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Month: July

Company – Book profits – Computation – Amount disallowed u/s 14A cannot be included

31 Sobha Developers Ltd. vs. Dy. CIT(LTU) [2021] 434 ITR 266 (Karn) A.Y.: 2008-09; Date of order: 1st April, 2021 Ss. 14A and 115JB of ITA, 1961

Company – Book profits – Computation – Amount disallowed u/s 14A cannot be included

This appeal u/s 260A was preferred by the assessee and was admitted by the Karnataka High Court on the following substantial question of law:

‘Whether the Tribunal is justified in law in holding that the indirect expenditure disallowed u/s 14A read with rule 8D(iii) of Rs. 24,64,632 in computing the total income under normal provisions of the Act is to be added to the net profit in computation of book profit for Minimum Alternate Tax purposes u/s 115JB and thereby importing the provisions of section 14A read with rule 8D into the Minimum Alternate Tax provisions on the facts and circumstances of the case?’

The High Court held as under:

‘Sub-section (1) of section 115JB provides the mode of computation of the total income of an assessee-company and tax payable on the assessee u/s 115JB. Sub-section (5) of section 115JB provides that save as otherwise provided in this section, all other provisions of this Act shall apply to every assessee being a company mentioned in this section. The disallowance u/s 14A is a notional disallowance and therefore, by recourse to section 14A, the amount cannot be added back to the book profits under clause (f) of Explanation 1 to section 115JB.’

Section 28(i) – Disallowance of loss made merely on ad interim order of SEBI and in absence of any material to prove that assessee entered into dubious transactions deliberately to show business loss, was liable to be deleted

29 Kundan Rice Mills Ltd. vs. Asst. CIT [2020] 83 ITR(T) 466 (Del-Trib) IT(TP) Appeal No. 853 (Del) of 2020 A.Y.: 2015-16; Date of order: 9th July, 2020

Section 28(i) – Disallowance of loss made merely on ad interim order of SEBI and in absence of any material to prove that assessee entered into dubious transactions deliberately to show business loss, was liable to be deleted

FACTS
The assessee company was engaged inter alia in trading in shares, futures and options. During the year under consideration, it claimed loss on account of trading in stock options. The A.O. found that SEBI had passed an ex parte interim order in the matter of illiquid stock options wherein the name of the assessee company also figured in the list of entities which had entered into non-genuine, fraudulent trades to generate fictitious profits / losses for the purpose of tax evasion / facilitating tax evasion.

However, the assessee explained before the A.O. that (i) it had acted as a bona fide trader as it had been doing in the past and complied with all procedures and requirements of the stock exchange, (ii) at the time of the relevant transactions / trades, the assessee could not have had any idea about any profit or loss in the said transactions, and (iii) the assessee was not connected with the counter-parties in the trade and there was no grievance of any of the investors or BSE. It also claimed that only 4.85% sale transactions allegedly matched with entities named by SEBI. The A.O., however, rejected this submission of the assessee and disallowed loss in trading from stock options. The Commissioner (Appeals) upheld the addition made by the A.O. on the basis that since detailed investigation was carried out by SEBI, no separate investigation was required to be done by the A.O. to disallow the bogus losses.

Aggrieved, the assessee filed an appeal before the ITAT.

HELD
The disallowance of loss made by the A.O. was deleted by the ITAT. In doing so, it observed that:

1. Trading in stock futures and options was done by the assessee regularly since past several years. The transactions were recorded in the books of accounts. The intrinsic value mentioned in the SEBI order was only one of the ways of calculating and there is no set formula / law / rule / circular which defines intrinsic value or prohibits trading below intrinsic value.
2. The A.O., in the assessment order, had observed that in screen-based electronic trading, ideally, it was not possible to choose the counter party for trade. The circuit breaker limits set by SEBI were not applicable to the Futures and Options (F&O) segment.
3. SEBI subsequently directed that there was no need to continue with the directions issued against the assessee company and others (these were the same orders relied upon by the Income-tax authorities). Thus, in principle, the interim order and subsequent orders of the SEBI which were the basis of passing the assessment order in question, were vacated by SEBI itself.
4. The assessee filed complete documentary evidence before the authorities like carrying out transactions through banking channels, fulfilling margin requirements mandated by SEBI, etc. The same were supported by contract notes. There was also no allegation made by BSE against any of the transactions carried out by the assessee company. The A.O. as well
as the Commissioner (Appeals) did not conduct any investigation on the documentary evidences filed by the assessee.
5. Loss on account of similar nature of transactions was incurred in the preceding year, which was not disallowed and hence, the A.O. ought to have followed the principle of consistency.
6. The ad interim order of SEBI was passed without hearing the objections of the assessee and when
those objections were considered, the interim order was diluted by giving permission to the assessee to deal
in the transactions. Since both the orders of SEBI relied upon by the A.O. were vacated by the SEBI, there was no material available with the authorities below so as to conclude that the assessee has entered into any dubious or other transactions deliberately to show business losses.
7. The ad interim order which was passed by SEBI ex parte would not disclose any precedent or ratio which may be binding on the Income-tax Department.

Based on the above observations, the disallowance was finally deleted.

ITAT allows claim of interest – Sets aside CIT(A)’s order arbitrarily restricting interest rate at 12% p.a. – Treats expenditure as allowable u/s 36(1)(iii)

28 Shri Bhavarlal Mangilal Jain [2021] TS-420-ITAT-2021 (Mum)b A.Y.: 2012-13; Date of order: 4th May, 2021 Section 36(1)(iii)

ITAT allows claim of interest – Sets aside CIT(A)’s order arbitrarily restricting interest rate at 12% p.a. – Treats expenditure as allowable u/s 36(1)(iii)

FACTS
The assessee, an individual, had wrongly claimed certain interest expenditure under ‘income from other sources’ which was disallowed by the A.O. during assessment. At the appellate proceedings with the CIT(A), the assessee raised an additional ground that such interest be allowed under the head ‘Profits & Gains of Business / Profession’. The CIT(A) allowed the interest expenditure, but restricted the rate of interest to 12% p.a. The interest paid in excess of 12% was disallowed on the grounds that the rate of interest is higher (the assessee had paid interest ranging from 5% to 24%) than the interest received on Partnership Capital Account. The CIT(A), thus made a disallowance of interest in excess of 12% p.a.

Aggrieved, the assessee preferred an appeal with the Tribunal.

HELD
The Tribunal observed that the Department had accepted the genuineness of the loan transactions and also the same being for business purposes. Once the expenditure has been accepted to be business expenditure, the interest rate cannot be arbitrarily restricted. In order to disallow interest beyond a certain rate, it has to be shown that such interest was excessive or for extraneous consideration. Based on facts, the Tribunal noted that some of the parties to whom interest was paid at a rate of more than 12% included banks, non-banking financial institutions and some private lenders, and none of these parties was related to the assessee within the provisions of section 40A. Thus, the assessee’s appeal was allowed.

ITAT allows assessee to claim the property cohabited by her as ‘let-out’ – Allows eligible deductions u/s 24 in computation of income under ‘house property’

27 Hima Bindu Putta [2021] TS-428-ITAT-2021 (Hyd) A.Y.: 2009-10; Date of order: 3rd May, 2021 Section 23

ITAT allows assessee to claim the property cohabited by her as ‘let-out’ – Allows eligible deductions u/s 24 in computation of income under ‘house property’

FACTS

The assessee, an individual, filed her return of income declaring loss under the head ‘house property’. She was in ownership of a property which was let-out by her to a company in which her husband was a director-employee. The company in turn provided this property by way of accommodation to her husband, Mr. A, with whom she resided in the property. The assessee treated this property as a let-out property and offered the rental income in her computation. The A.O. treated 50% of the property as let-out and the balance 50% as self-occupied, as the assessee was also residing in the property. Accordingly, he restricted deductions u/s 24 to 50% of the allowable amounts. The CIT(A) dismissed the assessee’s appeal.

Aggrieved, the assessee is in appeal before the Tribunal.

HELD


The Tribunal, relying on the material available on record, found that there was no dispute that the assessee was the owner of the property and she had purchased it with borrowed capital. Further, the property had been let-out to the company and she had offered the rental income in her computation for the relevant assessment year. ‘The assessee is the wife of Mr. A, who was given the property as residential accommodation by the company, and therefore it cannot he held that the assessee herself is occupying the property.’

The Tribunal ruled in favour of the assessee, stating that such income has to be treated as income from ‘house property’ and all eligible deductions including interest on borrowed capital was to be allowed in computing such income.

The assessee’s appeal was thus allowed.

Right to collect toll is an intangible asset which qualifies for depreciation @ 25%

26 BSC C&C Krunali Toll Road Ltd. vs. DCIT TS-381-ITAT-2021 (Del) A.Ys.: 2012-13 & 2013-14; Date of order: 18th May, 2021 Section: 32

Right to collect toll is an intangible asset which qualifies for depreciation @ 25%

FACTS

The assessee company developed a toll road on the Kurla-Kiratpur section in Punjab on BOOT basis. The contract was awarded by the National Highways Authority of India (NHAI). The entire cost of construction was Rs. 441,27,05,614, including a grant of Rs. 43.92 crores from the NHAI. The assessee, in its return of income, claimed depreciation thereon @ 25%. While assessing its total income u/s 143(3), the A.O., following the judgment of the Allahabad High Court in CIT vs. Noida Toll Bridge Co. Ltd. 213 Taxman 333, restricted depreciation on the toll road to 10%.

Aggrieved, the assessee preferred an appeal to the CIT(A) who confirmed the action of the A.O.

The assessee then preferred an appeal to the Tribunal where it contended that the lower authorities erred in holding that it was the owner of the road. Actually, the assessee had only been given the right to collect toll fee from vehicles entering the road which right could not be equated with ownership. On behalf of the assessee, reliance was placed on the following decisions:

(a) North Karnataka Expressway Ltd. vs. CIT [Appeal No. 499 of 2012]; (b) West Gujarat Expressway Ltd. [ITA Nos. 5904 & 6204/M/2012; order dated 15th April, 2015]; (c) Progressive Construction Ltd. [ITA No. 214/Hyd/2014; order dated 7th November, 2014]; (d) Kalyan Toll Infrastructure Ltd. vs. ACIT [ITA Nos. 201 & 247/Ind/2008; order dated 14th December, 2010]; and (e) Mokama Munger Highway Ltd. vs. ACIT [ITA Nos. 1729, 2145 & 2146/Hyd/2018; order dated
3rd July, 2019].

HELD


The Tribunal noted that there were conflicting decisions rendered by the High Court and the Special Bench of the Tribunal. The Bench then noted the ratio of the decisions of the Tribunal in the case of ACIT vs. West Gujarat Expressway Ltd. (Supra) and also of the Special Bench decision of the Tribunal in ACIT vs. Progressive Construction Ltd. Following the ratio of the decision of the Bombay High Court and also the Special Bench decision, the Tribunal held that the assessee is entitled to claim depreciation @ 25%.

Gain received by assessee owing to fluctuation in foreign exchange rates in respect of loan which was given, as also received back in US dollars, by assessee to his cousin in Singapore under Liberalised Remittance Scheme issued by Reserve Bank of India, is a capital receipt not chargeable to tax

25 Aditya Balkrishna Shroff vs. ITO [2021] 127 taxmann.com 343 (Mum-Trib) A.Y.: 2013-14; Date of order: 17th May, 2021 Sections: 2(24), 4, 56

Gain received by assessee owing to fluctuation in foreign exchange rates in respect of loan which was given, as also received back in US dollars, by assessee to his cousin in Singapore under Liberalised Remittance Scheme issued by Reserve Bank of India, is a capital receipt not chargeable to tax

FACTS
In the course of assessment proceedings, the A.O. noticed that as per AIR Information and as per capital account filed by the assessee, he was in receipt of Rs. 1,12,35,326. Upon seeking an explanation, the assessee informed that on 29th March, 2010, he had granted an interest-free loan of US $2,00,000 to his cousin in Singapore. The remittance was made under the Liberalised Remittance Scheme of the RBI. The rate of exchange prevailing on that date was Rs. 45.14. On 24th May, 2012 the assessee received back the said loan of US $2,00,000. The exchange rate on the date of receiving back the loan was Rs. 56.18. Accordingly, the capital account of the assessee was credited with a sum of Rs. 1,12,35,326.

The A.O. was of the view that the difference in amount of Rs. 22,04,568 was of the nature of income. The assessee explained that the loan was given on a personal account to his cousin and was not a business transaction and there was no motive of any economic gain in the transaction. It was done in terms of the Liberalised Remittance Scheme of the RBI inasmuch as it was a permitted transaction and specifically on capital account. It was further explained that the transaction was capital in nature, therefore ‘the gain is in the nature of capital receipt and hence not offered for taxation’.

But these submissions did not impress the A.O. who held that ‘the gain on realisation of loan would partake the character of income under the head “income from other sources”’. Accordingly, he added a sum of Rs. 1,12,35,326 to the total income of the assessee as ‘income from other sources’.

Aggrieved, the assessee preferred an appeal to the CIT(A) who confirmed the action of the A.O. The assessee then preferred an appeal to the Tribunal.

HELD


The Tribunal held that when a receipt is in the capital field, even if that be a gain, it is in the nature of a capital gain, but then as the definition of income stands u/s 2(24)(vi), only such capital gains can be brought to tax as are permissible to be taxed u/s 45. In other words, a capital gain which is not taxable under the specific provisions of section 45 or which is not specifically included in the definition of income by way of a specific deeming fiction, is outside the ambit of taxable income. All ‘gains’ are not covered by the scope of ‘income’. Take, for example, capital gains. It is not even the case of the authorities below that the capital gains in question are taxable u/s 45. Thus, the reasoning adopted by the A.O. was incorrect.

The Tribunal observed that the CIT(A)’s line of reasoning was no better. While he accepts that the transaction in question was in the capital field, he proceeds to hold that ‘income’ arising out of the loan transaction is required to be treated as ‘interest’ or ‘income from other sources’, but all this was a little premature because he proceeded to decide as to what is the nature of the income or under which head it is to be taxed, without dealing with the foundational plea that the scope of income does not include gains in the capital field. According to the Tribunal, if the transaction was in the capital field, as he accepts, ‘where is the question of a capital receipt being taxed as income unless there is a specific provision of bringing such a capital receipt to tax?’

The Tribunal held that where the loan is in a foreign currency and the amount received back as repayment is exactly the same, there is no question of any interest component at all.

The Tribunal allowed this ground of appeal filed by the assessee.

Amendment made to section 54B by the Finance Act, 2013 w.e.f. 1st April, 2013 making HUFs entitled for claiming benefit u/s 54B is clarificatory

24 Shri Sitaram Pahariya (HUF) vs. ITO [2021] 127 taxmann.com 618 (Agra) A.Y.: 2012-13; Date of order: 31st May, 2021 Section: 54B

Amendment made to section 54B by the Finance Act, 2013 w.e.f. 1st April, 2013 making HUFs entitled for claiming benefit u/s 54B is clarificatory

FACTS
During the previous year relevant to the assessment year under consideration, the assessee HUF sold agricultural land and claimed benefit u/s 54B on subsequent purchase of another plot of land. The A.O., while assessing the total income of the assessee, denied the claim made by the assessee.

Aggrieved, the assessee preferred an appeal to the CIT(A) who confirmed the denial of claim on the ground that for the assessment year under consideration, section 54B does not apply to HUFs.

Aggrieved, the assessee preferred an appeal to the Tribunal.

HELD
The Tribunal held as under:

(i) the Hindu undivided family was entitled to the benefit of 54B even prior to the insertion of ‘the assessee being an individual or his parent, or a Hindu undivided family’ by the Finance Act, 2013;
(ii) the assessee is a person subjected to tax under the Act, and the person includes the individual as well as the Hindu undivided family. Therefore, the benefit of provisions of 54B cannot be restricted to only individual assessees;
(iii) the Revenue is duty-bound to make out a clear case of debarring the HUF from availing the benefit of section 54F / 54B and the assessee cannot be denied the benefit merely based on its interpretation. If the Revenue wanted to tax the assessee (HUF), then the statute should have provided specifically that the assessee in 54B is only restricted to a living individual and is not applicable to a Hindu undivided family;
(iv) further, the High Court had not considered that individual assessee and HUF can both be used as and when the context so desires and it will not lead to any absurdity. In case the assessee is a Hindu undivided family, the second part of section 54B, i.e., ‘of parents of his’, would not be applicable. Harmonious interpretation is required to be invoked so that the word used in the provisions would not become redundant or otiose;
(v) in case of doubt or confusion, the benefit in respect of taxability or exemption should be given to the assessee rather than to Revenue;
(vi) the Co-ordinate Bench in the matter of Sandeep Bhargava (‘HUF’) [(2020) 117 taxmann.com 677 (Chandigarh-Trib)] has held that an HUF is entitled to claim benefit of section 54B;
(vii) on the facts of the present case, the Tribunal found that the assessee, within two years of the sale of agricultural land, had invested the amount and purchased land in accordance with the requirement of section 54B and was entitled to the benefit of 54B;
(viii) the assessee HUF is entitled to the benefit of section 54B for the assessment year under consideration as the word assessee used in 54B had always included HUF, and further, the amendment brought on by the Finance Act, 2013 in section 54 by inserting ‘the assessee being an individual or his parent, or a Hindu undivided family’ was classificatory in nature and was introduced by the Ministry with a view to extend the benefit to the Hindu undivided family;
(ix) the Hindu undivided family (HUF) has been recognised as a separate tax entity; therefore, before and after the amendment, if the agricultural land which was being used by the HUF for two years prior to the transfer has been transferred by it and it purchases any other agricultural land within two years of such transfer, then it shall be entitled to the benefit of section 54B/54F.

Receipt in the form of share premium cannot be brought to tax as revenue receipt

23 ACIT vs. Covestro India Private Limited (formerly Bayer Sheets India Private Limited) TS-394-ITAT-2021 (Mum) A.Y.: 2011-12; Date of order: 27th April, 2021
Section: 4

Receipt in the form of share premium cannot be brought to tax as revenue receipt

FACTS
The assessee, a private limited company engaged in the business of manufacturing and trading of polycarbonate sheets, articles and high impact polystyrene articles, commenced business operations in the previous year relevant to the assessment year under consideration. For the A.Y. 2011-12, it filed its return of income declaring therein a loss of Rs. 17,39,073.

During the year under consideration, the assesse had issued 7,00,000 equity shares of Rs. 10 each at a premium of Rs. 115.361351 per share. Of the 7,00,000 equity shares issued, 3,57,000 were issued to a foreign company Bayer Material Science for a monetary consideration; 3,08,000 shares were issued to Malibu Plastica Private Limited (‘MPPL’) and 35,000 to Malibu Tech Private Limited (‘MTPL’) for non-monetary consideration, i.e., for purchase of polycarbonate extrusion and thermo-forming sheet material from the said Indian companies.

While assessing the total income of the assessee, the A.O. treated share premium of Rs. 8,07,52,945 (7,00,000 x 115.361351) as taxable u/s 56 on the ground that the assessee sought to justify the issue price of the shares by adopting the DCF method without furnishing business plans and projections to justify the premium; the year of issue of shares was the first year of business of the assessee; and the assessee has utilised the share premium for purposes other than those specified u/s 78 of the Companies Act, 1956; hence, the receipt of share premium partakes the character of revenue receipt taxable as income.

Aggrieved, the assessee preferred an appeal to the CIT(A), who upheld the action of the A.O. The assessee then preferred an appeal to the Tribunal.

HELD
The Tribunal noted that the addition had been made by the A.O. u/s 56(1) and hence what is to be adjudicated is limited and confined to the fact as to whether receipt of share premium per se could be treated as revenue receipt so as to make it taxable u/s 56(1).

It held that receipt of share premium per se cannot be treated as income or revenue receipt. In order to make a particular receipt taxable within the ambit of section 56(1), the receipt should be in the nature of income as defined in section 2(24). Share premium received by the company admittedly forms part of share capital and shareholders’ funds of the assessee company. When receipt of share capital partakes the character of a capital receipt, the receipt of share premium also partakes the character of capital receipt only. Hence, at the threshold itself, the receipt in the form of share premium cannot be brought to tax as revenue receipt and consequently be treated as income u/s 56(1).

The Tribunal noted that the Co-ordinate Bench of the Tribunal in the case of Credit Suisse Business Analysis (India) (P) Ltd. vs. ACIT [72 taxmann.com 131 (Mum-Trib)] has addressed the very same issue and decided in favour of the assessee. This order was the subject matter of challenge by the Revenue before the High Court and the question of law was not admitted by the High Court on the addition made u/s 56(1). A similar view has been taken by the Tribunal in the case of Green Infra Ltd. vs. ITO [38 taxmann.com 253].

The Tribunal dismissed in limine the observation made by the A.O. in his order that receipt of premium was akin to a gift and hence taxable u/s 56(1). It held that receipt of share capital and share premium is normal in case of a limited company and the same by no stretch of imagination can be equated with a gift. Moreover, a gift can be received only by individuals or HUFs and not by a company.

The Tribunal held that the case of Cornerstone Property Investment Pvt. Ltd. vs. ITO [ITA No. 665/Bang/2017 dated 9th February, 2018], on which reliance was placed by the Revenue, is distinguishable on facts as in that case addition had been made u/s 68 by doubting the genuineness of the parties from whom share premium had been received.

The ground of appeal filed by the assessee was allowed.

Where accrual of income takes place but its realisation becomes impossible, such hypothetical income cannot be charged to tax

22 Nutan Warehousing Co. Pvt. Ltd. vs. ACIT TS-396-ITAT-2021 (Pune) A.Y.: 2013-14: Date of order: 11th May, 2021 Section: 4

Where accrual of income takes place but its realisation becomes impossible, such hypothetical income cannot be charged to tax

FACTS

The assessee company filed its return of income for A.Y. 2013-14 declaring a total income of Rs. 66,41,800. The A.O., in the course of assessment proceedings, observed from 26AS data that the assessee has not shown bank interest amounting to Rs. 26,125 from deposits with The Rupee Co-operative Bank Ltd. He added this sum of Rs. 26,125 to the total income returned.

Aggrieved, the assessee preferred an appeal to the CIT(A). The CIT(A) was of the view that the assessee is following the mercantile system of accounting. Once interest has accrued to the assessee, it becomes chargeable to tax, notwithstanding its non-receipt. He upheld the action of the A.O.

Aggrieved, the assessee preferred an appeal to the Tribunal.

HELD


The Tribunal observed that the bank had become defunct, no financial transactions were allowed and RBI had banned its transactions. Due to the ban, even the principal amount deposited by the assessee became doubtful of recovery, much less the interest in question that was not received. It noted that the assessee stated before the CIT(A) during the course of the first appellate proceedings in the year 2017 that the interest was not received even till that time.

The Tribunal held that the concept of ‘accrual of income’ needs to be considered in the light of the ‘real income theory’. Where accrual of income takes place but its realisation becomes impossible, such hypothetical income cannot be charged to tax. In the case of the mercantile system of accounting, an accruing income can be charged to tax only when it is likely to be received under the given circumstances. In a case where receipt of income, after its accrual, is marred with complete uncertainty as to its realisation, such an accrual gets deferred to the point of clearing of the clouds of uncertainty over it.

On consideration of the mercantile system of accounting in juxtaposition with the ‘real income theory’, the Tribunal held that the inescapable conclusion which follows is that the interest income of Rs. 26,125 cannot be included in the total income of the assessee for the year under consideration. Such income may be appropriately charged to tax on the regularisation of the operations of the bank, coupled with the possibility of receipt of income in the foreseeable future. For the year under consideration, the interest cannot be charged to tax.

AMENDMENT IN FOREIGN DIRECT INVESTMENT RULES

(A)   BACKGROUND

Under the erstwhile
FEMA regulations governing Foreign Direct Investment into India (‘FDI’), i.e.
FEM 20(R), Foreign Exchange Management (Transfer of Issue of Security by a
Person Resident outside India) Regulations, 2017 (‘FDI Regulations’) dated 7th
November, 2017, the RBI had powers to govern FDI which included equity
investments into India.

 

However, the above
position governing FDI has been overhauled since then. The Government of India,
with effect from 15th October, 2019, assumed power from RBI to
regulate non-debt capital account transactions which would include equity
instruments, capital participation in LLP, etc. by issuing the Foreign Exchange
Management (Non-Debt Instruments) Rules, 2019 (‘Non-Debt Rules’) for governing
non-debt transactions.

 

Therefore, upon
issuance of the above Non-Debt Rules, the power to regulate FDI into India was
taken over by the Central Government from RBI.

 

(B)   AMENDMENTS TO NON-DEBT RULES BY NOTIFICATION
DATED 27TH APRIL, 2020

 

(I)   Acquisition of equity shares by purchasing
rights entitlement from person resident in India

The Government of
India issued the above notification for amending Rule 7 of the Non-Debt Rules
which deals with investment by a person resident outside India in equity shares
(other than share warrants) issued by an Indian company on rights issue which
are renounced by the person to whom it is offered.

 

The amendment now
inserts Rule 7A which provides that whenever a person resident outside India
purchases rights for investing in equity shares (other than warrants) from a
person resident in India who has renounced it, investment by the person
resident outside India has to follow the applicable pricing guidelines laid
down in Rule 21 of the Non-Debt Rules. The pricing guidelines are given as
under:

(i)   In case of listed companies – As per SEBI
guidelines;

(ii)   In case of unlisted companies – As per
internationally accepted pricing methodology.

 

The earlier
Non-Debt Rules did not provide for any different pricing guidelines in case of
investment by person resident outside India in rights shares by purchase of
rights renounced by person resident in India. The earlier Non-Debt Rules
provided for following conditions in case of investment by person resident
outside India through either subscription to rights shares or purchase of
rights renounced by person resident in India:

 

Sr.
No.

Rights
issued by

Pricing
guidelines for rights issue and subscription pursuant to purchase of rights
renounced

1

Listed Indian company

Price determined by Indian company

2

Unlisted Indian company

Price not less than price offered to
person resident in India

 

Implications
of above amendment to Non-Debt Rules

Under the erstwhile
Non-Debt Rules which were similar to the FEMA 20(R) provisions governing FDI,
where a person resident outside India purchased rights entitlement to equity
shares which were renounced by a person resident in India, such non-resident
could invest at the same price at which they were offered to the person
resident in India. However, there are no pricing guidelines which are
applicable on issuance of shares on rights basis under the Companies Act, 2013.

 

Hence, whether a
non-resident purchased rights entitlement which was renounced by a person
resident in India or participated in rights issue as it was holding equity
shares, there was no change in pricing guidelines related to issuance of rights
shares.

 

However, post amendment to the Non-Debt Rules, a new criterion has been
drawn for a person resident outside India who purchases rights entitlements
from a person resident in India wherein pricing guidelines will be different as
compared to a person resident outside India who invests in rights issue. The
same is summarised as under:

 

Sr.
No.

Investment
by person resident outside India

Rights
issued by

Pricing
guidelines for rights issue

1

Participation in rights issue

Listed Indian company

Price determined by Indian company

2

Unlisted Indian company

Price not less than price offered to
person resident in India

3

Participation in rights issue through
purchase of rights entitlement

Listed Indian company

As per SEBI guidelines

4

Unlisted Indian company

As per internationally accepted
valuation methodology

 

The above amendment
will result in a peculiar situation which can be explained by way of the
following example:

 

Mr. NRI is a person
resident outside India who is holding 1,000 equity shares in an existing
unlisted Indian company, X Ltd. which has undertaken rights issue wherein Mr.
NRI will be eligible for 100 equity shares on rights basis. Equity shares are
issued on rights basis at the same price of Rs. 20 per equity share to both
resident as well as non-resident shareholders. Accordingly, Mr. NRI will
purchase his entitlement, i.e. 100 rights equity shares at the rights price of
Rs. 20 per share.

 

Further, Mr. NRI
also purchases rights entitlements for 50 equity shares from a person resident
in India. In such a scenario, the investment by Mr. NRI for purchasing 50
equity shares by way of rights entitlement would be at a price based on an
internationally accepted valuation methodology which can be different from the
price at which X Ltd. has issued the rights shares.

 

Hence, in a rights issue by an Indian company to the same non-resident
investor, there would be two different prices, one price for the purchase of
rights shares and another price for the purchase of rights shares acquired
through acquiring rights entitlement from a person resident in India.

 

Further, the new
Rule 7A does not cover situations where a person resident outside India has
purchased rights entitlement from persons resident outside India. In such a
situation the amendment does not apply.

Additionally, as per section 62(1) of the Companies Act, 2013, where a
shareholder to whom rights offer is made declines to exercises his right, the
Board can dispose them in a manner which is not disadvantageous to the company.
In such a situation, if the Board allocates those rights to an existing foreign
investor, the same cannot be considered to be purchase of rights renounced by
Indian investor and hence the amendment will not apply. Thus, a foreign
investor can acquire shares in the Indian company at the rights issue price
even if it is below fair market value.

 

(II)  Amendment in sourcing
norms for single brand product retailing

Earlier regulations
provided that sourcing norms shall not be applicable up to three years from
commencement of the business, i.e., opening of the first store for entities
undertaking single brand retail trading of products having ‘state-of-art’ and
‘cutting-edge’ technology and where local sourcing is not possible.

 

The amendment now
clarifies that exemption from sourcing would be applicable for three years
starting from the opening of the first store or the start of online retail,
whichever is earlier.

 

(III) Amendment in FDI limit
for insurance intermediaries

FDI in insurance
intermediaries, including insurance brokers, re-insurance brokers, insurance
consultants, corporate agents, third-party administrators, surveyors and loss
assessors and such other entities, as may be notified by the Insurance
Regulatory and Development Authority of India from time to time, is now
permitted up to 100% under the Automatic Route.

 

(IV) Amendment for FPIs

The amendment has
now provided that where FPI’s investment breaches the prescribed limit,
divestment of holdings by the FPI and its reclassification into FDI shall be
subject to further conditions, if any, specified by SEBI and RBI in this
regard.

 

SUMMARY OF
RECENT COMPOUNDING ORDERS

An analysis of some
interesting compounding orders passed by RBI in the months of January and
February, 2020 and uploaded on the website1  are given below. Article refers to regulatory
provisions as existing at the time of offence. Changes in regulatory
provisions, if any, are noted in the comments section.

_________________________________________

1   https://www.rbi.org.in/scripts/Compoundingorders.aspx

 

 

FOREIGN DIRECT INVESTMENT (FDI)

 

A. M/s Congruent Info-tech Pvt. Ltd.

Date of order:
19th December, 2019

Regulation: FEMA
20/2000-RB [Foreign Exchange Management (Transfer or Issue of Security by a
Person Resident Outside India) Regulations, 2000]

 

ISSUE

(1) Violation of pricing guidelines in issue of
shares,

(2) Delay in refund of consideration,

(3) Transfer of shares from resident to
non-resident by way of gift without RBI’s approval,

(4) Taking on record transfer of shares in the
books of the company without RBI’s approval.

 

FACTS

  •     Applicant company was
    engaged in the business of writing, modifying, testing of computer programmes
    to meet the needs of a particular client excluding web-page designing.
  •     The company received
    foreign inward remittance of Rs. 13,32,900 from Mr. Mani Krishna Murthy, USA
    towards subscription to shares which was duly reported to RBI.
  •     The applicant company
    allotted 10,000 equity shares at a face value of Rs.10 each amounting to Rs.
    1,00,000 as against their Fair Value of Rs. 92.50 to a person resident outside
    India on 9th October, 2003. The shortfall of Rs. 8,25,000 was
    brought in by way of inward remittance on 1st July, 2019 after a
    delay of approximately 15 years and 8 months.
  •     Further, the company
    refunded an amount of Rs. 10,30,900 without the permission of RBI on 5th
    April, 2011 (approximately three years from its deemed date of receipt, i.e. 29th
    November, 2007).
  •     The resident shareholder,
    Mr. V.S. Krishna Murthy, had transferred 20,000 equity shares of fair value Rs.
    92.50 each, amounting to Rs. 18,50,000, to a non-resident Mr. Mani Krishna
    Murthy on 9th October, 2003 by way of gift without RBI’s approval.
  •     The above transfer of
    shares was also taken on record by the applicant company without obtaining
    RBI’s approval.

 

Regulatory provision

  •     Paragraph 5 of Schedule I
    to Notification No. FEMA 20/2000-RB, ‘the price of shares issued to persons
    resident outside India shall not be less than the fair value of shares.    ’
  •     Paragraph 8 of Schedule I
    to Notification No. FEMA 20/2000-RB read with A.P. (DIR Series) Circular No. 20
    dated 14th December, 2007, ‘the shares have to be issued / amount
    refunded within 180 days from the date of receipt of the inward remittance    .’
  •     Regulation 10A(a) of
    Notification No. FEMA 20/2000-RB, ‘a person resident in India who proposes
    to transfer to a person resident outside India any security by way of gift
    shall make an application to Reserve Bank    .’
  •     Regulation 4 read with
    Regulation 10(A)(a) of Notification No. FEMA 20/ 2000-RB, ‘the company can
    take the transfer of shares by way of gift, on record, after the approval of
    Reserve Bank    .’

 

CONTRAVENTION

Relevant
Paragraph of FEMA 20 Regulation

Nature
of default

Amount
involved
(in INR)

Time
period of default (approximately)

Paragraph 5 of Schedule I

Violation of pricing guidelines in issue
of shares to non-resident

Rs. 8,25,000

15 years, 8 months and 22 days

Paragraph 8 of Schedule I read with A.P.
(DIR Series) Circular No. 20

Delay in refund of receipt of
consideration

Rs. 10,32,900

2 years, 10 months and 9 days

Regulation 10(A)(a)

Transfer of shares by way of gift from
resident to non-resident without prior approval from RBI

Rs. 18,50,000

15 years, 10 months and 18 days

Regulation 4 read with Regulation
10(A)(a)

Taking on record transfer of shares by
way of gift without RBI approval

Rs. 18,50,000

15 years, 10 months and 17 days

 

Compounding
penalty

Compounding penalty
of Rs. 2,15,519 was levied.

 

Comments

Under the erstwhile FEMA 20 Regulations as well as under Non-Debt
Rules, transfer of shares from resident to non-resident by way of gift requires
prior approval of RBI. Hence, unless approval from RBI is obtained, the Indian
company whose shares are being transferred should also not record the transfer
from resident to non-resident by way of gift.

 

B. Atrenta (India) Private Limited

Date of order:
30th January, 2020

Regulation: FEMA
20/2000-RB [Foreign Exchange Management (Transfer or Issue of Security by a
Person Resident Outside India) Regulations, 2000]

 

ISSUE

Transfer of shares
of the applicant from NRI to Non-Resident company without prior approval of
RBI.

 

FACTS

  •     Applicant Company had
    allotted 96,600 and 4,600 fully paid up equity shares to M/s Atrenta Inc. (NR)
    and Mr. Ajoy Kumar Bose (NRI), respectively, as part of subscription to the
    memorandum on 26th May, 2001.
  •     Further, the applicant
    company allotted 2,35,620 and 80 fully paid equity shares to M/s Atrenta Inc.
    and Mr. Ajoy Kumar Bose, respectively, on 10th October, 2001.
  •     Mr. Ajoy Kumar Bose (NRI)
    transferred 4,598 and 80 equity shares on 26th May, 2011 and 17th
    October, 2001 to M/s Atrenta Inc. (NR) without obtaining prior approval of RBI.
  •     The applicant company also
    took the transfer of shares from NRI to NR on record.

 

Regulatory
provision

•    Regulation 4 of FEMA 20, ‘save as
otherwise provided in the Act or Rules or Regulations made thereunder, an
Indian entity shall not issue any security to a person resident outside India
or shall not record in its books any transfer of security from or to such
person. Provided that the Reserve Bank may, on an application made to it and
for sufficient reasons, permit an entity to issue any security to a person
resident outside India or to record in its books transfer of security from or
to such person, subject to such conditions as may be considered necessary.’

 

CONTRAVENTION

Relevant
paragraph of FEMA 20 Regulation

Nature
of default

Amount
involved
(in INR)

Time
period of default (approximately)

Regulation 4

Transfer of shares of the applicant from
NRI to Non-Resident Company without prior approval of the Reserve Bank of
India

Rs. 46,780

16 years and 5 months

 

Compounding
penalty

Compounding penalty
of Rs. 79,526 was levied on the applicant company.

 

Comments

It is interesting
to note that the above penalty was levied on the applicant company for taking
on record transfer of shares from NRI to non-resident without prior approval of
RBI. Additionally, the NRI2 
was also levied penalty of similar amount for transferring its shares to
non-resident company without prior approval of RBI. Thus, penalty was levied
twice on the same transaction, one which was levied on the company, and the
second which was levied on the NRI.

 

It should also be
noted that under the earlier FEMA 20 Regulations (which were applicable till
November, 2017), an NRI could transfer equity shares by way of sale or gift to
another NRI only and not to any other non-resident. However, post November,
2017 under the erstwhile FEMA 20(R) as well as under the revised Non-Debt Rules
governing FDI from October, 2019 an NRI can transfer shares to any person
resident outside India by way of sale or gift without any approval from RBI.

 

ESTABLISHMENT
IN INDIA OF A BRANCH OFFICE OR A LIAISON OFFICE OR A PROJECT OFFICE OR ANY
OTHER PLACE OF BUSINESS

 

C. M/s Quanticate
International Limited, Branch Office

Date of order:
27th June, 2019

Regulation: RBI
approval letter dated 24th September, 2010 and Master Direction –
Establishment of Branch Office (BO) / Liaison Office (LO) / Project Office (PO)
or any other place of business in India by foreign entities, FED Master
Direction No. 10/2015-16

 

ISSUE

Payment of expenses
of the branch office directly by the parent company to the third party.

 

FACTS

  •     The applicant company was
    engaged in the business of statistical consultancy, statistical programming,
    pharmaco-vigilance, analysing and data management services to its head office.
  •     The applicant company
    established a branch office in India with the permission of RBI vide
    letter No. FE.CO.FID/7508/10.83.318/2010-11 dated 24th September,
    2010.
  •     The branch office (BO) had
    an account with RBS Bank to carry out its transactions. After the closure of
    RBS operations in India, the branch office closed this account on 19th
    August, 2016 and opened a new account with Standard Chartered Bank on 19th
    September, 2016.

______________________________________________

2   Ajoy Kumar Bose – CA. No 5047 / 2019 dated 12th
February, 2020

 

  •     Although the BO had an
    account with Standard Chartered Bank, the remittances of Rs. 5,40,42,300 were
    made directly by the parent company of the BO to a third party account for
    payment of expenses, particularly their staff, landlord and supplier in India
    during the period 21st September, 2016 to 23rd March,
    2017.

 

Regulatory
provisions

  •     Paragraph 6 of the
    permission letter states that the entire expenses of the office in India will
    be met either out of the funds received from abroad through normal banking
    channels or through income generated by it in India by undertaking permitted
    activities.
  •     Paragraph 11 of the
    permission letter states that the office may approach AD Bank in India to open
    an account for its operation in India. Credits to the account should represent
    the funds received from the head office through normal banking channels for
    meeting the expenses of the office and profit made by the BO. Debits of this
    account shall be for the expenses incurred by the BO and towards remittance of
    profit / winding up proceeds.
  •     Paragraph 3(ii) of FED
    Master Direction No. 10/2015-16 dated 1st January, 2016 also
    reiterates what was stated in paragraph 11 of the permission 11.

 

CONTRAVENTION

Relevant
provision

Nature
of default

Amount
involved
(in INR)

Time
period of default

Paragraph 6 and Paragraph 11 of RBI
approval letter read with Paragraph 3(ii) and 2(i) of FED Master Direction
No. 10/2015-16

Payment of expenses of the Branch Office
directly by the parent company to third party

Rs. 5,40,42,300

2 years, 3 months and 27 days

 

Compounding
penalty

Compounding penalty
of Rs. 2,46,169 was levied.

 

Comments

The companies which
have set up branch offices in India need to closely monitor their activities
and it needs to be ensured that all payments of branch offices should be
undertaken only through the branch’s Indian bank account and not  directly from its parent company.

 

D. M/s ETF Gurgaon Project Office (MG-SE-17)

Date of order:
11th October, 2019

Regulation: FEMA
22(R)/2016-RB [Foreign Exchange Management (Establishment in India of a branch
office or a liaison office or a project office or any other place of business)
Regulations, 2016]

 

ISSUE

Inter-project
transfer of funds and transfer of project assets from one project to another.

 

FACTS

  •     The applicant, M/s ETF, a
    company incorporated and registered under the laws of France, specialises in
    construction and maintenance of railway networks, urban transport networks and
    industrial siblings. It was involved in the development of railway
    infrastructure, high-speed lines, concrete slab tracks, metal and rubber
    wheeled tramway systems, etc.
  •     The applicant had
    established the following project offices in India for executing the following
    contracts:

i.    Contract MG-SE-17 with IL&FS Rail
Limited (referred to as MG-SE-17, Gurgaon);

ii.   Railway Infrastructure contract awarded by
Rail Vikas Nigam Limited (RVNL) – Construction contract with SEW-ETF-AIL JV2
(referred to as RVNL Kanpur);

iii.  Contract CT19A (referred as CT-19A Noida).

 

  •     Project expenses relating
    to a particular contract were met from the contract receipts relating to the
    said contract, or from remittances obtained from the Head Office in France
    depending upon the requirement of funds.
  •     There were, however,
    occasions where funds available in the bank account for a particular contract
    were insufficient to meet the expenses of the said contract necessitating
    inter-project transfer of funds.
  •     During the F.Y. 2016-17, ETF has obtained approval from RBI for
    inter-project transfer of funds up to Rs. 1,00,00,000 from the project office
    of MG-SE-17 to CT-19A.
  •     During the F.Ys. 2016-17
    and 2017-18, the Gurgaon project office did inter-project utilisation of funds
    and allocation of common expenditure amounting to Rs. 4,60,55,459.
  •     The above activity
    (inter-project utilisation of funds) of the Gurgaon project office did not
    relate to the contract secured by the foreign entity for which the project office
    was established.
  •     In the Annual Activity
    Certificates (AAC) for the years ended 31st March, 2017 and 31st
    March, 2018, the auditor had qualified the AACs by observing that the
    inter-project transfers were done without RBI approval.
  •     Further, transfer of
    project assets from the Gurgaon project office to another amounting to Rs.
    1,06,44,273 was also done without RBI approval.
  •     The applicant was granted post
    facto     approval subject to compounding of the contravention.

 

Regulatory
provisions

  •     Regulation 4(k) of
    Notification No. FEMA.22(R)/RB-2016 dated 31st March, 2016 states
    that a person resident outside India permitted under these Regulations to
    establish a branch office or liaison office or project office may apply to the
    Authorised Dealer Category-I bank concerned for transfer of its assets to a
    joint venture / wholly owned subsidiary or any other entity in India.
  •     Regulation 4(l) (Annex D)
    of Notification No. FEMA.22(R)/RB-2016 dated 31st March, 2016 states
    that the branch office / liaison office may submit the Annual Activity
    Certificate (Annex D) as at the end of 31st March along with the
    audited financial statements, including receipt and payment account on or
    before 30th September of that year.

 

CONTRAVENTION

Relevant
provision

Nature
of default

Amount
involved
(in INR)

Time
period of default

Regulation 4(k), Regulation 4(f) read
with Annex D of Regulation 4(l) of Notification No. FEMA.22(R)/RB-2016

Inter-project utilisation of funds and
transfer of project assets from one project to another

Rs. 5,66,99,732

2 years, 9 months and 9 days

 

Compounding
penalty

Compounding penalty
of Rs. 2,56,799 was levied.

 

Comments

Where foreign companies have set up more than one project office in
India, adequate care needs to be taken to ensure that funds of these project
offices are not transferred amongst themselves without prior approval of RBI.

 

EXPORT OF GOODS AND SERVICES

E. M/s Dalmia Cement (Bharat)
Limited (Legal Successor of OCL India Ltd.)

Date of order:
28th January, 2020

Regulation: FEMA
23/2000-RB [Foreign Exchange Management (Export of Goods and Services)
Regulations, 2000]

 

ISSUE

Failure to realise
the export proceeds (by the erstwhile OCL India Ltd.) within the stipulated
time period.

 

FACTS

  •     The applicant company, M/s
    Dalmia Cement (Bharat) Limited (the legal successor of M/s OCL India Limited,
    consequent upon a merger ordered by NCLT vide order dated 18th
    July, 2019) was engaged in the business of export of refractory materials,
    cement, etc.
  •     The erstwhile M/s OCL India
    Limited, a ‘Star Export House’ engaged in the business of export of refractory
    materials, cement, etc., had made exports under 13 different invoices between
    February, 2008 and May, 2012.
  •     M/s OCL India Limited was
    not able to realise and repatriate the export proceeds pertaining to 13
    invoices within the stipulated time.
  •     Subsequently, M/s OCL India
    Limited had written off the amount in its books.
  •     However, as the company was
    under investigation by the Directorate of Enforcement, the above bills could
    not be written-off by the applicant on its own or by its AD bank.
  •     The applicant filed a
    petition in the Hon’ble High Court of Delhi for regularising the above
    write-off.
  •     The Hon’ble Court disposed
    of the matter with directions to the applicant to apply for compounding again
    to the RBI along with fresh fee for compounding.

 

Regulatory
provisions

  •     Regulation 9 of
    Notification No. FEMA.23/2000 which states that the amount representing the
    full export value of goods or software exported shall be realised and
    repatriated to India within six months (applicable up to 3rd June,
    2008) and twelve months (as applicable subsequently) from the date of export.

 

CONTRAVENTION

Relevant
Provision

Nature
of default

Amount
involved (in INR)

Time
period of default

Regulation 9 of FEMA 23/2000-RB

Failure to realise export proceeds
within stipulated time period

Rs. 39,22,447

Approximately 11 years

 

Compounding
penalty

Compounding penalty
of Rs. 79,419 was levied.

 

Comments3

In the instant
case, the applicant company had initially filed a compounding application with
RBI for write-off of export proceeds. However, the said compounding application
was returned by RBI on the ground that compounding application can be filed
only after transactions are regularised by RBI. Further, RBI advised the
applicant company to approach the Trade Division of RBI for regularising its
export transactions. However, as the applicant company was under investigation
by ED, it could not write off its export receivables and hence had initially
filed compounding application before RBI. As RBI returned its compounding
application, it filed a writ petition with the Delhi High Court for writing off
export receivables.

_________________________________________________________________________

3   Based on Delhi High Court order in case of
OCL India Limited [W.P.(C) 8265/2018 & CM Nos. 31684/2018 dated 18th
July, 2019]

 

 

During the
hearing before the Delhi High Court, counsel for RBI submitted that there is no
provision which precluded RBI from considering and processing compounding
application where investigation is pending. Accordingly, based on RBI’s
submission that the matter be remanded back to RBI for fresh consideration, the
Court dismissed the writ petition and directed RBI to consider the compounding
application of the applicant afresh and not reject it on the basis of
approaching another department of RBI. Interestingly, the Delhi High Court also
stayed proceedings initiated by ED till
the applicant’s compounding application was considered by RBI.

Banking as a Service

Have you opened a bank
account or a Demat account at a bank recently? Signatures are required at ten
to twelve places. Some time back I opened an account for a minor and 12
signatures were required and for a Demat account 32 signatures. Signatures on
pages and pages of ‘fine print’ that no one can fathom nor has a choice to
change – this is a cumbersome chore for a fundamental service like banking.
Much of it is like pressing ‘I Agree’ when downloading apps and like someone
put it – ‘I Agree’ is the biggest lie ever.

A few months back a top
private sector bank relationship manager said that they would open a Demat
account for an NRI customer only if there was in-person verification (which
later I found was wrong even as per the internal guidelines). Finally the
non-resident people came in after a few months, and a very junior person did
‘in-person verification’ and the bank opened the account after daily follow-up.

Another case is that of a
charitable trust. A 167-year-old MNC bank gave a list of acceptable address
proofs. This list of some 13 items did not include a single proof that was
applicable to a non-business charitable entity. Therefore, they said you won’t
be KYC compliant and therefore your account could be blocked or closed. A
charitable trust is often registered at the office of the Trustees. The bankers
could offer only one option – to take the address of the trustees to be the
address of the charitable trust for KYC purposes, which meant that the trust
communication would go to trustees’ residential address instead of the office.
It felt like being a hostage since the trust had deposits u/s 12, and there was
no option but to bend.

In another case, a European
bank, since eight months are unable to close a LO bank account after MCA has
approved the LO closure and tax department has given an NOC. The bankers are
asking for documents that the LO has already submitted on a yearly basis
because the bank cannot find them. And all this is for a meagre sum. In another
case, another top private sector bank is asking for Physical Copies during
COVID lockdown (when no post or courier is working) to change the address in
bank records in spite of providing documents through registered email and in
spite of ROC records updated for a local address change. 

Today, after more than a
decade of the Satyam scam, I can say that most bankers do not send direct
confirmations to auditors in spite of client instructions and authorisation.
The RBI perhaps is looking for a bigger corporate fatality to learn the lesson!
Can RBI not formulate a regulation to ensure that a comprehensive confirmation
of all the facilities is sent to auditors? 

An
over-the-top example is that of credit card interest and finance charges of
3-4% per month that most banks charge on delayed payments. Only Dilbert
cartoons can explain this. Most of us have come across such appalling service
levels, extreme nit-picking, and unreasonable attitude of bankers and banks.
These, from my experience, are deep and pervasive across the sector.

No doubt
that the banks have done a lot of good work too but they have lost loads of
money as well. Banks as a sector is a huge boulder blocking ease of doing
business for small and medium players especially. NPA track record shows a
dismal performance of PSBs when it comes to protecting money of depositors. For
most people, money is life, because people spend days and months and years to
earn it. The present Rs. 5 lakhs DICGC insurance cover which I am told has not
yet come into effect  (and was raised
from Rs. 1 lakh after 27 years) is paltry. In the event of a bank failure, this
insurance gets paid post all investigation process, which takes a lifetime,
literally. Every taxpayer deserves better service from banks and better cover
for her wealth in a bank. This is a big taxpayer concern: service of the bank
and the safety of her tax-paid money with the bank. If tax-paid money is unsafe
in a bank, then taxes are not working for taxpayers!

 

 

 

 

 

Raman
Jokhakar

Editor

INTERLINKING BETWEEN GST AND CUSTOMS

LEGISLATIVE FRAMEWORK – GST  VIS-À-VIS CUSTOMS

The levy of GST finds its genesis under
Articles 246A and 269A of the Constitution of India. Article 246A confers
powers on both Parliament and the State Legislature to make laws with respect
to goods and services tax imposed by the Union or such State. Two points to be
noted here are:

 

(a) Vide the proviso to
Article 246A, Parliament has been given the exclusive power to make laws with
respect to goods and services tax where the supply of goods or services or both
is in the course of interstate trade or commerce. The mechanism for levy,
collection and sharing of tax on such supplies is provided under Article 269A.
Explanation 1 to Article 269A further provides that the supply of goods or
services in the course of import into the territory of India shall be deemed to
be a supply in the course of interstate trade or commerce.

(b) Article 286 restricts the states from
levying tax on sale or purchase of goods or services or both if such supply
takes place outside the state or in the course of import into or export out of
the territory of India.

 

It is by virtue of the above framework that
Parliament has enacted the Integrated Goods & Services Tax (IGST) Act, 2017
and the Central Goods & Services Tax (CGST) Act, 2017 for levy and
collection of tax on interstate supplies and intrastate supplies, respectively.
Similarly, the states have enacted the State Goods & Services Tax (SGST)
Act, 2017 for levying tax on intrastate supplies. The determination whether or
not a supply is in the course of interstate trade or commerce is dealt with
under sections 7 and 8 of the IGST Act, 2017. Section 7 thereof provides that
supply of goods imported into the territory of India till they cross the
customs frontiers of India shall be treated as supply of goods in the course of
interstate trade or commerce.

 

There is an apparent dual levy on import of
goods under the Constitution in view of Article 269A treating import of goods
as interstate supply of goods or commerce and Article 246 empowering the levy
of customs duties. It is for this reason that the charging section for levy of
IGST u/s 5 specifically excludes the levy and collection of integrated tax on
goods imported into India from its purview and provides that the same shall be
levied and collected in accordance with the provisions of section 3 of the CTA,
1975 on the value determined under the said Act at the point when the duty of
customs is levied on the said goods u/s 12 of the Customs Act, 1962.

 

Therefore, when dealing with a cross-border
transaction involving goods, there is a close interplay between the provisions
of GST and Customs requiring determination of the statute under which the duty
/ tax has to be discharged. It therefore becomes important to understand the
meaning of the terms ‘imported goods’, ‘importer’ and the process to be
followed in the case of importation of goods.

 

‘IMPORTED GOODS’ AND ‘IMPORTER’

‘Imported goods’ is defined u/s 2(25) of the
Customs Act, 1962 to mean any goods brought into India from a place outside
India but does not include goods which have been cleared for home consumption. Similarly,
section 2(26) defines the term ‘importer’ in relation to any goods at any
time between their importation and the time when they are cleared for home
consumption, includes [any owner, beneficial owner] or any person holding
himself out to be the importer.

 

When goods are imported into India, there
are generally two sets of transactions which are undertaken, one being the
filing of Bill of Entry for Home Consumption, in which case the importer has to
pay duty as applicable on the said goods and get the goods cleared from the
Customs Authorities. Once this is done, the goods are no longer imported goods
and therefore, on all subsequent transfers the tax will be levied and collected
under the GST mechanism by classifying the transaction either as intrastate or
interstate. The second option is to file Bill of Entry for Warehousing, in
which case the goods shall be stored either at a public or a private warehouse
by executing a bond. In the second option, the goods continue to be classified
as imported goods and the payment of duty on such goods gets deferred till the
time the goods are kept in the bonded warehouse and the same shall be assessed
to tax when a bill of entry for home consumption in respect of such warehoused
goods is presented.

 

In other words, till the time the goods are
cleared for home consumption, i.e., an order permitting clearance of such goods
for home consumption is passed, the goods would be treated as imported goods
and will be subjected to levy and collection of tax u/s 12 of the Customs Act,
1962.

 

TAX
TREATMENT OF HIGH SEAS SALES

In the case of high seas sales, the sale
takes place before the goods are cleared for home consumption, i.e., a bill of
entry for home consumption is filed and an order permitting the clearance of
such goods is issued by the proper officer. This position has also been
accepted by the Board vide Circular 33/2017 – Customs dated 1st
August, 2017 wherein they have clarified that in case of high seas sales
transactions (single or multiple), IGST shall be levied and collected only at
the time of importation, i.e., when declarations are filed before the Customs
Authorities for clearance purposes after considering the value addition on
account of such high seas transactions. Even the Authority for Advance Ruling
has held so in BASF India Private Limited [2018 (14) GSTL 396 (AAR –
GST)].

 

Further, Schedule III has been amended
w.e.f. 1st February, 2019 vide the insertion of Entry 8(b) to
provide that supply of goods by the consignee to any other person, by
endorsement of documents of title to the goods, after the goods have been
dispatched from the port of origin located outside India but before clearance for
home consumption, shall be treated as neither being supply of goods nor supply
of services.

 

TAX
TREATMENT OF WAREHOUSED GOODS

A similar treatment will be accorded to
goods where a bill of entry for warehousing is filed, i.e., goods are kept at a
bonded warehouse which falls within the purview of customs area defined u/s
2(11) of the Customs Act, 1962 as any area of a customs station or a warehouse.
This is because when a bill of entry is filed for warehousing, the goods are
not cleared for home consumption and therefore such goods continue to be
classified as imported goods and subject to levy and collection of tax under
the Customs Act, 1962. This view has been followed by the AAR in Sadesa
Commercial Offshore De Macau Ltd. [2019 (21) GSTL 265 (AAR – GST)] and Bank
of Nova Scotia [2019 (21) GSTL 238 (AAR – GST)]. In fact, in Sadesa
Commercial the AAR has also held that if they are engaged exclusively
in undertaking such supplies, i.e., sale of warehoused goods, they would not be
liable to obtain registration under GST.

 

Prior to the amendment referred to above,
the Board had issued Circular 46/2017-Cus. dated 24th November, 2017
wherein it was clarified that tax will be levied on multiple occasions, one at
the time when the warehoused goods are sold before clearance for home
consumption, and secondly when the bill of entry for home consumption of such
warehoused goods is presented for clearance. However, vide a later
Circular 3/1/2018 dated 25th May, 2018, it was clarified that
integrated tax shall be levied and collected at the time of final clearance of
the warehoused goods for home consumption only.

 

In addition, Circular 46/2017-Cus. was
withdrawn to align with the amendment to Schedule III of the CGST Act, 2017
which deemed supply of warehoused goods to any person before clearance for home
consumption as neither a supply of goods nor supply of services w.e.f. 1st
April, 2018.

 

IMPORTS BY
SEZ DEVELOPERS / UNITS

A similar analogy will apply for the purpose
of goods imported into a Special Economic Zone as well. Section 53(1) of the
SEZ Act, 2005 provides that SEZs shall be deemed to be a territory outside the
Customs territory of India for undertaking the authorised operations. However,
this does not imply that the provisions of the Customs Act, 1962 shall not
apply to SEZs as held by the Gujarat High Court in the case of Diamond
& Gem Development Corporation vs. Union of India [2011 (268) ELT 3 (Guj.)].
It is for this reason that when goods are imported into an SEZ, a bill of entry
for re-warehousing has to be filed. Of course, in view of section 26 of the SEZ
Act, 2005 which provides exemption from duties of customs on goods imported
into India to carry on the authorised operations, no duty of customs –
including IGST – is leviable on such imports.

 

However, a challenge arises when the said
goods are cleared for use in DTA. The goods imported into an SEZ are under a
Bill of Entry for re-warehousing. However, since an SEZ is deemed to be outside
the customs territory of India, section 30 of the SEZ Act, 2005 provides that
any goods removed from an SEZ to the DTA shall be chargeable to duties of
customs, including anti-dumping, countervailing and safeguard duties under the
CTA, 1975 (51 of 1975), where applicable, as leviable on such goods when
imported. In other words, if goods imported into an SEZ are cleared into DTA, a
fresh Bill of Entry for Home Consumption would have to be filed in view of the
fact that the same would be treated as import of goods from a territory outside
India. The Bill of Entry can be filed either by the SEZ unit or by the buyer of
the goods.

 

TAX TREATMENT OF DUTY FREE SHOPS

The levy of tax on goods sold by Duty Free
Shops (DFS) has always been a subject matter of scrutiny, first under the
pre-GST regime and now under the GST regime. DFS are shops which are set up at
airports / sea ports within the customs territory, i.e., after a person goes
through customs formality if he is commencing an international travel, or
before a person goes through customs formality if he is returning from an
international travel.

 

The DFS are treated as warehouses licensed
u/s 58A of the Customs Act, 1962. Once the goods reach the DFS, there are two
possibilities –the goods may be bought by an outbound passenger or the goods
may be bought by an inbound passenger. But the fact remains that the goods have
been sold by the DFS before a Bill of Entry for home consumption was filed.
Thus the question that remains is whether or not such sales would be liable to
GST, irrespective of whether the same is from the departure area or the arrival
area. In this context, it would be imperative to refer to the following
decisions of the Supreme Court:

 

(A) In the case of J.V. Gokal &
Co. (Pvt.) Ltd. vs. Assistant Collector of Sales Tax [1990 (110) ELT 106 (SC)],
the Court explained the phrase ‘in the course of import of goods into the
territory of India’ to mean

(1) The course of import of goods starts at
a point when the goods cross the customs barrier of the foreign country and
ends at a point in the importing country after the goods cross the customs
barrier,

(2) The sale which occasions the import is a
sale in the course of import,

(3) A purchase by an importer of goods when
they are on the high seas by payment against shipping documents of title (Bill
of Lading) is also a purchase in the course of import, and

(4) A sale by an importer of goods, after
the property in the goods passed to him either after the receipt of the
documents of title against payment or otherwise, to a third party by a similar
process is also a sale in the course of import.

 

(B) In the case of Hotel Ashoka vs.
Assistant Commissioner of Commercial Taxes [2012 (276) ELT 433 (SC)],
specifically in the context of DFS, the Court had held that the sale of goods
from DFS was from outside India and therefore, they were not liable to sales
tax. The Court further held that the sale of goods was before they were cleared
for home consumption, i.e., it was a sale of goods in the course of import into
India and for this reason the state did not have the power to levy tax on such
transactions.

 

Even in the context of GST, reference to the
decision of the Bombay High Court in the case of Sandip Patil vs. Union
of India [2019 (31) GSTL 398 (Bom.)] is important. In this case, not
only did the Court agree with the above contention, it also held that supply of
goods to outbound passengers would be treated as export of goods and in case of
supply of goods to inbound passengers such inbound passengers would be treated
as importers and they would also not be liable to pay any duty in view of
Notification 43/2017-Cus. dated 30th June, 2017 and 2/2017-IT (Rate)
dated 28th June, 2017 r.w. duty-free allowance under the Baggage
Rules. The High Court further held that the DFS would be entitled to claim
refund of accumulated ITC on account of export of goods u/r 89 of the CGST
Rules, 2017. A similar view has also been taken in the case of A1
Hospitality Services Private Limited vs. Union of India [2019 (22) GSTL 326
(Bom.)] as well as Atin Krishna vs. Union of India [2019 (25)
GSTL 0390 (All.)].

 

One should, however, note that the AAR has,
in the case of Rod Retail Private Limited [2018 (12) GSTL 206 (AAR –
GST)] on the contrary held that the supply of goods from DFS would be
liable to GST. However, this AAR, while referring to the decision of the
Supreme Court in the case of Ashoka Hotel referred above, has
held it to be not applicable since ‘under GST law, scenario has changed and
therefore decision of Apex Court not applicable’. Instead, it refers to the
decision in the case of Collector vs. Sun Industries [1988 (35) ELT 241
(SC)] which was completely on a different footing. It is imperative to
note that the High Court had in the case of Sandeep Patil
distinguished this ruling on the grounds that the facts in the case of Rod
Retail were different since the same was a ‘Duty Paid Shop’ and not a
‘Duty free shop’ as clarified by the Board vide Circular dated 29th
May, 2018 and therefore the dispensation allowed to DFS would not be affected
in any manner.

 

Reference is also invited to the recent
decision of the Supreme Court in the case of Nirmal Kumar Parsan vs.
Commissioner of Commercial Taxes [SCA No. 7863 of 2009] wherein in the
case of warehoused goods the Court upheld the liability to pay VAT on goods
sold as stores to foreign-going vessels. However, in this case, the Court made
a peculiar observation that the appellant had not shown anything to demonstrate
that the subject bonded warehouse came within the customs port / customs land
station area and, more so, the state sales occasioned the import of goods
within the territory of India.

 

INPUT TAX CREDIT IMPLICATIONS

In view of the amendment to section 17(3),
it is further provided that the supply of goods covered under Schedule III
would not be treated as exempted supply and therefore there is no requirement
to reverse Input Tax Credit on account of the same.

 

RCM ON OCEAN FREIGHT

Generally, when a contract for sale of goods
is executed, the parties need to agree when the risk and rewards associated
with the goods would get transferred. There are two commonly used terms,
namely, CIF – i.e., cost, insurance and freight included; and FOB – i.e., Free
on Board, meaning once the goods reach the port at the foreign country, the
risks and rewards associated with such goods are transferred to the buyer in
which case he shall make arrangements to bring the goods from the foreign port
to a port in India by entering into a separate contract for such services.

 

For customs, depending on the agreed terms,
the assessable value is generally adjusted, either for actual freight incurred
or on notional basis. For example, if freight cost is not available, the same
is assumed at 20% of the FOB value and the same is added to the transaction
value for determining the assessable value. [Refer Rule 10 of the Customs
Valuation (Determination of Value of Imported Goods) Rules, 2007]. This implies
that the customs duty along with IGST is paid not only on the transaction value
but also on the actual various or notional value of expenses incurred during
the import of such goods. This would also mean that tax is charged indirectly
on the transportation cost in the CIF contracts as well, though the service
provider (shipping line) and the service receiver (foreign seller) may not be
in India.

 

Despite the transaction being indirectly
taxed, Entry 10 of Notification 10/2017-IT (Rate) dated 28th June,
2017 imposes a liability on the importer, as defined in section 2(26) to pay
tax on ‘services supplied by a person located in non-taxable territory by
way of transportation of goods by a vessel from a place outside India up to the
customs station of clearance in India’. The Notification further provides
that where the value of taxable service provided by a person located in
non-taxable territory to a person located in non-taxable territory by way of
transportation of goods by a vessel from a place outside India up to the
customs station of clearance in India is not available with the person liable
for paying integrated tax, the same shall be deemed to be 10% of the CIF value
(sum of cost, insurance, and freight) of imported goods.

 

Therefore, it is apparent that there is a
dual taxation of the freight component, once at the time of clearance of goods
with the customs authorities where the value of freight is included in the
assessable value, and secondly, the tax liability created through the
Notification 10/2017-IT (Rate). Similar provisions existed under the Service
Tax Regime as well where the Gujarat High Court had struck down the entry
imposing liability to pay tax under reverse charge in the case of Sal
Steel Limited vs. Union of India [R/SCA No. 20785 of 2018]. The levy
was struck down primarily because section 94 did not permit the Central
Government to make rules for recovering service tax from a third party who is
neither the service provider nor the service receiver. The Court further held
that there was no machinery provision to demand the tax from the importer.

 

Under GST, the AAR has on multiple occasions
such as India Potash Limited [2020 (32) GSTL 53 [AAR – AP)]; M.K.
Agrotech Limited [2020 (32) GSTL 148 (AAR – KA)]; E-DP Marketing Private
Limited [2019 (26) GSTL 436 (AAR – MP)] held that there is a liability
to pay GST under RCM on such transactions. However, the Gujarat High Court has
in the case of Mohit Minerals Private Limited vs. UoI
[2020-TIOL-164-HC-AHM-GST] struck down Entry 10 as ultra vires
for the following reasons:

(a) The importer is not the service
recipient since the GST law defines the service recipient as the person liable
to pay consideration,

(b) The place of supply provisions apply
only in case where either the location of supplier or the recipient of services
is outside India. In this case, both the location of supplier as well as
recipient are outside India,

(c) The point of taxation would never get
triggered since neither the payment to the supplier would be reflected in the
books of accounts of the importer, nor the invoice of the shipping line would
be in the name of the importer.

 

While the levy has been struck down, one
should note that the Revenue is likely to file an appeal before the Supreme
Court and therefore reliance on this decision should be placed keeping in mind
other aspects as well. For instance, in case the decision is overturned by the
Court and the liability to pay tax is confirmed, the same would be along with
consequential interest and probably no Input Tax Credits. Penalty can be
contested on bona fide belief, but it would be a long way away,
especially considering the fact that the payment of tax might in many cases be
a revenue-neutral exercise.

 

INTERNATIONAL JOB WORK

Section 2(68) of the CGST Act, 2017 defines
the term ‘job work’ as ‘any treatment or process undertaken by a person on
goods belonging to another person’. This activity is deemed to be a supply
of service under GST in view of Entry 3 of Schedule II of the CGST Act, 2017.

 

The modus operandi in this kind of
transaction is that the owner of goods (generally known as principal) desirous
of getting some work done on his goods, sends the said goods to his job-worker
without any consideration. The said job-worker shall work on the said goods and
return the goods to the principal and recover the charges for carrying out the
said activities from the principal.

 

Therefore, there are three different events
involved in a transaction of job work, namely, receipt of goods, working on the
said goods (treatment / process) and lastly, return of the said goods. When
both the parties, i.e., principal and job-worker are in the same territory,
there are no tax implications at the time of receipt of goods and sending back
the goods. However, when in the same transaction one of the parties is outside
India, customs duty comes into the picture because there is either an import of
goods, i.e., goods coming into India from a territory outside India in case of
inbound job work or export of goods, i.e., goods being taken out of India in
case of outbound job work.

 

Under the Customs Act, 1962 the import of
goods for job work is dealt with by Notification 32/1997-Cus. dated 1st
April, 1997. This Notification exempts goods imported for jobbing from payment
of customs duty leviable under the First Schedule and additional duty leviable
u/s 3 of the CTA, 1975 subject to satisfaction of the condition prescribed.
However, it is imperative to note that vide Notification 26/2017-Cus.
dated 29th June, 2017 in the context of additional duties u/s 3 of
the CTA, 1975, the exemption is restricted only to the extent of additional
duties leviable under sub-sections (1), (3) and (5) thereof. This would imply
that the integrated tax on import of goods, which is leviable u/s 3(7) of the
CTA, 1975 would be liable to IGST in case of goods imported for job work
purposes, though no consideration is payable by the importer job worker on such
import of goods. The same applies in case of outbound job work, where goods are
re-imported. Notification 45/2017-Cus. dated 30th June, 2017 exempts
additional duties leviable u/s 3 in the case of re-import.

 

The first question that would need
consideration is whether the job-worker importing the goods would be liable to
claim credit of integrated tax paid on such imports? For the same, one would
need to refer to section 16 of the CGST Act, 2017 to ensure that the conditions
prescribed therein are satisfied or not. The primary conditions to be satisfied
in this set of transactions are that the goods should have been received in the
course or furtherance of business, the recipient should be in possession of
such tax-paying document as may be prescribed, the recipient should have actually
received the goods, and lastly, he should have furnished the return u/s 39. It
is beyond doubt that the above conditions are getting satisfied and therefore,
the claim of integrated tax paid on receipt of goods for job work by the
job-worker as importer should be allowed. This view has also been accepted by
the AAR in Chowgule & Co. Pvt. Ltd. [2019 (27) GSTL 405 (AAR)].

 

The next question that would need
consideration is in two parts, taxability of services provided by the job
worker, and secondly whether sending back of goods would amount to exports or
not? As discussed above, the commercial transaction in the current case is
undertaking activity on goods owned by the principal for which the job worker
recovers charges from the said principal. Since this is deemed to be a supply
of service, section 13 of the IGST Act, 2017 shall come into play which deals
with determination of place of supply in case where either the location of the
supplier of service or the location of the recipient of service is outside India,
which applies to the current transaction. Accordingly, one needs to refer to
the various scenarios laid down u/s 13 thereof to identify the applicable rule
for determining the place of supply.

 

The most directly concerned rule for this
kind of service appears to be section 13(3)(a) which provides that the place of
supply of service in case where the services supplied in respect of goods which
are required to be made physically available by the recipient of services to
the supplier of services, or to a person acting on behalf of the supplier of
services in order to provide the services, shall be the location where such
services are actually performed. In this sense, it would have implied that the
goods on which job work services are being performed being located in India,
the place of supply u/s 13(3) shall be India and accordingly the same would be
liable to tax and not treated as export of services. Similarly, in case of an
outbound job work transaction, the situation would be reverse and job work charges
paid to the foreign job worker would not be liable to GST under import of
services since place of supply would be outside India.

 

This situation would apply till 31st
January, 2019 post which the proviso to section 13(3) has come into
force. The proviso provides that section 13(3)(a) shall not apply to
cases where goods are temporarily imported into India for repairs or for any
other treatment or process and are exported after such repairs or treatment or
process without being put to any use in India, other than that which is
required for such repairs or treatment or process. Therefore, w.e.f. 1st
February, 2019, in case of inbound job works, the place of supply shall be the
location of the recipient of service, i.e., outside India and subject to the
satisfaction of conditions u/s 2(6) of the IGST Act, 2017 shall be treated as
export of service. That being the case, such job-worker may be entitled to
claim refund of accumulated ITC or tax paid on supply of such Zero-Rated
Services. However, in case of an outbound job work transaction, the Indian
principal would now be liable to pay tax under import of services.

 

It is important to note that this proviso
does not impose any time limit within which the goods have to be exported after
the repairs / process and therefore, no such time limit can be enforced for
return of such goods. One may refer to the recent decision of the Supreme Court
in Bombay Machinery Works [2020–VIL16–SC] which was on a similar
aspect, though in the context of section 6(2) of the Central Sales Tax Act,
1956.

 

Notification 32/1997-Cus. dated 1st
April, 1997 requires that the goods should be re-exported within six months
from the date of clearance of such goods or within such extended time period as
the Assistant Commissioner of Customs may allow. It may be noted that the
definition of exports, under GST as well as Customs, is similar and means taking
out of India to a place outside India. Therefore, the sending back of goods
would qualify as export for the purpose of Customs as well as GST.

One important issue which was taken up in
the AAR case of Chowgule & Co. Pvt. Ltd. was that of
eligibility of refund claim. In the said case, the applicant was engaged in
undertaking job work on iron ore which attracts nil rate of duty. In this case,
the AAR held that since the goods being exported are liable for export duty,
the refund of accumulated ITC would not be available in view of the second proviso
to section 54. However, this appears to be on a wrong footing because the
supply undertaken by the applicant was that of supply of services to which the
restriction does not apply.

 

TAXATION OF INTANGIBLES

Section 2(22) of the Customs Act, 1962
defines the term ‘goods’ to include, among other things, any other kind of
movable property. The Supreme Court has, in the case of TCS vs. State of
Andhra Pradesh [2004 (178) ELT 2 (SC)] dealt with what shall constitute
goods. While dealing with this subject, the Constitution Bench held that goods
may be tangible or intangible property. A property becomes goods provided it
has the attributes having regard to utility, capability of being bought and
sold and capability of being transferred, transmitted, delivered, stored and
possessed.

 

There can be
different types of intangibles, such as patents, designs, copyrights,
trademarks, etc. Each of these is governed by specific statutes. Such rights
can be transferred either by way of license or assignment. License is a
temporary transfer of rights without any change in the ownership, which would
amount to rendition of service in view of Entry 5(c) of Schedule II of the CGST
Act, 2017, while assignment would mean a change in ownership of the rights and
therefore would be treated as supply of goods in view of Entry 1(a) of Schedule
II. This distinction has been explained in the case of CST vs. Dukes
& Sons Private Limited [1988 (SCC) Online Bom 448].

 

However, an issue that arises is with
respect to the situs in case of assignment of intangibles. What shall be
the situs of such transfer, i.e., whether the location where the
intangible is registered shall be the situs, or the location of the
owner of such intangible shall be considered the situs? In this regard,
one may refer to the decision of the Bombay High Court in the case of Mahyco
Monsanto Biotech India Private Limited vs. Union of India [2016 (44) STR 161
(Bom).] where the Court has followed the principle of mobilia
sequuntur personam, i.e., location of owner of intangible asset would be
closest approximation of situs of his intangible asset and the location
where agreement is entered would not be relevant.

Given this background, it may be argued that
in case the rights owned by a person outside India are assigned, the same would
be treated as import of goods and therefore no tax can be levied on the same
u/s 5 of the IGST Act, 2017. However, the bigger issue would be whether or not
such imports would be liable to tax u/s 12 of the Customs Act, 1962, especially
when the document of title evidencing assignment of rights is received
electronically? In case the document of title is brought into India, either as
a courier or baggage, there may be customs duty implications on such imports,
but on what value would the same be payable would be a subject matter of
dispute.

 

A similar challenge would be seen in case of
export transactions, i.e., assignment of rights from India to a person outside
India. Whether such person would be liable to treat such assignment as export
of goods without there being a corresponding shipping bill and, accordingly,
the consequential impact on adjudication of refund claims?

 

IMPORTS VIS-À-VIS TRANSFER OF RIGHT TO USE
GOODS

Another aspect to be noted is that of cases
where there is a transfer of right to use goods and in pursuance of which goods
are imported into India. Entry 5(f) of Schedule II of the CGST Act, 2017 treats
activities of transfer of right to use goods for any purpose as supply of
services. Therefore, when such service of transfer of right to use such goods
is provided by a foreign party, which would trigger bringing goods from outside
India to India, there will be a dual challenge, one being the levy of IGST on
the rental payments under import of service, and the second being the levy of
IGST u/s 12 of the Customs Act, 1962 which would be on the value of goods and
therefore highly disproportionate to the transaction being undertaken.

 

To avoid this dual levy of tax, Notification
72/2017-Cus. dated 16th August, 2017 provides exemption from the
levy of basic customs duty and integrated tax. While 100% exemption is not
provided for under basic customs duty, integrated tax u/s 3(7) of CTA, 1975 is
granted, provided the importer gives an undertaking that he shall discharge the
tax on the said services as import of services.

 

GOODS SENT FOR EXHIBITIONS

Various exhibitions are held all over India
where people participate and display their goods. There can be a scenario where
an exhibition is being held in India and a person from outside India showcases
his product, in which case he shall bring the goods from outside India to
India; and secondly, a case where a person in India intends to showcase his
products at an exhibition being held outside India.

 

The procedure for import of goods for
exhibition purposes is dealt with under Notification 8/2016-Cus. dated 5th
February, 2016. The said Notification provides for exemption from payment of
customs duty and additional customs duty subject to conditions, such as
execution of bond, re-export of goods within the prescribed period of six
months, etc. At times it so happens that the goods are sold at such exhibitions
and therefore, instead of re-exporting the said goods, the same have to be
cleared for home consumption by paying the appropriate customs duty.

 

However, in such cases such person will have
to apply for registration as a non-resident taxable person and discharge the
applicable tax on the sale value after claiming Input Tax Credit only of the
tax paid on goods imported by him u/s 16. Such non-resident taxable person
shall not be allowed credit of any other inward supplies, except for tax paid
on goods imported by him. Similarly, in case of goods sent for exhibition
abroad, Notification 45/2017-Cus. dated 30th June, 2017 provides
that no tax shall be payable on re-importation of such goods. This has also
been clarified by the Board Circular 21/2019-Cus. dated 24th July,
2019.

 

BRANCH TRANSFER

Branch transfer is a common terminology used
when a branch sends goods to another branch. Under GST, Entry 2 of Schedule I
of the CGST Act, 2017 deems supply of goods or services or both between related
persons or between distinct persons as specified in section 25 when made in the
course or furtherance of business as supply, even though made without
consideration which would require the transaction to be valued at arm’s length
and tax discharged.

 

The application of this entry in the context
of international branch transfer needs to be analysed. The term ‘distinct
persons’ is dealt with u/s 25(4) which provides that a person who has
obtained or is required to obtain more than one registration, whether in one
State or Union territory or more than one State or Union territory shall, in
respect of each such registration, be treated as distinct persons for the
purposes of this Act.

 

In other words, it is only the domestic
branches of an entity which come within the purview of distinct persons.
Similarly, a domestic H.O. and foreign branch, or vice versa would not
come within the purview of related persons, since the same would have entailed
existence of more than one person, which is not so in the case of branch transfers.
It is for this reason that in case of domestic transactions the concept of
‘distinct person’ has been introduced.

 

In this background, one would need to
analyse the tax implications when international branch transfer is undertaken,
i.e., goods are sent to foreign branch / H.O. or vice versa, goods are
received from foreign branch / H.O.

 

In an outward branch transfer case, it would
be a transaction of export of goods – both under customs as well as GST since
goods are actually going out of India. The supplying branch would have an
option to export the goods under LUT / Bond or on payment of duty.

 

However, in case of inward branch transfer,
the importer would be required to pay the applicable duty – customs as well as
integrated tax on such imports, subject to specific exemptions or cases where
the import of goods fall under specific scenarios.

 

CONCLUSION

While both the
Customs and the GST laws operate in different domains with different objectives
in mind, in view of the disconnect in certain cases, one finds instances of
overlap and interplay between these two laws.

 

LEARNINGS FOR AUDIT FIRMS IN THE ERA OF PCAOB AND NFRA

INTRODUCTION

Audit firms have
always been subject to regulatory review by both the ICAI as well as the
regulators. Whilst initially they only underwent scrutiny by the ICAI in terms
of the disciplinary mechanism, over a period of time ICAI introduced the
concept of review of individual audits undertaken by the firms, as also the
firm itself through the FRRB, Peer Review and QRB mechanism.
Recently, the QRB Reviews have been substituted through oversight and
regulation by the NFRA for firms involved in auditing a certain class of
entities, whereas the QRB will be involved in other matters.

 

Accordingly,
it would be pertinent to note the background and role played by the NFRA and
its implications on the future of audit firms.

 

NFRA

After the
Satyam scandal took place in 2009, the Standing Committee on Finance proposed
the concept of establishing a National Financial Reporting Authority (NFRA) for
the first time in its 21st Report. The Companies Act, 2013
subsequently gave the regulatory framework for its composition and constitution.
The Union Cabinet approved the proposal for its establishment on 1st
March, 2018. The establishment of NFRA as an independent regulator is an
important milestone for the auditing profession and will improve the
transparency and reliability of financial statements and information presented
by listed companies and large unlisted companies in India.

 

The NFRA
was  constituted on 1st
October, 2018 by the Government of India u/s 132(1) of the Companies Act, 2013.
As per the said section, NFRA is responsible for recommending accounting and
auditing policies and standards in the country, undertaking investigations and
imposing sanctions against defaulting auditors and audit firms in the form of
monetary penalties and debarment from practice for up to ten years.

 

APPLICABILITY

As per Rule 3
of the NFRA Rules, 2018, the Authority shall have power to monitor and enforce
compliance with accounting standards and auditing standards and oversee the
quality of service u/s 132(2) or undertake investigation u/s 132(4) in respect
of auditors of the following class of companies and bodies corporate, namely:

 

(a) Companies whose securities are listed on any
stock exchange in India or outside India;

(b) Unlisted public companies having paid-up
capital of not less than Rs. 500 crores or having annual turnover of not less
than Rs. 1,000 crores, or having, in aggregate, outstanding loans, debentures
and deposits of not less than Rs. 500 crores as on the 31st of March
of the immediately preceding financial year;

(c) Insurance companies, banking companies,
companies engaged in the generation or supply of electricity, companies
governed by any special Act for the time being in force or bodies corporate
incorporated by an Act in accordance with clauses (b), (c), (d), (e) and (f) of
sub-section (4) of section 1 of the Act;

(d) Any body corporate or company or person, or any
class of bodies corporate or companies or persons, on a reference made to the
Authority by the Central Government in public interest; and

(e) A body corporate incorporated or registered
outside India, which is a subsidiary or associate company of any company or
body corporate incorporated or registered in India as referred to in clauses
(a) to (d) above, if the income or net worth of such subsidiary or associate
company exceeds 20% of the consolidated income or consolidated net worth of
such company or body corporate, as the case may be, referred to in clauses (a)
to (d).

 

Thus, the
NFRA has stepped into the shoes of the QRB to concentrate on audit firms involved
in entities which are perceived as public interest entities. Currently
all private limited companies even if they satisfy the thresholds as per clause
(b) above are not covered. Consequently, the QRB will henceforth be
involved in the review of audits firms involved in undertaking audits other
than those covered above.

 

The concept
of establishing the NFRA has been greatly influenced by the establishment and
functioning of the PCAOB in the USA and hence it would not be out of place at
this stage to briefly discuss its role.

 

PCAOB

The Public
Company Accounting Oversight Board (‘PCAOB’) is a private-sector, non-profit
corporation created by the US Sarbanes-Oxley Act of 2002 (‘SOX’) to oversee
accounting professionals who provide independent audit reports for publicly
traded companies only, unlike NFRA which covers large unlisted public entities,
too. The annual budget of PCAOB for the year 2019 is $273.7 million for a
market cap of $9.8 trillion. The PCAOB’s responsibilities include the
following:

 

(i)   registering public accounting firms;

(ii) establishing auditing, quality control, ethics,
independence and other standards relating to public company audits;

(iii) conducting inspections, investigations and
disciplinary proceedings of registered accounting firms; and

(iv) enforcing compliance with SOX.

 

Registered
accounting firms that issue audit reports for more than 100 issuers (primarily
public companies) are required to be inspected annually. This is usually around
ten firms. Registered firms that issue audit reports for 100 or fewer issuers
are generally inspected at least once every three years. Many of these firms
are international non-U.S. firms who are involved in the audit of
publicly-traded companies on the US Stock Exchanges. Consequently, some
Indian audit firms who are involved in issuing audit reports are required to be
registered with PCAOB and hence be subject to PCAOB inspections.

 

INSPECTION REPORTS

The PCAOB periodically issues inspection reports
of registered public accounting firms. While a large part of these reports are
made public (called ‘Part I’), portions of the inspection reports that deal
with criticisms of, or potential defects in, the audit firm’s quality control
systems are not made public if the firm addresses those matters to the Board’s
satisfaction within 12 months of the report date.

 

Those portions are made public (called ‘Part II’)
only if (1) the Board determines that a firm’s efforts to address the
criticisms or potential defects were not satisfactory, or (2) the firm makes no
submission evidencing any such efforts.

 

IL&FS OUTBURST

After having understood the role of NFRA and to a
certain extent PCAOB, it would be pertinent at this stage to examine the public
outbursts against the closely-held financial sector giant ILFS which piled up
huge debts amounting to around Rs. 90,000 crores by September, 2018. The
problems initially surfaced with defaults in the repayment of the most liquid
and known safest form of debt, viz., commercial paper, followed by a domino
effect which threatened and called into question the stability of the entire
NBFC sector. This understandably led to a public outburst on various aspects
and called into question the role of the government, the RBI and the auditors,
amongst others. The following were some of the key matters which triggered the public outburst:

 

(1) What was the RBI doing all these years as a
part of its inspection process, considering that there were reports of breach
of NOF, group exposure and capital adequacy norms in case of one of the group
entities?

(2) How did the Credit Rating Agencies fail to see
through the high leverage and the potential defaults without any warnings and
suddenly downgraded the rating from stable to default?

(3) The impact of the defaults on the mutual funds
which had heavily invested in the debt instruments and the consequential impact
on the common investors;

(4) The bailing out by the government through
investments by LIC and SBI and other similar profitable PSUs (‘family jewels’)
thereby potentially jeopardising the savings of millions of investors and
policy-holders;

(5) As is always the case, the role of the auditors
was also called into question on many fronts like adherence to independence
requirements, maintaining professional scepticism, failure to comply with
regulatory requirements, provide early warning signals, etc.

