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S. 254 — A Division Bench decision which is directly contrary to a Larger Bench decision cannot be said to have any binding force.

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(2009) 32 SOT 132 (Mum.)

ACIT v. MSS India (P.) Ltd.

A.Y. : 2003-04. Dated : 29-5-2009

S. 254 — A Division Bench decision which is directly
contrary to a Larger Bench decision cannot be said to have any binding force.

For the relevant assessment year, the Transfer Pricing
Officer made certain additions to the total income of the assessee. The CIT(A)
deleted the additions. Before the Tribunal, the Revenue relied upon the
decision of Five-Member Bench of the Tribunal in the case of Aztec Software
& Technology Services Ltd. v. Asstt. CIT, (2007) 107 ITD 141 (Bang.) (SB).
The assessee, however, relied upon the decision of a Division Bench in the
case of Philips Software Centre (P.) Ltd. v. Asstt. CIT, (2008) 26 SOT
226 (Bang.) submitting that the Bangalore Bench had duly considered the impact
of Aztec decision (supra) by the Five-Member Bench of the Tribunal.

The Tribunal held as under :

(1) The view of the Division Bench of the Bangalore
Tribunal was diametrically opposite to the decision of an earlier
Five-Member Special Bench of the Tribunal in the case of Aztec Software &
Technology Services Ltd. (supra).

(2) It is only elementary that a judicial forum’s
approach to disregard a binding precedent from a superior judicial forum,
including by Larger Benches of the same judicial institution, is contrary to
the first principle of the theory of judicial precedence.

(3) A Division Bench cannot even disregard decision of
another Division Bench of equal strength leave aside a Larger Bench.

(4) When the law mandates that a Division Bench cannot
disregard another Division Bench and there is a Division Bench decision
which is directly contrary to a Larger Bench decision, the order so
disregarding the Larger Bench cannot be said to have any binding force.

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Nirav Shah

S. 37(1) — For the expenditure to be allowable u/s.37(1), it may be incurred ‘voluntarily’ and without any ‘necessity’ and if it is incurred for promoting business and to earn profits, assessee can claim deduction u/s.37(1), even though there was no compe

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(2009) 32 SOT 9 (Pune)

Dy. CIT v. Kolhapur Zilla Sahakari Dudh
Utpadak Sangh Ltd.

A.Ys. : 1993-94, 1995-96 to 1999-2000 and 2001-02 Dated :
28-3-2008

S. 37(1) — For the expenditure to be allowable u/s.37(1),
it may be incurred ‘voluntarily’ and without any ‘necessity’ and if it is
incurred for promoting business and to earn profits, assessee can claim
deduction u/s.37(1), even though there was no compelling necessity to incur
such expenditure.

For the relevant assessment years, the Assessing Officer
disallowed animal husbandry expenditure incurred by the assessee on the
following grounds :

(a) Assessee did not own any cattle.

(b) It did not procure milk directly from cattle owners.

(c) It collected milk from primary societies which, in
turn, collected milk from the cattle owners.

(d) Providing services for animal husbandry was not a
business activity of the assessee.

(e) The animal husbandry expenditure benefited the cattle
owners and not the business of the assessee, particularly because the
assessee-society was not buying milk directly from the cattle owners.

The CIT(A) deleted the disallowance made by the Assessing
Officer on the ground that the expenditure incurred by the assessee resulted
in increasing the quality and productivity of milk which the assessee was
purchasing as part of its business.

The Tribunal upheld the CIT(A)’s order. The Tribunal noted
as under :

(1) Although one might argue that the assessee could have
carried on its business without incurring the above expenditure and that it
was not ‘necessary’ for the assessee to incur that expenditure in order to
carry on its business of purchase and sale of milk, such an argument was not
relevant for deciding the question whether an expenditure was allowable
u/s.37(1).

(2) The expression ‘wholly and exclusively’ used in S.
37(1) does not mean ‘necessarily’.

(3) An expenditure may be incurred ‘voluntarily’ and
without any ‘necessity’ and if it is incurred for promoting the business and
to earn profits, the assessee can claim deduction u/s.37(1) even though
there was no compelling necessity to incur such expenditure. The fact that
somebody other than the assessee is also benefited by the expenditure should
not come in the way of an expenditure being allowed by way of deduction
u/s.37(1).

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Nirav Shah

S. 271(1)(c) — AO must have definite evidence to refuse assessee’s claim or explanation — Mere non-acceptance of explanation cannot indicate concealment of income.

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(2009) 31 SOT 474 (Mum.)

Twin Star Jupiter Co-operative Hsg.

Society Ltd. v. ITO

A.Ys. : 1998-99, 1999-2000 and 2000-01

Dated : 15-4-2009

S. 271(1)(c) — AO must have definite evidence to refuse
assessee’s claim or explanation — Mere non-acceptance of explanation cannot
indicate concealment of income.

For the relevant assessment year, the Assessing Officer
made certain additions to the total income of assessee and, thereafter, levied
penalty u/s. 271(1)(c). The CIT(A) deleted the penalty partly.

The Tribunal deleted the entire penalty. The Tribunal noted
as follows :

(1) The proceedings u/s.271(1)(c) can be initiated only
if the Assessing Officer or the first appellate authority is satisfied, in
the course of any proceeding under the Act, as per clause (c) that any
person has concealed the particulars of his income or has furnished
inaccurate particulars of such income.

(2) There cannot be a straitjacket formula for detection
of these defaults of concealments or of furnishing inaccurate particulars of
income and indeed concealment of particulars of income and furnishing of
inaccurate particulars of income may at times overlap.

(3) The Assessing Officer cannot invoke provisions of S.
271(1)(c) on the basis of routine and general presumptions. Whether it be a
case of only concealment or of only inaccuracy or both, the particulars of
income so vitiated would be specific and definite and be known in the
assessment proceedings by the Assessing Officer who, on being satisfied
about each concealment or inaccuracy of particulars of income, would be in a
position to initiate the penalty proceedings on one or both of the grounds
of defaults as may have been specifically and directly detected.

(4) Part A of the Explanation 1 to S. 271(1)(c) states
that “if the assessee fails to offer an explanation or offers an explanation
which is found by the AO or the CIT(A) or the CIT to be false”. This
Explanation can, therefore, be applied only where the assessee has either
not offered any explanation or where he has offered any explanation, the
same is found to be false by the AO, etc. Mere non-acceptance of explanation
offered by the assessee cannot form a basis for the satisfaction of the AO
to the effect that the assessee has concealed particulars of his income. The
AO must have some definite evidence to refuse the assessee’s claim or
explanation.

(5) When the assessee is able to offer a reasonable
explanation based on some evidence, the AO cannot invoke Part B of the
Explanation 1 unless he has given a finding based on some contradictory
evidence to disapprove that explanation offered by the assessee which the
assessee is not able to substantiate and fails to prove that such
explanation is bona fide and that all the facts relating to the same
and material to the computation of his total income have been disclosed by
him.

(6) In this case, the assessee had disclosed all relevant
material for the purpose of computation of total income. It was also found
that the assessee had furnished an explanation in this regard, which was not
found false by the Assessing Officer. When the assessee had filed all the
particulars of income, the correct assessment and calculation of total
income had to be done by the Assessing Officer. If in such process the
Assessing Officer found different total income to be assessed than the
income offered by the assessee, in such case it was not automatically a case
where penalty u/s.271(1)(c) was leviable.

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Nirav Shah

If assessee offers income or furnishes accurate particulars of income before the AO takes up the issue and comes across information, then there was no concealment of income or furnishing of inaccurate particulars of income.

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(2009) 31 SOT 97 (Delhi) (TM)

Addl. CIT v. Prem Chand Garg

A.Ys. : 2003-04 and 2004-05

Dated : 11-5-2009

S. 271(1)(c) r.w. S. 68 :

(a) If assessee offers income or furnishes accurate
particulars of income before the AO takes up the issue and comes across
information, then there was no concealment of income or furnishing of
inaccurate particulars of income.

(b) Mere omission of surrendered amount from the
return of income is neither concealment of income nor furnishing of
inaccurate particulars of income unless and until there is some evidence to
show or some circumstances are found from which it can be gathered that
omission was attributable to an intention or a desire on part of assessee to
hide or conceal income so as to avoid imposition of tax thereon.

During the previous years relevant to the assessment years
in question, the assessee had received two gifts. Consequent upon the search,
a notice u/s.153A was issued to the assessee. In response to the said notice,
the assessee replied that the original returns filed be taken as returns under
the aforesaid provision. Thereafter, the assessee offered/surrendered the
amount of gifts within four days of the receipt of the notice u/s.153A for
taxation by way of a letter. The Assessing Officer held that the assessee had
furnished inaccurate particulars of income and concealed the particulars of
income in both the years and he levied penalty u/s.271(1)(c). The CIT(A)
deleted the penalty on the following grounds :

No evidence was found in the course of search
indicating that these gifts were not genuine.

The only question asked by the Assessing Officer in the
course of assessment proceedings was whether the assessee had taken or given
any loan or gift in the period under consideration and to give details
thereof.

The assessee furnished the details of the gifts from
NRIs, furnished copies of gift deeds and also mentioned that the gifts were
surrendered for taxation to buy peace and to avoid dispute in the matter;
that the surrender was made subject to the condition that penalty
proceedings would not be initiated.

The course of events narrated above showed that the AO
did not have any information to hold that the gifts were not genuine or that
they formed part of the total income of the assessee.

Since there was a difference of opinion between the
Members, the matter was referred to the Third Member u/s.255(4).

The Third Member upheld the order of the CIT(A) deleting
the penalty. The Third Member noted as under :

(1) It was true that the letter of surrender did not
obliterate the original return and suppression of income therein, but when
the surrender was made before detection or without any material on record
suggesting that income was withheld, it would be a case of voluntary offer
and, in that case, there would not be concealment of income by the assessee.

(2) The surrender of the amount after receipt of the
questionnaire could not lead to an inference that it was not voluntary in
absence of any material on record suggesting it to be bogus or untrue.

(3) The question, whether there is concealment of income
or whether inaccurate particulars thereof have been furnished, is
essentially a question of fact. To find out or to decide the same, all the
attending circumstances have to be taken into account. The question is at
what point of time this material fact is to be found out. Generally, it is
with reference to the return of income and at that time it is to be seen
whether there was concealment of income or furnishing of inaccurate
particulars thereof in the return of income chargeable to tax. By the time
the Assessing Officer takes up the issue and comes across the information in
his possession, if the assessee makes up the deficiency and offers the
income or furnishes accurate particulars thereof, he cannot be held guilty
of concealment of income or furnishing of inaccurate particular of his
income. Any action rectified relates back to the original act and to the
date and time of filing the return. When the Assessing Officer started
scrutiny of the return and initiated assessment proceedings there was
nothing concealed and the inaccuracy, if any, disappeared. Therefore, the
assessee could not be held guilty of concealment.

(4) The correct and accurate disclosure may be made by
filing the revised return or by furnishing the particulars of such income
before the detection by the Assessing Officer. The mere fact that the
assessee had not revised his returns or that the offer was made by letter to
avoid harassment to the assessee and the donors who were non-resident
persons, it could not convert an offer to tax as concealment of income.
Therefore, the assessee had not furnished inaccurate particulars of the
income in the returns before detection by the Revenue.

(5) Apart from the surrender, there was nothing more on
record to hold the assessee guilty of offering the said amount on detection
of the concealment. Even in the assessment order there was nothing of that
sort. On a perusal of the questionnaire, it was evident that it was general
in nature, without specifying the name of the donors or any other such
details. On the basis of the questionnaire, it could not be presumed that
the AO had information to call for specific information. There was neither
any detection nor any information in the possession of the Revenue nor in
the manner of its communication to the assessee, which might lead to a
detection of concealment.

(6) On the face of the evidence in the shape of
confirmation letters, bank accounts, passports, etc., in the hands of the
assessee, it might be valid gift that would have convinced a reasonably
minded person, specially a person exercising a judicial function. The
accepted position of law is that merely because an assessee had agreed to
the assessment, it cannot bring in automatic levy of penalty.

(7) Therefore, the CIT(A) was right in deleting the
penalty and his order was to be affirmed.

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Nirav Shah

S. 2(22)(e) — Deemed dividend can be assessed only in the hands of a person who is a registered shareholder of lender company.

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(2009) 31 SOT 76 (Delhi)

Dy. CIT v. National Travel Services

A.Ys. : 2003-04 and 2004-05

Dated : 31-3-2009

S. 2(22)(e) — Deemed dividend can be assessed only in the
hands of a person who is a registered shareholder of lender company.

For the relevant assessment year, the Assessing Officer
invoked the provisions of S. 2(22)(e) in respect of a loan taken by the
assessee-firm from a company in which the assessee-firm was a shareholder
through its partners. The AO treated the loan of Rs.21.95 lacs given by the
company to the assessee-firm as deemed dividend. The CIT(A) held that since
the assessee-firm was not a registered shareholder, the loan could not be
treated as deemed dividend in the hands of the assessee-firm.

The Tribunal, relying on the Special Bench decision of the
Mumbai Tribunal in the case of ACIT v. Bhaumik Colour (P.) Ltd., (2009)
27 SOT 270 upheld the CIT(A)’s order. The Tribunal noted as under :

(1) The assessee-firm on whose behalf the partners had
become the shareholders in the company which had given the loan to it could
not be said to be a registered shareholder for the purpose of S. 2(22)(e).

(2) Since the assessee-firm was not a registered
shareholder of the company, the condition necessary to invoke S. 2(22)(e)
was not satisfied.

(3) The deemed dividend can be assessed only in the hands
of a person who is a registered shareholder of the lender company and not in
the hands of a person other than a registered shareholder.

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Nirav Shah

S. 50 r.w. S. 54EC — Since depreciation was never claimed by assessee on the building sold, S. 50 was not applicable.

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29. (2009) 31 SOT 38 (Mum.)

Dr. (Mrs.) Sudha S. Trivedi v. ITO

A.Y. : 2002-03. Dated : 20-2-2009

S. 50 r.w. S. 54EC — Since depreciation was never claimed
by assessee on the building sold, S. 50 was not applicable.

For the relevant assessment year, the assessee claimed
exemption u/s.54EC in respect of capital gains arising to her from sale of her
business premises on which she had not claimed any depreciation in the past.
The Assessing Officer held that even if no depreciation was allowed to the
assessee in the earlier years, the mandate of Explanation 5 to S. 32(1) would
be attracted since the building sold by the assessee was falling within the
‘block of asset’ and the resultant capital gain would be covered u/s.50 being
taxable as short-term capital gain. The Assessing Officer, therefore, denied
the exemption u/s.54EC and computed the short-term capital gain. The CIT(A)
upheld the order of the Assessee Officer.

The Tribunal, relying on the decision in the case of CIT
v. Ace Builders (P.) Ltd., (2006) 281 ITR 210/ (2005) 144 Taxman 855, held
that the assessee was eligible for exemption u/s.54EC. The Tribunal noted as
under :

2. In order to be covered within the provisions of S. 50,
the following two conditions should be simultaneously fulfilled :

à the capital asset transferred should be an asset
forming part of the ‘block of assets’; and

à the capital asset is such in respect of which
depreciation has been allowed under this Act.

3. Explanation 5 to S. 32(1) was inserted by the Finance
Act 2001 w.e.f. 1-4-2002. It is, therefore, clear that from the A.Y. 2002-03
the deduction in respect of depreciation shall be granted automatically,
notwithstanding the fact that the assessee has not claimed this deduction.

4. Therefore, from the A.Y. 2002-03, Explanation 5 to S.
32(1) would apply only if the assessee has not claimed depreciation. If,
however, the asset has been sold in the previous year, relevant to the A.Y.
2003-03 and there is no other asset in that block, then there cannot be any
question of allowing depreciation on the asset sold and, as such, the
application of Explanation 5 would be ruled out.

5. Since the assessee had not claimed depreciation on the
building in any of the earlier years, the denial of exemption u/s.54EC on the
ground that Explanation 5 to S. 32(1) would apply was out of place. Further,
since the second condition of S. 50, being ‘in respect of which depreciation
has been allowed under this Act’, was wanting in the instant case, the
provisions of S. 50 treating the capital gains arising from the transfer of
such capital asset as short-term capital gain would not be applicable.

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Nirav Shah

S. 28(i) read with S. 56 of the Income-tax Act — Whether the amount received by licensed bookmaker from hedge bets placed with another bookmaker was integral part of his business activity as a bookmaker and was not liable to be taxed u/s.115BB — Held, Yes

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23 (2008) 114 ITD 638 (Pune)

ACIT v. Raghunath B. Taware

A.Ys. : 1991-92, 1992-93, 1994-95

Dated : 31-5-2007

S. 28(i) read with S. 56 of the Income-tax Act — Assessee was
a licensed bookmaker who ran a business of booking races — Besides, he also used
to bet on horse races to minimise his probable losses —Whether the amount so
received by the assessee from hedge bets placed with another bookmaker had close
nexus or link with total amount received or paid for bets accepted by him on a
particular horse, and hence, same was integral part of his business activity as
a bookmaker and was not liable to be taxed u/s.115BB — Held, Yes.

Facts :

The assessee was a licensed bookmaker operating at the Pune
race course, under the terms and conditions for a bookmaker’s licence formulated
by Royal Western India Turf Club (RWITC). The assessee used to accept bets for
‘win’ or ‘place’ from the punters on the horse races as per the guidelines
formulated by RWITC. To minimise losses, a bookmaker, under the club rules, is
permitted to make a hedge bet with another bookmaker, subject to the condition
that total amount of such hedge bet laid over by one bookmaker should not exceed
the total amount of the bets accepted by him on a particular horse, at the time
of such lay-over. In case, the amount of laid-over bet exceeds the total amount
of bets accepted, then the last laid-over bet will be treated as independent
bet. Winnings from such hedge bets was called ‘Tote Winnings’.

During the relevant assessment years, the assessee had earned
income from tote winnings. The AO was of the view that such income was taxable
under the head ‘Income from Other Sources’ u/s.56(2)(ib), and not as business
income.

On appeal, the CIT(A) held that hedge betting was a part of
the business transactions in respect of business of bookmaking, inasmuch as
hedging was permitted, and such tote winnings was to be brought to tax as
business income.

On Revenue’s appeal, the Tribunal held as under :

1. The bookmaker is allowed to make hedge bet with another
bookmaker to the extent of total amount of bets collected by him on horsewise
basis and not with reference to aggregate total amount of bets collected by him
on all the horses. Thus, hedge betting by one bookmaker with another in respect
of the bets already accepted by him on a particular horse is an integral part of
the activity of a bookmaker accepting bets on horse races from others. The
position of the assessee-bookmaker is distinct and different from that of a
punter, and he cannot be deemed to have stepped in the shoes of the punter while
making a hedge bet.

2. Taking reference to CBDT Circular No. 461, dated 9-7-1986,
the Tribunal observed that where there is an integral relation of any payment as
to the very source of activity, the same should be treated as a part of the same
primary transaction or activity, and cannot be viewed independently so as to
divorce the same from its source. Thus, as is in the case of gross winnings from
lotteries and certain percentage deducted therefrom by the Government or lottery
agencies conducting the lottery, hedge betting by a bookmaker will also be
considered to be an integral part of the same activity.

3. The receipts from hedge betting cannot be considered in
isolation from the receipts and payments made by the assessee as a bookmaker on
bets accepted by him, so as to permit the revenue authority to tax the same
independently, at the rates specified u/s.115BB. Therefore, the same were
chargeable to tax as business income, and not income from other sources.

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Nirav Shah

S. 43B — Business disallowance — Certain deductions to be made only on actual payment — A service provider acts as an agent of the Government and is not entitled to claim deduction on account of service tax — S. 43B not applicable to service tax

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22 114 ITD 573 (Mad.)

ACIT v. Real Image Media Technologies (P.) Ltd.

A.Y. : 2002-03. Dated : 31-12-2007

S. 43B of Income-tax Act — Business disallowance — Certain
deductions to be made only on actual payment — A service provider acts as an
agent of the Government and is not entitled to claim deduction on account of
service tax. — For applicability of S. 43B, claim should be first preferred by
assessee, and the same should be disallowed for reason of failure to make
payment — in the instant case, assessee had not even preferred a claim towards
service tax — Whether on this account alone, addition u/s.43B could not have
been made, and CIT(A) had correctly deleted addition so made — Held, Yes.

Facts :

The assessee company was engaged in the business of running a
recording and dubbing studio, production of advertisement films, software
development, etc. During the assessment proceedings, the AO noticed that service
tax was not being routed through the Profit & Loss Account, and the assessee had
shown a liability towards service tax of Rs. 5,72,374 as on 31-3-2002 in its
balance sheet. The AO made additions to the assessee’s income contending that
the service tax had been collected, but had not been paid to the Government.

In its appeal before the CIT, the assessee made two-fold
submission, stating that for the applicability of S. 43B, claim should be
preferred by the assessee, and disallowance could be made only on account of
failure to make actual payment, and secondly with reference to Rule 6 of Service
Tax Rules, service tax is required to be paid only on the value of taxable
service received in a month or quarter and not on the gross amount charged or
billed. The CIT(A) having found force in the assessee’s submissions deleted the
addition.

On Revenue’s appeal before the Tribunal, it was held as under
:

1. S. 43B starts with the non-obstante clause and specifies
that the deduction ‘otherwise allowable’ under the Act shall not be allowed
unless it is actually paid. The rigour of S. 43B might be applicable to excise
or sales tax, but the same could not be applicable in the case of service tax
due to two reasons :

(i) The assessee merely acts as an agent of the
Government in collection of service tax, and is not entitled to claim
deduction on account of service tax.

(ii) S. 43B(c) uses the expression ‘any sum payable’. For
making any disallowance, it has to be established that such sum is payable.
A reading of Rule 6 of the Service Tax Rules states that the liability to
pay such service tax arises on receipt of payments towards the value of
taxable service. If there is no liability to make the payment to the
Government, because of non-receipt of payments from the receiver of
services, then it cannot be said that such service tax had become payable in
terms of S. 43B(a).

2. S. 145A includes sales tax, excise duty, etc. in the
turnover of purchases and sales of goods, but it does not apply to services
and hence service tax cannot be included in the turnover.

3. In the given case, the assessee had not preferred a
claim for the amount of service tax. Further, there was no liability on the
assessee to make payments to the credit of Central Government because of
non-receipt of payments from the receiver of services. Therefore, the rigour
of S. 43B is not attracted and the CIT(A) was right in deleting the additions
made on account of disallowance u/s.43B.

Case referred to :

(i) Srikaollu Subbarao & Co. v. Union of India,
(1988) 173 ITR 708 (AP)

Case distinguished :

(i) Chowranghee Sales Bureau Ltd. v. CIT, (1977) 110
ITR 385 (Cal.)

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Nirav Shah

S. 45 — Conversion of shares into stock-in-trade valid u/s.45(2) even if assessee not carrying on the business of shares and securities before such conversion

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20 (2008) 23 SOT 512 (Mum.)

ACIT v. Jehangir T. Nagree

ITA No. 7503 (Mum.) of 2004 and

3927 (Mum.) of 2005

A.Y. : 2001-02. Dated : 10-4-2008

S. 45 of the Income-tax Act, 1961 — Conversion of shares into
stock-in-trade would be valid u/s.45(2) even if the assessee was not carrying on
the business of shares and securities before such conversion.

On 1-4-2000 the assessee, a manufacturer and seller of
furniture, having short-term capital loss in earlier years, converted his
investment in shares brought forward from A.Y. 2000-01 into stock-in-trade.

Besides trading in shares and securities which were
converted, the assessee had made further purchases of shares and securities and
during the accounting year he had engaged himself in speculation of shares of
very high volume. The assessee incurred loss in share transaction activity and
also in speculation of shares and claimed deduction of the same as business
loss. The Assessing Officer rejected the assessee’s claim, holding that the
provision of S. 45(2) contained the words ‘of business carried by him’ and since
as on date of conversion the assessee had no business of share transaction, the
said conversion was not valid. The Assessing Officer, accordingly, held that by
this arrangement, the assessee had gained immensely by setting off income in
various other heads against the business loss, which benefit would not have been
available had this loss been treated as a short-term capital loss and disallowed
the assessee’s claim.

The CIT(A) held that the conversion made by the assessee was
valid and not a device, especially in view of the fact that the assessee had
done large volume of transactions during the year in speculation account and had
also made fresh purchases of shares for share business.

The Tribunal held that the assessee was entitled to benefit
u/s.45(2). The Tribunal noted as under :

(1) Having seen the volume of transactions undertaken by
the assessee in the impugned assessment year, it was very difficult to hold
that the assessee still held the investment in shares and securities. It was
the sweet will of the assessee to decide as to when he intended to convert his
investment in stock-in-trade.

(2) In S. 45(2), the words ‘business carried on by him’ do
not mean that before conversion of investment or capital assets into
stock-in-trade the assessee must carry on business of share transaction or
such a business must be in existence.

(3) The restrictive meaning as suggested by the Revenue
should not be given to the words ‘business carried on by him’ in the light of
the use of the words in other Sections like S. 28(i).

(4) The assessee could undertake multiple business
activities under his proprietary concern. Besides the manufacturing and sale
of furniture, the assessee could also deal in trading in shares in the name of
same proprietary concern keeping the stock-in-trade of shares separate.

(5) Thus, conversion of investment in shares and securities
into stock-in-trade would be valid u/s.45(2) even if business of trading of
shares is not carried on by the assessee before such conversion.

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Nirav Shah

Double Standards applied by Income-Tax Department

S. 194-I of the Income-tax Act, 1961 (‘Act’) was amended to include rental payments for use of plant and machinery. After the amendment, the Department (TDS) officers were of the view that the transportation services from transport vendors fall under the purview of S. 194-I of the Act and not the S. 194C of the Act.

On this basis, various surveys were undertaken on numerous corporates by the Department and huge amounts of tax were recovered on the ground that TDS should have been deducted at 10% u/s.194-I instead of 2% u/s.194C.

This controversial issue was litigated by corporates in the Tribunal and Court, which ultimately provided relief to the taxpayers.

In order to find out what the Tax Department has done or is doing in a similar transaction, entered with the transport contractors, an application under the Right to Information Act, 2005 (‘RTI’) was made. The following information was asked in the application :

1. Under which Section of the Act, does the Income-tax Department deduct tax while making payment to transport contractors for transportation services? Please provide your answer in respect of services received from transport contractor,

Before 13th July 2006;

On or after 13th July 2006 (that is after the amendment to S. 194-I of the Income-tax Act with effect from 13th July 2006).

2. Could you please let me know the reasons in brief for deducting TDS under the relevant Sections of the Act?

In reply to the application, the Department accepted that, tax had been deducted at 2.06% u/s. 194C of the Act even after 13th July 2006 and not u/s.194-I.

This clearly shows even after the amendment, the Department was deducting tax at source at 2.06%, while on the other hand pressuring the corporate to deduct at an higher rate u/s.194-I (on identical type of services and agreements) so as to increase the tax collection.

Is such double standard adopted by the Department acceptable and fair?

Is it fair to the taxpayer, who is providing an honorary service of collecting taxes by deducting tax at source to the Government/tax-office?

The CBDT should issue a circular to stop this unfair practice of harassing taxpayers.

Nirav Shah

Is it fair to have such a cumbersome process for refund under MVAT Act, 2002

Is It Fair

The MVAT Act, 2002, as we all know, has been made effective
from 1-4-2005 after wide-ranging protests and demonstration by business
community. The benefits of Vat, as academically explained in many books &
literature, were mainly — removing the cascading effect of tax on taxes,
transparency in the administration, self assessment, phasing out of CST & Octroi,
taxpayer-friendly approach, etc.

It is the 4th year of MVAT in Maharashtra and the tax
practitioner community perhaps knows better – how far these objectives have been
achieved; especially on administrative front. This article examines some of the
hardships experienced by the taxpayers in the implementation of the new levy :

1. The Return forms under MVAT have been amended TWICE in a
short period of 3½ years. (The fundamental accounting presumption of
consistency does not apply to so-called user-friendly tax administration)

2. Even the Vat Audit Report (Form 704) has been amended.
The Amendment comes in the midst of financial year, which results into several
hardhips on the Dealer as the information asked in the Audit Form 704 was not
required to be provided in return forms. The dealer has to recompile the
information at the time of preparing Audit Report in Form 704.

3. There were several extensions to the filing of Vat Audit
report for the financial year 2005-2006 and 2006-2007. (The repeated extension
of due date of audit must be unique to the Indian Tax System.)

4. Certain information viz. cash purchases, cash
sales, Maharashtra sales, oms sales, etc. and asking the reason for change
with reference to the previous year seems irrelevant. What purpose is going to
be served by having such information, is beyond comprehension.

5. Refund : Since MVAT is a multi-stage system of
taxation; it gives rise to refunds in many situations, such as exporters,
resellers, etc. The MVAT Act does not allow carry forward of such refunds to
the subsequent financial year. However, till financial year 2006-07, such
carry forward was allowed under administrative Circular issued by the Sales
Tax Department. But this practice has been discontinued from Financial Year
2007-08 and a dealer has to compulsorily claim refund of excess set-off by
making an application in Form No. 501. Some of the difficulties and hardships
suffered by the dealers in such procedure are as below :

(a) The dealer has to pay the tax liability arising in
subsequent period from his own pocket, even though excess tax paid by him in
the earlier period is lying with Government in the form of this refund claim.

(b) There is no monetary compensation to the dealer in the
form of interest.

(d) The dealer is required to furnish copies of challans
and returns even when the data is already available, since the returns are
already filed online.

(e) Details of purchases for the relevant period are to be
submitted in a specified format as well as on a CD. Compilation of data in the
specified format itself is a cumbersome task, as the software used by the
dealer might not be able to generate the data of purchases in the specified
format. This information is to be given in respect of all the purchases during
a given period, irrespective of the amount of refund. This sometimes becomes a
very difficult exercise for a dealer. e.g., if there is a refund claim
of Rs.10000 only, but the turnover of purchases is Rs.5 crores, the details of
all purchases have to be submitted, which is a time-consuming exercise.

(f) Recent Trade Circular No. 35T of 2008, dated 10th
October 2008 has devised a new scheme known as Voluntary Refund Scheme. Under
this scheme, refund claim will be restricted to those purchases whose
suppliers’ return filing is confirmed.

(g) It also specifies that the dealer may voluntarily
furnish the proof of filing return by suppliers.

(h) For the balance refund arising due to subsequent
confirmation of filing of return by the suppliers, the dealer has to make
another application. Thus for the default committed by the suppliers, the
dealer may be penalised in the form of late refund or even no refund.

(i) The newly registered Large Taxpayer Units are to be
processed on priority basis. Where does the small dealer go who has been
paying taxes ?

It is a known phenomenon that difficulties on administrative
fronts are the main causes of corruption and tax evasion. If the Government
really wants to make the administration transparent and taxpayer friendly, this
entire process of obtaining refund should be done away with. Refund should be
granted immediately on the basis of returns filed by the dealer (similar to the
process under the Income-tax Act), with selective scrutiny and stringent
penalties for false claim — like S. 271(1)(c) of the Income-tax Act, 1961.
Alternatively, the option of carry forward of excess set-off to subsequent
periods should be restored.

levitra

Nirav Shah

Part B : Some recent judgements

I. Supreme Court:

1. Banking and other financial services:

Whether the service tax is leviable on equipment leasing and hire-purchase finance activities?

Association of Leasing & Financial Service Companies v. Union of India, 2010 (20) STR 417 (SC)

The issue before the Apex Court was whether hire-purchase and leasing transactions involved any element of service, in order for the service tax to apply, or such transactions were explicitly chargeable to VAT, being a tax in relation to goods.

The appellants, members are engaged in the business of hire-purchase and leasing. 46th Amendment to the Constitution of India had inserted Article 366(29A) whereby a set of six transactions were enumerated therein to be deemed as sale of goods. These six transactions included the transfer of the right to use any goods for any purpose as well as hire-purchase transactions. Consequently, the entire amount paid to the hirer/lessor by way of instalments was chargeable to VAT. It was further argued that once the subject matter of hire-purchase and leasing was constitutionally characterised as a ‘deemed sale’, the transaction could not be taxed by the Central Government.

The Supreme Court took note of this contention and concluded that the taxable service category ‘banking and other financial services’ under service tax, included within it hire-purchase and leasing transactions.

The appellant’s members are non-banking financial companies (‘NBFC’). Certain NBFCs undertake activities of equipment leasing and hire-purchase financing in addition to giving loans. The concept of ‘banking and other financial services’ has been clarified with relevant explanations:

(a) Funding or financing the transaction covers two different and distinct transactions i.e., the financing transaction and the equipment leasing/hire-purchase transaction. While the former is exigible to service tax, the latter is exigible to local sales tax/VAT.

(b) There is a difference between a ‘finance lease’ and an ‘operating lease’. In the case of hire purchase agreement, the periodical payments made by the hirer is made up of (a) consideration for hire and (b) payment on account of purchase.

(c) The taxable event is the rendition of service. The tax is not on material or sale; it is on activity/service rendered by the service provider to its customer. Therefore, the Centre undoubtedly had legislative competence to charge the tax on the above service.

The Supreme Court upheld the charge of service tax on hire-purchase and leasing transactions, if forming part of financial leasing services under service tax law, notwithstanding that the same transactions were chargeable to VAT. There was no double taxation of one transaction to two taxes in this instance, as per the Supreme Court, even though both taxes were chargeable on the same base. It also noted that the service tax was, in fact, chargeable only on 10% of the finance or leasing charge.

II. HIGH COURT:

2. Admissibility of CENVAT credit of service tax:

Whether the services of repair, maintenance and civil construction used in residential colony for employees qualifies for input service?

Commissioner of Central Excise, Nagpur v. Manikgarh Cement, 2010 (20) STR 456 (Bom.)

The respondent-assessee engaged in the manufacture of cement was disallowed the credit of service tax paid on repairs, maintenance and civil construction, etc. as the services were used in their residential colony on the ground that the said services were not covered under the definition of input service and hence ineligible as input service.

According to the Revenue, as per decision of the Apex Court in the case of Maruti Suzuki Ltd. v. Commissioner of Central Excise, Delhi, 2009 (240) ELT 641 (SC), it must be held that the CESTAT was wrong in holding that the assessee was entitled to credit of service tax paid on services of repair, maintenance and civil construction used in the residential colony, whereas as per the assessee, establishing a residential colony was indirectly connected with the manufacturing activity in question related to the business and therefore, the Tribunal was justified in holding that they were entitled to the credit.

The High Court observed that establishing a residential colony for the employees and rendering taxable services in that residential colony may be a welfare activity undertaken while carrying on the business. However, to qualify as an input service, the activity must have nexus with the business of the assessee. The expression ‘relating to business’ in Rule 2(l) of the CENVAT Credit Rules, 2004 refers to activities which are integral to the business activity and not welfare activities undertaken by them.

The High Court held that unless the nexus is established between the services rendered and the business carried on by the assessee, the benefit cannot be allowed. In the present case, rendering taxable services at the residential colony established by the assessee for the benefit of the employees is not an activity integrally connected with their business and therefore, the Tribunal was not justified in holding that the services such as repairs, maintenance and civil construction rendered at the residential colony constitutes ‘input service’ for claiming credit.

3. Information Technology Service: Service tax:

Should information technology software be considered goods or services?

Infotech Software Dealers Association v. Union of India, 2010 (20) STR 289 (Mad.)

The petitioner, an association of software resellers prayed for a writ to declare S. 65(105)(zzzze) of Chapter V of the Finance Act, 1994 as null and void, ultra vires and unconstitutional of provisions of Article 245, Entries 92C and 97 of List I and Entry 54 of List II and contended as follows:

Softwares are considered as ‘goods’ and are liable to VAT, as the transaction is of sale of goods.

Imposing service tax on canned software would result in increase in cost by 13% and if VAT and service tax both are levied, then the cost may increase up to around 25%.

Software was held to be goods by the Supreme Court in the case of Tata Consultancy Services v. State of Andhra Pradesh, (2004 (178) ELT 22). Dominant intention of the transaction should be considered, following the judgment in Bharat Sanchar Nigam Ltd. v. Union of India and Others, (2006 (2) STR 161), to determine whether the transaction would be considered as sale or service. In the present case, the transaction is related to supply of goods on which only VAT should be levied.

When a transaction is covered by VAT under Entry 54 of State List, the Central Government does not have the competence to introduce service tax under Entry 97 of Union List.

The respondents put forth the following claims:

The standardised softwares are not like any other goods and it may not be considered as sale, es-pecially when the software is supplied with End User Licence Agreement. The software requires a key to activate the software. Further, updates are also provided by the original manufacturer to the end user for a definite period. Therefore, original manufacturer only provides the right to use to the end user and it is not provided with a right to tamper, modify or rectify error of such software.

The said transaction involves three activities, namely, right to install such software, right to run such software and receive updates. Therefore, the same may not be considered as absolute sale. The canned software is capable of being sold off the shelf and the same is excisable goods. However, in case of customised software, service element can be segregated clearly. Providing ‘right to use’ constitutes service which is liable to service tax.

Though Entry 92C is inserted, the same is not given effect to and therefore the residual Entry 97 empowers Union to enact the law.

The Court made the following observations:

Article 366(12) of the Constitution of India defines ‘goods’ to include all materials, commodities and articles. Goods as defined are of wide connotation and include everything of use or value which can be the object of trade and commerce.

The Apex Court in Tata Consultancy Services (supra) had held that the test to determine whether the property is goods or not depends on the capability of abstraction, consumption, use and whether the same can be transmitted, transferred, delivered, stored, possessed, etc. Since software program consists of various commands, it becomes goods, once the appellant makes copies of the same. It may be pertinent to note that the buyer is purchasing intellectual property and not the media. Moreover, while concluding on definition of goods by majority in the Apex Court, observed that goods includes tangible as well as intangible ones. Whether an item would be considered as goods, should be decided based on the following attributes, namely, (i) utility, (ii) capable of being bought and sold, (iii) capable of being transmitted, transferred, delivered, stored and possessed.

In case of 20th Century Finance Corporation [2000(6) SCC 12] it was observed that the transfer of right to use goods is the basis to tax and not the delivery of the goods. However, such goods must be available at the time of transfer of right to use such goods as held in BSNL case (supra).

The present case does not deal with branded or unbranded software, therefore, the issue is not discussed at length, however in view of the above-stated judgments software is ‘goods’ for the purpose of Article 366(12).

Software other than packaged one is priced inclusive of cost of initial installation and modi-fications required. However, copyrights of the software are protected with the creator. Sale of such software is with a condition for exclusive use by the customer and the effective possession and control is passed on to the buyer and annual maintenance charges are recovered for certain services which are chargeable to service tax.

Packaged software attracts excise duty, whereas customised software is exempted from excise duty vide Notification No. 6/2006. Further, document to title conveying the right to use such information technology software services is ex-empted from Basic Customs Duty vide Notification No. 21/2002.

Software sold through Internet downloads would not satisfy the test of ‘goods’, since it does not fit within the ambit of ‘IT software on any media’.

In case of exclusive sale, legislative competence of the State Government under Entry 54 of List II should be accepted and in case when service element is involved, Entry 97 has power to impose service tax.

However, the case of software is not of exclusive sale and therefore, introduction of IT software services is constitutionally valid. Moreover, the nature of transaction is of utmost importance. As held by the Supreme Court in Gannon Dunker-ley’s case (IX STC 353), dominant intention of the parties decides the tax route. The Apex Court observed that in the case of composite contracts not covered by Article 366(29A), unless the transaction in truth represents two distinct and separate contracts, States would not have power to levy VAT.

To form a view whether the transfer of software amounts to sale or services in case of software resellers, the following eminent factors can be looked upon:

(a) Through Master End-user Licence Agreement, normally the developer grants right to use and the copyrights of the software are kept with developer in case of all types of software i.e., canned, packaged or customised.
(b) Further, through that Master End-user Licence Agreement, the members of the association enter into an End-user Licence Agreement. ‘End user’ is the one who uses the product/ service but he does not have any contact with the developer.
(c) Therefore, the transaction is not sale of software as such, but is sale of contents of the data stored in the software, which would amount to service. Only when there is a transfer of right to use any ‘goods’, it would be considered deemed sale under Article 366(29A).

In the present case, the appellants’ contention was that software is considered as ‘goods’ and therefore, the transaction should be considered as ‘sale’. However, it was argued that though software is ‘goods’, all transactions need not be in the nature of ‘sale’, it may vary as per the terms of End-user Licence Agreement. As discussed earlier, Parliament has the power to introduce service tax levy on Information Technology Software services under Entry 97 of Union List. However, all transactions have to be perceived from an independent view whether to be considered as sale or service.

Finally, the Court dismissed the writ petition holding that software are ‘goods’ and whether a transaction would amount to sale or service would depend upon the facts of each transaction.

4. Outdoor catering service — Service tax v. sales tax:

Whether food and beverages supplied to passengers on board trains is leviable to VAT or not?

Indian Railways C. & T. Corp. Ltd. v. Govt. of NCT of Delhi, 2010 (20) STR 437 (Delhi)

The petitioner, a Government company provided catering services on board trains run by the Indian Railways. The consideration for these services is included in the fare charged by the Indian Railways collected from the passengers, and then paid to the company by Indian Railways. They had paid service tax on 50% of the value, availing abatement provided under the law, however, no VAT was paid thereon by them.

The issue before the Court was whether the petitioner was liable to VAT. The Court observed as follows:

It is open to the States to levy sales tax/Value Added Tax on the whole of the consideration, in transactions of sale of goods, such as sale to a customer in a restaurant, irrespective of the incidental element of service which is necessarily involved in sale of goods of this nature.

In case of composite transactions, there are two distinct contracts, one for sale of goods and the other for providing services. In respect of the present case, it is not permissible to fragment such a composite contract, so as to levy VAT on the component which involves sale of goods.

In the case of Tamil Nadu Kalyana Mandapam Assn. v. Union of India (UOI) and Ors., (2004) 135 STC 480, it was held that services rendered by out-door caterers are clearly distinguishable from the service rendered in a restaurant or hotel. Outdoor catering has an element of personalised service provided to the customer. The customer is at a liberty to choose the time and place where the food is to be served and the service element is more weighty, visible and predominant. However, in case of a restaurant, the customer’s choice of food is limited to the menu card.

In view of the petitioner, providing of food, snacks and water to the passengers on board the trains is altogether different from an outdoor catering service. The passengers travelling in the trains are served food and beverages as per a fixed menu approved by the Railway Board. Neither the petitioner nor the passenger has any choice in respect of articles to be served in the trains or with respect to the quantity each passenger gets.

The transaction of providing meals and snacks to the passengers is not a composite contract.

The element of service by way of heating the food, heating/freezing the beverages and then serving them to the passengers is purely incidental and minimal required for the sale of food and beverage in this transaction.

Once the property in those goods is transferred to Indian Railways, on account of their being loaded on the trains and kept in the gadgets belonging to Indian Railways, those goods become the property of Railways and at the time of service of those goods to the passengers, title in the goods vests in the Railways and not in the petitioner-company. Thus, it can be said that merely by loading, the property got transferred.

In case, if an accident takes place before the food is served to the passengers, nothing prevents the petitioner agreeing to bear the risk, despite property in the goods having already been transferred to the purchaser. However, risk and reward may not be the conclusive criteria to decide the date of transfer of property in goods.

At the time of execution of the contract, as soon as the meals and snacks are cooked and, being in a deliverable state, are appropriated to the contract by loading them on the compartments of Indian Railways and keeping them in the equip-ment belonging to the Railways, the property in the goods passes on to the Indian Railways. Future goods are also chargeable to VAT.

Payment to the petitioner is required to be made by the Indian railways even if the food is not consumed by the passenger.

The constitutional right cannot be denied to the State, to levy such a tax merely because service tax authorities have already collected service tax from the petitioner.

It was held that the transaction between the petitioner and the Indian Railways does not amount to a contract of providing outdoor catering service but is a transaction of sale of food and beverages by the petitioner-company to the Indian Railways.

5. Recovery of dues:

Are directors personally liable for arrears of State and Central Sales Tax dues from the Company?? Om Prakash Walecha v. State of Haryana, 2010 (20) STR 384 (P & H)

The question before the High Court was whether the directors can be made personally liable to pay arrears of Central and State Sales Tax dues of a company. The Department contended that u/s.18 of the Central Sales Tax Act 1956, if the Company is wound up then the arrears of State and Central Sales Tax can be recovered from any person who was director for the period when the tax became due. However, in the present case, the company was not wound up or formally liquidated and other judgments on the subject-matter were not disputed by the Department. Therefore, the High Court allowed the writ petition.

III. TRIBUNAL:

6. Appeal:

Whether Committee of Commissioners can review the order already reviewed by the previous Committee of Commissioners?
Commissioner of C. Ex., Surat-II v. Gujarat Borosil Ltd., 2010 (20) STR 377 (Tri.-Ahmd.)

The Committee of Commissioners reviewed the order passed in favour of the respondents and found the same in accordance with the law and decided not to file appeal against it. The respondents applied for refund as a consequential relief and the same was rejected by the Department.

Thereafter, the Committee of Commissioners again reviewed the earlier order and filed an appeal with application for condonation of delay of 440 days. The Department contended that the length of delay was not relevant and what really matters is ‘sufficient cause’ for delay and that the Tribunal should liberally construe the phrase ‘sufficient cause’. The order was passed without considering the Supreme Court’s decision in the case of CCE, Allahabad v. Hindustan Safety Glass Works Ltd., (2005 (181) ELT 178).

The assessee contended that the Committee of Commissioners did not have power to review earlier order of the Committee of Commissioners and the case relied upon by the Department was not applicable to the fact of their case.

The Tribunal observed that the Committee had taken a conscious decision of not filing the appeal. Moreover, the said decision of Hindustan Safety Glass Works was available at the time of passing the order and also at the time of review. Therefore, it could not be considered as ‘sufficient cause’ for condonation of delay. Further, subsequent Committee of Commissioners cannot again review the order passed by the precedent Committee of Commissioners, since the matter had attained finality. The appeal was thus dismissed.

7. CENVAT credit:

(i) Whether service tax paid on C & F services is allowed as CENVAT credit to a 100% EOU?

Adani Pharmachem (P) Ltd. v. Commissioner of C. Ex., Rajkot, 2010 (20) STR 386 (Tri.-Ahmd.)

The Department contended that the order passed by the Commissioner (Appeals) was based on the Tribunal’s decision in the case of Gujarat Ambuja Cement Ltd. v. CCE, Ludhiana 2007 (212) ELT 410 wherein it was held that the appellants were not eligible for CENVAT credit. However, the appellants relied on the Departmental Circular and the Tribunal’s decision in case of CCE, Rajkot v. 6 respondents including appellants.

The Tribunal allowed the CENVAT credit of service tax?paid?on C&F services to the appellants who are 100% EOU for the reason that the place of removal in case of C&F or FOB exports is load port.

(ii) Whether various services used by the appellants qualify to be input services in terms of Rule 2(l) of the CENVAT Credit Rules, 2004?

Commissioner of Cus. & C. Ex., Raipur v. H. E. G. Ltd., 2010 (20) STR 312 (Tri.-Del.)

Services utilised in relation to generation of steam and electricity towards maintenance of the plant:

Since the steam and electricity generated was not liable to excise duty and therefore, service utilised in relation thereto was not available as CENVAT credit in Department’s view. However, since the issue was decided in favour of the assessee in case of Sanghi Industries Ltd. v. CCE, Rajkot (2009(13) STR 167) and the services were used within the factory premises, CENVAT credit was held as allowed.

Car insurance:

The Department contended that excise duty paid on cars was not allowed as CENVAT credit and therefore, car insurance was also not allowed. However, the respondents submitted that repairs and maintenance of car was allowed as credit in case of CCE, Jaipur-II v. J. K. Cement Works, (2009(14)STR 538). The Tribunal allowed credit treating insurance as maintenance activity.

Maintenance of air cooler, pay loader, dumper repairing and changing of damaged asbestos sheet of canteen building within factory:

The Department contended that this was not used in or in relation to manufacture of final product. However, the activity was undertaken within the factory premises and it had nexus with the business activity and therefore was allowed.

Security services at a place other than factory premises:

Since the direct nexus with activities relating to manufacture was not established, the Tribunal remanded back the matter to the original authority.

Rent-a-cab services:

The services were utilised by executives in relation to procurement of raw material, sale of finished goods and therefore, the same was held as connected to the business activity and was allowed. Reliance was placed on Ace Glass Containers Ltd. v. CCE, Meerut-II, [2010 (250) ELT 110].

Commission on sales:

Commission paid in relation to procurement of orders and consequently for business activity was held as allowable.

Mobile phone services:

Following the Gujarat High Court’s decision in the case of CCE v. Excel Crop Care Ltd., [2008 (12) STR 436], this was allowed.

(iii) Does the activity of commission agent for sales promotion fall under the definition of
‘input service’?

Commissioner of C.Ex., Jallandhar v. Ambika Over-seas, 2010 (20) STR 514 (Tri.-Delhi)

A manufacturer-exporter of tools appointed an overseas commission agent for sales promotion activities in the overseas market. They paid service tax along with interest on the commission as recipients and took eligible credit of the same, treating the services of agents as ‘input service’. This was challenged by the Department holding that services rendered by them cannot be held to be utilised in the manufacture of final products and therefore, cannot be treated as inputs services. The activity of a commission agent was considered a post removal activity.

Since the definition of ‘inputs services’ included any services used in relation to ‘sales promotion’, the activities of overseas commission agents were clearly part of sales promotion activities, the case was decided in favour of the respondents.

(iv) In case of closure of factory, can cash refund of CENVAT credit be claimed?

Commissioner of C. Ex., Ludhiana v. Manish Spinning Mills (P) Ltd., 2010 (20) STR 540 (Tri.-Delhi)
The assessee’s finished goods were destroyed in a fire. They applied for remission to the Commissioner. The Assistant Commissioner granted refund in the form of CENVAT credit. The Commissioner (Appeals) had accepted the plea of the assessee for cash refund. Relying on the case of Slovak India Trading Co. P. Ltd. v. CCE, Bangalore, 2006 (205) ELT 956 (Tri.-Bang.) upheld by the Karnataka High Court in 2006 (201) ELT 559 (Kar.) wherein it was held that Rule 5 of the CENVAT Credit Rules, 2002 did not expressly prohibit cash refund of unutilised credit, the Tribunal held that the ratio of the decision was applicable to the present case and therefore Revenue’s appeal against cash refund was rejected.

8. Manufacturer: Service tax under commis-sioning and installation service:

Whether service tax is leviable on erection, commissioning and installation services rendered by a manufacturer on which excise duty is already paid by including the same in the assessable value?

Alidhara Texspin Engineers v. Commissioner of C. Ex. & Customs, Vapi, 2010 (20) STR 315 (Tri.-Ahmd.)
The appellants were engaged in the manufacturing of textile machineries. The appellants were entering into a composite contract for sale and supply of such machineries in fully installed, commissioned and in operational condition. Moreover, gross amount charged was inclusive of installation and commissioning charges and excise duty was levied on the same. Further, such work was sub-contracted and the sub-contractor was paying service tax on the same. The Department held that the appellants were engaged in providing erection, installation and commissioning services u/s.65(39a) of the Finance Act, 1994 and it levied service tax on the whole gross amount charged in absence of segregation of quantum of such service charged received by the appellants. It was held that S. 65(39a) of the Finance Act, 1994 covered commissioning and installation agencies, whereas the appellants were a manufacturing unit and had paid excise duty on the same treating the process as incidental to comple-tion of manufactured product. Relying on various judgments, the appeal was allowed.

