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Where Assessing Officer failed to bring evidences to support his finding that assessee was involved in rigging price of shares held by her so as to get an undue benefit of exemption u/s 10(38), transactions of sale and purchase of such shares by assessee through recognized stock exchange could not be treated as bogus so as to make additions under Section 68

13 Mrs. Neeta Bothra vs. ITO  [[2021] 92 ITR(T) 450 (Chennai – Trib.)] ITA Nos.: 2507 & 2508 (CHNY.) of 2018 A.Ys.: 2012-13 and 2013-14, Date of order: 8th September, 2021

Where Assessing Officer failed to bring evidences to support his finding that assessee was involved in rigging price of shares held by her so as to get an undue benefit of exemption u/s 10(38), transactions of sale and purchase of such shares by assessee through recognized stock exchange could not be treated as bogus so as to make additions under Section 68

FACTS
Assessee purchased and sold shares of M/s. Tuni Textile Mills Limited (hereinafter referred to as ‘TTML’). She earned Long Term Capital Gains on the said transaction which was claimed exempt u/s 10(38) of the Act. The Assessing Officer held the transaction to be bogus and added the entire sale consideration u/s 68 of the Act for the reason that TTML was named as a penny stock in the report prepared by investigation wing of the Department and that though the assessee had sold the shares at a higher price in the market, the financials of TTML did not justify such a price rise in a short period of just two years. Aggrieved, the assessee filed appeal before the CIT(A). However, CIT(A) also decided the appeal against the assessee mainly on the basis of mere circumstantial evidences like:

(i) The broker through which assessee carried out the transaction was previously charged by SEBI under the relevant law for being found guilty of violating regulatory requirements.

(ii) The assessee, based in Chennai, carried out the lone instant transaction through a broker in Ahmadabad.

(iii) Shares of TTML have been specifically named as penny stocks by investigation wing of the Department.

(iv) Assessee was not able to explain how a company having negligible financial strength had split its equity shares in the ratio of 1:10 and further, failed to explain how price of shares were quoted at a record 9,400% growth rate in a short span of two years.

Therefore, the CIT(A) opined that mere furnishing certain evidences like broker notes, bank statements, etc is not sufficient to prove genuineness of transaction, when other circumstantial evidences show that transaction of share trading is not genuine.

Aggrieved, the assessee preferred appeal before the ITAT.

HELD
The ITAT observed that the fact of purchase and sale of the shares being through Recognized Stock Exchange was not disputed. However, both the Assessing Officer as well as CIT(A) had proceeded predominantly on the basis of analysis of financial statements of TTML. Even though the fact that the financial statements of TTML did not paint a very rosy picture coupled with the fact that TTML was a penny stock was brought to notice by both the lower authorities, the said facts alone are not sufficient to draw adverse inference against the assessee, unless the AO linked transactions of the assessee to organized racket of artificial increase in share price. It further observed that though the broker may be engaged in fraudulent activities, whether the assessee was a part of those activities was to be seen. There was no evidence on record to show that assessee was part of the organized racket of rigging price of shares in the market. The findings of the Assessing Officer was purely based on suspicion and surmises.

It stated that the Assessing Officer predominantly relied on the theory of human behaviour and preponderance of probabilities for the reason that the assessee was never involved in purchase and sale of shares and the instant transaction in question was the only one. However, the said fact was found to be erroneous by the ITAT.

Therefore, the ITAT concluded that unless the Assessing Officer brings certain evidences to support his finding that the assessee was also involved in rigging share price to get undue benefit of exemption u/s 10(38) of the Act, the transactions of sale and purchase of shares through recognized stock exchange could not be treated as unexplained cash credit u/s 68 of the Act.

Adjustment u/s 143(1)(a) without adjustment is legally invalid

12 Arham Pumps vs. DCIT  [TS-355-ITAT-2022(Ahd)] A.Y.: 2018-19; Date of order: 27th April, 2022 Section: 143(1)(a)

Adjustment u/s 143(1)(a) without adjustment is legally invalid

FACTS
For A.Y. 2018-19, assessee firm filed its return of income declaring therein a total income of Rs. 26,03,941. The said return was processed by CPC under section 143(1) and a sum of Rs. 28,16,680 was determined to be the total income, thereby making an addition of Rs. 2,10,743 to the returned total income on account of late payment of employees contribution to PF and ESIC which were disallowed u/s 36(1)(va) of the Act.

Aggrieved, assessee preferred an appeal to CIT(A), which appeal was migrated to NFAC as per CBDT notification. NFAC gave two opportunities to the assessee and upon not receiving any response decided the matter, against the assessee, based on documents and materials on record.

HELD
The Tribunal noted that the NFAC, in its order, has dealt with the matter very elaborately and has upheld the addition by following the decision of jurisdictional High Court in Gujarat State Road Transport Corporation 41 taxmann.com 100 (Guj.) and Suzlon Energy Ltd. (2020) 115 taxmann.com 340 (Guj.).

It also noted that in the intimation there is no description/explanation/note as to why such disallowance or addition is being made by CPC in 143(1) proceedings. The Tribunal having gone through the provisions of section 143(1) of the Act and the proviso thereto held that a return can be processed u/s 143(1) by making only six types of adjustments. The first proviso to section 143(1)(a) makes it very clear that no such adjustment shall be made unless an intimation has been given to the assessee of such adjustment either in writing or in an electronic mode. In this case, no intimation was given to the assessee either in writing or in electronic mode.

The Tribunal held that CPC had not followed the first proviso to section 143(1)(a). Also, NFAC order is silent about the intimation to the assessee. The Tribunal held that since the intimation is against first proviso to section 143(1)(a), the entire 143(1) proceedings are invalid in law.

It observed that NFAC has not looked into the fundamental principle of “audi alteram partem” which has been provided to the assessee as per 1st proviso to section 143(1)(a) but has proceeded with the case on merits and also confirmed the addition made by the CPC. It held that NFAC erred in conducting the faceless appeal proceedings in a mechanical manner without application of mind. The Tribunal quashed the intimation issued by the CPC and allowed the appeal filed by the assessee.

Proviso to section 201(1) inserted by the Finance (No. 2) Act, 2019 is retrospective as it removes statutory anomaly over sums paid to non-residents

11 Shree Balaji Concepts vs. ITO, International Taxation [TS-393-ITAT-2022(PAN)] A.Y.: 2012-13; Date of order: 13th May, 2022 Sections: 201(1) and 201(1A)    

Proviso to section 201(1) inserted by the Finance (No. 2) Act, 2019 is retrospective as it removes statutory anomaly over sums paid to non-residents

FACTS
The assessee purchased an immovable property from Elrice D’Souza and his wife for a consideration of R10 crore. However, it did not deduct tax at source as was required u/s 195 of the Act. The Assessing Officer (AO) held the assessee to be an assessee in default and levied a tax of Rs.2,26,60,000 u/s 201(1) and interest of Rs. 1,22,36,400 u/s 201(1A) of the Act.

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

Aggrieved, the assessee preferred an appeal to the Tribunal.

HELD
The Tribunal noted that the payees in the instant case having filed their return of income and disclosed the consideration in their respective returns and have duly complied with the amended provisions of section 201[1] of the Act, which has been inserted in Finance [No. 2] Act, 2019.

After considering the decisions as relied upon by the appellant for the proposition that any provision which has been inserted with an object to remove any difficulty or anomaly, then the said provision has to be given retrospective effect:

(a) Celltick Mobile Media Pvt. Ltd. vs. DCIT (2021) 127 taxmann.com 598 (Mumbai-Trib.);

(b) CIT vs. Ansal Land Mark Township Pvt. Ltd. (2015) 61 taxmann.com 45 (Delhi);

(c) CIT vs. Calcutta Export Company [2018] 93 taxmann.com 51 (SC);

(d)  DCIT vs. Ananda Marakala (2014) 48 taxmann.com 402 (Bangalore-Trib.).

The Tribunal held that the said proviso to section 201(1) wherein the benefit has also been extended to the payments made to non-residents is meant for removal of anomaly, is required to be given with retrospective effect.

The Tribunal held that the appellant assessee cannot be held as an assessee in default as per proviso to section 201(1) of the Act, in view of the amended provisions of section 201(1) of the Act, being inserted in Finance (No. 2) Act, 2019.

The Tribunal deleted the demand raised by the AO and confirmed by the CIT(A) u/s 201(1) of the Act of Rs. 2,26,60,000.

As regards the sum of Rs. 1,22,36,400 levied as interest u/s 201(1A) of the Act, the Tribunal noted that the said property was sold by the appellant on 17th September, 2011 and the return of income by the two payees have been filed on 30th July, 2012. Thus, interest amount u/s 201(1A) of the Act has to be calculated for the period 7th October, 2011 to 30th July, 2012 being the date of filing of the return by the two payees.

The Tribunal directed the AO, to re-compute the interest u/s 201(1A) of the Act, for the period 7th October, 2011 to 30th July, 2012 till the date of filing of the return by the two payees.

Section 56(2)(vii)(c) does not apply to bonus shares received by an assessee

10 JCIT vs. Bhanu Chopra  [TS-388-ITAT-2022 (DEL)] A.Y.: 2015-16; Date of order: 29th April, 2022 Section: 56(2)(vii)

Section 56(2)(vii)(c) does not apply to bonus shares received by an assessee

FACTS
For A.Y. 2015-16, assessee filed a return of income declaring a total income of R31,99,25,740. While assessing the total income, the Assessing Officer (AO) computed FMV of bonus shares of HCL Technologies in terms of Rule 11UA to be R47,21,93,975 and consequently added this amount to the total income of the assessee by applying the provisions of section 56(2)(vii)(c) of the Act.

The AO observed that the taxable event is receipt of property without consideration or for a consideration which is less than its FMV. According to the AO, the assessee received property in the form of bonus shares and therefore the FMV of the same is taxable u/s 56(2)(vii)(c) of the Act.

Aggrieved, the assessee preferred an appeal to CIT(A) who deleted the addition made by the AO.

Aggrieved, revenue preferred an appeal to the Tribunal.

HELD
The Tribunal noted that the CIT(A) has –

(i)    while controverting the findings of the AO and coming to the conclusion that provisions of section
56(2)(vii)(c) are not applicable to the case of the assessee has followed the decision of the Apex Court in CIT vs. Dalmia Investment Co. Ltd. (1964) 52 ITR 567 (SC);

(ii)    while deciding the issue he has also relied upon the decision in the case of Dr. Rajan vs. Department of Income Tax (ITA No. 1290/Bang/2015) wherein, the judgment referred above of the Apex Court in the case of the CIT vs. Dalmia Investment Co Ltd (supra) was also relied upon by the Tribunal and in the case of Sudhir Menon HUF vs. ACIT (ITA No. 4887/Mum/2013) wherein, it was clearly held by the Tribunal that allotment of bonus shares cannot be considered as received for an inadequate consideration and therefore, it is not taxable as income from other sources u/s 56(2)(vii)(c) of the Act;

(iii)    held that the issue of bonus share is by capitalization of its profit by the issuing company and when the bonus shares are received it is not something which has been received free or for a lesser FMV. Consideration has flown out from the holder of the shares may be unknown to him/her, which is reflected in the depression in the intrinsic value of the original shares held by him/her.

The Tribunal held that –

(i) even the CBDT vide Circular No. 06/2014 dated 11th February, 2014 has clarified that bonus units at the time of issue would not be subjected to additional income tax u/s 115R of the Act, since issue of bonus units is not akin to distribution of income by way of dividend. This may be inferred from provisions of section 55 of the Act which prescribed that “cost of acquisition” of bonus units shall be treated as Nil for purposes of computation of capital gains tax;

(ii) further, the CBDT vide Circular No. 717 dated 14th August, 1995 has clarified that “in order to overcome the problem of complexity, a simple method has been laid down for computing of cost of acquisition of bonus shares. For the sake of clarity and simplicity, the cost of bonus shares is to be taken as “Nil? while the cost of original shares is to be taken as the amount paid to acquire them. This procedure will also be applicable to any other security where a bonus issue has been made;

(iii) the issue under consideration has been elaborately considered by the Tribunal in various cases such as Rajan Pai Bangalore vs. Department of Income Tax and Sudhir Menon HUF (supra) and even by the Apex Court in the case of CIT vs. Dalmia Investment Co. Ltd. (supra) as relied upon by the CIT(A) while holding that the provisions of section 56(2)(vii)(c) of the Act are not applicable to the bonus shares;

(iv) there is neither any material nor any reason to controvert the findings of the CIT(A).

The Tribunal dismissed the appeal filed by the revenue.

WHAT IS SPECIAL ABOUT SPECIAL PURPOSE FRAMEWORK? WHEN TO APPLY SA 700 VS. SA 800?

The article discusses when auditor issues report under Standard on Auditing (SA) 700 – Forming an Opinion and Reporting on Financial Statements vs. SA 800 – Special Considerations – Audit of Financial Statements Prepared in Accordance with Special Purpose Frameworks.

SPECIAL PURPOSE FINANCIAL STATEMENTS
SA 800 defines special purpose financial statements as financial statements prepared in accordance with a special purpose framework. SA 210 – Agreeing the Terms of Audit Engagements states that a condition for acceptance of an assurance engagement is that the criteria referred to in the definition of an assurance engagement are suitable and available to intended users. Therefore, it is imperative that for auditing special purpose financial statements, intended users is one of the key considerations.

Having said that, the manner of opining on special purpose financial statements is similar to opining on general purpose financial statements. SA 800 requires the auditor to apply the requirements of SA 700 when forming an opinion and reporting on special purpose financial statements. Similarly, title of audit reports for both the types of financial statements remain the same i.e. “Independent Auditor’s Report”.

What are the examples when special purpose financial statements are prepared and when general purpose financial statements are prepared?

General purpose financial statements

Special purpose financial statements

• Financial statements prepared under Ind
AS / Indian GAAP to meet the provisions in sale / purchase agreements.

• Financial statements prepared in
accordance with financial reporting provisions of a contract.

• Financial statements are prepared under
Ind AS / Indian GAAP for the purpose of submission to a lender.

• Financial statements prepared on the
cash receipts and disbursements basis of accounting for cash flow
information that may be requested by a key supplier.

 

• Financial information prepared for
consolidation purposes to be submitted by a component to its parent entity,
prepared in accordance with instructions issued by group management to the
component.

FAIR PRESENTATION FRAMEWORK VS. COMPLIANCE FRAMEWORK
The financial statements (both general purpose financial statements and special purpose financial statements) can be either under fair presentation framework or compliance framework.

In case of fair presentation framework, as the name goes, fair presentation of financial statements is to be achieved. Therefore, management may provide disclosures beyond those specifically required by the framework and it is acknowledged by the management. It also acknowledges that it may depart from the framework to achieve fair presentation. In such framework, the auditor opinion uses following language:

(a) “In our opinion, the accompanying financial statements present fairly, in all material respects, […] in accordance with [the applicable financial reporting framework]; or

(b) In our opinion, the accompanying financial statements give a true and fair view of […] in accordance with [the applicable financial reporting framework].”

In case of compliance framework, financial statements need to follow the requirements of the framework. Therefore, the management acknowledgements discussed above in fair presentation framework do not exist in compliance framework. In such framework, the auditor opinion uses following language:

“In our opinion, the accompanying financial statements are prepared, in all material respects, in accordance with [the applicable financial reporting framework].”

REPORTING ON FINANCIAL STATEMENTS PREPARED IN ACCORDANCE WITH A GENERAL PURPOSE FRAMEWORK FOR A SPECIAL PURPOSE
In such cases, financial statements prepared for a specific purpose are prepared in accordance with a general purpose framework, such as Ind AS or Indian GAAP, because the intended users have determined that such general purpose financial statements meet their financial information needs.

In contrast, financial information prepared for consolidation purposes to be submitted by a component to its parent entity prepared in accordance with instructions issued by group management to component is not in accordance with general purpose framework. The reason is Ind AS / IFRS / Indian GAAP / US GAAP or similar general purpose framework is not followed for such financial information.

In such scenario, the audit report should be prepared in accordance with SA 700. The auditor may include “Other Matter” paragraph in accordance with SA 706 Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report. Paragraph A14 of SA 706 discusses restriction on distribution or use of the auditor’s report. It states that when audit report is intended for specific users, the auditor may include “Other Matter” paragraph, stating that the auditor’s report is intended solely for the intended users, and should not be distributed to or used by other parties. Such inclusion of “Other Matter” paragraph in the audit report is not mandatory. The auditor will use his judgment in the circumstances to determine whether distribution or use of his audit report needs restriction or not and accordingly will determine inclusion of such “Other Matter” paragraph in his audit report.

Fair presentation framework vs. Compliance framework
Usually, the audit reports issued in India use general purpose fair presentation framework. However, illustration 5 in SA 700 also provides an example of auditor’s report on financial statements of non-corporate entity prepared in accordance with a general purpose compliance framework.

REPORTING ON FINANCIAL STATEMENTS PREPARED IN ACCORDANCE WITH A SPECIAL PURPOSE FRAMEWORK
In such scenario, the audit report should be prepared in accordance with SA 800. SA 800 requires description of the applicable financial reporting framework. In case of financial statements prepared in accordance with the provisions of a contract in the example above, the auditor shall evaluate whether the financial statements adequately describe any significant interpretations of the contract on which the financial statements are based.

SA 800 also adds to the responsibility of management when it has a choice of financial reporting frameworks in the preparation of financial statements. The new responsibility is management has to determine that the applicable financial reporting framework is acceptable in the given circumstances. Therefore, the paragraph in auditor’s responsibility that describes management’s responsibility shall refer to such additional responsibility also as follows:

“Management is responsible for the preparation of these financial statements in accordance with [basis of accounting], for determining the acceptability of the basis of accounting, and for such internal control as management determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error.”

There is a risk that the special purpose financial statements may be used for purposes other than those for which they were intended. To mitigate such risk, the auditor is required to include an Emphasis of Matter (EOM) paragraph in the audit report stating that it may not be suitable for other purposes.

In addition to EOM paragraph mentioned above, the auditor may consider it appropriate to indicate that the auditor’s report is intended solely for the specific users. This is not a mandatory requirement although. Usually as part of the engagement acceptance consideration, before accepting the engagement to audit non-statutory financial statements, the auditor will consider the basis on which he may agree for the auditor’s report to be made available to third parties.

If EOM and restriction on use paragraph is to be used, it may be worded as follows:

“Basis of Accounting and Restriction on Distribution and Use

Without modifying our opinion, we draw attention to Note [X] to the financial statements, which describes the basis of accounting. The financial statements are prepared to assist the partners of [name of partnership] in preparing their individual income tax returns. As a result, the financial statements may not be suitable for another purpose. Our report is intended solely for [name of partnership] and its partners and should not be distributed to or used by parties other than [name of partnership] or its partners.”

Fair presentation framework vs. Compliance framework
SA 800 provides illustrations of auditor’s reports on special purpose compliance framework as well as special purpose fair presentation framework.

When financial statements are prepared based on the needs of a regulator, by itself it does not mean that those are special purpose financial statements. The test of whether such financial statements are special purpose financial statements or general purpose financial statements is the framework used to prepare those financial statements. For example, Section 129(1) of the Companies Act, 2013 requires financial statements to comply with accounting standards notified under section 133 and to be in the form prescribed in Schedule III. In such cases, the regulator has prescribed compliance with accounting standards, which is a general purpose framework. Therefore, these are general purpose financial statements. In addition to complying with accounting standards, the regulator requires the format to be in Schedule III, but that does not change the underlying framework itself.

It is not the intended users (public at large or specific identified users) that distinguish general purpose financial statements as against special purpose financial statements. It is the underlying framework used for preparation of financial statements, that decides whether the financial statements are general purpose or special purpose financial statements.

FINANCIAL STATEMENTS IDENTIFIED AS “SPECIAL PURPOSE FINANCIAL STATEMENTS” IN GUIDANCE NOTES
Some of the Guidance Notes issued by The Institute of Chartered Accountants of India identifies financial statements discussed in respective guidance notes as “special purpose financial statements”. As a result, such financial statements may be considered as “special purpose financial statements” even if those may not meet the definition of this term as given in SA 800 and discussed above. For example, the Guidance Note on Combined and Carve-out Financial Statements states that the said Guidance Note should not be construed to be applicable to the general purpose financial statements as the combined / carve out financial statements are prepared for specific purpose and, therefore, are “special purpose financial statements”. Similarly, the Guidance Note on Reports in Company Prospectuses refers to SA 800 and the Guidance Note on Combined and Carve-out Financial Statements as the format to be used for specific report.

CONCLUSION
The auditor must have clarity about the difference between general purpose financial statements and special purpose financial statements. The audit reports on these two types of financial statements are governed by two different auditing standards (SA 700 and SA 800). Depending on the type of financial statements, contents of the audit report differ such as description of framework under which financial statements are issued, describing basis of accounting in the audit report, etc.

MLI SERIES MLI ASPECTS IMPACTING TAXATION OF CROSS-BORDER DIVIDENDS

INTRODUCTION
The issues related to the taxability of dividends have always remained significant due to the inherent two-level taxation compared to other income streams like interest. Further, the taxing provisions are drafted in varied manners in an attempt to rein in any tax avoidance on such incomes. Taxation of dividends in the international tax arena has had its own set of complexities. In India, for a considerable period of time there used to be double taxation on foreign shareholders due to limited availability of credit for Dividend Distribution Tax (DDT) paid by Indian companies under the Income-tax Act. However, after the abolition of the DDT concept vide Finance Act 2020, cross-border dividends are now taxable in the hands of non-resident shareholders – bringing up issues of beneficial ownership, classification, conduit arrangements, etc.

This article concludes the series of articles for the BCAJ on Multi-lateral Instrument (MLI). The series of articles have explained the multilateral efforts to reduce tax avoidance and double non-taxation through MLI – a result of the Base Erosion and Profit Shifting (BEPS) Project of the G20 and OECD. MLI has acted as a single instrument agreed upon by a host of countries1 through which several anti-abuse rules are brought in at one stroke in the DTAAs covered by the MLI.

Article 8 of the MLI provides anti-avoidance rules for Dividend Transfer- Transactions. This article attempts to highlight how the MLI has affected cross-border taxation of dividends, which has gained importance following the change in Income-tax Act from 1st April 2020. At the same time, it does not deal with the cross-border or domestic law issues that affect dividend payments in general, as it would be beyond the outlined scope of this article.

 

 

1   99 countries as on 10th May, 2022

TAXABILITY OF DIVIDENDS UNDER TREATIES
Under the double tax avoidance agreements (DTAAs), as far as tax revenue sharing is concerned between the two countries entering into the agreement, specific caps are prescribed for passive incomes like dividends, interest, royalty and fees for technical services. As per Article 10 of the OECD and UN model conventions, while the Country of Residence (COR) is allowed the right to tax dividends, the Country of Source (COS) is also allocated a right to tax such dividends. For dividend incomes, the COR is the country where the recipient of dividends is a resident; and the COS is the country where the company paying dividends is a resident of.

However, there is a cap on the tax which can be levied by the COS under its domestic laws, if the Beneficial Owner (BO) of such dividends is a resident of the other contracting state (i.e., COR). While typically, this cap is set at around 20-25% in DTAAs, a concessional rate of around 5-15% is prescribed if the BO is a company which meets the prescribed threshold of holding a certain minimum shareholding in the company paying dividends. This is considered to be a relief measure for cross-border corporate ownership structures, as against third-party portfolio investors who would generally hold a much lesser stake in the company paying dividends. The relief is explained below through an illustration:

Illustration 1: C Co., a Canadian Co., owns 12% voting power in I Co., an Indian Co. I Co. declares a dividend. The applicable dividend provisions of the India-Canada DTAA are as under:

Article 10
1. Dividends paid by a company which is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other State.

2. However, such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident, and according to the laws of that State, but if the recipient is the beneficial owner of the dividends the tax so charged shall not exceed:

(a) 15 per cent of the gross amount of the dividends if the beneficial owner is a company which controls directly or indirectly at least 10 per cent of the voting power in the company paying the dividends;

(b) 25 per cent of the gross amount of the dividends in all other cases.

As can be seen from the above, Article 10(2)(b) of the India-Canada DTAA provides for a cap of 25% on tax leviable in India (the COS in this case). However, as C Co., the beneficial owner of dividends from I Co., owns at least 10% voting power in I Co., the condition for minimum shareholding as specified for concessional rate in Article 10(2)(a) is met. Thus, the cap of 25% stands reduced to 15% as per Article 10(2)(a) of the India-Canada DTAA. This is the relief which is sought by group companies receiving dividend incomes on their investments in Indian companies.

PRONE TO ABUSE
The above reduced tax rate has led to abuse of this provision in cases where companies try to take benefit of the concessional rate by meeting the threshold requirement only for the period that the dividend is received. A simple illustration for understanding how this provision is abused is as follows:

Illustration 2: Continuing our example above, Con Co., a Canadian group Co. of C Co., also owns a 9% share capital of I Co. This holding would not allow for the concessional rate of tax to be applied when I Co. pays dividends to Con Co. However, just before the declaration of dividend by I Co., Con Co. buys an additional 1% stake in I Co. from its group Company C Co., which, as explained above, already holds a 12% stake in I Co. After this transaction C Co. continues to hold 11% stake in I Co.; while Con Co. will now hold 10% stake in I Co. As both Con Co. and C Co. now hold 10% or more in I Co., they fulfil the threshold requirement under Article 10(2)(b), and the concessional tax rate of 15% is applied. As this transaction is done only to avail the concessional rate, as soon as the dividend is distributed, the additional 1% holding is transferred back by Con Co. to C Co.

In this manner, by complying with the threshold requirement in a technical sense, Con Co. avails of the concessional tax rate. This is possible as the India-Canada DTAA does not provide for a minimum period for which the prescribed threshold for shareholding of 10% is required to be held for. This means that even if Con Co. meets the threshold for just the day when it receives the dividend from I Co., even then it can avail the concessional rate.

The Report on BEPS Action Plan 6 had identified this abuse and provided a possible solution to counter it by prescribing a threshold period for which shareholding is required to be held. This solution has been enacted in the form of Article 8 of the MLI – “Dividend Transfer Adjustments”, which is explained below.

STRUCTURE AND WORKING OF ARTICLE 8 OF THE MLI
Article 8 of the MLI provides that the concessional rate shall be available only if the threshold for minimum shareholding is met for a period of 365 days which includes the day of dividend payment. It should be noted that while Article 10 of the DTAA covers all recipients of dividends, the concessionary rate is available only to companies. Thus, the new test as per Article 8 of MLI also applies only to companies. At the same, time relief has been provided for ownership changes due to corporate re-organisation. [Para 1]
    
This condition shall apply in place of or in the absence of the minimum holding period condition existing in the DTAA. [Para 2] Thus, wherever Article 8 of the MLI applies, the new test of a 365-day holding period would be applied in the following manner:

• Where the treaty already contains a holding period test– such period would get replaced with the 365-day test; or

• In case of treaties where no such test exists, such a test would be introduced.

However, it should be noted that Article 8 of the MLI is an optional anti-abuse provision of the MLI. It is not a mandatory provision. Thus, the new minimum holding period test applies only to treaties where both the contracting states (countries party to the treaty) not only agree to the applicability of Article 8, but also to the manner in which it is applicable. The following options are available to the countries with regard to the applicability of Article 8:

• Para 3(a) provides that a country may opt out entirely from this new test; or

• Para 3(b) provides that a country may opt out to the extent the DTAA already provides for:

i. A Minimum Holding Period; or

ii. Minimum Holding Period shorter than 365 days; or

iii. Minimum Holding Period longer than 365 days.

Each country has to list which option it would be exercising from the above. Further, it also has to list down the DTAAs to which the above provision may not apply. Thus, India has opted out of Article 8 by way of reservation under Para 3(b)(iii) covering the India-Portugal DTAA as the treaty provides for a threshold period of 2 years already, which is higher than the one proposed under Article 8 of the MLI. Hence, the existing condition of 2 years will continue to apply in India-Portugal DTAA irrespective of India signing the MLI.

Para 4 states that countries shall notify the DTAA provision unless they have made any reservation. When two countries notify the same provision, only then will the 365-day threshold apply. India has notified such provision in its DTAAs with 24 countries. However, not all of these 24 countries have corresponded similarly. Hence, Article 8 of the MLI applies if the corresponding country has also notified its treaty with India under the same provision. A couple of illustrations will show how Article 8 of MLI works:

Illustration 3: Both India and Singapore have notified Illustration 3: Both India and Singapore have notified India-Singapore DTAA as a Covered Tax Agreement which will get impacted by MLI. India has notified the treaty under Article 8(4) of MLI. Basically, India agrees to apply the new 365-day test to the treaty. The India-Singapore treaty presently does not provide for such a test. However, Singapore has reserved the right for the entirety of Article 8 not to apply to its Covered Tax Agreements [Para 3(a)]. Hence, while India has opted for applying MLI Article 8, Singapore has not. Thus, the Dividend Article of India-Singapore DTAA will not be affected by Article 8 of MLI even though India has expressed its willingness for the same.

Now let us consider another illustration:

Illustration 4: India and Canada both have made a notification under Article 8(4). No reservation has been made by any country for the relevant provision. Thus, there is no mismatch and Article 8 of MLI applies to the India-Canada DTAA. While before the MLI, there was no holding period requirement under the India-Canada DTAA, on the application of the MLI, the 365-day holding period gets inserted in the DTAA.

Considering the above, the following is the list of Indian treaties which have been amended by Article 8 of the MLI as both India, and the corresponding country have agreed to the applicability of Article 8 in the same manner, along with the respective dates for entry into effect of the MLI:  

    

Country

Threshold period for shareholding (pre-MLI)

Threshold period for shareholding (post-MLI)

Entry into Effect in India for TDS

Entry into Effect in India for other taxes

Canada

Nil

365
days

1st
April, 2020

1st
April, 2021

Denmark

Nil

365
days

1st
April, 2020

1st
April, 2021

Serbia

Nil

365
days

1st
April, 2020

1st April,
2020

Slovak
Republic

Nil

365
days

1st
April, 2020

1st April,
2020

Slovenia

Nil

365
days

1st
April, 2020

1st April,
2020

The above treaties already had specific thresholds for applicability of the concessional rates which are provided below for ease of reference:

Country

Condition for minimum shareholding / voting power

Concessional rate if condition is met

Tax rate if condition is not met

Canada

10%

15%

25%

Denmark

15%

15%

25%

Serbia

25%

5%

15%

Slovak
Republic

25%

15%

25%

Slovenia

10%

5%

15%

The illustration below will explain the changes pre and post MLI.

Illustration 5: SE Co., Serbia owns 21% shares of IN Co., India. On 1st April, 2021, SE Co. buys an additional 4% stake in IN Co. from a group company. IN Co. declares and pays a dividend on 15th December, 2021. SE Co. exits its stake of 4% on 1st January 2022. Pre-MLI, India-Serbia DTAA provided for a concessional tax rate of 5% where a minimum holding of 25% was met, even if such stake was held for only the day when dividend was earned. However, that has changed post-MLI. Post MLI, Article 10 of the India-Serbia treaty, as modified by Article 8 of MLI, provides that the concessional tax rate will be available only if the condition for a minimum holding period of 365 days is met. As that would not be met in this case, the concessional rate of tax on dividend income would not be available to SE Co.

365-DAY TEST
As per the MLI provisions, the recipient company shall hold the prescribed percentage of share capital for a period of 365 days to avail the concessional rate. The exact provision that gets added to the Dividend Article of the above-mentioned DTAAs is as follows:

[Subparagraph of the Agreement dealing with concessional rate] shall apply only if the ownership conditions described in those provisions are met throughout a 365 day period that includes the day of the payment of the dividends…

As can be seen above, the 365-day period would include the date of payment of the dividend. Thus, the language entails a “Straddle Holding Period” – a period covering the dividend payment date – but extending before or after such date. An illustration for the same is as follows:

Illustration 6: Continuing from Illustration 5 above, let us consider a case where SE Co. of Serbia continues to hold its stake of 25% in IN Co., India, for the foreseeable future after acquiring the 4% stake on 1st April, 2021. In such a case, even though the 365-day test is not met on the date of declaration of dividend, i.e., 15th December 2021, SE Co. would be able to claim the concessional rate of tax if it continues holding its stake of 25% in IN Co. at least up to 31st March, 2022, i.e., 365 days from 1st April 2021. In such a case, when it files its tax return, it can claim the lower rate of tax of 5% as it has met the 365-day test as prescribed under the modified India-Serbia treaty.

ISSUES RELATED TO STRADDLE-HOLDING PERIOD
There are a few issues with regard to the straddle-holding period. Let us take the above illustration in which IN Co. would be paying a dividend to SE Co on 15th December, 2021. IN Co. needs to deduct tax at source u/s 195 of the Income-tax Act before making payment of the dividend to SE Co. Since the 365-day test is not met as on the date of payment, can the concessional rate of tax be considered at the stage of deduction of tax at source? There is no clarity or guidance on this aspect, but as the law stands, IN Co. may need to deduct tax at 15%, ignoring the concessional rate of tax of 5%, as it would not be able to ascertain whether SE Co. will or will not be able to meet the 365-day test in the future. An expectation, howsoever strong, of SE Co. meeting the 365-day test would not allow IN Co. to apply the lower rate on the date it needs to deduct tax at source. It should be noted that in such a case, SE Co. can still claim the concessional rate by filing its tax return and claiming a refund for the excess tax deducted at source by IN Co.

The above view finds favour with the Australian Tax Office, which has issued a similar explanation by way of “Straddle Holding Period Rule”2 for its treaties modified by the MLI. A similar view has been expounded by the New Zealand Tax Office3. A similar clarification from the Indian tax department would provide certainty on this aspect.

Consider another illustration.

Illustration 7: SE Co. has invested 25% in shares of IN Co. on 1st February, 2022. Dividend has been declared by IN Co. on 28th February, 2022. As explained above, IN Co. would deduct tax at the higher rate of 15% as it would not be able to ascertain whether SE Co. would be in a position to meet the 365-day test or not. SE Co. would be able to meet the test only by 31st January, 2023. In this case, a further complication is that SE Co. would itself also face difficulty in claiming the concessional rate of tax in its tax return. This is because it would be required to file its tax return in India for A.Y. 2022-23 by either 30th September or 30th November, 2022. However, it would not have met the 365-day test by the return-filing deadline. Even the extended deadline of 31st December, 2022 for filing a revised tax return would fall short for SE Co. in meeting the 365-day test prescribed under the modified treaty. Such a situation would lead to practical issues where although the claim would be held valid at a future date, it would be difficult to make such a claim in the tax return filed.

 

 

2   QC 60960

3              Commissioner’s
Statement CS 20/03
The above illustrations show how the otherwise simple and objective 365-day test can become a difficult claim for the company earning the dividend income in certain situations.

It must also be noted that the 365-day test is an objective test – similar to the one for holding a prescribed minimum stake in shareholding or voting power. Such objective tests are prone to abuse. Consider a case where SE Co., in our illustration above, holds the stake in IN Co. for a period of 366 days, i.e.; it liquidates its stake as soon as the threshold period is met. It should be noted that the 365-day test is a simplistic representation of the income earner’s substance requirement as far as cross-border shareholding is concerned. But as is the case with every such specific test, while clarity in the law is available, abuse of the provisions may still be possible, even if such an exercise becomes more difficult.