 

It would be
pertinent at this point to dwell on NFRA and assess its role and duties in
conducting Audit Quality Review (AQR) of CA firms. The first such
AQR was completed in December, 2019 in respect of the audit undertaken by a
firm of one of the IL&FS group entities, which is an NBFC, being the first
such within that group which is in the public domain and which has been used as
a basis for the discussion hereunder.

 

AQR PROCESS

This is one of the important tools provided to the
NFRA to regulate and monitor audit firms as covered in the Rules referred to
earlier, which was conducted by the Quality Review Board. The QRB Review and
AQR can also be considered as equivalent to the PCAOB reviews conducted in the
case of the US-listed entities referred to earlier.

Scope
and regulatory force

The scope and
the regulatory force for the AQR are provided in Rule 8 of the NFRA Rules,
2018. The said Rules provide that the NFRA may, for the purpose of
enforcing compliance with the Auditing Standards, undertake the following
measures which would broadly constitute the scope for the AQR:

(A) Review working papers and other documents and
communications related to the audit;

(B) Evaluate the sufficiency of the quality control
system followed by the auditor; and

(C) Perform such other testing of the audit,
supervisory and quality control procedures of the auditor as may be considered
necessary or appropriate.

 

Though Section 133 of the Companies Act, 2013 requires
the NFRA to inter alia monitor and enforce compliance with both the
Accounting and the Auditing Standards, the main focus of the AQR, which
we will discuss in the subsequent section, is on compliance with the auditing
and quality control standards.

 

Steps
involved in undertaking the AQR

The AQR which
is undertaken is not a one-way traffic but follows an elaborate process of
seeking information from the audit firm, followed by the draft findings against
which the replies of the audit firm are sought before the final report is
issued. The following are the various steps which are broadly undertaken before
the final report is issued and the same are included in a separate Annexure to
the report so that there is no ambiguity:

(a) Formal letter sent by NFRA to the engagement
partner (EP) asking for the audit file of the client selected for review.

(b) Subsequent letter sent to the EP asking for the
list of related parties and the details of the audit and non-audit revenue of
the selected client under affidavit.

(c) NFRA’s letter sent to the EP containing a
questionnaire sent via email and the replies against the same by the audit
firm.

(d) NFRA’s letter to the EP conveying its prima
facie observations against the various issues in the questionnaire referred
to in (c) above and the reply there against.

(e) Issuance of the Draft AQR Report (DAQR).

(f) Presentation made by the EP and the other team
members to the NFRA in pursuance of the observations in the DAQR.

(g) Written replies furnished by the EP to NFRA in
response to the observations in the DAQR.

(h) Issuance of the final AQR Report by NFRA.

 

Summary
of the NFRA’s conclusions in the AQR

The culmination of the above process resulted in
several findings, recommendations and conclusions covering a wide spectrum of
issues which were analysed under the following broad categories as tabulated
hereunder. Whilst a detailed discussion thereof is beyond the scope of this
article, the main findings as discussed here would not only provide an insight
into the thinking of the NFRA but also serve as an eye-opener to the audit
firms, especially the small and medium-sized ones, to enable them to ramp up
their audit quality keeping in mind the current circumstances.

 

Area

Key Findings / Observations
and Conclusions

 

 

Compliance with independence requirements

The NFRA has come down heavily on the independence requirements
violated by the audit firm, as evidenced by the following matters:

a) The audit firm had grossly violated the provisions of section
144 of the Companies Act, 2013 by providing various prohibited services
and also not taking the approval of the Audit Committee, including in
respect of services provided by associated / connected firms / companies
to both the company and its holding or subsidiary companies. The total
fees for such non-audit engagements in excess of the corresponding audit fees
has, in the words of the NFRA used in the Report, ‘undoubtedly fatally
compromised the windependence in mind required by the Audit Firm’

b) The approval of the Board of Directors for such
services is not permissible where the company has an Audit Committee and the
same would amount to an override of controls

c) There was a clear violation of the RBI Master
Directions since the EP was involved in the audit for a period of five
years as against the mandatory rotation after a period of three
years

d) The Senior Audit Engagement team comprising of the Audit
Director and Audit Senior Manager were involved in the audit for a period
in excess of seven years which is against the spirit of the staff
rotation and familiarity threat principles enshrined in SQC-1. The
contention of the audit firm that such requirements were applicable only to
the EP and the Engagement Quality Control Review (EQCR) Partner
was not acceptable to the NFRA since the EQCR is an entirely independent
exercise. This clearly compromised on the audit firm’s independence both in
letter and in appearance

 

 

Role of the EP

The reference by NFRA to the role of the EP is both interesting
as well as insightful, as reflected through the following key observations:

a) The practice of the audit firm in designating two partners
as EPs is clearly a violation of SQC-1 as well as SA-220 – Quality control
for an Audit of Financial Statements, which clearly mandates that member
firms should have only one EP, which aspect was also clearly laid down even
in the audit firm’s Internal Quality Manual

b) The time spent by the signing partner (who is
considered by the NFRA as the EP) and the evidence of the review of
documentation by him during the course of the audit, clearly shows
that almost all the important work of audit, i.e., independence evaluation,
risk assessment, audit plan, audit procedures, audit evidence, communications
with management or those charged with governance (TCWG) was not adequately
directed / supervised / reviewed
by the EP

 

 

Communication with TCWG

Since an ongoing two-way communication between the audit firm
and TCWG is an important element in the audit process, the following
observations by the NFRA in this regard merit attention:

a)The audit firm was not able to produce a single document
minuting the discussions held with TCWG

b) The assertion of the audit firm that they have
exercised their professional judgement in making their written communications
cannot be taken as a justification that nothing was required to be
communicated. This also runs contrary to the fact that the RBI
inspections and subsequent correspondence had revealed serious
non-compliances relating to NOFs, CRAR, NPAs and Group entity exposures,
amongst others, which are significant and require to be communicated under
SA-250 on Consideration of Laws and Regulations in an Audit of Financial
Statements and SA-260 on Communication to Those Charged with Governance

c) As per the minutes of the meetings of the Board of
Directors and the Audit Committee, there was also nothing on record to
demonstrate that the audit firm representatives had attended any meetings at
which the above matters were discussed, except the meeting at which the
accounts were approved and adopted. Further, even at the said meeting the
contention of the audit firm that there were no serious non-compliances with
laws and regulations does not hold water, considering the correspondence
referred to above and the non- disclosure in the
financial statements

 

 

Evaluation of Risk of Material Misstatement
(ROMM) Matters

Assessment of ROMMs being an important component in the entire
audit process has naturally received due attention by NFRA and the following
are some of the important observations in respect thereof:

a) The reference in the audit work papers to
compliance with International Auditing Standards is a clear
non-compliance with section 143(9) of the Companies Act, 2013. The Report
further states that ‘the Companies Act refers only to SAs prescribed by
that statute and to no other. Hence, any reference to any SAs other than so
prescribed is clearly non-compliant with the Companies Act. NFRA, as a body
constituted under the Companies Act, 2013,

obligated to consider only what is compliant with
that Act.’

b) The audit firm failed to appropriately deal with
identification, categorisation and minimisation of engagement risk,
especially looking at the size, nature and economic significance of the
auditee company. The risk of misstatement due to fraud was also ruled out by
the audit firm, especially with regard to revenue recognition which is a
presumed fraud risk as per SA-240. This led to inadequate audit responses.
Some specific instances to highlight the same are discussed in points
(d) to (f) below

c) There were significant contradictions in the assessment of
ROMM which lead to the conclusion that the assessment had been carried out in
so casual a manner as to result in a complete sham

d) There is no reference in the audit file to the fact that
the audit firm has noted the SI – NBFC character of the entity whilst
undertaking a risk assessment and the consequential risk classification as
normal which is reflective of an inadequate understanding of the
financial and business sectors of the economy. The NFRA has further
remarked that ‘the RBI, as the chief regulator of financial and
monetary matters, makes this determination, which
needs to be

respected and not treated
cavalierly.’

e) There were several inadequacies found in the testing and
evaluation of NPAs, including the requirement of early recognition of
financial distress and the resolution thereof and the classification of
Special Mention

Accounts in terms of the RBI guidelines

f) The audit firm should have maintained professional
scepticism throughout the audit by recognising the possibility that a
material misstatement due to fraud could exist as per SA-240, notwithstanding
the auditor’s past experience of the honesty and integrity of the entity’s
management and TCWG, by performing specific and adequate procedures to
address the following matters, amongst others:

(i) Suppression of defaults due to regular
‘ever-greening’ of loans,

(ii) Manual overriding of controls for a substantial
portion of loans sanctioned during the year as evidenced by the statement /
analysis in the audit file and the corresponding observations in respect
thereof in the

RBI Inspection Report,

(iii) 
Procedures to test the completeness and accuracy of the listing of
NPAs,

(iv) Testing of journal entries, especially those
pertaining to items posted after the closing date, significant period end
adjustments and estimates, inter-company transactions, etc.

Testing / disclosure of specific matters arising
out of RBI Inspection Reports

a) The audit firm did not question the management and challenge
the inflation of profit by a material amount through inclusion of the value
of a derivative asset which was entirely unjustified. The Report mentions
that ‘the actions of the auditor in not having done so, and having
accepted the stand of the management without question, shows clearly a gross
dereliction of duty and negligence on the part of the audit firm’

b) The audit firm accepted the stand of the management
about not disclosing the fact that the Net Owned Funds (NOF) and the Capital
to Risk Assets Ratio (CRAR) of the entity as on 31st March, 2018
were both negative, based on the RBI Inspection Report and related
communications and that this situation could lead to cancellation of the NBFC
license of the entity. The audit firm also certified the accounts as showing
positive NOF and CRAR, accepting the explanations of the management which
were clearly contrary to law. The explanation of the audit firm seems to
imply that this communication of the RBI was not available to them. This
explanation was held to be unacceptable for the reason that this clearly
showed the complete lack of due diligence and professional scepticism on the
part of the audit firm. Had proper inquiries been made both with TCWG and the
RBI, it is certain that this communication would have been formally made
available to the audit firm

c) Consequent to the above matter, the audit firm did not
adequately question the going concern assumption on the basis of which
the management had prepared the financial statements

 

 

Learnings
and challenges for audit firms

A careful
evaluation of the findings arising out of the above report provides several
learnings as well as challenges, especially for the small and medium-sized
firms, considering that the observations have been made in respect of an
international firm which is supposed to have robust processes. The challenges
before the SMPs are broadly analysed under the following headings:

 

Adverse
publicity / reputational risk:

Unlike the
earlier QRB Review Reports, the NFRA shares its findings and publishes the
reports on its website and hence the same are available in the public domain,
which immediately leads to bad publicity and adverse reputational risk for both
the audit firm and the client / entity concerned. This is in line with the authority
provided to it in terms of Rule 8(5) of the NFRA Rules. It may,
however, be noted that Rule 8(6) of the NFRA Rules provides that no confidential
or proprietary information should be so published unless there are
reasons to do so in the public interest which are recorded in writing. However,
what constitutes confidential or proprietary information has not been defined.

 

One of the
ways in which this can be achieved is by dividing its report into two parts as
is done by the PCAOB as discussed earlier.

 

EMPHASIS ON AUDIT INDEPENDENCE AND AUDIT ADMINISTRATION /
COMMUNICATION

There is now
a growing expectation of independence both in letter and in spirit.
Whilst prima facie the requirements under the statute may appear to have
been complied with, independence of the mind in the eyes of the external
stakeholders / users of the audit report is also important. This may be a challenge
to smaller firms who have a limited number of audits and staff to perform the
same, making them vulnerable to the familiarity threat. Accordingly, in
future audit firms would have to keep in mind these aspects before they accept
fresh audit engagements since the ICAI / QRB has the power to regulate all
entities. Further, the general tendency of being an all-weather friend and
trusted adviser would need to be carefully calibrated with the regulatory
guidelines. Finally, a lot of emphasis would have to be placed on the extent
of the role played by the EP as against the tendency to rely on the work done
at the junior level due to both time and technical constraints (e.g. the EP
being a tax specialist). In this context, the observation of the NFRA of the audit
firm designating two EPs may not help since the concept of shared
responsibility did not cut ice with the NFRA. To mitigate these
problems, small and medium-sized firms would do well to undertake external
consultation on a more formalised and frequent basis since it is
also recognised as an important element in the overall quality control process
in terms of SQC-1.

 

IMPORTANCE OF FRAUD AND RISK ASSESSMENT

The
importance of these two aspects cannot be overemphasised. The current
environment of regulatory overdrive makes audit firms vulnerable to greater
scrutiny on these aspects. Several specific observations by NFRA on granular
aspects of fraud and risk assessment in the audit report like ever-greening of
loans, valuation of derivatives, testing of related party and inter-company
transactions, manual override of controls, etc. makes it imperative for audit
firms to exercise greater degree of professional scepticism since their
professional judgements would come under greater scrutiny. To mitigate these
problems, audit firms, especially the small and medium-sized ones, should have
regular training and orientation programmes, both external and internal, so
that apart from sharpening the technical skills the necessary soft skills are
also developed. Such training costs should not be considered as a cost but as
an investment.

 

COMPLIANCE WITH AND ATTENTION TO REGULATORY MATTERS

The NFRA Report has sent out a clear message that
audit firms ignoring regulatory matters do so at their own risk. Further, NFRA
has taken a strict view on certain matters like risk classification in case of
Systemically Important (SI) – NBFCs as greater than normal, which is
questionable. Another area flagged by them involves inadequate
communication and dialogue with the management and TCWG on regulatory matters.
Accordingly, it is important for audit firms to rigorously follow the
requirements laid down under SA-250 and SA-260 even though the primary
responsibility for compliance with laws and regulations rests with the management
and TCWG.

 

Robust
documentation of the audit engagement and firm level policies

The oft-used
phrase what is not documented is not done and also the fact that
audit documentation should be self-explanatory and be able to stand on its own,
has been clearly in evidence in the NFRA’s findings in several places,
e.g. reference to International Standards on Audit (this provides a subtle
message to the firms with an international affiliation that compliance with
international requirements is no substitute for compliance with the local
regulations, guidelines and pronouncements), non-availability of minutes of
meetings of discussions / communication with the management on important
matters, no specific documentation evidencing performance of key audit procedures
in respect of certain transactions having greater risk and fraud potential and
so on.

 

One of the
most important learnings for audit firms involved in the audit of covered
entities is to streamline and standardise routine audit documentation
by laying down clear policies, checklists and other documentation for execution
of audit engagements in general and keeping in mind the specific documentation
requirements as laid down in the various Standards on Auditing, as also on the
various elements of the system of quality control, as under, as laid down in
SQC-1:

 

(I)   Leadership responsibilities for quality within
the firm;

(II)   Ethical requirements (including independence
requirements);

(III)  Acceptance and continuance of client
relationships and specific engagements;

(IV) Human Resource policies covering recruitment,
training, performance evaluation, compensation, career development, assignment
of engagement teams, etc.;

(V)  Engagement performance, including
consultation, engagement quality review, engagement documentation retention and
ownership, etc.

 

Whilst
framing policies in respect of the above and any other related matters, care
should be taken to avoid mechanically copying the requirements laid down in the
Standards. The policies should be framed keeping in mind, among other things,
the size of the firm, the nature and complexity of the clients served and the
competence of the personnel to implement the same.

 

How
small and medium-sized firms can prepare for NFRA review

One of the
most important elements is to have an audit manual in place covering the
policies and procedures, with all templates, formats, and checklists in place
to ensure compliance with the applicable Auditing Standards. The structure and
significant content of the audit manual could be as follows:

 

  • INTRODUCTION AND FUNDAMENTAL PRINCIPLES:

This chapter
introduces the fundamental principles related to reasonable assurance,
objective of an audit, audit evidence, documentation, financial reporting
framework, quality control, ethics, professional scepticism, technical
standards.

  •   PRE-ENGAGEMENT
    ACTIVITIES:

In this chapter the
manual deals with the basic engagement information, engagement evaluation:
client acceptance / continuance, independence declarations, staff assessment
and audit budget, planning meetings, terms of the engagement.

  •   PLANNING THE AUDIT:

This chapter covers
the audit approach, gathering knowledge of the business, laws and regulations
and understanding the accounting systems and internal controls, fraud risk
discussions and indicators, related parties.

  •  RISK ASSESSMENT PROCEDURES:

This chapter will
help auditors comply with the standards of auditing related to the
identification and mitigation of risk of material misstatement, fraud risk and
going concern risk at the initial stage of audit.

  • PLANNING MATERIALITY:

Planning
materiality is one of the most critical elements of an audit as it determines
the coverage of the audit. Planning materiality should be determined at the
planning stage and should be updated if required during the execution phase.

  •   AUDIT PROGRAMMES:

A well-designed
audit programme ensures compliance of auditing standards and quality standards
while performing the audit and also acts as a guiding checklist for the
engagement team.

  • TEST OF CONTROLS AND SUBSTANTIVE TESTS:

This chapter guides
the team in determining the reliance on the test of controls vis-a-vis the test
of details, resulting in a balanced approach between the two to ensure an
efficient and effective audit.

  •   PERFORMING THE AUDIT:

This chapter is the
heart of the audit documentation. It deals with documentation of the execution
of the entire audit, determining the audit sampling, audit sampling procedures,
consideration of applicable laws and regulations, inquires with management and those
charged with governance, external confirmation procedures, analytical
procedures, procedures to audit accounting estimates and fair value
measurements, identification of related parties, going concern considerations,
considering the work of internal audit or experts, physical verification
procedures, etc.

  •  FINALISATION: AUDIT CONCLUSIONS AND
    REPORTING:

The auditor needs
to ensure the adequacy of presentation and disclosure, subsequent event and
going concern consideration, final analytical review, evaluation of audit test
results, issue of the auditor’s report, communicate with those charged with
governance and coverage of management representations.

 

 

 

CONCLUSION

What is
not documented is not done has been the age-old mantra! Audit documentation helps the auditors to prove to the user of the
financial statements, usually the authorities, that a proper audit was
conducted. The data that has been recorded can help in ensuring and encouraging
that the quality of the audit is maintained. It also provides an assurance that
the audit that was performed was in accordance with the applicable auditing
standards.  

 

 

WORKING CAPITAL CHALLENGES FOR CA FIRMS IN COVID TIMES

Historically, in India Chartered Accountants
have practised as proprietary concerns or partnership firms. But since the
introduction of the Limited Liability Partnership Act (LLP) and the permission
of the ICAI for Chartered Accountants to practise as LLPs, many members of the
Institute in practice have either formed LLPs or have converted their
partnership firms into LLPs. Most of the Chartered Accountant practising units
(the firms) were small or of medium size and their working capital needs were
fully taken care of by funding from the partners and the retained profits.

 

As the size of many of these firms grew and
the number of partners increased, they started needing more space to operate.
Given that the investment for purchase of office premises, especially in
metropolitan cities, was high, many firms started using rented premises.
Furnishing of these offices was carried out using partners’ capital and
borrowing from banks and other lenders. In many cases, the purchase of vehicles
was also done by borrowing from banks or from Non-Banking Finance Companies
(NBFCs). Most of the firms hardly needed to borrow for their working capital as
their income was in the nature of service income being generated from a number
of clients and spread uniformly. Borrowing for office premises, furniture,
equipment or vehicles was common but if a firm borrowed for working capital
needs, it could have been an indication that either the proprietor or one or
more of the partners had overdrawn their capital.

 

REVENUE CYCLE TURNS
CYCLICAL: With the mandate to compulsorily follow
the fiscal year by the government, the revenue cycle of Chartered Accountant
firms also became somewhat cyclical. The major part of the work is required to
be performed between April and November and the major billing starts happening
between May and December every year. This has resulted in a majority of the annual
cash inflow of the firms coming in during the second and third quarter of a
financial year. Generally, the months of February, March and April are ‘dry’
with regard to billing and recovery of funds. This results in low liquidity in
firms after the payment of advance taxes in March, which lasts till the end of
May / June, depending on the practice areas of the firms. However, the firms
are conscious about this unevenness of the fund flow and they accumulate the
required cash during the peak work season to pay for taxes as well as expenses
in the lean months. This discipline keeps most of the firms away from borrowing
for working capital.

 

However, Covid-19 has changed the scenario
for firms and even the individual practices of professionals. The lockdown,
starting from 25th March, 2020, potentially has serious
repercussions on the working capital of firms. Most of the firms are cushioned
until the month of May as they have provided for low recoveries in the
beginning of the year as usual. However, due to postponement of the due date of
completion of audits, tax audits and filing of various returns, the billings
are getting postponed by at least two to three months. Further, most of the
clients may not be able to pay the expected fees promptly due to the squeeze on
their working capital and profitability on account of the prolonged lockdown.
Small businesses are suffering due to temporary closures and a steep fall in
demand. The competition from online suppliers and from certain larger
suppliers, who can manage the logistics of home delivery, has further eroded
their business.

 

FATE OF SMALL-SCALE
MANUFACTURERS: The fate of small-scale
manufacturers is no different. This has substantially affected the capacity of
small clients to pay fees to their chartered accountants, though generally
their fees are cleared promptly. The larger businesses in key sectors have also
suffered due to the lockdown and this may result in delay in payment of the
bills of the firms. The clients will use their funds primarily for their
business priorities before allocating them to payments for services such as
those of chartered accountants. This is likely to result in delayed recovery of
fees, and in some cases even bad debts. It is likely that as in many other
businesses or professions, the F.Y. 2020-21 is likely to be tough for chartered
accountants in practice.

 

The delay in recovery of fees and some
recoveries turning doubtful can cause strain not only on the profitability of
the firms but also on their working capital. The laws have not reduced any
compliances or any complications but many due dates are deferred due to the
lockdown. Therefore, the same volume of services needs to be delivered by the
firms to the client, though with extended deadlines. This scenario will keep
the expenditure of the firms at the same level as that of the earlier years, as
they will not be able to get their work done with fewer man-hours or overheads,
unless well-directed efforts are made in that direction. However, income for
the firms may come down and be likely to be recovered late. This may result in
a major working capital gap for the firms, especially between the months of
June and December.

 

It appears for now that the need of working
capital will be temporary in nature. The squeeze may last the current financial
year with the possibility of spilling over to the next year. Generally, the
need of working capital augmentation should be around 50% of the annual
expenditure of the firm, though in many cases depending upon the size and
practice areas, an amount equal to 25-30% of such expenditure should allow the
firm to sail through smoothly. This is so mainly because the lag of billing and
recovery is likely to be around three to four months but in
case of some firms it can extend to six months. The working capital of firms
can be augmented from the following sources:

 

BORROWING FROM THE
PARTNERS: This is the simplest way of raising
working capital if one or more partners are willing to contribute the required
amount. Interest can be paid to such contributing partners based on the
partnership agreement, or based on the prevailing bank rate, or as mutually
agreed by the partners. It may also be possible to borrow against the fixed
deposits of the partners from banks if facilitated by one or more partners.
Such an arrangement can result in low interest cost and it may prevent
disturbing the personal finances of the partners. The partners may also agree
to bring deposits from their family members or even from friends which may be
interest-bearing or interest-free, based on the mutual agreement between the
partners.

 

BORROWING FROM
BANKS: Most of the banks are willing to extend
working capital facility to Chartered Accountant firms but the question of
security may crop up. Banks are not happy to grant such loans without any
security and it may not be easy for the firm to provide such security because
the firm may not have such acceptable assets and it may not be desirable to
request one or some of the partners to give security of their personal assets.
These borrowings can come under MSME loans and in that case may be subject to a
charge of reduced rate of interest. If the firm already has existing loans
taken for its premises or its furniture and fixtures, it may be possible to
take a top-up loan on the said loan, with accelerated equal monthly
instalments, or by increasing the term of the loan. In such a case, the
security remains the same and the documentation can be quick and easy. While
borrowing from banks it is essential to keep in mind that the borrowing should
be done just in time to reduce the interest liability. The working capital need
is not going to be front-loaded and it will be consumed month after month for
monthly expenses. Therefore, a staggered drawing of the loan amount would be
more desirable as against securing an upfront term loan.

 

BORROWING FROM
NBFCs: Non-Banking Finance Companies can be a good
source of borrowing for the short-term working capital needs of a firm. A loan
from an NBFC is generally more expensive than that from a bank, but it can be
procured faster with fewer formalities. Similarly, partners can negotiate and
combine their individual unsecured borrowing limits into the borrowing limit of
the firm, but such a loan will attract personal guarantees of all the partners.
Borrowing against security of assets can be much easier if a firm or its
partners can offer the same. Such an arrangement can be made with an
appropriate understanding between the partners. As the expected working capital
requirement is for a short term, in case of insistence of security by the
lender, it is advisable to grant security of moveable properties, which can be
pledged faster and at less cost as compared to an immoveable property.

 

USE OF CREDIT
CARDS: A firm can use credit cards of the firm or
those of its partners for making various payments for utilities, telephone
bills, stationeries, books, etc. Though these expenses do not make up the major
working capital needs of a firm, they can partially mitigate the working
capital gap. When the working capital cycle improves, the firm can repay the
credit outstanding along with interest. It should be kept in mind that funding
from credit cards is the easiest, but it is one of the most expensive avenues.
Further, credit card liability would have to be paid in instalments as per the
terms of the credit card and delays can attract substantial penal charges and
can also affect the CIBIL rating of the card-holder.

 

REDUCING,
STAGGERING OR POSTPONING WITHDRAWALS BY PARTNERS:
In most of the firms, partners draw fixed amounts every month to meet their
normal expenses. The excess credit balance in their capital account is drawn
either towards the end of the year or at the beginning of the following year.
Though it is difficult to get back the money paid earlier to the partners as
such amount may be invested, committed or spent, the partners can agree to not
draw their normal drawings for a few months, or draw lower amounts for those
months so as to conserve the working capital of the firm. Such an arrangement
does not change the profit share of the partners but it does postpone the
outflow of funds from the firm. This arrangement can help the firm to partly
cover its working capital gap.

 

POSTPONING PART
SALARIES OF SENIOR STAFF: The partners of a firm
can also make arrangements with senior staff of the firm who are drawing
salaries above a certain threshold, to defer a part of the salary payments for
a certain period to overcome the working capital gap. The arrangement can be different
from employee to employee. They should take appropriate care of the minimum
monthly needs of the employees, including their respective loan instalments. In
the current times of lockdown and gradual unlocking, the actual expenditure of
many people has reduced because there are fewer avenues for meaningful
spending. People are also in the mood to save as the future remains uncertain.
Therefore, this type of arrangement may not be out of place. Further, in case
of specific needs of an employee, some flexibility or modifications in the
payment schedule can be made by the partners of the firm.

 

DEFERMENT OF BONUS
FOR THE YEAR: Many firms give an annual bonus at
the time of Diwali. It is possible that the financials of the firms at this
year’s Diwali may not be strong enough to pay out a large amount as annual
bonus. This difficulty can be overcome by partly or fully deferring the bonus
payment till the end of the financial year, by which time the finances of the
firms are likely to improve. Such a deferment can only give partial relief to
the firm by reducing its working capital gap at a crucial time.

 

RECEIVING FEES IN
ADVANCE FROM SOME CLIENTS: A firm can also request
a few large net worth clients or companies to pay their fees in advance, or
grant an advance against future billings. The long-standing clients of a firm
with good liquidity may be able and willing to oblige. However, such advances
should be avoided from audit clients – and the provisions of the Companies Act
and the Code of Ethics of the ICAI should be properly observed. While taking
such advances, GST repercussions may also be considered.

The Covid-19 pandemic has raised several
issues related not only to the physical and mental well-being of people, but
also related to the financial stability of individuals, businesses, companies
and even the government. The financial planning of many individuals and
families has suffered a serious setback and nobody has a clear answer as to
when things will improve. In the current situation, the Chartered Accountant
professionals are comparatively more protected as the major part of their
revenue is earned out of statutory compliances that have not been done away
with.

 

Medical professionals are working very hard
and they can expect their finances to remain steady as their services are in
high demand. However, other professionals providing legal, architectural,
engineering, designing services, etc. may have much more serious working
capital problems as compared to a firm of chartered accountants. Their mismatch
of working capital may not get resolved by the end of the current financial
year and it may take longer to get back on track. Such professionals and their
firms will need to secure long-term working capital arrangements from banks or
NBFCs to tide over their needs, unless the partners can make up the deficit in
the working capital by capital induction or otherwise.

 

Undoubtedly, Covid-19 has caused and is
going to cause even further disruption in our professional activities. It may
cause a turnover of the staff as many may prefer to work at places as near as
possible to their homes. Senior staff may be ready to take temporary reductions
in their take-home salaries. Clients are likely to feel the pinch in their
businesses and requests for reduction in fees are going to be very common. The
work volume may not be reduced at least during F.Y. 2020-21 as most of us will
be working on the transactions of the clients entered into in F.Y. 2019-20,
which were at normal levels. The request for lower fees may continue for one
more year as the turnover and activities of F.Y. 2020-21 are likely to be on
the lower side as compared to the previous year. So the pain is likely to last
for a couple of years for our profession. In the given circumstances, our
profession needs to rationalise and control costs and stand by our clients
gracefully, accepting reduction of fees in deserving cases. This will result in
a lower bottom line for the profession, but the gesture may go a long way with
the client.

 

The times are
unprecedented, tough and full of uncertainties. In such times, innovation,
caution and thrift will go a long way to take the professionals out of the
crisis, physically, mentally and financially, without much damage. 

CURRENT THEMES IN CORPORATE RESTRUCTURINGS AND M&As

This article attempts to consolidate recent key commercial and regulatory developments having a bearing on Corporate Restructurings and Mergers & Acquisitions. It could help decision-makers in preparing for the expected resurgence of corporate actions as we step into ‘Mission Begin Again’.

BACKDROP

The F.Y. 2019-20 was hampered by a global structural slowdown which got further amplified with the novel Covid-19 pandemic bearing significant impact on business models and corporate actions.

From a sustenance stand-point, raising fresh capital for organic and inorganic needs is clearly the need of the hour. We are seeing the outlier transaction of Jio Platforms’ Rs. 115,693 crores aggregate fund raise1  and then we have the flurry of announcements for rights issues, NCDs, venture debts and loan top-ups. From the startups’ perspective, pricing and dilution issues are forcing them towards debt and venture debt with unique situations around collaterals and dynamic business models with cash burn.

With Unlock 1.0 and the expectation of ‘normal’ monsoon2  serving as a confidence-booster, markets and industries are moving in a green zone, at least on a month-on-month basis, including for capital markets.

Index Current levels (1st June, 2020) % change from 1st Jan to 31st Mar % change from 31st Mar to 1st June
SENSEX 33,303 – 29% + 13%

Subject to the possibility of Covid continuing to lash out again and again in waves, Q3FY21 and Q4FY21 may provide some clarity on business feasibilities, cash runways, etc. which could act as a direct feeder for potential internal and external restructurings and M&A actions and consolidation across sectors.

1   https://www.bseindia.com/xml-data/corpfiling/AttachHis/715b628f-8f44-413a-b509-2943a2dd3f22.pdf
2  http://internal.imd.gov.in/press_release/20200601_pr_827.pdf

Each corporate action, irrespective of its nature, size and scale, has its unique internal and external challenges, including:

From the preparedness point of view, the above agenda clearly needs at least two to four months of planning before actual execution of corporate action. So, the time is NOW.

With almost all the businesses exposed due to the pandemic, it is absolutely essential to take a hard look / relook at the story, rephrase it and create a platform for market participants for ease of deal-making.

On the M&A horizon, we are seeing re-negotiations of live transactions, revalidating offerings and numbers to see if strategic reasons still hold good, to re-assess deal valuations, covenants, etc. For already ‘closed’ transactions, re-negotiations are expected in the capital structure (cap tables, as they are known commonly), earn-out targets, valuation covenants, agreed business plans and covenants in the shareholder / transaction agreements. Such re-negotiations may also get extended to ESOPs and sweat equity allocations and agreed benchmarks.

For us professionals, we can add significant value on both sides of the table, especially keeping tax and regulatory requirements in mind.

RIGOROUS OPERATIONAL ASSESSMENTS COULD LEAD TO RESTRUCTURINGS AND DEALS

An assessment of costs, commitments, scenario analyses, markets and stakeholders’ concerns during the lockdown could help in identifying ‘good apples’ and ‘bad apples’.

Consolidation (mergers) and hive-offs (de-mergers or slump sale or itemised sale) can be evaluated for the following scenarios:

Indicator Possible solution
New-age business or product Hive-off to attract new-age capital
Excess capacities, facilities and assets Hive-off and sale / leases, white-labelling arrangements, joint ventures
Unviable undertakings / companies Consolidation with parent to optimise on costs going forward
Business succession issues due to shifting of talent, labour and resources Merger / consolidation with other market participants

 

Creating group or sector-level outsourcing vehicles with independent business plan
High-performing businesses Separating from common hotchpotch and value realisation

At times, segregation of businesses with distinct cash flows could help could lead the way forward for the company, investor interest and fund-raising. Such a raise also helps promoters to bring their contribution in the bank settlements which are generally in 20%-25% ratio of restructuring and thereby helping and working on an overall bailout plan.

The Insolvency and Bankruptcy Code, 2016 (‘IBC’) has fast-tracked the insolvency and resolution process requiring swift action on the part of management in the rescue attempt. It is often seen that viable assets / businesses are drawn into distress if not segregated in time.

By way of example, recently Gold’s Gym filed for bankruptcy protection in the US3. Interestingly, they have closed company-owned gyms; however, licensing (franchising) business is expected to keep the company a going concern. We have had many such examples in India in the past.

Global companies and investors are looking out for replacing China with India and other developing countries. In times like these, corporates which are placed well from the structure, clarity of business plan, readiness and compliance point of view could be the preferred choice for external investors and also help in faster ‘closing’ of deals.

3   https://www.goldsgym.com/restructure/

Even a simple decision of choice of a legal entity between Limited Liability Partnership vs. Private Limited Company could have significant impact on the IRR of the project merely due to the difference in applicable income tax rates.

In October, 2019 RIL created a structural as well as technological platform providing flexibility in deal-making4.

Structures like these provide significant flexibility in deal-making or primary listing at a multiple level, like platform company, telecom company, investees or even any combination thereof.

The current slowdown and the ability to go back to the drawing board can certainly be leveraged to prepare for M&As, restructurings and the expected resurgence in Q3FY21 onwards. Going by experience, we often find ourselves hard-pressed for availability of sufficient time to implement the most effective structure and thereby compromising on possible savings even in time value of money terms.

From the balance sheet optics point of view, historically, companies have also used the capital reduction process u/s 66 of the Companies Act to adjust negative reserves or assets which have lost value against the capital. Companies can evaluate such strategies to right-size the balance sheet, especially absorbing the Covid impact.

IMPACT OF COVID-SPECIFIC ANNOUNCEMENTS

As announced under the Atmanirbhar Bharat initiatives and further ratified by the IBC (Amendment) Ordinance, 2020 dated 5th June, 2020:

  • No application for IRP shall be filed for any default arising on or after 25th March, 2020 for a period of six months or such further period not exceeding one year from such date; and
4   https://www.ril.com/DownloadFiles/Jio%20Presentation_25Oct19.pdf

(ii)   there shall be a permanent ban on filing of applications for any default which may occur during the aforesaid period.

Separately, government also intends to raise the minimum threshold to initiate fresh IBC proceedings to Rs. 1 crore.

Corporates can use this for their benefit in multiple ways, including:

(a)   Design and negotiate a restructuring strategy directly with lenders and creditors;

(b) Speedy disposal of internal restructuring schemes involving merger, de-merger, capital reduction, etc. due to expected reduction in the burden of cases on NCLTs.

The Government of India has also proposed multiple schemes such as the Rs. 3 lakh crores Collateral-free Automatic Loans for Business5, including MSMEs; Rs. 20,000 crores Subordinate Debt for MSMEs; Rs. 50,000 crores equity infusion through MSME Fund of Funds. Ultimately, financing under any such scheme will be subject to the strength of the business and balance sheet. Corporates have been using mergers as a tool to demonstrate higher asset and capital base.

Other recent initiatives announced by the government giving impetus to transactions include:

(1)   Direct listing of securities by Indian public companies in foreign jurisdictions;

(2)   Sector-specific initiatives and reforms in agriculture, defence, space, coal, food processing, aircraft MRO, logistics, education, etc.;

(3)   Private companies which list NCDs on stock exchanges need not be regarded as listed companies.

OVERSEAS LISTING OF PUBLIC COMPANIES – A NEW PARADIGM

In December, 2018 SEBI published the Expert Committee Report6 suggesting a framework for listing shares of Indian companies on overseas exchanges and vice versa.

In March, 2020 the Companies (Amendment) Bill, 2020 introduced in the Lok Sabha proposed to amend section 23 and provide for – such class of public companies may issue such class of securities for the purposes of listing on permitted stock exchanges in permissible foreign jurisdictions or such other jurisdictions, as may be prescribed.

5   https://www.eclgs.com/
6   Report of the Expert Committee for Listing of Equity Shares of companies incorporated in India on Foreign Stock Exchanges and of companies incorporated outside India on Indian Stock Exchanges, dated 4th December, 2020As of today, Indian companies can access the equity capital markets of foreign jurisdictions through the American Depository Receipts (‘ADR’) and Global Depository Receipts (‘GDR’) regimes. Indian companies can list their debt securities on foreign stock exchanges directly through the masala bonds and / or foreign currency convertible bond (‘FCCB’) / foreign currency exchangeable bonds (‘FCEB’) framework.

The proposed framework is expected to provide:

As stated in the Expert Committee Report, over the period 2013-2018, 91 companies with business operations primarily in China raised US $44 billion through initial public offerings on NYSE and NASDAQ in the USA. This indicated the potential for Indian companies, especially unicorns, to tap additional capital in the new structure.

The report also listed jurisdictions where listing could be allowed – USA, China, Japan, South Korea, UK, Hong Kong, France, Germany, Canada and Switzerland.

Key beneficiaries of this could be IT/ITES, unicorns, healthcare, infrastructure, companies having significant global exposure, companies having strong corporate governance and having third-party investors such as PE, VC investors.

From the process point of view, some of the critical aspects of the process include:

Key nuances of overseas listings include:

  1. Relatively higher process and adviser costs;
  2. Approximately six months of overall timelines;

iii.         Potential class action suits for significant drops in the prices, etc.;

  1. Understanding of and compliance with foreign regulations such as stock exchange regulations, regulations such as FCPA (anti-corruption regulations), FATF compliances; and
  2. Enhanced disclosures and continuous investor, market engagements.

Before this becomes a reality, substantial changes are expected across the spectrum from corporate law to securities law and tax laws.

OTHER RECENT REGULATORY DEVELOPMENTS

With the number of new proposals, disclosure requirements could also lead to re-assessment of group structures.

CARO 2020

Under CARO 20207, a disclosure is required whether a company is a Core Investment Company (‘CIC’) as per RBI regulations and whether the group has more than one CIC. As a fallout, if at such group level the aggregate asset of the CICs exceeds Rs. 100 crores, such CICs are required to be registered with RBI as ‘Systematically Important CICs’ (CIC-ND-SI).

Some of the legacy groups could unintentionally run into unwanted, tedious registration or compliance requirements with such new disclosures and focused assessment. It could even be reason enough to liquidate or consolidate unwanted holding / operating companies with the objective to cut costs and streamlining operations to reduce the regulatory burden.

7   Applicability extended from financial year 2019-20 to financial year 2020-21 onwards

Minority squeeze-outs

On 3rd February, 2020 sub-sections 11 and 12 were introduced in section 2308  to provide for compromise or arrangement to include takeover offers made in such manner as may be prescribed (except for listed companies where SEBI regulations are to be followed).

The MCA also notified the National Company Law (Amendment) Rules 2020 (‘NCLT Rules’) and the Companies (Compromises, Amalgamations and Arrangements) Amendment Rules, 2020 (‘Companies Rules’) to deal with the rules and procedures.

This will certainly provide an additional and specific window for companies looking to delist and provide them with a framework to eliminate the minority shareholders completely. This will help them to effectively take 100% control over operations and help in decision-making during corporate actions.

SEBI’s Press Release for Listed Companies having Stressed Assets9 and other relaxations

The timing of SEBI’s Press Release (PR No./35/2020) could not have been better. It principally deals with relaxation in the pricing of preferential issues and exemption from making an open offer for acquisitions in listed companies having ‘Stressed Assets’ (as per the eligibility criteria set out) by way of:

  1. Relaxation of pricing guidelines and limiting the pricing calculation based on past two weeks’ data only. Existing regulations also mandate considering 26 weeks’ price data which may not capture the Covid disruption;
  2. Exemption from making an open offer even if the acquisition is  beyond  the  prescribed threshold or if the open offer is warranted due to change in control.

The above proposal comes with conditions such as non-applicability for allotment to promoters, approval of majority of the minority shareholders, disclosure and monitoring of proposed use and lock-in period of three years.

8   https://tinyurl.com/ycdc3tvs
9. https://www.sebi.gov.in/media/press-releases/jun-2020/relaxations-for-listed-companies-having-stressed-assets_46910.html

Further, SEBI also issued PR No./ 36 / 2020 temporarily relaxed pricing guidelines (up to 31st December, 2020) for all the corporates and provided an additional option to price the preferential allotments at the higher of 12-week or two-week prices with lock-in of three years.

The above decisions could help in faster resolution of stress and avert liquidation proceedings under IBC and large M&As and also provide an incentive to the promoters to provide liquidity to the companies at current prices.

Peculiar situations arising in deals

Declining valuations create opportunities to seek deals that create long-term value and total shareholder returns

 

In fact, the numbers of buyers could also be limited in today’s times. This could be the single most important reason for deals to return soon and chase companies that have survived the impact of Covid-19

Valuation and volatility issues around primary markets are expected to spur secondary market deals and M&As at least for the rest of F.Y. 2020.

Ex-IBC M&A activity itself has seen a lull even in F.Y. 2019. For various reasons, transactions also take too long to close. Limited partners of PE Funds have also advised the general partners and fund managers to tread with caution and focus on situations in existing portfolio companies during Covid.

Key discussions amongst the investment community are revolving around the following points:

(a) Re-negotiations are rampant;

(b) Decision-making has slowed across the globe and parties are trying to fully understand the impact of Covid-19 on businesses;

(c) M&A deal-making teams need to identify what would be the ‘new normal’;

(d) Sectors like healthcare, agri, logistics and technology would get more investments in the near future, as their inherent need has been clearer due to the Covid situation. On the other hand, discretionary spends like luxury goods, hotels, tourism, etc. might have longer downturns;

(e) The deal-making process will change to more virtual meetings, online DDs, etc., managements may not be immediately comfortable in taking such strategic decisions through virtual meetings, leading to slower deal-making processes;

(f) Companies / business models which are cash-positive will be more in demand and would attract buyers’ interest;

_____________________________________________________________

8   https://tinyurl.com/ycdc3tvs
9   https://www.sebi.gov.in/media/press-releases/jun-2020/relaxations-for-listed-companies-having-stressed-assets_46910.html
10  MINISTRY OF FINANCE (Department of Economic Affairs) NOTIFICATION, New Delhi, 22ndApril, 2020

(g) Keeping a tab on regulatory changes, compliance timelines, ability to avail of fiscal benefit has been an area of concern. For example, post-22nd April, 202010 , foreign investment from neighbouring countries will require prior government approval.

Key changes in some of the deal-making aspects are dealt with as under:

Constrained due diligences with renewed focus areas:

The security of supply chains, possible crisis-related special termination rights in important contracts and other issues that were considered low-risk in times of economic growth will become more important.

Areas requiring special focus or an expert opinion during the diligences include:

(i)   Business Continuity Plan,

(ii) IT infrastructure and data security,

(iii) Insurance and Risk Mitigation policies,

(iv) Impact and scenario analysis, especially for fiscal benefits,

(v) Strength of supply chain.

One solution here could be ready with a vendor due diligence (‘VDD’) report upfront.

Pricing and instrument structuring: Pricing is generally a forward-looking exercise on the back of the latest financial performance.

Earnings / profitability-based pricing models are more relevant in case of established businesses, whereas indicators such as Daily Active Userbase (DAU), Merchandise Value or traction are used in valuing new-age businesses.

Due to changing dynamics and demand / supply chain disruptions, the problem is around sustainability of earnings of F.Y. 2020 and the estimation of earnings for F.Y. 2021.

In such situations, pricing based on a stable period which could be F.Y. 2021 or even F.Y. 2022, could be looked at whereby consideration can be back-ended or involving escrow arrangements. Such structures would also necessitate careful structuring from the income tax point of view.

Further, in case of FDI / cross-border transactions, transfer of equity instruments between an Indian resident and a non-resident, an amount not exceeding 25% of the total consideration –

(A) may be deferred or settled through escrow for a period not exceeding 18 months from the date of transfer agreement; or

(B) may be indemnified by the seller for a period not exceeding 18 months from the date of the payment of the full consideration.

While point (A) is often seen in practice, it does provide limited flexibility of 18 months. To address this, one can consider structuring staggered acquisition of shares over a period of time where performance needs to be comforted with an appropriate legal documentation or even using dilutive convertible instruments to the extent possible.

Disclosure lists, indemnities, representation and warranties:

While some of the risks are still not insurable, significant reliance and discussions could be around various disclosures since some of the standard representations may not hold good; let’s say the possibility of one of the largest customers calling off a contract, or a vendor renegotiating prices causing material adverse effect, etc.

It is imperative to provide for sufficient headroom for financial covenants typically agreed in shareholder agreements, especially for credit or quasi-credit deals.

Transaction structuring-related aspects:

Most often we see peculiar structuring needs around optimising tax costs, timelines, low compliances, etc. Table A (See below) provides a quick view of key parameters of some basic structuring ideas.

CONCLUSION

At the cost of many innocent lives, these unprecedented times are expected to bring in significant focus on sustainability and on an essentially minimalist and fundamental approach for any action or decisions. The ongoing fiscal, regulatory and geo-political changes are expected to add to the vibrancy for a living or corporal person.

Depending upon the strategy a business may adopt, defensive measures could help to protect the future and aggressive actions could actually help in transforming or even re-writing the future. On this positive note, we continue to look forward to some interesting corporate actions and decision-making.

Table A

Important Covid-19 Parameters Share Acquisition / Slump Sale Scheme of Arrangement (NCLT Route)
Consideration Cash flows or share swaps More flexible & comprehensive. Issue shares, convertible instruments, other securities or cash flow
Valuation Limited flexibility on account of certain taxation and commercial aspects and related costs Ability to structure the valuation subject to going concerns and future parameters
Tax Outflow Immediate tax liability – could put pressure on cash flows Could be structured as tax neutral combination or divestment, thereby postponing actual tax incidence to the liquidity event
Timelines 1 to 2 months

 

(Could increase in case of regulatory involvement)

 4 to 8 months subject to NCLT process
Stamp Duty Costs Subject to state-specific laws

 

Could range between 0.25% to 3%, depending upon transfer of shares or transfer of business

 Subject to state laws

 

Example, in Maharashtra – It is higher of 0.7% of value of shares issued and 5% of value of immoveable property situated in the state, subject to overall cap of 10% in the value of shares issued
GST Share transfers excluded. Asset sale subject to GST Transfer of business undertakings may not be subject to GST

TAX AND TECHNOLOGY: ARE TAX PROFESSIONALS AT RISK?

INTRODUCTION


There is a curious
story unfolding in the technology environment today. While dramatic advances
are being made in emerging spaces such as 5G communication, artificial intelligence
(AI), virtual reality (VR) and augmented reality (AR), these tectonic shifts
are erupting at dizzying speeds, triggering confusion at individual levels.
Paradigm shifts, game-changing breakthroughs and once-in-a-lifetime events are
now converging in the same time frame, adding to the hype on the timeline for
benefits.

 

The developments
bring to mind an oft-repeated quote of Microsoft founder Bill Gates: ‘We always
overestimate the change that will occur in the next two years and underestimate
the change that will occur in the next ten.’

 

Admittedly, there are barriers and impediments such as concerns about
privacy and data security, combined with natural reluctance and resistance to
change, that will slow the progress. However, public interest in transparency
and accountability is likely to settle the competing objectives of transparency
and confidentiality with appropriate regulatory restrictions on the use,
storage and transfer of data.

 

While the debate
about the pace at which the quantum leaps in technology will develop and how
quickly they will affect the tax professions continues, there is no doubt that
markets are already moving: preparing for and indeed expecting to see progress
and adoption of these technologies and these changes.

 

META-TRENDS IN TECHNOLOGY IMPACTING TAX
PROFESSION

In any case,
regardless of the current experience, developments in various technologies will
continue to be transformational, influencing both professional and personal
lives. The following are the five meta-trends in technology that will
materially affect the tax profession in the future:

 

(1) Data – big data
sets, massively improved performance and memory capacity at scale;

(2) Process automation –
robotic process automation and integration of financial and other systems;

(3) Decision-making –
AI augmenting compliance and consulting capabilities;

(4) Democratisation of knowledge – publicly available and easily accessible knowledge and
information: A ‘Google for tax rules’;

(5) Open networks –
talent sourcing, crowd problem-solving and sharing eco-systems.

 

These patterns will
characterise the way tax regulators change and how organisations must react.
These patterns are, likewise, open doors for organisations and may frame the
establishment of any digital tax strategy and associated transformation.

 

(1) DATA

The phenomenon of
‘big data’ is having a dramatic impact on the way tax work is undertaken. The
increasing processing power and capacity of machines removes any limitation on
the amount of data that can be analysed.

 

The granularity of
data that is usable; the way transactions are recorded and accessed; real-time
reporting; and unlimited time-periods for data retention and storage will
transform the application of tax rules regulation. Instead of data sampling,
estimating and extrapolating, the professionals will be working with precise
and complete data sets. Very soon, the businesses will be at a point where the
details of all transactions can be quickly and easily classified and
investigated for tax purposes.

 

Besides, the way
transactions are effected will change with greater digital impact on
transactions and dealings between taxpayers and tax authorities and judicial
bodies. For example, the Income-Tax Department has already started deploying
data-mining and data analytics by linking various big data from internal as
well as external sources such as Statement of Financial Transaction (SFT), data
received from Investigation Wing, information received under Automatic Exchange
of Information (AEOI), FATCA, Ministry of Corporate Affairs and GSTN to identify
persons / entities who have undertaken high-value financial transactions but
have not filed their returns. Several tax administrations around the world have
started providing pre-filled returns and automating various tax compliances
based on comprehensive and accurate third-party data available with them.

 

In some territories, tax authorities already
require full accounts payable (AP) and receivable (AR) ledgers (with
invoice-level detail) and subsequent periodic trial balance financial ledgers
to be submitted. These countries include Brazil, Poland, France and Spain
(where AP and AR ledger details are required to be provided within four days of
the invoice issuance). India, too, will join this club once e-invoicing is
rolled out.

 

The Organisation
for Economic Co-operation and Development (OECD) in its report on ‘Advanced
Analytics for Better Tax Administration – Putting Data to Work (2016)’
highlights that several tax administrations (including Ireland, Malaysia, the
Netherlands, New Zealand and Singapore), in addition to building statistical
models to predict VAT fraud or error, are carrying out Social Network Analysis
(SNA) to help detect VAT carousel fraud (a VAT carousel is a complex form of
missing-trader fraud which exploits the VAT-free treatment of cross-jurisdictional
sales) and other group-level risks. SNA helps administrations to identify risky
groups in situations where individual-level assessments may fail to detect
anything of concern. It identifies links between individuals (for instance, through
company directorships, joint bank accounts, or shared telephone numbers) and
assembles connected individuals into easily visualised networks. Case-workers
can then browse these networks to profile individual risks. Equally, the
networks can be scored for risk using either a rules-based assessment or a
statistical model trained on historical data. This report also provides an
overview of the application of advanced analytics by various tax
administrations for:

 

(i) audit case selection,

(ii) filing and payment compliance,

(iii) taxpayer
service,

(iv) policy
evaluation,

(v) taxpayer segmentation.

 

(2) PROCESS AUTOMATION

In the past data
collection has often been ad hoc and laborious. It typically requires
analysis and rework of data to classify for tax purposes. Businesses have
worked on structuring their data and recording it in their financial and other
systems, and more recently have adopted technologies such as robotic process
automation to streamline collection processes.

 

Today, multiple tax
compliance solutions help in generating accurate tax returns by leveraging data
collected as part of core business functions. In future, this is likely to
change dramatically. Increasingly, the classification of transactions will be
automated using machine learning applications that perform text-based search
and apply preset rules, learning from previous analysis to predict the
appropriate tax treatment.

 

AI will do the job
without needing to rely on upfront recording in structured accounting ledgers
or after-the-event manual review and allocation in spreadsheets. Combined with
the increase in the extent of data to work with, these cognitive technologies
will produce a much higher degree of accurate tax classification for all
transactions and business events that taxpayers undertake.

 

(3) DECISION-MAKING

AI will have a
similarly dramatic impact on the application of tax judgement. These same
cognitive technologies improving data classification will enhance the
professional’s decision-making capabilities: machine learning, pattern
matching, fuzzy logic and natural language processing will allow complex tax
analysis to be undertaken by technology. These developments pose a significant
opportunity to reduce time and effort, improve quality and accuracy and
ultimately to raise the bar of what can be achieved.

 

A leading firm has
developed a tax-related application for large organisations with complex tax
affairs in the area of classifying expenses for correct treatment in the
corporate or indirect tax returns. This application goes beyond rules-based
solutions, using ‘human eye matching’ (fuzzy) and artificial intelligence,
where the tool ‘learns’ from the user’s tax decisions. The tool can rapidly
analyse complete sets of data, eliminating the risk of both human error and
sampling. In addition to its versatility which allows it to cater to a variety
of compliance-related needs, this tool offers a fully documented process that
reports on the decisions made and tax positions taken. Software features allow
the reviewer to focus on the most important or contentious decisions, which can
be manually overridden if the reviewer is uncomfortable with the machine’s
decision. Time savings are realised immediately as analyses that would
otherwise be done manually have been automated, while the evolving rule set can
be rolled forward to future years which builds further efficiency over time.
All in all, the tool makes a considerable contribution to effective tax risk
management at a time when tax authorities are bringing increased pressure to
bear on taxpayers.

 

 

 

In the US, there
is now a system that can predict the outcome of the US Supreme Court decisions
as accurately as leading legal scholars. It ‘knows’ or ‘understands’ nothing
about the law. Instead, it makes a prediction based on 200 years of case data,
each one described by up to 240 variables (the nature of the case, the justices
involved and so on).

 

The eighth edition
of the OECD’s Tax Administration Series Report (2019) provides insight into how
several tax administrations have adopted the use of behavioural insights and
analytics to better understand how and why taxpayers act and to use these
insights to design practical policies and interventions. It cites the example
of the Inland Revenue Authority of Singapore (IRAS) and how it complemented the
use of Business Intelligence (BI) with analytics to encourage taxpayers to pay
their overdue taxes as early as possible. IRAS built predictive models to
identify taxpayers with high payment compliance risk, before incorporating
uplift modelling to select and contact taxpayers who were more likely to
respond to interventions, i.e., outbound calls which enabled IRAS to focus its
compliance efforts on the high-risk taxpayer group and to apply BI
interventions strategically to achieve greater impact and efficacy.

 

(4) DEMOCRATISATION OF KNOWLEDGE

Some 15 years ago,
an in-house US tax team might have approached an adviser and asked what the tax
rate was in, say, India. The adviser would have looked it up and maybe checked
with its local contacts in India and then written back with the answer – for
which he would have charged a time-based fee. Today this seems very unlikely.
Unless there are some severe complications, the in-house tax team would have
direct access to this information through a variety of online sources. This
trend will continue and, over the next five years, practitioners will get ever
more sophisticated access to information and knowledge of the tax rules and
regulations to which they are subject. Besides, increasing transparency and
access to information and knowledge will have implications for global tax
policy and will change the interaction between authorities and taxpayers.

 

(5) OPEN NETWORKS

Online work
platforms have grown significantly in many areas of the economy. Labour
platforms such as Guru.com with some 1.5 million people, Upwork.com and
Mechanical Turk (mturk.com) are creating widespread networks of freelancers
available for task-based work. Tax teams are no longer entirely based on
traditional or full-time employees.

 

However,
crowd-sourcing or open talent models in the tax market seem further off when
compared to the use in IT, graphic design and finance. This situation is likely
to change over the next three to five years as three distinct developments in
tax converge. The tax professionals will require new skills around data,
analytics and technology. The breaking down of tax processes into individual
tasks through automation and standardisation will highlight specific work
routines that could be allocated to new workers not needing deep tax skills.
The evolution of the sharing and social economy will better connect potential supply
and demand and open new resource pools keen to work in different, remote and
virtual ways and within different reward models.


TOMORROW’S TAX WORLD

The combined effect
of these broader technology developments will bring about a sea change in the
way tax authorities and other regulators meet their objectives and manage their
responsibilities.

 

There has already
been a significant shift towards e-administration with increasing options and
uptake of online filing of tax returns as well as online payments and the full
or partial pre-filling of tax returns. Digital contact channels (online, email,
digital assistance) now dominate and the number of administrations using or
developing mobile applications continues to grow. Electronic data from third
parties, including other tax administrations, as well as internally generated
electronic data, is used in an increasingly conjoined way across tax
administration functions for improving services and enhancing compliance. This
trend also shows in the large number of administrations that now employ data
scientists.

 

Revenue authorities
already require large volumes of data to be filed. They have defined the
structure and format in which data needs to be maintained and provided. For
example, filing schemas and standard audit files like SAF-T, an international
standard for the electronic exchange of reliable accounting data from
organisations to a national tax authority or external auditors, defined by the
OECD, are being widely adopted.

 

Gradually, most tax
authorities will be requiring fuller data sets to be filed or made available
and in real-time or close to it. Indeed, they are likely to move beyond this.
Rather than require the data to be filed and managing the transfer and storage
of large volumes of data, they may simply mandate the algorithmic routines that
they require to be run across data sets and then review the results.

 

This real-time
access to the taxpayer’s financial data will save the effort of data transfer
and rely on taxpayers to maintain a digital record. Such a development will
also accelerate the time at which revenue authorities can review and
investigate a client’s information.

 

TOMORROW’S TAX PROFESSION

These developments
pose an essential question: What will be the nature and volume of future work
for professionals? When the impact of automation and augmentation increases,
what will tomorrow’s workforce do to replace the time currently spent on
today’s processes? Ultimately, what will be the right balance between human and
machine?

Daniel Susskind and
Richard Susskind also raise the following profound questions in their book ‘The
Future of the Professions’:

 

  • Might there be entirely new ways of organising professional work,
    ways that are more affordable, more accessible and perhaps more conducive to an
    increase in quality than the traditional approach?
  •     Does it follow that
    licensed experts can only undertake all the work that our professionals
    currently do?
  •     To what extent do we trust
    professionals to admit that their services could be delivered differently, or
    that some of their work could responsibly be passed on to non-professionals?
  •     Are our professions fit for
    purpose? Are they serving our societies well?

 

They have
identified the following changes that are taking place across various professions
that are relevant to the tax profession:

 

  •     More-for-less challenge
    – Across the professions, institutions and individuals are being asked to
    deliver more service, with fewer resources at their disposal.
  •     Existence of new
    competition     – Many of the technology-driven changes are being driven by
    people and institutions outside the boundaries of the traditional professions
    (often tech startups), with very different training and experience to
    traditional professionals.
  •     Productisation of
    services     – Many professionals think of their work as a form of craft, like
    an artist starting each project afresh with a blank sheet of paper, or akin to
    a tailor stitching a suit to fit the particular bodily contours of his clients.
    Now we see a move away from that view, recognising that professional work does
    not have to be handled in this bespoke way.

 

  •     Increasing decomposition
    of professional work     – Many professionals think of their work as solid,
    indivisible lumps of endeavour that must all be handled by particular types of
    professionals, working in certain ways, organised in specific forms of
    institutions. Increasingly, however, we are instead seeing professional work
    being broken down into composite tasks and activities. Once this is done, it
    often becomes clear that the work can either be performed by non-professionals
    or can be automated.
  •     Increasing
    commoditisation of professional work     – When professional work is broken
    down in this way, it transpires that many of the tasks involved in it are not
    particularly complicated, they are relatively ‘routine’ and can be automated
    accordingly.

A TECHNOLOGY-BASED INTERNET SOCIETY

The Susskinds see a
different set of models for producing and sharing practical expertise emerging
as we evolve into a technology-based internet society:

(A) Networked experts or ‘workers on tap’ model –
Here, it is still professionals that are involved in producing practical
expertise. However, rather than being employed in a particular brick-and-mortar
institution (a firm, hospital or school), professionals instead use online
platforms to work in a far more flexible, more ad hoc way in solving
professional problems. Doctors-on-Demand in medicine and Axiom Law in the legal
world are two examples.

(B) Para-professional model – Here, less
expert people, using new technologies, can perform tasks that would have
required more expert people in the past. Take the medical diagnostic system
developed at Stanford. It is entirely conceivable that in primary care of the
future, one may not necessarily be treated by a doctor but by a nurse
practitioner who, using one of these systems, can offer the sort of diagnostic
support that might have required a more expert person in the past.

 

(C) Knowledge-engineering model – This is
what we were doing in the 1980s: engineering systems, derived from the
knowledge of experts, for non-experts to use (in our case, to help solve legal
problems). Many readily-available online DIY tax preparation software and
contract-drafting tools rely on this model.

(D) Communities of experience model – Social
networks are now a ubiquitous feature of contemporary life. Also familiar are
professional networks, where practitioners gather to share their expertise.
Less familiar, though, are communities of experience – where patients, rather
than practitioners, meet to share their experience and advice. Take, for
example, PatientsLikeMe, an online network of more than 600,000 patients who
come together to share experiences of their symptoms and treatments, receiving
support and solving problems that might have required more expert medical
professionals in the past.

 

(E) Embedded knowledge model – To grasp
this, consider the card game Solitaire (also known as Patience). If this game
is played with physical playing cards and a player tries to put a red five
under a red six, this is possible (even if it is called ‘cheating’). Putting
two cards of the same colour on top of one another is, of course, against the
rules. Now imagine a player who is playing the same game but on a smartphone.
If the player tries the same move, it is not possible for him to do so because
the system simply returns the offending card. The rules are embedded in the
system. A breach is not merely prohibited, it is impossible to perform.
Likewise, as more of our lives become digitised, practical expertise will not
be invoked through the intervention of human beings but will be embedded in our
everyday systems instead.

(F) Machine-generated model – Here,
increasingly capable systems and machines produce and share practical expertise
without any human involvement. Of the six models, this is the most radical,
where traditional recipients of professional work would have access to
technologies that obviate the need for human experts altogether. Although this
scenario is the most widely discussed in the popular debate, it is essential to
keep in mind that this model is only one of six.

 

While digital transformation will require significant change and pose
considerable challenges, that future will also offer significant opportunities.
It seems clear that revenue authorities will embrace technological change and
use it to gain access to global data sets and thereby create more tax
transparency. This development will increase the demands on tax professionals
coming from increased complexity, rapid change and heightened risk. However, by
embracing the new technologies for handling and analysing data, tax
professionals will be able to improve compliance processes, enrich their tax
analysis and provide greater understanding and value to their organisations.

 

Over the short
term, it appears that there will be more work to do in both managing the change
and the consequences it will lead to: The greater accuracy that the new
technologies will offer and require for both tax processes. Moreover, the
nature of that work will be different. The digital transformation will reduce
time spent processing, improve analytical capabilities and create significant
new opportunities for businesses to manage their tax obligations.

 

It’s difficult to
be precise about what the tax digital future will be like, but certain
characteristics seem clear. As a society and as professionals:

(a) We will be data-driven, leading to a more
holistic approach at the enterprise level. We will manage that data better. We
will harness its power to act faster, provide richer insights and create
business value for the organisations we serve.

(b) Big data will lead to greater granularity,
precision and accuracy. We will work with integrated data sets, including all
aspects of the underlying transactions – both the structured and unstructured
data elements. It will result in enhanced analysis in detail rather than
sampling and estimation.

(c)   Algorithms will increasingly be the way we
apply our expertise, our knowledge and experience. Furthermore, we will need to
apply that expertise earlier in processes as real-time reporting takes hold and
accelerates the times at which data is submitted.

(d) Robots will take more of the strain. Robotic
process automation technologies will evolve, become easier and cheaper to
deploy and as a result will become ubiquitous tools for professionals to use to
streamline processes. Besides, they will become smarter, infused with AI, and
therefore have a greater impact.

(e) The user experience will be more digital. We
will consume information in a more personalised way through the video and other
mixed reality media. At the moment, work in systems such as email involves
interacting through a keyboard. In the future, we can expect much more use of
natural language processing, talking to virtual agents and connecting through
online forums.

 

TOMORROW’S TAX PROFESSIONAL

With these dramatic
changes will come a significant impact on the tax professionals’ lives – how we
work and what we do. The relationships and roles within our organisations and
with advisers will be different. They will be expected to do more work earlier
in the process as transactions are recorded, or internal controls put in place,
and also in the later stages, in areas of controversy and dispute resolution.

 

Consequently, the
skills and capabilities required will be very different from today with a blend
of ‘automation and augmentation’ impacting the workforce. Manual processes will
be replaced by automation of data flows and the impact of robotic process
automation. At the same time, professionals will be augmented by AI
technologies embedded in the ways knowledge is accessed and experience used to
apply it to business circumstances. An example of this is an AI-driven tool
that can act as a virtual research assistant that can help in searching for
relevant case laws, analysing rulings and assessing whether a tax case is
likely to be successful.

 

The above
transformation will trigger a complete overhaul of the processes and the
resource models to get tax work done. Tax processes will be broken down into
individual tasks and allocated to new workers not always needing deep tax
skills. For example, several BPO firms carry out tax return compilation and
filing work on a large scale by employing graduates who work with the tax
return preparation software with minimal training. The evolution of the sharing
and social economy will open up talent networks, crowd-sourcing models and the
so-called ‘gig’ economy to the tax marketplace on the lines of examples given
under the networked expert or workers on tap model above.

 

The skills required
for tomorrow’s tax professional will continue to include the traditional skills
such as core technical expertise (to deal with increasing complexity in the
ever-changing tax and regulatory landscape) and professional ethics; the tax
professional will need to imbibe additional skills such as:

(I)   Increased technology skills specifically with
respect to the familiarity with continuously changing applications such as
specialist tax software, electronic tax administration platforms and also other
disruptive technologies, such as artificial intelligence / digital assistants,
to augment their output.

(II) Business and commercial skills to think and
align tax and business strategy.

(III) Risk assessment and management skills in
respect of tax positions taken, corporate structures, existing and emerging
laws, regulations, political initiatives and shifting public perceptions.

(IV) Communication and collaboration to manage
relationships – engage, interact, influence and inform stakeholders in finance,
statutory audit and tax administrations. Ability to translate tax jargon for
non-technical stakeholders such as boards, management, investors, clients and
media.

(V)  Advocacy and negotiation. Advocacy for tax
policy and strategy. Dispute resolution – internal and external.

 

SUM IT

Change for tax professionals is just round the corner. Like other
professionals, they, too, will continue to ride the rapid wave of technology
changes and associated risks as humankind continues to pursue the digital
future. While it is difficult to predict decisively what the future holds, the
meta-trends are recognisable in the technologies today as we try to anticipate
and shape our plans accordingly.

 

At the same time,
we must also realise that in five years we may be working with technologies
that are yet to be invented. Hence, riding the crest implies tireless
monitoring of developments and agility in experimenting with and adopting new
technologies. The new road for tax professionals could be fraught with no speed
limits as the pace of digital transformation hastens. The professionals must
map out the potential impact of all disruptive technology and actively engage
with the emerging trends. Relentless evolution and adaptability will continue
to be the cornerstones, while yet retaining their core strengths.

 

In this context, it
may be worth remembering Mahatma Gandhi’s recommendation: ‘The future
depends on what we do in the present‘.

 

REFERENCES

1.   Deloitte (2019), ‘Our digital future – A
perspective for tax professionals’; https://www2.deloitte.com/content/dam/Deloitte/global/Documents/Tax/dttl-tax-deloitte-our-digital-future.pdf

 

2.   OECD (2019), Tax Administration 2019:
Comparative Information on OECD and other Advanced and Emerging Economies;
https:/doi.org/IO.1787/74d162b6-en

 

3.   OECD (2016), Advanced Analytics for Better
Tax Administration: Putting Data to Work;
http://dx.d0i.org/10.1787/9789264256453-en

 

4.   Susskind R. and Susskind D. (2015), ‘The
Future of the Professions: How Technology will transform the Work of Human
Experts’

 

5.         Diamandis
P. and Kotler S. (2020), ‘The Future Is Faster Than You Think’

 

THE RUN-UP TO AUDIT IN THE 2030s

Sometime in the 2030s, if not earlier, most
of the functions involved in a financial audit will be automated and the team
size will drop by half. Automation, AI and machine learning will do a majority
of accounting work and it is only logical that this will have an impact on
audits. The accountants and auditors aren’t going to die soon; we will need
them to orchestrate the maelstrom of change.

 

SEVEN things are discernible in the run-up
to the 2030s and those in the attest function will have to see how to stay
afloat.

 

TREND 1: THE RISE OF
AUTOMATION

Ever since the Industrial Revolution kicked
off more than 175 years ago, the human fascination for technology has
multiplied. Companies have automated a lot of their manufacturing and service
processes. Over the years, these have affected the staid old professions of
accounting and audit, too. From 13 columnar sheets to an AI-driven data
analysis pack, we have come a long way.

 

Let us not associate technology only with
large publicly-listed companies. In fact, it is the smaller entities that are
far more nimble. MSMEs, which are characterised by a high degree of
centralisation in decision-making and deficiency in internal controls, too, embrace
technology as they step onto the growth highway. Auditors, too, must keep pace
with the times and embrace new audit technologies. Since these tools and audit
laboratories can be expensive, small and medium firms will use cloud-based
tools on pay-per-use model.

 

IPA (Intelligent Process Automation), which
is the next upgrade from RPA (Robotic Process Automation), has come to stay as
an advanced data extraction tool, with its inbuilt artificial intelligence
module helping in decision-making. Such changes compel us to evaluate our
competency levels. Are auditors prepared to do it in the areas they specialise
in: audit, accounting, consultancy, tax and compliance? The ICAI has stepped in
to help in this direction. Recently, it released Version 2.0 of the Digital
Competency Maturity Model for Professional Accounting Firms (DCMM), which helps
accounting firms make these self-assessments. DCMM provides implementation
guidance on how far one should move ahead. However, being competent and mature
enough to handle digitalisation is just the beginning. There is a long way to
travel on the road to execution.

 

The winners will emerge from among those who
assess themselves, make the necessary shift and go the full distance on
technology.

 

TREND 2: WE WILL HAVE TO DEFINE AUDIT QUALITY

Judging audit quality is both subjective and
challenging. It is beyond compliance with standards and processes, adherence to
legislation and zero defects. Today, we are unable to define ‘quality.’ We go
back to an oft-quoted statement on photography: ‘I don’t know what’s good
quality photography, but I know it when I see one.’ We have taken a similar
stand on what constitutes audit quality. This stand must stand (pun
intended).

 

In the next two years, we must have a
generally accepted definition of Audit Quality. By the way, the ICAI has
initiated steps to establish a framework for an Audit Quality and Audit Quality
Maturity Model. Apart from the auditors, the clients, too, must take cognisance
of this development. If that happens, it will add cheer to the auditors’
efforts and minimise the audit-expectation gap.

 

Thankfully,
audit reporting has slowly moved from template-based reporting to a more
‘entity-specific’ reporting. The SA-706 ‘Emphasis of Matter and Other Matters’
and SA-701 ‘Key Audit Matters’ have been the key differentiators. These have
helped improve the quality of audit and enhanced the relevance of audit opinion
to users. CARO 2020, which is exhaustive and looks onerous, is also a step
toward reducing the expectation gap.

 

It’s crucial to define the expectation gap
and identify the reasons for it. ‘Expectation gap’ is the difference in
perception between ‘what the public thinks auditors do’ and ‘what the
public wants auditors to do.’ This gap hasn’t narrowed with time and
there are three reasons for this.

 

First, Knowledge Gap: What auditors do is different from what the public thinks they are
doing and this is called Knowledge Gap. Professional bodies communicate with
audit firms by making available updated information on changes in regulations
and the need for change. Audit firms, in turn, interact with clients and sound
them out on these changes. But, somewhere down the line, the message the public
receives is feeble and not forceful because there is a perceived absence of
wide-reaching platforms.

 

Second, Performance Gap: What auditors are supposed to do
differs from what they actually do and this is known as Performance Gap. Let us
underscore one aspect. ICAI, as a standard setter, has been continuously
responsive by updating standards on accounting, audit and ethics and by providing
implementation guidance. The action on lax and inefficient auditors is not as
fast as some would have wished it to be and so the public perception is one of
laxity.

 

Third, Evolution Gap: What the public wants the auditors to do and what the auditors are
supposed to do, is called Evolution Gap. Society is unmindful of what the
auditors are supposed to do. True, regulatory changes are taking place at
breakneck speed. New legislations, new standards or revisions in the existing
ones have been coming in at a rapid pace. The auditors are also not lagging in
compliance with the amended laws. Despite this, the public expects audits to
evolve in a way so as to prevent the failure of the audited-client. We in the
profession must look at this expectation gap and narrow it down.

 

The winners will emerge from among those who
can bridge the performance gap fully and the other two gaps as much as they
can.

 

TREND 3: SEPARATE GRAMMAR FOR A SEPARATE CLASS OF
COMPANIES

Standards are the grammar of both accounting
and auditing. There will be a different set of financial reporting guidelines
for ‘Less Complex Entities’ (LCEs). The auditing standards now apply to all
audits irrespective of their nature, size and structure. This practice is
leading auditors to focus on ‘compliance’ and not on ‘judgement.’ In the years
ahead, we will most likely have a different set of standards for auditing. Such
a package would make documentation and risk assessment disclosures easy.
Judgement will be back in auditing.

 

Limited internal controls and management
override characterise several MSME audits. These are demanding situations that
affect efficient audit performance. Worse still, these situations come with low
remuneration. If an auditor assumes that the examination of an SME client
carries lower engagement risk compared to that of a large entity, the auditor
is mistaken. SMEs most often scale at a high growth rate and do not have robust
internal control systems and other governance oversights to manage the pace of
growth. It is nobody’s case that work should be done only to the extent of fees
received. But if truth be told, that’s an overriding reality in at least some.
We will see audit firms agree upon and insist on a minimum fee commensurate
with the nature and size of the engagement.

 

Winning firms will be those that realise the
engagement risk in every engagement – small, medium, or large – and who either
cover it or seek a price for it.

 

TREND 4: FRAUD IS AUDITOR’S OBLIGATION

‘Fraud’ will be the biggest challenge in the
future. An auditor of financial statements has a fraud detection
responsibility, especially if it leads to a material misstatement in the
financial statements. Remember, SA-240 lays the primary responsibility for
preventing fraud at the door of the management. But the auditor is responsible
for providing reasonable assurance. The truth is that there are certain
limitations in audit and even if the audit is planned appropriately, some
material misstatements may remain undetected. If we want to be in the attest
function, we must learn to live with this reality.

 

Look at the challenges. Under the Companies
Act, 2013 the auditor has to report the fraud to the Central Government. But it
does not require the auditor to carry out a roving investigation to detect
fraud. A reading of the Auditing Standards and the Companies Act, 2013 throw up
a couple of aspects. First, an audit engagement requires the auditor to express
a ‘true and fair’ view on the financial statements. But such a commitment does
not envisage that all frauds would be detected. Second, a fraud not being
exposed does not mean that the auditor has not carried out his engagement
correctly.

 

When no fraud is reported or comes to light,
we don’t compliment the auditor for a job well done. But at the faintest hint of
scandal, the stakeholders descend on the auditor like a tonne of bricks and
bombard him with a barrage of questions. We in the audit profession must never
lose sight of this reality.

 

While auditing, an auditor maintains the
mindset that fraud is always possible. When the auditor is a fraud examiner, he
begins his / her assignment with the belief that someone is committing fraud
and affirms that belief unless the evidence shows no signs of fraudulent
activity. In a regular audit, we must be alert towards the perpetrators and the
impact on the defrauded organisation. The best practices would include:

 

(i)    Implementing audit procedures that throw up
warning signals.

(ii)   Recognising that submission of financial
results is merely the end-result of an audit process that runs through the
year, during which the integrity of auditing should be unquestionable.

(iii) No member of the audit team can entertain the
view that detecting fraud is not an auditor’s job. If this were the case, then
compliance with auditing standards on fraud detection may become a rote
exercise.

(iv) Being alert to factors that may create
incentives or pressures for management to commit fraud and might permit
opportunities to do so.

(v)   Recognising that improper revenue recognition
is a fraud risk in particular where estimates and judgement involved is high.

(vi) Evaluating transactions and events in which
management override has been applied over internal control matters, causing a
dent on reliability.

(vii) If the audit process determines that evidence
of fraud may exist, the auditor should consider the organisation’s position and
report it to appropriate authorities.

 

Often, there have been concerns about the
independence of auditors. These arose in the context of the appointment
methodology, a significant part of the audit market space being occupied by a
few firms, the high cost of audit of Public Interest Entities (PIE) and the
increasing complexity of business operations. Besides, one can perceive changes
in personal value systems because of the increased materialism that the world
has chosen.

 

There is also
the increasing awareness that the line between profession and business is
thinning. For a pure Chinese wall to be built, audit firms must focus only on
certifications and assurance. Everything else should be under a different
entity that maintains an arm’s length distance. Mere departmentalisation won’t
do in this regard.

 

The earlier firms understand these technical
niceties and make the necessary adjustments, the faster they will step onto the
growth track.


TREND 5: CODE OF ETHICS

Professional independence should be felt,
experienced and be visible, however tough that may be. This is the hallmark of
any profession and this is what will bring in public trust. As with the profession
of medicine, ours is the profession of trust and so our work must be executed
without a hint of interdependence.

 

The new version of the Code of Ethics,
effective 1st July, 2020, is a significantly large document. By
imposing restrictions in particular for PIE, on taxation services to audit
clients, by introducing assessments for ‘threat to independence’ and specifying
reporting obligations for non-compliance with laws and regulations (NOCLAR),
the document shows that its heart is in the right place. For it to succeed, we
need to follow it both in letter and in spirit. Many a time, we do see
instances of bending of the law without breaking it. Some of the provisions,
especially relating to networks, might appear onerous but if we have to pass
the test of public scrutiny on independence, we must follow them. Independence
is the foundation for trust in an Audit Opinion and it is worth walking the
extra mile to protect the respect for and enhance the stature of the audit
profession. As the profession evolves more fully, we will see a lot more
changes to the Code to keep it current and modern, not archaic and ancient.

 

The firms that traverse the distance from
being good to great will practice both value and ethics in thought, deed and
action.

 

TREND 6: GLOBAL TRENDS WILL AFFECT INDIA

Two reports merit attention: the Brydon
Report and the three-year strategic plan of the International Forum of
Independent Audit Regulators (IFIAR).

 

At the instance of the Department for
Business, Energy & Industrial Strategy, UK (BEIS), Sir Donald Brydon
undertook an in-depth review of audit quality and effectiveness. In December,
2019 his report was placed in the public domain. It contains path-breaking
suggestions, calling for extensive reforms for accomplishing improved audit
quality.

 

Here are some of its suggestions that give
you a heads-up of what you can experience in the coming years.

(a) Redefine the purpose of audit: The purpose of an audit is to help establish and maintain the
deserved level of confidence in a company, its directors and the information
they report, including the financial statements.

(b) Introduce the concept of suspicion: Auditors exercise professional judgement and appropriate scepticism
and suspicion throughout their work. Auditors must act in the public interest
and should consider the interest of all users and not just the shareholders.

(c) Enhance
the informative nature of the audit report: Auditors need to create continuity between
successive audit reports, provide greater transparency over differing
estimations, perhaps disclosing graduated findings, and call out
inconsistencies in the information made public.

 

The second is the set of initiatives taken
by the International Forum of Independent Audit Regulators (IFIAR). In its
three-year strategic plan, IFIAR is focusing on achieving ‘significantly
improved audit quality on a global basis’. It has revisited the role of Audit
Committees (AC) in different jurisdictions and is actively reviewing whether
ACs should select the external auditor, determine their fees and assess audit
performance. A set of Audit Quality Indicators for evaluating external auditors
is also under evolution.

 

The audit firms that are 2030-ready will
keep a constant vigil on the global best practices and developments and
internalise them to the extent possible.

 

TREND 7: ANYWHERE, ANYTIME, ANYONE

This was waiting to happen. The
infrastructure was in place and the competence was there; it only needed a push
and societal acceptance. Covid-19 gave us just that. Even as audits have gone
beyond the paper-and-pen phase and with global audits already being done from
remote locations, the next jump will be carrying out reviews from anywhere you
may be: office, home or cafeteria. As the world steps into a new order of
freelancing as opposed to full-time employment, as travel becomes increasingly
cumbersome, as Generation Z steps into the workplace, audits from anywhere and
anytime will become the norm. Footfalls in clients’ places will drop just as
footfalls in audit offices dropped during the last 20 years.

 

 

With AI, RPA,
Blockchain, big data and machine learning, the world of accounting is changing.
People will not log data; machines will. Already, many accounting applications
today can put the smartest of analysts to shame with the speed of execution and
dexterity of operations. Neither accounting nor auditing is so quickly going to
disappear. As long as there is cricket, there will be scorekeepers and umpires.
Accounting is about scorekeeping and auditing is about umpiring. What’s
changing is how frequently we want to see the scores, in what mediums we want
to see them and how many of the documents can be digitalised. The firms that
will lose out are the ones that are not seeing the gathering storm and not
preparing for it: the Kodaks of the world. Have an influential culture,
modernise and use emerging technology and you will win.

 

Today is perhaps the best time in history to be
in accounting and audit as the world of work around us is changing incredibly,
right before us.

OVERCOMING THE CHALLENGE OF RISK MANAGEMENT IN PROFESSIONAL SERVICES

In his seminal tome
‘Against the Gods – The Remarkable Story of Risk’, Peter L.
Bernstein says that the revolutionary idea that defines the boundary between
modern times and the past, comprising thousands of years of history, is that of
the mastery of risk: the notion that the future is more than a whim of the gods
and that humans are not passive before nature. The book weaves across
generations to tell stories of thinkers whose remarkable vision showed the
world how to understand risk, measure it and weigh its consequences, converting
risk-taking itself into one of the prime catalysts that drives modern society.

 

This article is an
attempt to expose to a professional (other than one who has made risk
management itself as her professional calling) some facets of risk and give
pointers to develop an integrated risk management framework in which risk can
be understood and managed, if not entirely mitigated. While my experience has
almost wholly been as a professional practising in the area of taxation and my
thoughts will therefore reflect that bias, I am sure some of what I say may
have universal application for all professional service providers.

 

Globalisation of
the market place, advances in information technology, rapidly changing laws,
growing intolerance of compliance being only in letter but not in spirit, with
a simultaneous emphasis on good corporate governance, proliferation of
litigation and increased diversity in services offered and even the emerging
global megatrend of ‘tax morality’ are some of the current issues faced by a
professional. When one reflects on professional services firms, even as they
often are called in by clients to advise them on risk management, they
themselves are struggling to keep risks at bay in this Volatile, Uncertain,
Complex and Ambiguous (‘VUCA’) world.

 

Accounting firms
traditionally provide services to clients in three major areas: Audit or
Assurance, Tax, and Advisory Services. The business risk associated with each
of these three services includes loss of future income, loss of reputation and
exposure to legal liability. These risks are not mutually exclusive and, given
the inter-dependent way in which one or more services are often provided to the
same client, a professional firm may be exposed to one or more of the above
risks simultaneously. While external insurance protection is indeed available
and can, to an extent, mitigate financial risk, it cannot protect against loss
of reputation, which in my view is the biggest risk.

 

Fundamental to a
professional’s engagement is the premise that she will deliver quality services
and besides meeting clients’ expectations on this count, this is now more often
demanded by regulators and other third parties who may have relied on a
professional’s work. Though quality is often difficult to precisely define in
the professional services arena, professionals can and should ensure that they
adhere to the guiding principles on quality. A few of these are listed below (see
tabulation):

 

(a)

Proper scoping of the work laying down,
wherever possible, scope limitations and caveats;

(b)

Matching of the work to what has been
contracted for;

(c)

Proper planning of the engagement;

(d)

Involvement and engagement of partner or
other senior resources;

(e)

In complex situations or where stakes
are very high, involvement of a Quality Review Partner;

(f)

Where necessary, involvement of internal
or external experts, including counsel;

(g)

Where necessary, appropriate engagement
with regulators or authorities;

(h)

Appropriate and adequate documentation;

(i)

Suitable communication with clients;

(j)

Periodic and regular Quality Performance
Reviews and corrective actions.

 

A robust risk
management framework will also contain thoughtfully designed processes,
encompassing the entire life-cycle of a professional engagement. Some of these
are as follows:

 

(A) Independence

The importance of
being independent cannot be overemphasised. From very basic concepts such as
not performing a management or an employee function, this concept straddles
almost all situations, real or perceived, which can lead to compromising a
professional’s independence. The risk of blurring professional and personal and
financial relationships is sometimes fatal to continuing to serve clients
objectively.

 

(B) Client acceptance

This process is
critical to the long-term sustainability of a professional firm. In today’s
environment where perceptions often cloud reality, association with dubious
clients to whom a professional may have provided professional services can be a
significant barrier to maintain and enhance a spotless professional reputation.
Appropriate background checks before accepting a client has rightly become a
mandatory hygiene process. Firms may introduce additional filters on the basis
of their experience and expertise, for example, high-risk industries,
politically-connected persons, cash-based businesses, etc. to narrow down their
universe of serviceable clients. Further, the client acceptance process is not
a static one-time task. It needs to be renewed and reviewed periodically,
preferably at least once each year to check that nothing has adversely changed,
either with the client’s business or in the environment.