9. Stock broker’s service:
Whether the sub-broker is liable to pay service tax when the stock broker has paid service tax on the same transaction?
Vijay Sharma & Co. v. Commissioner of C. Ex., Chandigarh, 2010 (20) STR 309 (Tri.-LB)

The Revenue submitted that the sub-brokers reg-istered with SEBI or made application for registration under SEBI Act, 1992, were covered within the definition of stock broker u/s.65(101) of the Finance Act, 1994 with effect from September 10, 2004. Further, the services provided by sub-brokers or stock -brokers in relation to sale or purchase of listed securities are taxable services and sub-brokers were liable for service tax. The appellants contended that they paid service tax to the main broker who ultimately has discharged the same on behalf of the sub-broker. A sub-broker provides services to a stock-broker who in turn provides services to its clients. Therefore, sub-brokers are not liable to service tax since sub-brokers and stock- brokers are agent and principal and this would amount to double taxation.

There being conflicting judgments of the Tribunal for the issue, the High Court referred the matter to the Larger Bench for deciding the same afresh in view of the amendment in the law.

The Larger Bench observed that sub-brokers were covered in the definition of stock-broker with effect from September 10, 2004. However, service being event of levy of tax, same service cannot be taxed twice. Therefore, the sub-brokers and the stock-brokers being agent and principal, the same transaction shall not be liable to double taxation. In the present case, the matters were remanded back for verification of payment of service tax by stock brokers. ?If?found that the stock-broker had paid service tax on behalf of the sub-broker, then the Department was directed to reduce the sub-broker’s demand.

10. Waiver of penalty:

Whether delay in obtaining registration and pay-ment of service tax amounts to evasion?
Star Energy Systems v. Commissioner of Service Tax, Ahmedabad, 2010 (20) STR 479 (Tri.-Ahmd.)

The appellant is a proprietor providing erection, commissioning and installation services. The category came into effect on 1-7-2003, however the appellant got itself registered on 26-10-2004 and voluntarily paid service tax with interest for the period 1-7-2003 to 26-10-2004 and on filing the returns, the Department began proceedings. Thereafter, with the introduction of Notification No. 18/2003-ST exemption benefit was claimed by the appellant whereby individuals providing commissioning and installation services were provided exemption. The appellant did not challenge the liability of service tax or seek refund of the same, but requested for waiver of penalties. It was held that an individual to be treated as a commercial concern cannot be accepted. In spite of the fact that the appellant could have challenged the liability, he did not even seek refund of voluntarily paid service tax and interest. Therefore, it cannot be said that there was an intention to evade tax and the appeal was allowed.

Nirav Shah

Conditioned Mind and Conditioned Living

Namaskaar

Our lives are conditioned by the accumulations of the past
and expectations of the future. We have been taught to live in destiny,
pre-conditioned as it is, it prevents us from breaking out of the cocoon or the
shell. We try to console ourselves for the misfortunes or the tragedies that
befall us in our lives, and meekly blame it on our destinies. From there on and
to everything in our lives, there is a deep-rooted conditioning, by building a
fort or a wall around us to conclude that all else other than the accumulated
impressions are false. To be unconditioned simply means to be un-caged.
Religiosity and spirituality help one to discover the true nature of life and it
is the quintessence of being totally free.

What needs to be done to get us out of the shackles of
conditioning ? A mind of deep contemplation and a sensitive approach to natural
instincts that have weathered out from us, over centuries, on account of
materialistic desires. A religious and spiritual bent of mind to understand the
subtle forces that prevail in nature are the hallmarks of an unconditioned mind.
But let us be clear that religiosity does not mean rituals and dogmas, but
something beyond it.

The superficial mind is momentary, conditioned and
artificial. Delving deep into the inner self, the serious mind begets questions
all about life and not willing to be conditioned by conflicts about the
externalities of living. Contemplation leads to frugal living and less of
desires, it prompts seriousness in every walk of life, be it with respect to
work or in relationship. It is only the deeper mind that can experience total
silence and blissfulness whatever may be the state of ones being. There is no
craving for ‘becoming’, but it is always a state of ‘being’.

All our lives we have lived with what we have gathered and
what we have accumulated. We have lived by what others have told us. It is a
beaten path. Delving a little deeper, we would be able to see much more than
what we have been told and what we have been taught or seen. By searching for
it, the human mind gathers a lot of composure, it will respond without conflict
or tension. To live, will become more meaningful even without seeking for it.
Tragedies in life are taken at strides without having to bother about such
consequences, for they are natural part of our life process. A meaningful leaf
can be taken from ‘The Road Not Taken, by Robert Frost’.

‘Somewhere ages and ages hence :

Two roads diverged in a wood, and I —

I took the one less travelled by,

And that has made all the difference’.

To be in the state of receptivity or in the state of a subtle
mind, always requires a serious approach and an earnest effort, irrespective of
what subject we are dealing with. There is a sense of divinity and all
pervasiveness in such an approach and at such stages the mind does not and will
not hanker for results.

Jiddu Krishnamurthy, the world philosopher, has dealt
exhaustively on the unconditioned mind; for him it was the unconditioned mind
that could seek the absolute truth. Glimpses of what he has got to say on the
unconditioned mind are here for the readers to experience :

‘He thought that the mind was conditioned by reason and the
expectations of our society, culture, and personal needs. He held that having a
conditioned mind is an obstacle that needs to be overcome through insight
in order for an individual to move to a higher state of consciousness. He talked
in multiple ways about the conditioned mind. One of these ways is through the
analogy of the pendulum. He used this analogy to show that normal consciousness
swings from past to future, and then reverses. Humans are always in one of the
two states, either the past which consists of memories, or the future which
consists of expectations. He claimed that at the centre of the pendulum swing,
the present exists, and it is at this infinitesimal moment when a preconscious
state of mind can be cultivated. By training the mind to ‘live’ in the
present, it can be emptied of all contents in order to facilitate a true
awareness of what is. Awareness of ‘what is’ comes through insight and signifies
the development of the religious mind.’

The aim should be to get to the ‘centre of the pendulum’ and
enjoy the present.

levitra

Nirav Shah

Recent Global Developments in International Financial Reporting Standards

Subject : Recent Global Developments in International Financial Reporting Standards

Venue : IMC Hall, Churchgate, Mumbai

Speaker : N. P. Sarda, CA, Past President, ICAI

Date : 25th November, 2009

1. Bird’s-eye view of Development of International Accounting Standards from inception to date :

1.1 In 1973, Accounting Standards Committee was formed to propose International Accounting Standards. In 2001, the name of the committee was changed to International Accounting Standard Board and the standards that were prescribed by the Board were titled as International Accounting Standards (IAS). The Accounting Standards hitherto published will be merged with IFRS. In the course of time, new standards may be formulated which will get added. Under the old regime of IAS, forty-one International Accounting Standards were introduced, out of which 12 standards were withdrawn or superseded by new standards, leaving twenty-nine International Accounting Standards. There are nine IFRS already in existence. The 9th IFRS has been issued on 12th November 2009.

1.2 So far, several interpretations were issued on International Accounting Standards (IAS). Henceforth, interpretations on new Standards (IFRS) will be included in literature on IFRS.

2. The global developments, their present status and issues embedded therein :

2.1 In India in 1987, decision was taken to set up at our Institute’s level an Accounting Standard Board. After its formation, it was decided to formulate our own independent Accounting Standards (AS), rather than verbatim adopting their international counterpart. Subsequently, in 2007, it was decided to convert present Indian standards to IFRS.

2.2 In 1997, it was decided to achieve comparability and to improve existing standards. It was decided to revise ten Accounting Standards, such as AS-2 Valuation of inventory, AS-7 Accounting for construction contracts, etc.

2.3 In 2003, another improvement project was undertaken by International Accounting Standard Board of revising fourteen Accounting Standards.

2.4 There exist three types of Accounting Standards, viz. US GAAP evolved by US, International Accounting Standards and National Accounting Standards of each country. US GAAP was competing with International Accounting Standards. On many issues. However, it was decided to co-ordinate and close down the differences by taking up long term/short-term projects in that direction.

2.5 There is one fundamental difference between US GAAP and International Financial Reporting Standars, namely, US GAAP lays down the rules, whereas IFRS sets out the principles.

2.6 On 15th November, 2007 a decision was taken that companies located outside the US can follow principles of IFRS which need not be reconciled with US GAAP. But, if any company has to enter US capital market, then it must reconcile its accounts with US GAAP requirement.

2.7 The European Union with its twenty-seven member countries and their respective parliaments decided that consolidated financial statements of listed companies should be as per IFRS. As regards unlisted companies or stand-alone units like holding companies and their subsidiaries it was left to discretion of member states. The trend of thinking of these governments is to make IFRS mandatory even to unlisted companies and stand-alone accounts. Thus, there are three-tier arrangements presently existing for dealing with presentations, disclosure requirements and the rules applicable to listed companies and stand-alone companies.

2.8 Pursuant to this decision, the UK Parliament has passed legislation that all listed companies and even stand-alone companies will have to prepare consolidated account statements as per IFRS principles. For unlisted companies, IFRS applicable to SME i.e., Small & Medium Enterprises sector will be used and for very small enterprises (Micro Units) another standard as prescribed will be used. Similarly, for companies in the US, there are three-tier arrangements for presentation and consolidation.

3. IFRS for SMEs :

3.1 The printed materials by way of Accounting Standards, Interpretation iterature in case of US GAPP runs into 17,000 pages and in case of IFRS, this runs into 2,500 pages. For small and medium sector companies, IFRS printed material is only 250 pages which, such SMEs will have to follow.

3.2 In Europe, all the 27 member countries took a decision to totally adopt and follow IFRS and parliament passed suitable legislations accepting IFRS.

3.3 Countries like Australia, New Zealand, Korea, and Sri Lanka have adopted IFRS, subject to their right to exercise their option about additional disclosures.

3.4 A need to have a second look at the disclosure requirements of IFRS is being felt. A project called project on evaluation of disclosures is being undertaken to avoid conflict between IFRS requirements about disclosures, local requirements and economic situation in India. A decision is taken keeping in mind the strong view taken by IFRS that though guidance note can be provided, it should not conflict with principles pronounced in IFRS. Such guidance notes will not form part of the standards prevailing in the country. The IFRS Board is very assertive on this point. This makes it a difficult task to convert Indian Standards into IFRS with narrow scope for variation. In Europe, its twenty-seven member countries as well as countries in rest of the world have decided to go nearer to IFRS, but at the same time, retaining their right to deviate if local situations so demand. Though many changes are not permitted, the countries can decide about the dates/years from which the new standards will become applicable. So, many countries have decided to go for modified standards which will be close to IFRS instead of adopting IFRS directly.

3.5 The regulators of Accounting Standards in India hold the same view. The Ministry of Corporate Affairs, SEBI, RBI, IRDA & ICAI are unanimous on issuing Indian Standards and not to endorse IFRS directly.

3.6 Global situation : The countries in Europe, Australia, New Zealand made their own standards. The countries like Korea, Sri Lanka, Hong Kong followed the IFRS verbatim. But, Singapore and Philippines accepted some of the standards and dis-agreed with some others. For example Interpretation Note No. 2 & 15 were not accepted by Singapore. Obviously, they cannot certify IFRS compliance. Some countries like India have made new standards applicable from 2011. So also Pakistan, Indonesia, Taiwan, Vietnam are trying to go nearer to IFRS in next four years. China has prepared thirty-eight Accounting Standards, which are at par with IFRS.

4. Issues and controversies arising from IFRS :

4.1 Recent global development and the financial crisis : In the last two years, a lot of debate has generated on whether crisis is due to accounting failure or due to some other reasons. The final view is that the crisis is attributable to failure of economic system. Banks were advancing loans on mortgage of properties. Attention was given only to value of property and not to repayment capacity and integrity of borrower. This practice worked well till property prices were rising. But this over-optimism brought about the disaster when property prices started dwindling. The borrowers opted to surrender properties, overflowing the banks’ balance sheets with properties in place of recoverable loans. In India, however, due to proper monitoring by RBI about secured loans against mortgage, restricting the discretion of banks on the extent to which such loans can be given, the disaster could be avoided to some extent.

4.2 Another reason for the economic crisis was that in India, the bankers not only look into the sufficiency of security but also verify integrity of bor-rower. But in the USA the scenario was that when loans were transferred to another bank, the portfolio of investments held as security were also transferred as financial products. The insurance companies gave guarantee. But when portfolio became bad, the recovery of debt became doubtful. The financial products, valuation of which is complex, when transferred to other bank, no conservative principles were followed. So also, when loans were given against property, the erosion in value of property resulted in losses to lender institutions. In the process of finding solution, it was decided that the standard-setters of financial reports should come out with new standards. As financial products are complex for evaluation, the standard-setters should give guidance on principle to be followed for financial instruments. IAS-39 is proposed to be revised by issuing IFRS-9. Another reason for the crisis was that many companies are having financial commitments which remain outside the books and do not get reflected in balance sheets. To illustrate, companies enter into Derivative contracts, the profit or loss gets crystallised when contracts are settled or options are exercised at future dates. Some companies enter into forward contracts for covering foreign exchange risk pertaining to purchase/import of raw materials. The fluctuations in import prices are very high. So, very often companies suffer heavily on actual settlements of contracts entered into, say, before 12 or 24 months. Such obligations do not get reflected in the accounts. This is a lacuna. In March, 2008, the Institute came out with Notification about derivative instrument in AS-30 which is not yet made mandatory, but recommendatory. Still, if a company desirous of following it, keeping in mind concept of prudence as per AS-1, can make suitable provision for losses that are likely to arise in derivatives, forward contracts and make account statements transparent and realistic. The financial failures of business enterprises due to such contracts of derivatives also have contributed to economic crisis.

4.3 As a step in the direction of solution, Financial Advisory Board was appointed by International Accounting Standard Board. US Financial Advisory Board is advised to study the situation and submit its report and recommendations.

4.4 The Board has observed that failure of the economy is not due to erroneous accounting but due to inherent system failure in incorporating liabilities and losses arising from derivatives, forward contracts, credit policies of granting loans against properties and financial instruments. It also recommended simplification of Accounting Standards on Financial Instruments (IAS-39) by issue of guidance note. International Accounting Standard Board took review of IAS-39. The issues arising therefrom touching subjects of presentation, disclosures were incorporated in IAS-32 issued in 1995. The other complex issues like recognition, measurement and valuation and other difficult issues were taken up in 1999, which were incorporated in IAS-39. For presentation and disclosures, IFRS-7 was issued. Now the AS-32 will contain only disclosure requirements. Some radical changes were made in basic concepts in accounting hitherto followed. For example, in IFRS, redeemable preference shares are not treated as capital or shareholders’ funds. It is a liability and not equity. Similarly, for IFRS, fully convertible debentures are considered as equity and not liability. Hence, when AS-32 will become effective, Schedule VI of the Companies Act will have to be revised. For IFRS, substance is more important than form. Therefore, for giving effect to IFRS, changes will have to be made in Financial Instruments Standard by simplifying it. These changes will be necessary in IAS-32 on financial instruments and in IFRS-7 on disclosures. The impact of financial instruments of liabilities arising through forward contracts, derivatives and other liabilities not appearing in balance sheet, age analysis of credit risks, portfolio valuation based on rate of interest. All present disclosures in standards on fixed assets and inventory does not cover issues arising in financial instruments.

The applicable standards are :

IAS-32 for Presentation

IAS-39 on Recognition Measurement and Valuation

IRRS-7 on Disclosures

4.5 IAS-39 on Recognition, Measurement and Valuation is being discussed globally on simplification. In India, on this issue AS-30, AS-31 & AS-32 are introduced; AS-30 deals with Recognition and Measurement. AS-31 is on Presentation and AS-32 is on Disclosure. The contents of these standards are at par with corresponding International Standards, but they are yet to be made effective. A project is undertaken in three parts by International Accounting Standards Board.

4.6 In the first part, issues on recognition, measurement and valuation are dealt with.

In the second part, impairment of investment and in third part, issues on hedging will be dealt with.

The first part is completed on 12th November, 2009 called IFRS-9. The second and third part will be completed in last quarter of 2010.

5. Classification, recognition & valuation of financial instruments :

5.1 There are four categories — Financial instruments include investments, loans and advances, deriva-tives and other financial assets and on liability side it includes every debt and equity other than current liability. The principles of valuation in IFRS-39 require adoption of fair value and not market value. So, if the inflow of actual yield of interest and amount due on maturity is known, then the fair value will have to be arrived at. To illustrate, investment of Rs.100 is purchased at Rs.91 which on maturity after 3 years will fetch Rs.100 and in inter-mediary years, it is fetching interest @ 7% and market value is, say, Rs.95. For fair value, one has to find out discounted value. In this case, the inflow will be @ 7% for 3 years and Rs.100. On maturity. after three years, suppose, discounted value is Rs.97, then for IFRS, the historical cost of Rs.91 as well as market value of Rs.95 is not relevant but discounted value Rs.97 will have to be adopted. This method of valuation is called amortised cost method. There are two methods in IFRS either amortised cost or fair value. This method can be followed if inflow is known and certain. The present value of such inflow is considered.

5.2 In IFRS-9, there are three methods of classification. First is fair value and second is amortised cost or discounted cost. Third is loans and advances to be valued at amortised value. To illustrate, if the loan of Rs.10 crores is given on security of property of Rs.8 crores and recovery is not likely, then under IFRS, for valuing security offered, the time that will be required for realisation of security will be taken into account. If the time for realisation is, say, 3 years, then discounted value of security of Rs.8 crores will be considered at say Rs. 5.50 crores. The difference between loan of 10 crores and present worth of securities i.e., Rs. 4.50 crores will be charged to Profit & Loss account by way of provision for bad and doubtful debt. The value of secured advance will appear at Rs. 5.50 and not Rs.8 crores for IFRS and the advance will become performing asset for presentation in balance sheet. So, the time value of money plays an important role in IFRS.

5.3 In IFRS-4, the following principles are extremely important. They are :

1. Historical costs do not play any role. It is always the present worth or discounted value, because user of financial statements is not interested in historical cost but present worth or fair value. For arriving at fair value, allowance is to be given to discounted value.

2. Time value of money : If the asset subjected to valuation carries normal interest which is realisable, then no discounting is necessary. But where no interest is likely to be received, then the value of asset needs discounting.

3. Substance over form : This is illustrated by a hypothetical case. If a company has declared VRS for its employees giving certain time allowance to opt, the company expects that, say 10 employees will accept retirement. But, actually, say, only 3 employees have opted and the company accepted their retirement. Then, as per IFRS, the provision for liability should not be only for three employees, but for all the likely employees, since the liability exists on balance sheet date. Such liability can be discounted. So, though legal obligation has not arisen, the constructive obligation requires consideration under IFRS.

In case of holding and subsidiary companies, for deciding whether consolidation will be required, the company will have to consider effect of the powers vested in holding company. If company ‘A’ is holding 49% of shares of company ‘B’ and under a contract or a MOU, the right to appoint managing director and finance director is vested in company ‘A’, then though holding is less than 50%, still the company ‘A’ holds right to decide effective financial management of the company ‘B’. Hence, consolidation of both Balance Sheets will become necessary. The same situation will prevail if majority of directors can be appointed by the company ‘A’. So, lead control test is satisfied. Thus, in IFRS substance over the form requires consideration.

4. For IFRS, the balance sheet plays more important role. Normally, the Profit & Loss account is considered important, since it decides profit for the year, the tax liability, the quantum of staff bonus, the dividend policy and other effects. In IFRS, balance sheet is supreme, since user of financial statements is more concerned with real state of affairs of the company. He needs an assurance that all provisions are made for actual or constructive liabilities and assets are valued not by historical cost but at fair value by making provision for impairment. At the same time, extra prudence through excessive provisions should not harm the interest of existing shareholders. The balance be-tween interests of existing and prospective shareholders is expected to be maintained. IFRS-9 will become mandatory from the year 2012.

6. Difference between IAS-39 and IFRS-9 :

6.1 Instead of the above four categories of principles in IAS-39, the fourth terminology for categorisation of shares and securities, is securities available for sale. Where securities cannot be termed as trade investments or long-term investments or other investments, then the same can be categorised under the head ‘Securities available for sale’. If value of such investments have materially appreciated, then the difference can be recognised by considering investment at fair value or realisable value and crediting other comprehensive income which shown in the balance sheet under ‘Reserves’.

6.2 In IFRS-9 instead of four methods only two methods are suggested, namely, fair value and amortised cost or discounted value of future proceeds. The intention for making investment will decide its category. Considering practical difficulties in determining fair value, International Accounting Standards Board, in its exposure draft has provided guidance on measurement of fair value. If there is active market for investments, then such value or in absence of active market, there is an alternative formula in finding out fair value. First level is evidence of trend of active market, second level is comparison of your security with similar security in active market. The third level is to consider cost of investment as surrogate of fair value.

6.3 When security is intended to be held till maturity and its amortised cost is considered, the variations in market value will have no effect on value, since it is to be held till maturity. But, if any of such securities are disposed of before maturity, still as per IFRS-9, revaluation need not be carried out. In IAS-39 on valuation of investment there were different rules to deal with appreciation and depreciation. In IFRS-9, these rules are substituted by simple principles viz., the impairment is to be identified with specific investments.

6.4 As regards valuation of equity shares, the principle in IAS-39 deals with embedded derivatives. In derivative contracts, what a party can receive or pay depends on price of commodity, rate of inflation or rate of exchange or rate of interest. An embedded derivatives are still complex. If asset is given on lease and if the rent is made depend on say rate of inflation say if inflation goes up by 1% the rent will go up by say 20%. This is contract of embedded derivative where outcome cannot be preciously determined. IFRS-9 covers only financial assets and not financial liabilities. Impairment of holding are to be considered later.

7. The present status of IFRS-9 & IAS-39 applicable to India :

7.1 The concerned authorities in India are ICAI, Ministry of Corporate Affairs, SEBI, RBI, Insurance Authority and the companies. The issues to be tack-led are — whether IFRS is to be adopted in total in the same form whereby Indian standards will cease to exist.

7.2 The trend of thinking of the above authorities is that IFRS can be applied only to public interest entities and Indian Standards will continue to apply to other entities.

7.3 Public interest entities need to be defined. It will include top listed companies or corporations, which have borrowed abroad or companies having subsidiaries abroad or have issued equities abroad. Therefore, IFRS will be applicable from 1-4-2011 to Insurance, Banking and Financial Institutions.

7.4 From 1-4-2013, the IFRS will be applicable to category 2 companies which will include all listed companies or companies having turnover over Rs.2,000 crores or borrowing more than Rs.500 crores.

7.5 For all the rest of companies, the question is whether they should follow existing AS or IFRS. These categories are SME’s (Small & Medium Enterprises), which are not equipped with advanced knowledge, required for IFRS. They can follow simpler accounting standards in India and progressively be prepared to follow IFRS by knowing its under-lying principles. A change in their mindsets and taking steps towards appreciating differences between Indian Standards and IFRS is the need of the day.

The learned speaker thereafter replied the questions raised from audience and concluded his speech.

The meeting was terminated with vote of thanks to the speaker.

to sense it and stub it.

that the pro-active action the Chairman, prevented a brewing crisis in human relations which would have adversely impacted the company’s operations.

the importance of HR policies and timely action.

that HRD keeps its finger on the ‘pulse’ of the organisation.

Nirav Shah

Taxation of Payments for Technical Plan or Technical Design Part II

International Taxation

Part II

In the first part of the article published in December 2010
issue of BCAJ, we discussed broadly the issues which arise while making payments
for designs and drawings acquired from foreign entities for diverse business
purposes, definitions of the terms Royalty and Fees for Technical Services (FTS)
under the Income-tax Act, 1961 (the ACT), under Model Conventions and under some
important Indian DTAAs. We also discussed meaning of the terms ‘design’,
technical and plan, as per various dictionaries.

In this part, we will discuss taxability of the payment for
technical plans and technical design with reference to various judicial
pronouncements with a view to understand how the case law has developed over the
years and to cull out guiding principles.

Taxation of Payment for Technical Plan or

Technical Design as explained in various judicial

pronouncements :

Taxation of Payments for Technical Plan or Technical Design
has been examined, explained and applied by various judicial authorities in
India

A gist of relevant cases is given below. It is important to
note that in the gist of cases given below, we have only considered and analysed
the aspect relating to taxation of payments for Technical Plan or Technical
Design. Other aspects relating to royalty, FTS, PE, etc. have not been discussed
or analysed here. For this, the reader should consider and refer the text of the
decisions.

1. CIT v. Davy Ashmore India Ltd. (Cal.)

(1991) 190 ITR 626 (India-UK DTAA) :

Nature of payment :

Import of concept designs and drawings for enabling the
assessee to prepare the detailed manufacturing drawings for purposes of
manufacture of the terminal equipments which were required to be supplied by the
assessee.

Issue :

Whether the payment made to the non-resident company were in
the nature of royalty within the meaning of Explanation 2 to S. 9(1)(vi) ?

Held :

That the non-resident did not retain the property in the
designs and drawings. The designs and drawings were imported under the import
policy with the approval of the RBI on the basis of the letter of intent. The
import of the designs and drawings postulated an out and out transfer or sale of
such designs and drawings. The consideration paid for the transfer was not
assessable as royalty.

2. CIT v. Klayman Porcelains Ltd. (AP)

(1998) 229 ITR 735 (India-Germany DTAA) :

Nature of payment :

Under the agreement, consideration was paid for
construction/installation of a kiln. The amount paid under that memorandum by
the Indian company to the non-resident company was payment for technical
drawings towards engineering for the kiln.

Issue :

Whether the lump sum payment made by the resident company to
the non-resident company for supply of designs and drawings (engineering for the
kiln) did not constitute ‘income’ by way of royalty of the non-resident company,
within the meaning of the provisions of S. 9(1)(vi) ?

Held :

The Tribunal on construing the relevant portion of the
agreement recorded the finding that this was a case of a foreign company
undertaking to supply, erect and commission a kiln in India, the only service
rendered in India being that of supervision by an expert deputed by the foreign
company. The amount was not paid for imparting any information concerning the
working of, or the use of, a patent, invention, model, design, secret formula or
process or trade mark or similar property falling under clause (ii) of
Explanation 2 to S. 9(1)(vi) or for imparting of any information concerning
technical, industrial, commercial or scientific knowledge, experience or skill
within the meaning of clause (iv) of Explanation 2. A close reading of the
second type of work as well as the other items of the memorandum showed that the
consideration was paid for construction/installation of the kiln. Therefore, the
payment made by the assessee to the non-resident company did not constitute
‘income’ by way of royalty of the non-resident company, within the meaning of
the provisions of S. 9(1)(vi) of the Act.

3. Leonhardt Andra Und Partner, GmbH v. CIT

(2001) 249 ITR 418 (Old India-Germany DTAA) :

Nature of payment :

Payment was made to the German company in connection with the
design of the bridge to be built.

Issues :

1. Whether the sums received by the assessee for design and
technical services for the construction work are chargeable to income-tax under
the Act ?

2. Whether the transfer of the drawings, designs and
technical services under the collaboration agreement constituted an out and out
transfer of such rights and as such the sums received therefor could be treated
as royalty for the purpose of the Indo-German DTAA and liable to Indian
Income-tax ?

3. Whether, the sum received by the assessee for the supply
of designs, drawings and technical services constituted ‘industrial and
commercial profits’ for the purpose of the Indo-German DTAA and, as such, the
same is assessable under the Act ?

Held:

Royalty was not defined in the old India-Germany DTAA and was
not included within the term ‘industrial and commercial profits’. The term
‘royalty’ not being defined in the DTAA, the definition in the Act would
prevail. Therefore, the sums received by the assessee for design and technical
services for the construction work were in the nature of royalty within the
meaning of the term in S. 9(1)(vi) of the Act, which was taxable and did not
constitute industrial and commercial profits. The fact that the assessee had no
permanent establishment in India was of little consequence.

Note :

CIT v. Davy Ashmore India Ltd., (1991) 190 ITR 626 (Cal.) was distinguished on the ground that as royalty was not defined in the Old India-Germany DTAA and as such the statutory provision will prevail.

4. Munjal Showa Ltd. v. ITO, (2001) 117

Taxman 185 (Delhi) (Mag.) (India-Japan DTAA)

Nature of payment:

The Japanese company undertook to provide to assessee technical know-how and services in connection with manufacture of shock absorbers. The assessee sought drawings and designs of equipments in order to fabricate plant and machinery in India and the Japanese company charged a sum towards cost of supplying the same.

Issue:

Whether such supply of drawings and designs was an outright sale in the Japanese company’s hands and purchase in the assessee’s hands, and, accordingly, consideration paid was commercial profit of Japanese company within meaning of Article III(1) of DTAA?

Held:

The ITAT held that:

As per the contract agreement, the assessee-company had received the licence to use the industrial property rights for manufacture of shock absorbers and also technical documents and know-how relating to the process for manufacturing shock absorbers.

In consideration, the assessee-company had agreed to pay royalty to the Japanese company at the rate of 3% of the ex-factory sale price of the shock absorbers manufactured. The royalty so agreed to be paid was clearly for allowing the assessee-company to manufacture the shock absorbers as per the technical know-how developed by the Japanese company and for supply of technical information, know-how, documentation, etc., relating to the production of shock absorbers and also information and assistance in setting up the manufacturing facilities for production of shock absorbers.

The agreement, however, did not provide for supply of requisite machinery for the plant. Rather the machinery required had to be procured by the assessee-company, though under the advice and specifications given by the Japanese company.

The assessee-company instead of importing the required machinery being costlier, decided to get the same fabricated indigenously and as per requirement of the fabricators, the drawings and designs of the machinery were agreed to be obtained from the Japanese company under an arrangement separate from the collaboration agreement for consideration.

The supply of drawings and designs of the machinery for setting up of the plant was an outright sale in the hands of the Japanese company and purchase in the hands of the assessee-company and, accordingly, the consideration paid was the commercial profit of the Japanese company within the meaning of para 1 of Article III of DTAA.

Apart from the approval accorded by the Government of India to the collaboration agreement, separate approval was sought and granted for the import of drawings and designs by the Government of India and the payment to be made to the Japanese company for import of drawings and designs had also been approved by the Reserve Bank of India.

Had there been a provision in the collaboration agreement for supply of such drawings and designs for manufacturing of machinery for the plant, there would have been no necessity of having a separate arrangement and approval of the Government of India.

There clearly was a distinction between the consideration to be paid for licence and right to use the technical know-how and documentation, etc., for manufacturing of shock absorbers. As per the collaboration agreement, the same was directly linked to the sale of the product and had rightly been termed as ‘payment of royalty’ within the meaning of clauses (e) and (f) of Article X of DTAA and there was no dispute as such about its taxability in India, whereas the payment of US $ 32729 was a consideration for outright purchase of drawings and designs of the machinery required for setting up of the plant and the amount paid was apparently commercial profit of the Japanese company within the meaning of para 1 of Article III of DTAA.

Admittedly, the Japanese company had no permanent establishment in India within the meaning of para 2 of Article III of DTAA and, accordingly, the payment made of US $ 32729 was not liable to be taxed in India as per Article III of DTAA.

Hence, the payment made represented business commercial profits of the Japanese company and the Japanese company having no permanent establishment in India, the said payment was not subject to tax in India as per provisions of Article III of DTAA.

5. Pro-Quip Corporation — AAR

(2002) 255 ITR 354 (India-USA DTAA):

Nature of payment:

Linde Process Technologies (India) Ltd. (LPT) received a purchase order from another Indian company for design, engineering technical know-how and erection and commissioning of hydrogen generation plant. As part of execution of the project, LPT was required to obtain and supply the engineering drawings and designs for the setting up of the plant.

The engineering drawings and designs were available with?Pro-Quip?Corporation, USA, the applicant. LPT placed a purchase order with the applicant for the purpose of specified engineering drawings and designs for the construction of hydrogen generation plant for the Indian company.

Issue:

Whether the applicant is liable to tax on the amount received from Linde Process Technologies (India) Ltd. towards consideration for the sale of engineering, drawings and designs received under purchase order of Linde Process Technologies (India) Ltd.?

Held:

The AAR held that:

This was a case of out and out sale of engineering drawings and designs by the applicant, a non-resident American company to LPT an Indian company to enable LPT to execute an order received by it from another Indian company.

The payment basically was not made for any service to be rendered by the American company. This was not a case of a licensing agreement or sale being coupled with a restrictive clause.

The purchaser was entitled to use the engineering designs and drawings as it liked. It was entitled to sell or transfer the properties purchased.

The agreed price of the sale CIF Mumbai airport was fixed and not subject to any escalation or variation until complete execution. All costs, taxes and duties were to be borne by the seller. The agreed price included cost of documentation.

The total price of the purchase order was to be the sole consideration for supply of goods as described in the purchase order. If any alienation of right or property was made for consideration and such consideration was payable contingent upon productivity, use or disposition, as the case may be, of that property, such payment might come within the expanded definition of royalty. This would not include an out and out sale as in the instant case.

There was no such contingent clause. Payment received by LPT or the sale of engineering, design or drawing was not contingent upon any of the things mentioned in clause (3) of paragraph (3). Therefore, this payment could not be treated as royalty at all.

Moreover, drawings and designs which constitute know-how and are fundamental to an assessee’s manufacturing business are treated as ‘plant’ u/s.32 of the Indian Income-tax Act. If the only source of income of the applicant was the consideration for sale of engineering drawings and designs under purchase order, then the applicant would not be liable to pay any tax in India under Article 12.

6. Gentex Merchants (P.) Ltd. v. DDIT(IT)

(2005) 94 ITD 211 (Kol.) (India-USA DTAA):

Nature of payment:

The assessee-company entered into an agreement with a US company for development of water features at premises owned by it. Under this agreement, the US company was not only to provide schematic ideas but also to provide technical designs, drawings and information, on basis of which the assessee was to execute and install water features. Moreover, the US company was to ensure that features executed by contractors at site conformed to drawings, designs specifications provided by it.

Issue:

Whether since the US company was required to deliver technical designs or plan for sole use by the assessee-company in India, payments effected under agreement squarely fell within definition of ‘fees for technical services’ mentioned in Article 12(4)(b) of India-USA DTAA?

Held:

The ITAT held that:

On reading of the agreement between the parties as a whole, it was noted that various phases contemplated in the agreement were composite and cumulative. Every phase was related to each other and the contract was a single composite contract and the non-resident company was to undertake the work on cumulative basis for which composite non-divisible fee was to be paid.

It was clear from the agreement that each phase was depended on the other and each phase was carried out in succession and only on completion of all phases the scope of work envisaged in the agreement stood fulfilled. It was, therefore, incorrect to say that the agreement merely provided for giving advice to the assessee and there was no transfer of any design or knowledge.

The reading of the agreement clearly indicated that the assessee-company was to execute the water features at its premises in accordance with the designs, drawings and technical specifications provided by the non-resident company and the non-resident company was to ensure that the features executed by the contractors at the site conformed to the drawings, designs specifications provided by it.

From the agreement between the assessee and the foreign company, it was also quite clear that the non-resident company was not only to provide the schematic ideas but also to provide technical designs, drawings and information on the basis of which alone the Indian company was to execute and install the water features. Article 12(4)(b) of DTAA provides that fees for included services shall include ‘services which makes available technical knowledge, experience, skill, know-how or consists of development and transfer of technical plan or technical design’.

For deciding the issue under Article 12(4) it is not material as to whether the assessee acquired on outright basis any technical knowledge, know-how, technical plan or design. Article 12(4) is attracted the moment a person resident of one state (country) makes available technical knowledge, experience or transfers a technical plan or technical design to the person of other contracting state (country).

From the agreement between the assessee and the non-resident company it was apparent that the later was to deliver the technical drawings and designs to the former for its own use and benefit in India. The term transfer as used in Article 12(4) does not refer to the absolute transfer of rights of ownership. It refers to the transfer of technical drawing or designs to be effected by the resident of one state to the resident of other state which is to be used by or for the benefit of resident of other state. The said Article 12(4)(b), does not contemplate transfer of all rights, title and interest in such technical design or plan.

Even where the technical design or plan is transferred for the purpose of mere use of such design or plan by the person of other contracting state and for which payment is to be made, Article 12(4)(b) will be attracted.

The facts on record clearly indicated that under the agreement the non-resident company was required to deliver such technical designs or plan for the sole use by the assessee-company in India. In fact, the assessee did use those technical plans and drawing for constructing and/or installing the water feature in the premises.

In the above circumstances, the payments effected under the agreement with the non-resident company squarely fell within the definition of ‘fees for included services’ and therefore, the assessee was liable to deduct tax at the rate of 15% of the amount payable, u/s.195.

7. Indian Hotels Company Ltd. v. CIT [IT Appeal No. 553 (Mum.) of 2000, dated 14-12-2005] India-Singapore DTAA:

[Decision not yet reported. However, the same has been cited with approval in the case of Abhisek Developers v. ITO, (2008) 24 SOT 45 (Bang.) (URO).] The relevant portion cited in the decision of Abhisek Developers is reproduced below. “The facts of the case on hand are identical with the facts of the case dealt by the Mumbai ‘B’ Bench of the Tribunal in IT Appeal No. 553 (Mum.) of 2000, order dated 14-12-2005 in the case of Indian Hotels Co. Ltd. v. ITO, wherein at para 7 it is held as follows: “A careful reading of the above clauses of the agreement between the assessee company and M/s. HBA clearly shows that the fees payable to M/s. HBA are neither fees paid for technical services nor are in the nature of royalty as defined in various articles of the DTAA between India and Singapore. As per the various clauses of the said agreement it is clear that?M/s. HBA has to hand over and transfer all layout plans and interior concepts in regard to the areas defined in the agreement and all the interior design, drawings and presentation material shall become the property of the assessee-company. All design work submitted by M/s. HBA is for the use solely on this project and cannot be used as part of any other design and the transfer of property in the interior design, drawing, presentation material shall take place in Singapore. It is specifically provided in clause 4.5 of the agreement that all interior design, drawing and specifications shall become the property of the client and the same shall be used for any other purpose other than that covered by this agreement by the interior designer. The services were only to create ‘design’ and title in the design, etc. has passed in this case to the assessee-company. In these facts of the case, we hold that the fee payable to M/s. HBA is not a fee for technical services and is not in the nature of royalty as per the articles of DTAA between India and Singapore and therefore, the assessee was not liable to deduct tax from remittances to M/s. HBA (P.) Ltd. The assessee-company has purchased and acquired interior design and drawing from M/s. HBA and the property therein has in fact passed to the assessee-company. In this view of the matter, the issue is decided in favour of the assessee and the grounds of appeal of the assessee are allowed.”

8. DCIT v. All Russia Scientific Research

Institute of Cable Industry, Moscow

(2006) 98 ITD 69 (Mum.)

(India-Russian Federation DTAA):

Nature of payment:

The assessee, a Russian company, possess-ing knowledge and experience in the field of manufacturing technique of a particular product, entered into an agreement with IPL, an Indian company under which the assessee-company was to provide to IPL a “non-exclusive right to use the ‘know-how’ for the purpose of realisation of the process and the technical process and the special process in the territory and sell the licensed product and the special product in the territory and zone of non-exclusive right”. Under this arrangement, the assessee was, upon a request from the IPL, to render ‘technical assistance’.

Issue:

Whether or not the payment in consideration of supply of technical documentation, on the facts of this case, is to be treated as ‘royalty’ or not?

Held:

The ITAT held that:

An outright sale of designs and drawings essentially implies unfettered right of the assessee to use the same. However, the agree-ment would establish that it was not so in the instant case. Under clause 2.1 of the agreement, the assessee had granted IPL non-exclusive right to use the ‘know-how’ for a specific purpose and that ‘know-how’ included the technical designs and drawings set out in clause 3 of the agreement.

Under clause 12.2 ‘IPL’ could not assign any rights under the said agreement, including, thus, the right to use the designs and drawings to anyone else. In any event, the right to use the ‘know-how’ was a clearly non-exclusive right and, therefore, the assessee retained property in the same even while the ‘know-how’ was made available to IPL.

Under clause 7 of the agreement, IPL was under an obligation to maintain the confidentiality, about the designs and drawings. The IPL had an obligation not only to maintain confidentiality, but also to make every effort that it was not divulged to third parties without the assessee’s specific permission.

Clause 7.2 further provided that in case the drawings and designs were so known to the third parties, IPL would make good the resultant losses incurred to the assessee.

In the light of that factual position, it could not be said that IPL had outrightly purchased the designs and drawings and that consequent to supply of those drawings and designs, the non-resident assessee did not have any interest in the same.

The very fact that IPL could be hauled up to pay damages under Article 7.2 of the agreement would clearly show that the non-resident assessee had valuable property and interest in the drawings and designs which were supplied to IPL and in consideration of which were received by the assessee.

In CIT v. Davy Ashmore India Ltd., (1991) 190 ITR 626 (Cal.), the High Court had categorically observed that where the transferor retains the property right in the designs, secret formulae, etc., and allows the use of such rights, consideration received for such use is royalty.

It was only in the case of outright sale that the consideration for such sale was not to be treated as ‘royalty’.

The instant case was not a case of an out-right sale, nor was it a case of importation of drawings under the import policy. It was a case of collaboration of drawings under the import policy. It was a case of collaboration agreement and a case of limited non-exclusive use of certain drawings and designs for that purpose and therefore, consideration in question was taxable as royalty in hands of the assessee.

In the next part of the Article, we shall discuss some more judicial decisions on the subject.

Nirav Shah

Commitment

You can’t keep a committed person from succeeding’ – Peter Drucker

What is ‘commitment’ ? Is it living and working for an idea, a thought which is action based ? Dictionary defines ‘commitment’ as :

‘An instance of being obligated or emotionally impelled : the action of committing oneself to a course of action : it is a pledge or promise to do something’.

‘Commitment’ is the essential required for both success and happiness in life. Every human being is committed to some ideal or action in life — his polestar — because without that ‘polestar’ a human-being does not ‘live’, he only exists. Let us for a moment pause to reckon as to how many ‘commitments’ we have in life, irrespective of whether we are conscious or not of those ‘commitments’. We are committed to :

our family
our job
our society
our nation and above all we are

committed to ourself, because unless we are committed to ourself we cannot fulfil our other commitments. But what do we mean by ‘commitment’ to ourself ?

In my view this commitment to ‘ourself’ means being true to ourselves. It is a promise to yourself. In other words, it means being in a position to analyse our thoughts and motives and also being in a position to chanelise our actions in conformity with our thoughts and beliefs.

I also believe that a plan without commitment remains a plan and no thoughtful and conscious action can be taken without ‘commitment’. Hence, success in every action is based on ‘commitment’. Even the action of a ‘suicide bomber’ is based on and motivated by ‘commitment’. ‘Commitment’ forsakes excuses, it breaks resistance, it makes our work light and not loaded. It represents honesty and leads to excellence. It lends strength to our character. It has been rightly said ‘commitment in the face of conflict produces character’. ‘Commitment’ represents conscious hunger to succeed and above all to live. According to Sri Sri Ravi Shankar :

“Life runs with ‘commitment’ and

‘commitment’ lends strength”.

The most salient commitment which we all have experienced is ‘mother’s commitment to her child’. It is what builds our character, because it is based on love — it is there — even when the recipient is not conscious of it.

Let us consider a few examples of ‘commitment’ :

Albert Einstein’s commitment to invent

Albert Schweitzer’s commitment to serve

Gandhi’s commitment to Swaraj

Kennedy’s commitment to put man on moon

Sachin’s commitment to cricket

Vivekananda’s commitment to preach Vedanta

It is apparent to us as to what they achieved with ‘commitment’. Obama’s commitment to peace and progress with change in attitude has got him the ‘Nobel’.

However, the questions which bother me are :

Are we fully conscious of our ‘commitments’ because according to Imre Lakatos ‘blind commitment to a theory is an intellectual crime’?

and

Do we really put commitment into our actions ?

Let us pause and think about this simple word ‘commitment’ and make our life consciously successful, satisfying and, above all, happy.

Nirav Shah

The substance our world is built of

Namaskaar

There is one implicit underlying belief that truly motivates
nearly all our actions. We don’t notice it, yet we are infused with it. When we
go to bed we believe that we will wake up the next morning. When we leave home
each morning we believe that we will return. When we buy something we believe
that it will function the way it’s expected to. When we delegate work to our
team we believe it will get done. Without this one attribute, human
relationships turn into poison, families collapse, society deteriorates,
countries turn suspicious and stand in arms against each other. That belief is
Trust in ourselves and others.

TRUST — is the one vital foundation on which our life is
built, sustained and fulfilled. Can you imagine a person — who mistrusts most
people; who suspects the outcomes of his efforts to be adverse, who generally
disbelieves what others say; who often doubts the coming moment to turn
untoward; who is consistently wary of motives behind good deeds of others. What
would these beliefs make such a person ? Possibly a bundle of nervousness,
apprehension and defensiveness, which eventually leads to resentment,
frustration, blame, hostility and total dysfunction. Without TRUST, life RUSTs
(note the partial anagram)

The increasing challenge we face today is that of diminishing
interpersonal trust, within families, in businesses, in polity and
internationally. A friend from Japan who was visiting Mumbai recently, mentioned
that the driver of a taxi she took was a fine man. As they talked during the
ride he mentioned that people these days did not trust one another and therefore
the situation had turned the way it was. Today we wonder when we get financial
advice or a medical prescription — whether it is really for our benefit or it’s
going to benefit the advisor only. The collapse of financial markets reveals
that trust was breached by many who were trustees of wealth and savings. The
author of MEGATRENDS 2010 has put it well when she writes :

Greed destroys wealth. Trust and integrity, by contrast
foster prosperity.

Having said this, the question is — Where does change lie ? A
contemporary author Stephen M. R. Covey writes beautifully in his book to tell
us to start with ‘Self Trust’. Self trust, he writes, is made of :

Integrity (congruence between intent and behaviour),

Intent (your agenda),

Capabilities (the skills, knowledge, attitude that make you relevant), and

Results (your record of behaviour — how and what you got out of your actions).

Recently, I had a powerful experience of broken trust. The
people I trusted most, broke a commitment. They spoke about a self-created rule
on which their actions were based. The same people represented an institution
that taught right living, but in action they were not walking their talk. Former
US Fed Chief Greenspan wrote :

“Rules cannot take the place of character.” How
true !

The thing I like best is how Covey articulates capabilities.
He calls it the sum total of T-A-S-K-S — Talents, Attitudes, Skills, Knowledge
and Style. Only when we improve upon our capabilities, constantly upgrade our
knowledge and behaviour then we can be trusted. If our knowledge is current,
then we remain relevant. Tiger Woods, the legendary golfer, is an example of
someone who continually improved himself even though he was better than the
best. He took a year and half ‘slump’ to improve his swing. The Golf Digest
aptly referred to his ways as the :

“Tiger Creed : I improve therefore I am.”

But at the end of the day nothing works like results. Results
speak the loudest. Results want people to extend more trust. On the other hand,
result sans the other three attributes makes them unsustainable. It’s all about
walking the talk. As an anonymous writer has put it :

People don’t listen to as you speak; they watch your feet.

Happy walking this new year 2009 !

levitra

Nirav Shah

RISK de jure

Risk Management

1. Introduction :

Risk — we have been using this word frequently these days (or
more precisely in the last decade) particularly after the corporate scandals in
the early 2000. The word has legion synonyms and is perhaps one of the few words
in English taxonomy to have so many twins. Call it uncertainty, randomness,
chaos, entropy, volatility, catastrophe, threat, complexity, vulnerability or
‘black swans’ (a word coined by Nicholas Taleb in his book Black Swan to refer
to the impact of highly improbable events); or simply call it risk, the list is
long. Interestingly its thesaurus list is just as long as is the list of its
definitions. The avalanche in the definitions of ‘risk’ and ‘risk management’,
by different theorists, epistemologists, institutes, text books and consultants
makes ‘risk’ and ‘risk management’ one of the most debated concepts of
management literature. Ironically, the confusion and differences in the
understanding of this subject also makes it a lucrative business option for
consultants to leverage upon.

The debate is not restricted to the management hemisphere.
Even the physicists are busy doing auto-psy of this term (albeit in different
context) for more than half a century to find the answers of origin of this
universe and thereby refining our Weltanschauung. The Heisenberg’s Uncertainty
Principle, which is frequently used by Einstein in explaining ‘General
Relativity’, has for decades created a similar anxiety among physicists as it
has among the management literates. Stephen Hawkings, a renowned physicists and
noble laureate, quotes the following words in his book ‘A Brief History of Time
: From Big Bang to Black Holes’ in explaining the ‘uncertainty’ principle :

“Quantum mechanics does not predict a single definite result
for an observation. Instead, it predicts a number of different possible outcomes
and tells us how likely each of these is. That is to say, if one made the same
measurement on a large number of similar systems, each of which started off in
the same way, one would find that the result of the measurement would be A in
certain number of cases, B in different number and so on. One could predict the
approximate number of times that the result would be A or B, but one could not
predict the specific result of an individual measurement. Quantum mechanics
therefore introduces an unavoidable element of unpredictability or randomness
into science. Einstein objected this very strongly, despite the important role
he had played in the development of these ideas. Einstein was awarded the Nobel
Prize for his contribution to quantum theory. Nevertheless, Einstein never
accepted that the universe was governed by chance; his feelings were summed up
in his famous statement — God does not play dice.”

According to me, ‘risk’ is more a subject of behavioural
science and psychology than a subject of organisational management. This is
because each individual has its own definition of risk and has its own approach
of practising risk. We all have different risk appetites or risk taking
abilities. And this in turn is the function of the manner in which we have
grown, the environment to which we have been exposed to and myriad events that
have shaped our lives. Our society, beliefs, perceptions, value system and
culture have an equal role to play. It is not only that the risk taking ability
differs from individual to individual, but for one individual also it keeps
varying from time to time. Risk is not a word that is discussed only at board
and executive level; we have been frequently using this word or its twin even in
our day-to-day life to refer to different events that shape our ‘risk appetite’.

Not mooting as to what constitutes precise definition of risk
and narrowing its application to the theory of business organisation, this
article tries to initiate a discourse and provoke thought process on the
following two aspects of risk management :

Integrated assessment of risk that considers interplay and interdependencies
of risks, and

Significance of behavioural and group dynamics in risk management process that
may dilute the likely benefits from risk management exercise.

2. Risk Management :

Committee of Sponsored Organisation (‘COSO’) of Treadway
Commission, published a technical paper on risk management titled ‘Enterprise
Risk Management — Integrated Framework’, wherein it has extensively detailed the
approach, methodology and framework for managing risk across the enterprise.
Ever since its publication, the framework has been incorporated into policy,
rule, and regulation, and used by thousands of enterprises to improvise their
governance and risk management processes. According to the paper, the threads of
risk management include — Internal environment, objective setting, event
identification, risk assessment, risk response, control activities, information
and communication and monitoring.

