated. Thus, the only issue which arises is about the year of taxability of
income and it is certainly not a question of concealment of income and / or
filing of inaccurate particulars of income by the assessee.

The above concurrent finding of facts as well as
the acceptance of the assessee’s explanation by CIT(A) and the Tribunal has not
been shown to be perverse. Therefore, the question as proposed does not give
rise to any substantial question of law. Thus, not entertained. Accordingly,
the appeal is dismissed.

11. TDS – ‘Work’ – include all work carried right from planning the schedule to post production processes, which would make the programme fit for telecasting – Thus, the payments made for dubbing as well as print processing were held to be fall within the ambit of section 194C.

The CIT, TDS vs. M/s. Sahara One Media
and Entertainment Ltd. [ Income tax Appeal no 894 of 2014, with 1031 of 2014 dt
: 23/10/2013 (Bombay High Court)].

[ACIT, TDS vs. M/s. Sahara One Media and
Entertainment Ltd,. [ITA No. 4548/MUM/2012, 4549/MUM/2012, 4550/MUM/2012 ;
Bench : E ; dated 23/10/2013 ; 2008-2009, 2009-2010 & 2010-11. Mum. ITAT ]

The assessee is engaged in the business of
production of cinematographic motion features and small screen programmes. In
the process of carrying on its business, the assessee made payments to others
on account of production, print processing fees and dubbing. At the time of
making these payments, the assessee deducted tax at source (TDS) u/s. 194C at
2% as the payment was made for carrying out work pursuant to a contract.

The AO was of the view that the print
processing fees and dubbing expenses paid were in the nature of fees of
technical services and tax had to be deducted u/s. 194J at 10%. Resultantly,
the DCIT (TDS) held that there was short deduction of tax in respect of the
dubbing expenses and fees paid for print processing. Consequently, the assessee
was deemed to be an assessee in default u/s. 201 (1) to the extent of short
deduction of tax.

In appeal, the ld. CIT(A), observed that it
was evident from the sample Agreement that the assessee used to hire the
producers (who first approach the assessee) for producing TV programmes for it,
on a commissioned work basis and pay consideration to such assigned producer
for producing the programmes. He further observed that under the provisions of
section 194C of the Act, it has been provided that expression ‘work’ shall
include, inter alia, broadcasting and telecasting including production
of programmes for such broadcasting and telecasting. Therefore, where the
payment was made for production of TV programmes, it was covered by provisions
of section 194C. He further observed that the principal purpose of entering
into the Agreements was to get the programmes produced through the assigned
producers on a commissioned work basis. The assessee was the exclusive owner of
the programmes to be produced by the producer. He therefore held that the
payment for carrying out the work of producing programmes on behalf of assessee
was in the nature of ‘work’ as defined in section 194C and the same could not
be treated as ‘fees for technical services’ or ‘royalty’ u/s. 194J of the Act.
While holding so he relied upon the judgement of the Hon’ble Delhi High Court
in the case of ‘CIT vs. Prasar Bharti Broadcasting Corpn. Of India’ [292
ITR 580]. In the said case, the assessee was a government
corporation engaged in controlling various TV channels of Doordarshan. It was
held that the payments made by it to various producers of programmes were
covered under Explanation III(b) to section 194C, as a contract for production
of programmes for broadcasting or telecasting and not as a fee for professional
services or royalty; hence the tax deduction at source was required to be made
@2% u/s 194C and section 194J was not applicable. He therefore accepted the
contention of the assessee that tax was deductable @2% u/s. 194 C of the act and
not @ 10% u/s.194 J.

Being aggrieved, the Revenue carried the
issue in appeal to the Tribunal. The Tribunal upheld the view taken by the
CIT(A) and observed that the definition of ‘work’ as provided u/s. 194C would
include all work carried right from planning the schedule to post production
processes, which would make the programme fit for telecasting. Thus, the
payments made for dubbing as well as print processing were held to be fall within the ambit of section 194C.

Being aggrieved, the Revenue filed a appeal
before High Court and contended that the payments made for dubbing and print
processing would be the payments in the nature of technical fees. Therefore,
tax would be deductible u/s. 194J and not as contract for work u/s.194C.

The Hon. High
Court noted that definition of ‘work’ as provided in section 194C, which reads
as under :

“ Explanation – For the purposes of this
section – (i) …. (ii) …. (iii) …. “(iv) “work” shall include – (a) ….. (b)
Broadcasting and telecasting including production of programmes for such broadcasting
or telecasting; (c) ….. (d) …. (e) ….” (f) .