 

(C) Engagement acceptance

This is a document
created for every new engagement of an existing or new client and contains all
background information on the engagement and the nature of work to be
performed. It will document the applicable statutory provisions to be
considered, e.g., auditor independence and standards applicable to the
engagement; for example, the ICAI Code of Ethics. It will also lay out unusual
risk factors, if any, and their impact, as also steps taken to mitigate or
manage such risks. It will document third-party involvement, such as counsel
opinions to be obtained. It will also contain the names, designations and
experience of team members who will execute the engagement. And it will lay out
the range of fees that is usually charged by the firm for the type of
engagement.

 

(D) Engagement contract or letter

Externally, this is
perhaps the most important document, second only to the actual engagement
deliverable, and it forms the very basis of the contract for performance of
professional service. Having a well-laid-out clear and simple engagement
contract, containing the complete scope of work with all scope exclusions,
limitations and caveats, as also the fees that would be charged and the
milestones at which these would be charged, and the liability assumed for the
deliverable, reduces the possibility of disagreements later. It also restricts
the liability of any deliverable so long as the deliverable is properly
referenced to the engagement contract. And it contains usual clauses governing
the professional relationship, including a force majeure clause, and
lays down the roles and responsibilities of each party to the contract.

 

(E) Evaluation and on-boarding of third-party service
providers

This is assuming a
very important dimension because very often service providers are being held
responsible for not only their own deliverables but also for the actions and /
or inactions of other service providers who may have played a part in the
engagement. The processes described above, viz., independence, client
acceptance, etc., must also be carried out for each third-party service
provider. It must be ensured that third parties working together either as
co-partners or sub-contractors, share the same value systems as the
professional. Wherever necessary and feasible, the third-party service provider
must be imparted the relevant risk trainings to avoid any misunderstanding.
Clear documentation of the role, risks and rewards that will be shared with the
third-party service provider must be documented and assented to by that
provider as well.

 

(F) Data protection
– safeguards and developments in legal obligations

Professional firms possess and process a lot of sensitive professional
and personal data, especially of their clients and employees. Many clients,
too, expect adequate processes and compliance with local and global legal
regulations (like the European GDPR) as a pre-condition for engaging professionals.
These obligations span rules for gathering, storing, protecting and processing
of personal information as well as mechanisms to deal with breaches.

 

(G) Mandatory risk management trainings

Devising and
implementing risk management trainings frequently to all relevant staff
members, regardless of their designation and standing in a professional firm is
a sine qua non for the risk management strategy to survive in any
organisation. Over-communication of a professional firm’s risk management
policy and processes is a virtue and should not be viewed as an evil to be
tolerated. Here the tone must be set from the top, with senior-most partners
taking the lead on rolling out these trainings and frequently setting out
screensavers, posters, etc. in the workplace to keep reminding everyone about
the basic concepts.

(H) Insider-trading and other statutory regulations

Today, more than
ever, regulations are increasing the burden on professional firms and must be
followed in order to continue to discharge honourably the obligation that
society has cast on professionals. However, the ‘Gold Standard’ in a risk
framework must go beyond statutory compulsions and must inculcate a ‘smell
test’ foundation. The question, ‘What if this act is reported on the front page
of leading newspapers or anywhere in the media?’ must be the idea that needs to
be brought to life in any risk management framework.

 

(I) Mandatory
escalation of any breaches or perceived violations

The risk management
framework must be designed in a manner to encourage anyone in the firm to
independently report any real or perceived violations without any fear of
sanctions. Many risk-laden situations can be mitigated if escalated at the very
beginning of any breach or perceived violation.

 

(J) Zero tolerance

There ought to be
zero tolerance within the firm for anyone breaching risk rules, either
explicitly or impliedly, with graded financial sanctions to be imposed or even
dismissals and separations to be considered and enforced in serious situations
(especially where there is a violation of the firm’s ethics and / or involves
committing acts of moral turpitude).

 

(K) Risk management framework review process

It is a good practice to have at least two or three types of reviews
done periodically. The first is to internally refresh the entire Risk
Management Framework – ideally at least once thoroughly every two years and a
refresh to be carried out every year. This is in addition to external events
which can necessitate an immediate modification or addition to the framework.
The second is to have another independent firm peer-review the risk framework
and mutually share best practices. Yet another could be to adopt and customise
a few best practices that one may pick up in international professional
seminars and conferences.

 

RISK OF OBSOLESCENCE AMIDST CHANGE

Finally, one of the
biggest risks that a tax professional faces today is the rapidly changing
landscape of tax services. The quest to stay relevant to society is now more
acute than ever before. Going forward, in my opinion the entire platform of tax
services will rest on three main pillars. These will broadly define how tax
professionals may need to specialise their skill sets and garner focused
experience. These are (1) Technology-enabled tax compliance, (2) High-end
advisory services, including on complex transactions, and (3) Litigation.

 

 

The astute
professional realises that tax services can no longer be delivered in the same
fashion as has endured for some years now. Technology is ruthlessly being
embraced – not only by clients but also by the authorities. The professional
must learn to adapt and even master technology to stay ahead of the game.
Technology tools using Artificial Intelligence (AI) and Machine Learning (ML)
must take over a considerable number of repetitive tasks; and leveraging on cost-effective
resources will be the new normal soon. Further, non-professional technology
firms already have disrupted and usurped the lower end of the compliance
market.

 

Simultaneously,
there are attempts to achieve a global consensus on the tax basis and methodologies
on the back of a relentless drive to stop tax-base erosion. This has resulted
in radical changes in domestic and international laws and the emergence of and
seeping in of transaction tax type levies, giving rise to fresh challenges for
the professional to overcome. Today’s professional reality is the coming
together of accounting and tax principles, giving clear preference to the
doctrine of substance over form and with new and ever-changing company law,
foreign exchange and SEBI regulations. A clear need has arisen for
professionals who have experience in more than just one or two core areas and
also for those professionals who can collaboratively work together with other
professionals in different disciplines to evolve solutions to overcome complex
problems which do not fall foul of any regulations. In this arena, too, it is
common experience that sister professions are nibbling away at pieces of work
that Chartered Accountants traditionally performed. This calls for a
longer-term strategy to develop and nurture appropriate talent.

 

Given the complexity in tax laws and the tendency of both taxpayers and
tax assessors to be aggressive, a professional will need to master Litigation
Strategy, if she must perfect the tools of her trade. Today, more than ever,
clients need hand-holding and guidance on which litigations to pursue and which
ones not to, having regard to the alternate forums of dispute resolution
available under domestic laws as well as under India’s tax treaties.

 

Both individuals
and firms are busy meeting many of the challenges highlighted above. Broadly,
any strategy must include devising a detailed compliance framework, including
establishing a crisis management plan, purchasing appropriate insurance cover,
implementing the right technology and systems, and creating a culture of
compliance throughout the organisation.

 

Finally, managing
risk is very different from devising economic strategy to grow and be
successful. Risk management must focus on the negative – dangers and failures rather
than opportunities and achievements. And it’s tempting to relegate risk
management as a ‘good to have’ rather than a ‘must have’. Instances of failure
of other professionals is often viewed as being specific to those sets of
individuals and is rarely acknowledged as a shortcoming of the way a
professional firm is run on a daily basis. It’s also antithetic to a culture of
‘winning more and winning bigger’, hence tends to find few takers willing to
invest both time and money now, in order to avoid an unknown future problem
that may not even occur. However, as the history of humankind has shown,
vulnerabilities have existed through various times – good and bad – and the
foundation of any long-term sustainable and successful strategy must include a
robust risk management system. After all, any firm’s ability to weather a storm
depends very much on how seriously top management takes its risk-management
function when the sun is shining brightly, with scarcely a cloud on the
horizon.

DEDUCTIBILITY OF FOREIGN TAXES

ISSUE FOR CONSIDERATION

Section 40 of the Income Tax Act, 1961 deals with amounts
that are not deductible in computing income under the head ‘Profits and Gains
of Business or Profession’. This section, in particular clause (a)(ii)
thereof,  reads as under:

 

‘Notwithstanding
anything to the contrary in sections 30 to 38, the following amounts shall not
be deducted in computing the income chargeable under the head “Profits and
gains of business or profession”, –  

(a) in the case of any assessee—

(i)  ………..

(ia) …………….

(ib) ……………

(ic)  …………….

(ii)  any sum paid on account of any rate or tax
levied on the profits or gains of any business or profession or assessed at a
proportion of, or otherwise on the basis of, any such profits or gains.

Explanation 1. —
For the removal of doubts, it is hereby declared that for the purposes of this
sub-clause, any sum paid on account of any rate or tax levied includes and
shall be deemed always to have included any sum eligible for relief of tax
under section 90 or, as the case may be, deduction from the Indian income-tax
payable under section 91.

Explanation 2. —
For the removal of doubts, it is hereby declared that for the purposes of this
sub-clause, any sum paid on account of any rate or tax levied includes any sum
eligible for relief of tax under section 90A.’

 

Explanations 1 and
2 were inserted with effect from Assessment Year 2006-07. Prior to that there
was much litigation on whether income taxes paid in a foreign country were an
allowable deduction or not. These explanations were added to prevent a double
relief or benefit , since in most cases such foreign taxes for which deduction
was being claimed were also entitled to tax relief under sections 90, 90A or
91. After the amendment, the issue still remains alive insofar as taxes which
are not entitled to the relief or even a partial relief under sections 90, 90A
or 91, and under the rules only a part of the foreign taxes paid may be
entitled to the relief u/s 90 or u/s 90A in some cases.

 

An issue has arisen
involving the deductibility of the foreign tax paid on account of the profits
or gains of a foreign business or profession in computing the income under the
head ‘profits and gains of business and profession’ under the Income-tax Act,
1961. While there have been conflicting decisions on the subject, of the Ahmedabad
bench of the Tribunal post amendment, to really understand the controversy one
would need to understand the two conflicting decisions of the Bombay High Court
on the issue, one of which was rendered after the amendment but dealt with a
period prior to the amendment.

 

THE S. INDER SINGH GILL CASE

The issue came up before the Bombay High Court in the case
of S. Inder Singh Gill vs. CIT 47 ITR 284.

 

In this case,
pertaining to assessment years 1946-47 to 1951-52, under the Income-tax Act,
1922 the assessee was a non-resident. A resident was treated as the assessee’s
statutory agent u/s 43 of the 1922 Act (corresponding to representative
assessee u/s 163 of the 1961 Act).

 

In the original
assessments, income from certain Bombay properties was assessed to tax in
computing the total income. The Income Tax Officer later found that the
assessee owned certain other properties also in the taxable territories whose
income had escaped assessment, and therefore initiated re-assessment
proceedings. In response to the notice, the assessee filed his return of
income.

 

In the return,
among other deductions the assessee claimed that in computing his world income,
the tax paid by him to the Uganda government on his Ugandan income should be
deducted. This claim of the assessee was disallowed by the tax authorities. The
assessee’s first appeal was dismissed by the Appellate Assistant Commissioner.
The Tribunal also rejected the contention that tax paid to the Uganda
government on his foreign income should be deducted in determining his foreign
income and in including it in his total world income.

 

The Bombay High
Court in deciding the issue, noted that the Tribunal had observed as under:

 

‘We are not
aware of any commercial practice or principle which lays down that tax paid by
one on one’s income is a proper deduction in determining one’s income for the
purposes of taxation’.

 

The Bombay High
Court held that no reason had been shown to it by the assessee to differ from
the conclusion that the Tribunal had reached. The Court therefore rejected the
reference made to it by the assessee.

 

A similar view was
taken by the Calcutta High Court in the case of Jeewanlal (1929) Ltd. vs.
CIT 48 ITR 270, also a case under the 1922 Act, where the issue was
whether business profits tax paid in Burma was an allowable deduction.

 

Again, a similar
view was taken by the Karnataka High Court in Kirloskar Electric Co. Ltd.
vs. CIT 228 ITR 676, prior to the amendment, by applying section
40(a)(ii). Besides, the Madras High Court, in CIT vs. Kerala Lines Ltd.
201 ITR 106, has also held that foreign taxes are not allowable as a
deduction.

 

THE RELIANCE INFRASTRUCTURE CASE

Recently, the issue
again came up before the Bombay High Court in the case of Reliance
Infrastructure Ltd. vs. CIT 390 ITR 271.

 

This was a case
pertaining to A.Y. 1983-84. During the year, the assessee executed projects in
Saudi Arabia. The income earned in Saudi Arabia had been subjected to tax in
Saudi Arabia. While determining the tax payable under Indian tax laws, the
assessee sought the benefit of section 91, claiming relief from double taxation
of the same income, i.e., the Saudi income which was included in the total
income of the assessee.

 

The assessee
claimed the benefit of double taxation relief on the amounts of Rs. 47.3 lakhs,
otherwise claimed as deduction u/s 80HHB, and Rs. 5.59 lakhs on which a
weighted deduction was otherwise claimed u/s 35B. The A.O. dismissed the
assessee’s claim for relief u/s 91 on the ground that the relief u/s 91 would
be possible only when the amount of foreign income on which the foreign tax was
paid was again included in the taxable income liable to tax in India, i.e., the
relief was possible only where the same income was taxed in both the countries.

 

The Commissioner
(Appeals) rejected the assessee’s appeal, holding that the assessee had, in
respect of his Saudi income, 
claimed  deductions u/s 80HHB and
section 35B and such income did not suffer any tax in India and was therefore
not eligible for the benefit of relief u/s 91.

 

Before the
Tribunal, the assessee urged that the Commissioner (Appeals) ought to have held
that in respect of such percentage of income which was deemed to accrue in
India, and on which the benefit of section 91 was not available, the tax paid
in Saudi Arabia should be treated as an expenditure incurred in earning income,
which was deemed to have accrued or arisen in India, and reduced therefrom.

 

The Tribunal
dismissed the assessee’s appeal, holding that the issue stood concluded against
the assessee by the decision of the Andhra Pradesh High Court in the case of CIT
vs. C.S. Murthy 169 ITR 686. The Tribunal also held that the tax paid
in Saudi Arabia on which even where no double tax relief could be claimed, was
not allowable as a deduction in computing the income under the provisions of
the Income-tax Act. As regards tax in respect of income which had accrued or
arisen in India, the Tribunal rejected the assessee’s contention on two grounds
– that such a claim had not been raised before the Commissioner (Appeals), and
that the disallowance  was as per the
decision of the Bombay High Court in S. Inder Singh Gill’s case
(Supra).

 

It was claimed on
behalf of the assessee before the Bombay High Court inter alia that the
assessee  should be allowed a deduction
of the foreign tax paid in Saudi Arabia, once it was held that the benefit of
section 91 was not available for such tax. It was emphasised that the deduction
was claimed only to the extent that tax had been paid in Saudi Arabia on the
income which had been deemed to have accrued or arisen in India.

 

It was pointed out
to  the Bombay High Court that such a
deduction had been allowed by the Tribunal in the assessee’s own case for A.Y.
1979-80 and therefore the principle of consistency  required the Tribunal to adopt the same view
as it did in A.Y. 1979-80. It was pointed out that Explanation 1 added to
section 40(a)(ii) with effect from A.Y. 2006-07 was clarificatory in nature, as
was evident from the fact that it began with the words ‘for removal of doubts’.
It should therefore be deemed to have always been there and would apply to the
case before the High Court. It was argued that if it was held that section 91
was not applicable, then the bar of claiming deduction to the extent of the tax
paid abroad would not apply.

 

Reference was made
on behalf of the assessee to the commentary on ‘Law and Practice of Income
Tax’ by Kanga & Palkhivala (8th Edition), wherein a
reference was made to the decisions of the Bombay High Court in CIT vs.
Southeast Asian Shipping Co. (IT Appeal No. 123 of 1976) and CIT
vs. Tata Sons Ltd. (IT Appeal No. 209 of 2001)  holding that foreign tax did not fall within
the mischief of section 40(a)(ii) and that the assessee’s net income after
deduction of foreign taxes was his real income for the purposes of the
Income-tax Act.

 

It was therefore
argued on behalf of the assessee that the decision of the Bombay High Court in S.
Inder Singh Gill (Supra) would not apply and the tax paid in Saudi
Arabia on the income accrued or arising in India was to be allowed as a
deduction to arrive at the real profits which were chargeable to tax in India.

 

On behalf of the
Revenue, it was submitted that the issue stood concluded against the assessee
by the decision of the Bombay High Court in S. Inder Singh Gill (Supra).
It was submitted that the real income theory was inapplicable in view of the
specific provision of section 40(a)(ii) which prohibited deduction of any tax
paid. It was submitted that in terms of the main provisions of section
40(a)(ii), any sum paid on account of any tax on the profits and gains of
business or profession would not be allowed as a deduction.

 

It was argued on
behalf of the Revenue that the Explanation 2, inserted with effect from A.Y.
2006-07, only reiterated that any sum entitled to tax relief u/s 91 would be
covered by the main part of section 40(a)(ii). It did not take away the taxes
not covered by it out of the ambit of the main part of section 40(a)(ii).

 

The Bombay High
Court held that the Tribunal was justified in not following its order in the
case of the assessee itself for A.Y. 1979-80, as it noted the decision of the
Bombay High Court in S. Inder Singh Gill (Supra) on an identical
issue. The Court observed that the decisions in South Asian Shipping Co.
(Supra) and Tata Sons Ltd. (Supra) were rendered not at
the final hearing but while rejecting the applications for reference u/s 256(2)
and at the stage of admission u/s 260A, unlike the judgment rendered in a
reference by the Court in S. Inder Singh Gill, and therefore
could not be relied upon in preference to the decision in S. Inder Singh
Gill.

 

Further, the Court
observed that it was axiomatic that income tax was a charge on the profits or
income. The payment of income tax was not a payment made or incurred to earn
profits and gains of business. It could therefore not be allowed as an
expenditure to determine the profits of the business. Taxes such as excise
duty, customs duty, octroi, etc., were incurred for the purpose of doing
business and earning profits or gains from business or profession and
therefore, they  were allowable as
deduction to determine the profits of the business. It is the profits and gains
of business, determined after deducting all expenses incurred for the purpose
of business from the total receipts, which were subjected to income tax as per
the Act. The main part of section 40(a)(ii) did not allow deduction of tax to
the extent the tax was levied  on the
profits or gains of the business. According to the Court, it was on this
general principle, universally accepted, that the Bombay High Court had
answered the question posed to it in S. Inder Singh Gill in
favour of the Revenue.

 

The Bombay High
Court went on to observe that it would have followed the decision in the case
of S. Inder Singh Gill. However, it noticed that that decision
was rendered under the 1922 Act and not under the 1961 Act. The difference
between the two Acts was that the 1922 Act did not contain a definition of
‘tax’, unlike the 1961 Act where such term was defined in section 2(43) as
‘income tax chargeable under the provisions of this Act’. In the absence of any
definition of ‘tax’ under the 1922 Act, the tax paid on income or profits and
gains of business or profession anywhere in the world would not be allowable as
a deduction for determining the profits or gains of the business u/s 10(4) of
the 1922 Act, and therefore the decision in S. Inder Singh Gill
was correctly rendered on the basis of the law then prevalent.

 

Proceeding on the
said lines,  the Bombay High Court held
that by insertion of section 2(43) for defining the term ‘tax’, tax which was
payable under the 1961 Act on the profits and gains of business that alone was
not allowed to be deducted u/s 40(a)(ii), notwithstanding sections 30 to 38.
According to the Court, the tax, which had been paid abroad would not be
covered within the mischief of section 40(a)(ii), in view of the definition of
the word ‘tax’ in section 2(43). The Court said that it was conscious of the
fact that section 2, while defining the various terms used in the Act,
qualified it by preceding the definition with the words ‘in this Act, unless
the context otherwise requires’. It noted that it was not even urged by the
Revenue that the context of section 40(a)(ii) would require it to mean tax paid
anywhere in the world and not only tax payable under the Act.

 

The Court analysed
the rationale for introduction of the Explanations to section 40(a)(ii), as set
out in the Explanatory Memorandum to the Finance Act, 2006, recorded in CBDT
Circular No. 14 of 2006 dated 28th December, 2006. It  recorded the fact that some assessees, who
were eligible for credit against the tax payable in India on the global income
to the extent that the tax had been paid outside India u/s 90/91, were also
claiming deduction of the tax paid abroad as it was not tax under the Act. In
view of the above, the explanation would require in the context thereof that
the definition of the word ‘tax’ would also mean tax which was eligible to the
benefit of section 90/91. However, as per the High Court, this departure from
the meaning of the word ‘tax’ as defined in the Act was  restricted to the above-referred section 90/91
only and gave no license to widen the meaning of the word ‘tax’ to include all
taxes on income or profits paid abroad for the purposes of section 40(a)(ii).

 

The Court further
noted that it was undisputed that some part on which tax had been paid abroad
was on income that had been deemed to have accrued or arisen in India. To that
extent, the benefit of section 91 was not available for such tax so paid
abroad. Therefore, such tax was not hit by the Explanation to section 40(a)(ii)
and was to be considered in the nature of an expenditure incurred to earn
income. The Court then held that the Explanation to section 40(a)(ii) was
declaratory in nature and would have retrospective effect.

 

The Bombay High
Court therefore held that the assessee was entitled to deduction for foreign
taxes paid on income accrued or arisen in India in computing its income, to the
extent that such tax was not entitled to the benefit of section 91.

 

OBSERVATIONS

Before looking at
the applicability of section 40(a)(ii), one first needs to examine whether
income tax is at all an expenditure, and if so, whether it is a business
expenditure. Accounting Standard 22, issued by the Ministry of Corporate
Affairs under the Companies Act, provides that ‘Taxes on income are
considered to be an expense incurred by the enterprise in earning income and are accrued
in the same period as the revenue and expenses to which they relate.’ It
therefore seems that income tax is an expenditure under accounting principles.

 

Since only certain
types of business expenditure are allowable as deductions while computing
income under the head ‘Profits and Gains of Business or Profession’, the
question that arises is whether tax is a business expenditure. Accounting
Standard 22 states that ‘Accounting income (loss) is the net profit or loss
for a period, as reported in the statement of profit and loss, before deducting
income tax expense or adding income tax saving.’ Ind AS 12 issued by the
Ministry of Corporate Affairs states ‘The tax expense (income) related to
profit or loss from ordinary activities shall be presented as part of profit or
loss in the statement of profit and loss.’

 

However, if one
looks at the manner of presentation in the final accounts, it is clear that
income tax is treated quite differently from business expenditure, being shown
separately as a deduction after computing the pre-tax profit. Therefore, it
appears that while tax is an expense, it may not be a business expenditure.
This is supported by the language of AS 22, which states that ‘Accounting
income (loss) is the net profit or loss for a period, as reported in the
statement of profit and loss, before deducting income tax expense or adding
income tax saving.’

 

Further, the
fundamental issue still remains as to whether such foreign income taxes can
ever be a deductible expenditure under sections 30 to 38. Even on basic
commercial principles, income tax is not an expenditure for earning income; it
is a consequence of earning income. Whether such income tax is a foreign tax or
tax under the 1961 Act is irrelevant – it is still an application of income
after having earned the income. This view is supported by the decision of the
Madras High Court in the Kerala Lines case (Supra),
where the High Court observed that the payment of foreign taxes could not be
regarded as an expenditure for earning profits; they could at best be
considered as an application of profits earned by the assessee.

 

In the Reliance
Infrastructure case, the decision of the Bombay High Court was primarily
focused and based on the language of section 40(a)(ii), the Explanation thereto
read with the definition of ‘tax’ u/s 2(43). However, it needs to be kept in
mind that section 40 is a section listing out expenses, which are otherwise
allowable under sections 30 to 38, but which are specifically not allowable.
The provisions of section 40(a)(ii) will therefore come into play where an item
of expenditure is otherwise allowable as a business expenditure under sections
30 to 38. If such expenditure is in any case not allowable under sections 30 to
38, the question of applicability of section 40(a)(ii) does not arise.

 

The Bombay High
Court, in the case of CIT vs. Plasmac Machine Mfg. Co. Ltd. 201 ITR 650,
considered a situation of payment of tax liability of a transferor firm by the
transferee company, where the company had taken over the business of the
transferor firm. It held that the expenditure representing the liability of the
transferor, which was discharged by the transferee, was a capital expenditure
forming part of the consideration for the acquisition of the business and was
therefore not deductible in the computation of income. Hence, the question of
applicability of section 40(a)(ii) did not arise.

 

Under what clause
would foreign income taxes be allowable under sections 30 to 38? The only
possible provision under which such income taxes may fall for consideration as
a deduction would be section 37(1). Section 37(1) allows a deduction for
expenditure (not being in the nature of capital expenditure or personal
expenses) incurred wholly and exclusively for the purpose of business or
profession. Is a foreign income tax an expenditure incurred wholly and
exclusively for the purpose of business or profession, or is it an application
of the income after it has been earned?

 

The House of Lords,
in the case of Commissioners of Inland Revenue vs. Dowdall O’Mahoney
& Co. Ltd. 33 Tax Cases 259, had occasion to consider this issue in
the case of an Irish company which had branches in England; it claimed that in
computing the English profits, it was entitled to deduct that proportion of the
Irish taxes attributable to those profits. The House of Lords held that payment
of such taxes by a trader was not a disbursement wholly and exclusively laid
out for the purposes of the trade and this was so whether such taxes were
United Kingdom taxes or foreign or Dominion taxes. The House of Lords further
observed that taxes like these were not paid for the purpose of earning the
profits of the trade; they were the application of those profits when made and
not the less so that they were exacted by a Dominion or foreign government. It
further observed that there was not and never was any right under the
principles applicable to deduct income tax or excess profits tax, British or
foreign, in computing trading profits. According to the House of Lords, once it
was accepted that the criterion is the purpose for which the expenditure is
made in relation to the trade of which the profits are being computed, no
material distinction remained between the payment to make such taxes abroad and
a payment to meet a similar tax at home. A similar view was taken by the Madras
High Court in Kerala Lines (Supra).

 

In the Reliance
Infrastructure case, the Bombay High Court, while referring to this
basic principle, also accepted by it in the S. Inder Singh Gill
case, did not lay down any rationale for departing from this principle while
deciding the matter. It perhaps was swayed by the Explanation to section 90/91
and section 2(43), both of which had no application on the subject of allowance
of deduction of the foreign tax in computing the business income in the first
place.

 

The issue of
deductibility of foreign taxes had also come up recently before the Ahmedabad
Bench of the Tribunal, in which the Tribunal took differing views. In both
these cases the assessee had claimed foreign tax credit under section 90/91 on
the basis of the gross foreign income, but was allowed tax credit on the basis
of net foreign income taxable in India. It alternatively claimed deduction for
such foreign taxes not allowed as credit. In the first case, DCIT vs.
Elitecore Technologies (P) Ltd., 165 ITD 153, the Tribunal held, after
a detailed examination of the entire gamut of case laws on the subject, that
foreign taxes were not a deductible expenditure. It pointed out aspects which
had not been considered by the Bombay High Court in the Reliance
Infrastructure case. In the subsequent decision in Virmati
Software & Telecommunication Ltd. vs. DCIT, ITA No 1135/Ahd/2017 dated 5th
March, 2020, the Tribunal took a contrary view, following the Bombay
High Court decision in the Reliance Infrastructure case, that
such foreign taxes not allowed credit u/s 91 were deductible in computing the
income. The Mumbai Bench of the Tribunal, in the case of Tata Motors Ltd.
vs. CIT ITA No. 3802/Mum/2018 dated 15th April, 2019, has
also followed the Bombay High Court decision in Reliance Infrastructure
and held that the deduction for foreign taxes not entitled to relief under
section 90/91 could not be the subject matter of revision u/s 263.

 

The Mumbai Bench of
the Tribunal, on the other hand, in the case of DCIT vs. Tata Sons Ltd.
43 SOT 27, has, while disallowing the claim for deduction of foreign
taxes u/s 37(1), observed that if it was to be held that the assessee was
entitled to deduction of tax paid abroad, in addition to admissibility of tax
relief u/s 90 or section 91, it would result in a situation that on the one
hand double taxation of income would be eliminated by ensuring that the
assessee’s total income-tax liability did not exceed the income-tax liability
in India or the income-tax liability abroad, whichever was greater, and, on the
other hand, the assessee’s domestic tax liability would also be reduced by tax
liability in respect of income decreased due to deduction of taxes. Such a
double benefit to the assessee was contrary to the scheme of the Act as well as
the fundamental principles of international taxation.

 

Interestingly, the
Mumbai Bench of the Tribunal, in Tata Consultancy Services Ltd. vs. ACIT
203 TTJ 146, considered a disallowance of US and Canadian state taxes
and held that such taxes were not covered by section 40(a)(ii) and were
therefore allowable.

 

A question arose in
Jaipuria Samla Amalgamated Collieries Ltd. 82 ITR 580 (SC) where
the assessee, a lessee of mines, incurred statutory liability for the payment
of road and public works cess and education cess, and claimed deduction of such
cess in its computation of income. The A.O. disallowed such claim relying on
section 10(4) of the 1922 Act, corresponding to section 40(a)(ii) of the 1961
Act. In that decision, the Supreme Court held that the words ‘profits and gains
of any business, profession or vocation’ which were employed in section 10(4),
could, in the context, have reference only to profits or gains as determined
u/s 10 and could not cover the net profits or gains arrived at or determined in
a manner other than that provided by section 10. Can one apply the ratio
of this decision to foreign income taxes, which are levied on income computed
in a manner different from that envisaged under the 1961 Act?

 

Subsequently, the
Supreme Court itself in the case of Smithkline & French India Ltd.
vs. CIT 219 ITR 581 has taken a different view in the context of surtax.
The Supreme Court observed in this case:

‘Firstly, it may
be mentioned, s.10(4) of the 1922 Act or s.40(a)(ii) of the present Act do not
contain any words indicating that the profits and gains spoken of by them
should be determined in accordance with the provisions of the IT Act. All they
say is that it must be a rate or tax levied on the profits and gains of
business or profession. The observations relied upon must be read in the said
context and not literally or as the provisions in a statute…’

 

This argument
therefore seems to no longer be valid. In this case, the Supreme Court has also
approved the Bombay High Court decision in Lubrizol India Ltd. vs. CIT
187 ITR 25, where the Bombay High Court noted that section 40(a)(ii)
uses the term ‘any’ before ‘rate or tax’. The High Court had observed:

 

‘If the word “tax” is to be given the meaning
assigned to it by s.2(43) of the Act, the word “any” used before it will be
otiose and the further qualification as to the nature of levy will also become
meaningless. Furthermore, the word “tax” as defined in s.2(43) of the Act is
subject to “unless the context otherwise requires”. In view of the discussion
above, we hold that the words “any tax” herein refers to any kind of tax levied
or leviable on the profits or gains of any business or profession or assessed
at a proportion of, or otherwise on the basis of, any such profits or gains’.

 

This view is in
direct contrast to the view expressed in the Reliance Infrastructure
case, and having been approved by the Supreme Court in the case of Smithkline
& French (Supra), this view should prevail. Perhaps, the ratio
of the Reliance Infrastructure case was largely governed by the
fact that the non-applicability of section 2(43) to section 40(a)(ii) was never
urged by the Department before it.

 

Therefore, the better view is that foreign
income taxes are not a deductible expenditure in computing income under the
1961 Act, irrespective of whether they are eligible for credit under sections
90, 90A or 91.

GST ON PAYMENTS MADE TO DIRECTORS – SOME CLARITY

In my article ‘GST
on payments made to Directors’ published on Page 24 of the BCAJ
issue of June, 2020, I had discussed in detail the various types of payments
made to Directors (whether Whole-Time Directors or Independent Directors) and
the GST implications of the same. That was on the basis of some judicial
precedents and a few contradictory Advance Rulings.

 

The inconsistent
Advance Rulings and the representations made by the trade and industry seeking
finality in the matter may have prompted the GST Policy Wing of the Central
Board of Indirect Taxes and Customs (the Board) to issue a clarification and to
avoid unnecessary confusion and costly litigation. The clarification was issued
vide Circular No. 140/10/2020-GST dated 10th June, 2020.

 

The clarification
has categorised the payments made to Directors under two scenarios – the applicability
of GST on remuneration paid by companies to:

(a) Independent Directors or those Directors who
are not employees of the company; and

(b) Whole-Time Directors, including Managing
Director, who are employees of the company.

 

The clarification
has laid emphasis on the relation of the Director with the company to decide
the leviability of GST and relied on the definition of Independent Directors
and Whole-Time Directors from the Companies Act, 2013. The same is summarised
hereunder.

 

Independent
Directors or those Directors who are not employees of the company

As per section
149(6) of the Companies Act, 2013, read with Rule 12 of the Companies (Share
Capital and Debentures) Rules, 2014, ‘independent directors’ are such Directors
who have not been an employee or proprietor or a partner of the said
company in any of the three financial years immediately preceding the financial
year in which he is proposed to be appointed in the said company.

 

And a ‘whole
time-director’ is defined u/s 2(94) of the Companies Act, 2013 in an inclusive
manner, to include a person who may not be an employee of the company.

 

In both the cases
mentioned above, where the Directors are not employees of the company, the
amounts paid to them for the services provided to the company would be outside
the scope of Schedule III of the CGST Act and would thus become taxable under
GST. As mentioned in the article earlier, such services would get covered under
Entry 6 of Notification No. 13/2017-CT (Rates) and No. 10/2017-IT (Rates), both
dated 28th June, 2017, effective from 1st July, 2017,
issued under the CGST Act (‘Reverse Charge Notification’) and, consequently,
GST shall become payable under Reverse Charge Mechanism by the company being
recipient of the services.

 

Whole-Time Directors, including Managing Director, who are employees
of the  company

The clarification
provides that if a Director has been considered to be an employee of the
company, it would be pertinent to examine whether the activities performed by
the Director are in the course of an employer-employee relation. The
clarification emphasises that the services provided should be ascertained to be
under a ‘contract of service’ or ‘contract for service’ since the remuneration
under the latter would become taxable under GST.

 

To classify the
service being provided under the above categories, the Board has taken
cognisance of the treatment given to the remuneration under the Income-tax Act,
1961 (‘IT Act’) wherein the salaries are subjected to Tax Deducted at Source
(‘TDS’) u/s 192 of the Act and fees other than salaries, is liable for TDS u/s
194J.

 

Accordingly,
remuneration which is subjected to TDS u/s 192 shall be treated as
consideration for ‘services by an employee to the employer in the course of or
in relation to his employment’ and would get covered under Schedule III of the
CGST Act, 2017.

 

It has also been
clarified that if an amount paid to the Director is declared as Fees for
Professional or Technical Services and subjected to TDS u/s 194J, it shall be
treated as consideration for providing services and become taxable under GST.
In such cases, the liability shall be of the recipient of services, i.e., the
company, under the Reverse Charge Notification.

Provided
below is a comparative table for a quick reference on the applicability of GST
/ RCM on payments to Directors:

 

Payments
to Directors

Employer–Employee
Relationship

TDS
u/s

Applicability
of GST

Applicability
of RCM

Remark

Salary

Yes

192

No

No

Entry I of Schedule III of
CGST Act, 2017

Commission, Professional Fees,
Sitting Fees

Yes

192(2B)

No

No

Commission

No

194-H

Yes

Yes

Entry 6 of Reverse Charge
Notification

Contract Payment

No

194-C

Yes

Yes

Professional Fees, Sitting
Fees

No

194-J

Yes

Yes

Rent

No

194-IB

Yes

Yes

 

 

[Appellate Tribunal in I.T.A. No. 5535/Mum/2014; Date of order: 11th January, 2017; A.Y.: 2003-04; Bench ‘F’ Mum.] Appeal u/s 260A – Penalty u/s 271(1)(c) – The question relating to non-striking off of the inapplicable portion in the section 271(1)(c) show cause notice goes to the root of the lis and is a jurisdictional issue – Issue can be raised first time before High Court – Penalty cannot be imposed for alleged breach of one limb of section 271(1)(c) of the Act while proceedings are initiated for breach of the other limb of section 271(1)(c) – Penalty deleted

7. Ventura Textiles Ltd. vs. CIT –
Mumbai-11 [ITA No. 958 of 2017 Date
of order: 12th June, 2020 (Bombay
High Court)

 

[Appellate
Tribunal in I.T.A. No. 5535/Mum/2014; Date of order: 11th January,
2017; A.Y.: 2003-04; Bench ‘F’ Mum.]

 

Appeal u/s 260A – Penalty u/s 271(1)(c) – The question relating to
non-striking off of the inapplicable portion in the section 271(1)(c) show
cause notice goes to the root of the lis and is a jurisdictional issue –
Issue can be raised first time before High Court – Penalty cannot be imposed
for alleged breach of one limb of section 271(1)(c) of the Act while
proceedings are initiated for breach of the other limb of section 271(1)(c) –
Penalty deleted

 

The issue involved in the
above appeal related to the imposition of penalty of Rs. 22,08,860 u/s
271(1)(c) of the Act by the A.O. on account of disallowance of Rs. 62,47,460
claimed as a deduction u/s 36(i)(vii) on account of bad debt and subsequently
claimed as a deduction u/s 37 as expenditure expended wholly and exclusively
for the purpose of business.

 

The assessee company filed
its ROI declaring total loss at Rs. 4,66,68,740 for A.Y. 2003-04. During the
assessment proceedings, it was found amongst other things that the assessee had
debited Rs. 62,47,460 under the head ‘selling and distribution expenses’ and
claimed it as bad debt in the books of accounts, thus claiming it as a
deduction u/s 36(1)(vii). Subsequently it was found that the aforesaid amount
was paid to M/s JCT Ltd. as compensation for the supply of inferior quality of
goods. Thus, the A.O. held that the amount of Rs. 62,47,460 claimed as bad debt
was not actually a debt and therefore it was not allowable as a deduction u/s 36(1)(vii).
The A.O. further held that the said claim was also not admissible even u/s
37(1), with the observation that payment made to M/s JCT Ltd. was not wholly
and exclusively for business purposes but for extraneous considerations. In
view thereof, the assessee’s claim was rejected. The A.O. initiated penalty
proceedings u/s 271(1)(c) of the Act for furnishing inaccurate particulars of
income.

The A.O. issued notice u/s
274 r/w/s 271 on the same day, i.e., on 28th February, 2006, to the
assessee to show cause as to why an order imposing penalty should not be made
u/s 271. It may, however, be mentioned that in the pertinent portion of the
notice the A.O. did not strike off the inapplicable portion.

 

The assessee had challenged
the disallowance of bad debt along with other disallowances in the assessment
order by filing an appeal before the CIT(A) who, by an order dated 14th
November, 2012, confirmed the disallowance of bad debt while deleting other
disallowances.

 

In the penalty proceedings,
the A.O. took the view that the assessee’s claim was not actually bad debt but
represented payment made to M/s JCT Ltd. which was also not incurred wholly and
exclusively for the purposes of business. Thus, by the order dated 14th
February, 2014, the A.O. held that by making an improper and unsubstantiated
claim of bad debt of Rs. 62,47,460, the assessee had wilfully reduced its
incidence of taxation, thereby concealing its income as well as furnishing
inaccurate particulars of income. Therefore, the A.O. imposed the minimum
penalty quantified at Rs. 24,99,200 which included penalty on another
disallowance.

 

The CIT(A) deleted the
penalty on the other disallowance. Regarding the penalty levied on Rs.
62,47,460 claimed as bad debt in the assessment proceedings, the CIT(A) held
that the assessee had made a wrong claim by submitting inaccurate particulars
of income by claiming bad debt which was not actually a debt and also not an
expenditure allowable u/s 37(1). Thus, it was held that the assessee had
wilfully submitted inaccurate particulars of income which had resulted in
concealment. Therefore, the penalty amount of Rs. 62,47,460 levied was upheld.

 

The Tribunal upheld the order
of the CIT(A) and rejected the appeal of the assessee. According to the
Tribunal, it was rightly held by the CIT(A) that the assessee had made a wrong
claim by submitting inaccurate particulars of income by claiming a bad debt
which was not actually a debt and also not an expenditure allowable u/s 37(1).
Therefore, the finding recorded by the CIT(A) that the assessee had wilfully
submitted inaccurate particulars of income which had resulted in concealment
was affirmed.

 

Before the High Court the
first contention was raising a question of law for the first time before the
High Court though it had not been raised before the lower authorities; the
Court referred to a series of decisions, including of the Supreme Court in
Jhabua Power Limited (2013) 37 Taxmann.com 162 (SC) and of the Bombay
High Court in Ashish Estates & Properties (P) Ltd. (2018) 96
Taxmann.com 305 (Bom.) wherein it is observed that it would not
preclude the High Court from entertaining an appeal on an issue of jurisdiction
even if the same was not raised before the Tribunal.

 

The Court further noted and
analysed the two limbs of section 271(1)(c) of the Act and also the fact that
the two limbs, i.e., concealment of particulars of income and furnishing
inaccurate particulars of income, carry different connotations. The Court further
noted that the A.O. must indicate in the notice for which of the two limbs he
proposes to impose the penalty and for this the notice has to be appropriately
marked. If in the printed format of the notice the inapplicable portion is not
struck off, thus not indicating for which limb the penalty is proposed to be
imposed, it would lead to an inference as to non-application of mind.

 

Therefore, the question
relating to non-striking off of the inapplicable portion in the show cause
notice which is in printed format, thereby not indicating therein as to under
which limb of section 271(1)(c) the penalty was proposed to be imposed, i.e.,
whether for concealing the particulars of income or for furnishing inaccurate
particulars of such income, would go to the root of the lis. Therefore,
it would be a jurisdictional issue. Being a jurisdictional issue, it can be
raised before the High Court for the first time and adjudicated upon even if it
was not raised before the Tribunal.

 

The Hon. Court relied on
decisions of SSA’s Emerald Meadows (2016) 73 Taxmann.com 241 (Karnataka);
Manjunath Cotton & Ginning Factory 359 ITR 565 (Kar.); and
Samson Pernchery (2017) 98 CCH 39 (Bom.) wherein the issue was
examined, i.e. the question as to justification of the Tribunal in deleting the
penalty levied u/s 271(1)(c). It was noted that the notice issued u/s 274 was
in a standard proforma without having struck off the irrelevant clauses
therein, leading to an inference as to non-application of mind.

 

A similar view had been taken
in Goa Coastal Resorts & Recreation Pvt. Ltd. (2019) 106 CCH 0183
(Bom.); New Era Sova Mine (2019) SCC OnLine Bom. 1032; as well as Shri
Hafeez S. Contractor (ITA Nos.796 and 872 of 2016 decided on 11th
December, 2018).

 

On the facts of the present
case, the Court noticed that the statutory show cause notice u/s 274 r/w/s 271
of the Act proposing to impose penalty was issued on the same day when the
assessment order was passed, i.e., on 28th February, 2006. The said
notice was in printed form. Though at the bottom of the notice it was mentioned
‘delete inappropriate words and paragraphs’, unfortunately, the A.O. omitted to
strike off the inapplicable portion in the notice. Such omission certainly
reflects a mechanical approach and non-application of mind on the part of the
A.O. However, the moot question is whether the assessee had notice as to why
penalty was sought to be imposed on it?

 

The Court observed that in
the present case, the assessment order and the show cause notice were both
issued on the same date, i.e., on 28th February, 2006, and if they
are read in conjunction, a view can reasonably be taken that notwithstanding
the defective notice, the assessee was fully aware of the reason as to why the
A.O. sought to impose penalty. It was quite clear that the penalty proceedings
were initiated for breach of the second limb of section 271(1)(c), i.e., for
furnishing inaccurate particulars of income. The purpose of a notice is to make
the noticee aware of the ground(s) of notice. In the present case, it would be
too technical and pedantic to take the view that because in the printed notice
the inapplicable portion was not struck off, the order of penalty should be set
aside even though in the assessment order it was clearly mentioned that penalty
proceedings u/s 271(1)(c) had been initiated separately for furnishing
inaccurate particulars of income. Therefore, this contention urged by the
appellant / assessee was rejected.

 

Having held so, the Court
went on to examine whether in the return of income the assessee had furnished
inaccurate particulars. As already discussed above, for the imposition of
penalty u/s 271(1)(c) either concealment of particulars of income or furnishing
inaccurate particulars of such income are the sine qua non. In the
instant case, the penalty proceedings u/s 271(1)(c) were initiated on the
ground that the assessee had furnished inaccurate particulars of income.

 

The Court observed that in
the assessment proceedings the explanation of the assessee was not accepted by
the A.O. by holding that the subsequent payment made to M/s JCT Ltd. would not
be covered by section 36(1)(vii) since the amount claimed as bad debt was
actually not a debt. Thereafter, the A.O. examined whether such payment would
be covered u/s 37(1) as per which an expenditure would be allowable as a
deduction if it pertains to that particular year and has been incurred wholly
and exclusively for the purpose of business. The A.O. held that the assessee’s
claim was not admissible even u/s 37(1) as the circumstances indicated that the
payments were not made wholly and exclusively for business purposes. While
disallowing the claim of the assessee, the A.O. took the view that since the
assessee had furnished inaccurate particulars of income, penalty proceedings
u/s 271(1)(c) were also initiated separately.

 

The Court noticed that in the
statutory show cause notice the A.O. did not indicate as to whether penalty was
sought to be imposed for concealment of income or for furnishing inaccurate
particulars of income, although in the assessment order it was mentioned that
penalty proceedings were initiated for furnishing inaccurate particulars of
income. In the order of penalty, the A.O. held that the assessee had concealed
its income as well as furnished inaccurate particulars of income.

 

But concealment of
particulars of income was not the charge against the appellant, the charge was
of furnishing inaccurate particulars of income. As discussed above, it is trite
that penalty cannot be imposed for alleged breach of one limb of section 271(1)(c)
while penalty proceedings are initiated for breach of the other limb of the
same section. This has certainly vitiated the order of penalty. In the appeal,
the CIT(A) took a curious view, that submission of inaccurate particulars of
income resulted in concealment, thus upholding the order of penalty. This
obfuscated view of the CIT(A) was affirmed by the Tribunal.

 

While the charge against the
assessee was of furnishing inaccurate particulars of income whereas the penalty
was imposed additionally for concealment of income, the order of penalty as
upheld by the lower appellate authorities could be justifiably interfered with,
yet the Court went on to examine whether there was furnishing of inaccurate
particulars of income by the assessee in the first place because that was the
core charge against the assessee.

 

The Court referred to the
decision of the Supreme Court in Reliance Petroproducts Pvt. Ltd. 322 ITR
158 (SC) wherein it was held that mere making of a claim which is not
sustainable in law by itself would not amount to furnishing inaccurate
particulars regarding the income of the assessee. Therefore, such claim made in
the return cannot amount to furnishing inaccurate particulars of income.

The Court noted that this
decision was followed by the Bombay High Court in CIT vs. M/s Mansukh
Dyeing & Printing Mills, Income Tax Appeal No. 1133 of 2008, decided on 24th
June, 2013. In CIT vs. DCM Ltd., 359 ITR 101, the Delhi
High Court applied the said decision of the Supreme Court and further observed
that law does not debar an assessee from making a claim which he believes is
plausible and when he knows that it is going to be examined by the A.O. In such
a case, a liberal view is required to be taken as necessarily the claim is
bound to be carefully scrutinised both on facts and in law. Threat of penalty
cannot become a gag and / or haunt an assessee for making a claim which may be
erroneous or wrong. Again, in CIT vs. Shahabad Co-operative Sugar Mills
Ltd., 322 ITR 73, the Punjab & Haryana High Court held that the
making of a wrong claim is not at par with concealment or giving of inaccurate
information which may call for levy of penalty u/s 271(1)(c) of the Act.

 

In view of the above, in the
present case it is quite evident that the assessee had declared the full facts;
the full factual matrix of facts was before the A.O. while passing the
assessment order. It is another matter that the claim based on such facts was
found to be inadmissible. This is not the same thing as furnishing inaccurate
particulars of income as contemplated u/s 271(1)(c).

 

Thus, on an overall
consideration, the appeal was allowed and the order of penalty as affirmed by
the appellate authorities was set aside. 

 

 

 

 

 

Search and seizure – Assessment u/s 153A of ITA, 1961 – Scope of section 153A – Assessee can raise new claims for deduction in return filed u/s 153A; A.Y. 2008-09

33. Principal
CIT vs. JSW Steel Ltd. [2020]
422 ITR 71 (Bom.) Date
of order: 5th February, 2020 A.Y.:
2008-09

 

Search and
seizure – Assessment u/s 153A of ITA, 1961 – Scope of section 153A – Assessee
can raise new claims for deduction in return filed u/s 153A; A.Y. 2008-09

 

The assessee is a widely-held public limited company engaged in various
activities including production of sponge iron, galvanised sheets and
cold-rolled coils through its steel plants located at Dolve and Kalmeshwar in
Maharashtra. For the A.Y. 2008-09, the assessee had filed return of income on
30th September, 2008 under the provisions of section 139(1) of the
Income-tax Act, 1961, declaring loss at Rs. 104,17,70,752. The assessee’s case
was selected for scrutiny and notice u/s 143(2) was issued on 3rd
September, 2009. During the pendency of the assessment proceedings, a search
was conducted u/s 132 of the Act on the ISPAT group of companies on 30th
November, 2010. Following the search, notice u/s 153A was issued. In response,
the assessee filed return of income declaring total loss at Rs. 419,48,90,102
on 29th March, 2012. In this return of income, the assessee made a
new claim for treating gain on prepayment of deferred value added tax / sales
tax on the net present value (NPV) basis for an amount of Rs. 318,10,93,993 as
‘capital receipt’. This new / fresh claim of the assessee was disallowed by the
A.O. while finalising the assessment u/s 143(3) read with section 153A. The
primary question that arose before the A.O. was whether the claim which was not
made in the earlier original return of income filed u/s 139(1) could be
considered in the subsequent return filed by the assessee in pursuance of
notice u/s 153A? The A.O. held that the assessee could not raise a new claim in
the return filed u/s 153A which was not raised in the original return of income
filed u/s 139(1). Thereafter, the claim was disallowed and was treated as
‘revenue receipt’.

 

The Tribunal
allowed the assessee’s claim.

 

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

 

‘i)   Section 153A of the Income-tax Act, 1961
provides for the procedure for assessment in search cases. The section starts
with a non-obstante clause stating that it is notwithstanding anything
contained in sections 147, 148 and 149. Further, clause (a) of section 153A(1)
provides for issuance of notice to the persons in respect of whom search was
conducted u/s 132 to furnish a return of income. However, the second proviso
to section 153A makes it clear that assessment relating to any assessment year
filed within a period of the six assessment years pending on the date of search
u/s 132 of the Act shall abate.

 

ii)   Thus, if on the date of initiation of search
u/s 132 any assessment proceeding relating to any assessment year falling
within the period of the six assessment years is pending, it shall stand abated
and the assessing authority cannot proceed with such pending assessment after
initiation of search u/s 132. The crucial expression is “abate”. To
“abate”, as applied to an action, is to cease, terminate, or come to an
end prematurely. Once the assessment abates, the original return which had been
filed loses its originality and the subsequent return filed u/s 153A takes the
place of the original return. In such a case, the return of income filed u/s
153A(1) would be construed to be one filed u/s 139(1) and the provisions of the
Act shall apply to it accordingly.

 

iii)  If that be the position, all legitimate claims
would be open to the assessee to raise in the return of income filed u/s
153A(1). It is open for the assessee to lodge a new claim in a proceeding u/s
153A(1) which was not claimed in his regular return of income.’

 

Loss – Set-off of – Sections 72(2), 72A and 263 of ITA, 1961 and sections 18 and 32(2) of SICA, 1985 – Amalgamation of companies – Provision for carry forward by amalgamated company of accumulated loss and unabsorbed depreciation of amalgamating company – Sick industrial company – Sanction of scheme by Board for Industrial and Financial Reconstruction implies that requirements of section 72(2) satisfied; A.Y. 2004-05

32. CIT
vs. Lakshmi Machine Works Ltd. [2020]
422 ITR 235 (Mad.) Date
of order: 13th February, 2019 A.Y.:
2004-05

 

Loss –
Set-off of – Sections 72(2), 72A and 263 of ITA, 1961 and sections 18 and 32(2)
of SICA, 1985 – Amalgamation of companies – Provision for carry forward by
amalgamated company of accumulated loss and unabsorbed depreciation of
amalgamating company – Sick industrial company – Sanction of scheme by Board
for Industrial and Financial Reconstruction implies that requirements of
section 72(2) satisfied; A.Y. 2004-05

 

Two spinning
units of a company amalgamated with the assessee under a rehabilitation scheme
under the Sick Industrial Companies (Special Provisions) Act, 1985 by an order
of sanction by the Board for Industrial and Financial Reconstruction. The
assessee claimed the carried forward loss u/s 72A of the Income-tax Act, 1961
in its return. The A.O. issued notices under sections 142(1) and 143(2) of the
1961 Act and required the assessee to show compliance with the conditions laid
down u/s 72A. The assessee submitted that it was entitled to the claim for
carry forward of loss u/s 72A by virtue of the scheme having been sanctioned by
the Board for Industrial and Financial Reconstruction which took into account the
provisions of that section as well. The A.O. agreed with the view of the
assessee and allowed the claim in his order u/s 143(3). But the Commissioner
was of the view that there was no application of mind by the A.O. while he
allowed the claim made by the assessee u/s 72A and that there were no reasons
in support thereof. Accordingly, he passed a revision order u/s 263 of the 1961
Act.

 

The Tribunal
held that the very fact that the Board for Industrial and Financial
Reconstruction had sanctioned the scheme was sufficient and no further
compliance was called for in regard to the conditions set out u/s 72A as the
provisions of the 1985 Act overrode those of the 1961 Act, and confirmed the
order of the A.O. allowing the claim of the assessee for the carry forward of
loss. Accordingly, the Tribunal set aside the order of the Commissioner passed
u/s 263.

 

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

 

‘i)   The financial viability or otherwise of the
amalgamating company has to be determined first in order to attract the
provisions of section 72A of the Income-tax Act, 1961. After the enactment of
the Sick Industrial Companies (Special Provisions) Act, 1985 and the
constitution of the Board for Industrial and Financial Reconstruction, the
question of sickness or robust health of the entity is to be determined by the
Board. It is only when the Board is satisfied that it would have entertained
applications for revival, sanctioning an appropriate scheme for rehabilitation.
Thus, a sanction by the Board for the scheme of amalgamation implies that the
requirements of section 72A have been met.

 

ii)   The view taken by the A.O. to the effect that
the claim of the assessee u/s 72A of the 1961 Act was liable to be allowed in
the light of the provisions of section 32(2) of the 1985 Act and its
interpretation by the Supreme Court was the correct one. Section 263 of the
1961 Act empowered the Commissioner to revise an order of assessment if it was
erroneous or prejudicial to the interests of the Revenue. Both conditions were
to be satisfied concurrently. The action of the A.O. though prejudicial, could
hardly be termed “erroneous” insofar as the A.O. had followed the dictum laid
down by the Supreme Court in the case of Indian Shaving Products Ltd. vs.
BIFR [1996] 218 ITR 140 (SC). Thus, in the absence of concurrent
satisfaction of the two conditions u/s 263 of the 1961 Act, the action of the
Commissioner was contrary to the statute and was therefore to be set aside.

 

iii)  The appeal filed by the Revenue is dismissed.
The substantial question of law is answered in favour of the assessee and
against the Revenue.’

Exemption u/s 10(17A) of ITA, 1961 – Award for meritorious service in public interest – Scope of section 10(17A) – Approval of State Government or Central Government – Formal approval not mandatory – Approval may be implied; A.Y. 2010-11

31. K.
Vijaya Kumar vs. Principal CIT [2020]
422 ITR 304 (Mad.) Date
of order: 26th February, 2020 A.Y.:
2010-11

 

Exemption
u/s 10(17A) of ITA, 1961 – Award for meritorious service in public interest –
Scope of section 10(17A) – Approval of State Government or Central Government –
Formal approval not mandatory – Approval may be implied; A.Y. 2010-11

 

The
petitioner has had a distinguished career in the Indian Police Service and is
at present engaged as a senior security adviser to the Union Home Ministry. In
the course of his service, he had been appointed as the Chief of the Special
Task Force (STF) leading ‘Operation Cocoon’ against forest brigand Veerappan,
leading to Veerappan’s fatal encounter on 18th October, 2004. In
recognition of the special and commendable services of the STF, the Government
of Tamil Nadu had issued G.O. Ms. No. 364, Housing and Urban Development
Department, dated 28th October, 2004 instituting an award in
national interest to STF personnel for the valuable services rendered by them
as part of the team. Pursuant thereto, the petitioner had received a cash award
of Rs. 1,08,43,000 in the F.Y. 2009-10, relevant to A.Y. 2010-11. This amount
was sought to be assessed as income by the Commissioner u/s 263 of the
Income-tax Act, 1961 for which the assessee claimed exemption u/s 10(17A). The
Commissioner directed the A.O. to allow the claim of exemption u/s 10(17A) only
if the assessee was able to produce an order granting approval of exemption by
the Government of India u/s 10(17A)(ii).

 

The assessee
filed a writ petition and challenged the order of the Commissioner. The Madras
High Court allowed the writ petition and held as under:

 

‘i)   The object of section 10(17A) of the
Income-tax Act, 1961 is to reward an individual who has been recognised by the
Centre or the State for rendition of services in public interest. While clause
(i) of section 10(17A) is concerned with an award whether in cash or in kind,
instituted in public interest by the Central or any State Government or
instituted by any other body and approved by the Central Government in this
behalf, clause (ii) refers to a reward by the Central or a State Government for
such purposes as may be approved by the Central Government in this behalf in
public interest.

 

ii)   No specification or prescription has been set
out in terms of how the approval is to be styled or even whether a formal
written approval is required. Nowhere in the rules or forms is there reference
to a format of approval to be issued in this regard. That apart, one should
interpret the provision and its application in a purposive manner bearing in
mind the spirit and object for which it has been enacted. It is clear that the
object of such a reward is by way of recognition by the State of an
individual’s efforts in protecting public interest and serving society in a
significant manner. Thus, the reference to “approval” in section 10(17A) does
not only connote a paper conveying approval and bearing the stamp and seal of the
Central Government, but any material available in the public domain indicating
recognition for such services rendered in public interest.

 

iii)  The assessee had been recognised by the
Central Government on several occasions for meritorious and distinguished
services and from the information available in the public domain, it could be
seen that he was awarded the Jammu and Kashmir Medal, Counter Insurgency Medal,
Police Medal for Meritorious Service (1993) and the President’s Police Medal
for Distinguished Service (1999). Specifically for his role in nabbing
Veerapan, he was awarded the President’s Police Medal for Gallantry on the eve
of Independence Day, 2005. The assessee was entitled to exemption on the awards
received from the State Government. The writ petition is allowed.’

Deduction u/s 80-IB(10) of ITA, 1961 – Housing projects – Scope of section 80-IB(10) – Not necessary that developer should be owner of land – Joint venture agreement showing assessee was developer – Assessee entitled to special deduction u/s 80-IB(10); A.Y. 2010-11

30. Bashyam
Constructions P. Ltd. vs. Dy. CIT [2020]
422 ITR 346 (Mad.) Date
of order: 30th January, 2019 A.Y.:
2010-11

 

Deduction
u/s 80-IB(10) of ITA, 1961 – Housing projects – Scope of section 80-IB(10) –
Not necessary that developer should be owner of land – Joint venture agreement
showing assessee was developer – Assessee entitled to special deduction u/s
80-IB(10); A.Y. 2010-11

 

A claim for deduction u/s 80-IB(10) of the Income-tax Act, 1961 was
allowed by the Commissioner (Appeals) but denied by the Tribunal. The reason
assigned by the Tribunal for reversing the order passed by the Commissioner
(Appeals) was that the assessee could not be considered a developer of the
housing project, as a joint venture would happen only when the owner, that is,
the assessee, treated the land as stock-in-trade in its books of accounts.

 

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

 

‘i)   A plain reading of section 80-IB(10) of the
Income-tax Act, 1961 makes it clear that deduction is available in a case where
an undertaking develops and builds a housing project. The section clearly draws
a distinction between “developing” and “building”. The provision does not
require that the ownership of land must vest in the developer for it to qualify
for such deduction.

 

ii)   The joint venture agreement clearly showed
that the assessee was the developer and ETA was the builder and mutual rights
and obligations were inextricably linked with each other and undoubtedly, the
project was a housing project. Therefore, the assessee would be entitled to
claim deduction u/s 80-IB(10).’

 

Business expenditure – Disallowance u/s 40(a)(ia) of ITA, 1961 – Amounts not deductible – Payments liable to deduction of tax at source – Failure to deduct tax at source – Law applicable – Effect of amendment of section 40(a)(ia) with effect from 1st April, 2013 providing for cases where recipient has declared income in question and paid tax thereon – Amendment retrospective – Non-deduction of tax at source not causing loss to Revenue – Disallowance not applicable; A.Y. 2005-06

29. CIT
vs. S.M. Anand [2020]
422 ITR 209 (Kar.) Date
of order: 23rd August, 2019 A.Y.:
2005-06

 

Business
expenditure – Disallowance u/s 40(a)(ia) of ITA, 1961 – Amounts not deductible
– Payments liable to deduction of tax at source – Failure to deduct tax at
source – Law applicable – Effect of amendment of section 40(a)(ia) with effect
from 1st April, 2013 providing for cases where recipient has
declared income in question and paid tax thereon – Amendment retrospective –
Non-deduction of tax at source not causing loss to Revenue – Disallowance not
applicable; A.Y. 2005-06

 

In the
appeal by the Revenue, the following question of law was raised:

 

‘Whether the
second proviso to section 40(a)(ia) of the Act inserted by the Finance
Act, 2012 is clarificatory and retrospective in nature and cancellation of the
disallowance u/s 40(a)(ia) by the Tribunal is justifiable where the recipient
of the amount has already discharged his tax liability therein?’

 

The
Karnataka High Court held as under:

 

‘i)   The scheme of section 40(a)(ia) of the
Income-tax Act, 1961 is aimed at ensuring that an expenditure should not be
allowed as deduction in the hands of an assessee in a situation in which income
embedded in such expenditure has remained untaxed due to tax withholding lapses
by the assessee. It is not a penalty for tax withholding lapse but a sort of
compensatory deduction restriction for an income going untaxed due to tax
withholding lapse. The penalty for tax withholding lapse per se is
separately provided for in section 271C and section 40(a)(ia) does not add to
it. The provisions of section 40(a)(ia), as they existed prior to insertion of
the second proviso thereto, went much beyond the obvious intentions of
the lawmakers and created undue hardships even in cases in which the assessee’s
tax withholding lapses did not result in any loss to the exchequer.

 

ii)   In order to cure these shortcomings of the
provision, and thus obviate the unintended hardships, an amendment in law was
made. In view of the well-settled legal position to the effect that a curative
amendment to avoid unintended consequences is to be treated as retrospective in
nature even though it may not state so specifically, the insertion of the
second proviso must be given retrospective effect from the point of time
when the related legal provision was introduced. The insertion of the second proviso
to section 40(a)(ia) is declaratory and curative in nature and it has
retrospective effect from 1st April, 2005, being the date from which
sub-clause (ia) of section 40(a) was inserted by the Finance (No. 2) Act, 2004.

 

iii)  It was not disputed that the payments made by
the assessee to the sub-contractors had been offered to tax in their respective
returns of income, uncontroverted by the authorities. There was no actual loss
of revenue. Hence, section 40(a)(ia) was not applicable.

 

iv)  Accordingly, we answer the substantial
question of law against the Revenue and in favour of the assessee.’

 

Business expenditure – Section 37 of ITA, 1961 – General principles – Donations made by company under corporate social responsibility – Deductible u/s 37; A.Y. 2010-11

28. Principal CIT vs. Gujarat Narmada
Valley Fertilizer and Chemicals Ltd. [2020]
422 ITR 164 (Guj.) Date
of order: 16th July, 2019 A.Y.:
2010-11

 

Business
expenditure – Section 37 of ITA, 1961 – General principles – Donations made by
company under corporate social responsibility – Deductible u/s 37; A.Y. 2010-11

 

The assessee
was engaged in the business of manufacturing, sale and trading of chemical
fertilizers and chemical industrial products. The company was also engaged in
the business of information and technology. For the A.Y. 2010-11 the assessee
claimed expenditure of Rs. 17,50,36,756 u/s 37(1). Such claim was put forward
in fulfilment of its corporate social obligation and responsibility. The A.O.
disallowed the claim. The Appellate Tribunal relied on its order passed for
A.Y. 2009-10 and took the view that the assessee was entitled to claim
deduction towards the expenditure incurred for discharging its corporate social
responsibility u/s 37(1).

 

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

 

‘The word
“business” used in section 37(1) in association with the expression “for the
purposes of” is a word of wide connotation. In the context of a taxing statute,
the word “business” would signify an organised and continuous course of
commercial activity, which is carried on with the end in view of making or
earning profits. Under section 37(1), therefore, the connection has to be
established between the expenditure incurred and the activity undertaken by the
assessee with such object. The concept of business is not static. It has
evolved over a period of time to include within its fold the concrete
expression of care and concern for society at large and the people of the
locality in which the business is located in particular. It is not open to the
Court to go behind the commercial expediency which has to be determined from
the point of view of a businessman.

 

The test of
commercial expediency cannot be reduced to a ritualistic formula, nor can it be
put in a water-tight compartment. As long as the expenses are incurred wholly
and exclusively for the purpose of earning income from the business or
profession, merely because some of these expenses are incurred voluntarily,
i.e., without there being any legal or contractual obligation to incur them,
those expenses do not cease to be deductible in nature.

 

Explanation 2 to section 37(1) comes into play with effect from 1st
April, 2015. This disallowance is restricted to the expenses incurred by the
assessee under a statutory obligation u/s 135 of the Companies Act, 2013, and
there is thus now a line of demarcation between expenses incurred by the
assessee on discharging corporate social responsibility under such a statutory
obligation and under a voluntary assumption of responsibility. As for the
former, the disallowance under Explanation 2 to section 37(1) comes into play,
but for the latter there is no such disabling provision as long as the
expenses, even in discharge of corporate social responsibility on voluntary
basis, can be said to be “wholly and exclusively for the purposes of business”.

 

The assessee company was a polluting company. The assessee company was
conscious of its social obligations towards society at large. The assessee
company was a Government undertaking and, therefore, obliged to ensure
fulfilment of all the protective principles of State policy as enshrined in the
Constitution of India. The moneys had been spent for various purposes and could
not be regarded as outside the ambit of the business concerns of the assessee.
The order passed by the Appellate Tribunal was just and proper and needed no
interference in the present appeal.’

Appeal to Appellate Tribunal – Duty of Tribunal to decide appeal on merits – Rule 24 of ITAT Rules, 1963 Rectification of mistakes – Section 254 of ITA, 1961 – Order of Tribunal dismissing appeal ex parte for non-prosecution – Rejection of application for recall on ground of limitation – Not justified – Assessee granted liberty to apply for recall of order; A.Y. 2006-07

27. Golden
Times Services Pvt. Ltd. vs. Dy. CIT [2020]
422 ITR 102 (Del.) Date
of order: 13th January, 2020 A.Y.:
2006-07

 

Appeal to
Appellate Tribunal – Duty of Tribunal to decide appeal on merits – Rule 24 of
ITAT  Rules, 1963

 

Rectification
of mistakes – Section 254 of ITA, 1961 – Order of Tribunal dismissing appeal ex
parte for non-prosecution – Rejection of application for recall on ground
of limitation – Not justified – Assessee granted liberty to apply for recall of
order; A.Y. 2006-07

 

The relevant
year is the A.Y. 2006-07. In an appeal before the Income-tax Appellate Tribunal,
the petitioner company had challenged the addition of Rs. 19,00,000 which was
confirmed by the Commissioner (Appeals). The appeal was filed on 11th
December, 2014 and was heard on 30th August, 2016. The appeal was
dismissed by an order dated 18th October, 2016. In the said order,
the Tribunal, while noting that no one was present on behalf of the assessee at
the time of hearing, proceeded to dispose of the appeal, observing that notice
was sent to the assessee on 15th July, 2016 at the address mentioned
in the memo of appeal but despite that the assessee remained unrepresented. It
was further noted that the notice had come back unserved with a report that the
property was locked for quite some time. It was also noted that the earlier
notice, sent on 1st June, 2016 on the same address of the assessee,
had also been received back unserved with similar comments. The Tribunal, thus,
held that the assessee was presumably not serious in pursuing the appeal and
dismissed the same in limine. At the same time, the assessee was granted
liberty to approach the Income-tax Appellate Tribunal for a recall of the order
if it was able to show a reasonable cause for non-appearance. Thus, there was
no adjudication on the merits of the appeal.

 

On 8th February,
2018 when an inquiry was made about the status of the appeal, the petitioner
came to know that the appeal had been dismissed ex parte for
non-prosecution. Thereafter, on 8th March, 2018 an application was
filed for recall of the order dated 18th October, 2016. The petitioner
filed the application giving the grounds for non-appearance, with an
explanation that the absence was beyond its control. However, the application
was dismissed by an order dated 30th August, 2019 on the ground that
the same is barred by limitation u/s 254(2) of the Act.

 

The
petitioner filed a writ petition and challenged the order of the Tribunal. The
Delhi High Court allowed the writ petition and held as under:

 

‘i)   Rule 24 of the Income-tax (Appellate
Tribunal) Rules, 1963 mandates the Appellate Tribunal to decide the appeal on
its merits. It is the duty and obligation of the Appellate Tribunal to dispose
of the appeal on merits after giving both the parties an opportunity of being
heard. No limitation is provided in Rule 24 of the Rules.

 

ii)   Section 254(2) of the Income-tax Act, 1961
refers to suo motu exercise of the power of rectification by the
Appellate Tribunal, whereas the second part refers to rectification and
amendment on an application being made by the Assessing Officer or the assessee
pointing out the mistake apparent from the record. Section 254(2) was amended
by the Finance Act, 2016 with effect from 1st June, 2016 and the
words “four years from the date of the order” were substituted by
“six months from the end of the month in which the order was passed”.

 

iii)  Section 254(3) stipulates that the Appellate
Tribunal shall send a copy of the order passed by it to the assessee and the
Principal Commissioner. Further, Rule 35 of the Income-tax (Appellate Tribunal)
Rules, 1963 also requires that the orders are required to be communicated to
the parties. The section and the Rule mandate the communication of the order to
the parties. Thus, the date of communication or knowledge, actual or
constructive, of the orders sought to be rectified or amended u/s 254(2) of the
Act becomes critical and determinative for the commencement of the period of
limitation.

 

iv)  The appeal had been dismissed ex
parte for non-prosecution. At the same time, the assessee was granted
liberty to approach the Appellate Tribunal for recall of the order if it was
able to show a reasonable cause for non-appearance. Thus, there was no
adjudication on the merits of the appeal. The dismissal of the application for
recall of the order on the ground of limitation was not valid.

 

v)  The course adopted by the Appellate Tribunal
at the first instance, by dismissing the appeal for non-prosecution, and then
compounding the same by refusing to entertain the application for recall of the
order, cannot be sustained. We, therefore have no hesitation in quashing the
impugned order. Accordingly, the present petition is allowed. The order dated
30th August, 2019 is quashed and the matter is remanded back to the
Income-tax Appellate Tribunal with a direction that they shall hear and dispose
of I.T.A. No. 6739/Del/2014 on merits.’

Explanations 6 and 7 to section 9(1)(i) of the Act – Indirect transfer tests of 50% threshold of ‘substantial value’ (Explanation 6) and small shareholder (Explanation 7) are to be applied retrospectively

12. AAR No. 1555 to 1564 of 2013 A to J, In Re

 

Explanations 6 and 7 to section 9(1)(i) of
the Act – Indirect transfer tests of 50% threshold of ‘substantial value’
(Explanation 6) and small shareholder (Explanation 7) are to be applied
retrospectively

 

FACTS

In F.Y. 2013-14,
Applicant 1 (buyer, a Jersey-based company) and Applicant 2 (sellers /
shareholders based in the US, UK, Hong Kong and Cayman Islands) entered into a
transaction for sale of 100% shares of a British Virgin Islands-based company
(BVI Co). Individually, each seller had less than 5% shareholding in BVI Co.

 

BVI Co was a
multinational company and had subsidiaries across the globe. It indirectly held
100% shares in an Indian company (I Co) through a Mauritian company (Mau Co).
The sellers submitted the valuation report of the shares of BVI Co, as per
which the value derived directly or indirectly from assets located in India was
26.38%. The applicants approached AAR in December, 2013 with respect to
taxability arising in India as regards the transfer of the shares of BVI Co.

 

Indirect transfer
provisions were introduced in the Act in 2012. These were amended in 2015 by
introducing Explanation 6 and Explanation 7 to section 9(1)(i). The amended
provisions provided the following benchmarks:

  •     50%
    value threshold to ascertain substantial value of foreign shares or interest,
    from assets in India (50% threshold).
  •     Proportionate
    tax (i.e., to the extent of value of assets in India).
  •     Indirect
    provisions not to apply to shareholders having less than 5% shareholding, or
    voting power, or interest in foreign company or entity, if they have not
    participated in management and control during the 12-month period preceding the
    date of transfer (small shareholder exemption).

 

The question before
the AAR was whether amendments made in 2015 could be applied to a transaction
retrospectively?

 

HELD

  •     From
    2012 to 2015, the term ‘substantially’ was statutorily not defined, though it
    was interpreted by the High Court1 
    and the AAR2. Both rulings held that the term ‘substantially’
    would only include a case where shares of a foreign company derived at least
    50% of their value from assets in India.
  •     The
    provision inserted in 2015 begins with the expression ‘for the purposes of
    this clause, it is hereby declared…’.     Relying on the principles of
    statutory interpretation dealing with declaratory states3, AAR held
    that declaratory or curative amendments made ‘to explain’ an earlier provision
    of law should be given retrospective effect.
  •     Explanation
    6 pertaining to 50% threshold is clarificatory in nature. Similarly,
    Explanation 7 pertaining to small shareholder exemption is inserted to address
    genuine concerns of small shareholders. Hence, both should apply
    retrospectively to give a true meaning and make the indirect provisions
    workable.

 

The AAR concluded
on principles and did not adjudicate on valuation. It held that tax authorities
could scrutinise the valuation report to ascertain whether it met the 50%
threshold and satisfied the conditions of small shareholders exemption. 

______________________________________________

1   DIT
vs. Copal Research Ltd., Mauritius [2014] 49 taxmann.com 125 (Delhi)

2     GEA Refrigeration Technologies GmbH, In
re [2018] 89 taxmann.com 220 (AAR – New Delhi)

 

3   Principles
of Statutory Interpretation by Justice G.P. Singh (Sixth Edition 1996)

 

 

PRAYERS: OUR SEARCH ENGINE

In today’s technology-driven era, people
seeking information use Google or any other search engine. The search engine
being accessed does not have any data, it searches and lists out the websites
where the information being sought is available. The preciseness of such a
search depends on how specific is the question that is keyed in.

 

Leaving this discussion aside, let me take
up another aspect of our life – Prayers. Let me clarify here that by prayers I
am not referring to the scripted prayers pertaining to any religion or
community whatsoever, that I have been uttering without actually understanding
their meaning. Further, for prayers I don’t know why but I am taught to visit a
temple, stand in front of an idol, and so on.

 

What I am referring to by prayers here is
the ‘inner conversation’ that we hold with an unseen energy, ‘The Universe’.
May be, the conversation (inner talk) is initiated by the name and with the
imagination of a deity. Going deeper into this inner talk, what exactly am I
doing? Broadly, I am either in a mode of (1) gratitude, (2) seeking help, or
(3) seeking forgiveness.

 

While in the mode of ‘gratitude’, I
basically express my thankfulness for all that I have attained / achieved.
Being in satiety, my thought process is fine-tuned to the best with the
universe, thereby enabling me to take rational, considered decisions which
further uplifts me in all aspects of life.

 

In the mode of ‘seeking help’, I am, for
some moments, focusing on a particular issue that is being experienced or faced
by me, trying to narrate it as it is being experienced by me and raising a few
questions thereto which makes me uncomfortable. In the process, my clarity on
the issue magnifies and my thought process is energised on that precise issue.
In such a circumstance, I generate the possibilities which can resolve my
issues. I focus on them, short-list them and undertake that if it so happens,
then I would undertake some sort of sacrifice. Thus, I am committing myself to
work on the path of a possible solution. In this mode, the clearer I am in
focusing on the possible solutions, the higher is the possibility of the issue
getting resolved.

 

In the mode of ‘seeking forgiveness’, from
my inner-most thoughts I admit my wrong-doings and seek forgiveness from the
Universe. In the process, I realise my wrongs and, having realised them, would
certainly restrain myself from repeating them. This gets me to the mode of
improvement, upliftment, betterment. The more the clarity about my wrong deeds,
the more would be the tendency of avoiding repetition of such deeds.

 

Now, correlating the two seemingly
independent activities discussed above, viz., a search engine and a Prayer, the
similarity lies in the clarity of the question / issue being raised. Be it a
Google Search or be it a Prayer, clarity in you, your desires, as to what you
are seeking, is what leads you to the path of success. Yes, the analogy between
a ‘search engine’ and a ‘Prayer’ is that what a search engine does in the
‘world wide web (www)’ is what our Prayers do in the ‘Universe’.

 

This is like making a proper blue-print for
constructing a bridge. However, the blue-print does not give you a bridge. That
is not the result. Taking action in that direction is like constructing a
bridge after making a proper blue-print, leading to the destination and
fulfilment of desires. Without action, it is just a blue-print, lying in a
file, and nothing constructive about it.

 

To conclude, be it a search engine or a
Prayer, clarity (visualisation) followed by action is what leads to
actualisation. Hein ji, sab sambhav hai!  

ACCOUNTING RELIEF FOR RENT CONCESSIONS ON LEASES

On 28th May, 2020,
the International Accounting Standards Board (the IASB) finalised an amendment
to IFRS 16 Leases titled ‘Covid-19-Related Rent Concessions –
Amendment to IFRS 16’. The Institute of Chartered Accountants of India
(ICAI) has already issued an Exposure Draft mirroring the IFRS 16 amendment.
This will become a standard in India when it is notified by the Ministry of
Corporate Affairs (MCA).

 

The modified standard
provides lessees with an exemption from assessing whether a Covid-19-related
rent concession is a lease modification. The amendments require lessees that
have elected to apply the exemption to account for Covid-19-related rent
concessions as if they were not lease modifications. It may be noted that
accounting for lease modification can be very cumbersome and time consuming for
many lessees that have significant leases on their balance sheet. If the
modification accounting applies, a lessee does not recognise the benefits of
the rent concession in profit or loss straight away. Instead, the lessee will
recalculate its lease liability using a revised discount rate and adjust its
right-of-use assets. If the modification accounting does not apply, the profit
or loss impact of the rent concession would generally be more immediate.

 

The practical expedient in
many cases will be accounted for as a variable lease payment. If accounted for
as a variable lease payment, the concession is accounted for in profit or loss
in the period in which the event or condition that triggers those payments
occurs.

 

It may be noted that the
practical expedient is a choice and it is not mandatory to apply. The practical
expedient is not available to lessors. The practical expedient applies only to
rent concessions that meet all the following conditions (paragraphs 46A and
46B):

 

Condition 1
– The rent concession occurs as a direct consequence of the Covid-19 pandemic.

 

Condition 2
– The change in lease payments results in revised consideration for the lease
that is substantially the same as, or less than, the consideration for the
lease immediately preceding the change.

 

Condition 3
– Any reduction in lease payments affects only payments originally due on or
before 30th June, 2021.

 

Condition 4
– There is no substantive change to other terms and conditions of the lease.

 

Let’s take a few scenarios to
assess the applicability of the practical expedient.

 

ISSUE

Base fact
pattern

  •  Lessor leases commercial space to lessee,
  • Lease term is four years and rental is fixed at Rs. 4,000 p.m.

 

Whether practical expedient
is available in the following scenarios?

Scenario

Facts

Can practical
expedient be applied?

1

  •  Year 2020: Rent is reduced
    to Rs. 3,000 p.m. for May-July, 2020 due to business disruption as a result
    of Covid-19

 

  •  No change in subsequent years and no other change in


lease contract

Yes, as rent concession is as a direct
consequence of the Covid-19 pandemic and all the other three conditions are
also met

2

  •  Year
    2020: Rent is reduced to Rs. 3,000 p.m. for


May-July, 2020

 

  •   Year 2021: Rent for
    Aug.-Oct., 2021 is increased by Rs. 1,000 p.m. from the original rent. B will
    pay Rs. 5,000 p.m. for


Aug.-Oct., 2021

Yes, because reduction in lease payments affects
only payments originally due on or before 30th June, 2021.
Additionally, the increase in lease rental is beyond 30th June,
2021 and is in proportion to the concession provided. For Condition 3,
amendment acknowledges that a rent concession would meet this condition if it
results in reduced lease payments on or before 30th June, 2021 and
increased lease payments that extend beyond 30th June, 2021

3

  •  Lessor agreed for a six-month rent holiday from May – Oct., 2020, i.e.,
    concession of Rs. 24,000

 

  • However, in the month of March, 2021, the lessee pays this amount along with interest of Rs. 3,000, which totals to Rs. 27,000

 

Here, though there is a rent holiday, but those
rents are paid subsequently, along with interest. IASB has noted in their
basis of conclusion that if the cash flows have increased to compensate the
time value of money, it would appear to be appropriate for entities to assess
that Condition 2 is met. Other increases in consideration, such as penalties
that are included in the deferral, would cause this criterion to be not
satisfied

4

  • Year 2020 & 2021: Rent is reduced to Rs. 3,000 p.m. for May, 2020 – Dec.,
    2021

 

  • Year
    2022 & 2023: Rent for Jan. 2022 – Aug. 2023 is increased by Rs. 1,000
    p.m. from original rent. B will pay     Rs. 5,000 p.m. for Jan., 2022 – Aug., 2023

 

No. In this scenario, the rent reduction is as a
direct consequence of Covid. However, the reduction of Rs. 1,000 affects the
payments originally due for the period even beyond 30th June,
2021. The timeline prescribed in the amendment is purely rule-based. It would
not be appropriate to interpret it in such a way that rental concession can
be applied to the rent covering the period up to 30th June, 2021
and for rent changes beyond 30th June, 2021 the normal accounting
of lease modification can be applied. One should consider the changes in the
lease rentals in their entirety. It is not acceptable that rent concessions
are accounted such that one portion satisfies the criterion (i.e. May, 2020 –
June, 2021, i.e., 30th June is the date beyond which rent
concessions completely disqualify the entity from applying the accounting
relief) and the remaining portion, i.e., July, 2021 to August, 2023 does not
satisfy the criterion

5

  • Year 2020: Rent is reduced to Rs. 3,000 p.m. for


May-July, 2020

 

  • Year 2021: Rent for Aug.-Oct., 2021 is increased by Rs. 4,000 p.m. from original rent. B will pay Rs. 8,000 p.m. for
    Aug.-Oct., 2021

No, because the reduction is of Rs. 1,000 in 2020
but in 2021 the rent increased by Rs. 4,000 from original rent which is not
in proportion to the concession provided

6

  • Lessor offers to reduce the monthly rent on the condition that its space is
    reduced from 8,000 sq. ft. to 5,000 sq. ft.

No, it would be a substantive change to other
terms and conditions, and therefore the practical expedient would be unavailable
for that rent concession

7

  • Rent holiday for May-July, 2020

 

  • At the end of the lease term, it gets extended for three months on the terms
    and conditions contained in the original lease agreement

 

Yes, because the lease extension is not considered
as a substantive change to other terms and conditions of the lease. This
point has been clarified in basis for conclusion of the standard

 

 

 

Comparison
between applying the practical expedient and lease modification

Example –
rent abatement

Entity A leases retail space
from Entity B. As at 31st May, 2020, Entity B grants Entity A a
one-month rent abatement, where rent of Rs. 1 million that would otherwise be
due on 1st June, 2020 is unconditionally waived. The rent concession
satisfies the criteria to apply the practical expedient. The rent concession is
a lease modification because it is a change in consideration for a lease that
is not part of the original terms and conditions of the lease. The rent
concession meets the definition of a lease modification and it would be
accounted for as such if the practical expedient is not elected by Entity A.

           

 

Practical expedient not applied – lease
modification accounting (Ind AS 16.39 – 43)

Practical expedient is applied – variable lease
payment accounting [Ind AS 16.38(b)]

Effect on
lease liability

Reduced to
reflect the revised consideration

Reduced to
reflect the revised consideration

Effect on
discount rate

The total
revised, remaining consideration is re-measured using an updated discount rate
as at the effective date of the lease modification

No change
in discount rate

Effect on
right-of-use asset

The
offsetting adjustment is recorded against the carrying value of the
right-of-use asset

No effect

Effect on
profit or loss

None as at
the time of modification; but will result in modified finance expense and
depreciation in subsequent periods

The
offsetting adjustment is recorded in profit or loss

 

As is
visible from the above example, the practical expedient provides relief to the
lessee in the following ways:

(a) The lessee does not have to assess each rent
concession to determine whether it meets the definition of a lease
modification;

(b) It also simplifies the
calculations that are prepared by the lessee, since it does not require a revised
discount rate;

(c) The rent concession is accounted in profit or
loss in the period in which the event or condition that triggers the revised
consideration occurs, rather than being reflected in future periods as revised
finance expense and depreciation of the right-of-use asset.

 

CONCLUSION

The author believes that the
practical expedient is a welcome relief for lessees that have a large number of
leases, for example, airline, telecom, retail and other entities. However,
applying practical expedient may not be as simple as it appears and there could
be numerous complexities in determining what scenarios can be subjected to a
practical expedient, as well as the accounting of the practical expedient.

 

If the lessee applies the
practical expedient, it shall disclose if it has applied the expedient to all
lease contracts or the nature of the contracts to which it has applied the
expedient. The lessee should also disclose the P&L impact of applying the
practical expedient.