Amongst the above, one of the most difficult thread to
implement is ‘risk assessment’. The paper provides a different perspective and
also a technique, to assess risk, be it in quality or quantity terms. While
quantification of risk is still in its nascent stage, the enterprises have been
largely assessing risk in quality terms based on the parameters of impact and
likelihood. While quantification of risk in numbers has its own advantages, it
is against the management wisdom that says that one should manage ‘business’ and
not ‘numbers’. Further, quantification has its limitations as it is subject to
number of assumptions and hypothesis, which may again become a matter of debate.
Due to its simplicity and pragmatism and its advantage of providing better
perspective of risk, qualitative risk assessment is more favoured by risk
experts and business executives (sparing the banking and financial industry)
over quantitative risk assessment. The qualitative assessment score, when
plotted on 2 x 2 graph, assists in concocting risk response strategies.

Akin to any other decision-making activity, risk management is also a group and consensus seeking exercise, wherein the intelligence of many is preferred over wisdom of an individual. There are many social, behavioural and psychological factors that operate behind any such group exercise that can exacerbate it or invigorate it. The identification of risks and its assessments are culmination of ratings of different executives, divisional and functional managers (alias process owners or risk champions). As a corollary, the risk management exercise is also vulnerable to symptoms of behavioural decision-making, which in majority of cases in real world tends to dilute the real benefit that is purportedly expected from risk management exercise. This paper also discusses some of these symptoms, which a risk manager should be cautious of, for effective traction of benefits of risk management.

2.1 Risk Assessment: Measuring the Domino Effect of Risk:

In real world, risks seldom operate in isolation. A particular risk interacts with various other risks with varying intensities; these interactions further keep varying at different point of time and so does their intensities. The complexity, dynamism and frequency of change of the systems in real world, be it ecological system or financial system or economic system or company’s internal control system, contribute to these very characteristic, making accurate risk assessment an utopia.

This characteristic of risk is also colloquially referred to as domino effect of risk. The physicists also refer to it as the butterfly effect or chain effect and allusion of which is also reflected in Edward Lorenz Chaos Theory. The domino effect is a chain reaction that occurs when a small change causes a similar change nearby, either on linear trajectory or in skewed manner.

The integration of global financial and commodity markets, urge of world economies to adopt the capitalist framework, avalanche of cross-border acquisitions, spree of local companies to go global, emergence of black swan known to be cloud computing and information technology and various similar other black swans, increases the domino effect in an exponential manner, making the understanding of risk (in right spirit) similar to arranging of desks on a sinking Titanic. There can be myriad instances that can be quoted to exemplify the domino effect of risks:

The recent sub-prime crises and financial melt-down creating cues of the Great Depression of 1930’s.

The volcanic eruption in Iceland creating turbulence in network of flights.

Greece crises dimming the hope of economic recovery and depressing corporate revival strategies.

Threat of global warning compelling large corporate to re-engineer their strategies to make it more sustainable.

The snow-balling effects of corporate failures of early 2000 on the entire fraternity of economists, accountants and directors.

For a manufacturing operation increase in inflation adversely impacts cost of inputs and compels it to modify its marketing and pricing strategies to pass on additional cost to the customers; its inability to pass the burden of inflation to the customers, may force the companies to adopt lay-off and retrenchment strategies in order to sustain its survival — a phenomenon which we recently observed, particularly in west, before the recovery cues.

Sporadic interest rates triggering volatility in exchange rates, which in turn may lead company to hive off its foreign investments or postpone is global expansion plans or cease its import or export transactions.

A decision to enter a new line of business, with significant incentives tied to reported performance, can increase risks of error in application of accounting principles and of fraudulent reporting.

The combined effect of such interdependent risks, which although individually may be of low magnitude (low impact and low likelihood), may create apocalyptic massacre for a company. And rectifying such injury may either become impossible or would necessitate a complex surgery.

The following words of Nicholas Taleb from his book ‘The Black Swan — Impact of Highly Improbable Events’, are apt to exemplify the domino effect of risk, particularly in era of globalisation:

“Globalisation creates interlocking fragility, while reducing volatility and giving the appearance of stability. In other words, it creates devastating Black Swans. We have never lived before under the threat of a global collapse. Financial Institutions have been merging into a smaller number of very large banks. Almost all banks are interrelated. So the financial ecology is swelling into gigantic, incestuous, bureaucratic banks — when one fails, they all fall. The increased concentration among banks seems to have the effect of making financial crises less likely, but when they happen, they are more global in scale and hit us very hard. We have moved from a diversified ecology of small banks, with varied lending policies, to a more homogeneous framework of firms that all resemble one another. True, we now have fewer failures, but when they occur . . . . I shiver at the thought.

Banks hire dull people and train them to be even more dull. If they look conservative, it’s only because their loans go bust on rare, very rare occasions. But (. . .) bankers are not conservative at all. They are just phenomenally skilled at self-deception by burying the possibility of a large, devastating loss under the rug. The government-sponsored institution Fannie Mae, when I look at its risks, seems to be sitting on a barrel of dynamite, vulnerable to the slightest hiccup. But not to worry : their large staff of scientists deemed these events ‘unlikely’ ”.

The COSO framework categorically emphasises that looking at interrelationships of risk likelihood and impact is an important management responsibility, since it can significantly impact company’s perspective of risks. However, the framework does not explicitly discern the techniques to measure and assess the interplay of risk, as it does for assessment of individual risks. In practice, consideration of risk interplay becomes a paper exercise and is seldom implemented while performing risk assessments. Due to limited guidance on the measurement of risk interactions, risk assessments are often performed for individual risks only, which in all probability is likely to give deluding picture of risk, if not incorrect.

This domino effect can be measured using statistical tool viz. correlation coefficient (r). This would, of course, envisage the following additional threads in addition to those in existing COSO framework.

Identification of Risk Baskets :

Identifying interrelated risks (i.e., the risks that are interdependent on each other) and creating risk baskets or risk portfolios.

Measuring Risk Correlation

Measuring the correlation between the risks within a risk basket. For establishing such correlation, individual risk scores for reasonable period in the past would be necessitated. Using the historical individual risk scores and establishing the trend in their manoeuvrability, we can measure strength of nexus between risks in the risk baskets.

Assessment Matrix and Risk Response Strategy:

Plotting of consolidated scores of a risk basket and its correlation coefficient on a 2 x 2 matrix, provides better perspective of entity’s risk exposure and also assists in prioritising risks and strategising risk responses. Such prioritisation of risk baskets based on correlation coefficient can lead to different risk strategies, as against prioritisation of individual risks without measuring their interrelation.

Allusion is drawn to an article on risk management published by Wharton on the cloud (www.knowledge.wharton.upenn.edu)

“. . . . Risk management has no silver bullet. As a result, many companies need to develop a more integrated view of risk. ‘We have seen a tendency to separate risks into rigid silos — operational risk, market risk, credit risk and so on,’ says Wharton’s Herring. ‘But what we have found is that major shocks and problems do not come that way. For instance, in the financial world, you would see trading desks staffed with people who were experts in market risk, but they were trading instruments that were laden with credit risk. The skills you need to think about each of those kinds of risk are very distinctive, and unless you have an integrated view of risk, you could encounter major problems.’ . . .

. . . Historic data does not shape the future anymore, given how rapidly the world is changing. We usually look at the known issues and make a nice diagram with probability on one axis and impact on the other. That’s Risk Management 1.0. Risk Management 2.0 is (going) beyond the known issues to look at the links and interdependencies. You can no longer look at the risks independently of each other …”

2.2 Breaking the Abilene Paradox:
The Abilene anecdote goes something like this:

On a hot afternoon visiting in Coleman, Texas, the family is comfortably playing dominoes on a porch, until the father-in-law suggests that they take a trip to Abilene (53 miles north) for dinner. The wife says, ‘Sounds like a great idea.’ The husband, despite having reservations because the drive is long and hot, thinks that his preferences must be out-of-step with the group and says, ‘Sounds good to me. I just hope your mother wants to go.’ The mother-in-law then says, ‘Of course I want to go. I haven’t been to Abilene in a long time.’

The drive is hot, dusty, and long. When they arrive at the cafeteria, the food is as bad as the drive. They arrive back home four hours later, exhausted.

One of them dishonestly says, ‘It was a great trip, wasn’t it?’ The mother-in-law says that, actually, she would rather have stayed home, but went along since the other three were so enthusiastic. The husband says, ‘I wasn’t delighted to be doing what we were doing. I only went to satisfy the rest of you.’ The wife says, ‘I just went along to keep you happy. I would have had to be crazy to want to go out in the heat like that.’ The father-in-law then says that he only suggested it because he thought the others might be bored.

The group sits back, perplexed that they together decided to take a trip which none of them wanted. They each would have preferred to sit comfortably, but did not admit to it when they still had time to enjoy the afternoon …”

The Abilene paradox is a paradox in which a group of people collectively decide on a course of action that is counter to the preferences of any of the individuals in the group. It involves a common breakdown of group communication in which each member mistakenly believes that their own preferences are counter to the group’s and, therefore, does not raise objections. A common phrase relating to the Abilene paradox is a desire to not ‘rock the boat’.

This is what typically happens in any management meet, particularly when it is discussing intricate subject such as risk. A risk, which each individual process owners may perceive as high, may get rated as low or medium as each process owner may think that his/her risk perception is counter to that of the group. The paradox may also be contagious during risk identification and risk mitigation threads, rendering the exercise to be fragile. The snowballing effect of such Abilene’s assumption may significantly dilute the benefits of risk management exercise, keeping the board & executives under self-deluding folly of having effective risk management framework.

2.3 Handling Delphi carefully:
Qualitative risk assessment is essentially based on average score of risk ratings perceived by each process owner, within risk management team. The scores (be it in terms of 1 to 5 rating scale or in terms of high, medium or low) by selected process owners are consolidated and averaged out to derive singular risk rating.

This technique, which is theoretically termed as Delphi technique, is widely used in any group decision-making process. However, a major limitation of Delphi which can rob all its benefits is that it tacitly tends to avoid the extremes and mild the ratings of a risk, which purportedly was a black swan. The resultant risk score and big picture becomes distorted. It brings in a myopic and conservative sense of ‘All is well’, when in fact the company is boarding on sinking Titanic. It blinds the management from potential and actual black swans, satiating them with complacency syndrome. Delphi tends management to satisfy itself with non-existence of black swan and then landing them with surprise of ‘How did we, suddenly, landed in such complex situation?’, when potential black swan triggers.

While Delphi continues to gain favours of risk managers, it should be used with caution of its tendency to preclude traction of extremes.

2.4 Avoiding GroupThink syndrome:
GroupThink is yet another syndrome that carries with it the bacteria, similar to Abilene & Delphi and has potential to brittle risk management process. The term was first coined by Irvis Janis in early seventies and occurs when a group makes faulty decisions because group pressures lead to a deterioration of mental efficiency, reality testing, and moral judgment. Groups affected by GroupThink ignore alternatives and tend to take irrational actions. A group is especially vulnerable to groupthink when its members are similar in background, when the group is insulated from outside opinions, and when there are no clear rules for decision-making. The psychologist has prescribed following symptoms of GroupThink, which a risk manager must be aware of:

GroupThink occurs when groups are highly cohesive and when they are under considerable pressure to make a quality decision. When pressures for unanimity seem overwhelming, members are less motivated to realistically appraise the alternative courses of action available to them. This leads to carelessness and irrational thinking.

A risk group is also often diagnosed of the above GroupThink symptoms, which a risk manager and risk group should be careful about.

3. Conclusion:

Following cues can be drawn from the above:

It is imperative to realise that interdependencies of risks can be more jeopardising than individual risk/s. A couple of interrelated risks with medium rating can be together become a potential black swan and can be more jeopardising than an individual risk with high rating

There is need to have an integrated view of risk and measure the risk domino effect using the ‘r’ factor. The Board/CEO today can have only 5-10 key risks on tips of fingers, rather than have a plethora and long list of risks in their risk register, which lends them nowhere

A risk manager should be cautious and aware of behavioural & psychological factors that can paralyze any group & consensus seeking exercise like risk management. These factors alone can risk the risk management exercise, despite of having contemporary frameworks and models

A risk management team should comprise of members who can independently and emphatically put forth their opinions and assessments, without getting carried away by group opinions

A risk manager should be aware of limitation of Delphi and should not be oblivion of extremes that often gets buried under shelter of law of averages

It is desirable to have an independent and external perspective during risk management exercise who can constructively challenge the decisions, thinking and assumptions of risk management team and break their self-deluding complacency.

Risk management, like any other science of management, is function of intuition, imagination, pragmatism and leadership. There is greater need to change the organisation mindset and culture towards risk, rather than change systems and adopt new models and frameworks, which many times may be appealing and glittering but are seldom gold.

God not only plays dice, but He also sometimes throws the dice where they cannot be seen . . . . He still has few tricks up His sleeves.

— Professor Stephen W. Hawking

Nirav Shah

Human Resources Risk Management — Case study

Human Resources :

1. Success of an organistation depends on its people – they make or mar an organisation. ‘Human resources’ is a term used to refer to how people are managed by organisations. The field has moved from a traditionally administrative function to a strategic one that recognises the link between talented and engaged people and organisational success. The field draws upon concepts developed in Industrial/Organisational Psychology and System Theory. Human resources have, at least two related interpretations depending on context. The original usage was in economics, where it was traditionally called labour, one of four factors of production viz., land, labour, capital and enterprise. This perspective is changing because of ongoing research into more strategic approaches to HR. Today ‘human resources development’, goes beyond just organisations and national economies, and encompasses global developments. However, the traditional meaning of HR — Human resources management within corporations and businesses refers to the individuals — department — within an organisation that deals with recruiting, training, retaining and removing — in short, managing people.

Human Resources and Risks :

HRD has a role in risk management — for example :

People per se are a source of risk, e.g., shortage of employees, people doing sloppy work, people frequently committing mistakes, individuals refusing to take on additional responsibility or people leaving within a short time after completion of a one-year training programme and above all, key persons leaving the organisation.

People are important for handling risk, e.g., using their ingenuity and being proactive in solving unexpected problems and unforeseen situations, employees going the extra mile for the good of the organisation, a key employee redesigning his/her own job to improve performance, or an employee persuading a talented friend to apply for a position in the organisation.

HRD contributes to the synergy of the organisation, where the sum of the whole is greater than the sum of the parts.

2. The risks are :

attrition at a rate more than industry average.

lack of commitment to the job exhibited by sloppy work.

people committing or repeating the same mistake.

people shunning responsibility.

people not completing assignment within the prescribed time frame.

trainees leaving within a short period of completing their training.

HR covers people working at all levels. In short, HRD’s activities would cover from ‘president to peon’.

3.1 The function of the HRD is to ensure congenial working environment in an organisation and thereby extracting the best out of everyone for the benefit of the organisation. This is achieved by :

clear job description.

adequate training.

selecting right people — by checking background, education and experience of the candidate.

reasonable clarity about growth prospects within an organisation.

motivating individuals to do more than expected to ensure individual growth.

motivating — encouraging people to innovate in performing their assignments.

avoiding shocks by having a clear succession plan for key functions — that is — developing leaders.

dialogue with key personal at regular intervals to understand issues and the dialogue should be both at the individual and group levels.

timely ‘performance appraisal’ and ensuring timely encouragement to avoid dissatisfaction and attrition.

quick reprimand and punishment for failures.

establishing clear lines of communication with labour leaders.

3.2 The organisation needs to periodically evaluate and review its :

HR strategy, policy design and processes

Employee compensation, equity plans

Retirement and benefit plans

Executive and labour contracts

Employment and labour law compliance

Executive and management structure

Cultural compatibility/change readiness assessment

Communications audit

Development of transition plan — key tasks/activities

Regular monitoring of these issues will ensure that HR risks are kept within manageable levels.

4. Extended scope of Human Resources :

Human resources include more than regular full-time employees. They include: all management and labour personnel, family and non-family members, full-time and part-time people, and or seasonal and year-around employees. In fact with the advent of concept of outsourcing, external contractors, and consultants and contract employees are also a part of the review of HRD.

5. Managing Human Resource Risk :

Risk specialists have traditionally focussed mostly on important causes of risk, such as weather, disease and natural calamities, and ways to deal with these risks. Risk management has paid little attention to human resources and human calamities, such as divorce, chronic illness, accidental death or the impact of interpersonal relations on businesses and families. Including human resources in risk management reflects the fact that people are fundamental to accomplishing organisational goals. Human resources affect operations such as : production, financial and marketing decisions. People can help in or obstruct accomplishing what managers have planned. Smaller family businesses do not escape the impact of people. In these businesses as in larger businesses, people are a source of risk and are important to the business’ ultimate success or failure. Overdependence on family members to manage HR can at times negatively affect family business effectiveness and efficiency because of over-powering character of a family member.

6. Implementation of Risk Management :

Effective HR activities are necessary to keep human resources in harmony with the risk management tools adopted by the management team. Risk management decisions are carried out by people. Having the ‘right’ people in place, trained, motivated and rewarded are essential to success in risk management.

7. This month’s case study is on Human Resources Risk Management :

Corporate Consultants Private Limited are a leading consultancy company in the field of media and entertainment. The company is one of the top ten firms in the industry and has some of the leading companies in the region as its clients. The company also has some of the best names in media, advertisement and entertainment on its advisory board, among its consultants and full-time staff.

Of late, retaining key personnel especially at senior management level has become an issue. The Chairman of the company is concerned at the growing instances of employees leaving at short notice and few instances of complaints of insubordination and also of victimisation.

Hence, the company seems to be facing some HR problems which could have serious consequences on client relationship, retention and on the operations of the company.

The Chairman has approached you as an HR consultant to diagnose the malaise and devise a strategy.

8.1 The plan devised is to :

have a detailed discussion with the :

Chairman himself to understand from him his perception of the organisation and the reasons for the problem.

the existing key personnel on one-to-one basis.

some of the middle-level executives.

some of the members of the staff including helpers in the organisation.

meet the key people in the clients organisation who were being serviced by individuals who have left the organisation during the last six months.

compile and study compensation plan in the industry and the organisation.

if possible meet some of the executives who have left the organisation during the last six months.

The plan was discussed with the chairman who approved of the same and assisted in identifying the clients and executives — who had left the organisations for inputs.

The HR consulted in the absence of detailed employee records first studied the data available on the existing executives and those who had left the organisation during the last six months. He especially concentrated on identifying the status of their family relationships and problems.

8.2 The HR consultant and his team after two months of going through records and holding several meetings identified the following :

Mr. A — the so-called right-hand man of the Chairman — had created a coterie of about four midlevel executives and was abrasive and authoritative with his peers thus alienating his colleagues and others in the office — resulting in those juniors working with him ignored even the other seniors in the office, resulting in insubordinate behaviour.

lack of availability of family data of senior and midlevel executives.

lack of system of annual appraisal and discussion with the concerned executive.

lack of a plan identifying growth prospects following the good old saying ‘either you are moving up or moving out’.

9. The HR consultant recommended :

immediate removal of Mr. A and at least two of his colleagues out of four, who were supposed to be very close to him.

introduction, maintance and annual updating of employee family data.

introducing a system of annual appraisal of the entire staff by the department head and discussion with the appraisee.

introducing a system of annual appraisal of the senior and mid-level executives by the managing director along with the HR consultant followed by a discussion with the appraisee.

?a ballot appraisal of the managing director by senior and midlevel executives.

holding of an annual office get-together including everyone from the ‘president to the peon’.

holding bi-annual gathering of senior and mid level executives with spouses.

holding of quarterly meeting with the senior and midlevel executives to review company operations and plans including financial targets.

having a succession policy as it is a family controlled operation.

identifying a successor for every key assignment in every department to avoid shocks on sudden attrition.

development of job specification.

developing a recruitment policy after considering business growth plans.

10. The first recommendation was immediately accepted and acted upon — which acted as shock therapy. This gave visible results by improving discipline in the office and client service.

The managing director personally called on some of the key clients and deputed senior executives to others. This improved client relationship thus avoided loss of clients. This was the damage control strategy suggested by the HR consultant.

11. The HR consultant got the assignment to look into other recommendations and identify a midlevel executive from the organisation to assist him and take over the function of HR executive probably in addition to his executive assignment — thus opening an opportunity for a deserving individual for improving his prospects.

Nirav Shah

Survey — Legal, Tax and Accounting Aspects

Lecture Meeting

Subject : Survey — Legal, Tax and Accounting Aspects

Speaker : Dilip Lakhani, Chartered Accountant

Past President, BCAS

Venue : I.M.C. Hall, Churchgate, Mumbai.

Date : 26th November 2008

1. Introduction :

At the outset while identifying the reasons prompting the Tax
Department to conduct a survey is that though theoretically every assessee has
to pay tax on income he actually earns, in actual practice the assessee pays tax
only on the income he discloses. Very often, the gap between the two is found to
be mordantly large, resulting in generation of undisclosed income and
undisclosed wealth. To counteract this practice, the Legislature has given wide
powers to tax authorities to conduct surveys and search proceedings. Though
these provisions are legally valid, controversies arise in their implementation.
It also gives rise to many issues in accounting the differential incomes
disclosed at the conclusion of the survey or search.

2. Search (S. 132) and survey [S. 133(A)]

— comparative study :

Though repercussions of Search are more drastic, the Survey
provisions, according to the speaker are more risky for the following reasons :

The first reason is that a warrant for search needs approval
of the highest administrative authority,
namely, Director General of Investigation (a rank equal to Chief Commissioner)
who issues the warrant only after careful and in-depth study of all relevant
facts, circumstances and background of the case.

Another safeguard is that before coming to the decision of
taking search of any assessee, care is taken to ensure that the assessee’s case
satisfies at least one of the three basic conditions. The authority must record
the reason to believe that the assessee is understating his income. He has to
spell out why the search is to be conducted and what is the information
available for conducting the Search.

This process of collection of data to arrive at this
satisfaction takes two to three months. It is only after such satisfaction that
the Director General of Investigation issues a warrant.

As compared to this, S. 133A does not contain similar
preconditions of satisfaction. It provides that the Income-tax authorities may
visit the place of business of the assessee to carry out the Survey. It can take
place if there is fall in turnover, fall in G.P. ratio or non-compliance by the
assessee during assessment proceeding. The only condition is to get approval of
the Additional Commissioner of Income-tax.

3. Analysis of legal, accounting and tax aspect of survey proceedings :

Survey connotes comprehensive inspection of place of business
or profession. A survey cannot be conducted at place of residence. The survey
party can inspect the books of accounts, documents, take inventory of stock,
cash, valuables, investments, all of which thereafter will be inventorised.

After 1-6-2002, survey party is given power to impound books
of accounts and documents and take custody of the same after inventorisation. No
other asset can be impounded.

Normally survey cannot be conducted at residence, since it is
not a place of business. If in the return of income it is shown as any other
place of business, then the survey can be conducted at residence as well as in
any other place of business, say, godown or branch or additional place.

4. Timing for commencement of proceedings :

As regards timing to commence Survey, the same should be
within normal business hours. Once proceedings start, the same can continue till
it is concluded i.e., even beyond hours of business. The Search
proceedings should commence only between sunrise and sunset.

5. Places that can be covered under survey proceedings :

Where the assessee states that his books of accounts are with
his C.A. or Advocate, then the survey can be conducted even in office of the
C.A. or Advocate. However, In 1994, the CBDT issued a Circular stating that
normally Survey should not be conducted in office of C.A., but he should be
asked to produce those books at the place of business of his client who is being
surveyed. If the C.A. refuses to co-operate, then the office of the C.A. can be
surveyed. But the scope of survey will have to be restricted to the books and
other documents of that particular client only and not to books, etc. of C.A.
himself or his other clients.

6. Authorities who can conduct the survey proceedings :

The Income-tax authorities defined in explanation to S. 133
are Commissioner, Asst. Commissioner, Income-tax officer and Inspector, so also
officers of investigation wing i.e., Asst. Director, Director of
Investigation, Deputy Director of Investigation, Additional Director of
Investigation and Inspector. But Chief Commissioner and Director of
Investigation cannot conduct survey. The reason is they are senior officers.

7. Rights conferred on the Officers :

The rights of officers in survey party include right to enter
premises and verify whatever is available in the premises. But the officers
cannot take personal search. The officers in such cases ask the assessee and
others present to empty their pockets and place the papers, documents before the
officers’ table which can then be inspected. It is important to note that though
inspector is an authority in search party, his powers are very limited viz.
to verify books and documents and put identification marks on books and
documents. Except these two powers, he has no other authority. However, in
practice, stock inventory, cash count is done by the inspector. So also very
often statement is recorded in handwriting of the Inspector and signed by the
assessee and countersigned by an officer. The statement is recorded u/s.133A(3),
in search proceedings u/s.132(4), the oath is to be administered before the
statement is recorded. However, u/s.133A, the authorities have no power to
administer oath. Therefore, even if the assessee makes a false statement,
provisions of prosecution under the Indian Penal Code cannot be invoked. Three
important Sections of I.P.C. are excluded in survey proceedings. These are S.
179, S. 180 and S. 181 of the Indian Penal Code, which apply to refusal to make
statement, refusal to give evidence and refusal to give reply. But in search
proceedings, if any of these events occurs, the assessee can be prosecuted. S.
166 of I.P.C. provides that if a Government servant exercises any power for
which he is not authorised, he can be imprisoned for one year.

8. Rights of assessee during survey :

As far as search proceedings are concerned, the rights are given as guideline. These are applicable even during the survey proceedings. The assessee can do his normal functions required for carrying on his business activity, he and his assistants can go out for the assessee’s work. The only restriction is that he should remain present when his statement is to be recorded.

There is no power to arrest or confine the assessee to his business premises.

After inventory is taken, the assessee is asked to put values against each item of stock inventorised. But per law, after inventorisation, the function of survey comes to end. It is only at the time of assessment that the assessee can be called upon to evaluate and prove the valuation and to reconcile the same with stocks shown in books.

During the survey the search party insists on valuation and to quantify the difference solely with a view to persuade or compel the assessee to make high amount of declaration. But such action is not as per law. The survey party or even search party cannot restrict the movement of the assessee. This is held by Delhi High Court in its discussion on rights of assessee during survey proceedings, refer 194 ITR. U / s.132, governing search proceedings, there is power to break open doors, cupboards, cash boxes, false ceiling while making search of unaccounted valuables. No such power exists in S. 133A. If the cupboard or safe is locked, the officer can record his satisfaction about existence of valuable stored in it and get search warrant, whereby he can get the power to break open such containers.

As regards sealing of business premises or god owns, there is no such power to seal premises or god own with search authorities, nor survey authorities. [Shyam Jewellers 196 ITR 239.]

Generally survey proceedings end with recording statement and taking declaration from the assessee.

9. Retraction of declaration of disclosed amounts by assessee:

Whether the statement can be retracted? The statement is not recorded on oath. If it is so recorded, then it casts higher burden on the assessee to prove what he said was not correct.

Before retracting the statement the assessee should first consider the material gathered during survey and its value. Mere blanket retraction will not help the situation. But where materials gathered indicating concealed income form a small part of the disclosed amount, which is either through pressurisation or otherwise, then the assessee can retract his statement saying that it is taken under coercion. Retraction shall be made at the earliest point of time. Retraction statement should clearly set out the circumstances and factual events compelling him to disclose higher amount in his original statement recorded.

10. Three basic principles to be borne in mind are:

i) The amount disclosed in statement is not a conclusive evidence. One has to give due weightage to the circumstances leading to disclosure.

ii) Confessional statement given under ignorance of legal rights is not having evidential value. To illustrate, an assessee not aware of exemption to capital gain, discloses and includes such amount in his declaration statement, still no tax can be levied on such capital gain.

iii) The law is always open to convict a person if evidence is found to be false. Hence, even if declaration is produced before the Court, which is retracted, the Court will verify whether the evidence or material gathered, is sufficient to justify declared sum. If the answer is affirmative, then retraction will not stand the test of law. In converse situation, the Court will uphold retraction.

11. Issue of summons during survey proceedings:

The power to issue summons is given when the assessee is creating hindrance in proceedings or not giving statement when called upon, then the officer can issue summons u/s.131 calling the assessee to attend his office on appointed day and time. S. 131 gives all powers of a Civil Judge to Af), Actually, if the assessee has cooperated and if stocks, cash valuables are inventorised, then summons is not necessary. This was held in 58 ITD 492 and 27 BCAJ 475, which supports the law that summons cannot be issued indiscreetly.

As decided in 246 ITR 353, a bar is put on recording the statement of the assessee over long periods. The recording of statements has to be completed within reasonable time.

In survey proceedings, the authorities persuade the assessee to declare large amount assuring him that penal proceedings will not be invoked if he discloses such amount as indicated by officers. However, such assurance has no legal base.

Penalty u/s.271(1)(c) can be levied only when there is concealment of income or filing of inaccurate particulars. Hence, filing of returns is a prerequisite. If the due date for filing the returns of current year is not yet expired and if the disclosed amount is not related or attributable to earlier year’s income, then there is no ground to initiate S. 271(1)(c)proceedings.

12. Accounting treatment to stock and cash difference :

The undisclosed stock included in the stock inventorised can be brought into books by debiting stock and crediting income. Thereafter the assessee can pay tax as Advance Tax. In 190 ITR 43 (Born.) it was held that where due date for filing has not yet expired, no penalty can be levied if such difference is submitted to tax as income. So, if the undisclosed stock or cash or any valuables not disclosed relate to current financial year and not earlier year, then the assessee need not file declaration regarding such stock, but can incorporate the same in current year income and pay tax. This position will not be applicable if such undisclosed income relates to earlier year. The speaker said that a survey is something like voluntary disclosure scheme always available to the assessee by disclosing it as current year income.

13. Power to impound stocks, cash and other assets, books of accounts & documents:

Prior to 1st June, 2002, there was no power to impound anything from business premises. After 1st June, 2002, officers can impound books of accounts and documents and no other assets. The definition of books of accounts is contained in S. 2 (12A) and documents are defined in S. 2(22A). So any loose papers noting unaccounted sale may not fall in the definition of books of accounts, still survey party can inventorise them and will require the assessee to produce them at the time of assessment proceedings. Those documents which are unsigned, which are undated, unsigned Memorandum of Understanding, may not be documents.

14. Presumptions:

In S. 132(4A) there are certain presumptions, viz. (i) contents of documents are presumed to be true; (ii) The handwriting will be presumed to be of the assessee unless proved otherwise, (iii) signatures will be presumed to be of assessee unless proved otherwise.

However, all these presumptions available during search proceedings are not available during survey proceedings.

15. Presence of CA. during the course of surveyor search:

The speaker felt that such presence will facilitate the proceedings in its smooth functioning. Unfortunately, S.C in 62 Taxrnan 73, has held that whatever is noted in proceedings is the statement of facts. The concerned person is not yet accused and no charge sheet is filed against him, so the work of investigation is in nature of finding of facts, hence CA. or an Advocate has no role in these proceedings. Based on this their presence is not permitted.

16. Time limit for return of impounded documents:

After impounding the documents, ten days’ time is given to retain them, after which those documents are returned unless the officer takes permission of CIT or Director of investigation to retain them for further time by recording the reasons. Such recording is necessary even at the time of impounding.

In 156 ITR, S.c. has held that documents collected even during illegal search can be a piece of evidence which the Dept. can use against the assessee. The Commissioner while giving permission for retaining documents beyond ten days has to record the reason for giving such permission and according to the Speaker, he should intimate the same to the assessee. In search & survey, no appeal is provided. The only remedy is writ which is expensive.

When disclosure of excess cash and excess stock is made, the difference is treated as income. But where there is a shortage, then the Dept. will presume that the difference is unaccounted sale. But entire estimated sale price will not constitute income, a due deduction of cost of material can be claimed from such sale. The same is the position of cash on hand. If cash of, say, Rs.5 lakhs is found but cash per books is, say, Rs.1 lakh, the entire difference though treated as unaccounted sale, the assessee can claim cost of unaccounted purchase as deduction and the difference alone will be concealed income. Again, since the source for unexplained investment is proved, provision of S. 69C or other sub-sections of S. 69 will not apply. Therefore entire shortage of stock or cash will never constitute income. Accounting entries to regularise excess stock or excess cash in the same financial year by debiting stock or cash and crediting income. The entry can be made at any time, at the time of surveyor thereafter. Excess stock can be entered in stock book with corresponding entries in financial books. However, in case of a manufacturer, the incorporating entries of sales (unaccounted) will expose him to liability under indirect taxes like excise, sales tax, vat. In case of traders, if the amount is credited as commission, then service tax gets attracted. As against this, it is possible to argue that income was from derivative trading speculation or commodity trading. Though the source gets explained, the confrontation in Indirect Taxes, VAT, etc. can be avoided. In case of less cash and more stock being found, a set-off can be claimed. Hence due care should be taken when the assessee is made to disclose. He can reserve his explanation till the date of assessment proceedings.

17. Copies of statements recorded:

Can the assessee ask the authority to furnish him copies of statements – The answer is in the negative. The judicial view is that the assessee gets the right to demand it only when any such statement is used against him.

The meeting then terminated with a vote of thanks to the learned speaker.

Nirav Shah

Income-tax — Instruction No. 7/2009, dated 22nd/23rd December, 2009 — F. No. 275/23/2007-IT(B) — Government of India, Ministry of Finance, Department of Revenue, Central Board of Direct Taxes, New Delhi.

New Page 1

Income-tax — Instruction No. 7/2009, dated 22nd/23rd
December, 2009 — F. No. 275/23/2007-IT(B) — Government of India, Ministry of
Finance, Department of Revenue, Central Board of Direct Taxes, New Delhi.

To,

All Chief Commissioners & Directors Generals of Income Tax,
All Commissioners of Income Tax (TDS),
Director of Income Tax (TDS).

Certificate of lower deduction or non-deduction of tax at
source under Section 197 of Income-tax Act — matter reg.

I am directed to bring to your notice on the subject of
issue of certificates under Section 197. Instruction No. 8/2006, dated
13-10-2006, was issued stating that certificates for lower deduction or nil
deduction of TDS u/s.197 are not to be issued indiscriminately and for issue
of each certificate, approval of the JCI/Addl. CIT concerned need to be taken
by the Assessing Officer (AO). Further, a letter of even number dated
16-10-2008 was issued stating that power of issue of certificates under
Section 197 would ordinarily be exercised by the officers manning TDS
Administration. However, instances are being brought to the notice of Board
that the AOs are issuing certificates for lower or non-deduction of tax at
source u/s.197 indiscriminately, in contravention of relevant Income-tax Rules
and Instructions.

I am, therefore, directed to communicate to you that
further to the contents of Instruction No. 8/2006, prior administrative
approval of the Commissioner of Income-tax (TDS) shall be taken (where the
cumulative amount of tax foregone by non-deduction/lesser rate of deduction of
tax arising out of certificate under Section 197 during a financial year for a
particular assessee exceeds Rs.50 lakh in Delhi, Mumbai, Chennai, Kolkata,
Bangalore, Hyderabad, Ahmedabad and Pune stations and Rs.10 lakh for other
stations. Once the CIT (TDS) gives administrative approval of the above, a
copy of it has to be endorsed invariably to the jurisdictional CIT also.

The content of the above instruction may be brought to the
notice of all officers working in your charge for strict compliance.

Sd/-

(Ansuman Pattnaik)
Director (Budget)

levitra

Nirav Shah

Income-tax — Instruction No. 6/2009, dated 18-12-2009 F. No. 225/11/2006/ITA. II, Government of India, Ministry of Finance, Dept. of Revenue, CBDT, New Delhi.

New Page 1

Income-tax — Instruction No. 6/2009, dated 18-12-2009 F.
No. 225/11/2006/ITA. II, Government of India, Ministry of Finance, Dept. of
Revenue, CBDT, New Delhi.

To,

All Cadre Control Chief Commissioners of
Income-tax/Directors General of Income-tax

Scheme for improving quality of assessments — regarding :

For past sometime the Board has been concerned about the
need for improving general quality of scrutiny assessments on a sustainable
basis. In this connection, reference is invited to Board’s Instruction No.
2/2006, dated 27-4-2006 which required monitoring of scrutiny assessments by
Range Heads under the powers available to them under Section 144A of the
Income-tax Act. Instructions have also been issued from time to time for
strengthening the machinery for review of assessments and inspection of
assessment charges. However, it is felt that there is significant scope for
improving the quality of scrutiny system. The matter came up for discussion
during 25th Annual Conference of Chief Commissioner of Income-tax held in
August 2009. A presentation was made by the CCIT Chandigarh outlining a scheme
for improving quality assessments implemented in NWR Region. After taking into
account various suggestions, it was decided to devise a similar scheme with
appropriate flexibility for country-wide implementation.

2. Accordingly, it has now been decided that the following
scheme for improving quality of assessments shall be implemented from calendar
year 2010 onwards :

(i) At the beginning of each calendar year i.e.,
in the month of January, the Range Head in consultation with the concerned
Assessing Officer would identify at least 5 pending time-barring assessment
cases in respect of each Assessing Officer of his Range for monitoring.
These should normally include cases taken up for scrutiny with the
permission of the CCIT. The selection should be done jointly by the Range
Head and the concerned Assessing Officer. Cases of PSUs and loss-making
concerns should normally not be identified for this purpose. This exercise
should also include those Ranges which are held as additional charge by a
Range Head in January.

(ii) The Range Head would issue directions u/s. 144A in
the identified cases for the guidance of the Assessing Officer regarding the
course of investigation to enable him to complete these assessments in a
proper manner. This should be done at the earliest available opportunity so
as to allow the Assessing Officer to have sufficient time to complete the
assessment proceedings. A copy of the directions issued by the Range Head
would also be endorsed to the CIT. The Range Head should also monitor the
subsequent developments in the assessment proceedings in these cases.

(iii) On completion of the assessment the Assessing
Officer shall send a copy of the assessment order to the Range Head and the
CIT.

(iv) In the event of a Range Head holding more than one
Range, the concerned CCIT may appropriately relax the requirement for issue
of directions u/s.144A in respect of the cases of the Range(s) held as
additional charge.

(v) For the purpose of this instruction, a quality
assessment would be one in which issues arising for consideration are
clearly identified, investigation of basic facts in respect of these issues
is carried out, adequate opportunity to rebut adverse evidence is given to
the assessee, the rival evidence are suitably analysed and evaluate in the
light of correct interpretation of law, and these efforts result in
substantial addition to the returned income. The benchmark for the quantum
of addition to the returned income, which may quality for being a quality
assessment, may be decided by the concerned CCIT depending upon the
potential of the given Range/Charge. Normally, this should not be less than
Rs.5 lakh, excluding additions on account of recurring issues. It is
expected that the selected cases will meet the parameters for quality
assessment.

(vi) As regards the remaining scrutiny assessments, it is
expected that 30% of assessments completed by the Range Head, 20% of the
remaining scrutiny assessments completed by DC/ACIT and 10% of ITOs will
result in quality assessments. These benchmarks can be reviewed once the
scheme has been in operation for some time.

(vii) The parameters for determining whether an
assessment is a quality assessment should be decided by the concerned Chief
Commissioner in the light of the above and should be widely circulated at
the beginning of the calendar year i.e., in the month of January of
every year.

(viii) At the end of the financial year, the data
regarding assessments, completed by Assessing Officers of the CCIT Region
shall be got evaluated by the concerned CCIT in the month of next April
according to the parameters decided earlier. The overall results will be
tabulated in the enclosed proforma and circulated in the CCIT (CCA) Region
for information. Separate performance ranking should be done for Range Heads
in respect of cases completed by them u/s.143(3) out of the cases selected
under Instruction 4 of 2007, dated 16-5-2007, and those monitored by them
under this instruction.

(ix) CCsIT may also devise methods for commending good
performance of AO in the area of quality assessments and reflecting the same
in the annual appraisals. Important cases involving large successful
additions may be reported to the Board in monthly D.O. letters. These can
also be sent to DTI (RSP&PR) for inclusion in the Annual Report of good
assessment cases.

3. These instructions may please be brought to the notice
of all officers working in your Cadre Control region immediately for proper
compliance.

Sd/-

(S.
S. Khan)
Member (Income Tax)sessing Officers

Nirav Shah

New rules for valuation of perquisites and ESOPs notified — Notification No. 94/2009, dated 18-12-2009.

New Page 1

New rules for valuation of perquisites and ESOPs notified —
Notification No. 94/2009, dated 18-12-2009.

Post FBT, Budget 2009 had restored taxation of perquisites
given to employees. The perquisite valuation rules (Rule 3) has been notified
with retrospective effect from 1st April 2009. Even the rule for ESOP
valuation and taxation thereof has been notified with effect from 1st April
2009.

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Nirav Shah

Clarification regarding applicability of Section 194J to Third Party Administrators — Circular No. 8/2009, dated 24-11-2009.

New Page 1

Clarification regarding applicability of
Section 194J to Third Party Administrators — Circular No. 8/2009, dated
24-11-2009.

It has been clarified in this Circular that payments made
by TPAs to the hospitals on behalf of the insurance companies are liable to
deduct tax at source under Section 194J of the Act. However, in case, in the
past defaults have occurred in this matter, the Board has clarified the
following :

No
proceedings u/s.201 be initiated after expiry of six years from end of
financial year of default

No demand
u/s.201(1) be enforced if TPAs are able to satisfy the jurisdictional TDS
officer that the hospitals have duly paid the taxes along with a certificate
to this effect from the auditors of hospitals.

However, the liability of interest u/s.201(1A) of the Act
till payment of taxes by hospitals as well as penalty implications would apply
to the TPAs.

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Nirav Shah

Clarification on remittances of consular receipts — Circular No. 9/2009, dated 30-11-2009.

New Page 1

Clarification on remittances of consular receipts —
Circular No. 9/2009, dated 30-11-2009.

It has been clarified by the Board that for the purpose of
remittance of consular receipts abroad, diplomatic missions in India need to
submit only a self-certified undertaking in Form No. 15CA to the remitter
bank. They are not required to obtain a certificate from an
accountant/certificate of Assessing Officer in Form 15CB, since their receipts
are tax exempt.

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Nirav Shah

Part A — Service Tax Refund for exporters of goods

New Page 2

1. Background :

Financial crisis led by US subprime mortgage debacle has
already slowed down Indian exports. In the scenario, exporters struggling hard
to survive are anxious to get refund of service tax paid on input services used
for exports. In the January 2008 issue of BCAJ, a write-up on the subject was
provided. However, considering the expanded scope of Notification 41/2007-ST,
dated 6-10-2007 by various subsequent amendments, a need was felt to provide an
updated account of the issue for guidance of many readers.

2. Scope and coverage :

Notification No. 41/2007 (supra), which was amended
vide Notifications No. 42/2007-ST, dated 29/11/2007-ST and 43/2007-ST, dated
29-11-2007 was further amended by Notifications No. 3/2008-ST, dated 19-2-2008,
17/2008-ST, dated 1-4-2008, 24/2008-ST, dated 10-5-2008, 32/2008-ST, dated
18-11-2008 and 33/2008-ST, dated 7-12-2008. Vide the entire amendments, 19
taxable categories of services have been notified, in respect of which exemption
by way of remission mechanism for filing a claim of refund is prescribed.

A list containing specified services, the date of their
notification and specific compliance/requirement as to documentation is
tabulated at the end of the write-up.

3. General conditions for claiming refund :

An exporter is eligible to claim refund only when service tax is actually paid
on specified services.

No CENVAT credit of service tax paid on the services should have been availed
for which refund is claimed.

Refund of service tax paid on the specified services should not be made in any
manner otherwise than under this Notification viz. No. 41/2007-ST.

Export should be made without availing drawback of service tax paid on the
specified services under Customs, Central Excise Duties and Service Tax Drawback
Rules, 1995. It may be noted that this condition is omitted recently with effect
from December 07, 2008 (refer Notification No. 33/2008-ST).

(Note : Specific conditions for each specified
service category are provided in the table at the end of this write-up)

4. Exemption to exporter
when he is also a person liable for payment of service tax under reverse charge
mechanism :

When an exporter is liable to pay service tax being an
availer/user of any of the above specified services, he is exempt from payment
of service tax on such services. For instance, if an exporter has used goods
transport agency’s service for movement of goods from ICD to port and thereby he
is liable to pay service tax under the reverse charge mechanism, he is eligible
to claim exemption from service tax under this Notification as he is otherwise
also eligible for the refund of the service tax paid on such services used for
the exported goods.

5. Procedure for claiming refund :

5.1 Is there a prescribed format for lodging a claim of
refund ?

No specific form is prescribed in Notification No. 41/2007-ST
for claiming refund on the lines of Form R prescribed by the Government u/s.11B
of the Central Excise Act, 1944 or Form A under Rule 5 of the CENVAT Credit
Rules, 2004 (CCR). In the scenario, an exporter may follow the format of Form A
for submission of the claim of refund, as the details under the said format
would serve the purpose of the claim of refund to be made under this
Notification also.

5.2 Where to submit the application of refund ?

à
A manufacturer exporter is required to submit the application with the
Assistant/Deputy Commissioner of Central Excise having jurisdiction over the
factory where the goods are manufactured.

à
A merchant exporter is required to submit the application with the Assistant
Deputy Commissioner who has jurisdiction over the registered office of the
merchant exporter.

5.3 What procedure is prescribed to be followed when an
exporter is not registered ?

à
The exporter, whether a merchant or a manufacturer who is not registered under
Central Excise or Service Tax authority is required to file a declaration in the
prescribed form (provided in the Notification) with the respective
jurisdictional Assistant/Deputy Commissioner prior to filing a claim for refund
of service tax under this Notification and obtain a Service Tax Code — (STC)
number which would be granted within seven days from the date of submission of
the said Declaration Form.

5.4 Is there a time limit for filing a claim of
refund ?

5.4.1 The refund claim is required to be filed on quarterly basis within 6 months from the end of the relevant calendar quarter during which the goods are exported. The earlier time limit was 60 days. However, from 18-11-2008 the time limit is amended to 6 months vide Notification No. 32/2008-ST.

5.4.2 Although the Notification does not clarify or provide definition of ‘quarter’, the Service Tax Rules, 1994 provide for quarter as a calendar quarter, like January to March, July to September, etc.

5.4.3 The exports will be regarded to have been made on the date on which the Customs appraising officer has permitted clearance and loading of the goods in accordance with S. 51 of the Customs Act, 1962. The officer issues an order known as ‘let export order ‘.

(Note: One should not consider the actual date of export or the date of sailing of vessel as the ‘date of export’. The date of ‘let export order’ is the date of export. Therefore, while claiming refund, the relevant quarter may be decided considering the date of the ‘let export order’.

6. Documents required to be enclosed with the claim of refund:

6.1 Documents substantiating export of goods and other relevant details:

Documents such as ARE-1 duly endorsed by the Customs authorities, copy of shipping bill, non-negotiable copy of bill of lading along with the copy of the export invoice, invoice of the provider of service, etc. should be submitted.

For each specified service, specific documentation is prescribed by the Government. Table at the end may be referred to for the same.

6.2 Documents evidencing payment of service tax to input service providers:

Invoice copies of service providers of specified services, along with proof of payment of the amount mentioned in invoices such as copies of bank statements or copy of challan in GAR-7 and/or receipt of the service provider, etc. should be enclosed with the claim of the refund.

In practice, it is observed that exports are effected through availing the services of custom house agents or freight forwarders – intermediaries. Therefore the specified service providers are paid by these agents or intermediaries. CHAs/intermediaries should be instructed to provide certificate of payment to specified service providers. Further, it should be ensured to follow practice of providing reference of shipping bill number on the invoice issued by service providers. In case of port services and transportation services of rail and road, the notification does not provide requirement of bills to be in the name of exporters. However, the proof of specified service used for export goods would have to be provided. Therefore photo-copies of invoices of specified service providers bearing shipping bill reference should be obtained to the extent possible in order to avoid rejection of the claim for want of proof.

Copy of agreement entered into by the exporter with the buyer wherever applicable i.e., in cases when refund is conditional upon mention of requirement of the specified service in the written agreement.

6.3 Category of service of the service provider:

Since refund is eligible only in case of specified services, the exporter may ensure to obtain invoice with category of service written on it or obtain proof of payment like copy of GAR-7 challan or copy of registration certificate of the service provider.

7. Recoverability of Refund:

If the exporter has not been able to realise sale proceeds for exported goods within stipulated period under FEMA 1999 including any extension of the period, service tax refunded shall be recoverable, treating the recovery as service tax erroneously refunded. Under FEMA (Export of Goods and Services) Regulations 2000, export sale proceeds have to be realised within six months from the date of exports. However, in case of certified status holder exporters, 100% EOUs, and units under STPs BTP schemes, etc. realisation and repatriation is permissible up to twelve months. Under certain circumstances this limit is further extended by RBI.Therefore, if proceeds are not realised within this time limit, then only recovery provisions would be invoked.

8. Some issues:

8.1 X, a merchant exporter has not filed claim of refund for the quarter ended December 2008. The stipulated time limit under Notification No. 41/ 2008-SThas been amended vide Notification No. 32/2008-ST from 60 days to six months. If X files his refund claim by the end of January 2009,he would be within the time limit of 6 months. However, if the Department contends that the amendment is prospective and corresponding to quarter ended September 2008,the time limit of 60 days under earlier dispensation of Notification only would apply. What remedy is left for X under the law?

8.1A The time limit of 60 days was revised to 6 months from 60 days vide Notification 32/2008-ST, dated 18-11-2008.The amendment was made prior to the expiry of 60 days from the end of September 2008 i.e., before November 30, 2008. Therefore, the case can be argued both ways. If the claim is rejected by the Department, the case of the exporter is fairly arguable on the following grounds:

The time limit has been revised, considering genuine hardship faced by the exporters as regards non-receipt of documents before 60 days, pendency remaining for payment of invoicing of input service provider on account of dispute, cash flow problem, etc. The beneficial amendment therefore may be interpreted liberally and not strictly.

Procedural lapses are often condoned if substantive compliance is made. Reliance can be made in the case of IN RE Barot Exports, 2006 (2003)ELT 321 (GOI), where it was held that substantive benefit be given by condoning non mandatory procedural provisions. Similarly,in the case of Cotfab Exports, 2006 (20S)ELT107 (GOI), it was held that procedural infractions of Notification/Circulars be condoned if exports have taken place.

8.2 ABC Exports Ltd. filed its refund claim within the prescribed time limit of 60 days for Y.E. September 30, 2008.However, the documents enclosedwith the claim evidencing export of goods and payment of service tax were found inadequate by the Department. Whether the Department can rejectthe refund claim on the ground of inadequate evidence?

8.2A The Department generally would issue a show-cause notice and point out deficiencies in the claim lodged therein. Following the principle of natural justice, the Department is required to issue a show-cause notice and provide opportunity to the claimant to present his reasons for not attaching the required documents with the claim. If other compliances are found bona fide, the claim could be entertained with/without modifications in the amount claimed if deficiency is made good by filing documents not attached with the claim. If no opportunity is granted, the claimant has a remedy under the law to file an appeal.

To overcome this difficulty of not being able to provide all relevant enclosures within 60 days, the time limit has been extended to six months, which is reasonable for any exporter to make available the required documents. However, the point is that if the entire claim of refund and export is genuine, depending on the facts of each case, the refund claim if rejected could be fought out.