In such a case, it should be noted that this test is only one among many anti-tax avoidance measures that the MLI provides. The Principal Purpose Test, the Limitation of Benefits clauses, etc., are other anti-tax avoidance measures under the MLI which may come into play where it is proven that even the 365-day test has been abused.

CORPORATE REORGANISATION
The MLI considers situations where ownership has changed due to corporate reorganisations like mergers or demergers. The language provided in the Article 8 is as follows:

…for the purpose of computing that period, no account shall be taken of changes of ownership that would directly result from a corporate reorganisation, such as a merger or divisive reorganisation, of the company that holds the shares or that pays the dividends.

Thus, the holding period of 365 days would apply across changes in ownership. The point to be noted is that such change would be ignored in ownership of the company that holds the share investment as also the company paying the dividends. Thus, both the parties to the dividend transaction need not consider the 365-day test from the date of reorganisation, but from the date of original holding. The intent seems to be that corporate reorganisation would not entail a change in ultimate ownership, but only a change in the holding structure within the group – for which the holding period test should not be reset.

CONCLUSION
To reiterate the above explanation in a few lines, Article 8 of MLI provides an additional objective test to avail the concessional rate available for dividend incomes under the treaties. The concessional rate is already subject to a minimum shareholding requirement. However, there was no compulsion of a minimum period for which such holding had to be maintained. This led to abuse of the relief provision. Through MLI Article 8, treaties will now provide for a 365-day shareholding period. Shareholders who meet this test can avail the lower concessional rate. However, as it is not a mandatory article of the MLI, at present only 5 Indian treaties have been impacted.
 
Taxation of dividend incomes has always remained an interesting topic for various reasons. The MLI provisions explained above make the subject even more interesting. Coupled with the recent controversies surrounding the applicability of Most Favoured Nation clauses (which is beyond the scope of the present article), we are ensured of interesting times ahead in the field of cross-border dividend taxation.

EPILOGUE
With this article, BCAJ completes a journey of over a year in providing a series of articles dealing with the most important aspects of the MLI – with a view to explain the provisions in as easy a manner as possible. The scope of the MLI provisions is vast, and it would not be possible for the BCAJ to cover all the myriad aspects. However, a reader wishing to avail a basic understanding of the MLI can access the articles starting from the April 2021 issue of the Journal. For readers interested in a deeper study of the subject, BCAS has published a 3 VOLUME COMPENDIUM ON THE MLI spread over 18 Chapters authored by experts in the field, which is a must-read for every international tax practitioner. Further, a research article “MLI Decoded” by CA Ganesh Rajgopalan provides a thread-bare analysis of each of the provisions of India’s treaties modified by the MLI and is available as free e-publication on the BCAS Website at https://www.bcasonline.org/Files/ContentType/attachedfiles/index.html.  

Articles
in MLI Series (Volume 53 and 54 of BCAJ)


Sr. No

Title of the Article

Month of Publication

1

INTRODUCTION AND BACKGROUND OF MLI,
INCLUDING APPLICABILITY, COMPATIBILITY AND EFFECT

April,
2021

2

DUAL RESIDENT ENTITIES – ARTICLE 4 OF MLI

May,
2021

3

ANTI-TAX AVOIDANCE MEASURES FOR CAPITAL
GAINS: ARTICLE 9 OF MLI

June,
2021

4

MAP 2.0 – DISPUTE RESOLUTION FRAMEWORK
UNDER THE MULTILATERAL CONVENTION

August,
2021

5

ANALYSIS OF ARTICLES 3, 5 & 11 OF THE
MLI

September,
2021

6

ARTICLE 13: ARTIFICIAL AVOIDANCE OF PE
THROUGH SPECIFIC ACTIVITY EXEMPTION

October,
2021

7

ARTICLE 10 – ANTI-ABUSE RULE FOR PEs
SITUATED IN THIRD JURISDICTIONS (Part 1)

December,
2021

8

ARTICLE 10 – ANTI-ABUSE RULE FOR PEs
SITUATED IN THIRD JURISDICTIONS (Part 2)

January,
2022

9

ARTICLE 6 – PURPOSE OF A COVERED TAX
AGREEMENT AND ARTICLE 7 – PREVENTION OF TREATY ABUSE

February,
2022

10

COMMISSIONAIRE ARRANGEMENTS AND CLOSELY
RELATED ENTERPRISES

May,
2022

11

MLI ASPECTS IMPACTING TAXATION OF CROSS BORDER
DIVIDENDS

June,
2022

BCAJ Subscribers can access the e-versions of the above articles by logging in to bcajonline.org

FREEMIUM BUSINESS MODEL

INTRODUCTION
The term ‘freemium’ is coined by combining the words ‘free’ and ‘premium’. Over the last decade, this business model has become a dominant business model among internet start-ups and smartphone app developers.

Venture capitalist Fred Wilson was the first to describe the Freemium business model back in 2006. He summarized the pattern as follows: ‘Give your service away for free, possibly ad supported but maybe not, acquire a lot of customers very efficiently through word of mouth, referral networks, organic search marketing, etc., then offer premium priced value-added services or an enhanced version of your service to your customer base.’ The term’s coinage goes back to a post that Wilson put on his blog calling for a fitting name for this business model. ‘Freemium’ was chosen as the most appropriate term and has since become firmly established.

In the freemium business model, the users get basic features of the product at no cost and can access the richer functionality of the product for a subscription fee. The basic version of an offering is given away for free to eventually persuade the customers to pay for the premium version. The free offering can attract the highest volume of customers possible for the company. The generally smaller volume of paying ‘premium customers’ generates the revenue, which also cross-finances the free offering.

For a visual representation of the Freemium model readers may refer –

EXAMPLES

The Internet and the digitization of services are the main drivers that have enabled the development of the Freemium business model. Let us explore examples of companies implementing the Freemium business model in their operations.

1. Gmail

Gmail offers a basic inbox and email service for free. However, the inboxes come with limited storage for messages. Users can upgrade their storage by paying a monthly or annual fee beyond the free storage limit.

Hotmail and Dropbox also follow the freemium model.

2. Spotify

Spotify offers its free users access to the music streaming service for a limited number of hours each day, thus providing an incentive to switch to the premium version of the service. Free users are forced to watch and listen to advertisement posts they get during the free time to listen to Spotify music.

 

3. Amazon

Amazon uses the freemium model exclusively for its diversified product ranges. Let us discuss a few popular products of Amazon following the freemium model.

•  Amazon Web Services (popularly known as ‘AWS’) gives away free “credits” to its new customers. The customers can utilize these credits to set up one’s infrastructure on the AWS cloud computers and avail themselves of AWS services. However, as the demand for the company’s product grows and the need for space exceeds the capacity covered by the free credits, the customer becomes a paying customer for the additional use.

• Amazon Kindle: Amazon gives a free 1-month trial for its premium subscription “Kindle Unlimited” or Audibles which allows the customer unlimited access to media such as e-books, magazines, and audiobooks for a flat fee payable every month. This enables customers to test the service and Amazon to upsell the full subscription to the free trial users.

• Audibles is an audiobook and podcast service that allows users to purchase and stream audiobooks and other forms of spoken word content following the Amazon Kindle model or the Freemium Model.

 

4. Video Conferencing Apps
Video Conferencing App companies have taken the Freemium business model a notch up by offering various plans, thereby addressing the needs of a wider customer base.

• Skype founded in 2003 (now owned by Microsoft) offers its users a Voice-over-Internet Protocol (VoIP) program that enables them to call anywhere in the world over the Internet. In addition, Skype offers its customers the option to purchase call credits for use with landlines and mobile phones.

 

• Zoom video conferencing platform gained popularity in the Covid era. This enabled Zoom to have a large base of free users in a short period. To leverage a free user base, Zoom’s direct salesforce undertakes funnelling and filtering activities to identify business users from the database of its free users. Thereby, converting its free user to paying customers.

5. Gaming – Zynga Farmville

Zynga games are free to play. Let us take the example of Farmville. Here the basic game is available for free download. However, if gamers wish to expand their virtual farm and progress quickly through the game, they either invite their friends to the game or purchase virtual goods by spending real money. From the Company’s perspective, the basic version is used to engage the audience, hook them and thereby funnel them into paying customers.

 

MAKING A FREEMIUM BUSINESS MODEL SUCCESSFUL

To make a freemium business model successful, the following parameters are to be considered from an operational point of view:

• The free user must be continuously supported so that in the future, they can be converted into a paying customer.

• The conversion ratio of paying to non-paying customers is an important indicator of the business performance of the Freemium Model.

• Considering that the vast majority of people will continue to use the free version of the product, the cost of offering the basic product must be very low, ideally zero.

• The business must be profitable along with supporting free users.

POINTS TO BE CONSIDERED BY PROFESSIONAL SERVICE FIRMS FOR APPLYING FREEMIUM MODEL IN THEIR PRACTICE

Virtually every Chartered Accountant firm prices its work, bills its clients, compensates its employees, and rewards its owners based on the amount of time and effort required to produce and deliver professional accounting, taxation or consulting services.

1. Chartered Accountant in Practice

Writing articles/posts (on LinkedIn, Medium or blog post), and speaking at industry events, thereby educating clients in your area of expertise (e.g. latest updates in corporate laws and taxation laws) is one of the easiest way to attract potential clients and build trust and credibility in a market. If your posts or seminars are valuable, your customers and clients will tweet, share, blog, update and like it publicly, and do the marketing for you.

During the process, other fellow Chartered Accountants will also learn something from you that puts you in a position of authority and may offer work through referrals.

2. Following on Social Media

Social media platforms allow you to provide enormous value to the world for free. You may offer some services to your client for free and ask them to Pay With a Tweet. By this, your customers are actings as your Brand Ambassadors.

3. Slack periods

During slow revenue months, invest more in research, training and pro bono work. During the off period, CAs can connect with incubators, co-working spaces, accelerators etc. and offer services on a pro bono basis. This will enable many practising CAs to establish a relationship with start-ups at their early stage and participate in evolving needs of the start-ups.

We would like to read or listen to your views about the freemium business model. Where have you noticed the application of the freemium business model or any variant of this business model? We look forward to your views.

Note: All images reproduced in this article are sourced from the respective company websites and are depicted herein solely for informational and educational purposes.

AMENDMENTS IN THE CHARTERED ACCOUNTANTS ACT

The Chartered Accountants, The Cost and Works Accountants and The Company Secretaries (Amendment) Bill, 2021, was introduced in Parliament on 17th December, 2021. This Bill was referred to the Standing Committee on Finance, which submitted its Report in March, 2022. The Bill has been passed by Parliament on 5th April, 2022. Now, The Chartered Accountants, The Cost and Works Accountants and The Company Secretaries (Amendment) Act, 2022, has received the assent of the President on 18th April, 2022. This Act will come into force on such date as the Central Government may notify. Some amendments have come into force from 10th May, 2022 by a Notification dated 10th May, 2022. Some of the important amendments made in the Chartered Accountants Act, 1949, are discussed in this article.

1. SECTION 4 – CAP ON ENTRANCE FEES
At present, entrance fees for those eligible to register as members cannot exceed Rs 3,000. This can be increased up to Rs 6,000 with the permission of the Central Government. This cap on the entrance fee has now been removed from 10th May, 2022 and the Central Council can fix such fees.

2. SECTION 5 – CAP ON FEES FOR FELLOW MEMBERS
Under this section, on the admission of an Associate Member as a Fellow Member, a fee up to Rs 5,000 (Which can be increased up to R10,000 with Central Government approval) can be charged. This cap on fees has been removed from 10th May, 2022 and the Central Council can decide the amount of fees to be charged.

3. SECTION 6 – CAP ON FEES FOR CERTIFICATE OF PRACTICE (COP)
Section 6(2) is amended in line with the amendment to Section 4. Here also the cap of Rs 3,000 (which can be increased up to Rs 6,000 with Central Government approval) has been removed from 10th May, 2022.  Hence, the Central Council can now fix the fees for COP.

4. NEW SECTION 9A – CO-ORDINATION COMMITTEE
New Section 9A has been inserted in the Act effective from 10th May, 2022. This section provides that a Co-ordination Committee of the three Institutes shall be constituted. The constitution and functions of this committee shall be as under:

(i) The Co-ordination Committee shall consist of the Presidents, Vice-Presidents and Secretaries of each of the three Institutes of Chartered  Accountants, Cost Accountants and Company Secretaries.

(ii) The Meetings of the Co-ordination Committee shall be Chaired by the Secretary of Ministry of Corporate Affairs.

(iii) The objective of the formation of this Committee is the development and harmonisation of the professions of Chartered Accountants, Cost Accountants and Company Secretaries.

(iv) This Committee shall meet once in every quarter of the year.

(v) The Committee shall be responsible for the effective coordination of the functions assigned to each Institute and shall perform the following functions:

(a) Ensure quality improvement of the academics, infrastructure, research and all related works of the Institute.

(b) Focus on the coordination and collaboration among the professions to make the profession more effective and robust.

(c) Align the cross-disciplinary regulatory mechanisms for inter-professional development.

(d) Make recommendation in matters relating to the regulatory policies for the professions.

(e) Perform such other functions incidental to the above functions.

5. SECTION 10 – RE-ELECTION OR RE-NOMINATION TO COUNCIL
(i) At present, the term of the Central Council is three years, and a Council Member can seek election for three consecutive terms. In other words, no Council Member can be a member of the Council for more than 9 consecutive years. This provision also applies to Regional Council Members and Nominated Members.

(ii) Now, the amendment provides, effective from 10th May, 2022, that the term of the Council (including the Regional Council) shall be Four Years. Further, it is also provided that no Member can continue to be a member of the Council for more than two consecutive terms. In other words, no council Member can be a member of the Council for more than 8 consecutive years.

(iii) However, if a Council Member is holding office at present for the first term of 3 years, he can contest election for two more terms of 4 years each. Similarly, if a Council Member is holding office at present for the second term of 3 years, he can contest election for one more term of 4 years.

6. SECTION 12 – PRESIDENT AND VICE-PRESIDENT
(i) At present, the President of the Institute is the “Chief Executive Authority” of the Central Council. By the amendment of Section 12, effective from 10th May, 2022, it is now provided that the Secretary of the Institute shall be the “Chief Executive Officer” of the Institute.

(ii) The President will now be the “Head” of the Council. It is further provided as under:    

(a) The President shall preside at the meeting of the Council.

(b) The President and the Vice-President shall exercise such powers and perform such duties and functions as may be prescribed.

(c)  It shall be the duty of the President to ensure that the decisions taken by the Council are implemented.

(d) In the absence of the President, the Vice-President shall act in his place and exercise the powers and perform the duties of the President.

7. SECTION 15 – FUNCTIONS OF THE COUNCIL
Besides the existing functions, effective from 10th May, 2022, the Council has to discharge the following functions:

(i) The Council shall conduct investor education and awareness programmes.

(ii) The Council can enter into any Memorandum or Arrangement, with the prior approval of the Central Government, with any agency of a foreign country, for the purpose of performing its functions under the Act.

8. SECTION 16 – OFFICERS OF THE INSTITUTE
As stated earlier, it is now provided that the Secretary of the Institute shall be the “Chief Executive Officer” of the Institute. He shall perform the administrative functions of the Institute. Further, the Director (Discipline) and Joint Directors (Discipline), not below the rank of Deputy Secretary of the Institute, shall perform their functions as per the Rules and Regulations framed under the Act. It may be noted that the appointment of Joint Directors (Discipline) is provided for the first time by the Amendment Act.

Further, it is also provided that the appointment, re-appointment or termination of appointment of Director or Joint Director (Discipline) shall be subject to prior approval of the Central Government.

9. SECTION 18 – FINANCES OF THE COUNCIL
At present, the Auditors to audit the accounts of the Council can be appointed by the Council. This provision is amended, effective from 10th May, 2022, and it is now provided that the Council can appoint, every year, a Firm of Chartered Accountants which is on the panel of auditors maintained by C&AG as Auditors. However, if any of the partners of a CA Firm is or has been a member of the Council during the last four years, that Firm cannot be appointed as Auditors. The existing provisions for getting the Special Audit under specified circumstances will continue.

10. SECTION 19 – REGISTER OF MEMBERS
In respect of the particulars of members to be stated in the Register of Members, it is now provided that the particulars about any actionable information or complaint pending and particulars of any penalty imposed on the member under Chapter V shall be stated.  This provision comes into force on 10th May, 2022.

11. NEW SECTIONS 20A TO 20D – REGISTER OF FIRMS
New Chapter IVA containing Sections 20A to 20D are inserted. These sections deal with the maintenance of the Register of Firms by the Council. These Sections provide for recording the information about the constitution of the Firm, its partners and other incidental information such as particulars of pending complaints, penalties imposed, etc. If any member or Firm is aggrieved by the removal of the name of any member or Firm, provision is made for review of the decision by the Council.

12. SECTIONS 21 TO 22G – DISCIPLINARY MATTERS
Significant changes are made in the provisions dealing with the Disciplinary Directorate and the procedure to be followed in disciplinary proceedings relating to misconduct by members of the Institute and CA Firms. Existing Sections 21 (Disciplinary Directorate), 21A (Board of Discipline), 21B (Disciplinary Committee), 21D (Transitional Provisions) and 22 (Professional or Other Misconduct), are replaced by new sections 21, 21A, 21B, 21D and 22.  Section 21C is deleted. These new sections make significant changes in dealing with cases of misconduct by members or Firms. In some respects, the powers of the President, Vice-President and Council Members are curtailed, and a strict time limit is fixed for the disposal of cases of misconduct by members. These amended provisions are as under:

12.1 DISCIPLINARY DIRECTORATE
At present, the entire burden is on the Director (Discipline). Now, section 21 provides that the Disciplinary Directorate shall have one Director (Discipline) and at least two Joint Directors (Discipline). The Disciplinary Directorate must make investigations either suo moto or on receipt of an Information or a Complaint. The procedure to be followed by the Director (Discipline) (herein referred to as a “Director”) is as under:

(i)  Within 30 days of the receipt of the information or complaint, he has to decide whether the information or complaint is actionable or is liable to be closed as non-actionable. If required, he may call for additional information from the informant or the complainant by giving 15 days’ time before taking his decision.

(ii) If he decides that the information or the complaint is non-actionable, he must submit the matter to the Board of Discipline (BOD) within 60 days. The BOD, after examining the matter, may direct him to conduct further investigation.

(iii) In respect of the actionable information or complaint, the Director has to give an opportunity to the Member or the Firm calling for a written statement within 21 days. This time limit can be expended up to another 21 days in specified circumstances.

(iv) Upon receipt of the above written statement, the Director has to send a copy of the same to the informant or the complainant for submitting his rejoinder within 21 Days.

(v) Upon receipt of the written statement and the rejoinder, the Director has to submit his preliminary examination report within 30 days if a prima facie case is made out against the Member or the Firm. If the matter relates to Misconduct under the First Schedule, this report is to be submitted to the Board of Discipline. If it relates to the Second Schedule or to both First and Second Schedule, this report is to be submitted to the Disciplinary Committee.

(vi) There is one disturbing provision which is made for the first time. It is now provided that in case of any complaint or information filed by any authorized officer of the Central or State Government or any Statutory Authority duly supported by an investigation report or relevant extract of the investigation report along with supporting evidence, then the Director (Discipline) need not make any inquiry as stated above. Such Government complaint or information will be considered as the preliminary examination report. In other words, the Government complaint or information will be considered as a prima facie case against the Member or the Firm.

(vii) It is now provided that a complaint filed with Disciplinary Directorate shall not be withdrawn under any circumstances.

(viii) The status of actionable complaints or information pending with the Disciplinary Directorate as well as cases pending before the Board of Discipline and the Disciplinary Committee, together with orders passed by these Disciplinary Authorities, shall be made available in the public domain in such manner as may be prescribed.

12.2     BOARD OF DISCIPLINE
(i) At present, the Board of Discipline (BOD) consist of a person who has experience in law and having knowledge of disciplinary matters and profession, is to be appointed by the Council to be the presiding officer of the Board of Discipline. Besides the above, there is one elected Council Member and other Central Government Nominee.

(ii) Now, section 21A is replaced by a new section 21A. Under this section, the presiding officer of the BOD will be nominated by the Central Government. Such person should not be a member of the Institute. He should have experience in law and knowledge of disciplinary matters and of the profession. The selection of such person shall be made by the Central Government from a panel of persons prepared by the Council in such manner as may be prescribed. Further, there will be one member to be nominated by the Central Government and one member to be nominated by the Council from the above panel who shall be members of BOD. It is also provided that there may be more than one Board of Discipline, and the Government Nominees may be common in more than one BOD.

(iii) The BOD, while considering the cases placed before it has to follow such procedure including faceless proceedings and virtual hearing as may be specified.
    
(iv) On receipt of the preliminary examination report from the Director (Discipline) or a Government complaint or information as stated in Para 12.1 (vi) by the BOD, it shall call upon the concerned member or the Firm to submit a written statement within 21 days. This time can be extended up to further 21 days in exceptional circumstances. The BOD has to conclude its inquiry within 90 days of the receipt of the preliminary examination report.

(v) Upon inquiry, if BOD finds that the member is guilty of professional or other misconduct mentioned in the First Schedule, it has to pass an order awarding punishment after affording an opportunity of hearing to the member within 30 days of its finding. This punishment will be in the nature of any one or more of the actions against the member, such as, (a) reprimand the member, (b) remove the name of the member for up to 6 Months, or (c) impose a fine up to Rs 2 lakhs.

(vi) If during the inquiry relating to a member, the BOD finds that the member, who is a partner or owner of a CA Firm, has been repeatedly found guilty of professional or other misconduct as stated in the First Schedule during the last 5 years, the BOD can (a) prohibit the CA Firm from undertaking any activity relating to the CA profession for a period up to one year, or (b) impose fine on the CA Firm up to Rs 25 lakhs. If the fine imposed on the member or the Firm is not paid within the specified time, the Council can remove the name of the member or the Firm from the Register of Members / Firms for such period as the Council may decide. It is not clear whether the period of 5 years stated in the section includes the period before the section comes into force.

12.3    DISCIPLINARY COMMITTEE
This existing section 21B is replaced by a new section 21B. This new section provides about the constitution and functions of the Disciplinary Committee (D.C.) as under:

(i) At present, D.C. is constituted by the council. In this Committee, President or the Vice President is the Presiding Officer. Further, there are two elected members of the Council and two Central Government nominees. The Council can appoint more than one D.C.

(ii) Under the new section 21B, the Presiding Officer of D.C. will be nominated by the Central Government. Such person shall not be a member of the Institute. He should have experience in law and knowledge of disciplinary matters and of the profession. The selection of such person shall be made by the Central Government from a panel of persons prepared by the Council in such manner as may be prescribed. Further, there will be two members having experience in the field of law, economics, business, finance or accountancy, not being a member of the Institute, will be nominated by the Central Government from the above panel prepared by the Council. The Council will be able to nominate two members out of the above panel. In other words, the President, Vice-President or any Council Member will not be a member of the Disciplinary Committee unless the Rules to be framed for constituting the panel, as stated above, permit to include the names of Council Members in the Panel. The section provides that there can be more than one D.C.

(iii) On receipt of the preliminary examination report from the Director (Discipline) or a Government complaint or information as stated in Para 12.1 (vi) above, by the D.C., it shall conduct the inquiry in the case of the concerned member or the Firm in the same manner as stated in Para 12.2 (iii), (iv), (v) and (vi) relating to proceedings before BOD. The only difference between the proceedings before BOD and D.C. is as under:

(a) The D.C. has to complete the inquiry within 180 days from the receipt of the preliminary examination report.

(b) The D.C. can award punishment by way of (i) reprimand, (ii) removal of the name of the member permanently or for such period as it may think fit, or (iii) impose fine upto Rs 10 lakhs.

(c) If the member, who is a partner or owner of a CA Firm, is repeatedly found guilty of professional or other misconduct as stated in the Second Schedule or both the First and Second Schedules during the last 5 years, D.C. can (i) prohibit the CA Firm from undertaking any activity relating to the CA profession for a period up to 2 years, or (ii) suspend or cancel the registration of the Firm and remove the name from the Register of Firms permanently or such period as it thinks fit, or (iii) impose a fine up to Rs 50 lakhs. If the fine is not paid within the specified time, the council can remove the name of such member or Firm from the Register of Members / Firms for such period as it may deem fit.     

12.4 APPEAL TO AUTHORITY
(i) Existing Section 22G provides for Appeal to the Appellate Authority. Sub-Section (3) is added in this section which defines the terms “Member of the Institute” and “Firm” as under:

(a) “Member of the Institute” includes a person who was a member on the date of the alleged misconduct although he has ceased to be a member of the Institute at the time of inquiry.

(b) “Firm” registered with the Institute shall also be held liable for misconduct of a member who was its partner or owner on the date of the alleged misconduct, although he has ceased to be such partner or owner at the time of the inquiry.

(ii) Another disturbing provision introduced in Section 22G states that no action taken under the provisions of chapter V dealing with “Misconduct” will bar a Central Government Department, a State Government, any Statutory Authority or a Regulatory Body from taking action against a member or a CA Firm. This will mean that apart from the disciplinary action faced by a member or a CA Firm by the Council, as stated above, the Central / State Government or any Government Authority can take action against the Member or CA Firm. It may so happen that even if the Council holds a member or CA Firm as not guilty, any Government Department may hold the Member or CA Firm guilty and award punishment under any other applicable law.

13. CA ACT VS. COMPANIES ACT
It may be noted that u/s 132 of the Companies Act, 2013, National Financial Reporting Authority (NFRA) has been constituted. NFRA has power to take action against certain specified Audit Firms. It can also investigate complaints against any such Audit Firm and the concerned partners for misconduct in the performance of their duties. Up to now, the CA Act permitted the Council to take action against misconduct by members. Now, power is given to the Council to take action against the CA Firms also. Section 132 (4) (a) of the Companies Act, 2013 specifically provides that no other Institute or Body shall initiate or continue any proceedings in such matters of misconduct where NFRA has initiated an investigation u/s 132. In view of this provision in the Companies Act, the Board of Discipline or Disciplinary Committee shall not be able to conduct an inquiry in the case of a CA Firm or its Partner if NFRA has started an inquiry against such CA Firm or its Partner. It may be noted that there is no similar provision in the CA Act as now amended. Therefore, if BOD or D.C. has started any inquiry about misconduct against a CA Firm or its partner, it cannot continue the same if the matter is referred to NFRA and it initiates proceeding u/s 132 of the Companies Act 2013.

14. TO SUM UP
14.1 The above article discusses the amendments made in the Chartered Accountants Act. Similar amendments are made by this single Act called “The Chartered Accountants, The Cost and Works Accountants and The Company Secretaries (Amendment) Act, 2022”. Thus, the other two Acts, namely, the Cost Accountants Act and the Company Secretaries Act, also stand amended in a similar manner.

14.2 The Statement of Objects and Reasons appended to the Bill when introduced, stated that the amendments are based on the recommendations of a High-Level Committee constituted by the Ministry of Corporate Affairs. It is also stated that the recent corporate events have put the profession of Charted Accountants under considerable scrutiny. Further, it is stated that the three Acts are amended to (i) strengthen the disciplinary mechanism by augmenting the capacity of the Disciplinary Directorate and providing time-bound disposal of disciplinary cases, (ii) address conflict of interest between the administrative and disciplinary arms of the Institute, (iii) include Firms under the purview of the disciplinary mechanism, (iv) enhance accountability and transparency by providing for the audit of accounts of the three Institutes by a CA Firm to be appointed by the council from the panel of Auditors maintained by the C&AG, and (v) provide autonomy to the Council of the three Institutes to fix various fees to be changed to members, Firms and students.

14.3 Reading the various amendments made in the Chartered Accountants Act, as discussed above, it is evident that most of the powers of the President, Vice-President and Council Members in the matters relating to disciplinary cases are now curtailed. The entire disciplinary mechanism will now be controlled by officers nominated by the Central Government. The only advantage will be that the decisions will be available in a time-bound manner.

14.4 One disturbing provision in the Amendment Act is that any Complaint or Information from any Government Department will have to be considered a prima facie case of misconduct, and an inquiry will have to be conducted. Further, if a Partner of a Firm is found to be guilty of misconduct under the First or Second Schedule, action can be taken against the Firm also.

14.5 By these amendments, an impression is created that the autonomy of the Council of the Institute to regulate the conduct of the Members of CA Profession is curtailed. The power to punish the guilty members will now be in the hands of the officers nominated by the Central Government. If these officers have no experience about the profession, the life of our members will become difficult.

 

BEPS 2.0 SERIES PILLAR ONE – A PARADIGM SHIFT IN CONVENTIONAL TAX LAWS – PART I

(This article is written under the mentorship of CA PINAKIN DESAI)

TAXATION OF DIGITAL ECONOMY – A GLOBAL CONCERN

1.1. The digital revolution has improved business processes and bolstered innovation enabling businesses tosell goods or provide services to customers remotely, without establishing any form of physical presence (such as sales or distribution outlets) in market countries(i.e. countries where customers are located).1.2. However, fundamental features of the current international income tax system, such as permanent establishment (PE) and the arm’s length principle (ALP), primarily rely on physical presence to allocate taxing rights to market countries and hence, are obsolete and incapable of taxing digitalised economy (DE) effectively. In other words, in the absence of physical presence, no allocation of income for taxation was possible for market countries, resulting in deprivation of tax revenue in the fold of market jurisdictions.1.3. For example, instead of using a local sales office in India, foreign companies can sell goods to customers in India through a website. In the absence of a PE, India cannot tax profits of the foreign company from the sale made to Indian customers. Another example is that a foreign company establishes an Indian company for distributing goods in India; but the Indian distributor performs limited risk sale and distribution activity in India and hence, is allocated limited returns on ALP basis, whereas the foreign company enjoys the residual profits which are offered to tax in its home jurisdiction.

1.4. In the absence of efficient tax rules, taxation of DE has become a key base erosion and profit shifting (BEPS) concern across the globe. While the Organisation for Economic Co-operation and Development’s (OECD) BEPS 1.0 project resolved several issues, the project could not iron out the concerns of taxation of DE. Hence, OECD and G20 launched BEPS 2.0 project, wherein OECD, along with 141 countries, is working towards a global consensus-based solution to effectively tax DE.

1.5. Pillar One of BEPS 2.0 project aims to modify existing nexus and profit allocation rules such that a portion of super profits earned by a large and highly profitable Multinational Enterprise (MNE) group is re-allocated to market jurisdictions under a formulary approach (even if MNE group does not have any physical presence in such market jurisdictions), thereby expanding the taxing rights of market jurisdictions over MNE’s profits.

2. CHRONOLOGY OF PILLAR ONE DEVELOPMENTS

TIMELINE OECD DEVELOPMENT REMARKS
October, 2020 OECD secretariat released a report titled ‘Tax Challenges Arising from Digitalisation- Report on the Pillar One Blueprint’ (the ‘Blueprint’) The blueprint represented the OECDs extensive technical work along with members of BEPS Inclusive Framework (IF)1 on Pillar One. It was a discussion draft prepared with an intention to act as a solid basis for negotiations and discussion between BEPS IF members.
July, 2021 OECD released a statement titled ‘Statement on a Two-Pillar Solution to Address the Tax Challenges arising from the Digitalisation of the Economy’ (‘July Statement’) The ‘July statement’ reflected the agreement of 134 members of BEPS IF on key components of Pillar One, including nexus and profit allocation rules.
October, 2021 OECD released an update to the ‘July statement’ (‘October statement’) In the ‘October statement’, 137 members of BEPS IF, out of 141 countries2 (which represent more than 90% of global GDP) reinstated their agreement on the majority of the components agreed in the ‘July statement’ and also agreed upon some additional aspects of Pillar One.
February, 2022 till May, 2022 OECD released series of public consultation documents Since the beginning of 2022, OECD has been releasing public consultation documents which provide draft rules on building blocks of Pillar One. OECD is seeking feedback from stakeholders before the work is finalised and implemented.
2023 Implementation of Pillar One Pillar One targeted to come into effect for critical mass of jurisdictions. 
1   BEPS IF was formed by OECD in January, 2016 where more than 141 countries participate on equal footing for developing standards on BEPS-related issues and reviewing and monitoring its consistent implementation.

IMPLEMENTATION OF PILLAR ONE

3.1. The implementation of Pillar One rules will require modification of domestic law provisions by member countries, as also the treaties signed by them.The proposal is to implement a “new multilateral convention” (MLC) which would coexist with the existing tax treaty network. Further, OECD shall provide Model Rules for Domestic Legislation (Model Rules) and related Commentary through which Amount A3 would be translated into domestic law. Model Rules, once finalised and agreed by all members of BEPS IF, will serve basis for the substantive provisions that will be included in the MLC.3.2. It has been agreed that, once Pillar One is effective, all the unilateral Digital Service Tax and other similar measures undertaken by various countries will also need to be withdrawn by member countries.

4. COMPONENTS OF PILLAR ONE

4.1. As mentioned above, Pillar One has two components – Amount A and Amount B.

4.2. Amount A – new taxing right: To recollect, Pillar One aims to allocate certain minimum taxing rights to market jurisdictions where MNEs earn revenues by selling their goods/ services either physically or remotely in these market jurisdictions. In this regard, new nexus and profit allocation rules are proposed wherein a portion of MNE’s book profits would be allocated to market jurisdictions on a formulary basis. Mainly, the intent is to necessarily allocate certain portion of MNE profits to a market jurisdiction even if sales are completed remotely. MNE profit recommended by Pillar One to be allocated to market jurisdictions is termed as “Amount A”. It is only if there is a positive value of Amount A that taxing right shall be allocated to market jurisdictions. If there is no Amount A, Pillar One does not contemplate the allocation of taxing rights to market jurisdiction.

2   The IF comprises 141 member jurisdictions. The only IF members that have not yet joined in the October, 2021 statement are Kenya, Nigeria, Pakistan, and Sri Lanka. Significantly, all OECD, G20, and EU members (except for Cyprus, which is not an IF member) joined the agreement, seemingly clearing the way for wide-spread adoption in all major economies.
3   Refer Para 4.2 for concept of Amount A

4.3. Amount B – Safe harbour for routine marketing and distribution activities – a concept separate and independent of Amount A:

a. Arm’s length pricing (ALP) of distribution arrangements has been a key area of concern in transfer pricing
(TP) amongst tax authorities as well as taxpayers. In order to enhance tax certainty, reduce controversy,
simplify administration under TP laws and reduce compliance costs, the framework of Amount B is proposed.

b. “Amount B” is a fixed return for related party distributors who are present in market jurisdictions and perform routine marketing and distribution marketing and distribution activities. In other words, Amount B is likely to be a standard % in lieu of routine functions performed by marketing and distribution entities.

c. Unlike Amount A, which can allocate profits even if sales are carried out remotely, Amount B is applicable only when the MNE group has some form of physical presence carrying out marketing and distribution functions in the market jurisdiction. Currently, the agreed statements suggest that Amount B would work independent of Amount A, and there is no discussion of the interplay of the two amounts in the blueprint or agreed statements. Also, even if Amount A is inapplicable to the MNE group (for reasons discussed below), the MNE group may still need to comply with Amount B.

d. The scope and working of Amount B are still being worked upon by OECD, and hence, guidance is awaited on the framework of Amount B, such as – what will be scope of routine marketing and distribution functions? How will Amount B work if the distributor performs beyond routine functions? Will the fixed return reflect a traditional TP approach to setting the fixed return, or will it be a formulaic approach? Will fixed return vary by region, industry and functional intensity? Will implementation
of Amount B require changes to domestic law and tax treaty?