 

Article 13 of India-Mauritius DTAA; section 245R of the Act – As gain on sale of shares by a Mauritius company in a Singapore company which derived substantial value from assets in India was, prima facie, designed for avoidance of tax, applications were to be rejected under clause (iii) to proviso to section 245R(2) of the Act

11. [2020] 116
taxmann.com 878 (AAR-N. Del.) Tiger Global
International II Holdings, In re Date of order: 26th
March, 2020

 

Article 13 of
India-Mauritius DTAA; section 245R of the Act – As gain on sale of shares by a
Mauritius company in a Singapore company which derived substantial value from
assets in India was, prima facie, designed for avoidance of tax, applications
were to be rejected under clause (iii) to proviso to section 245R(2) of
the Act

 

FACTS

The applicants were
three Mauritius companies (Mau Cos), which were tax resident of Mauritius. They
were member companies of a private equity fund based in USA. Mau Cos
collectively invested in shares of a Singapore Company (Sing Co). Sing Co, in
turn, invested in multiple Indian companies. Sing Co derived substantial value
from assets located in India. All investments were made prior to 31st
March, 2017. The Mau Cos transferred their shares in Sing Co to an unrelated
Luxembourg buyer pursuant to contracts executed outside India.

 

Before executing
the transfer of shares, the applicants applied to tax authorities for nil
withholding certificate u/s 197. The applications were rejected on the ground
that the applicants did not qualify for benefit under the India-Mauritius DTAA.

 

The applicants
subsequently approached the AAR to determine the chargeability of share
transfer transaction to income tax in India. The tax authorities objected to
the admission of the application.

 

 

HELD

Pending
proceedings

  •     Proceedings relating to
    issue of nil withholding certificate are concluded when the certificate was
    issued by the tax authority.
  •     Even if the tax withholding
    certificate was applicable for the entire financial year and could have been
    modified, it could not be given effect to after the transaction was closed and
    payment was made.
  •     Accordingly, there was no
    pending proceeding on the date of making the application to the AAR.

 

Application
before AAR was concerned only with chargeability to tax and question of
determination of FMV did not arise

  •     The applications pertained
    only to determination of taxability of transfer of shares.
  •     Tax authority can undertake
    valuation of shares and computation of capital gains arising from shares only
    after the transaction is found to be exigible to tax. Therefore, the
    application cannot be rejected on this ground.

 

Prima facie avoidance
of tax

  •     At the stage of admission
    of the application before the AAR, there is no requirement to conclusively
    establish tax avoidance; rather, it only needs to be demonstrated that prime
    facie     the transaction was designed for avoidance of tax.
  •     The following factors
    established that the control and management of the Mau Cos was not in
    Mauritius:

•    Authorisation to operate bank account above
US $250,000 was with Mr. C who was not a Director of the Mau Co but was the
ultimate owner of the PE Fund.

•    Since the applicants were located in
Mauritius, logically a Mauritius resident should have been authorised to sign
cheques and operate bank accounts. However, the applicants could not justify
why Mr. C was authorised to do so.

•    Since Mr. C was the beneficial owner of the parent
company of the applicants and also the sole director of the ultimate holding
company, the authorisation given to him was not coincidental. This fact
established that the funds were controlled by Mr. C.

•    Further, Mr. S (US resident general counsel
of the PE fund) was present in all the Board meetings where decisions on
investment and sale of securities were taken. Despite this, decisions in
respect of any transaction over US $250,000 were taken by Mr. C. This suggested
that notwithstanding that decisions were undertaken by the Board of Directors
of the applicants, these were ultimately under the control of Mr. C because of
his power to operate bank accounts.

•    Thus, the real management and control of the
applicants was not with the Board of Directors, but with Mr. C who was the
beneficial owner of the group. The Mau Cos were only pass-through entities set
up to avail the benefits of the India-Mauritius DTAA.

  •     Hence, prima facie, the transaction
    was designed for avoidance of tax and, accordingly, it could not be admitted.

 

Applicability
of India-Mauritius DTAA

•    The Mau Cos derived gains from transfer of
shares of the Sing Co and not those of the I Cos. The India-Mauritius DTAA
(post-2016 amendment), as also Circular No. 682 dated 30th March,
1994 suggest that the intent of the DTAA is only to protect gains from transfer
of shares of an Indian company and not transfer of shares of a Singapore
company. Exemption from capital gains tax on sale of shares of a company not
resident in India was never intended under the original or the amended DTAA
between India and Mauritius.

 

Section 271(1)(c) – Disallowance u/s 43B in respect of service tax, not debited to P&L, does not attract penalty u/s 271(1)(c)

10. C.S.
Datamation Research Services Pvt. Ltd. vs. ITO (Delhi) R.K. Panda (A.M.) and Amit Shukla (J.M.) ITA No. 3915/Delhi/2016 A.Y.: 2011-12 Date of order: 15th June, 2020

Counsel
for Assessee / Revenue: Salil Kapoor / Jagdish Singh

 

Section 271(1)(c) – Disallowance u/s 43B in
respect of service tax, not debited to P&L, does not attract penalty u/s
271(1)(c)

 

FACTS

The assessee
company, engaged in the business of manpower supply and operational support,
filed its return of income on 24th March, 2012 declaring an income
of Rs. 33,89,810. On being asked by the A.O. to furnish complete details of
‘other liabilities’ of Rs. 4,61,10,276 under the head Current Liabilities, the
assessee filed a revised computation of income wherein it included an amount of
Rs. 1,45,61,540 being amount disallowable u/s 43B of the IT Act due to
non-payment of service tax. The A.O. noted from the tax audit report that there
is clear mention of this amount as having not been paid within the stipulated
time period and disallowable u/s 43B. Since the tax audit report was not
furnished along with the return of income, the A.O. held that it was a
deliberate attempt on the part of the assessee to suppress the amount. The A.O.
thereafter completed the assessment at a total income of Rs. 1,79,51,350
wherein he made an addition of Rs. 1,45,61,540 being the amount of service tax
disallowable u/s 43B.

 

The assessee
did not prefer any appeal against this order. Subsequently, the A.O. initiated
penalty proceedings u/s 271(1)(c). Rejecting various explanations given by the
assessee and observing that the assessee has concealed its particulars of
income and furnished inaccurate particulars, the A.O. levied penalty of Rs.
48,36,979 being 100% of the tax sought to be evaded u/s 271(1)(c).

 

Aggrieved,
the assessee preferred an appeal to the CIT(A) who upheld the action of the
A.O.

 

Still
aggrieved, the assessee preferred an appeal to the Tribunal where it contended
that the notice was bad in law since the A.O. had not struck off the
inappropriate words and also that, on merits, the penalty is not leviable.

 

HELD

The Tribunal
held that the levy of penalty u/s 271(1)(c) is not valid in law in view of
non-striking off of the inappropriate words in the penalty notice.

 

On merits,
the Tribunal noted that the Hon’ble Delhi High Court in the case of Noble
& Hewitt (I) (P) Ltd. (305 ITR 324) has held that where the
assessee did not debit the amount to the P&L account as an expenditure nor
did the assessee claim any deduction in respect of the amount where the
assessee was following mercantile system of accounting, the question of
disallowing the deduction not claimed would not arise.

 

The CIT(A) in
the assessee’s own case for A.Y. 2012-13, deleted the addition of unpaid
service tax amounting to Rs. 94,68,278 which was added back by the assessee in
its revised computation of income, and Revenue had not preferred any appeal
against the order of the CIT(A) deleting the addition made by the A.O. on
account of the unpaid service tax liability, although the assessee in its
revised computation of income had added the same u/s 43B. Therefore, the issue
as to addition u/s 43B on account of non-payment of service tax liability when
the same has not been debited in the P&L account nor claimed as an expenditure,
has become a debatable issue. It has been held in various decisions that
penalty u/s 271(1)(c) is not leviable on account of additions which are
debatable issues.

 

The Tribunal
held that even on merits penalty u/s 271(1)(c) is not leviable

 

The appeal filed by the assessee was allowed.

Section 148 – Assessment completed pursuant to a notice u/s 148 of the Act issued mechanically without application of mind is void and bad in law

9. Omvir Singh vs. ITO (Delhi) N.K.
Billaiya (A.M.) and Ms Suchitra Kamble (J.M.) ITA No. 7347/Delhi/2018 A.Y.: 2009-10 Date of order: 11th June, 2020

Counsel
for Assessee / Revenue: Rohit Tiwari / R.K. Gupta

 

Section 148 – Assessment completed pursuant
to a notice u/s 148 of the Act issued mechanically without application of mind
is void and bad in law

 

FACTS

The A.O., based on AIR information that the
assessee has deposited a sum of Rs. 19.19 lakhs in his savings bank account
maintained with Bank of India, Mehroli, Ghaziabad, issued a notice u/s 148 of
the Act along with other statutory notices. No one attended the assessment
proceedings and no return was filed in response to the notice u/s 148. The A.O.
proceeded to complete the assessment ex parte. Cash deposit of Rs.
19,19,333 was treated as unexplained and added to the returned income of the
assessee.

 

Aggrieved,
the assessee preferred an appeal to the CIT(A) and questioned the validity of
the notice u/s 148, and furnished some additional evidence invoking Rule 46A of
the I.T. Rules. The CIT(A) did not admit the additional evidence and confirmed
the addition made by the A.O.

Aggrieved,
the assessee preferred an appeal to the Tribunal raising two-fold grievances,
viz. the issuance of notice u/s 148 is not as per the provisions of law and the
addition of Rs. 19,19,333 made by the A.O. in respect of cash found to be
deposited in the savings bank account is incorrect.

 

HELD

The Tribunal
noted that the undisputed fact is that in the proforma for recording reasons
for initiating proceedings u/s 148, under Item No. 8A the question is ‘Whether
any voluntary return had been filed’ and the answer is mentioned as ‘No’.
Whereas Exhibit Nos. 6 and 7 show that the return of income was filed with Ward
2(1), Ghaziabad on 30th March. 2010 and the notice u/s 148 is dated
3rd February, 2016.

 

This clearly
shows that the A.O. issued the notice mechanically without applying his mind.
Such action by the A.O. did not find any favour with the Hon’ble High Court of
Delhi in the case of RMG Polyvinyl [I] Ltd. (396 ITR 5).

 

The Tribunal,
having noted that the facts of the instant case were identical to the facts of
the case before the Delhi High Court in RMG Polyvinyl (I) Ltd. (Supra)
followed the said decision and held that the A.O. wrongly assumed jurisdiction,
and accordingly it quashed the notice u/s 148 of the Act, thereby quashing the
assessment order.

 

The appeal
filed by the assessee was allowed.

 

Notional interest on security deposit received from lessee is not taxable even during the period when the property was sold, but the deposit continued with the lessee as the lease agreement had lock-in clause Only the incomes which fall under the deemed provisions which have been explicitly mentioned in the Act can be brought to tax under the deeming provisions but not any other notional or hypothetical income not envisaged by the Act

8. Harvansh
Chawla vs. ACIT (Delhi) Sushma Chowla (V.P.) and Dr. B.R.R. Kumar (A.M.) ITA No.
300/Delhi/2020 A.Y.: 2017-18 Date of
order: 3rd June, 2020

Counsel for Assessee / Revenue: Rohit Tiwari / Anupam Kant Garg

 

Notional interest on security deposit received
from lessee is not taxable even during the period when the property was sold,
but the deposit continued with the lessee as the lease agreement had lock-in
clause

 

Only the
incomes which fall under the deemed provisions which have been explicitly
mentioned in the Act can be brought to tax under the deeming provisions but not
any other notional or hypothetical income not envisaged by the Act

 

FACTS

The assessee
owned a property in DLF, Phase-II, Gurgaon against which he received a security
deposit of Rs. 5,29,55,200 for leasing the same. During the year, no rent was
offered to tax and on inquiry it was found that the said property had been sold
for Rs. 2.75 crores in the year 2013-14, hence no income from rentals was
offered. However, the assessee continued to hold the security deposit of Rs.
5.29 crores as the lease agreement had a lock-in period.

 

The A.O.
charged to tax a sum of Rs. 63,54,632 under the head ‘Income from Other
Sources’ being the amount deemed to have been derived from such security
deposit.

 

Aggrieved,
the assessee preferred an appeal to the CIT(A) who confirmed the action of the
A.O. on the ground that the assessee is benefited by way of having the deposit
still lying with him.

 

The assessee
then preferred an appeal to the Tribunal.

 

HELD

The Tribunal
observed that –

(i)   the issue before it is whether notional
interest is taxable as per the provisions of the Act or not;

(ii)  the issue as to how to treat the security
deposit after the completion of the lock-in period is not the issue
before it;

(iii) the A.O. has not brought forth anything about
earning of interest by the assessee which has not been offered to tax;

(iv) the addition was on the sole premise that the
assessee having the security deposit must have earned the interest.

 

The Tribunal
held that in order to tax any amount, the Revenue has to prove that the amount
has indeed been earned by the assessee. Only the incomes which fall under the
deemed provisions which have been explicitly mentioned in the Act can be
brought to tax under the deeming provision but not any other notional or
hypothetical income not envisaged by the Act. The Tribunal directed that the
addition made by the A.O. on account of notional income on the security deposit
cannot be held to be legally valid.

 

Section 153C – Assessment u/s 153C which has been initiated without issuance of notice u/s 153C is bad in law

7. Krez Hotel
& Reality Ltd. (formerly Jaykaydee Industries Ltd.) vs. JCIT (Mumbai) Shamim Yahya
(A.M.) ITA No.
2588/Mum/2018 A.Y.: 2008-09 Date of
order: 16th June, 2020

Counsel for Assessee / Revenue: Mani Jani & Prateek Jain /
Chaitanya Anjaria

 

Section 153C
– Assessment u/s 153C which has been initiated without issuance of notice u/s
153C is bad in law

 

FACTS

In this case,
the assessee preferred an appeal against the order dated 30th
October, 2014 passed by the CIT(A). Although various grounds were taken in
appeal, one of the grounds pressed was that the A.O. did not have valid
jurisdiction to make the assessment.

 

Before the
CIT(A) also, the assessee raised an additional ground contending that the
assessment was bad in law since, for the impugned assessment year, the
proceedings were not initiated by issue of notice u/s 153C of the Act.

 

The CIT(A)
rejected the assessee’s claim referring to the decision of the Indore Bench of
the Tribunal in the case of .

 

Aggrieved,
the assessee preferred an appeal to the Tribunal contending that the issue is
squarely covered by the decision of the Delhi High Court mentioned in the
decision of the ITAT Delhi Bench in ITA No. 504/Del/2015 vide
order dated 27th June, 2018.

 

HELD

The Tribunal,
after noting the ratio of the decision of the Delhi High Court (Supra)
held that in a case where the assessment is to be framed u/s 153C of
the Act, the proceedings should be initiated by first issuing such a notice.
The issue of such notice is mandatory and a condition precedent for taking
action against the assessee u/s 153C. The assessment order passed without
issuance of notice u/s 153C was held by the Court to be void, illegal and bad
in law.

 

The Tribunal
examined the present case on the touchstone of the ratio of the decision
of the Delhi High Court and found that the A.O. had not issued notice u/s 153C.
This, the Tribunal held, is fatal. Following the above-stated precedent, the
Tribunal set aside the order of the authorities below and held that the
assessment was devoid of jurisdiction.

 

This ground
of appeal filed by the assessee was allowed.

Rule 34 of the Income-tax Appellate Tribunal Rules – The period of 90 days prescribed in Rule 34(5) needs to be computed by excluding the period during which lockdown was in force

15. [2020] 116 taxmann.com 565 (Mum.)(Trib.) DCIT vs. JSW Ltd. ITA Nos. 6103 & 6264/Mum/2018 A.Y.: 2013-14 Date of order: 14th May, 2020

 

Rule 34 of the Income-tax Appellate
Tribunal Rules – The period of 90 days prescribed in Rule 34(5) needs to be
computed by excluding the period during which lockdown was in force

 

FACTS

In this case, the hearing of the appeal was concluded on 7th
January, 2020 whereas the order was pronounced on 14th May, 2020,
i.e. much after the expiry of 90 days from the date of conclusion of hearing.
The Tribunal, in the order, suo motu dealt with the procedural issue of
the order having been pronounced after the expiry of 90 days of the date of
conclusion of the hearing. The Tribunal noted the provisions of Rule 34(5) and
dealt with the same.

 

HELD

The Tribunal noted
that Rule 34(5) was inserted as a result of the directions of the Bombay High
Court in the case of Shivsagar Veg Restaurant vs. ACIT [(2009) 317 ITR
433 (Bom.)]. In the rule so framed as a result of these directions, the
expression ‘ordinarily’ has been inserted in the requirement to pronounce the
order within a period of 90 days. It observed that the question then arises
whether the passing of this order beyond 90 days was necessitated by any
‘extraordinary’ circumstances.

It also took note of the prevailing unprecedented situation and the
order dated 6th May, 2020 read with the order dated 23rd
March, 2020 passed by the Apex Court, extending the limitation to exclude not
only this lockdown period but also a few more days prior to, and after, the
lockdown by observing that ‘In case the limitation has expired after 15th
March, 2020 then the period from 15th March, 2020 till the date
on which the lockdown is lifted in the jurisdictional area where the dispute
lies or where the cause of action arises shall be extended for a period of 15
days after the lifting of lockdown’.

 

The Tribunal also
noted that the Hon’ble Bombay High Court, in an order dated 15th
April, 2020 has, besides extending the validity of all interim orders, also
observed that, ‘It is also clarified that while calculating time for
disposal of matters made time-bound by this Court, the period for which the
order dated 26th March, 2020 continues to operate shall be added and
time shall stand extended accordingly’, and also observed that the
‘arrangement continued by an order dated 26th March, 2020 till 30th
April, 2020 shall continue further till 15th June, 2020’.

 

The extraordinary
steps taken suo motu by the Hon’ble jurisdictional High Court and the
Hon’ble Supreme Court also indicate that this period of lockdown cannot be
treated as an ordinary period during which the normal time limits are to remain
in force.

 

The Tribunal held
that even without the words ‘ordinarily’, in the light of the above analysis of
the legal position, the period during which lockout was in force is to be
excluded for the purpose of time limits set out in Rule 34(5) of the Appellate
Tribunal Rules, 1963.

 

The order was
pronounced under Rule 34(4) of the Income Tax (Appellate Tribunal) Rules, 1962,
by placing the details on the notice board.

 

Section 143(3), CBDT Instruction No. 5/2016 – Assessment order passed upon conversion of case from limited scrutiny to complete scrutiny, in violation of CBDT Instruction No. 5/2016, is a nullity

14. TS-279-ITAT-2020 (Delhi) Dev Milk Foods Pvt. Ltd. vs. Addl. CIT ITA No. 6767/Del/2019 A.Y.: 2015-16 Date of order: 12th June, 2020

 

Section 143(3), CBDT Instruction No. 5/2016
– Assessment order passed upon conversion of case from limited scrutiny to
complete scrutiny, in violation of CBDT Instruction No. 5/2016, is a nullity

 

FACTS

For assessment year
2015-16, the assessee filed its return of income declaring a total income of
Rs. 19,44,88,700. The case was selected for limited scrutiny through CASS.

 

In the assessment
order, the A.O. stated that the assessee’s case was selected for limited
scrutiny with respect to long-term capital gains but it was noticed that the
assessee had claimed a short-term capital loss of Rs. 4,20,94,764 which had
been adjusted against the long-term capital gains. The A.O. was of the view
that the loss claimed by the assessee appeared to be suspicious in nature
primarily because the loss could possibly have been created to reduce the
incidence of tax on long-term capital gains shown by the assessee. The A.O.
further stated in the assessment order that in order to verify this aspect,
approval of the Learned Principal Commissioner of Income Tax (PCIT) was taken
to convert the case from limited scrutiny to complete scrutiny and that the
assessee was also intimated about the change in status of the case.

 

The A.O. held that
the purchase of shares did not take place and the transactions were sham in
view of documentary evidence, circumstantial evidence, human conduct and
preponderance of probabilities. He observed that the entire exercise was a
device to avoid tax. The A.O. completed the assessment u/s 143(3) after making
an addition of Rs. 4,20,94,764 on account of disallowance of short-term capital
loss, Rs. 8,41,895 for alleged unexplained expenditure on commission, and Rs.
1,93,20,000 on account of difference in computation of long-term capital gains.
Thus, the total income was computed by the A.O. at Rs. 25,67,43,360.

 

Aggrieved, the
assessee preferred an appeal to the CIT(A) who upheld the additions made by the
A.O. on merits.

 

The assessee
preferred an appeal to the Tribunal challenging the validity of the order
passed by the A.O. inter alia on the ground that the return was
primarily selected for limited scrutiny only on the limited issue of long-term
capital gains (LTCG) on which aspect, as per the order of the CIT(A), there
remains no existing addition, and conversion of limited scrutiny to complete
scrutiny was on mere suspicion only and for verification only, on the basis of
invalid approval of the PCIT-3; consequently, the entire addition on account of
disallowance of short-term capital loss of Rs. 4,20,94,764 and Rs. 8,41,895 as
alleged unexplained commission expense is not as per CBDT instructions (refer
Instruction Nos. 19 and 20/2015 of 29th December, 2015) on the
subject and is ultra vires of the provisions of the Act.

 

HELD

The Tribunal, on
perusal of the instructions issued by CBDT vide its letter No. DGIT
VIF/HQ SI/2017-18 dated 30th November, 2017, observed that the
objective behind the issuance of these instructions is to (i) prevent the
possibility of fishing and roving inquiries; (ii) ensure maximum objectivity;
and (iii) enforce checks and balances upon the powers of an A.O.

 

The Tribunal
observed that the proposal drafted by the A.O. on 5th October, 2017
for converting the case from limited scrutiny to complete scrutiny and the
original order sheet entries, do not have an iota of any cogent material
mentioned by the A.O. which enabled him to reach the conclusion that this was a
fit case for conversion from limited scrutiny to complete scrutiny.

 

Examining the
proposal of the A.O. of 5th October, 2017 and the approval of the
PCIT dated 10th October, 2017 on the anvil of paragraph 3 of CBDT
Instruction No. 5/2016, the Tribunal held that no reasonable view is formed as
mandated in the said Instruction in an objective manner, and secondly, merely
suspicion and inference is the foundation of the view of the A.O. The Tribunal
also noted that no direct nexus has been brought on record by the A.O. in the
said proposal and, therefore, it was very much apparent that the proposal of
converting the limited scrutiny to complete scrutiny was merely aimed at making
fishing inquiries. It also noted that the PCIT accorded the approval in a
mechanical manner which is in clear violation of the CBDT Instruction No.
20/2015.

The Tribunal noted
that the co-ordinate bench of the ITAT at Chandigarh in the case of Payal
Kumari in ITA No. 23/Chd/2011, vide order dated 24th
February, 2011 has held that even section 292BB of the Act cannot save
the infirmity arising from infraction of CBDT Instructions dealing with the
subject of scrutiny assessments where an assessment has been framed in direct
conflict with the guidelines issued by the CBDT.

 

In this case, the
Tribunal held that the instant conversion of the case from limited scrutiny to
complete scrutiny cannot be upheld as the same is found to be in total violation
of CBDT Instruction No. 5/2016. Accordingly, the entire assessment proceedings
do not have any leg to stand on. The Tribunal held the assessment order to be
null and quashed the same.

 

The appeal filed by
the assessee was allowed.

 

Section 5 – When an assessee had an obligation to perform something and the assessee had not performed those obligations, nor does he even seem to be in a position to perform those obligations, a partial payment for fulfilling those obligations cannot be treated as income in the hands of the assessee

13. [2020] 116
taxmann.com 898 (Mum.) ITO vs. Newtech
(India) Developers ITA No.
3251/Mum/2018 A.Y.: 2009-10 Date of order: 27th
May, 2020

 

Section 5 – When
an assessee had an obligation to perform something and the assessee had not
performed those obligations, nor does he even seem to be in a position to
perform those obligations, a partial payment for fulfilling those obligations
cannot be treated as income in the hands of the assessee

 

FACTS

The assessee, under
the joint venture agreement entered into by it with Shivalik Ventures Pvt.
Ltd., was to receive Rs. 5.40 crores on account of development rights from the
joint venture and this payment was to be entirely funded by Shivalik Ventures
Pvt. Ltd., the other participant in the joint venture. Out of this amount, the
assessee was paid Rs. 86.40 lakhs at the time of entering into the joint
venture agreement, Rs. 226.80 lakhs was to be paid on ‘obtaining IOA and
commencement certificate’ by the joint venture, and Rs. 226.80 lakhs was to be
paid upon ‘all the slum-dwellers vacating said property and shifting to
alternate temporary transit accommodation.’

 

In terms of the
arrangement the amount of Rs. 86.40 lakhs was to be treated as an advance until
the point of time when at least 25% of the slum-dwellers occupying the said
property vacated the premises. The agreement also provided that in case the
assessee was unable to get at least 25% of the slum-dwellers occupying the said
property to vacate the occupied property in five years, the entire money will
have to be refunded to Shivalik Ventures Pvt. Ltd., though without any
interest, within 60 days of the completion of the five years’ time limit.
However, even till the time the re-assessment proceedings were going on, the
assessee had not been able to get the occupants of the property to vacate it.
In the financial statements, the amount of Rs. 86,40,000 received was reflected
as advance received.

 

The assessee was of
the view that no income has arisen in the hands of the assessee in respect of
the above-mentioned transaction. However, the A.O. was of the view that under
the mercantile method of accounting followed by the assessee, the transactions
are recognised as and when they take place and under this method, the revenue
is recorded when it is earned and the expenses are reported when they are
incurred. He held that the assessee has already received an amount of Rs.
86,40,000 during the year and the balance amount will be received by him in
instalments after the fulfilment of the conditions as mentioned in the
agreement. As regards the agreement terms, the A.O. was of the view that since
the stipulation about the payment being treated as an advance till at least 25%
occupants have vacated the property was by way of a modification agreement, it
was nothing but a colourable device to evade taxes.

 

The A.O., in an
order passed u/s 147 r/w/s 143(3) of the Act, taxed the entire amount of Rs. 5,40,00,000
in the year under consideration.

 

Aggrieved, the
assessee preferred an appeal to the CIT(A) who held that the crux of the issue
was whether income had accrued to the assessee. The basic concept is that the
assessee should have acquired a right to receive the income. Drawing support
from the decisions of the Tribunal in R & A Corporate Consultants
India vs. ACIT (ITA No. 222/Hyd/2012) and K.K. Khullar vs. Deputy
Commissioner of Income Tax – 2008 (1) TMI 447 – ITAT Delhi-I, the
CIT(A) held that income can be considered to accrue or arise only when the
assessee is able to evacuate 25% slum-dwellers as per the agreement / deed. If
the assessee is unable to comply with this, the assessee will have to return
the sum to Shivalik.

 

The Revenue was
aggrieved by this and preferred an appeal to the Tribunal,

 

HELD

The Tribunal
observed that –

i)   the payment to be received by the assessee
was for performance of its obligations under the joint venture agreement;

ii)   when an assessee had an obligation to perform
something and the assessee had not performed those obligations, nor did he even
seem to be in a position to perform those obligations, it cannot be said that a
partial payment for fulfilling the obligations can be treated as income in the
hands of the assessee;

iii)  it was a composite agreement and, irrespective
of whether the modifications are looked at or not, all the terms of the
agreement are to be read in conjunction with each other;

iv)  what essentially flows from the decision of
the Apex Court in E.D. Sassoon & Co. Ltd. vs. CT [(1954) 36 ITR 27
(SC)] is that a receipt cannot have an income character in the hands of
the person who is still to perform the obligations, if the amount to be
received is for performance of such obligations;

v)  since the obligations of the assessee under
the joint venture agreement are not yet performed, there cannot be any occasion
to bring the consideration for performance of such obligations to tax;

vi)  the very foundation of the impugned taxability
is thus devoid of any legally sustainable basis.

 

As regards the
supplementary agreement, it observed that even if the same were to be
disregarded, income could accrue only on performance of obligations under the
joint venture agreement. In any case, it cannot be open to the A.O. to
disregard the supplementary, or modification whichever way one terms it, only
because its result is clear and unambiguous negation of tax liability in the
hands of the assessee. It also observed that whether the amount is actually
refunded or not, nothing turns on that aspect either.

 

Under the terms of
the joint venture agreement, the assessee was to receive the payment for
performance of its obligations under the agreement and in view of the
uncontroverted stand of the assessee that the obligations have not been
performed till date, the Tribunal held that the income in question never
accrued to the assessee.

The Tribunal held
that the taxability of Rs. 5.40 crores, on account of what is alleged to be
transfer of development rights, is wholly devoid of merits.

 

The appeal filed by
the Revenue was dismissed.

 

CAN AGRICULTURAL LAND BE WILLED TO A NON-AGRICULTURIST?

INTRODUCTION

A person can
make a Will for any asset that he owns, subject to statutory restrictions, if
any. For instance, in the State of Maharashtra a person cannot make a Will for
any premises of which he is a tenant. A similar question that arises is, ‘Can
a person make a Will in respect of his agricultural land?’ A
Three-Judge Bench of the Supreme Court had an occasion to decide this very
important issue in the case of Vinodchandra Sakarlal Kapadia vs. State of
Gujarat, CA No. 2573/2000, order dated 15th June, 2020.

 

APPLICABLE LAW

It may be noted that Indian
land laws are a specie in themselves. Even within land laws, laws relating to
agricultural land can be classified as a separate class. Agricultural land in
Maharashtra is governed by several Acts, the prominent amongst them being the
Maharashtra Land Revenue Code, 1966; the Maharashtra Tenancy and Agricultural
Lands Act, 1948; the Maharashtra Agricultural Lands (Ceiling on Holdings) Act,
1961; etc.

 

The Maharashtra Tenancy and
Agricultural Lands Act, 1948 (‘the Act’), which was earlier known as the Bombay
Tenancy and Agricultural Lands Act, 1948, lays down the situations under which
agricultural land can be transferred to a non-agriculturist. The Act is
applicable to the Bombay area of the State of Maharashtra. The Bombay
Reorganisation Act, 1960 divided the State of Bombay into two parts, namely,
Maharashtra and Gujarat. The Act is in force in most of Maharashtra and the
whole of Gujarat.

 

PROHIBITIONS UNDER THE ACT

Under section 63 of the Act,
any transfer, i.e., sale, gift, exchange, lease, mortgage, with possession of
agricultural land in favour of any non-agriculturist shall not be valid unless
it is in accordance with the provisions of the Act. The terms sale, gift,
exchange and mortgage are not defined in this Act, and hence the definitions
given under the Transfer of Property Act, 1882 would apply.

This section could be
regarded as one of the most vital provisions of this Act since it regulates
transactions of agricultural land involving non-agriculturists. Even if a
person is an agriculturist of another state, say Punjab, and he wants to buy
agricultural land in Maharashtra, then section 63 would apply. The above
transfers can be done with the prior permission of the Collector subject to
such conditions as he deems fit.

 

If land is transferred in
violation of section 63, then u/s 84C the transfer becomes invalid on an order
so made by the Mamlatdar. If the parties give an undertaking that they
would restore the land to its original position within three months, then the
transfer does not become invalid. Once an order is so made by the Mamlatdar,
the land vests in the State Government. The amount received by the transferor
for selling the land shall be deemed to be forfeited in favour of the State.

 

Further, section 43 of the
Act states that any land or any interest therein purchased by a tenant cannot
be transferred by way of sale or assignment without the Collector’s
permission. However, such a permission is not needed if the partition of the
land is among the members of the family who have direct blood relations, or
among the legal heirs of the tenant.

 

Sections 43 and 63 may be
considered to be the most important provisions of the Act. In this background,
let us consider a case decided by the Supreme Court recently.

 

FACTS OF THE CASE

The
facts in the case before the Supreme Court were very straight forward. An
agriculturist executed a Will for the agricultural land that he owned in
Gujarat in favour of a non-agriculturist. On the demise of the testator, the
beneficiary applied for transferring the land records in his favour. The
Revenue authorities, however, found that he was not an agriculturist and
accordingly proceedings u/s 84C of the Act were registered and notice was
issued to the appellant.

Ultimately, the Mamlatdar passed
an order that disposal by way of a Will in favour of the appellant was invalid
and contrary to the principles of section 63 of the Act and therefore declared
that the said land vested in the State without any encumbrances. A Single Judge
of the Gujarat High Court in Ghanshyambhai Nabheram vs. State of Gujarat
[1999 (2) GLR 1061] took the view that section 63 of the Act cannot
deprive a non-agriculturist of his inheritance, a legatee under a Will can also
be a non-agriculturist. Accordingly, the matter reached the Division Bench of
the Gujarat High Court which upheld the order of the Mamlatdar and held:

 

‘….Act has
not authorised parting of agricultural land to a non-agriculturist without the
permission of the authorised officer, therefore, if it is permitted through a
testamentary disposition, it will be defeating the very soul of the
legislation, which cannot be permitted. We wonder when testator statutorily
debarred from transferring the agricultural lands to a non-agriculturist during
his life time, then how can he be permitted to make a declaration of his
intention to transfer agricultural land to a non-agriculturist to be operative
after his death. Such attempt of testator, in our view, is clearly against the
public policy and would defeat the object and purpose of the Tenancy Act…
Obvious purpose of Section 63 is to prevent indiscriminate conversion of
agricultural lands for non-agricultural purpose and that provision strengthens
the presumption that agricultural land is not to be used as per the holders
caprice or sweet-will (sic)’.

 

The same view was taken by
the High Court in a host of cases.

 

ISSUE IN QUESTION

The issue reached the Supreme
Court and the question to be considered by it was whether sections 63 and 43 of
the Act debarred an agriculturist from transmitting his agricultural land to a
non-agriculturist through a ‘Will’ and whether the Act restricted the transfer
/ assignment of any land by a tenant through a Will?

 

DECISION OF THE APEX COURT

The Supreme Court in the case
of Vinod (Supra) observed that a two-member Bench (of the Apex
Court) in Mahadeo (Dead through LR) vs. Shakuntalabai (2017) 13 SCC 756
had dealt with section 57 of the Bombay Tenancy and Agricultural Lands Act,
1958 as applicable to the Vidarbha region of the State of Maharashtra. In that
case, it was held that there was no prohibition insofar as the transfer of land
by way of a Will is concerned. It held that a transfer is normally between two
living persons during their lifetime. A Will takes effect after the demise of the
testator and transfer in that perspective becomes incongruous. However, the
Court in Vinod (Supra) observed that its earlier decision in Mahadeo
(Supra) was rendered per incuriam since other, earlier contrary
decisions of the Supreme Court were not brought to the notice of the Bench and
hence not considered.

 

It held that a tenancy
governed by a statute which prohibits assignment cannot be willed away to a
total stranger. A transfer inter vivo would normally be for
consideration where the transferor gets value for the land but the legislation
requires previous sanction of the Collector so that the transferee can step
into the shoes of the transferor. Thus, the screening whether a transferee is
eligible or not can be undertaken even before the actual transfer is effected.
The Court observed that as against this, if a Will (which does not have the
element of consideration) is permitted without permission, then the land can be
bequeathed to a total stranger and a non-agriculturist who may not cultivate
the land himself; which in turn may then lead to engagement of somebody as a
tenant on the land. The legislative intent to do away with absentee landlordism
and to protect the cultivating tenants, and to establish direct relationship
between the cultivator and the land, would then be rendered otiose.

 

Accordingly, the Court held
that the restriction on ‘assignment’ without permission in the Act must include
testamentary disposition as well. By adopting such a construction, the statute
would succeed in attaining the object sought to be achieved.

 

It also cautioned against the
repercussions of adopting a contrary view. If it was held that a Will would not
be covered by the Act, then a gullible person could be made to execute a Will
in favour of a person who may not fulfil the requirements and may not be
eligible to be a transferee under the Act. This may not only render the natural
heirs of the tenant without any support or sustenance, but may also have a
serious impact on agricultural operations. It held that agriculture was the
main source of livelihood in India and hence the restrictions under the Act
cannot be given the go-by by such a devise.

 

Another connected question
considered was whether any prohibition in State enactments which were
inconsistent with a Central legislation, such as, the Indian Succession Act,
1925 must be held to be void? The Court held that the power of the State
Legislature to make a law with respect to transfer and alienation of
agricultural land stemmed from Entry 18 in List II of the Constitution of
India. This power carried with it the power to make a law placing restrictions
on transfers and alienations of such lands, including a prohibition thereof. It
invoked the doctrine of pith and substance to decipher the true object of the
Act. Accordingly, the Supreme Court observed that the primary concern of the
Act was to grant protection to persons from disadvantaged categories and confer
the right of purchase upon them, and thereby ensure direct relationship of a
tiller with the land. The provisions of the Act, though not fully consistent
with the principles of the Indian Succession Act, were principally designed to
attain and sub-serve the purpose of protecting the holdings in the hands of
disadvantaged categories. The prohibition against transfers of holdings without
the sanction of the Collector was to be seen in that light as furthering the
cause of legislation. Hence, the Apex Court concluded that in pith and
substance, the legislation was completely within the competence of the State Legislature
and by placing the construction upon the expression ‘assignment’ to include
testamentary disposition, no transgression ensued.

 

CONCLUSION

Persons owning agricultural
land should be very careful in drafting their Wills. They must take care that
the beneficiary of such land is also an agriculturist or due permission of the
Collector has been obtained in case of a bequest to a non-agriculturist. It is
always better to exercise caution and obtain proper advice rather than leaving
behind a bitter experience for the beneficiaries.  

 

 

USEFUL FEATURES OF WhatsApp

WhatsApp, launched in 2009, is incredibly popular across all age groups. It’s a free service and allows for messages and calls across various mobile, tablet and computer operating systems. It is continuously introducing new features, some of which are not known to all. Awareness of these lesser-known features will definitely help us to communicate more efficiently and securely.

In the previous article (in the December, 2019 issue of the BCAJ) we covered ten useful features of WhatsApp, such as pin user, search, mute conversation, mark message as read, starred messages, chat without saving mobile number, group call, invite link, voice messages and WhatsApp desktop. In this concluding part, we shall cover some additional useful features of WhatsApp.

1. BACKUP / SECURITY

With most of our official communications and special moments with friends and families stored in the form of text messages, videos or photos on WhatsApp, we may be concerned about their availability in case we shift to a new mobile device. The option is to automate the back-up process so as to retrieve and replicate the WhatsApp conversation on the new device whenever required.

Open WhatsApp

Tap More options > Settings > Chats > Chat backup
Tap Backup to Google Drive and select a back-up frequency other than Never
Select the Google account that is activated on your phone and to which you would like to back up your chat history
Tap Back-up Over to choose the network you want to use for back-ups. Please note, backing up over a cellular data network might result in additional data charges.

At 2 a.m. every day, local backups are automatically created and saved as a file on your phone. So an individual does not have to deal with a situation where information in a WhatsApp chat is lost.

Restoration of data on WhatsApp

Install WhatsApp on your new device and register with your registered mobile number. Once authenticated, WhatsApp will provide the option to restore the previously backed up data. Click Restore and in a few moments all WhatsApp conversations with media files will be restored on the new device.

2. GROUP / BROADCAST

Group

WhatsApp group is like a joint family. All the members stay in one house known as the group in WhatsApp where the head of the family (group admin) has more rights and powers. When a group is created, only one chat thread is formed for everyone and all the conversations happen inside the group chat.

Open WhatsApp.

Tap More options > New Group > then select members to add to the group

Group Message aspects

WhatsApp group is a many-to-many type of communication. Members added to a group can send messages to the group and all the members can see the messages from everyone.

Broadcast

Broadcast is like sending the same message to multiple recipients being delivered as if the sender has individually sent a chat message. Unlike group chat, the response from recipient will be sent only to the sender of the broadcast message.

Open WhatsApp.

Tap More options > New Broadcast > then select members to add to the broadcast list
Broadcast Message aspects
1. You are the admin of your broadcast and only you can add or remove the recipients.
2. You cannot broadcast your message to contacts blocked by you in the chat.
3. In broadcast, only recipients who have added your number in their devices will receive their messages through the broadcast.
4. Replies in the broadcast will only come to you, not to the others who are added in your broadcast list.
5. No one can leave a broadcast that has been created by you, but if they remove you from their contacts, then they’ll not receive your messages.
6. You can easily see which one of them has seen the message that has been sent by you.
7. Broadcast lists are good for notification and replies do not need to go back to the group.
8. If you need a survey and wish to get response privately, then you can use the broadcast.
9. Other members of the group cannot bombard in the broadcast, only the admin can send these messages to the members directly in one go.

3. MEDIA FILES

When you download a media file, it will automatically be saved to your phone’s gallery. The Media Visibility option is turned on by default. This feature only affects new media that’s downloaded once the feature has been turned On or Off and doesn’t apply to old media.

To stop media from all your individual chats and groups from being saved,

  • Open WhatsApp
  •  Tap More options > Settings > Chats
  •  Turn off Media visibility.

To stop media from a particular individual chat or group from being saved,
Open an individual chat or group

  • Tap More options > View contact or Group info
  • Alternatively, tap the contact’s name or group subject
  •  Tap Media visibility > No > OK.

4. STORAGE SPACE UTILISATION

Considering the large number of messages and media files being exchanged on WhatsApp, there is a drastic increase in storage space consumed by WhatsApp. But WhatsApp facilitates identifying the chat that consumes storage space with details of category of files, viz. audio, video, documents, images, etc.

– Open the app and tap on the three dots on the top-right corner
– Tap on Settings option and tap on Data and Storage Usage option
– Next tap on Storage Usage option and you are done.

In the Android app, tapping Settings, Data and Storage Usage will take you to a list of your conversations, ranked by how much space they’re taking up on your phone.

You can touch any of these conversations to see a detailed breakdown of all the different types of messages – texts, images, GIFs, videos, audios, documents, locations, contacts – in the conversation. You can then selectively delete the data based on different type – texts, images, GIFs, videos, audios, documents, locations and contacts.

5. ONLINE LOCATION SHARING

You and your friends are planning to meet at New Restaurant in the city. You have reached the restaurant but your friend is struggling to find and reach the place. In such a scenario, you may share your online location with your friend to make it easy for him to find and reach the place identified and selected by both of you.

Start GPS… Launch the WhatsApp app and open the chat window of the person you wish to stream your location to
After this, tap on the attach option on the text input bar
Now click on ‘Location’ icon
Press the ‘Share live location’ bar and select continue
Thereafter, you need to choose the duration for which you wish to share your location
Select your desired duration and tap on the green arrow to begin the location sharing process. You may also add some text to customise the activity
To share your live location, you will need to enable location permissions for WhatsApp by going to your phone’s Settings > Apps & notifications > Advanced > App permissions > Location > turn on WhatsApp.

6. HIDE WHATSAPP GROUP PHOTOS AND VIDEOS FROM GALLERY

Most of us don’t have much control over what content is pushed to our phones via WhatsApp groups and this content showing up in our phone’s gallery can be a huge problem.

To stop media from all your individual chats and groups from being saved,
Open WhatsApp
Tap More options > Settings > Chats Turn off Media visibility.
To stop media from a particular individual chat or group from being saved
Open an individual chat or group
Tap More options > View contact or Group info
Alternatively, tap the contact’s name or group subject
Tap Media visibility > No > OK.
This method won’t remove already existing WhatsApp images in your gallery (you will have to delete them) and will hide new incoming media only.

7. HIDE PARTICULAR CONTACTS FROM VIEWING YOUR STATUS

WhatsApp status is a great way of expressing your mood and can be quite personal. If you don’t want to share it with all WhatsApp contacts, you can prohibit particular contacts from viewing your status updates or stories as they now stand.

Open your WhatsApp, tap on the dotted icon at the top-right corner of your screen and select Settings.
From there, select Account,
From there, select Privacy,
Check down and click Status. From here you can control who is permitted to see your status. You can allow it to all your contacts or select contacts who can see your status or hide your status from selected contacts.

To hide your status from selected contacts – Tap on Status and My contacts except… All your contacts are shown, select the one or two people to hide your status from and tap on the green mark icon beneath your screen.
Henceforth, these people will no longer see your stories / status updates.

8. WHATSAPP FOR BUSINESS

WhatsApp Business was built with the small business owner in mind.
WhatsApp Business makes interacting with customers easy by providing tools to automate, sort and quickly respond to messages.

Some of the features currently on offer in the app are:

  • Business profile to list important information, such as a company’s address, email and website
  • Statistics to see how many messages were successfully sent, delivered and read
  • Messaging tools to quickly respond to customers.

a. Setting up business profile

1. If you already have a business number which is primarily used for WhatsApp, you will first need to backup your chat data to cloud storage.
2. To do this, head to Chats > Chat backup > and then hit the ‘Back Up’ button. Ensure that the upload to the cloud is complete.
3. Next, download the app from the Google Play Store, install it and then launch it by tapping on the new WhatsApp Business icon on your smartphone’s home screen.
4. Once you open the app, you will first need to verify your business phone number. This will be the same number that you will use in your business to communicate with your customers.
5. Once your number is verified, you can choose to restore a previous chat associated with the mobile number. This would be the one you backed up in Step 1.
6. Set your business name and then once in the chat area, tap on the menu button and head to Settings > Business settings > Profile. Out here you will get a variety of fields similar to a contact card and you can fill in all the details that you want to share with your customers.

b. Messaging Tools

To set Away messages:
Tap More options > Settings > Business settings > Away message.
Turn on Send away message.
Tap the message to edit it > OK.
Under Schedule, tap and choose among:
Always Send to send the automated message at all times.
Custom Schedule to send the automated message only during specific times.
Outside of business hours: To send the automated message only outside of business hours. This option is only available if you have set your business hours in your business profile. Learn how in this article.
Under Recipients, tap and choose between:
Everyone, to send the automated message to anyone who messages you after business hours.
Everyone not in address book, to send the automated message to numbers that aren’t in your address book.
Everyone except… to send the automated message to all numbers except a select few.
Only send to… to send the automated message to select recipients.
Tap Save.

WhatsApp is undoubtedly a fabulous messaging tool and gets better with every new update.

WhatsApp, which is owned by Facebook, has added several convenient and productive features over the years, but since its recent tie-up with Reliance Jio it is sure to come up with many more.

Keep messaging, keep connecting.

PROPOSAL FOR SOCIAL STOCK EXCHANGES – BOLD, INNOVATIVE AND TIMELY

Imagine a situation where a humanitarian
crisis or disaster takes place. A cyclone, floods, or, as is happening right
now, the Covid crisis. But even without a crisis there are human misery and
needs of various kinds. In the ordinary course, the government, some Indian /
international charitable organisations do take the initiative to provide
relief. However, often there is confusion and a scramble. Those in need do not
know whom to approach for help. Those who wish to donate funds or services do
not know who needs the funds / services and also which are the reliable
organisations that will really help the needy. Even the relief organisations
may be at a loss to find the needy and / or find those who can fund the relief
measures that they are ready to carry out.

 

Now, imagine if there was a smooth and
seamless system to coordinate the efforts of all such persons – the needy, the
donors / volunteers, the relief organisations, etc. – a system whereby funds
from those willing to help definitely reach the needy. The proposed model of
Social Stock Exchange (‘SSE’) as envisaged by a recent SEBI Working Group
Report, envisages just that. A whole eco-system is proposed in which, in a
variety of innovative ways, funds from those who have and also want to give,
reach those who need those funds. What’s more, there is also scope for
investors to participate in it and earn returns!

 

The objective essentially is to provide not
just information and coordination to all concerned, but also lay down a system
of checks and balances, reliable information, well-defined disclosure standards
and an audit mechanism. The system can use existing and new infrastructure and
systems to help raise funds in the form of securities and other instruments.

 

Such a report has just been released and
comments have been invited on it. However, considering the ambitious goals and
also the numerous structural changes and the set-up needed, it may be years
before they are fully implemented. However, a quick start is quite possible and
some major steps could be taken in a short time.

 

BACKGROUND

The Finance Minister had, in her Budget
Speech for financial year 2019-20, declared the decision of the Government of
India to set up a Social Stock Exchange to help raise funds for social impact
investing. She said, ‘It is time to take our capital markets closer to the
masses and meet various social welfare objectives related to inclusive growth
and financial inclusion. I propose to initiate steps towards creating an
electronic fund-raising platform – a social stock exchange – under the
regulatory ambit of Securities and Exchange Board of India (SEBI) for listing
social enterprises and voluntary organisations working for the realisation of a
social welfare objective so that they can raise capital as equity, debt or as
units like a mutual fund.’

 

Shortly thereafter, a working group was set
up and, after due consultations / deliberations, its report giving
recommendations has been published for public comments.

 

It is a fairly detailed report that makes
several suggestions on how to go about implementing the proposals made by the
Finance Minister. It surveys the global scenario and consciously makes
proposals much beyond most practices in prevalence. It envisages not just the
setting up of an SSE but discusses several other aspects of the eco-system and
also various products / structures that can be developed to ensure a
sophisticated and effective system.

 

The needy

That India has numerous needy sections
requiring relief goes without saying. Rural poverty, medical relief,
educational assistance, etc. are broad needs, while disaster relief is also
often required. The relief does not have to be merely the giving away of cash,
but also assistance in kind and / or service in various forms. Often, such
needy persons inhabit the interior parts of the country and hence it is also
vital that the relief has to be structured in such a way that it reaches them.
Such needy persons are unlikely to have direct knowledge and contact with those
who are able and willing to provide relief.

 

The relief organisations

The report
suggests that in India there are more than 30,00,000 (30 lakh) NGOs and other
organisations, small and large, able and willing to provide relief to the
needy. These include small social service organisations with a tiny set-up, to
large international organisations having extensive manpower, systems and
knowhow. They, however, need information about those who are in need of relief
and also knowledge of those who may provide funds for relief. They also need
knowhow of how to present their credentials to demonstrate that they have been
doing effective work. This would include a language of standardised benchmarks
and parameters to show their effectiveness. That they meet such benchmarks also
needs to be certified by ‘social auditors’ competent in this field.

 

The donors

There are several large international
donors, small and medium-sized donors / trusts, corporate donors (particularly
those who allocate funds for CSR work) and of course the millions of individual
donors who would want to make a difference to the needy. Then there is the
government itself which allocates large amounts of monies for relief work of
various types. However, all these need either direct access to the needy if the
relief provided is simple, or to organisations carrying out relief work to whom
they can donate funds or even provide honorary services. For this purpose, they
would want to be assured that their funds and services are put to the most
effective use so as to have the best social impact.

 

SOCIAL STOCK EXCHANGE – A model that brings together the various parties and helps
set up an eco-system

The report recognises that there are many
scattered organisations of various types who offer relief and provide
coordination and information in this regard. The need, however, is for a
complete and common eco-system whereby the needy, the relief organisations, the
donors and various other service entities are connected with each other. At
present, some bodies do provide part of such services / eco-system. However,
the report suggests that a Social Stock Exchange could serve as a centralised
body for enabling such an eco-system. Internationally, there are many SSEs of
varying kinds. However, the report seeks to go far ahead of such SSEs and
provide not just an information system but also a wide variety of funding
structures including listed securities that are tailor-made to meet such needs.
Some of the suggestions in this regard are described here.

 

Information repository

An accessible database of various relief
organisations would be set up under the aegis of the SSE. It would have
detailed information of the governing bodies, financials, track records of
relief work in a language of benchmarks and parameters that are well
established, well defined and understood by those familiar with the system. The
repository would have other relevant information, too. Anyone, including
donors, can access the information and find the relevant information.

 

Standards / benchmarks and disclosure
standards

Just as financial statements have a language
to present financial information to financially literate users, a similar set
of languages / standards and so on would be needed so that relief organisations
can present the work they have done in objectively understood / measurable
parameters. This would demonstrate their effectiveness.

 

Social auditors

Like auditors of financial statements,
social auditors would be needed to verify that the information disclosed by
relief organisations is fairly and correctly stated. This would give
reassurance to readers of such statements.

 

SECURITIES AND INSTRUMENTS OF VARIOUS
KINDS

While stock exchanges are normally conceived
of as a place / platform for transactions in securities of various kinds, the
SSE would not be focused on equities in the traditional sense. The securities
on the SSE would enable finance to reach relief organisations. The investments
may be in the form of equity or bonds of various kinds. If the projects in
which investments are made achieve the social benefit / impact promised, the
investors would get their monies back, possibly with some returns. Donors and
similar organisations would effectively provide monies for return of the funds.
The securities could also be traded on the SSE. If the project fails wholly or
partially, the amount invested may not be wholly returned. Loans from banks /
NBFCs may also be made in a similar manner. Different structures have been
suggested depending upon whether the organisation is For-Profit or
Not-For-Profit. The varying legal structures of such organisations (e.g.,
trust, section 8 companies or even individual / firm / company) have been noted
in the report and that the funding / securities structure would be different
for each such group.

 

The report also provides a structure for
deployment of CSR funds, including even trading in CSR certificates. Thus, for
example, CSR spends in excess of the prescribed minimum could be transferred to
others who have not been able to find appropriate projects for their own
spends.

 

Alternative Mutual Funds are also expected
to carry out a significant role in helping routing of such funds in the form of
units.

 

LEGAL / TAX HURDLES

The report conceives of an eco-system for
which much would be needed in terms of amendments in securities, tax and other
laws to enable it to fructify. The SSE itself would be under primary regulation
of the SEBI subject to possibly a separate sector regulator at a later point of
time. The SSE could be a separate platform under existing stock exchanges since
they already have the infrastructure.

 

However, several changes would have to be
made in law.

 

The securities laws would have to be amended
to enable the new forms of securities suggested. The Regulations relating to
Alternative Investment Funds would also require amendments. SEBI would have to
be given powers to provide for registration for various agencies, for
supervision, for prescribing disclosure requirements, levy of penalty, etc.

The report emphasises several changes in tax
laws. Requirements relating to registration / renewal of charitable
organisations, particularly the changes made in the recent Finance Act, 2020,
are suggested to be simplified and relaxed. Further, tax benefits for CSR
spends through such SSEs, for donations / investments made through an SSE, etc.
are recommended.

 

CONCLUSION

The implementation of the proposed structure
would take place in stages. It may even otherwise take time for various
organisations and entities to understand and become part of the proposed
eco-system. However, the recommendations do make for an inspiring read. The
system could provide the most effective use of the funds given in the form of
grants, donations and even investments. Organisations that work well would get
formal recognition in a language and in the form of parameters that are
commonly understood in the industry. There would be faith in the system that
would be reinforced by the supervision and discipline of SEBI.

 

Chartered Accountants would obviously have a
major role to play. They would be closely involved in advising corporates,
relief organisations and even donors on law, tax, structuring, etc. Preparation
of financial statements and even reports to present the social impact /
performance of such entities would be a new and refreshing challenge. It is not
expected that their involvement would be purely honorary or as social work.

 

One looks forward to speedy implementation
of the recommendations of this report which could usher in substantial changes
in the present system

 

INTRA-COMPANY TRANSACTIONS UNDER GST

INTRODUCTION

The charging
section for the levy of GST is under section 9 of the CGST Act, 2017 and the
taxable event, which triggers the levy, is supply, the scope of which is
defined u/s. 7. Section 7(1)(a) thereof defines the normal scope of supply to
include transactions which are generally carried out in the normal course of
business. Section 7(1)(b) includes import of services for a consideration
within the scope. Section 7(1)(c) then refers to schedule I of the Act, wherein
the activities listed are deemed to be included in the scope of supply, even if
made or agreed to be made without a consideration.

 

Schedule I lists
four specific activities which shall be treated as supply even if made without
a consideration. In this article, we shall discuss entry 2, which reads as
under:

 

“2. Supply of goods or services or both between
related persons or between distinct persons as specified in section 25, when
made in the course or furtherance of business”.

 

The scope of the
above deeming fiction is, inter alia, to treat transactions between related
persons or distinct persons as supply, making it liable to tax in the state
from where the supply originates with a corresponding credit, subject to
provisions of section 17 in the state where the supply culminates.

 

Therefore, what
needs to be analysed to interpret the scope of the above entry is:

  •     What is meant by related person?
  •     What is meant by distinct person, as
    specified in section 25?
  •     When can it be said that a supply of goods
    or services has taken place between distinct persons?

 

RELATED PERSON – SCOPE

Vide explanation to
section 15 of the CGST Act, it has been provided that persons shall be deemed
to be related persons, if:

(i)  such persons
are officers or directors of one another’s businesses;

(ii) such persons
are legally recognised partners in business;

(iii) such
persons are employer and employee;

(iv) any person
directly or indirectly owns, controls or holds 25% or more of the outstanding
voting stock or shares of both of them;

(v)        one of
them directly or indirectly controls the other;

(vi) both of them
are directly or indirectly controlled by a third person;

(vii)       together, they directly
or indirectly control a third person; or;

(viii) they are members of the same family.

 

DISTINCT PERSON – SCOPE

Section 22(1) read
with section 25(1) of the CGST Act, 2017 provides that every supplier is
required to obtain registration in every such state from where he makes a
taxable supply of goods or services or both. Therefore, every taxable person
supplying goods or services or both from multiple states shall be required to
obtain registration in all such states.

 

Sections 25(4) and
25(5) of the CGST Act deems such separate places from where supplies are made,
whether registration has been obtained or not, to be distinct persons for the
purposes of the Act. In other words, all the locations of a taxable person,
within India but in different states, are treated as distinct persons for the
purpose of GST law.

 

IDENTIFYING SUPPLIES BETWEEN DISTINCT PERSONS

The important
question that needs consideration while analysing whether entry 2 is triggered
or not, is determining when a supply of goods or services has taken place
between distinct persons. While determining the same in the context of goods
may not be a challenge, owing to the tangibility factor, there will be a
challenge from the perspective of identifying the existence of a service. This
is because when it comes to services, there appears to be confusion on the
scope of the above deeming fiction. Let us try to understand the same with the
help of the following examples of various activities which take place within a
legal entity:

 

a.  A multi-locational entity having a centralised
accounting department for all India operations, which includes a centralised
tax compliance department, too;

b.  The head office of a multi-locational entity
receiving auditing services for multiple locations across the country,
including the foreign branches;

c.  The senior management, responsible for the
overall operations of the legal entity, operating from the head office which
results in various supplies being made by the multiple locations;

d.  An employee from one branch is asked to
support the other branch for a particular project;

e.  Multiple branches work on a project, for which
the front-ending to the client is done by a particular branch / head office.

 

In the above, it is also important to note that at times, the companies
might be accounting the costs / revenue identifying the location to which it
pertains, in which case there will be always a revenue mismatch as costs will
be accumulated in one location while revenue will be lying in another location,
resulting in revenue-cost mismatch and credit accumulation in cost-incurring
locations and liability payout in cash in revenue-generating locations.

 

A view is therefore
being proposed that in cases where the costs and the corresponding revenues are
booked in distinct jurisdictions, there should be a cross charge of the costs
from the expense-incurring jurisdiction to the income-bearing jurisdiction. Such
cross charge would constitute a consideration for the rendition of ‘service’ by
the expense-incurring jurisdiction to the income-earning jurisdiction and such
deemed / inferred service would be liable for payment of GST due to the
provisions of schedule I entry 2 referred to above. In case the costs are
common costs incurred for multiple revenue-earning jurisdictions, there should
be some reasonable basis of apportionment of costs with similar consequences as
stated above. This view is further corroborated by the ruling of the Authority
for Advance Ruling in the case of Columbia Asia Hospitals Private Limited
[2018 (15) GSTL 722 (AAR – GST)] which was confirmed by the Appellate
Authority as well. The matter is currently pending before the Karnataka High Court.

Though the
objective of schedule I entry 2 and the view expressed above may be to ensure a
smooth flow of credits across multiple jurisdictions, the essential legal
position is that the entry deems certain activities / supplies to be taxable
and therefore imposes a tax in one of the jurisdictions. Therefore, the
question that needs consideration is to what extent can the deeming fiction be
extended to deem an activity carried out by a taxable person as supply of
service?

 

It is now a settled
proposition of law that a provision imposing a tax has to be strictly
interpreted and cannot be inferred. In fact, the Supreme Court has time and
again held that before a tax can be imposed, the levy has to be certain. To
define this certainty of levy, it is understood that the following constitute
the key corner-stones of the levy:

 

  •  Certainty of the taxable
    event;
  •  Certainty of the person on
    whom the levy is cast;
  •  Certainty about the
    recipient of service;
  •  Certainty in the rate of
    tax;
  •  Certainty in the value on
    which the tax has to be charged; and
  •  Certainty as regards the
    time at which the tax has to be discharged.

 

The proposition of
requirement of cross charge canvassed above may not be a correct legal
proposition since there is technically no service rendered by the head office
to the branches and therefore, the deeming fiction needs to be restricted to
the fiction created by the said provision and there are significant
uncertainties in the implementation of the cross charge proposition, resulting
in the probability of the alleged levy itself getting struck down. In
subsequent paragraphs, an attempt is made to understand the answers to the
above issues.

 

Whether there is certainty of the taxable
event?

The taxable event
under GST is the supply of goods or services or both. It may be important to
note the legislative background of GST. While a plethora of indirect tax
legislations pertaining to various goods and services have been subsumed under
the GST legislation, it is evident that the fundamental distinction between
goods and services is still relevant. It is still not a very comprehensive tax
on all supplies but rather a tax on goods or services or both. This is the
reason why both these terms are defined separately and there are provisions to
determine the nature of supply as either being that of goods or services, or
neither. Further, many provisions like time of supply, rate of tax and place of
supply are distinct for goods and for services.

 

The term service is
defined u/s. 2(102) as anything other than goods, money and securities.
However, this definition appears to be sketchy and does not in any way define
the essence of what constitutes service and what does not. It is, therefore,
felt necessary that before one embarks to understand the scope of the deeming
fiction referred to above, it may be important to determine the essence of what
constitutes goods and what constitutes services and the essential differences
between the two.

 

Prior to the
introduction of GST, it was always felt that the fundamental attributes of
goods would be utility, possession, transferability and storage value.
Similarly, the fundamental attributes of service were understood to be an
activity carried out by a person for another for a consideration under an
enforceable contract. It is evident that the concept of ‘goods’ is distinct
from the concept of transaction in ‘goods’ like sale of goods. For example, a
person may possess ‘goods’ and such goods will have utility and value (some
inherent value) and such possession may have no linkage with consideration or
any contract or another person. In distinction to goods, by their very nature
services cannot be viewed in isolation of their rendition or provision. It is
felt that this very essence of goods or services does not change due to the
introduction of GST. The definitions have to be read in this context.

 

On a co-joint
reading of the definitions under various legislations and the judicial
interpretation, it can be argued that an enforceable contract between two
parties and consideration are essential elements for something to be defined as
a service in general. For example, a musician singing on the road cannot be
treated as providing services to passersby since there is no enforceable
contract between the two. Similarly, acquiring knowledge by reading books
cannot be considered as a service even if the said knowledge is for furtherance
of the business in the future. Most businesses receive free advice from
consultants – all and sundry. The businesses may not even perceive a value in
such advises.

 

One would generally
consider that an actor provides a service to a film producer. This is because
generally, the producer approaches the actor and pays him a fee for acting in
the movie. However, if a struggling newcomer approaches a producer and offers
to pay him a fee and also act in the movie, one would say that the producer has
provided a service to the actor since the flow of consideration is from the
actor to the producer. Further, it would not be correct to even say that the
actor provided a free service in this case since neither the producer nor the
trade nor the actor himself perceives a value for the ‘acting’ carried out by
him. In that sense, the acting is carried by the actor for himself and not for
the producer.

 

It is, therefore,
felt that despite a wide residuary definition of service, the essential
attributes of service would be:

 

  •  An enforceable contract between
    two persons;
  •  A consideration flowing from
    one person to another;
  •  A defined activity set carried
    out by one person for another under specific instructions of another
    person.

 

The issue to be
examined here is whether and to what extent do the above essential elements of
service get diluted due to the deeming fiction prescribed under schedule I
entry 2.

 

Clearly, the cost
and revenue mismatches across jurisdictions are on account of imbalances in the
underlying activities carried out at the different jurisdictions. For example,
a litigation pertaining to Chennai may land up in Delhi in the Supreme Court
and may be supported by the in-house legal counsel from Mumbai. Would these
activities fall within the mischief of the above deeming fiction?

 

Admittedly, the
various locations where a taxable person may be registered are deemed to be
distinct persons for the purposes of the GST law since they bear separate GST
registrations. However, does the deeming fiction restrict itself merely to the
distinctness of a person (i.e., entity) or does it create a distinctness
amongst all its relationships with business, employees, clients, assets,
suppliers, government authorities, judiciary, etc.? In order to fit within the
deeming fiction entry mentioned earlier, a series of deeming fictions will have
to be created. This will have its own set of challenges. For example,

 

  •  The different locations for
    which registration would have been obtained would be treated as distinct
    persons. This has been provided in section 25. However, nowhere is it stated
    that due to such distinctness of establishments, the legal existence of the
    taxable person is to be totally ignored;
  •  In the above example, the
    in-house counsel will have to be treated as an employee of the legal entity.
    This is a deeming fiction, but this is nowhere provided under the law. Further,
    the reason for treating him as an employee of Maharashtra registration is
    merely because he generally sits in the Maharashtra office. This is again a
    deeming fiction since the person who is the employer cannot be determined by
    the location where the employee usually sits. Similarly, the payment of the
    salary to the in-house counsel may be accounted in the books in Maharashtra. In
    most of the cases, the entity maintains common books of accounts. Further,
    accounting principles cannot determine the tax implications;
  •     Most
    of the other regulations, employment contract, the expectations of the
    stakeholders and the conduct of the employee, would not in any way suggest that
    the counsel is an employee of a particular registration. Even the GST law may
    not restrict the interpretation of the person being an employee of a particular
    registration and not the legal entity as a whole. If such an interpretation is
    taken by the GST authorities, under which authority could such in-house counsel
    located in Mumbai be summoned? Similarly, section 137 of the GST law provides
    for liability of officers responsible for the conduct of the business as being
    guilty of the offence.

 

Similarly, can one
really say that the litigation is that of legal entity or will it be said to be
that of registration (and what would be the principles which will determine
this aspect)? Will the artificial distinctness then imply that one office
(registered) has rendered a service to another office (whether or not
registered) by providing the in-house legal counsel requiring a value to be
assigned to such alleged service with a corresponding tax liability in Mumbai
and credit in Chennai? What would be the scenario of hotel booking carried out
by the Delhi office for the in-house counsel? Will the concept of business also
be considered distinctly and, therefore, can it be argued by the Delhi officer
that the stay in the hotel is not for the furtherance of business of the Delhi
branch and therefore input tax credit should not be allowed?

 

Therefore, the
deeming fiction provided under schedule I entry 2 has to be restricted to the
fiction that it creates. In the absence of a clear intention to extend the
deeming fiction not only to the distinctness of the person but also to all
consequential relationships, it would not be correct to create layers of such
deeming fiction and thereby infer the existence of a service which does not
exist at all and then operationalise the deeming fiction.

 

Another way to deal
with the cost-revenue mismatch is to suggest that there can be a difference
between a receipt of a supply and the receipt of the benefit of the supply. The
distinction between a recipient of a supply and the beneficiary of the supply
is very well understood in the judicial context. Just because the benefit of a
supply is derived by an artificially dissected distinct person, can it be said
that the original recipient of the supply is a further supplier of service?

 

The GST law itself
considers the possibility of the recipient of service being distinct from the
beneficiary of service. In this context, the definition of recipient of service
provided under section 2(93) clearly demonstrates that the person liable to pay
the consideration is the recipient of the supply. Further, the definition of
location of recipient of service u/s. 2(70) envisages a joint receipt of
service by more than one establishment and suggests a tie-breaker test to
determine the establishment most directly connected with the supply. The
provision stops at that and does not further provide a deeming fiction to
further suggest that there is a secondary supply by the most directly connected
establishment to the less directly connected establishment.

 

If the above
proposition is taken as a legal requirement, one may even find the provisions
of input service distributor totally redundant.

 

In view of the
above discussions, it is felt that there is no element of service rendered by
the corporate office to the branches when there is a cost-revenue mismatch and
certain support functions are performed by the corporate office which may be
intended for the benefit of the branches.

 

Whether there is certainty about the
person who is liable to discharge the tax liability?

Another important
aspect is the determination of the person who is the service provider and
therefore liable to discharge the GST liability on the so-inferred deemed
supply. It is felt that this aspect itself can be a subject matter of severe
uncertainty.

 

Let us take an
example of two branches of a taxable person, say Maharashtra and Gujarat
jointly rendering a service to a client. Section 2(15) of the IGST Act will
define either one of the two branches as the establishment most directly
connected with the supply. The issue to be examined is whether there is any
service provided between the two branches? If yes, who renders service to whom?
This question cannot be answered in isolation at all. If at all a conservative
view has to be taken, an additional piece of information will be required as to
which of the two establishments is the establishment most directly concerned
with the supply and then only one can perhaps argue that the less directly
connected establishment is providing service to the most directly connected
establishment. It may be noted that there is no specific deeming fiction to
this effect.

 

Let us extend the
above example slightly and say that the two branches are jointly rendering free
service to the client. How would one now conservatively operationalise the
deeming fiction?

 

Therefore, it is
evident that it is difficult to examine who is the service provider with
certainty.

 

Whether there is certainty about the
person who is the service recipient?

Let us extend the
example provided above to the case of a disaster recovery centre which is
located in Andhra Pradesh. If due to cost-revenue mismatch it is inferred that
there is a requirement to deem a service flow, the question which arises is
whether the Andhra Pradesh unit is rendering services to the corporate office
in Maharashtra or to all the units located across the country? Who is the
recipient of the deemed service alleged to have been provided by the Andhra
Pradesh unit?

 

Even if a
proportionate cost allocation is carried out across the country, the same may
not be really representative of the receipt of service by the constituent units.
This is because in many cases there may not be a clear period-specific matching
of costs and revenues. To continue the example of VAT litigation, it may be
possible that when the litigation comes up before the Supreme Court, the unit
in Tamil Nadu may have already shut down and therefore there may not be any
distinct person in Tamil Nadu. In such a case, how would one define the
activity to be that of a rendition of service to Tamil Nadu when there is no
such unit? If the cost is cross-charged on proportionate basis to all other
states, the same may be incorrect since they have not received any service at
all.

 

Whether there is certainty on the nature
of supply and the rate of tax?

The next issue
which arises is the identification of the exact nature of the service rendered.
Each scenario may be different. In the above example, is it the case of legal
services rendered by the Maharashtra office to the Chennai office or is it a
sort of residuary service? The service cannot be described as a legal service
due to various reasons including the regulatory framework in the country. Even
if it is to be treated as a residuary service, the same should be capable of
some description. What is that description? A very common-place answer is that
the same constitutes business support services. This again appears to be a very
circuitous answer because in the normal course the in-house legal counsel would
be expected as a part of his employment contract to perform the said activity.
Notionally attributing a totally different name to the said activity may be
inappropriate.

 

Similarly, when the
logistics team of the company arranges for the transportation of the products
of the company, does it provide a ‘goods transport agency service’ and
therefore be liable for tax @ 5% or does it provide a business support service?
Does the F&B team provide ‘restaurant services’ or does it provide business
support services? There can be many more examples.

 

The answers are
obvious. There is really a significant uncertainty in defining the nature of
the supply and the consequent tax rate on such presumed supply.

 

Whether there is certainty in the value on
which the tax has to be charged?

It is also felt
that if a view is taken that there is a supply between distinct persons under
the above case, the provisions of the law have to provide with certainty the
value of the said supply on which the tax has to be discharged.

 

Section 15(1) of
the CGST Act, 2017 which deals with the provisions relating to value of taxable
supply, provides as under:

 

(1) The value of
a supply of goods or services or both shall be the transaction value, which is
the price actually paid or payable for the said supply of goods or services or
both where the supplier and the recipient of the supply are not related and the
price is the sole consideration for the supply.

 

In the instant
case, there is no transaction value, or the price actually paid by the branches
to the head office. Since there would be one single legal entity, there is no
occasion to maintain state-specific bank accounts and periodic settlements
through receipts or payments from such bank accounts. In some cases, there may
be an internal accounting entry to define location-specific profitability for
MIS purposes. However, this concept of accounting entry is notional and it
deals with location-specific entries and not ‘distinct person’ specific
entries. Further, in many cases there may not be an internal accounting entry
since there may not be any legal requirement to provide for the same.

 

In the absence of
the transaction value or price, one can say that the value of taxable supply is
NIL with a consequent NIL liability. However, a counter argument could be that
the transaction value is acceptable only if the supplier and the recipient are
not related persons.

 

The scope of
related persons has already been dealt with in the earlier paragraph. Further,
section 15(4), which is applicable in cases where valuation as per sub-section
(1) is not possible, provides as under:

 

(4) Where the
value of the supply of goods or services or both cannot be determined under
sub-section (1), the same shall be determined in such manner as may be
prescribed.

 

From the above, it
appears that reference to section 15(4) is required only when the provisions of
section 15(1) are not applicable, i.e., price is not the sole consideration and
parties are not related. Therefore, the issue is whether the supply made by the
head office to its distinct persons will be classifiable for valuation u/s.
15(1) of the CGST Act or not? This query arises because distinct persons are
not treated as related persons for the purpose of GST, as is evident from the
definition referred earlier.

 

It can be argued
that the definition of related person deals with legally distinct entities and
not with distinct persons as defined under the GST law. Therefore, the
transaction value of NIL u/s. 15(1) should not be disturbed.

 

Even if a view is taken
that the distinct persons as defined u/s. 25 fall within the definition of
related persons under explanation to section 15, the question which arises is
how the same will be valued keeping in view the provisions of valuation
prescribed under the CGST Rules. Chapter V of the CGST Rules contain the rules
for determination of value of supply in following specific cases:

 

  • Rule 27 – Value of supply of
    goods or services where the consideration is not wholly in money;
  • Rule 28 – Value of supply of
    goods or services or both between distinct or related persons, other than
    through an agent;
  • Rule 29 – Value of supply of
    goods made or received through an agent;
  • Rule 30 – Value of supply of
    goods or services or both based on cost;
  • Rule 31 – Residual method for
    determination of value of supply of goods or services or both.

 

Rule 28 of the CGST
Rules, 2017 prescribes for situations of defining a value of supply of services
between distinct persons. Rule 28(a) provides that the open market value of the
supply will be considered for the purposes of valuation. This provision itself
implies marketability of the support functions provided by the corporate
office. Most of the activities carried out by the employees at the corporate
office may be such that they may not be amenable to outsourcing or any element
of marketability. For example, it would not be correct to define the activities
carried out by a director for the company as services which are freely
marketable. Such activities are carried out only due to the specific
relationship as a director of the company. The activity and the relationship is
so closely knit with each other that the activity cannot be looked upon de
hors the relationship. In such cases, it may be incorrect to attribute
marketability and consequently open market value to such supply.

 

Similarly, the
activities carried out by the employees may be so unique that it may not be
possible to define a value of a service of like kind and quality and therefore
Rule 28(b) would also fail.

 

Rule 30 provides
for a mechanism to determine the value on the basis of the cost of provision of
service. However, the cost incurred on the activities may also not be easily
determinable. For example, if the in-house counsel appears for the matter in
the Supreme Court, will the salary cost be considered as the cost of provision
of service or will the company cost attributable to retirement benefits also be
added into the calculation? Will the notional cost of his cabin be added? Will
the electricity cost be added? How does one determine with precision the cost
of provision of service and attribute fixed overheads when the so-called
service itself is not clear and there is no identification of the unit of
measurement? Therefore, Rule 30 fails to provide a definitive answer to the
calculation of value of the presumed service.

 

The second proviso to Rule 28 specifies that the value declared in the
invoice shall be deemed to be the open market value of the goods or services in
cases where the recipient is eligible for full input credit. It is felt that
the condition mentioned in Rule 28 will have to be read down by the courts as
leading to artificial discrimination and also leading to a scenario where the
supplier is expected to demonstrate something which is impossible. Once the
condition is read down or read in context, it can lead to the conclusion that
the transaction value should be accepted.

 

Whether there is certainty as regards the
time at which the tax has to be discharged?

The next issue to
examine is whether there is any certainty as regards the time at which the tax
has to be discharged. Section 13(2) of the CGST Act prescribes the time of
supply of services to be the earliest of the following dates, namely,

 

(a) the date of
issue of invoice by the supplier, if the invoice is issued within the period
prescribed under sub-section (2) of section 31, or the date of receipt of
payment, whichever is earlier; or

(b) the date of
provision of service, if the invoice is not issued within the period prescribed
under sub-section (2) of section 31, or the date of receipt of payment,
whichever is earlier; or

(c) the date on
which the recipient shows the receipt of services in his books of account, in a
case where the provisions of clause (a) or clause (b) do not apply.

 

Essentially, if the
invoice is issued within the prescribed time, the date of issue of invoice or
the date of receipt, whichever is earlier becomes the time of supply. In the
instant case, there is no question of any amount exchanging hands and therefore
there is no date of receipt. One will therefore have to refer to the provisions
of the invoicing rules. Section 31(2) read with section 31(5) prescribes the
outer time limit within which the invoice has to be issued in the case of
continuous supply of services. Accordingly, it is mentioned that the invoice
shall be issued as under:

 

(i) where the
due date of payment is ascertainable from the contract, the invoice shall be
issued on or before the due date of payment;

(ii) where the
due date of payment is not ascertainable from the contract, the invoice shall
be issued before or at the time when the supplier of service receives the
payment;

(iii) where the
payment is linked to the completion of an event, the invoice shall be issued on
or before the date of completion of that event.

 

It is more than
evident that the above scenarios are not applicable in the instant case and
therefore the provisions relating to the time of supply cannot be implemented
with reasonable certainty.

 

To summarise, it is
felt that significant uncertainty exists over various elements towards the
implementation of the proposition to consider the impact of cost-revenue
mismatch as a deemed service by the cost-incurring state to the revenue-earning
state, and such uncertainties vitiate the charge sought to be created by
schedule I entry 2, especially vis-à-vis the supply of services between
distinct persons of the same legal entity.

 

In view of the above discussion, a view
that the common expenditure incurred by the head office, the benefits of which
are claimed by the various other branches, cannot be construed as supply by the
head office to branches is possible. Therefore, a cross charge may not be
required by the head office to the respective branches.

Articles 2, 11 and 12 of India-UAE DTAA – Education cess is in the nature of an additional surcharge – As Articles 11 and 12 restrict taxability and have precedence over the Act, royalty and interest could not be taxed at rates higher than that specified in the respective articles by including surcharge and education cess separately

14  [2019] 104 taxmann.com 380 (Hyderabad – Trib.) R.A.K. Ceramics, UAE vs.
DCIT ITA No: 2043 (HYD) of 2018 A.Y.: 2012-13 Date of order: 29th
March, 2019

 

Articles 2, 11 and 12
of India-UAE DTAA – Education cess is in the nature of an additional surcharge
– As Articles 11 and 12 restrict taxability and have precedence over the Act,
royalty and interest could not be taxed at rates higher than that specified in
the respective articles by including surcharge and education cess separately

 

FACTS

The
assessee was a company fiscally domiciled in, and tax resident of, the UAE.
During the relevant previous year, the assessee received royalty and interest
from its group company in India. Under Article 12(2) of the India-UAE DTAA such
receipt is taxable @ 10% and under Article 11(2)(b) interest is taxable @
12.5%.

 

While
the AO applied the aforementioned rates, he further levied 2% surcharge and 3%
education cess on the tax so computed. The CIT(A) upheld this order of the AO.

 

HELD

  •     Article
    2(2) of the India-UAE DTAA defines the expression ‘taxes covered’ in India as “(i)
    the income-tax including any surcharge thereon; (ii) the surtax; and (iii) the
    wealth-tax”.     Article 2(3) clarifies that “this Agreement shall also
    apply to any identical or substantially similar taxes on income or capital
    which are imposed at Federal or State level by either contracting state in
    addition to, or in place of, the taxes referred to in paragraph 2 of this
    Article”.
  •     In the context of India-Singapore DTAA, in
    DIC Asia Pacific (Pte.) Ltd. vs. Asstt. DIT [2012] 22 taxmann.com 310/52 SOT
    447 (Kol.)    , the Tribunal has observed that: “The education
    cess, as introduced in India initially in 2004, was nothing but in the nature
    of an additional surcharge … Accordingly, the provisions of Articles 11 and 12
    must find precedence over the provisions of the Income-tax Act and restrict the
    taxability, whether in respect of income tax or surcharge or additional surcharge
    – whatever name called, at the rates specified in the respective Article”.
  •     This view has also been adopted in a large
    number of cases (See NOTE below), including in the context of the
    India-UAE DTAA. Further, no contrary decision was cited nor any specific
    justification for levy of surcharge and education cess was provided.
  •     The
    provisions of the India-UAE DTAA are in pari materia with those of the
    India-Singapore DTAA, which was the subject matter of consideration in DIC
    Asia Pacific’s     case.
  •     Accordingly, the Tribunal directed the AO to
    delete the levy of surcharge and education cess.

 

{NOTE: Capgemini SA vs. Dy. CIT
(International Taxation) [2016] 72 taxmann.com 58/160 ITD 13 (Mum. – Trib.);
Dy. DIT vs. J.P. Morgan Securities Asia (P.) Ltd. [2014] 42 taxmann.com
33/[2015] 152 ITD 553 (Mum. – Trib.); Dy. DIT vs. BOC Group Ltd. [2015] 64
taxmann.com 386/[2016] 156 ITD 402 (Kol. – Trib.); Everest Industries Ltd. vs.
Jt. CIT [2018] 90 taxmann.com 330 (Mum. – Trib.); Soregam SA vs. Dy. DIT (Int.
Taxation) [2019] 101 taxmann.com 94 (Delhi – Trib.); and Sunil V. Motiani vs.
ITO (International Taxation) [2013] 33 taxmann.com 252/59 SOT 37 (Mum. –
Trib.).}

Article 5 of India-UAE DTAA – Section 9 of the Act – Grouting activity carried out by the assessee for companies in oil and gas industry did not constitute ‘construction PE’ under Article 5(2)(h) – Since assessee had placed equipment and stationed personnel on the vessel of the main contractor for carrying out grouting, the vessel was a fixed place of business through which the assessee carried on business – Hence, income of assessee was taxable in India

13 [2019] 105 taxmann.com 259 (Delhi – Trib.) ULO Systems LLC vs. DCIT ITA
Nos.: 5279 (Delhi) of 2011, 4849 (Delhi) of 2012 A.Y.s.: 2008-09 to 2012-13 Date of order: 29th
March, 2019

 

Article 5 of
India-UAE DTAA – Section 9 of the Act – Grouting activity carried out by the
assessee for companies in oil and gas industry did not constitute ‘construction
PE’ under Article 5(2)(h) – Since assessee had placed equipment and stationed
personnel on the vessel of the main contractor for carrying out grouting, the
vessel was a fixed place of business through which the assessee carried on
business – Hence, income of assessee was taxable in India

 

FACTS

The
assessee was a company incorporated in UAE. It was engaged in the business of
undertaking grouting work for customers in the oil and gas industry. Though the
assessee had executed contracts with Indian companies, it had not offered any
income from these contracts on the ground that it did not have any PE in India.

 

But
the AO held that grouting activity was carried out from a fixed place PE in
terms of Article 5(1) of the India-UAE DTAA. Hence, the income arising
therefrom was taxable in India.

 

Based
on its observations for assessment year 2007-08, DRP held that income from grouting
activity was taxable because of existence of PE in India under Article 5(1).

 

Before
the Tribunal, the assessee submitted that in terms of Article 5(2)(h) of the
India-UAE DTAA, its activities constituted a ‘construction PE’. Therefore, in
order to constitute a construction PE, each construction or assembly project
should have continued for a period of more than nine months in India. Since the
activities carried on by the assessee under contracts involved installation /
construction activities, and since none of the projects had continued for more
than nine months, the assessee could not be said to have a construction PE in
India in terms of Article 5(2)(h).

 

HELD

  •     For the purpose of Article 5(2)(h) of the
    India-UAE DTAA, sub-sea activities that can be treated as ‘construction’ are
    “laying of pipe-lines and excavating and dredging”. Thus, grouting activities
    carried on by the assessee being pipelines and cable crossing, pipeline and
    cable stabilisation, pipeline cable protection, stabilisation and protection of
    various sub-sea structures, anti-scour protection, etc., cannot be held to be
    ‘construction’ under Article 5(2)(h) of the India-UAE DTAA.
  •     Article 7 provides that business profits
    earned by a resident of UAE shall be taxable in India only if such resident
    carries on business in India through a PE. As the activity of the assessee was
    not a construction project, the activity of grouting carried out by the
    assessee for the main contractors could not be considered ‘construction’ under
    Article 5(2)(h).
  •     To bring an establishment of the kind not
    mentioned in Article 5(2) within the ambit of PE, the criteria in Article 5(1)
    should be satisfied. The two criteria are (a) existence of a fixed place of
    business; and (b) wholly or partly carrying out of business or enterprise
    through that place.
  •     The
    Tribunal held that the assessee had a fixed place PE in India in the form of
    the vessel on which equipment was placed and personnel were stationed for the
    following reasons:

 1.     For carrying out
the grouting activity, equipment was the main place of business for the
assessee and equipment was placed and personnel were stationed on the vessel of
the main contractor. Further, in terms of the contracts, the assessee was
required to ensure that whenever required by the main contractor, personnel and
equipment will come to India, and, after completion of work, were sent out of
India until required by the main contractor again. Thus, the equipment and
personnel were demobilised after the work was completed.

2.    Further,
the agreement entered into between the assessee and the customers in India
provided for free of charge food and accommodation to the personnel on board
the offshore vessel.

3.   Thus,
the assessee had a fair amount of permanence through its personnel and its
equipments, within the territorial limits of India, to perform its business
activity for contractors with whom it has entered into agreements.

4.    Thus,
the vessel on which equipment was placed and personnel were stationed, was the
fixed place of business through which business was carried on by the assessee.