8.3 Classification of service:

AB Exporters Ltd. filed a claim of refund under Notification No. 41/2007-ST for its exported goods in respect of service tax paid on port services, trans-port of goods by rail, etc. However, the steamer agent of the shipping line and/or freight forwarders have charged service tax under the nomenclature of Terminal Handling Charges (THC). Their service providers have paid service tax for this service under ‘business support service’ which is not specified in Notification No. 41/2007-ST. Is there a solution for this difficulty?

8.3A This is the difficulty faced by the entire fraternity of exporters, as most of the exporters ship their goods through a freight forwarder or a custom house agent acting as a freight forwarder who books cargo space for the shipper. Although THC consists of port levies, CONCOR charges and laC road transportation service, the services are obtained through intermediaries. Therefore, the intermediary’s service cannot be classified under the respective taxing entry specified in the Notification. The exporter i.e., user of the service on its own accord cannot change the classification. This principle was followed in the case of CCE v. Courtlaulds Packaging (I) Ltd., 2007) 217 ELT 399 (Tri.-Mum). However, the difficulty faced by AB Exporters Ltd. does not appear to get addressed for now, as in practice, most of the goods are exported through intermediaries and therefore the benefit intended to be provided may remain on paper only.

Nirav Shah

Odd man in

Light Elements

One should not have any objection to the politician, [I mean
minister, mayor, sarpanch (why not ?), leader of the opposition either ex or
existing or any other political personality] being invited for inaugurating a
conference wherein professionals deliberate upon some aspects of ‘legislation’
made by them. Of course they represent ‘us’, the people of this country.
Ironically, more often than not their standing in the public life is a cause of
concern for the intellectuals. Normally, they assume any crowd be it
intellectual or non-intellectual as their potential vote bank. Most of the time
they try to score out their political opponents through their speeches. They are
always in election mood. But the organisers have different perspective. They
feel that the conference should be inaugurated at the auspicious hands of that
political figure.

While giving a brief profile of the owner of the auspicious
hands, sometimes the overenthusiastic organiser makes us feel ‘unlucky’ by
disclosing the fact that he, I mean that political figure, had the ambition of
becoming CA, but alas he is a mayor, minister or somebody politically worth at
the given point of time . Here the organiser gains loud “laugh” [not applause]
in the auditorium. But the organiser does not stop here. He begins ‘sheroshayari’
in Hindi, the national language, to appease the political figure. I think the
trait of appeasement runs through the blood of Indians.

For them it is prestigious to get the conference inaugurated
at the ‘auspicious’ hands of a ‘political figure’. Fine enough up to this stage,
but when the organisers dare the audience to listen to the speech through the
‘auspicious’ mouth of the political figure, it’s a nightmare.

Recently I happened to be a participant in a conference held
in the metro city, where I heard this speech of the political figure. I
reproduce some funny statements made by him after thanking the dozens of
dignitaries on the dais :

“So this conference is organised by so and so (name of the
city) chartered accountants’ ‘firm’ (the conference was organised by the
branch of the Institute). The firm has done very good job for the benefit of
all coming from different parts of the country. [in fact audience consisted of
local members of the Institute and faculty were from the different parts of
the country right from Delhi to Kanyakumari] This conference is held at the
right time to know how to deal with global recession [I was floored, since the
faculty were supposed to deal with Income Tax law which has no connection with
global recession]. Chartered accountants render great service to the society.
They help us to file our return of income under income tax. They guide us how
to borrow from the banks. They are the backbone of Indian economy. They are
agents of the Government of India. I promise to give any help to them. I wish
them great success and great future. I once again thank the organisers for
inviting me to inaugurate this conference. (note that this statement was made
intermittently throughout the speech) . . . . .”

Peculiarity of Indian politicians is that they never
attend any function without ‘slogan shouting squad’, I mean supporters because
of fear of ‘protesters’. Normally they attend the function as late as they
could. Nowadays there is a display of high security exercise by the police
department, like sniffer dogs, security check from toe to head, police personnel
holding sten-guns, cavalcade of cars topped with red lights. If you ask what
threat you would perceive from professionals like us, you are scoffed at by
saying, “We are helpless, it’s routine security matters”.

At the end of the day you have to accept the ‘odd man in’.

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Nirav Shah

Alibaba Aur Chalis Chor

Light Elements

It is said that the scam largest in terms of magnitude is
unknown and still to happen. Why ? You can’t put limit to the human greed. Don’t
forget this gospel truth. In the recent past we heard about 2 G Spectrum scam,
the largest ever in the Indian economy which suggests that Indian economy is
growing by leaps and bounds. No problem. Then we had the CWG scam which showed
that it is just ‘a sport’ for people in power to indulge in corruption. People
out of power, media, public interest litigants and RTI activists, who should now
be recognised as ‘the Fifth Estate’ in the Indian democracy, act as ‘the
whistle-blowers’ for the people. Having heard about the magnitude and
high-profile persons involved in scams, our ears flood with spicy news and
piquant rumours of premature investigation results by various agencies right
from JPC, CAG, CBI to local police in an effort to bring the perpetrators of
scams to the justice. With the passage of time we all forget about those scams,
because we get instantly engrossed in fresh scams.

Be that as may be. Once I was deliberating these issues with
my friend Herambha Shastri a genius in his own right. As everyone does, he
condemned the corruption. However, he was more critical about bringing the
perpetrators of scams to justice. Why ? According to him the process of justice
was a mockery of justice itself. To prove his point of view he told me a very
interesting story.

Once upon a time, there was a gang of forty thieves headed by
Alibaba. All those forty thieves were loyal to Alibaba and to each other. Their
honesty and integrity was impeccable. It is said that people in the underworld
always operate and interact in ‘good faith’, since they have no written laws.
They would burgle houses indiscriminately at the wee hours, whatever they would
rob, would be contributed to the common kitty with Alibaba. Thereafter, Alibaba
would do its distribution according to the risk taken by each thief in burglary
operations. This practice went on for years together. They could not be
apprehended by the soldiers of the King.

One night Alibaba decided to target Radhanagari, the capital
city of the kingdom. They burgled a house and looted jewellery and valuable
articles. One of the thieves snatched a gold necklace from the lady of the
house. The lady shouted loudly. Some thieves overheard her shouting in the
commotion. In the hustle and bustle the thief’s mask slipped and he was face to
face with the lady. She saw his face clearly. The thief gave her an angry look.
Quickly the thief covered his face with mask and disappeared in the darkness of
the night, of course, with the gold necklace.

After this successful burglary the thieves returned to their
den. The next day the chief, Alibaba asked all the thieves to surrender the
booty on the table. The thief who had snatched the gold necklace decided not to
give the necklace. So he put few currency notes he had stolen on the table, but
not the necklace.

As Alibaba was observing the loot somebody whispered, what
about the gold necklace ? The whisper echoed in the den. Yes, somebody stole the
necklace, but it’s not being seen on the table. What happened to it ? The thief
who stole it also whispered the same doubt. Very cunning move indeed ! No one
could doubt him. Alibaba raised his voice, “Silence, silence, what’s the
matter ?” Dead silence fell in the den.

The cunning thief moved forward and declared, “Sardar, we
know somebody stole a gold necklace, but has not surrendered it”.

“Who is that traitor ?” Alibaba roared. Everyone was
squinting at each other with the million-dollar question in mind “Are you the
traitor ?” No one yielded. How to figure out the culprit ?

Alibaba was in deep thought. He hit on a very simple
solution. He ordered the cunning thief, as luck would have it, to revisit the
house they burgled the previous night and bring the lady to identify the
culprit.

The cunning thief after a couple of nights revisited the
house and kidnapped the lady and fled into the forest. Midway he halted his
horse, dismounted with the lady and removed his mask. The lady recognised him
immediately; he was the thief who had snatched her gold necklace. The lady was
scared and trembling. The thief said “I know, you saw me that night. You will be
asked to identify, who stole your gold necklace, but you will not identify me.
If you do identify me I warn you — I will slaughter your young son. Don’t even
glance at me when we reach the den”.

The lady was in utter confusion. It was a nightmare for her.
Still she gathered courage and asked the thief, “If your sardar threatens my
life if I fail to tell the truth, then what should I do ?”

The cunning thief thought over for a while and said, “In that
case you tell him that you could not see the face of the thief as it was covered
with the mask. We all cover our faces with masks during burglary. So you don’t
need to tell the truth and then I will not kill your son. But if you tell the
truth, Alibaba will not return the gold necklace, but you will lose your son. So
better not tell the truth. Is that clear to you ?”

Herambha Shastri stopped his narrative here. Looking at me curiously he said,
“I don’t need to tell the end of the story. But, think for yourself, who is
doing the justice in the story, think of what is being justified, think how the
culprit controls the process of justice, how the witness is being treated, and
how truth is sabotaged. That is why I say the whole process of justice itself is
a mockery of justice in the present scenario.”

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Nirav Shah

Agricultural land Laws : MLRC, 1966

Part 2

(In this Article, we continue our examination of the Maharashtra Land Revenue Code, 1966 (‘Code’) which deals with the law relating to agricultural land and land revenue in the State of Maharashtra.)

1. Uses of land:

1.1 The holder of any land which is assessed or held for agricultural purposes is entitled to himself or through his agents to erect farm buildings, wells, or make any other improvements for better cultivation of the land. Interestingly, the Code does not define the term ‘agricultural’. Reference may be made to the definition under various other Land Laws. Activities such as, horticulture, crop farming, grazing, dairy farming, poultry farming, livestock breeding, etc., would generally be covered under this definition. It is a matter of fact whether a particular land can be said to be used for agricultural operations or not.

1.2 Before commencing construction or renovation of any farm building on lands located in cities, certain types of municipal corporations, etc., the holder requires the prior permission of the Collector for such work. The permission is granted subject to certain conditions.

1.3 Without the prior permission of the Collector:

(a) No land which is used for agricultural purpose can be used for any non-agricultural purpose;

(b) No land which is used for one non-agricultural purpose can be used for any other non-agricultural purpose;

(c) No land which is used for one non-agricultural purpose can be used for the same purpose but in relaxation of any conditions imposed;

Land which is used for non-agricultural purpose is popularly known as ‘N.A. Land’. The Maharashtra Land Revenue (Conversion of Use of Land and Non-Agricultural Assessment) Rules, 1969 need to be complied with for converting an Agricultural Land into NA Land.

1.4 Procedure for conversion into N.A. Land:

(a) An applicant who desires to convert agricultural land into N.A. Land must make an application to the Collector for permission in the prescribed form and in the prescribed manner.

(b) The Collector must acknowledge the application within 7 days.

(d) In cases where the Collector fails to take any action within 90 days of the acknowledge-ment or within 90 days of receipt (if no acknowledgement is also granted, then the permission applied for is deemed to be granted).

(e) Once the permission is granted, the applicant must inform the Tahsildar about the change of user of the land within 30 days in the prescribed format.

(f) Once the land is permitted to be made into N.A., a sanad is granted by the Collector to the holder of the land.

(g) Once permission is granted for N.A. use, such use must be commenced within one year of the date of the Collector’s Order.

(h) Where permission is granted for construction of a structure to be used for a non-agricultural purpose, then the provisions of the Maharashtra Land Revenue (Conversion of Use of Land and Non-Agricultural Assessment) Rules, 1969 need to be complied with in this respect. These include provisions on the minimum open space to be maintained, the number of storeys to be constructed, the size of the building, the plinth area, the dimensions of a room used for residential purposes, types of building material to be used, construction of cess-pools, stables, privies, etc.

In the case of Jamunabai P. Shah v. Bajirao Kalbor, 1995 (1) Mah. LJ 143, it was held that NA use commences from the date on which the land is in fact put to non-agricultural use and not from the date of permission by the Collector.

1.5 Bona fide Industrial Use of Land:

1.5.1 In the following cases prior permission is not required for conversion of the use of agricultural land:

(a) If land is situated within the industrial zone of a development plan prepared under the Maharashtra Regional and Town Planning Act, 1966; or

(b) If the land is situated within the area where no plan exists for a bona fide industrial use; or

When land is so used, a sanad shall be granted in the prescribed form.

1.5.2 The conditions to be complied in this respect are as follows:

(a) The user has clear and proper access to such land

(b) The land should not be reserved for any public purpose

(d) It is not a land notified for acquisition by the State

(e) The industry/project is not within 30 metres of any railway line or 15 metres of any high voltage transmission line.

(f) No Central/State/Local laws are being contravened.

1.5.3 The following activities are treated as being of bona fide industrial purpose:

Manufacture, preservation or processing of goods

Handicraft

Industrial business or enterprise, carried on by any person

Construction of industrial buildings used for the manufacturing process or purpose. It should be noted that construction and real estate development per se are not permitted activities

Power projects

Ancillary industrial usages like:

Research and development

Godown

Canteen

Office building of the industry concerned
providing housing accommodation to the workers of the industry concerned

Establishment of an industrial estate includ ing co-operative industrial estate, service industry, cottage industry, gra-modyog units or gramodyog Vasahats

1.5.4 A special township project means one which is framed under the Regulations for Development of Special Township under the MRTP Act, 1966.

1.5.5 Whenever any agricultural land is converted into N.A. Land or is used for a bona fide industrial use, then the holder is liable to pay a Conversion Tax. This tax is equal to 5 times the non-agricultural assessment of the land.

1.5.6 Any person who contravenes the provision of change of use of land would be liable to pay non-agricultural assessment. Further, he would be liable to such fine as the Collector determines. He would also be liable to restore the land to its original use or carry out such actions as the Collector determines in respect to the land. In certain circumstances, the Collector has power to regularise unauthorised use of land, subject to the following conditions :

(a) the holder pays the applicable Conversion Tax.

(b) the holder pays the N.A. assessment with reference to the altered use since commencement of that use.

(d) he abides by all conditions imposed by the Collector.

It may also be noted that under the Foreign Ex-change Management Act and Regulations issued thereunder, an Indian company cannot raise Foreign Direct Investment for acquiring agricultural lands with an intention of subsequently making them N.A. Lands. Recently, a large real estate developer was questioned by the Enforcement Directorate/RBI for using FDI proceeds for buying agricultural lands.

2. Land revenue:

2.1 All agricultural and non-agricultural land is subject to land revenue.

2.2 Land revenue is assessed with reference to the use of the land:

(a) for the purpose of agriculture,
(b) for the purpose of residence,

(d) for the purpose of commerce,

(e) for any other purpose.

2.3 Non-agricultural assessment of lands :

2.3.1 N.A. assessment of lands is determined with reference to the use which such land is put to and whether it is situated in urban or non-urban areas.

2.3.2 The Collector would classify the villages in non-urban areas into Class-I and Class-II after considering the market values of the land, their situation, the non-agricultural purpose for which they are used, their advantages, disadvantages, etc. Class-I N.A. lands are assessable at a rate not exceeding 10 paise per square metre per year, while for Class -II N.A. lands the rate is not exceeding 5 paise per square metre per year.

2.3.3 In the case of N.A. assessment in urban areas, the Collector would divide them into blocks on the basis of the market value of lands, their N.A. use, advantages, disadvantages, etc. The N.A. assessment of such lands cannot exceed 3% of the full market value. The term full market value means:

Market Value of the Land

+ Capitalised Assessment

Capitalised Assessment means an amount equal to 16 times the assessment on the land for the time being in force. The full market value is estimated on the basis of sales, leases, land acquisition awards, etc., which have taken place in a period of five years immediately preceding the year in which the standard rate for N.A. assessment is being fixed (see para 6.3.4 below).

2.3.4 The Collector has powers to fix the rate of N.A. assessment per square metre of land in each block or urban area. Such rate is called the ‘the standard rate of non-agricultural assessment’ and is fixed as a percentage of the full market value. Each standard rate remains in force for a block of five years. In the year 2002, the Code was amended to provide that the non-agricultural assessment for the guaranteed period of five years commencing from 1st August 2001 shall not exceed:

(a) thrice the non-agricultural assessment rate of 1991 for land in a municipality and twice such rate for other lands in cases which are already assessed for non-agricultural purposes; and

(b) six times the non-agricultural assessment rate of 1991 for land in a municipality and four times such rate for other lands for cases to be assessed for non-agricultural purposes.

The rate of assessment, depending upon the type of land use, is as follows:

2.3.5 The method of computing the standard rate is as follows:

(a) The Collector first estimates the full market value of non-agricultural land in each block of land separately for each of the five years immediately preceding the year for which standard rate is being worked out.

(b) He then determines the full market value per square metre of land in each block of land.

(c) The standard rate of non-agricultural assessment per square metre of land in each block = 3% of the full market value per square metre of land.

(d) These rates are to be approved by the State Government. They are then published in the Official Gazette and they come into force from the date of publication.

3. Recovery of land revenue:

3.1 Chapter XI of the Code is a very important Chapter since it provides for the manner of recovery of land revenue. The claims of the State Government have precedence over all other debts, claims, etc., against any land. If the land revenue due is not paid by the prescribed dates, then it becomes an arrear of land revenue and the person responsible for its payment becomes a defaulter. In several Acts one comes across the phrase ‘all sums required to be paid under this Act may be recovered as an arrear of land revenue’. For instance, S. 46 of the Bombay Stamp Act, 1958 empowers the Collector to recover any duties or sums due under that Act as if they were an arrear of land revenue. Hence, it is important to understand what is the process prescribed for the recovery of land revenue under the Code.

3.2 The process of recovery of land revenue specified u/s.176 of the Code may be briefly described as follows:

(a) by serving a written notice on the defaulter

(b) by forfeiture of his occupancy

(c) by selling his movable property, other than certain necessary personal effects, tools of an artisan, articles for religious endowments

(d) by attaching and selling his immovable property, other than houses belonging to an agriculturist and occupied by him

(e) by arresting and imprisoning him. The arrest process would be stayed if the defaulter furnishes adequate security to the Collector.

(To be continued)

Nirav Shah

General Clauses Act

Laws and Business

1. Introduction :

The General Clauses Act, 1897 (‘the Act’) is a unique
Act in the sense that its utility lies in the interpretation of other
enactments. Interpretation of statutes is a vexed issue which professionals in
general and tax practitioners in particular face time and again. The Act throws
light on some of these issues. This Article discusses the important provisions
of this unique Act.

2. Definitions :

S. 2 of the Act defines certain important terms. However,
unlike definitions in other acts, these definitions apply to all Central Acts
and Regulations made after March 1897 unless there is anything repugnant in the
subject or context. Some of the important terms defined by S. 2 are as follows :

2.1 The term Act when used with reference to an
offence or a civil wrong, shall include a series of acts, and words which refer
to acts done, extend also to illegal omissions.

2.2 The term affidavit includes an affirmation and
declaration in the case of persons by law allowed to affirm or declare instead
of swearing.

2.3 The term commencement, when used with reference to
an Act or Regulation, shall mean the day on which the Act or Regulation comes
into force.

2.4 The term Document includes any matter written,
expressed or described upon any substance by means of letters, figures or marks,
or by more than one of those means which is intended to be used or which may be
used, for the purpose of recording that matter. This definition is of particular
importance under the Stamp Acts, Registration Act, etc. Other enactments which
define the term document are the Indian Evidence Act, 1872 and the Indian Penal
Code. These two Acts also contain a similar definition of the term ‘document’.

2.5 The term financial year means the year commencing
on the first day of April;

2.6 A thing shall be deemed to be done in good faith
where it is in fact done honestly, whether it is done negligently or not.

2.7 The term immovable property has been defined to
include land, benefits to arise out of land and things attached to the earth, or
permanently fastened to anything attached to the earth. This is a very important
definition which is relevant for various Acts such as the Stamp Acts, Sale of
Goods Act, Sales Tax Acts, Registration Act, Central Excise Act, etc. The Bombay
Stamp Act has incorporated this definition in the Act itself. The two leading
decisions on this definition are those of the Supreme Court in the case of
Sirpur Paper Mills (1998) 1 SCC 400 and the recent case of Duncan’s
Industries (2000) 1 SCC 633. The Central Board of Excise and Customs
has issued an order u/s.37B of the Central Excise
Act, 1944 (Order No. 58/1/2002-CX, dated 15-1-2002) wherein after considering
seven Supreme Court decisions including the two mentioned above, the CBEC has
explained its position on when is a property immovable or movable. Moveable
property is defined to mean property of every description, except immovable
property. These two definitions apply to all Central Acts made after January,
1868.

2.8 Local authority is defined to mean a municipal
committee, district board, body of port commissioners or other authority legally
entitled to, or entrusted by the Government with, the control or management of a
municipal or local fund. Various decisions have held that the following
authorities are covered within the definition of a local authority — a Village
Panchayat, a Port Trust, a University, a State Road Transport Corporation, a
Dock Labour Board, a Metropolitan Development Authority, a Cantonment Board, a
Tahsildar, a District School Board, etc.

2.9 An offence means any act or omission made
punishable by any law. If an act done is made punishable by law, it is an
offence. Similarly, an offence is committed if an omission is made by a person
and that omission is punishable.

2.10 A person is defined as including any company or
association or body of individuals, whether incorporated or not.

2.11 A rule means a rule made in exercise of a power
conferred by any enactment, and includes a regulation made as a rule under any
enactment.

2.12 The term sign with its grammatical variations and
cognate expressions, shall, with reference to a person who is unable to write
his name, include mark, with its grammatical variations and cognate expressions.

2.13 The term son, in the case of anyone whose
personal law permits adoption, includes an adopted son; similarly, father,
in the case of anyone whose personal law permits adoption, includes an adoptive
father.

2.14 A will includes a codicil and every writing
making a voluntary posthumous disposition of property.

2.15 A year means a year computed according to the
British calendar.

3. General Rules of Construction :

3.1 Unless provided otherwise, any central Act comes into
force from the day it receives the assent of the President.

3.2 Repeal of Acts :

3.2.1 S. 6 to S. 8 deal with repealed acts and their
effects. S. 6 provides that in case any Central Act or Regulation is repealed by
any subsequent law, then, unless a different intention appears, the repeal shall
not :

(a) revive anything not in force or existing at the time at
which the repeal takes effect; or

(b) affect the previous operation of any repealed act or
anything duly done or suffered thereunder; or

(d) affect any penalty, forfeiture or punishment incurred
in respect of any offence committed against the repealed act; or

(e) affect any investigation, legal proceeding or remedy in
respect of any such right, privilege, obligation, liability, penalty,
forfeiture or punishment aforesaid.

Further, any such investigation, legal proceeding or remedy,
may be instituted, continued or enforced, and any such penalty, forfeiture,
liability or punishment may be imposed as if the repealing Act or Regulation had
not been passed.

Two decisions of the Constitution Benches of the Supreme Court in the cases of Rayala Corpn. (P) Ltd. and M. R. Pratap, (1969) 2 SCC 412 and Kolhapur Canesugar Works Ltd., (2000) 2 SCC 536 have observed that there is a difference between’ omission’ of a statute and its ‘repeal’ and S. 6 of the Act applies to a repealed Section and not to one which has been omitted. The Apex Court in Kolhapur’s case held that repeal of a statute or deletion of a provision, unless covered by S. 6(1) of the Act or a saving provision, totally obliterates it from the statute book and the proceedings pending thereunder stand discontinued. These judgments were recently followed in another decision of the Supreme Court in the case of General Finance Co. v. Asst. CIT, 124 Taxman 432 (SC). The Apex Court held that the principle underlying S. 6 of the Act as saving the right to initiate proceedings for liabilities incurred during the currency of an act will not apply to omission of a provision in an act but only to repeal, because an omission is different from a repeal. Hence, while dealing with a case for prosecution for non-compliance u/s.269SS of the Income-tax Act, 1961, the Court held that as S. 276DD which dealt with prosecution for offences u/ s.269SS had been omitted (and not repealed) from the statute books, and prosecution could not be launched or continued by invoking S. 6 of the General Clauses Act after its omission. Hence, the prosecution proceedings were quashed.

3.2.2 Any Act which repeals any other enactment by which the text of any Act or Regulation was amended by the express omission, insertion or sub-stitution of any matter, then, unless a different intention appears, the repeal shall not affect the continuance of any such amendment made by the enactment so repealed and in operation at the time of such repeal. This Section refers to textual amendments and clarifies the effect of repeal of amending statutes. It is a well-settled law that the repeal of a statute does not repeal such portion of the statute as has been incorporated into another statute. Even if the original Act is repealed, the incorporated Sections still operate in the later Act. When a sub-sequent Act amends an earlier one in such a manner as to incorporate itself in the earlier one, then the earlier Act must be read and construed as if the altered words had been written into the earlier Act and the old words are cancelled, so that there is no need for a reference to the amending Act.

3.2.3 In order to revive any enactment which has been wholly or partially repealed, the purpose to do so must be expressly stated in the Act.

3.2.4 Any act which repeals and re-enacts, with or without modification, any provision of a former enactment, then references in any other enactment or in any instrument to the provision so repealed shall, unless a different intention appears, be construed as references to the re-enacted provision. In Mahindra & Mahindra v. UOI, AIR 1979 SC 798 it was held that if a provision of one statute is incorporated in another, any subsequent amendment in the former statute or even its total repeal, would not affect the provision as incorporated in the latter statute. In Gauri Shankar Gaur v. State of UP, AIR 1994 SC 169, it was held that if a later Act merely makes a reference to the earlier Act, it is only by way of a reference and all amendments, repeals, new law subsequently made will have effect, unless its operation is saved by this provision.

3.2.5 Where any Act or Regulation is repealed and re-enacted, then, any Notification, order, scheme, rule, form, or bye-law made or issued under the re-pealed Act or Regulation, shall, insofar as it is not inconsistent with the provisions re-enacted, continue to be in force, and be deemed to have been made or issued under the provisions so re-enacted.

3.3 S. 9 deals with the commencement and completion of time. It states that for the purpose of excluding the first in a series of days or any such period, it is sufficient if the Act uses the word ‘from’ and for including the last in a series of days or any such period of time to use the word ‘to’. Thus, if an Act uses the word ‘from’, then the first day should not be counted and if it uses the word ‘to’, then the last day should be included. Thus, in the case of Cartwright v. Mac Cormack, (1963) 1 All ER 11,where an insurance policy was issued for ‘IS days from the commencement of the policy’, it was held that the first day was excluded and the policy commenced from midnight of that day. In Union Bank Official Liquidator v. Padmanabha Menon, AIR 1955 NUC 1824, an application had to be made within three years from the date of appointment of the liquidator and in computing that period, the first day was to be excluded. It was held that the principle of S. 9 does not apply only when the words ‘from’ and ‘to’ are used in a statute. It only indicates that if the first day has been excluded, it is sufficient to use the word’ from’ and if the last day is to be included the word to be used is ‘to’.

3.4 According to S. ID, in case any Act requires something to be done in any Court or office on a particular day, and the same is closed on that day or on the last day of a period, then the action may be done on the next working day. However, this does not apply in cases where the Limitation Act applies. The object is to enable a person to do on the next working day what he could have done on a holiday. Thus, an act of the Court should not prejudice a person’s legal remedy, as the law does not compel the performance of an impossibility. There is a cleavage of judicial decisions over whether S. 10 applies to decrees and orders of the Courts. According to one school of thought, the Section applies and hence, if the time specified by the decree for doing something, say a payment, falls on a holiday, then the money can be deposited on the next working day. However, the other view is that S. 10 only applies to a case in which an act is allowed to be done by an Act, and not to an act to be done under a decree. If the payment is not done on the specified date since the day was a holiday, the decree can be executed. In this respect, the Supreme Court’s decision in the case of C. F. Angadi v. Y. S. Hirannayya (1972) 1 SCC 191 is relevant. The Apex Court held that where a party to a consent decree is given time to do an act on a day and he fails to do so on account of impossibility of performance, but he does on the next practicable day, then it must be held that the act was done in time and in terms of the consent decree. It is submitted that this is the more rational view. In an interesting decision in the case of Dharmsi Morarji Chemicals v. Occhavlal Hargovaindas Shah, AIR 1927 Bom. 480, a suit was to be filed and the due date for filing the suit (3 years from the date of payment) under the Limitation Act expired on 20th April. However, the suit was filed only in June. The Court ignored the delay, because in the interim period the High Court was closed on account of its annual summer vacation. It was held that if an act of a party is delayed on account of an act of the Court, then he is entitled to an extension over that period during which he is delayed by the Court’s action.

3.5 S. 11 states that distance, for the purposes of any Act, is to be measured in a straight line on a horizontal plain, unless a contrary intention appears from the statute. In Rex v. [okhu, AIR 1948 All 299, it was held that where the words used in an Act were ‘within the distance of two miles from the limits of a public ferry’, there was no reason why the distance contemplated should not be the shortest distance between the two points. This principle is also helpful under the Income-tax Act for determining whether a land is an urban agricultural land or a rural agricultural land. S. 2(14)(iii) of the Income-tax Act excludes an agricultural land from the definition of a capital asset if it is more than within 8 kilometers from the local limits of any municipality.

3.6 U/s.12, where any Act specifies any Customs/ Excise duty is to be based on any given quantity, e.g., weight, measure, value, etc. of the goods, then a similar duty is leviable according to the same rate on a pro rata basis on a greater or lesser quantity of goods.

3.7 S. 13 states that words in masculine gender would be deemed to include females and words in singular shall include the plural and vice versa. However, both these provisions apply provided they are not repugnant to the subject or the context. In E. Alfred v. First Addl. ITO, Salem, AIR 1958 Mad, it was held that the liability under the Income-tax imposed on the legal representative of a deceased attaches itself to all the legal representatives of the deceased. As per S. 13(2) of the General Clauses Act, the word ‘singular’ includes the plural and hence, when there are many representatives within the knowledge of the ITO, all of them must be served with notices. In the case of Vijaya Manohar Arbat v. Kashirao Sawai (1987) 2 SCC 278, the Court held that the expression ‘his father or mother’ in the Code of Criminal Procedure is not confined only to the father or mother of a son, but also applies to the parents of a daughter. Accordingly, the daughter has an obligation even after marriage to maintain her parents if they are unable to do so. A daughter after her marriage does not cease to be a daughter of her parents. However, the Supreme Court in the case of Dhandhania Kedia v. CIT, AIR 1959 SC 219, held that this Section can be applied only when there is nothing to the contrary Where the words of the Income-tax Act are Clear, then there is no room for application of this Section.

4. Orders, Rules:

4.1 Whenever a power to issue any Notification, order, scheme, rule, form, or bye-law is conferred, then the power includes the power to add to, amend, vary or rescind the same.

4.2 In case any Act or Regulation which is not to come into force immediately on its passing, confers a power to make rules or bye-laws, or to issue orders with respect to various matters, then that power may be exercised at any time after the passing of the Act or Regulation. However, the rules, bye-laws or orders so made or issued shall not take effect till the commencement of the Act or Regulation.

4.3 In case a power to make rules or bye-laws is conditional upon the same being made after their previous publication, then the following provisions would apply:

a) first a draft of the proposed rules or bye-laws would be published in the prescribed manner for the information of persons likely to be affected.

b) the draft should include a notice specifying a date on or after which the draft will be taken into consideration;

c) the rule-making and sanctioning authority shall consider any objection or suggestion with respect to the draft;

d) once the rule or bye-laws purported to have been made in exercise of a power to make rules or bye-laws are published in the Gazette, then it shall be conclusive proof that the same have been duly made.

5. Others:

5.1 S. 63 to S. 70 of the Indian Penal Code and the provisions of the Code of Criminal Procedure in relation to the issue and the execution of warrants for the levy of fines shall apply to all fines imposed under any Act, Regulation, rule or bye-law, unless provided otherwise. This provision is based on the Rule of Convenience, i.e., there is a uniform procedure for all enactments to be followed for recovery of fines, unless the statute itself provides another mode.

5.2 In case an act or omission is an offence under two or more Acts, then the offender shall be liable to be prosecuted and punished under either or any of those enactments, but he shall not be liable to be punished twice for the same offence. Thus, where an act is an offence under two or more enactments, the offender cannot be punished twice for the same offence.

5.3 Where any Act or Regulation authorises or requires any document to be served by post, the service shall be deemed to be effected by properly addressing, pre-paying and posting by registered post, a letter containing the document, and, unless the contrary is proved, to have been effected at the time at which the letter would be delivered in the ordinary course of post. Thus, a uniform procedure has been laid down in all cases requiring service of notice by post. However, this proposition may be rebutted by providing evidence to show that actually there was no service of notice. In a case where a notice was served for specific performance of an Agreement by a Registered AD and returned un-served due to alleged refusal, it was held that the Notice must be deemed to have been served – Bhabhia Devi v. P. Yadav, (1997) 3 SCC 631. In the following cases it was held that the notice is deemed to have been duly served: Shimla Development Authority v. Santosh Sharma, (1997) 2 SCC 637 (Notice sent by Registered AD, but neither the unserved notice nor the AD card was received); State of Kerala v. VTK Udaya, 1995 Suppl. (3) SCC 518 (Notice returned with endorsement ‘not known’); Harcharan Sing v. Shiv Rani, AIR 1981 SC 1284 (Addressee refused to accept letter).

5.4 Any enactment may be cited by reference to the title or short title by reference to the number and year thereof, and any provision in an enactment may be cited by reference to the Section or sub-section of the enactment in which the provision is contained. Any Act or Regulation in which a description or citation of a portion of another enactment is made shall be construed as including the word, Section or other part mentioned or referred to as forming the beginning and as forming the end of the portion comprised in the description or citation.

6. Conclusion:

The Courts have, in innumerable pronouncements, held that if a term is not defined in a particular Act, Rule, etc., then the definition given in the General Clauses Act will prevail. For instance, in the case of Karam Chand Thapar, AIR 1961 SC 838, the Supreme Court held that the purpose of the Act is to place in a single Act provisions as regards definitions of words and legal principles of interpretation which would otherwise have to be incorporated in many Acts and Regulations. The definition and the rules of interpretation contained in the Act have to be read in every other statute governed by it. Similarly, in Dulichand Laxminarayan, 29 ITR 535 (SC), it was held that the definitions given in S. 3 of the Act apply when there is nothing repugnant in the subject or the context.

Hence, knowledge of the basic provisions/principles of the General Clauses Act will assist the Auditor not only in interpreting the provisions of the Corporate and Tax Laws, but also in adding value to his advisory services.

Nirav Shah

Chinese restaurant has robots as waitresses !

New Page 1

39. Chinese restaurant has
robots as waitresses !

A new restaurant has opened
in Shandong province of China which has robots as waitresses. The Dalu Robot
Restaurant, in Jinan, has six robot waitresses and can cater to up to 100
diners. The website Orange reported that the restaurant’s 21 tables are set in
circles and the robots follow a fixed route to serve diners in rotation. After
serving, the robots return to the kitchen to refill their carts for the next
round. Restaurant spokeswoman Wang Xianwei said all of the waiting on tables is
done by robots. However, the food is prepared by humans, and people are also
employed to welcome customers.

(Source : The Economic
Times, dated 11-12-2010)

“Many bought into the idea
that America could go from a technology-based, export-oriented powerhouse to a
services-led, consumption-based economy — and somehow still expect to
prosper . . . . That idea was flat wrong . . . . Our economy tilted instead
toward the quicker profits of financial services.”

— Jeffrey R. Immelt, Chairman
and Chief Executive, GE.

“Even if you’re doing a good
job, it doesn’t always get reported that way.”

— Steven A. Ballmer, Chief
Executive, Microsoft.

It takes about 1,000 litres
of water to produce a kg of grain, while it takes over 100,000 litres to produce
a kg of beef.

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Nirav Shah

Intel-Tech giant plans creating ‘Sub-Atom’ chip In India

New Page 1

37. Intel-Tech giant plans
creating ‘Sub-Atom’ chip In India

Efforts to take PCs to the
masses in India hasn’t had a great record. Yet, Intel is taking new initiatives
in that direction.

The company’s chief
technology officer, Justin Rattner, said that he’s starting what he calls a
‘frugal engineering’ effort at its India facility. “It’s intended to bring high
technology to these huge populations, to those whom our products for the most
part do not touch today. And India seemed to be the perfect place to do that
kind of work,” he said.

Rattner said his lab was
‘kicking around ideas’ in the space. “We want to do very low-cost PCs, very
power efficient, very robust in the face of unreliable power sources. So we are
moving from a US/European audience, with hundreds of millions of customers, to
an audience of a billion or two billion. Give them online reach, but at a price
point that is unprecedented,” he said.

For this, he is even looking
at developing a new processor, a ‘Sub-Atom’ as he called it. Atom is currently
Intel’s cheapest processor and is used for netbooks, net tops, smartphones and
the company’s smart TV platform.

Rattner expects the India
lab to do a lot of rethinking on how to provide various functions on a chip.
“The India lab is currently working on absolutely leading-edge technologies, now
moving from 32 nanometre chips to 22 nm ones. What if we backed off, and used
chips of two generations back, say 65 nm ? Now, those plants are fully
depreciated, so the wafer costs are dramatically lower. But for a very high
volume, low-cost product, that technology may be sufficient. It’s a big mental
shift for Intel”, he said.

(Source : Extracts from
an article written by Mr. Sujit John in The Times of India, dated 13-12-2010)

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Nirav Shah

Cell towers likely sources of radiation, disease : Study of DoT says India should tighten norms

New Page 1

38. Cell towers likely sources
of radiation, disease : Study of DoT says India should tighten norms

Cellphone operators have
long denied their transmitting towers atop buildings or on highways have any
adverse bearing on the health of humans or animals, despite several studies
across the world concluding the contrary. Now a report for the Department of
Telecommunication by a faculty of the Indian Institute of Technology, Powai,
reinforces what scientists have long held : that areas around cellphone towers
are high-radiation and consequently high-risk zones. Moreover, it recommends
that India, which has very ‘relaxed radiation norms’, must raise the safety bar.

Girish Kumar, professor,
electrical engineering department of the Powai institute, said : “These towers
transmit radiation 24×7, so people living nearby will receive 10,000 to
10,000,000 times stronger signal than required for mobile communication. In
India, crores of people reside in these high radiation zones.”

Kumar noted that the cell
phone industry was becoming “another cigarette industry, which for long kept
claiming smoking is not harmful. In fact, cellphone/tower radiation is worse
than smoking as one cannot see it or smell it, and its effect on health is noted
after a long period of exposure. Unfortunately, all of us are absorbing this
slow poison unknowingly.”

Cell shocking :

(1)
Cancer risk :

Use of mobile phones for
more than years poses a risk of brain cancer. Children and teenagers are five
times more susceptible as their brain is not fully developed and radiation
penetration is much deeper.

(2)
Infertility :

Studies confirm cell phone
radiation can drastically affect male fertility. Studies have found 30% sperm
decrease in intensive mobile phone users, in addition to damage of sperms.

(3)
Neurodegenerative diseases :

People living near mobile
phone base stations are also at risk of developing neuropsychiatric problems
as headache, memory loss, nausea, dizziness, tremors, muscle spasms, numbness,
tingling, altered reflexes, muscle and joint paint, leg/foot pain, depression,
and sleep disturbance. More severe reactions include seizures, paralysis,
psychosis and stroke.

(4)
Skin damage :

Radiation from cell towers
and mobile phones affects human skin. It can result in an increase in mast
cells, leading to the clinical symptoms of itch, pain, edema and erythema. It
also may be instrumental in higher concentration of the transtyretin protein,
which has an important role in causing nerves diseases like Alzheimers.

(5)
Interference with other gadgets :

Radio frequency exposure
from cellular phone base antennas and mobiles can affect patients with
pacemakers, implantable cardiovascular defibrillators and impulse generators.

(6)
Melatonin reduction :

Melatonin, a vital
neurohormone, regulates our circadian rhythm. Studies with animals show a
reduction in melatonin levels following radio frequency radiation exposure
from cell phones and cell towers. Turning off transmitters resulted in a
significant increased melatonin levels within few days.

(7)
Ear & eye damage :

Radiation emitted by
mobiles may damage the delicate workings of the inner ear, and long-term and
intensive use for more than four years and for longer than 30 minutes a day
creates high risk of irreversible hearing loss. Frequent use of mobiles can
also damage the visual system.

(8)
Sleep disorders :

Use of handsets before
going to bed delays and reduces sleep, and causes headaches, confusion and
depression. The findings are especially alarming for children and teenagers as
they use cell phones at night and keep the phone next to their head, it may
lead to mood and personality changes, depression, lack of concentration and
poor academic performance.

(Source : The Times of
India, dated 7-12-2010)

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Nirav Shah

Not the worst of times

New Page 1

36. Not the worst of times

As 2010 draws to a close,
the opening lines of Dickens’ A Tale of Two Cities seem appropriate. What we see
is an unusual combination of bad headlines and good economic data — not just in
India but the world as a whole. The headlines talk of Europe being in a
debt-cum-currency crisis, and President Obama battling slow growth and high
unemployment. What the headlines don’t catch is that the International Monetary
Fund has upped its global growth forecast for (calendar) 2010, from 4.2% in
April to 4.8% in October. That is not very far from the average of about 5%
growth achieved in the three years from 2005 to 2007, before the Great Recession
hit. Note also that all talk of a double-dip recession has evaporated.

This combination, of
negative headlines masking good economic data, is evident in India too. The
Government is in crisis, corruption scandals rock the nation, and Parliament is
non-functional. But the economy chugs along, with GDP growth in April-September
at 8.9% — higher than forecast. The full year could see a return to 9% growth,
buoyed by a bumper kharif harvest. Tax revenue is doing well, the foreign
exchange reserves continue to climb, and the inflation curve is dipping. As Jack
Nicholson might say, this is as good as it gets.

If the macro-economic
numbers are so good, what explains the general sense of crisis ? The answer in
the West is that the problem is not growth per se, but its distribution.
While India and China grow at 9% to 10%, the developed economies are managing
barely 2% — not fast enough to reduce the unemployment numbers that surged
during the recession of 2009. The bigger worry is that many of the rich
economies, having piled up massive debt, fear a decade of slow growth as they
pay off the debt; in other words, there will be no quick exit — not just for
Greece and Ireland but also for Britain and others.

In India, the issues that
dominate the headlines can be licked more easily, provided one decides that
every crisis can be made into an opportunity. The Raja scandal can be used to
clean up the telecom rules once and for all. The mining and land acquisition
scandals have already provoked new Bills to clean up policies in these
problem-ridden sectors. All that one needs then is for the Government to decide
that, if it is willing to have the Supreme Court oversee the investigation of
the telecom scandal, it can live with a fully independent Central Bureau of
Investigation. Manmohan Singh must see that it is not enough for him to be
honest, his Government must be honest too. The only way he can ensure that is by
having an effective crime investigation agency that is immune to political
influence.

(Source : Extracts from
an article written by Mr. T. N. Ninan in Business Standard, dated 11-12-2010)

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Nirav Shah

Short of judges, govt. to start 2 IAS-like services

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35. Short of judges, govt.
to start 2 IAS-like services

The Centre is finalising the
creation of two all India services Indian Judicial Service (IJS) and Indian
Legal Service (ILS) to fulfil its promise to create 15,000 additional courts by
2012 and meet the demand for services of legal professionals from various
departments of the Union and State governments.

We will create two all-India
services IJS and ILS mainly aimed at capacity building at the lower levels of
the judiciary and to provide professional legal advice to various departments,
Law Minister M. Veerappa Moily told TOI.

Though he was tight-lipped
about the time frame of the plan, the Minister said the IJS would help attract
talent from all over the country for
appointment at the sessions judge level.

The ministry’s Vision
Document prepared last year had promised the creation of 15,000 posts of judges
for two years to tackle the backlog of nearly 2.5 crore cases in the trial
courts. But with that apparently not working out, the Government is keen to add
to the number of nearly 17,000 trial court judges by creating the IJS.

Law leash on lawyers conduct
likely soon :

The Government has proposed
a law, the Legal Practitioners (Regulations and Maintenance of Standards in
Professions, Protecting the Interest of Clients and Promoting the Rule of Law)
Act, 2010, to oversee the conduct of more than one million legal professionals
and supervise legal education. It also envisages a Legal Services Board that
will establish a panel to represent the interests of clients of legal
professionals.

(Source : The Times of
India, dated 5-11-2010)

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Nirav Shah

Govt. proposes super regulator for lawyers

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34. Govt. proposes super
regulator for lawyers

The Centre came out with a
proposed legislation to create a super regulatory body to oversee the ethics and
conduct of more than one million advocates and legal professionals as well
supervise the legal education system.

Given the flexing of muscle
by the Bar Council of India (BCI) in the recent past by being the sole
regulatory body for advocates, the ministry’s move is seen by experts as one
that would clip the wings of BCI.

Importantly, the proposed
law Legal Practitioners (Regulations and Maintenance of Standards in
Professions, Protecting the Interest of Clients and Promoting the Rule of Law)
Act, 2010 aims to control the conduct of legal professionals solicitors not
appearing in courts, those appearing in tribunals or even representing clients
in departmental inquiries who had not been within the ambit of the regulatory
mechanism of BCI.

It aims to protect clients
from harassment at the hands of those legal professionals who are not covered
under the Advocates Act, 1961, having not been registered by the concerned State
Bar Councils. The ministry has sought comments on the proposed law from the
public and the legal fraternity.

In addition, the Legal
Services Board (LSB), proposed to be set up under the Act in line with the one
functioning in the UK, would establish and maintain a panel of persons to be
known as consumer panel to represent the interests of consumers and clients of
the legal professionals. This move is meant to check exploitation of litigants
and clients by legal professionals, including advocates. The consumer panel
shall have a fair degree of representation of both the consumers/clients of the
legal professionals and those who are using or may be contemplating using the
services of the legal professionals as consumers/clients, the proposed law
mentioned.

(Source : The Times of
India, dated 5-11-2010)

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Nirav Shah

The right to privacy

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33. The right to privacy

For a government that has
been busy granting the people of India rights to employment, education and food,
the United Progress Alliance has been lackadaisical in protecting the citizens’
right to privacy. Industrialist Ratan Tata was, therefore, right to seek the
protection of the Supreme Court in the matter relating to leaked tapes of
telephone tapping undertaken by the Union Government’s tax authorities. After
finishing its internal investigations, the Government must tell the Parliament
as to why the Income-tax Department ordered the tapping of the telephone of
public relations professional Niira Radia, what relevant information was
procured and what action taken and, most importantly, how those secret tapes got
leaked. A government has the right to gather information about illegal and
anti-national activities of a citizen, provided due procedure is followed. Even
so, there can be no justification for leaking such tapes to the media and making
private conversations public. If the tapes have revealed any act of criminality,
illegality and such like penal offences, the Government is duty-bound to take
action against such offenders. However, no government should allow its
intelligence arms to be used to play favourites with corporate houses, the media
or political rivals.

When conversations taped are
purely private in nature, perhaps malevolent, perhaps in bad taste, perhaps
revealing a lack of integrity or judgement on the part of the interlocutors, but
not pointing to any criminal misconduct, agencies of the Government have no
business to go public. The Government has correctly decided to probe the leak of
these tapes and the guilty ought to be punished.

The leaking of the tapes
has, of course, contributed to some soul-searching within the media and the
corporate world, and that is a good thing. A positive consequence of the ongoing
controversies could be that new norms of corporate, political, governmental and
media conduct will be adopted by all concerned. While the consequences of an
illegal act, namely the leaking of the tapes, have been positive both for the
media and public life, the act itself should not go unchallenged. There have
been far too many instances of a breach of privacy and governmental intrusion
into a citizen’s private life in recent months. An atmosphere of fear is being
generated. People worry if they are being spied upon and their privacy intruded.
What’s troubling is that rather than any national interest, such investigations
seem to serve political and corporate interests. There has to be a greater
degree of transparency in the functioning of revenue and intelligence agencies.
These agencies should not be seen as handmaidens of vested interests and those
in power. Shades of the ignominious Emergency Era are being painted, with
detractors of the ruling dispensation finding themselves in difficult
situations. These tendencies should be nipped in the bud. Hopefully, the Supreme
Court will do its bit to empower the citizen, defending the right to privacy
without in any way coming in the way of the normal functioning of various arms
of the Government. For their part, both the media and the corporate world have
their lessons to learn.

(Source : The Business
Standard, dated 1-12-2010)

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Nirav Shah

Bihar : Victory for hope

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32. Bihar : Victory for hope

Governance trumps caste
politics as NDA sweeps Bihar. One hopes that political parties across all
colours pay heed to development agenda and jettison caste-based politics.

In this season of scams, the
Bihar assembly election outcome comes as welcome relief. The massive endorsement
given to Nitish Kumar, who sought a fresh mandate for his record in office and
emphasised a politics of governance over caste and communal paradigms, has
far-reaching implications not just in Bihar but also for the rest of the
country. A better-governed Bihar, one of India’s most populated and
underdeveloped states, will have a positive impact on the social and economic
profile of the country.

The Bihar verdict is
extraordinary for a variety of reasons. The scale of the result itself is
astounding because no political party or coalition has swept assembly elections
in Bihar in this manner in recent times. The success of the Janata Dal (United)-BJP
combine is comprehensive. The wins have come from across the state, and a
three-fourths majority could not have been possible but for support cutting
across caste and communal divides. Clearly, Nitish Kumar’s tenure as chief
minister has been a departure from the chaos under Lalu Prasad and Rabri Devi.

Nitish didn’t radically
transform Bihar, but gave Biharis hope of a better future. The turnaround in the
law and order situation, a prerequisite for state building, was the first step
towards realising that. A beginning was made in building infrastructure in the
state. Roads, bridges and culverts were built which made it possible for people
to travel and made small businesses viable. School education got a fillip with
massive recruitment of teachers, while school-going girls were given uniforms
and bicycles. The rise in enrolment figures and fall in school dropout rates
indicate that these interventions have succeeded. Women have been major
beneficiaries of these interventions and they voted in large numbers, presumably
for Nitish and allies.

The challenge now is to
deliver on the mandate. The current consensus in Bihar is for social peace and
economic development. Hopefully, the opposition in Bihar too will take the cue
from the election results and reorient its politics accordingly.

(Source : Times of
India, dated 25-11-2010)

(Comment : One hopes
that political parties across all colours pay heed to development agenda and
jettison caste-based politics)

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Nirav Shah

What will India do with UNSC membership ?

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31. What will India do with UNSC membership ?

Now that India has been
elected as a non-permanent member of the United Nations Security Council (UNSC),
for a two-year term, the Government and India’s diplomatic and strategic policy
community have to decide what to do with it. There is no doubt that India has
come a long way from the ignominious defeat of 1996, when India lost the UNSC
Asian seat to Japan 40 : 142 votes, winning this time 187 : 5 votes. India’s
economic rise in the past decade and its new strategic relationships with
several major and rising powers have all contributed to this impressive vote in
its favour. However, getting into the Security Council is only the first step.
India’s problem is that on many vital global and regional issues, there is no
genuine national consensus at home. Given the weakness of inherently fractious
and myopic coalition politics, there is always the danger that on vital issues,
the Government may find its hands and feet tied when it comes to taking a
position at the UNSC.

Hence, now that India is a
UNSC member, the Government should pro-actively seek to build a national
consensus on foreign policy issues of vital concern to India. In a democracy,
there will always be some critics of Government. That is both a necessary and
valuable aspect of a democracy. However, within the national mainstream, there
has to be some consensus on important international and regional issues where
India would be required to articulate its views at the UNSC. Apart from building
political consensus on international issues, the Government must also revitalise
and strengthen its foreign policy machinery. India has one of the smallest
foreign offices among major and rising powers. Its institutional capacity and
capability for diplomacy has not kept pace with the challenges of the new
post-Cold War and increasingly multipolar world that India now deals with.
Increasing recruitment at the entry level will not suffice. India needs a
quantum increase in manpower and intellectual capability in its foreign policy
machinery in a short period of time. This can only come from lateral entry of
professionals from other walks of life into diplomatic service. This challenge
will become even more pressing once India takes over the UNSC Asia seat from
Japan.