4.4. Since the framework of Amount B is still being developed at OECDs level and not much guidance is available on the scope and working of Amount B; and the focus of OECD is currently building the framework of Amount A, the scope of this article is limited to the concept and working of Amount A. This article does not deal with Amount B.

4.5. The nuances of Pillar One will be presented in a series of articles. This is the first article in the Pillar One series, which will focus on the scope of Amount A, i.e. what conditions are to be satisfied by an MNE group to be covered within the scope of the Amount A regime.

5. ‘AMOUNT A’ WORKS ON MNE LEVEL AND NOT ON ENTITY-BY-ENTITY APPROACH

5.1 As per existing tax laws, income earned by each entity of an MNE group is taxed separately, i.e. each entity is assessed to tax as a separate unit. However, Amount A significantly departs from this entity-by-entity approach. Amount A (including the evaluation of the applicability of Amount A rules) works on the MNE group level.

5.2 The draft rules issued by OECD define “Group” as a collection of Entities (other than an excluded entity) whose assets, liabilities, income, expenses and cash flows are, or would be, included in the Consolidated Financial Statements (CFS) of an ultimate parent entity (UPE).

5.3 Entity is defined as any legal person (other than a natural person) or an arrangement, including but not limited to a partnership or trust, that prepares or is required to prepare separate financial Statements (SFS). Thus, if a person (other than individuals) is required to prepare SFS, such person can qualify as an entity irrespective of whether or not it actually prepares SFS. However, certain entities are specifically excluded from the Amount A framework. This includes government entities, international organisations, non-profit organisations (NPO), pension funds, certain investment and real estate investment funds, and an entity where at least 95% of its value is owned by one of the aforementioned Excluded Entities.

5.4 As mentioned above, Group is defined by reference to CFS prepared by UPE. Hence, the concept of UPE is inherently important in the Amount A framework. To qualify as UPE, an entity needs to satisfy the following conditions:

(i) Such entity owns directly or indirectly a Controlling Interest4 in any other Entity.

(ii) Such entity is not owned directly or indirectly by another Entity (other than by Governmental Entity or a Pension Fund) with a Controlling Interest.

(iii) Such entity itself is not a Governmental Entity or a Pension Fund.

5.5 It may be noted that an entity that qualifies as UPE is mandatorily required to prepare CFS as per qualifying financial accounting standards (QFAS)5. It is specifically provided that even if a UPE does not prepare CFS in accordance with QFAS, it must produce CFS for purposes of Amount A.

4   Controlling Interest is defined as ownership interest in an Entity whose financial statements are consolidated or would be consolidated on line-by-line basis as per qualifying accounting standards.
5   Qualifying Financial Accounting Standards mean International Financial Reporting Standard (IFRS) and GAAP of countries like Australia, Brazil, Canada, EU, EEA Member states, Japan, China, Hong Kong, UK, USA, Mexico, New Zealand, Korea, Russia, Singapore, Switzerland and India.

5.6 The above concepts may be understood with the following examples:

(i)    Group 1: Promotor held group structure

Group 2: Government entity held group structure

6. CONDITIONS FOR APPLICABILITY OF ‘AMOUNT A’ TO MNE GROUP

6.1. Amount A shall revolutionise the existing taxation system. Amount A represents profits to be allocated to market jurisdictions for the purpose of taxability, even if, as per existing taxation rules, no amount may be allocable to market jurisdictions.

6.2. Considering the drastic change in the tax system, the Amount A regime is agreed to be made applicable only to large and highly profitable MNE groups. Hence, scope rules for applicability of Amount A to the MNE group have been kept at very high thresholds quantitatively and objectively, such that they are readily administrable and provide certainty as to whether a group is within its scope.

6.3. MNE Groups who do not fulfil any of the scope conditions discussed below will be outside Amount A profit allocation rules. However, where these conditions are fulfilled, an MNE group would need to determine Amount A as per the proposed new profit allocation rules (which would be determined on a formulary basis at the MNE level) and allocate Amount A to eligible market jurisdictions.

6.4. Criterion for determining whether Group is in-scope of Amount A framework as agreed by members of BEPS IF

(i) In a global consensus statement released in October, 2021, members of BEPS IF agreed on the following as scope threshold:

(a) An MNE group shall qualify as a “covered group” within the scope of Amount A if it has a global turnover of above € 20 billion and profitability (i.e. profit before tax/revenue) above 10%.These thresholds will be determined using averaging mechanisms.

(b) The turnover threshold of € 20 billion stated above will be reduced to € 10 billion after relevant review in this regard based on successful implementation, including tax certainty on Amount A. The relevant review in this regard will begin seven years after the Pillar One solution agreement comes into force. The review shall be completed within a timeframe of one year.

(ii) By virtue of such a high threshold, it is expected that it would cover only the top 100 MNE groups across the globe6, out of which about 50% of the MNEs in the scope of Amount A are likely to be US-based MNEs, about 22% are headquartered in other G7 countries, and about 8% are headquartered in China7. Most Indian headquartered MNE groups are unlikely to satisfy such high thresholds, except, large and profitable groups like the Reliance and Tata groups.

6.5 Criterion for determining whether a Group is in-scope of Amount A framework as provided in the draft scope rules

(i) Basis the broad scope agreed by BEPS IF members in October 2021, OECD released draft model rules for the Scope threshold. As per the draft rules, a Group qualifies as a Covered Group for a particular period (i.e. current period) if the following two tests are met:

(a) Global revenue test – Total Revenues of the Group for the current period should be greater than € 20 billion. While the threshold is provided in a single currency (i.e. euros), OECD is exploring coordination issues related to currency fluctuations.

6   As per OECD report “Tax Challenges Arising from Digitalisation – Economic Impact Assessment”.
7   Kartikeya Singh, “Amount A: The G-20 Is Calling the Tune and U.S. Multinationals Will Pay the Piper,” Tax Notes International, vol. 103, August 2, 2021.

(b) Profitability test – 3-step profitability test:

•    Period test – Group’s profitability exceeds 10% threshold in the current period.

•    Prior period test – Group’s profitability exceeds 10% threshold in 2 or more out of 4 periods preceding the current period8.

•    Average test – Group’s profitability exceeds 10% threshold on average across the current period and the four periods immediately preceding the current period.

(ii) All the above-mentioned tests should be cumulatively satisfied, i.e. if any condition is not satisfied, the Group is outside the scope of the Amount A regime.

(iii) Rationale for introducing prior period test and average test in draft rules – These tests seek to deliver neutrality and stability to the operation of Amount A and ensure Groups with volatile profitability are not inappropriately brought into its scope, which limits the compliance burden placed on taxpayers and the tax authorities.

(iv)    Adjustments to be made to revenue and profits for computing scope thresholds – It is noteworthy that for Global revenue test and Profitability test, adjusted revenues and adjusted profits are to be considered.

(a)    For revenues, the starting point is revenues reported in Group’s CFS to which certain adjustments are to be made such as:

•    Adding share of revenue derived from joint venture;

•    Subtracting dividends, equity gain/loss on ownership interest, and

•    Adjusting eligible restatement adjustments like prior period items.

(b) For profits, the starting point is profit or loss reported in the CFS to which certain book to tax adjustments are made, such as:

•    Adding tax expense (including deferred tax), dividends, equity gain on ownership interest, policy disallowed (bribe, penalty, fines etc.);

•    Subtracting of equity loss on ownership interest; and

•    Adjusting eligible restatement adjustments like prior period items.

8   If there is a Group Merger/ Demerger in the current Period or any of the three Periods immediately preceding the current Period, the calculation of profitability for prior period test and average test should be basis revenues and profits of Acquiring Group/ Existing Group (in case of merger) and Demerging Group (in case of Demerger).

(v) Weighted average to be considered for computing Average test:

(a) For the Average test (which requires evaluation of whether the Group’s profitability exceeds 10% threshold on average across the current period and the four periods immediately preceding the current period), the term “average” is defined as:

“Average” means the value expressed as a percentage by:

a. multiplying the Pre-Tax Profit Margin of each of the Period and the four Periods immediately preceding
the Period, by the Total Revenues of that same Period; and

b. summing the results of (a), and dividing it by the sum of the Total Revenues of the Period and the four Periods immediately preceding the Period.

(b) Further, it is specifically clarified that the calculation in subparagraph (a) of the definition of average requires that the pre-tax profit margin of each period are weighted according to the respective total revenues of the same period. The average calculation is, therefore, a weighted average calculation.

6.7. Ongoing discussions at OECD level on draft scope threshold rules

(i) The draft scope rules indicate that the profitability test requires evaluation of the profitability of 4 years prior to the current period, and also the average profitability of 5 years (i.e. the average of the current year and 4 prior years); whereas for the global revenue test, only the current year profits need to be considered. Thus, the global revenue test will be met even if revenues in prior years do not exceed € 20 billion.

(ii) However, it is noteworthy that the framework provided in the draft rules does not reflect the final or consensus views of the BEPS IF members, and the OECD is currently exploring a number of open questions in this area.

(iii) One of the issues being evaluated is whether the total revenues of a Group should be subject to the prior period test and the average test as well (which applies to profitability); and

(iv) Another issue is whether the prior period test and the average test should apply as a permanent feature of the Scope rules or, alternatively, apply as an “entry-level test” only. Under the latter option, once a Group falls in the scope of Amount A for the first time, the prior period test and the average test would no longer apply, and thereafter only the total revenues and profitability of the Group in the current period would determine whether the Group is in scope.

6.8. Anti-fragmentation rule to prevent circumvention of global revenue test

(i) The draft rules also provide for an anti-fragmentation rule (AF rule) as a “targeted deterrent and anti-abuse rule” to prevent a Group from restructuring in order to circumvent the global revenue test of € 20 billion.

(ii) The AF rule applies where a group (whose UPE is directly or indirectly controlled by an excluded entity, investment fund or real estate vehicle) in totality meets the global revenue test and the profitability test, but the group is artificially split to create one or more Fragmented Groups with the principal purpose of circumventing the global revenue test of €20 billion. Consider the following example:

(iii) By virtue of the AF rule, revenues of such fragmented groups shall be aggregated, and the global revenue test shall be met where such aggregated revenue exceeds € 20 billion. It may be noted that the AF rule shall provide for a grandfathering clause such that the rule shall be made effective only for restructurings that take place after a set date. Discussions are ongoing at the OECD level on what should be such date of grandfathering.

7. SECTOR EXCLUSIONS- EXCLUSION FOR EXTRACTIVE AND REGULATED FINANCIAL SERVICES

7.1. In the global consensus statement released in October, 2021, members of BEPS IF agreed that the extractive sector and regulated financial services sector must be excluded from the framework of Amount A. The revenues and profits earned by a group from extractive activities and regulated financial services are to be excluded while evaluating scope thresholds (i.e. global revenue of € 20 billion and the profitability test of 10%) as well as computation of Amount A for covered
groups.

7.2. In 2022, OECD released draft rules for the scope of this sector exclusion for extractive activities and regulated financial services.

7.3. Exclusion for profits and revenues of Regulated Financial Institutions (RFI)

(i) Profits and revenues of Entities that meet the definition of RFI are wholly excluded from Amount A. Alternatively, profits and revenues of an Entity that does not meet that definition (i.e. non RFI) is wholly included in Amount A. Hence, the exclusion works on an entity-by-entity basis. What is excluded is the entire profit of the RFI entity and not the segmental activity.

(ii) MNE groups need to evaluate the global revenue test and profitability test discussed in Para 6 above after excluding revenues and profits of RFI. If the MNE group still crosses the scope thresholds, such a residual group will qualify as a covered group under Amount A.

(iii) The rationale for providing this exclusion is that this sector is already subject to a unique form of regulation, in the form of capital adequacy requirements, that reflect the risks taken on and borne by the firms. This regulatory driver generally helps to align the location of profits with the market.

(iv) Definition of RFI

(a) RFI includes 7 types of financial institutions: Depositary Institution; Mortgage Institution; Investment Institution; Insurance Institution; Asset Manager; Mixed Financial Institution; and RFI service entity.

(b) Each type of RFI is specifically defined and generally contain 3 elements – all of which need to be satisfied: a license requirement, a regulatory risk-based capital requirement, and an activities requirement. For example, to qualify as a depositary institution, the following condition should be satisfied:

• It must have a banking license issued under the laws or regulations of the jurisdiction in which the Group Entity does that business.

• It is subject to capital adequacy requirements that reflect the Core Principles for Effective Banking Supervision provided by the Basel Committee on Banking Supervision.

• It accepts deposits in the ordinary course of a banking or similar business.

• At least 20% of the liabilities of the entity consist of Deposits as of the balance sheet date for the period.

(c) Entities whose substantial business is to provide regulated financial services to Group Entities of the same Group are not RFI.

7.4. Exclusion for extractive activity

(i) The extractive exclusion will exclude the Group’s revenues and profits from extractive activities from the scope of Amount A.

(ii) Definition of extractive activity

(a) As per the draft rules released in April 2022, an MNE group shall be considered to be engaged in “Extractive Activity” if such MNE group carries out exploration, development or extraction of extractive product and the group sells such extractive product. Thus, the extractive activities definition contains a dual test:

• a product test (i.e. the sale of an extractive product), and

• an activities test (i.e. conducts exploration, development or extraction).

(iii) Both of the above-mentioned tests must be satisfied to qualify as “Extractive Activity”. Thus, where a MNE group earns revenue from commodity trading only (without having conducted the relevant Extractive Activity), or revenue from performing extraction services only as a service provider (without owning the extractive product), such MNE may not be considered as carrying on “Extractive Activity”.

(iv) As per the OECD, these two conditions for extractive exclusion reflect the policy goal of excluding the economic rents generated from location-specific extractive resources that should only be taxed in the source jurisdiction, while not undermining the comprehensive scope of Amount A by limiting the exclusion in respect of profits generated from activities taking place beyond the source jurisdiction, or later in the production and manufacturing chain.

(v) The two tests in definition of “Extractive Activities” may be understood basis the following example:

7.5.  Revenues and profits from extractive activities to be excluded

(i) Unlike regulated financial services, the extraction exclusion does not exclude all revenues and profits of entities engaged in the extraction business.

(ii) In fact, where an MNE group is carrying on Extractive Activity, the consultation draft provides a complex mechanism to compute revenue and profits from such extractive activity on a segmented basis.

(iii) MNE groups need to evaluate the global revenue test and profitability test discussed in Para 6 above after excluding revenues and profits from extractive activities. If the MNE group still crosses the scope thresholds, such residual group will qualify as covered group under Amount A.

8. CONCLUSION

The discussion in this article highlights that rules to determine whether an MNE group is within the scope of the Amount A regime itself is a complex process. Where the entry test for Amount A rules itself is so convoluted, one can imagine the intricacies which the new profit nexus and profit allocation rules under Amount A will entail.

MNE groups who do not fulfil any of the scope conditions discussed in this article will be outside the Amount A profit allocation rules. However, where the above conditions are fulfilled, an MNE would need to determine Amount A as per the proposed new profit allocation rules (which would be determined on a formulary basis at the MNE level) and allocate Amount A to eligible market jurisdictions. These aspects will be discussed in detail in the next articles in this series. Stay tuned!

DELIGHT OF WRITING

In this Editorial (my penultimate one), I am sharing what I have learnt about writing, especially as an Editor of BCAJ, being a professional for twenty-five years and reading quite a lot of material on writing. Many people had told me to write on writing after I wrote about Reading (‘Top Notch Habit’ in January 2021). Here is all I could fit in two pages out of the tiny speck I have learned after writing and editing for 60 months.

Writing follows an idea. To me, best ideas have come on long walks, post morning wake up time, while reading or listening to exceptional people, or observing something that interests me or bothers me.

An idea germinates as one spends time with the idea. Taking notes1 (your brain is for having ideas, not storing them) when they come unannounced (writing a few words can preserve an epiphany forever), talking to others who are into that subject, gathering more facts and experiences, and seeing it from multiple perspectives to derive clarity, helps the idea to evolve.

Shape the flow: Like a river that makes its trajectory, ideas need shape. Right points need emphasis. Expanding points to the extent the reader needs gives an idea its shape the size. Bullet points serve as the test of clarity. What I learnt decades ago: As a writer I must know what I want to say? And after writing, I must answer the question: Did I say it?

Use of words: Keep it simple2 (it doesn’t mean ordinary). Use the right words, fewer words, and shorter sentences. Know the point and keep to the point. Don’t state the obvious. Be emphatic, declarative and not unsure or hesitant. Rather than being clever, be clear.

Edit: Slash and Burn ruthlessly when you review your own writing. Writing improves not only by what we can add, but also by what we keep out. Self-edit of 30% of initial writing is a sign that you have done well. Make sentences tighter by removing/replacing elements that are useless. ‘The secret of good writing is rewriting3’.

 

1   I use Google Keep. You can clip great reads
to Evernnote.

2  Simplicity is the ultimate sophistication –
Leonardo da Vinci

3   William Zinsser, in his book ON WRITING WELL

Process: Come to the point quickly, unless writing a suspense movie/novel or a sequence leading to a reasoned end. Readers’ attention is under the assault of many competing things. They want to know what’s in it for them. More ideas in less pages, one idea in more pages – know which one to choose depending on situation and readership; comprehensive and concise both have their places. Use subheadings, it’s easier to fill them and easier for readers to register, grasp and revisit. Weave points together – see the beginning and end to ensure they are woven in the middle by sense and purpose.

Cut out the interruptions as you write. Uninterrupted or Indistractable4 time is an absolute must.

Words not to use: Be that as it may (habit driven), notwithstanding (legalise), I believe, I think (what you write is obviously that),…keep the sentence clean, sharp and shining. Many words serve no purpose; they are clutter, distraction and a burden on the reader. A bit like Ads when you are watching a show!

Learning to write: You learn writing by writing just as you become a better cook by cooking or a better swimmer by going into the water. Use active voice. ‘I read it’ is crisper than ‘it was read by me’. Writing is talking to someone on paper. Read your written material aloud and see how it sounds to eliminate the risk of sounding verbose, pretentious or (unnecessarily) complicated or even unnatural.

Use ‘meaning dense’ words so you can use fewer words. I like to use a word from another or local language that conveys meaning better than an English word and translate it so that those who understand will get the point much better. Sometimes bright ideas lose their power when presented in the vessel of unsuitable words.

 

4  Recommended reading: Nir Ayal
(Indistractable:…) and Carl Newport (Deep Work)

Language power is a must. One can develop it over time. Grammar, syntax and vocabulary make it tick. You have many free tools at hand. Be obsessively meticulous.

What helps writing and why writing helps: Writing is thinking and talking on paper. But thinking can be haywire, all over the place, as it has no limits/borders. Therefore, when thinking needs expression or communication, writing makes it effective.

Professional Writing: I have been doing sessions on professional writing for more than eight years. Even legal and professional writing need not ‘sound’ like reading an ‘Act’. From appeal to rectification, writing that lands on the other side and prompts action, works. In England, lawyers were paid per word, so they used the same word 10 times. We can spare the reader.

Unlearn from the Worst: The worst form of writing is on our shelves: Income tax Act, Companies Act etc. Take them as examples of obnoxious writing. Remember Curse of Knowledge5, the writer’s inability to place herself in the position of a reader. Use of technical terms/phrases (technobabble) not intelligible to many readers will make them feel excluded if these terms are not explained (example: ‘bright line test’). A writer should strike a balance between choosing the right word, proof of the author’s expertise and understanding of it by the reader.

Learn from the Best: Imitation is part of learning. Today we can enter the minds of the best people for free via internet – articles, videos, podcasts. Another approach I have liked is extrapolating the ideas expressed in a seemingly different situation / context to my own.

 

5   Coined by Steven Pinker

Writing Resources I like: Follow Nicolas Cole, Dickie Bush and David Parell on Social Media. Books: The Elements of Style (by Strunk), On Writing Well (by Zinsser), On Writing (Stephan King), Several Short Sentences About Writing (by Klinkenbourg). Grammarly, is a good extension to a browser.

Finally, Goswami Tulsidas, in the initial verses of RamaCharitaManas, gives a statement of purpose of writing the 12000 verses that follow. He says I composed the story of RaghuNaath for my own delight: I think like every other expression, writing in the end is for one’s own delight.

Let me leave you with a few quotes on writing:

‘Actually a simple style is the result of hard work and hard thinking; a muddled style reflects a muddled thinker or a person too arrogant, or too dumb, or too lazy to organize his thoughts’.

‘The secret to good writing is to use small words for big ideas, not to use big words for small ideas’.

‘Your writing is only as good as your ability to delete sentences that don’t belong’.

‘You can’t revise or discard what you don’t consciously recognize’.

“If you’re thinking without writing, you only think you’re thinking.”

 
Raman Jokhakar
Editor    

CELEBRATING 75 YEARS OF INDEPENDENCE RAMSINGH KUKA

17th January, 1872. A historic event in the struggle for India’s freedom. Most deplorable manifestation of the cruelty of the British Government.

Fifty persons, ardent followers of Shri Ramsingh Kuka, were to be shot dead in one go! It was in a village called Malerkotla in Ludhiana. The freedom fighters rejected the British Officer – Coven’s proposal to wrap their faces and shoot them from the back. They insisted that they would prefer to be shot from the front with their eyes wide open.

Many British families had assembled to watch this incident as ‘entertainment’. Coven ordered firing at 49 individuals one by one. The last one was a 12-year-old kid. Coven’s wife had lost her son of that age. She could not bear this scene and requested her husband to leave him. Coven offered to leave him if he left Ramsingh Kuka’s movement. However, since he used bad words about Kuka, the boy jumped in anger and held Coven’s beard tightly, so much so that the soldiers had to cut his hand to relieve Coven! The inevitable outcome was that Coven ordered the boy’s killing too!

Who was this Ramsingh Kuka?

He was born in 1816 at Baini Village in Ludhiana. His father, Jassasingh, had a small business, and his mother, Sadan Kaur, was a pious lady. Jassasingh was a respected person in the locality. Ramsingh got married at the age of 7, according to the prevailing custom.

Ramsingh’s maternal uncle Kabulsingh was a soldier in Rana Ranjitsingh’s army. Ramsingh also joined Ranjitsingh’s army at the age of 20. Ramsingh acquired knowledge and insight into social problems and tried some reforms. His behaviour was exemplary, and it influenced many around him. Rana Ranjit died in 1839, and there were serious disputes between his son and his ministers. Britishers took advantage of this situation and conquered Lahore from Sikhs.

Ramsingh returned to his village and became a spiritual leader. He experienced pain to see the misbehaviour of people and the torturous attitude of Britishers. They used to convert the prisoners and spread their religion. Even Ranjitsingh’s son Dilip Singh was converted! The common man was impressed and attracted to the British style of living.

Ramsinigh’s wife, Jassan, was sincerely supporting Ramsingh’s activities. There were many sects in Sikhism – like Namdhari, Khalsa and Keshdhari. Ramsingh’s sect came to be known as Kuka.

Ramsinigh’s behaviour was so perfectly clean and pure that people started treating him as the rebirth of Guru Govindsingh. He guided many people to give up bad habits, addictions, etc. and made social reforms. To relieve people from excessive spending on weddings, he started the system of collective wedding ceremonies. This came to be known as ‘Anand Vivah’ (Happy weddings). Selfish priests objected to this system of group weddings. However, even today, this system is in vogue in the Kuka sect. Kuka then took the initiative to bring about intercaste marriages, and permitted re-marriage of widows, which were taboo until then. He encouraged women to participate in social activities.

Thereafter, the Kuka sect entered the political scene – to fight for India’s freedom. One respectable person named Ramdas advised Kuka to do so. They also took up the task of protecting cows. He promoted Swadeshi – use of indigenous goods; they boycotted foreign goods. On 14th April, 1837, he planned to drive away the Britishers from a particular location. They boycotted going to Government offices and courts and also gave up travelling by railways.

Kuka set up his own messaging systems to maintain secrecy from the Britishers. He appointed 22 officers to maintain discipline and execute the work. They were called ‘Sooba’.

Kuka’s followers were spread not only in adjacent states, but right upto Russia. They were the pioneers in reaching foreign countries to seek help for our freedom struggle.

British Commissioner, Ambala R.G. Teller, gathered a lot of information about the Kuka sect. He had noted that the day was not far off when these Kukas will attack the Britishers. The other commissioner of Ambala, J. W. Macnub, recorded that religious movements are transforming into political activism. Despite troubles, the Kuka sect’s strength shot up to 4,30,000 numbers!

The British then adopted their usual trick of ‘Divide and Rule’. They created animosity between Hindus and Muslims; and also other communities and castes. They started selling beef outside Gurudwaras and temples. The unrest flared up. Britishers started arresting the Kuka sect people. They harassed and tortured common people.

Kuka felt that because of his followers, common people are facing injustice at the hands of Britishers. So, he advised them to surrender themselves. His followers did accordingly. Many innocent people were sentenced to death. Kuka followers proudly went to the gallows dancing and chanting bhajans.

Many Kukas were unjustly hanged at many places. In open court, one of them said “I will take rebirth in a Sikh family and will take revenge of such inhuman killings!”

In a similar incident of injustice, one young Kuka – Hirasingh vowed to take revenge. Ramsingh tried to control him and advised him to avoid recklessness.

Hirasingh led a group of 140 Sikh volunteers, and they attacked the Britishers on 15th of January, 1872. They didn’t have weaponry and had only swords. When Hirasingh saw that they would be defeated, he decided to surrender; 68 Kukas followed him, and all of them were mercilessly killed on 17th of January. Then 50 more were killed.

Interestingly, there was Varayam Singh, who was very short in height. Bullets were going above his head. Britishers allowed him to run away. But he went and stood on a stone and asked them to shoot him! Ramsingh and a few other Kukas were arrested on the 14th of January.

His 100 letters addressed to his followers are available. They are full of affection and deep thinking about society and nation.

Namaskaars to this heroic son of our country!

CORONA? IT’S A MINOR PROBLEM!

A Chartered Accountant was under a lot of tension. He had lost quite a few friends and relatives due to Corona. Many others known to him had tested positive and were hospitalised. Although he had stopped watching news channels, the negativity in his mind refused to subside. When the stress became unbearable, he surrendered to a Sadhu Maharaj. The following was the dialogue between the two:

CA: Pranaam, Sadhu Maharaj.

Sadhu: Vatsa, kaunsi chinta tumhe mere paas laayi hai? (My child, what’s brought you here to me?)

CA: Guruji, you may be aware that this Corona is playing havoc everywhere in our country.

Sadhu:    It is world-wide.

CA: Yes, but this second wave in India is more disastrous than in any other country. I have lost my sleep. Even in my dreams I see Corona viruses all around.

Sadhu: I wonder why we Indians are so afraid of Corona. There is another virus which is very familiar to you and it has been killing the country over the last seven decades.

CA: Achchha! I was not aware. What is that?

Sadhu: Surprising! Are you really a CA?

CA: Maharaj, I was so much engrossed with my practice that I never read anything about any other virus which is so serious.

Sadhu: That other virus is so dangerous that this Corona is nothing before it.

CA: In what way, Guruji?

Sadhu: See, Corona stays with a person for just eight to 15 days. After that, either the Corona goes or the person goes. And some money also goes. But the other virus stays with you all your life and takes away your money every day.

CA: How is it that I never heard about it?

Sadhu: That other virus is omnipresent. It is present in Corona testing. It decides whether you are Covid positive or negative. It decides whether you should be hospitalised. Without it you cannot even get a hospital bed. That other virus decides what treatment to give. It arranges for medicines, including Remdesivir. Without it, how can you get oxygen?

CA: You mean it is some Government Authority? Or some Minister?

Sadhu: Arey nahi, vatsa. It is neither a Minister nor an authority. But it is there with every Minister and authority.

CA: (Completely puzzled) Maharaj?

Sadhu: Not only this, but that other virus decides whether or not there is a Corona wave. It decides whether vaccines are available. It decides how much gap should be there between two doses of the vaccine.

CA: Guruji, it was after a lot of effort that I have only now come to understand GST and other tax laws; and even Accounting Standards to some extent. I attempted to know even ICDS. But what you are telling me is simply baffling. I can’t even imagine how I never learnt about the other virus. And you are saying it is even more dangerous.

Sadhu: Many times more dangerous than this Covid-19. It has many variants and mutations. There is no place in our country where it is not there. It is in cities as well as in villages, in every walk of life – education, health, administration, judiciary and defence.

CA: Maharaj, it also comes in waves?

Sadhu:    No, it is constant. It never dies. It is ever increasing. If you try to suppress it, it bounces back, it grows. Even the statistics of this Corona are controlled by that other virus.

CA: Please give me some clue.

Sadhu: What more do you want? It is there even in our spiritualism. It kills many things at a time. It kills many men, it kills our character, it destroys our values, it spoils our social and personal life. I will give you a clue. The first three letters of the other virus are the same as those of Corona.

CA: Maharaj, I understood! That other virus is  ‘CORruption!’ Thank you. I am aware that this Corona can be treated, cured or at least controlled, but the other one has no remedy. Now, my fear about this Corona has completely vanished. Once again, Pranaam to you, Maharaj!

FIT AND PROPER PERSON (A widely worded test to refuse entry in the securities market)

BACKGROUND
Persons desiring to do business in the securities markets are usually required to obtain a license of sorts – a registration – from the Securities and Exchange Board of India (‘SEBI’). This is especially so for those who are known as ‘intermediaries’ and who render various forms of services. They may be stock-brokers, portfolio managers, those handling mutual funds, etc. Each category has a different set of requirements for being eligible to be registered which may include qualifications, net worth requirements, etc. Once registered, they also have to follow prescribed rules and usually a Code of Conduct. Failure to follow such rules / Code may result in action which may include penalties, suspension or even cancellation of certificates.

However, there is one overriding requirement and test common across almost all intermediaries. And that is the ‘Fit and Proper Person’ test. A person needs to be ‘fit and proper’ to obtain registration. Unlike other requirements which are well defined and strictly applied, the ‘fit and proper’ requirement may appear at first glance as vague, broadly defined and subjectively applied. In several cases, entities have been debarred or refused entry in the securities market on the ground that they failed this ‘fit and proper’ test.

So what is this test and requirement? Is it as arbitrary as it appears to be? There have been several rulings of the Securities Appellate Tribunal (‘SAT’) and orders of SEBI over the years in this regard. This article describes the legal provisions and discusses, in the light of several precedents, how this test has been applied. While some areas of doubt and concern still remain, the rulings have been generally on similar lines applied consistently.

THE LEGAL DEFINITION OF ‘FIT AND PROPER’ UNDER SECURITIES LAWS

This term has different connotations and definitions under different laws. The Reserve Bank of India, for example, has a different connotation of this test for appointment of directors in public sector banks. Further, without using this term, other laws, too, apply similar principles while granting or rejecting licenses / registration. However, we shall focus here on the definition under Securities Laws.

The definition has seen significant change over the years and the current definition and criteria are given in Schedule II to the SEBI (Intermediaries) Regulations, 2008 (‘the Regulations’) which reads as under:

CRITERIA FOR DETERMINING A ‘FIT AND PROPER PERSON’

For the purpose of determining as to whether an applicant or the intermediary is a ‘fit and proper person’ the Board may take account of any consideration as it deems fit, including but not limited to the following criteria in relation to the applicant or the intermediary, the principal officer, the director, the promoter and the key management persons by whatever name called –

(a) integrity, reputation and character;
(b) absence of convictions and restraint orders;
(c) competence, including financial solvency and net
        worth;
(d) absence of categorisation as a wilful defaulter.

Earlier, there were full-fledged and separate Regulations focused on this aspect – the Securities and Exchange Board of India (Criteria for Fit and Proper Person) Regulations, 2004. The wordings in the earlier Regulations were similar but lengthier. The general pattern and essence remain the same in the new criteria and, hence, the rulings thereon can be generally relied on and are indeed followed for the Intermediaries Regulations.

BROAD AND VAGUE WORDING OF THE CRITERIA

The test applies not just to the applicant / intermediary but also to its director, promoter, key managerial person, etc. The criteria are striking in their wideness and even vagueness in wording. The ‘integrity, reputation and character’ of the person is examined, but no specific benchmark has been provided as to how it would be measured or judged. And whether it would be limited to the person’s work or even his personal life can be considered.

‘Absence of convictions and restraint orders’ may sound clear at first glance but becomes complicated when looked at closely. If there is a conviction for which punishment or a restraint order is continuing, it would be obvious that he cannot be registered in violation of such orders. However, does the conviction / restraint have to be on acting as such intermediary? Or is it, and which is more likely, that the conviction / restraint may be on any area that may reflect adversely on the character of the person? In any case, it is not clear whether the conviction or restraint needs to be subsisting in the sense that it is being undergone or is a past one. If a past one, whether even a conviction / restraint from the distant past is also to be considered?

Competence, including financial solvency and net worth, is to be considered. But, again, no benchmarks are given – whether any specific qualification or area of experience would be considered. The term ‘financial solvency’ is easy to understand in a negative way as not being insolvent. But considering that it is used with the term ‘net worth’, perhaps the intention, to judge from context, may be that the net worth may be commensurate with the nature of registration sought.

As we will see later, there is a reason why the criteria are broadly worded with lack of specific, measurable parameters. The intention seems to be to judge the person in a subjective manner on such parameters. However, subjectivity is compensated in a different manner by ensuring that only those adverse aspects that are serious are considered.

PRECEDENTS

This subject has again come to the fore due to a recent Supreme Court ruling (reported in the media) on certain on-going appeals before SAT on decisions of SEBI on brokers in the NSEL matter. However, there is a longer history of precedents and generally there has been consistency in them following the principles laid down in an early SAT ruling of 2006.

Jermyn LLC vs. SEBI [2007] 74 SCL 246 (SAT – Mum.)
This was one of the earliest rulings (affirmed by the Supreme Court in the second appeal) that laid down the basic principles for application of the criteria. The matter related to the alleged Ketan Parekh scams. Simplified a little bit, the broad issue was whether persons who have been subjected to bans and investigations of serious violations could re-enter the market through a different name. The question was about determining whether a non-resident entity registered with SEBI was indeed associated with the KP group that faced serious allegations. It was alleged that there was commonality / association with persons allegedly connected with the KP group and several factors were placed on record. The entity contended that the allegations against the KP group were not finally proved, that many investigations were still going on, and so on. SAT took a broader view of the requirements relating to ‘fit and proper person’. It held that it was fair to consider serious allegations as relevant even if the proceedings do not yet have a final outcome. It also held that subjective judgment was acceptable. The following words can be usefully referred to since they have been applied in later cases (emphasis supplied):

‘9. A reading of the aforesaid provisions of the Regulations makes it abundantly clear that the concept of a fit and proper person has a very wide amplitude as the name “fit and proper person” itself suggests. The Board can take into account “any consideration as it deems fit” for the purpose of determining whether an applicant or an intermediary seeking registration is a fit and proper person or not. The framers of the Regulations have consciously given such wide powers because of their concern to keep the market clean and free from undesirable elements… In other words, it is the subjective opinion or impression of others about a person and that, according to the Regulations, has to be good. This impression or opinion is generally formed on the basis of the association he has with others and / or on the basis of his past conduct. A person is known by the company he keeps. In the very nature of things, there cannot be any direct evidence in regard to the reputation of a person whether he be an individual or a body corporate. In the case of a body corporate or a firm, the reputation of its whole-time director(s) or managing partner(s) would come into focus.