5.    Accordingly,
criteria under Article 5(1) were satisfied.

 

  •     Both the OECD Commentary and Professor Klaus
    Vogel’s commentary mention that as long as the presence is in a physically
    defined geographical area, permanence in such fixed place could be relative
    having regard to the nature of business. Hence, the placing of equipment and
    stationing of the personnel on the vessel of the main contractor constituted a
    fixed place of the business of the assessee in India.
  •     The Coordinate bench’s decision in the
    assessee’s own case for the A.Y. 2007-08 (see NOTE below) needed
    reconsideration in view of the fact that the existence of a fixed place PE has
    been decided by holding that ‘equipment’ cannot be held as a fixed place of
    business and such view was not in accordance with the Supreme Court’s decision
    in case of Formula One World Championship Ltd. (80 taxmann.com 347).

 

{NOTE:
For the A.Y 2007-08, the Delhi Tribunal had ruled in favour of the tax-payer by
stating that activities carried out by assessee amounts to ‘construction’ and
since the duration test of each contract is not satisfied, there was no
construction PE in India. Further, it held that Article 5(1) could not be
applied where activities are covered under the specific construction PE article
[Article 5(2)(h)] of the DTAA.}

 

Section 91 of the Act – Credit for state taxes paid in USA can be availed u/s. 91 of the Act Section 91 of the Act – A ‘resident but not ordinarily resident’ being a category carved out of ‘resident’ – Such assessee is a resident – Entitled to claim tax credit u/s. 91

12 [2019] 105 taxmann.com 323 (Delhi – Trib.) Aditya Khanna vs. ITO ITA No: 6668 (Delhi) of 2015 A.Y.: 2011-12 Date of order: 17th
May, 2019

 

Section 91 of the Act
– Credit for state taxes paid in USA can be availed u/s. 91 of the Act

 

Section 91 of the Act
– A ‘resident but not ordinarily resident’ being a category carved out of
‘resident’ – Such assessee is a resident – Entitled to claim tax credit u/s. 91

 

FACTS

The
assessee was an individual. During the relevant year, in terms of section 6(6)
of the Act, he was ‘resident but not ordinarily resident in India’ and had
earned salary in the USA as well as in India. In the USA, the assessee had paid
federal income tax, alternate minimum tax, New York State tax and local city
tax. The assessee had stayed in India for 224 days. Accordingly, he offered
salary proportionate to the period of his stay in India and claimed
proportionate tax credit.

 

He
contended before the AO that he had claimed credit for local taxes u/s. 91 of
the Act and relying on the decision in CIT vs. Tata Sons Ltd. 135 TTJ
(Mumbai). Alternately, the assessee contended that if the AO does not
consider claim for credit of state taxes, they may be allowed as deduction from
the salary earned abroad.

 

The
AO noted that Article 2 of the India-USA DTAA mentions only federal income
taxes imposed by internal revenue code and hence the tax credit should be
limited only to those taxes. He further noted that sections 90 and 91 stand on
different premises. Section 90 deals with the situation wherein India has an
agreement with foreign countries / specified territories, whereas section 91
deals with the situation where no agreement exits between India and other
countries. Since an agreement exists between India and the USA, section 90
would apply which refers to DTAA, and as per DTAA, only federal income taxes
paid in USA qualify for tax credit.

 

On
appeal, even the CIT(A) did not accept the contentions of the assessee.

 

HELD I:

  •     In Wipro Ltd. vs. DCIT [382 ITR 179],
    the Karnataka High Court has held that “The Income-tax in relation to any
    country includes Income-tax paid not only to the federal government of that
    country, but also any Income-tax charged by any part of that country meaning a
    State or a local authority, and the assessee would be entitled to the relief of
    double taxation benefit with respect to the latter payment also. Therefore,
    even in the absence of an agreement u/s. 90 of the Act, by virtue of the
    statutory provision, the benefit conferred u/s. 91 of the Act is extended to
    the Income-tax paid in foreign jurisdictions.”
  •     In Dr. Rajiv I. Modi vs. The DCIT
    (OSD) [ITA No. 1285/Ahd/2014],     dealing with a similar issue, the
    Ahmedabad Tribunal has also granted credit for state taxes.
  •     In light of these judicial precedents, u/s.
    91 of the Act, the assessee is entitled to credit of federal as well as state
    taxes paid by him.

 

HELD II:

  •     Section 91(1) and (2) provide tax credit to
    a person who is a ‘resident’ in India. Section 6(6) has carved out a separate
    category of ‘not ordinarily resident’ in India. However, such person is
    primarily a ‘resident’. Hence, the contention of the tax authority that a
    ‘resident but not ordinarily resident’ in India does not qualify for the
    benefit u/s. 91(1) cannot be accepted.

Section 145 – The project completion method is one of the recognised methods of accounting and as the assessee has consistently been following such recognised method of accounting, in the absence of any prohibition or restriction under the Act for doing so, the CIT(A) is correct in holding that the AO’s assertion that the project completion method is not a legal method of computation of income is not supported by facts and judicial precedents

9 ITO vs. Shanti Constructions
(Agra) Members: Sudhanshu
Srivastava (JM) and Dr. Mitha Lal Meena (AM) ITA No. 289/Agra/2017 A.Y.: 2012-13 Date of order: 16thMay,
2019 Counsel for Revenue /
Assessee: Sunil Bajpai / Pradeep K. Sahgal and Utsav Sahgal

 

Section 145 – The
project completion method is one of the recognised methods of accounting and as
the assessee has consistently been following such recognised method of
accounting, in the absence of any prohibition or restriction under the Act for
doing so, the CIT(A) is correct in holding that the AO’s assertion that the
project completion method is not a legal method of computation of income is not
supported by facts and judicial precedents

 

FACTS

The
assessee, a partnership firm engaged in the business of real estate and
construction of buildings for the past several years, filed its return of
income declaring therein a total income of Rs. 1,12,120. The AO completed the
assessment u/s. 143(3) of the Act, assessing the total income of the assessee
to be Rs. 3,94,62,580. While assessing the total income of the assessee, the AO
rejected the books of accounts on the ground that the assessee did not produce
bills / vouchers before him for ascertaining the accuracy and correctness of
the books of accounts; that it did not furnish evidence regarding closing
stock; and that the assessee is following the project completion method and not
the percentage completion method. The AO observed that the project completion
method has no existence since 1st April, 2003 and laid emphasis on
revised AS-7 introduced by the ICAI in 2002.

 

Aggrieved, the assessee preferred an appeal to CIT(A) who
noted that in the assessee’s own case in the assessment proceedings for AY
2014-15, the AO has accepted the project completion method. The CIT(A) allowed
the appeal filed by the assessee.

 

But the Revenue preferred an appeal to the Tribunal where
it placed reliance on the decision of the Supreme Court in the case of CIT
vs. Realest Builders & Services Ltd. [(2008) 22 (I) ITCL 73 (SC)].

 

HELD

The Tribunal observed that the assessee’s business came
into existence on 11th March, 2003 and since then it has been
consistently following the project completion method of accounting. It is well
settled that the project completion method is one of the recognised methods of
accounting and as the assessee has consistently been following such recognised
method of accounting, in the absence of any prohibition or restriction under
the Act for doing so, it can’t be held that the decision of the CIT(A) was
erroneous or illegal in any manner. The judgement in the case of CIT vs.
Realest Builders & Services Ltd. (supra) relied on by the DR on the
method of accounting is rather in favour of the assessee and against the
Revenue in the peculiar facts of the case. As such, the appeal filed by the
Revenue was dismissed.

Section 54A – Acquisition of an apartment under a builder-buyer agreement wherein the builder gets construction done in a phased manner and the payments are linked to construction is a case of purchase and not construction of a new asset – Even in a case where construction of new asset commenced before the date of sale of original asset, the assessee is eligible for deduction of the amount of investment made in the new asset

8  Kapil Kumar Agarwal vs. DCIT (Delhi) Members: Amit Shukla (JM)
and Prashant Mahrishi (AM) ITA No. 2630/Del./2015 A.Y.: 2011-12 Date of order: 30th
April, 2019 Counsel for Assessee /
Revenue: Piyush Kaushik / Mrs. Sugandha Sharma

 

Section 54A –
Acquisition of an apartment under a builder-buyer agreement wherein the builder
gets construction done in a phased manner and the payments are linked to
construction is a case of purchase and not construction of a new asset – Even
in a case where construction of new asset commenced before the date of sale of
original asset, the assessee is eligible for deduction of the amount of
investment made in the new asset

 

FACTS

During
the previous year relevant to the assessment year under consideration, the
assessee, an individual, sold shares held by him as long-term capital asset.
The long-term capital gain arising from the sale of shares was claimed as
deduction u/s. 54F of the Act. In the course of assessment proceedings, the AO
noted that the shares were sold on 13th July, 2010 for a
consideration of Rs. 80,00,000 and a long-term capital gain of Rs. 79,85,761
arose to the assessee on such sale. The assessee claimed this gain of Rs.
79,85,761 to be deductible u/s. 54F by contending that it had purchased a
residential apartment by entering into an apartment buyer’s agreement and
having made a payment of Rs. 1,42,45,000.

 

The
AO was of the view that the assessee has not purchased the house but has made
payment of instalment to the builder for construction of the property. He also
noted that the assessee has started investing in the new asset with effect from
18th August, 2006, that is, three years and 11 months before the
date of sale. Further, around 90% of the total investment in the new asset has
been made before the date of sale of the original asset. The AO denied claim
for deduction of Rs. 79,85,761 made u/s. 54F of the Act. He observed that the
assessee would have been eligible for deduction u/s. 54F had the entire
investment in the construction of the new asset been made between 13th July,
2010 and 12th July, 2013.

 

Aggrieved,
the assessee preferred an appeal to the CIT(A) who upheld the action of the AO.
Still not satisfied, the assessee preferred an appeal to the Tribunal.

 

HELD

The Tribunal held that the question as to whether the
acquisition of an apartment under a builders-buyers agreement wherein the
builder gets construction done in a phased manner and the payments are linked
to construction is a case of purchase of a new asset or construction of a new
asset has been answered by the Delhi High Court in the case of CIT vs.
Kuldeep Singh [(2014) 49 taxmann.com 167 (Delhi)]. Referring to the
observations of the Delhi High Court in the case,  the Tribunal held that acquisition of an
apartment under a builders-buyers agreement wherein the builder gets construction
done in a phased manner and the payments are linked to construction is a case
of purchase and not construction of a new asset.

 

The Tribunal observed that the second question, viz.,
whether the construction of new asset even if commenced before the date of sale
of the original asset, the assessee is eligible for deduction of the amount of
investment made in the property, has been examined in the case of CIT vs.
Bharti Mishra [(2014) 41 taxmann.com 50 (Delhi)]. The Tribunal observed
that the issue in the present case is squarely covered by this decision of the
Delhi High Court. It held that the assessee has purchased a house property,
i.e., a new asset, and is entitled to exemption u/s. 54F of the Act despite the
fact that construction activities of the purchase of the new house started
before the date of sale of the original asset which resulted into capital gain
chargeable to tax in the hands of the assessee. The Tribunal reversed the order
of the lower authorities and directed the AO to grant deduction u/s. 54F of Rs.
79,85,761 to the assessee. In the event, the appeal filed by the assessee was
allowed.

Section 50C(2) – By virtue of section 23A(1)(i) being incorporated with necessary modifications in section 50C, the correctness of a DVO’s report can indeed be challenged before CIT(A) in an appeal – In the event of the correctness of the DVO’s report being called into question in an appeal before Commissioner (Appeals), the DVO is required to be given an opportunity of a hearing

7 Lovy Ranka vs. DCIT (Ahmedabad) Members: Pramod Kumar (VP)
and Madhumita Roy (JM) ITA No. 2107/Ahd./2017 A.Y.: 2013-14 Date of order: 1stApril,
2019 Counsel for Assessee /
Revenue: Chitranjan Bhardia / S.K. Dev

 

Section 50C(2) – By
virtue of section 23A(1)(i) being incorporated with necessary modifications in
section 50C, the correctness of a DVO’s report can indeed be challenged before
CIT(A) in an appeal – In the event of the correctness of the DVO’s report being
called into question in an appeal before Commissioner (Appeals), the DVO is
required to be given an opportunity of a hearing

 

FACTS

The
assessee, an individual, sold a bungalow for Rs. 1,15,00,000; the stamp duty
value of the same was Rs. 1,40,00,000. The assessee contended that the fair
market value of the bungalow was lower than its stamp duty value. The AO made a
reference to the DVO u/s. 50C(2). The valuation as per the DVO was Rs.
1,27,12,402. The assessee made elaborate submissions on the incorrectness of
this valuation. But the AO completed the assessment by adopting the valuation
done by the DVO as he was of the view that the valuation done by the DVO binds
him and it is his duty to pass an order in conformity with the DVO’s report.
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 where the Revenue contended
that the AO is under a statutory obligation to adopt the valuation as done by
the DVO and as such no fault can be found in his action; therefore, the
appellate authorities cannot question that action either.

 

HELD

The Tribunal considered the question whether it can deal
with the correctness of the DVO’s report particularly when the AO apparently
has no say in this regard. Upon examining the provisions of section 50C(2) and
also the provisions of sections 23A(6) and 24(5) of the Wealth-tax Act, 1957
the Tribunal held that what follows from these provisions is that in the event
that the correctness of the DVO’s report is called in question in an appeal
before the Commissioner (Appeals), the DVO is required to be given an
opportunity of a hearing. The provisions of section 24(5) of the Wealth-tax
Act, 1957 make a reference to section 16A and the provisions of section 50C
specifically refer to the provisions of section 16A of the Wealth-tax Act,
1957.

 

The Tribunal held that the correctness of the DVO report
can indeed be challenged before it as well, as a corollary to the powers of the
CIT(A) which come up for examination before it, once again the rider being that
the Valuation Officer is to be given an opportunity of a hearing. This
opportunity of a hearing to the DVO is a mandatory requirement of law. This is
the unambiguous scheme of the law.

 

It also held that the CIT(A) ought to have examined the
matter on merits. Of course, before doing so the CIT(A) was under a statutory
obligation to serve notice of hearing to the DVO and thus afford him an
opportunity of a hearing. The Tribunal held that the correctness of the DVO’s
report is to be examined on merits and since there was no adjudication, on that
aspect, by the CIT(A), the Tribunal remitted the matter to the file of the
CIT(A) for adjudication on merits in accordance with the scheme of the law,
after giving a due and reasonable opportunity of hearing to the assessee, as
also to the DVO, and by way of a speaking order.

 

As
such, the Tribunal allowed the appeal filed by the assessee.

Section 143 r.w.s. 131 and 133A – Assessing Officer could not make additions to income of the assessee company only on the basis of a sworn statement of its managing director recorded u/s. 131 in the course of a survey without support of any corroborative evidence

23  [2019] 199 TTJ (Coch) 758 ITO vs. Toms Enterprises ITA No. 442/Coch/2018 A.Y.: 2014-15 Date of order: 7th
February, 2019

 

Section
143 r.w.s. 131 and 133A – Assessing Officer could not make additions to income
of the assessee company only on the basis of a sworn statement of its managing
director recorded u/s. 131 in the course of a survey without support of any
corroborative evidence

 

FACTS

A survey action u/s. 133A was conducted in the business
premises of the assessee firm. During the course of survey, summons u/s. 131(1)
was issued by the AO to TCV, managing partner of the firm, and statement u/s.
131 was recorded in which he indicated the gross profit of the assessee at 15%.
On verification of the profit and loss, the AO found that the assessee had
shown gross profit at 10.55% instead of 15% as indicated by the managing
partner. The AO assessed the gross profit at 15% and made an addition to the
income returned.

 

Aggrieved by the assessment order, the assessee preferred
an appeal to the CIT(A). The CIT(A) observed that the statement of the managing
partner was not based on any books maintained by the assessee and, therefore,
no addition could be made based on such general statements.

 

Being aggrieved by the CIT(A) order, the Revenue filed an
appeal before the Tribunal.

 

HELD

The Tribunal held that u/s. 131 the income tax authority
was empowered to examine on oath. The power invested u/s. 131(1) was only to
make inquiries and investigations and not meant for voluntary disclosure or
surrender of concealed income. As per section 31 of the Indian Evidence Act,
1878 admissions were not conclusively proved as against admitted proof. The
burden to prove ‘admission’ as incorrect was on the maker and in case of
failure of the maker to prove that the earlier stated facts were wrong, these
earlier statements would suffice to conclude the matter. The authorities could
not conclude the matter on the basis of the earlier statements alone.

 

If the assessee proved that the statement recorded u/s.
131 was involuntary and it was made under coercion or during their admission,
the statement recorded u/s. 131 had no legal validity. From the CBDT Circular
in F. No. 286/98/2013-IT (Inv. II) dated 18th December, 2014 it was
amply clear that the CBDT had emphasised on its officers to focus on gathering
evidences during search / survey operations and strictly directed to avoid
obtaining admission of undisclosed income under coercion / under influence.

 

The uncorroborated statements collected by the AO could
not be the evidence for sustenance of the addition made by the AO. It had been
consistently held by various courts that a sworn statement could not be relied
upon for making any addition and must be corroborated by independent evidence
for the purposes of making assessments.

 

From the foregoing discussion, the following principles
could be culled out: Firstly, an admission was an extremely important piece of
evidence but it could not be said that it was conclusive and it was open to the
person who made the admission to show that it was incorrect and that the
assessee should be given a proper opportunity to show that the books of
accounts did not correctly disclose the correct state of facts. Secondly,
section 132(4) enabled the authorised officer to examine a person on oath and
any statement made by such person during such examination could also be used in
evidence under the Income-tax Act.

 

On the other hand,
whatever statement was recorded u/s. 133A could not be given any evidentiary
value for the obvious reason that the officer was not authorised to administer
oath and to take any sworn statement which alone had evidentiary value as
contemplated under law. Thirdly, the word ‘may’ used in section 133A(3)(iii),
viz., record the statement of any person which may be useful for, or relevant
to, any proceeding under this Act, made it clear that the materials collected
and the statement recorded during the survey u/s. 133A were not a conclusive
piece of evidence in themselves. Finally, the statement recorded by the AO u/s.
131 could not be the basis to sustain the addition since it was not supported
by corroborative material.

Section 2(15) r.w.s. 10(23C) – Where assessee was conducting various skill training programmes for students to get placement, activities would fall within definition of education u/s. 2(15), thus entitling it for exemption u/s. 10(23C)(iiiab)

22  [2019] 199 TTJ (Del) 922 Process-cum-Product
Development Centre vs. Additional CIT ITA No. 3401 to
3403/Del/2017 A.Y.s: 2010-11 to 2013-14 Date of order: 4th
February, 2019

 

Section 2(15) r.w.s.
10(23C) – Where assessee was conducting various skill training programmes for
students to get placement, activities would fall within definition of education
u/s. 2(15), thus entitling it for exemption u/s. 10(23C)(iiiab)

 

FACTS

The assessee society was engaged in imparting education
and in the same process trained students by sending them to sports industries,
etc. It conducted various short-duration training programmes of computer
training, training in Computer Accounting System, cricket bat manufacturing,
carom board manufacturing, training in R/P workshop, wood workshop, etc. The
assessee got raw material from industries and after manufacturing the goods
through its trainees, returned the finished goods after receiving its job charges.
The assessee claimed exemption u/s. 10(23C)(iiiab). The AO declined the
exemption on the ground that the assessee did not exist solely for educational
purposes.

 

Aggrieved, the assessee preferred an appeal to the CIT(A).
The CIT(A) also declined the exemption and recorded further in his order that
the issue of charitable activities of the assessee society being of charitable
nature was not relevant in the instant case as the assessee was yet to be
registered u/s. 12AA.

 

HELD

The Tribunal held that the main objects of the assessee
society were to be examined. The AO had relied upon the decision rendered by
the Supreme Court in the case of Sole Trustee Loka Shikshak Trust vs. CIT
[1975] 101 ITR 234 wherein the word ‘education’ as referred in section
2(15) was explained. The Supreme Court had categorically held that ‘education’
connoted the process of training and developing the knowledge, skill, mind and
character of students by normal schooling.

 

When the training imparted to the students was not to
produce goods of world standard by doing necessary marketing research and by
identifying products for domestic and export market, such training would be of
no use and the students who had been given training would not be in a position
to get placement. Examination of the audited income and expenditure account of
the assessee society showed that substantial income was from training courses
and there was a minuscule income from job receipts.

 

The
assessee society was admittedly getting raw material from various industries to
produce sport goods for them and the job charges paid by them were again used
for running the training institute, therefore it could not be said by any
stretch of the imagination that the assessee society was not being run for
educational / training purpose. The word ‘education’ was to be given wide
interpretation which included training and developing the knowledge, skill,
mind and character of the students by normal schooling. So, the assessee
society was engaged in imparting training to the students in manufacturing
sport goods and leisure equipments without any profit motive.

 

Further,
the exemption sought for by the assessee society u/s. 10(23C)(iiiab) was
independent of exemption being sought by the assessee u/s. 12AA. So, the
exemption u/s. 10(23C)(iiiab) could not be declined on the ground that
registration u/s. 12A had been rejected. The assessee society, substantially
financed by the Government of India, was engaged only in imparting
research-based education / skill training to the students in manufacturing of
sports goods and leisure equipments without any profit motive, to enable them
to get placement; this fell within the definition of education u/s. 2(15),
hence it was entitled for exemption u/s. 10(23C)(iiiab).

 

Section 148 – Mere reliance on information received from Investigation Wing without application of mind cannot be construed to be reasons for reopening assessment u/s. 148

21 [2019] 70 ITR (Trib.) 211
(Delhi) M/s. Key Components (P) Ltd.
vs. the Income Tax Officer ITA. No.366/Del./2016 A.Y.: 2005-2006 Date of order: 12th
February, 2019

 

Section 148 – Mere
reliance on information received from Investigation Wing without application of
mind cannot be construed to be reasons for reopening assessment u/s. 148

 

FACTS

The assessee’s case was reopened on the basis of
information received from the Investigation Wing of the Income-tax Department
that the assessee company has taken accommodation entries. The assessee
objected to the reopening; however, the AO completed the assessment after
making an addition of undisclosed income on account of issue of share capital.
The assessee challenged the reopening of the assessment as well as the addition
on merits before the Commissioner (Appeals). The CIT(A), however, dismissed the
appeal of the assessee on both grounds. Aggrieved, the assessee preferred an
appeal on the same grounds to the Tribunal.

 

HELD

The
Tribunal observed that in this case the AO has merely reproduced the
information which he received from the Investigation Wing, in the reasons
recorded u/s. 148 of the Act. He has neither gone through the details of the
information nor has he applied his mind and merely concluded that the
transaction SEEMS not to be genuine, which indicates that he has not recorded
his satisfaction. These reasons are, therefore, not in fact reasons but only
his conclusion, that, too, without any basis. The AO has not brought anything
on record on the basis of which any nexus could have been established between
the material and the escapement of income. The reasons fail to demonstrate the
link between the alleged tangible material and formation of the reason to
believe that income has escaped assessment, the very basis that enables an
officer to assume jurisdiction u/s. 147.

 

The
Tribunal remarked, “Who is the accommodation entry giver is not mentioned. How
can he be said to be ‘a known entry operator’ is even more mysterious.”

 

In
coming to the conclusion, the Tribunal discussed the following decisions at
length:

 

1.    Pr. CIT vs. Meenakshi Overseas Pvt. Ltd. [395
ITR 677] (Del.)

2.    Pr. CIT vs. G&G Pharma India Ltd. (2016)
[384 ITR 147] (Del.)

3.     Pr. CIT vs. RMG Polyvinyl (I) Ltd. (2017)
[396 ITR 5] (Del.)

4.    M/s. MRY Auto Components Ltd. vs. ITO – ITA.
No. 2418/Del./2014, dated 15.09.2017

5.    Signature Hotels Pvt. Ltd. vs. Income-tax
Officer Writ Petition (Civil) No. 8067/2010 (HC)

6.    CIT vs. Independent Media Pvt. Limited – ITA
No. 456/2011 (HC)

7.    Oriental Insurance Company Limited vs.
Commissioner of Income-tax [378 ITR 421] (Del.)

8.    Rustagi Engineering Udyog (P) Limited vs.
DCIT W.P. (C) 1293/1999 (HC)

9.    Agya Ram vs. CIT – ITA No. 290/2004 (Del.)

10.  Rajiv Agarwal vs. CIT W.P. (C) No. 9659 of
2015 (Del.)

 

Section 234E – In case of default in filing TDS statement for a period beyond 1st June, 2015, fees u/s. 234E cannot be levied for the period before 1st June, 2015

20 [2019] 70 ITR (Trib.) 188 (Jaipur) Shri Uttam Chand Gangwal vs.
The Asst. CIT, CPC (TDS), Ghaziabad ITA No. 764/JP/2017 A.Y.: 2015-16 Date of order: 23rd
January, 2019

 

Section
234E – In case of default in filing TDS statement for a period beyond 1st
June, 2015, fees u/s. 234E cannot be levied for the period before 1st
June, 2015

 

FACTS

The assessee filed TDS statement in Form 26Q for Q4 of
F.Y. 2014-15 on 22nd July, 2015 for which the due date was 15th
May, 2015. The TDS statement was processed and the ACIT, TDS issued an
intimation dated 30th July, 2015 u/s. 200A of the Act imposing a
late fee of Rs. 13,600 u/s. 234E of the Act for the delay in filing the TDS
statement. On appeal, the Learned CIT(A) confirmed the said levy. The assessee
therefore filed an appeal to the Tribunal.

 

HELD

The Tribunal observed that though the quarterly statement
pertains to the quarter ended 31st March, 2015, the fact remains
that there is a continuing default even after 1st June, 2015 and the
statement was actually filed on 22nd July, 2015. It further observed
that an assessee who belatedly filed the TDS statement even though pertaining
to the period prior to 1st June, 2015 cannot be absolved from levy
of late fee when there is a continuous default on his part even after that
date. The Tribunal, therefore, concluded that, irrespective of the period to
which the quarterly statement pertains, where the statement is filed after 1st
June, 2015, the AO can levy fee u/s. 234E of the Act.

 

At the same time, in terms of determining the period for
which fees can be levied, the only saving could be that for the period of delay
falling prior to 1st June, 2015, there could not be any levy of fees
as the assumption of jurisdiction to levy such fees has been held by the Courts
to be prospective in nature. However, where the delay continues beyond 1st
June, 2015, the AO is well within his jurisdiction to levy fees u/s. 234E for
the period starting 1st June, 2015 to the date of actual filing of
the TDS statement. In the result, the Tribunal partly allowed the assessee’s
appeal by deleting fees for the period prior to 1st June, 2015 and
confirmed the fees levied for the subsequent period.

Section 154 – Non-consideration of decision of Jurisdictional High Court or of the Supreme Court can be termed as ?mistake apparent from the record’ which can be the subject matter of rectification application u/s. 154 even if not claimed earlier by the assessee during assessment proceedings or appellate proceedings

19 [2019] 71 ITR (Trib.) 141 (Mumbai) Sharda Cropchem Limited vs.
Dy. Comm. of Income Tax ITA No. 7219/Mum/2017 A.Y.: 2012-2013 Date of order: 14th
February, 2019

 

Section 154 –
Non-consideration of decision of Jurisdictional High Court or of the Supreme
Court can be termed as ?mistake apparent from the record’ which can be the
subject matter of rectification application u/s. 154 even if not claimed
earlier by the assessee during assessment proceedings or appellate proceedings

 

FACTS

The assessee’s income was subject to assessment u/s. 143(3).
Additions were made u/s. 35D as also under other sections. The assessee did not
contest addition u/s. 35D but filed appeal against the other additions. In the
meanwhile, the assessee filed an application for rectification to allow the
expenditure on issue of bonus shares, in terms of decision of the Bombay High
Court in CIT vs. WMI Cranes Limited [326 ITR5 23] and the Supreme
Court in CIT vs. General Insurance Corporation [286 ITR 232].
However, the AO denied the rectification; consequently, the assessee appealed
to the Commissioner (Appeals) against the AO’s order rejecting his
rectification application. However, the assessee’s claim was rejected by the
Commissioner (Appeals) also. The assessee then filed an appeal to the Tribunal.

 

HELD

The Tribunal observed that the assessee moved
rectification petition u/s. 154 for the first time towards his claim u/s. 35D
relying upon the decision of the Hon’ble Supreme Court as well as the decision
of the jurisdictional High Court. The only basis on which the same was denied
by first appellate authority is the fact that there was no mistake apparent
from the record. The Tribunal considered the decision of the Supreme Court in ACIT
vs. Saurashtra Kutch Stock Exchange Ltd. [305 ITR 227]. It observed
that non-consideration of a decision of the Jurisdictional High Court or of the
Supreme Court could be termed as ‘mistake apparent from the record’.

 

The Tribunal also analysed the said facts from the angle
of constitutional authority – in terms of Article 265 of the Constitution of
India, no tax is to be levied or collected except by the authority of law. It
is trite law that true income is to be assessed and the Revenue could not
derive benefit out of the assessee’s ignorance or procedural defects. The
Tribunal finally allowed the appeal filed by the assessee considering the
principles of rectification pronounced in Saurashtra Kutch Stock Exchange
Ltd. (supra) and merits of the case as held in General Insurance
Corporation (supra).

 

Section 143 r.w.s. 148 – Failure to issue notice u/s. 143(2) of the Act after the assessee files the return of income renders the re-assessment order illegal and invalid

18 [2019] 105 taxmann.com 118
(Pune) ITO
(Exemptions) vs. S. M. Batha Education Trust ITA No. 2908/Pun/2016 A.Y.: 2012-13 Date of order: 4th
April, 2019

 

Section 143 r.w.s.
148 – Failure to issue notice u/s. 143(2) of the Act after the assessee files
the return of income renders the re-assessment order illegal and invalid

 

FACTS

The AO issued a notice u/s. 148 of the Act dated 29th
September, 2014 to the assessee, a trust engaged in educational
activities. The assessee neither replied to the notice nor filed its return of
income. Thereafter,
the AO issued two separate notices u/s. 143(2) of the Act on 29th
April, 2015 and 1st July, 2015. Subsequently, the assessee filed the
return of income on 21st October, 2015.

 

The AO completed the assessment and passed a reassessment
order. Aggrieved, the assessee preferred an appeal to the CIT(A).

 

Revenue also preferred an appeal to the Tribunal. The
assessee filed cross-objections challenging the re-assessment proceedings to be
bad in law since no statutory notice u/s. 143(2) was issued by the AO after the
assessee filed the return of income. The Tribunal decided this jurisdictional
issue.

HELD

The Tribunal held that the AO is required to issue
statutory notice u/s. 143(2) of the Act after the assessee files the return of
income in response to notice issued u/s. 148 of the Act. In the absence of such
a statutory notice after return of income is filed by the assessee, the
re-assessment order made by the AO was held to be invalid and illegal.

 

The Tribunal dismissed the appeal filed by Revenue and
allowed this ground raised by the assessee in its cross-objections.

Section 143 – Assessment order passed in the name and status of the HUF where the notice was issued in the name and status of an individual is invalid and such an assessment order deserves to be quashed

17 [2019] 105 taxmann.com 201
(Pune) Pravin Tilokchand Oswal
(HUF) vs. ITO ITA No. 1917/Pun/2018 A.Y.: 2007-08 Date of order: 4th
April, 2019

 

Section 143 –
Assessment order passed in the name and status of the HUF where the notice was
issued in the name and status of an individual is invalid and such an
assessment order deserves to be quashed

 

FACTS

The assessment order was passed in the status of the HUF,
whereas proceedings were initiated by issue of notice u/s. 143(2) of the Act in
the name of the individual. Both the individual and the HUF were assessed to
tax and had different and distinct PAN numbers. The first notice for getting
jurisdiction to make the assessment was issued u/s. 143(2) of the Act in the
name of the individual and the PAN number of the individual was clearly
mentioned. However, assessment was made in the hands of the HUF.

Aggrieved,
the assessee preferred an appeal to the CIT(A) who decided it on merits but did
not decide the jurisdictional issue and passed an ex parte order against
the assessee.

 

The aggrieved assessee preferred an appeal to the Tribunal
where it was pointed out that the information received under the Right to
Information Act clearly mentioned that notice was issued for the individual and
proceedings were carried out for the individual. However, the assessment was
made in the name of the HUF.

 

HELD

The Tribunal held that since notice was issued in the name
of the individual and assessment completed and made in the name of the HUF, the
assessment order was invalid and bad in law. The Tribunal quashed the
assessment order. It decided in favour of the assessee.

VALUATION OF STARTUPS

Generally, the
valuation approaches or methodologies are based on the evaluation of assets,
revenue, profitability, etc. of the business. However, in case of startups,
they neither have an asset base nor revenue. For example, the valuation of
Airbnb is over twice as much as that of Hyatt – although Airbnb is effectively
the world’s largest hotel chain without owning a single hotel room! Hence, the
exercise of valuing a startup poses various challenges to the valuer.

 

In effect, valuing a startup is an exercise of calculating the best
estimate of the sum of its parts, i.e., all its resources, intellectual
capital, technology, brand value and financial assets that the startup brings
to the table. In this article we will cover the basics of startup valuation
progressing over stages of financing, need of valuing start-ups and methods of
valuation, followed by a case study in the Indian market.

 

So what does a
startup mean?

 

WHAT IS A STARTUP?

A startup is a
business enterprise incorporated to solve a problem by delivering a new product
or service under conditions of extreme uncertainty. It is a company typically
in the early stages of its development.

 

These
entrepreneurial ventures are typically started by one to three founders who
focus on capitalising upon a perceived market demand by developing a viable
product, service or platform. The founders’ effort is to turn their idea into a
repeatable and scalable business.

 

In the Indian
scenario, the Department for Industrial Policy and Promotion (DIPP) issued a
notification in February, 2019 defining a startup as an entity which is in
existence up to a period of ten years from the date of incorporation /
registration with a turnover for any of the financial years since incorporation
/ registration not exceeding Rs. 100 crores and working towards innovation,
development or improvement of products or processes or services or, if it is a
scalable business model, with a high potential of employment generation or
wealth creation – provided that an entity formed by splitting up or
reconstruction of an existing business shall not be considered a startup.


STAGES OF FUNDING

At the initial
stage, startups are self-funded by members of the founding team who also try to
secure funding through an investor or obtain a loan to help fund their venture.
There are various stages when a startup raises funds and its valuation differs
in each stage or round of funding.

 

1.  Angel/Seed Funding – This is typically
the very first stage where the funding is required for market research and
developing the product. At this stage the founder personally invests or raises
funds from acquaintances, or it comes from someone not known to the founder
called an ‘Angel Investor’. Seed capital is often given in exchange for a
percentage of the equity of the business, usually 20% or less;

2.  Series A Funding – It is when startups
have a strong idea about their business and product and may have even launched
it commercially. Series A Funding is typically used to establish a product in
the market and take the business to the next level, or to make up the shortfall
of the startup not yet being profitable;

3.  Series B Funding – The startup has
established itself but needs to expand, either with organic growth, with new
markets or acquisitions;

4.  Debt Funding – When a startup is fully
established it can raise money through a loan or debt that it will pay back,
such as venture debt, or lines of credit from a bank. A venture debt fund
typically lends when the startup is backed by known investor funds;

5.  Mezzanine Financing – It is also known
as bridge financing because it finances the growth of companies prior to an
IPO. This is usually short-term debt with the proceeds of the IPO or buyout
paying it back;

6.  Leveraged Buyout (LBO) – This form of
funding is made up of convertible debt or preferred shares which are more
costly and provide investors certain rights over the holder of common equity.
It is a strategy where someone acquires an existing company with a significant
amount of borrowed funds. Usually, the assets of the business being purchased
are used as leverage and collateral for the loan used to purchase it;

7.  Initial Public Offering (IPO)
– An IPO is when the shares of a company are sold on a public stock exchange
where anyone can invest in the business. IPO opening stock prices are usually
set with the help of investment bankers.

 

A point to note is
that a startup valuation is required at each stage of funding.

 

CONSIDERATIONS FOR
STARTUP VALUATION


Startup valuation
means believing in the story and the founders’ strength to turn it into
reality. It could be the sum of all resources, technology, brand value and
financial assets that the startup has developed.

 

Startups usually
have little or no revenue or profit and are still in a stage of instability.

 

For startup
businesses one should consider the top-down approach by looking at the total
market available to the product / service and derive the cash flow to the firm
/ company therefrom. The following factors need to be considered and evaluated:

 

  •     Traction –This
    includes analysis of the active and non-active user base / subscriber base /
    customers of the company for the past period since inception. How fast the
    startup is growing vis-à-vis its competitors and where it is likely to
    reach in the next 12 to 24 months;
  •     Reputation of the team
    – The assessment of the track record of the founders includes their coming up
    with good ideas or running successful businesses, or development of the product,
    procedure or service which already has a good reputation. The risk analysis of
    the ventures promoted by such a team would be a bit liberal;
  •     Prototype – Whether
    the model or release of product built to test the concept or process is ready
    and tested successfully. Any prototype that a business may have that displays
    the product / service will help;
  •     Revenues – The visibility of
    revenue-generation like charging users / subscribers / customers, etc. There is
    also a need to check how diversified is the revenue model in different target
    customers or geographies or different products;
  •     Funding supply and
    demand     – An investor is likely to pay a premium to a startup for early
    mover advantage. Discuss, understand and analyse the visibility of a successful
    business venture in a similar space, product differentiation;  the market forces, such as at what prices are
    similar deals being priced and the amounts of recent exits can affect the value
    of startups in a specific sector;
  •     Distribution channel
    – The valuation of a startup with a proper distribution channel in place will
    certainly be higher than that of one without such a channel;
  •     Industry – In case
    of a new idea of doing traditional business, e.g., a fintech platform,
    understanding and research on a particular sector is very important. If a
    particular industry is booming or popular (e.g. gaming), the value of the
    business may be more if it falls into the right industry.

 

VALUATION APPROACHES
AND METHODS

Startups don’t have a long track record of generating cash flow and
valuations in such cases are highly subjective. While making an investment
decision, investors assess the valuation of such startups blending various
methods together.

 

The following are
the various valuation methodologies generally used to value startups.

 

VALUATION METHODS VIS-A-VIS PRINCIPLES

1   Berkus

Valuation based on the assessment of five
key success factors

2   Risk Factor Summation

Valuation based on a base value adjusted
for 12 standard risk factors

3   Scorecard

Valuation based on a weighted average
value adjusted for a similar company

4   Comparable Transactions

Valuation based on a rule of three with a
KPI from a similar company

5   Book Value

Valuation based on the tangible assets of
the company

6   Liquidation Value

Valuation based on the scrap value of the
tangible assets particularly to be used in a liquidation scenario

7   Discounted Cash Flow

Valuation based on the sum of all future
cash flows generated

8   First Chicago

Valuation based on the weighted average of three valuation scenarios

9   Venture Capital

Valuation based on the ROI expected by the
investor

10 Price of Recent Investment

Valuation based on the price of the recent
investment round in the company

 

Berkus Method

The Berkus method, developed by Dave Berkus, is used to value pre-revenue
startups and is mostly applied to technology companies. This method is based on
the assumption that the company has the potential to reach $20 million or more
in revenues by the 5th year of operation.

 

The Berkus method applies a scale to the following five components of a
startup, rating each from zero up to $0.5 million:

(a) Sound idea (attract of core business to buyer)

(b) Quality of management (good management in
place)

(c) Strategic alliance (go-to-market)

(d) Product prototype

(e) Product rollout and sales plan

 

Using this method, the highest valuation could be a maximum of up to $2.5
million and, in case of a pre-revenue startup, it could only score up to $2
million.

 

Risk Factor Summation Method

This is a slightly
more evolved version of the Berkus Method. It is widely used by Angel Investors
for pre-revenue startups when determining seed investing and subsequent
financing rounds. The method is based on the average industry pre-money
valuation and adjusted for the following 12 risk factors associated with the
startup and its industry:

 

I.      Management risk

II.     Stage of the business

III.    Legislation / political
risk

IV.    Manufacturing risk (or
supply chain risk)

V.    Sales and marketing risk

VI.    Funding / capital
raising risk

VII.   Competition risk

VIII.  Technology risk

IX.    Litigation risk

X.    International risk

XI.    Reputation risk

XII.   Exit value risk

 

Each risk factor is
assessed and scored on a scale of 5 to a range of +$500K to -$500K (+$500K,
+$250K, 0, -$250K and -$500K). The net out-ratings / scores are adjusted to the
average industry pre-money valuation to arrive at the startup’s pre-money
valuation.

 

Scorecard Method

The Scorecard
Method, developed by Bill Payne, is similar to the Risk Factor Summation and
Berkus Methods and is usually used to value pre-revenue startups. This method
uses a combination of industry data and weighted percentages based on detailed
analysis of the following quantitative and qualitative factors:

 

(1) Management team
(0-30%)

(2) Size of
opportunity (0-25%)

(3) Product /
technology or service (0-15%)

(4) Competitive
environment (0-10%)

(5) Marketing /
sales channels / partnerships (0-10%)

(6) Need for
additional investment (0-5%)

(7) Other factors
(0-5%)

The sum of the
above factors is multiplied to the industry average pre-money valuation to
arrive at the startup’s pre-money valuation.

 

Comparable Transactions Method

This method is used in case of both pre-revenue and post-revenue startup
valuation. It involves determining similar merger or investment transactions in
the recent past and in the same industry as that of the subject company
business. The relevant comparable transactions valuation is analysed based on
the relevant key metrics of the industry and a range of multiples is derived
which is used in the determination of the valuation of the subject company.

 

Book Value Method

The Book Value
Method is an asset-based valuation approach and refers to the net worth of the
company. Here, the book value is calculated by deducting the value of
intangible assets and liabilities from the value of the total tangible assets.
The value of total tangible assets in this case is the cost at which the asset
is recorded in the balance adjusted for accumulated depreciation and impairment
costs.

 

Liquidation Value Method

In this method the
assessor determines the Fair Value of an asset when the company gets liquidated
or if the asset is no longer usable. The method considers only tangible assets
like plant and machinery, fixtures, inventory, etc., and intangibles are not
considered irrespective of the value they may hold. The net liquidation value
is calculated by deducting the value of liabilities from the total liquidation
value of all the tangible assets.

 

Discounted Cash Flow Method

The Discounted Cash
Flow method determines the attractiveness of the investment in the startup
based on the present value of the cash flows and that the startup is expected
to generate in future. The investor assesses the value derived from this method
and the cost of the investment. In case of pre-revenue startups, the cash flows
are normalised based on the stage of the life cycle of its business and once
the business starts growing at a steady pace, it is believed that the business
will generate cash flows for an indefinite period.

 

First Chicago Method

This method is used
to value post-revenue startups. It is based on probabilities with the following
three scenarios of financial forecast of the startup:

1.  Worst case

2.  Normal case

3.  Best case

 

Each valuation is made with the Discounted Cash Flow Method and assigned
a percentage reflecting the probability of each scenario occurring.

 

Venture Capital Method

The Venture Capital Method, described by Prof. Bill Sahlman in 1987 at
Harvard Business School, is based on the expected future returns of the
investor.

 

In this method the investor assumes that after a span of ‘n’ years the
startup could be sold for ‘x’ amount. Based on the expected return on
investment and the sale value, the investor determines the price he / she is
willing to pay today for investing in the startup, after adjusting for dilution
and future rounds between now and the company sale.

 

Price of Recent Investment Method

The recent
investment in the business is often taken as the base value if there are no
substantial changes since the last investment.

 

The Price of a Recent Investment valuation technique is likely to be
appropriate but only for a limited period after the date of the relevant
transaction. Given the relatively high frequency with which funding rounds are
often undertaken for seed and startup situations, or in respect of businesses
engaged in technological or scientific innovation and discovery, this method
will often be appropriate for valuing investments in such circumstances.
Generally, Fair Value would be indicated by the post-money valuation. The
length of the period for which it would remain appropriate to use this
valuation technique will depend on the specific circumstances of the investment
and is subject to the judgement of the valuer.

 

ASSESSMENT OF KEY
PERFORMANCE INDICATORS AND METRICS

The application of
the above methods is based on the assessment of risk parameters and other
factors discussed earlier specific to the startup under valuation. The common
set of target milestones would be established at the time of making the
assessment; these will vary across types of investments, specific companies and
industries, but are likely to include:

Financial
Measures:

– revenue growth;

– profitability
expectations;

– cash burn rate;

– covenant
compliance.

 

Technical
measures:

– phases of
development;

– testing cycles;

– patent approvals;

– regulatory
approvals.

 

Marketing and
sales measures:

– customer surveys;

– testing phases;

– market
introduction;

– market share.

 

In addition, the
key market drivers of the company, as well as the overall economic environment,
are relevant to the assessment.

 

FACTORING SCENARIOS

Therefore, using
the scenario-based DCF method (DCF with First Chicago Method) that considers
one or more future scenarios and assigning the probability of success to each
scenario gives a reliable indication of Fair Value. Further, there is also a
probability-weighted expected return model (PWERM) whereby probabilities can be
assigned to the expected up rounds, flat rounds or down rounds to arrive at a
value.

 

The option pricing
method (OPM), a forward-looking method that considers the current equity value
and then allocates that value to the various classes of equity considering a
continuous distribution of outcomes rather than focusing on distinct future
scenarios or a hybrid of a scenario-based method and OPM, can be considered.

 

For seed, startup
or early-stage companies in the absence of significant revenues, profits or
positive cash flows, other methods such as earning multiple are generally inappropriate.
The most appropriate approach to assess Fair Value may be a valuation technique
that is based on market data.

 

It is appropriate
to use an enhanced assessment based on industry analysis, sector analysis,
scenario analysis and / or milestone analysis. In such circumstances
industry-specific benchmarks / milestones approach, which are customarily and
routinely used in the specific industries of the company to be valued, can be
used in estimating Fair Value where appropriate.

 

The DCF method may
be used as cross-check; the disadvantages inherent in DCF, arising from the
high levels of subjective judgement, may render the method inappropriate
without corroborating support.

 

CASE STUDY

Let us discuss how
one can apply the valuation approaches discussed above in a newly-started
company which operates an online fund-raising platform, which connects
fund-seekers with lenders. It is intended to be an end-to-end connected and
fully integrated system providing a one-stop solution for individual and SME
borrowers, lenders and service providers such as finance professionals and
investment bankers.

 

The company has got the necessary approvals as required by the
regulatory bodies in India. The company would further require approvals for
using bureau data, KYC data and other government data. The company has also
entered into agreements with multiple banks and NBFCs in India. However, the
revenue generation is yet to be initiated.

 

Valuation Issues:

The company is in the initial stage of business life cycle. There are
various competitor platforms available in the market selling a boutique of
similar products and allied services.

 

Revenue generation is dependent on regulatory approvals and success fee
commission from tie-ups with financial institutions.

 

The business model
shared by the company projects a revenue growth at a CAGR of 200% in the first
five years.

 

Valuation Approach & Methodology:

We start with understanding the business model, the market it addresses
and the total size of the market, percentage share of the same the business is
trying to achieve, identifying the key valuation drivers, i.e., growth rate of
subscriber base and variation in success fee.

 

We then analyse the
comparable transactions at various stages of funding similar to the target entity
(i.e., Series A and Series B).

 

The Series A
transactions were dated a year or two back to the valuation date and at a
comparatively higher valuation range due to the different market scenario at
the time of funding. Hence, a discount was applied to such valuation range
arrived. The discounted EV / revenue multiple for Series B transactions (being
the recent ones) was considered for validation check.

 

We then consider
the discounted cash flow method considering three scenarios assuming lower
growth rates and lower success fee ratios.

 

We need to consider
a higher discount rate based on the expected returns of the investors and high
risks associated with the achievement business model.

 

Valuation Conclusion:

On the basis of the above analysis, we have
arrived at a valuation range using CTM and validated based on multiple
scenarios and sensitivity analysis on projections and discounting rate as per
DCF.

TAXATION OF STARTUPS

BACKGROUND

What do you
generally mean by a startup? The Collins English Dictionary defines it in this
way: “A startup company is a small business that has recently been started by
someone.” But the Oxford English Dictionary calls it “a company that is just
beginning to operate”. The Merriam-Webster Dictionary, on the other hand,
describes it as “a fledgling business enterprise”. Therefore, any new business
in its infancy is a startup.

 

In India, the information
technology (IT) industry has been a significant driver of growth, employment
and exports. Using technology effectively, startups can ramp up scale and grow
significantly within a short period of time. The government, through the
Ministry of Commerce, has therefore been seeking to encourage startups through
initiatives such as Start-up India.

 

Initially, and with
effect from February, 2016 under the Start-up India initiative an entity was
considered a startup:

 

a. Up to five years
from the date of its incorporation / registration;

b.  If its turnover for any of the financial years
has not exceeded Rs. 25 crores; and

c.  It is working towards
innovation, development, deployment or commercialisation of new products,
processes or services driven by technology or intellectual property.

 

However, an entity
formed by splitting up or reconstruction of an existing business is not to be
considered a ‘startup’.

 

On 23rd May,
2017, the definition was amended by:

 

i.   Increasing the period from five to seven years
and, in case of startups in the biotechnology sector, from five to ten years;
and

 

ii.   Amending the nature of
activity to “working towards innovation, development or improvement of products
or processes or services, or if it is a scalable business model with a high
potential of employment-generation or wealth-creation”.

The definition was further amended on 19th February, 2019
under Start-up India; now, an entity is considered a start-up:

 

a.  Up to a period of ten years from the date of
incorporation / registration, if it is incorporated as a private limited
company (as defined in the Companies Act, 2013), or registered as a partnership
firm (registered u/s. 59 of the Partnership Act, 1932), or a limited liability
partnership (under the Limited Liability Partnership Act, 2008) in India;

b.  The turnover of the entity for any of the
financial years since incorporation / registration has not exceeded
Rs. 100 crores; and

c.  The entity is working towards innovation,
development or improvement of products or processes or services, or if it is a
scalable business model with a high potential of employment-generation or
wealth-creation.

 

One of the
categories of incentives offered to startups is of certain income tax benefits.
There are, however, other tax provisions which have been a source of harassment
to startups. What are these tax benefits and tax provisions and how well have
they achieved their purpose?

 

TAX BENEFITS

1.  Lower rate of tax –
section 115BA

One of the benefits
which was supposedly meant for startups has been section 115BA, which provides
for a lower rate of tax of 25% for eligible domestic companies with effect from
assessment year (AY) 2017-18. These eligible domestic companies are those that:

 

a.  are set up or registered on or after 1st
March, 2016;

b.  engaged only in the business of manufacture or
production of any article or thing, and research in relation to, and
distribution of such manufactured / produced articles / things; and

c.  the total income is computed without certain
incentive provisions, including additional depreciation, and deduction u/s.
80-IAC.

 

Given the fact that today most mid-sized and small companies (those
whose turnover in 2016-17 did not exceed Rs. 250 crores) are liable to pay tax
at only 25%, the tax rate of 25% u/s. 115BA is no longer an incentive rate.
Further, the restrictions for claiming a benefit under that section meant that
it was restricted only to manufacturing companies and most startups, which
provide services, were not able to avail of the benefit of this provision at
all.

 

In any case, today
most startups would qualify for the normal lower corporate tax rate of 25% of
their profits (provided, of course, if they have any taxable profits).

 

2.  Deduction of 100%
profits – section 80-IAC

This incentive
provision, meant specifically for startups, was introduced with effect from AY
2017-18. The objective of this provision, as explained in the Explanatory
Memorandum to the Finance Bill, 2016, was to provide an impetus to startups and
facilitate their growth in the initial phase of their business.

 

Under this section, an eligible startup can claim deduction for 100% of
profits and gains of eligible business for three consecutive assessment years
out of the first seven (increased from the first five, with effect from AY
2018-19) assessment years beginning from the year of its incorporation.

 

An eligible startup
is one which meets the following requirements:

 

(a) It is a company or a Limited Liability
Partnership (LLP);

(b) It carries on eligible business;

(c) It is incorporated on or after 1st April,
2016 but before 1st April, 2021;

(d) The total turnover of its business does not
exceed Rs. 25 crores in the relevant previous year;

(e) It holds a certificate of eligible business
from the Inter-Ministerial Board of Certification as notified in the Official
Gazette by the Central Government;

(f)  It is not formed by the splitting up or
reconstruction of a business already in existence; and

(g) It is not formed by transfer of
used plant or machinery to a new business. Used plant and machinery can,
however, constitute up to 20% of the total value of the plant and machinery
used in the business without it being regarded as a violation of this
condition. Further, plant and machinery used outside India is not regarded as used
plant and machinery if it is imported into India, was not previously used in
India before installation by the eligible startup, and no depreciation has been
allowed / was allowable in India on such plant and machinery for any period
prior to the date of installation by the eligible startup.

Till AY 2017-18, the definition of “eligible business” was comparatively
narrow and restrictive – “a business which involves innovation, development,
deployment or commercialisation of new products, processes or services driven
by technology or intellectual property”. From AY 2018-19, the amended
definition is “a business carried out by an eligible startup engaged in
innovation, development or improvement of products or processes or services or
a scalable business model with a high potential of employment-generation or
wealth-creation”. This wide definition has the potential of encompassing a
large number of businesses and not just those engaged in the IT sector or
providing services using technology as a disruptor.

 

Till the third week
of November, 2018, out of a total 14,036 (19,287 as of 20th June,
2019) startups registered with the Department for Promotion of Industry &
Internal Trade (DPIIT), Ministry of Commerce, Government of India under the
Startup India programme, 91 (94 till 20th June, 2019) startups had
received approval for the tax exemption. The procedure for applying for
approval is quite simple – Form 1 (which is a fairly simple form) has to be
filed along with the Memorandum of Association / LLP Agreement, board
resolution, copies of accounts and income-tax returns for the last three years.
The Board can call for further documents or information, and make enquiries,
before granting or refusing registration.

 

A partnership firm,
although it may be registered as a startup with DPIIT, is not eligible for the
benefit of deduction u/s. 80-IAC, even though an LLP, which is also taxed as a
partnership firm, qualifies for the benefit of such deduction.

 

Since this is a
deduction of profits and under Chapter VI-A such deduction may not really be of
much use to most startups which require five or more years to attain
profitability, and then, once they attain profitability, would first be setting
off their brought-forward losses before being eligible to claim exemption under
Chapter VI-A. Further, such deduction is not allowable for MAT / AMT purposes
and hence a startup would end up paying MAT / AMT at 18.5% of its profits while
claiming deduction u/s. 80-IAC in its normal computation of taxable income.
Ideally, to be really effective and meaningful, the benefit should have been
provided for any three out of the first ten years beginning from the year of
commencement of business and not from the year of incorporation, and such
deduction should have been excluded from book profits or adjusted total income.

The turnover limit of Rs. 25 crores is also too low for most startups to
be profitable and be eligible to claim the deduction – it should have been kept
at the same level as in the definition of “startup” in Startup India of Rs. 100
crores.

 

3.  Taxation of share
premium u/s. 56(2)(viib)

Section 56(2)(viib)
was introduced with effect from AY 2013-14. It seeks to tax amounts received by
a company in which the public are not substantially interested (a closely-held
company) from a resident as consideration for issue of shares at a premium, to
the extent that the consideration exceeds the fair market value of the shares.

 

If one looks at the intention behind the introduction of section
56(2)(viib), the Explanatory Memorandum to the Finance Bill 2012 lists this
amendment under “Measures to Prevent Generation and Circulation of Unaccounted
Money”.

 

The fair market
value of the shares is the higher of:

 

a.  the value determined as per Rule 11U read with
Rule 11UA, or

b.  the value as substantiated by the company to
the satisfaction of the Assessing Officer, based on the value, on the date of
issue of the shares, of its assets, including intangible assets, being
goodwill, know-how, patents, copyrights, trademarks, licences, franchises or
any other business or commercial rights of similar nature.

 

Rule 11UA(2)
permits the company to adopt either the book value (break-up value) method, or
the Discounted Free Cash Flow Method for determining the fair market value of
unquoted equity shares of the company.

 

An exemption is provided for consideration received by a venture capital
undertaking from a venture capital fund (VCF). There is also a provision for
notification of a class or classes of persons (investors) by the Central
Government for exemption. Two notifications have been issued under this clause
– Notification No. 45/2016 dated 18th February, 2016 and
Notification No. 24/2018 dated 24th May, 2018. Notification No.
45/2016 granted exemption for subscription by a resident person to a startup
company, which fulfilled the conditions of a startup as per the DIPP
Notification dated 17th February, 2016. Notification No. 24/2018
granted exemption to consideration received for issue of shares from an
investor in accordance with the approval granted by the Inter-Ministerial Board
of Certification as per DIPP Notification dated 11th April, 2018.

Again, so far as
investments by non-resident investors are concerned, the provisions of section
56(2)(viib) do not get attracted, since they apply only to investments by
resident investors.

 

Grant of approval for exemption

The procedure for
grant of approval is contained in DIPP Notification No. 364 of 11th
April, 2018 as modified by Notification No. 34 of 16th January,
2019, and further modified by DPIIT Notification No. 127 dated 19th
February, 2019.

 

Initially, the
conditions for approval were as follows:

 

i.   the aggregate amount of paid-up share capital
and share premium of the startup after the proposed issue of shares does not
exceed Rs. 10 crores;

ii.   the investor / proposed investor, who
proposed to subscribe to the issue of shares of the startup has,

(a) the average
returned income of Rs. 25 lakhs or more for the preceding three financial
years; or

(b) the net worth
of Rs. 2 crores or more as on the last date of the preceding financial year;
and

iii.  the startup has obtained a
report from a merchant banker specifying the fair market value of shares in
accordance with Rule 11UA of the Income-tax Rules, 1962.

 

The amendments
brought about by DIPP Notification No. 34 of 16th January, 2019 were
that:

 

a.  The average returned income of Rs. 25 lakhs
over the preceding three years was replaced by a returned income of Rs. 50
lakhs or more during the financial year preceding the year of investment; and

b.  The requirement of a report from a merchant
banker under Rule 11UA was done away with.

 

Significant
amendments were carried out to the conditions vide DPIIT Notification No. 127
dated 19th February, 2019 as under:

 

(1) The upper limit
for the aggregate amount of paid-up share capital and share premium of the
startup after the proposed issue of shares was increased from Rs. 10 crores to Rs. 25 crores. Further, in counting this amount
of Rs. 25 crores, amounts received from non-residents, venture capital
funds and frequently traded listed companies (whose net worth on the last date
of the financial year preceding the year in which shares are issued exceeds Rs.
100 crores or turnover for the financial year preceding the year in which
shares are issued exceeds Rs. 250 crores) are to be excluded;

(2) Further,
amounts received for subscription from such listed companies are to be exempt
from section 56(2)(viib);

(3) The requirements of investor returned
minimum income and minimum net worth were deleted; and

(4) An additional condition was inserted to the effect that the company
should not have invested in the following assets, and shall not invest in such
assets for a period of seven years from the end of the financial year in which
the approved share issue at a premium takes place:

 

a.  building or land appurtenant thereto, being a
residential house, other than that used by the startup for the purposes of
renting or held by it as stock-in-trade, in the ordinary course of business;

b.  land or building, or both, not being a
residential house, other than that occupied by the startup for its business or
used by it for purposes of renting or held by it as stock-in-trade, in the
ordinary course of business;

c.  loans and advances, other than loans or
advances extended in the ordinary course of business by the startup where the
lending of money is substantial part of its business;

d.  capital contribution made to any other entity;

e.  shares and securities;

f.   a motor vehicle, aircraft, yacht or any other
mode of transport, the actual cost of which exceeds Rs. 10 lakhs, other than
that held by the startup for the purpose of plying, hiring, leasing or as
stock-in-trade, in the ordinary course of business;

g.  jewellery other than that held by the startup
as stock-in-trade in the ordinary course of business;

h.  asset, whether in the nature of capital asset
or otherwise, specified in sub-clauses (iv) to (ix) of clause (d) of
Explanation to 56(2)(vii), viz., archaeological collections, drawings,
paintings, sculptures, works of art and bullion.

 

The Inter-Ministerial Board of Certification (IMBC), which is the
authority to grant the approval, has taken certain positive decisions in this
regard. At its meeting on 16th May, 2019 the following decisions
were taken, inter alia:

 

i.   It was observed that a large number of
applications were being rejected for availability of similar products /
services. The applications should not be rejected merely on the basis of
similar products / services as it could mean higher demand and competition.

ii.   Startups from remote / rural areas and women
entrepreneurs should be encouraged to apply.

iii.  IMBC may ask for video presentation of a
defined duration with specific areas to be covered by a startup for applying
for the tax exemption.

iv.  IMBC may also hold video conference with the
startup, if required.

 

The objective of
IMBC, therefore, clearly seems to be to encourage genuine startups to apply for
and to grant the exemption from section 56(2)(viib). One understands from press
reports that so far 672 startups have been given approval u/s. 56(2)(viib).

 

Difficulties faced by startups

So far as most
startups which are innovating are concerned, their business is based on a
novel, untested concept. Their future business projections are based on hope
that their business concept or model will succeed. Investors place faith in the
startup founders’ ability and invest in the company based on such rosy
projections, knowing full well that the business model or concept is untested
and untried and that there is a high risk that the business may not succeed.
The investor investment at high valuations is based on the small chance that
the start-up may succeed and do so well that the consequent appreciation in
value of investment may more than compensate for the loss suffered on
investment in other startups. That is why investors spread their risks by
investing across various start-ups.

 

It is quite common
for a startup investor to invest in a company at the seed stage at a premium,
when the business is yet to commence, and all that is in existence is the idea
and a business concept in the mind of the startup founder. Similarly, most such
investments are made at premium valuations when the startups are still
incurring huge losses, with no profits in sight for the next few years. The
investment and its valuation is therefore more of an expression of confidence
by the investor in the founder and his business plan and not based on the
accuracy of the future numbers.

 

The problem faced by startups was that from AY 2013-14 till almost AY
2016-17, the provisions of section 56(2)(viib) applied without the benefit of
any exemption notification being available to them. Even from February, 2016,
many startups could not meet the DIPP criteria to qualify as a startup and
hence could not avail the benefit of exemption u/s. 56(2)(viib). The April,
2018 Notification and procedure did apply to more issues by startups, but was
still comparatively restrictive. It is only with effect from 2019 that startups
really started getting the benefit of exemption. Therefore, startups faced
serious problems of large demands in assessments for earlier years, due to
additions made in respect of premiums received on share subscriptions.

 

Since a vast majority of startups do not succeed in their business, when
the assessments for the year of investment came up for scrutiny, the numbers
actually achieved by the startups came nowhere close to the numbers that they
had presented to investors at the time of investment. The valuation based on
the actual numbers was thus a fraction of the valuation at which the investment
was made a few years ago. As a result, AOs sought to use the benefit of
hindsight to reject the pre-investment valuation provided by the company based
on projected financials and substitute it with a far lower post-investment
valuation based on actual financials. Since the investments were made at a far
higher premium, the provisions of section 56(2)(viib) were invoked to tax the
startups on such alleged “excess premium”.

 

At times, where
resident investors had invested along with venture capital funds or
non-resident investors at the same valuations, it led to an absurd situation.
While the investments by the VCFs or the non-resident investors were spared
from the provisions of section 56(2)(viib), the provisions were invoked for the
similar investments by resident investors. Indeed a very peculiar situation,
given that the valuation of the resident investment was validated by the
valuation of the VCF or non-resident investment!

 

Further, the stated
purpose of section 56(2)(viib) was almost completely ignored by the AOs. Even
cases where the investments were being made out of known sources of income of
the resident they were being taxed as income of the issuer company, even though
this could in no way be regarded as generation or circulation of unaccounted
money. Therefore, such action was contrary to the purpose of the provision.

 

Pending issues

The DPIIT Notification No. 127 of 19th February, 2019 states
that the notification for exemption would apply irrespective of the dates on
which shares are issued by the startup from the date of its incorporation,
except for the shares issued in respect of which an addition u/s. 56(2)(viib) has
been made in an assessment order before the date of issue of the notification
(i.e., 19th February, 2019). Therefore, if a startup has made any
issue of shares for which assessment is pending or has not been completed prior
to 19th February, 2019, it is advisable for it to obtain such
approval from the DPIIT, with consequent approval from the IMBC. In fact, even
startups whose case has not been selected for scrutiny in the year of such
issue of shares may find it beneficial to obtain such approval, to protect
themselves from any possible reassessment proceedings.

 

The most common
issue that many startups face is the fate of pending assessments and appeals,
where large demands have already been raised. There is no express provision in
such cases and the matters would have to be decided independently in appeal in
such cases. It would have been far better if a resolution process had been laid
down in such cases, which the appellate authority could have followed. For
instance, any startup fulfilling the conditions of exemption could have been
granted relief after verification of compliance with the conditions.

 

The other issue
faced by startups is the restriction on acquiring certain specified types of
assets, before and for seven financial years after the end of the year of share
issue, which could result in loss of the exemption. There is no minimum value
for such assets. Take a few situations: A startup buys a painting for its
office, costing Rs. 2,000; a startup gives a loan of Rs. 10,000 to its
employee; a startup buys a delivery vehicle for Rs. 11 lakhs; a startup invests
Rs. 1 lakh in a subsidiary. Any of these could result in a possible loss of
exemption! Perhaps, such interpretations were not intended. The objective of
the condition of investment in assets is to ensure that under the guise of
raising capital for the business, a startup does not become an investment
vehicle, and not to prohibit such normal business transactions.

 

A startup is merely
required to file a declaration that it has not invested in such assets and
shall not invest in such assets for seven years, in Form 2 with the DPIIT,
which will forward it to the IMBC. The IMBC will then grant the exemption. The
withdrawal of exemption will also be by the IMBC. In order to avoid unnecessary
loss of exemption for certain common business transactions, it is essential
that clarifications are issued by the DPIIT, clarifying that certain normal
transactions would not attract withdrawal of exemption. So also, a minimum
limit of, say, Rs. 5 lakhs, should be prescribed, below which limit,
acquisition of the specified types of assets would not invite withdrawal of
exemption.

 

Further, no procedure has been laid down for cancellation of the
exemption notification. However, before any cancellation of exemption is
resorted to, the basic principles of natural justice would have to be followed
by IMBC. This would require that the startup would have to be given a show
cause notice for that purpose, in response to which it would have a right to be
heard.

 

4.  Set-off of Losses
under Section 79

Under section 79,
where there is a change in beneficial ownership of 51% of voting power of a
closely-held company from the end of the year in which a loss was incurred to
the end of the year in which the set-off of the loss is claimed, the benefit of
set-off and carry forward of loss is not available. The objective behind this
provision is to prevent transfer of loss-making companies for sale of losses,
where the benefit of the set-off of losses can be availed of by the acquirers.

 

In startups, such
change in beneficial ownership of voting rights is quite common on account of
dilution by the founders in each round of funding, and not by transfer of
shares. A concession has therefore been provided to startups in section 79(2)
with effect from Assessment Year 2018-19. A startup which is eligible for
deduction u/s 80-IAC can continue to obtain the benefit of carry forward and
set off of losses of the first seven years from the date of incorporation,
provided all the shareholders holding shares of the company in the year in
which the loss was incurred continue to be shareholders of the company as at
the end of the previous year in which the set-off of the loss is being claimed.

 

From the language of the section, it appears that in case of a startup
even if one shareholder transfers his nominal shareholding before set-off of
the loss, the benefit of carry forward of the first seven year losses will be
lost, as opposed to a less stringent 49% permissible transfer in case of other
closely-held companies. Also, there is a lack of clarity as to losses incurred
by startups after the first seven years – whether the
provisions of section 79(1) would apply or whether there would be no
restrictions at all.

 

CONCLUSION

Startups which have
raised funds at high valuations in recent years have faced a torrid time in the
past few years. Fortunately, the government has responded to their request for
relief and laid down a procedure which, by and large, excludes such startups
from the rigours of section 56(2)(viib). One only wishes that other businesses
were also spared from the unnecessary litigation that section 56(2)(viib) has
generated.

 

The government has spared startups from a nuisance provision. But has it
really provided enough tax incentives? The provision u/s. 80-IAC for tax
deduction of profits is not really a significant incentive. Today, compliance
involves a significant cost for most businesses, having become fairly onerous.
What startups would perhaps better appreciate is a tax regime with lesser
compliance hassles – exemption from tax deduction requirements as well as
having tax deducted at source from their incomes, exemption from scrutiny
assessment u/s. 143(3), etc. This would allow startups to focus on their
business, instead of having a part of their energies diverted towards
compliance, and definitely result in an improvement of productivity of the
startups.

 

The above provisions are based on their
legal status as on 23rd June, 2019.

STARTUPS AS AN INVESTMENT ASSET CLASS

Funding startups
is glamorous, but the big question is how much returns can they generate as an
investment asset class?

 

Start-ups are
young, emerging companies working on breakthrough innovations that would fill
the need gap or eradicate existing complexities in the ecosystem. These
companies are in a constant endeavour for new development and researching new
markets. They have agility embedded in their inventive thinking. Angel investors
fund a startup for several reasons but the first and foremost reason is that
they believe in that idea, project or passion. They want to make the
entrepreneur startup successful with the help of the disposable capital
available at their end.

 

Investing in
startups is more an art and less of a science – it isn’t meant for everyone; it
is subjective. There is no method to this madness, nor a defined college degree
to help you learn venture investing. Every deal, experience and strategy shared
in the public domain is anecdotal. Angel investors provide capital for small
entrepreneurs but are not in the money-lending or financing business. The
finance they provide is for that first round of seed capital to make the idea /
vision into a reality. Entrepreneurs can also find angel investors in their
family and / or friends who will support them with capital on terms favouring
them. Angels risk their money in people, teams and ideas which are fragile in
nature. Hence this is termed risk capital investment.

 

Angels are
individuals who have a good, successful background; their names evoke trust in
the minds of customers or future investors. They back the startup by
associating their name with it, which provides the entrepreneurs the required
creditworthiness in the market.

 

Why I love startups
as an asset class for investment is because I can offer my time besides my
capital. In other investments like public equities or real estate I can’t
influence an outcome. Venture investing is a people business, so if you
like meeting, working and helping people, then your chances of success are very
high. With early stage startups as their lead investor, I work closely with the
founders to create a positive outcome. Before beginning a discourse on the
merits and demerits of investing in startups, let’s first understand investing
in startups from the bottom up.

 

What is investing?
It is the process of putting money into various physical or abstracted assets
with the expectation of making a profit. One can expect to make a profit on the
money invested by seeing an increase in the value of the asset – whether real
or perceived – and selling off the asset at the increased value. When you
invest in a company – public or private – you invest in the asset that is the
company itself; you get a part of the ownership of the company. As the value of
the company increases, so does the profit you can make by selling off your
stake. A key difference between investing in public companies and private ones
like startups is that in public companies selling off your stake is far easier
and near instantaneous. The same cannot be said about private investments –
hence investments in startups is one of the most illiquid asset classes. It can
give you huge profits, but those profits will be only on paper for the most
part because realising an exit takes a lot of time. It is an illiquid
investment.

 

A basic,
fundamental point that every early-stage investor should know is that startups
follow the law of power – a small percentage of the startups you invest in will
give you the majority of your profits. Take (for example) Andreseen Horowitz’s
portfolio. They’re one of the top VC firms – and about 60% of their returns
come from about 6% of their deals. What does this tell us? It means that to
truly make a profit from startup investments, you should be able to access
those 6% of deals. The rest of your investments may or may not materialise
significant returns for you – but that 6% of your portfolio is where the real
return is. If you invest in few startups it’s like buying a lottery; it’s the
portfolio approach which helps the early-stage investor create mega returns.

 

Given this
background, let us come to the question at hand, “Are startups a good
investment?” Startups are high-risk high-return investments which follow the
power law. It is not about the number of hits you have, but the magnitude of
those hits. That’s where we find the answer to our question. The wealth
creation opportunity that startup investments provide is nearly unparalleled.
But it is also extremely risky and conditional. So when are startups good
investments?

 

It is a good idea to invest in startups when one has the appetite and the
capacity for the high risk involved. The investor with the mission to give
first, to help founders and build business will win this game. One must be
capable of creating a significantly sized portfolio of investments in the hope
that some of the investments are part of the 6% and give one huge returns. One
can create a startup portfolio by investing about 5-10% of one’s total
investment capacity in such an illiquid asset class. It is worth noting that
the money invested here must be thought of as a sunk cost – until and unless an
exit is realised. The investors must be able to stay patient with their capital
– the best companies can give returns after ten years.

 

The toughest part of investing in startups is gaining access to the top
tier of deals that can give you the huge hits. When one has access to those 6%
of deals, it is a great idea to invest in startups. One cannot ascertain at the
beginning whether a particular investment will provide the returns one hopes
for – but one can invest in startups that can give the unparalleled returns
that one hopes for if they work out. To gain access to the top startups, one has
to put in time and effort to become a part of the startup ecosystem, become a
part of various investor networks and collaborate with other lead investors and
VC firms.

 

Startup investments can provide disproportionate wealth-creation
opportunities. Before investing in startups, every investor should ask himself
– Am I ready to take on the capital risk? Do I have the required time and
effort to build a portfolio? And, last but not the least, do I have the
patience to wait for the disproportionate return?

 

Investing in early stage companies is
about capturing the value between the startup phase and the public company
phase.

LANRUOJ TNATNUOCCA DERETRAHC YABMOB EHT (JACB)

TASK FORCE REPORT – HOW THE NEXT 50 YEARS
LOOK FOR JACB

 

“It is tough
to make predictions, especially about the future.”

 

Your journal
celebrated its golden jubilee anniversary this March. Like any other
responsible, accountable institution, we do understand that one cannot take
value-creating decisions without forecasting and modeling the future. Your
Journal Committee therefore deliberated the matter and accordingly decided to
set up a Task Force comprising of experts to prepare a report on what the next
50 years look like.

 

We present herein below extracts of the Task Force’s Report.

 

a)  Approach
And Methodology Used By The Task Force

 

Basis Vaangmay1 created by JACB over the past fifty years, big
data, intensive research, field study, empirical methods, qualitative insights
and scientific forecasting methods.

 

Guiding
Principle The task force was guided by the
principle – “The old rule of forecasting was to make as many forecasts as
possible and publicise the ones you got right. The new rule is to forecast so
far in the future, no one will know you got it wrong.” – Breakout Nations:
In Pursuit of the Next Economic Miracles.

 

1 Citation:767 (2019) 50-B/JACB

b)  The Task Force’s Report

Task Force Report: How the Next 50 Years look like for JACB

2020

2030

2040

2050

2060

2021

2031

2041

2051

2061

2022

2032

2042

2052

2062

2023

2033

2043

2053

2063

2024

2034

2044

2054

2064

2025

2035

2045

2055

2065

2026

2036

2046

2056

2066

2027

2037

2047

2057

2067

2028

2038

2048

2058

2068

2029

2039

2049

2059

2069

 

FROM UNPUBLISHED ACCOUNTS

 

Provisions

Provisions are made
for all foreseeable personal expenditure of the founder directors and their
family members including the exorbitant costs of funding a destination wedding
of the third child of the second promoter who post the event, will no longer be
classified as promoter from next quarter.

 

ETHICS AND U (TURN)

(Cloudy morning)

 

ACA Arjun (A) – Krishna, a pleasure talking to you again. Looking forward to more
valuable insights from you.

 

FCA Sri. Krishna
(S) – My blessings to you as usual. But wait, I see
your mind seems agitated!

 

A – My duties that is….. I am seriously contemplating withdrawing
from audit engagements of listed companies.

 

S – Tch.Tch! I was afraid you would say so one of these days. Go
ahead and immerse yourself in the audits and let the truth come out in your
report.

 

A – I fear the consequences. To be specific.…. the unintended
consequences.

 

S– Consequences? Remember, no one who does good work will ever
come to a bad end, either here or in the world to come.

 

A – I wish to resign from audit engagements. You don’t seem to
appreciate the risks that I am facing. Don’t I have the right to resign? Of
course, I do have. Now, do you want me to quote the relevant sections?

 

S – Remember, your right is only to perform your duty. You do not have
right to expect any consequences there of.

A – The consequences are grave. I am totally honest and abide by
values but what appears as a good company, a good balance sheet may just blow
away. True and fair! An illusion? Maya?

 

S – You signed up to give a report – Unmodified or qualified, you need to
report. You were not appointed to quit.

 

A – Now, listen to me and understand. I am talking about
floundering management value systems, flouting of corporate governance norms,
internal controls on paper, serious accounting issues, financial
irregularities, non-disclosures, withholding of information necessary for
audits, blatant violation of rules and policies, lack of oversight by
independent directors, management override, no credible risk management,
misappropriation and what not. The consequences are…what do I say…. humongous
risks in audits….

 

(Dark clouds start gathering in the background)

 

S – (with a heavy heart) Then Resign.

 

A – (In trauma)

 

S – Resign Arjun! Resign!!

 

A – What are you saying? Oh No! 
What’s happening? Have you given up on me? You are the one who lifts my
mood and spirits. You the upholder of values, want me to resign? If I resign
from all engagements, what will I bill?

 

S – I reiterate,
resign. The only solution to your dilemma is to resign.

 

Ahem! I meant resign
to your fate.

 

Resignation is as
sure for that which is appointed, as birth is for that which is dead.

 

Therefore grieve
not for what is inevitable.

(Background sound effect – conch shell blowing)

 

THE
LIGHT ELEMENTS

CA M.S. Badnaam1

 

(Kam Se KAM2)



Capitalistic as may be the World,
In a world

Where governance
does not matter…

Regulations do not
matter…

Respected Kam
Hi Kam (2)

 

In a world

Where audits do not
matter

Tax, internal or
external,

Lo! The need to
share Key Audit Matters! (2)

Kam Se KAMs?

Audit Committee;

Do not mind (2)

Ultimately, It’s my
Mind over your Matter,

The Key Audit
Matter

 

As they say

Those who matter
don’t mind

Those who mind,
doesn’t matter!

Kam Se KAM

Itna kaha hota!

(The Builder and the Home Buyer)

 

Fully I paid

?Tis Five longeth
years

Foundation, tis
still not laid

 

Woh Ghar (2)

 

Na Mera, Na Tera

umeed

shayad ab RERA3   

 

1 CA Main Shayar Badnaam

2 KAM – Key Audit Matter

3
RERA – Real Estate Regulatory Authority

 


INTERVIEW MATTHEW EMERMAN, CFO OF JIOSAAVN

From Inception,
Capital Raises to Strategic Acquisition

In this second interview of the July special issue, BCAJ Editor
Raman Jokhakar talks to Matthew Emerman, CFO of JioSaavn. The company recently
underwent a merger valued at $1 billion and was widely reported. Matt joined
Saavn since its inception in 2007 and has seen it from inside as its CFO and
Global Head of Corporate Development. This interview walks the reader through
an amazing journey of 12 years from early start up days and culminating in a
merger with one of the largest companies in India.

 

In a free
flowing interview, Matt talks about initial idea of Saavn and how it filled a
market void at that time, challenges of early stage funding, addressable market
and selecting Jio as its partner in the next leg of its journey. Matt has been
a member of the founding management team and has seen the challenges that a technology
driven startup goes through.

 

 

Q. Can you tell us a bit about Saavn the
company and its journey from its founding in 2007, to acquiring rights to about
50 million music tracks and 100 million active users – and to the recent deal
with Jio Music?

 

A. When we started in the US it was a B2B
distribution company. We were taking Indian movies, bringing them across the
cable services in North America and the UK. We realised that there was a void
in the market for Indian music when a lot of it was not digital.
Historically, it has always been mostly pirated music. So we started licensing
content exclusively from the likes of T-Series and Saregama and distributing
these to different services like iTunes and B2C platforms. When the users
started downloading say from iTunes, Indian music was difficult for consumers
to discover or search for the specific songs they were looking for. Services at
that time were not designed for Indian music. Many a times users looking for
content didn’t really know what they were searching for – they would know the
movie name, they would know the actor’s name but they would not know which song
they were looking for. So a lot of the metadata that was there was not designed
for digital.

 

So we worked really closely
with Apple and Google at that time and we decided internally that the future
was to move the business to a more direct to consumer focused model. At that
point of time we worked really closely with Google who was creating a new
Operating System that we know today as Android. And we realised that for us to
really move into the future, direct-to-consumer was the best path. 

We started our
direct-to-consumer business called SAAVN (South Asian Audio Visual Network).
This new business model approach led to us raise our first institutional
funding in June 2011 from Tiger Global. That funding really put us on the map.
From 2011 to 2017 we raised well over a hundred million dollars of
institutional funding. Over that period of time we raised capital from world
renowned institutional investors such as Bertelsmann, Liberty Media, Wellington
Management, Steadview Capital.  We also
attracted investment from some of the top global artistes and managers,
including Guy Oseary, U2 and many other top global musicians. We have been
really lucky in our journey in terms of having incredible people who believed
in us.

 

We were in a very difficult
space – in terms of having global investors that really understood India and
especially the content and entertainment eco-system. It was hard for investors
to understand the growth opportunity which was there. Building a service for
the Indian market also has a lot of challenge from a regional perspective, from
a language perspective, device capabilities and historically connectivity was
always an issue.

 

We saw the shift, this
inflection point in September, 2016 when Reliance Industries launched Jio. For
the first time, cellular streaming eclipsed Wi-Fi. This is really a systemic
change in the entire digital eco-system across the country. And we saw that
everything changed after this – our user base and our engagement increased with
introduction of 4G throughout the country.

 

In terms of how we thought
about our partnerships we have had long conversations with almost all the top
tech companies and others. India has a lot of headwinds but when you think of
the tailwinds, Jio was really doing something amazing of having 0 to 300
million subscribers till today in a short time frame. They are adding 10
million subscribers each month.  We had
20 million users at the time of the transaction that has multiplied many times
over and now we are the largest music streaming platform in the country.

 

There were various factors
which were at play. Innovation in the way they think about building businesses,
the way they truly appreciate this market and all the dynamics that are there.
Then there are regional dynamics and challenges, you have people coming online
for the first time, how do you really understand the consumer, how do you
target the consumer by saying that now you are not going to go for the pirated
experience but are going to go online, going digital and going online with
digital payments. It’s a completely new experience. When we thought of what was
that next level for Saavn, it was this $1 billion transaction.

 

Q. Way back in 2007, how did the founders come
up with this idea of Saavn? Were they trying to solve a certain problem and was
it that something like this never existed at that point in time?

 

A. Almost everything in life is about timing. Lot
of it was an opportunity where there was a void. Cable companies in the US were
losing a lot of subscribers to satellite. And we thought we want to have a
South Asian video on demand channel. There was a void in the market and
consumers were very hungry for this content. So how do we bring movies to North
America, US and UK so that cable companies have a competitive offer? People
were paying $60 – $70 per month for the services to experience the content they
were used to when they were back in India. So that is where the genesis of the
opportunity existed and slowly realising that there is a void from a music
perspective.

 

Q. You seem to have started by taking Indian
content to the other side – and now you have brought the entire thing back
here! Do you still have that set-up back there in the US?

 

A. Yes we are really a global company. We have
offices in New York, California and that is really important from a talent
perspective but also from a global tech perspective.  We have an incredible engineering team based
in Mountain View, CA. That’s a very interesting perspective that we bring to
the market.

 

What separates us from
anyone else is the data that we have. Since the launch of our streaming
services way back in 2010-11, we have terrific data of the consumers. This
(data) is in terms of their listening behaviour, patterns of listening when it
comes to music specifically, when it comes to Indian music from a regional
perspective and how that is curated is what makes our algorithms, our
technology, our backend really unique. Everything is customised and built
inhouse, nothing is outsourced. We have incredible engineering, product and
design teams split across India and the US.

 

Company
communication is so important for us, because we are working all round the
clock. And we have been really lucky from a point of view of having an
incredible culture. How we as an organisation ensured that everyone was an
actual owner of the business and incentivise the team members to be a part of
something. That’s part of the journey and it’s really important for people.
It’s happening more and more where companies are offering equity incentive
plans to their teams. There is such incredible talent that is here in India.
And what we are seeing for the first time here. Historically,  from a tech perspective, there has been brain drain. Some of the brightest
minds have historically moved abroad to work at tech companies like Microsoft,
Google, Apple, etc.

 

From a
recruiting perspective, we are getting incredible talent from the IITs. We have
a first day recruiting programme with all the IITs and it’s been phenomenal. We
are also seeing a shift in executives who have got incredible experience in the
US, want to come back because of what is happening in the eco-system here.

 

Q.What was the trigger for the alliance with
Jio?

 

 A. Like I said everything is timing. If you look
at the music space in the market you have Apple music, Spotify, Amazon, YouTube
music is here. There are local players like Gaana and Wynk. So there is a lot
of noise and a lot of perception vs. reality. There are people that make these
press announcements. And then there is a certain standard kind of matrix that
is there – industry standard like monthly active users, and streams. Some of
these press announcements give a feeling about perception vs. reality whether
you are a private company or a public company, the difference about what is
happening on the ground is different.

 

So we looked at the notion
of saying that we have brought the business to a certain level of user base and
scale. To really get to the platform where you have 200-300- 500 million users,
it was really important for us to find a strategic partner who has the vision,
who has patience from a capital perspective and a longer timeline than
institutional investors. And that from timing perspective made a lot of sense
for us. And like I said before we know and respect all the major companies
globally that are there in the music playing technology space. But there was no
better partner for us.  From the founding
team that is leading this initiative and from Reliance perspective, when you
think about the digital services business, it was important for them to find an
incredible group of entrepreneurs, a team and culture that would really fit
within the eco-system.


Q. What were some of the elements that you
looked for which helped you determine that this strategy and this partner would
really work and that this is someone you want to have an alliance with?

 

 A. I think a lot of it is looking at just the way
they built Jio and looking at what they built in terms of the digital services
business. If you use some of the services apps that are there, they have such
an incredible team, and they have done an amazing job of building what they
have built. You walk on their campus in RCP in Navi Mumbai you feel like you
are in any large tech company’s campus in California. It’s really incredible
when you talk about any large tech companies worldwide. So when you think about
that stage that they are in, it made a lot of sense. From a strategic
perspective we have an incredible team of brilliant minds collectively working
together on how do we achieve this kind of targets that we have in our
business.