(Source : The Business
Standard, dated 14-10-2010)

(Comment : We also
need lateral entry of professionals in other areas of policy making !).

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Nirav Shah

Any bona fide measures taken by revenue to prevent circulation of black money, cannot be objected as interference with personal liberty or freedom of a citizen — SC

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Any bona fide measures taken by revenue to
prevent circulation of black money, cannot be objected as interference with
personal liberty or freedom of a citizen — SC

The carrying of a huge sum itself gives rise to a
legitimate suspicion; the intelligence officers of revenue are, therefore,
entitled to satisfy themselves, not only that the money is from a legitimate
source, but also satisfy themselves that such a large amount is being carried
for a legitimate purpose; therefore, even if the carrier is not guilty of any
offence in carrying the money, the verification or seizure may be warranted to
ensure that the money is not intended for commission of a crime or offence.

Rajendran Chingaravelu v. R. K. Mishra, Addl. CIT,
(Civil Appeal No. 7914 of 2009) dated November 24, 2009.

(Source : Internet & Media Reports, dated 14-12-2009)

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Nirav Shah

Foreign investment proposals — via Mauritius

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Foreign investment proposals — via Mauritius

As per recent press reports, the Foreign Investment
Promotion Board (FIPB) has rejected the view of the Tax Authorities to reject
foreign direct investment (FDI) proposals where such investments are proposed
to be made via Mauritius. The FIPB is said to have taken a policy decision not
to overrule such FDI proposals merely because they are proposed to be made
from Mauritius. The Tax Authorities are suspecting that ‘Treaty shopping’ is
being done by foreign investors by using Mauritius jurisdiction for investing
in India.

This question came up before the FIPB while considering a
proposal by a Mauritian holding company which wanted to invest a large sum of
money in a fund in India (India Value Fund). It is reported that rejecting the
‘Treaty shopping’ objection of the Department of Revenue, Ministry of Finance
(Revenue Department), the FIPB has approved this proposal and the proposal
will now be placed for final approval before the Cabinet Committee of Economic
Affairs (CCAE) of the Government of India.

The Revenue Department was having a generic objection to
foreign investment routed through Mauritius, with which India has signed a
DTAA. The concern of the Revenue Department is that Treaty shopping by a
resident of a third country results in loss of tax revenue for the Indian
Government by claiming capital gains tax exemption in India under the DTAA. It
is worth mentioning here that a large portion of FDI in India comes from
Mauritius.

The view of the FIPB is that since India has signed a DTAA
with Mauritius which is in force, the Revenue Department cannot take a generic
objection of ‘Treaty shopping’ for denying the foreign investment proposed via
Mauritius.

[It will be pertinent to note here that the Revenue
Department has issued a clarification dated 13 April 2000 (Circular No. 789)
clarifying that Foreign Institutional Investors (FIIs) and other foreign
investors who hold a valid ‘Tax Residency Certificate’ granted by Mauritius
Tax Authorities, will be regarded as residents of Mauritius and also the
beneficial owners of shares, etc. for granting of capital gains tax exemption
in India as per the India-Mauritius DTAA. The legal validity of this Circular
was later approved by the Supreme Court of India in its landmark ruling in the
case of Union of India v. Azadi Bachao Andolan, (2003) 263 ITR 706.]

(Source : Business Standard, New Delhi, dated
7-11-2009)

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Nirav Shah

Non-residents can work on Indian projects only on employment visa; Business visa norms to be tightened.

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Non-residents can work on Indian projects only on
employment visa; Business visa norms to be tightened.

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

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

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

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

(This information was given by the Minister of State for
Labour and Employment Shri Harish Rawat in a written reply in the Rajya Sabha.)

(Source : Internet & Media Reports, dated 16-12-2009)

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Nirav Shah

Anti-money laundering Act : RBI tightens KYC norms for politically exposed persons

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Anti-money laundering Act : RBI tightens KYC norms for
politically exposed persons

With the Prevention of Money Laundering (Amendment) Act,
2009 (No. 21 of 2009) coming into force from June 1, the RBI has advised all
NBFCs to maintain records of clients for a period of 10 years from the date of
transaction. The NBFCs will have to keep records of the identity of the
clients, both domestic or international, which will permit reconstruction of
individual transactions so as to provide, if necessary, evidence for
prosecution of persons involved in criminal activity.

However, records pertaining to the identification of the
customer and his address (e.g., copies of documents like passports,
identity cards, driving licences, PAN card, utility bills, etc.) obtained
while opening the account and during the course of business relationship would
continue to be preserved for at least 10 years after the business relationship
is ended as required under Rule 10.

RBI has further issued detailed guidelines on Customer Due
Diligence (CDD) measures to be made applicable to Politically Exposed Persons
(PEP) and their family members or close relatives. It is further advised that
in the event of an existing customer or the beneficial owner of an existing
account, subsequently becoming a PEP, NBFCs (including RNBCs) should obtain
senior management approval to continue the business relationship and subject
the account to the CDD measures as applicable to the customers of PEP category
including enhanced monitoring on an ongoing basis.

(Source : Internet & Media Reports, dated 17-11-2009)

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Nirav Shah

Fin panel moots dual rate for GST, end to all sops

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Fin panel moots dual rate for GST, end to all sops

A task force on GST set up by the Thirteenth Finance
Commission has recommended that the tax on all goods and services be dropped
to 5% at the Centre and 7% at the state level, and that all exemptions be
scrapped. It does not, however, recommend a concessional rate for essential
items, as is the norm at present with the central excise and state value-added
tax.

The task force recommendations need not form the basis of
any decision on GST framework made by the Centre and states, both of which are
at an advanced stage of finalising their proposals for a dual GST. However, it
would serve as an input for the Finance Commission to work out the formula for
sharing Centre’s tax revenues with states. The report suggests that states as
well as the Centre completely give up their discretion to effect any changes
to tax rates unilaterally.

The changes will have to be approved by a council of
ministers, which would have the state finance ministers and the Union finance
minister as members. States would see this as an encroachment on their fiscal
autonomy. The council is to be a constitutional body, unlike the empowered
panel of state FMs which is a toothless body.

The panel has recommended that exemptions given to SEZs be
scrapped, and instead all goods and services exports be zero-rated. Only
public services provided by all levels of government, unprocessed food covered
by the PDS, education and health are to be exempt.

Other far-reaching recommendations include bringing real
estate into the ambit of GST. Thirteenth Finance Commission Chairman Vijay
Kelkar had been keen on this, and said as much at various fora. GST on real
estate would benefit homebuyers. Prices would fall as developers would get
credit for taxes paid on all inputs.

The impact of broadbasing the tax and dropping the rate
would be mixed. At one level, tax rates on most items will plummet,
translating into lower prices for buyers. The report suggests the transition
to the ‘flawless GST’ would result in a 1.22-2.53% drop in the prices of most
manufactured goods. Conversely, a host of items that are currently outside the
tax net or enjoy concessional rates — such as agri commodities and services —
may become slightly expensive.

(Source : The Economic Times, dated 16-12-2009)

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Nirav Shah

The CAG report on public sector units is a scandal in numbers.

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The CAG report on public
sector units is a scandal in numbers.

419 number of Central public sector undertakings.

Rs.4,77,191 crore invested in equity and loans in
government companies, corporations and institutions.

284 companies and corporations audited by CAG. Of these
185 earned profits, 70 were in the red and 24 were not operational.

30 number of PSUs that were defunct or under liquidation.

13 number of companies recommended for closure, winding
up.

72 number of companies with a negative net worth.

Rs.94,428 crore accumulated losses of the 72 companies in
2007-08.

(Source : Business India Magazine, dated 8-11-2009)

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Nirav Shah

No entry for foreign law firms : Bombay High Court

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No entry for foreign law
firms : Bombay High Court

Foreign law firms have finally got a firm no-entry sign for
India. Almost 15 years after the RBI permitted three foreign law firms to set
up shop in India, the Bombay High Court said the decision of the bank was
unjustified under the existing laws that governed advocates and their practice
in the country.

Putting a full stop on the ‘can-they-can’t-they’ arguments
over entry of foreign law firms into India even for practice on only
non-litigious matters, the HC Bench headed by the Chief Justice held that
foreign law firms were barred from practising in the country under the
existing Advocates Act of 1961 and the various bar councils under it.

The HC disposed of a public interest litigation filed by
Lawyers’ Collective way back in 1995 against the permission given by the RBI
to the three foreign law firms. In 1995, the HC had stayed the bank’s
decision, but then the matter lay in cold storage for years before a lengthy
and heated hearing on the issue took place in Court for and against the
proposition. The Government said that practice by lawyers under the law meant
only litigious practice in Court, but dismissing that argument, the HC held
that, “It would mean that advocates debarred for professional misconduct would
then merrily carry on with practice in litigious matters.’’

“When efforts are being made to see that the legal
profession stands tall in the fast-changing world, it would be improper to
hold that the 1961 Advocates Act and the bar councils have limited role to
play in the field relating to practice of law,’’ the Court held.

But on the issues of reciprocity and other rules to enable
practice by foreign law firms in India, the HC directed the Central Government
which has been dealing with the issue for the last 15 years, to take an
appropriate decision ‘expeditiously’. The Centre was all for paving the way
for foreign law firms, but the Bar Council of India (BCI) was against letting
them in.

Till the Government decides to come out with a new law or
amend the existing laws, the HC said that persons practising the legal
profession whether in litigation or non-litigation work will be governed by
the Advocates Act, the Bar Council of India and the various state bar councils
as well as Courts to take action for professional misconduct.

Non-litigious practice of law in India is not unregulated
said the HC, quashing an argument made by the pro-foreign law firms’ lobby
that the law in India only covered practice in Court.

(Source : The Times of India, dated 17-12-2009)

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Nirav Shah

Fill vacant OBC quota seats with general category candidates : SC

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34 Fill vacant OBC quota seats with general category
candidates : SC

The Supreme Court today declared that the seats re-served
for ‘other backward classes’ (OBC) in Central educational institutions that
remain unfilled can’t be carried over to the next year and would have to be
filled in the same year from the general category.

The Court also ruled that the relaxation of marks for the OBC
category should not be more than 10% of those fixed for the general category.

These orders will come into effect this year itself.

The Constitution Bench headed by Chief Justice K. G.
Balakrishnan passed the orders while hearing an application seeking
clarifications in a recent judgment on the OBC quota in Central educational
institutions, especially the ones like the IITs and IIMs. In that judgment, a
few Judges had made certain observations on the limit for relaxation of rules
for the OBC candidates. Today’s order puts to rest doubts over the issue in
Government circles, educational institutions’ managements and students.

Moving the application, senior counsel K. K. Venugopal raised
another controversial issue, namely, the economic criterion for identifying the
OBC community. He referred to a reported decision of the Union Cabinet to make
every family with income up to Rs.4.5 lakh eligible for the reservation.

The counsel said that this was contempt of Court as it was
intended to circumvent the ‘creamy layer’ rule. He recalled the declaration of
the Kerala Government some time ago that there was no ‘creamy layer’ to be kept
out of the benefit in that State. The Supreme Court had struck down the
Notification.

The Judges told the counsel that this was a separate issue
and if a petition was moved regarding this, they would consider it. Venugopal
said he would move a petition challenging the Cabinet decision.

(Source : Business Standard, dated 15-10-2008)

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Nirav Shah

A reader’s feedback in Outlook Business dated 18-10-2008

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33 A reader’s feedback in Outlook Business dated 18-10-2008

“Your story says that India Inc is suffering unfairly because
of imbroglios such as Singur. But, remember villagers who have no other means to
make a living are affected by such uncontrolled indus-trialisation. Progress
should be equitable, with no one left behind.”

— Anirbhan Dasgupta, Kolkata

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Nirav Shah

Greenspan admits to ‘flaw’ in his

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31 Greenspan admits to ‘flaw’ in his market ideology

Former Federal Reserve Chairman Alan Greenspan said a
“once-in-a-century credit tsunami” has engulfed financial markets and conceded
that his free-market ideology shunning regulation was flawed.

“Yes, I found a flaw,” Greenspan said in response to a
grilling from the House Committee on Oversight and Government Reform. “That is
precisely the reason I was shocked because I’d been going for 40 years or more
with very considerable evidence that it was working exceptionally well.”

Greenspan said he was “partially” wrong in opposing
regulation of derivatives and acknowledged that financial institutions didn’t
protect shareholders and investments as well as he expected. Forecasting is an
inexact science, he said.

In May 2005 speech, Greenspan said that “private regulation
generally has proved far better at constraining excessive risk-taking than has
government regulation.”

Committee Chairman Henry Waxman, a California Democrat, said
Greenspan had “the authority to prevent irresponsible lending practices that led
to the sub-prime mortgage crisis.”

“You were advised to do so by many others,” he told
Greenspan. “And now our whole economy is paying the price.”

Greenspan opposed increasing financial supervision as Fed
Chairman from August 1987 to January 2006. Policy makers are now struggling to
contain a financial crisis marked by record foreclosures, falling asset prices
and almost $ 660 billion in writedowns and losses tied to US sub-prime
mortgages.

(Source : Business Standard, dated 24-10-2008)

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Nirav Shah

US Court verdict on software process patent stirs debate

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29 US Court verdict on software process patent stirs debate

A US Federal Court judgment disallowing business method (or
process) patenting, may have a direct impact on the ongoing debate over
amendments to the Indian patents manual. The US judgment could help in
interpreting whether business processes or software written in India can be
patented or not.

While large IT players like Microsoft, IBM have given a
thumbs up to the Bilski judgment, Indian companies like Infosys had been
lobbying for patents on software systems and methods. A US Federal Court for
appeals in Washington ruled against Bernard Bilski, who wanted to patent a
method for managing weather-related risk through commodities trading. The Court
said that business methods (like Amazon.com Inc’s one-click to buy goods on the
Internet, which was quashed later) cannot be patented.

Sun Microsystems’s director, Jaijit Bhattacharya said that it
was a positive move towards an appropriate interpretation of innovation and
patentability of software. “It would allow a more open regime and would help in
wider access to computing technologies,” he said.

Companies like IBM, Microsoft lobbied against business method
patenting. But companies like Accenture, Royal Philips Electronics NV, Bain
Capital LC were asking for more protection for business method patenting.

However, the ruling does not significantly impact large
Indian IT services companies, as none are majorly into product development and
patenting, at least at present. India’s largest IT services company TCS said
that it’s reviewing its stand on software patenting in the light of the current
judgment.

“The ideas and frameworks for business processes should not
be patentable but the content written within those frameworks should be allowed
to be copyrighted. Indian law is also within boundaries of the US Court
judgment,” said Nasscom President Som Mittal. There are few world famous Indian
IT products — like Flexcube and Finacle. But the judgment may affect smaller
companies which want to innovate, but were earlier being strangled by large
corporations on account of patenting of a process.
The judgment may also be used in the larger debate on software patenting in the
country. Venkatesh Hariharan, founding member of Knowledge Commons, an NGO,
said : “Business method patents are seven times more likely to be litigated as
compared to other patents, because it’s difficult to determine the boundaries of
abstract patents categories like business method and software patents. Indian
law is against software patents, but in practice, several software and business
method patents have been granted and these will need to be weeded out to prevent
future litigation. Overall, this is a good decision because it will reduce the
risk of litigation that hangs over users and developers of software.” Knowledge
Commons is lobbying for ‘no patents on software in India’ if it (the software)
is not tied to a specific hardware.

According to S. 3(k) of the Indian Patent Act : “A
mathematical or business method or a computer programme per se or
algorithms are not patentable.” But software in conjunction with hardware is
patentable in accordance with Indian law, which is giving rise to ambiguity. The
Bilski judgment may however be used as a reference for drafting the amendments
to the Indian Patents Manual and will also help in interpretation of the Indian
Patent Act. While rulings over the years have used different methods to
determine if a process is patentable, the Federal Court ruling said the sole
analysis should be the ‘machine-or-transformation’ test — which requires showing
that the claimed invention is either tied to a particular machine or that it
transforms an ‘article’ (such as a substance or data).

(Source : The Economic Times, dated 1-11-2008)

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Nirav Shah

Declare war on terror

New Page 4

30 Declare war on terror

We, the people of India,

Declare war on terror today.

We face the gravest threat as a nation.

We pledge to

Fight against those who kill the innocent

Support measures that insure our safety

Expose corruption and incompetence that endanger

our security

Defeat the enemy by having zero tolerance of terror

Eliminate the forces which propagate hate

Be united in our resolve

Till victory is ours

(Source : India Today, dated 15-12-2008)

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Nirav Shah

Freedom from economics — Olympics in numbers

New Page 4

28 Freedom from economics — Olympics in numbers

91,000 :

The number of seats available in the Bird’s Nest.

50 :

In minutes, the time it took to send all the athletes present
back to the Olympic Village after the ceremony.

10,000 :

The number of raincoats prepared for the athletes in case of
rain.

22,000 :

The number of performers and advisors for the ceremony.

314,224 :

Couples tied the knot across China on 8-8-2008, a one-day
record for marriages since 1949, when the People’s Republic of China was
founded. In Beijing alone, the host city of the Olympics, 15,646 couples were
married, 23 times the daily average.

75 :

In minutes, the time it took for the audience to leave after
the ceremony, which was 15 minutes less than expected.

(Source : The Economic Times, 11-8-2008)

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Nirav Shah

Is India poor, who says ? Ask Swiss banks

New Page 4

26 Is India poor, who says ? Ask Swiss banks

With personal account deposit bank of $ 1500 billion in
foreign reserve which have been misappropriated, an amount 13 times larger than
the country’s foreign debt, one needs to rethink if India is a poor country ?

Dishonest industrialists, scandalous politicians and corrupt
IAS, IRS, IPS officers have deposited in foreign banks in their illegal personal
accounts a sum of about $ 1500 billion, which have been misappropriated by them.
This amount is about 13 times larger than the country’s foreign debt. With this
amount 45 crore poor people can get Rs.1,00,000 each. This huge amount has been
appropriated from the people of India by exploiting and betraying them.

Once this huge amount of black money and property comes back
to India , the entire foreign debt can be repaid in 24 hours. After paying the
entire foreign debt, we will have surplus amount, almost 12 times larger than
the foreign debt. If this surplus amount is invested in earning interest, the
amount of interest will be more than the annual budget of the Central
Government. So even if all the taxes are abolished, then also the Central
Government will be able to maintain the country very comfortably.

Some 80,000 people travel to Switzerland every year, of whom
25,000 travel very frequently. “Obviously, these people won’t be tourists. They
must be travelling there for some other reason,” believes an official involved
in tracking illegal money. And, clearly, he isn’t referring to the Commerce
Ministry bureaucrats who’ve been flitting in and out of Geneva ever since the
World Trade Organisation (WTO) negotiations went into a tailspin !

Just read the following details and note how these dishonest
industrialists, scandalous politicians, corrupt officers, cricketers, film
actors, illegal sex trade and protected wildlife operators, to name just a few,
sucked this country’s wealth and prosperity. This may be the picture of deposits
in Swiss banks only. What about other international banks ?

Black money in Swiss banks — Swiss Banking Association
report, 2006 details bank deposits in the territory of Switzerland by nationals
of the following countries : Top five

India … … … $ 1,456 billion

Russia … … … $ 470 billion

UK … … … $ 390 billion

Ukraine … … … $ 100 billion

China … … … $ 96 billion

Now do the maths — India with $ 1456 billion or $ 1.4
trillion has more money in Swiss banks than rest of the world combined. Public
loot since 1947 : Can we bring back our money ? It is one of the biggest loots
witnessed by mankind — the loot of the Aam Aadmi (common man) since 1947,
by his brethren occupying public office. It has been orchestrated by
politicians, bureaucrats and some businessmen.

The list is almost all-encompassing. No wonder, everyone in
India loots with impunity and without any fear. What is even more depressing is
that this ill-gotten wealth of ours has been stashed away abroad into secret
bank accounts located in some of the world’s best known tax havens. And to that
extent the Indian economy has been stripped of its wealth. Ordinary Indians may
not be exactly aware of how such secret accounts operate and what are the rules
and regulations that go on to govern such tax havens. However, one may well be
aware of ‘Swiss bank accounts,’ the shorthand for murky dealings, secrecy and of
course pilferage from developing countries into rich developed ones.

In March 2005, the Tax Justice Network (TJN) published a
research finding demonstrating that $ 11.5 trillion of personal wealth was held
offshore by rich individuals across the globe. The findings estimated that a
large proportion of this wealth was managed from some 70 tax havens.

Further, augmenting these studies of TJN, Raymond Baker — in
his widely celebrated book titled ‘Capitalism’s Achilles Heel : Dirty Money and
How to Renew the Free Market System’ — estimates that at least $ 5 trillion have
been shifted out of poorer countries to the West since the mid-1970.

It is further estimated by experts that one per cent of the
world’s population holds more than 57% of total global wealth, routing it
invariably through these tax havens. How much of this is from India is anybody’s
guess.

What is to be noted here is that most of the wealth of
Indians parked in these tax havens is illegitimate money acquired through
corrupt means. Naturally, the secrecy associated with the bank accounts in such
places is central to the issue, not their low tax rates as the term ‘tax havens’
suggests. Remember Bofors and how India could not trace the ultimate beneficiary
of those transactions because of the secrecy associated with these bank
accounts ?

(Source : Internet, 8-9-2008)

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Nirav Shah

Judicial interpretation of the term ‘Input Service’

1. Background :

Since the introduction of tax on services in 1994 and till the prescription of CENVAT Credit Rules, 2004 — (CCR), service tax on various key services like telephone, insurance, consulting engineers, advertising, manpower recruitment, management consultancy, audit, etc. meant a cost addition initially of 5% and from 2003 of 8% for the entire manufacturing — industrial sector. As a measure of integrating tax on goods and services, extension of intersectoral credit was introduced by prescribing CENVAT Credit Rules, 2004 to come into effect on 10th September, 2004 both under the Central Excise Act, as well as under the service tax law which is part of the Finance Act, 1994. Under the premise that credit would be available of service tax paid on input services, the rate of service tax was simultaneously increased from 8% to 10%.

A Press Note dated August 12, 2004, [Reported at 2004 (17) ELT-T19] highlighted salient features of the proposed CENVAT Credit Rules. The relevant paras (iii) and (iv) are reproduced below :

(iii) In principle, credit of tax on those taxable services would be allowed that go to form a part of the assessable value on which excise duty is charged. This would include certain services which are received prior to commencement of manufacture but the value of which gets absorbed in the value of goods. As regards services received after the clearance of the goods from the factory, the credit would be extended on services received up to the stage of place of removal (as per S. 4 of Central Excise Act). In addition to this, services like advertising, market research, etc. which are not directly related to manufacture but are related to the sale of manufactured goods would also be permitted for credit.

(iv) Full credit of service tax on services (such as telephone, security, construction, advertising service, market research, etc.) which are received in relation to the offices pertaining to a manufacturer or service provider would also be allowed.

2. During the past five years of introduction of CENVAT Credit of service tax on input services, innumerable litigations across the country took place at all levels involving both interpretational as well as procedural issues. However, the most significant among them revolved around interpretation of the definition of ‘input service’ and more so in relation to the manufacturing activity. Consequent upon divergent views and conflicting opinions of various Benches of CESTAT, at least in two important cases the matter was referred to Larger Benches. The decision in both viz. CCE, Mumbai-V v. GTC Industries Ltd., 2008 (12) STR 468 (Tri. – LB) and ABB Ltd. v. Commissioner of C. EX. & S.T., Bangalore 2009 (15) STR 23 (Tri. – LB) — (provided in BCAJ in Part-B under Service Tax feature in December 2008 and July 2009 issues, respectively) analysed the term ‘input service’ to reach the conclusion. Soon thereafter, independently i.e., without considering any of the above decisions, the Bombay High Court in the case of Coca Cola India Pvt. Ltd. v. CCE-Pune-III, 2009 (15) STR 657 (Bom.) examined and made in-depth analysis of ‘input service’.

3. What is ‘input service’ :

The term ‘input service’ in Rule 2(1) in CCR is defined as follows :

‘Input service’ means any service, —

(i) used by a provider of taxable service for providing an output service; or

(ii) used by the manufacturer, whether directly or indirectly, in or in relation to the manufacture of final products and clearance of final products up to the place of removal, and includes services used in relation to setting up, modernisation, renovation or repairs of a factory, premises of provider of output service or an office relating to such factory or premises, advertisement or sales promotion, market research, storage up to the place of removal, procurement of inputs, activities relating to business, such as accounting, auditing, financing, recruitment and quality control, coaching and training, computer networking, credit rating, share registry, and security, inward transportation of inputs or capital goods and outward transportation up to the place of removal.” (emphasis supplied)

4. In the case of GTC Industries Ltd. (supra), the Larger Bench of CESTAT, Mumbai examined the above definition in a fairly detailed manner. The definition was analysed in the context of services of outdoor caterer used by the manufacturer in the canteen for workers. Both the appellant and the respondent agreed in principle that the said service of outdoor caterer was to be considered as one relating to business and therefore, would fall under the inclusive part of the definition and not the main definition. Therefore, the analysis of the definition was focussed with special and specific reference to the word ‘includes’ and the term ‘activities relating to business’ used in the definition. The appellant in this case contended that the term ‘includes’ enhances the scope of the definition and therefore it cannot take a restrictive approach. In this regard, inter alia the extract from the Apex Court’s decision in the case of Regional Director v. Highland Coffee Works, 1991 (3) SCC 617 was cited as follows :

“The word ‘include’ in the statutory definition is generally used to enlarge the meaning of the preceding words and it is by way of extension, and not with restriction. The word ‘include’ is very generally used in interpretation clauses in order to enlarge the meaning of words or phrases occurring in the body of the statute; and when it is so used, these words or phrases must be construed as comprehending, not only such things as they signify according to their natural import but also those things which the interpretation clause declares that they shall include. [See (i) Stroud’s Judicial Dictionary, 5th edn. Vol. 3, p. 1263 and (ii) CIT v. Taj Mahal Hotel 1, (iii) State of Bombay v. Hospital Mazdoor Sabha]”

It was further contended that the term ‘such as’ used in the definition was an adjective indicative of the draftsman’s intention that he is assigning the same meaning or characteristic to the noun as has been previously indicated, but it does not prohibit any other activity which can define noun in a similar way and therefore, the expression only connotes that whatever activities are given are only illustrations that relate to the business. Therefore, any activity relating to business of the assessee would be covered as an input service. Further, stress was laid for this interpretation by stating that the words ‘such as’ used after the expression ‘activity relating to business’ in the inclusive part of the definition further supported the contention that the activities mentioned therein were illustrative and not exhaustive and it could not limit the scope of the definition of the input service once the term was used after the usage of the word ‘includes’ in the said definition. In this context, the reference was also made to the extract of the Press Note of the Draft Rules made at point 1 above. By facilitating comparison between the Draft Credit Rules and the CCR, the scope and application of the term ‘activities relating to business’ was construed wide enough to cover various aspects of the activities relating to business. The submissions of the Revenue with the aid of several Supreme Court decisions however revolved around contending that the list in the inclusive part of the definition is exhaustive. The Larger Bench however concluded with the following remark :

“We find that it is well settled that every clause of the statute should be construed with reference to the context in which it is issued. A bare mechanical interpretation of words and application of legislative intent is devoid of concept and purpose will reduce most of the remedial and beneficial legislations to futility. To be literal in meaning is to see the skin and miss the soul.” . . . . “The context in which and the purpose for which the Credit Rules have been issued are clear from the Press Note dated August 12, 2004 issued by the Ministry of Finance, prior to introduction of the Credit Rules wherein the draft rules were circulated for inviting comments from trade and industries. This Note clearly states that “in principle, credit of tax on those taxable services would be allowed that go to form a part of the assessable value on which excise duty is charged.”

5. Little different dimension and perspective was provided by the Larger Bench in the case of ABB Ltd. v. CCE & ST, Bangalore (supra). While examining allowability of CENVAT credit service tax paid on outward transportation service for movement of final products from the place of removal till the customer’s place, it was observed that the definition of input service could be conveniently divided into the following five categories vis-à-vis the manufacturers :

Any service used by the manufacturer, whether directly or indirectly, in or in relation to the final products.

Any service used by the manufacturer, whether directly or indirectly, in or in relation to clearance of final products from the place of removal.

Services used in relation to setting up, modernisation, renovation or repairs of a factory, or an office relating to such factory.

Services used in relation to advertisement or sales promotion, market research, storage up to the place of removal, procurement of inputs.

Services used in relation to activities relating to business and outward transportation up to the place of removal.

On making the above division, the Larger Bench observed that each of the above was an independent benefit or concession and even if one was satisfied, the credit on input service would be admissible.

In this case also, the expression ‘activities relating to business’ was analysed in depth by examining the expression ‘in relation to’ as analysed in the case of Doypack Systems (P) Ltd. v. UOI, (1988) (36) ELT 201 (SC) and also examining the qualification ‘activities’ and the expression ‘such as’.

In the case of ABB Ltd. (supra), the Bench relying on and discussing the decisions of Kerala State Co-op-erative Marketing Federation Ltd. & Ors. v. CIT, (1998) 5 SCC 48, Share Medical Care v. UOI, 2007 (209) ELT 321 (SC) and HCL Ltd. v. Collector, 2001 (130) ELT 405 (SC) held that when the general expression ‘activities relating to business’ covered transportation up to the customer’s place, credit could not be denied by relying on specific coverage of outward transportation up to the place of removal in the inclusive clause. According to the Bench, the principle laid down in various Supreme Court cases that a specific provision will override a general one did not apply to exemptions. On the basis of this contention, the Bench held that the Revenue’s view was incorrect to contend that “since outward transportation was specifically mentioned in the inclusive clause of the definition, credit for outward transportation could not be allowed with reference to other general limb of the definition. Also, in this decision, there was a categorical observation by the Larger Bench as to the wide import of the word ‘business’ as held in the case of Mazagaon Dock Ltd. v. CIT, (AIR 1958 SC 861). The Tribunal reached the conclusion by stating that the use of the expression ‘outward transportation’ in the inclusive clause was by way of abundant caution so as to avoid any dispute being raised on the ‘means’ clause (which refers to clearance from place of removal).

According to the Larger Bench in ABB Ltd.’s case (supra), as opposed to the decision in the case of GTC (supra) discussed above, there was no requirement in law that the cost of freight should have entered transaction value to qualify for admissibility of credit or stated in other words non-inclusion of a particular cost in the transaction value by itself is not a limiting factor for admissibility of credit as the issue did not relate to valuation of excisable goods and the issues of ‘valuation’ and CENVAT credit were independent of each other.

(Note : Karnataka High Court has stayed the operation of decision in the above ABB Ltd.’s case.)

It is to be noted here that the Punjab and Haryana High Court, a few months earlier, also reached a similar decision in the case of Ambuja Cement Ltd. v. UOI, 2009 (14) STR 3 (P & H) that outward transportation up to the place of removal was an input service. However, the premise under which this was held was somewhat different. In this case, reliance was placed on the Board’s Circular No. 97/6/2007-ST of 23/08/2007 and the principle that the Revenue was precluded from challenging the correctness of the Circular which provided that when the ownership of the goods remained with the seller of the goods till its delivery, the seller bore the risk of change during transit to destination and when the freight formed part of the price of goods, the credit was admissible. Further, a subtle mention was also made to the definition of ‘input service’ that the definition inter alia includes outward transportation up to the place of removal and since in the instant case, ownership of goods remained with the seller till the doorstep of the buyer, insurance was borne by the seller and also that freight formed part of the value of goods, the conditions of the Circular were satisfied and therefore, the credit was admissible. To sum up, this case did not discuss or analyse the definition of input service to reach the conclusion.

However, the decision of the Bombay High Court in the case of Coca Cola India Pvt. Ltd. v. CCE, 2009 (15) STR 657 (Bom.) — 22 STT 130 (Bom.) (discussed in BCAJ October 2009 issue) interpreted the definition ‘input service’ at great length discussing the terms used in the definition ‘means’, ‘includes’, ‘such as’, ‘business’ while examining whether or not advertising service used by a concentrate manufacturer was an admissible credit when the soft drinks were bottled and removed for sale by a group company and the advertisement related to the final product as bottled and sold by the latter.

In the case of Coca Cola India (supra) while interpreting the definition, relying on the decisions in cases like Regional Director v. Highland Coffee Works, 1991 (3) SCC 617 (reiterated in CIT v. TTK Health Care Ltd., 2007 (11) SCC 796), M/s. Mahalakshmi Oil Mills v. State of Andhra Pradesh, AR 1989 Supreme Court 335 and Bharat Co-operative Bank (Mumbai) Ltd. v. Co-op. Bank Employees Union, (2007) 4 SCC 685, it was held that the expression ‘means and includes’ is exhaustive. By the word ‘includes’ the services which otherwise may not have come within the ambit get included and by the word ‘means’, they are made exhaustive.

After reaching this conclusion, the High Court considered and analysed the meanings of the term ‘such as’ relying on Good Year India Ltd. v. Collector, 1997 (95) ELT 450 and concluded that the words ‘such as’ are illustrative and not exhaustive.

Next, it was held that the expression ‘business’ meant a continuous activity, which is not confined to a mere manufacture of the product. Therefore, activities in relation to business could cover all the activities related to the functions of business. Relying on State of Karnataka v. Shreyas Paper Pvt. Ltd., 2006 SCC and Mazagaon Dock (supra), [(also relied on by the Larger Bench in ABB Ltd., (supra),] it was held that the ‘business’ in particular in fiscal statutes is of wide import.

Thereafter in paras 26 to 30, the phrase ‘activity relating to business’ was analysed citing extracts from Supreme Court cases viz. Doypack Systems Limited v. UOI, 1988 (36) ELT 261 (SC), CIT v. Chandulal Keshavlal & Co., (1961 38 ITR 61 (SC), Eastern Investments Ltd. v. CIT, 1951 (20) ITR 1 and Allahabad High Court’s decision in Additional Commissioner of Income Tax v. Symonds Distributors (P) Ltd., (1977) 108 ITR 947 (All) to conclude that the scope of the said phrase widens the scope of the definition. Among the quotes used in the decision, the following extract from the speech of Lord Hope of Craighead in the context of credit under VAT in Customs and Excise Commissioners v. Redrow Group Plc, (1999 Simon Tax cases 161) is both apt and interesting to note :

“The word services is given such a wide meaning for the purposes of value added tax that it is capable of embracing everything which a taxable person does in the course or furtherance of a business carried on by him which is done for a consideration. The name or description, which one might apply to the service, is immaterial, because the concept does not call for that kind of analysis. The service is that which is done in return for the consideration. As one moves down the chain of supply, each taxable person receives a service when another taxable person does something for him in the course of furtherance of a business carried on by that other person for which he takes a consideration in return. Questions such as who benefits from the service or who is the consumer of it are not helpful. The answers are likely to differ according to the interest, which various people may have in the transaction. The matter has to be looked at from the standpoint of the person who is claiming the deduction by way of input tax. Was something being done for him for which, in the course or furtherance of a business carried on by him, he has had to pay a consideration which has attracted value added tax ? The fact that some-one else, in this case the prospective purchaser, also received a service as part of the same transaction does not deprive the person who instructed the service and who has had to pay for it for the benefit of the deduction.” (emphasis supplied)

Like in the case of ABB Ltd., (supra), in the case of Coca Cola India (supra) as well, it was discussed that the definition of ‘input service’ could be effectively divided into five categories vis-à-vis a manufacturer (not reproduced here as it is along the same lines as provided above at para 5).

7. It is further noteworthy at this point that in all the three cases viz. GTC Industries Ltd. (supra), ABB Ltd. (supra) and Coca Cola India (supra), the definition of ‘input service’ as a whole was examined with reference to Draft CENVAT Credit Rules, 2004, Ministry’s Press Note on the subject matter and considering the underlying factor that service tax is a value added tax and therefore the ultimate burden of service tax must be borne by the ultimate consumer and not the intermediary i.e., the manufacturer or the service provider.

8. With the above important decisions in place, the readers may be shocked to note that in a very recent decision given by the Single Member Bench of the Mumbai CESTAT in the case of CCE, Nagpur v. Manikgarh Cement Works, 2009 TIOL 2059 CESTAT-Mum. wherein primarily the Tribunal examined the allowability of credit on service tax paid on construction service, repairs and maintenance service, manpower recruitment service, etc. used for residential colony outside the assessee’s factory and relying on the Supreme Court’s decision in the case of Maruti Suzuki Ltd. v. CCE, Delhi 2009 (240) ELT 641 (SC) (this decision related to examination of the term ‘input’ vis-à-vis use of fuel in the electricity generation, the excess of which was sold to power grid), held as follows :

“Where an inclusive part of a definition provides a list of items, any such item should also satisfy the quint-essential ingredients of the main part of the definition. In other words, the definition has to be considered in its entirety. The inclusive part is not independent of the main part. It is not a stand-alone provision. This ruling in the case of Maruti Suzuki Ltd. (supra) is applicable to ‘input services’ given the definition of this expression under Rule 2(1) of the CENVAT Credit Rules. There is nothing in this definition to indicate that the legislative intent behind it is different from the one underlying the definition of ‘input’.

Accordingly, I hold that any service which is apparently covered by the parameters of the inclusive part of the definition of ‘input service’ should also satisfy the quintessential requirements of the main part of the definition and, accordingly, any person claiming the benefit of CENVAT credit on input service in terms of the inclusive part of the definition of ‘input service’ should establish that such service was used, directly or indirectly, in or in relation to the manufacture of the final products or the clearance of such products from his factory.”

The Tribunal went on to further hold that the Supreme Court’s ruling in Maruti Suzuki Ltd. (supra) case implicitly overruled the High Court’s decision in Coca Cola India Pvt. Ltd. (supra) and is constitutionally binding on the Tribunal. As a matter of fact, in the earlier case of the same assessee, the Coordinate Bench of the Tribunal had held that CENVAT credit was admissible [refer to 2008 (9) STR 554 (Tri.-Mum.)] (the decision is presently under challenge by the Revenue before the High Court).

Conclusion :

From the above, it can be observed that in spite of the two Larger Benches of the Tribunal and a High Court doing in-depth analysis of the term ‘input service’, the era of dispute sees no end, given the fact that the issue involved in the decision in the case of ABB Ltd would be examined a fresh by Karnataka High Court. Much remains to be examined yet as to the allowability of credit on service tax paid on various services used for providing output services in spite of the fact that various Tribunals have examined this aspect and rendered decisions using pragmatism. One such instance is the case of Deloitte Tax Service India Pvt. Ltd. v. CCE, Hyderabad-IV, 2008 (11) STR 266 (Tri.-Bang). Nevertheless, seeing conflicting stands followed by various Benches of the Tribunals, both manufacturing and service sector would like to see the issue settled, given the fact that service tax is a value added tax and that interpretation of the term is done with the underlying consideration that intersectoral credit was facilitated with a view to reducing cascading effect of the taxes.

Nirav Shah

Delay in granting refund for the Asst. Year 2007-08

Representation

11th December 2008

Hon. Shri Hardayal Singh

Ombudsman

Mumbai

Dear Sir,

Subject : Delay in granting refund for the Asst. Year
2007-08

The Returns of Income for the above Assessment Year have been
furnished by the assessees by 31-7-2007 and 31-10-2007 as per the applicable due
dates of furnishing Returns of Income under S. 139(1) in their cases. As per the
Government policy, such Returns of Income should be processed u/s.143(1) and the
refund, if any, due to the assessees should be granted within a period of four
to six months.

We understand that the task of processing such returns and
granting refund for the above Assessment Year has got delayed for one reason or
the other. In fact, this factual position is borne out in Instruction No. 12 of
2008, dated 5-9-2008. We understand from our members that even till date large
number of cases involving refunds have remained pending for processing, with the
result that the assessees have still not received their refunds for the
Assessment Year 2007-08.

In the present circumstances of global economic slowdown and
liquidity crisis, the assessees would have expected at least to receive their
refunds, so that their hardships in the business get mitigated to that extent.
Therefore, it is utmost necessary that such refunds should be cleared at the
earliest, which will also provide some liquidity to the assessees in these days
of crisis.

In view of the above, we have to request your honour to
kindly use your good offices and take-up the matter with the CBDT for resolving
the issue of granting refunds, so that there is no further delay in receipt of
such refunds.

Thanking you,

Yours faithfully

Anil Sathe	Kishor Karia	Mahendra Sanghvi	Pradip Shah
President	Chairman,	President	Chairman,
(BCAS)	Taxation Committee (BCAS)	(CTC)	Law & Representation Committee (CTC)

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Nirav Shah

Representation on FDI in Limited Liabilities Partnership

Representation

BCAS/MBN/38
4th November, 2010

To,

The Concerned Officer,

Foreign Investment Promotion Board (FIPB),

Department of Economic Affairs,

Ministry of Finance,

Government of India,

North Block, New Delhi-110001.

Sir,

Subject :
Submission of Representation on Limited Liabilities Partnership

We are pleased to submit our
considered representation on the aspects of Foreign Direct Investments into
Limited Liability Partnerships.

We hope that the same would be
useful and would find your favour.

Please feel free to contact us
for any further clarification or explanation in the matter.

We shall be pleased to assist
you in involving a pragmatic policy on Foreign Direct Investment in Limited
Liability Partnerships.

Thanking you,

Yours
faithfully,

Mayur B. Nayak

President

Bombay Chartered Accountants’
Society

Views and suggestions in respect
of Discussion Paper on Foreign Direct Investment in Limited Liability
Partnerships

Preface :

One of the major factor in
favour of LLP structure in the Indian context for foreign entities is the lack
of any easy exit route under the provisions of the Companies Act, 1956 in the
event of the joint venture not working out to the expectation of the parties.

On the basis of our interactions
with a number of foreign entities, we are of the view that LLPs as a structure
has a great potential to facilitate FDI and foreign joint ventures in India in a
number of areas.

Accordingly, our view is that we
should approach the question of permitting FDI in LLPs with positive frame of
mind albeit with adequate safeguards to take care of concerns and issues
highlighted in the discussion paper arising out of peculiarity of this form of
business entity.

Our views & suggestions in
respect of issues for consideration given in para 6.00 of the Discussion Paper :

(a) Should FDI be permitted in LLP at all ? Can it be argued that given its limited attractiveness for large investments, allowing FDI in LLP will not significantly accelerate FDI into the country while disproportionately increasing the regulatory burden ? Does the present uncertainty on how this business model will proceed as well its yet un-established case law, magnify these concerns?
(i) LLP is internationally a very often used business structure due to its lower cost, greater flexibility in operations, better control over management, limited liability and easy exit route.

In view of recessionary conditions in major economies of the world other than India & China, India is being looked upon as a very important investment destination. Accordingly, it is strongly suggested that FDI should be permitted in LLPs (a structure familiar to major investors outside India) as it would be a great facilitator of bringing in FDI in India.

(ii) In our considered view, the regulatory concerns expressed in the discussion paper are not insurmountable. With incorporation of adequate safeguards in the FDI policy relating to LLPs, permitting FDI in LLPs would not disproportionately increase the regulatory burden. The regulatory concerns could be addressed with minimal and well considered modifications in the existing regulatory provisions.

(a)

(b)
(iii) The LLP Act, 2008 is similar to the UK & Singapore LLP statutes which are successfully in operation for more than a decade. In addition, the provisions of LLP Act, 2008 which have been framed after considerable thought and debate by an expert committee, take care of the various concerns expressed in the discussion paper.

(a)

(b)

(c)

(iv) Therefore, in our view, there is strong basis to assume that with adequate safeguards built into the FDI policy the LLP business model would successfully proceed to achieve its desired objectives.

(v) The LLP form of business structure is extremely popular, time tested and oft-used structure in various developed countries of the world. Concerns about the absence of judicial precedents are, thus, unfounded.

(b) What should be the definition of ‘person resident in India’ ? The definition provided in the LLP Act or the definition provided in FEMA ?

(i) The definition of ‘person resident in India’ in the FDI policy is important from the point of view of control of the LLPs. Since we are concerned with FDI in LLPs, it is felt that the definition of ‘person resident in India’ provided in the LLP Act would be more relevant.

(ii) Furthermore, the definition of ‘person resident in India’ given in the LLP Act does not contain the exceptions given in S. 2(v)(B) of the Foreign Exchange Management Act, 1999 (FEMA) whereby a person who comes to and stays in India, in either case for carrying on in India a business or vocation in India, is considered to be a person in resident in India, irrespective of his no. of days stay in India in the previous year. As per the definition in the LLP Act, a person who comes to India for doing business in India or for taking up employment in India would not immediately become a person resident in India. From a ‘Control’ perspective, the LLP would still need a person resident in India to be one of the ‘designated partners’ until the non-resident becomes a person resident in India as per the definition given in the LLP Act.

(c) Given the complexity of some of the issues raised in S. 5, would it be preferable to adopt a calibrated approach to the induction of FDI in LLPs? Initially, should FDI in LLP be restricted to sectors without caps, conditionalities or entry route restrictions? Should FDI be allowed up to 100% in these sectors or should there necessarily be an Indian partner? Should such approval be confined to the Government Route?

(i) In our view, with incorporation of adequate regulatory safeguards [refer our comments on (g) below], majority of the issues raised in S. 5 of the discussion paper can be properly addressed. Thus, there may not be a need to have a calibrated approach to the induction of FDI in LLPs. However, in order to gain the implementation experience and problems faced in the process of implementation, initially, FDI in LLP could be restricted to all those sectors which do not have caps, conditionalities or entry route restrictions.

(ii) As per the provisions of S. 7(1) of the LLP Act (as mentioned in para 5.4.5 of the Discussion paper) every LLP shall have at least two designated partners who are individuals and at least one of them shall be a ‘person resident in India’. Since this a primary requirement mentioned in the LLP Act, an Indian Partner will be required. The FDI policy on investment in LLPs may specify that compliance with this requirement is necessary even if 100% investment is permitted under the FDI policy.

(iii) FDI in LLPs should not be confined to the Government Route. On the contrary it should be under Automatic Route. The policy should be exception-based. As long as the prescribed criteria are met, investment must be under the Automatic Route. Where, however, there are deviations, than prior approval from FIPB must be prescribed.

(d) Should LLP be mandated not to make downstream investment and should foreign-owned or controlled Indian companies be barred from investing downstream in LLP ? Should investment by FII/ FVCI or ECB be prohibited for LLP?

(i) In view of the issues raised and concerns expressed in respect of ownership and control of LLPs, initially LLPs should not be permitted to make downstream investments and FDI should be allowed in operating LLPs only.

(ii) In respect of investment by FII/FVCI, the same policy as is applicable for FDI in Indian companies should be adopted. The same norms of ECB policy as is presently applicable in case of corporates should be made applicable to ECBs for LLPs. If any additional funds are required, the partner(s) must bring in the same by way of capital contribution.

(e) Following the Foreign Exchange Management (Investment in Firm or Proprietary Concern in India) Regulations 2000, should it be mandated that foreign participation in the capital structure of LLP should be on a percentage basis, received only by way of cash consideration by inward remittances through normal banking channels, or by debit to the NRE/FCNR account of the person concerned maintained by an authorised dealer? Should it be mandated that foreign investments in LLP engaged in agricultural/plantation activity or real estate are prohibited?

(i) In view of the issues involved in determining FDI in LLP in accordance with the capital sharing percentage of the foreign investors, foreign participation in the capital structure of LLPs should be determined with reference to the profit sharing percentage i.e., right to the share of profits of the LLP.

(ii) Foreign participation in the capital structure of LLP should be initially received only by way of cash consideration by inward remittances through normal banking channels, or by debit to the NRE/FCNR account of the person concerned maintained by an authorised dealer. However, the policy should be reviewed in the light of final policy view taken in respect of discussion paper on issue of shares for consideration other than cash.

(iii) It should be mandated that foreign investments in LLPs engaged in agricultural/plantation activity or real estate are prohibited since these activities are prohibited under the existing FDI policy in case of FDI in Indian companies. The same rules should apply to FDI in LLPs so as to provide for a level playing field and to avoid misuse.

(f) Should FDI policy treat LLP akin to companies? In such a case, how should the issues relating to ownership, valuation, control, downstream investment and non-cash contributions, raised in S. 5 above, be addressed ? Should this be only through the Government Route?

(i) An LLP is a hybrid entity. It incorporates the features of both a company as well as a traditional partnership. It would not be advisable to treat them akin to companies for all purposes.

(ii) Ownership of an LLP be determined on the basis of the profit-sharing ratio between the partners.

(iii) Valuation be undertaken on the basis of DCF method, as is presently prescribed under FDI policy.

(iv) Control be determined by looking at the LLP agreement between the partners to determine the roles, rights and duties of each partner viz-à-viz the LLP and the other partners.

(v) An LLP should not be permitted to undertake downstream investments.

(vi) After the initial experience, a certain amount of flexibility could be given to the partners to bring in non-cash contribution and to determine the value of the non-cash consideration. This is so because non-cash contributions will have a customs duty/service tax as well as income-tax implications.

(vii) The policy should be exception-based. As long as the prescribed criteria are met, investment must be under the Automatic Route. Where, however, there are deviations, than prior approval from FIPB must be prescribed.

(g) Will treating LLP akin to companies under FDI policy demand the stipulation of certain features of the LLP agreement? Should this include unambiguous specification of profit/loss-sharing percentage; clear specification of the power to appoint Designated Partners; congruence of legal and economic ownership; timely notification of changes including conversion from and to companies/partnerships? Should it be mandated that LLP cannot have corporate bodies other than companies registered under the Companies Act as partners? Is inclusion and coverage of such issues in FDI policy warranted? Would the consequent increase in the regulatory burden be justified?

(i)Treating the LLPs in certain aspect akin to companies, may require the stipulation of certain features in the LLP agreement.

(ii) Some of the stipulations in respect of unambiguous specification of profit/loss-sharing percentage; clear specification of the power to appoint Designated Partners; congruence of legal and economic ownership; timely notification of changes including conversion from and to companies/partnerships, are statutorily required to be incorporated in the LLP agreement as per the existing provisions of the LLP Act. If any additional stipulations are required, the same can be prescribed in respect of LLP agreement and/or also by way of yearly reporting (as is presently applicable to companies) so as to obtain adequate and appropriate information.

(iii) All types of entities should be permitted to invest in LLPs under the FDI policy. This will ensure that a large number of investors can invest in LLPs and give a fillip to FDI investment by accelerating capital flows.

(iv) FDI policy should be appropriately amended so as to permit investment in LLPs by foreign nationals as well as foreign LLP/LLC/companies, etc. and inclusion and coverage of such issues in FDI policy is certainly warranted.

(v) Any additional regulatory burden will be justified provided the regulations are drafted in manner that will reduce the transaction cost, provide transparency, are easy to implement and result in increase in FDI.

(h) What additional regulatory safeguards are required to enfold LLP into the FDI policy? Are amendments to any existing regulations required? Should the responsibility for periodic monitoring of compliance with FDI stipulations be allotted to a particular agency?