The Board as a regulator has been assigned a statutory duty to protect the integrity of the securities market and also interest of investors in securities apart from promoting the development of and regulating the market by such measures as it may think fit. It is in the discharge of this statutory obligation that the Board has framed the Regulations with a view to keep the marketplace safe for the investors to invest by keeping the undesirable elements out… One bad element can not only pollute the market but can play havoc with it which could be detrimental to the interests of the innocent investors. In this background, the Board may, in a given case, be justified in keeping a doubtful character or an undesirable element out from the market rather than running the risk of allowing the market to be polluted.

We may hasten to add here that when the Board decides to debar an entity from accessing the capital market on the ground that he / it is not a fit and proper person it must have some reasonable basis for saying so. The Board cannot give the entity a bad name and debar it. When such an action of the Board is brought to challenge, it (the Board) will have to show the material on the basis of which it concluded that the entity concerned was not a fit and proper person or that it did not enjoy a good reputation in the securities market. The basis of the action will have to be judged from the point of view of a reasonable and prudent man. In other words, the test would be what a prudent man concerned with the securities market thinks of the entity.’

This ruling and the principles it laid down were followed in many later cases such as:
1. Mukesh Babu Securities Limited vs. SEBI (Appeal No. 53 of 2007, dated 10th December, 2007, SAT);
2. SEBI’s order in case of Motilal Oswal Commodities Broker Private Limited dated 22nd February, 2019;
3. SEBI’s order in case of Anand Rathi Commodities Limited dated 25th February, 2019;
4. SEBI’s order in case of Phillip Commodities India Pvt. Ltd. dated 27th February. 2019.

ISSUES AND CONCLUSION


The series of decisions shows that the application of the criteria to determine whether a person is a fit and proper person is seen from a different perspective. The core objective is that persons with dubious reputation and image should not be allowed entry in the capital market. A person may have several cases against him about alleged scams, serious wrongdoing, etc. The final outcome of these cases may take years, even decades. Can such person enter or continue in the securities markets? Would it be sufficient that he discloses on-going cases? The governing principles as laid down suggest that SEBI can take into account such allegations even if there is no final outcome. In its subjective view, it can refuse entry to such persons. For this purpose, SEBI may take into account developments which may occur at various intermediary stages – observations of courts, reports of investigative agencies, etc. Many of the principles of natural justice such as right of cross-examination, providing of all underlying information / documents, etc., may not be strictly applied. The material SEBI has relied on is seen in a more substantive manner.

That said, this does not mean that SEBI has indiscriminate and unquestionable powers. Each of the cases has shown that the allegations on record have been fairly serious and multifarious. Such serious allegations are enough to put a person in a bad enough light to be refused entry in securities markets at least in the interim. SEBI as a gatekeeper thus has broader powers.

The test of ‘fit and proper person’ at present has application to intermediaries under the Regulations. However, it may not be surprising if such test, or at least the principles thereof, may get wider application to other persons associated with the capital markets and who play a key role. One example that can be thought of is Independent Directors.

FAMILY SETTLEMENTS: OPENING UP NEW VISTAS

INTRODUCTION
As families grow, new generations join the business, new lines of thinking emerge and disputes originate between family members regarding assets, properties, businesses, etc. Finally, these lead to a family settlement. Such a family arrangement is one of the oldest alternative dispute resolution mechanisms. The scope of a family arrangement is extremely wide and is recognised even in ancient English Law. This is because the world over, courts lean in favour of peace and amity within the family rather than on disputes. In the last 60 years or so, a good part of the law in India relating to family settlements is well settled through numerous court decisions. In recent years, both the Supreme Court and the High Courts have delivered some important judgments on this very vital issue. The key tenets from these decisions have been culled out and analysed in this month’s feature.

PRINCIPLES SETTLED SO FAR

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

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

(b) An oral family settlement involving immovable property needs no registration. Registration (where immovable property is involved) is necessary only if the terms of the family arrangement are reduced to writing. Here, a distinction should be made between a document containing the terms and recitals of a family arrangement made under the document and a mere memorandum prepared after the family arrangement has already been made either for the purpose of the record, or for information of the court for making necessary mutation. In such a case the memorandum itself does not create or extinguish any rights in immovable properties and it is, therefore, not compulsory to register it.

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

(d) By virtue of a family settlement or arrangement, the members of a family descending from a common ancestor or a near relation seek to sink their differences and disputes, settle and resolve their conflicting claims or disputed titles once and for all in order to buy peace of mind and bring about complete harmony and goodwill in the family.

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

The decision in the case of Sita Ram Bhama vs. Ramvatar Bhama, (2018) 15 SCC 130 is different from the scores of decisions which have held that family settlements do not require registration. However, this difference is on account of the facts of this case. Here, a father agreed to divide his self-acquired properties between his two sons. He died without doing so and also did not make a Will. Consequently, the two brothers, their two sisters and mother all became entitled to the properties under the Hindu Succession Act. The brothers executed a document titled ‘Memorandum of Family Settlement’ dividing the properties between the two of them as per their late father’s wishes. This document was also signed by their sisters and mother. The question was whether the instrument was to be registered or whether stamp duty was to be paid on the same? Distinguishing (on facts), the catena of decisions on the issue, the Supreme Court held that the document was to be registered and duly stamped. This was because it was not a memorandum of family settlement. The properties in question were the self-acquired properties of the father in which all his legal heirs had a right. The instrument took away the rights of the sisters and the mothers. It was a relinquishment of rights by them in favour of the brothers. It did not merely record the pre-existing rights of the brothers. Hence, it was held that the properties could not be transferred on the basis of such an instrument.

When on this subject, one must also consider the three-judge bench decision in the case of Vineeta Sharma vs. Rakesh Sharma, CA 32601/2018, order dated 11th August, 2020. Though not directly on the issue, it is equally relevant. It held that a daughter would not have a coparcenary right in her father’s HUF which was partitioned before 20th December, 2004. For this purpose, the partition should be by way of a registered partition deed / a partition brought about by a Court Decree. The Supreme Court held that the requirement of a registered deed was mandatory. The intent of the provisions was not to jeopardise the interest of the daughter but to take care of sham or frivolous transactions set up in defence unjustly to deprive the daughter of her right as coparcener. In view of the clear provisions of section 6(5), the intent of the Legislature was clear and a plea of oral partition was not to be readily accepted. However, in exceptional cases where the plea of oral partition was supported by public documents and partition was finally evinced in the same manner as if it had been effected by a decree of a Court, it may be accepted. A plea of partition based on oral evidence alone could not be accepted and had to be rejected outright.

Another relevant decision is that of the Delhi High Court in the case of Tripta Kaushik vs. Sub-Registrar, Delhi, WP(C) 9139/2019, order dated 20th May, 2020. In that case, a Hindu male died intestate and his wife and son inherited his property. The son renounced his share in favour of his mother by executing an instrument. The issue was one of stamp duty on such instrument. It was contended that the son had inherited half share in the property on the death of his father under the Will left by his father and, therefore, the Relinquishment Deed be considered as a family settlement not chargeable to Stamp Duty. It was held that the Relinquishment Deed did not make any reference to the Will of the late father of the petitioner, or to any purported family settlement. Accordingly, it was held that the instrument was a Release Deed liable to stamp duty and registration.

MEMORANDUM OF FAMILY SETTLEMENT NEEDS NO REGISTRATION

As opposed to the above case, the decision of the Supreme Court in Ravinder Kaur Grewal vs. Manjit Kaur, CA 7764/2014, order dated 31st July, 2020 is diametrically opposite. In this case, a family settlement was executed in relation to a dispute between three brothers and their families. There was a specific recital in the memorandum that the appellant was accepted as the owner in possession of the suit property. He had constructed 16 shops and service stations on the same. In other words, it proved that he was being considered as the owner in possession of the suit property. Prior to execution of the memorandum on that day the family compromised not to raise any dispute regarding his ownership. Accordingly, the Court held that the document in question was a writing with regard to a fact which was already being considered and admitted by the parties. Hence, it could not be said that the document itself created rights in immovable property for the first time. Further, the parties to the document were closely related and hence the instrument did not require any registration. It was only a memorandum of family settlement and not a document containing the terms and recitals of a family settlement. Accordingly, the Court concluded that the document was valid and all parties were bound to act in accordance with the same. This decision reiterates the principle laid down by the Supreme Court in Kale’s case (Supra). Further, the case held that once the memorandum is acted upon, the same is binding upon the parties even though it is unregistered.

VALIDITY OF UNSTAMPED, UNREGISTERED DOCUMENT FOR OTHER PURPOSES

In the above case of Sita Ram (Supra), the Supreme Court also examined whether such an instrument which was required to be registered and stamped could be used for any collateral purpose. It held that it was not possible to admit such an instrument even for any collateral purpose till such time as the defect in the instrument was cured. It relied on Yellapu Uma Maheswari and another vs. Buddha Jagadheeswararao and others, (2015) 16 SCC 787 for this purpose. The documents could be looked into for collateral purpose provided the parties paid the stamp duty together with penalty and got the document impounded.

However, the Supreme Court in the recent case of Thulasidhara vs. Narayanappa, (2019) 6 SCC 409 and also in the earlier case of Subraya M.N. vs. Vittala M.N. and Others, (2016) 8 SCC 705 has held that even without registration, a written document of family settlement / family arrangement can be used as corroborative evidence as explaining the arrangement made thereunder and the conduct of the parties.

PARTIES WITH WHOM A HINDU WOMAN CAN ENTER INTO A FAMILY SETTLEMENT

The decision in Khushi Ram vs. Nawal Singh, CA 5167/2010, order dated 22nd February, 2021 is a landmark decision. It has examined the scope of the term family when it comes to a Hindu woman. The issue here was whether a married woman could execute a valid family settlement with the heirs from her father’s side. The woman had executed a memorandum of family settlement with the sons of her late brother, i.e., her nephews. The Court referred to an old three-judge bench decision in Ram Charan Das vs. Girjanandini Devi, 1965 (3) SCR 841 which had analysed the concept of family with regard to which a family settlement could be entered. It was held that every party taking benefit under a family settlement must be related to one another in some way and have a possible claim to the property, or a claim, or even a semblance of a claim. In Kale’s case (Supra) it was held that ‘family’ has to be understood in a wider sense so as to include within its fold not only close relations or legal heirs, but even those persons who may have some sort of antecedent title. In the Kale case, a settlement between a person and the two sisters of his mother was upheld.

The Court looked at the heirs who could succeed to Hindu women. It held that the heirs of the father are covered in the heirs who could succeed. When the heirs of the father of a woman were included as persons who can possibly succeed, it could not be held that they were strangers and not members of the family qua the woman. Hence, the settlement between the aunt and her nephews was upheld.

This decision, along with the vital three-judge bench decision in the case of Vineeta Sharma vs. Rakesh Sharma, CA 32601/2018, order dated 11th August, 2020, has upheld the rights of Hindu daughters in their father’s family. While this case reiterates her right to enter into settlements with the heirs from her father’s side, the latter decision has explicitly laid down that a Hindu daughter, whenever born, has a right as a coparcener in her father’s HUF.

As an aside, a settlement from an aunt in favour of her nephews is covered by the exemption for relatives u/s 56(2)(x) of the Income-tax Act but a reverse case is not covered since a nephew is not a relative for an aunt. In such a case, reliance would have to be placed on the family settlement itself to show that the receipt of property is not without adequate consideration.

BENAMI LAW AND FAMILY ARRANGEMENTS

In the case of Narendra Prasad Singh vs. Ram Ashish Singh, SA No. 229/2002, order dated 4th July, 2018, the Patna High Court was faced with the question whether a property purchased in the name of one family member out of joint family funds would be hit by the provisions of the Benami Transaction (Prohibition) Act, 1988. The Court held that this proposition could not at all be accepted since acquisition of the land in the name of a member of a family from the joint family property was not regarded as a benami transaction within the meaning of section 2 of that Act. A benami transaction had been defined u/s 2(a) of the Act as any transaction in which property is transferred to one person and a consideration is paid or provided by another person. In the present case, the consideration had been found to have been provided by the joint family fund which could not be treated as the fund of another person. In any event, the owner claimed his title purely on the basis of a family arrangement and not as a benamidar and, therefore, the case was not said to be hit by the Act.

In this respect it should be noted that the Act requires that the property should be purchased out of ‘known sources of funds’. Earlier, the Bill contained the words ‘known sources of income’ which were replaced with the present wordings. The Finance Minister explained the reason for this change as follows:

‘…. The earlier phrase was that you have purchased this property so you must show money out of your known sources of income. So, the income had to be personal. Members of the Standing Committee felt that the family can contribute to it, ……which is not your income. Therefore, the word “income” has been deleted and now the word is only “known sources”. So, if a brother or sister or a son contributed to this, this itself would not make it benami, because we know that is how the structure of the family itself is….’

CAN MUSLIMS ENTER INTO A FAMILY SETTLEMENT?


This issue was dealt with by the Karnataka High Court in Smt. Chamanbi and Others vs. Batulabi and Others, RSA No. 100004/2015, order dated 15th March, 2018. An oral family settlement was executed between a Muslim family and pursuant to the same a Memorandum of Family Settlement was executed for mutation of rights in the land records. The plea was that the document was unenforceable since Muslims could not execute a family settlement. The Court held that it was true that there was no joint family under Mohammedan Law but family arrangement was not prohibited. The Court referred to the Supreme Court’s decision in Shehammal vs. Hasan Khani Rawther, (2011) 9 SCC 223 which had held that a family arrangement would necessarily mean a decision arrived at jointly by the members of a family. Accordingly, the memorandum was upheld.

CONCLUSION


From the above discussion it would be obvious that our present laws relating to family settlement, be it stamp duty, registration, income-tax, etc., are woefully inadequate. Rather than making possible a family settlement, they do all they can to hamper it! India is a land of joint families and family-owned assets and yet we have to run to the courts every time a family settlement is to be acted upon. Consider the precious time and money lost in litigations on this count. It is high time amendments are made to various laws to facilitate family settlements.

DEFERRED TAX LIABILITY ON GOODWILL DUE TO AMENDMENT IN FINANCE ACT, 2021

As per an amendment carried out by the Finance Act, 2021, from 1st April, 2020 (F.Y. 2020-21), goodwill (including existing goodwill) of a business or profession will not be considered as a depreciable asset and depreciation on the same would not be allowed as a tax deduction. Whilst depreciation of goodwill is no longer tax-deductible, the tax goodwill balance is tax-deductible when the underlying business is sold on a slump sale basis – except where goodwill has not been acquired by purchase from previous owner. This article deals with the accounting for the deferred tax liability (DTL) on account of abolition of goodwill depreciation for tax purposes consequent to the Finance Act amendment.

ISSUE
An entity acquired a business on a slump sale basis and recorded goodwill in its stand-alone accounting books maintained under Ind AS, which was hitherto deductible for tax purposes. On 1st April, 2020 the carrying amount of goodwill in the balance sheet was INR 1,000 and the tax written down value (tax base) for tax purposes was INR 750. Consequently, a DTL was recorded on INR 250 (INR 1,000 carrying amount-INR 750 tax base) by applying the applicable tax rate on INR 250. From 1st April, 2020, with the amendment coming into effect, the amount of INR 750 is no longer tax-deductible (other than in a slump sale). Whether an additional DTL is required to be created on the difference of INR 750, i.e., carrying amount (INR 1,000) minus tax base (zero) minus already existing DTL on temporary difference (INR 250) in the preparation of Ind AS financial statements for the year ended 31st March, 2021)?

RESPONSE
To address the above question, the following paragraphs in Ind AS 12 Income Taxes are relevant:

Paragraph 15
A deferred tax liability shall be recognised for all taxable temporary differences, except to the extent that the deferred tax liability arises from:
a. the initial recognition of goodwill; or
b. the initial recognition of an asset or liability in a transaction which:
i. is not a business combination; and
ii. at the time of the transaction, affects neither accounting profit nor taxable profit (tax loss).

Paragraph 51
The measurement of deferred tax liabilities and deferred tax assets shall reflect the tax consequences that would follow from the manner in which the entity expects, at the end of the reporting period, to recover or settle the carrying amount of its assets and liabilities.

Paragraph 51A
In some jurisdictions, the manner in which an entity recovers (settles) the carrying amount of an asset (liability) may affect either or both of:
    
a. the tax rate applicable when the entity recovers (settles) the carrying amount of the asset (liability); and
b. the tax base of the asset (liability).

In such cases, an entity measures deferred tax liabilities and deferred tax assets using the tax rate and the tax base that are consistent with the expected manner of recovery or settlement.

Paragraph 60
The carrying amount of deferred tax assets and liabilities may change even though there is no change in the amount of the related temporary differences. This can result, for example, from:
(a) a change in tax rates or tax laws;
(b) a reassessment of the recoverability of deferred tax assets; or
(c) a change in the expected manner of recovery of an asset.

The resulting deferred tax is recognised in profit or loss, except to the extent that it relates to items previously recognised outside profit or loss (see paragraph 63).

ANALYSIS & CONCLUSION
Temporary differences may arise as a result of changes in tax legislation in a variety of ways, for example, when an allowance for depreciation of specified assets is amended or withdrawn [Ind AS 12.60]. The initial recognition exception in [Ind AS 12.15] does not apply in respect of temporary differences that arise as a result of changes in tax legislation. It can only be applied when an asset or a liability is first recognised. Any change in the basis on which an item is treated for tax purposes alters the tax base of the item concerned. For example, if the Government decides that an item of intangible assets that was previously tax-deductible is no longer eligible for tax deductions, the tax base of the intangible assets is reduced to zero. Accordingly, under Ind AS 12 any change in tax base normally results in an immediate adjustment of any associated deferred tax asset or liability and the recognition of a corresponding amount of deferred tax income or expense. In our example, DTL would be created on the additional temporary difference of INR 750, caused by the change in tax law, and which did not arise on initial recognition.

The measurement of deferred tax assets or liabilities reflects management’s intention regarding the manner of recovery of an asset or settlement of a liability. [Ind AS 12.51, 51A]. Some companies may argue that the goodwill continues to be tax deductible if the acquired business were to be sold on a slump sale basis in the future. Consequently, they argue that no additional temporary difference is created as a result of not allowing the amortisation of goodwill for tax deduction. In other words, in our example, they argue, the tax-deductible goodwill (the tax base) continues to be stated at INR 750 because the business along with the underlying goodwill could be sold in the future and tax deduction availed. As a result, there is no additional temporary difference, and therefore no additional DTL is required to be created. This position is not acceptable because where the entity expects to recover the goodwill’s carrying amount through use a temporary difference arises in use. If, however, a number of years after acquiring the business the entity changes its intended method of recovering the goodwill from use to sale, the tax base of the goodwill reverts to its balance tax deductible amount (i.e., INR 750 in our example).

The goodwill’s carrying amount needs to be tested for impairment annually and whenever there is an indication that it might be impaired. Any impairment loss is recognised immediately in profit or loss. Some companies may argue that there might not appear to be an expectation of imminent recovery through use if goodwill impairment is not expected in the foreseeable future. In other words, they argue that goodwill is a non-consumable asset, like land. Such an argument is too presumptuous and does not fit well with the principles in Ind AS 12, particularly paragraph 15 which requires DTL to be recognised on all taxable temporary differences, subject to the initial recognition exception.

Under Ind AS, goodwill is not amortised for accounting purposes but that does not mean that goodwill arising in a business combination is not consumed. It may not be apparent that goodwill is consumed because new goodwill replaces the old goodwill that is consumed. If goodwill is amortised for tax purposes, but no impairment is recognised for accounting purposes, any temporary differences arising between the (amortised) tax base and the carrying amount will have arisen after the goodwill’s initial recognition; so, they should be recognised.

The expected manner of recovery should be considered more closely. When a business is acquired, impairment of the goodwill might not be expected imminently; but it would also be unusual for a sale to be expected imminently. So, it might be expected that the asset will be sold a long way in the future; in that case, recovery through use over a long period (that is, before the asset is sold) should be the expected manner of recovery. If however, the plan is to sell the business (along with the underlying goodwill) in the near term, the expected manner of recovery would be sale. If this was indeed the case, and can be clearly demonstrated, DTL should not be created as a result of change in the tax law. This is because the tax base, INR 750 in our example, continues to remain at INR 750 as this amount would be tax-deductible as cost of acquisition of the underlying business, in the sale transaction which is expected to occur in the near term.

During 2009 and 2010 the IASB received representations from various entities and bodies that it was often difficult and subjective to determine the manner of recovery of  certain categories of assets for the purposes of IAS 12. This was particularly the case for investment properties accounted for at fair value under IAS 40 which are often traded opportunistically, without a specific business plan, but yield rental income until disposed of. In many jurisdictions rental income is taxed at the standard rate, while gains on asset sales are tax-free or taxed at a significantly lower rate. The principal difficulty was that the then extant guidance (SIC 21 – Income Taxes – Recovery of Revalued Non-Depreciable Assets) effectively required entities to determine what the residual amount of the asset would be if it were depreciated under IAS 16 rather than accounted for at fair value, which many regarded as resulting in nonsensical tax effect accounting. To deal with these concerns, in December, 2010 the IASB amended IAS 12 so as to give more specific guidance on determining the expected manner of recovery for non-depreciable assets measured using the revaluation model in IAS 16 and for investment properties measured using the fair value model in IAS 40. An indefinite-life intangible asset (that is not amortised because its useful economic life cannot be reliably determined) is not the same as a non-depreciable asset to which this amendment would apply. Similar considerations apply to goodwill.  

EQUALISATION LEVY ON E-COMMERCE SUPPLY AND SERVICES, Part – 1

The taxation of digitalised economy is a hotly debated topic in the international tax arena at present, with the OECD and its Inclusive Framework trying to come to a consensus-based solution and with the United Nations recently introducing a new article 12B on taxation of Automated Digital Services in the UN Model Tax Convention. In our earlier article (BCAJ, March, 2021, Page 24), we had covered the provisions relating to Significant Economic Presence (‘SEP’) and the extended source rule, introduced by India in order to tax the digitalised economy. While the provisions relating to SEP have now been operationalised vide Notification No. 41/2021 issued on 3rd May, 2021, the Equalisation Levy (‘EL’) was the first provision introduced by India to tackle the issues in the taxation of the digitalised economy. After their introduction in the Finance Act, 2016 to cover online advertisement services (‘EL OAS’), the EL provisions have been extended vide the Finance Act, 2020 to bring more transactions within their scope. Similarly, while the application of the SEP provisions would be limited, in case of non-applicability of the DTAA or absence of a DTAA, the EL provisions may be applied widely. In this two-part article, we seek to analyse some of the intricacies and issues in respect of the Equalisation Levy as applicable to E-commerce Supply or Services (‘EL ESS’).

1. BACKGROUND
The rapid advancement of technology has transformed the digital economy and it now permeates all aspects of the economy; therefore, it is now impossible to ring-fence the digital economy. Today, technology plays an extremely significant role in the way business is conducted globally. This is clearly evident in the on-going pandemic wherein one is able to work within the confines of one’s home without visiting the office in most of the sectors thanks to the use of technology and the various tools available today. However, this technological advancement has also resulted in enabling an entity to undertake business in a country without requiring it to be physically present in the said country. For example, advertising which was done through physical hoardings or boards, can now be done on social media targeting the residents of a particular country without physically requiring any space in that country. Similarly, traditional theatres are being replaced by various Over-the-Top (‘OTT’) platforms which enable a viewer to watch a movie on her device without having to physically visit a theatre.

Another example is the replacement of the physical marketplace by e-commerce sites wherein sellers can sell their goods or services to buyers without having to go to the physical marketplace. Countries realised that the tax rules, which are more than a century old, do not envisage undertaking a business in a country without having physical presence and therefore do not provide for taxing rights to the source or market jurisdictions. ‘Addressing the Tax Challenges of the Digital Economy’ was identified as the 1st Action Plan out of the 15 Action Plans of the OECD Base Erosion and Profit Shifting (‘BEPS’) Project. This signifies the importance given to the issue by the OECD and other countries participating in this Project.

Interestingly, the workflow on digital economy was not included in the BEPS Project as endorsed by the G20 at the Los Cabos meeting on 19th June, 20121. However, it was considered as Action Plan 1 when it released the Action Plans in July, 2013 even though it did not fit under any of the structural headings of the OECD’s Plan of Action of ‘establishing international coherence of income taxation’, ‘restoring the full effects of the international standards’, ‘ensuring tax transparency’ of ‘developing a tool for swift implementation of the new measures’2. In other words, while the other Action Plans specifically dealt with countering BEPS measures, Action 1 seeks to re-align the tax rules irrespective of the fact that such rules give rise to any BEPS concerns.

BEPS Action Plan 1 did not result in a consensus and therefore it was agreed that more work would be done on this subject. However, the Action Plan shortlisted three alternatives for countries to implement as an interim measure. India was one of the first countries to enact a unilateral measure when it introduced the EL OAS in the Finance Act, 2016. Subsequently, several countries introduced similar measures in their domestic tax laws. India introduced the EL ESS in the Finance Act, 2020 to bring to tax e-commerce transactions. Interestingly, while the EL OAS was introduced at the time of introduction of the Finance Bill, 2016 during the annual Union Budget, the EL ESS provisions were not a part of the Finance Bill, 2020 and were introduced only at the time of its enactment. The absence of a Memorandum explaining the provisions of the EL ESS has resulted in a lot of confusion regarding the intention of certain provisions which is an important aspect one needs to consider while interpreting the law. While the Finance Act, 2021 did clarify a few issues, some of the issues are still unresolved. Moreover, the clarification in the Finance Act, 2021, which was made retrospective from 1st April, 2020, has also resulted in some issues. In the first part of this two-part article, the provisions of the EL ESS are analysed. However, before analysing the EL ESS provisions, given the interplay and overlap with the EL OAS, the ensuing paragraph briefly covers the EL OAS provisions.

___________________________________________________________________
1 B. Michel, ‘The French Crusade to Tax the Online Advertisement Business:
Reflections on the French Google Case and the Newly Introduced Digital
Services Tax,’ 59 Eur. Taxn. 11 (2019), Journal Articles & Papers IBFD
(accessed 28th January 2020)
2 Ibid
2. EQUALISATION LEVY ON ONLINE ADVERTISEMENT SERVICES

Recognising the need of the hour and the significance of the issues relating to the taxation of the digital economy, the Finance Ministry constituted the Committee on Taxation of E-commerce. It consisted of members of the Department of Revenue, representatives of some professional bodies, representatives from industry and other professionals, expert in the field. The Committee examined the Action 1 Report as well as the literature from several well-known authors on the subject and released its proposal in February, 2016.

The Finance Act, 2016 introduced the provisions of EL OAS. Unlike the SEP provisions and the extended source rule, the EL OAS (as well as EL ESS) is not a part of the Income-tax Act, 1961 (‘ITA’). EL OAS applies on specified services rendered by non-residents to a person resident in India or to a non-resident having a Permanent Establishment (‘PE’) in India. Specified service for the purpose of EL OAS has been defined in section 164(i) of the Finance Act, 2016 as follows:
‘“specified service” means online advertisement, any provision for digital advertising space or any other facility or service for the purpose of online advertisement and includes any other service as may be notified by the Central Government in this behalf.’

Under the EL OAS provisions, a person resident in India or a non-resident having a PE in India shall deduct EL at the rate of 6% on payment for specified service to a non-resident if it satisfies the following conditions:
a. The service rendered is not effectively connected to a PE of the non-resident service provider;
b. The payment for the specified service exceeds INR 100,000 during the previous year; and
c. The payment is in respect of the specified services utilised in respect of a business or profession carried out by the payer.

Therefore, the EL OAS applies only in respect of Online Advertisement Services or any facility or service for the purpose of online advertisement. Further, EL OAS provisions place the onus of responsibility of collection of the levy on the payer being a resident or on the payer being a non-resident having a PE in India.

While there are various issues and intricacies in relation to the EL OAS, we have not covered the same as the objective of this article is to cover the EL ESS provisions and the issues arising therefrom. However, some of the common issues, such as whether EL provisions are restricted by a tax treaty, have been covered in the second part of this two-part article.

3. EQUALISATION LEVY ON E-COMMERCE SUPPLY OR SERVICES

3.1 Scope and coverage
The Finance Act, 2020 extended the scope of EL to cover consideration received by non-residents on E-commerce Supply or Services (‘ESS’) made or facilitated on or after 1st April, 2020.

EL ESS applies at the rate of 2% on the consideration received by a non-resident on ESS, which has been defined in section 164(cb) of the Finance Act, 2016 to mean:
(i) Online sale of goods owned by the e-commerce operator; or
(ii) Online provision of services provided by the e-commerce operator; or
(iii) Online sale of goods or provision of services, or both, facilitated by the e-commerce operator; or
(iv) Any combination of activities listed in clauses (i), (ii) or (iii).

Further, the Finance Act, 2021 has also extended the definition of ESS for this clause to include any one or more of the following online activities, namely,
(a) Acceptance of offer for sale; or
(b) Placing of purchase order; or
(c) Acceptance of the purchase order; or
(d) Payment of consideration; or
(e) Supply of goods or provision of services, partly or wholly.

Moreover, EL ESS applies for consideration received or receivable by a non-resident in respect of ESS made or provided or facilitated by it to the following persons as provided in section 165A(1) of the Finance Act, 2016 as amended by the Finance Act, 2020:
(i) A person resident in India; or
(ii) a person who buys such goods or services, or both, using an internet protocol (IP) address located in India; or
(iii) a non-resident under the following specified circumstances:
a. sale of advertisement which targets a customer who is resident in India, or a customer who accesses the advertisement through an IP address located in India;
b. sale of data collected from a person who is resident in India, or from a person who uses an IP address located in India.

Further, the provisions of EL ESS shall not apply in the following circumstances:
(i) Where the non-resident e-commerce operator has a PE in India and the ESS is effectively connected to the PE;
(ii) Where the provisions of EL OAS apply; or
(iii) Whether the sales, turnover, or gross receipts of the e-commerce operator from the ESS made or provided or facilitated is less than INR 2 crores during the previous year.

Lastly, section 10(50) of the ITA provides an exemption from tax on the income which has been subject to EL OAS and EL ESS.

3.2 Non-resident
EL ESS applies in respect of consideration received or receivable by a non-resident from ESS made or provided or facilitated. The term ‘non-resident’ has not been defined in the Finance Act, 2016.

However, section 164(j) of the Finance Act, 2016 provides that words and expressions not defined in it but defined in the ITA shall have the meanings assigned to them in the Finance Act, 2016 as well. In other words, in respect of undefined words and expressions, the meaning as ascribed in the ITA would apply here as well.

Accordingly, one would import the meaning of the term ‘non-resident’ from section 2(30) read with section 6 of the ITA.

3.3 Online sale of goods
The EL ESS provisions apply in respect of ESS which has been defined in section 164(cb) of the Finance Act, 2016 as provided in paragraph 3.1 above. Accordingly, EL ESS applies in respect of consideration on online sale of goods made or facilitated by a non-resident. The term ‘online sale of goods’ has not been defined in the Finance Act, 2016 and therefore some of the issues in respect of various aspects of the term have been provided in the paragraphs below.

3.3.1 What is meant by ‘online’
The first condition in respect of the term ‘online sale of goods’ is that the goods have to be sold ‘online’. The term ‘online’ has been defined in section 164(f) of the Finance Act, 2016 to mean the following,
‘…a facility or service or right or benefit or access that is obtained through the internet or any other form of digital or telecommunication network.’

Therefore, the term is wide enough to cover most types of transactions undertaken through means other than physically. Thus, goods sold through a website, email, mobile app or even through the telephone would be considered as sales undertaken ‘online’.

3.3.2 What is meant by ‘goods’
The term ‘goods’ has not been defined in the Finance Act, 2016 or in the ITA. Therefore, the question arises as to whether one can import the term from the Sale of Goods Act, 1930 (‘SOGA’).

Section 2(7) of the SOGA provides that
‘“goods” means every kind of movable property other than the actionable claims and money; and includes stock and shares, growing crops, grass, and things attached to or forming part of the land which are agreed to be severed before the sale or under the contract of sale;’

On the other hand, section 2(52) of the Goods and Services Tax Act, 2017 (‘GST Act’) refers to a different definition of the term as follows,
‘“Goods” means every kind of movable property other than money and securities but includes actionable claims, growing crops, grass and things attached to or forming part of the land which are agreed to be severed before supply or under a contract of supply.’

The issue in this regard is whether one should consider the definition of the term under the SOGA or the GST Act, with the major difference in the definition under both the laws being that SOGA includes shares and stock as ‘goods’, whereas the GST Act does not do so. This issue is relevant while evaluating the applicability of the EL ESS provisions to the sale of shares and stock. While an off-market sale of shares may not trigger the EL provisions as there may be no consideration paid or payable to an e-commerce operator, one may need to evaluate whether the provisions could apply to a transaction undertaken on an overseas stock exchange (assuming that the overseas stock exchange is considered as an e-commerce operator).

In the view of the authors, it may be advisable to consider the definition under SOGA as this is the principal law dealing with the sale of goods, whereas the GST Act is a law to tax certain transactions. In other words, the transaction of sale of shares and stock on a stock exchange may be considered as an online sale of goods and may be subject to the provisions of EL provided that the stock exchange satisfies the definition of ‘e-commerce operator’ and other conditions are also satisfied. An analysis of whether an overseas stock exchange would be considered as an ‘e-commerce operator’ has been undertaken in paragraph 3.5.3 below.

However, in respect of an aggregator for booking hotel rooms or a hotel situated outside India providing online facility for booking hotel rooms, it would not be considered as undertaking or facilitating sale of goods as rooms would not be considered as ‘goods’. The issue of whether the said facility would constitute a covered provision of services for the application of the EL provisions in respect of booking of hotel rooms is discussed in subsequent paragraphs.

3.3.3 What is meant by ‘online sale of goods’?
Having analysed the meaning of the terms ‘online’ and ‘goods’, the crucial aspect that one may need to consider is whether the ‘sale’ of the goods has been undertaken online as the EL ESS provisions refer to consideration received or receivable for online ‘sale’ of goods made or facilitated by the non-resident e-commerce operator. This term has been generating a lot of confusion and uncertainty as one needs to understand as to whether the goods have been sold online. In other words, the issue that needs to be addressed is whether the EL provisions could apply in a situation where the goods are sold online but the delivery of the goods is undertaken offline.

In this regard, section 19 of the SOGA provides,
‘(1) Where there is a contract for the sale of specific or ascertained goods, the property in them is transferred to the buyer at such time as the parties to the contract intend it to be transferred.’

Therefore, SOGA provides that the title in the goods is transferred when the parties to the contract intend it to be transferred. Moreover, the terms and conditions of various e-commerce sites provide that the risk of loss and title passes to the buyer upon delivery to the carrier.