 

It’s also the notion of the
actual current addressable market in India. You have 1.3 billion people here
and how do you not have 700-800 million users? You have Tencent Music which has
over 700 million users worldwide. These numbers are staggering. I think there
is the reality of what is the actual addressable market that is here. For
example you think about the users in the amount of subscribers that Jio has
today, and so it was something that we really took a lot of time to think about
what was the aspiration that we have as a business.

 

We also thought from the
perspective of giving access to content. Not just from music perspective but we
have over 50 million tracks, and from having worked very closely with all the
music labels these 10 years. We were the pioneers of other forms of audio
content – in terms of podcasting, and other shows, and original music.  We were the first ones to start doing
original music and giving the community and independent artistes’ a platform.
Historically, music consumption in India has been film based. And there are so
many incredibly talented bands and musicians that that never had a place for
the music to be heard. So we were able to give a platform to independent
artists. There has been an explosion of independent music scene here over the
last few years.

 

Q.You spoke about the valuation of over a
billion dollars and also spoke about how it worked out in terms of number of
customers and so on. Do you want to tell us a little bit more about arriving at
the value for a transaction like this one?

A. In this case it is a combination of value of
an existing business and of JioMusic and then looking at it from a value per
user basis. Generally for this type of business, and if you look at other tech
companies there is per user value that is attributed to that. There is
traditionally DCF and all that but that doesn’t generally work for technology
companies. Multiples are very different for technology companies when you
compare them to traditional companies.

 

All investors have their
target ownership, what’s been invested to date in the business on both sides,
value that is there on both sides and then the intangibles, the brand names
that are there, the consumer confidence in the businesses, all of these are
very important. All of these come together and then at the end of the day it’s
like in any other deal – negotiations.

 

We had some incredible
advisers and the deal was closed in record time of under 2 months. It required
incredible coordination amongst our legal counsels and tax advisers from both
sides.

 

It’s so
important having people you can trust in the market. We have an international
corporate structure and so we have to think how to structure this kind of a
transaction especially when it involved a public company in India. So there was
a lot of consideration that was there. Having trusted advisers by your side and
I would actually call them trusted partners. Because of the time zones that
were involved we had to be very flexible, late IST calls and early morning EST
calls. We worked Saturdays and pretty much on all Sundays. Seven days a week
throughout the transaction for six weeks or so and that takes incredible
relationship to close a deal of this magnitude in this period of time.

 

It was
a great learning experience. And what’s so important is to really have your
advisers and team members by your side from day one and that they have context
to your business.

 

Q. Would you like to share something about
what you learnt which makes a deal like this work on both sides? Especially
since it all happened within two months? Attributes that each side displayed
which you think made a deal like this work?

 

A. Incredible communication – of being able to
work so closely with people. We were partners even before the deal was closed.
It’s also very telling in terms of what the future is going to be like. If you
can close something of this size in such a short span of time imagine what you
can build together.

 

And again every deal has
its moments of complexity, there is no question about it. I think communication
across the board on both sides was important when we had aggressive timelines.
In hindsight it is really communication. As a CFO you can’t miss anything and
have to ensure full communication with teams at all times.  The passion everyone showed, seven days a
week. That’s when you talk about people feeling like an owner of the company,
part of something, you can’t teach that.
I think that’s something really incredible.

 

Q.Coming to the wider canvas of the
music-streaming world and all its bits and pieces, how do you see it going
forward? You have a vision and your perspective of the market – and you are
perhaps creating some of it. How do you see this whole thing evolve from what
we see today?

 

A. I think what you will see especially from the
India perspective is consolidation. I think one thing that you are seeing with
companies like Netflix is that consumers are really willing to pay for good
content. And I think that’s what is so unique.

 

Then there
are challenges from infrastructure point of view.  Like you go to see a big festival in India,
you know three days before it was an empty field. So that is something that is
really changing. Especially, things like Jio Garden or Jio World Center which
is completely world-class state of the art facility that will be opening
shortly. I think there is going to be a new consumer experience that is going
to happen. This is really important and people are really hungryfor it.

 

Q. On the technology landscape, do you feel
that some of this is going to get disrupted? What will improve further, or is
something else going to come up in the future in place of what we have today?

 

 A. I think what is happening more and more is
curation. From the data that we have of a user that comes to the app – we know
what kind of music he would like to listen to. Based on certain patterns – are
they in the gym in the morning and what they listen there, do they listen to
devotional content in the morning and what do they listen to when they are
driving to work for forty five minutes. So you kind of track the pattern and
from an AI perspective and Algorithm technology perspective you are delivering
a service where a consumer goes WOW – this understands me. It’s intuitive

 

And when you look at a
million peoples’ apps every user experience is customised and is unique to that
person, their behaviour and what they are listening to.

 

This is what is happening
now. And again music is so emotional and so in the core. When you think about
incredible moments in your life there are songs for them. You might watch a
movie for a few times but you will listen to the same song hundreds of times if
not thousands of times. So music has a different way of connecting us
individually with ourselves but also connect us to our friends. Look at
playlists sharing.

 

Q.Can you share some takeaways from the last
12 years? Did you ever think when you started out with Saavn that this day
would come, that you would go through what you have gone through so far?

 

A. I think it’s been an incredible journey. I
love spending time with entrepreneurs. But it’s that kind of resilience. It
takes special individuals to go through hundreds of VC pitches. And it not just
an individual but teams to go through that. It’s not easy to do it. Like
raising institutional funding, building a business, these are challenging
things. Having resilience, having really good advisers by you, it’s so
important.

 

We also found that
leadership development training and personal and professional development is
critical for the growth of teams.  I
think people really take it for granted that more you are able to invest in
people the more you are able to get out of them.

 

But besides
that what keeps the founding teams and the people together is resilience. The
notion of being positive, having a sense of humour and having the conviction
that this will work out. The people you surround yourself with, who gave you a lot of inspiration
and advise. It’s ok to not have all the answers. I think you are really in
trouble when you think you know everything because that’s when you are going to
be taught certain lessons which you thought you are never going to experience.
So it’s really important to be really humble. And kind of being able to
appreciate what you are able to do every day! And when you are able to do that
you find things that start to come your way. Those times that were the
hardest building the business were the most humbling and those were some of the
greatest things and greatest experiences that we know.

INTERVIEW GAURAV ANAND, STARTUP CO-FOUNDER

In this interview, we talk to Gaurav Anand, co-founder of Namaste Credit, about his start-up journey. The interview walks one through the journey of a founder. Gaurav discusses how he decided to switch from a job with the largest rating agency in NYC to starting off into uncharted territory. What drives an entrepreneur and what are the challenges and how he perceives them. Gaurav also shares his views on why finding a real problem and solving that problem is the bedrock of entrepreneurship and how an enterprise needs constant passion and relentless execution.

Gaurav runs Namaste Credit, an online marketplace founded in 2014 that dynamically matches SME businesses looking for financing with lenders. It leverages on technology to obtain optimal loan products from lenders and NBFCs across India. In this interview BCAJ Editor Raman Jokhakar speaks to the young founder of a FINTECH startup to tell his tale.

Can you tell us about your background, your life journey till you reached that moment of choice, deciding that you want to start something on your own?

I am originally from Delhi, did my MBA from N.M. College, Mumbai. Along with my post-graduation, I did CFA and Financial Risk Management (FRM) as well. My first job was with Credit Suisse. I spent about four years in London as part of a training team. Then I moved to New York to work with the world’s largest rating agency Moody’s, leading the North America practice of risk analytics, advising financial institutions, including Wall Street banks. That’s where I met my co-founder Lucas Bianchi. We thought of moving from a cushy job – from monthly pay cheques to a startup life. Essentially, it was based on two key pivots – a passion and a drive to make a meaningful impact on others’ lives; and second, the supreme confidence that we can execute our ideas and our vision. These beliefs gave us the urge to take the plunge. We wanted to touch the larger eco-system, in fact, improve the eco-system – in this case the SME lending space – and impact a wider audience.

You felt that these features were not present in the system?

People are always looking for the bigger and wider spaces available in the world, where we can go and disrupt them, and also the right time to disrupt them. We chose and started in India because India has the largest SME base, and from the technology point of view, India has a large market potential. We believed this was the right time for this space to get disrupted. We saw the huge market potential and the right timing for us to start.

What were the learnings from your earlier work profiles / experiences that helped you to get the confidence to execute?

These are large institutions / corporates where you learn how to work within the rules / framework and how to be super-efficient at it. People who are very successful at large corporates are very good at working within the rules. You do not have significant room to push the envelope so you have to be super-efficient to play within the rules and yet execute very well. Whereas in the startups world, there are no rules, no regulatory body for startups, you write your own rules and play by your own rules. However, having worked in a more restrained environment, that allows you to narrow down, put your thoughts and execution plans in action and work on them. This gives you that added discipline in a startup, otherwise it is easy to get carried away with no ring-fencing.

Considering your experience, exposure and knowing where India was, you could spot the opportunity. Can you take us through the process – spotting a problem, believing that you can solve it and choosing the right time to do it?

In 2013-2015, we saw disruption happening in the developed world. Fintech had started to play a significant role in the US and European markets. There was maturity in the financial market from the Fintech point of view. If you break the developed world into smaller portions and rule out the purchasing power parity, these are small islands of opportunity for you.

Although a company like PayPal has been in the market for two decades, the new-age companies, especially in the SME lending space, were starting to take some giant strides. So, from the timing perspective, we could either be a part of a crowded market or jump into a bigger market with 50 million SMEs with hardly any technology adoption and disruption and create our own niche or brand. We chose the longer path because of lack of digital infrastructure then. The first two years were a struggle because of lack of digital infrastructure where these initiatives could be scaled up. We chose to bite the bullet and knew we could make it through our execution.

Being a founder of a startup, having an idea in place and the decision to leave the US… as a founder, what kind of challenges you had visualised – what if all this didn’t work out?

It was a big personal decision. I had the vision for this startup and my family supported me to make it work. But the real driving factor was the passion and the urge to make a much bigger impact than what I could think of making as part of the corporate world. Although we were working with the largest financial institutions in the world, we were still away from the ground reality. It was a personal decision and also a decision of the family. Had we remained in the corporate world, the impact would have been quite shielded or guarded. It would have a limited multiplier effect in a broader eco-system. Therefore, we thought that we had to develop our skills and get to the bottom of the problem to emerge with an impactful solution.

Bearing in mind the uncertainty in Indian regulations (say a sudden new tax) and where there is no answerability for such flip-flop changes, did you think of the risks while returning to India with the startup idea in mind?

The first challenge was to get a grip of the sheer size, complexity and diversity of India and assimilate certain facts. It was like dealing with 28 countries because in India each state behaves like a country. To have a pan-India presence, we have to deal with a lot of moving parts; like the Central and State Governments are at different tangents, they take whimsical decisions on the fly. Even with respect to day-to-day operations or lifestyle, we have a lot of complexity, unlike the developed world where most things are automated or pre-set. India doesn’t work as per that clock.

This was the first and the biggest challenge – setting up new and better ideas in India is difficult because everybody questions you due to lack of successful predecessors. Seriously, you have to convince yourself first, then your client and then your other stakeholders that this idea can really work in India.

The next challenge for a new venture is to have and find like-minded people, both from the aptitude and from the passion points of view. It is very important to have the right team. We have been very conscious of building the right partners in our business model, the right teams and the right functional heads. Today, we have a 300-member team and we have various leaders in each function. Like-minded and similarly driven people – from skill set, to vision and the execution point of view.

The third biggest challenge was that being in India tends to give you a false sense of security, that I have a fallback option, my family is here – they can afford it if I have to relinquish my startup and live an ordinary lifestyle. Therefore, to stay away from leaning on our support system, we set up our headquarters in Bangalore and not in Delhi – we set up in a new state and started from ground-up in a new city.

Finally, you need to have that constant drive, to literally question your instinct – day in and day out – ‘am I doing the right thing, am I on the right path?’ But then when you don’t have successful predecessors to guide you, you become your own guide and you become your own positive agent.

How would you classify the different stages of your journey, these three years since having started?

I can divide these years into broadly three stages:

1. Proving the concept, which also encapsulates the team formation (what kind of founding team); are the building-blocks strong enough or not; when you continue to get questioned on proof of concept do you prove that it works?
2. In India there is a slight advantage in proving the concept, in that you can taste some initial success. It gives you confidence that the concept is working with limited stakeholders. This is where you taste initial success;
3. The third stage, where we are right now, is how to scale it up in such a wide and diverse country; scale up consistently and at a pan-India level. How can we work it consistently and where are the levers?

Most of the foreign investment is coming to India chasing the same middle class that comprises of the top 20 to 30%. There is hope that they will become more upper class (30 to 40%) and the remaining 80% will eventually become that 20 to 30% middle class. Everybody is betting on the fact that India as a country has scale, is still growing at 7 to 7.5% average for the last four to five years, it has democracy and the rule of law. The hope is that purchasing power will eventually catch up with the advent of technology and with more globalisation.

In our business model, we also struggled with the same. We were targeted on SME lending. This has its own challenges, so the proof of concept was first to find out whether my solution is cutting across all industry and all segments of SMEs that we are dealing with. Secondly, after tasting some initial success, how can I make my solution more pervasive and more omnipresent? This is what we continue to prove. I think we have clearly emerged as one of the largest online SME lending market places. We are the only company in Fintech which licenses its technology to some of the leading financial institutions who are also suppliers of credit on our platform. Those,
I would say, are the three stages.

What kind of professional support did you receive from chartered accountants or any other professionals? Was it useful and would you like to say something about it?

In the Fintech space, the chartered accountant community has a massive role to play. In fact, in our business model, CAs played a significant role. We have a network of 7,000 influencers who work with us digitally, out of whom 2,000 plus are CA partners.

Our CA helped us incorporate our company in India and also register the patent and a company in Mauritius. He was extremely helpful as we had limited insight about the rules of the game and what regulations would apply. In my view, professional help of CAs is a must for initial infrastructure blocks and regulatory adherence. I believe the CA community has the wherewithal and carries a responsibility to play a much more active role in guiding startups, in nurturing them and also participating in their growth. The advice of a CA does influence when it comes to taking credit decisions in SMEs. It has been a great help from our CA partners network and a big thanks to the whole community.

Some startups are bootstrapped and some go for other funding options. How did funding work in your startup business?

Right from day one we approached the business with the thought that we should not be solely dependent on external funding to make our idea work. We always wanted to use external or equity funding in the business as the growth engine, but not as a proof of concept. In India, people don’t fund you on the basis of the idea; even we had to go through the path where we had to show proof of the concept’s success in the initial stage. We actually ended up scaling at profitable economics which was a great validation that this model in SME lending is a profitable venture.

You need capital to scale it up since you have to deploy a lot of capital expenditure in the business and you are trying and testing out new things, that’s where you actually end up spending most of your equity investment. However, if the fundamentals are strong enough – then if tomorrow there is no funding, your business can run on its own. Our motto was that our business model should be self-sustaining even if tomorrow there is no funding… we should run on our own lends. Funding was for growth.

And it was easy to find the right chemistry with the venture partners and all that?

I think it is not easy because in India still a lot of venture capital people do not have a real-life entrepreneur experience to understand the challenge of running a business. Most of the VCs in India are still boardroom-grown or boardroom-groomed without real-life experience of how to create scale and execute; so when we finalised with NEXUS, although we had three or four more options on the table, the reason we went ahead with them was that they had a global reach; so as and when we want to grow globally, their portfolio has a lot of global companies, which means a better eco-system and a network to leverage and penetrate. Besides, some of the partners had real-life entrepreneur experience so they could connect with the challenges, the execution, the scale and the day-to-day humdrum of the entrepreneur. We can have a much more tactical and strategic discussion and execution-oriented discussion with them rather than just having a talk on, say, this is the GMV or “this is the top ten we have to achieve by… and I don’t care how”.

But to your question – yes, it’s difficult to get the right frequency, to get the right chemistry; we have seen a lot of young entrepreneurs who are just out of college getting to the nitty-gritty of choosing the right venture / investor partners and ending up diluting the whole entrepreneurial instinct. We were lucky because we had prior experience in the corporate world, we could figure out who were the good partners; and then the conviction that we wanted like-minded people as part of the deal.

Having been part of the Fintech space in western countries, how do you see the Fintech landscape in India currently (within which you are operating) and how will it shape up in future?

In my view, Fintech is a global phenomenon which has actually matured into a global juggernaut. It is here to stay; it continues to change and create an impact in the overall financial eco-system globally.

The journey of Fintech in India for the last eight to ten years – Fintech initially starts by solving basic problems like e-commerce or payments solutions that are low value but significantly impactful solutions. This is how it happens in the western world, too. Fintech improves the core infrastructure, digitises it, automates it. The journey typically starts from B2C and then moves towards B2B since that is slightly more complex and more nuanced. Thereafter, you move up the value chain.

At Namaste Credit we are essentially solving the SMEs’ credit-lending problems. It is one of the most complex and heterogeneous spaces given the diversity of SMEs. It is a less disruptive market. We see a two-year trajectory – how Fintech is nurturing and getting into a more complex space and chipping in on edge as of now before becoming a dominant player.

We believe that the next stage is an amalgamation of AI with Fintech. We are very proud to say that we have filed three patents – two of these are an amalgamation of Fintech which is our core engine, and topping it up with artificial intelligence and machine learning. The space we operate in is more up the value chain and more complex, where we are adding the power of artificial intelligence to process the data which is a critical component in SME lending to create more predictive analytics back to the financiers, so that they can lend faster and lend more. From the SMEs’ point of view, it’s accessing the platform that uses artificial intelligence for matching which gives them the highest conversion rate for loan application and funding.

Can you tell us a bit about how the process works on your platform if someone logged into your portal?

For the B2C side, we have the origination engine for SMEs and our network of influencers. They can digitally upload the documents on the platform. Based on this, our credit under-writing engine performs the credit assessments. Afterwards, it goes into the matching algorithm, which has the policy framework of 60 large financial institutions (probable lenders). The matching algorithm closely matches and shows where this SME is most likely to get the loan from and what is the right loan product, given its requirement and credit assessment. By a combination of these two factors – credit assessment and matching – it results in an over 70% conversion rate of applications through our platforms.

The second engine we have built is an automation engine which is built on AI and machine learning, given on license to banks. The issue we are solving is, how can banks take better and faster decisions in credit and SME underwriting? In this we analyse 100 times more data points than the traditional underwriting function at banks. Since we use automation, we are able to process in 90% less time. This is the power of technology and should allow banks to disseminate credit to the SME segment which is due.

Can you explain how do machines work on uploaded documents?

We have trained our OCR to read the scanned documents from different banks. On the analytics engine it fits in the slot so that we can get a highly-qualified credit assessment. Then it gets matched with banks’ policy, which gives a super-optimal outcome. We are solving a discovery problem – that for an SME what is the right product, which is the right bank; and from the banks’ point of view, which is the right SME they should lend to? By bringing technology and by adding layers of advanced data on the core engine, we are able to make it much more intelligent. We rely less on user input data and more on credible and verified information like bank statements, financial statements, GST returns, etc., on the basis of which banks can take a credit call.

Do you feel that there is some missing link in the SME lending space? Is there a missing ‘good to have’ enabler for lending to meet its logical end?

I think in India we have somehow not been able to bridge or build a deep credit market. Whatever little credit market we have has literally been accessed by corporates. For SMEs there is still no secondary market. Due to this, banks are very selective in SME lending because they know that regulation is not hard enough for them to go after the SMEs, so they (the banks) would rather have a proven and conservative credit policy before they lend.

Imagine a scenario where you have the data being readily shared amongst the banks. Secondly, you also have a much more vibrant and deeper secondary market where you can actually float your own assets much more freely than what happens today where you have to securitise almost your entire portfolio with some other party. Securitisation is a much more illiquid form of secondary market. Imagine you have a very deep secondary market, a very clear and transparent data flow amongst the banks (not just the CIBIL score – which accounts for a tenth of the component), you still have a 90% component which is not shared amongst the banks. It allows each of the lenders to (a) risk-price the SME better, and (b) be able to freely trade or lend to the SME based on the risk-based pricing that each lender comes up with. Today, everything is an island. No data-sharing or exchange or performance data-sharing. Due to this the deserving SME gets marginalised.

For someone who is thinking of starting on their own, what are some of the lessons that you would like to share?

For any entrepreneur, it’s very important that they pick up a problem to solve that has a meaningful impact. We do come across lots of ideas but are all the ideas solving the real problems of people? That’s the first and foremost decision you need to arrive at before turning an idea into a business. Once you cross this hump, you need to put all your might and ingenious approach to make sure that your idea succeeds.

India is still a tough market to operate in, it has its own legacy issues and it has a high cost of running business. Although we hear a lot about venture capital funding in India, no one is giving funding on the basis of ideas. This is in contrast with the developed world where you can raise decent money for a solid idea. In India, despite having a good idea you need to really prove execution and you need to show some scale for anybody to trust you with funding.

VOICE-BASED VIRTUAL ASSISTANTS HAVE COME CALLING!

Gone are the days when we
said, “Lets Google it”. The millennials say, “Hey Google!”
or “Alexa!” or “Hey Siri!”

 

Haven’t we seen ads of
Alexa and Google Home on local TV where songs are played, or the latest news is
delivered, or informative general knowledge is easily dispensed just for the
asking? Such devices are getting immensely popular and changing the fabric of
how home entertainment works.

 

So, how do they work?
Essentially, these virtual assistant devices have a mic (that’s short for
microphone!) and a speaker. They have the circuitry to connect them to a WiFi.
Therefore, when you ask a question, it’s captured by the mic and sent via WiFi
to the respective server where the request is processed. The response from the
server is sent back to the device from where the content is delivered via the
speakers. This content may be a piece of information or a song. Today, you can
ask via these devices to cast a YouTube video on to your TV or even play a
Netflix film!

 

Now, voice-based virtual
assistants are available on the phone, too. No more clumsy typing or even
tapping on the screen. Just ask what you want the phone to do. This is the
future of interaction on the phone. The creators of these technologies
initially provided a simple way to get routine mobile tasks done via voice.
These included: “Set an Alarm…”, or “Call…”, or
“Send text to…”. But that was a few years ago. Later, they added more
capability like playing songs and so on. Today, almost any information that is
available in the public domain is accessible via voice. Such apps are available
on both iPhone as well as Android phone.

 

Another popular term is
“chatbots”. This usually refers to the virtual assistants that are
available online. Customer support is the most popular application on websites
that gets millions of support requests on a daily basis. Such requests are
usually typed on a chat window on the website and are processed by a virtual
assistant at the backend. Usually, chatbots are not voice-enabled.

 

This article focuses on Google
Assistant and how a virtual assistant can be used for an organisation or
association. But first some non-so technical understanding of how it all works.

 

The Google Assistant is a voice-enabled virtual assistant app
built by Google. It is available for free on phones (both Android and iPhones)
and allows you to ask for any information that is in the public domain. Just
open the app and ask for it. Examples of information that can be asked are:
“what is the latest news”, or “when is the next eclipse”,
or “what is today’s Sensex”, or “when was GST implemented in
India”? You will be surprised at how much of what you want to know can
just be asked and answered. Easier and quicker.

 

The only difference
between the Google Assistant app and the Google Home device is that the phone
app has a screen (the phone) to show information besides speaking out the
answer. In fact, now both Amazon
(Alexa devices) as well as Google (Home devices) have devices with a screen.
Think of them as specialised screens meant for the Assistant app.

 

What powers the ability of
such applications and devices?

 

The first technology is
the Speech-to-Text engine, or S2T. Its job is to convert the speech into text
as accurately as possible. Imagine the challenge of such a system to understand
all the different ways in which humans speak. Each one of us has a different
tone of voice, different speeds at which we speak, the depth / shrillness of
our voice and our own style / accent while speaking. Even when watching movies
we know the difference in understanding the words spoken in an American film as
opposed to a British one, and how different it is from an Aussie accent. The
S2T engine must have the ability to support all this. To add to this is the
external noises that cannot be avoided. Imagine, you are in a local train or
bus and asking for information via the virtual assistant. It needs to recognise
the difference in the sound that comes from you and those external sounds that
penetrate the mic. Once it does that, it should ignore those extraneous sounds.
And all that is done today by the S2T engine.

Unknown to most of us,
today’s technology has been improvised thanks to the work done over decades. In
the beginning, the quality of the S2T engines was very poor and required the
user to “speak” her / his voice for a few hours to get it recognised. Today, it
works with no training or very limited training. The magic behind this is a
statistical method called “Machine Learning”. Millions of sample
voices of different dialects and regions and people have been fed into massive
computers. Each of these samples also has the actual words listed which are fed
into the computers. Statistical algorithms crunch all this data and come up
with what is called a “model”. The words spoken by the user are fed
into this model which predicts the likely text being spoken. You will be amazed
at its accuracy!

 

For this to work, the
voice spoken on the phone is sent to large servers sitting in a
“cloud” to process and return the equivalent text. This is then moved
to the next stage. In fact, in the next one year even this step of sending the
text to the “cloud” will be eliminated and the voice will get transcribed on
the phone itself, making it almost instantaneous!

 

Assuming that it has
correctly transcribed the spoken words, the system next needs to interpret them
correctly. This is the most difficult part of the entire process. It is called
“Natural Language Processing” or NLP. Some also call it “Natural Language
Understanding” or NLU. Imagine that you are a librarian who has access to a
vast body of knowledge. When someone approaches you with a question, you
understand the query and, thanks to your knowledge of the library, you go to
the right section to dig out the information and give it out. That ability is
the job of the NLP. Since the request is now known (after getting converted by
the S2T engine), the NLP needs to first figure out what the information is
about. Is it about a person, or about some geographical data, or about some
prices, or about current affairs? Possibly, for each of these categories of
information, there is a source available that can provide the information. Much
like the different sections of the library.

 

Have you tried asking any
of the virtual assistants for the latest news? If not, please do. How would
people ask for the latest news? “Tell me the latest news”, or
“What is the news now”, or “What is happening in the world
now”? People will not have a standard way of asking for a particular bit
of information. Each one of us has our own style and choice of words. The NLP
needs to understand that all these are different ways of asking and mean the
same thing, viz., “Tell me the news”. Once it has established what
the user is asking, the response will be something like, “The news as
per… is…”

What the NLP engine is
doing is simple; having interpreted the request to be asking for news, it gets
the information from one of the popular sources to which it is linked. It could
be BBC, or Times News Network, or any other source with which it has a
relationship.

 

Can you guess what happens
when we ask the system to play a song? Well, once it establishes that it is a
song that it is being requested to play, it will immediately forward the
request to the songs library which could be Google Music or Saavn or Gaana from
where the song is played.

 

Have you tried asking
information about a person? Even if the person is not very famous, the Google
Assistant will provide some info with links to its source. How does it do it?
When it detects that you are asking about a person, it usually goes to one of
its two popular sources, Linked In or Wikipedia, and delivers the best-guess
person’s details. In case there are many people with the same name, it will use
some other criterion to decide which amongst them it would choose.

 

The effectiveness of the
voice-based digital assistant primarily lies in the NLP engine rightly
detecting what the user is asking for and retrieving the relevant information
from one of its sources. This is called determining the “Intent” of the
request.

 

Can it go wrong? Of
course! Just like humans can make mistakes, the NLP, too, would. Besides, the
NLP is not as wise as a human. It does not have the versatility of a human
being. But over time it does a pretty good job. The first point of failure can
come where the S2T engine does not transcribe your speech correctly. Perhaps,
re-asking it with greater care would solve that problem. Then, when you ask for
information about a person, it could so happen that it picks another person
with a name similar to yours. In which case, perhaps, the query should be more
refined. At times it may misunderstand the category. You are asking about a
place while it may misunderstand it to be something else. Most users of virtual
assistants accept that it is not perfect, yet it serves an important function
and seems to be improving over time.

 

Since the Google Assistant
is such a wonderful and easily-used app, how do we enable it to ask information
that is private or local to a company? For example, would it not be convenient
to query the HR manual of a company using such a feature? Or training all the
office personnel on the products of a company? Or know the rules of GST for a
particular category of products? Just by asking. Sounds like a perfect fit,
doesn’t it?

Google Assistant has a
feature whereby an organisation or association (like the BCA) can set up its
own channel. Google calls this an “Action”. In such cases, user requests are
not processed by the Google engine but by the company’s engine. Let’s take an
example. Suppose BCA wishes to provide information to its members which is
similar to what its website provides today.

 

BCA can inform Google that
it wishes to set up a Channel called, say, “Chartered News”. What
this will do is that if the user says, “Talk to Chartered News”, the
request will be passed on to the BCA’s server for processing. It will not be
processed by Google. Now, all that BCA needs to do is to have some relevant software
put in place which will “understand” the request and give a suitable
response. And this will continue for all requests that the user makes until the
user says “Goodbye”. If required, such a channel can be restricted to
only the members of BCA.

 

This is an extremely
potent manner in which the future of all information is likely to be dispensed.
There are tools available that will help organisations create such a channel
quite easily. These tools will have to be configured to understand the query
based on the content that is put up by the organisation.

 

Where is the technology
moving?

 

Well, today Google
Assistant supports Hindi and has announced that it will soon be adding other
Indian languages such as Gujarati, Kannada, Urdu, Bengali, Marathi, Urdu, Tamil,
Telugu and Malayalam. New phones (like Nokia 3.2 and Nokia 4.2) are being
introduced which have a dedicated “Google Assistant” button. This makes it more
convenient for users to access the virtual assistant. Just click on it and ask!

 

This is the new reality:
Virtual assistants are the new way to access information. If you have not
started yet, please do so or you will be left behind!

TAKE ACTION, BUT TREAD CAUTIOUSLY

SEBI oversees and regulates
dealings in shares and other securities traded on the stock exchanges. However,
for several years now it has also been regulating trading in commodity
derivatives on commodity exchanges. It has replaced the Forward Markets
Commission and the SEBI Act and Regulations / Circulars issued thereunder have
effectively replaced the Forward Contracts (Regulation) Act, 1952.

While the regulator is
common between the two markets now, and although there are fundamental
similarities between trading in securities on stock exchanges and on commodity
exchanges, there are fundamental differences, too. The contracts in derivatives
have broad similarities in both the markets. The regulator also recognises a
fundamental similarity, that is, ensuring fair price discovery in a
regulated market that is free of wrongful influences. Thus, for example,
price manipulation is as much a cause for worry for commodity markets as it is
for stock markets.

The volumes of trades in
commodity exchanges are fairly high. However, other than the much-discussed
matter of NSEL, there have been few orders by SEBI relating to the commodity
market. A recent SEBI order (“the Order”), which has been promptly reversed on
appeal to the Securities Appellate Tribunal (“SAT”), thus becomes a good case
study to review some broad aspects pertaining to the commodity market.

However, apart from
considering issues specific to commodity markets, this order also raises some
important issues relating to the type of orders that SEBI can pass; for
example,

  • What are the situations where SEBI can pass ex
    parte     interim orders?
  • Under what circumstances can SEBI debar parties
    from dealing in the markets?

These questions are
important because an ex parte interim order debarring a person may not
only result in huge losses to him but may even sound the death knell for his
business.

THE BACKGROUND

One of the primary concerns
in the commodities market is the cornering of stocks in a particular commodity.
A person cornering a very large percentage of the stock of a particular
commodity can be in a position to dictate its price. Thus, SEBI has specified
limits on trades by persons and these limits apply to a single person or a
group of persons acting in concert.

To ensure that groups
acting in concert are also brought under this rule, SEBI has specified generic
and specific tests to determine whether a group of persons is acting
independently of each other or is acting in concert. Hence, having certain
specified relations or commonalities would show such persons as acting in
concert. However, the exchanges can use generic criteria based on facts of
individual cases to determine whether ‘persons are acting in concert’.

 

Cornering market beyond the
specified limits, though a violation in itself, can potentially lead to
additional violations.

The case in question, as
seen below, allegedly had both the concerns specified above.

THE FACTS AND THE SEBI ORDER

Vide an order dated 28th
February, 2019 SEBI passed an ex parte interim order against 26 persons
for certain violations while acting in concert. SEBI initiated this action
based on the advice of the commodity exchange concerned. SEBI was informed that
three persons were holding more than 75% of the total exchange deliverable
stock of mentha oil. The exchange had applied the tests specified by SEBI to
determine whether these three persons were acting in concert. These three
persons were found to have been funded by a certain person.

The large holding was
accumulated not only by purchases on the exchange platform, but also through
off-market transactions. They had transferred their purchases to the specified
three persons. These parties were also alleged to be connected with each other
on the basis of findings made by the exchange.

The acquisitions and
holdings of these parties were tabulated by SEBI over nearly a year and it was
found that the deliveries taken by them as a percentage of total deliveries
showed that the cumulative deliveries were almost 75% of the total deliveries.

The order then analysed in
detail the relationship between the parties as well as the flow of funds
between them to demonstrate that they were acting in concert.

Further, the order
highlighted an aspect that strengthens SEBI’s case. It pointed out that some of
these parties traded for the first time. A few opened their trading accounts
during this period itself. Many traded beyond their capacity (i.e., net worth)
– for example, in an extreme case, a person whose declared net worth was Rs. 15
lakhs had taken delivery of goods worth Rs. 34.94 crores, which was 23,293% of
his net worth!

The order also considered
the numerical limits specified for the commodity and noted that such persons, allegedly
acting in concert, violated these limits on most of the days.

SEBI also alleged that NEFM
who ultimately funded the transactions, ‘intentionally created false and
misleading appearance of trades’. Further, the act of concealment was devised
to ‘deliberately mislead the market and hold a dominant stock position’. These
actions were in violation of the SEBI PFUTP Regulations. The registered broker
through whom the transactions were channelled by the parties was also alleged
to have prima facie violated various provisions, including incorrect
reporting and not exercising due skill, care and diligence, etc.

SEBI held that the parties
had not only violated provisions of law and accumulated a dominant position but
such position could put them in a position to manipulate the price of the
commodity.

 

In view of the above facts
SEBI debarred the parties from dealing in or being associated with markets in
any manner till further directions. Post-order hearing was granted to the
parties since this was an interim order.

The appeal and the
order of SAT (North End Foods Marketing (P) Ltd. vs. SEBI {[2019] 105
taxmann.com 69 (SAT – Mumbai)}

The parties so debarred
appealed to the Securities Appellate Tribunal (SAT) against the interim ex
parte order debarring them from trading. SAT set aside the order on several
grounds. Interestingly, the parties sought an interim order from SAT for
immediate reliefs.

The primary appellant
contended that it was involved in the business of procurement of commodities
and warehousing of commodities for which it received orders from its clients
and, in turn, placed orders for such commodities with its agents. These agents
procured such commodities and delivered those commodities to the appellant who,
in turn, delivered such commodities to its clients. Thus, the allegation of
acting in concert was denied.

The presumptions of SEBI
were questioned. For example, it was contended that the basis of presuming the
dominance in market was incorrect. It was argued that the total volume of trades
should be taken as the basis. If that were done, then, even if all the parties
were clubbed together their delivery would be less than 2% of the total volume
of trades. Thus, there was no dominance.

It was also contended that
though the transactions were completed, none of the price manipulations that
SEBI alleged had taken place. Thus, SEBI’s fears had no basis even on facts.

The order even debarred
parties from dealing in other commodities. Many commodities had limited shelf
life and there would be financial and physical loss if these deals were not
completed.

The SAT considered the
contentions and set aside SEBI’s order.

However, SAT upheld SEBI’s
power to pass interim ex parte orders and also highlighted various
pre-conditions to be satisfied before interim ex parte orders should be
passed. There has to be urgency for passing orders without granting a hearing
to the parties and this need particularly has to be justified. Further, SEBI
has to establish that there would be serious consequences if such an order is
not passed.

SAT noted that the events
described in the SEBI order were of the past. No useful purpose would be served
by debarring the parties at this stage. The derivatives contracts entered into
by the parties had already been executed and SEBI had not recorded any finding
of manipulation that it suspected had taken place. The order debarred parties
not only from dealing in mentha oil, but also all other commodities. This
obviously was too broad and too harsh. The order had also frozen the demat
accounts and mutual fund investments of the parties which had no bearing on the
alleged violations. SAT held that no purpose would be served in preventing
their dealings through an interim order.

Thus, the order failed in
complying with the necessary basic conditions of an interim ex parte
order. SAT set aside the order, though allowing SEBI to initiate and continue
such proceedings and inquiries on the matter as it deemed fit.

CONCLUSIONS

Interim ex parte
orders are often passed and it is well settled that SEBI has powers to pass
such orders. The basic features of interim ex parte orders are:

  • No opportunity to explain is given. Restrictions
    are often placed on the activities of the parties that can cause financial and
    reputational losses. Such interim orders often continue for years pending
    inquiry and investigations;
  • Hence, SAT held that SEBI has to establish
    exceptional need to pass ex parte interim orders.

There is another aspect
that is common to all orders of debarment – whether interim or final. Debarment
in ordinary course should be for prevention. Freezing bank accounts and sale of
assets should be done to ensure that funds are not siphoned off in anticipation
of orders of penalty, disgorgement, etc. However, it is often seen that the
debarment operates as a punishment. An order debarring dealings in securities
can result in loss and even closure of business. Hence, unless it can be shown
that dealings by parties would harm the markets, interim ex parte orders
cannot be sustained and should not be passed.

 

In the author’s opinion
SAT’s order lays down certain basic precautions that need to be taken by SEBI
while passing ex parte interim orders.

Section 54 – Condition of not owning more than a residential house on the date of transfer of the original asset would mean absolute ownership and does not cover within its sweep a case where the assessee jointly owns residential house together with someone else

16[2019] 105 taxmann.com 204 (Mum) Ashok G. Chauhan vs. ACIT ITA No. 1309/Mum/2016 A.Y.: 2010-11 Date of order: 12th
April, 2019

 

Section 54 –
Condition of not owning more than a residential house on the date of transfer
of the original asset would mean absolute ownership and does not cover within
its sweep a case where the assessee jointly owns residential house together
with someone else

 

FACTS

The
assessee, an individual, filed his return of income after claiming deduction
u/s. 54F of the Income-tax Act, 1961 (“the Act”) in respect of capital gains
arising from transfer of tenancy rights. In the course of re-assessment
proceedings, the Assessing Officer (AO) observed that the assessee was owner of
two residential houses, one of which was jointly held by him with his wife. The
AO rejected the claim for deduction u/s. 54F on the ground that the assessee
owned two flats on the date of transfer of tenancy rights.

 

Aggrieved,
the assessee preferred an appeal to the Commissioner of Income-tax (Appeals)
who upheld the order passed by the AO.

 

HELD

The
Tribunal observed that the Legislature has used the word ‘a’ before the words
‘residential house’ and held that what was meant was a complete residential
house and not shared interest in a residential house. It held that joint
ownership is different from absolute ownership and that ownership of
residential house means ownership to the exclusion of all others. The Tribunal
relied on the judgement of the Supreme Court in the case of Seth Banarasi
Dass Gupta vs. CIT [(1987) 166 ITR 783] wherein it is held that a
fractional ownership was not sufficient for claiming even fractional
depreciation u/s. 32 of the Act.

 

The
Tribunal noted that because of this judgement, the Legislature had to amend
section 32 with effect from 1st April, 1997 by using the expression
‘owned wholly or partly’. But while the Legislature amended section 32 it chose
not to amend section 54F. The Tribunal held that since section 54F has not been
amended the word ‘own’ in section 54F would include only the case where a
residential house is fully and wholly owned by the assessee and consequently
would not include a residential house owned by more than one person.

 

Hence
it was held that the claim for exemption u/s. 54F could not be denied. The
appeal filed by the assessee was allowed.

HAPPINESS

When you change the way you look at things, the
things you look at change – Wayne Dyer

 

Who does not want to be happy! However, the fact is that happiness
eludes us despite the fact that all our actions are motivated to be ‘happy’.
The issue is: can one predict or plan happiness or does ‘happiness happen’?
I believe when we plan for happiness it does not happen, because by nature we
harbour a doubt about whether our plan will work. There is a good old
saying ‘when you doubt power, you give power to doubt’.

 

I also believe ‘happiness happens’ because we have experienced
happiness without any effort on our part – for example, we are happy seeing a
flower bloom, the rising sun, the view of a beautiful moon or even a glance of
appreciation from another human being. Even a bird’s singing makes us happy.
What is the reason for this? This is because happiness is our nature. Happiness
has no reason – it happens when we are free from our concerns and worries even
for a second.

 

Despite the fact that we are all seekers of happiness – happiness is not
there. Have we stopped to observe in an elevator, or on the road, in a train or
bus, or even in a restaurant that people rarely sport a smile? A smile
represents happiness. So the issue is: where has happiness vanished? This is
despite the fact that according to every concept our nature is happiness and
all religions guide us to be happy – even an atheist seeks happiness. Nerenberg
says ‘we are living in a society that is overly serious’.

 

The fact is that
we have managed to cover happiness with our problems and concerns. To be happy
let us do our best and leave the result to HIM and, believe me, we will always
be happy. It is rightly said that effort and action are in one’s hands but not
the result. Acceptance of result is karma – based on the concept that
every action has a reaction and reaction is not in our hands. Accept the result
and be content with everything as the play of destiny – Destiny rules.

The irony is: “We confuse ‘happiness’ with ‘pleasure’
forgetting that ‘pleasure’ is transitory and ‘happiness’ is eternal because it
is our nature”. According to Dada Vaswani, happiness depends on our peace of
mind and peace of mind is not dependant on possessions. Let us celebrate what
we have. Oprah Winfrey says,

 

‘The more you celebrate your life, the more there
is in life to celebrate’

 

Happiness is not in possession or fame. Happiness is in living,
practising forgiveness and being consciously considerate to others and
ourselves and, above all, being conscious of the fact that happiness is our
nature – the source of ‘happiness’ is contentment.

 

I would conclude by quoting Bertrand Russell:

 

‘To be without some of the things you want is an
indispensable part of happiness’

 

To be happy,
do your best and be contented.



Section 4 of ITA, 1961 – Income – Capital or revenue – Sale of shares upon open offer letter – Additional consideration paid in terms of letter of open offer due to delay in making offer and dispatch of letter of offer – Additional consideration part of share price of original transaction not penal interest for delayed payment – Additional consideration was capital receipt

26 CIT vs. Morgan Stanley
Mauritius Co. Ltd.; 41 ITR 332 (Bom) Date of order: 19th
March, 2019

 

Section 4 of ITA, 1961 – Income – Capital or revenue –
Sale of shares upon open offer letter – Additional consideration paid in terms
of letter of open offer due to delay in making offer and dispatch of letter of
offer – Additional consideration part of share price of original transaction
not penal interest for delayed payment – Additional consideration was capital
receipt

 

An
open offer was made by Oracle to the shareholders of I-flex at the price of Rs.
1,475 per share. The letter of open offer stated that additional consideration
per share would be paid due to delay in making the open offer and dispatch of
the letter of offer based on the time-line prescribed by the Securities and
Exchange Board of India. The consideration was revised to Rs. 2,084 per share
and the additional consideration for delay was revised to Rs. 16 per share. In
response to the open offer, the assessee tendered its holding of 13,97,879
shares in I-flex and received Rs. 2,89,77,45,900, which included additional
consideration of Rs. 2.20 crores. The Department contended that the additional
sum received was a revenue receipt and taxable in the hands of the assessee.

 

The
Tribunal held that the additional consideration received was for delayed
payment of principal and that it was part of the original consideration and
hence not taxable.

 

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

 

“i)   The additional amount received by the
assessee was part of the offer from the sale of shares made by it. The reason
to have increased the sum per share by the company Oracle to the shareholders
of I-flex might be on account of delay of issuance of the shares, but it was
part of the sale price of the share. The revised offer which the company
announced for issuance of the shares included the additional component of the
increased sum per share and was embedded in the share price. This component
could not be treated as interest on delayed payment on price of the share.

 

ii)   The additional sum was part of the sale price
and retained the same character as the original price of the share. The
additional receipt of the assessee relatable to this component was a capital
receipt.”

Section 80-IB(10) of ITA, 1961 – Housing project – Special deduction u/s. 80-IB(10) – No condition in section as it stood at relevant time restricting allotment of more than one unit to members of same family – Allottees later removing partitions and combining two flats into one – No breach of condition that each unit should not be of more than 1,000 sq. ft. – Assessee entitled to deduction

25  Prinipal CIT vs. Kores India Ltd.; 414 ITR 47 (Bom) Date of order: 24th
April, 2019 A.Y.: 2009-10

 

Section 80-IB(10) of ITA, 1961 – Housing project –
Special deduction u/s. 80-IB(10) – No condition in section as it stood at
relevant time restricting allotment of more than one unit to members of same
family – Allottees later removing partitions and combining two flats into one –
No breach of condition that each unit should not be of more than 1,000 sq. ft.
– Assessee entitled to deduction

 

The
assessee was engaged in the business of constructing residential houses. He
constructed residential houses of less than 1,000 sq. ft. and claimed deduction
u/s. 80-IB(10) of the Income-tax Act, 1961. The AO rejected the claim on the
ground that the assessee has breached the condition of 1,000 sq. ft. per flat
as several units adjacent to each other were allotted to members of the same
family.

 

The
Tribunal allowed the claim.

 

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

 

“i)   At the relevant time when the housing project
was constructed and the residential units were sold, there was no condition in
section 80-IB(10) restricting the allotment of more than one unit to the
members of the same family. The assessee was therefore free to have allotted
more than one unit to members of the same family.

 

ii)   According to the materials on record, after
such units were sold under different agreements, the allottees had desired that
the partition wall between the two units be removed. It was the decision of the
members to remove the walls and not a case where the assessee had, from the
beginning, combined two residential units and allotted such larger unit to one
member.

 

iii)   The order of the Tribunal rejecting the
objections raised by the Department was not erroneous. No question of law
arose.”

 

Section 10(23C)(iiiab) of ITA, 1961 – Educational institution – Exemption u/s. 10(23C)(iiiab) – Condition precedent – Assessee must be wholly or substantially financed by Government – Meaning of “substantially financed” – Subsequent amendment to effect that if grants constitute more than specified percentage of receipts, assessee will be deemed “substantially financed” by Government – Can be taken as indicative of Legislative intent – Assessee receiving grant from Government in excess of 50% of its total receipts – Assessee entitled to benefit of exemption for years even prior to amendment

24  DIT (Exemption) vs. Tata Institute of Social Sciences; 413 ITR 305
(Bom) Date of order: 26th
March, 2019 A.Y.s: 2004-05, 2006-07 and
2007-08

 

Section 10(23C)(iiiab) of ITA, 1961 – Educational
institution – Exemption u/s. 10(23C)(iiiab) – Condition precedent – Assessee
must be wholly or substantially financed by Government – Meaning of
“substantially financed” – Subsequent amendment to effect that if grants
constitute more than specified percentage of receipts, assessee will be deemed
“substantially financed” by Government – Can be taken as indicative of
Legislative intent – Assessee receiving grant from Government in excess of 50%
of its total receipts – Assessee entitled to benefit of exemption for years
even prior to amendment

 

The
assessee was a trust registered u/s. 12A of the Income-tax Act, 1961. For the
A.Y.s 2004-05, 2006-07 and 2007-08, it sought exemption u/s. 10(23C)(iiiab) on
the ground that it was substantially financed by the government. It was
submitted by the assessee before the AO that it was an institution solely for
educational purposes and that the grants received from the government were in
excess of 50% of the total expenditure incurred and the total receipts during
the years. The AO denied the benefit u/s. 10(23C)(iiiab) on the grounds that
the assessee was not substantially financed by the government and that the
grant received was less than 75% of the total expenditure. He referred to
section 14 of the Controller and Auditor General (Duties, Powers and Conditions
of Service) Act, 1971 and applied the measure of 75%.

 

The
Commissioner (Appeals) held that the 1971 Act was not applicable in the absence
of any reference to it and allowed the assessee’s appeal. The Tribunal found
that the grant from the government was approximately 56% of the total receipts
and upheld the order of the Commissioner (Appeals).

 

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

 

“i)   Subsequent legislation might be looked at in
order to see what was the proper interpretation to be put upon the earlier
legislation, where the earlier Act was obscure or ambiguous or readily capable
of more than one interpretation. The same principle would apply to an amendment
made to an Act to understand the meaning of an ambiguous provision, even when
the amendment was not held to be retrospective. The Explanation to section
10(23C)(iiiab) inserted w.e.f. 1st April, 2015 which provides that
where the grant from the government was in excess of 50% of the assessee’s
total receipts, it would be treated as substantially financed by the
government, could be taken as the exposition of Parliamentary intent of the
unamended section 10(23C)(iiiab). The assessee was entitled to the benefits of
exemption u/s. 10(23C)(iiiab) for the assessment years prior to the
introduction of the Explanation.

 

ii)   The vagueness attributable to the meaning of
the words ‘substantially financed’ was removed by the addition of the
Explanation to section 10(23C)(iiiab) read with rule 2BBB of the Income-tax
Rules, 1962. The Explanation to section 10(23C)(iiiab) was introduced by the Finance
(No. 2) Act, 2014 w.e.f. 1st April, 2015 to clarify the meaning of
the words ‘substantially financed by the government’. It stated that the grant
of the government should be in excess of the prescribed receipts in the context
of total receipts (including voluntary donations). Rule 2BBB provided that the
government grant should be 50% of the total receipts. The assessee admittedly
satisfied the test of ‘substantially financed’ for the A.Y.s. 2006-07 and
2007-08 as the AO had recorded a finding in his order which was not disputed.
If the Explanation was to be read retrospectively, the orders of the
authorities would be required to measure the satisfaction of the words
‘substantially financed’ in terms of Explanation, i.e., qua total
receipts and not qua total expenditure.”

Sections 37 and 43B of ITA 1961 – Business expenditure – Deduction only on actual payment – Nomination charges levied by State Government emanating from a contract of lease – Not statutory liability falling under “tax, duty, cess or fee” by whatever name called in section 43B – Provision for allowance on actual payment basis not applicable

23 Tamil Nadu Minerals Ltd. vs. JCIT; 414 ITR 196
(Mad) Date of order: 22nd
April, 2019 A.Y.: 2004-05

 

Sections 37 and 43B of ITA 1961 – Business expenditure
– Deduction only on actual payment – Nomination charges levied by State
Government emanating from a contract of lease – Not statutory liability falling
under “tax, duty, cess or fee” by whatever name called in section 43B –
Provision for allowance on actual payment basis not applicable

 

The
assessee was a State Government undertaking engaged in mining, quarrying,
manufacture and sale of granite blocks from the mines leased out to it by the
State. For the A.Y. 2004-05, the Assessing Officer (AO) disallowed u/s. 43B of
the Income-tax Act, 1961 the sum paid by the assessee as nomination charges at
the rate of 10% of the turnover to the State Government on the ground that the
payment was not made within the stipulated time allowed to file the return.

 

The
Commissioner (Appeals) and the Tribunal upheld the AO’s order.

 

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

 

“i)   The object and parameters of section 43B are
defined and do not permit transgression of ‘other levies’ made by the State
Government in the realm of contractual laws to enter the specified zone of
impost specified in it.

 

ii)   The nomination charges specified and
prescribed by the State Government through various orders were none of the four
imposts, namely, tax, duty, cess or fees, specified u/s. 43B, which had to be
paid on time. It was only a contractual payment of lease rental specified by
the State Government being the lessor for which both the lessor and the lessee
had agreed at a prior point of time to fix and pay such prescription of
nomination charges. A mere reference to rule 8C(7) of the Tamil Nadu Minor
Minerals Concession Rule, 1959 did not make it a statutory levy, in the realm
of ‘tax, duty, cess or fees’. The reasons assigned by the authorities below on an
incorrect interpretation for application of section 43B made to the levy in
question were not sustainable.

 

iii)   Since section 43B did not apply to the
payments of ‘nomination charges’ the question of applying the rigour of payment
within the time schedule would not decide the allowability or otherwise of such
payment under the section, which would then depend upon the method of
accounting followed by the assessee; and if the assessee had made a provision
for the payment in its books of accounts and had claimed it as accrued
liability in the assessment year in question, it was entitled to the deduction
in the assessment year in question without any application of section 43B.”

GST @ 2 – A SHORT WISH LIST

The Editor of BCAJ assigned me the responsibility of writing an
article with the above title. What a thoughtful title this is! GST was launched
two years ago with much fanfare and celebrations on 1st July, 2017
and has substantially lived up to the expectations. The fireworks are now over.
The benefits of GST are there for the country to see. However, as it completes
two years of existence, the million-dollar question is “What next?” The
question begs attention also in the context of the results of the Lok Sabha
elections and the re-institution of the NDA government in its second term. With
the government looking towards a “New India” and simplified taxation under the
leadership of a new Finance Minister, it is now time to look at new ideas and
present a wish list which could capitalise on the journey traversed so far and
take India to the next trajectory in terms of consolidation, improving “Ease of
Doing Business” and putting the country on the path towards achieving a $5
trillion economy. So here we go:

 

1. EXPAND THE COVERAGE OF PRODUCTS AND
SERVICES UNDER GST


The success of GST is there for all to see. If, as legislators, we
believe that GST has been a path-breaking reform towards simplification of
indirect taxes, what forces us to exclude certain pockets of industry from reaping
the benefits of this simplification? The unanimity of numerous decisions taken
in the GST Council over the last couple of years has shown that the dynamics of
conflicting Centre-State interests no longer takes precedence over national
interest and that where there is a will, there is a way. If that be so, it’s
time to step away from the easy approach of providing excuses and postponing
the inevitable – and to take that bold step to include petroleum, real estate
and electricity into the GST Net.

 

Despite all noble intentions, exemptions from payment of tax are provided
under the legislation. At first brush, the industry welcomes such exemptions
and resists the withdrawal of such exemptions. However, as reality sinks in,
the industry realises that each exemption results in additional costs in terms
of denial of credits. Also, the innovative minds of the tax administrators can
result in a treatise of narrow interpretation of exemption entries resulting in
virtual uncertainty and rude shocks – a recent advance ruling denying the
benefit of exemption to skill development courses on a hyper-technical
distinction between the words ‘course’ and ‘programme’ being a case in point.
It is, therefore, time to relook at the list of exemptions and specifically identify
those that primarily pertain to the B2B sector. It may make sense to engage
with the impacted stakeholders and build a consensus towards moving from
exemption to a preferential rate of tax with seamless credits.

 

2. DO NOT DEVIATE – COME BACK TO THE CENTRAL
THEME OF SEAMLESS CREDITS


That brings us to the unique selling proposition (USP) of GST –
availability of seamless credits reducing the cascading impact of taxes across
the supply chain. This has been talked about so often that it has perhaps lost
its context. How else does one explain the deviations from this concept of
seamless credits in the case of restaurants and real estate developers? Let’s
look at the background of the changes in this regard. The GST rate of 12% and
18% on restaurants started impacting the consumer prices of food. The
government wants to control inflation and therefore decides to reduce the rate
to 5% – so far so good. But the government has revenue considerations as well
and finds it easy to deny input tax credit in such cases.

 

While trying to balance the interests of all stakeholders, we now end up
in a situation of damaging the core of the GST legislation, i.e., seamless
credits. And knowingly or unknowingly, we cooked up a recipe for endless
litigation – a series of advance rulings where the authorities need to
interpret the distinction between a restaurant and a shop are clearly
necessitated by such differential tax treatments for similar products. A
similar initiative to reduce the rate of tax on under-construction units coupled
with denial of credit to the real estate developer is another example, but
let’s leave the analysis thereof for some other time.

 

The impact is loud and clear – a lower output tax rate with denial of
input tax credit effectively means taking money out of businesses and putting
it in the hands of the consumer. While this objective sounds laudable, we need
to understand the economics of the free market which effectively nullifies this
objective in the shortest possible timeframe as businesses will increase the
base price to absorb the loss of input tax credit. An even louder and clearer
message – there should be no case of absolute denial of input tax credit. A
lower rate of output tax neither justifies nor empowers the government to
deviate from the core of GST, i.e., seamless credits.

 

Let’s also remember that we actually started with some deviation in the
form of ‘blocked credits’ right from 1st July, 2017. While the
hangover of the earlier tax regimes resulted in that deviation to start with,
there is no reason to continue with that deviation forever. Don’t we all
(including the government) believe and agree that the earlier tax regimes were
archaic and unjust? If that is the collective consensus, what makes us
collectively reconcile ourselves to some traces of such archaic laws with a
myopic vision? The wish list therefore is to eliminate altogether or at
least prune the list of goods and services which form a part of blocked
credits.

 

One more deviation from the core of GST is the concept of ‘reverse charge
mechanism’. While a cross-border reverse charge mechanism is understandable, a
domestic reverse charge mechanism is perhaps unique to India. To what extent is
it logical to shift the burden of levy from the supplier to the recipient? How
far is it correct to expect the recipient to not only pay the tax but also
maintain extensive documentation in the form of payment vouchers and ‘self
invoices’ – a term invented specifically for this context? And while expecting
the honest tax payer to do all this, we must not lose track of the fact that
all of this dilutes and interferes with the fundamental principles of GST like
credits, exemptions and the like.

 

Well, it’s time to accept that you cannot travel long distances in a
vehicle that’s in reverse gear – an accident is in the making. Can we not
eliminate all cases of domestic reverse charge mechanism? Remember, excise law
never had the reverse charge mechanism and many VAT laws had, out of
experience, dumped the obnoxious purchase tax (a simpler cousin of the reverse
charge mechanism) and the administrators were able to administer the law
without these crutches.

 

3. RESPECT LEGISLATIVE PROCESSES


Legislatures in India have been known to possess wide powers of
delegation. However, the legislature cannot delegate, in the words of the
Supreme Court, “unchannelised and uncontrolled power”. Thanks to the long-drawn
process of bringing about an amendment, the last two years witnessed only one
legislative amendment. However, what is important and bewildering is the countless
changes brought about through amendments in rules, removal of “difficulty”
orders, notifications and the like (averaging at more than one a day – see the
next point for statistics). Whether it be suspension of tax on advances for
goods, or the composition option provided to service providers, the
substitution of the return filing process, or a fundamentally new scheme of
apportionment of credit based on carpet area for real estate developers, all of
these conveniently found place through such non-legislative processes.

 

History is full of situations where courts have interfered and placed a
very low priority on such provisions not contained in the Act but in the rules
and notifications. It’s time to learn from such experiences and not place the cart
before the horse. It really is time to comprehensively review the legislation
and bring about amendments in the law to simplify processes, realign to ground
level realities and synchronise the government intent with that prescribed in
the law. At the end of the day, the law is the best reflection of government
intent.

 

4. CONSOLIDATE THE JOURNEY SO FAR


The journey of two years resulted in the issuance inter alia of
179 Central tax notifications, 87 Central tax rate notifications, 19 integrated
tax notifications, 90 integrated tax rate notifications, 101 Central tax
circulars, four integrated tax circulars, 17 Central tax orders and ten removal
of difficulty orders. Coupled with UT tax notifications and circulars, ignoring
state tax notifications and circulars to avoid duplication, we still end up
with a total count of 773 documents at an average of more than one per day!

 

We are yet to factor in the sector-specific booklets, FAQs, press
releases, Twitter responses, flyers and what not! Time and again, governments
have realised that such overdose has resulted in chaos rather than clarity. The
concept of master circulars and notifications is not alien to our legislators.
Before things really go out of control, it is time to have one master
notification covering all exemptions and concessions and one master
clarification (like an education guide) replacing all existing circulars and
clarifications.

 

5. LOOK AT THE BIGGER PICTURE


Along with the comprehensive review of the legislations and the
amendments, it is also time to have a relook at the policy. As accountants, we
understand the concept of materiality. In management parlance, we say “look at
the big picture”. If there are hardly any exemptions or exclusions, does it
make sense to have a complicated mechanism to determine the proportion of
ineligible credits? How does one reconcile to the requirement of reverse
credits on account of transactions in securities? What is the revenue generated
by the government and whether the time and efforts of millions of tax payers,
their accountants and consultants is justified in generating this revenue? Can
we not liberate ourselves from these shackles? What is the rationale of
demanding interest on gross tax before utilisation of credit? Why can’t the
processes for export refunds be simplified? Why is such an elaborate definition
of “business” required?

 

At one point of time, we had wealth tax and it was observed that the cost
of collecting wealth tax was more than the revenue it generated. Naturally,
wiser counsel prevailed and we scrapped the tax itself. While there is no case
for scrapping GST, it’s definitely time to carry out an analysis of each of the
provisions of the law and review the revenue generated vis-à-vis the time and
efforts involved in compliance with every specific provision. The data will
speak for itself and guide us on the way forward for substantial simplification
in the law and processes.

 

6. IN AN OCEAN, EACH DROP COUNTS


Having highlighted the need to not miss the woods for the trees, it is
also important to count the trees. After all, in an ocean each drop counts.
Many associations and chambers including ICAI and BCAS have time and again sent
representations to highlight the difficulties in the existing legislation. This
article is not one where the entire laundry list can be reproduced or
discussed. But an indicative sample will definitely not be out of place:

 

a.  Delete definitions which are
obsolete and realign conflicting definitions. The legislature is not expected
to miss words or to add superfluous words in the statute. Let’s align the GST
legislation with this time-tested expectation. For example, how does one
justify the simultaneous existence of the definition of ‘associated
enterprises’ and ‘related person’?

b.  While it is notable that levy of
GST is restricted to supplies made in the course or furtherance of business,
the very wide definition of business, and even wider interpretation canvassed
by a few advance rulings, virtually make the definition redundant. It’s time to
realign the definition to what it could logically mean.

c.  The term ‘service’ is defined to
mean anything other than goods. While the definition is picked up from
international experiences, the framework is not comparable. In the absence of a
full-fledged GST, such a wide definition of service results in indirectly
taxing subjects which are outside the purview of GST (for example, development
rights in land). A more specific definition like the one under the erstwhile
service tax legislation may be a good reference point.

d.  The benefit of refunds on
account of inverted rate structure needs to be extended to services as well.

e.  The advance ruling authority
should also consist of judicial members. Similarly, the appellate Tribunal
should have more or at least equal numbers of judicial and non-judicial
members.

 

7. SIMPLIFY PROCESSES

It is often said that a bad law which is administered well is better than
a good law which is not administered well. Tax collection and administration
processes should be such that they are simple, stable and fair. While use of
technology for tax collection and administration cannot be disputed, the
processes will have to consider situations where the technology or systems
fail. A human touch may then be required. Having said that, the element of subjectivity
needs to be kept at the bare minimum in such face-to-face interactions. Again,
a lot has been said and written about the desired process improvements, but let
me just take the case of returns. There is really no reason not to permit the
revision of returns filed. After all, we know that to err is human. And if so,
an opportunity to revise the return has to be provided.

 

8. DON’T OVERSTRETCH INTERPRETATIONS

Taxation of
services always flummoxed the administrators. Fearing the risk of ridicule and
censure from the CAG, it was not uncommon for the superintendents to
overstretch the interpretations to factual situations. When an employee resigns
from the company and the company recovers notice period pay from his full and
final settlement, a view is canvassed that the company renders a service to the
employee – the service of tolerating the act of the employee prematurely
terminating his employment! Is this not an overstretched interpretation?

 

Again, when a
cost-benefit analysis is undertaken, where do we see the data point in terms of
cost of compliance and revenue generated? When the CFO of a company
headquartered in Maharashtra attends a tax hearing in Delhi, does the
Maharashtra branch render services to the Delhi branch? If yes, we enter the fragile
territory of interpretations – one could even contend that the Delhi branch
rendered services to the Mumbai branch by facilitating the CFO to attend the
hearing. We may even end up with a maze of dotted lines with absolute zero
clarity on the head or the tail of each arrow. It’s time to live naturally and
not overstretch and draw unnecessary dotted lines.

 

9.    SWIM
WITH THE TIDE

It is generally understood that tax is a sub-set of business. It is
expected to facilitate business and not conflict with the natural flow of
business. Let’s take the case of the supply chain of pharmaceuticals. Due to
the peculiar nature of the products, there is reverse logistics in the form of
rejections and sales returns. Necessarily, such rejections and sales returns go
on to reduce the sales of the organisation and are supported by credit notes.
But a clarification in GST law permits the buyer to issue a tax invoice for
such rejections. Is this not swimming against the tide? Could this have
implications in terms of accounting and legal relationships? Let’s not create
conflicting sets of documentation and then aim for reconciliations between
them.

 

10.     BURY
THE PAST

In one of the earlier wish lists, the problem of overstretched
interpretation was highlighted. The earlier tax regimes generated sufficient
baggage of litigation which still exists in the pipeline. Showing their wisdom,
many state governments announced amnesty schemes to reduce litigation under the
VAT regimes. It is time for the Central government to take a cue from this and
announce an amnesty scheme for pending litigation under the service tax, excise
duty and customs duty laws. This will help bury the past.

 

CONCLUSION

I can go on and on. However, the Editor has cautioned me to restrict
myself to around 2,500 words. I am sure that there are many more items which
could enter this wish list but I have chosen to limit myself to ten important
wishes at a macro level. This article is not a balance sheet of the GST law but
only suggests a few critical action points for the way forward!

 

Over to you,
Madam Finance Minister.

STARTUPS

The best
education that anyone can have is getting out there and doing it –
Richard Branson

 

Entrepreneurship
is one of the finest expressions of the human spirit. Over the ages we have
seen and benefited from this quality of bringing thought to fruition, of being
able to imagine something and also making it happen. Very few things exhilarate
a person more than creating something. It’s magical, but it’s not a trick. The
movement from I CAN DO IT to DOING IT actually, is often difficult but
invigorating.

 

Entrepreneurship
is one of the oldest human endeavours. It has a multi-dimensional impact from
the social to the financial arena. Many startups have made millionaires out of
ordinary people. It not only works for founders but entire founding teams and
others. It injects competition and innovation. It disrupts and yet creates. An
important point is the attitude startups have towards innovation compared to
large companies. Startups innovate in breakthrough technologies and large
companies mostly in incremental ones (predictable and risk-controlled).
Startups have a wave effect. Many founders worked previously with other
startups. The chance of winning is low but the winner gets colossal returns.

 

This
Annual Special issue of BCAJ is focussing on startups. Recently, India has seen
huge growth in this area. Almost everyone has been touched by them in some way
or other – digital wallets, taxis, e-commerce, food delivery, online insurance
and loans, software as a service (SaaS), hotel aggregator, messaging app,
online grocery, music streaming and more. Twenty six of them have become
‘unicorns’ at the end of 2018. (China created one unicorn every 3.8 days in
2018 in comparison and had 186 unicorns in total with a combined valuation of 1
trillion Yuan.) India still remains the third largest in terms of number of
unicorns.

 

A recent
news report1  from a survey of
33,000 startups in India said corruption and bureaucracy were the biggest
challenges. Only 88 startups have benefited from section 80-IAC. According to
the definition in this section, even Facebook and Apple would not have
qualified for the benefits had this section been there at the time of their
inception! Clearly, the landscape and policies need to be conducive and
constructive.

 

Take the issue
of registering a patent. Patent registration takes four to six years in India.
If bureaucrats decide eligibility, there is no light at the end of the tunnel;
115BBF should be allowed to all and not just patent-registered startups. The
preposterous attitude of government is perhaps the single largest impediment to
business today. It’s late, yet the government must understand the hundreds of
benefits arising out of having a healthy startup eco-system. Take the case of
China where 80,000 companies in strategic emerging industries received services
from government-run incubators. The Chinese government runs a 40-billion Yuan
fund. The Beijing City government has set up a fintech and blockchain
industrial park as part of its selective resource allocation and favourable
regulatory environment and drives it as a national agenda. The Chinese central
bank is one of the world’s largest patent-holders in blockchain technology. The
startup eco-system could therefore be one of the finest ways to increase the
tax base and generate meaningful and gainful employment.

 

This
Annual Special issue covers three important topics – valuation of startups,
startups as an investment class and taxation of startups. We also carry two
very interesting interviews – one with the co-founder of an early-stage fintech
startup and another with the CFO of a 12-year-old company that recently had a
merger valued at $1 billion with Jio Music. I hope you enjoy reading these
alongside the budget proposals!


 

Raman
Jokhakar

Editor

 

CO-OWNERSHIP AND EXEMPTION UNDER SECTION 54F

ISSUE FOR CONSIDERATION

An assessee,
whether an individual or an HUF, is exempted from payment of income tax on
capital gains arising from the transfer of any long-term capital asset, not
being a residential house, u/s. 54F of the Income-tax Act on the purchase or
construction of a residential house within the specified period. This exemption
from tax is subject to fulfilment of the other conditions specified in section
54F. One of the important conditions required to be satisfied in order to be
eligible for claiming exemption u/s. 54F is about the ownership of another
residential house, other than the one in respect of which the assessee intends
to claim the exemption, as on the date of transfer of the asset.

 

This limitation on ownership of another
house is placed in the Proviso to section 54F(1). Till the assessment year
2000-01, the condition was that the assessee should not own any other
residential house on the date of transfer other than the new house in respect
of which the assessee intends to claim the exemption. Thereafter, the rigours
of the Proviso to section 54F(1) were relaxed by amending the same by the
Finance Act, 2000 w.e.f. 1st April, 2001 so as to provide that the
assessee owning one residential house as on the date of transfer of the
original asset, other than the new house, is also eligible to claim the
exemption u/s. 54F. This condition prescribed by item (i) of clause (a) of the
Proviso to section 54F(1) reads as under: “Provided that nothing contained
in this sub-section shall apply where – (a) the assessee – (i) owns more than
one residential house, other than the new asset, on the date of transfer of the
original asset; or…”

 

Therefore, ownership of more than one
residential house, on the date of transfer, is fatal to the claim of exemption
u/s. 54F.

 

In respect of this condition, the
controversy has arisen in cases where the assessee is a co-owner of a house
besides owning one house on the date of the transfer. The question that has
arisen is whether the residential house which is not owned by the assessee
exclusively but is co-owned jointly with some other person should also be
considered while ascertaining the number of houses owned by the assessee as on
the date of transfer of the original asset. The issue involves the
interpretation of the terms ‘owns’ and ‘more than one residential house’ as
used in the provision concerned.

 

The Madras High Court has allowed the
exemption by holding that the co-ownership of a house as on the date of
transfer of the original capital asset was not an impediment in the claim of
exemption, while the Karnataka High Court has denied the benefit of exemption
by considering the house jointly owned by the assessee with others as the house
owned by the assessee which disqualified the assessee from claiming the
exemption.

 

The conflict was first examined by BCAJ
in March, 2014 when the controversy was fuelled by the two conflicting decisions
of the appellate Tribunal. In the case of Rasiklal N. Satra, 98 ITD 335,
the Mumbai bench of the Tribunal had taken a stand that the co-ownership of a
house at the time of transfer does not amount to ownership of a house and is
not an impediment for the claim of exemption u/s. 54F; on the other hand, the
Hyderabad bench of the Tribunal had denied the benefit of section 54F in the Apsara
Bhavana Sai case, 40 taxmann.com 528 where the assesses have been found
to be holding a share in the ownership of the house as on the date of transfer
of the asset. This difference of view continues at the high court level and
therefore requires a fresh look.

 

THE DR. P. K. VASANTHI RANGARAJAN CASE

The issue first came up for consideration of
the Madras High Court in the case of Dr. P.K. Vasanthi Rangarajan vs. CIT
[2012] 209 Taxman 628 (Madras). In this case, the long-term capital
gains arising from the execution of a joint development agreement was offered
to tax in the return of income for the assessment year (AY) 2001-02 and the
corresponding exemption was claimed u/s. 54F on reinvestment of such gains in
purchasing the residential premises. However, considering the fact that
possession of the property was handed over in the previous year relevant to AY
2000-01, the assessee finally conceded the view of the  assessing officer that the gains were taxable
in AY 2000-01. So, the exemption provisions contained in section 54F, as it
then stood prior to the amendment by the Finance Act, 2000, effective from 1st
April, 2001, were applicable to the case.

 

So far as the exemption u/s. 54F was
concerned, the AO observed that the assessee owned 50% share in the property
situated at 828 and 828A, Poonamallee High Road which consisted of a clinic on
the ground floor and a residential portion on the first floor. The balance 50%
share was owned by the husband of the assessee. In view of the fact that the
assessee owned a residential house as on the date of transfer of the rights by
virtue of the development agreement, the exemption u/s. 54F was denied by the
AO as the conditions prescribed therein in his opinion were not satisfied. The
CIT (A) confirmed the rejection of the claim by the AO.

 

On appeal by the assessee, the Tribunal
rejected the assessee’s claim u/s. 54F on the ground that the assessee was the
owner of 50% share in the residential property on the date of transfer and as a
result was disentitled to the benefit of section 54F inasmuch as she was found
to be the owner of the premises other than the new house on the date of
transfer. It was held that even though the property was not owned fully, yet, as
the assessee was having 50% share in the residential property, the conditions
envisaged u/s. 54F were not fully satisfied, hence the assessee was not
entitled to exemption u/s. 54F.

 

It was innovatively claimed before the High
Court on behalf of the assessee that the assessee’s share in the property was
to be taken as representing the clinic portion alone and that the residential
portion being in the name of her husband, the proviso denying the exemption
u/s. 54F had no application to the assessee’s case. However, this contention
was found to be contrary to the facts of the case by the High Court. The
assessee as well as her husband had offered 50% share each in the income of the
clinic in the income-tax assessment and had claimed depreciation thereon. Besides,
50% share in the said property in the wealth tax proceedings was offered by the
assessee and her husband.

 

It was further argued that for grant of
exemption u/s. 54F, the limitation applied only where the premises in question
were a residential house, was owned in the status as an individual or an HUF as
on the date of the transfer; that holding the house jointly could not be held
to be owned in the status of individual or HUF. As against this, the Revenue
contended that the co-ownership of another house as on the date of transfer,
even in part, would disentitle the assessee of the benefit of section 54F and
the proviso would be applicable to her case.

 

Given the fact that the assessee had not
exclusively owned the house, but owned it jointly with her husband, the High
Court held that unless and until the assessee was the exclusive owner of the
residential property, the harshness of the proviso to section 54F could not be
applied to deny the exemption. A reading of section 54F, the court noted, clearly
pointed out that the holding of the residential house as on the date of
transfer had relevance to the status of the assessee as an individual or HUF
and when the assessee, as an individual, did not own any property in the status
of an individual as on the date of transfer, joint ownership of the house would
not stand in the way of claiming an exemption u/s. 54F. Accordingly, the High
Court allowed the exemption to the assessee.

 

THE M.J. SIWANI CASE

The issue, thereafter, came up for
consideration of the Karnataka High Court in CIT vs. M.J. Siwani [2014]
366 ITR 356 (Karnataka).

 

In this case,
the assessee and his brother, H.J. Siwani, jointly owned a property at 28,
Davis Road, Bangalore which consisted of land and an old building. During the
year relevant to the assessment year 1997-98, they transferred this property by
executing an agreement to sell. The resultant long-term capital gains arising
on the transfer of the said property was claimed to be exempt u/s. 54 or, in
the alternative, u/s. 54F. The claim of exemption was denied on various grounds
including for owning few more houses as a co-owner on the date of the transfer.

 

The claim of exemption u/s. 54F was denied
since as on the date of transfer, both the assessees owned two residential
houses having one-half share each therein. As the assessee was in possession of
a residential house on the date on which the transaction resulting in long-term
capital gains took place, the AO as well as the first appellate authority
refused to grant any benefit either u/s. 54 (for reasons not relevant for our
discussion) or u/s. 54F in respect of capital gains income derived by the
assessees.

 

The Tribunal, on appeal, however, reversed
the findings of the authorities below holding that ‘a residential house’ meant
a complete (exclusively owned) residential house and would not include a shared
interest in a residential house; in other words, where a property was owned by
more than one person it could not be said that any one of them was the owner. A
shared property, as observed by the Tribunal, continued to be of the co-owners
and such joint ownership was different from absolute ownership. The Tribunal
relied upon the decision of the Supreme Court in Seth Banarasi Dass Gupta
vs. CIT [1987] 166 ITR 783 wherein it was held that a fractional
ownership was not sufficient for claiming even fractional depreciation u/s. 32
as it stood prior to the amendment with effect from 1st April, 1997 whereby the
expression ‘owned wholly or partly’ was inserted.

 

On appeal by the Revenue, the High Court,
allowing the appeal held that even where the residential house was shared by
the assessee, his right and ownership in the house, to whatever extent, was
exclusive and nobody could take away his right in the house without due process
of law. In other words, a co-owner was the owner of a house in which he had a
share and that his right, title and interest was exclusive to the extent of his
share and that he was the owner of the entire undivided house till it was
partitioned. The Court observed that the right of a person, might be one half,
in the residential house could not be taken away without due process of law and
such right continued till there was a partition of such residential house.
Disagreeing with the view of the Tribunal, the High Court decided the issue in
favour of the Revenue denying the exemption u/s. 54F to both the assessees by
holding that the ownership of a house, though jointly, violated the condition
of section 54F and the benefit could not be granted to the assessees.

 

OBSERVATIONS

The issue as to whether the expression “owns
more than one residential house” covers the case of co-ownership of the house
or not can be examined by comparing it with the expressions used in other
provisions of the Act. In this regard, a useful reference may be made to the
provisions of section 32 which expressly covers the cases of whole or part
ownership of an asset for grant of depreciation. The term ‘wholly or partly’
used after the term ‘owned’ in section 32(1) clearly conveys the legislative
intent of covering an asset that is partly owned for grant of depreciation. In
its absence, it was not possible for a co-owner of an asset to claim the
depreciation as was held in the case of Seth Banarasi Dass Gupta (Supra).
In that case, a fractional share in an asset was not considered as coming
within the ambit of single ownership. It was held that the test to determine a
single owner was that “the ownership should be vested fully in one single
name and not as joint owner or a fractional owner”. The provisions of
section 32 were specifically amended thereafter to insert the words ‘wholly or
partly’ in order to extend the benefit of depreciation to the assessee owning
the relevant assets in part.

 

Since the words ‘wholly or partly’ have not
been used in the Proviso to section 54F(1), its scope cannot be extended to
even include the residential house which is owned partly by the assessee or is
co-owned by him and to deny the benefit of exemption thereby. The Tribunal did
decide the issue in the case of M.J. Siwani (supra) by relying
upon the aforesaid decision of the Supreme Court in the case of Seth
Banarasi Dass Gupta (Supra).Following the very same decision of the
Supreme Court, very recently, the Mumbai bench of the Tribunal has also decided
this issue in favour of the assessee in the case of Ashok G. Chauhan
[2019] 105 taxmann.com 204.

 

Further, section 54F uses different terms,
‘a residential house’, ‘any residential house’ and ‘one residential house’ at
different places. It is also worth noting that one expression has been replaced
by another expression through the amendments carried out in the past as
summarised below:

AMENDMENTS
AND THEIR EFFECT

Prior to the Finance Act, 2000

Main provision of section 54F(1) used the term ‘a
residential house’, the purchase or construction of which entitled the
assessee to claim the exemption;

Proviso to section 54F(1) used the term ‘any
residential house’, the ownership of which disentitled the assessee to claim
the exemption

Amendment by the Finance Act, 2000

A new Proviso was inserted replacing the old Proviso
whereunder the expression ‘more than one residential house’ was used.
After the amendment, the assessee owning more than one residential house was
disentitled to claim the exemption; The main provision remained unchanged

Amendment by the Finance (No. 2) Act, 2014

The main provision was also amended replacing the expression
‘a residential house’ by ‘one residential house’

 

The expression ‘one
residential house’ used in the Proviso in contrast to the other expressions
would mean one, full and complete residential house, exclusively owned, as
distinguished from the partial interest in the house though undivided. Holding
such a view may cut either way and might lead to the denial of exemption in the
case where the assessee has acquired a partial interest in the residential
house and seeks to claim the benefit of exemption from gains on the strength of
such reinvestment. The main operative part of section 54F itself now refers to
‘one residential house’.

 

In our opinion, for
the benefit of reinvestment of gains the case of the assessee requires to be
tested under the main provision and not the Proviso thereto. One should be able
to distinguish its implication on the basis of the fact that the subsequent amendment
replacing ‘a residential house’ by ‘one residential house’ in the main
provision is intended to deny the exemption where  more than one house is acquired and not for
denying the exemption in cases where a share or a partial interest in one house
is acquired. In any case, the provisions being beneficial provisions, the
interpretation should be in favour of conferring the benefit against the denial
thereof, more so where two views are possible.

 

Further, since the
provisions of section 54F apply only to an individual or an HUF, owning of the
house by the assessee in his status as individual or HUF is relevant for the
purpose of Proviso to section 54F(1) as held by the Madras High Court. If the
residential house is owned by a group of individuals and not by the individual
alone, then that should not be considered as impediment in the claim of
exemption.

The ratio of the
Supreme Court decision in the case of Dilip Kumar
and Co. (TS-421-SC-2018) holding that the
notification conferring an exemption should be interpreted strictly and the
assessee should not be given the benefit of ambiguity, would not be applicable
where two views are legitimately possible and the benefit is being sought under
the provisions of the statute and not under a notification. The inference that
ownership of the house should not include part ownership of the house flows
from the Supreme Court decision in the case of Seth Banarasi Dass Gupta
(Supra) and it can be said that there is no ambiguity in its
interpretation.

 

It may be noted that the assessee had filed
a Special Leave Petition before the Hon’ble Supreme Court against the decision
of the Karnataka High Court in the case of M.J. Siwani (supra) which
has been dismissed. However, as held by the Supreme Court in the case of Kunhayammed
vs. State of Kerala [2000] 113 Taxman 470 (SC), dismissal of SLP would
neither attract the doctrine of merger so as to stand substituted in place of
the order put in issue before it, nor would it be a declaration of law by the
Supreme Court under Article 141 of the Constitution for there is no law which
has been declared. Therefore, it cannot be said that the view of the Karnataka
High Court has been affirmed by the Supreme Court.

 

The better view, in our considered opinion,
is that the premises held on co-ownership should not be considered to be
‘owned’ for the purposes of the application of restrictions contained in
Proviso to section 54F(1) of the Income-tax Act so as to enable the claim of
exemption.

THE ANCESTRAL PROPERTY CONUNDRUM

INTRODUCTION

Hindu Law is often difficult to understand because most of it
is uncodified and based on customs and rituals, while some of it is based on
enactments. One feature of Hindu Law which attracts a lot of attention is “ancestral
property”. After the 2005 amendment to the Hindu Succession Act, 1956 this
issue has gained even more traction. One controversy in this area is whether
ancestral property received by a person can be transferred away.

 

WHAT IS ANCESTRAL PROPERTY?

Under the Hindu Law, the term “ancestral property” as
generally understood means any property inherited from three generations above
of male lineage, i.e., from the father, grandfather, great grandfather. The
Punjab and Haryana High Court has held that property inherited by a Hindu male
from his father, grandfather or great grandfather is ancestral for him – Hardial
Singh vs. Nahar Singh AIR 2010 (NOC) 1087 (P&H). Hence, property
inherited from females, such as mothers, etc., would not fall within the
purview of ancestral property. The same High Court, in the case of Harendar
Singh vs. State (2008) 3 PLR 183 (P&H), has held that property
received by a mother from her sons is not ancestral in nature. Further, three
generations downwards automatically get a right in such ancestral property by
virtue of being born in the family. Thus, the son, grandson and great grandson
of a Hindu all have an automatic right in ancestral property which is deemed to
be joint property. This view has also been held by the Privy Council in Muhammad
Hussain Khan vs. Babu Kishva Nandan Sahai, AIR 1937 PC 238.

 

View-1: Ancestral property cannot be alienated

One commonly accepted view in relation to ancestral property
is that if the person inheriting it has sons, grandsons or great grandsons,
then it becomes joint family property in his hands and his lineal descendants
automatically become coparceners along with him. In Ganduri Koteshwaramma
vs. Chakiri Yanadi, (2011) 9 SCC 788, the Court held that the effect of
the 2005 amendment to the Hindu Succession Act was that the daughter of a
coparcener had the same rights and liabilities in the coparcenary property as
she would have had if she had been a son and this position was unambiguous and
unequivocal. Thus, on and from 9th September, 2005, according to this view, the
daughter would also be entitled to a share in the ancestral property and would
become a coparcener as if she had been a son.

 

A corollary of property becoming ancestral property is that
it cannot be willed away or alienated in any other manner by the person who
inherits it. Thus, if a person receives ancestral property and he has either a
son and / or a daughter then he would not be entitled to transfer such ancestral
property other than to his children. Hence, he cannot under his Will give it to
his son in preference over his daughter or vice versa. This has been the
generally prevalent view when it comes to ancestral property as modified by the
Hindu Succession Act amendment which placed daughters on an equal footing with
sons. Of course, if a person inherits ancestral property and he has no lineal
descendants up to three degrees downwards, male or female, then in any event he
is free to do what he wants with such property. Further, this concept only
applies to inheritance of property, i.e., property received on intestate
succession of the deceased.

 

JURISPRUDENCE ON THE SUBJECT

This concept of ancestral
property automatically becoming joint coparcenary property has undergone
significant changes. The Supreme Court in the case of CWT vs. Chander Sen
(1986) 161 ITR 370 (SC) examined the issue of whether the income /
asset which a son inherits from his father when separated by partition should
be assessed as income of the HUF of the son or as his individual income /
wealth? The Court referred to the effect of section 8 of the Hindu Succession
Act, 1956 which lays down the general rules of succession in the case of males.
The first rule is that the property of a male Hindu dying intestate shall
devolve according to the provisions of chapter II and class I of the schedule
provides that if there is a male heir of class I, then upon the heirs mentioned
in class I of the schedule. The heirs mentioned in class I of the schedule are
son, daughter, etc., including the son of a predeceased son but does not
include specifically the grandson, being a son of a son living.