(i) Certain additional regulatory safeguards, which in view are required are as under:

(a) Compulsory audit of the LLPs having FDI, by Chartered Accountants on the same lines and manner, as mandated under the Companies Act, 1956. This would ensure that LLP as a structure is not misused and reliability of the accounts and other information is ensured.

(b) LLPs desirous of having FDI, should have ‘Fixed’ and ‘Floating’ capital accounts in its capital structure. FDI should be allowed ONLY in the Fixed Capital which should be linked to the profit-sharing ratio and which should not be permitted to be withdrawn except in the same circumstances and manner in which buy back of the shares of the companies are provided.

(c) In order to prevent the probable misuse of LLP structure (which allows capital contribution and withdrawal) for free flow of funds by the non-resident partners thus by passing the ECB norms presently prescribed for companies, it is suggested that even the floating capital should have a lock in period of 3 years except that the income/profit share should be allowed to be repatriated freely.

(d) Reporting requirement — A Form similar to Form FC-GPR both at the time of introduction of capital as well as at the end of the year, should be introduced in the FDI policy.

(e) Prohibition on downstream investments by the LLPs having FDI.

(ii) Appropriate amendments to FDI policy will be required. Also new Form(s) will have to be prescribed or existing Form FC-GPR will have to be appropriately modified.

(iii) Since RBI is presently monitoring FDI as well as ODI, it would be appropriate for it to also monitor FDI in LLPs as well, since it is part of the overall FDI policy itself.

Nirav Shah

Valuation of intangible assets

M & A

Unlike in accounting, where
the accounting for tangible assets and intangible assets is different, the same
is not the case in valuation. Whether an asset is a tangible asset or an
intangible asset, the concept of valuation does not change. However, globally
with the exchange of only intangible assets being infrequent and the market for
intangible assets not fully developed, the subjectivity involved in the
valuation of intangible assets is more than, say, for valuation of equity shares
or valuation of a business. In this article we will discuss the various methods
of valuation of intangible assets. We will not discuss the identification or
recognition of intangible assets here, but the valuation of an identified
intangible asset.

At the end of the discussion
we will also touch upon the recent acquisition of Cadbury by Kraft Foods.

Examples of intangible
assets :

Different industries have
different value drivers and thus different intangible assets. There is no
exhaustive list of intangible assets, but accounting guidance from US GAAP and
IFRS give us the following examples as given in the chart.

Approaches to valuation of
intangible assets :

Similar to valuation of any other asset,
there are three basic approaches to valuation of intangible assets viz. the cost
approach, the market approach and the income approach. Again as applicable to
valuation of any other asset, the use of any of the above approaches differs
from asset to asset and industry to industry. Also an intangible asset in one
industry may not be an intangible asset in another industry and the economic
benefit of the same intangible may differ from industry to industry and in the
same industry from company to company. The following are the generally accepted
methods that are used in valuation of intangible assets :

Cost approach :

l Valuation is based on the cost to reproduce or replace the asset and the
principle of substitution

l The valuation of an asset using the cost
approach is based upon the concept of replacement as an indicator of value

l The premise is that a prudent investor would pay no more for an asset than
the amount required to replace the asset afresh. Value is not the actual
historical cost of creating the subject intangible asset. It is also not the
sum of the costs for which the willing seller would like to be compensated

l The approach establishes value based on the cost of reproducing or
replacing the asset, less depreciation from physical deterioration and
functional obsolescence, if present and measurable

l Applications :

Reproduction cost

Replacement cost

Market approach :

l Valuation is based on transactions involving the sale or licence of
similar intangible assets in the market place and the principles of
competition and equilibrium

l Value is derived by analysing similar intangible assets that have recently
been sold or licensed and then comparing these transactions to the subject
intangible asset

l Applications :

Transaction multiples derived from (the sale or
licensing) of the comparative intangible asset.

Income approach :

l Valuation is based on the present value of expected future cash flows to
be derived from ownership of the asset and the principle of future benefits

l Value of the subject intangible asset is the present value of the expected
economic income to be earned from the ownership of a particular intangible
asset

l Primary applications :

Relief from royalty

Excess earnings

l Other applications :

Discounted cash flow

Incremental cash flows/profits

Profit split

Valuation methodologies for intangible assets :

Replacement cost method under

the cost approach :

This method represents the hypothetical cost that would be
incurred to replace the subject asset by a new asset of similar utility.

Reproduction cost method under

the cost approach :

This method represents the hypothetical cost that would be
incurred to recreate or reproduce (either by constructing or by acquiring) the
subject asset by a new asset of similar utility.

After establishing the replacement/reproduction costs,
adjustments are made to represent any losses in value resulting from physical
deterioration and from functional and economic obsolescence. The above methods
are generally used when a substitute can be developed in-house and are normally
used in valuing intangible assets like assembled workforce, internally developed
software, etc.

Comparable transactions method under the market approach :

l The value of an asset under this method is measured through an analysis of sales and offering prices for the comparable asset. Such prices are then adjusted for differences, if any, between the comparable asset and the subject asset. This method is similar to the comparable transaction multiples approach used in business valuations.

-> The two requisites in this approach are an active public market and an exchange of comparable assets.

-> The key is to select the most appropriate/ relevant transaction multiples involving intangible assets. The difficulty however is in finding comparable assets and the adjustments required to make it comparable to the subject asset.

-> On account of the infrequent activity happening in intangible assets, generally this method can be made applicable to brands only.

Relief from royalty method under the income approach:

-> This method is based on the principle of opportunity cost.

-> The value of an asset under this method is the present value of the future savings that is available to the owner on account of his owning the subject asset.

l Had the owner not owned the asset, he/she would have had to license in the asset for which it would have had to pay a royalty. By owning the asset, the owner is thus saving these costs. This savings is generally quantified in terms of royalty savings on revenues.

l The general steps to implement this method are:

research licensing transactions with comparable assets to establish a range of market levels for royalty rates

select a royalty rate or range of royalty rates

apply the selected royalty rate to the future revenue stream attributable to the asset

use the appropriate marginal tax rate to arrive at an after-tax royalty rate

discount the resulting cash flow stream to the present using an appropriate risk-adjusted discount rate.

Excess earnings method under the income approach:

This method is based on the principle of elimination and residual value and is similar to the discounted cash flow method except that it does not take into account the cash flows but the earnings.

This method considers assets in isolation from all other assets. Assets do not generate cash flows in a vacuum — they also utilise contributory assets to generate earnings and hence to isolate the earnings attributable only to the subject asset, contributory charge on such assets are deducted.

The main steps under this method are:

estimate and forecast the earnings from the subject asset

deduct applicable tax charge on these earnings

deduct an appropriate required rate of return on all other assets (tangible and intangible) used in obtaining such earnings — the residual earnings thus obtained are ‘excess earnings’ arising from the use in the business of the subject asset being valued

assess an appropriate discount rate for the forecast after-tax excess earnings

discount the excess earnings to obtain the value of the subject asset.

In addition to the above, there are also various adaptations of the income approach like the

Discounted cash flows method

Incremental cash flows/profits method

Profits split method

There are also various valuation concepts applicable generally and some specifically to intangible asset valuations like

Tax amortisation benefit factor,

Residual life of the intangible asset

Return ‘on’ and return ‘off’

Market value of invested capital

Invested capital analysis

Weighted average return on assets.

All of the above we shall discuss in the next article where we shall start with the purchase price allocation process and by a case study cover all the above points including the valuation of intangible assets under each of the approaches.

Cadbury acquisition:

On February 2, 2010 Kraft Foods’ Cadbury acquisition was valued at $ 18,546 million ($ 17,485 million net of cash and cash equivalents). As part of that acquisition, Kraft Foods acquired the following assets and assumed the following liabilities:

The above goodwill of $ 9.1 billion was attributable to Cadbury’s workforce and the significant synergies that were expected from the acquisition. Also $ 10.1 billion of the intangible assets acquired were expected to be having an indefinite life.

If we analyse the above details, the following observations can be made:

74% of the asset value paid was attributable to intangibles and goodwill (which is nothing but unidentified intangible).

Though there is no official information available, Cadbury primarily being in the food and confectionery business, the intangible assets could primarily have been brands, trademarks, trade names, logos, marketing & distribution network, non-compete agreements and vendor relationships.

Brand Finance (R) Global 500 February 2010 summary report on the world’s most valuable brands ranks Cadbury brand at No. 274 with an enterprise value of USD 21,196 million and a brand value of USD 3,261 million which is about 15% of the enterprise value. The same report values Kraft at an enterprise value of USD 6,277 million and a brand value equivalent to USD 2,168 million which is 35% of the enterprise value. The Kraft brand has been ranked at No. 437.

Nirav Shah

Net Assets Method of Valuation

Background :

There are many methods of valuation of shares or businesses. One of the commonly used approaches of valuation is Net Assets Approach. Before we look into the finer aspects of this method, it may be important to note that each method of valuation proceeds on different fundamental assumptions. The data which is used for valuation has to be carefully chosen. In current times, when you have lots of data available at a click of the mouse, one needs to obtain and analyse only the relevant data. It is observed that lots of time is wasted in reviewing irrelevant information and at the end, time at disposal to review the relevant data is limited. One more factor which has materially changed in last couple of years is the time available to complete the valuation. There are times when the urgency is self-created or artificial. Only in few cases the urgency is justified.

Let us now look at some finer aspects of Net Assets Method.

1. The Net Assets Method represents the value of a share with reference to the historical cost of the assets owned by the company and the attached liabilities on the valuation date. Such value represents the support value of a share of a going concern. It is usual to ignore the market value of the operating assets under this method.

2. While the historical cost is adopted in respect of the assets that are to continue as a part of the going concern, it is necessary to adjust the market value of non-operating assets such as investments and any assets which are capable of being easily disposed of, without affecting the operations of the company.

3. The value as per Net Assets Method can also be arrived at by considering the replacement cost or the realisable value of the assets owned by the entity. This value generally represents the amount, which the company can fetch, if the assets are sold.

4. Under what situations Net Assets Method is adopted ?

The method to be adopted for a particular valuation must be judiciously chosen. Net Assets Method may be adopted in the following cases :

In case of start-up companies, where the commercial production has not yet started.

In case of manufacturing companies, where fixed assets have greater relevance for earning revenues. It would also be appropriate to use Net Assets Method for valuation in case of companies operating in the industry, which is capital intensive and is relevant to revenues in an industry, where norms are related to the capital cost per unit.

In case of companies where there is no reliable evidence of future profits due to significant fluctuations in the business or disruption of business.

In case of companies, where there is an intention to liquidate it and to realise the assets and distribute the net proceeds.

5. Methodology :

The value as per Net Assets Method is arrived at as follows :

Net Assets value represents equity value which is arrived at after reducing all external liabilities and preference shareholders’ claims, if any, from the aggregate value of all assets, as valued and stated in the balance sheet as on valuation date. It is very important that the valuer critically goes through the financial statements (Directors Report, Management Analysis and Discussions, Auditors Report, Accounts including notes). It is experienced that on review of all the above documents, chances of missing any important adjustments are very less.

The value so arrived at is further adjusted for contingent liabilities, if any, as on valuation date and increase in realisable value of surplus assets and investments on a net of tax basis to arrive at the value as per Net Assets Method.

6. Some issues and its treatment in valuation :

The following are some issues which one has to deal with in arriving at the Net Assets Valuation :

6.1 Contingent liabilities :

The amount of contingent liabilities as disclosed in the financial statements of the entity or otherwise needs to be given due consideration. The management’s perception of such liability materialising may also be considered. It is observed that certain items of contingent liabilities may involve a very peculiar technical or legal issue. It is not uncommon in such situations to seek some expert’s view in the matter. The valuer should mention in his report the adjustments made based on opinion of the expert. When an impact of contingent liabilities is captured in the valuation, if the item is tax deductible, the amount should be considered after taking into account the tax impact. For example if contingent liability on account of excise duty liability is, say, Rs.100. If the valuer has taken probability of 50% for such liability, the amount to be reduced from Net Assets of the company should be Rs.33 [Rs.100 X 50% X (100% — 33.99%)]. If the claim is in arbitration and the award is likely to take a long time, it is usual to take present value of such liability.

6.2 Investments :

If the entity which is being valued is holding shares in other companies, the same needs to be valued and captured in the overall valuation. Investment in shares and securities, which are regularly traded in a stock exchange, may be valued on the basis of the prices quoted on the stock exchange. It is usual to take either 3 months or 6 months average if the holding is large. For small lots a single day market price may be used. It must, however, be seen that there is regular trading in those securities. An isolated transaction may lead to erroneous results.

In case of quoted shares with isolated transactions and also in case of unquoted shares, if the amount is material, a secondary valuation of such shares may be necessary using accepted methodology of valuation.

In case of investment in subsidiary company, net asset value of the subsidiary may be considered instead of the cost.

The appreciation or diminution in the value of any investment needs to be taken after taking into account notional tax implications, as applicable.

6.3 Surplus assets :

There are many entities which are holding certain assets which are surplus in nature. They are not used for any operations of the entity. It could be a vacant flat, vacant land or a closed factory. It is generally observed that if such assets are disposed off, it will not affect the operations of the entity. The identification of surplus assets is an important task. Generally the valuer accepts management’s representation on the same. However it is always better to review the facts based on which a particular asset has been identified as surplus. In many cases it is observed that the assets identified as surplus were not surplus in nature. For example area vacant between two factory buildings was identified as surplus in one case. However it was not actually possible to dispose of that piece of land as it would have materially affected the operation of the plant. In such case it is not surplus asset.

It is usual to take the market value of the surplus assets based on a report of the technical valuer. The appreciation or depreciation in the value of surplus assets adjusted for the tax liability on such appreciation or depreciation would be added/deducted from the Net Assets Value.

6.4 Fixed assets :

While valuing the Shares/Business of a Company, the valuer takes into consideration the last audited financial statements and works out the net asset value. Following factors needs consideration in respect of fixed assets :

It has to be seen that book value is arrived at after charging adequate depreciation consistently. Any capital improvements in the past, which have been charged-off to revenue, should also be taken into account.

In taking the value of plant and machinery, the factor of obsolescence due to technological improvements, changes in designs, etc., should be given due consideration. If due to technical improvements, the present machinery is found to be so outdated that it has to be discarded, then the value which the plant and machinery would fetch, if sold piece-meal, should alone be taken account of.

At times, when a transaction is in the nature of transfer of asset from one entity to another, or when the intrinsic value of the assets is easily available, or when the projections of future profits cannot be made with reasonable accuracy or where there are losses or where the value of the entity is derived substantially from the value of its assets, the valuer can consider the intrinsic value of the underlying assets. For determining the intrinsic value of fixed assets, the valuers can place reliance on report from the approved Chartered Engineers or other approved valuers.

6.5 Inventory and debtors :

Due allowance should be made for any obsolete, unusable or unmarketable stocks held by the company. In case of debtors, bad debts and debts, which are doubtful of recovery need to be adjusted. If the valuation is carried after the Due Diligence Review, all adjustments arising on account of such review need to be captured in the valuation.

6.7 Contingent assets :

If the company has made escalation claims, insurance claims or other similar claims, then the possibility of their recovery should be carefully made, particularly having regard to the time frame in which they are likely to be recovered. The present value of such claims can be added to the valuation.

6.8 Qualifications & Notes to Accounts :

Qualifications in the Auditors Report and Notes to Accounts should also be given due consideration. If it calls for any adjustment, the same should be carried out while arriving at the Net Assets Value. Such items could be diminution in the value of long term investments not provided for, provision for gratuity and leave encashment not made, provision for doubtful debts not made, etc.

6.9 Liquidation :

Where the business of the company is being liquidated, its assets have to be valued as if they were individually sold and not on a going concern basis. In such cases, the total net realisable value will often be less than that on the basis of a going concern.

Regard should also be had to the tax consequences of liquidation. If fixed assets are to be sold at a price in excess of cost, the capital gains tax should be taken into account.

6.10 Brought forward losses :

Brought forward tax losses of a business should be considered if the buyer of the business would be entitled to take benefit of set off of such losses. Generally there is a practice to share the benefit of tax losses between both the parties.

6.11 Warrants :

If the Company has issued warrants which are yet to be exercised, the valuer has to take a call considering the current fair value and the amount to be paid on warrant conversion. If the fair value is higher, the warrant holder is likely to exercise his right. In such cases, amount receivable on warrant is added to the Net Assets Value. To arrive at the per share value, the current number of shares as well as the additional shares on exercise of warrants is considered.

Conclusion :

In many cases, Net Assets Method may not be relevant particularly where human capital or intangible are main assets used for generating revenues. In such cases, the Maintainable Profit Basis or the Discounted Cash Flow Method may be adopted.

For companies using tangible assets such as plant and machinery, building, etc, this method is relevant. Net Assets Method may sometimes be used as a backup to support the value arrived at as per other methods. In many cases, particularly valuation for mergers, Net Assets Method is used alongwith other methods but is given a lower weightage in arriving at final fair value. In many court cases where valuations were challenged, usage of Net Assets value as one of the methods of valuation was well accepted.

Following is an illustration of Valuation of Company PQR Ltd. as per the Net Assets Method :

Nirav Shah

Whether issue of shares to persons or more is a public issue — recent controversial decision of SEBI

Securities Laws

Is issue of shares by a
company to 50 persons or more a public issue requiring compliance with various
requirements, procedures, etc. ? Recently SEBI passed an order (‘the Order’) in
regard to certain companies of the Sahara Group and decided on this and certain
other issues. This decision can have far-reaching implications.

As per press reports,
however, a stay has been granted by the Allahabad High Court. That being said,
it appears that the basic findings of law have not yet been examined by the
Court. The object here in any case is not to consider whether the allegations or
the ‘findings’ of facts by SEBI are correct or not. The exercise here is to
determine what conclusions in the law did SEBI reach and what implications the
same can have.

In essence, the allegations
were that two companies of the Sahara Group raised large funds (just one company
raised nearly Rs.5000 crore) through issue of Optionally Fully Convertible
Debentures (‘OFCDs’). Also, allegedly, the cost of the projects for which these
OFCDs were issued was Rs.20,000 crore for each company. SEBI came across this
accidentally whilst examining a Red Herring Prospectus filed by another company
of the Sahara Group. SEBI sought various details from these two companies who
had issued the OFCDs to determine whether the issue was a ‘public issue’. The
two companies made certain submissions with regard to the information sought,
but in essence they inter alia stated that SEBI had no jurisdiction in
the matter as the matter was being examined by the Ministry of Company Affairs.

Since SEBI did not receive
the information it asked for, it compiled certain information as available on
the MCA website. It found out, for example, that the OFCDs were issued of
amounts between Rs.5,000 to Rs.24,000. Since specific information was not
available from the company, SEBI extrapolated that the number of persons to whom
such OFCDs of an amount of around Rs.5000 crore in just one company were issued
must be large, but in any case not less than 50 persons.

SEBI alleged that in view of
the provisions of S. 67(3) of the Companies Act, 1956, the issue of OFCDs
amounted to a public issue requiring compliance with the provisions relating to
public issue including the Companies Act, 1956, as well as the SEBI (ICDR)
Regulations, 2009. The companies stated (on the basis of legal opinions
obtained) that these provisions did not apply and hence there was no question of
compliance.

At this stage, a broad
description of the scheme of provisions may be in order. The Companies Act,
1956, as duly aligned with the provisions of the SEBI Act and the SEBI (ICDR)
Regulations, 2000 (‘the Regulations’) essentially requires that an issue of
shares can be on a ‘private placement’ basis or a public issue. Loosely stated,
in case of a private placement, a selected group of people are approached for
subscription of the securities. The issue of securities is restricted to them
and the ‘right’ to subscribe, generally speaking, is not transferable. In case
of a public issue, however, persons beyond this known group are approached for
such subscription. The scheme of the law intends that if such a wider issue is
made public, certain procedures and restrictions in regards to the interests of
investors should be followed. These would include certain mandatory disclosures
regarding the company, listing of the securities to ensure easy transferability,
etc. These provisions are formalised in certain provisions of the Companies Act,
1956, and the SEBI Act, Regulations, etc.

Let us first consider the
provisions of S. 67(3) which is one of the central points to this controversy.
Essentially, as readers are aware, S. 67 seeks to ‘deem’ certain issues of
securities as issues to the public. The Section is reproduced below for ready
reference (emphasis supplied in this section and in other extracts later herein)
:

“67. Construction of
references to of fering shares or debentures to the public, etc.

Any reference in this Act or
in the articles of a company to offering shares or debentures to the public
shall, subject to any provision to the contrary contained in this Act and
subject also to the provisions of Ss.(3) and Ss.(4), be construed as including a
reference to offering them to any section of the public, whether selected as
members or debenture holders of the company concerned or as clients of the
person issuing the prospectus or in any other manner.

Any reference in this Act or
in the articles of a company to invite the public to subscribe for shares or
debentures shall, subject as aforesaid, be construed as including a reference to
invitations to subscribe for them extended to any section of the public, whether
selected as members or debenture holders of the company concerned or as clients
of the person issuing the prospectus or in any other manner.

No offer or invitation shall
be treated as made to the public by virtue of Ss.(1) or Ss.(2), as the case may
be, if the offer or invitation can properly be regarded, in all circumstances —

as not being calculated to
result, directly
or indirectly, in the shares or debentures becoming available for subscription
or purchase by persons other than those receiving the offer or invitation; or

otherwise as being a
domestic concern of the persons making and receiving the offer or invitation.

Provided that nothing
contained in this sub-section shall apply in a case where the offer or
invitation to subscribe for shares or debentures is made to fifty persons or
more :”

The question was whether the
issue by the Sahara Group companies was an issue to the public in terms of S.
67(3). SEBI observed and held as follows in its Order :

“14. In order to curb the companies from offering shares and debentures to a wider group of people by disguising it as ‘domestic concern’, vide the Companies (Amendment) Act, 2000, with effect from December 13, 2000, a proviso was inserted to S. 67(3) stating that nothing contained therein shall apply in a case where the offer or invitation to subscribe for shares or debentures is made to fifty persons or more. Therefore, if an offer is made to fifty or more persons, it would be deemed to be a public issue, even if it is of ‘domestic concern’ or shown that “the shares or debentures are not available for subscription or purchase by persons other than those receiving the offer or invitation”. First proviso to S. 67(3) of the Act is as clear as that. In other words, even if an issue is made by way of private placement to fifty or more persons, it would be deemed to be a public issue, irrespective of whether it was offered to public at large or to just a section of the public chosen, in whatever manner.”

Curiously, SEBI has held that “even if an issue is made by way of private placement to fifty or more persons, it would be deemed to be a public issue, irrespective of whether it was offered to the public at large or to just a section of the public chosen, in whatever manner.” This statement can have far reaching implications. It is possible that many public companies make such a private placement of securities to more than 50 persons and in such a case, as per this ruling, the provisions of S. 67(3) would be per se attracted and the provisions relating to public issue would have to be complied with.

SEBI further explained the reasoning of its ruling as follows:
“15. The intention of the Legislature, more specifically as evinced in the amendment to the Act referred to above, is very clear that any and all mobilisation of funds from a group of investors, fifty or more in number should be classified as a ‘public issue’ and consequently be accorded all the safeguards provided, that typically accompanies the safety and protection accorded to their funds, in law. In view of the above, the contention of the companies that the OFCDs are issued by way of private placement basis to friends, associates, group companies, workers/employees and other individuals who are associated/affiliated or connected in any manner with Sahara India Group of Companies, would not give it a different colour. The rigour of the procedures enshrined in law, for the protection of investors who subscribe to an issue of securities would have to be preserved in toto. Though, the companies have stated that the offer was made on private placement to a select group, they could not provide any details of the group despite the fact that SEBI has issued summons seeking such information. This would lead to an adverse inference that they were offering OFCDs to fifty or more persons.”

Another contention raised by the companies was that the provisions of S. 67(3) should not apply to them since they had passed a resolution u/s.81(1A) for the issue of the OFCDs. This contention was rejected by SEBI stating the following:

“The companies, on the basis of the legal opinion received by them, have stated that they had passed the resolution u/s.81(1A) of the Act (which states that further shares may be offered to any persons in any manner whatsoever) and that their offer to a select set of persons should not be construed as a public offer. S. 81(1A) of the Act cannot have an overriding effect on the provisions relating to public issue, specified in the Act. S. 81 of the Act deals with further issue of securities and only gives pre-emptive rights to the existing shareholders of a company so that the subsequent offer of securities have to be offered to them as their ‘rights’. S. 81(1A) is only an exception to the said rule, subject to the procedural requirements contained therein. However, any further issue of capital, even pursuant to a resolution made u/s.81(1A) of the Act, is subject to the provisions of Part III of the Act, if the offer is made to fifty persons or more. Hence, the views submitted in the legal opinion that since the companies had passed resolutions u/s.81(1A) of the Act, the issuance of shares/debentures to a select group (however large, they may be), ceases to be an offer to the public, is devoid of any legal basis and hence cannot be accepted. It is quite obvious from a reading of S. 81(1A) that it was never intended to dilute the provisions of the Act relating to the definition of public issues. Whether an issue is a public or not is to be decided on the basis of S. 67 of the Act. As stated above in this Order, the first proviso to S. 67(3) of the Act makes it very clear that any offer or invitation to subscribe of shares or debentures to fifty persons or more should be treated as a public issue.”

The other contention of the companies was that S. 60B(9) effectively allows for a system where the Red Herring Prospectus needs to be filed only with the Registrar of Companies and once this is done, no other procedure is to be followed if the intention is not to get the shares of the company listed. SEBI rejected this argument too, stating that this would go counter to the scheme of provisions relating to public issue of shares and listing. SEBI held that as soon as the shares are offered to the public, the intention to list or not to list becomes irrelevant. The company has to list their shares and since this is mandatory, an attempt to take shelter u/s.60B(9) on claim that it never intended to list will not help.

An argument that was also made was that the is-sue was made that on a ‘private placement’ basis to friends, group companies, etc. and particularly to ‘other individuals who are associated/affiliated or connected in any manner with Sahara India Group of Companies’. SEBI had made a finding that apart from a declaration obtained that a particular subscriber was ‘associated’ with the Sahara Group, no other association was established. On this and other grounds discussed above, SEBI did not ac-cept that this did not amount to a public issue.

SEBI also considered the fact that they filed a prospectus with the Registrar supporting the view that the companies intended to raise funds from the public.

SEBI drew attention to S. 73(4) of the Companies Act, 1956, which provides that any condition that binds an applicant into making waiver of the requirement of that Section is null and void. Hence, listing was mandatory and it cannot be the subject matter of any ‘intention’ once the basic conditions are attracted.

As discussed, the Order may be considered by the Court on various grounds. One will have to see whether the Court disposes the petition only on the issue of jurisdiction or whether even the issue and ruling on S. 67(3), S. 81(1A) and S. 60B are also decided upon. For companies seeking to issue shares to 50 persons or more, this Order of SEBI has to be considered and the further developments in Court to be closely watched.

Nirav Shah

The CII Corporate Governance Code — a fresh and realistic approach — and a glimpse of things to come

Securities Laws

(1) The Confederation of Indian Industry (CII) has issued a
draft Corporate Governance Code (‘the Code’). The Code has importance for
certain reasons. The fact that the topmost of thinkers, who are usually
associated with drafting of such Codes or law, makes it almost certain that it
will receive wide acceptance and get included in forthcoming amendments in law.
Those thinkers amongst others include Naresh Chandra, Dr. J. J. Irani, our past
President Y. H. Malegam.

(2) The Code represents a fresh and innovative approach and
after almost a decade of trial and error where mostly foreign models were
adopted, this Code now takes into account some essential unique features of
Indian listed companies.

(3) The Code however, comes at a time when the concept of
corporate governance is being viewed with cynicism. Both Enron and Satyam were
perfect and award-winning companies for adopting best corporate governance
model. Everything was done right in having the finest and reputed persons as
Independent Directors, members of Audit Committee, to having top audit firms,
etc. — and everything went horribly wrong.

(4) What I find special is that the Code finally recognises
that India has unique features. Most of Indian companies are promoter-controlled
and managed with the Promoters having either
substantial or majority holding. This is in contrast with US and other Western
companies where the holding of the management is often in single digit and even
this holding is not concentrated in a single family
or group but is often dispersed. The Code specifically comments that in India,
typically, the Promoter Group/family holds at least 50% of the voting capital.
With such dominant promoter holding and control the problems and issues of
governance are very different from companies where the Promoter holding is
barely a small percentage. Hence, if the problems are different, the solutions
have to be different. Adopting Western Corporate Governance models and concepts
make them not only inappropriate in the Indian context, but creates resistance
and results only in paper acceptance. This ‘box-ticking’ acceptance, in the
author’s view creates a false sense of assurance. A good example of such
difference relates to the recom-mendation of having separate offices of Chairman
and CEO. In Western countries, the CEO typically does not belong to a Promoter
group and there is a need to have a check on him, since it is often found that
malpractices originate from this office. If the CEO is also the Chairman,
considerable power gets concentrated in one person as compared to other
directors and officers. In India, the power is concentrated with the Promoters
and the CEO and Chairman are often from the Promoter group and, if not, they are
often effectively nominated by such group. Requiring that these two offices are
separated in India, firstly, does not serve any purpose and, secondly, creates
practical problems of requiring a non-promoter as ‘Chairman’ which could be
counter-productive. Take an example of, say, a company such as Bajaj Auto or
Reliance Industries. The company would be forced to have a Chairman
from the non-promoter group. The CII Code recog-nises this anomaly and unique
Indian conditions and notes that this does not make total sense in India. At the
end, though, it makes a compromise and instead of recom-mending that the present
requirement be wholly dropped, it only suggests that wherever possible, the two
offices should be separated.

(5) Having said that, the CII Code strangely contradicts
itself and instead of consistently taking a total Indian approach, the Code, for
several important requirements, recognises the Indian differences but still,
recommends following of foreign models.

(6) Let us now examine some important requirements of the
Code.

(7)
The Code is voluntary :

(a) The CII Code clearly specifies that it is voluntary and
it is up to the Company to decide whether and how much to follow its
recommendations. Of course, one could argue that this is a spacious point
since CII does not have any statutory authority to enforce the Code. But the
point makes sense on a different footing since the intention is that the Code
be enshrined in law, the acceptance may be mandatory. The danger is and will
always remain that mandated Governance Codes are often followed only in the
letter. Hence, in the author’s view the code though voluntary should be based
on the concept of ‘comply or explain’.

(b) While keeping the Code voluntary is commendable, it
needs to be reckoned that the code is not meant for mere quiet internal
adoption but is for public knowledge. Hence the concept of ‘comply or
explain’, because the public should know its ethical practices. In case the
company adopts, in my opinion, it gains reputation which eventually helps it
‘commercially’.

(c) In the absence of ‘comply or explain’ model there would
be uneven reporting. It is not as if the choice is that the Code can be
adopted wholly or rejected wholly. The Company may adopt it wholly. The
Company may adopt only some of the recommendations. The Company
may even adopt a modified version. The public should know the reasons for
non-adoption. Good governance requires transparency in reporting.

Appointment of Independent Directors :

(d) The Code attempts to meet the serious dilemma of the
manner of appointment of Independent Directors. The issue faced is how to make
the Independent Director really independent even for appointment. If the
Independent Director’s appointment is left to the Promoters, the purpose may
be lost.

(e) For this requirement, however, the Code does not take a
fresh approach. The Code leaves the present concept of having a Nomination
Committee as it is and merely provides for certain procedural requirements of
evaluation of Independent Directors.

Duties, liabilities and remuneration of Independent Directors :

(f) The Code recognises the present problem that while a relatively new concept of Independent Director has been introduced for adoption by all listed companies, there are no special provisions for their rights, duties, and remuneration.

g) Perhaps realising that the law may or may not make provisions for these matters and makes a unique suggestion of making the obligations, duties, etc. contractual by appointment letters. The Code further makes an interesting requirement that the details of this appointment letter be disclosed to the shareholders at the time of their appointment.

h) Thus, the duties and obligations will not only be transparent, but to a certain degree can even be enforced, albeit through the Company. In a way, this requirement fills in the lacuna in law.

Remuneration of Independent Directors :

i) The Code recognises a special problem in India and that is the statutory limits on managerial remuneration. As may be recollected, in India, the maximum remuneration is linked as a percentage of profits, though certain minimum remuneration can be paid under certain circumstances. This archaic requirement creates problems even for Independent Directors since particularly for loss-making companies or companies with inadequate profits, payment of reasonable remuneration may become difficult. The Code recommends that the law be amended to make suitable exceptions.

j) Of course, the remuneration issue is anomalous from a different angle. Pay too less remuneration and the Independent Director is not available even for appointment. Pay too much and the Independent Director loses his independence! Actually, the root problem also is that the remuneration is effectively decided by the Promoters, but this issue is not seriously addressed by the Code.

Audit Committee :

The Code rightly says that the recent amendment in clause 49, whereby only the majority of the Audit Committee members need to be Independent Directors, is unwarranted. Thus, the Code makes a valid suggestion that the Audit Committee should consist only of Independent Directors.

Another important recommendation is that all related party transactions should be pre-approved by the Audit Committee.

Auditors :

There are several recommendations in respect of Auditors that may be found radical but realistic also. There are numerous requirements made and a more detailed study would be required. A few of the requirements are highlighted.

The Code recognises audit firms often have networking arrangement or relations with group or other entities that render non-audit services. When such group entities render non-audit services, the independence of the audit firm may be compromised and at the very least, the fees paid to such firms should be taken into account while determining whether the audit firm is independent and for disclosure and limits on such other revenue by such related entities.

The Code also recognises that if the audit firm is unduly dependent on one group for its fees, then its independence could be lost. The Code places, however, a fairly low benchmark of 10% of the total revenues of the audit firm for calculation whether the firm is dependent on a group.

The Code also suggests a requirement of ‘audit partner rotation’ and also of the audit team.

The Code makes the radical requirement of creating unlimited auditor liability and also specifically makes the requirement that all the partners of the audit firm and not merely the signing partner should have unlimited liability. If the audit firm is a limited liability partnership, still, the Code says, the audit partner should have unlimited liability for at least the audit under question. One will have to see how far this recommendation will be effective unless statutory provisions and not mere corporate governance codes or even contractual terms seek to create such unlimited liability.

Then the Code raises issue regarding the numerous disclaimers and varying drafting of qualifications in the audit report. The Code recommends that the ICAI involve outside nominees, particularly government representative, and come out with requirements to avoid this.

There are several other recommendations in the Code. While suffering on some counts, the Code attempts to inject some fresh life and practical use-fulness in corporate governance requirements.

Nirav Shah

Insider Trading — Recent Amendments — Six-month lock-in on directors/officers and total ban on derivatives and many ‘outsiders’ now insiders

Securities Laws

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

(1) Directors and officers of listed companies cannot now
carry out reverse trades for six months if they buy or sell even one share. They
cannot also at all hold any positions in derivatives. Moreover, any person who
receives any inside information now is an insider and apparently the requirement
of having connection with the company or a ‘real’ insider is now no longer
required. These are some of the far-reaching but poorly publicised amendments
which have been recently made to the SEBI
Insider Trading Regulations, 1992 (‘the Regulations’).

(2) Let us consider some of these amendments made vide the
Notification dated 19th November 2008.

(3)
Insiders and Outsiders — any person receiving or having access to insider
information is now automatically an insider

(a) An important amendment is to the definition of
‘insider’. No word has been added or deleted, but by dropping a comma and
breaking the definition into two parts, a significant change has been made.

(b) Before the amendment, an Insider had to, firstly,
be a person connected or deemed to be connected to the Company. Such
connected person should then either be reasonably expected to have
access to unpublished price-sensitive information (‘UPSI’) or should
have received it or had access to it.

(c) This definition was ambiguous. A person merely
receiving UPSI or merely having access to it could also be said to be an
Insider, as per one interpretation. It is probably this ambiguity that the
amendment tackles, though by changing the definition upside down !

(d) Now, the amendment says that an Insider is :

(i) a person connected or deemed to be connected to the
Company and who can be reasonably expected to have access to UPSI. OR

(ii) a person who receives or has access to UPSI.

(e) Thus, a new category of what one could call deemed
insiders has been created.

(f) Readers may recollect the classic case of the printer
of company documents who used the price-sensitive information in such
documents to deal in their shares and make profit (United States v.
Chiarella, 445 US 222). Of course, the Supreme Court acquitted this
printer, since from what little I recollect, the allegation was that he
violated fiduciary duty to shareholders of the target Company and the Court
held that he did not. A version of this case was also fictionalised by the
best-selling novelist Lawrence Sanders in his novel “Timothy’s Game”. Such a
printer would though be an Insider in India as per this amended definition, so
would any other person who receives or has access to UPSI.

(g) In practice, such a broad definition may cause
problems. Taken to its extreme, would even a hard-working analyst who takes a
lot of effort and puts 2 and 2 and 2 and 2 together and counts 8, also become
an Insider, since he now has access to UPSI ? I feel that the answer is no for
various reasons, but the law could have said that a link with the company is
specifically required. This may even have also been intended, since the words
used are that such persons should have ‘received’ or ‘had access to’ UPSI.

(4)
Dependents of Insiders also covered for certain purposes

(a) Listed companies and certain other persons are required
to frame a code of internal procedures intended to prevent Insider Trading
(‘the Code’). The Code should be framed ‘as near thereto the Model Code’
provided. It is now provided that the framing of the Code as near to
such model should be ‘without diluting it in any manner’. Further, the
Company should ‘ensure compliance of the same’.

(b) Disclosures of holding and changes therein are now
required in respect of even dependents (as defined by the Company) of the
directors or officers of the listed company. Disclosure of such changes is now
also required to be made to the stock exchanges. Disclosure of holdings in
derivatives is also to be made when a person becomes a director or officer.

(5)
Total ban on further opposite trades for six months/total ban on derivatives

(a) The Model Code itself has been amended. There are two major changes.

(b) Clause 4.2 of the Model Code has been amended. As per this amended clause, directors/officers/designated employees, who buy or sell shares, cannot now carry out a reverse transaction for six months. Thus, if such person buys even 1 share, he cannot sell any shares for six months and if he sells even one share, he cannot buy any shares for six months. Further, such persons cannot deal, at all, in derivatives of the Company. This bar is over and above the general prohibition on insider dealing.

(i) The devil in me tells me that the ban is only on such directors, etc. and the dependents of such persons are not affected by such ban ! Of course, such dependents may have to answer to the charge of Insider Dealing generally.

(ii) This bar also does not apply to Promoters ! ! ! This is absurd. Of course those Promoters who are directors, officers or designated employees would face the bar. So also, the prohibition on Insider Trading generally would continue to apply.

(iii) The bar also does not apply to other Insiders.

(c) This bar on such transactions is total. There are no circumstances’ – whether of urgent need or otherwise – under which the bar can be lifted. There is also no provision under which even SEBI could grant exemption.

(d) An interesting question arises. Does the bar apply also to shares acquired through exercise of employees’ stock options or under a Share Purchase Scheme? This can be seen in two ways. If such a person has sold shares, can he acquire shares under an ESOPs scheme in the next six months? Alternatively, if he has acquired shares under an ESOPs scheme, can he sell shares in the next six months?

(i) The crucial word to examine is ‘buy’. I think there is a good case to argue that the word ‘buy’ would include shares acquired under an ESOP scheme. However, I still think that shares acquired under ESOP schemes are not intended to be covered. Consider a related bar on shares acquired through an IPO. The existing clause, continued without any change, requires shares acquired by such persons through IPO should be held for at least 30 days. Obviously, if the intention was to cover shares bought in any manner, then such a separate bar was not required at all. I know the provisions are not happily worded. I also know it could be argued that the 30-day lock-in for IPO acquired shares is meant to be a special case. However, taking all things into account, perhaps the intention is not to cover shares acquired under ESOP schemes.

6. No penal consequences for violating the new trading restrictions on Insiders?

(a) As discussed earlier, directors, etc. are barred from carrying out opposite transactions for six months and holding positions in derivatives (let us call such transactions as ‘Specified Transactions’).

(b) The question is what are the consequences of violation of these two restrictions?

(c) The SEBI Act provides for severe punishment for Insider Trading. U/s.15G, the specified acts by an Insider attract a penalty of Rs. 25 crores or 3 times the profits made from Insider Trading, whichever is higher. U/ s.24, violation of the Regulations could result in imprisonment up to 10 years or a fine of up to RS. 25 crores or both. There can be other consequences also.

(d) Would any of such consequences be attracted for violating the bar on carrying out such Specified Transactions – i.e., such opposite transactions or derivatives? The answer seems to be No.

(e) Violations of the Code are to be punished by the company internally and the Model Code suggests that they ‘may be penalised and appropriate action may be taken by the company’. The violators shall also be ‘subject to disciplinary action by the company, which may include wage freeze, suspension, ineligible for future participation in employee stock option plans, etc.’.

(f) Beyond this, it appears that SEBI cannot levy the said penalties of RS.25 crores, etc. or prosecute and get such person imprisoned, etc. The reason is the peculiar placement of the amendments. The bar on Specified Transactions is contained in the Model Code. Regulation 12 merely requires listed companies and other entities to ‘frame’ and ‘enforce’ a Code on the lines of the Model Code. There is no requirement in the Act or the Regulations that the Code so made should be followed. While an obligation and enforcement relation has been created between the company, etc. and such persons, no such obligation or enforcement relation has been created between SEBI and such persons.

(g) If, e.g., the company does not frame the Code of Conduct as prescribed, SEBI can levy penalties, and take other penal and other action. Further, if a company does not enforce the Code, then also such penal consequences would follow. But the Regulations do not go further and require that the Code so framed should also be complied with by the directors, etc.

(h) Is this intentional or is it an unintentional drafting lapse? On first impression, one could be tempted to consider that this is intentional. The Consultative Paper on proposed amendments to Insider Trading of March 2008 did consider the requirements of the Model Code to be akin to corporate governance requirements. In fact, it discussed that disclosure of non-compliance was perhaps a better way to punish a company economically through the markets. It also recommended dilution of the punitive requirements. Effectively, it appeared to suggest a change in approach. However, even considering these original thoughts, it still appears to me that it is not intended by SEBI that such violations should not attract penal conse-quences.

(i) I think it is not only an unintentional lapse and this also arises on account of an improper appreciation of the structure of the Regulations. SEBI has all along assumed that violations of the Code as framed by the Company are not only punishable with monetary penalties and directions, but also subject to prosecution. In the aforesaid Consultative Paper of March 2008, SEBI recommended that the violations of the Code should not result in imprisonment. It further said that “other powers of monetary penalties and directions should be continued”. Thus, SEBI assumed that the violations already attracted all these penal consequences.

(j) On this erroneous presumption, perhaps, SEBI placed the bar on the Specified Transactions in the Model Code.

(k) But where is the provision, in the Act or the Regulations, saying that violations of the Code will attract such penal consequences? No-where, I think.

(l) Thus, by possibly an unintentional drafting lapse, the bar on the Specified Transactions will not attract the penalties, prosecution, etc. Taking this further, even violation of the 30-day lock-in for shares acquired in IPO or, for that matter, violation of any other provision of the Code, would not attract such punishment.

(m) Of course, this does not mean that such persons can merrily carry out Insider Trading as defined – i.e., trade in shares on the basis of unpublished price-sensitive information or communicate such information, etc. Also, persons violating the bars on ‘specified transactions’ would also face, as discussed above, action by the company for violation of the Code.

(7) There are a few other amendments and issues, but considering space constraints, only certain important amendments have been discussed.

(8) A common thread amongst these amendments appears to be that SEBI seems to have preferred a total ban and also creating a ‘deemed category’ of insiders without leaving any scope for subjective exemptions. While the merits of such an approach could be debated, it is likely that at least in the short run, many persons may unwittingly carry out ‘Insider Trading’ as so now widely defined – in terms of persons as well as transactions. This is the sad consequence of the poorly publicised and arbitrary amendments.

Nirav Shah

Appellate Tribunal — Strictures against Department for filing appeal in avoidable litigation.

[Commissioner of Central Excise, Chandigarh-II v. Gee EMM Polyvin Ltd., 2011 (273) ELT 223 (P & H)]

The appeal had been preferred by the Revenue authorities u/s.35G of the Central Excise Act, 1944 against the order of CESTAT.

In original proceedings on the issue of deficient payment of excise duty on account of wrongful availment of Cenvat credit were dropped. This order had been upheld by the Commissioner (Appeals) and had been further upheld by the Tribunal. The Tribunal, inter alia, observed:

“The Department deserves to be complimented for their perseverance as the Tribunal’s decision dated 4-7-2008 in the previous set of proceedings on the main issue is in favour of the party, the question of allowing this appeal of the Department does not arise.”

In spite of the above observations, the Department had chosen to file the appeal before the High Court claiming that there is a substantial question of law. The Court held that the above action only shows total carelessness and nonapplication of mind. Apart from the fact that the original authority, the Appellate Authority and the Tribunal decided against the Department, the amount involved was only Rs.39,117. In spite of the judgments of the Supreme Court as well as observations made by the Court, the Department is turning a deaf ear and is wasting public money on avoidable litigation.

Accordingly, the appeal was dismissed with costs at Rs.10,000 to be recovered from the person taking decision to file the appeal within three months and to be deposited with the High Court Legal Services Committee.

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Nirav Shah

Appellate Tribunal — Precedent — Judicial propriety — Co-ordinated Benches of Tribunal.

The Supreme Court while deciding an appeal under the Customs Act, 1962 against the order of CESTAT, noticed difference of opinion between co-ordinate Benches of Tribunal on an identical issue. The Court showed their deep concern on the conduct of the two Benches of the Tribunal while deciding appeals in the cases of two parties, namely, IVRCL Infrastructures & Projects Ltd. and Techni Bharathi Ltd. After noticing the decision of a co-ordinate Bench in the present case, they still thought it fit to proceed to take a view totally contrary to the view taken in the earlier judgment, thereby creating a judicial uncertainty with regard to the declaration of law involved on an identical issue in respect of the same Exemption Notification. It needs to be emphasised that if a Bench of a Tribunal, in identical fact-situation, is permitted to come to a conclusion directly opposed to the conclusion reached by another Bench of the Tribunal on earlier occasion, that will be destructive of the institutional integrity itself. What was important is the Tribunal as an institution and not the personality of the members constituting it. If a Bench of the Tribunal wishes to take a view different from the one taken by the earlier Bench, the propriety demands that it should place the matter before the President of the Tribunal so that the case is referred to a larger Bench, for which provision exists in the Act itself. The Court referred to the observations of a three-Judge Bench of the Court in Sub-Inspector Rooplal & Anr. v. Ltd. Governor & Ors., (2000) 1 SCC 644. The Court further directed that all the Courts and various Tribunals in the country shall follow these salutary observations in letter and spirit.

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Nirav Shah

DP World Pvt. Ltd. vs. DCIT ITAT Mumbai Bench ‘D’ Mumbai Before D. Manmohan (V. P.) and N.K. Billaiya (A. M.) ITA No.3627/Mum/2012 A.Y.: 2008-09. Dated: 12-10-2012 Counsel for Assessee/Revenue: Rajan Vora & Nikhil Tiwari/Rupnder Brari

10. DP World Pvt. Ltd. vs. DCIT
ITAT Mumbai Bench ‘D’ Mumbai
Before D. Manmohan (V. P.) and N.K. Billaiya (A. M.)
ITA No.3627/Mum/2012
A.Y.: 2008-09. Dated: 12-10-2012
Counsel for Assessee/Revenue: Rajan Vora &
Nikhil Tiwari/Rupnder Brari

Ss. 28(iv)/56(2) – Gift of residential flats through transfer of shares by foreign company to Indian company – Whether taxable – Held no.

Facts:

The assessee had received by way of a gift, three residential flats in Hill Park from its sister concern viz., BISNCL, a UK based company. BISNCL was holding shares of Hill Park Ltd. which entitled it for use and occupation of the said three flats and the gift was effected by transfer of the said shares. Both, the assessee and BISNCL, were 100% subsidiary of a U.K. based entity which in its turn was 100% subsidy of a Dubai based entity. This transaction, in the eyes of the AO, was a colourable device who taxed the value adopted for WT purpose as income from other sources. However, the same, in the eyes of the CIT[A], was nothing but a benefit derived by the donee out of its business relations with the donor company and therefore, he taxed the same as profit and gains of business & profession.

The issue before the tribunal was whether such transaction can be termed as a ‘Gift ‘or Income in the hands of the Donee.

Held:

According to the tribunal, such a transfer may trigger capital gains ramifications in India, since the shares of an Indian company were situated in India and when the transferor is a non-resident, the deeming provisions of section 9(i)(i) of the I.T. Act, 1961 came into play. However, referring to section 47(iii), the tribunal noted that the transfer of a capital asset, amongst others, under a gift is not treated as transfers for the purposes of section 45 of the Act. Referring to the provisions of section 5 and section 122 of the Transfer of Property Act (‘TPA’), the tribunal noted that there was no requirement in the TPA that a ‘gift’ can be made only between two natural persons out of natural love and affection which means that as long as a donor company is permitted by its Articles of Association to make a ‘gift’, it can do so. In case where donor is a foreign company, the tribunal noted that the relevant corporate/commercial law of the jurisdiction where the donor is based needs to be considered. Referring to the Certificate and Attestation by the Notary Public of the City of London, England, wherein the authority has inter alia certified and attested that the Deed of Gift was binding on BISNCL in accordance with the relevant provisions of English law, the tribunal concluded that BISNCL was legally authorised to give gift of shares.

Therefore, it held that the gift of shares of an Indian Company by a foreign company without consideration has to be treated as gift within the meaning of section 47(iii) of the Act.

As regards the order of the CIT(A) applying the provisions of section 28(iv), it observed that simply because both the donor and the donee happened to belong to the same group cannot ipso facto establish that they have any business dealings to attract the provisions of section 28(iv). Therefore, it was held that in the absence of any specific provision taxing a Gift as a deemed business income, provisions of section 28[iv] cannot be applied

As regards the applicability of the provisions of section 56 relied upon by the AO, the tribunal noted that a plain reading of the provisions show that not every receipt is taxable under the head ‘Income from other sources‘ but only those which can be shown as ‘Income‘ can be brought to tax under this head, if it does not fall directly under other heads of income specified in section 14 of the Act. According to it, the issue involved under the present appeal got covered under the clause (viia) of section 56(2). However, the said clause was introduced with effect from 1st day of June, 2010, hence, not applicable to the case of the assessee.

Accordingly, it was held that the transaction involved in the present appeal was nothing but a Gift and thus it was a capital receipt not taxable under the provisions of the Act.

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Nirav Shah

Kewal Silk Mills v. ACIT ITAT Mumbai `A’ Bench Before I. P. Bansal (JM) and Rajendra (AM) ITA No. 4335/Mum/2012 A.Y.: 2009-10. Dated: 12-10-2012. Counsel for assessee/revenue: Rajan Vora & Hemen Chandriya/Surinder Vit Singh

9. Kewal Silk Mills v. ACIT
ITAT Mumbai `A’ Bench
Before I. P. Bansal (JM) and Rajendra (AM)
ITA No. 4335/Mum/2012
A.Y.: 2009-10. Dated: 12-10-2012.
Counsel for assessee/revenue: Rajan Vora & Hemen Chandriya/Surinder Vit Singh

S/s 2(14), 45, 55(2) – Right to use a portion of the shed, in which the looms and machinery taken on license basis are situated, by way of permissible use on license basis as incidental to using the said looms and machinery is covered by the term “any kind of property” and is therefore a capital asset. Amount received on surrender of such right is chargeable to tax under the head Income from Capital Gains and not Income from Other Sources. Amount received by Licensees who are deemed to be tenants u/s. 15A of the Bombay Rent, Hotel & Lodging and House Rates Control Act, 1947, by virtue of amendment in 1973, on surrender of such license/tenancy is chargeable to tax under the head Income from Capital Gains.