Hence, one could possibly argue that in such situations there is no online sale of goods made or facilitated by the e-commerce operators which merely facilitate the placement of the order for the said goods, and therefore the provisions of EL do not apply.

One could also take a similar view in the case of certain sites which offer e-bidding services for the goods.

However, this issue has been covered in the Finance Act, 2021 with retrospective effect from 1st April, 2020 wherein it has been provided that for the purpose of the definition of ESS, ‘online sale of goods’ shall include any one or more of the following online activities (‘extended activities’):
a. Acceptance of offer for sale; or
b. Placing of purchase order; or
c. Acceptance of the purchase order; or
d. Payment of consideration; or
e. Supply of goods or provision of services, partly or wholly.

Therefore, now, if any of the above activities are undertaken online, the transaction may be considered as ESS and may be subject to the provisions of EL (refer to the discussion in paragraph 3.5 as to whether the definition of e-commerce operator is satisfied in case the non-resident only undertakes the above activities online).

3.4 Online provision of services
The provisions of EL ESS apply in case of online sale of goods or online provision of services. Having analysed some of the nuances regarding the online sale of goods, let us now consider some of the nuances of online provision of services. Generally, the applicability of EL ESS to online provision of services may pose complexities which are significantly higher than those related to online sale of goods.

Some of the issues have been explained by way of an example in two scenarios.

(Scenario 1) Let us first take the example of a person resident in India booking a room in a hotel outside India (the ‘Hotel’), owned and managed by a non-resident, through its website. Let us assume that payment for the booking of the room is made immediately on booking itself. Now, the question arises whether the said transaction would be considered as an online provision of services by the Hotel and whether the provisions of EL would apply on the same.

The first question is whether there is any sale of goods or provision of services. Arguably, the renting out of rooms may be considered as a service rendered by the Hotel. Now, the question is whether any service is rendered online.

In this case, one may be able to argue, and rightfully so, that the service rendered by the Hotel of rental of rooms is not provided online but is rendered offline and, therefore, this is not a case of online provision of services. However, it is important to note that the Hotel is also providing a facility for booking the rooms online, which in itself is a service, independent of the rental of the rooms. This booking service is rendered online and, therefore, may be considered as an online provision of service by the Hotel to the person resident in India.

On the other hand, one may be able to argue that no consideration is received by the Hotel for providing the online facility and that the entire consideration received is that for the letting out of the rooms (this may be the case, for example, if the rate for the rooms is the same irrespective of whether booked online or directly at the hotel). In such a case, one may be able to argue that in the absence of consideration received or receivable, the provisions of EL cannot apply. Further, even if one were to counter-argue that the consideration received towards the rental of the room includes consideration towards providing the service of provision of online booking and the same can be allocated on some scientific basis, the dominant nature of the activities for the composite service is that of letting out of the hotel room, which is not provided online. Accordingly, in the view of the authors, the provisions of EL shall not apply in such a scenario.

(Scenario 2) Let us now take the same example wherein a person resident is booking a room in a hotel, situated outside India, but the same is booked through a room aggregator called ABC. Let us further assume that the entire consideration for the room is paid by the customer to ABC at the time of booking and then ABC, after deducting its commission or fees, pays the balance amount to the hotel.

Now, the first question to be evaluated here is whether the service rendered by ABC falls under sub-clause (ii) or (iii) of section 164(cb) of the Finance Act, 2016. Sub-clause (ii) of section 164(cb) refers to online provision of services by the e-commerce operator, whereas sub-clause (iii) of section 164(cb) refers to facilitation for online provision of services.

One may take a view that given that there is a specific clause relating to facilitation, which is what is provided by the aggregator ABC, one should apply sub-clause (iii). However, the said sub-clause applies only in respect of facilitation of online provision of services and the services which are being facilitated are in respect of letting out of the rooms of the hotel which are not rendered online. Therefore, the provisions of sub-clause (iii) may not apply.

Alternatively, one could argue that the service rendered by ABC is through an online facility and therefore it would fall under sub-clause (ii) relating to online provision of services. In such a case, the question arises whether the service is rendered to the customer booking the room or to the hotel. In case the service is considered as rendered to the hotel, the provisions of EL may not apply as it may be considered as a case of services rendered to a non-resident. However, in the view of the authors, the service rendered by ABC, of facilitating the letting out of the rooms of the hotel, is a service rendered by ABC to both, to the hotel and the customer who is booking the rooms. This would be the case even though the commission / fees for the services rendered by ABC is paid for by the hotel and the customer is not aware of the commission payable to ABC for facilitation out of the total amount paid by her.

3.5 E-commerce operator
Having analysed some of the issues relating to online sale of goods or online provision of services, this paragraph covers some issues in respect of the e-commerce operator.

3.5.1 Who is considered as an e-commerce operator?
An e-commerce operator is defined in section 164(ca) of the Finance Act, 2016 to mean the following:
‘“E-commerce operator” means a non-resident who owns, operates or manages digital or electronic facility or platform for online sale of goods or online provision of services, or both;’

Therefore, in order for a non-resident to be considered as an e-commerce operator, the following cumulative conditions are required to be satisfied:
a. There should be a digital or electronic facility or platform; and
b. The said facility or platform should be for online sale of goods or online provision of services, or both; and
c. The non-resident should own, operate or manage the said facility or platform.

3.5.2 Will sale of goods or providing services via e-mail be subject to the provisions of EL?
The biggest concern most non-residents were facing at the time of the introduction of the EL ESS provisions was whether the sale of goods concluded over exchange of emails could be subject to the provisions of EL ESS.

If such a transaction were to be covered under the provisions of EL ESS, there could be major repercussions for a lot of MNCs as a lot of intra-group transactions are undertaken over email. The confusion increased significantly after the amendments undertaken in the Finance Act, 2021 wherein the definition of ‘online sale of goods’ or ‘online provision of services’ has been extended to include acceptance of offer, placing of purchase order, acceptance of purchase order, payment of consideration, etc.

In this case, while ‘email’ may be considered as an online facility, the seller of the goods is not operating, owning or managing the email facility which is managed by the IT company (such as Microsoft or Google). Further, even if one considers that the seller is operating the facility, it is a facility for communication and it is not a facility for online sale of goods or for online provision of services. Moreover, it is important to highlight that there is a difference in the operation of the facility or platform and the operation of an account on the platform. Therefore, if one is operating an email account, it may not be appropriate to contend that one is operating the entire facility.

Accordingly, in the view of the authors, the transactions undertaken through email may not be subject to EL ESS as the seller of goods over exchange of emails may not come within the definition of ‘e-commerce operator’.

This would also be the case for services rendered through email, say an opinion given by a foreign lawyer to a client on email. In such a scenario, the lawyer cannot be considered as an ‘e-commerce operator’.

The absurdity of considering transactions undertaken through email as subject to EL is magnified in the case of transactions undertaken through a telephone. As telecommunication is considered as an online facility u/s 164(f) of the Finance Act, 2016, would one consider goods ordered through a telephone as being subject to the provisions of EL?

In this regard, it may be highlighted that even if one takes a view as explained in paragraph 3.5.4 below that the extended activities list should also apply to the definition of ‘e-commerce operator’, the argument that email is a facility or platform for communication and not for online sale of goods or provision of services, including the extended activities, should hold good.

Similarly, in the case of teaching services rendered online by universities, or conferences organised by various organisations online, the question arises whether the said services rendered by the universities or the organisations could be subject to the provisions of EL ESS. If the platform through which the services are rendered is owned, operated or managed by the university or organisation, such entities may be considered as e-commerce operators, and therefore the fees received by them may be subject to the provisions of EL ESS. However, if these entities are merely using the platform or facility owned and managed by a third party and only operate as users of the platform, then such entities cannot be considered as owning, managing or operating the facility or platform but merely operating or managing an account on the platform. In such cases, they may not be considered as e-commerce operators and the consideration received by them shall not be subject to the provisions of EL.

3.5.3 Will sale of shares on a stock exchange be subject to the provisions of EL?
As evaluated in paragraph 3.3.2 above, ‘shares’ may be considered as ‘goods’. Further, the platform through which the sale is undertaken in most overseas stock exchanges could be considered as an online facility as it would be undertaken through the internet, digital or telecommunication network. Now the question arises whether the platform is for the purpose of online sale of goods, the answer to which would be in the affirmative.

Therefore, if the platform or facility is owned, operated or managed by the overseas stock exchange, the non-resident owning the overseas stock exchange may be considered as an ‘e-commerce operator’ and the transaction may be subject to the provisions of EL.

3.5.4 Can a transaction be subject to EL only because the payment of consideration is undertaken online?
In this regard an interesting point to note is that while the terms ‘online sale of goods’ and ‘online provision of services’ have been extended to include certain online activities as provided in the Explanation to section 164(cb) (extended activities), the terms are provided in two clauses in section 164, namely:
a) Clause (ca) of section 164 defining the term ‘e-commerce operator’ wherein the facility or platform is for online sale of goods or online provision of services, or both.
b) Clause (cb) of section 164 defining the term ESS which means online sale of goods or online provision of services made or facilitated by the e-commerce operator.

The Finance Act, 2021 extended the terms ‘online sale of goods’ and ‘online provision of services’ only in respect of clause (cb), dealing with definition of e-commerce supply or services and not in clause (ca). The Explanation to clause (cb) provides as follows,
‘For the purposes of this clause “online sale of goods”…..’

Further, the definition of the term ‘e-commerce operator’ in clause (ca) does not include the term ‘e-commerce supply or services’ which is defined in clause (cb). Therefore, on a literal reading of the language, one may be able to argue that for a non-resident to be considered as an e-commerce operator, the sale of goods or the provision of services needs to be undertaken online. Moreover, the provisions of EL ESS may not apply in a scenario where only the extended activities are undertaken online without the actual sale of goods or provision of services undertaken online as the extended definition of the term ‘online sale of goods’ or ‘online provision of services’ applies only for the definition of ESS and not for an e-commerce operator.

While this is a literal reading of the provision, the above view may be extremely litigious and may not be accepted by the courts as it may result in the above amendment in the Finance Act, 2021 being made infructuous and would be against the intention of the Legislature.

However, if one takes a view that the extended activities would apply even to the definition of ‘e-commerce operator’ and therefore can result in the application of the EL ESS provisions, it may result in a scenario where EL ESS provisions could possibly apply even when none of the activities of the provision of services or sale of goods is undertaken online but only the payment is done online.

Let us take the earlier example of a foreign lawyer rendering advisory services over email to an Indian client, who would make the payment online through an app operated by a non-resident. In this regard, as discussed in paragraph 3.5.2, as the lawyer would not be considered as an ‘e-commerce operator’, the transaction may be subject to EL ESS as one of the extended activities, i.e., payment of consideration is undertaken online and the e-commerce operator is providing an online service of facilitating the payment. However, in this case the e-commerce operator would be the non-resident operating the app through which the payment is made and not the lawyer.

3.5.5 Can there be multiple e-commerce operators for the same transaction?
If one takes a view that the extended activities shall apply to the definition of ‘e-commerce operator’ as well, the question arises whether there can be multiple e-commerce operators for the same transaction?

One can evaluate this with an example. Let us consider a scenario where the goods of ABC, a non-resident, are sold through its website and the payment for the goods is done by the resident customer through a payment gateway, owned by XYZ, another non-resident. In this case, both ABC and XYZ would be considered as e-commerce operators. Further, the same amount may be subject to EL in the hands of multiple e-commerce operators. Continuing the above example, the consideration paid by the resident customer to ABC through the payment gateway would be subject to EL ESS. Further, if one considers that the payment gateway of XYZ has rendered services to both, the resident customer as well as ABC, the consideration received by XYZ from ABC would also be subject to EL ESS as it is consideration received by an e-commerce operator for services rendered to a resident.

3.6 Amount on which EL to be levied
EL ESS applies on consideration received or receivable by an e-commerce operator from ESS. The ensuing paragraphs deal with some of the issues in respect of consideration.

3.6.1 Whether EL to be applied on the entire amount
One of the key issues that require to be addressed is what would be the amount which would be subject to EL. The issue is explained by way of an illustration.

Let us take an example wherein goods are sold online by the e-commerce operator. Further, while the sale of the goods is concluded online, the e-commerce operator does not own the goods but merely facilitates the online sale of the goods. Let us assume that the price of the goods is 100 and the commission of the e-commerce operator is 15. In this scenario, the e-commerce operator may receive 100 from the Indian buyer of the goods and transfer 85 to the seller of the goods after retaining its fees or commission. The question which arises is, as EL is applicable on the consideration received, would the EL apply on the 100 received by the e-commerce operator, or would it apply on the 15 which is the income earned by the e-commerce operator?

Earlier, one could take a view that the EL ESS provisions seek to tax the e-commerce operator and the consideration is compensation paid to the e-commerce operator for his services and, therefore, the EL ESS provisions should apply on the 15 and not the entire 100. Another argument for this view was that the 85 received by the e-commerce operator does not belong to it and by the principles of diversion of income by overriding title, one can argue that the amount of 85 is not consideration which is subject to EL ESS.

However, the Finance Act, 2021 has provided, with retrospective effect from 1st April, 2020, that the consideration which is subject to EL ESS would include the consideration for sale of goods irrespective of whether or not the goods are owned by the e-commerce operator. Therefore, in the above example, now the entire 100 would be subject to EL ESS.

This may result in a scenario wherein offshore sale of goods, not sold through an e-commerce operator or facility, would not be subject to tax in India on account of the decision of the Supreme Court in the case of Ishikawajima-Harima Heavy Industries Ltd. (2007) 288 ITR 408, goods sold through an e-commerce operator would now be subject to EL on the entire amount.

Further, this may result in various practical challenges as the margin of the e-commerce operator may not be sufficient to bear the levy on the entire consideration received.

3.6.2 Consideration received in respect of sale of goods by a resident
When the EL ESS provisions were introduced for F.Y. 2020-21, the provisions of section 10(50) of the ITA provided an exemption to any income arising from ESS which has been subject to EL ESS.

The provisions did not specify to whom the exemption belonged. Therefore, one could possibly take a view that if a resident is selling goods through a non-resident e-commerce operator and the entire consideration for the sale of goods is subject to EL ESS, the exemption u/s 10(50) would exempt the income of the resident seller as well. This is due to the fact that while the consideration is changing hands twice – once from the customer to the e-commerce operator and then from the e-commerce operator to the resident seller – there is only one transaction, sale of goods by the resident seller to a resident buyer through the e-commerce operator.

On the other hand, there was concern that if the resident seller is taxed on the income and the exemption u/s 10(50) does not apply, it could result in double taxation for the same transaction.

The Finance Act, 2021 has amended the provisions of the Finance Act, 2016 with retrospective effect from 1st April, 2020 to provide that the consideration which is subject to EL ESS shall not include the consideration towards the sale of goods or the provision of services if the seller or service provider is a resident or is a non-resident having a PE in India and the sale or provision of services is effectively connected to the PE.

Therefore, in such a situation now, only the consideration as is attributable to the e-commerce operator would be subject to EL ESS.

3.6.3 Levy on consideration received by e-commerce operator
It is important to highlight that for the EL ESS provisions to apply, consideration needs to be received or receivable by the e-commerce operator. While the amendment in the Finance Act, 2021 extends the coverage of the term ‘consideration’ to include the consideration for the sale of goods as well (100 from the example in paragraph 3.6.1), the extended scope would apply only if the entire consideration is received by the e-commerce operator. Therefore, even after the amendment, if the entire consideration (100 in the example used in paragraph 3.6.1) is paid by the buyer directly to the non-resident seller, who pays the fees or commission to the e-commerce operator, EL ESS shall apply only on the amount of commission or fees received by the e-commerce operator (15). This is due to the fact that EL ESS applies on consideration received or receivable by the e-commerce operator, and if the e-commerce operator does not receive the entire consideration for the sale of goods or provision of services but only receives a sum as facilitation fees or commission, EL ESS shall apply only on the portion received by the e-commerce operator.

4. CONCLUSION
Due to the absence of the Memorandum at the time of introduction of the EL ESS provisions, a lot of ambiguity and confusion exists in respect of various aspects. While the Finance Act, 2021 has made certain amendments with retrospective effect in order to clarify certain issues, the ambiguity in various other aspects continues to exist. In the next part of this two-part article, we shall seek to cover various other issues in respect of the EL ESS such as issues relating to residence and the situs of the consumer, issues relating to the turnover threshold, issues relating to the sale of advertisement and the sale of data, interplay of the EL ESS provisions with various other provisions such as the SEP provisions, EL OAS provisions, royalty / FTS and section 194-O of the ITA.

Revision u/s 264 – Offering income inadvertently – Not liable to be taxed – Revision provisions are meant for the benefit of the assessee and not to put him to inconvenience – Commissioner should have examined the existing material in the light of Circular No. 14 (XL – 35) of April, 1955 and Article 265 of the Constitution of India

5 Aafreen Fatima Fazal Abbas Sayed vs. Assistant Commissioner of Income Tax & Ors. [W.P. (L) No. 6096 of 2021, date of order: 08/04/2021 (Bombay High Court)]

Revision u/s 264 – Offering income inadvertently – Not liable to be taxed – Revision provisions are meant for the benefit of the assessee and not to put him to inconvenience – Commissioner should have examined the existing material in the light of Circular No. 14 (XL – 35) of April, 1955 and Article 265 of the Constitution of India

The petitioner challenged the order dated 12th February, 2021 passed by the Principal Commissioner of Income Tax, rejecting the revision petition filed by it u/s 264.

For the A.Y. 2018-19, the assessment year under consideration, the petitioner, who is an individual, declared a total income of Rs. 27,05,646 and after claiming deductions and set-off on account of TDS and advance tax, the refund was determined at Rs. 34,320. However, while filing the return of income on 20th July, 2018 for A.Y. 2018-19, the figure of long-term capital gain of Rs. 3,07,60,800 was purported to have been wrongly copied by the petitioner’s accountant from the return of income filed for the earlier A.Y., i.e., 2017-18, which had arisen on surrender of tenancy rights by the petitioner for that year. It is submitted that the assessment for A.Y. 2017-18 was completed u/s 143(3) vide assessment order dated 24th December, 2019. The petitioner has not transferred any capital asset and there can be no capital gains in the assessment year under consideration and therefore no tax can be imposed on such non-existent capital gains for A.Y. 2018-19.

The returns filed by the petitioner for A.Y. 2018-19 were processed u/s 143(1) vide order dated 2nd May, 2019 and a total income of Rs. 3,34,66,446, including long-term capital gains of Rs. 3,07,60,800 was purported to have been inadvertently shown in the return of income, thereby leading to a tax demand of Rs. 87,40,612. It is the case of the petitioner that the Central Processing Centre (‘CPC’) of the Department at Bengaluru accepted the aggregate income for the year under consideration at Rs. 25,45,650 as presented in column 14; however, the taxes were computed at Rs. 87,40,612 on the total income of Rs. 3,33,06,450 as described above. It is submitted that upon perusal of the order u/s 143(1) dated 2nd May, 2019, the petitioner realised that the amount of Rs. 3,07,60,800 towards long-term capital gains had been erroneously shown in the return of income for the year under consideration.

Realising the mistake, the petitioner filed an application u/s 154 on 25th July, 2019 seeking to rectify the mistake of the misrecording of long-term capital gains in the order u/s 143(1) as being an inadvertent error as the same had already been considered in the return for the A.Y. 2017-18, assessment in respect of which had already been completed u/s 143(3). It was submitted that the application for rectification was still pending and Respondent No. 1 had not taken any action with respect to the same, although it appears that the same has been rejected as per the statement in the Respondent’s affidavit in reply.

In the meanwhile, the petitioner also made a grievance on the E-filing portal of the CPC on 4th October, 2019 seeking rectification of the mistake where the taxpayer was requested to transfer its rectification rights to AST, after which the petitioner filed various letters with Respondent No. 1, requesting him to rectify the mistake u/s 154.

In order to alleviate the misery and bring to the notice of higher authorities the delay being caused in the disposal of the rectification application, the petitioner approached Respondent No. 2 u/s 264 on 27th January, 2021 seeking revision of the order dated 2nd May, 2019 passed u/s 143(1) narrating the aforementioned facts and requesting the Respondent No. 2 to direct Respondent No. 1 to recalculate tax liability for A.Y. 2018-19 after reducing the amount of long-term capital gains from the total income for the said year.

However, instead of considering the application on merits, vide order dated 12th February, 2021 the Respondent No. 2, Principal Commissioner of Income Tax-19, dismissed the application filed by the petitioner on the ground that the same was not maintainable on account of the alternate effective remedy of appeal and that the assessee had also not waived the right of appeal before the Commissioner of Income Tax (Appeals) as per the provisions of section 264(4).

Being aggrieved by the order of rejection of the application u/s 264, the petitioner moved the High Court.

The Court observed that in the petitioner’s return for A.Y. 2018-19, the figure of long-term capital gains of Rs. 3,07,60,800 on surrender of tenancy rights in respect of earlier A.Y. 2017-18 had inadvertently been copied by the petitioner’s accountant from the return for A.Y. 2017-18. The assessment for A.Y. 2017-18 was completed u/s 143(3) vide assessment order dated 24th December, 2019. In the financial year corresponding to A.Y. 2018-19, the petitioner declared a total income of Rs. 27,05,646 and after claiming deductions and set-off on account of TDS and advance tax, a refund of Rs. 34,320 was determined. No capital asset transfer had taken place during A.Y. 2018-19, therefore no tax on capital gains can be imposed. The error had crept in through inadvertence. There is neither any fraud nor malpractice alleged by the Revenue. The rectification application u/s 154 filed earlier was stated in the Respondent’s affidavit to have been rejected. The application u/s 264 has been dismissed / rejected on the ground that the application was not maintainable as an alternate effective remedy of appeal was available and there was no waiver of such appeal by the assessee.

The Court referred to the Delhi High Court decision in the case of Vijay Gupta vs. Commissioner of Income Tax [2016] 386 ITR 643 (Delhi), wherein the assessee in his return of income had erroneously offered to tax gains arising on sale of shares as short-term capital gains, instead of the same being offered as long-term capital gains exempt from tax, where the section 154 application of the assessee was refused / not accepted and when the assessee filed a revision application u/s 264, the same was rejected on the ground that section 143(1) intimation was not an order and was not amenable to the revisionary jurisdiction u/s 264. The Delhi High Court negated these contentions of the Revenue and further held in Paragraph 39 as under:

‘39:- When the Commissioner was called upon to examine the revision application u/s 264 of the Act, all the relevant material was already available on the record of the Assessing Officer, the Commissioner instead of merely examining whether the intimation was correct based on the material then available should have examined the material in the light of the Circular No. 14(XL-35) of 1955, dated April, 1955 and article 265 of the Constitution of India. The Commissioner has erred in not doing so and in failing to exercise the jurisdiction vested in him on mere technical grounds.’

The Court observed that in the facts of the present case, the Commissioner has failed to exercise the jurisdiction vested in him on fallacious grounds which cannot be sustained. In the facts of the present case also, the Commissioner has not considered the petitioner’s case on merits and simply on the ground of availability of an alternate remedy of filing appeal had rejected the application u/s 264. Therefore, on the basis of the above decision, the Commissioner’s order was liable to be set aside.

Under section 264, the Principal Commissioner is mandated not to revise any order in two situations: first, where an appeal that lies to the Commissioner (Appeals) but has not been made and the time within which such appeal may be made has not expired, and second, where the assessee has not waived his right of appeal. What emerges from this is that in a situation where there is an appeal that lies to the Commissioner (Appeals) and which has not been made and the time to make such an appeal has not expired, in that case the Principal Commissioner or Commissioner cannot revise any order in respect of which such appeal lies. The language is quite clear, that the two conditions are cumulative, viz., there should be an appeal which lies but has not been made and the time for filing such appeal has not expired; in such a case, the Principal Commissioner cannot revise. However, if the time for making such an appeal has expired, then it would be imperative that the Principal Commissioner would exercise his powers of revision u/s 264.

The other or second situation is when the petitioner assessee has not waived off his right of appeal; even in such a situation, the Commissioner cannot exercise his powers of revision u/s 264(4)(a). In clause (a) of section 264(4), in the language between filing of an appeal and the expiry of such period and the waiver of the assessee to his right of appeal, there is an ‘or’, meaning thereby that there is an option, i.e., either the assessee should not have filed an appeal and the period of filing the same should have expired, or he should have waived such right. Therefore, there are two situations which are contemplated in the said sub-section(4)(a) of section 264. The section cannot be interpreted to mean that for the Principal Commissioner to exercise his powers of revision u/s 264 not only that the time for filing the appeal should have expired but also that the assessee should have waived his right of appeal. In the facts of the case, the petitioner has not filed an appeal against the order u/s 143(1) u/s 246-A and the time of 30 days to file the same has also admittedly expired.

The Court held that a plain reading of the section suggests that it would not then be necessary for the petitioner to waive such right. That waiver would have been necessary if the time to file the appeal would not have expired. The Court also observed that in matters like these, where the errors can be rectified by the authorities, the whole idea of relegating or subjecting the assessee to the appeal machinery or even discretionary jurisdiction of the High Court was uncalled for and would be wholly avoidable. The provisions in the Income-tax Act for rectification, revision u/s 264 are meant for the benefit of the assessee and not to put him to inconvenience. That cannot and could not have been the object of these provisions.

The order dated 12th February, 2021 passed by Respondent No. 2 was set aside. The Writ Petition was allowed, directing the Pr.CIT to decide the application on merits.

Vivad se Vishwas Scheme – Objective of scheme – Beneficial nature – Search case – Circulars are to remove difficulties and to tone down the rigour of law and cannot be adverse to the assessee

4 Bhupendra Harilal Mehta vs. Pr. Commissioner of Income Tax & Ors.
[W.P. No. 586 of 2021, date of order: 05/04/2021 (Bombay High Court)]

Vivad se Vishwas Scheme – Objective of scheme – Beneficial nature – Search case – Circulars are to remove difficulties and to tone down the rigour of law and cannot be adverse to the assessee

The petitioner was an individual; his assessment for A.Y. 2015-16 was completed vide an order dated 27th December, 2017 u/s 143(3), wherein one addition of Rs. 84,25,075 was made u/s 68 and another addition of Rs. 11,75,901 u/s 69C. The additions were made by the A.O. on the basis that the petitioner had booked artificial long-term capital gains of Rs. 5,73,23,123 and claimed exemption u/s 10(38) thereon by selling shares of M/s Lifeline Drugs and Pharma Limited for a total consideration of Rs. 5,87,95,055. The case of the A.O. was that the price of this share was artificially rigged by certain operators; the details of this were divulged in the course of a search u/s 132 carried out by the Kolkata Investigation Wing of the Income-tax Department during which some statements were recorded u/s 132(4), and in the course of a survey action u/s 133A on the premises of M/s Gateway Financial Service Limited and Korp Securities Limited where also statements of directors were recorded. By an order dated 18th February, 2019 u/s 154, the addition u/s 68 was revised to Rs. 5,87,95,055. Aggrieved by both the aforesaid orders, the petitioner filed appeals to the Commissioner (Appeals).

While the aforesaid appeals were pending, the Direct Tax Vivad se Vishwas Act, 2020 (‘DTVSV Act’) was passed, giving an option to taxpayers to settle their income tax disputes by making a declaration to the designated authority and paying varying percentages of the disputed tax as specified u/s 3 of the new Act.

On 22nd April, 2020, the Central Board of Direct Taxes issued Circular No. 9 of 2020 and on 4th December, 2020 another Circular, No. 21, making further clarifications in the form of Questions and Answers. While the petition was pending, the CBDT issued yet another Circular, No. 4/2021 dated 23rd March, 2021, further clarifying the answer to Q. No. 70.

The petitioner filed a declaration in Form No. 1 u/s 4(1) of the DTVSV Act read with Rule 3(1) of the DTVSV Rules on 16th December, 2020. The disputed income was declared to be Rs. 5,98,90,960 and the disputed tax thereon Rs. 2,02,69,581. The petitioner submitted that the gross amount payable by it was 100% of the disputed tax, i.e., Rs. 2,02,69,581, out of which a sum of Rs. 69,31,892 was declared to have been paid and the balance of Rs. 1,33,37,689 was declared to be payable by the petitioner.

By an order dated 26th January, 2021, the Designated Authority passed an order in Form No. 3 u/s 5(1) of the DTVSV Act read with Rule 4 of the DTVSV Rules, determining the tax payable by the petitioner to be Rs. 2,57,67,714, being 125% of the disputed tax as against Rs. 2,02,69,581 being 100% of the disputed tax declared by the petitioner.

Being aggrieved by the aforesaid order, the petitioner challenged it before the High Court by way of a Writ Petition including the Circular No. 21.

The petitioner submitted that for A.Y. 2015-16 the assessment was not made on the basis of any search but the addition was made only on the basis of certain information obtained in the course of a search conducted on the premises of other entities. The petitioner contended that he has not been subjected to any search action. As per section 3 of the DTVSV Act, sub-clause (a) is applicable to its case as the tax arrear is the aggregate amount of disputed tax, interest chargeable or charged on such disputed tax, and penalty leviable or levied on such disputed tax and, therefore, the amount payable by the petitioner would be the amount of the disputed tax. Only in a case as contained in sub-clause (b) of section 3, where the tax arrears include tax, interest or penalty determined in any assessment on the basis of a search u/s 132 or section 132A of the Income-tax Act, only then would the amount payable under the DTVSV Act be 125% of the disputed tax and in no other case.

It was submitted that the Circular has been issued under sections 10 and 11. Sub-section (1) of section 11 states that an order can be passed by the Central Government to remove difficulties; however, the same cannot be inconsistent with the provisions of the Act. Although section 3 of the DTVSV Act states in unequivocal terms that 125% of the disputed tax is payable only in those cases where an assessment is made on the basis of a search, the impugned order based on the Circular would make it contrary to the provisions of the Income-tax Act and also to several judgments of the Supreme Court; to that extent, the Circular is liable to be quashed. In any event, in interpreting the scope of a provision of a statute, the Courts are not bound by the Circulars issued by the CBDT.

The petitioner further relied on Circular No. 4/2021 dated 23rd March, 2021 with respect to the clarifications issued by the CBDT with reference to FAQ No. 70 of Circular No. 21/2020. It was submitted that to remove any uncertainty it is clarified that a search case means an assessment or reassessment made u/s 143(3)/144/147/153A/153C/158BC in the case of a person referred to in sections 153A, 153C, 158BC or 158BD on the basis of a search initiated u/s 132, or a requisition made u/s 132A, modifying FAQ No. 70 of Circular 21/2020 to that extent. It was submitted that the petitioner is not a person referred to in section 153A or 153C.

For their part, the respondents submitted that since the assessment order was framed based on search / survey inquiries conducted by the Directorate of Income Tax (Investigation), Kolkata on 2nd July, 2013, the designated authority has rightly computed the petitioner’s liability under the Vivad se Vishwas Act by adopting the rate of 125% of disputed tax applicable to a search case in accordance with section 3 of the DTVSV Act. The assessment order passed u/s 143(3) is on the basis of the search and seizure action and the statement recorded u/s 132(4), coupled with post-search inquiries, and as the petitioner had failed to demonstrate the genuineness of the transactions, the addition was made.

In other words, the Department submitted that as per the DTVSV Act, 2020 it is not material that a ‘search case’ essentially should be a case wherein a warrant is executed u/s 132. To emphasise this, it relied on FAQ No. 70 and stated that it was identical to section 153C wherein cases are considered as ‘search case’ even though a warrant is not executed but transaction or information is found from the person subjected to search action u/s 132.

The Court referred to the statement of objects and reasons of the DTVSV Act and observed that this Act is meant to provide a resolution for pending tax disputes which have been locked up in litigation. Taxpayers can put an end to tax litigation by opting for the scheme and also obtain immunity from penalty and prosecution by paying percentages of tax as specified therein. This would bring peace of mind, certainty, saving of time and resources for the taxpayers and also generate timely revenue for the Government.

Referring to the answer to Q. No. 70, it was observed that the said question and its answer in Circular No. 21 was clarified vide Circular No. 4/2021 dated 23rd March, 2021 that a ‘search case’ means an assessment or reassessment made u/s 143(3)/144/147/153A/153C/158BC in the case of a person referred to in section 153A, section 153C, section 158BC or section 158BD on the basis of a search initiated u/s 132, or a requisition made u/s 132A. Thus, the answer to FAQ No. 70 of Circular No. 21/2020 has been replaced by the above meaning.

The Court observed that to be considered a search case, the assessment / reassessment should be:
(i) under sections 143(3)/144/147/153A/153C/153BC; and
(ii) be in respect of a person referred to in section 153A, section 153C, section 158BC or section 158BD; and
(iii) should be on the basis of a search initiated u/s 132, or a requisition made u/s 132A.

If all the three elements / criteria as above are satisfied, the case is a search case.

The Court held that it is not the case of the Revenue that action pursuant to sections 153A or 153C had been initiated in the case of the petitioner. These facts are not disputed. Therefore, criterion No. (ii) necessary for a case to be a search case is not satisfied. Admittedly, no search has been initiated in the case of the petitioner. The assessment order dated 22nd December, 2017 also suggests that the case of the petitioner was selected for scrutiny under ‘CASS’ selection and notices under the Act were issued to the petitioner not pursuant to any search u/s 132 or requisition u/s 132A. Assessment refers only to section 143(3) and is not read with any provision of search and seizure contained in Chapter XIV-B of the Income-tax Act where the special procedure for assessment of a search case is prescribed. The name of the petitioner figures nowhere in any of the statements u/s 132(4) of the searches referred to in the assessment order, nor in the statements pursuant to the survey action of persons under search or survey.

In view of Circular No. 4/2021 modifying / replacing the answer to FAQ No. 70 in Circular No. 21, the case of the petitioner would not be a search case. The Court further observed that these Circulars are to remove difficulties and to tone down the rigour of the law and cannot be adverse to the assessee, especially keeping in mind the beneficial nature of the legislation carrying a lot of weight. Since the petitioner’s case cannot be regarded as a search case, consequently the order dated 26th January, 2021 in Form No. 3, passed by the Designated Authority, would be unsustainable. The Writ Petition filed by the assessee was accordingly allowed.

Penalty – Mistake in notice not to affect validity – Scope of section 292B – Mistake in specifying assessment year for which penalty was levied – Mistake could not be corrected u/s 292B

28 SSS Projects Ltd. vs. Dy. CIT [2021] 432 ITR 201 (Karn) A.Y.: 2008-09; Date of order: 01/02/2021 Ss. 221 and 292B of ITA, 1961

Penalty – Mistake in notice not to affect validity – Scope of section 292B – Mistake in specifying assessment year for which penalty was levied – Mistake could not be corrected u/s 292B

The assessee is a company and for the A.Y. 2008-09 it had paid the tax on the assessed income. However, the A.O. passed an order dated 9th February, 2009 and levied a penalty of Rs. 50,00,000 u/s 221 for the A.Y. 2008-09. The assessee pleaded that it appeared that the A.O. had considered the facts of the case for the A.Y. 2007-08 for levying the penalty for the A.Y. 2008-09 and had passed an order u/s 221 to raise the demand of Rs. 50,00,000.