 

Therefore, the short
question is, when the son as heir of class I of the schedule inherits the
property, does he do so in his individual capacity or does he do so as karta
of his own undivided family? The Court held that in view of the preamble to the
Act, i.e., that to modify where necessary and to codify the law, it was not
possible that when schedule indicates heirs in class I to say that when son
inherits the property in the situation contemplated by section 8 he takes it as
karta of his own undivided family. The Act makes it clear by section 4 that one
should look to the Act in case of doubt and not refer to the pre-existing Hindu
law. Thus, it held that the son succeeded to the asset in his individual
capacity and not as a karta of his HUF.

 

Again, in Yudhishter vs. Ashok Kumar, 1987 AIR 558,
the Supreme Court followed its aforesaid earlier decision and held that it
would be difficult to hold that property which devolved on a Hindu under
section 8 of the Hindu Succession Act, 1956 would be HUF property in his hand
vis-a-vis his own sons. Thus, it held that the property which devolved upon the
father of the respondent in that case on the demise of his grandfather could
not be said to be HUF property.

 

Once again, in Bhanwar Singh vs. Puran (2008) 3 SCC 87,
it was held that having regard to section 8 of the Act, the properties ceased
to be joint family property and all the heirs and legal representatives of the
deceased would succeed to his interest as tenants-in-common and not as joint
tenants. In a case of this nature, the joint coparcenary did not continue. The
meaning of joint tenancy is that each co-owner has an undefined right and
interest in property acquired as joint tenants. Thus, no co-owner can say what
is his or her share. One other important feature of a joint tenancy is that
after the death of one of the joint tenants, the property passes by
survivorship to the other joint tenant and not by succession to the heirs of
the deceased co-owner. Whereas tenants-in-common is the opposite of joint
tenancy since the shares are specified and each co-owner in a tenancy in common
can state what share he owns in a property. On the death of a co-owner, his
share passes by succession to his heirs or to the beneficiaries under the Will
and not to the surviving co-owners.

The Supreme Court in Uttam vs. Saubhag Singh, Civil
Appeal 2360/2016 dated 02/03/2016 held that on a conjoint reading of
sections 4, 8 and other provisions of the Act, after joint family property has
been distributed in accordance with section 8 on principles of intestacy, the
joint family property ceases to be joint family property in the hands of the
various persons who succeeded to it and they hold the property as tenants in
common and not as joint tenants.

 

View-2: Ancestral Property becomes Sole Property

The Delhi High Court has
given a very telling decision and a diametrically opposite view in the case of Surender
Kumar vs. Dhani Ram, CS(OS) No. 1732/2012 dated 18/01/2016.
In this case, the issue was whether the properties of the deceased were HUF
properties in the hands of his legal heirs. The grandson of the deceased
claimed a share as a coparcener in the properties since they were inherited by
his grandfather as joint family properties and hence, they continued to be so.
The Delhi High Court negated this claim and laid down the following principles
of law as regards joint family properties:

 

(a) Inheritance of
ancestral property after 1956 (the year in which the Hindu Succession Act was
enacted) does not create an HUF property and inheritance of ancestral property
after 1956 therefore does not result in creation of an HUF property;

(b) Ancestral property can
only become an HUF property if inheritance is before 1956 and such HUF property
which came into existence before 1956 continues as such even after 1956;

(c) If a person dies after
passing of the Hindu Succession Act, 1956 and there is no HUF existing at the
time of the death of such a person, inheritance of an immovable property of
such a person by his heirs is no doubt inheritance of an “ancestral property”
but the inheritance is as a self-acquired property in the hands of the legal
heir and not as an HUF property, although the successor(s) indeed inherits
“ancestral property”, i.e., a property which belonged to his ancestor;

(d) The only way in which a
HUF / joint Hindu family can come into existence after 1956 (and when a joint
Hindu family did not exist prior to 1956) is if an individual’s property is
thrown into a common hotchpotch;

(e) An HUF can also exist if paternal ancestral properties
are inherited prior to 1956, and such status of parties qua the properties has
continued after 1956 with respect to properties inherited prior to 1956 from
paternal ancestors. Once that status and position continues even after 1956 of
the HUF and of its properties existing, a coparcener, etc., will have a right
to seek partition of the properties;

(f) After passing of the
Hindu Succession Act, 1956, if a person inherits a property from his paternal
ancestors, the said property is not an HUF property in his hands and the
property is to be taken as self-acquired property of the person who inherits
the same.

 

Accordingly, the Court held that a mere averment that
properties were ancestral could not make them HUF properties unless it was
pleaded and shown that the grandfather had inherited the same prior to 1956 or
that he had actually created an HUF by throwing his own properties into a
common hotchpotch or family pool. A similar view was expressed by the Delhi
High Court earlier in Sunny (Minor) vs. Raj Singh CS(OS) No. 431/2006;
dated 17/11/2005.

 

AUTHOR’S VIEW

It is submitted that the
view expressed by the Delhi High Court in the case of Surender Kumar
(supra) is correct. A conjoined reading of the Hindu Succession Act,
1956 and the decisions of the Supreme Court cited above show that the customs
and traditions of Hindu Law have been given a decent burial by the codified Act
of 1956! The law as understood in times of Manusmriti is not what it is today.
Hence, a parent is entitled to bequeath by his Will his ancestral property to
anyone, even if he has a son and / or a daughter. It is not necessary that such
ancestral property must be bequeathed only to his children. The property (even
though received from his ancestors and hence ancestral in that sense) becomes
the self-acquired property of the father on acquisition and he can deal with it
by Will, gift, transfer, etc., in any manner he pleases.

 

CONCLUSION

“Ancestral property” has
been and continues to be one of the fertile sources of litigation when it comes
to Hindu Law. Precious time and money is spent on litigating as to whether the
same can be alienated or not. It is time for the government to revamp the Hindu
Succession Act en masse and specifically address such burning issues! 

RECENT IMPORTANT DEVELOPMENTS – PART I

In this issue we are covering recent major developments in the field of
International Taxation and the work being done at OECD in various other related
fields. It is in continuation of our endeavour to update readers on major
International Tax developments at regular intervals. The items included here
are sourced from press releases of the Ministry of Finance and CBDT
communications.

 

DEVELOPMENTS IN INDIA
RELATING TO INTERNATIONAL TAX

 

(I) CBDT’s proposal for amendment of Rules
for Profit Attribution to Permanent Establishment

 

The CBDT vide its communication dated 18th
April, 2019 released a detailed, 86-page document containing a proposal for
amendment of the Rules for Profit Attribution to Permanent Establishment, for
public comments within 30 days of its publication. The CBDT Committee suggested
a ‘three-factor’ method to attribute profits, with equal weight to (a) sales,
(b) manpower, and (c) assets. The Committee justifies the three-factor approach
as a mix of both demand and supply side that allocates profits between the
jurisdictions where sales takes place and the jurisdictions where supply is
undertaken. The CBDT Committee has recommended far-reaching changes to the
current scheme of attribution of profits to permanent establishments.

 

The report outlines the formula for
calculating “profits attributable to operations in India”, giving weightage to
sales revenue, employees, wages paid and assets deployed.

 

The relevant portion of the ‘Report on
Profit Attribution to Permanent Establishments’ containing the
Committee’s conclusions and recommendations in paragraphs 179 to 200 is given
below for ready reference:

 

“Conclusions and
recommendations of the Committee

179.   After detailed analysis of the issues related to attribution of
profits, existing rules, their legal history, the economic and public policy
principles relevant to it, the international practices, views of academicians
and experts, relevant case laws and the methodology adopted by tax authorities
dealing with these issues, Committee concluded its observations, which are
summarised in following paragraphs.

 

11.1 Summary of Committee’s
observations and conclusions

 

180.   The business profits of a non-resident enterprise is subjected to
the income-tax in India only if it satisfies the threshold condition of having
a business connection in India, in which case, profits that are derived from
India from its various operations including production and sales are taxable in
India, either on the basis of the accounts of its business in India or where
they cannot be accurately derived from its accounts, by application of Rule 10,
which provides a wide discretion to the Assessing Officer. Where a tax treaty
entered by the Central government is applicable, its provisions also need to be
satisfied for such taxation. As per Article 7 of UN model tax convention (which
is usually followed in most Indian tax treaties, sometimes with variations),
only those profits of an enterprise can be subjected to tax in India which are
attributed to its PE in India, and would include profits that the PE would be
expected to make as a separate and independent entity. Under the force of
attraction rules, when applicable, it would include profits from sales of same
goods as those sold by the PE that are derived from India without participation
of PE. Profits attributable to PE can be computed either by a direct accounting
method provided in paragraph 2 or by an indirect apportionment method provided
in paragraph 4 of Article 7.

 

181.   An analysis of Article 7 and its legal history shows that there
are three standard versions. The Article 7 which exists in UN model tax
convention is similar to the Article 7 as it existed in the OECD model
convention prior to 2010, except that the UN model tax convention allows the
application of force of attraction rules and restricts deduction of certain
expenses payable to the head office by the PE. This Article in the OECD model
convention was revised in 2010. Under the revised article the profits
attributable to the PE are required to be determined taking into account the
functions, assets and risk, and the option of determining them by way of
apportionment has been excluded.

 

182.   One of the primary implications of the 2010 revision of Article 7
by OECD was that in cases where business profits could not be readily
determined on the basis of accounts, the same were required to be determined by
taking into account function, assets and risk, completely ignoring the sales
receipts derived from that tax jurisdiction. This amounts to a major deviation,
not only from the rules universally accepted till then, but also from the
generally applicable accounting standards for determining business profits,
where business profits cannot be determined without taking sales into account.

 

183.   Economic analysis of factors that affect and contribute to
business profits makes it apparent that profits are contributed by both demand
and supply of the goods. Accordingly, a jurisdiction that contributes to the
profits of an enterprise either by facilitating the demand for goods or
facilitating their supply would be reasonably justified in taxing such profits.
The dangers of double taxation of such profits can be eliminated by tax
treaties. If taxes collected facilitate economic growth in that jurisdiction,
the demand for goods rises, which in turn also benefits the tax-paying
enterprise, resulting in a virtuous cycle that benefits all stakeholders. On
the contrary, if the jurisdiction is unable to collect tax from the
non-resident suppliers, it would be forced to collect all the taxes required
from the domestic tax-payers, which in turn would reduce the ability of
consumers to pay, reduce their competitiveness, hurt economic growth and the
aggregate demand, resulting in a vicious cycle, which will adversely affect all
stakeholders, including the foreign enterprises doing business therein.

 

184.   Broadly, possible approaches for profit attribution can be summed
in three categories – (i) supply approach allocates profits exclusively to the
jurisdiction where supply chain and activities are located; (ii) demand
approach allocates profits exclusively to the market jurisdiction where sales
take place; (iii) mixed approach allocates profits partly to the jurisdiction
where the consumers are located and partly to the jurisdiction where supply
activities are undertaken.

185.   The mixed approach appears to have been most commonly adopted in
international practices, though in some cases demand approach has also been
favoured. In contrast, supply side does not appear to have been adopted
anywhere, except in the 2010 revision of Article 7 of the OECD model
convention, which requires determination of profits without taking sales into
account. As a consequence, the contribution of demand to profits is completely
ignored.

 

186.   A purview (sic) of academic literature and views suggests a
wide acceptance in theory that demand, as represented by sales, can be a valid
ground for attribution of profits. There also exists a diversity of views among
academicians and experts on the validity of the revised OECD approach for
profit attribution contained in the AOA. A number of international authors
disagree with it and many have been critical of this approach.

 

187.   The AOA approach can have significant adverse consequences for
developing economies like India, which are primarily importers of capital and
technology. It restricts the taxing rights of the jurisdiction that contributes
to business profits by facilitating demand, and thereby has the potential to
break the virtuous cycle of taxation that benefits all stakeholders. Instead,
it can set a vicious cycle in place that can harm all stakeholders.

 

188.   The lack of sufficient justification or rationale and its
potential adverse consequences fully justify India’s strongly-worded position
on revised Article 7 of OECD model convention, wherein India has not only found
it unacceptable for adoption in Indian tax treaties, but also rejected the
approach taken therein. This view of India, that since business profits are
dependent on sale revenues and costs, and since sale revenues depend on both
demand and supply, it is not appropriate to attribute profits exclusively on
the basis of function, assets and risks (FAR) alone, has been communicated and
shared with other countries consistently and on a regular basis.

 

189.   Since, the revised Article 7 of OECD model tax convention has not
been incorporated in any of the Indian tax treaties, the question of AOA being
applicable on Indian treaties or profit attributed therein cannot arise. For
the same reason, additional guidance issued by OECD with reference to AOA in
respect of the changes in Article 5 introduced by the Action 7 of the BEPS
project on Artificial Avoidance of PE Status, also does not have any relevance
to Indian tax treaties. This, however, means that India cannot depend on OECD
guidance and gives rise to a need for India to consider ways and means for
bringing greater clarity and objectivity in profit attribution under its tax
treaties and domestic laws, especially in consequence to the changes introduced
as a result of Action 7.

 

190.   An analysis of case laws indicates that the courts have upheld the
application of Rule 10 for attribution of profits under Indian tax treaties. In
several such cases, the right of India to attribute profits by apportionment,
as permissible under Indian tax treaties, has also been upheld by the courts.
The judicial authorities do not appear to have insisted on a universal and
consistent method. They have also upheld the wide discretion in the hands of
the Assessing Officer under Rule 10 of the Rules, but corrected or modified his
approach for the purpose of ensuring justice in particular cases. Thus, diverse
methods of attributing profits by apportionment under Rule 10 of the Rules are
in existence. In the view of the Committee, the lack of a universal rule can
give rise to tax uncertainty and unpredictability, as well as tax disputes.
Thus, there seems to be a case for providing a uniform rule for apportionment
of profits to bring in greater certainty and predictability among taxpayers and
avoid resultant tax litigation.

 

191.   A detailed analysis of methods adopted by tax authorities for
attributing profits in recent years also highlights similar diversity in the
methods adopted by assessing officers for attribution of profits, which
reaffirms the need to consider possible options that can be consistently
adopted as an objective method of profits attribution under Rule 10 of the
Rules, and bring greater clarity, predictability and objectivity in this
exercise. Any options considered for this purpose must be in accordance with
India’s official position and views and must address its concerns.

 

192.   Accordingly, the Committee considered some
options based on the mixed or balanced approach that allocates profits between
the jurisdiction where sales take place and the jurisdiction where supply is
undertaken. The Committee did not find the option of formulary apportionment
method apportioning consolidated global profits feasible, in view of the
practical constraints in obtaining information related to jurisdictions outside
India. Thus, the Committee considers that it may be preferable to adopt a
method that focuses on Indian operations primarily and derives profits applying
the global profitability, with necessary safeguards to prevent excessive
attribution on the one hand and protect the interests of Indian revenue on the
other.

 

193.   The Committee found the option of Fractional
Apportionment based on apportionment of profits derived from India permissible
under Indian tax treaties as well as Rule 10, and relatively feasible as it is
based largely on information related to Indian operations. Out of various
possible options of apportioning profits by a mixed approach, the Committee
found considerable merit in the three-factor method based on equal weight
accorded to sales (representing demand) and manpower and assets (representing
supply, including marketing activities).

 

194.   After taking into account the principle laid down by the Hon’ble
Supreme Court in the case of DIT vs. Morgan Stanley, and the need to avoid
double taxation of profits from Indian operations in the hands of a PE, which
is primarily brought into existence either by the presence of an Indian
subsidiary carrying on parts of an integrated business, whose profits are
separately taxed in its hands in India, the Committee found it justifiable that
the profits derived from Indian operations that have already been subjected to
tax in India in the hands of a subsidiary should be deducted from the
apportioned profits. The Committee observed that in a case where no sales takes
place in India, and the profits that can be apportioned to the supply
activities are already taxed in the hands of an Indian subsidiary, there may be
no further taxes payable by the enterprise.

 

195.   In this option, in order to ensure objectivity and certainty,
profits derived from India need to be defined objectively. The Committee considers
that the same can be arrived at by multiplying the revenue derived from India
with global operational profit margin [in order to avoid any doubt the global
operational profit margin is the EBITDA margin (earnings before interest,
taxes, depreciation and amortization) of a company]. However, the Committee
also noted the need to protect India’s revenue interests in cases where an
enterprise having global losses or a global profit margin of less than 2%,
continues with the Indian operations, which could be more profitable than its
operations elsewhere. In the view of the Committee, the continuation of Indian
operations justifies the presumption of higher profitability of Indian
operations, and in such cases a deeming provision that deems profits of Indian
operations at 2% of revenue or turnover derived from India should be
introduced.

 

196.   After taking into account the developments in taxation of digital
economy and the new Explanation 2A, inserted by the Finance Act, 2018,
explicitly including significant economic presence within the definition of
business connection, the Committee considered it necessary to take into account
the role and relevance of users in contributing to the business profits of
multi-dimensional business enterprises. Users can be a substitute to either
assets or employees and supplement their role in contributing to profits of the
enterprise.

 

197.   After considering various aspects of users’ contribution, the
Committee came to the conclusion that user data and activities contribute to
the profits of the multi-dimensional enterprises and there is a strong case of
taking them into account, per se, as a factor in apportionment of profits
derived from India by enterprises conducting business through multi-dimensional
business models where users are considered crucial to the business. The
Committee concluded that for such enterprises, users should also be taken into
account for the purpose of attribution of profits, as the fourth factor for
apportionment, in addition to the other three factors of sales, manpower and
assets.

 

198.   Although a recent amendment of the 2016 proposal for CCCTB has
proposed assigning a weight to the users that is equal to the other three
factors of sales, manpower and assets, the Committee found it preferable to assign
a relatively lower weight of 10% to users in low and medium user intensity
models and 20% in high user intensity models at this stage, with the
corresponding reduction in the weightage of employees and assets except for
sales being assigned 30% weight in apportionment in both the fact patterns.
Given the rapid expansion of digital economy and the ongoing developments
related to rules governing its taxation, it may be necessary to monitor the
role of users and their contribution to profits in future and accordingly
assess the need for considering a review of the weight assigned to users in
subsequent years.

 

11.2 Recommendations

 

199.   In view of the above, the Committee makes the following
recommendations:

 

(i)   Rule 10 may be amended to provide that in the case of an assessee
who is not a resident of India, has a business connection in India and derives
sales revenue from India by a business all the operations of which are not
carried out in India, the income from such business that is attributable to the
operations carried out in India and deemed to accrue or arise in India under
clause (i) of sub-section(1) of section 9 of the Act, shall be determined by
apportioning the profits derived from India by three equally weighted factors
of sales, employees (manpower and wages) and assets, as under:

 

Profits attributable to
operations in India =

‘Profits derived from
India’ (“Profits derived from India” = Revenue derived from India x Global
operational profit margin as referred in paragraph 159.) x [SI/3xST + (NI/6xNT)
+(WI/6xWT) + (AI/3xAT)]

 

Where,

SI = sales revenue derived
by Indian operations from sales in India

ST = total sales revenue
derived by Indian operations from sales in India and outside India

NI =number of employees
employed with respect to Indian operations and located in India

NT = total number of
employees employed with respect to Indian operations and located in India and
outside India

WI = wages paid to
employees employed with respect to Indian operations and located in India

WT = total wages paid to
employees employed with respect to Indian operations and located in India and
outside India

AI = assets deployed for
Indian operations and located in India

AT = total assets deployed
for Indian operations and located in India and outside India

 

(ii)  The amended rules should provide that ‘profits derived from Indian
operations’ will be the higher of the following amounts:

a. The amount arrived at by
multiplying the revenue derived from India x Global operational profit margin,
or

b. Two percent of the
revenue derived from India

 

(iii) The amended rules should provide an exception
for enterprises in case of which the business connection is primarily
constituted by the existence of users beyond the prescribed threshold, or in
case of which users in excess of such prescribed threshold exist in India. In
such cases, the income from such business that is attributable to the
operations carried out in India and deemed to accrue or arise in India under
clause (i) of sub-section (1) of section 9 of the Act, shall be determined by
apportioning the profits derived from India on the basis of four factors of
sales, employees (manpower and wages), assets and users. The users should be
assigned a weight of 10% in cases of low and medium user intensity, while each
of the other three factors should be assigned a weight of 30%, as under:

 

Profits attributable to
operations in India in cases of low and medium user intensity business models =

‘Profits derived from
India’ x [0.3 x SI/ST + (0.15 x NI/NT) + (0.15 x WI/WT) + (0.3 x AI/3xAT)] +
0.1]

In case of digital models
with high user intensity, the users should be assigned a weight of 20%, while
the share of assets and employees be reduced to 25% each after keeping the
weight of sales as 30% as under:

 

Profits attributable to
operations in India in cases of high user intensity business models =

‘Profits derived from
India’ x [0.3 x SI/ST + (0.125 x NI/NT) + (0.125 x WI/WT) + (0.25 AI/3xAT)] +
0.2]

 

(iv) The amended rules should also provide that where the business
connection of the enterprise in India is constituted by the activities of an
associate enterprise that is resident in India and the enterprise does not
receive any payments on accounts of sales or services from any person who is
resident in India (or such payments do not exceed an amount of Rs. 10,00,000)
and the activities of that associated enterprise have been fully remunerated by
the enterprise by an arm’s length price, no further profits will be
attributable to the operation of that enterprise in India.

 

(v) However, where the
business connection of the enterprise in India is constituted by the activities
of an associate enterprise that is resident in India and the payments received
by that enterprise on account of sales or services from persons resident in
India exceeds the amount of Rs. 10,00,000 then profits attributable to the
operation of that enterprise in India will be derived by apportionment using
the three factors or four factors as may be applicable in his case and
deducting from the same the profits that have already been subjected to tax in
the hands of the associated enterprise. For this purpose, the employees and
assets of the associated enterprise will be deemed to be employed or deployed
in the Indian operations and located in India.

 

200.   The Committee recommends the amendment of Rule
10 accordingly. The Committee also recommended that an alternative can be
amendment of the IT Act itself to incorporate a provision for profit
attribution to a PE.”


The Bombay Chartered Accountants’ Society has also given its comments and
suggestions in this regard. The final rules based on the public comments
received are awaited.

 

(II)    Finance Minister N. Sitharaman bats for
‘SEP’-based solution to vexed digitalisation issue at G-20 meet (Source:
Press Release of Ministry of Finance dated 9th June, 2019)

The Union Minister for Finance and Corporate
Affairs, Mrs. Nirmala Sitharaman, attended the G-20 Finance Ministers’ and
Central Bank Governors’ meeting and associated events and programmes on 8th
and 9th June, 2019 at Fukuoka, Japan. She was accompanied by Mr. Subhash C. Garg, Finance Secretary and Secretary,
Economic Affairs, Dr. Viral Acharya, Deputy Governor of the RBI, and other
officers.

 

Mrs. Sitharaman flagged serious issues
related to taxation and digital economy companies and to curb tax avoidance and
evasion. She highlighted the issue of economic offenders fleeing legal
jurisdictions and called for cohesive action against them.

 

The Finance Minister noted the urgency to fix
the issue of determining the right nexus and profit allocation solution for
taxing the profits made by digital economy companies. Appreciating the
significant progress made under the taxation agenda, including the Base Erosion
and Profit Shifting (BEPS), tax challenges from digital economy and exchange of
information under the aegis of G-20, she congratulated the Japanese Presidency
for successfully carrying these tasks forward.

 

She noted that the work on tax challenges
arising from the digitalisation of economy is entering a critical phase with an
update to the G-20 due next year. In this respect, Mrs. Sitharaman strongly
supported the potential solution based on the concept of ‘significant economic
presence’ of businesses taking into account the evidence of their purposeful
and sustained interaction with the economy of a country. This concept has
been piloted by India and supported by a large number of countries, including
the G-24. She expressed confidence that a consensus-based global solution,
which should also be equitable and simple, would be reached by 2020.

 

Welcoming the commencement of automatic
exchange of financial account information (AEOI) on a global basis with almost
90 jurisdictions successfully exchanging information in 2018, the Finance
Minister said this would ensure that tax evaders could no longer hide their
offshore financial accounts from the tax administration. She urged the G-20 /
Global Forum to further expand the network of automatic exchanges by
identifying jurisdictions, including developing countries and financial centres
that are relevant but have not yet committed to any timeline. Appropriate
action needs to be taken against non-compliant jurisdictions. In this respect,
she called upon the international community to agree on a toolkit of defensive
measures which can be taken against such non-compliant jurisdictions.

 

Earlier, she participated in the Ministerial
Symposium on International Taxation and spoke in the session on the ongoing
global efforts to counter tax avoidance and evasion. During the session, she
also dwelt on the tax challenges for addressing digitalisation of the economy
and emphasised that nexus was important. Mrs. Sitharaman also raised the need
for international co-operation on dealing with fugitive economic offenders who
flee their countries to escape from the consequences of law. She also
highlighted the fugitive economic offenders’ law passed by India which provides
for denial of access to courts until the fugitive returns to the country. This
law also provides for confiscation of their properties and selling them off.

 

She drew attention to the practice permitted
by many jurisdictions which allow economic offenders to use investment-based
schemes to obtain residence or citizenship to escape from legal consequences
and underlined the need to deal with such practices. She urged that closer
collaboration and coordinated action were required to bring such economic
offenders to face the law.

 

India’s Finance Minister highlighted the need
for the G-20 to keep a close watch on global current account imbalances to
ensure that they do not result in excessive global volatility and tensions. The
global imbalances had a detrimental effect on the growth of emerging markets.
Unilateral actions taken by some advanced economies adversely affect the
exports and the inward flow of investments in these economies. She wondered if
the accumulation of cash reserves by large companies indicated the reluctance
of these companies to increase investments. This reluctance could have adverse
implications on growth and investments and possibly leading to concentration of
market power. She also urged the G-20 to remain cognizant of fluctuations in
the international oil market and study measures that can bring benefits to both
the oil-exporting and importing countries.

In a session on infrastructure investment,
Mrs. Sitharaman emphasised on the importance of making investments in
cost-effective and disaster resilient infrastructure for growth and
development. She suggested the G-20 focus on identifying constraints to flow of
resources into the infrastructure sector in the developing world and solutions
for overcoming them. She also took note of the close collaboration of India,
Japan and other like-minded countries, aligned with the Sendai Framework, in
developing a roadmap to create a global Coalition on Disaster Resilient
Infrastructure.

 

The Japanese Presidency’s priority issue of
ageing was also discussed. Mrs. Sitharaman highlighted that closer
collaboration between countries with a high old-age dependency ratio and those
with a low old-age dependency ratio was necessary for dealing with the policy
challenges posed by ageing. She suggested that if ageing countries with
shrinking labour force allow calibrated mobility of labour with portable social
security benefits, the recipient countries can not only take care of the aged
but also have a positive effect on global growth. She said that India’s
demography presented a dual policy challenge since India’s old-age dependency
ratio is less than that of Japan, while at the same time India’s aged
population in absolute numbers exceeds that of Japan. She detailed the policy
measures that the Government of India is taking to address these challenges.

 

While speaking on the priority of Japanese
Presidency on financing of universal health coverage (UHC), she emphasised the
importance of a holistic approach which encompasses the plurality of pathways
to achieve UHC, including through traditional and complementary systems of
medicine.

 

(III) Ratification of the
Multilateral Convention to Implement Tax Treaty-Related Measures to Prevent
Base Erosion and Profit Sharing (Source: Press Release of the Ministry of
Finance dated 12th June, 2019)

 

Text of the Press Release
of the Ministry of Finance dated 12th June, 2019:

 

“Ratification of the
Multilateral Convention to Implement Tax Treaty-Related Measures to Prevent
Base Erosion and Profit Shifting.

 

The Union Cabinet, chaired
by the Prime Minister, Mr. Narendra Modi, has approved the ratification of
the Multilateral Convention to Implement Tax Treaty-Related Measures to
Prevent Base Erosion and Profit Shifting (MLI).

 

IMPACT

The Convention will modify India’s treaties
in order to curb revenue loss through treaty abuse and base erosion and profit
shifting strategies by ensuring that profits are taxed where substantive
economic activities generating the profits are carried out and where value is
created.

 

DETAILS

i. India has ratified the
Multilateral Convention to Implement Tax Treaty-Related Measures to Prevent
Base Erosion and Profit Shifting, which was signed by the Hon’ble Finance
Minister, Mr. Arun Jaitley, at Paris on 7th June, 2017 on behalf of
India;

ii.   The Multilateral Convention is an outcome of the OECD / G-20
Project to tackle Base Erosion and Profit Shifting (the “BEPS
Project”) i.e., tax planning strategies that exploit gaps and mismatches
in tax rules to artificially shift profits to low or no-tax locations where
there is little or no economic activity, resulting in little or no tax being
paid. The BEPS Project identified 15 actions to address base erosion and profit
shifting (BEPS) in a comprehensive manner;

iii.  India was part of the ad hoc group of more than 100 countries
and jurisdictions from G-20, OECD, BEPS associates and other interested
countries which worked on an equal footing on the finalisation of the text of
the Multilateral Convention, starting May, 2015. The text of the Convention and
the accompanying Explanatory Statement was adopted by the ad hoc Group on 24th
November, 2016;

iv.  The Convention enables all
signatories, inter alia, to meet treaty-related minimum
standards that were agreed as part of the final BEPS package, including the
minimum standard for the prevention of treaty abuse under Action 6;

v. The Convention will
operate to modify tax treaties between two or more parties to the Convention. It
will not function in the same way as an amending protocol to a single existing
treaty, which would directly amend the text of the Covered Tax Agreement. Instead,
it will be applied alongside existing tax treaties, modifying their application
in order to implement the BEPS measures;

vi.  The Convention will modify India’s treaties in order to curb
revenue loss through treaty abuse and base erosion and profit shifting
strategies by ensuring that profits are taxed where substantive economic
activities generating the profits are carried out and where value is created.

BACKGROUND

The Convention is one of
the outcomes of the OECD / G-20 project, of which India is a member, to tackle
base erosion and profit shifting. The Convention enables countries to implement
the tax treaty-related changes to achieve anti-abuse BEPS outcomes through the
multilateral route without the need to bilaterally re-negotiate each such
agreement which is burdensome and time-consuming. It ensures consistency and
certainty in the implementation of the BEPS Project in a multilateral context.
Ratification of the multilateral Convention will enable application of BEPS
outcomes through modification of existing tax treaties of India in a swift
manner.

 

The Cabinet Note seeking
ratification of the MLI was sent to the Cabinet on 16th April, 2019
for consideration. Since the said Note for Cabinet could not be taken up in the
Cabinet due to urgency, the Hon’ble Prime Minister, vide Cabinet Secretariat
I.D. No. 216/1/2/2019-Cab dated 27.05.2019 has approved ratification of MLI and
India’s final position under Rule 12 of the Government of India (Transaction of
Business) Rules, 1961 with a direction that ex-post facto approval
of the Cabinet be obtained within a month. Consequent to approval under Rule
12, a separate request has already been sent to the L&T Division, MEA, for
obtaining the instrument of ratification from the Hon’ble President of India
vide this office OM F.No. 500/71/2015-FTD-I/150 dated 31/05/2019.”

 

In Part II of the Article, we will cover
various developments at the OECD relating to International Taxation. We sincerely
hope that the reader would find the above developments to be interesting and
useful. 

 


 

LESSEE’S LEASE OBLIGATION – BORROWINGS VS. FINANCIAL LIABILITY

ISSUE

Ind AS 17 Leases required lessees to
classify leases as either finance leases or operating leases, based on certain
principles, and to account for these two types of leases differently. The asset
and liability arising from finance leases was required to be recognised in the
balance sheet, but operating leases could remain off-balance sheet.

 

Information reported about operating leases
lacked transparency and did not meet the needs of users of financial
statements. Many users adjusted a lessee’s financial statements to capitalise
operating leases because, in their view, the financing and assets provided by
leases should be reflected on the balance sheet. Some tried to estimate the
present value of future lease payments. However, because of the limited
information that was available, many used techniques such as multiplying the
annual lease expense by eight to estimate, for example, total leverage and the
capital employed in operations. Other users were unable to adjust and so they
relied on data sources such as data aggregators when screening potential
investments or making investment decisions. These different approaches created
information asymmetry in the market.

 

The existence of two different accounting
models for leases, in which assets and liabilities associated with leases were
not recognised for operating leases but were recognised for finance leases,
meant that transactions that were economically similar could be accounted for
very differently. The differences reduced comparability for users of financial
statements and provided opportunities to structure transactions to achieve an
accounting outcome.

 

To bridge the problems discussed above, IFRS
16 Leases was issued. Correspondingly, in India the Ministry of
Corporate Affairs issued Ind AS 116 – ‘Leases’, which is notified and
effective from 1st April, 2019 and replaces Ind AS 17. Ind AS 116 requires
lessees to recognise a liability to make lease payments and a corresponding
asset representing the right to use the underlying asset during the lease term
for all leases, except for short-term leases and leases of low-value assets, if
the lessee chooses to apply such exemptions. For lessees, this means that more
liabilities and assets are recognised if they have leases, compared to the
earlier standard, Ind AS 17.

 

Ind AS 116 requires lease liabilities to be
disclosed separately from other liabilities either in the balance sheet or in
the notes to accounts. However, Indian companies are also required to comply
with the presentation and disclosure requirements of division II – Ind AS
Schedule III to the Companies Act, 2013 (Ind AS-compliant Schedule III). As per
the Schedule III format, under financial liabilities – borrowings are required
to be presented separately. Borrowings need to be further bifurcated and
presented in the notes to accounts as follows:

 

Borrowings shall be classified as: (a) Bonds
or debentures; (b) Term loans (i) from banks or (ii) from other parties; (c)
Deferred payment liabilities; (d) Deposits; (e) Loans from related parties; (f)
Long-term maturities of finance lease obligations; (g) Liability
component of compound financial instruments; (h) Other loans (specify nature).

 

Neither Schedule III nor the guidance note
on Schedule III issued by the Institute of Chartered Accountants of India has
been revised to take cognisance of the change in the lease accounting (due to
introduction of Ind AS 116), under which there is no classification as finance
leases or operating leases for lessees. On implementation of Ind AS 116 w.e.f.
1st April, 2019 lessees will not bifurcate leases into finance leases and
operating leases and all leases will be capitalised (subject to a few
exemptions). To comply with the disclosure requirement mentioned in the
preceding paragraph, there is confusion whether (a) all lease liabilities
should be classified as borrowings; or (b) all lease liabilities should be
shown as financial liabilities because the requirement to disclose finance
lease obligation as borrowings by lessees no longer applies (the lessee does
not distinguish between operating and finance lease); or (c) for purposes of
disclosure only, the lessee distinguishes the lease as finance and operating
and discloses the finance lease obligations as borrowings and operating leases
as financial liabilities.

 

If lease obligations are presented as
borrowings in the financial statements, it will negatively impact debt
covenants, the debt-equity ratio, and will have other significant adverse
consequences for lessees. It may be noted that globally, under IFRS, companies
will not be subjected to such adverse consequences because they do not have to
comply with Schedule III or an equivalent requirement.

 

In summary, the following questions emerge:

 

1. On application of Ind AS 116, whether
lessee would disclose the entire lease obligation in its financial statements
under financial liabilities or borrowings?

2. Though not required under Ind AS 116,
whether lessees need to bifurcate all leases into finance lease and operating
lease only for the limited purpose of complying with the disclosure requirements
of Ind AS-compliant Schedule III?

 

RESPONSE

The following three views are theoretically
possible:

 

OPTIONS AND RATIONALES

 

Options

Rationale

Option 1 –

Present entire lease
obligation under financial liabilities as separate line item either on the
face of balance sheet or in the notes to accounts

Ind AS 1 deals with the presentation of financial
statements and it does not require borrowings to be presented as a minimum
line item on the face of the balance sheet. As per para 54(m) – Financial
liabilities [excluding amounts shown under 54 (k) – Trade and other payable
and 54 (l) – provisions] need to be presented as minimum line item on the
face of the balance sheet.

 

Accordingly, in the absence of
Schedule III, borrowings would have been presented as financial liabilities
in the financial statements. Under IFRS, this is indeed the case and there is
no requirement to show borrowings separately from financial liabilities;

 

Ind AS 116 requires lease liabilities to be disclosed
separately from other liabilities either in the balance sheet or in the notes
to accounts. It does not require such financial liabilities to be termed as
borrowings;

 

Schedule III requires finance lease obligation to be
disclosed under borrowings. However, under Ind AS 116, there is no finance
lease classification for lessees and all leases are capitalised, subject to
some exemptions. Since there is no finance lease obligation under Ind AS 116,
nothing is required to be presented as borrowings;

 

Further, Schedule III states the following which may
be used as the basis to present it separately from borrowings:

 

“Line items, sub-line items and sub-totals shall be
presented as an addition or substitution on the face of the Financial
Statements when such presentation is relevant to an understanding of the
company’s financial position or performance, or to cater to industry or
sector-specific disclosure requirements, or when required for compliance with
the amendments to the Companies Act, 2013, or under the Indian Accounting
Standards.”

 

It may be noted that Option 1 is completely in
compliance with the accounting standards.

Option 2 –

Present entire lease obligation as borrowings

As Ind AS 116 does not require bifurcation of leases
into finance and operating and requires all leases (other than short-term and
low-value leases) to be capitalised, the entire lease liabilities need to be
disclosed in borrowings to comply with the spirit of Ind AS-compliant
Schedule III requirements;

 

Further, this will also eliminate the difference
between the two categories of companies, i.e., Borrow to buy vs. Leasing the
assets.

Option 3 –

Bifurcate leases into finance and operating and
disclose only finance lease obligations as borrowings. Operating leases will
be presented as financial liabilities

Though Ind AS does not require bifurcation but to
comply with the Schedule III one may need to do such bifurcation;

 

Accordingly, disclose finance lease obligations as
borrowings and operating lease obligations as financial liabilities.

 

 

 

CONCLUSION AND THE WAY FORWARD

The author does not believe that Option 3
is appropriate, because it is not so intended under the Standard or Schedule
III. Additionally, this issue has arisen because Schedule III is not amended
post -Ind AS 116, to either eliminate the requirement to disclose finance lease
obligations as borrowings, or alternatively to require all lease obligations
(other than low-value and short-term leases) to be disclosed as borrowings.

 

Between Option 1 and 2, MCA
needs to make its position clear, either through a separate notification or by
amending Schedule III. In the absence of that, an ITFG clarification will be
necessary to ensure consistency in the financial reporting.  

 

Section 28 (i) – Business income vs. income from house property – Income received from leasing out of shops and other commercial establishments – Also received common amenities charges, maintenance charges, advertisement charges – Held to be assessable as business income

12 Pr. CIT-6 vs. Krome Planet
Interiors Pvt. Ltd. [Income-tax appeal No. 282 of 2017; dated 15th
April, 2019 (Bombay High Court)]

 

[Krome Planet Interiors Pvt. Ltd. vs. ACIT; A.Y.:
2008-09; Mum. ITAT]

 

Section 28 (i) – Business income vs. income from house
property – Income received from leasing out of shops and other commercial
establishments – Also received common amenities charges, maintenance charges,
advertisement charges – Held to be assessable as business income

 

The
assessee is a private limited company engaged in the business of leasing out
shop space in shopping malls. The assessee had filed his return for the A.Y.
2008-2009 declaring the income received from such activity of leasing out of
shops and other commercial establishments to various persons as business
income. In addition to rental income, the assessee had also received certain
charges from the licensees such as common amenities charges, maintenance
charges and advertisement charges.

 

However,
the assessing officer (AO) held that the income was from house property and not
business income.

 

The
issue eventually reached the Tribunal. The Tribunal, by the impugned judgement
held that the income was business income. It noted that the assessee had
entered into a leave and license agreement with the licensee which shows that
the building was constructed for the purpose of a shopping mall with the
approval of the Pune Municipal Corporation. The assessee was providing various
facilities and amenities apart from giving shopping space on lease. The
agreement contained the list of facilities to be provided by the assessee. The
charges for the facilities and utilisation were included in the license fees
charge for leasing the shop space. The additional charges towards the costs of
electricity consumed would be payable by the licensees. The period of license
was 60 months. The Tribunal also noted that no space in the shopping mall was
given on rent simplicitor. The Tribunal, therefore, held that the object of the
assessee to exploit the building as a business is established. The assessee had
also taken a loan facility from a bank for the shopping mall project.

 

Being
aggrieved with the ITAT order, the Revenue filed an appeal to the High Court.
The Court held that the assessee had obtained a loan from a bank for its mall
complex project; that the assessee had entered into leave and license
agreements with individuals for letting out commercial space; a majority of the
licenses were for 60 months; in addition to providing such commercial space on
lease, the assessee also provided a range of common amenities, a list of which
is reproduced earlier. These facilities included installation of elevators,
installation of a fire hydrant & sprinkler system, installation of central
garbage collection and disposal system, installation of common dining
arrangement for occupants and the staff, common water purifier and dispensing
system, lighting arrangement for common areas, etc.

 

Thus,
in plain terms, the assessee did not simply rent out a commercial space without
any additional responsibilities. He executed leave and license agreements and also
provided a range of common facilities and amenities upon which the occupiers
could run their business from the leased out premises. The charges for such
amenities were also broken down in two parts. Charges for several common
amenities were included in the rentals. Only on a consumption-based amenity,
such as electricity, would the occupant be charged separately. All factors thus
clearly indicate that the assessee desired to enter into a business of renting
out commercial space to interested individuals and business houses.

 

The Revenue, however, strongly relied on
the decision of the Supreme Court in the case of Raj Dadarkar &
Associates vs. Assistant Commissioner of Income-tax, reported in (2017) 81
taxmann.com 193. It was, however, a case in which on facts
the Supreme Court held that the assessee was not engaged in systematic activity
of providing service to occupiers of the shops so as to constitute the receipt
as business income. In the result, the Revenue appeal was dismissed.

Section 80-IB(11A) – Profits derived from the business of the industrial undertaking – Subsidies – Eligible for deduction u/s. 80-IB – Liberty India 317 ITR 218 (SC) is distinguishable on facts

11 Pioneer Foods & Agro
Industries vs. ITO-18(3)(4) [ITA No. 142 of 2017; dated 22nd April,
2019 (Bombay High Court)]

 

[Pioneer Foods & Agro Industries vs. ITO-18(3)(4);
dated 20th July, 2016; A.Y.: 2009-10; ITA No. 6088 &
6089/Mum/2013, Mum. ITAT]

Section 80-IB(11A) – Profits derived from the business
of the industrial undertaking – Subsidies – Eligible for deduction u/s. 80-IB –
Liberty India 317 ITR 218 (SC) is distinguishable on facts

 

The assessee is a partnership firm engaged in the business
of manufacturing and exporting honey. The assessee had filed return of income
for the A.Y. 2009-10. In relation to the export of the said product, the
assessee had claimed deduction u/s. 80IB(11A) of the Act in relation to benefit
received by the assessee for the export under the Vishesh Krishi and Gram Udyog
Yojana (“VKGUY” for short).

 

The AO having disallowed the claim, the issue eventually
reached the Tribunal. The Tribunal, by the impugned judgement, upheld the
addition. On appeal before the High Court, the assessee had confined its
grievance in relation to the benefits received under the VKGUY scheme.

 

The
assessee submitted that the Supreme Court in the case of CIT vs.
Meghalaya Steels Ltd. [2016] 383 ITR 217 (SC) had an occasion to
examine a case where the assessee was engaged in the business of manufacture of
steel and ferro silicon and had claimed similar subsidies. The assessee had
claimed deduction u/s. 80IB(4) of the Act in relation to such subsidies. The AO
had disallowed the claim. The issue reached the Supreme Court.

 

The
Supreme Court noted the speech of the Finance Minister while presenting the
budget for the assessment year 1999-2000 in relation to the Government of
India’s Industrial Development Policy for the North-Eastern region. It also
noted the distinction between the expressions “attributable to” and “derived
from” as discussed in various earlier judgements. The Supreme Court
distinguished the judgement in the case of Liberty India (supra),
observing that in the said case the Court was concerned with the export
incentive which is far remote from the activity of export. The profit,
therefore, cannot be said to have been derived from such activity. In the
opinion of the Court, the case on hand was one where the transport and interest
subsidy had a direct nexus with the manufacturing activity inasmuch as these
subsidies go to reduce the cost of production.

 

In the present case, the Court observed that the objective
of the VKGUY scheme was to promote the export of agricultural produce and their
value-added products, minor forest produce and their value-added variants, gram
udyog products, forest-based products and other produces as may be notified. In
relation to the exports of such products, benefits in the form of incentives
would be granted at the prescribed rate. The objective behind granting such
benefits was to compensate the high transport cost and to offset other
disadvantages. In order to make the export of such products viable, the
Government of India decided to grant certain incentives under the said scheme.
Clearly, thus, the case was covered by the decision of the Supreme Court in the
case of Meghalaya Steels Ltd. (supra). This was not a case akin
to export incentives such as DEPB which the Supreme Court in the case of Liberty
India (supra) held was a benefit far remote from the assessee’s
business of export. In the result, the assessee’s appeal was allowed.

 

Section 54F – Capital gains – Investment in residential house – Flat was owned by a co-operative housing society on a piece of land which was granted under a long-term lease – Eligible for deduction

10  Pr. CIT-23 vs. Jaya Uday Tuljapurkar [Income tax appeal No. 53 of 2017;
dated 22nd April, 2019 (Bombay High Court)]

 [ACIT vs. Jaya Uday Tuljapurkar; dated 28th September,
2015; Mum. ITAT]

 

Section 54F – Capital gains – Investment in
residential house – Flat was owned by a co-operative housing society on a piece
of land which was granted under a long-term lease – Eligible for deduction

 

The
assessee, an individual, was a joint owner of a residential property in the
nature of a flat. He had received the said property under a Will dated 15th
October, 2006 made by his father. The flat complex was owned by a co-operative
housing society on a piece of land which was granted under a long-term lease.
The father of the assessee was a member of the said society and owned the flat.
After his death, the assessee received half a share, the other half going to
his mother. These co-owners sold the flat under a registered deed dated 18th
July, 2008 for a sale consideration of Rs. 23 crores. The assessee, after
the sale of the flat, invested a part of the sale consideration of Rs. 2.89
crores in the purchase of a new residential unit. In his return of income filed
for the A.Y. 2009-2010, he had shown the sale consideration of Rs. 11.50 crores
which was his share of the sale proceeds by way of capital gain. He claimed the
benefit of cost indexation and also claimed exemption of the sum of Rs. 2.89
crores while computing his capital gain tax liability in terms of section 54 of
the Act.

 

The
assessing officer (AO) rejected his claim on the ground that the assessee had
not transferred the building and the land appurtenant thereto. In the opinion
of the AO, since this was a pre-condition for application of section 54 of the
Act, the assessee was not entitled to the benefit of exemption as per the said
provision.

 

On appeal to the CIT(A) it was held that the fact that the
residential building in which the flat was situated was constructed on a leased
land, would not change the nature of transaction. He accepted the assessee’s
contention that as per the provisions of the Maharashtra Ownership Flats
(Regulation of the Promotion of Construction, Sale, Management and Transfer)
Act, 1963, the assessee would be the owner of the flat in law. The Commissioner
(A) also held that for applicability of section 54, the assessee had to sell a
capital asset in the nature of building or land appurtenant thereto. The word
‘or’ cannot be read as ‘and’ in the context of the said provision.

 

The Revenue carried the matter in appeal before the
Tribunal. The Tribunal dismissed the Revenue’s appeal, upon which the appeal
was filed before the Hon’ble High Court.

The
Revenue submitted that for availing benefit of section 54 of the Act, the
assessee has to sell a capital asset in the nature of building and land
appurtenant thereto. In the present case, the complex was situated on land
which itself was granted on lease. The co-operative housing society was not the
owner of the land. Therefore, what the assessee had transferred under a
registered sale deed was a mere building and not the land appurtenant thereto.
In support of his contention that in the context of section 54 of the Act the
word ‘or’ should be read as ‘and’, the Revenue relied on the commentaries of
certain renowned authorities on income-tax law.

 

The
Court held that the facts noted above were not in dispute. The father of the
assessee was allotted a flat in a residential complex in a co-operative housing
society. The complex was constructed on land which was not owned by the society
but was being enjoyed on long-term lease. According to the Revenue, the sale of
a flat in such a society and investing any sale proceeds for acquisition of a
new residential unit would not satisfy the requirements of section 54 of the
Act. Firstly, there is no such prescription u/s. 54(1) of the Act. Secondly,
such a rigid interpretation would disallow every claim in case of transfer of a
residential unit in a co-operative housing society.

 

The
very concept of such a society is that the society is the owner of the land and
continues to be so irrespective of the coming and going of members. A member of
such a society has a possessory right over the plot of land which is allotted
to him. In case of a constructed building of a co-operative housing society,
the member owns the constructed property and along with other members enjoys
the possessory rights over the land on which the building is situated. In
either case, a member of the society, even when he sells his house, never
transfers the title in land to the purchaser. The present case is no different.
Merely because the housing complex in the present case is situated on a piece
of land which is occupied by the co-operative housing society under a long-term
lease, would make no difference. In the result, the Department appeal was
dismissed.

 

Section 80-IA(2A) of ITA, 1961 – Telecommunication services – Deduction u/s. 80-IA(2A) – Scope – Payment by third parties for availing of telecommunication services of assessee – Late fees and reimbursement of cheque dishonour charges received from such third parties – Income eligible for deduction u/s. 80-IA(2A)

30  Principal CIT vs. Vodafone Mobile Services Ltd.; 414 ITR 276 (Del) Date of order: 3rd
December, 2018 A.Y.: 2008-09

 

Section 80-IA(2A) of ITA, 1961 – Telecommunication
services – Deduction u/s. 80-IA(2A) – Scope – Payment by third parties for
availing of telecommunication services of assessee – Late fees and
reimbursement of cheque dishonour charges received from such third parties –
Income eligible for deduction u/s. 80-IA(2A)

 

The
assessee was engaged in the business of providing telecommunication services.
For the A.Y. 2008-09, the AO denied the benefit of section 80-IA(2A) of the
Income-tax Act, 1961 on the profits and gains earned by the assessee from
sharing of infrastructure facilities in the form of cell-sites and fibre cable
with other companies or undertakings engaged in “telecommunication services”.
This, he held, would amount to leasing of the assets to third parties and
income from the leasing would not be income derived from “telecommunication
services”. The assessee had also paid bank charges as cheques issued by some of
the customers had been dishonoured. These charges were also levied to the
customers but the entire amount could not be recovered. The AO held that late
payment charges or cheque dishonour charges were in the nature of penalty and
not income derived from telecommunication business and hence not eligible for
deduction u/s. 80-IA(2A).

 

The
Commissioner (Appeals) and the Tribunal allowed the claims.

 

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

 

“i)   The finding of
the Assessing Officer that income from sharing fibre cables and cell-sites was
income by way of leasing and hence not includible in revenue earned for
computing profits from ‘telecommunication service’ was far-fetched and
misconceived. The assets, i.e., cell-sites and fibre cables, were not
transferred. Third parties wanting to avail of the spare capacity were only allowed
usage of the facilities for consideration. Payments so made by the third
parties were to avail of and use the telecommunication infrastructure. They
would qualify as payments received for availing of ‘telecommunication
services’. The income from sharing of fibre cables and cell-sites qualified for
deduction u/s. 80-IA(2A).

 

ii)   The Tribunal was also justified in upholding
the reasoning and order of the Commissioner (Appeals) on cheque dishonour and
late payment charges.”

Sections 147, 148,159 and 292B of ITA, 1961 – Reassessment – Valid notice – Notice issued in name of dead person – Effect of sections 159 and 292B – Objection to notice by legal representative – Notice not valid

29  Chandreshbhai Jayantibhai Patel vs. ITO.; 413 ITR 276 (Guj) Date of order: 10th
December, 2018 A.Y.: 2011-12

 

Sections 147, 148,159 and 292B of ITA, 1961 –
Reassessment – Valid notice – Notice issued in name of dead person – Effect of
sections 159 and 292B – Objection to notice by legal representative – Notice
not valid

 

The
petitioner is the son of the late Mr. Jayantibhai Harilal Patel who passed away
on 24th June, 2015. The AO issued notice u/s. 148 of the Income-tax
Act, 1961 dated 28th March, 2018 in the name of the deceased for
reopening the assessment for the A.Y. 2011-12. In response to the said notice,
the petitioner vide communication dated 27th April, 2018 objected to the
initiation of reassessment proceedings and informed that his father had passed
away on 24th June, 2015 and urged the AO to drop the reassessment
proceedings. The petitioner maintained the objections in the subsequent
proceedings. By an order dated 14th August, 2018, the AO rejected
the objections and held that in the absence of knowledge about the death of the
petitioner’s father, it cannot be said that the notice of reassessment is bad
in law and that the reassessment proceedings may be carried out in the name of
the legal heirs of the late father of the petitioner. Being aggrieved, the petitioner
filed a writ petition before the High Court and challenged the order.

 

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

 

“i)   A notice u/s. 148 is a jurisdictional notice
and existence of a valid notice u/s. 148 is a condition precedent for exercise
of jurisdiction by the Assessing Officer to assess or reassess u/s. 147.

 

ii)   Clause (b) of sub-section (2) of section 159
of the Act provides that any proceeding which could have been taken against the
deceased if he had survived may be taken against the legal representative.
Section 292B, inter alia, provides that no notice issued in pursuance of
any of the provisions of the Act shall be invalid or shall be deemed to be
invalid merely by reason of any mistake, defect or omission in such notice if
such notice, summons is in substance and effect in conformity with or according
to the intent and purpose of the Act.

 

iii)   A notice issued u/s. 148 of the Act against a
dead person is invalid, unless the legal representative submits to the jurisdiction
of the Assessing Officer without raising any objection. Therefore, where the
legal representative does not waive his right to a notice u/s. 148, it cannot
be said that the notice issued against the dead person is in conformity with or
according to the intent and purpose of the Act which requires issuance of
notice to the assessee, whereupon the Assessing Officer assumes jurisdiction
u/s. 147 of the Act and consequently, the provisions of section 292B of the Act
would not be attracted.

 

iv)  The case fell within the ambit of section
159(2)(b) of the Act. The notice u/s. 148, which was a jurisdictional notice,
had been issued to a dead person. Upon receipt of such notice, the legal
representative had raised an objection to the validity of such notice and had
not complied with it. The legal representative not having waived the
requirement of notice u/s. 148 and not having submitted to the jurisdiction of
the Assessing Officer pursuant to the notice, the provisions of section 292B of
the Act would not be attracted and hence, the notice u/s. 148 of the Act had to
be treated as invalid.”

Section 115JB of ITA, 1961 – MAT (Banking Companies – Provisions of section 115JB as it stood prior to its amendment by virtue of Finance Act, 2012 would not be applicable to a banking company governed by provisions of Banking Regulation Act, 1949

28  CIT vs. Union Bank of India; [2019] 105 taxmann.com 253 (Bom) Date of order: 16th
April, 2019 A.Y.: 2005-06

 

Section 115JB of ITA, 1961 – MAT
(Banking Companies – Provisions of section 115JB as it stood prior to its
amendment by virtue of Finance Act, 2012 would not be applicable to a banking
company governed by provisions of Banking Regulation Act, 1949

 

The
assessee bank filed its return for the A.Y. 2005-06 declaring certain taxable
income. The AO completed assessment u/s. 143(3) of the Income-tax Act, 1961. He
also computed the book profits u/s. 115JB for determining the assessee’s tax
liability.

 

The
Tribunal held that the provisions of section 115JB were not applicable to the
assessee bank.

 

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

 

“i)   The question
that calls for consideration is whether the machinery provision provided under
sub-section (2) of section 115JB is workable when it comes to the banking
companies and such other special companies governed by the respective Acts. In
this context, the question would also be of the legislative intent to cover
such companies within the sweep of section 115JB of the Act. These questions
arise because of the language used in sub-section (2) of section 115JB. As per
sub-section (2) of section 115JB, every assessee being a company would for the
purposes of the said section prepare its profit and loss account for the
relevant previous year in accordance with the provisions of Parts II and III of
Schedule VI of the Companies Act, 1956. It is undisputed that the assessee a
banking company is not required to prepare its accounts in accordance with the
provisions of Parts II and III of Schedule VI of the Companies Act, 1956. The
accounts of the banking company are prepared as per the provisions contained in
the Banking Regulation Act, 1949. The Department may still argue that
irrespective of such requirements, for the purposes of the said Act and special
requirements of section 115JB, a banking company is obliged to prepare its
profit and loss account as per the provisions of the Companies Act, as mandated
by sub-section (2) of section 115JB of the Act. The assessee’s contention would
be that such legislative mandate is not permissible.

 

ii)   This legal dichotomy emerging from the
provisions of sub-section (2) of section 115JB particularly having regard to
the first proviso contained therein in case of a banking company, would
convince the Court that machinery provision provided in sub-section (2) of
section 115JB of the Act would be rendered wholly unworkable in such a
situation.

 

iii)   For the completeness of the discussion, one
may note that section 211 of the Companies Act, 1956 pertains to form of
contents of balance sheet and profit and loss account, sub-section (1) of
section 211 provided that every balance sheet of a company shall give true and
fair view on the state of affairs of the company at the end of the financial
year and would be subject to the provisions of the said section and be in the
form set out in the Forms 1 and 2 of schedule VI. This sub-section contained a
proviso providing that nothing contained in said sub-section would apply to a
banking company or any company engaged in generation or supply of electricity
or to any other class of company for which a form of balance sheet shall be
specified in or under the Act governing such company. Thus, Companies Act, 1956
excluded the insurance or banking companies, companies engaged in generation or
supply of electricity or companies for which balance sheet was specified in the
governing Act, from the purview of sub-section (1) of section 211 of the
Companies Act, 1956 and as a consequence from the purview of section 115JB of
the Act.

iv)  There are certain significant legislative
changes made by the Finance Act, 2012 which must be noted before concluding
this issue. It can be seen that sub-section (2) of section 115JB has now been
bifurcated into two parts covered in the clauses (a) and (b). Clause (a) would
cover all companies other than those referred to in clause (b). Such companies
would prepare the statement of profit and loss in accordance to the provisions
of schedule III of the Companies Act, 2013 (which has now replaced the old Companies
Act, 1956). Clause (b) refers to a company to which second proviso to
sub-section (1) of section 129 of the Companies Act, 2013 is applicable. Such
companies, for the purpose of section 115JB, would prepare the statement of
profit and loss in accordance with the provisions of the Act governing the
company. Section 129 of the Companies Act, 2013 pertains to financial
statement. Under sub-section (1) of section 129 it is provided that the
financial statement shall give a true and fair view of the state of affairs of
the company, comply with the accounting standard notified under section 113 and
shall be in the form as may be provided for different classes of companies.

 

v)   Second proviso
to sub-section (1) of section 129 refers to any insurance or banking companies
or companies engaged in the generation or supply of electricity or to any other
class of company in which form of financial statement has been specified in or
under the Act governing such class of company. Combined reading of this proviso
to sub-section (1) of section 129 of the Act, 2013 and clause (b) of
sub-section (2) of section 115JB of the Act would show that in case of
insurance or banking companies or companies engaged in generation or supply of
electricity or class of companies for whom financial statement has been
specified under the Act governing such company, the requirement of preparing
the statement of accounts in terms of provisions of the Companies Act is not
made. Clause (b) of sub-section (2) provides that in case of such companies for
the purpose of section 115JB the preparation of statement of profit and loss
account would be in accordance with the provisions of the Act governing such
companies. This legislative change thus aliens class of companies who under the
governing Acts were required to prepare profit and loss accounts not in
accordance with the Companies Act, but in accordance with the provisions
contained in such governing Act. The earlier dichotomy of such companies also,
if one accepts the Revenue’s contention, having the obligation of preparing
accounts as per the provisions of the Companies Act has been removed.

vi)  These amendments in section 115JB are neither
declaratory nor classificatory but make substantive and significant legislative
changes which are admittedly applied prospectively. The memorandum explaining
the provision of the Finance Bill, 2012 while explaining the amendments under
section 115JB of the Act notes that in case of certain companies such as
insurance, banking and electricity companies, they are allowed to prepare the
profit and loss account in accordance with the sections specified in their
regulatory Acts. To align the Income-tax Act with the Companies Act, 1956 it
was decided to amend section 115JB to provide that the companies which are not
required under section 211 of the Companies Act to prepare profit and loss
account in accordance with Schedule VI of the Companies Act, profit and loss
account prepared in accordance with the provisions of their regulatory Act
shall be taken as basis for computing book profit under section 115 JB of the
Act.

 

vii)  Further, Explanation (3) below section
115JB(2) starts with the expression ‘For the removal of doubts’. It declares
that for the purpose of the said section in case of an assessee-company to
which second proviso to section 129 (1) of the Companies Act, 2013 is
applicable, would have an option for the assessment year commencing on or
before 1st April, 2012 to prepare its statement of profit and loss
either in accordance with the provisions of schedule III to the Companies Act,
2013 or in accordance with the provisions of the Act governing such company.
This is a somewhat curious provision. In the original form, sub-section (2) of
section 115JB of the Act did not offer any such option to a banking company,
insurance company or electricity company to prepare its profit and loss account
at its choice either in terms of its governing Act or as per terms of section
115JB of the Act. Secondly, by virtue of this explanation if an anomaly which
has been noticed is sought to be removed, it cannot be said that the
Legislature has achieved such purpose. In plain terms, this is not a case of
retrospective legislative amendment. It is stated to be a clarificatory
amendment for removal of doubts. When the plain language of sub-section (2) of
section 115JB did not permit any ambiguity, one cannot say that the Legislature
by introducing a clarificatory or declaratory amendment cured a defect without
resorting to retrospective amendment, which in the present case has admittedly
not been done.

 

viii) In the result, it is held that section 115JB as
it stood prior to its amendment by virtue of Finance Act, 2012 would not be
applicable to a banking company. In the result, Revenue’s appeal is dismissed.”

Section 244A(2) of ITA, 1961 – Interest on delayed refund – Where issue of refund order was not delayed for any period attributable to assessee, Tribunal was correct in allowing interest to assessee in terms of section 244A(1)(a) – Just because the assessee had raised a belated claim during the course of the assessment proceedings which resulted in delay in granting of refund, it couldn’t be said that refund had been delayed for the reasons attributable to the assessee and assessee wasn’t entitled to interest for the entire period from the first date of assessment year till the order giving effect to the appellate order was passed

27  CIT vs. Melstar Information Technologies Ltd.; [2019] 106 taxmann.com
142 (Bom) Date of order: 10th
June, 2019

 

Section 244A(2) of ITA, 1961 – Interest on delayed
refund – Where issue of refund order was not delayed for any period
attributable to assessee, Tribunal was correct in allowing interest to assessee
in terms of section 244A(1)(a) – Just because the assessee had raised a belated
claim during the course of the assessment proceedings which resulted in delay
in granting of refund, it couldn’t be said that refund had been delayed for the
reasons attributable to the assessee and assessee wasn’t entitled to interest
for the entire period from the first date of assessment year till the order
giving effect to the appellate order was passed

 

The
assessee had not claimed certain expenditure before the AO but eventually
raised such a claim before the Tribunal upon which the Tribunal remanded the proceedings
to the CIT (A). The additional benefit claimed by the assessee was granted.
This resulted in refund and the question of payment of interest on such refund
u/s. 244A of the Income-tax Act, 1961.

 

The
Tribunal came to the conclusion that the delay could not be attributed to the
assessee and therefore, directed payment of interest.

 

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

 

“i)   As is well
known, in case of refunds payable to the assessee, interest in terms of
sub-section (1) of section 244A would be payable. Sub-section (2) of section
244A, however, provides that if the proceedings resulting in the refund are
delayed for reasons attributable to the assessee whether wholly or in part, the
period of delay so attributable, would be excluded from the period for which
interest is payable under sub-section (1) of section 244A of the Act.


ii)   The Revenue does not dispute either the
assessee’s claim of refund or that ordinarily under sub-section (1) of section
244A of the Act such refund would carry interest at statutorily prescribed
rate. However, according to the Revenue, by virtue of sub-section (2) of
section 244A of the Act, since the delay in the proceedings resulting in the
refund was attributable to the assessee, the assessee would not be entitled to
such interest.

 

iii)   Sub-section
(2) of section 244A of the Act refers to the proceedings resulting in the
refund which are delayed for the reasons attributable to the assessee. There is
no allegation or material on record to suggest that any of the proceedings hit
the assessee’s appeal before the Tribunal or remanded the proceedings before
the CIT (A) whether in any manner delayed on account of the reasons
attributable to the assessee. The Tribunal, was, therefore correct in allowing
the interest to the assessee.”

Have you shifted to digital note-taking yet?

I don’t remember the last time I used a
physical diary. Digital note-taking may be a bit inconvenient to start with,
but over a period of time, you start wondering how you managed without it for
so long. And you already carry your phone and/or tablet everywhere you go, and
your diary goes with you!

 

Here are several advantages of digital note
taking including recording anything, everything, everywhere:

 

–   Edit, copy and share
easily.

–    Search and retrieval
made extremely easy.

–   Synchronise across
multiple devices, access through smart phone.

–   Workflow made easy
through integration with apps such as Outlook and Browser.

–    Clip from web
important reading material to read later or for reference.

–    Handwritten notes
using a digital pen also feasible.

–    Audio, text, video or
picture, etc. formats supported adding further to the efficiency. For
example, you can include photos of say audit work paper into a note directly.

–    Organise various
work areas – Clients, Staff, BCAS and Personal through separate
notebooks, section groups, sections, pages, sub-pages, and tags.

–    Prioritise through
tags, etc. to increase productivity and efficiency. Maintain to do lists
with reminders.

–    Collaborate with
teams to work simultaneously on these notes, share and even manage simple
projects. Assign tasks and initiate Workflows.

 

With the
hundreds of digital diaries available now, it is a task to select the right
diary. Obviously, they are not all equal – some are simple and light whereas
some others are very complex and intense. Here are a few notable Note-Taking
Apps to help you become an efficient note-taker:

 

Monospace is a
minimalist note-taking app, built from the ground up. No fancy bells and
whistles for this note taking app – it just allows standard editing features.
The formatting is also minimal with support for Bold, Italics, Strikethrough,
Bullet, Quote and a bunch of size-related formatting styles. It has built in
internal sync (Pro package only) that lets you keep all your devices on the
latest version’s of your notes, and lets you edit anywhere.

 

Monospace Writer’s hashtags feature replace
the classic folder system. Simply add hashtags (which can be nested) to the
last line of a file and Monospace will take care of the file/folder
organisation for you.

 

Overall, a minimalist Note-Taker – useful
for those who take a few notes temporarily.http://bit.ly/2L1r3rp

 

Squid allows you
to take handwritten notes naturally on your Android tablet, phone, or
Chromebook supporting Android apps! With Squid you can write just like you
would on paper using an active pen, passive stylus, or even your finger. You
can easily markup PDFs to fill out forms, edit/grade papers, or sign documents.
Import images, draw shapes, and add typed text to your notes. And you can turn
your device into a virtual whiteboard or give presentations in a meeting or
conference by wirelessly casting to a TV/projector (e.g. using Miracast,
Chromecast). You can export notes as PDFs or images, then share them with
others or store them in the cloud!http://bit.ly/2Igkqng

 

ColorNote is a
popular note taking app. Very light and simple to use.

 

It is a quick and simple note-taking tool
for notes, memos, emails, to-do lists and much more. Taking notes is just like
typing into a basic wordprocessing program – just type as much as you want,
select a colour to the note, share or even set a reminder for the note. In the
to-do list mode, you can make a checklist of various to-do items, and tick them
off, one by one when each of the items gets done.

 

You can view the notes in the traditional
ascending order, in grid format, or by note colour. You can even password
protect important notes and put them as sticky notes on your home screen.
Online backup and sync cloud service is available which also allows you to
share your notes across devices. http://bit.ly/2Iek3K4

 

Microsoft To-Do
is a simple and intelligent to-do list that makes it easy to plan your day. It
combines intelligent technology and beautiful design to empower you to create a
simple daily workflow. Organise your day with To-Do’s smart Suggestions and
complete the most important tasks or chores you need to get done, every day.
To-Do syncs between your phone and computer, so you can access your to-dos from
just anywhere – work, home or even while you’re traveling around the world.

 

You can quickly add, organise and schedule
your to-dos while you’re on the go. And if you have to-dos that you need to
tick off on a daily, weekly or yearly basis you can set up recurring due dates
to remind you each and every time. To-Do also works with your Outlook Tasks,
making it easier to manage all of your tasks in whichever app you’re in.

 

It can also double up as a note-taking app,
adding detailed notes to every to-do – from addresses, to details about that
book you want to read, to the website for your favourite café. You can collect
all your tasks and notes in one place to help you achieve more.
http://bit.ly/2Id96s5

Google Keep is
one of the best tools to keep yourself up-to-date. Take notes of whatever you
need, wherever you need and recall anytime, anywhere!

 

Notes could be text, pictures or lists with
check boxes. They may be for personal or official use. You could type them from
your phone, or computer. You can also take pics or take voice memos from your
phone and store them as notes. The notes can be colour coded in eight different
colours for easy visual access. You can also share your notes with whomsoever
you desire.

 

And, of course, you can set reminders. The
reminders could be based on date and time and also on where you are! Imagine
going to the office and up pops a reminder about the numerous things you need
to do today. Or visiting a particular client and having a list of pending
issues coming up on your phone!

 

Keep is a wonderful tool which you can use
from your phone, computer, laptop or tablet. Available on Android, iPhone and
Computers. Start using Keep and you will Keep using it forever!
http://bit.ly/2L0C3W4

 

OneNote is a
multipurpose powerhouse —great for collecting and organising long-term data
like statements, minutes of meetings and task lists.

 

You can type, hand write, draw, and clip
things from the web to get down your thoughts into your notebook. You can place
content anywhere you want. You can even scan hand written notes or pages
straight into OneNote and make them searchable. You can use the Lasso Tool
to select handwritten text, then click Ink to Text in the Draw
menu to instantly convert it into text — all while retaining colours,
capitalisation, and relative sizes.

 

OneNote helps you get organised, collaborate
with others and accomplish more. It is part of the Office family and works
great with your favourite apps, such as Excel or Word to help you do more.

 

OneNote is tightly integrated with Outlook.
You can send emails from Outlook to OneNote and you can also email your
notebook pages directly from OneNote. It’s also possible to assign a task to a
specific person through OneNote. This task will appear in that person’s Outlook
task list. When they complete it in Outlook, the update will be synchronised
with OneNote. http://bit.ly/2IekJ24

 

Evernote is one
of my favourite note-taking tools. Evernote makes it easy to remember things
big and small from your everyday life, using your computer, phone, tablet and
the web. You can write notes on any of your devices and they will be
automatically synced to all your other devices. If you are in a meeting and
take notes on your tablet or phone, the minute you login to your office / home
computer, you will find them there!

 

Evernote is truly cross-platform. It
supports iOS, Blackberry, Windows and Android on Smartphones and Tablets, and
Mac OS X, Windows, Safari, Chrome and Firefox on Computers. It just syncs
seamlessly.

 

Your notes could be text, audio, picture
notes, check lists, webclips, dictations or even sketches. So remember
everything, access anywhere and find things fast. Best of all, it is free to
install on each one of your devices. Free Accounts have a 60MB upload limit,
per month, but I have never even reached half of it in any month. The paid
version has multiple levels of features and you can upgrade as per your needs
and convenience. My current favourite. No gifts of Diaries for me next New
Year! http://bit.ly/2L0ykIc

 

Which note-taking app is your favourite?
Why? What kind of notes do you take? Are there any free ones that I missed?
Please do write to journal@bcasonline.org  

Percentage Of Completion Method (POCM) Illustration For Real Estate Companies Under Ind AS 115 & Comparison With Guidance Note (GN)

Background

On 28th March
2018, the Ministry of Corporate Affairs (MCA) notified the new revenue
recognition standard, viz., Ind AS 115 Revenue from Contracts with Customers.
Ind AS 115 is applicable for the financial years beginning on or after 1st
April 2018 for all Ind AS companies. It replaces virtually all the existing
revenue recognition requirements under Ind AS, including Ind AS 11 Construction
Contracts, Ind AS 18 Revenue and the Guidance Note on Accounting
for Real Estate Transactions (withdrawn by ICAI vide announcement dated
01-06-2018) (GN).

 

One of the industries where
the impact is significant is the real estate industry. In addition to not being
able to apply POCM invariably, there are numerous other accounting challenges.
Here we take a look at the following issues:

 

1.  Evaluating if building is a separate
performance obligation (PO) from the underlying land in a single-unit vs. a
multi-unit sale.

2.  Understanding clearly the requirements for
POCM eligibility under Ind AS 115.

3.  Where a real estate sale is eligible for POCM
– the differences in POCM between the GN and Ind AS 115.

4.  POCM illustrations under the GN and Ind AS
115, highlighting the underlying differences.

 

Whether Land &
Buildings are separate POs?

The diagram below depicts
the requirements with respect to identifying goods and services within a
contract.

 


Whether land and building
are two separate POs will depend upon whether the underlying real estate sale
is a single-unit or a multi-unit sale. An example of a single-unit sale is
where a customer is sold an individual plot of land with a construction of a
villa on that plot of land. In this example, the customer receives the
ownership of the land and the villa. On the other hand, a multi-unit sale is
where a customer is sold a flat in a multi-floor, multi-unit building. Here the
customer receives the finished apartment and the undivided interest in the
land.

 

In the case of a
single-unit sale, land and building in most circumstances will be separate POs.
The International Financial Reporting Interpretation Committee (IFRIC)
considered this issue and felt land and building are two separate POs for the
following reasons:

 

–   When
evaluating step 1 above, whether goods/services are capable of being distinct
based on the characteristics of the goods or services themselves; the
requirement in the standard is to disregard any contractual limitations that
might preclude the customer from obtaining readily available resources from a
source other than the entity. Further, customer could benefit from the plot of
land on its own or together with other resources.

 

–   When
evaluating step 2 above, it is important to understand if the relationship
between land and building is functional or transformative. The relationship
between land and building is functional, because building cannot exist without
the land; its foundations will be built into the land. However, in order for
the two POs to be combined as one PO, the relationship has to be
transformative. The relationship between land and building is not
transformative. The building does not alter or transform the land and vice-versa.
There is no integration or the two POs do not modify each other.

 

In the case of a multi-unit
sale, the undivided interest in the land and the building in most circumstances
will be one PO because the customer receives a combined output, i.e. a finished
apartment. The customer does not benefit from the undivided interest in the
land on its own or buy it independently or use it with other readily available
resources. The customer does not receive ownership of the land. The real estate
entity may probably transfer the land after project completion to a society
established by all the home-owners.

 

When is over-time (POCM) revenue recognition
criterion met under Ind AS 115?

An entity shall recognise
revenue when (or as) the entity satisfies a performance obligation by
transferring a promised good or service (i.e. an asset) to a customer. An asset
is transferred when (or as) the customer obtains control of that asset. For
each performance obligation, an entity shall determine at contract inception
whether it satisfies the performance obligation over time or satisfies the performance
obligation at a point in time. If a performance obligation is not satisfied
over time (explained later), an entity satisfies the performance obligation at
a point in time. The Standard describes when performance obligations are
satisfied over time. Consequently, if an entity does not satisfy a performance
obligation over time, the performance obligation is satisfied at a point in
time. The point in time is the time when the control in the goods or service is
transferred to the customer.

 

An entity transfers control
of a good or service over time and, therefore, satisfies a performance
obligation and recognises revenue over time, if one of the following criteria
is met:

 

(a) the customer simultaneously receives and
consumes the benefits provided by the entity’s performance as the entity
performs (for example, interior decoration in the office of the customer);

 

(b) the entity’s performance creates or enhances an
asset (for example, work in progress) that the customer controls (as defined in
the Standard) as the asset is created or enhanced; or

 

(c) the entity’s performance does not create an
asset with an alternative use to the entity and the entity has an enforceable
right to payment for performance completed to date.

 

Let us consider an example,
to see how the above criterion is applied.

 

Example 1 – Application of Over time revenue
recognition criterion

 

Issue

–   An
entity is constructing a multi-unit residential complex

 

–   Customer
enters into a binding sales contract with the entity for a specified unit

 

–   The
customer makes milestone payments as per contract, which cumulatively are less
than work completed to date plus a normal profit margin

 

–    A
significant contract price is paid by customer to entity on delivery (but the
contract is enforceable under Ind AS 115)

 

–   In
case customer wishes to terminate the contract, either customer or entity can
identify a new customer, who will pay the remaining amount as per milestone
schedule.

–    The
new customer compensates the original buyer, for payments made to date. The
compensation may be higher or lower than the cumulative payments made by the
original customer

 

–    The
contract is silent when new buyer cannot be identified. However, as per local
laws, the entity cannot enforce claim for remaining payments from the original
customer.

 

Whether the performance
obligation is satisfied at a point in time or over time?

 

Response

Similar issue was
considered by IFRIC.

 

IFRIC Agenda Decision : Revenue
recognition in constructing a multi-unit building:

Ind
AS 115 Para

Analysis

Met
(v) / Not met (X)

35
(a) – The customer is receiving and consuming the benefits of the entity’s
performance as the entity performs

Entity’s
performance creates an asset, i.e., the real estate unit that is not consumed
immediately.  Therefore this criterion
is not met.

X

35
(b) – The entity creates or enhances an asset that the customer controls as
it is created or enhanced

Control
criterion not  met because:

? Asset created is the real
estate unit itself and not the right to obtain the real estate unit in the future
– The right to sell or pledge this right is not evidence of control

? Customer has no ability to
direct the construction or structural design of the real estate

? Customer’s exposure to
change in market value does not give the customer the ability to direct use
of the unit

X

35
(c) – (i) The entity’s performance does not create an asset with alternative
use and

 

(ii)
the entity has a right to payment for performance completed to date

In
most of the contract, the asset created by an entity’s performance does not
have an alternative use to an entity

v

Entity
may not have enforceable right to payment for performance completed to date,
because:

 

? The customer can walk away
without making the rest of the payment

 

To
meet this criterion, entity should have a contractual/legal right to receive
payments for work completed to date including a reasonable profit
margin.  A satisfactory resolution of
the problem does not mean that the entity has an enforceable right to payment
for work completed to date.

X

Many real estate companies in India may not
qualify for POCM on transition date contracts. 
However, the third criterion discussed above can be incorporated in
future contracts to achieve POCM recognition.

 

 

Example 2 – Over time revenue recognition requirement
met

 

Issue

–   An
entity is constructing a multi-unit residential complex. A customer enters into
a binding sale contract with the entity for a specified unit.

–   The
customer pays a non-refundable deposit upon entering into the contract and will
make progress payments during construction of the unit. The contract has
substantive terms that preclude the entity from being able to direct the unit
to another customer.

 

–    In
addition, the customer does not have the right to terminate the contract unless
the entity fails to perform as promised.

 

–    If
the customer defaults on its obligations by failing to make the promised
progress payments as and when they are due, the entity would have a right to
all of the consideration promised in the contract if it completes the
construction of the unit.

–   The courts have previously
upheld similar rights that entitle developers to require the customer to
perform, subject to the entity meeting its obligations under the contract.

 

Does the
real estate entity meet the criterion for overtime recognition of revenue?

 

Response

–   The
entity determines that the asset (unit) created by the entity’s performance
does not have an alternative use to the entity because the contract precludes
it from transferring the specified unit to another customer.

 

–    The
entity does not consider the possibility of a contract termination in assessing
whether the entity is able to direct the asset to another customer.

 

–   The
entity also has a right to payment for performance completed to date. This is
because if the customer were to default on its obligations, the entity would
have an enforceable right to all of the consideration promised under the
contract if it continues to perform as promised.

 

–   Therefore,
the terms of the contract and the practices in the legal jurisdiction indicate
that there is a right to payment for performance completed to date.

 

Consequently, the criteria
for recognising revenue over time under Ind AS 115 are met and the entity has a
performance obligation that it satisfies over time.

 

What is enforceable right to payment?

There are a couple of
points one needs to consider to understand if a real estate contract provides
an enforceable right to payment:

 

1.  The enforceable right to payment for work
completed to date would include cost incurred to date plus a normal profit
margin.

 

2.  The right should be enforceable both under the
contract as well as legislation.

 

3.  The law may provide contract enforceability,
however the RERA authorities may issue interpretations and judgement that are
consumer friendly. The Maharashtra Estate Regulatory Authority in Mr.
Shatrunjay Singh vs. Arkade Art  Phase 2
opined that the customer is not eligible for refund of the amounts paid to the
developer even if customer is not able to pay due to financial difficulty.
However, it did not rule that the contract was enforceable against the
customer, and that the entity had a right to collect payment for work completed
to date. Real estate entities should therefore clearly evaluate the legal
position and obtain legal opinions to support over time revenue recognition.
Since different RERA authorities may take different positions, a real estate
entity should obtain legal opinion for all major states where it has
operations.

 

4.  The right to payment does not mean that the
entity has the right to invoice every day or week or month or other than based
on mile-stone. Rather, if the customer walks-away from the contract, the entity
should be able to enforce payment for work completed to date (plus normal
profit margin).

 

5.  The existence of the right is important.
Whether the real estate entity chooses to exercise the right is not relevant.

 

6.  A satisfactory resolution of the problem as
explained in Example 1, does not mean that the real estate entity has an
enforceable right to payment. A clear enforceable right to payment should be
granted both under the contract and the legislation.

 

7.  If a customer can walk away by paying a
penalty (which is not equal to or greater than cost incurred to date plus
normal profit margin), then there is no enforceable right to payment.

 

8.  In a 10:90 scheme, the contract itself may not
be enforceable. However, in a mile-stone based real estate contract, a 10%
received upfront, may be sufficient to demonstrate contract enforceability.
Evaluating contract enforceability and right to payment is a continuous process
throughout the project period.

 

POCM under GN vs Ind AS 115

Even when real estate
entities meet the POCM criterion under Ind AS 115, the POCM as per the GN
(withdrawn) and Ind AS 115 are dissimilar in many respects. A comparison is
given below.

 

Point
of difference

GN

Ind
AS 115

Threshold
for revenue recognition

??All
critical approvals obtained

??Construction
and development costs = 25%

??Saleable
project area is secured by
contracts = 25%

??Realised
contract consideration = 10%

 

Revenue
to be recognised straight-away and there is no condition for achieving any
threshold.  However, contract
enforceability criterion is required to be met for recognizing revenue.  Therefore, more revenue will be recognised
upfront under Ind AS 115 as compared to the GN. If the entity is unable to
reasonably estimate progress, an entity should recognise revenue upto cost
incurred to date, unless the contract is onerous.

Borrowing
cost

Included
in POCM

Borrowing
costs cannot contribute to performance. Therefore borrowing costs would be
excluded from the measure of progress.

Land
cost

Included
in POCM, when threshold is achieved.

Preferred
view is that it is included in POCM on commencement of the project.

20:80/
10:90 Schemes

Revenue
can be recognised subject to thresholds

Contract
may not be eligible as valid contract under Ind AS 115

Financing
component

No
requirement to separate financing component

Explicitly
required to separate financing component

 

 

POCM under GN

 

Illustration

 

Particulars

Scenario 1

Scenario 2

Total
saleable area

20,000 sq. ft.

20,000 sq. ft.

Estimated
Project Costs

 

 

Land
cost

INR 300 lakh

INR 300 lakh

Construction
cost

INR 300 lakh

INR 300 lakh

Cost
incurred till end of reporting period

 

 

Land
cost

INR 300 lakh

INR 300 lakh

Construction
cost

INR 60 lakh

INR 90 lakh

Total
Area Sold till the date of reporting period

5,000 sq. ft.

5,000 sq. ft.

Total
Sale Consideration as per Agreements of Sale executed

INR 200 lakh

INR 200 lakh

Total
sales consideration (estimated)

INR 800 lakhs

INR 800 lakh

Amount
realised till the end of the reporting period

INR 50 lakh

INR 50 lakh

Fair
value of the land & building (each)

INR 400 lakhs

INR 400 lakhs

 

Response

 

Particulars

Scenario 1

Scenario 2 – land is considered as contract
activity

Scenario 2 – land is not considered as contract
activity

Construction
and development costs = 25%

60/300 = 20%

90/300 = 30%

90/300 = 30%

Saleable
project area is secured by contracts = 25%

5,000/20,000 = 25%

5,000/20,000 = 25%

5,000/20,000 = 25%

Realised
contract consideration

=
10%

50/200 = 25%

50/200 = 25%

50/200 = 25%

POCM

360/600 = 60%

390/600 = 65%

90/300 = 30%

Revenue
can’t be recognised in scenario 1, as first condition is not met

 

 

 

(i)
Revenue Recognised

–

INR 130 lakhs

(200 * 65%)

INR 60 lakhs

(200*30%)

(ii)
Proportionate Cost /

–

INR 97.5 lakhs

(600 * 65%*1/4)

INR 45 lakhs

(600*30%*1/4)

Profit
[ (i) – (ii) ]

–

INR 32.5 lakhs

INR 15 lakhs

WIP

INR 360 lakhs

(300+60)

INR 292.5 lakhs

(390-97.5)

INR 345 lakh

(390-45)

 

 

1.  In Scenario 1, construction and development
cost criterion of 25% is not fulfilled and since threshold is not met, no
revenue is recognised.

 

2.  Scenario 2 where land is considered as
contract activity is clearly in accordance and as illustrated in the GN. Once
the 25% criterion is met, land is included in the determination of the POCM and
revenue/cost is recognised on that basis.

 

3.  Scenario 2 where land is not considered as
determining the contract activity (POCM) is the author’s interpretation of
Paragraph 5.4 of the GN. Paragraph 5.4 of the GN states that “Whilst the method
of determination of state of completion with reference to project cost incurred
is the preferred method, this GN does not prohibit other methods of
determination of stage of completion, eg, surveys of work done, technical
estimation, etc.”

 

POCM under Ind AS 115 in single-unit apartment

As already discussed above,
in a single-unit apartment, in most cases, land and building will be two
separate POs. The question that arises at what point in time revenue on land is
recognised. Theoretically there are three options on how land revenue is recognised
at (a) commencement, (b) settlement or (c) over time. These options are
presented below based on the earlier illustration (scenario 2).