Facts:

The assessee, a partnership firm, through its partners entered into an agreement dated 13.6.1972 with Modern Textile Rayon and Silk Mills Pvt. Ltd. (Modern) whereby it took on license basis, for a period of one year, loom and machinery described in first schedule of the said agreement on a monthly compensation of Rs. 3,250 per month. Modern was the tenant of the shed belonging to Mr. Paresh S. Shah. This agreement referred to the assessee as licensee. The assessee was entitled to use a portion of the shed in which the looms were situated by way of permissible use on license basis only as incidental to using the said looms and machinery. The agreement provided that the assessee shall never be construed as sublessee in any form of the said portion of the said shed. The assessee was also provided with access to the said portion of the said shed through portion of the shed retained by the licensors or otherwise. Thus, as per the agreement the assessee had incidental right of premises through which the looms were to be used. The said right of the assessee was recognised from the date of the agreement till the date of its surrender.

The assessee regarded this right as sub-tenancy and in the return of income filed the amounts received on surrender thereof were offered for taxation under the head Income from Capital Gains after claiming exemption u/s. 54EC of the Act.

The Assessing Officer after going through various clauses of the agreement dated 13.6.1972 came to the conclusion that the assessee was not a sub-tenant of the land which had been sold by the owner thereof but only had an incidental right to use the shed and that the amounts received are not assessable as capital gains. He also examined the purchasers of the said land who mentioned that only Modern and M/s Saurdeep Chemicals Pvt. Ltd were tenants of the land purchased by them. However, actual possession and occupation was held by the assessee and payments have been made to the assessee in order to get peaceful and vacant possession of the property. The AO observed that the payment received was in the nature of nuisance value and assessee did not have any capital right since the possession of portion of the shed was incidental to the license granted to it for use of machinery. The amount received was assessed to tax under the head Income from Other Sources.

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

Held:

The Tribunal noted that the incidental right to use the premises was provided by the agreement dated 13.6.1972 itself and also that the assessee was referred to as the licensee in the said agreement. By an amendment in 1973, which is subsequent to the date of the agreement entered into by the assessee, certain licensees have been deemed to be tenants u/s. 15A of the Bombay Rent, Hotel & Lodging and House Rates Control Act, 1947 and were to be considered as tenants. Therefore, in any case the assessee had acquired the status of tenant of the landlord. As per provisions of section 55(2) tenancy right has been considered to be a capital asset. Moreover, the definition of capital asset as per section 2(14) of the Act is wide enough to cover “property of any kind” and the type of right acquired by the assessee in the property used by it cannot in any manner be said to be less than “any kind of property” held by the assessee.

The Tribunal also observed from some of the rent receipts filed by the assessee before the Tribunal that the amount being paid by the assessee was considered to be rent by the other parties and thus parties in principle had accepted that the assessee was the tenant from whom the rent was being received by the other party. The further correspondence between the assessee and its licensor, the purchaser of the land and the assessee are also describing the right of the assessee as tenancy right only and the deed executed between purchaser of the premises and the assessee is also described as deed of surrender of tenancy. Thus, the assessee was enjoying a right over the property in the nature of being tenant of the same for the last so many years and that right of the assessee cannot be considered as evaluated much less than the right of tenancy right.

The assessee, in fact, was enjoying the possession of the impugned property and for peaceful vacation thereof it had received the impugned amount which was described by both the parties as the amount paid for surrender of tenancy rights. The assessee had acquired the said right long back and licensor to the assessee also had recognised the said right of the assessee. The right of the assessee was undisputed and nature thereof was “property of any kind” which was held by the assessee and was to be termed as capital asset within the meaning of section 2(14) of the Act. Tenancy right has also been recognised as capital asset within the meaning of section 55(2)(a) of the Act.

The tribunal held that the amount received by the assessee is assessable as capital gains and not as income from other sources. The appeal filed by the assessee was allowed.

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Nirav Shah

Chandrakant K. Shah v. ITO ITAT Mumbai `C’ Bench Before Dinesh Kumar Agarwal (JM) and B. Ramakotaiah (AM) ITA No. 4913/Mum/2011 A.Y.: 1993-94. Dated: 17-10-2012. Counsel for assessee/revenue: Aasifa Khan/ Rajarshi Dwivedy

8. Chandrakant K. Shah v. ITo
ITAT Mumbai `C’ Bench
Before Dinesh Kumar Agarwal (JM) and B.
Ramakotaiah (AM)
ITA No. 4913/Mum/2011
A.Y.: 1993-94. Dated: 17-10-2012.
Counsel for assessee/revenue: Aasifa Khan/ Rajarshi Dwivedy

Section 234B – At the time of passing an order giving effect to order of ITAT, interest u/s. 234B is to be computed on tax on total income finally determined under regular assessment as reduced by the amount of TDS and self assessment tax. Interest u/s. 234B cannot be levied on amount of interest chargeable u/s. 234A and 234C.

Facts:

The assessee filed its return of income declaring income of Rs. 1,51,351. The Assessing Officer (AO) vide order passed u/s. 143(3) of the Act assessed the total income of the assessee to be Rs. 15,93,220. After giving effect to the order of ITAT, the total income was determined at Rs. 14,41,074 as per order dated 28.11.2006 giving effect to the order of ITAT. The AO while charging interest u/s. 234B calculated interest @ 2% per month for 19 months on Rs. 8,44,797 (i.e. Rs 5,63,906 amount of tax worked out after giving credit of TDS and self assessment tax (+) Rs. 1,09,440 amount of interest charged u/s. 234A (+) Rs. 1,70,230 amount of interest u/s. 234B up to 15.5.1994 and Rs 1221 amount of interest charged u/s. 234C). According to the assessee, the interest u/s. 234B was chargeable only on Rs 5,63,906 which is amount of tax worked out after giving credit of TDS and self assessment tax. Thus, according to the assessee interest u/s. 234B worked out to Rs. 2,14,284 as against Rs. 8,44,797 charged by the AO. The assessee filed an application u/s. 154 of the Act objecting that interest charged u/s. 234B is not correctly computed.

The AO rejected the claim of the assessee vide order dated 15.4.2010. Aggrieved, the assessee preferred an appeal to the CIT(A) who held that the AO had rightly rejected the appellant’s request for rectification of amount of interest charged u/s. 234B of the Act.

Aggrieved, the assessee preferred an appeal to the Tribunal.

Held:

The Tribunal noted that the there is no dispute that the interest u/s. 234B is leviable. The dispute was on the amount on which interest u/s. 234B is leviable. Having noted the provisions of section 234B of the Act, the Tribunal held that in the facts of the assessee’s case, interest u/s. 234B for the relevant period is chargeable @ 2% per month for 19 months on the amount of Rs. 5,63,906 worked out after giving credit of TDS and self assessment tax.

The Tribunal directed the AO to verify the amount of interest calculated by the assessee as mentioned hereinabove and if he finds that the same is in order, reduce the levy of interest u/s. 234B accordingly. The appeal filed by the assessee was allowed.

Compiler’s Note: Though not mentioned in the order, it appears that 15.5.1994 was the date of filing of return by the assessee.

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Nirav Shah

Shri Rumi K. Pali v. Dy CIT ITAT Mumbai `D’ Bench Before D. Manmohan (VP) and N. K. Billaiya (AM) ITA No. 7314/Mum/2011 A.Y.: 2008-09. Dated on: 17-10-2012. Counsel for assessee/revenue: Reepal Tralshawala/A B Koli

7. Shri Rumi K. Pali v. Dy CIT
ITAT Mumbai `D’ Bench
Before D. Manmohan (VP) and N. K. Billaiya (AM)
ITA No. 7314/Mum/2011
A.Y.: 2008-09. Dated on: 17-10-2012.
Counsel for assessee/revenue: Reepal Tralshawala/A B Koli

S/s 10(11) – ITAT can consider a new deduction which, inadvertently, was not claimed in the return filed by the assessee. Assessee is entitled to claim interest on PPF to be exempt even though the same was not claimed in the incometax return.

Facts:

The assessee in the return of income filed, which return of income was revised on two occasions, as well as in the two revised returns filed by him offered for taxation under the head Income from Other Sources, Rs 3,81,565 being interest on PPF. The Assessing Officer (AO) completed the scrutiny assessment by accepting the returned income.

In an appeal to CIT(A), the assessee contended that he should be allowed exemption in respect of interest on PPF deposit u/s. 10(11) of the Act. The CIT(A), relying on the decision of the Apex Court in the case of Goetze India Ltd. (284 ITR 323) held that no fresh claim can be made by the assessee. He dismissed the appeal filed by the assessee.

Aggrieved, the assessee preferred an appeal to the Tribunal where on behalf of the assessee, it was contended that a statutory claim can be made at any stage; mistake which has crept in the income-tax return was inadvertent; and the assessee cannot be put in a position so as to be taxed on something which he is not legally bound to. Reliance was also placed on the decision of Bombay High Court in the case of CIT v Pruthvi Brokers & Shareholders Pvt. Ltd. (ITA No. 3908 of 2010).

Held:

The Tribunal noted that the assessee failed to claim interest on PPF deposits as exempt from tax even in the revised returns and the impugned amount of interest is exempt from tax u/s. 10(11) of the Act. It noted that the Supreme Court, in the case of National Thermal Power Company Ltd. v CIT 229 ITR 383 (SC), has observed that even if a claim is not made before the AO, it can be made before the Appellate authority. It also noted that the decision of the Bombay High Court on which assessee has placed reliance, having considered the decisions of the Supreme Court in the case of Goetze India Ltd. (supra) and also National Thermal Power Company Ltd. v CIT (supra), held as under:

“The jurisdiction of the appellate authorities to entertain such a claim has not been negated by the Supreme Court in this judgment. In fact, the Supreme Court made it clear that the issue in the case was limited to the power of the assessing authority and that the judgement does not impinge on the power of the Tribunal u/s. 254.”

Following the above mentioned decision of the Bombay High Court, the Tribunal directed the AO to allow exemption of interest on PPF deposit at Rs. 3,81,565. The appeal filed by the assessee was allowed.

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Nirav Shah

Accident claim — Legal representative — Married daughter — Motor Vehicles Act, section 166.

(Smt. Joy Minocha & Ors. v. Vijay Kumar & Ors., AIR 2011 Chhattisgarh 166)

The appellant No. 1 Smt. Joy Minocha was daughter of deceased persons Naresh Arora and Smt. Bharti Arora. The other appellants are minor children of the appellant No. 1. The deceased persons had expired in a road accident. The appellant along with the minor children being legal heirs had filed petition for compensation. The Tribunal dismissed the claim petition on the ground that the appellant No. 1 was married daughter of the deceased persons, therefore not entitled to receive any compensation.

The question that arose before the High Court was whether any compensation is payable where the claim is filed by legal representatives of the deceased who were not dependent on them?

The Court observed that the expression ‘Legal Representative’ had not been defined in the Motor Vehicles Act or the Rules made thereunder. However, it has been defined in s.s (11) of section 2 of the Code of Civil Procedure, 1908 which reads as under:

‘Legal representative’ means a person who in law represents the estate of a deceased person, and includes any person who intermeddles with the estate of the deceased and where a party sues or is sued in a representative character the person on whom the estate devolves on the death of the party so suing or sued;’

Almost in similar terms is the definition of ‘legal representative’ u/s.2(1)(g) of the Arbitration and Conciliation Act, 1996.

The Court relying on the decision of Smt. Manjuri Bera v. Oriental Insurance Company Ltd., AIR 2007 SC 1474, observed that the right to file claim application has to be considered in the background of right to entitlement. Further section 166 of the Motor Vehicles Act corresponds to section 110 of the Motor Vehicles Act, 1939 (old Act). It provides that an application for compensation may be made by all or any of the legal representatives of the deceased in case where death has resulted from the accident.

In view of the above it was held that though there is no loss of dependency, yet the claimants being legal representatives are entitled to inherit the estate of the deceased persons, therefore, in the facts of the present cases, the appellants were entitled to receive compensation under no fault liability in terms of section 140(2) of the Act. Hence the claim petitions was maintainable as filed by the legal representatives of the deceased.

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Nirav Shah

COMPANIES BIL, 2011 Provisions relating to Accounts and Audit

The Companies Bill, 2009, was introduced in the Lok Sabha on 3rd August, 2009. It was referred to the Standing Committee of Finance which submitted its report on 31st August, 2010. After consideration of the recommendations of the Standing Committee and suggestions of various chambers of commerce, professional bodies and others, the Government has made changes in the original bill and now introduced a revised Companies Bill, 2011, in the Lok Sabha on 14th December, 2011. This Bill will replace the 55-year-old Companies Act, 1956 (existing Act). The new Bill proposes to introduce far-reaching changes which will have impact on the registration of companies, management and administration of companies, shareholder’s rights, director’s responsibilities, maintenance of accounts and audit of companies and other provisions relating to mergers, acquisitions, winding up of companies, etc. The new Bill is divided into 29 Chapters and contains 470 sections and 7 Schedules. The new Bill is likely to be considered and adopted in the Budget session of the Parliament in March, 2012 and may come into force on the date to be notified by the Government. In this article, some important provisions in the new Bill relating to Accounts and Audit are discussed.

2. Accounts of companies

Sections 128 to 138 deal with accounts to be maintained by all companies. It is provided in section 128 that every company shall maintain books of accounts on mercantile system of accounting. These provisions are on the same lines as provisions in section 209 of the existing Act. At present, a company can adopt any accounting year for maintaining its accounts. It is now provided that all companies will have to follow uniform accounting year ending 31st March of every year. The existing companies which are following different accounting years will have to comply with the new provisions within a period of two years from the date when the Companies Act, 2011, comes into force. Exemption from this provision can be claimed by obtaining permission of the National Company Law Tribunal (Tribunal) in respect of foreign subsidiary companies which are required, by the laws of the foreign countries, to adopt different accounting year.

3. Financial statements

3.1 Section 129 provides that every company has to prepare financial statements for each accounting year and place them before the Annual General Meeting of the company. The term financial statements has been defined to include Balance Sheet, Profit and Loss A/c. or Income & Expenditure A/c., Cash Flow statement, A statement of changes in equity and notes to accounts. These financial statements have to comply with Accounting Standards prescribed by the Government as provided in section 133. If the company has one or more subsidiary companies, associate companies or joint ventures, the financial statements of these companies and joint ventures will have to be consolidated and these consolidated financial statements will also be required to be placed before the General Meeting. Further, such a company is also required to attach with the financial statements a statement of salient features of the subsidiaries including associates and joint ventures in the prescribed manner. The Government has power to notify any class of companies to which these provisions will not apply.

3.2 Every company will have to prepare financial statements every year in the Form given in Schedule III. This Schedule gives forms of Balance Sheet, Statement of Profit and Loss and General Instructions for preparation of Consolidated Financial Statements. This Form of Balance Sheet and Statement of Profit and Loss is similar to present Schedule VI as revised from 1-4-2011. The above financial statements have to be approved by the Board of Directors. The procedure for adoption of these statements is similar to section 215 of the existing Act.

4. Reopening of accounts

4.1 This is a new provision. At present, there is no provision to reopen the accounts of the company. Section 130 now provides that if any Court or Tribunal passes an order that accounts for any accounting year have been prepared in a fraudulent manner or the affairs of the company were mismanaged and there is a doubt about reliability of financial statements, the accounts of that year shall be reopened. Before passing such order the Court/Tribunal shall invite comments from the Government and the Income-tax Department. If the financial statements are revised by the company as per the above order, such statements shall be final.

4.2 Section 131 provides that it is also possible for the Board of Directors to revise the financial statements or the report of Board for any of the three previous financial years if they find that these statements and/or report are not in accordance with the requirements of sections 129 to 134. For this purpose, the Board will have to take the approval of the Tribunal. Before giving such approval the Tribunal has to give notice to the Government and the Income-tax Department and invite their comments. Such revision of accounts can be made only once in a financial year. The Board will have to give detailed reasons for such revision of financial statements in its report to the members. Copies of the revised financial statements or Board Report will have to be sent to the members of the company and the Registrar of Companies. The revised financial statements will have to be approved by the members in General Meeting.

4.3 The Government is authorised to make Rules about the form in which application is to be made to the Tribunal for this purpose. These rules will also provide about the role of the company’s Auditors about their report on the accounts audited by them. The Directors have also to take such steps as may be provided in these rules.

5. Accounting and auditing standards

5.1 At present, the accounting standards to be followed by companies are formulated by the Institute of Chartered Accountants of India (ICAI). The Government has appointed a National Advisory Committee on Accounting Standards. This Committee examines these standards and makes recommendations to the Government. Thereafter, the Government notifies the accounting standards to be adopted by companies in the preparation of financial statements. So far as auditing standards are concerned, they are issued by ICAI and auditors have to follow these standards for conducting the audit of companies.

5.2 New sections 132, 133 and 143 give very wide powers to the Government to notify the accounting and auditing standards and to take action against the auditors who do not comply with these requirements. These provisions are as under.

(i) Section 132 provides that the Government will appoint a National Financial Reporting Authority (NFRA) for formulation of accounting and auditing standards and for enforcement of these standards. The NFRA will have a chairman and 15 members who will be appointed by the Government. For this purpose, the Government will notify the detailed rules and procedure.

(ii) The Government will notify the accounting standards as recommended by ICAI in consultation with NFRA u/s.133.

(iii) Similarly, the Government will notify the Auditing Standards as recommended by ICAI in consultation with NFRA u/s.143. This will mean that the present authority of ICAI to formulate auditing standards will now be taken over by the Government.

(iv) NFRA has been given powers to monitor and enforce compliance with the accounting and auditing standards, oversee the quality of professional services of auditors and suggest measures to make improvement in such services.

v) NFRA can investigate about the professional or other misconduct of Chartered Accountants, Cost Accountants and Company Secretaries in practice while rendering professional services to any company and take disciplinary action against the members or firms rendering such services. Once NFRA starts disciplinary proceedings against any member or firm, the respective Institutes cannot take any action against such member or firm. This particular provision will mean that the powers of the three Institutes of Chartered Accountants, Cost Accountants and Companies Secretaries to take disciplinary action against their members in such matters will be transferred to this NFRA appointed by the Government.

vi) NFRA has been given powers of a civil court for conducting this investigation. For the purpose of deciding whether there is professional or other misconduct on the part of the member or firm, it is provided that the items listed in section 22 of the Act governing the three Institutes will apply.

vii) If a member or a firm is found guilty of professional or other misconduct, the NFRA has power to

a) impose a minimum penalty of Rs. one lac on the Individual member and a minimum penalty of Rs.10 lacs on the firm, and

b) debar the member or the firm from professional practice for a minimum period of six months or for such higher period up to 10 years.

viii) Any member or firm aggrieved by the above order of the NFRA can file appeal before the Appellate Authority constituted u/s.22A the
Acts governing the three Institutes.

ix) The detailed provisions are made in section 132 for day-to-day administration of the NFRA, its accounts, audit, etc.

6. Report of the Board of Directors

Section 134 provides that the Board of Directors of a company shall adopt the financial statements for each financial year and get the auditors report on the accounts. The Board has to prepare its report to the members every year and submit to the members at the Annual General Meeting along with the financial statements and audit report. The report of the Board should contain the information as required under the existing Act as well as some additional items as under.

i) Statement of declaration given by Independent Directors u/s.149(6).

ii) In the case of a listed company or any other company as specified by the Rules as provided in section 178(1), the company’s policy on director’s appointment and remuneration, criteria for determining qualifications, positive attributes, independence of directors, etc.

iii) Particulars of loans, guarantees or investments in subsidiaries as provided in section 186.

iv) Particulars of contracts or arrangements with related parties as stated in section 188.

v) A statement indicating development and implementation of risk management policy for the company which in the opinion of the Board may threaten the existence of the company.

vi) Details about policy developed and implementation of corporate social responsibility policy.

vii) In the case of listed and other specified companies a statement indicating formal annual evaluation made by the Board about its performance and of its committees and Independent Directors.

viii) Such other matters as provided in the Rules notified by the Government.

6.2 The Board has to send the financial state-ments with Audit Report, Directors report, etc. to each member before the Annual General Meeting. The Meeting should be held within six months of close of financial year i.e., before 30th September every year. These provisions are more or less on the same lines as existing provisions. These statements and reports have to be filed with the Registrar of Companies in the same manner as at present.

7. Internal audit

This is a new provision. At present, the Internal Audit can be conducted by the company’s staff. Now section 138 provides that such class or classes of companies as may be prescribed, the Board of Directors will have to appoint a Chartered Accountant, Cost Accountant or other professional for carrying out Internal Audit. For this purpose, the Government is authorised to make Rules as to how this audit should be conducted.

8. Corporate social responsibilities

8.1 This is a new provision made in section 135. This section applies to every company having net worth of Rs.500 crore or more or turnover of Rs.1000 crore or more or a net profit of Rs.5 crore or more during any financial year. The Board of such a company has to constitute a corporate social responsibility committee consisting of 3 or more directors of which one should be an Independent Director. The Board Report to the members should disclose the details of composition of this committee.

8.2 The functions of this committee shall be as under:

i) To formulate and recommend to the Board a Corporate Responsibility Policy giving details of activities in the fields listed in Schedule VII.

ii) To recommend about the expenditure to be incurred for these activities.

iii) To supervise the implementation of this policy.

8.3 The Board has to consider the recommendations of this committee and formulate the policy for such expenditure every year. The Board should make all efforts to spend at least 2% of the average profits of the preceding 3 years for this purpose. If the Board is not able to spend this amount it will have to give reasons for not spending the same.

8.4 The type of activities for which the company has to spend for its social responsibilities, as listed in Schedule VII, are as under:

i) Eradicating extreme hunger and poverty.

ii) Promotion of education, gender equity, empowerment of women, reducing child mortality and improving maternal health.

iii) Combating HIV, AIDS, malaria and other diseases.

iv) Ensuring environment sustainability.

v) Enhancing vocational skills and social business projects.

vi) Contribution to P.M. National Relief Fund or any other fund set up by Central or State Governments for social development and relief work, welfare of SC, ST and backward classes, minorities and women.

9. Audit of accounts of companies

Sections 139 to 148 deal with provisions for audit of accounts of companies and auditors. Every company is required to get its accounts audited for each financial year from a Chartered Accountant or a Firm of Chartered Accountants. For this purpose, ‘Firm’ will include a Limited Liability Partnership (LLP) engaged in the profession as Chartered Accountants. U/s.139, the first auditor can be appointed by the Board of Directors. At present, auditors are appointed by the members at the Annual General Meeting every year. Now, at the annual general meeting the members have to appoint auditors for a term of 5 years. Thereafter, on expiry of every 5 years, the members have to appoint auditors for a further term of 5 years. It is also provided in section 139 that the members will have to follow the procedure for selecting the auditors as per the Rules which will be notified by the Government. The company has to file the notice of appointment of auditors within 15 days with the Registrar of Companies.

10. Rotation of auditors

10.1 In the case of listed companies and such class or classes of companies as may be prescribed a new provision is made in section 139(2) for rotation of auditors. This provision is as under:

i) An Individual auditor shall not be appointed for more than 5 consecutive years.

ii) A firm of auditors shall not be appointed for more than 10 consecutive years.

iii) The auditors who have completed the above term, cannot be reappointed as auditors of that company for a period of 5 years. This restriction for reappointment shall apply to the audit firm which is to be appointed after completion of the above term to any audit firm in which one or more partners are partners in the firm which has completed its term as stated above.

iv) In respect an existing company to which this provision applies it is provided that such company shall comply with the above provision within 3 years from the date of commencement of the Companies Act, 2011.

v) Members of the company can resolve that the firm of auditors appointed by them shall rotate the audit partner and his team every year or the members may decide to appoint two or more audit firms as auditors of the company.

vi) The Government may frame rules about the manner in which the companies shall rotate the auditors.

10.2 As regards Government companies the procedure for appointment and removal of auditors by C & AG is the same as existing at present. The provisions relating to appointment of another auditor in the case of casual vacancy in the office of auditor due to resignation, death, etc. are more or less the same as existing at present.

11. Removal of auditors

11.1 The auditor of a company once appointed can be removed before expiry of his term by passing a special resolution after obtaining previous approval of the Government as provided in the rules. If the auditor submits his resignation before the expiry of his term of office, he has to file within 30 days a statement in the prescribed form about the reasons and other facts relevant to whis resignation with the company and the ROC. If this statement is not filed by the auditor he can be penalised by levy of minimum fine of Rs.50,000 which may extend up to maximum of Rs.5 lac.

11.2 On the expiry of the term of the appointment of the auditor, the retiring auditor is to be appointed if he is eligible for this purpose. If the members desire to appoint another person as auditor in his place, special notice from a member is required for this purpose. The procedure to be followed by the company is similar to the existing provisions for appointment of another auditor in place of retiring auditor.

12. Penal provisions

Section 140(5) gives very wide powers to the Tribunal to take action against the auditor or the audit firm. It is provided in this section that if the Tribunal is satisfied on its own, or on an application by the Government or any person that the auditor of a company has acted in a fraudulent manner or assisted in any fraud by the company, its directors or officers, it can order the company to change the auditor. Further, if the Government makes an application to the Tribunal, and it is satisfied, the Tribunal can pass an order within 15 days that the auditor of the company shall not function as auditor and the Government shall, thereafter, appoint another auditor in place of the auditor so removed. It is also provided that if any final order is passed by the Tribunal against the auditor u/s.140, such auditor will not be eligible for appointment as auditor of any company for 5 years. Further, section 447 provides that if found to be guilty of fraud he shall be punishable with imprisonment for a minimum period of six months which may extend up to 10 years. If the fraud involves public interest, the minimum period of imprisonment shall be 3 years. Apart from this punishment, such auditor shall also be liable to pay minimum fine equal to the amount of the fraud which may extend up to three times of the fraud amount.

13. Qualifications of auditors

13.1 Section 141 provides that only Chartered Accountants can be appointed as auditors of a company. A firm of Chartered Accountants or LLP engaged in the practice as Chartered Accountants can also be appointed as auditors.

13.2 It is, however, provided that the following persons cannot be appointed as auditors of a company:

i) A Body Corporate other than LLP.

ii) An officer or an employee of the company or a person who is a partner or who is in employment of the officer or employee of the company.

iii) A person (including his relative or his partner) who (a) holds any security or interest in the company, its subsidiary, its holding or its associate company, etc. It may be noted that if such security or interest is less than Rs.1,000 or such sum as may be prescribed by rules, this provision will not apply. (b) is indebted to or who has given guarantee for any debt in relation to the company, its subsidiary, its holding company or its associate company of such amount as may be prescribed.

iv) A person or a firm has business relationship with the company, its subsidiary, its holding or its associate company directly or indirectly.

v) A person who is relative of a director or is in the employment of the company as a director or key managerial personnel.

vi) A person who is convicted by any Court of an offence involving fraud, and a period of 10 years has not elapsed from the date of such conviction.

vii) Any person, firm or its associate is engaged on the date of appointment in consulting and specified services as provided in section
144.

13.3 A person who is an employee of any other organisation cannot be appointed as auditor of a company. Further, the auditor should not be auditor of more than the specified number of companies as provided by the rules to be framed by the Government.

14. Remuneration of auditors and other functions

The remuneration of the auditors of a company shall be fixed in its General Meeting or shall be determined in such a manner as may be decided by General Meeting. As regards powers and duties of the auditors and the reporting requirements, the provisions are contained in section 143 which are more or less similar to section 227 of the existing Act. It is also provided that every auditor shall comply with the auditing standards as notified by the Government. The Government is also given authority to pass an order specifying the matters on which the auditors have to report. Such order can be passed in consultation with the NFRA appointed u/s.132. If the auditor of a company finds that an offence involving fraud has been committed against the company by officers or employees of the company he has to report to the Government within such time and in such manner as may be prescribed by rules. The above provisions apply even to a Cost Accountant in practice relating to cost audit of a company u/s.148 as well as to the Company Secretary in practice conducting secretarial audit u/s.204.

15. Consultancy services

15.1 Section 144 is a new section in which it is provided that the auditors of a company can render such other services as are approved by the Board of Directors or the Audit Committee. It is, however, provided that such services shall not include:

i. Accounting and book-keeping services.

ii. Internal audit.

iii. Design and implementation of any financial information system.

iv. Actuarial services.

v. Investment advisory, investment banking or any other financial services.

vi. Management services.

vii. Any other services as may be prescribed by rules.

15.2 It is clarified in this section that the above services cannot be rendered to the company either directly or indirectly by the auditors of the company. In the case of an individual auditor or an audit firm, such services cannot be rendered by any relative or any other partners or by any of the associate concerns in which the auditors have significant influence or control or whose name or trade mark or brand is used by the auditor or audit firm or any of the partners of the audit firm.

16. Punishment for contravention

If the auditors of a company contravene the provisions of sections 143 to 145, the auditors shall be punishable with a minimum fine of Rs.25,000 which may extend up to Rs.5 lac. It is further provided that if the auditor has contravened these provisions with the intention to deceive the company or its shareholders or creditors or other persons interested in the company, he shall be punishable with imprisonment for a term which may extend up to one year or with a minimum fine of Rs.1 lac which may extend up to Rs.25 lac. Further, the auditor is also liable to refund the remuneration received by him and pay for damages to the company or other person for loss arising out of incorrect or misleading statement made in the audit report.

17. Some suggestions

17.1 The above provisions relating to accounts and audit contained in the Companies Bill, 2011, will have far-reaching impact on the companies and auditors. It appears that these provisions are being made with a view to curb the present-day tendency on the part of some companies to manipulate accounts with a view to benefit those in management or with a view to reduce tax. Some of these provisions are harsh and they are likely to affect the development of the profession of Chartered Accountants.

17.2 At present, the National Advisory Committee of Accounting Standards (NACAS) is working satisfactorily. There is no need to replace this body by appointment of NFRA. Further, the provisions of sections 132 and 133 giving wide powers to this authority to regulate the auditing profession cut at the very root of autonomy conferred on ICAI which is set up by an Act of the Parliament. It is, therefore, suggested that the existing advisory body viz. NACAS should not be replaced by NFRA.

17.3 Further, ICAI is the only competent authority to issue auditing standards for members of C.A. profession. Therefore, provisions in section 143(10) giving power to the Government to notify the auditing standards will curtail the autonomy given to ICAI under the C.A. Act.

17.4 Section 139(2) provides for maximum limit of 10 years for an audit firm to continue as auditors of any listed or large specified companies. Thereafter, there is a cooling period of 5 years. When this provision is made there is no need of again providing in section 139(4) that the Government can notify the rules for rotation of auditors in cases of such companies.

17.5 The provisions of section 140 for removal of auditors and punishment of erring auditors as discussed in para 11 and 12 above are very harsh and apply to auditors of all companies. It is suggested that these provisions should be restricted to only auditors of listed and large specified companies.

17.6 Similarly, provisions of section 147 providing for punishment and fine as discussed in para 16 above also apply to auditors of all companies. These provisions should be made applicable to only auditors of listed and large specified companies.

17.7 The provisions of section 144 prohibiting auditors from rendering certain consultancy services apply to all companies. This will hamper the development of C.A. profession. It is, therefore, suggested that section 144 should be made applicable to listed and large specified companies only.

17.8 If the present Companies Bill is passed in its present form it will curtail the autonomy of ICAI in relation to issue of auditing standards and disciplinary matters. Further, considering the additional responsibilities being thrust on the auditors it appears that small and medium-size audit firms will find it difficult to continue in audit practice. This will affect the development and progress of auditing profession in India.

Whoever fights monsters should see to it that in the process he does not become a monster.
— Friedrich Nietzsche

Nirav Shah

2012-TIOL-703-ITAT-KOL Sri Raajkumar Jain v ACIT A. Y.: 2004-05. Dated: 07-09-2012

20. 2012-TIOL-703-ITAT-KoL
Sri Raajkumar Jain v ACIT
A. Y.: 2004-05. Dated: 07-09-2012

S/s 263, 271(1)(c) – An order sheet entry dropping the penalty which was never communicated to the assessee can be construed as an order to take up action u/s. 263. What the CIT himself cannot do, he cannot get it done through the assessing authority by exercising revisional powers.

Facts:

There was a search and seizure operation in the case of Sri Gopal Lal Badruka and M/s Ahura Holdings on 26.7.2006, a copy of an agreement for sale deed dated 26.8.2003 was found, according to which the assessee had entered into an agreement for purchase of plot admeasuring 1529 sq. yards @ 11570 per sq. yard from M/s Ahura Holdings. The total sale consideration worked out to Rs. 1,79,65,750. In the registered sale deed the sale consideration was mentioned as Rs. 56,20,000 which worked out @ Rs 4000 per sq. yard. During the assessment proceedings in the case of M/s Ahura Holdings, Sri Gopal Lal Badruka had confirmed that he had received entire consideration of Rs. 1,65,08,750 from the assessee for 1405 sq. yards @ 11750 per sq. yard. As the difference of Rs. 1,08,88,750 between amount admitted to have been received by Sri Gopal Lal Badruka and the amount mentioned in the registered sale deed, represents the assessee’s unaccounted purchase consideration of plot from M/s Ahura Holdings for the AY 2004-05, the AO issued notice u/s. 148. In response thereto, the assessee filed revised return admitting additional income of Rs. 1,08,88,750. The assessment was completed u/s. 143(3) r.w.s. 147 on 28.4.2010. The AO initiated penalty proceedings for concealment of income u/s. 271(1)(c) of the Act.

The AO after considering the submissions made by the assessee dropped the penalty proceedings u/s 271(1)(c) by order sheet noting as follows:

“The assessee filed a detailed explanation in response to the notice u/s. 271(1)(c) of the Act read with section 274. Considering the facts and circumstances of the case and in the light of the explanation filed, the penalty proceedings initiated u/s. 271(1)(c) of the Act are dropped.”

The CIT invoking his jurisdiction u/s. 263 of the Act held that the dropping of penalty proceedings u/s. 271(1)(c) is erroneous and prejudicial to the interest of the revenue. Aggrieved, the assessee preferred an appeal to the Tribunal.

Held:

Even an order sheet entry as to be considered as an order in view of the judgment in the case of H H Rajdadi Smt. Badan Kanwar Medical Trust v CIT (214 ITR 130)(Raj). On merits, the Tribunal noted that the additional income was offered in revised return only on evidence found in search and on the basis of the statement of acceptance of the transaction by Sri Gopal Lal Badruka of M/s Ahura Holdings. The Tribunal noted that the reply given by the assessee was considered by the AO and his conclusion is based on the explanation offered by the assessee and he has taken one possible view. If the CIT is not agreeable with that proposal he cannot say that the order of the AO is erroneous and prejudicial to the interest of the revenue. Levy of penalty is a quasi criminal proceeding. The AO must have enough material to prove that there is concealment of income or furnishing of inaccurate particulars of income. He cannot presume that there is concealment or furnishing of inaccurate particulars. The Gujarat High Court has in the case of CIT v Parmanand M. Patel (278 ITR 3) held that the CIT is not empowered to record satisfaction by invoking section 271(1)(c) of the Act and if he is not entitled to do so, on his own, he cannot do it by directing the assessing authority. The Court observed that in other words, what the CIT himself cannot do, he cannot get it done through the assessing authority by exercising revisional powers. Considering these observations, the Tribunal vacated the direction of the CIT to AO to levy penalty u/s 271(1)(c) of the Act.

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Nirav Shah

2012-TIOL-771-ITAT-KOL DCIT v Rajeev Goyal A.Y.: 2007-08. Dated: 01-06-2012

19. 2012-TIOL-771-ITAT-KoL
DCIT v Rajeev Goyal
A.Y.: 2007-08. Dated: 01-06-2012

S/s 2(31), 54EC, 64(1A) – In a case where the income of minor child is clubbed with the income of the assessee u/s. 64(1A), the assessee is eligible for separate deduction u/s 54EC of the Act on investment in specified bonds on account of minor’s income being long term capital gains. Prior to insertion of proviso to section 54EC, for the purpose of section 54EC, the investment is limited to Rs 50 lakh in respect of a person and not in respect of an assessee. Minor child being a separate person, investment in the name of minor child, whose income is to be clubbed in the hands of the assessee, is eligible for separate limit of investment prior to insertion of proviso to section 54EC.

Facts:

During the previous year, the assessee and his two minor children sold shares which resulted in long term capital gains. The assessee invested Rs 50 lakh in bonds qualifying for deduction u/s 54EC of the Act. He also invested Rs. 49.50 lakh and Rs. 39.50 lakh in the names of two minor children. In the return of income filed, the assessee included total income of two minor children after claiming separate deduction for investment made in bonds, qualifying for deduction u/s. 54EC, in the names of the respective minor children. Thus, total deduction claimed u/s. 54EC was Rs. 139 lakh.

The Assessing Officer, relying upon Notification No. 380/2006 dated 22.12.2006, restricted the deduction u/s. 54EC to Rs 50 lakh.

Aggrieved, the assessee preferred an appeal to CIT(A) who allowed the appeal of the assessee. Aggrieved, the revenue preferred an appeal to the Tribunal.

Held:

Section 54EC provides that capital gain is not to be charged to tax if net consideration is invested in certain bonds. Therefore, investments made in certain bonds shall be outside the scope of capital gain for the purpose of computation of total income itself. It is not a deduction under Chapter VI-A which comes into picture only after computing the total income and the deductions are being allowed from gross total income as per section 80A(1).

There is a difference between the word `assessee’ and the word `person’. The notification on which the AO relied upon has not put any embargo on investments by an assessee but the embargo is on allotment of the bonds to a `person’ and such embargo is on the allotting authority. The bonds have been allotted to the three persons as per the notification itself and the assessee is entitled to the benefits as per provisions of section 54EC under which restriction has been put only for investments from 1.4.2007.

The Tribunal noted that the ratio of the decision of Mumbai Tribunal in the case of JCIT v Govind Rohira alias Srichand Rohra 95 ITD 77 (Mum) and also other decisions of the High Courts is that even if the income of the minor is clubbed with the income of the other individual, all the deductions are to be allowed while computation of income of the minor /spouse and only the net taxable income is to be clubbed u/s. 64.

The Tribunal allowed the claim of the assessee and directed the AO to re-compute the long term capital gains accordingly.

The appeal filed by the revenue was dismissed.

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Nirav Shah

(2011) 132 ITD 296 (Del) Mrs. Maninder Sidhu vs. ACIT A.Y.: 2004-05. Dated: 09-04-2010

18. (2011) 132 ITD 296 (Del)
Mrs. Maninder Sidhu vs. ACIT
A.Y.: 2004-05. Dated: 09-04-2010

Section 271(1)(c) – Set off long term capital loss against short term capital gain wrongly claimed by assessee – Withdrew the claim during course of assessment- Revenue did not prove or show falsity of facts as disclosed by assessee in computation of income – In fact revenue accepted computation of capital loss and gain – Assessee under bonafide belief that set off is allowed – in absence of any proof of falsity of facts in computation of income as submitted by assessee, penalty not to be leviedwrong claim is to be distinguished from false claim.

Facts:

The assessee had incurred long-term capital loss and short term capital gain. The loss was adjusted against the gain. However, after issue of notice u/s. 143(2), the claim of the adjustment was withdrawn in the course of hearing. Assessee explained that the adjustment was a mistake made while preparing the return. However, the AO initiated penalty proceedings u/s. 271(1)(c) of the Act as according to the him if there was no mala fide intention in making the claim, the assessee could have withdrawn the claim before the receipt of the notice. However, the claim was withdrawn only when notice was issued to the assessee.

Held:

The claim of assessee was a bona fide mistake. All facts regarding computation of the loss and the gain were furnished along with the return of income. Thus, it is neither a case of concealment of income nor furnishing inaccurate particulars of income.

Falsity of facts made by the assessee in computation of long-term capital loss or short-term capital gain was not proved by the revenue. On the contrary, computation of the loss and the profit had been accepted by the revenue.

Setting off of the loss against the gain was an inadvertent mistake by the assessee which should be taken as bona fide mistake. In absence of proof of falsity in the details regarding computation of income, it was held that the assessee cannot be charged with the penalty. In such matters, one has to distinguish between a wrong claim and a false claim. There was no falsity in the assessee’s case. Penalty ought not to have been levied on assessee in respect of inadvertent but wrong claim.

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Nirav Shah

(2012) 77 DTR 235 (Jodhpur) Amit Jain vs. DCIT A.Y.: 2007-08. Dated: 17-09-2012

17. (2012) 77 DTR 235 (Jodhpur)
Amit Jain vs. DCIT
A.Y.: 2007-08. Dated: 17-09-2012

Section 56(2)(vi) – Gift by father to son directly out of borrowings from HUF does not necessarily mean gift by HUF to the son and hence no tax leviable on such gift.

Facts:

The assessee received a gift of Rs. 5 lakh from his father to enable the assessee to purchase a new flat. The father had received a loan of Rs. 5 lakh in bank account of his proprietary concern from his HUF and on the same day he made gift of Rs. 5 lakh from that bank account. According to the Assessing Officer, the HUF had made payment to the assessee rotating the money through the father. Hence, the Assessing Officer treated the gift of Rs. 5 lakh as gift from HUF of father to the assessee. Since HUF is not covered under the definition of “relative” as given in the Explanation to section 56(2)(vi), the Assessing Officer treated the amount of Rs. 5 lakh received as gift as income from other sources. The learned CIT(A) upheld the stand of the Assessing Officer stating that the so-called loan transaction between HUF to individual has to be ignored and real transaction was in the nature of gift from HUF to the assessee.

Held:

In the given case, the assessee received a gift of Rs. 5 lakh from his father who was assessed to income-tax. The father of the assessee being a donor asserted in the declaration of the gift that he had given an absolute and irrevocable gift out of natural love and affection of Rs. 5 Iakh to his son i.e., the assessee. Also the father was having opening balance in his capital account at Rs. 20.24 lakhs and closing balance of Rs. 20.53 lakhs. Therefore, it is clear that the donor was having the capacity to give the gift which was given to his son under love and affection, there was also an occasion for which gift was received and this contention of the assessee that the gift was received for purchase of a flat at Mumbai, has not been rebutted at any stage. The amount which was paid by way of an account payee cheque by HUF to father had been shown under head “loan and advance” by HUF. Also the gift made by father to son was by way of an account payee cheque.

Therefore, the transaction was a genuine transaction. In the instant case, nothing was brought on record to substantiate that the loan received by the father of the assessee from his HUF was bogus or non-genuine or it was taken with an intention of non-payment. In the present case, the donor was identifiable, his creditworthiness was not doubted and occasion for giving the gift was also there. The donor being the father of the assessee, was a close relative and therefore it was a genuine gift received by the assessee from his father and the same is not chargeable to tax as ‘income from other sources’ u/s. 56(2)(vi).

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Nirav Shah

(2012) 77 DTR 89 (Mum) Chemosyn Ltd. vs. Asst. CIT A.Y.: 2007-08. Dated: 07-09-2012

16. (2012) 77 DTR 89 (Mum) Chemosyn Ltd. vs. Asst. CIT A.Y.: 2007-08. Dated: 07-09-2012

Section 37 (1) Business Expenditure Allowability – Premium paid by company on purchase of own shares from warring group of shareholders as per order of Company Law Board is revenue expenditure and allowable as business expenditure.

Facts:

The assessee, a pharmaceutical company had two groups holding shares of a company i.e. one owning 66% and other 34%. Owing to differences between two groups which were headed by two brothers. The disputes between them reached the Company Law Board which directed assessee to buy 34% shareholding. The assessee purchased 34% shareholding and paid Rs. 6.81 crores as premium on purchase and cancellation of own shares. As per Assessing Officer, the said expenditure was incurred as a part of family dispute settlement and the same could not be attributed to the business of the company. The Assessing Officer disallowed the expenditure stating that even otherwise, the same was a capital expenditure since incurred for acquisition of a capital asset. The action of the Assessing Officer in disallowance was upheld by the learned CIT(A) stating that the purchase of shares was a result of mutual settlement amongst family members and hence was of personal nature.

Held:

In the given case, the warring group of shareholders were creating problems in the smooth functioning of the business. The total sales of the assessee which were in the range of Rs. 20 to 25 crore p.a. during the pre-dispute period had come down in the range of Rs. 10 to 14 crore during litigation period. After the settlement period there was substantial increase in sales. Similarly, negative profits during the period of disputes became positive after the settlement. Very few new products were launched by the assessee company during the period of disputes, while many new products were launched during the post-settlement period giving boost to assessee’s business.

Documentary evidence showed that demand notices were issued by the Debt Recovery Tribunal to the assessee for recovery of debts during the period of disputes, whereas a fresh loan was sanctioned by bank to the assessee for the purpose of working capital as well as for the purpose of acquiring new assets after the settlement. All these facts are sufficient to show that the dispute among the shareholders had affected the day-to-day business of the assessee and that the settlement of the said dispute certainly helped the assessee to run its business smoothly and effectively. Therefore, expenditure incurred by the assessee company on payment of premium for purchase of its own shares from warring group of shareholders and cancellation thereof is revenue expenditure and is allowable as business expenditure.

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Nirav Shah

TDS: F. Y. 2012-13: Certificate u/s. 197: Cannot be denied on the ground that the assessee had violated the provisions of TDS and proceedings u/ss. 276B and 271C were pending:

[Serco BPO (P) Ltd. Vs. ACIT ; 253CTR 410 (P&H):]

On 03/04/2012, the assessee filed an application u/s. 197 of the Income-tax Act, 1961 for issuance of a Nil tax deduction certificate for the F.Y. 2012-13. The application was rejected on the ground that proceedings u/ss. 276B and 271C of the Act were pending.

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

“i) Issue of certificate u/s. 197(1) of the Act is mandatory on fulfillment of conditions enumerated under the rules.

ii) Rejection of application of assessee on the ground that the assessee had violated the provisions of TDS and proceedings u/ss. 276B and 271C were pending was not sustainable. None of these grounds validly form part of reasons for rejecting an application filed by an assessee u/s. 197(1) r/w. r. 28AA.

iii) The Assessing Officer is directed to redecide the application within a period of two weeks.”

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Nirav Shah

TDS: Section 194C: A. Y. 2005-06: Contract for purchase of natural gas: Transportation charges paid to seller: Transportation part of sale transaction: No works contract or contract for carriage of goods: Section 194C not attracted:

[CIT Vs. Krishak Bharati Co-operative Ltd.; 349 ITR 68 (Guj): 253 CTR 402 (Guj):]

Assessee was engaged in the manufacture of fertilisers. It consumed natural gas which was supplied by different agencies through pipelines. The Department took the view that the agreement involved works contract for transport of the gas and the assessee was required to deduct tax at source at the appropriate rate u/s. 194C on the transportation charges. The Tribunal held that the assessee did not hire any service of carriage of goods and that, therefore, the case would not fall in clause (c) of Explanation III to section 194C of the Act.

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

“i) The contract of sale of gas itself envisaged that gas would be supplied by the seller to the assessee at the receiving point of the assessee’s factory. For such purpose, the seller would be laying down its pipelines and other equipment and would maintain such paraphernalia. The seller would also have the right to use such pipelines and equipment for the purpose of distributing gas to other gas consumers. The ownership of the gas was passed on from the seller to the assessee only at the point of delivery and not before.

ii) The agreement essentially was for purchase and sale of gas. Transportation of gas was only a part of the entire sale transaction. The clear understanding of the parties that the ownership of gas would pass on to the buyer at the delivery point, showed that the transport of gas by the seller was a step towards execution of contract for sale of gas and there was no contract for carriage of goods.

iii) Thus the case was not covered u/s. 194C. The transportation charges did not depend on the consumption of quantity of gas but were a fixed monthly charges to be borne by the assessee as part of the agreement between the parties. Therefore, the application of section 194C did not arise.”

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Nirav Shah

A.P. (DIR Series) Circular No. 51, dated 23-11-2011 — External Commercial Borrowings (ECB) Policy.

This Circular revises the all-in-cost ceiling for ECB as follows

This change which has come into force with immediate effect will be applicable till 31-3-2012.

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Nirav Shah

A.P. (DIR Series) Circular No. 50, dated 23-11-2011 — Comprehensive guidelines on over-the-counter (OTC) foreign exchange derivatives — Foreign currency — INR swaps.

Presently, net supply of foreign exchange in the foreign currency — INR swap market cannot exceed US $ 100 million.

This Circular removes this cap/limit of US $ 100 million on net supply of foreign exchange in the foreign currency — INR swap market.

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Nirav Shah

Pilot Construction Pvt. Ltd. v. ITO ITAT Mumbai `C’ Bench Before Rajendra Singh (AM) and Vivek Varma (JM) ITA No. 5307/Mum/2011 A.Y.: 2007-08. Dated: 21-11-2012. Counsel for assessee/revenue: Uttamchand Bothra / Vijay Kumar Jaiswal

6. Pilot Construction Pvt. Ltd. v. ITO
ITAT Mumbai `C’ Bench
Before Rajendra Singh (AM) and Vivek Varma (JM)
ITA No. 5307/Mum/2011
A.Y.: 2007-08. Dated: 21-11-2012.
Counsel for assessee/revenue: Uttamchand Bothra / Vijay Kumar Jaiswal

S/s 44AB, 271B – In case of an assessee following project completion method, advance received which is required to be adjusted against future income cannot be considered as gross receipt of business or turnover. Bonafide belief constitutes reasonable cause for non levy of penalty.

Facts:

The assessee company was engaged in business of construction. It was following project completion method of accounting. In respect of a SRA project taken up by the assessee, it had received a booking advance of Rs. 11.25 crore from M/s Welspun Gujarat Stahi Robern Ltd. The advance was subsequently returned in 2010 since the property had several encroachments.

The assessee did not get its accounts audited as required u/s. 44AB of the Act since it was of the view that the provisions of section 44AB would apply only when sales, turnover or gross receipts exceed Rs 40 lakh. Since the assessee had only received an advance which was later refunded and the assessee was following project completion method and the sales would be accounted in the year of completion of the project.

The Assessing Officer (AO) relying on the decision of Lucknow Bench of ITAT in the case of Gopal Krishan Builders (91 ITD 124) levied penalty u/s. 271B of the Act. Aggrieved the assessee preferred an appeal to CIT(A) who confirmed the action of the AO.

Aggrieved, the assessee preferred an appeal to the Tribunal.

Held:

The Tribunal noted that the assessee was following project completion method, the advance received has been subsequently returned, the project in respect of which advance was received had not commenced even when the matter was being heard by the Tribunal. It also noted that section 44AB applies only when sales, turnover or gross receipts of business exceed Rs. 40 lakh. The amount of advance received was only from one party and also this advance was subsequently returned.