Both the Commissioner (Appeals) and the Tribunal dismissed the appeals filed by the assessee.

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

‘i) From a close scrutiny of section 292B it is evident that no return of income, assessment, notice, summons or other proceeding, furnished or made or issued or taken or purported to have been furnished or made or issued or taken in pursuance of any of the provisions of this Act shall be invalid or shall be deemed to be invalid merely by reason of any mistake, defect or omission in such return of income, assessment, notice, summons or other proceeding if such return of income, assessment, notice, summons or other proceeding is in substance and effect in conformity with or according to the intent and purpose of this Act. In other words, any clerical or typographical error or omission in the return of income, assessment, notice, summons or other proceeding shall not invalidate the proceedings. When there is no confusion or prejudice caused due to non-observance of technical formalities, the proceedings cannot be invalidated and therefore, a defective notice to an assessee u/s 292B of the Act is not invalid.

ii) The order of penalty referred to the A.Y. 2008-09. The order by which the penalty was levied by the A.O. had been affirmed by the Commissioner (Appeals) and similarly, the Tribunal had held that the penalty had been levied in respect of the A.Y. 2008-09. From a perusal of the memorandum of appeal it was evident that the assessee had paid tax in respect of the A.Y. 2008-09. The assessee had committed a default in respect of the A.Y. 2007-08 and did not pay the tax on account of financial hardship. However, the authorities under the Act had taken into account the facts in respect of the A.Y. 2007-08 and had held the assessee to be in default in respect of the A.Y. 2008-09 and had levied the penalty u/s 221 in respect of the A.Y. 2008-09.

iii) The mistake could not be condoned u/s 292B under which only clerical error or accidental omissions can be protected. The order of penalty was not valid.’

Limitation – Assessment u/s 144C – Section 144C does not exclude operation of section 153 – Notice by DRP four years after direction by Tribunal – Barred by limitation

26 ROCA Bathroom Products Pvt. Ltd. vs. DRP [2021] 432 ITR 192 (Mad) A.Ys.: 2009-10 and 2010-11; Date of order: 23/12/2020 Ss. 144C and 153 of ITA, 1961

Limitation – Assessment u/s 144C – Section 144C does not exclude operation of section 153 – Notice by DRP four years after direction by Tribunal – Barred by limitation

For the A.Y. 2009-10, by an order dated 18th December, 2015, the Tribunal had set aside the order passed u/s 144C and remanded the matter to the Dispute Resolution Panel (DRP) for fresh examination. For the A.Y. 2010-11, by an order dated 23rd September, 2016, the Tribunal had set aside the order passed u/s 144C and remanded the matter to the A.O. for passing a fresh order. No further proceedings were initiated by the DRP and the A.O. pursuant to the order of the Tribunal. Therefore, on 21st August, 2019, the assessee wrote to the A.O. seeking refund of the tax paid for both the years. The aforesaid letter triggered notices dated 6th January, 2020 from DRP calling upon the assessee to appear for a hearing. The assessee filed writ petitions and challenged the notices on the ground of limitation.

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

‘i) Section 144C is a self-contained code of assessment and time limits are in-built at each stage of the procedure contemplated. Section 144C envisions a special assessment, one which includes the determination of arm’s length price of international transactions engaged in by the assessee. The Dispute Resolution Panel (DRP) was constituted bearing in mind the necessity for an expert body to look into intricate matters concerning valuation and transfer pricing and it is for this reason that specific timelines have been drawn within the framework of section 144C to ensure prompt and expeditious finalisation of this special assessment. The purpose is to fast-track a specific type of assessment.

ii) This does not, however, lead to the conclusion that overall time limits have been eschewed in the process. In fact, the argument that proceedings before the DRP are unfettered by limitation would run counter to the avowed object of setting up of the DRP, a high-powered and specialised body set up for dealing with matters of transfer pricing. Having set time limits at every step of the way, it does not stand to reason that proceedings on remand to the DRP may be done at leisure sans the imposition of any time limit at all. Sub-section (13) to section 144C imposes a restriction on the A.O. and denies him the benefit of the more expansive time limit available u/s 153 to pass a final order of assessment as he has to do so within one month from the end of the month in which the directions of the DRP are received by him, even without hearing the assessee concerned. The specific exclusion of section 153 from section 144C(13) can be read only in the context of that specific sub-section and, once again, reiterates the urgency that sets the tone for the interpretation of section 144C itself.

iii) The notices issued by the Dispute Resolution Panel after a period of four years from the date of order of the Tribunal would be barred by limitation by application of the provisions of section 153(2A). The writ petitions are allowed.’

Income – Income or capital – Receipt from sale of carbon credits – Capital receipt – Amount not assessable merely because of erroneous claim for deduction u/s 80-IA

25 S.P. Spinning Mills Pvt. Ltd. vs. ACIT [2021] 433 ITR 61 (Mad) A.Y.: 2011-12; Date of order: 19/01/2021 S. 4 of ITA, 1961

Income – Income or capital – Receipt from sale of carbon credits – Capital receipt – Amount not assessable merely because of erroneous claim for deduction u/s 80-IA

The assessee, a private limited company, had claimed deduction of Rs. 3,17,77,767 u/s 80-IA for the A.Y. 2011-12 in respect of the revenue generated for adhering to the clean development mechanism. This included receipts on sale of carbon credits. The A.O. found that the assessee is engaged in the generation of electrical power which is used for its own textile business and the remaining is wheeled to the Tamil Nadu Electricity Board. He held that the income from generation of electricity and the carbon credit earned by the assessee are totally separate and the source of the income is also separate. Therefore, the income derived from the generation of electrical power alone can be construed as income from the eligible business for the purpose of deduction u/s 80-IA. Therefore, the assessee is not entitled to deduction u/s 80-IA in respect of the carbon credit.

Before the Commissioner (Appeals), the assessee contended that without prejudice to its claim for deduction u/s 80-IA, the carbon credit revenue is to be held as a capital receipt and ought to have been excluded from the taxable income. The Commissioner (Appeals) noted the decision of the Chennai Tribunal relied on by the assessee in the case of Ambika Cotton Mills Ltd. vs. Dy. CIT [2013] 27 ITR (Trib) 44 (Chennai) ITA No. 1836/Mds/2012, dated 16th April, 2013, wherein it was held that carbon credit receipts cannot be considered as business income and these are a capital receipt. Hence, the assessee’s claim u/s 80-IA is untenable as deduction u/s 80-IA is allowable only on profits and gains derived by an undertaking. The Tribunal took note of the submission made by the assessee and the decisions relied on and confirmed the finding of the Commissioner (Appeals) largely on the ground that the assessee itself regarded it as a business income and claimed deduction u/s 80-IA.

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

‘i) The task of an appellate authority under the taxing statute, especially a non-departmental authority like the Tribunal, is to address its mind to the factual and legal basis of an assessment for the purpose of properly adjusting the taxpayer’s liability to make it accord with the legal provisions governing his assessment. Since the aim of the statutory provisions, especially those relating to the administration and management of Income-tax is to ascertain the taxpayer’s liability correctly to the last pie, if it were possible, the various provisions relating to appeal, second appeal, reference and the like can hardly be equated to a lis or dispute as arises between two parties in a civil litigation.

ii) The assessee while preferring the appeal before the Commissioner (Appeals), had specifically raised a contention that the receipts from sale of carbon credits was a capital receipt and could not be included in the taxable income. Though this ground had been recorded in the order, the Commissioner (Appeals) did not take a decision thereon. A similar ground was raised by the assessee before the Tribunal, which was not considered by the Tribunal, though the Tribunal referred to all the decisions relied on by the assessee, and rejected the assessee’s claim made u/s 80-IA.

iii) This finding of the Tribunal was wholly erroneous and perverse. The Tribunal was expected to apply the law and take a decision in the matter and if the Commissioner (Appeals) or the A.O. had failed to apply the law, then the Tribunal was bound to apply the law. The receipt by way of sale of carbon credits had been held to be a capital receipt. Therefore, it was of little consequence to the claim made by the assessee u/s 80-IA or in other words, the question of taking a decision as to whether the deduction was admissible u/s 80-IA was a non-issue. Receipt from sale of carbon credits is a capital receipt.’

Deemed income u/s 56(2)(viib) – Company – Receipt of consideration for issue of shares in excess of their fair market value – Determination of fair market value – General principles – Assessee valuing shares following prescribed method – No evidence that method was erroneous – Addition based on estimate by A.O. – Not justified

24 Principal CIT vs. Cinestaan Entertainment Pvt. Ltd. [2021] 433 ITR 82 (Del) A.Y.: 2015-16; Date of order: 01/03/2021 S. 56(2)(viib) of ITA, 1961

Deemed income u/s 56(2)(viib) – Company – Receipt of consideration for issue of shares in excess of their fair market value – Determination of fair market value – General principles – Assessee valuing shares following prescribed method – No evidence that method was erroneous – Addition based on estimate by A.O. – Not justified

For the A.Y. 2015/16, the assessee had filed its return of income declaring Nil income. The case of the assessee was selected for ‘limited scrutiny’ inter alia for the reason ‘large share premium received during the year [verify applicability of section 56(2)(viib)(b)]’. By an order dated 31st December, 2017, the assessment was framed u/s 143(3) determining the total income of the assessee at Rs. 90,95,46,200, making an addition u/s 56(2)(viib).

The Tribunal deleted the addition and held that neither the identity nor the creditworthiness and genuineness of the investors and the pertinent transaction could be doubted. This fact stood fully established before the A.O. and had not been disputed or doubted. Therefore, the nature and source of the credit stood accepted. It held that if the statute provides that the valuation has to be done as per the prescribed method and if one of the prescribed methods had been adopted by the assessee, then the A.O. had to accept it.

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

‘i) Section 56(2)(viib) lays down that amounts received by a company on issue of shares in excess of their fair market value will be deemed to be income from other sources. Valuation is not an exact science and therefore cannot be done with arithmetic precision. It is a technical and complex problem which can be appropriately left to the consideration and wisdom of experts in the field of accountancy, having regard to the imponderables which enter the process of valuation of shares.

ii) The shares had not been subscribed to by any sister concern or closely related person, but by outsider investors. The methodology adopted was a recognised method of valuation and the Department was unable to show that the assessee adopted a demonstrably wrong approach, or that the method of valuation was made on a wholly erroneous basis, or that it committed a mistake which went to the root of the valuation process. The deletion of addition was justified.’

Deemed business income u/s 41(1)(a) – Remission or cessation of liability – Scope of section 41(1)(a) – Amount obtained mentioned in provision refers to actual amount obtained – Royalty payment claimed as expenditure in A.Y. 1990-91 – Tax deducted at source on such payment and interest paid to treasury – Royalty amount written back in accounts in A.Y. 1995-96 – Tax deducted at source and interest not refunded – Such amounts not includible u/s 41(1)(a)

23 Carbon and Chemicals (India) Ltd. vs. CIT [2021] 433 ITR 14 (Ker) A.Y.: 1995-96; Date of order: 01/03/2021 S. 41(1)(a) of ITA, 1961

Deemed business income u/s 41(1)(a) – Remission or cessation of liability – Scope of section 41(1)(a) – Amount obtained mentioned in provision refers to actual amount obtained – Royalty payment claimed as expenditure in A.Y. 1990-91 – Tax deducted at source on such payment and interest paid to treasury – Royalty amount written back in accounts in A.Y. 1995-96 – Tax deducted at source and interest not refunded – Such amounts not includible u/s 41(1)(a)

The assessee claimed a deduction of Rs. 53,71,650 for the A.Y. 1990-91 as expenditure, being royalty payable to a foreign collaborator. Though the deduction was allowed, the amount was not actually remitted outside India. In the meantime, an amount of Rs. 13,65,060 was paid towards tax deducted at source on the royalty amount and a further amount of Rs. 9,38,438 towards interest, under orders passed u/s 201(1A). Thus, a total amount of Rs. 23,03,498 was paid by the assessee towards tax and interest due to the Department against the deduction claimed towards royalty payable to the foreign collaborator. In the A.Y. 1995-96, the amount claimed as deduction for the A.Y. 1990-91, excluding the tax deducted at source and interest paid, was written back by the assessee into its accounts on account of the cessation of liability. Thus, in the return filed for the A.Y. 1995-96, the assessee had written back only Rs. 30,68,152 u/s 41(1). The A.O. held that the entire amount of Rs. 53,71,650 ought to be treated as a deemed profit u/s 41(1)(a) due to cessation of liability with the foreign collaborator.

The Tribunal upheld the addition.

On a reference by the assessee, the Kerala High Court allowed its claim and held as under:

‘i) A reading of section 41(1)(a) indicates that a legal fiction is created to treat the amount which was once deducted as an expenditure, if received back in another assessment year, as income from profits and gains of business. For the purpose of attracting section 41(1) it is necessary that the following conditions are satisfied: (i) the assessee had made an allowance or any deduction in respect of any loss, expenditure, or trading liability incurred by him; (ii) any amount is obtained in respect of such loss or expenditure or any benefit is obtained in respect of such trading facility by way of remission or cessation thereof; and (iii) such amount or benefit is obtained by the assessee in a subsequent year. Once these conditions are satisfied, the deeming provision enacted in the closing part of section 41(1)(a) gets attracted and the amount obtained becomes chargeable to Income-tax as profits and gains of business or profession.

ii) The purpose behind creating a fiction u/s 41(1)(a) is to tax the amount, earlier deducted but subsequently received back, to the extent recouped. It is a measure of taxing the amount recouped. Though a legal fiction must be given full effect, it should not be extended beyond the purpose for which it is created. It is true that Income-tax is a portion of the profits payable to the State and the tax payable is not a permissible deduction. Section 198 provides that all sums deducted for the purpose of computing income of an assessee, including the tax deducted at source, shall be treated as income received. However, this principle cannot be applied while determining the amount to be deemed as profits and gains u/s 41(1)(a). Such an interpretation, if adopted, will in fact be expanding the fiction created and even transform the chargeability.

iii) The words employed in section 41(1)(a) are “amount obtained by such person or the value of benefits accruing to him”. The “amount obtained” can only mean the actual amount obtained. The fiction created under the provision cannot be expanded to include amounts that may be obtained in the future. The legal fiction is intended to deem the actual amount obtained as profits and gains from business and to tax the actual amount. Section 41(1) employs, on the one hand, words such as “allowance” or “deduction”, and on the other hand “loss”, “expenditure”, or “trading liability”. These words are of general import and are understandably employed to take care of several fluid dynamics. These expressions are relatable to words used in section 41(1)(a), i. e., “the amount obtained by such person or the value of benefit accruing to him shall be deemed to be profits, gains, etc.” Therefore, an entry made in one previous year as an allowance or deduction towards “loss”, “expenditure” or “trading liability” when written back in a subsequent previous year, on account of the cessation of such liability, becomes taxable as profit or gains of business. But the tax liability should be commensurate with the actual amount received or the value of benefit accrued to the assessee in that financial year and not on the unrecovered amount or unacknowledged benefit by the assessee. The unrecovered amount becomes taxable only in the previous year when it is recovered or actually obtained.

iv) The amount of tax deducted at source and interest could be deemed to be profits and gains and chargeable to tax only on refund. The amounts paid as tax had not been obtained in 1995-96 as they had not been refunded. Until the amount of tax deducted at source was refunded, that amount could not be treated as an amount obtained by the assessee. The addition made by the A.O. was not justified.’

Charitable purpose – Registration of trust – Loss of all records in respect of registration due to floods in 1978 – Exemption granted in assessments up to A.Y. 2012-13 – Absence of documents cannot be ground to presume registration never granted and to deny exemption – Other contemporaneous records to be scrutinised to ascertain issuance of registration certificate

22 Morbi Plot Jain Tapgachh Sangh vs. CIT [2021] 433 ITR 1 (Guj) A.Ys. 2013-14 to 2016-17; Date of order: 25/03/2021 Ss. 11, 12A, 12AA of ITA, 1961

Charitable purpose – Registration of trust – Loss of all records in respect of registration due to floods in 1978 – Exemption granted in assessments up to A.Y. 2012-13 – Absence of documents cannot be ground to presume registration never granted and to deny exemption – Other contemporaneous records to be scrutinised to ascertain issuance of registration certificate

The assessee was a charitable trust established in 1967 and registered with the Charity Commissioner. Thereafter, it was registered u/s 12A. In orders passed u/s 143(3) for the A.Ys. 1977-78 to 1982-83, the Department had accepted the assessee’s claim for exemption u/s 11 and for the A.Ys. 1986-87 to 2012-13, the exemption u/s 11 was allowed accepting the return of income u/s 143(1) under the provisions applicable to a registered trust drawing the benefits of registration u/s 12A.

The entire records of the assessee, including the books of accounts, registration certificate as trust and other documents related thereto were destroyed in the devastating flood in the year 1978. From A.Y. 2013-14, the assessee was required to E-file its return of income in which the details as regards the registration of trust u/s 12A/12AA were to be furnished. If the registration number was not mentioned an error would be indicated and the assessee would not be able to upload the return of income. In the absence of the registration certificate and the registration number, the Department did not grant the exemption u/s 11 for the period between 2013-14 and 2016-17. The assessee was granted a fresh certificate from A.Y. 2017-18 onwards.

The assessee filed a writ petition seeking a direction to grant the benefit of exemption for the A.Ys. 2013-14 to 2016-17. The Gujarat High Court allowed the writ petition and held as under:

‘i) Though in the absence of the registration number to be mentioned in the course of E-filing of the return, the benefit of exemption u/s 11 could not be granted, the assessee trust should not be denied the benefit of exemption u/s 11 only on account of its inability to produce the necessary records which got destroyed during the floods of 1978. There was nothing doubtful as regards the assessee. The stance of the Department that as the record was not available with the assessee or with the Department, it should be presumed that at no point of time the certificate of registration u/s 12A was granted, could not be accepted.

ii) There was contemporaneous record available with the assessee which could be produced by it and should be considered minutely by the Department so as to satisfy itself that the assessee had been issued a registration certificate u/s 12A and had been availing of the benefit of exemption over a period of time u/s 11.

iii) The Department is expected to undertake some homework in this regard seriously. The trust should not be denied the benefit of exemption u/s 11 only on account of its inability to produce the necessary records which got destroyed during the floods of 1978. We do not find anything doubtful or fishy as regards the trust.

iv) In such circumstances, we are of the view that whatever record is available with the trust, as on date, should be produced before the Department and the Department should look into the records minutely and also give an opportunity of hearing to the trust or its legal representative and take an appropriate decision in accordance with law.

v) We dispose of this writ application with a direction that the writ applicant-trust shall produce the entire record available with it as on date before the Department and the Department shall look into the entire record closely and threadbare and ascertain whether the trust being a registered charitable trust had been issued the registration certificate u/s 12A. A practical way needs to be found out in such types of litigation. Let this entire exercise be undertaken at the earliest and be completed within a period of four weeks from the date of receipt of the order by the Department.

vi) We hope and trust that the controversy is resolved by the parties amicably and the trust may not have to come back to this Court.’

Capital gains – Computation – Deeming provision in section 50C – Applicable only when there is actual transfer of land – Assessee acquiring right in land under agreement to purchase land – Sale of land to third party with consent of assessee – Section 50C not applicable

21 V.S. Chandrashekar vs. ACIT [2021] 432 ITR 330 (Karn) A.Y.: 2010-11; Date of order: 02/02/2021 Ss. 45 and 50C of ITA, 1961

Capital gains – Computation – Deeming provision in section 50C – Applicable only when there is actual transfer of land – Assessee acquiring right in land under agreement to purchase land – Sale of land to third party with consent of assessee – Section 50C not applicable

The assessee was a dealer in land. On 23rd December, 2005, it had entered into an unregistered agreement with ‘N’ for purchase of land measuring 3,639.60 square metres for a consideration of Rs. 4.25 crores. Under the agreement, the assessee was neither handed over possession of the land nor was the power of attorney executed in his favour. ‘N’ sold the land in question by three sale deeds. In the first two transactions the assessee was not a party to the deed, whereas in the third transaction the assessee was a consenting witness. The assessee claimed the loss arising from the transaction as a business loss. The A.O. applied section 50C and made an addition to his income. This was upheld by the Tribunal.

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

‘i) It is a well settled rule of statutory interpretation with regard to taxing statutes that an assessee cannot be taxed without clear words for that purpose and every Act of Parliament has to be read as per its natural construction of words.

ii) From a perusal of sections 2(47) and 50C it is axiomatic that Explanation 1 to section 2(47) uses the term “immovable property”, whereas section 50C uses the expression “land” instead of immovable property. Wherever the Legislature intended to expand the meaning of land to include rights or interests in land, it has said so specifically, viz., in section 35(1)(a), section 54G(1), section 54GA(1) and section 269UA(d) and Explanation to section 155(5A). Thus, section 50C applies only in case of transfer of land.

iii) Section 50C was applicable only in case of a transferor of land which in the instant case was ‘N’ and not a transferor or co-owner of the property. The provisions of section 50C were not applicable to the case of the assessee.

iv) The question whether the loss sustained by the assessee fell under the head “Business” or “Capital gains” required adjudication of facts.’

DEDUCTION FOR PENALTIES AND FINES UNDER THE MOTOR VEHICLES ACT, 1988

ISSUE FOR CONSIDERATION
Section 37 allows a deduction for any revenue expenditure, laid out or expended wholly and exclusively for the purposes of business or profession, in computing the income under the head Profit and Gains from Business and Profession, provided the expenditure is not of a nature covered by sections 30 to 36.

Explanation 1 to section 37(1) provides that no deduction or allowance shall be made in respect of an expenditure incurred for any purpose which is an offence or which is prohibited by law; such an expenditure shall not be deemed to have been incurred for the purposes of business and profession.

Explanation 1, inserted for removal of doubts with retrospective effect from 1st April, 1962, has been the subject matter of fierce litigation even before it was inserted by the Finance No. 2 Act, 1998. Disputes regularly arise about the true meaning of the terms ‘for any purpose which is an offence’ or ‘which is prohibited by law’ in deciding the allowance of an expenditure incurred. The courts have been disallowing expenditure incurred against the public policy or payments that were made for serious violation of law even before the insertion of Explanation 1. Issues also arise about the legislative intent of Explanation 1 and about the scope of Explanation 1; whether the Explanation has limited the law as it always was or whether it has expanded its scope, or has reiterated what was always there.

In the last few years, the legislatures, Central and State, have increased the fines and penalties many-fold for violation of traffic laws and with this enormous increase the issue of allowance or deduction of such payments has also attracted the attention of the taxpayers who hitherto never viewed these seriously. The issue has been considered on several occasions by the courts and is otherwise not new, but it requires consideration in view of the sizeable increase in the quantum of expenditure and the dexterous implementation of the new fines by the traffic authorities with vigour hitherto unknown in this vast country. The recent decision of the Kolkata Bench of the Tribunal holding that such an expenditure is not allowable as a deduction in contrast to many decisions regularly delivered for allowance of such payments, requires us to examine this conflict once more, mainly with the intention to recap the law on the subject and share some of our views on the same.

THE APARNA AGENCY LTD. CASE

The issue recently came up for consideration in Aparna Agency Ltd. 79 taxmann.com 240 (Kolkata-Trib). In that case the assessee was engaged in the business of clearing and distribution of FMCG products and of forwarding agents and had claimed deduction for expenses in respect of payments made to State Governments for violating the provisions of the Motor Vehicles Act, 1988 (M.V. Act) for offences committed by its employees. The A.O. disallowed the payments by holding that such payments were made for infraction of law and could not be allowed as a deduction. The Commissioner (Appeals) confirmed the action of the A.O. but reduced the quantum of disallowance.

In an appeal to the Tribunal, the assesse challenged the orders of the A.O. and the Commissioner (Appeals). It submitted that the payments were made to the traffic department for minor traffic violations committed by its delivery vans, and the payments were not against any proved violation or infraction of law but were made in settlement of contemplated governmental actions that could have led to charging the assessee with an offence. It submitted that the payment did not prove any guilt and was made with a view to avoid prolonged litigation, save time and litigation cost.

The assessee relied on the decision of the Madras High Court in CIT vs. Parthasarathy, 212 ITR 105 to contend that the payment that was compensatory in nature should be allowed as a deduction so long as the said payment was not found to be penal in nature.

The Tribunal examined the provision of the M.V. Act, 1988, and in particular the relevant sections concerning the offence and the levy of the fine, namely, sections 119, 122, 129 and 177. It noted that the term ‘offence’ though not defined under the Income-tax Act, 1961, was, however, defined exhaustively by section 3(38) of the General Clauses Act, 1887 to mean ‘any act or omission made punishable by any law for the time being in force’. It was also noted that even the expression ‘prohibited by law’ has not been defined in the I.T. Act. Under the circumstances, the Tribunal held that the expression should be viewed either as an act arising from a contract which was prohibited by statute or which was entered into with the object of committing an illegal act. The Tribunal quoted with approval the following paragraph of the decision of the Supreme Court in the case of Haji Aziz and Abdul Shakoor Bros. vs. CIT 41 ITR 350:

‘In our opinion, no expense which is paid by way of penalty for a breach of the law can be said to be an amount wholly and exclusively laid for the purpose of the business. The distinction sought to be drawn between a personal liability and a liability of the kind now before us is not sustainable because anything done which is an infraction of the law and is visited with a penalty cannot on grounds of public policy be said to be a commercial expense for the purpose of a business or a disbursement made for the purposes of earning the profits of such business’.

The Tribunal, on perusal of various statutory provisions of the M.V. Act under which the payments in question were made, for offences committed by the employees for which the assessee was vicariously liable, held that such payments were not compensatory in nature and could not be allowed as a deduction by upholding the order of the Commissioner (Appeals) to that extent.

BHARAT C. GANDHI’S CASE


A similar issue had arisen in the case of DCIT vs. Bharat C. Gandhi, 10 taxmann.com 256 (Mum). The assessee in the case was an individual and the proprietor of Darshan Roadlines which specialised in transporting cargo consignments of huge or massive dimensions where the weight and the size of the same exceeded the limits laid down under the M.V. Act and the rules thereunder. The assessee paid compounding fees aggregating to Rs. 73,45,953 to the RTO on various trips during the year for transportation of the massive consignments on its trailers by way of fines at the check-post at Bhachau, Gujarat on various trips during the year for Suzlon Energy Ltd. The A.O. disallowed the assessee’s claim in respect of the said payments, holding that it was in the nature of penalty and, thus, not allowable u/s 37(1). The Commissioner (Appeals), however, held that the expenditure was not in violation of the M.V. Act and the payments could not be termed as penalty. He further relied on the clarifications given by the Central Government vide letter dated 3rd August, 2008 and allowed the expenditure.

On Revenue’s appeal, the Departmental Representative submitted that the issue was not of nomenclature but the intention of the Legislature in not allowing the amounts paid for violation of law. It was further submitted that it was nowhere stated that the assessee satisfied the conditions of the Circular referred to by it before the Commissioner (Appeals). It was submitted that the payment was a penalty for violating the law and could not be allowed.

In reply, the assessee contended that the massive (or over-dimensioned) consignment was indivisible and could not be divided into parts and pieces and hence there was no other way to transport it except by exceeding the permitted limits. It was submitted that transportation in such a manner was a business necessity and commercial exigency and did not involve any deliberate intention of violating any law or rules. It was further submitted that even though it was a compounding fees paid u/s 86(5) of the M.V. Act to the RTO, it was an option given to the assessee and hence payment could not be referred to as a penalty. It was further submitted that such over-dimension charges were also paid to Western Railways for crossing the railway tracks and an amount of Rs. 2,71,380 was allowed by the A.O. It was highlighted that the Central Government vide letter dated 3rd August, 2008 had clarified that transport could take place on payment of the fines.

The assessee further referred to section 86(5) of the M.V. Act and relied on the precedents on the issue in the following cases:
(i) Chadha & Chadha Co. in IT Appeal No. 3524/Mum/2007
(ii) CIT vs. Ahmedabad Cotton Mfg. Co. Ltd. 205 ITR 163(SC)
(iii) CIT vs. N.M. Parthasarathy 212 ITR 105 (Mad)
(iv) ACIT vs. Vikas Chemicals 122 Taxman 59 (Delhi)
(v) CIT vs. Hero Cycles Ltd. 17 Taxman 484 (Punj. & Har.)
(vi) Kaira Can Co. Ltd. vs. Dy. CIT 32 DTR 485 (Mum-Trib)
(vii) Western Coalfields Ltd. vs. ACIT, 27 DTR 226 (Nag-Trib)

The Tribunal noted that the issue was elaborately discussed by the ITAT in the case of Chadha & Chadha Co., IT Appeal No. 6140/Mum/2009, dated 17th September, 2010 relied upon by the assessee wherein the ITAT in its order has considered as under:

‘9. The liability for additional freight charges was considered in the case of ITO vs. Ramesh Stone Wares by the ITAT Amritsar Bench in 62 TTJ (Asr.) 93 wherein the additional freight charges paid to Railway Department for overloading was considered and held that the expense was not penal in nature because it is not the infringement of law but same is violation of contract that too not by the assessee but by his agent, i.e., Coal Authority of India. In terms of an agreement, if coal is finally found by the authorities to be overloaded then the assessee has to pay additional freight charges which according to the terminology of the contract is called penalty freight. This liability was not considered as penal nature and allowed. In the assessee’s case also the overloading charges are to be incurred regularly in view of the nature of goods transported for the said steel company and since the nature of the goods is indivisible and generally more than the minimum limit prescribed under the Motor Vehicles Act, the assessee has to necessarily pay compounding charges for transporting goods as part of the business expenses. These are not in contravention of law and the RTO authorities neither seized the vehicle nor booked any offence but are generally collecting as a routine amount at the check-post itself while allowing the goods to be transported. In view of the nature of collection and payment which are necessary for transporting the goods in the business of the assessee, we are of the opinion that it does not contravene the M.V. Act as stated by the A.O. and the CIT(A).

10. Similar issue also arose with reference to fine and penalty paid on account of violation of National Stock Exchange Regulations in the case of Master Capital Services Ltd. vs. DCIT and the Hon’ble ITAT Chandigarh “A” Bench in ITA No. 346/Chd/2006, dated 26th February, 2007 108 TTJ (Chd) 389 has considered that fines and penalties paid by the assessee to NSE for trading beyond exposure limit, late submission of margin certificate due to software problem and delay in making deliveries of shares due to deficiencies are payments made in regular course of business and not infraction of law, hence allowable. In the assessee’s case also these fines are paid regularly in the course of the assessee’s business for transportation of goods beyond the permissible limit and these payments are being made in the regular course of business to the same RTO authorities at the check-post every year, in earlier years and in later years also. Accordingly, it has to be held that these payments are not for any infraction of law but paid in the course of assessee’s business of transportation and these are allowable expenses under section 37(1).’

In view of the legal principles established by the decisions referred to and noticing that the assessee had made about 230 trips by paying compounding fees, as per the rules in the M.V. Act, the Tribunal held that it could not be stated that the assessee’s payments of compounding fees was in violation of law. Since the assessee was engaged in transporting of over-dimensioned goods, in excess of specified capacities in its transport business, it was a necessary business expenditure, wholly and exclusively incurred for the purpose of business, and the same was allowable u/s 37(1). The order of the Commissioner (Appeals) on the issue was confirmed and in the result, the appeal of the Revenue was dismissed.

OBSERVATIONS
Section 37 is a residual provision that allows a business deduction for an expenditure not specified in sections 30 to 36, provided that the expenditure in question is incurred wholly and exclusively for the purposes of business, an essential precondition for any allowance under this section. Any expenditure that cannot be classified as such a business expenditure gets automatically disallowed under this provision unless it is specifically allowed under other provisions of the Act. Likewise, under the scheme of the Act, an expenditure of capital nature or a personal nature is also not allowable in computing the total income. The sum and substance of this is that a payment which cannot be construed as made for the purposes of business gets disallowed.

In the context of the discussion here, it is a settled position in law that the purpose of any ordinary business can never be to offend any law or to commit an act that violates the law and therefore any payments made for such an offence or as a consequence of violating any law is not allowable; such an allowance is the antithesis of the business deduction. Allowance for such payments has no place for the deduction in the general scheme of taxation. Such payments would be disallowed irrespective of any express provision, like Explanation 1, for its disallowance. It is for this reason that the payments of the nature discussed have been disallowed even before the insertion of Explanation 1 by the Finance (No. 2) Act, 1998 w.r.e.f. 1st April, 1962. It is for this reason that the insertion of this Explanation has been rightly labelled as ‘for removal of doubts’ to reiterate a provision of law which was always there.

Under the circumstances, the better view of the law is that the insertion of the Explanation is not to limit the scope of disallowance; any expenditure otherwise disallowable would remain disallowable even where it is not necessarily provided for by the express words of the Explanation. It is with this understanding of the law that the courts have been regularly disallowing the expenditure against public policy, for committing illegal acts, for making payments which are crimes by themselves and even, in some cases, expenditure incurred for defending the criminal proceedings. The disallowance here of an expenditure is without an exception and the principle would apply even in respect of an illegal business unless when it comes to the allowance of a loss of such business, in which case a different law laid down by the courts may apply.

The decisions chosen and discussed here are taken with the limited objective of highlighting the principles of the law of disallowance, even though they may not be necessarily conflicting with each other and maybe both may be correct in their own facts. The settled understanding of the law provided by the decisions of the Supreme Court in a case like Haji Aziz and Abdul Shakoor Bros. 41 ITR 350 has been given a new dimension by the subsequent decisions of the said court in the cases of Prakash Cotton Mills, 201 ITR 684 and Ahmedabad Cotton Manufacturing Co. Ltd., 205 ITR 163 for making a distinction in cases of payment of redemption fine or compounding fees. The court in these case held that it was required to examine the scheme of the provisions of the relevant statute providing for payment of an impost, ignoring its nomenclature as a penalty or fine, to find whether the payment in question was penal or compensatory in nature and allow an expenditure where an impost was found to be purely compensatory in nature. It was further held that when an impost was found to be of a composite nature, the payment was to be bifurcated and the part attributable to penalty was to be disallowed.

Following this distinction, many courts and tribunals have sought to allow those payments that could be classified as compensatory in nature. Needless to say, the whole exercise of distinguishing and separating the two is discretionary and at times results in decisions that do not reconcile with each other. For example, some courts hold that the penalty under the Sales Tax Act is not disallowable while a few others hold that it is disallowable. At times the courts are led to decide even the payment admittedly made for an offence or violation of law was allowable if it was incurred under a bona fide belief out of commercial expediency.

The other extreme is disallowance of payments that are otherwise bordering on immorality as perceived by society. The Supreme Court in the case of Piara Singh 124 ITR 40 and later in the case of Dr. T.A. Qureshi 287 ITR 647 held that there was a clear distinction between morality and law and the decision of disallowance should be purely based on the considerations rooted in law and not judged by morality thereof. These decisions also explain the clear distinction in principle relating to a loss and an expenditure to hold that in cases of an illegal business, the loss pertaining to such a business may qualify for set-off against income of such business.

As noted earlier, the Income-tax Act has not defined the terms like ‘offence’ or ‘prohibited by law’ and it is for this reason, in deciding the issue, that the taxpayer and the authorities have to necessarily examine the relevant statute under which the payment is made, to determine whether such a payment can be classified to be made for any purpose which is an offence or which is prohibited by law under the respective statutes.