The definition of ‘work’ as provided in the
Explanation to section 194C of the Act is itself inclusive. It include all work
necessary for preparation / production of any programme so as to put it in a
state fit for broadcasting and / or telecasting. In view of the self evident
position in law, by virtue of the definition of “work” as provided in section
194C of the Act.

In view of the self-evident position in law,
no substantial question of law arises for consideration . Thus, the appeal was
dismissed. 

10. Business expenditure – Service tax – The Assessee was obliged under the law to pay service tax to the Government and paid when such payment is not forthcoming from the client/customer – Allowable : Section 37 of the Act

CIT vs. Prime Broking Company (I) Ltd. [
Income tax Appeal no 847 of 2014 dt : 14/10/2016 (Bombay High Court)].

[ACIT vs. Prime Broking Company (I) Ltd.
[ITA No. 5632/MUM/2012 ; Bench : C ; dated 31/10/2013 ; A Y: 2009- 2010. MUM.
ITAT ]

The Assessee is engaged in the business of
broking in Government and other securities. The Assessee raises an invoice on
its clients for the transaction done on its behalf in respect of its broking
services. The total amount of bill in the invoice is the aggregate of brokerage
and applicable service taxes thereon. During the subject assessment year, some
of the clients of the Assessee did not pay the service tax as required in terms
of the invoice for onward payment to the Government of India. In these
circumstances, the Assessee paid the service tax payable out of its own
resources and claimed the same as deduction u/s. 37(1).

The AO disallowed the claim for deduction
holding that the obligation to pay the service tax is on the customer /client
and the same cannot be shifted to the Assessee.

The CIT (A) allowed the Assessee’s appeal.
This is on the ground that in terms of section 68 of the Finance Act, 1994, the
obligation to pay the service tax into the treasury is of the service provider,
i.e. the Assessee. The failure of its client/customer to pay service tax to the
Assessee would not absolve the obligation of the Assessee to pay the same to
the Government of India. The CIT (A) held that the deduction of the service tax
paid to the Assessee was a business expenditure incurred on account of
commercial expediency and deductible u/s. 37(1).

Being aggrieved, the Revenue carried the
issue in appeal to the Tribunal. The Tribunal upheld the view of the CIT
(Appeals).

On further appeal, the High Court held that
the Assessee was obliged under the law to pay service tax to the Government
even when such payment is not forthcoming from the client/customer. Therefore,
it would be a deductible business expenditure u/s. 37(1). It is undisputed that
the obligation under the Finance Act, 1994 to pay the service tax is on the
Assessee being the service provider. This obligation has to be fulfilled by the
service provider whether or not it receives the service tax from its
clients/customers. Non-payment of such service tax into the treasury would
normally result in demand and penalty proceedings under the Finance Act, 1994.
Therefore, the payment is on account of expediency, exclusively and wholly
incurred for the purposes of business, therefore, deductible u/s. 37(1).

The High Court dismissed the above appeal on
the ground that the same did not give rise to any substantial question of law.
The appeal is dismissed.

36. Housing project – Deduction u/s. 80IB(10) – A. Y. 2006-07 – Ceiling on built up area – terrace in pent house is not part of built up area – Finding that assessee was developer and built up areas were within specified limits – Assessee entitled to deduction u/s. 80IB(10)

CIT vs. Amaltas Associates; 389 ITR 175
(Guj):

The assessee had developed a housing
project. In the A. Y. 2006-07, the assessee claimed deduction u/s. 80IB(10) in
respect of the profits from the said housing project. The Assessing Officer
disallowed the claim on two grounds. Firstly, he held that the assessee is not
a developer but a contractor. Secondly, he held that the condition for built up
area is not satisfactory. He included the terrace area into the built up area.
The Tribunal held that the assessee was a developer and that the terrace area
is not to be included into the built up area. The Tribunal accordingly held
that the condition of built up area is satisfactory. Accordingly, the Tribunal
allowed the claim for deduction u/s. 80IB(10) of the Act.

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

“i)   The Tribunal had found
that the assessee was a developer. The assessee had undertaken full
responsibility of constructing the residential units and had also been
responsible for the resultant profit or loss arising out of such venture. The
assessee, thus, had undertaken full risk.

ii)   The Tribunal had rightly held
that the open space attached to a pent house cannot be included in the term
“balcony”. The Tribunal was right in law and on facts in allowing deduction
claimed by the assessee u/s. 80IB(10) of the Act.”