The Tribunal relying on the decision of the Delhi High Court in the case of Dinesh Kumar Goel (239 ITR 46) held that the advance received which is required to be adjusted against future income cannot be considered as gross receipt of business or turnover. The decision of the Lucknow Bench of Tribunal in the case of Gopal Krishan (supra) cannot be followed in view of the decision of the Delhi High Court in Dinesh Kumar Goel. Moreover, the issue being debatable, the plea of the assessee that it was of the view that books were not required to be audited u/s 44AB has to be considered as bonafide. Bonafide belief constitutes a reasonable cause.

The Tribunal set aside the order of CIT(A) and deleted the penalty levied.

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Nirav Shah

(i) Commission paid to UK agent for engaging artists from outside India was not taxable in India as the services were performed outside India and agent had no PE in India. (ii) Reimbursement of expenses to UK agent was not chargeable to tax in India.

New Page 2

14. ACIT v. Wizcraft International

Entertainment Pvt. Ltd. (unreported)

ITA No. 3208/Mum./2003

Articles 5, 7, 18, India-UK DTAA

Dated : 19-11-2010

(i) Commission paid to UK agent for engaging artists from
outside India was not taxable in India as the services were performed outside
India and agent had no PE in India.

(ii)
Reimbursement of expenses
to UK agent was not chargeable to tax in India.

Facts :

ICo was engaged in the business of entertainment event
management and marketing. It had organised events/performances of renowned
foreign artists/groups in India. For various events/performances of
international artists in India, ICo had entered into agreement with a UK
agent. The UK agent was also acting as an agent for various event management
companies.

Under the agreement, ICo granted limited authority to the
UK agent to act on its behalf; enter into contract with artists; and other
ancillary acts required to be performed outside India. Apart from payment of
fees to artists, ICo agreed to pay certain commission to the UK agent and also
to reimburse expenses incurred by it in connection with visits and
performances of artists in India.

ICo deducted tax from the fee paid to the artist as it was
taxable in India in terms of Article 18 of India-UK DTAA. However, it did not
deduct any tax either from the commission paid, or reimbursement of expenses,
to the UK agent, on the ground that the UK agent had rendered the services
outside India and it did not have PE in India. ICo also did not deduct tax
from reimbursement of artists’ travel and related expenses which ICo had
undertaken to bear in terms of its contract with artists.

Held :

The Tribunal held as follows :

(i) Commission paid to the UK agent was not for services of
entertainers/artists. The UK agent had also not taken any part in the events,
nor performed any activities in India. Hence, it was not covered by Article 18
of India-UK DTAA.

(ii) The UK agent did not have any PE in India. Relying on
the Supreme Court’s decision in Carborandum Co. v. CIT, (1977) 108 ITR 335
(SC) and CBDT Circular Nos. 17 (XXXVII) of 1953 at 17th July and 786, dated
February 7, 2001, commission paid to the UK agent was not taxable in India.
Consequently, there was no obligation on ICo to deduct tax as source.

(iii) From the details furnished by ICo, it was clear that
the payments were reimbursement of expenses. The law is well settled that
reimbursement of expense is not chargeable to tax and therefore, there was no
obligation to deduct tax at source.

levitra

Nirav Shah

Foreign tax paid by an assessee cannot be claimed as a deductible expense but is an appropriation of income, eligible for double taxation relief.

New Page 2

13. DCIT v. Tata Sons Ltd. (unreported)

ITA No. 4776/Mum./2004

S. 2(43), S. 37(1), S. 40(a)(ii), S. 90,

Income-tax Act

A.Y. : 2000-01. Dated : 24-11-2010

Foreign tax paid by an assessee cannot be claimed as a
deductible expense but is an appropriation of income, eligible for double
taxation relief.

Facts :

ICo was an investment company and a resident of India. ICo
was also engaged in the business of export of software and provision of
engineering consultancy. ICo paid taxes in the USA on income earned from the
USA. ICo had claimed tax credit in respect of foreign taxes paid by it. In terms
of S. 80HHC, ICo claimed exemption in respect of the income earned in the USA
and thus attracted no tax liability in India.

While computing its taxable income, apart from tax credit,
ICo also claimed deduction of foreign taxes as normal business expenditure. In
this respect, ICo relied on favourable ITAT decision in its own case for earlier
years against which the High Court had rejected the appeal.

As per the Tax Authority, income tax paid, whether in India
or overseas, was an application of income and not a charge on income which
qualified as deductible business expenditure. Also, ICo was entitled to tax
credit in respect of foreign taxes paid by it and foreign taxes were
specifically not allowable as a deduction, either u/s.37(1) or u/s. 40(a)(ii).

Held :

The Tribunal held as follows :

(i) By claiming overseas taxes as deduction in computing
taxable profits, ICo had treated foreign taxes as a ‘charge’ on income. By
claiming tax credit in respect thereof, it had also treated them as an
‘application’ of income. There cannot be any justification for making such
contradictory claims and obtaining overall tax relief larger than actual taxes
paid overseas.

(ii) In Lubrizol India Ltd. v. CIT, (1991) 187 ITR 25
(Bom.), the High Court has held that tax as defined is not restricted to tax
as levied under the Income-tax Act, but also includes taxes as levied by the
foreign country. In view of such direct precedent of the jurisdictional High
Court, it would not be correct to accept that foreign taxes on profit are not
tax covered by the restriction provision.

(iii) Referring to the said decision, the Tribunal observed
that “there is a categorical observation to the effect that the tax deducted
is a local tax and not a tax on profits, whereas in the present case it is an
undisputed position that the tax levied abroad, being income tax, is a tax on
profits of the assessee — whether on presumptive basis or on the basis of
actual profits earned by the assessee.

(iv) The foreign taxes paid by ICo are covered by S. 37(1)
or S. 40(a)(ii) and deduction of the same from taxable profits is not allowed
under the Income-tax Act.

levitra

Nirav Shah

(i) In absence of allegation that the agreement approved by regulatory authority is a sham, the tax authority cannot disregard the same.(ii) For transfer pricing analysis internal compar-ables are preferable over external compar-ables.(iii) While applyi

New Page 2

12. Abhishek Auto Industries Ltd. v. DCIT

(2010) TII 54 ITAT-Del.-TP

S. 92, Income-tax Act

A.Y. : 2004-05. Dated : 12-11-2010

(i) In absence of allegation that the agreement approved by
regulatory authority is a sham, the tax authority cannot disregard the same.

(ii) For transfer pricing analysis internal compar-ables
are preferable over external compar-ables.

(iii) While applying TNMM, only profits related to the
transaction with AEs should be compared and not profits of the company as a
whole.

Facts :

ICo was engaged in manufacture of car seat belts for Indian
markets. For certain types of seat belts, ICo imported raw materials and
obtained technical know-how from its Associated Enterprise (‘AE’) for assembling
seat belts which were supplied to domestic car manufacturers. In its transfer
pricing documentation, ICo had mentioned that (i) raw materials imported from
its AE were not available from any other supplier, (ii) In the circumstances it
was difficult to ascertain its arm’s-length price.

As regards to payment of royalty and technical know-how fees,
ICo had mentioned that as the payment was in accordance with agreements approved
by appropriate regulatory authority (viz. Central Government), question of
complying with arm’s-length price did not arise. Further, in hearing before
Transfer Pricing Officer (‘TPO’), ICo presented comparison of gross
profitability between AE and non-AE transactions.

In TP proceedings TPO concluded that :

l No
transfer of technology had taken place as the payments were included in the
price of raw materials supplied by AE.

l TNMM
was the most appropriate method for applying on totality basis.

Accordingly, adjustments were made on the basis of difference
between profit of selected
comparables and overall profit from both AE and non-AE transactions.

Held :

The Tribunal held as follows :

(i) It was erroneous on the part of Tax Authority to
disregard the agreement which was approved by regulatory authority. Commercial
expediency is the domain of the assessee and in the absence of allegation that
the agreement is a sham, it cannot be rejected arbitrarily without assigning
cogent reasons.

(ii) Internal comparables are preferable over external
comparables. As profit margin from AE transaction was higher than that from
non-AE transaction, international transactions complied with arm’s-length
requirement.

(iii) While applying TNMM, only profits related to the
transactions with AEs should be compared and not profits of the company as a
whole.

levitra

Nirav Shah

Reimbursement received by non-resident in respect of payment made on behalf of resident was not liable to tax in India.

New Page 2

DDIT v. M/s. Chubb Pacific Underwriting
Management Services Pte. Ltd. (Mumbai) (2009 TIOL 730 ITAT Mum.)

S. 195, Income-tax Act

A.Y. : 2003-04. Dated : 15-10-2009

Issue :

Reimbursement received by non-resident in respect of
payment made on behalf of resident was not liable to tax in India.

Facts :

The assessee, a tax resident of Singapore is engaged in the
business of providing technical services and rendering of network facilities.

The parent company of the assessee was an American company
which held shares in both the assessee as well as HDFC Chubb (JVCO) in India.
The JVCO was incorporated in February 2002 and it commenced operations in
October 2002.

Pending commencement of business by JVCO, for
administrative convenience and on request of JVCO, the assessee made payments
(including certain expenses) for purchase of software licence to Apex Systems
Pte. Ltd. (Apex).

While payments were made by the assessee, JVCO complied
with tax, withholding provisions with respect to such payments. The amount was
reimbursed by HDFC Chubb to the assessee during A.Y. 2003-04.

The Assessing Officer (AO) held that the amount received by
the assessee from JVCO was income of the assessee liable to tax, in India.

The assessee contended that the amount received from JVCO
was only reimbursement of expenses that were paid on behalf of JVCO as a
matter of administrative convenience and no income had arisen on account of
such transaction. The assessee also submitted that TDS was duly deducted by
JVCO from payment to Apex and therefore Apex had already been taxed in respect
of the transaction.

The CIT(A) accepted the contention of the assessee and
deleted the addition made by AO.

Held :

Confirming the order of the CIT(A), the ITAT held :

(a) The assesee was not a party to the contract for the
supply of software licences between Apex and JVCO. It was clear that the
payments were made only on behalf of JVCO due to JVCO’s inability to pay the
same before commencement of business.

(b) The amount received by the assessee was in the nature
of reimbursement of actual payment made by the assessee on behalf of JVCO to
Apex. There was no element of profit or income involved in such payment.

(c) Adequate taxes were deducted while making payment to
the supplier Apex, evidencing the fact that the true recipient of income had
been already subjected to tax.

(d) Such receipt, which was pure reimbursement of earlier
disbursement made on behalf of JVCO, was not taxable in the hands of the
assessee under the provisions of the Act.

levitra

Nirav Shah

Lump sum consideration towards technology transfer amounts to royalty. Sale of technical documentation which is incidental to grant of right to use the know-how does not affect taxability.

New Page 2

M/s. International Tire Engineering

Resources LLC

(2009 TIOL 25 AAR IT)

Article 12(3)(a), India-USA DTAA

S. 115A(1), S. 195, Income-tax Act;

Part II, First Schedule, Finance Act, 2009

Dated : 28-10-2009

Issues :

Lump sum
consideration towards technology transfer amounts to royalty. Sale of
technical documentation which is incidental to grant of right to use the
know-how does not affect taxability.

Consideration for designs transferred on outright basis is not taxable as
royalty.

Tax rate
applicable for withholding is the lower rate as prescribed by S. 115A, while
the scope of chargeable amount is determined having regard to the provisions
of the treaty.

Facts :

The applicant, an American company (‘USCO’), was engaged in
the business of supplying advanced technology for the manufacture of radial
tyres. The applicant entered into an agreement with an Indian company (‘ICO’)
for grant of perpetual irrevocable right to use know-how as also transfer
ownership in respect of certain designs. The agreement specified separate
consideration for right to use know-how and for transfer of designs. The
applicant had formulated the following questions for ruling of AAR :

(i) Whether consideration paid by ICO to USCO for
transfer of documentation was taxable under the Act ?

(ii) Whether the consideration paid by ICO to USCO for
consultancy and assistance was taxable under the Act ?

(iii) If answers to (i) and (ii) were wholly or partly
against USCO, how much consideration would be taxable and at what rate ?

The applicant claimed that the agreement involved transfer
of technical documents in the form of transfer of ‘chattel’ or a ‘plant’ which
was completed outside India. The amount was therefore not taxable in India.

The AAR noted the following to be the features applicable
to the grant of right of use of know-how :

(i) USCO had expertise and know-how for enabling ICO to
set up the plant. USCO agreed to transfer perpetual, irrevocable right to
use know-how. For this purpose, know-how was defined to include all
technical information, data, specifications, methodology, methods, material
and process specifications, etc. which would enable ICO to install, operate
and maintain its plants. It also included start-up, commissioning
assistance, training, etc.

(ii) ICO was required to pay lump sum consideration to
USCO. ICO was granted non-exclusive, irrevocable, perpetual, royalty-free
right to use know-how at its factory in India and to market the products
anywhere in the world.

(iii) The term of the agreement was for 8 years which
could be mutually extended by the parties. During the term of the agreement,
USCO had to provide updates of know-how to ICO.

(iv) Know-how so transferred could be used by ICO only in
its plants including future plants but could not be sold to third parties.

(v) The agreement clarified that ownership of know-how
continued with USCO.

(vi) For a separate consideration, USCO also agreed to
provide technical assistance by sending its personnel for rendering training
and supervision services.

The Tax Department contented that the amount was
chargeable as royalty. Alternatively, the Tax Department contended that
having regard to the activities undertaken in India in excess of 100 days,
USCO was liable to tax under service PE Article of DTAA.

Held :

In respect of taxability of know-how agreement, the AAR
held :

The essence
of the transactions was to provide right of use of know-how. To say that the
transaction is nothing more than sale of technical documents containing
know-how is to oversimplify the issue and to ignore the plain realities. In
reality and in substance, sale of technical documentation was not the end in
itself but was mere incident of the grant of right to use know-how.

USCO also
agreed to provide technical assistance and advice to ensure that such
know-how is put to effective and proper use. Payment was also made
conditional upon successful completion of certain tests. It is therefore
incorrect to say that the consideration was for transfer of technical
documents sold in the USA.

The grant
of use of know-how is completed only after USCO provides technical
assistance and trained the personnel of ICO about use of underlying
technology. The crux and predominant features of the arrangement was that it
equipped ICO with all that was necessary to effectively put know-how to use.
Know-how which was within the exclusive use of domain was parted in favour
of ICO by grant of non-exclusive, perpetual right and by putting in place
the requisite measure to enable ICO to use and absorb know-how.

The payment
was ‘royalty’ within the meaning of S. 9 as also in terms of Article 12 of
the treaty as it was for making available right of use of know-how belonging
to USCO.

Also, the
transaction of sale was not completed in the USA. The agreement provided
that the transaction was concluded only against delivery of know-how
documents against invoices and related documents. In terms of the agreement
between the parties, delivery was to be completed at the location of ICO and
courier of documents by USCO outside India did not amount to completion of
sale.

The
decision of the Supreme Court in Ishikawajima Harima Heavy Industries Ltd.
(288 ITR 408) is not relevant as the contract involving transfer of
technology and know-how cannot be treated as the transaction completed
outside India. In any case, there is a sufficient territorial nexus as
technical know-how embodied in various documents is received by ICO and is
put to use in India with the assistance and advice offered by technical
personnel of USCO deputed to India.

In relation to outright transfer of designs, AAR held :

The transaction of tread and sidewall design/ patterns (TSD) involved designs prepared and approved by ICO which USCO transferred exclusively to ICO. ICO can use such designs for self use or for selling it to third party. The agreement also confirmed that the proprietary intellectual property in design was to vest exclusively in ICO. Having regard to these features, AAR accepted the contention that the transaction involved outright transfer which was not taxable in India in absence of PE of USCO.

In relation to rate of TDS, AAR held :

For determining tax withholding obligation of ICO, ICO can take into account favourable rate available in terms of S. 115A of the ITA. ICO therefore can deduct tax at 10% + applicable surcharge after taking into account scope of chargeable income determined having regard to the provisions of the treaty.

Nirav Shah

University of Texas (UT) is a tax resident of the USA and entitled to treaty benefit even if certain income of UT is not liable to tax in the USA on account of exemption under the provisions of US tax laws.

New Page 2

Federation of Indian Chambers of Commerce and Industry

(2009 TIOL 30 AAR)

Articles 4, 12(4)(b), India-USA DTAA;

S. 9(1)(vii), S. 195, Income-tax Act

Dated : 30-11-2009

Issues :

University of Texas (UT) is a tax resident of the USA and
entitled to treaty benefit even if certain income of UT is not liable to tax
in the USA on account of exemption under the provisions of US tax laws.

Payment made by Indian entity to UT for training,
technology assessment, business development and project management as part of
commercialisation project is not ‘fees for included services’.

Facts :

FICCI, a non-profit company, registered under the Companies
Act, 1956 entered into MOU with Defense Research Development Organisation (DRDO).
Under the MOU, FICCI were to assist the DRDO laboratories in identifying
competitive global technologies from inventory of existing defense-related
inventions of DRDO so as to enable DRDO to decide upon commercialisation
policy. For this, FICCI and DRDO initiated joint programme for technology
assessment and commercialisation. While FICCI was responsible for providing
assistance to DRDO, FICCI entered into an agreement with UT for the purpose of
taking support for research in the area of market economics and other related
aspects involving commercialisation of technological innovations.

The services to be rendered by UT to FICCI were broadly
categorised under the following heads :

Training;

Technology
Assessment;

Business
Development; and

Program
Management

The scope of services under each of the above four segments
included the following.

Training :
Under this, UT was to conduct a workshop for DRDO officers and scientists at
management level to provide them with broad understanding of the key
principles involved in the technology commercialisation process. For this
purpose, two training programmes of 5 days each were conducted in India for
which facilities were made available by FICCI. The training materials were
stated to be customised modules which gave broad overview of factors which
the participant had to consider for the purposes of shortlisting the
innovations for taking them to the second phase of the programme.

Technology assessment : Under this, UT was expected to undertake
screening and assessment for evaluating the technologies and to shortlist
what UT perceived to be the unique and globally competitive technologies
which DRDO can market. This phase involved process of screening
technologies, eliminating those which did not score well from the point of
view of commercialisation, doing validation check for determining commercial
potential and submitting the report of such assessment for consideration by
the board of DRDO.

Business
Development : The third phase of the programme was commercialisation
process. In this phase, UT assisted in identifying about 20 global partners
with which DRDO can enter into licensing or other engagements in respect of
technologies identified under phase three. UT also was required to monitor
and support negotiations between DRDO and the potential partner.

Programme Management : Under this phase, UT agreed to provide programme
manager for administrative assistance and actual implementation.

For the above services, FICCI was required to provide lump
sum consideration to UT. In this background, the applicant sought ruling on
the following questions :

(i) Whether UT was covered by India-USA DTAA ?

(ii) Whether UT was not liable to pay tax in India on
payments received for the services ?

(iii) Whether FICCI was not required to deduct tax
u/s.195 in respect of payments to UT ?

(iv) If answers to (ii) and (iii) are in negative, which
amounts were liable to tax and at what rate ?

The Tax Department contended that the tax treaty covered
only those persons who are taxable in one of the countries and since income of
UT was exempt from tax in the USA, UT was not eligible for benefit of the
treaty. As a result, UT was liable to pay tax as payment to UT was in the
nature of fees for technical services. Alternatively, the services rendered by
UT were fees for included services as defined in Article 12 of the treaty and
hence liable for taxation in India.

Ruling :

The AAR held :

The fact
that UT is required to file tax return in the USA for certain unrelated
business income and is also having obligation of filing the tax return on an
annual basis supports that UT would qualify as ‘resident’ of the USA as
envisaged in the tax treaty between India and the USA. The fact that part of
its income is exempt from tax does not take it out of the category of tax
resident.

Under the
treaty, services can be taxed only if they are in the nature of fees for
included services (FIS). In order to be taxable as FIS under the tax treaty,
a mere provision of technical and other services would not suffice. It,
additionally, requires that the service provider should also make its
technical knowledge, experience, skill, know-how, etc. known to the
recipient of the service so as to equip him to independently perform the
technical function in future without the help of the service provider.

Although
most of the services falling within the scope of business development and
programme management, may answer the description of technical and
consultancy services, they do not really ‘make available’ the technical
knowledge or know-how, except perhaps in an incidental/indirect manner.
Therefore, it would not come within the purview of FIS.

In the circumstances, though the services involved certain attributes of teaching, they were only incidental to the primary objective of business promotion of technologies. The services would not constitute FIS and will also not fall in the exclusionary clause of the treaty which exempts teaching in or by educational institution.

The AAR confirmed that FICCI did not have obligation of withholding tax as the payments were not chargeable in the hands of the recipient.

Nirav Shah

(i) only proportionate credit of tax paid in USA can be claimed in India; and (ii) credit of State income-tax cannot be claimed as it is not a ‘tax covered’.

New Page 2

Part C — International Tax Decisions

13 Manpreet Singh Gambhir v.
DCIT

(2008) 119 TTJ (Del.) 615

Articles 2, 25, India-USA DTAA

A.Y. : 1999-2000. Dated : 30-9-2008

Issues :

Under India-USA DTAA :

(i) only proportionate credit of tax paid in USA can be
claimed in India; and

(ii) credit of State income-tax cannot be claimed as it
is not a ‘tax covered’.

Facts :

The assessee was a resident of India and had earned salary
income in the USA and in India. It also earned income from interest. The
assessee had paid Federal income-tax and State income-tax on his USA salary
income. He had claimed deduction u/s.80RRA in respect of his salary income from
the USA. He claimed credit in respect of Federal income-tax and State income-tax
by relying on provisions of Article 25(2)(a) of India-USA DTAA. The AO allowed
credit of taxes paid in the USA only to the extent of tax attributable in India
to the income earned in the USA.

In appeal before CIT(A), the assessee contended that while
allowing credit of taxes paid in the USA, not only the Federal income-tax but
also the State income-tax should be allowed. He further contended that
notwithstanding the deduction u/s.80RRA in India, as per India-USA DTAA, the
whole of the tax paid in the USA in respect of his salary income is eligible for
credit against Indian taxes payable. The CIT(A) accepted the contention that
credit should be given also for State income-tax. However, he did not accept the
other contention regarding grant of credit of whole of tax paid in the USA.

The Tribunal referred to the provisions of S. 90 of the
Income-tax Act, Article 25(2)(a) of India-USA DTAA and commentaries on OECD and
UN Model Conventions. It also referred to the decisions in CIT v. Dr. R. N.
Jhanji, (1990) 185 ITR 586 (Raj.) and CIT v. M. A. Mois, (1994) 210
ITR 284 (AP) wherein in the context of relief u/s.91(1) of the Income-tax Act,
the Courts had held that where the assessee is entitled to special deduction
u/s.80RRA to the extent of 50%, his entitlement to relief would be only to the
extent of tax paid on 50% of the foreign income. The Tribunal observed that
though these decisions were in the context of S. 91, the spirit of their ratio
would also apply to claim of credit u/s.90, as there cannot be payment of taxes
outside India and claim of refund in India if there is no liability of paying
taxes in India.

Held :

The Tribunal held that :

(i) the assessee is entitled only to the proportionate tax
credit and not the credit for the entire tax paid in the USA on the salary
income.

(ii) in terms of Article 2 (taxes covered) of India-USA DTAA, credit can be
claimed only in respect of Federal income-tax and not State income-tax.

levitra

Nirav Shah

Where income accrues or arises u/s.5(2), S. 9(1)(i) would have no application.

New Page 2

Part C — International Tax Decisions

12 Mustaq Ahmed, in re

(2008) (AAR) (Unreported)

S. 5(2), Explanation 1(b) to 9(1)(i), Income-tax Act

Dated : 19-11-2008

Issue :

Where income accrues or arises u/s.5(2), S. 9(1)(i) would
have no application.

Facts :

The applicant was a resident of Singapore. He carried on sole
proprietary business of manufacture and sale of gold jewellery in Chennai. He
was also engaged in the activity of purchasing and exporting gold ornaments. The
exports were made to Singapore company in which the applicant held substantial
shares. The purchase orders from SingCo were accepted and sales were executed in
India. Sale proceeds were also received in the assessee’s bank maintained in
India.

Before the AAR, the applicant contended that its activities
of purchase of gold and gold ornaments for exports was unrelated to its sole
proprietary business, since the purchase and export of gold jewellery was for
the purpose of export and since the applicant was a non-resident, the income
accruing or arising through or from these operations, which were confined to the
purchase of goods in India for the purpose of exports was not taxable in India
in terms of Explanation 1(a) and (b) to S. 9(1)(i). The applicant also contended
that ‘receipt’ follows ‘accrual’ and once there is no ‘accrual’ u/s.9, tax
liability cannot arise merely on account of ‘receipt’. The applicant also
contented that since Explanation 1(b) to S. 9(1)(i) is a beneficial provision
for promotion of exports from India, it should be construed so as to advance
that objective.

Before the AAR, the tax authorities contended that deeming
provisions of S. 9 had no role to play as the charge of taxation was attracted
u/s.5(2) and consequentially exemption carved out u/s.9 as the income actually
accrued in India and was received in India. The tax authorities supported their
contention with various documents which showed that exports were not to self (i.e.,
to applicant), but to foreign companies; exports were made in regular course of
business and in accordance with rules and regulations governing resident
exporters.

Held :

The AAR referred to S. 5(2) and S. 9(1)(i) and Explanation
thereto. It also referred to the following decisions :

CIT v. Ahmedbhai Umarbhai and Co., (1950) 18 ITR 472 (SC)
Anglo-French Textile Company Ltd. v. CIT, (1953) 23 ITR 101 (SC)
Bikaner Textile Merchants Syndicate Ltd. v. CIT, (1965) 58 ITR 169 (Raj.)
Turner Morrison & Co Ltd. v. CIT, (1953) 23 ITR 152 (SC)
Hira Mills Ltd. v. ITO, [1946] 14 ITR 417 (All.)
CIT v. Ashokbhai Chimanbhai, (1965) 56 ITR 42 (SC)

The AAR observed that the expression ‘subject to the
provisions of this Act’ in S. 5(2) would mean that a non-resident’s income from
whatever source derived on account of actual or deemed receipt or actual or
deemed accrual shall be computed in accordance with other provisions of the Act.

After considering the modus operandi of the business
of the applicant, the AAR held that the right to receive payment had arisen in
India; once the income actually accrued or arose in India, Explanation 1(b) did
not have the effect of altogether preventing the accrual of income. Hence, the
income derived by the applicant from purchase and exports activities undertaken
by him attracted charge to tax u/s.5(2), as it represented income accrued or
received in India. The AAR held that benefit of exception of Explanation 1(b) to
S. 9(1)(i) was not available to the applicant.

levitra

Nirav Shah

Interest received by non-resident company having PE in India on refund of income-tax is effectively connected with PE and hence, should be characterised as ‘business profits’ and not ‘interest’ and taxed accordingly

New Page 2

Part C — International Tax Decisions

11 BJ Services Company Middle East Ltd.
v. ACIT

(2008) 119 TTJ (Del.) 553

Articles 7, 12, India-UK DTAA

A.Y. : 2002-2003. Dated : 30-9-2008

Issue :

Interest received by non-resident company having PE in India
on refund of income-tax is effectively connected with PE and hence, should be
characterised as ‘business profits’ and not ‘interest’ and taxed accordingly.

Facts :

The assessee was a UK Company (‘UKCo’), which was
tax-resident of UK. UKCo had a PE in India. UKCo had received interest on the
refund of income-tax.

The AO held that the interest was earned by UKCo through its
PE in India and therefore, in terms of Article 12(6) of India-UK DTAA, it should
be characterised as business profits. Accordingly, tax rate applicable to
business income (i.e., 48%) and not that applicable to interest (i.e.,
15%) was applied. The CIT(A) upheld the Order of the AO.

Editorial note :

Article 12(6) provides that if beneficial owner of interest
carries on business through a PE and the debt-claim in respect of which the
interest is paid is effectively connected with that PE, provisions of Article 7
(business profits) apply to taxation of such interest income.

Before the Tribunal, UKCo’s representative relied upon AAR’s
ruling in Application No. P 17 of 1998, In re (1999) 236 ITR 637 (AAR)
wherein the AAR had ruled that : the applicant did not have a PE in India;
interest had not arisen out of any business operation in India; the debt-claim
was not connected with any activity of a PE in India; and hence, it was a case
falling under Article 12 and liable to concessional rate of tax.

The tax authorities’ representative submitted that since
interest had arisen through PE situated in India, Article 12(2) cannot apply.
The Department contended that the AAR ruling was also not applicable, as in the
case before AAR the non-resident applicant admittedly did not have any PE in
India.

Held :

The Tribunal held that : UKCo was a non-resident having PE in
India; it was carrying on business in India through a PE in India; the interest
was effectively connected with that PE in India; and therefore, in terms of
Article 12(6), the interest was chargeable under Article 7 as business profits.
The Tribunal also held that the AAR ruling relied upon by UKCo was
distinguishable on facts.

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Nirav Shah

(i) Reimbursement of customs duty by an importer to a service provider is not taxable u/s.44BB. (ii) Interest received by non-resident company on refund of income-tax to be characterised as ‘interest’

New Page 2

Part C — International Tax Decisions

10 Transocean Offshore Deep Water Drilling
Inc v. ACIT
(Delhi Trib.) (Unreported)

ITA No. 2160/Del./2006

S. 44BB, Income-tax Act; Article 11, India-USA DTAA

A.Y. : 2004-2005. Dated : 24-10-2008

Issues :

(i) Reimbursement of customs duty by an importer to a
service provider is not taxable u/s.44BB.

(ii) Interest received by non-resident company on refund
of income-tax should be characterised as ‘interest’ and taxed at the relevant
rate mentioned in Article dealing with ‘interest’.

Facts :

(i) The assessee was an American company (‘USACo’) which
was tax-resident of the USA. USACo was engaged in providing services in
connection with exploration and extraction of mineral oils. USACo had paid
customs duty on import of certain items which were imported by ONGC. ONGC
reimbursed the customs duty to USACo.

The AO charged tax on the income of the assessee u/s.44BB
of the Income-tax Act. Relying on the decisions in Sedco Forex
International Inc. v. CIT, (2008) 299 ITR 238 (Uttarakhand) and USACo’s
own case in CIT v. Trans Ocean Offshore Inc, (2008) 299 ITR 248
(Uttarakhand), the AO also included the aforesaid reimbursement of customs
duty in the income of USACo.

(ii) USACo had received interest u/s.244A on income-tax
refund. The AO assessed the income as income from other sources and charged
tax @ 41%. USACo claimed that it should be taxed either @15% in terms of
Article 11 of India-USA DTAA, or @ 20% u/s.115A(1)(a)(ii) of the Income-tax
Act if provision of India-USA DTAA are considered not to apply.

Held :

The Tribunal held that :

(i) Payment of customs duty is primarily the obligation of
the importer, namely, ONGC; USACo discharged ONGC’s primary liability; the
payments made by ONGC to USACo were not on account of provisions of services
and facilities in connection with, or supply of plant and machinery on hire
used, or to be used, in the prospecting for, or extraction or production of,
mineral oils in India and thus, reimbursements were not in connection with the
services mentioned in S. 44BB of the Income-tax Act; and therefore, it was not
includable for determining profits and gains u/s.44BB of the Income-tax Act.

(ii) In respect of chargeability of interest on refund, the
Tribunal relied on AAR decision in Application No. P 17 of 1998, In re
(1999) 236 ITR 637 (AAR), in the context of India-UK DTAA, where AAR held that
interest derived in respect of tax lying with Revenue authorities was covered
by the definition of interest in terms of Article 12(2) and in absence of PE
in India should be entitled to benefit of reduced withholding rate of 15%.

Tribunal held that the provisions of India-USA DTAA are
identical to India-UK DTAA; since the issue involved is identical, interest on
income-tax refund should be taxed under Article 11 (interest) of India-USA
DTAA @ 15%.

Editorial note :

As regards the issue whether interest on the Income-tax Act
refund should be characterised as ‘interest’ or as ‘business profits’, in BJ
Services Company Middle East Ltd. v. ACIT, (unreported) (digested above), on
similar facts, the Delhi Tribunal itself had held that such interest should be
characterised as ‘business profits’. Possibly, unlike the earlier decision, in
this case, the tax authorities do not appear to have brought out that USACo had
a PE in India and the interest on income-tax had a nexus with that PE.

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Nirav Shah

Liaison office of non-resident is chargeable to FBT even if no income is earned in India

New Page 2

9 Singapore Tourism Board, in re

(2008) 307 ITR 34 (AAR)

S. 115WA, S. 115WB, Income-tax Act

Dated : 17-10-2008

Issue :

Liaison office of non-resident is chargeable to FBT even if
no income is earned in India.

Facts :

The applicant was a company incorporated in Singapore with
the objective of promoting Singapore tourism (‘SingCo’). SingCo had set up
several liaison offices in India and had employees based in India, working in
these liaison offices. SingCo did not carry on any business activities through
these liaison offices; no income accrued or arose to SingCo in India; and the
expenses relating to the liaison offices were reimbursed by the Singapore office
of SingCo.

SingCo sought advance ruling on the question whether FBT
would be applicable in respect of its employees in its liaison offices in India.

Before the AAR, the tax authorities referred to AAR’s ruling
in Population Council Inc., In re (2006) 286 ITR 243 (AAR) and submitted
that while in that ruling, the applicant was a non-profit-making organisation,
in the present case, the applicant is a profit earning company though it is not
earning any income in India because RBI does not permit liaison offices of
foreign companies to do so. It further submitted that the applicant has incurred
expenses which would be subject to FBT and the earlier ruling should apply to
the applicant’s case.

Held :

The AAR referred to the observations in the earlier ruling
and ruled that :

(i) as per the scheme of Chapter XII-H and S. 115WA, FBT
liability is in addition to income-tax and is subject to separate provisions
with regard to return, assessment, payment of tax, etc.

(ii) FBT is a levy on certain types of expenditure rather
than tax on income. Taxability of income is not a prerequisite for liability
to FBT. S. 115WA(2) makes it clear that even when there is no liability to pay
income-tax, FBT liability may still be attracted.

(iii) a foreign entity not earning any income in India, but
having employees based in India, is liable to FBT if it pays fringe benefits
to those employees.

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Nirav Shah

(I) AO/TPO should establish that the taxpayer had manipulated prices to shift profits. (ii) After taxpayer discharges onus by conducting proper analysis, before determining ALP, AO/TPO should prove that one of four conditions in S. 92C(3) is satisfied. (

New Page 2

Part C — International Tax Decisions

8 Philips Software Centre (P) Ltd. v.
ACIT (2008) 26 SOT 226 (Bang.)

A.Y. : 2003-2004

S. 92C, S. 92CA, Income-tax Act

Dated : 26-9-2008

Issues :

(i) AO/TPO should establish that the taxpayer had
manipulated prices to shift profits.

(ii) After the taxpayer discharges onus by conducting
proper analysis, before determining ALP, AO/TPO should prove that one of the
four conditions in S. 92C(3) is satisfied.

(iii) Data used for comparability and analysis should
relate to the relevant financial year and should also be available as on the
specified date (i.e., the due date of filing tax return).

(iv)
Margin of comparable companies
cannot be taken as a benchmark without a proper FAR analysis to eliminate
differences.

Facts :

IndCo was engaged in providing software development services
to its associated enterprises. The Company claimed tax holiday under the
Income-tax Act, 1961 relating to the A.Y. 2003-04. While preparing its transfer
pricing documentation under Indian transfer pricing Rules for the relevant tax
year (2002-03), the Taxpayer selected the Cost Plus Method (‘CPM’) as the most
appropriate method for determining the arm’s-length price and also undertook a
benchmarking analysis using Transaction Net Margin Method (‘TNMM’). Based on the
analysis, the Taxpayer conducted a search on the electronic database available
in public domain and used various qualitative and quantitative filters. Data
till October 2003 (i.e., available up to the date of filing return of
income) was used for comparable analysis. The Taxpayer had made adjustment on
account of depreciation for difference in the depreciation policy adopted by the
him vis-à-vis comparable companies.

The TPO rejected the transfer pricing analysis undertaken by
IndCo on several grounds and determined the arm’s-length margin at higher
amount. On the basis of the TPO’s order, the Assessing Officer (‘AO’) made
adjustment to the total income of the Taxpayer.

Before ITAT, the assessee claimed that the adjustment was not
warranted as :

(a) The AO/TPO did not establish that the Taxpayer had
manipulated prices to shift profits outside India.

(b) The AO/TPO did not satisfy and communicate to the
Taxpayer the relevant clause u/s.92C(3) of the Act which alone empowers the AO
to disregard the analysis conducted by the Taxpayer.

(c) The AO/TPO conducted the analysis using the data that
did not exist by the specified date of filing the return of income and thus
contravened statutory requirement of using contemporaneous method.

(d) The AO/TPO did not grant suitable adjustments to
account for differences in functions performed, assets employed and risks
assumed between the Taxpayer and the comparable companies to arrive at the
ALP.

(e) The TPO had not granted the benefit of ±5% of tolerance
adjustment as provided under the Act.

Held :

The ITAT accepted most of the contentions of the appellant
and held that :

(i) The intention of the transfer pricing provisions is to
curtail avoidance of taxes by shifting profits outside India. The AO/TPO is
duty bound to demonstrate that the Taxpayer has manipulated its prices to
shift profits outside India, before a transfer pricing adjustment can be made.
The Taxpayer had also highlighted that the average rate of tax was much lower
in India than the tax rate applicable to the associated enterprise (‘AE’) in
the Netherlands. Accordingly, there was no motive on the part of the taxpayer
to shift profits out of India.

(ii) The AO/TPO did not establish, either before initiating
the transfer pricing proceedings or even at the time of concluding the
proceedings that the taxpayer had manipulated prices to shift profits. Since
the Taxpayer was availing tax holiday benefit, it would be devoid of logic to
argue that the Taxpayer had manipulated prices and shifted profits to an
overseas jurisdiction for the purpose of avoiding tax in India.

(iii) At no stage of the assessment proceedings the AO/TPO
established that the transfer pricing analysis of the Taxpayer could have been
rejected in terms of provisions of S. 92C(3) of the Act. The Taxpayer had
discharged its onus by conducting proper analysis. The AO/TPO cannot reject
such analysis unless they find deficiency or insufficiency in the
documentation of the Taxpayer.

(iv) As per the transfer pricing rules, for the purpose of
conducting the comparability analysis, subject to certain exceptions, the data
to be used for the comparability analysis need to relate to the relevant
financial year in which the international transaction has been entered into
and should exist latest by the specified date (i.e., the due date of
filing tax return). The ITAT held that both the conditions are cumulative in
nature. If any one of the conditions is not satisfied, the relevant comparable
cannot to be included in the analysis.

(v) The ITAT held that for the purpose of the analysis, the
comparables should not have transactions with its associated enterprises. Any
company having even a single rupee of related-party transaction cannot be
considered for benchmarking purpose.

(vi) The ITAT held that the margin of the comparable
companies cannot be directly taken as a benchmark without doing a proper FAR
analysis to eliminate differences on account of functions performed, risk
assumed and assets employed. By relying on the earlier Tribunal decisions in
case of Mentor Graphics (Noida) Pvt. Ltd. v. CIT, [(2007) 109 ITD 101]
and E-gain Communication (P) Ltd. v ITO, [(2008) 23 SOT 385], the ITAT
emphasised that adjustment needs to be made to the margins of the comparables
to eliminate differences on account of functions, assets and risks.

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Nirav Shah

Salary: Perquisite/Profit in lieu of salary: S/s 15 and 17: Keyman Insurance policy for employee/directors: Assignment of policy to employee/director receiving surrender value: Difference between actual premia paid and surrender value not assessable as salary:

[Maturity value of policy not assessable: CIT Vs. Rajan Nanda; 349 ITR 8 (Del):]

The employer company took keyman insurance policies on the lives of two employees/directors in different years. After paying premia for a certain period, they were assigned to the two employees/directors receiving the surrender value from them. For the remaining period of the policies, the insurance premia were paid by the assignees. The Assessing Officer held that the difference between the premia paid by the employer and the surrender value paid by the employee is the benefit to be taxed in the hands of the employees. The Tribunal deleted the addition and held that merely by assignment in a particular year when the policy was still continuing, no taxable event had taken place and, therefore, no tax could be charged. It also held that the amount in question could not be taxed as perquisite so as to fall within the scope of section 17(3).

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

“i) Explanation to section 10(10D) gives the meaning to “keyman insurance policy” and only that sum received under this policy would be treated as income. Sub-clause (ii) of clause (3) of section 17 taxes “any sum received in a keyman insurance policy”. The word “received” assumes significance. The Legislature in its wisdom thought to tax only that payment, which is received by the employee assessee under the keyman insurance policy. The purport of sub-clause (ii) is all together different. Such an amount due or received by the assessee has to be : (a) before joining any employment; or (b) after cessation of its employment. No such contingency occurred when the keyman insurance policy was assigned by the company in favour of the director assessee. The tax event did not occur, as no such amount was received at the time of assignment of the policy by the company as employer to the director assessee, as employee. The amounts were not taxable in the hands of the directors.

ii) There is no prohibition on the assignment or conversion of keyman insurance under the Act. Once there is an assignment, it leads to conversion and the character of the policy changes. The Insurance Company had itself clarified that on assignment, it does not remain a keyman policy and gets converted into an ordinary policy. Hence, the policy in question was not a keyman insurance policy and when it matured, the advantage drawn therefrom was not taxable.”

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Nirav Shah

Salary: Perquisite: S/s 17(2)(iii) and 17(2)(iv) of I. T. Act, 1961 and Rule 3 of I. T. Rules, 1962: Expenditure on repairs of residential accommodation occupied by employee:

[Not a perquisite: Scott R. Bayman Vs. CIT; 253 CTR 233 (Del): ]

The assessee was an employee (President and CEO) of a company M/s. GE. In the relevant year, the employer had spent an amount of Rs. 50 lakhs towards repair and renovation of the residential accommodation occupied by the assessee. The Assessing Officer treated this amount as perquisite and added in the salary income of the assessee. The Tribunal confirmed the addition.

On appeal by the assessee, the Delhi High Court reversed the decision of the Tribunal and held as under:

“i) Express provisions of Rule 3 which elaborates various contingencies in relation to perquisite of rent free accommodation rules out the intention of the Parliament to treat expenses in relation to improvement, repairs or renovation as falling within the meaning of “perquisite”.

ii) Argument on behalf of the Revenue that the repairs and renovation expenses constituted an obligation of the employee, which was borne by his employer is meritless. Lease deed nowhere spells out any obligation on the employee to carry out repairs and renovations. Section 17(2) (iv) cannot be made applicable.

iii If the Assessing Officer had returned a finding that the premises were to be valued at market value (of the rental), in case it is increased as a result of the renovations, the only prescribed mode was to apply the method indicated by Rule 3(a)(iii).

iv) In view of the above, the appeal has to succeed. The impugned order of the Tribunal is hereby set aside. The cost of repairs and renovation shall be deleted from the taxable income of the assessee.”

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Nirav Shah

Revision: Section 264: A. Y. 2007-08: Claim for exemption in return but by mistake not shown in computation: Intimation u/s. 143(1) denying exemption: Rejection of application for revision: Not justified:

[Sanchit Software and Solutions P. Ltd. Vs. CIT; 349 ITR 404 (Bom):]

For the A. Y. 2007-08, in the return of income, the assessee made a claim for exemption u/ss. 10(34) and 10(38) in respect of the dividend and long-term capital gains. However, by mistake, included the dividend of the long term capital gain in the total income in the computation. Intimation u/s. 143(1) of the Act denied the exemption. The assessee filed an application for rectification u/s. 154. The assessee also filed revision petition u/s. 264 of the Act which was rejected by the Commissioner.

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

“i) The entire object of administration of tax is to secure revenue for the development of the country and not to charge the assessee more tax than that which is due and payable by the assessee. On April 11, 1955, the CBDT issued a circular directing the Assessing Officer not to take advantage of the assessee’s ignorance or mistake.

ii) The Commissioner committed a fundamental error in proceeding on the basis that no deduction on account of dividend income and income from capital gains u/s. 10 of the Act was claimed. Therefore, there was an error on the face of the order and the order was not sustainable.

iii) The Assessing Officer was directed to treat the application dated 08/02/2010, as a fresh application at the earliest preferably within six weeks of the order.”

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Nirav Shah

Export profit: Deduction u/s. 80HHC: Retrospective amendment to section 80HHC(3) by Taxation Laws(Second Amendment) Act, 2005 to get over decision of Tribunal is not valid: Amendment prospective:

[Vijaya Silk House (Bangalore) Ltd. Vs. UOI; 349 ITR 566 (Bom):]

Dealing with the validity of the retrospective amendment to section 80HHC(3) of the Income-tax Act, 1961 the Bombay High Court held as under:

“i) The amendment made by the Taxation Laws (Amendment) Act, 2005, in order to overcome the decision of the Tribunal by insertion of the third and fourth provisos to section 80HHC(3) of the Income-tax Act, 1961, is violative for its retrospective operation and for depriving the benefit earlier granted to a class of assessees whose assessments were still pending, although such benefit will be available to assessees whose assessments have already been concluded. In this type of substantive amendment, retrospective operation can be given only if it is for the benefit of assessees and not in a case where it affects even a small section of assessees.

ii) Accordingly, the amendment could be given effect from the date of the amendment and not in respect of earlier assessment years in case of assessees whose export turnover is above Rs. 10 crore. In other words, the retrospective amendment should not be detrimental to any of the assessees.”

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Nirav Shah

Capital gains: Section 50C: A. Y. 2003-04: Stamp duty value higher than sale consideration: Reference to DVO: Report of DVO binding on AO:

[CIT Vs. Dr. Indira Swaroop Bhatnagar; 349 ITR 210 (All):]

In the previous year relevant to the A. Y. 2003-04, the assessee sold an immovable property for a consideration of Rs. 51,75,000/-. The Assessing Officer applied section 50C and substituted the stamp duty value of Rs. 1,38,00,000/- for the consideration. Assessee’s registered valuer valued the property at Rs. 48,37.500/. Assessing Officer rejected the said value and referred the matter to the DVO for determining the market value. The DVO determined the market value of the property at Rs. 58,50,000/- The Assessing Officer rejected the DVO’s report and adopted the stamp duty valuation. The Tribunal held that the valuation by the DVO had to be adopted.

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

“i) Section 50C of the Act provided that where the assessee claims that the value adopted or assessed for stamp duty purposes exceeds the fair market value of the property as on the date of transfer, the Assessing Officer may refer the valuation of the relevant asset to a Valuation Officer in accordance with section 55A. Generally, when the Assessing Officer has obtained the report of the DVO it is binding on him.

ii) The valuation of the DVO had to be adopted.”

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Nirav Shah

Capital gain: Exemption u/ss. 54 and 54EC: A. Y. 2007-08: Long term capital gain: investment in residential property and bonds: Inclusion of husband’s name as joint owner: Assessee entitled to exemption of entire investment:

[DI(Int Tax) Vs Mrs. Jennifer Bhide; 349 ITR 80 (Kar):]

In A. Y. 2007-08, the assessee sold her residential property and from the sale proceeds, purchased residential property and bonds. The property and the bonds were purchased in the joint names of herself and her husband. The assessing Officer allowed 50% of the claim for deduction. The Tribunal allowed the full claim.

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

“i) It was nobody’s case that the assessee’s husband had contributed any portion of the consideration for acquisition of the property or the bonds. The source for acquisition of the property and the bonds was the sale consideration.

ii) Once the sale consideration was utilised for the purpose mentioned u/s. 54 and 54EC, the assessee was entitled to the benefit of those provisions. As the entire consideration had flowed from the assessee and no consideration had flowed from her husband, merely because either in the sale deed or in the bond her husband’s name was also mentioned, in law he would not have any right. Therefore, the assessee could not be denied the benefit of deduction.”

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Nirav Shah

Penalty – Concealment of income – Suit for recovery by bank settled at Rs.42,45,477 as against Rs.52,07,873 outstanding in the assessee’s books of account – Not a case to which section 271(1)(c) would apply.

Northland Development and Hotel Corpn. V. CIT (2012) 349 ITR 363 (SC)

The assessee took loan from Citi Bank N.A. to buy a hotel (capital asset). Default was committed in repayment of loan. Suit was filed for recovery, which was settled by signing consent decree on 30th April, 1982. The consent decree recited that the borrowers acknowledged their liability to the plaintiff-bank in the sum of Rs.42,45,477, being the outstanding amount in the loan account of the bank as on 30th April, 1982. However, in the books of account of the assessee, the outstanding amount repayable to the bank was Rs.52,07,873 as on 30th April, 1982. Consequently, the Department came to the conclusion that there was a waiver by the bank to the extent of approximately rupees ten lakhs. This amount was sought to be taxed by the Department. The Department also initiated proceedings u/s. 271(1)(c) of the Incometax Act, 1961, against the assessee. The Supreme Court observed that, in the books of account of the assessee, the outstanding amount, as on 30th April, 1982, was Rs.52,07,873, including interest. However, the decree in favour of the bank was for Rs.42,45,477, because that was the amount indicated as the outstanding amount due and payable by the assessee to the bank in its books of account.

According to the Supreme Court it appeared that the bank had not calculated the interest over the years possibly for the reason that, in its accounts, this amount was classified as “NPA”. The Supreme Court held that in the peculiar facts and circumstances of this case, section 271(1)(c) of the Income-tax Act, 1961, was not applicable.

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Nirav Shah

A.P. (DIR Series) Circular No. 49, dated 22-11-2011 — Foreign investments in Infrastructure Debt Funds.

This Circular permits eligible non-resident investors, subject to certain terms and conditions, to invest in Infrastructure Debt Funds (IDF) as shown in tabular form on next page: The original/initial maturity period of the securities must be 5 years with a lock-in period of 3 years. However, transfer between eligible nonresident investors is permitted during this period.

Eligible instruments/securities for non-resident investment in IDFs
Eligible non-resident investor				Eligible instruments
(i)	SEBI-registered eligible non-resident investors			Foreign currency and Rupee denominated bonds and
	in IDF — Sovereign Wealth Funds, Multilateral			rupee denominated units issued by IDF
	Agencies, Pension Funds, Insurance Funds and
	Endowment Funds
(ii)	SEBI-registered FII who qualify as (i) above			Foreign currency and Rupee denominated bonds and rupee denominated units issued by IDF
(iii)	SEBI-registered FII who do not qualify	as	(i)	Rupee denominated bonds and units issued by IDF
	above
(iv)	NRI			Rupee denominated bonds and units issued by IDF

Investments by non-residents, other than NRI, must be within the overall cap/limit of US $ 10 billion within the overall cap of US $ 25 billion for FII investment in bonds/non-convertible debentures issued by Indian companies in the infrastructure sector or by infrastructure finance companies. There is no cap/limit on NRI investment IDF by way of Rupee denominated bonds/units. Foreign currency denominated bonds must comply with the External Commercial Borrowing guidelines/regulations.

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Nirav Shah

A.P. (DIR Series) Circular No. 48, dated 21-11-2011 — Mid-sea trans-shipment of catch by deep sea fishing vessel.

Annexed to this Circular are the GR declaration procedures based on the norms prescribed by the Ministry of Agriculture, Government of India. These have to be followed by exporters who undertake mid-sea trans-shipment of catches by Indian-owned vessels.

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Nirav Shah

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