Needless to reiterate, the scope of disallowance is not restricted by the Explanation and the expenditure otherwise held to be disallowed by the courts should continue to be disallowed and those covered by the Explanation would surely be disallowed. In applying the law, one needs to appreciate the thin line of distinction between an infraction of law, an offence, a violation and a prohibition, each of which may carry a different connotation while deciding the allowance or otherwise of a payment. In deciding the issue of allowance or otherwise, it perhaps would be appropriate to examine the ratio of the latest and all-important decision of the Supreme Court in the case of Maddi Venkataraman & Co. (P) Ltd., 229 ITR 534 where the Court held that a penalty for an infraction of law is not deductible on grounds of public policy, even if it is paid for an act under an inadvertence. The Full Bench of the Punjab and Haryana High Court in the case of Jamna Auto Industries, 299 ITR 92 held that a penalty imposed for violation of any law even in the course of business cannot be held to be a commercial loss allowable in law. One may also see the latest decision in the case of Confederation of Indian Pharmaceutical Industry vs. CBDT, 353 ITR 388 (HP) wherein the Court examined the issue of payment by the pharmaceutical company to the medical practitioners in violation of the rules of the Indian Medical Council.

It appears that the plea that the payment was made during the course of business and the businessman was compelled to offend or violate the law out of commercial expediency is no more tenable and, in our considered opinion, not an attractive contention to support a claim for a business deduction. A payment to discharge a statutory obligation, for correcting the default when permitted under the relevant statute, can be viewed differently and favourably in deciding the allowance of such payment, but such a payment may not be allowed when it is otherwise for an offence or for violating the law inasmuch as it cannot be considered as an expenditure laid out for the purpose of the business. An infraction of law cannot be treated as a normal occurrence in business.

Having noted the law and the developments in law, it is advisable to carefully examine the relevant law under which the payment is made for ascertaining whether the payment can at all be classified as a compensatory payment, for example interest, including those which are labelled as fines and penalties but are otherwise compensatory in nature and have the effect of regularising a default. Surely a payment made for compounding an offence to avoid imprisonment is not one that can be allowed as a deduction, even where such a compounding is otherwise permitted under the relevant statute?

The tribunal and courts in the following decisions, too, have taken a stand that payments made for traffic violations were not allowable as deductions:

  •  Vicky Roadways ITA No. 38/Agra/2013,
  •  Sutlej Cotton Mills ITA 1775/1991 (Del) HC, dated 31st October, 1997,
  •  Kranti Road Transport (P) Ltd. 50 SOT 15 (Visakhapatnam).

However, the tribunal and courts in the following cases have allowed the deduction for expenditure made for violation of the M.V. Act, 1988 in cases where the payment was made for overloading the cargo beyond the permissible limit, on the ground that the cargo in question was indivisible and there was a permission from the Central Government to allow the overloading on payment of fines:

  •  Ramesh Stone Wares, 101 Taxman 176 (Mag) (Asr),
  •  Vishwanath V. Kale ITA/20181/Mum/2010,
  •  Chetak Carriers ITA 2934/Delhi/1996,
  •  Amar Goods Carrier ITA 50 and 51/Delhi/199.

Limitation – Order of TPO – Mode of computing limitation

27 Pfizer Healthcare India Pvt. Ltd. vs. JCIT [2021] 433 ITR 28 (Mad) Date of order: 07/09/2020 Ss. 92CA, 144C and 153 of ITA, 1961

Limitation – Order of TPO – Mode of computing limitation

The petitioners filed returns of income, including income from transactions with associated entities abroad, thus necessitating a reference of issues arising under Chapter X to the Transfer Pricing Officer. The TPO has, after issuance of notices, passed orders dated 1st November, 2019. The petitioners filed writ petitions and challenged the validity of the orders of the TPO on the ground of limitation that there was a delay of one day.

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

‘i) The provisions of section 144C prescribe mandatory time limits both pre- and post- the stage of passing of a transfer pricing order. In this scheme of things, the submission that the period of 60 days stipulated for passing of an order of transfer pricing is only directory or a rough and ready guideline cannot be accepted. Section 153 states that no order of assessment shall be made at any time after the expiry of 21 months from the end of the assessment year in which the income was first assessable.

ii) In computing the limitation for passing the order in the instant case, the period of 21 months expired on 31st December, 2019. That must stand excluded since section 92CA(3A) stated “before 60 days prior to the date on which the period of limitation referred to in section 153 expires”. Excluding 31st December, 2019, the period of 60 days would expire on 1st November, 2019 and the transfer pricing orders thus ought to have been passed on 31st October, 2019 or any date prior thereto. The Board in the Central Action Plan also indicated the date by which the Transfer Pricing orders were to be passed as 31st October, 2019.

iii) The orders of the Transfer Pricing Officer passed on 1st November, 2019 were barred by limitation.’

Business expenditure – Disallowance u/s 40(a)(ia) – Payments liable to deduction of tax at source – Royalty: (i) Amendment to definition in 2012 with retrospective effect from 1976 – Assessee could not be expected to foresee future amendment at time of payment – Disallowance not called for; (ii) Disallowance attracted only for royalty as defined in Explanation 2 to section 9 – Channel placement fee of Rs. 7.18 crores to cable operators – Not royalty – Explanation 6 cannot be invoked to disallow payment

20 CIT vs. NGC Networks (India) Pvt. Ltd. [2021] 432 ITR 326 (Bom) A.Y.: 2009-10; Date of order: 29/01/2018 Ss. 9(1)(vi), 40(a)(ia), 194C, 194J of ITA, 1961

Business expenditure – Disallowance u/s 40(a)(ia) – Payments liable to deduction of tax at source – Royalty: (i) Amendment to definition in 2012 with retrospective effect from 1976 – Assessee could not be expected to foresee future amendment at time of payment – Disallowance not called for; (ii) Disallowance attracted only for royalty as defined in Explanation 2 to section 9 – Channel placement fee of Rs. 7.18 crores to cable operators – Not royalty – Explanation 6 cannot be invoked to disallow payment

During the previous year relevant to the A.Y. 2009-10, the assessee paid channel placement fees of Rs. 7.18 crores to cable operators deducting tax at source u/s 194C at the rate of 2%. The A.O. was of the view that the tax had to be deducted at source on payment at the rate of 10% u/s 194J as the payment was in the nature of royalty, as defined in Explanation 6 to section 9(1)(vi) and disallowed the entire expenditure of Rs. 7.18 crores u/s 40(a)(ia) for failure to deduct tax u/s 194J. The Dispute Resolution Panel upheld the assessee’s objections holding that deduction of tax at source was properly made u/s 194C. The A.O. passed a final assessment order accordingly.

On appeal by the Department, the Tribunal held that the assessee was not liable to deduct the tax at source at higher rates only on account of the subsequent amendment made in the Act, with retrospective effect from 1976.

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

‘i) The view taken by the Tribunal that a party could not be called upon to perform an impossible act, i. e., comply with a provision not in force at the relevant time but introduced later by retrospective amendment, was in accordance with the legal maxim lex non cogit ad impossibilia (law does not compel a man to do what he cannot possibly perform). The amendment by introduction of Explanation 6 to section 9(1)(vi) took place in the year 2012 with retrospective effect from 1976. It could not have been contemplated by the assessee when it made the payment during the assessment year that the payment would require deduction u/s 194J due to some future amendment with retrospective effect.

ii) Under section 40(a)(ia), royalty is defined as in Explanation 2 to section 9(1)(vi) and not in Explanation 6 to section 9(1)(vi). Undisputedly, the payment made for channel placement as a fee was not royalty in terms of Explanation 2 to section 9(1)(vi). Therefore, no disallowance of expenditure u/s 40(a)(i) could be made.’

The assessee being wholly managed and controlled from UAE, qualified for benefit under India-UAE DTTA – Limitation of benefit provision not applicable as it has been conducting bona fide business since years, long before start of India business

3 Interworld Shipping Agency LLC vs. DCIT [2021] 127 taxmann.com 132 (Mum-Trib) A.Y.: 2016-17; Date of order: 30th April, 2021 Articles 4 and 29 of India-UAE DTAA

The assessee being wholly managed and controlled from UAE, qualified for benefit under India-UAE DTTA – Limitation of benefit provision not applicable as it has been conducting bona fide business since years, long before start of India business

FACTS
The assessee was a tax resident of the UAE. Since 2000, it was engaged in business as a shipping agent and
also providing ship charters, freight forwarding, sea cargo services and so on. From March, 2015 it commenced shipping operations by chartering ships for use in transportation of goods and containers. Relying upon Article 8 of the India-UAE DTAA, the assessee claimed that freight earned by it from India was not taxable in India.

The A.O. denied benefit under the DTAA on the grounds that: (i) the assessee was a partnership in the UAE; (ii) it was controlled and managed by a Greek national (Mr. G) who was being paid 80% of profits; (iii) no evidence was brought on record to show either that there was any other manager or that Mr. G was in the UAE for a period exceeding 183 days and since Mr. G was a Greek national, the business was not managed or controlled wholly from the UAE; (iv) TRC was obtained based on misrepresentation of facts. Hence, invoking Article 29 of the India-UAE DTAA1, the A.O. concluded that the assessee was formed for the main purpose of tax avoidance and denied the DTAA benefit. The DRP upheld the order of the A.O.

Being aggrieved, the assessee appealed before the Tribunal.

HELD

  •  From a perusal of the license issued by the Department of Economic Development, the annual accounts, Memorandum of Association and Articles of Association, it was evident that the assessee was a company and not a partnership firm.

  •  The following facts showed that the assessee was controlled or managed from the UAE:

* The assessee had 14 expatriate employees who were issued work permits by the UAE Government for working with the assessee.
* Mr. G was in the UAE for 300 days during the relevant previous year. Hence, it was reasonable to assume that he was running the business from the UAE.
* Without prejudice, the presence of the main director will be material only if there is something to show that the business was not carried out from the UAE.
* The assessee was carrying on business since 2000 from its office in the UAE, while operations with Indian customers commenced much thereafter.
* The assessee had provided reasonable evidence to support the view that the business was wholly and mainly controlled from the UAE. The assessee cannot be asked to prove a negative fact, especially when such facts are warranted to be proved by the documents which the assessee is not required to maintain statutorily2.

  •  Considering the following reasons, it was not proper to invoke limitation of benefits under Article 29 of the India-UAE DTAA:

* The assessee was in business since 2000.
* While the assessee commenced shipping operations for transportation of goods and containers much later, in 2015, it cannot be said that the ‘main purpose of creation of such an entity was to obtain the benefits’ under the India-UAE DTAA.
* Article 29 cannot be invoked unless the purpose of creating the entity was to avail the India-UAE DTAA benefits.
* Even otherwise, the assessee was carrying on bona fide business activity.

Note: With effect from 1st April, 2020, Article 29 of the India-UAE DTAA is substituted with Paragraph 1 of Article 7 (PPT clause) of multilateral instrument (MLI).

__________________________________________________________
1    Article 29 provides for ‘Limitation of Benefits’. It reads as follows:
 ‘An entity which is a resident of a Contracting State shall not be entitled to the benefits of this Agreement if the main purpose or one of the main purposes of the creation of such entity was to obtain the benefits of this Agreement that would not be otherwise available. The cases of legal entities not having bona fide business activities shall be covered by this Article’

2    During assessment, the assessee did not provide Board minutes. It was represented that documents are not available and the UAE law does not mandate keeping Board of Directors’ Resolutions

In the absence of any incriminating and corroborative evidence, extrapolation of on-money received in one transaction cannot be done to the entire sales Addition u/s 68 in respect of unsecured loans cannot be made merely on the basis of statement of entry operators Only real income can be subject to tax – Addition cannot be made on the basis of notings in loose sheets which are not corroborated by any credible evidence

21 Mani Square Ltd. vs. Asst. CIT [2020] 83 ITR (T) 241 (Kol-Trib) A.Ys.: 2013-14 to 2017-18; Date of order:  6th August, 2020 Sections 132, 68, 5 and 145

In the absence of any incriminating and corroborative evidence, extrapolation of on-money received in one transaction cannot be done to the entire sales
Addition u/s 68 in respect of unsecured loans cannot be made merely on the basis of statement of entry operators
Only real income can be subject to tax – Addition cannot be made on the basis of notings in loose sheets which are not corroborated by any credible evidence

FACTS
1. The assessee was engaged in real estate development. A search action u/s 132 was undertaken on the assessee. Prior to this, a search action was undertaken on one of the buyers (an HUF) wherefrom certain documents were seized which suggested that the assessee had received on-monies for sale of the flat to that buyer. Based on those documents, the A.O. concluded that a certain percentage of the actual sale consideration for the flat and car parking was received in cash and was unaccounted. Thereafter, the A.O. extrapolated the on-money on the entire sales. The CIT(A) confirmed the addition in respect of the single flat sold to the HUF but deleted the balance addition in case of all other buyers on the ground that a singular instance cannot be extrapolated without evidence.

2. Addition was also made u/s 68 in respect of loans taken from parties allegedly linked to entry operators.

3. A further addition was made by the A.O. in respect of interest income receivable from a party. To put it briefly, in the course of the search at the assessee’s premises a document was recovered, containing notings which suggested a unilateral claim raised by the assessee against a third party. However, there was nothing in these documents which proved that the third party had ever accepted such claim of the appellant and nothing was brought on record by the A.O., too, to prove acceptance of the appellant’s claim by the third party. However, the A.O. made an addition on the basis of notings contained in the recovered document.

HELD
1. Addition u/s 68 on account of alleged on-money on sale of flats
The ITAT observed that the documents found in the course of third party search were loose sheets of paper which could not be construed as incriminating material qua the assessee. These documents neither contained the name of the assessee nor any mention of the assessee’s project, nor did it suggest that the seized document was prepared at the instance of the assessee and hence there was no mention of any cash payment to the assessee. No additions were made in the case of assessments of the parties, alleged to have given cash to the assessee, and hence addition was not warranted in the hands of the assessee, too.

In a subsequent search on the assessee’s premises, no corroborative material was found and in the absence of any incriminating material no addition was warranted. The extrapolation of unaccounted sales across all units sold by the assessee had no legs to stand on.

The A.O. had made an independent inquiry from each flat purchaser; however, he did not find any statement or material which could even suggest receipt of cash consideration not disclosed by the assessee. Therefore, based on legal as well as factual grounds, the ITAT upheld the CIT(A)’s decision to hold that the theory of extrapolation could not be applied on theoretical or hypothetical basis in the absence of any incriminating and corroborative evidence or material brought on record by the A.O.

2. Addition u/s 68 in respect of unsecured loans (from parties linked to entry operators)
The ITAT observed that, other than recording the statement of entry operators on oath, the A.O. had not shown any credible link between the person whose statement was relied upon and the company from whom loans were received by the assessee; the A.O. had neither personally nor independently examined even a single entry operator to verify the correctness of facts contained in the statement and to establish the link with the assessee if any, neither had he allowed the assessee to cross-examine the witnesses whose statements were extracted in the assessment order. The A.O. had also failed to objectively take into consideration the financial net worth of the creditors having regard to the facts and figures available in the audited accounts. Based on these grounds, the ITAT deleted the impugned additions.

3. Addition in respect of interest income
The ITAT held that the subject matter of tax under the Act can only be the ‘real income’ and not hypothetical or illusory income. The two methods recognised in section 145 only prescribe the rules as to when entries can be made in the assessee’s books but not the principles of time of ‘revenue recognition’. The same has to be judged with reference to the totality of the facts and surrounding circumstances of each case. Hence, the overall conduct of the third party and the fact that it has till date not made any payment whatsoever to the assessee indicates that notings on loose papers did not represent ‘real’ income accrued to the assessee and was rightly not offered to tax. The ITAT, accordingly, held that the alleged interest income was not taxable.

Evidence of data transmission and export of software by an assessee outside India is not a requirement to claim deduction u/s 10AA RBI approval for bank account maintained outside India not a requirement to be fulfilled to claim deduction u/s 10AA No requirement of maintaining separate books of accounts for various STPI / SEZ units if the primary books of accounts maintained by assessee are sufficient to compute profits of various STPI / SEZ units

20 IBM (India) Pvt. Ltd. vs. Asst. CIT [2020] 83 ITR(T) 24 (Bang-Trib) A.Y.: 2013-14; Date of order: 31st July, 2020 Section 10AA

Evidence of data transmission and export of software by an assessee outside India is not a requirement to claim deduction u/s 10AA

RBI approval for bank account maintained outside India not a requirement to be fulfilled to claim deduction u/s 10AA
No requirement of maintaining separate books of accounts for various STPI / SEZ units if the primary books of accounts maintained by assessee are sufficient to compute profits of various STPI / SEZ units

FACTS

The assessee company was engaged in the business of trading, leasing and financing of computer hardware, maintenance of computer equipment and export of software services to associated enterprises. It filed its return of income after claiming exemption u/s 10AA. However, the A.O. and the Dispute Resolution Panel denied the said exemption on various grounds which inter alia included the following:
a) There was no evidence of data transmission and export of software by the assessee outside India.
b) The assessee had not obtained RBI approval for the bank account maintained by it outside India with regard to export earnings.
c) Unit-wise P&L account of assessee did not reflect true and correct profits of its SEZ units.

Aggrieved by the above action, the assessee filed an appeal before the ITAT.

HELD


With regard to the objection that there was no evidence of data transmission and export of software by the assessee outside India, the ITAT held that declaration forms submitted before the Software Technology Park of India (STPI) or Special Economic Zone authority were sufficient evidence of data transmission / export of software. Further, it was held that for the purpose of claiming exemption u/s 10AA, such an objection did not have any relevance. Accordingly, this objection was rejected.

Another objection of the Revenue was that since the assessee was crediting export proceeds in a foreign bank account which was not approved by the RBI, therefore exemption could not be granted. The ITAT held that approval of the RBI was required only in order to claim benefit of Explanation 2 to section 10A(3) according to which export proceeds would be deemed to have been received in India if the same were credited to such RBI-approved foreign bank account within the stipulated time. It was held that even though the assessee cannot not avail exemption based on Explanation 2 to section 10A(3), but it could not be denied exemption under the main provision of section 10A(3) which only requires the export proceeds to be brought to India in convertible foreign exchange within the time stipulated in the said section. Accordingly, if the export proceeds were brought to India (even though from the non-approved foreign bank account) within the stipulated time period in convertible foreign exchange, then the exemption as per the main provision of section 10A(3) could not be denied.

As for the objection that the unit-wise profit & loss account of the assessee did not reflect the true and correct profits of its SEZ units and hence exemption u/s 10AA could not be granted, the ITAT held that there was no requirement of maintaining separate books of accounts for various STPI / SEZ units if the primary books of accounts maintained by the assessee are sufficient to compute the profits of various STPI / SEZ units. It was held that since Revenue had not disputed the sale proceeds claimed by the assessee against each STPI / SEZ unit, it could be said that bifurcations of profits of various STPI / SEZ units as given by the assesse were correct. Reliance was also placed on CBDT Circular No. 01/2013 dated 17th January, 2013 which clarifies that there is no requirement in law to maintain separate books of accounts and the same cannot be insisted upon by Revenue.

Capital gain – Investment in residential house – The date relevant for determining the purchase of property is the date on which full consideration is paid and possession is taken

19 ACIT vs. Mohan Prabhakar Bhide ITA No. 1043/Mum/2019 A.Y.: 2015-16; Date of order: 3rd March, 2021 Section 54F

Capital gain – Investment in residential house – The date relevant for determining the purchase of property is the date on which full consideration is paid and possession is taken

FACTS

The assessee filed his return of income claiming a deduction of Rs. 2,38,30,244 u/s 54F. The A.O., in the course of assessment proceedings, noted that the assessee had advanced a sum of Rs. 1,00,00,000 for purchase of new house property on 20th April, 2012, whereas the sale agreement for five commercial properties sold by the assessee was made in 2014 and 2015.

The A.O. held that the investment in question should have been made within one year before the sale of property or two years after the sale of property. Since this condition was not satisfied, he disallowed the claim for deduction of Rs. 2,38,30,244 made u/s 54F.

Aggrieved, the assessee preferred an appeal to the CIT(A) who noted that the date of agreement for purchase of the new residential house was 22nd July, 2015 and the assessee had taken possession of the new residential house on 22nd July, 2015; both these dates were within two years from the date of transfer. Relying on the decision in CIT vs. Smt. Beena K. Jain [(1996) 217 ITR 363 (Bom)], he allowed the appeal filed by the assessee.

Aggrieved, Revenue preferred an appeal to the Tribunal.

HELD


The Tribunal noted that the issue in appeal is squarely covered by the decision of the Bombay High Court in CIT vs. Smt. Beena K. Jain (Supra). The Tribunal held that the date relevant for determining the purchase of property is the date on which full consideration is paid and possession is taken. It observed that there is no dispute that this date is 22nd July, 2015 which falls within a period of two years from the date on which the related property was sold. However, the A.O. had proceeded to adopt the date on which the initial payment of Rs. 1,00,00,000 was made. The Tribunal held that the approach so adopted by the A.O. was ex facie incorrect and contrary to the law laid down by the jurisdictional High Court in the case of Beena K. Jain (Supra).

Penalty – Search case – Specified previous year – Addition made by taking the average gross profit rate cannot be considered to be assessee’s undisclosed income for the purpose of imposition of penalty u/s 271AAA

18 Ace Steel Fab (P) Ltd. vs. DCIT TS-311-ITAT-2021 (Del) A.Y.: 2010-11; Date of order: 12th April, 2021 Section 271AAA

Penalty – Search case – Specified previous year – Addition made by taking the average gross profit rate cannot be considered to be assessee’s undisclosed income for the purpose of imposition of penalty u/s 271AAA

FACTS

In the course of a search operation u/s 132(1), the value of stock inventory on that particular day was found to be lower than the value of stock as per the books of accounts. The A.O. concluded that the assessee made sales out of the books. He called upon the assessee to show cause why an addition of Rs. 15,53,119 be not made by taking a gross profit rate of 4.6% on the difference of stock of Rs. 3,13,12,889. In response, the assessee submitted that the discrepancy in stock was only due to failure of the accounting software. The A.O. did not accept this contention and made an addition of Rs. 11,52,314. The quantum appeal, filed by the assessee to the CIT(A), was dismissed.

The A.O. imposed a penalty u/s 271AAA which was confirmed by the CIT(A).

Aggrieved by the order of the CIT(A) confirming the imposition of penalty u/s 271AAA, the assessee preferred an appeal to the Tribunal.

HELD


The Tribunal noted that the question for its consideration is whether an addition made by taking the average gross profit rate can be considered to be the assessee’s undisclosed income for the purpose of imposition of penalty u/s 271AAA.

Although the A.O. had not accepted the contention of the assessee that the discrepancy in stock was due to malfunctioning of the ERP software, the assessee had demonstrated with evidence that due to malfunction of the software the accounts could not be completed in time and the assessee had had to approach the Company Law Board with a petition to extend the date for adoption of audited accounts. The petition of the assessee was accepted and the offence was compounded. The Tribunal held that the assessee had a reasonable explanation for the discrepancy found in stock and due credence should have been given to this explanation. It cannot be said that the assessee had no explanation to offer regarding the difference in stock. It also noted that penalty has been imposed only on an ad hoc addition made based on average gross profit rate and does not relate directly to any undisclosed income unearthed during the course of the search. In such a situation, penalty u/s 271AAA was not sustainable, hence the Tribunal set aside the order passed by the CIT(A) and deleted the impugned penalty.

Limited Scrutiny – Revision – Order passed in a limited scrutiny cannot be revised on an issue which was not to be taken up in limited scrutiny – Action of A.O. in not examining an issue which was not to be taken up in limited scrutiny cannot be termed as erroneous

17 Spotlight Vanijya Ltd. vs. PCITTS-310-ITAT-2021 (Kol) A.Y.: 2015-16; Date of order: 9th April, 2021 Sections 143(3), 263

Limited Scrutiny – Revision – Order passed in a limited scrutiny cannot be revised on an issue which was not to be taken up in limited scrutiny – Action of A.O. in not examining an issue which was not to be taken up in limited scrutiny cannot be termed as erroneous

FACTS
In the present case, for the assessment year under consideration the assessee’s case was taken up for limited scrutiny under CASS and a notice u/s 143(2) was issued. Limited scrutiny was taken up for the following three reasons, viz.,
i) income from heads other than business / profession mismatch;
ii) sales turnover mismatch;
iii) investments in unlisted equities.

The A.O., after going through the submissions of the assessee, completed the assessment u/s 143(3), assessing the total income of the assessee to be Rs. 91,95,770 under normal provisions and Rs. 94,94,533 u/s 115JB.

Upon completion of the assessment, the PCIT issued a show cause notice (SCN) u/s 263 wherein he expressed his desire to interfere and revise the assessment order passed by the A.O. on the ground that a deduction of Rs. 10,02,198 has been claimed in respect of flats in Mumbai for which rental income of only Rs. 4,20,000 is offered under the head ‘Income from House Property’ and a standard deduction of Rs. 1,80,000 has been claimed.

The assessee, in response to the SCN, objected to the invocation of revisional jurisdiction on the ground that insurance premium was not one of the three items on which the case was selected for limited scrutiny. It was further stated that the insurance premium for flats is only Rs. 2,198 which has been added back while computing income under the head ‘Profits & Gains of Business or Profession’. The balance amount of Rs. 10,00,000 was premium for Keyman Insurance policy which is allowable as a deduction u/s 37. Consequently, the assessment order was not erroneous or prejudicial to the interest of the Revenue.

Aggrieved, the assessee preferred an appeal to the Tribunal.

HELD


The A.O.’s action of not looking into the issue of insurance premium (Keyman policy) cannot be termed as erroneous as such omission is in consonance with the dictum of CBDT on the subject, viz., CBDT Instruction No. 2/2014 dated 26th September, 2014, which directs the field officers to confine their inquiries strictly to CASS reasons and they were not permitted to make inquiries in respect of issues for which a case was not selected for limited scrutiny. Therefore, the order passed by the A.O. cannot be termed as erroneous and prejudicial to the interest of the Revenue and consequently the PCIT could not have invoked revisional jurisdiction.

The Tribunal held that the impugned action of the PCIT is akin to doing indirectly what the A.O. could not have done directly. It said the very initiation of jurisdiction by issuing an SCN itself is bad in law and, therefore, quashed the SCN issued by the PCIT. For this, the Tribunal relied upon the decisions in
i) Sanjib Kumar Khemka [ITA No. 1361/Kol/2016, A.Y. 2011-12, order dated 2nd June, 2017]; and
ii) Chengmari Tea Co. Ltd. [ITA No. 812/Kol/2019, A.Y. 2014-15, order dated 31st January, 2020].

Consequently, all further actions / proceedings, including the impugned order of the PCIT, were held to be non est in the eyes of the law.

Income from Other Sources – Interest on enhanced compensation for acquisition of agricultural land is a capital receipt not chargeable to tax u/s 56(2)(viii) r.w.s. 57(iv)

16 Nariender Kumar vs. ITO TS-298-ITAT-2021 (Del) A.Y.: 2014-15; Date of order: 12th April, 2021 Section 56(2)(viii) r.w.s. 57(iv)

Income from Other Sources – Interest on enhanced compensation for acquisition of agricultural land is a capital receipt not chargeable to tax u/s 56(2)(viii) r.w.s. 57(iv)

FACTS

The assessee filed his return of income for A.Y. 2014-15 declaring a total income of Rs. 12,250 and agricultural income of Rs. 3,50,000. During the previous year relevant to the assessment year under consideration, he had received Rs. 1.42 crores as enhanced compensation on land acquisition which included compensation of Rs. 56.90 lakhs and interest of Rs. 85.32 lakhs. The A.O. made an addition of Rs. 42.66 lakhs being 50% of interest of Rs. 85.32 lakhs u/s 56(2)(viii) r.w.s. 57(iv).

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 capital receipt, unless specifically taxable u/s 45 under the head Capital Gains, in principle is outside the scope of income chargeable to tax and cannot be taxed as income unless it is in the nature of revenue receipt or is specifically brought within the ambit of income by way of a specific provision of the Act. Interest received on compensation to the assessee is nothing but a capital receipt.

The Tribunal observed that:
(i) The CIT(A) has not given a finding as to why the A.O. is justified in making the addition;
(ii) The Apex Court in Union of India vs. Hari Singh (Civil Appeal No. 15041/2017, order dated 15th September, 2017) has held that on agricultural land no tax is payable when the compensation / enhanced compensation is received by the assessee;
(iii) The assessee received compensation in respect of his agricultural land which was acquired by the State Government;
(iv) The ratio of the decision of the Apex Court in the case of Hari Singh (Supra) is applicable to the present case.

The Tribunal held the addition to be against the law.

AUDIT: BUILDING PUBLIC TRUST

The spotlight has been sharply focused in the recent past on corporate failures and consequential loss of public trust. Various regulators and authorities, such as the Ministry of Corporate Affairs, the National Financial Reporting Authority, the Reserve Bank of India, SEBI’s Committee on Corporate Governance and Committees of the Institute of Chartered Accountants of India, have advised several measures with a clear focus on enhancing audit quality and improving the standards of corporate governance. In that context, this article traces various enablers relevant to audit quality.

ASSESS THE ECOSYSTEM

Audit framework and bridging the expectation gap on the role of an auditor
It is important to articulate what stakeholders should legitimately expect from the audit profession. This should be translated into an appropriate audit framework: should auditors merely opine in a limited manner on management’s financial statements, or should they go further and, if so, how far and which way? This will allow a course to be charted where the audit profession becomes a part of the national solution. It can contribute to fixing, maintaining and raising the standards of audit quality, as necessary, rather than being stigmatised as ‘guilty until proven innocent’.

The environment in which public company audits are conducted has changed drastically for several reasons, including increased business complexities, use of technology and intricate local and global regulations. However, the primary objective of an audit has remained the same over time, i.e., to provide stakeholders with a reasonable, though not absolute, assurance that the financial statements prepared by the management are fairly presented. The current audit framework continues to be based on the concept of watchdog and not bloodhound. However, the auditors’ responsibilities are continuously increasing and the expectation gap continues to remain unaddressed in terms of setting up or awareness of standards, and a level of audit outcome that is understood and acceptable to all concerned.

For creating trust, there is a need to educate the stakeholders, too. Some of the initiatives that may help bridge the gap include: (i) review of framework by the ICAI and mandatory inclusion of elements of technology and periodic forensic reviews, and auditors’ reporting thereon, (ii) disclosure of Audit Quality Indicators of an audit firm, (iii) a wider message that not every ‘business failure’ means that there was an ‘audit failure’, and (iv) an active platform between ICAI / auditors and various regulators to provide clarity in case of large-scale conflicts.

Enhanced role and accountability of audit committee

An audit committee, as a representative of the wider group of stakeholders, and not the management, is the client of the auditor. The audit committee should lead discussions around capability evaluation and, accordingly, decide on the appointment of auditors. In order to ensure transparency, disclosures to stakeholders may include detailed criteria for evaluation, selection and competitive analysis. The audit committee should monitor the auditor’s performance to ensure that auditors maintain professional scepticism, challenge management and deliver high quality audits. The audit committee should affirmatively confirm to the board periodically that the audit is adequately resourced, independent to undertake a quality audit, with commensurate fees.

Capacity-building and encouraging creation of large audit firms

There is a strong need to develop a forward-looking approach towards the growth of the audit profession in India. There is a need for larger and consolidated audit firms, with adequate skills, capacity, size and reach to deal with large corporations and conglomerates. The current capacity of audit firms in India is fragmented, with individual practitioners making the bulk and a minuscule number of large firms. It is important to encourage consolidation of the existing landscape of small and medium-sized firms. The current business / economic scenario and rapidly evolving technology in the country demand multiple skillsets for any business or regulatory propositions. Audit is not restricted to simple accounting and certainly needs support from specialised professionals skilled in the fields of law, taxation, information technology, forensics, cyber security and secretarial services. Given the environment, there is a strong need to encourage networking and consolidation. Multi-disciplinary firms, as already acknowledged by the Companies Act, 2013, will contribute immensely in this direction. Clarity of networking regulations for chartered accountants, including with overseas accounting firms, would also help in achieving this objective.

Centre of Excellence for Audit Quality

The creation of a Centre of Excellence for Audit Quality, with an objective to develop standards and parameters of audit quality, technology, tools, consistency of methodology and training to teach the highest levels of professional scepticism, would help in creating awareness and enhancing skills. The main objectives of the Centre could be to:

  • encourage and support capacity-building
  •  create opportunities to network and share best practices and views among firms
  •  enhance audit quality through use of technology, especially to provide better insights to stakeholders
  • knowledge dissemination to professionals on key matters
  •  contribute to harness talent and build relevant skills
  •  drive inclusive and balanced growth across the country
  •  enhance excellence in the audit profession.

Use of tools and technology in audits

The situation created by Covid-19 has established that technology can play a crucial role in any audit. The audit profession needs to evolve and respond to similar challenges by upskilling and adopting technology / tools and artificial intelligence in the audit process. Data & Analytics may play a significant role in achieving a higher satisfaction level in audits. In the current situation, even virtual audits may be as effective as traditional techniques. No doubt one has to be cautious, as would be the case in any technology-driven process. This also requires a shift in mindset to adopt technology and facilitate the process through extensive training programmes for practitioners.

There are two essential components for adopting technology in the audit process, viz., a Smart Audit Platform and a Data Analytics Tool. A Smart Audit Platform contains (i) an audit workflow; (ii) audit methodology, based on the regulatory framework; and (iii) document management system. A Data Analytics Tool helps in moving away from a limited sample testing to covering a larger population in many fields. Overall, this approach supports data extraction using scripts; smart analytics using the Tool; and exception reporting using visualisation techniques which helps assessing the existence / effectiveness of controls. To make it a success, we require a multi-disciplinary approach to invest in resources and related technology.

Auditor’s independence and conflict management

It is always presumed that any large-scale audit failure is due to the lack of independence of the auditors. While this may be true in certain cases, there may be a strong perception in many others. The existing statutory restrictions, comparable with international standards, are well established in this area. The new Code of Ethics issued by the ICAI is aligned to the International Code of Ethics issued by the IESBA. These, along with self-regulated safeguards exercised by auditors, monitoring by audit committees and enhanced disclosures required by SEBI should generally suffice to ensure independence.

Certain reforms and a strong monitoring mechanism to implement them would help in enhancing governance. For example, SEC requires every non-audit relationship with an audit client to be pre-approved by the audit committee. Further, instead of varying interpretations by stakeholders and regulators, clarity from the MCA on terms like Management Services would be appropriate. Any ambiguities in this area may be clarified by the ICAI through the Code of Ethics and Networking Guidelines. Certain regulators globally (such as PCAOB and SEC in the USA) have a process of regular interaction with the auditors / corporates. They do provide an opportunity to the auditors and corporates to objectively consult and provide guidance / solutions in case of issues of independence and professional conflicts. This consultative process is not only efficient and objective, it also creates an atmosphere of trust between the auditors and the regulators. It would be fruitful to have a similar arrangement here, instead of creating conflicting interpretations and prolonged legal resolution.