 

When land revenue is recognised?

View 1 – 
Commencement

 

View 2 – Settlement

 

View 3 –Overtime

POCM

90/300 = 30%

 

90/300 = 30%

 

90/300 = 30%

 

Land

Building

Total

Land

Building

Total

Land

Building

Total

(i)
Revenue Recognised

100

(400*1/4)

30

(400*1/4*

30%)

130

0

30

(400*

1/4*

30%)

 

30

30

(400*

1/4*

30%)

 

30

(400*1/4
*30%)

 

60

(ii)
Proportionate Cost

75

(300*1/4)

 

22.5

(300*1/4*

30%)

 

97.5

0

22.5

(300*

1/4

*30%)

 

22.5

22.5

(300*

1/4*

30%)

 

22.5

(300*1/4*
30%)

 

45

Profit  [(i) – (ii)]

25

7.5

32.5

0

7.5

7.5

7.5

7.5

15

WIP

225

(300-75)

 

67.5

(90-22.5)

 

292.5

300

67.5

(90-22.5)

 

367.5

277.5

(300-22.5)

 

67.5

(90-22.5)

 

345

 

 

Revenue
and cost of land is recognised at the completion of the contract.

 

 

 

The author believes that
View 1 below is the most appropriate response.

 

View 1: Control of the land
at commencement

 

The author believes land
revenue is recognised at commencement since the control of the land transfers
once the contract is enforceable. The contract restricts the ability of the
real estate entity to redirect the land for another use. Besides, the customer
has the significant risks and rewards of ownership from that time. Although the
legal title of the land does not transfer until settlement, this view considers
that the retention of legal title in this fact pattern is akin to a protective
right because the customer will not pay for the land until settlement.
Therefore, this contract is like many other contracts where the asset is
acquired on deferred payment terms. In this view, the real estate entity will
need to confirm that the existence of a contract criteria are met in IND AS
115.9, in particular that it is it is probable that the builder will collect
the consideration to which it will be entitled in exchange for the land and
house (single-unit) construction services.

View 2: Control of the land
transfers at settlement

 

Control of the land
transfers at settlement, which is when legal title transfers to the customer.
This provides clear evidence that the customer has obtained control of the
land. This outcome would also be consistent with other real estate sales
contracts that do not have a specific performance clause.

 

However, the major drawback
of this view is that it is counterintuitive for a  customer
to obtain  control
(forInd AS 115 purposes) of the
house prior to the obtaining control of the land. Hence this view is not
appropriate.

 

View 3: Control of the land
also transfers over time to the customer

 

Over time revenue
recognition is applicable to land because the real estate entity is
contractually restricted from redirecting the land to others. Besides the right
to sue for specific performance applies to the contract as a whole ( i.e land
and house construction). However, the major shortcoming of this view is that
the real estate entity’s performance does not create or enhance the land—the
land already exists. In other words land is not getting created, enhanced or
transformed overtime. Hence, this view is not appropriate.

 

POCM under Ind AS 115 in multi-unit apartment

As already discussed above,
in a multi-unit apartment land and building is treated as one performance obligation.
Theoretically there are 3 options available on how to apply POCM in a
multi-unit apartment where construction meets the overtime requirement in
35(c).

 

Options

If
land and building is a not separate PO

View
1

– Land treated as an input
cost and included in determination of POCM margins

– Consequently significant
revenue/cost gets recognised at commencement

View
2

– Land treated as an input
cost but not included in POCM

– Revenue recognised to the
extent of the input cost – no margins are recognised

– Significant revenue/cost
gets recognised at commencement

View
3

– POC determined on the basis
of development cost to date (excluding land) vs total development cost
(excluding land). POC is then applied on total contract revenue

– Consequently all
revenue/cost (including land) gets recognised overtime

 

 

View 1 and 3 seem
acceptable views, and are demonstrated below (Scenario 2)

 

Particulars

View 1

View 3

POCM

390/600 = 65%

90/300 = 30%

(i)
Revenue Recognised

INR 130 lakhs

(200*65%)

INR 60 lakhs

(200*30%)

(ii)
Proportionate Cost

INR 97.5 lakhs

(600*65%* 1/4)

INR 45 lakhs

(600*30%*1/4)

Profit
[(i) – (ii)]

INR 32.5 lakhs

INR 15 lakhs

WIP

INR 292.5 lakhs

(390-97.5)

INR 345 lakh

(390-45)

 

 

Conclusion

Ind AS 115 is very
complicated. The interpretations around Ind AS 115 are still emerging globally
and in India. Real estate entities will need to carefully study, analyse and
apply the requirements, without jumping to straight-forward conclusions. 

 

Goods Vis-À-Vis Intellectual Service

Introduction

Under
Sales Tax Laws tax could be levied on sale/purchase of goods. The term ‘goods’
is defined in the Constitution and it is also normally defined in the State
Sales Tax Laws. For example, the definition of ‘goods’ under MVAT Act is as
under in section 2(12):

 

“(12)
“goods” means every kind of movable property not being newspapers, actionable
claims, money, stocks, shares, securities or lottery tickets and includes live
stocks, growing crop, grass and trees and plants including the produce thereof
including property in such goods attached to or forming part of the land which
are agreed to be severed before sale or under the contract of sale;”

 

This
term is also discussed and interpreted in various judgements. The landmark
judgement is in case of Tata Consultancy Service (137 STC 620)(SC).
Regarding ‘goods’, Hon. Supreme Court has observed as under:

 

“17.
Thus this Court has held that the term ‘goods’, for the purposes of sales tax,
cannot be given a narrow meaning. It has been held that properties which are
capable of being abstracted, consumed and used and/ or transmitted,
transferred, delivered, stored or possessed etc. are ‘goods’ for the purposes
of sale tax. The submission of Mr. Sorabjee that this authority is not of any
assistance as a software is different from electricity and that software is
intellectual incorporeal property whereas electricity is not, cannot be
accepted. In India the test, to determine whether a property is ‘goods’, for
purposes of sales tax, is not whether the property is tangible or intangible or
incorporeal. The test is whether the concerned, item is capable of abstraction,
consumption and use and whether it can be transmitted, transferred, delivered,
stored, possessed etc. Admittedly in the case of software, both canned
and un-canned, all of these are possible.”

Inspite
of Supreme Court’s interpretation of the term ‘goods’ still the controversies
keep up coming from time to time.

 

Judgement of Tribunal in case of Sungrace Engineering Projects Pvt. Ltd.
(Second Appeal No.198 of 2015 dt.2.9.2016). 

 

Hon.
Maharashtra Sales Tax Tribunal had an occasion to deal with similar issue in
above judgment. 

 

Facts

The
facts are narrated by Tribunal as under:

 

“Appellant
is a Private Limited Company carrying on the business of sale of software,
conducting surveys, preparing reports and consultancy in various fields.
Appellant is duly registered under B.S.T. Act. Company is assessed under
Section 33 for the period 01/04/1999 to 31/03/2000 on 07/08/2002. Assessment
had resulted in Nil tax demand. Later on, the Deputy Commissioner of Sales Tax
(Adm.) M-61, Pune Division, Pune (in brief, “The Revision Authority”) took
this case for revision u/s. 57 of BST Act after noticing that, professional
receipts shown in the balance-sheet worth Rs.1,13,23,186/- are received on
account of sale of technical know-how i.e. preparing lay outs, surveys and
submitting report to the customers, Government which according to Revisional Authority
is one of the types of transfer of knowledge or transfer of technology; that
falls within the purview of Schedule entry C-I-26 (7) of the B.S.T. Act.
Technical know-how is taxable @ 4%. Assessing Authority failed to levy tax on
Rs.1,13,23,186/-.”

 

In
course of argument, appellant further elaborated the facts as under:

 

“4. On
merits of the case, Mr. Gandhi, Ld. Chartered Accountant further, explained
that appellant has collected amount of Rs.1,13,23,186/- stated above from
different Government Authorities and Private Agencies. The nature of services
rendered is mainly preparation of designs, drawings of all components of dam
under Maharashtra Krishna Valley Development Corporation in brief, ”MKVDC “) of
irrigation projects, consultancy services for survey of pipe lines alignments,
soil investigation, consultancy services for survey preparing financial
estimates, preparing reports including detail designs and drawings as mutually
agreed between the parties. Major work is done as a contractor client to the
Executive Engineer, Irrigation Department of Government of Maharashtra, and
there are some sub-contracts regarding government works but done on behalf of
other private parties. He further, explained that by no stretch of imagination,
the nature of work conducted by the appellant can be termed “sale of technical
know-how,” as prescribed in entry C-I-26(7) of the B.S.T. Act. He further,
explained that running bills clearly explains what was the nature of work done.
According to him, the Revision Authority and the First Appellate Authority have
wrongly held that the transactions were in the nature of sale of technical
know-how by applying one or two criteria without confirming that the
transactions confirm all necessary ingredients is illegal or cannot be sustained.
The said condition is as below:-

 

“All
the studies layouts, drawings, design notes which have been submitted to the
Maharashtra Krishna Valley Development Corporation shall become the absolute
property of MKVDC under the Copyright Act and the consultant shall not use the
same in whole or part thereof elsewhere for any purpose without explicit
written permission from MKVDC.”

 

The
department reiterated the contentions as per revision order and further relied
upon the judgement of Tribunal in case of I. W. Technologies Pvt. Ltd.
vs. The State of Maharashtra (SA No.429 of 2004, decided on 22/10/2008).

 

Hon.
Tribunal considered the arguments of both the sides and also referred to entry
C-I-26 of the BST Act and held
as under:

 

“9.  Heading of the said entry itself clearly
states that the goods are incorporeal or intangible characters are covered
under this entry, then question before us is whether the services rendered by
appellant are goods of intangible nature. We have to see the authorities referred
from both sides. M/s I.W. Technologies Pvt. Ltd. (cited supra).
The dealer was carrying on the business of selling water purification systems
and components and parts thereof. It used to undertake engineering and
consultancy services. It undertook work from M/s. Sudarshan Chemical Industries
Ltd. for upgrading their Effluent Water Treatment Plant at Roha. M/s. Sudarshan
Chemical Industries Ltd. carried out the work with their contractor as per
models, designs, drawings, specifications of civil works, electrical works
under the guidance and technical knowledge of M/s I.W. Technologies Ltd.
Therefore, it was held that there was sale of technical know-how. But in the
present case, surveys and reports, designs, drawings of the dam and the
irrigation projects are prepared as per specifications provided by the
employer. Appellant prepared reports, drawings, designs, etc., with the
help of their technical expertise in the field.

 

10.  The tender condition mentioned above, and
relying on the same departmental authorities levied tax as property is covered
under Copyright Act, there is sale of “Copy right .”

 

11.  Provision under Copyright Act, in section
17(d) it is prescribed that-

 

Section
17. “Subject to provisions of this Act the author of work shall be the first
owner of the Copyright therein provided that

 

(a) to
(c) not relevant

 

(d) in
the case of Government work, Government shall in the absence of contract to the
contrary be the first owner of the Copyright therein.”

 

In
view of this provision it is clear that whatever work, done by the appellant,
was owned by the Government and therefore there was no question of sale of
technical know-how.

 

Observing
as above Hon. Tribunal held that the levy of tax is not sustainable as it is
not sale of goods but rendering of services. Tribunal set aside the revision
order.

 

Conclusion     

The
judgement throws light on the nature of “goods”. Normally, the goods are first
produced and then delivered. However, when the transaction is for intellectual
service which is also not transferable to other parties, it will amount to
service and not goods. The judgement will be useful for making distinction
between goods and intellectual service.  

 

Refunds Under GST

Introduction

 

1.  Since GST works on the
principle of value addition, it is generally expected that on a net basis, the
tax payer will end up paying differential tax (excess of output tax over the
input tax credit) and there would be very few instances of refunds. However, in
certain scenarios, there could be a possibility of there being no differential
tax liability and in fact, there could be refund. Such refunds can be on
account of multiple reasons, such as:

 

–    Tax on inputs is higher than the tax on
output

 

–   Zero rated supplies, i.e., exports and SEZ supplies where there is no
tax on output while tax has to be paid on inputs

 

–   Excess payment of tax, either on account of
mistake, interpretation issue, dispute, pre-deposit in appeal, etc.

 

–    Excess tax payment resulting on account of
loss making business or discontinuance of business.

 

2.  Under the earlier tax regime,
in all the above scenarios, the above excess payment (irrespective of nature,
i.e., payment of tax or unutilised input tax credit) had to be dealt with under
the provisions of the respective laws, which had different principles and
timelines. For instance, under the VAT regime (in the context of Maharashtra
VAT), there was no restriction on claim of refund of such excess tax except for
the limitation period, which was 18 months from the end of the financial year.
However, under the Central Excise / Service Tax regime, the refund claim was
divided into two parts, namely refund of excess balance of credit and refund of
excess tax payment. The provision relating to refund of excess balance of
credit was primarily governed u/r 5 of CENVAT Credit Rules, 2004 which granted
refund of accumulated credit to exporters of goods / services. Similarly, the
provisions relating to refund of excess tax payments were governed u/s. 11B of
Central Excise Act, 1944. In both the scenarios, general limitation period for
claim of the said refund permitted the claim of refund only within a period of
one year from the relevant date. The entire process of claiming refund had seen
its fair share of litigation under the earlier tax regime with various landmark
decisions in the context of each legislation laying down various important
principles which shall be discussed at appropriate places in this article.

 

3.  We shall now analyse whether
the provisions relating to refund under GST regime, pursuant to the amalgam of
the above taxes, have succeeded in removing various difficulties faced under
the earlier regimes or not. We shall primarily cover the following topics
relating to refunds under GST, namely:

 

–   General provisions

 

–   Form & manner of application

 

–   Documentary evidence to be submitted along
with application

 

–    Various Issues relating to refund.

 

General
Provisions relating to refund under GST

 

4.  Section 54 of the CGST Act,
2017 read with Chapter X of the CGST Rules, 2017 deals with the provisions
relating to grant of refunds under GST. Refund of Integrated tax paid on zero
rated supplies is dealt with u/s. 16 of the IGST Act, 2017 but the same is also
governed by Chapter X of the CGST Rules, 2017. The general provisions relating
to refund under GST are covered u/s. 54 of the Act.

5.  Section 54 (1) provides that any person claiming refund of any tax & interest, if paid before the
expiry of two years from the relevant date, may make an application in such form & manner as may be prescribed.
This would encompass the claim of refund of balances appearing in electronic
cash ledger and electronic credit ledger as well as refund of any tax or
interest paid, but not appearing in the respective ledgers for any reason. The
general provisions relating to such refund claims can be listed as under:

 

–    Refund of balance in electronic cash ledger
– Vide proviso to section 54 (1), it has been clarified that the refund of
balances appearing in electronic cash ledger shall be claimed in the return to
be furnished u/s. 39

 

–    Refund of balance in electronic credit
ledger – There can be different reasons for balance in electronic credit
ledger. Section 54 (3) deals with the provisions relating to refund of
unutilised input tax credit and provides for claim of refund by a registered
person of unutilised input tax credit in following cases:

 

•    Zero rated supplies made
without payment of tax

•    Accumulation of credit on
account of rate of tax on inputs being higher than the rate of tax on output

•    Refunds due, but not reflected
in either of the ledgers – This would refer to situations such as:

•    Cases where zero rated
supplies have been made on payment of integrated tax and the liability has been
discharged using balance in credit / cash ledger, thus reducing the respective
balances

•    Cases where liability had been
disclosed & discharged wrongly in the returns

 

Form &
manner of application

 

6. Section 54 (1) provides that the application for refund shall be made
in the prescribed form & manner, which as per rule 89 is tabulated below:

 

Refund on account of

Prescribed form / manner

Balance in electronic cash ledger

In the return to be filed u/s. 39

Integrated tax paid on export of goods out of India

Automated refund subject to matching of information in
shipping bill with disclosures in GSTR 1 (Rule 96)

Unutilised input tax credit on account of zero rated supplies
other than export of goods out of India on payment of integrated tax

In Form RFD-01

Unutilized input tax credit on account of Deemed Exports
(either by recipient / supplier)

In Form RFD-01

On account of Order passed by Appellate Authority / Tribunal
/ Court

In Form RFD-01

Excess payment of tax, if any

In Form RFD-01

Any other

In Form RFD-01

 

7.  However, as of now, the
facility to file refund claim has been enabled only in case of refund on
account of zero rated supplies/ deemed exports.

 

Refund of
unutilised input tax credit:

 

8.  In order to determine the
amount eligible for refund out of unutilised input tax credit, Rule 89 (4)
prescribes elaborate formula to determine the amount eligible for refund from
the balance lying in the electronic credit ledger in case of zero rated
supplies made without payment of tax. The said Rule provides that the Refund
amount shall be derived by applying the following formula,

 

  
Turnover of Zero-rated supply of Goods +

Turnover of
Zero – rated supply of Services     *?Net
ITC

                     Adjusted Total Turnover

 

9.  Each of the terms used in the
above formula has been defined in the rules. For instance, Net ITC has been
defined to mean input tax credit availed on inputs & input services during
the relevant period other than input tax credit availed for which refund is
claimed u/r (4A) or (4B) for specified notifications

 

10. Turnover
of Zero rated supply of goods / services – has been defined to mean the value
of zero rated supply of goods / services made during the relevant period
without payment of tax under bond / letter of undertaking, other than turnover
for which refund is claimed u/r (4A) or (4B) or both. Further, zero rated
supply of services has been defined to include following payments in the
context of zero rated supplies:

Nature of Payments

Action

Aggregate of payments received during
relevant period for such supplies

Include

Advance received in earlier period for
zero rated supplies, where service provision has been completed during the
relevant period

Include

Advance received during the relevant period for zero rated
supplies, where service provision has not been completed during the relevant
period

Exclude

 

 

11. Adjusted Total Turnover has
been defined to mean the turnover in a State / Union Territory as defined u/s.
2 (112), i.e., aggregate value of all taxable supplies & exempt supplies
made including export of goods or services or both but excluding the value of
exempt supplies and the value on which refund has been claimed u/r (4A) or (4B)
during the relevant period.

 

12. Similarly, relevant period has
been defined to mean the period for which the refund claim has been filed.

 

13. Just like Rule 89 (4) deals
with determination of refund amount in case of zero rated supplies made, Rule
89 (5) deals with determination of refund amount in case of inverted rate
structure. For this situation, it has been provided that the maximum refund
amount shall be determined by applying the following formula:

 

Turnover of
Inverted rated supply of
                 Goods &
Services                           * Net ITC

           Adjusted Total Turnover

 

14. The definition of adjusted
total turnover as provided u/r 89 (4) has been borrowed for the purpose of Rule
89 (5) as well while Net ITC has been defined to mean input tax credit availed
on inputs during the relevant period other than input tax credit availed where
refund is claimed u/r (4A) and (4B).

 

Documentary
Evidences to accompany with refund application

 

15. Further, Section 54 (4)
provides that refund application shall be accompanied by prescribed documentary
evidences which demonstrate that

 

–   the amount of refund is due to the taxable
person; and

–   the incidence of the same has not been
passed on to any other person, later being required only in cases where the
amount of refund claim exceeds Rs. 2 lakhs.

 

16. In addition to the above, each
refund application needs to be supported with documentary evidence prescribed
u/r 89 (2) as under:

Clause

Reason for Refund

Supporting documentary evidence

(a)

Order of a Proper Officer / Appellate Authority / Appellate
Tribunal / Court

 

Refund of pre-deposit made at the time of appeal file before
the Appellate Authority / Appellate Tribunal

Reference number of the Order & copy of the Order passed

 

Reference number of payment of said amount

(b)

Export of goods – without payment of integrated tax

Statement containing the number & date of shipping bills
/ bill of export and the date of relevant export invoices

(c)

Export of Services – with or without payment of integrated
tax

Statement containing the number and date of invoices
containing the relevant BRC/ FIRC

(d)

Supply of goods to SEZ Unit / Developer

Statement containing number and date of invoices as provided
in rule 46 along with evidence in the form of endorsement on the invoice by
the specified officer of the Zone that the goods have been admitted in full
in the SEZ Unit / Developer

(e)

Supply of services to
SEZ Unit / Developer

Statement containing the number and date of invoices along
with evidence in the form of endorsement on the invoice by the specified
officer of the Zone that the services have been received for authorized
operations of the Unit / Developer

(f)

Supply of goods / services to SEZ Unit / Developer on payment
of integrated tax

A declaration from the Unit / Developer that they have not
availed the input tax credit of the tax paid by the supplier

(g)

Deemed Exports

Statement containing number and date of invoices

(h)

Inverted rate structure

Statement containing the number and date of invoices received
& issued during a tax period

(i)

Finalisation of provisional assessment

Reference number and copy of final assessment order

(j)

Reclassification of outward supply from intra-state to
inter-state supply

Statement showing details of such transactions

(k)

Excess payment of tax

Statement showing details of such payment

(l)

On account of (e), (g), (h), (i) or (j)

Declaration that the incidence of tax, interest or any other
amount has not been passed on to any other person where the amount exceeds
Rs. 2 lakhs

(m)

On account of (e), (g), (h), (i) or (j)

Certificate from a Chartered Accountant / Cost Accountant
confirming the declaration in clause (l)

 

 

Grant of Refund

 

17. On verification of the above,
if the Proper Officer is satisfied that the amount of claim is refundable, he
may make an Order accordingly and the refundable amount shall be credited to
the Consumer Welfare Fund, except in following cases (Section 54 (8)):

 

–   Refund is relatable to tax paid on
zero-rated supplies of goods or services or both or on inputs or input services
used in making such zero-rated supplies

 

–  Refund relates to unutilised input tax
credit as referred to in section 54 (3)

 

–    Refund relates to tax paid on supply, which
is not provided either wholly or partially and for which invoice has not been
issued or where refund voucher has been issued

 

–   Refund of tax in pursuance of section 77

 

–    Refund of tax & interest or any other
amount paid by the Applicant, if he has not
passed on the incidence of such tax & interest to any other person

 

–    Any tax or interest borne by such other
class of applicants as the Government may notify (Rule 89 (4A) & (4B) have
been inserted to grant refund in case of deemed exports to supplier/ recipient
subject to certain conditions).

 

Concept of
relevant date

 

18. The concept of “relevant date”
in the context of refund is important as it forms the basis for determining the
eligibility of the refund claim from the view point of limitation. The said
term is defined through Explanation 2 to Section 54 as under:

 

Reasons for Refund

Remarks

Relevant Date

Tax paid on Export of goods

By Sea or Air

Date on which the aircraft/ ship leaves India

 

By Land

Date on which goods pass the frontier

 

By Post

Date of dispatch of goods by Post Office concerned o/s India

 

Deemed export of goods

Date on which return relating to such deemed exports is
furnished

Tax paid on Export of Services

Supply completed prior to receipt of payment

Receipt of payment in convertible exchange

 

Advance received for supply prior to issuance of invoice

Issuance of invoice

Refund of Unutilised input tax credit

As per proviso to section 54 (3)

End of the financial year

Refund on account of

Finalisation of provisional assessment order

Date of adjustment of tax after finalization of assessment
order

 

Judgment/ decree/ order / direction of Appellate Authority /
Tribunal/ Court

Date of communication

Refund claimed by person other than supplier

 

Date of receipt of goods or services

Refund in any other case

 

Date of Payment

 

 

19. Having discussed the basic provisions relating to refund, we shall
now discuss on specific issues relating to claim of refund under the GST
regime.

 

Does the time
limit of 2 years apply in case of refund of balance in Electronic Cash Ledger?

 

20. A possible reason for balance in electronic cash ledger would be
instances of payment of tax under the wrong head / excess payment of tax. To
deal with such situations, section 54 (1) provides that any person claiming
refund of any tax & interest, if paid may make an application in such form
& manner as may be prescribed, before the expiry of two years from the
relevant date. Further, proviso to section 54 (1) provides that the refund of
any balance in electronic cash ledger has to be claimed in accordance with
provisions of section 49 (6) in the return furnished u/s .39 in such manner as
may be prescribed.

 

21. One important distinction in the above provisions is that while the
operative part of section 54 (1) specifically deals with refund of tax &
interest paid, the proviso deals with refund of balance in electronic cash
ledger. This distinction is important because it helps us in dealing with the
question of whether the two-year limit applies to claim refund of balance in
electronic cash ledger or not?

 

22. To answer this question, we will need to refer to the concept of PLA
under Central Excise wherein amounts deposited in PLA were treated as mere
deposits and not actual discharge of tax. In this context, reference to the
decision in the case of Jayshree Tea & Industries Limited vs. CCE,
Kolkata [2005 (190) ELT 106 (Kolkata)] may be relevant wherein the Tribunal
has dealt with the distinction between the amount appropriated towards duty and
amount deposited for payment of duty. The Tribunal held that in the first case,
duty which has been paid to the PLA and appropriated towards liability becomes
property of Government and no person would be entitled to get it back unless
there is provision of law to enable that person to get the duty already
appropriated back. However, for the second case, i.e., amount deposited for
appropriation towards future liability but not appropriated, the said amount
does not become property of Government unless goods are cleared and duty is
levied and therefore, the law of limitation does not apply to such refund
claims.

 

23. Similarly, in the context of GST, making payment in to electronic
cash ledger under GST is also treated as a “deposit” which is evident on a
reading of section 49 (1), which reads as “Every deposit made towards, tax, interest, penalty, fee or any
other amount by a person … …. … shall be credited to the electronic cash ledger
of such person … … …”

 

24. Therefore, a view can be taken that the limitation period may not
apply to balance lying in electronic cash ledger since the same is a deposit
and not in the nature of tax, interest, penalty, etc.

 

Will the above principles be applicable for
refund of pre-deposits made while filing appeal before Appellate Authority /
Tribunals?

25. Sections 107 & 112, which deal with the provisions relating to
Appeal to be filed before Appellate Authority or Appellate Tribunal provide for
pre-deposit of 10% / 20% of the disputed demand before filing of appeal under
the respective sections. The issue that needs consideration is whether the
time-barring principle will apply for such kind of payments, if in future the
matter is decided in favor of the taxable person making the pre-deposit?

 

26. To answer this question, foremost one needs to determine the manner
in which the pre-deposit compliance has been done by the taxable person, i.e.,
whether by debit in the electronic cash ledger / electronic credit ledger? This
is because once the Order from the Appellate Authority / Tribunal is received
and the Order Giving Effect to the same is given, the amounts will be
recredited to the respective cash / credit ledgers from where they were
initially debited.

 

27. Once the said amount forms part of cash ledger, the same shall
partake the character of deposit and hence, the above principles of applicability
of time-barring provisions shall continue to apply. In this regard, one can
also refer to the decision of Bombay HC while dealing with a similar issue in CCE,
Pune I vs. Sandvik Asia Limited [2017 (52) STR 112 (Bombay)] wherein it has
been held that the principles of unjust enrichment and Section 11B do not apply
to refund of amounts deposited in compliance with interim order. Similar view
has been held in the case of CCE, Coimbatore vs. Pricol Limited [2015 (39)
STR 190 Madras]

 

28. However, in cases where the pre-deposit is made through debit in
credit ledger, on receipt of the favorable Order, the pre-deposit amount would
be re-credited to the credit ledger and hence, the above principles shall not
be applicable for such re-credits.

 

What are the
specific issues in the context of filing of refund claim for unutilised input
tax credit balances appearing in electronic credit ledger?

 

29. As discussed earlier, section 54(1) provides for refund of any tax
& interest paid. One subset of the same would be balance lying in
electronic credit ledger, i.e., unutilised input tax credit which is dealt with
in section 54 (3). In the context of such balances, there is a specific
restriction on claim of refund except where the balance has arisen on account of:

–  Zero rated supplies made without payment of
tax

 

– Inverted rate structure, i.e., where the tax
rate applicable on outward supplies is lower than the tax rate applicable on
inward supplies.

 

30. Elaborate process has been prescribed u/r 89 to determine the form
& manner of making application and the amount of refund eligible, which has
been discussed earlier as well. For instance, Rule 89 (4) defines the formula
to be applied for determining the refund amount for zero rated supplies. The
said formula deals with certain terms, which have been defined in the Rules.
The definition has led to various issues which are discussed below.

 

Timing Issues

 

31. The core issue with the formula is the aspect of relevant period.
This is because all the terms, namely Net ITC as well as Turnover figures (both
turnover of zero rated supplies as well as adjusted total turnover) are defined
in the context of refund claim for the relevant period, i.e., the period for
which refund claim has been filed.

 

32. Many a times, there can be a scenario wherein the inward supplies
are received during one particular period prior to the relevant period during
which the outward supplies towards which the refund claim is being filed is
made. Due to this, there is a timing mis-match. Let us try to understand this
issue with the help of following example:

 

Example: ABC Limited is a manufacturer, predominantly exporting its’
manufactured products. They manufacture based on Orders received from
customers. During the period from January to March 2018, they received an
Export Order for INR 100000. They procured the materials for the same in
January for Rs. 60,000 on which GST @ 18% was charged (i.e., Rs. 10,800) and
claimed as credit. The manufacturing process completed in March 2018 and the
goods were exported in the same month. Applying the formula for refund of the
said tax in the month of March 2018, the same shall be determined as:

 

Turnover of Zero-rated
supply, i.e., Rs. 100000   * Net ITC (0) = 0

      
Adjusted Total Turnover, i.e., Rs. 100000                                      

 

33. Similar issue would arise in case refund is filed in January when
the turnover would be zero and hence again, refund amount would continue to be
zero only.

34. In view of the formula mismatch, unless the taxpayer has continuous
exports, there is a possibility of the refund amount reducing on account of
such timing mismatch.

 

35. While the method for calculating the amount of refund eligible is
similar to the method prescribed u/r 5 of CENVAT Credit Rules, 2004, the key
difference is in the determination of the denominator, i.e., Adjusted Total
turnover. While the Turnover of zero rated supply of services is determined on
the basis of the payments realised, adjusted total turnover merely refers to
the turnover of export of service, which would primarily cover the value of
services exported, whether or not payments realised. This is in contrast to the
method adopted u/r 5 of CCR, 2004 wherein it was specifically provided that the
value of export of services, for the purpose of total turnover also shall be
determined based on the payment realisation only.

 

Relevant period

 

36. Another departure from Rule 5 of the CENVAT Credit Rules, 2004 is
in the context of relevant period, or the period for which the refund claim is
being filed. While u/r 5 of the CENVAT Credit Rules, 2004, the refund claim was
to be filed on a quarterly basis, irrespective of the periodicity for filing
returns, under GST, the term “relevant period” has been defined to mean the
period for which the refund claim has been filed. While the term “period” has
not been defined under the GST law, the term ‘tax period’ has been defined to
mean the period for which return is required to be furnished. Therefore, for
taxable persons whose turnover exceeds Rs. 2 crores, refund claim will have to
be filed on a monthly basis while in case of others, depending on the option of
return filing exercised (monthly vs. quarterly), the periodicity of filing
refund claims should be required to be determined. However, on the portal, even
for taxable persons exercising the option to file quarterly returns, the refund
claims are required to be filed on monthly basis only.

 

Is it mandatory to file a refund claim in
case of refund of advances received for provision of services on which tax was
discharged or self-adjustment in returns is permissible?

 

37. Section 31 (3) (d) requires a taxable person to issue a receipt
voucher or any other document as may be prescribed at the time of receipt of
advance payment with respect to supply of goods or services or both. There can
be two outcomes against this advance, namely:

 

–   Supply is made & invoice is issued
against the advance received

 

–   Supply is not made & invoice is not
issued, the advance is refunded for which refund voucher shall be issued as
envisaged in Section 31 (3) (e)

 

38. The issue that arises is how to treat the adjustment of tax paid on
advances and subsequently refunded to the client. This is because Table 11 of
GSTR 1 provides for disclosure of only advances received & advances
adjusted during the tax period. While what is meant by advances adjusted has
not been dealt with specifically, notes to the format of GSTR 1 provides that
Table 11B shall include information for adjustment of tax paid on advances
received and reported in earlier tax period against invoices issued in the
current tax period. However, there is no specific mention of how the instances
covered u/s 31 (3) (e), i.e., refund of advances received before provision of
supply & issuance of invoice will be dealt with. 

 

39. While section 54 (8) (c) provides for refund of tax paid on such
supplies, it is important to note that the process for filing such refund
claims has not been enabled as on date and hence, if the view that
self-adjustment is not permissible for instances where tax was paid on advance
receipt and subsequently refunded, the same will result in blockage of funds in
the absence of proper mechanism with respect to the same.

 

Will refund on account of inverted rate structure be eligible if the
rate of inward input services is higher as compared to the rate on outward
supplies?

40. Proviso to section 54 (3) provides that refund of unutilised input
tax credit where the credit has accumulated on account of an inverted rate
structure, i.e., the rate of tax on inputs being higher that the rate of tax on
output supplies. Rule 89 (5) prescribes the method which shall determine the
refund amount in such cases. The formula prescribed for determining the refund
amount states that net ITC shall mean the credit availed on inputs during the
relevant period. The issue that arises is whether the term “input” used in
section 54 (3) refers the term “input” as defined u/s. 2 (59) or it has to be
read as “input supplies” in the context of “output supplies”?

 

41. This is essential because the formula for output supply covers
outward supplies of both, goods as well as services. Therefore, there is no
apparent logic for considering only the credit claimed on input goods for the
purpose of Net ITC and not input services also.

 

42. A logical argument is that the input referred to in the proviso has
to be read to be in correlation to the output supply. This is because the term
“output supply” has not been defined in the GST law. What is defined is outward
supply. Had it been a case that the proviso used the term “outward supply” and
not “output supply”, a strong ground to say that Net ITC should include inputs
as defined u/s 2 (59) would have been possible.

 

However, with use of words input & output supply, in our view, will
have to be read vis-à-vis each other, i.e., Net ITC should include the
credit availed on both inputs, as well as input services.

 

What will be the
scope of applicability of doctrine of unjustenrichment under GST?

 

43. One important aspect that needs to be analyzed while dealing with
the subject of refund is that the incidence of tax, interest or any other
amount that is being claimed as refund should not be passed on to another
person. This is known as the doctrine of unjust enrichment. The doctrine states
that if a person pays the tax to the Government and passes it on to his
customer by including it in the sales price, he effectively loses nothing. If
this tax is to be later on refunded to him on the ground that it was not
payable itself at first instance, the refund would be an undeserving benefit. This
principle has been exhaustively dealt with by the Hon’ble Supreme Court in many
cases, the landmark being Mafatlal Industries vs. Union of India [1997 (089)
ELT 0247 SC].

 

44. The circumstances under which refund shall be granted under GST, as
governed u/s. 54 (8) of the Act are similar to the provisions prescribed u/s.
11B of the Central Excise Act, 1944. Therefore, the principles of doctrine of
unjust enrichment, as applicable in the context of section 11B of Central
Excise Act, 1944 should continue to apply in the context of GST as well.
Therefore, unless specifically mentioned, the principles of doctrine of unjust
enrichment should not apply in the context of GST as well.   

18 Section 9(1)(v) of the Act – a non-resident, earned interest income on FCCBs issued by an Indian company abroad, entire proceeds of FCCBs had been utilised by Indian company in said country for repayment of an acquisition facility, interest income in question was not liable to tax in India as per exception carved out in section 9(1)(v)(b).

[2018] 94 taxmann.com 118 (Mumbai – Trib.)

Clearwater Capital Partners (Cyprus) Ltd.
vs. DCIT

A.Y.: 2011-12

IT Appeal Nos. : 843 and 1025 (Mum.) of 2016

Date of Order: 2nd May, 2018


Facts

The Taxpayer was a
tax resident of Cyprus. It had invested in FCCB issued by an Indian (“ICo”)
company engaged in the business of wind power generation, carrying on business
both in India and outside India. ICO had utilised the entire proceeds of FCCB
for repayment of funds borrowed for financing acquisition of a foreign company
(“FCo”). During the relevant year, the Taxpayer had received interest and
incentive fee from ICo.

 

The Taxpayer
claimed that since FCCB proceeds were raised and utilised outside India, in
terms of exception carved out in section 9(1)(v)(b)4, interest on
FCCB did not accrue or arise in India.

______________________________________________________________________________

4  
Section 9(1)(v), inter alia, provides that interest payable by a resident to a
non-resident in respect of debt incurred or moneys borrowed and used by
resident for a business carried on outside India by him or for earning any
income from any source outside India by him, is not deemed to accrue or arise
in India.

 

The AO rejected the
claim of the Taxpayer.

 

The DRP, directed
the AO to exclude the interest income received by the Taxpayer from the FCCB
after verifications.

 

Held

–    The entire FCCB proceeds
were utilized by ICo for repayment of funds borrowed for financing acquisition of a FCo.

 

–    If interest is payable by a
resident to a non-resident in respect of any debt incurred or moneys borrowed
and used for the purpose of business or a profession carried on by such person
outside India or for the purpose of making or earning any income from any source
outside India, such interest shall not be deemed to have accrued or arisen in
India.

 

–    Lower authorities had not
rebutted the contention of the Taxpayer that the money borrowed by ICo was used
for business carried on outside India or earning income from source outside
India.

 

–  Accordingly, the view taken by DRP was
correct.

 

–  DRP had
observed that FCCB were issued outside India and the moneys borrowed were
utilized by ICo outside India. Therefore, in view of the exception carved in
section 9(1)(v)(b) of the Act, the interest received on such FCCB by the
Taxpayer from ICo was not chargeable to tax in India.  

 

17 Article 5 of India-Finland DTAA; S. 9(1)(i) of the Act – [Majority view] in absence of PE, income from off-shore supply of equipment, which was installed by WOS of the non-resident under independent contracts from customers for separate remuneration was not taxable in India; negotiation, signing, network planning being preparatory or auxiliary activities, even if carried on from a fixed place did not constitute PE; since none of the parties had acknowledged any interest on delayed payment nor was any such interest paid by the customers, notional intertest could not be charged; – [Minority view] negotiation, signing, network planning were core marketing and core technical support functions vital to business could at least be equated with marketing services rendered by Indian PE for which profit was attributable to PE.

[2018] 94 taxmann.com 111 (Delhi – Trib.)
(SB)

Nokia Networks OY vs. JCIT

A.Ys.: 1997-98 & 1998-99

IT Appeal Nos.: 1963 & 1964 (Delhi) of
2001

Date of Order: 6th June, 2018


Facts

The Taxpayer was a company incorporated in,
and tax resident of, Finland. It was engaged in manufacturing and trading of
telecommunication systems, equipment, hardware and software. In 1994, it
established a LO in India, and in 1995, it established a wholly owned
subsidiary in India (“ICo”). The Taxpayer had entered into contracts for
off-shore supply of equipment. After incorporation of ICo, installation of the
equipment was undertaken by ICo under independent contracts with Indian Telecom
Operators. The Taxpayer did not file return of its income in respect of
off-shore supply contending that there was neither any business connection nor
was there a PE in India and hence, it was not liable to tax in India.

 

The AO completed the assessment holding that
both LO and ICo constituted PE of the Taxpayer. The AO held that 70% of the
revenue from supply of hardware was attributable to PE in India and 30% of the
revenue was attributable to supply of software. On the ground that the software
was licensed to telecom operators, the AO treated the revenue attributable to
supply of software as ‘royalty’ (on gross basis) both, under Article 13 of
India-Finland DTAA and u/s. 9(1)(vi) of the Act. The AO further added notional
interest on the ground that the Taxpayer had provided credit to customers but
had not charged interest.

 

Through successive stages, the matter
reached Delhi High Court, which remanded the matter to Tribunal for
adjudicating on following specific issues:

 

1 Whether having
regard to India-Finland DTAA, the Tribunal’s reasoning in holding that ICo was
a PE of the Taxpayer was right in law?

 

2   Whether the Tribunal was right in law in
holding that a perception of virtual projection of the foreign enterprise in
India resulted in a PE?

 

3   Without prejudice, if the answers to Q.1
& Q.2 were in affirmative, whether any profit was attributable to signing,
network planning and negotiation of offshore supply contracts in India and if
yes, the extent and basis thereof?

 

4   Whether in law the notional interest on
delayed consideration for supply of equipment and licensing of software was
taxable in the hands of the Taxpayer as interest from vendor financing?

 

Held [majority view]

 

1 Whether ICo was a PE under India-Finland
DTAA?

 

(i)  Whether ICo was PE under Article 5(2)?

?    A fixed place PE is
constituted if the business is carried on through
a fixed place of business. The term “through” assumes great significance since
even if the place does not belong to the non-resident but is at his disposal,
it would be his place of business. In Formula One World Championship Ltd vs.
CIT [2017] 394 ITR 80 (SC), the Supreme Court has observed that the
‘disposal test’ is paramount to ascertain existence of fixed place PE.

 

– The Tribunal
observed as follows.

 

(a) Neither AO nor CIT(A) had given any
categorical finding of fixed place PE except mentioning about co-location of
employees and availing of common administrative services.

 

(b) Presence of foreign expatriate employees
of ICo may support the case for a service PE but not fixed place PE. Indeed, in
absence of specific provisions in DTAA, PE would not be constituted.

 

(c) Post-incorporation of ICo, no evidence
of MD of ICo having signed contracts was adduced. Even assuming that he was
acting as representative of, or that he was receiving remuneration from, the
Taxpayer, it would not be relevant for examining fixed place PE.

 

(d) After incorporation of ICo the Taxpayer
had not carried out any other activity except off-shore supply of equipment.
ICo was an independent entity, which had entered into independent contracts and
income earned from such contracts was taxed in India.

 

(e) ICo was providing technical and
marketing support services to the Taxpayer for which it was remunerated at cost
plus 5% and in respect of which the AO had not taken any adverse action
possibly, because it was considered arm’s length remuneration.

 

(f) While administrative activities were
carried out by ICo, the AO had not alluded to any premise or a particular
location having been made available to the Taxpayer. Thus, ICo had not provided
any place ‘at the disposal’ of the Taxpayer.

 

(g) Provision of minor administrative
support services such as telephone, conveyance, etc. cannot form fixed
place PE.

(ii) Whether negotiation, signing,
network planning, etc. created PE?

 

–  The scope of
remand of the High Court was to examine whether signing, networking, planning
and negotiation would constitute PE. Article 5(4) of India-Finland DTAA
specifically excludes preparatory and auxiliary activities from being treated
as PE. The aforementioned activities were in the nature of ‘preparatory or auxiliary’
activities.

 

–  Even if it is
assumed that these activities created some kind of a fixed place, since they
were preparatory or auxiliary in character, that place could not be considered
a PE.

 

(iii) Whether ICo was dependent agent PE
(“DAPE”) under Article 5(5)?

 

–  A DAPE would be constituted if a dependent agent habitually
exercises authority to conclude contracts on behalf of a non-resident.

 

–    The contract for supply of
off-shore equipment was concluded by the Taxpayer outside India. Further, no
activity relating thereto was performed in India. There was nothing on record
to show that ICo had concluded contract on behalf of the Taxpayer.

 

–    To constitute a DAPE, the
activities of the agent should be under instructions, or comprehensive control,
of the non-resident and the agent should not bear any entrepreneurial risk. ICo
neither had authority to conclude supply contract nor any binding contract on
behalf of the Taxpayer. ICo was an independent entity, which had entered into
independent contracts with customers on principal-to-principal basis. ICo was
bearing its own entrepreneurial risk.

 

–   After becoming MD, the
erstwhile representative had not signed any contract for off-shore supply.
Monitoring by the Taxpayer of warranty and guarantee provided by ICo did not
yield any income to the Taxpayer but the income arose to ICo. Such income was
duly taxed in India.

 

–    Accordingly, on facts, the
Taxpayer did not have DAPE under Article 5(5).

 

(iv) Whether ICo
was deemed PE under Article 5(8)?

 

–    Article 5(8) of
India-Finland DTAA specifically provides that control over the subsidiary does
not result in creation of PE. of a non-resident in source state cannot give
rise to PE of the non-resident.

 

–    OECD and UN Model
Conventions also clarify this. Further, in ADIT vs. E Fund IT Solutions
[2017] 399 ITR 34 (SC), Supreme Court has also held accordingly.

 

(v) Whether ICo had ‘business connection’ under
the Act?

 

–    This issue is academic
since the Taxpayer did not have PE in India under India-Finland DTAA.

 

–    In case of the Taxpayer,
Delhi High Court has concluded that LO did not constitute PE, and that there
was no material which could support that LO could be ‘business connection’, of
the Taxpayer. Further, while place of negotiation, place of signing of
agreement or formula acceptance thereof or overall responsibility of the
Taxpayer are relevant circumstances, since the transaction pertains to sale of
goods, the relevant and determinative factor was where the property in goods
passed. However, supply under the agreement was made outside India and property
in goods was also transferred outside India.

 

–    Both marketing (for the
Taxpayer) and installation (for telecom operators) activities were undertaken
by ICo on principal-to-principal basis. For marketing activity, the Taxpayer
had remunerated on cost plus markup basis. Income from both were taxable in
India. Since there was no material change, conclusion of Delhi High Court in
case of LO would also apply in case of ICo.

 

2 Whether ICo was virtual projection in
India of the Taxpayer?

 

–    Concept of ‘virtual
projection’ postulates projection of a non-resident on the soil of the source
country. It is not relevant on a standalone basis.

 

–   If, on facts, a fixed place
is not established and disposal test is not satisfied, then virtual projection
by itself cannot create a PE.

 

3 Whether profit attributable for signing,
network planning, negotiation, etc.?

–    Since nothing was taxable
on account of negotiation, signing, network planning as they were preparatory
or auxiliary activities which were excluded from being treated as PE, question
of attribution of income on account of these activities would not arise.

 

4 
Whether notional interest taxable as interest from vendor finance?

 

–    Income tax is levied on
real income, i.e., on the profits determined on commercial principles. The
revenue had not brought on record that the Taxpayer had charged interest on
delayed payment or that any customer had actually paid such amount. Further,
the Taxpayer had not debited account of any of the customers for such interest.
Also, none of the parties had either acknowledged the debt or any corresponding
liability of the other party to pay such interest. Thus, no actual or
constructive ‘payment’ of interest had taken place.

 

–    Therefore, income which had
neither accrued nor was received by the Taxpayer could not be taxed on notional
basis.

 

Held [minority view]

–    The Taxpayer carried out
entire marketing and administrative support work in India through ICo, at a
fixed place in India and without adequate arm’s length consideration. The
visiting employees of the Taxpayer also used the premises of ICo and carried
out important core business functions from the place of ICo. At no stage the
Taxpayer had submitted details about names and duration of stay of the expatriate
employees who availed such support from ICo.

 

–   ICo was working wholly and
predominantly for the Taxpayer. The Taxpayer had given specific undertaking to
the end-customers of ICo that during the currency of their agreements with ICo,
the Taxpayer will not dilute its equity ownership below 51%.

 

–    All the installation work
generated for ICo was entirely in the control, and at the mercy, of the
Taxpayer. Operational personnel in ICo also included number of expatriates on
deputation, secondment or assignment from the Taxpayer. The role of the
Taxpayer was omnipotent in all the operations of ICo, not only because of the
ownership of ICo but also because of the business module adopted by the
Taxpayer. Installation and other post-sale services rendered by ICo were
complementary to the core business operations of the Taxpayer. ICo, in
substance and in effect, was a proxy of the Taxpayer in performance of
commercial activities. Accordingly, the office of ICo constituted the fixed
place of business through which the business of the Taxpayer was wholly or
partly carried out.

 

–    Since ICo was acting as
proxy and as an agent, the disposal test had to be vis-à-vis ICo and not
the Taxpayer directly. Thus, the Taxpayer carried on the business in India
through a fixed place of business, which was office of ICo. Consequently,
office of ICo was PE of the Taxpayer.

 

–   Negotiation, signing,
network planning are core marketing functions and core support technical
functions which are vital to the business of sale of equipment. These services
can be equated with marketing services rendered by the Taxpayer through its PE
in India. Thus, all the crucial marketing and support functions were rendered
by the Indian PE (i.e., ICo).

 

–   ICo rendered the important
and vital services on a non-arm’s length consideration and without adequate
compensation. Hence, following Rolls Royce plc vs. DCIT [2011] 339 ITR 147
(Del), 35% of the total profits should be attributable to PE.

16 Article 7 of India-UK DTAA; Section. 28(va) of the Act – non-compete fee received by the Applicant was ‘business income’ u/s. 28(va) of the Act; since the Applicant did not have PE in India, non-compete fee was not taxable in India in terms of Article 7 of India-UK DTAA.

[2018] 94 taxmann.com 193 (AAR – New Delhi)

HM Publishers Holdings Ltd., In re

A.A.R. No. 1238 of 2012

Date of Order: 6th June, 2018


Facts

The Applicant was a company incorporated in
UK. The Applicant owned majority equity shares of an Indian Company (“ICo”).
Shares of ICo were listed on stock exchanges in India. The Applicant entered
into a Share Purchase Agreement (“SPA”) with an Indian company for sale of its
shareholding in ICo. Under the SPA, the purchaser agreed to pay the
consideration towards purchase price of shares (INR 37.38 crore), which was
computed on the basis of the price of the shares on the stock exchange and
non-compete fee (INR 9.30 crore). The non-compete fee was to be paid in
consideration of the Applicant not competing with the business of ICo, not
soliciting employees of ICo and generally not disclosing any information about
ICo.

 

Before the AAR, the Applicant contended
that: the non-compete fee received by it from the purchaser was in the nature
of business income u/s. 28(va) of the Act2; and since it did not
have any PE in India, such income was not taxable in terms of Article 7 of
India-UK DTAA3.

_________________________________________________________________

2  
The Applicant relied on the decision in CIT vs. Chemtech Laboratories Ltd [Tax
case appeal No 1492 of 2007] (Madras)

3    The Applicant relied on the decision in Trans
Global PLC vs. DIT [2016] 158 ITD 230 (Kolkata – Trib)

 

Held

 

(i) Whether non-compete fee covered u/s
28(va)?

 

– The Applicant
was a shareholder of ICo but did not have any legally enforceable right to
carry on business which could be treated as ‘capital asset’ u/s. 2(14) of the
Act. Hence, question of transfer of right to carry on business did not arise.

 

– The fee
received by the Applicant was for a negative covenant (i.e., not to compete
with ICo) and not for transfer of a right to carry on business to the
purchaser.

– Since there was
no right, there was no extinguishment of right in a capital asset. Hence,
question of ‘transfer’ u/s. 2(47)(ii) of the Act did not arise. The term ‘extinguishment’ denotes
permanent destruction. The negative covenant was for a period of three years.
Thus, the right of the Applicant to carry on business was restricted only for
three years but was not permanently destroyed. Accordingly, such restriction
could not be said to be extinguishment. Consequently, there was no income
chargeable under the head ‘Capital Gains’.

 

–  Section 28(va)
is attracted in case where consideration is for agreeing not to carry on any
activity in relation to any business. It is not required that the recipient
should already be carrying on business. Accordingly, it is irrelevant whether
the recipient was carrying on the same business or a different business than
that of the payer.

 

–  Therefore,
non-compete fee received by the Applicant was taxable as business income u/s.
28(va) of the Act.

 

(ii) Whether non-compete fee taxable in
India?

 

– The Applicant
did not have any PE in India. Hence, in terms of Article 7 of India-UK DTAA,
the business income (i.e., non-compete fee) of the Applicant will not be
taxable in India.   

15 Articles 5, 7, 12 of India-Luxembourg DTAA; Section 9(1)(i) of the Act – on facts, absolute control of non-resident over operations and management constituted hotel in India as a fixed place PE; hence, income earned by non-resident was attributable to PE and taxable as ‘business income’ u/s. 9(1)(i) of the Act.

[2018] 94 taxmann.com 23 (AAR – New Delhi)

FRS Hotel Group (Lux) S.a.r.l. In re

A.A.R. No. 1010 of 2010

Date of Order: 24th May, 2018


Facts

The 
Applicant  was  a company incorporated in Luxembourg. It was
a member-company of a hospitality group engaged in development, operation and
management of chain of hotels, resorts and branded residences. The Applicant
provided management and operation services for hotels, of which, majority were
owned by third parties. The hotels were managed under different brands which
were licensed by one of the member-companies of the group. The Applicant was engaged by an Indian Company (“ICo”) for development and
operation of hotel of ICo. For this purpose, the Applicant and ICo entered into
five agreements for provision of services. ICo compensated the Applicant for
these services, either by way of, lumpsum payment (for technical services), or
percentage of revenue/market fee/construction costs.

 

Before the AAR, the Applicant raised limited
issue in respect of compensation under Global Reservation Services (“GRS”)
agreement (one of the five agreements), as to whether the receipt was
chargeable to tax as FTS or Royalty?

 

The tax authority contended that the primary
issue was whether the hotel in India constituted a PE of Applicant and
consequently, whether all income streams, including GRS, was business income.
The Applicant contended that since the question raised was limited to FTS or
Royalty, AAR should not adjudicate on the existence of PE.

 

Held

 

(i) Power of AAR to deal with issues other
than questions raised

 

–  The activity of
the Applicant is integrated and cannot be split into one or the other. The five
agreements are part of a wholesome arrangement. Hence, even though the issue
raised was on taxability of income under GRS agreement, it cannot be viewed on
standalone basis.

 

–  Rule 12 of the
AAR (Procedure) Rules, 1996 provides that the AAR “shall at its discretion
considered all aspects of the questions set forth”. Hence, ruling only on
certain income stream and leaving other income streams open for regular
assessment will render the exercise of approaching AAR futile.

 

(ii) Constitution of fixed place PE

 

–  In Formula
One World Championship Ltd vs. CIT [2017] 394 ITR 80 (SC), it is held that
fulfilment of following three conditions constitutes a fixed place PE:

 

(a)  Existence of a fixed place.

 

(b)  Such fixed place being at the disposal of
non-resident.

 

(c)  Non-resident carrying on its business, wholly
or partly, through such fixed place.

 

–    In the case of the
Applicant:

 

(a)  The hotel was a fixed place.

 

(b)  Perusal of various clauses of all the
agreements shows that the hotel was at the disposal of the Applicant. After
completion of the hotel, its operation and management was not only the
responsibility of the Applicant but ICo had undertaken that it will not
interfere in exercise of exclusive authority of the Applicant over such
operation and management. Every operational right vested in the Applicant and
ICo was even barred from directly contacting any hotel staff. Core functions
such as sales, marketing, reservation, etc. were out sourced to the
Applicant.

 

(c)  The business of the Applicant was operation
and management of the hotel and it had earned income through the different
agreements. The Applicant was carrying on all the activities from the hotel.
The relationship between the Applicant and ICo was that of
principal-to-principal and not principal-to-agent.

 

– Since all the
three conditions were fulfilled in case of the Applicant, hotel in India
constituted fixed place PE of
the Applicant.

 

(iii) 
Whether GRS income was FTS or Royalty?

 

– Hotel in India
constituted fixed place PE of the Applicant. The income under the agreements
was attributable to the fixed place PE of the Applicant. Since such income will
be taxable as ‘business profits’, the question whether it can be characterized
as FTS or Royalty is academic.

 

–  Even assuming
that it is characterized as FTS or royalty, having regard to Article 12(4) of
India-Luxembourg DTAA, it would be taxable as ‘business profits’ under Article
7.

 

–  Consequently,
provisions of section 9(1)(i) of the Act will apply.

14 Article 5, 7 of India-Belgium DTAA – Since the Applicant was a not-for-profit organization undertaking activities only for the benefit of its members, on the doctrine of mutuality, membership fee and contribution received from members was not taxable in India; since the Applicant was not carrying on business, question of LO constituting a PE in India could not arise under India-Belgium DTAA.

[2018] 94 taxmann.com 27 (AAR – New Delhi)

International Zinc Association, In re

A.A.R. No. 1319 of 2012

Date of Order: 24th May, 2018


Facts

The Applicant was a company incorporated in
Belgium, which was registered as an International Non-Profit Association. It
was a tax resident of Belgium. The Applicant helped to sustain long term global
demand for Zinc. The Applicant had obtained permission of RBI for establishing
a Liaison Office (“LO”) in India for promotion of uses of Zinc. The Applicant
received membership fee and contribution from members which were tax resident
in India.

 

Before the AAR, the Applicant raised the
following questions:

 

(i) Whether membership
fee and contribution received by the Applicant from its Indian members were
liable to tax in India under India-Belgium DTAA?

 

(ii) Whether LO
proposed to be established in India by the Applicant was liable to tax in India
under India-Belgium DTAA?

 

Held

– The Applicant
was hosting information of members on its website, publishing various material,
organising conferences, representing its members, etc. These activities
were not undertaken for deriving any profit for the Applicant and were undertaken
for the benefit of all members. They were performed in fulfilment of its
objects. Hence, they were not in the nature of ‘specific services’ as
contemplated in section 28(iii) of the Act.

 

– The LO was set
up on not-for-profit basis. The surplus that may be generated at the end of the
year cannot acquire the character of profit as contemplated under the Act
because the activities of the Applicant were not in the nature of business and
the surplus was to be utilised only for the objects of the Applicant. The
surplus was not to be distributed to the members. Accordingly, section 28(iii)
of the Act was not attracted. This view was also supported by the decision in CIT
vs. South Indian Films Chamber of Commerce [1981] 129 ITR 22 (Madras).

 

– The LO incurred
expenditure for organizing various events for which it did not charge any fee.
LO collected sponsorship fee only in case of large events and that too with
prior approval of RBI. Such fee was utilised for organizing the event without
the Applicant making any profit. The facts in CIT vs. Standing Conference of
Public Enterprises [2009] 319 ITR 179 (Delhi)1  squarely applied in case of the Applicant.
Thus, the Applicant cannot be said to have violated the doctrine of mutuality.

________________________________________________________

1  
The Supreme Court dismissed special Leave Petition of the revenue. Hence, the
decision of Delhi High Court stands affirmed.

 

–  In ICAI vs.
DCIT [2013] 358 ITR 91 (Delhi) it was held that the purpose and the
dominant object for which an institution carries on its activities is material
to determine whether the activities constitute business or not. The object of
the Applicant is primarily to serve its members. Hence, merely because of
receipts from some non-members activities of the Applicant cannot be termed as
business. No clause of the Article of Association of Applicant indicated that
the Applicant intended, either to carry on any business or to provide any
services to non-members. Further, in case of dissolution of the Applicant, the
surplus was to be handed over to another non-profit-organization and was not to
be distributed to members. The test of mutuality is satisfied if members agree
and exercise their right of disposal of surplus in mutually agreed manner.

 

–  Under Article 5
of India-Belgium DTAA, a PE is constituted if there is a fixed place of
business and the business of enterprise is wholly or partly carried on through
that fixed place. Since the Applicant was operating on the principle of
mutuality and was not set up for doing business or earning profit, the question
of the LO constituting a PE could not arise since there was no business.

 

– Accordingly,
membership fee and contribution received by the Applicant from its members were
not liable to tax in India, and the LO proposed to be established in India was
not liable to tax in India.

 

7 Section 40A(3) – Cash payments made out of business expediency allowed as expenditure.

A. Daga Royal
Arts vs. ITO

Members:  Vijay Pal Rao (J. M.) & Vikram Singh
Yadav (A. M)

ITA No.:
1065/JP/2016

A.Y.:
2013-14.  Dated : 15th May,
2018

Counsel for
Assessee / Revenue:  Rajeev Sogani / J.
C. Kulhari



Facts

During the year
under consideration, the assessee firm, the real estate developer, had
purchased 26 pieces of plot of land from various persons for a total
consideration of Rs. 2.46 crore. Out of which, payment amounting to Rs. 1.72
crore was made in cash to various persons. 
Cash payments were justified by the assessee on the ground that the
sellers were new to the assessee and refused to accept payment by cheque. The
assessee could have lost the land deals if the assessee had insisted on cheque
payment. However, according to the AO, the case of the assessee did not fall in
any of the sub-clauses of Rule 6DD and hence, he disallowed the sum of Rs. 1.72
crore paid in cash u/s. 40A(3). On appeal, the CIT(A) confirmed the order of
the AO.

 

Before the
Tribunal, the revenue justified the orders of the lower authorities and
submitted that since the matter didn’t fall in any of the exceptions provided
in Rule 6DD, the disallowance had been rightly made u/s. 40A(3).

 

Held

The Tribunal
noted the following undisputed facts:

–   Identity of the persons from whom the
purchases had been made, genuineness of the transactions of purchase of various
plots of land and payment in cash were evidenced by the registered sale deeds
and there was no dispute raised by the Revenue either during the assessment
proceedings or before the Tribunal.

–   Only at the insistence of the specific
sellers, the assessee had made cash payment and in case of other sellers, the
payment had been made by cheque. This, according to the Tribunal, established
that the assessee had business expediency under which it had to make payment in
cash and in absence of which, the transactions could not had been completed.

–   The source of cash payments was clearly
identifiable in form of the withdrawals from the assessee’s bank accounts and
the said details were submitted before the lower authorities and have not been
disputed by them.

 

Further, the Tribunal referred to the following observations of the Apex
court in the case of Attar Singh Gurmukh Singh vs. ITO (59 taxmann.com 11):

 

“The terms of section 40A(3) are not absolute.
Consideration of business expediency and other relevant factors are not
excluded. The genuine and bona fide transactions are not taken out of the sweep
of the section. It is open to the assessee to furnish to the satisfaction of
the Assessing Officer the circumstances under which the payment in the manner
prescribed in section 40A(3) was not practicable or would have caused genuine
difficulty to the payee.”

 

Thus, according to the Tribunal, so far as consideration of business
expediency and other relevant factors were concerned, the same continue to be
relevant factors, which need to be considered and taken into account while
determining the exceptions to the disallowance as contemplated u/s. 40A(3), so
long as the intention of the legislature was not violated.

 

According to the Tribunal, the amendment to Rule 6DD(j) by notification
dated 10.10.2008, providing for an exception only in a scenario where the
payment was required to be made on a day on which banks were closed on account
of holiday or strike – also do not change the above legal proposition laid down
by the Supreme Court regarding consideration of business expediency and other
relevant factors. 

 

According to the Tribunal, the above view finds resonance in decisions
of various authorities discussed below:

 

–   In the case of Harshila Chordia vs. ITO
(298 ITR 349) the Rajasthan High Court observed that as per the Board
circular dated 31.05.1977 [108 ITR (St.) 8], rule 6DD(j) has to be liberally
construed and ordinarily where the genuineness of the transaction and the
payment and the identity of the receiver is established, the requirement of
rule 6DD(j) must be deemed to have been satisfied and the rigors of section
40A(3) cannot be invoked. 

–   In Anupam Tele Services (362 ITR 92),
the Gujarat High Court overruled the decision of the Tribunal disallowing cash
payments u/s. 40A(3) since according to it, the Tribunal erred in not
considering ‘business expediencies’ when the assessee was compelled to make
cash payments.

–   In Ajmer Food Products Pvt. Ltd. vs.JCIT
[ITA No. 625/JP/14] where the genuineness of the transaction as well as the
identity of the payee were not disputed and the assessee was able to establish
business expediency, the co-ordinate bench of the Tribunal, following the above
decisions of the Gujarat High Court and of the Rajasthan High Court deleted the
addition made by the lower authorities u/s. 40A(3).

–   In the case of Gurdas Garg vs. CIT(A) (63
taxmann.com 289) where the facts of the case were pari materia to the
assessee’s case, the Punjab and Haryana high court allowed the assessee’s
appeal.

 

Further, the decisions in the following cases were also relied on by the
Tribunal:

–  M/s. Dhuri Wine vs. DCIT (ITA No. 1155
/ Chd / 2013 & others dated 09.10.2015);

–  Rakesh Kumar vs. ACIT (ITA No. 102 /
Asr / 2014 dated 09.03.2016);

–  ACE India Abodes Limited (Appeal No. 45/2012
dated 11.09.2017);

 

Taking into
account the facts and circumstances of the case and following the legal proposition
laid down by the various Courts and Coordinate Benches discussed above, the
Tribunal held that the intent and the purpose for which section 40A(3) has been
brought on the statute books has been clearly satisfied in the instant case.
Therefore, being a case of genuine business transaction, no disallowance is
called for.

6 Section 28 – Two properties sold by a builder within a short span of time in an industrial park developed by it at different rates cannot be a ground for presuming that the assessee has received ‘on money’.

Shah Realtors
vs. ACIT

Members: B. R.
Baskaran (A M) and Pawan Singh (J M)

ITA No.:
2656/Mum/2016

A.Y.:
2012-13.  Dated: 25th May,
2018

Counsel for
Assessee / Revenue: Dr. K. Sivaram and Sashank Dandu / Suman Kumar

Facts

The assessee is
a partnership firm, carrying on business as 
builder and developer.  During the
previous year relevant to the assessment year, the assessee sold various
buildings/ galas in the industrial park developed by it.  The AO observed variations in the selling
rates of two buildings viz., Rs. 1,948 in building No. 10 and Rs. 5,025 in
building No.3. He concluded that the assesse had taken ‘on money’. Accordingly,
he made addition of Rs.2.52 crore. On appeal, the CIT(A) confirmed the order of
the AO. 

 

Before the
Tribunal, the revenue justified the orders of the lower authorities and
submitted that there was about 75% difference in the rates of building No. 3
and 10 and the assessee failed to substantiate the reason when both the
buildings were sold within a short span of time.  It also relied on the decision of CIT vs.
Diamond Investments & Properties in ITA No.5537/M/2009 dated 29.07.2010
and the decision of the Supreme Court in Diamond Investment & Properties
vs. ITO [2017] 81 Taxmann.com 40.

 

Held

The Tribunal
noted that building No. 3, which according to the AO was sold at a higher rate,
was already in possession of the buyer (on leave and licence basis) and plant
and machinery were already fastened to earth. Besides the assessee also handed
over possession of approximately 12,000 sq. ft. of adjoining  plot for exclusive use by the said buyer.
Therefore, taking the advantage of situation, the said building was sold to
buyer at a lump-sum price of Rs. 4.25 crore. 

 

The Tribunal
further noted that the assessee had sold the Building No.3 & 10 at a rate
higher than the stamp value rate.  The AO
on his suspicion about the “on money” made the addition on the basis of
variation of rates between two buyers. According to the Tribunal, the onus was
upon the AO to prove that the assessee had received “on money” on sale of
building. He made the addition without any evidence in his possession.  No enquiry was made of the purchaser of
building no. 10 which was sold at a lower rate, which according to the Tribunal,
was necessary. 

 

The tribunal further
observed that, when the AO had required the assessee to show-cause as to why
there was a difference between two transactions and when the assessee had
offered an explanation, no addition could be made simply discarding his
explanation. There must be evidence to show that the explanation given by the
assessee was not correct. It is settled law that no addition can be made on
hypothetical basis or presuming a higher sale price by simply rejecting the
contention without cogent reason. 
According to it, the case law relied by AO in ITO vs. Diamond
Investment and Properties was not applicable, since in that case the flats
were sold to the related parties at lower price than the price charged to the
other parties.  The Tribunal also
referred to a decision of the coordinate bench of Tribunal in Neelkamal
Realtor & Erectors India Pvt. Ltd. 38 taxmann.com 195 where where the
assessee had offered an explanation for charging lower price in respect of some
of the flats sold by it and AO without controverting such explanation had made
addition to income of assessee by applying the rate at which another flat was
sold by it.  It was held that the AO was
not justified in his action.  The Tribunal
also referred to a decision of the Supreme Court in the case of K.P. Varghese
vs. ITO [1981] 131 ITR 597 where it was emphasised that the burden of
proving an understatement or concealment was on the Revenue.  In the result, the appeal of the assessee was
allowed.

 

14 Section 56(2)(vii)(b) – The provisions of section 56(2)(vii)(b) are applicable to only those transactions which are entered into on or after 1.10.2009.

[2018] 94 taxmann.com 39 (Nagpur-Trib.)

Shailendra Kamalkishore Jaiswal vs. ACIT

ITA No.: 18/Nag/2015

A.Y.: 2010-11.                                                    

Dated: 11th May, 2018.


FACTS

For assessment year
2010-11, the assessee, engaged in business of trading in country liquor, filed
his return of income on 31.3.2011 declaring therein a total income of Rs.
32,70,730.  The assessee is also a
director of M/s Infratech Real Estate Pvt. Ltd. 
The Assessing Officer (AO) obtained information that the assessee has
purchased an immovable property for a consideration of Rs.48,57,000. 

 

The AO asked the
assessee to furnish details in respect of this transaction and also made
inquiry with the office of the Sub-Registrar. 
From the submissions and the inquiry, the AO observed that on 6th
June, 2009, the assessee has purchased a plot of land from Infratech Real
Estate Pvt. Ltd. for a consideration of Rs. 48,57,000. The registered sale deed
stated that the consideration was paid vide cheque no. 573883 drawn on Canara
Bank, Badkas Chowk, Nagpur. However, the transaction was not recorded either in
the books of the assessee nor in the books of Infratech Real Estate Pvt. Ltd.

 

In the course of
assessment proceedings, the assessee submitted that Infratech Real Estate Pvt.
Ltd. needed finance and on approaching the finance company, Infratech Real
Estate Pvt. Ltd. was informed that the finance company would not be able to
sanction more than Rs. 1 crore in single name and therefore, Infratech Real
Estate Pvt. Ltd. had transferred the plot of land in the name of the assessee
for Rs. 48,57,000.  Loan obtained by the
assessee from the finance company was transferred to Infratech Real Estate Pvt.
Ltd.  The cheque issued to them was not
encashed by them.  It was contended that
the property is not received without consideration. Not satisfied with the
explanations furnished by the assessee, the AO made an addition of Rs.
48,57,000 by invoking the provisions of section 56(2)(vii)(b) of the Act.

 

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

At the outset, the
Tribunal noted that the addition in this case has been made u/s. 56(2)(vii)(b)
of the Act. It held that the provisions of section 56(2)(vii)(b) of the Act bring
into the ambit of income from other sources, stamp duty value of an immovable
property, to the transferee, which is received without consideration. This was
brought into statute book by Finance Act, 2010, w.e.f. 1st October
2009. Hence, prior to this date such transactions were not coming under income
u/s. 2(24) of the Act. 

 

It observed that,
it is evident that the above said provisions of the Act are applicable to
transactions which are entered into after 1st October 2009. It also
noted that Circular no.5/2010 issued by the CBDT clearly mentions that “these
amendments have been made applicable w.e.f. 1st October 2009 and
will accordingly apply for transaction undertaken on/or after such date“.
The Tribunal held that from the above provisions of law and CBDT circular, it
is clear that transfer of immovable property without consideration will be
taxable in the hands of transferee if the transaction took place after 1st
October 2009. There was no provision of law to tax such transaction prior to 1st
October 2009.

 

The impugned
transaction was entered into on 6th June 2009, as per registered
sale deed. Hence, there is no dispute that the impugned transaction is not hit
by the provisions of section 52(6)(vii)(b) of the Act. It is settled law that
CBDT circulars are binding upon Revenue authorities. It observed that no
contrary decision has been brought to its notice that the said amendment is
applicable retrospectively.

 

The Tribunal did
not adjudicate the other limbs of argument canvassed by the assessee since it
held that the assessee succeeds on this argument itself. The Tribunal set aside
the order of the CIT(A) and decided the issue in favour of the assessee.

 

The appeal filed by the assessee was
allowed.

13 Section 14A – Assessee having furnished details showing that its own funds were sufficient to cover the investments in shares and securities, no disallowance u/s. 14A was called for, more so when no objective satisfaction was recorded by AO before invoking the provisions of section 14A

[2018] 192 TTJ (Mumbai) 377
Bennett Coleman & Co. Ltd. vs. ACIT
ITA NO. : 3298/MUM/2012
A. Y. : 2008-09
Dated : 8th January, 2018

FACTS

–   During the A.Y. 2008-09,
assessee earned an exempt dividend income of Rs.15.68 crore from investments in
shares and securities. The company had also made long term capital gain of
Rs.51.22 crore on sale of equity shares and equity oriented mutual funds. The
dividend income and long term capital gains had been claimed as exempt from
income tax u/s. 10(34) and 10(38) of the Act respectively.

 

–   The AO held that assessee
had incurred interest expenditure and had not given exact details of the
sources of the investments in shares and mutual funds. The AO concluded that it
could not be ruled out that part of the interest incurred had a proximate
connection with the investments in tax free securities. Therefore, the AO made
the disallowance u/s. 14A.

 

–   This disallowance was
contested in an appeal before CIT(A) who upheld the disallowance.

 

–  Before the Tribunal, it was
contended that the assessee did not have any borrowings till 31-03-2006 as per
the audited balance sheet. The assessee had surplus own fund which could be
verified from the balance sheet. The comparative chart of assessee’s own funds
vis-à-vis investments right from 31-3-2006 to 31-3-2008 showed that the
assessee had sufficient interest free own funds to make investments in tax free
income yielding securities. 

 

HELD

–  The Tribunal noted that the
assessee had produced the chart showing the summary of source and application
of funds before the Assessing Officer. The assessee had replied to show cause
notice issued by the Assessing Officer and furnished details that its own funds
over the years were sufficient to cover the investments in the shares and
securities yielding exempt income.

 

–   The borrowings of the
assessee-company were utilised for other business requirements and not for
making investments. The entire interest expenditure incurred on borrowing fund
had been offered to tax.

 

–   No objective satisfaction
had been recorded by the Assessing Officer before invoking the provisions of
section 14A. It was necessary for the Assessing Officer to give opportunity to
the assessee to show cause as to why Rule 8D should not be invoked. Assessee
had placed on record all the relevant facts and it had also given the detailed
working of the disallowance voluntarily made for earning the exempt income in
the return of income.

 

–  The assessee had claimed
that it had sufficient funds to cover investments in tax free securities, which
fact was established by the financial audited report for various assessment
years. The AO had also recorded that assessee’s own funds were far more than
the investments in shares and securities yielding tax free income.

 

–  The Tribunal directed AO to
delete the disallowance made u/s. 14A.

12 Section 45 read with section 28(i) – Where assessee sold a property devolved on him after death of his father as a consequence of automatic dissolution of partnership firm in which his father was a partner, since there was nothing to suggest that assessee had undertaken any business activity, profit arising from sale of same was not taxable as business income.

[2018] 169 ITD 693 (Mumbai – Trib.)

Balkrishna P. Wadhwan vs. DCIT

ITA NO. : 5414 (MUM.) OF 2015

A.Y. : 2010-2011

Dated: 28th February, 2018


FACTS

–   During relevant year,
assessee had shown income under the head long-term capital gain on sale of an
immovable property. The property sold had devolved upon the assessee after the
death of his father as a consequence of automatic dissolution of the
partnership firm, in which his father was a partner.

 

–    The AO took a view that
since the assessee could not furnish the purchase and sale agreements of the
property in question, he was unable to verify the long term capital gain
declared by the assessee. For this reason, the AO considered the consideration
as ‘income from other sources’ and not as a long term capital gain.

 

–    Before the CIT(A), assessee
furnished the copies of the purchase and sale agreements of the property. On
that basis, the CIT (A) concluded that the consideration was received by the
assessee on sale of an immovable property, but according to him, the same was
not a ‘capital asset’. Therefore, he disagreed with the assessee that the
profit on sale of such property was assessable under the head ‘capital gain’.
Instead, CIT (A) concluded that the profit on sale of property was assessable
as ‘business income’.

 

–    The other three plots were
sold by the assessee in A.Y. 2008-09 and the gain arising therefrom was
declared as capital gain, and the same had also been accepted by the AO.

 

HELD

–    The material on record
showed that during the year under consideration, the assessee had sold a plot
of land admeasuring 966.40 sq. mtrs. for a consideration of Rs. 3.75 crore. The
material led by the assessee also revealed that the plot of land sold during
the year was a part of the four plots, which admeasured in total 4648.70 sq.
mtrs.

 

–    The Tribunal noted that the
share of assessee’s father devolved on his wife, two sons and four daughters,
and it was only by way of deed of release, that the assessee obtained complete
ownership of the plot of land from the other co-inheritors.

 

–   It was found that neither
the assessee had declared income from any business and nor any income under the
head ‘business’ had been determined by the AO. The assessee was engaged in the
business of dealing in lands, and the sources of income detailed in the return
of income were on account of salaries, capital gain and income from other
sources.

 

–   The basis for the CIT(A) to
treat the impugned plot of land as ‘stock-in-trade’ is the fact that the
property devolved on the assessee from the erstwhile partnership firm, where
assessee’s father was a partner. The property was acquired by the partnership
firm in 1972 and assessee’s father died in February, 1987. As per the CIT(A),
the final accounts of the erstwhile partnership firm were not available for
examination, therefore, the manner in which the impugned plot of land was
accounted for i.e. whether as capital asset or not, could not be verified.

 

–  The CIT(A) proceeded to
presume that the land was held by the erstwhile partnership firm as a ‘business
asset for the purpose of its business’. Apparently, it is nobody’s case that
upon dissolution of the erstwhile partnership firm, its business devolved on to
the assesse.

 

The fact is that
only the land devolved on the assessee. So far as the assessee was concerned,
there was nothing to establish that the same had been held by him for the
purpose of his business so as to be construed as stock-in-trade. In A.Y.
2008-09, the land devolved on the assessee from his father had already been
accepted as a ‘capital asset’. Therefore, there was no justification to treat
the plot of land in question as ‘stock-in-trade’ and the assessee was justified
in treating the gain on sale of the plot to be assessable under the head
‘capital gain’.

11 Section 32 read with section 43(3) – Depreciation – Assessee being in the business of manufacture and sale of soft drinks and required to supply the product to far off places in chilled condition. Visicoolers purchased by it and installed at the site of distributors to keep the product in cold saleable condition was entitled for additional depreciation.

[2017] 192 TTJ (Kol) 361

DCIT vs. Bengal Beverages (P) Ltd.

ITA NO : 1218/Kol/2015

A.Y. : 2010-11

Dated: 6th October, 2017


FACTS

–    The assessee company was
engaged in the business of manufacture of soft drinks, generation of
electricity through wind mill and manufacture of PET bottles for packing of
beverages. The assessee had installed visicoolers at distributors premises so
as to deliver product to ultimate consumer in its consumable form, i.e.,
chilled form. The assessee claimed additional depreciation on Visicooler.

 

–    The AO disallowed the claim
of additional depreciation on the ground that these Visicoolers were kept at
distributors premises and not at the factory premises of the assessee company.
The assessee submitted before the AO that Visicoolers were required to be
installed at the delivery point to deliver the product to the ultimate consumer
in chilled form, therefore these were part of assessee’s plant. However, the AO
rejected the assessee’s contention and held that assessee was not carrying out
manufacturing activity on the product of the retailer at retailer’s premises
and merely chilling of aerated water could not be termed as manufacturing
activity and even that chilling job was the activity of the retailer and not of
the assessee.

 

–    Aggrieved by the AO’s order
the assessee preferred an appeal before CIT(A). The CIT(A) deleted the addition
made by AO. The assessee’s contention that usage of visicooler at the
distributor’s premises so as to ensure that the drink is served ‘cold’ to the
ultimate consumer tantamounts to usage in the course and for the purposes of
business, was upheld by CIT(A).

 

HELD

–     The Tribunal held that the
benefit of additional depreciation is available to an assessee engaged in the
business of manufacture of article or thing. It is therefore clear that the
additional deprecation is available only to those assessees who manufacturer,
on the cost of plant & machinery. Additional depreciation allowance is not
restricted to plant & machinery used for manufacture or which has first
degree nexus with manufacture of article or thing. The condition laid down in
section 32(1)(iia) is that if the assessee is engaged in manufacture of article
or thing then it is entitled to additional depreciation on the amount of
additions to plant & machinery provided the items of addition do not fall
under any of the exceptions provided in clauses (A) to (D) of the proviso. ln
this case, the assessee was engaged in the business of manufacture of cold
drinks. This fact had not been disputed by the AO. Therefore, the assessee was
legally entitled to avail the benefit of additional depreciation u/s. 32(1)(iia).

 

–    The “visicooler”
is a “plant & machinery”. The said item falls within the category
of “plant & machinery” as laid down in the I.T. Rules, 1962. The
“visicooler” also does not fall within the exceptions provided in
clauses (A) to (D) of the proviso to section 32(1)(iia).

 

–    In the result, the appeal
filed by the Revenue was dismissed.

 

10 Section 45 – Capital gains – Settlement of accounts of partners on their retirement, and payment of cash by firm to retiring partners after revaluation of firm’s assets did not attract section 45(4) – there could be no charge of capital gains on assessee firm in such a case.

[2018] 193 TTJ (Mumbai) 8

Mahul Construction Corporation vs. ITO

ITA NO. : 2784/MUM/2017

A. Y. : 2009-10

Dated: 24th November, 2017


FACTS

–   The assessee firm was
engaged in the business of construction and was a builder and developer. This
firm vide an agreement acquired development rights over a piece of land for a
total consideration of Rs.4.67 crore. Subsequently, this partnership deed was
modified and new partners were inducted.

 

–    Subsequently, vide deed of
retirement & reconstitution, three partners retired from the partnership
firm and took the amount credited to their accounts, including surplus on
account of revaluation of asset.

 

–   The AO held that the
assessee firm had not carried out any development work till 1.4.2008.
Therefore, land was a capital asset and not stock-in-trade, and payment of
cash/bank balance by the firm for settlement of retiring partner’s revalued
capital balances amounted to distribution of capital asset as contemplated in
section 45(4).

 

–   Aggrieved by the assessment
order, the assessee preferred an appeal to the CIT(A). The CIT(A) confirmed the
action of the AO on both the issues by holding that the land was a capital
asset and not stock-in-trade, and
also that the amount distributed was taxable u/s.  45(4).

 

HELD

–    The Retiring partners
merely retired from the partnership firm without any distribution of assets of
the firm amongst the original and new incoming partners. Since, the
reconstituted firm consisted of 3 old partners and 1 new partner, it was not a
case where firm with erstwhile partners was taken over by new partners only. It
was not a case of distributing capital assets amongst the partners at the time
of retirement and therefore provisions of section 45(4) were not applicable.

 

–   It could not be inferred
that by crediting the surplus on revaluation to Capital account of 4 Continuing
Partners and allowing the 3 Retiring Partners to take equivalent cash
subsequently, amounted to distribution of rights by the Continuing Partners to the
Retiring Partners. Till the accounts are settled and the residue/surplus is not
distributed amongst the partners, no partner can claim any share in such assets
of the partnership firm. The entitlement of right in the assets/ property of
the partnership firm arises only on dissolution. While the firm is subsisting,
there cannot be any transfer of rights in the assets of the firm by any or all
partners amongst themselves because during subsistence of partnership, the firm
and partners do not exist separately. Therefore, it was not a case of
distributing capital assets amongst the partners at the time of retirement and,
therefore, provisions of section 45(4) were not applicable.

–    The AO wanted to tax the
amount credited in capital account of retiring as well as continuing partners u/s. 45(4). So far as amount credited to capital account of retiring partners
is concerned, notwithstanding the fact that there is no distribution by firm to
retiring partners, the transferor and transferee are like two sides of the same
coin. The capital gain is chargeable only on the transferor, and not on the
transferee.


–   In this case, the
transferor is the partners who on their retirement assign their rights in the
assets of the firm, and in lieu the firm pays the retiring partners the money
lying in their capital account. Hence, it is the firm and its continuing
partners who have acquired the rights of the retiring partners in the assets of
the firm by paying them lump sum amount on their retirement. So it cannot be
said that the firm is transferring any right in capital asset to the retiring
partner, rather it is the retiring partner who is transferring the rights in
capital assets in favour of continuing partners.

 

–   Accordingly, the assessee
firm was not liable to capital gains on the above transaction.


36 Recovery of tax – Attachment of bank account and withdrawal of amount from bank during pendency of appeal – Action without due procedure – Stay of recovery proceedings granted pending appeal – Revenue directed to refund 85% of the amount recovered

Sunflower
Broking Pvt. Ltd. vs. Dy. CIT; 403 ITR 305 (Guj); Date of Order: 08th
July, 2017:

A.
Y.: 2014-15:

Sections
143(3), 156 and 221 of ITA 1961 and Art. 226 of Constitution of India



For the A. Y. 2014-15,
order of assessment was passed u/s. 143(3) of the Income-tax Act, 1961 and a
demand of Rs. 19,22,770 was raised. Against this order, the assessee filed an
appeal before the Commissioner (Appeals) which was pending. Since the assessee
did not pay the demand in response to demand notice u/s. 156, a notice u/s. 221
dated 06/02/2017 was issued for recovery of the demand. By the said notice the
assessee was required to appear before the authority latest before 15/02/2017.
The notice itself was dispatched on 16/02/2017 and was received by the assessee
on 17/02/2017. On the first working day after that, the bank account of the
assessee was attached and full recovery made.

 

The assessee filed writ
petition challenging the said action. The Gujarat High Court allowed the writ
petition and held as under:

 

“i)  When the income-tax authority had taken an
action as strong as attachment of the bank account of the assessee and withdrawing
a sizable sum of more than Rs. 19 lakh from the bank account unilaterally, the
least that was expected of him was to ascertain that the notice was duly
dispatched and received by the assessee. Thus the authority effected recovery
from the bank account of the assessee without following due process.

 

ii)   It was true that the assessee ought to have
applied to the Assessing Officer or to the appellate authority for keeping the
additional tax demand in abeyance, which the assessee did not do. Nevertheless,
this would not enable the authorities to ignore the legal requirements before
effecting the recovery. Under the circumstances, the recovery of Rs. 19,22,770
made by the authority was illegal.

 

iii)  The respondent authority had
not set up a case that the assessee was a cronic defaulter, a person who may
ultimately not be able to pay the dues if the appeal were dismissed or that
there were other assessments or appeals pending, in which sizable tax demands
were held up.

 

iv)  The assessee should get the benefit of stay
pending the appeal on depositing 15% of the disputed tax dues. The respondent
should therefore refund 85% of the sum of Rs. 19,22,770 recovered from the
assessee and retain 15% thereof by way of tax pending the outcome of the
assessee’s appeal.”