Strengthening whistle-blower mechanism

A strong whistle-blower mechanism with strong legal protection goes a long way in keeping a check on potential unethical and corrupt practices. Several corporate frauds have been unearthed based on a good whistle-blower mechanism.

Increasing the role, responsibility, independence and accountability of internal auditors
An internal audit function provides much needed assurance on the effectiveness and reliability of internal controls and governance in any company. The internal audit team is uniquely positioned to provide early warning signals of impending failures. The recent reinstatement in CARO requiring an auditor to evaluate the internal audit system of a company is a step in the right direction. Audit committees should be responsible to ensure that the function is robust, independent and adequately resourced, with the scope of the work sufficient to provide the desired level of assurance. Internal auditors’ scope should move away from a transactional approach to substantive matters like design and operating effectiveness of critical controls.

DEEP DIVE IN CRITICAL AREAS

Recent experiences indicate certain critical aspects that require a deep dive and critical evaluation by the auditors. There is no alternative to the diligence and continuous scepticism of an auditor. An auditor is expected to consider and evaluate the economic substance of transactions while carrying out an audit.

Accountability and extent of reliance placed on others and management representations
While discharging their duties, auditors must critically evaluate the extent of reliance they intend to place on various elements, e.g., Regulatory Oversight (such as inspections carried out by Banking or Market Regulators), Specialists (such as Valuation or Information Technology Experts), Joint and Component auditors, Credit Rating agencies and Internal Auditors. Auditors are obligated to assess and critically evaluate such evidence before placing reliance on them.

Further, while a written representation from the management may provide audit evidence, it may not be ‘sufficient appropriate audit evidence’ on its own. Unwillingness to provide underlying evidence, replaced by a management representation, may be treated as a red flag and auditors would need to exercise scepticism in such cases. Accordingly, auditors must evaluate a management representation critically and obtain sufficient and appropriate underlying evidence. While ICAI’s existing guidance deals with the matter, ICAI may consider issuing case studies to clarify situations and showcase that accepting a management representation is not an alternative to appropriate audit procedures.

Related party transactions
It is the responsibility of a company’s management to identify and ensure an appropriate mechanism for related party transactions. However, this has been a matter of concern and governance in many ways. There are enhanced reporting requirements in the recently amended CARO also, which support an objective and deeper evaluation of related party transactions.

In this context, there have been instances of (i) incorrect / incomplete identification of related parties, (ii) lack of economic substance in related party transactions, and (iii) consequent inadequate or lopsided disclosures. Irrespective of these anomalies, such transactions may meet the regulatory and disclosure requirements.

Audit committees and auditors are well equipped to address the root cause. For example, (i) auditors have an obligation to exercise a high degree of scepticism and challenge the management on the economic substance of a related party transaction; (ii) auditors of a component in a group must have visibility of transactions with the group companies; (iii) the audit committees should affirmatively confirm to the Board on identification and adequate evaluation of such transactions; and (iv) related party transactions should mandatorily be included in the scope covered by internal auditors’ review.

Going concern
The appropriateness of going concern assumption in any audit is a fundamental principle. This forms the foundation for any stakeholder to place reliance on a company before making any decisions. There is a responsibility on a company’s management to assess its position and on the auditors to challenge and obtain appropriate evidence to support the same. There have been instances where the auditors failed to assess and report such situations and companies failed soon thereafter. This may be attributable to several reasons, including lack of transparency, or inadequate skills to assess. Specific situations like Covid-19 continue to pose additional challenges, creating responsibility on the auditors to maintain an appropriate level of scepticism.

There are certain measures that may help address these concerns, e.g., (i) auditors are supposed to challenge management assumptions of future projections, to avoid fatal errors and consequent sudden downfall of a company; (ii) in case auditors do not have expertise to validate future assumptions, sector experts, as specialists in audit process, must be involved to address the issue; and (iii) composition and skills of independent directors and the audit committee to understand the business and challenge management.

All this would involve a cost and skill-set worth investing in.

Third party complaints / whistle-blow mechanism
While the prime responsibility of addressing whistle-blower complaints is of the management, for auditors such complaints may lead to additional information, critical to assess any assertion in the financial statement audit. Even if such complaints are anonymous, it would not be wise for an auditor to ignore them without logical conclusions. The recent amendment in CARO, requiring an auditor to consider whistle-blow complaints, is a step in the right direction.

Documentation of audit evidence
While appropriate audit diligence is essential, an auditor’s work cannot be demonstrated without adequate documentation of evidence. Each audit essentially requires a logical sequence of work papers, demonstrating the work carried out at each stage of an audit. These may primarily include audit eligibility / independence requirements, acceptance of audit engagement, adequacy of planning and timing of proposed audit steps, team composition and appropriate delegation of work according to skills, control and substantive testing procedures to obtain sufficient / appropriate evidence, evaluation of work of any experts or component auditors involved, legal consultations, recording of audit observations and their resolutions, communications with those charged with governance, minutes of meetings with management, engagement with quality control review steps, supervisory controls including accountability and review of work done, management confirmations / representations and final opinion.

The framework clearly recognises that ‘if the work has not been documented, it has not been done’. At the same time, excessive expectation, focusing merely on audit documentation, could have an adverse effect where auditors may focus more on gathering documentary evidence than exercising professional scepticism given the limited time available. A balanced approach in this regard is necessary.

ENABLERS, CONDUCIVE ENVIRONMENT AND ROLE OF REGULATORS


A constructive role of a regulator, with the focus on remediation instead of disproportionate punishment and prolonged litigation, is important. The regulatory regime should provide greater confidence through effective policy measures. The recent move to decriminalise certain offences will help create the basis for consultation and a compromise and settlement approach. In a profession with scattered capacity, undertaking rapid investigation and constructive resolution, including commensurate punitive measures and remediation, will encourage audit quality. Certainly, there is a need to distinguish between criminality and professional negligence. In addition, clarity on the role, jurisdiction and multiplicity of regulators needs re-evaluation.

There have been significant efforts by the Government in the past few years to assess the adequacy of the current Regulatory Framework and clarify overlaps or areas of needed coordination among the regulators. A few such examples are (i) Recommendation by the MCA’s Committee of Experts, pursuant to the Supreme Court’s order; (ii) Consultation Paper by the MCA to look at critical areas relating to auditors and auditor independence; and (iii) Formation of the National Financial Reporting Authority (NFRA) as a new audit regulator. These activities demonstrate much-needed regulatory attention. There is a need to implement some of the measures recommended and that have been awaited since long.

In substance, a few initiatives will help establish trust between the regulators and the auditors, e.g., (i) a balanced approach towards time-bound penal action proportionate to the offence and / or negotiated settlements so that deterrence may be accomplished with minimal disruption; (ii) coordination amongst various regulators governing the auditors to provide uniform guidance and to avoid multiplicity and overlap; (iii) implementation of well-deliberated recommendations of committees formed in the past; and (iv) time-bound clarity and guidance on matters of interpretation or conflicts.

While there are no alternatives to the professional scepticism and diligence of an auditor to ensure audit quality, an overall ecosystem and a constructive role of the regulators are essential enablers in that direction.

(The views expressed here are the personal views of the author)

UNFAIRNESS AND THE INDIAN TAX SYSTEM

In a conflict between law and equity, it is the law which prevails as per the Latin maxim dura lex sed lex, meaning ‘the law is hard, but it is the law’. Equity can only supplement law, it cannot supplant or override it. However, in CIT vs. J.H. Gotla (1985) 156 ITR 323 SC, it is held that an attempt should be made to see whether these two can meet. In the realm of taxes, the tax collector always has an upper hand. When this upper hand is used to convey ‘heads I win, tails you lose’, the taxpayer has to suffer this one-upmanship till all taxpayers collectively voice their grievance loud and clear and the same is heard and acted upon. In this article, the authors would be throwing light on certain unfair provisions of the Income-tax Act.

Case 1: Differential valuation in Rule 11UA for unquoted equity shares, section 56(2)(x)(c) vs. section 56(2)(viib); section 56(2)(x)(c) read with Rule 11UA(1)(c)(b)

Section 56(2)(x)(c) provides for taxation under ‘income from other sources’ (IFOS), where a person receives, in any previous year, any property, other than immovable property, without consideration or for inadequate consideration. ‘Property’, as per Explanation to section 56(2)(x) read with Explanation (d) to section 56(2)(vii), includes ‘shares and securities’.

Section 56(2)(x)(c)(A) provides that where a person receives any property, other than immovable property without consideration, the aggregate Fair Market Value (FMV) of which exceeds Rs. 50,000, the aggregate FMV of such property shall be chargeable to tax as IFOS. Section 56(2)(x)(c)(B) provides that where a person receives any property, other than immovable property, for consideration which is less than the aggregate FMV of the property by an amount exceeding Rs. 50,000, the aggregate FMV of such property as exceeds such consideration shall be chargeable to tax.

The FMV of a property, as per the Explanation to section 56(2)(x) read with Explanation (b) to section 56(2)(vii) means the value determined in accordance with a prescribed method.

Rule 11UA(1)(c)(b) provides for determination of FMV of unquoted equity shares. Under this Rule, the book value of all the assets (other than jewellery, artistic work, shares, securities and immovable property) in the balance sheet is taken into consideration. In case of the assets mentioned within brackets, the following values are considered:
a) Jewellery and artistic work – Price which it would fetch if sold in the open market (OMV) on the basis of a valuation report obtained from a registered valuer;
b) Shares and securities – FMV as determined under Rule 11UA;
c) Immovable property – Stamp Duty Value (SDV) adopted or assessed or assessable by any authority of the Government.

SECTION 56(2)(viib) READ WITH RULE 11UA(2)(a)

Section 56(2)(viib) provides for taxation of excess of aggregate consideration received by certain companies from residents over the FMV of shares issued by it, when such consideration exceeds the face value of such shares [angel tax].

Explanation (a) to the said section provides that the FMV of shares shall be a value that is the higher of the value
a) As determined in accordance with the prescribed method; or
b) As substantiated by the company to the satisfaction of the Assessing Officer based on the value of its assets, including intangible assets.

Rule 11UA(2)(a) provides for the manner of computation of the FMV on the basis of the book value of assets less the book value of liabilities.

DISPARITY BETWEEN RULES 11UA(1)(c)(b) AND 11UA(2)(a)

Section 56(2)(x)(c) deals with taxability in case of receipt of movable property for no consideration or inadequate consideration. Thus, the higher the FMV of the property, the higher would be the income taxable u/s 56(2)(x). Hence, Rule 11UA(1)(c)(b) takes into consideration the book value, or the OMV or FMV or SDV, depending on the nature of the asset.

Section 56(2)(viib) brings to tax the delta between the actual consideration received for issue of shares and the FMV. Therefore, the lower the FMV, the higher would be the delta and hence the higher would be the income taxable under the said section. Rule 11UA(2) provides for the determination of the FMV on the basis of the book value of assets and liabilities irrespective of the nature of the same.

One may note the disparity between the two Rules in the valuation of unquoted shares. Valuation for section 56(2)(x)(c) adopts FMV or OMV, so that higher income is charged to tax thereunder. Valuation for section 56(2)(viib) adopts only book value so that a higher delta would emerge to recover higher angel tax.

The levy of angel tax is itself arbitrary, because such tax is levied even if the share issue has passed the trinity of tests, i.e., genuineness, identity and creditworthiness of section 68. No Government can invite investment as it wields this nasty weapon of angel tax. Adding salt to the wound, the NAV of unlisted equity shares is determined by insisting on adopting the book value of the assets irrespective of their real worth.

It is time the Government takes a bold move and drops section 56(2)(viib). Any mischief which the Government seeks to remedy may be addressed by more efficiently exercising the powers under sections 68 to 69C. In the meanwhile, the aforesaid disparity in the valuation should be immediately removed by executive action.

Case 2: Indirect transfer – Rule 11UB(8)
Explanation 5 to section 9(1)(i) provides that an asset or a capital asset being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be, and shall always be deemed to have been, situated in India if the share or interest derives, directly or indirectly, its value substantially from the assets located in India (underlying asset).

Explanation 6(a) to section 9(1)(i) provides that the share or interest, referred to in Explanation 5, shall be deemed to derive its value substantially from the assets (whether tangible or intangible) located in India if, on the specified date, the value of such assets
a) Exceeds Rs. 10 crores; and
b) Represents at least 50% of the value of all the assets owned by the company or entity, as the case may be.

Explanation 6(b) to section 9(1)(i) provides that the value of an asset shall be its FMV on the specified date without reduction of liabilities, if any, determined in the manner as prescribed.

Rule 11UB provides the manner of determination of the FMV of an asset for the purposes of section 9(1)(i). Sub-rules (1) to (4) of Rule 11UB provide for the valuation of an asset located in India, being a share of an Indian company or interest in a partnership firm or association of persons.

Rule 11UB(8) provides that for determining the FMV of any asset located in India, being a share of an Indian company or interest in a partnership firm or association of persons, all the assets and business operations of the said company or partnership firm or association of persons are taken into account irrespective of whether the assets or business operations are located in India or outside India. Thus, even though some assets or business operations are not located in India, their value would be taken into account, thereby resulting in a higher FMV of the underlying asset in India and hence a higher chance of attracting Explanation 5 to section 9(1)(i).

This is contrary to the scheme of section 9(1)(i) read with Explanation 5 which seeks to tax income from indirect transfer of underlying assets in India. Explanation 5 codifies the economic concept of location of the asset. Such being the case, Rule 11UB(8) which mandates valuation of the Indian asset ignoring the downstream overseas investments by the Indian entity, is ultra vires of Explanation 5. It offends the very economic concept embedded in Explanation 5.

Take the case of a foreign company [FC], holding shares in an investment company in India [IC] which has step-down operating subsidiaries located outside India [SOS]. It is necessary to determine the situs of the shares of the FC in terms of Explanation 5.

Applying Explanation 6, the value of the shares of IC needs to be determined to see whether the same would exceed Rs. 10 crores and whether its proportion in the total assets of FC exceeds 50%.

Shares in FC derive their value not only from assets in India [shares of IC] but also from assets outside India [shares of the SOS]. However, Rule 11UB(8) mandates that while valuing the shares of the IC, the value of the shares of the SOS cannot be excluded. It seeks to ignore the fact that the shares of IC directly derive their value from the shares of the SOS, and thus the shares of FC indirectly derive their value from the shares of the SOS. This is unfair inasmuch as it goes beyond the scope of Explanation 5 and seeks to tax gains which have no economic nexus with India.

This is a classic case of executive overreach. By tweaking the rule, it is sought to bring to tax the gains which may have no nexus with India, whether territorial or economic. It is beyond the jurisdiction of the taxman to levy tax on gains on the transfer of the shares of a foreign company which derive their value indirectly from the assets located outside India.

Taxation of indirect transfer invariably results in double taxation. Mitigation of such double taxation is subject to the niceties associated with complex FTC rules. Such being the case, it is unfortunate that the scope of taxation of indirect transfer is extended by executive overreach. Before this unfair and illegal action is challenged, it would be good for the Government to suo motu recall the same.

MLI SERIES ANTI-TAX AVOIDANCE MEASURES FOR CAPITAL GAINS: ARTICLE 9 OF MLI

(This is the third article in the MLI series that started in April, 2021)

This article in the on-going series on the Multilateral Instrument (MLI) focuses on Article 9 of the MLI, which brings in anti-tax avoidance measures related to capital gains earned by sale of immovable property through indirect means.

A break-up of the various DTAAs signed by India, whether or not modified by the MLI, appears later in this article along with what a Chartered Accountant needs to keep in mind in the post-MLI scenario. However, the first requirement is to understand the provisions and what changes have been brought about by them. Owing to a multitude of options and different ways in which they can apply, the language of Article 9 of the MLI is quite difficult to decipher, leave alone explain. Therefore, we have attempted to simplify the provisions with the help of a story, a narrative that can provide a basic understanding about the concepts. The reader should refer to the respective DTAAs and the application of the MLI on those DTAAs before forming any opinion.

1. ‘The Story’
Mr. A is a wealthy Australian businessman with interests in real estate around the world, including India. He wants to sell shares in an Australian Company and therefore approaches his tax consultant, Mr. Smart, to get an opinion on his tax liabilities. Here is the transcript of a conversation between Mr. A and Mr. Smart:

Mr. A – Hi, did you calculate my taxes on the sale of shares?

Mr. Smart – Yes, I did. And for your information, we also have to pay tax in India.

Mr. A – Why in India? This company is incorporated in Australia. What does India have to do with it?
Mr. Smart – Well, you’re right. Capital gains on transfer of shares of a company are generally taxed in the country of its incorporation which in this case is Australia. However, your company’s value is majorly derived from that immovable property you had once purchased in India1. Therefore, as per the Indian tax laws, read with Article 13(4) of the India-Australia Treaty, India has a right to tax such shares. Let me read out the excerpt of the India-Australia Treaty…

Article 13(4) reads: ‘Income or gains derived from the alienation of shares or comparable interests in a company, the assets of which consist wholly or principally of real property referred to in Article 6 and, as provided in that Article, situated in one of the Contracting States, may be taxed in that State’.

Mr. A – Ah! Though I know that I will get credit for those taxes paid against my Australian taxes, but I do not want the hassle of paying tax in another country. Is there any way out? You said that the company should derive value wholly or principally from the immovable property. Could we plan in a manner that we contribute other assets, shortly before the sale of the shares, to overcome this? That would dilute the proportion of the value of the shares that is derived from immovable property situated in India. For example, if my company has a total asset size of AUD 100, which currently includes AUD 90 of immovable property in India, the gain on the sale of such company’s shares would be taxable in India. However, just before such sale, can I infuse AUD 100 in the company and park it in a fixed deposit? Then, the share of immovable property in my company’s value will be reduced to 45% and the transaction of such sale of shares would be taxed only in the state of incorporation of the company (Australia) and not in the state where the immovable property is situated (India).

Mr. Smart – Where the businessman leads, the taxman follows! Well, this planning might have worked if you would have come to me before 1st April, 2020. Knowing that many taxpayers plan their affairs in such a manner, the India-Australia Treaty has to be read along with the Multilateral Instrument which now reads as follows:

The following paragraph 1 of Article 9 of the MLI
applies to paragraph 4 of Article 13 of this agreement:

ARTICLE 9 OF THE MLI – CAPITAL GAINS FROM ALIENATION OF SHARES
OR INTERESTS OF ENTITIES DERIVING THEIR VALUE PRINCIPALLY FROM IMMOVABLE
PROPERTY

Paragraph 4 of Article 13 of the agreement:

(a)

shall apply if the relevant value threshold is met at any time during
the 365 days preceding the alienation; and

(b)

shall apply to shares or comparable interests, such as
interests in a partnership or trust (to the extent that such shares or
interests are not already covered), in addition to any shares or rights
already covered by the provisions of the agreement

______________________________________________________________
1 Readers are requested to place FEMA issues aside for this story

As per clause (a), keeping money in a fixed deposit or any other asset for a short period of time would not work. If at any point of time during the preceding 365 days (period threshold), your company majorly derives value (proportion threshold) from immovable property situated in India, then the sales of shares would be taxable in India (source country).

Mr. A – Oh! Oh! They have plugged this loophole. I also see that in clause (b) comparable interest has been added. Does that mean that even if I hold immovable property in LLP, partnership firms, trust or any other similar forms, selling of those shares would also be under the ambit of India’s (source country) taxation?

Mr. Smart – You catch up really fast! Yes, that’s the case.
Mr. A – But how did this treaty change so quickly? Normally, treaty negotiations continue for decades. And till the time the taxman decides on taxing rights, technology and the way of doing business have already moved ahead.
Mr. Smart – It seems you don’t really catch up fast enough. You missed a small word in our conversation. I said that the treaty has to be read with the MLI, i.e., Multilateral Instrument, which has been signed by many countries [contracting jurisdictions (‘CJ’)] to prevent double non-taxation, or treaty abuse, or treaty-shopping arrangements. This way, instead of long bilateral negotiations, treaties could quickly be adapted to changes.
Mr. A – That’s interesting, so now all the signatory countries would have similar treaties. Things would become so simple in cross-border trade. Isn’t it?
Mr. Smart – I wish I could say that. See, this MLI is like a holy book. Every time you read it, you get a new perspective, or a new interpretation in technical terms. It is not that all the countries subscribe to one treaty, there are multiple options to choose from.
Mr. A – Options?
 
Mr. Smart – Let me explain. Imagine a dinner party which serves a lavish buffet. Not every guest is expected to talk to or sit with everyone. Only if there is mutual consent between two or more guests may they sit together. Even when they are sitting together, not all of them are expected to eat the same food. Everyone can pick their choices and only by mutual consent can they eat the same food together.

The same is true with MLI. You have various options on the menu. Whenever a country notifies that MLI should be applied to its treaty with another country, it is only if the other country reciprocates equivocally would their treaty be read with MLI (sit together). Similarly, even when the countries have decided that the treaty position will change, they still have options to not change all clauses and selectively they can choose and pick their options (eat together the same food).

Mr. A – Ok, that sounds delicious. What kind of options the countries have in case of such transaction of shares having underlying immovable property in another country?

Mr. Smart – You really want to understand that! This will take some time.
Mr. A – I am all ears. Go on
.
Mr. Smart – So any of the two countries who are MLI signatories have two broad options to choose from. Either to be governed by Article 9(1) or by Article 9(4). While article 9(4) prescribes the period threshold at a standard 50%, Article 9(1) allows countries to decide the relevant threshold or even usage of more general terms such as ‘the principal part’, ‘the greater part’, ‘mainly’, ‘wholly’, ‘principally’, ‘primarily’, etc.

Further, Article 9(1) provides a choice for inclusion / exclusion of the comparable interest condition [vide para 6(c)], whereas Article 9(4) makes comparable interest an integral and inseparable part of it. A country can select Article 9(4) or Article 9(1), but both cannot exist at the same time as they are alternatives to each other.

The Articles read as follows:
Article 9(1)
‘Provisions of a Covered Tax Agreement providing that gains derived by a resident of a Contracting Jurisdiction from the alienation of shares or other rights of participation in an entity may be taxed in the other Contracting Jurisdiction provided that these shares or rights derived more than a certain part of their value from immovable property (real property) situated in that other Contracting Jurisdiction (or provided that more than a certain part of the property of the entity consists of such immovable property (real property):

a. shall apply if the relevant value threshold is met at any time during the 365 days preceding the alienation; and
b. shall apply to shares or comparable interests, such as interests in a partnership or trust (to the extent that such shares or interests are not already covered) in addition to any shares or rights already covered by the provisions.’

Article 9(4)
‘For purposes of a Covered Tax Agreement, gains derived by a resident of a Contracting Jurisdiction from the alienation of shares or comparable interests, such as interests in a partnership or trust, may be taxed in the other Contracting Jurisdiction if, at any time during the 365 days preceding the alienation these shares or comparable interests derived more than 50 per cent of their value directly or indirectly from immovable property (real property) situated in that other Contracting Jurisdiction.’

Mr. A – So only two options to choose from. That is not so complex.

 
Mr. Smart – You jumped the gun. I wish it was that simple. A country may reserve the right for provisions of the MLI to not apply to its tax treaties in their entirety or a subset of its tax treaties, i.e., it may choose not to have dinner with all or a select group of other guests. Further, once the countries have chosen to be governed by Article 9, both the countries may decide on the following options:

1. Where both countries choose to apply the 365-day period threshold coupled with value threshold at a standard 50% under Article 9(4), then in such a case the more flexible option for anti-tax avoidance tests under Article 9(1) would not apply. [Article 9(8)]

2. However, even after choosing to apply Article 9(4) as above, a country may choose not to apply Article 9(4) to treaties with certain select countries. [Article 9(6)(f)] In that case, nothing changes for treaties with these countries and the treaty reads as it was pre-MLI.

3. Where no such reservation is made as per the above option, Article 9(4) applies. However, the countries need to choose which exact provision does Article 9(4) apply to in their existing Covered Tax Agreements. [Article 9(8)] If the other country also cites the same provision, then the language of the existing provision between treaties of both countries changes as per Article 9(4).

4. In the case where the same provision is not notified by the other country, even then Article 9(4) applies – as the countries have already agreed to apply it as per point No. 1 above. But in such a case, the wording of Article 9(4) would supersede the existing provisions of the Covered Tax Agreement to the extent it is incompatible with the present text of the Agreement. Thus, for example, if the Covered Tax Agreement at present cites a period threshold of only 60 days, as both countries have accepted to apply article 9(4), but not notified the same provision, the 365-day threshold will supersede the 60-day threshold.

5. Now, consider a situation where the countries notify that they do not want to apply the more flexible options under Article 9(1) to their treaties; and have also chosen not to apply the provision as per Article 9(4) – then in such a case there will be no change at all in their treaty language due to the provisions of Article 9 of the MLI. [Article 9(6)(a)] In essence, the anti-tax avoidance tests would not be part of the treaty.

6. Even where a country has chosen to apply Article 9(1), it can make a choice of applying only one of the anti-tax avoidance mechanisms, i.e., either the time threshold test or the comparable interest condition; or both. [Para 9(6)(b) to (e)] The other country can also make a similar choice and only the matching choices will get implemented. Thus, where a country chooses to apply both mechanisms, but the other country chooses to apply only the time threshold test, then only the time threshold test gets matched.

7. To the extent the choices made in respect of either or both of the mechanisms matches between both countries, the countries next need to specify which provision under their Covered Tax Agreement stands modified. [Article 9(7)] If the provision specified by both countries does not match, then the treaty language stands unchanged. Thus, even after choices have been made as per Article 9(6), such choices would apply only if the same provisions are earmarked by both countries for applying the changes.

So, as I said earlier, it is like even if the countries decide to sit at one dinner table, they can still reserve their right to not eat certain food items from the menu.

Mr. A – Gosh! That’s one dinner party I don’t want to be invited to. That’s too much to take in one day. As many of my friends the world over have properties in India, can you send me a note on the application of Article 9 with respect to India?

Mr. Smart – Sure, will do that. Have a nice day.
Mr. A – You, too, and keep reading ‘Multi-Level Inception’ (MLI). It’s really as thrilling and confusing as any of Christopher Nolan’s movies and in the end all people may have their own different opinions!
Mr. Smart – Ha, ha! Yes, it is!

2. Article 9 in the Indian?context
As can be seen from the above write-up, Article 9 has various permutations and combinations spelt out to deal with the tax avoidance schemes it seeks to target. Their relevance with respect to Indian treaties is as under:
* India has opted to apply Article 9(4). So where other Contracting Jurisdictions have also made such a notification, Article 9(4) will apply.
* In treaties, where a provision similar to Article 9(1) is already present, India has opted for application?of Article?9(1).
* The Indian position as on 30th?March, 2021 has been tabulated for ease of reference. Please do check the updated position while applying the same in practice.?Currently, India has DTAAs with 95 countries / territories and their position post-MLI is as under:

Conditions

Countries covered

No. of countries

No change in the existing
provision of the treaty due to MLI

Countries not signatories to MLI

Bangladesh, Belarus, Bhutan, Botswana, Brazil, Ethiopia, Kyrgyz
Republic, Libya, Mongolia, Montenegro, Mozambique, Myanmar, Namibia, Nepal,
Philippines, Sri Lanka, Sudan, Syrian Arab Republic, Taipei, Tajikistan,
Tanzania, Thailand, Trinidad and Tobago, Turkmenistan, Uganda, USA,
Uzbekistan, Vietnam, Zambia

29

Countries which have no CTA with India

China, Germany, Hong Kong, Mauritius, Oman, Switzerland

6

Where both the CJs didn’t agree upon the application of the
provision either by reservation or by notification

Albania, Austria, Cyprus, Czech Republic, Finland, Georgia,
Greece, Hungary, Iceland, Jordan, Latvia, Lithuania, Luxembourg, Malaysia,
Norway, Qatar, Saudi Arabia, Singapore, South Korea, Sweden, United Arab
Emirates, United Kingdom

22

Existing provision changed
due to MLI

Treaties where Article 9(4) is applied

Croatia, Denmark, Estonia, France, Indonesia, Ireland, Israel,
Kazakhstan, New Zealand, Poland, Portuguese Republic, Serbia, Slovak
Republic,

16

[Continued]

 

– which have similar provision to Article 13(4) – either
replaced or supersede the existing provision

Slovenia, Ukraine, Oriental Republic of Uruguay

 

Treaties where Article 9(4) is applied – which don’t have
similar provision to Article 13(4) – additional provision added

Canada, Japan, Malta, Russia, UAR (Egypt)

5

Treaties where Article 9(1) applied (both comparable interest
and testing period applied)

Australia,?Netherlands

2

Treaties where only comparable interest condition applied from
Article 9(1)

Belgium

1

Treaties whose conditions of
MLI are provisional

Not yet deposited ratified MLI instruments

Armenia, Bulgaria, Columbia, Fiji, Italy, Kenya, Kuwait,
Macedonia, Mexico, Morocco, Romania, South Africa, Spain, Turkey

14

Total

95

3. Applicability to transactions
Finally, what are the points to be taken care of by a Chartered Accountant while reviewing the application of Article 9 of the MLI to specific transactions? These are as under:

a. Review of transaction – Check whether foreign company’s shares derive value from Indian immovable property? If yes, then the transaction falls in the scope of this Article.
b. Review of respective DTAA – Check whether India’s DTAA with country of residence has various thresholds for attribution of taxation rights of such shares in India. If yes, whether the transaction meets the threshold?
c. Review of MLI – Check whether the country of residence has notified the application of Article 9. If yes, then apply the provisions as per the matching principle explained above. Synthesised text2, if available, could be used for ease of interpretation.

4. Authors’ remarks
1) A country-specific example (that of Australia) has been taken here to make the article practical and easy to understand. Specific country positions need to be understood for in-depth analysis.
2) Definition ambiguity: Immovable property is not defined by the DTAA and by MLI only additional description provided as real property; therefore, one needs to see the definition of immovable property / real property from domestic law.
3) Article 9(6) has given various combinations of reservations to the countries, thereby providing flexibility but also leading to complexity when applying the provision.
4) MLI’s position qua India indicates that most Contracting Jurisdictions have opted out of this Article, thereby choosing to stick to the existing position.
5) A Chartered Accountant while issuing a certificate u/s 195 on the payment made by a buyer, needs to consider the Act, DTAA and MLI in combination before considering the final tax liability.

CONCLUSION

As can be seen from the above, applying a simple anti-tax avoidance measure like Article 9 of the MLI becomes complex when it is sought to be made at one go through the MLI. A professional applying the provisions must bear in mind the intricacies and read the treaty correctly before going ahead with a transaction which involves Article 9 of the MLI.

______________________________________________________________
2 https://incometaxindia.gov.in/Pages/international-taxation/dtaa.aspx – select
DTAA Type as Synthesised text

CARO 2020 SERIES: NEW CLAUSES AND MODIFICATIONS PROPERTY, PLANT AND EQUIPMENT & INTANGIBLE ASSETS

“CARO 2020 is applicable for the statutory
audit of financial statements for periods beginning on or after 1st
April, 2021. ICAI had issued a detailed Guidance Note (GN) on the same
in June, 2020. A module is also available on the ICAI Digital Learning
Hub. Schedule III was also recently amended inter alia to align the
reporting requirements under CARO 2020 by statutory auditors. BCAJ is
pleased to bring you a clause-by-clause analysis via a series of
articles authored by four audit practitioners who have been auditors all
their lives. Each article will zoom into a clause or two and provide a
‘commentary’ on reporting issues and practices, views, and perspectives
to supplement the broad guidance covered by the GN. The purpose of this
series is to bring out practical nuances to the reader. The series will
cover only new clauses and modifications and exclude those already
covered by CARO 2016. We hope this will steer and support the readers
towards better understanding and reporting. – Editor”

MODIFICATIONS / ADDITIONAL REPORTING REQUIREMENTS

The
clause on reporting in respect of fixed assets has been there in the
earlier versions, too. CARO 2020 has modified parts of the first clause
and added reporting requirements as given below:

Modifications
a. Change in the terminology to Property, Plant and Equipment (PPE) in line with Accounting Standards and Schedule III.

b. Separate reporting requirement on maintenance of proper records for Intangible Assets.
c.
No reporting required for non-availability of title deeds, where the
company is a lessee and the lease agreement is executed in favour of the
company.
d. In
cases where title deeds of immovable properties are not held in the
name of the company, additional details in a prescribed format as under
are required to be given:

Description of the property

Gross
carrying value

Held in
the name of

Whether
promoter, director, their relative or employee

Period
held –
indicate range where
appropriate

Reason
for not being held in the name of the company

(also
indicate if in dispute)


Additional reporting

a.
Whether the company has revalued its PPE (including Right of Use Assets)
or intangible assets or both during the year and, if so –
  •  whether the revaluation is based on valuation by a Registered Valuer, and
  •  if change is 10% or more in the aggregate of the net carrying value of each class of PPE or intangible assets.

b. Whether any proceedings have been initiated or are pending against the company for holding any benami property under the Benami Transactions (Prohibition) Act, 1988 and rules made thereunder; and if so, whether the company has appropriately disclosed the details in its financial statements.

SPECIFIC CONSIDERATIONS

Specific considerations to be kept in mind whilst reporting on the above changes are discussed under the following broad heads:

Additional disclosures under amended Schedule III

While reporting on these matters, the auditor will have to keep in mind the amended Schedule III disclosures as under:
a.
The auditor will have to ensure that there is no material inconsistency
between the financial statement disclosures and his reporting under the
Order. Disclosure of changes in the aggregate net carrying value due to revaluation of each class of PPE and Intangible Assets by 10% or more in the aggregate and whether revaluation is based on the valuation by a Registered Valuer as defined in Rule 2 of the Companies (Registered Valuer and Valuation) Rules, 2017.

b. The information as specified earlier in respect of title deeds of Immovable Properties not held in the name of the company, except that the
disclosure should be given in the aggregate for the following line
items in the Balance Sheet, separately for Land and Building, as against the description of each individual property as per the Order:

 

  •  PPE
  •  Investment property
  •  PPE retired from active use and held for sale, non-current assets held for sale (Ind AS entities)
  •  Others

As disclosures under Schedule III are along the lines required to be given, it is imperative for the auditor to reconcile the information disclosed therein for completeness and accuracy.

c. In respect of proceedings initiated or pending in respect of benami property held, the following details are required to be disclosed:

i. Details of such property, including year of acquisition,
ii. Amount thereof,
iii. Details of beneficiaries,
iv. If held in the books, reference thereof to the item in the Balance Sheet,
v. If not held in the books, then the facts along with reasons thereof,
vi.
Where there are proceedings against the company as an abettor of the
transaction or as the transferor, details thereof shall be provided,
vii. Nature of proceedings, status thereof and company’s view of the same.

Practical challenges in reporting
The reporting requirements outlined above entail certain challenges which are discussed below:

a. In respect of properties owned jointly with others where the title deeds are not held in the name of the company, the above details are required to the extent of the company’s share.

b.
Similarly, if the company has changed its name, this will require
reporting under this clause till the new name is updated in the title
deed.

c. Identification of benami properties: The reporting on proceedings in respect of benami properties may pose challenges, especially if the properties are not reflected in the books.
In such cases, apart from the normal procedures like review of the
minutes, scrutiny of legal expenses, review of minutes of board of
directors, audit committee, risk management committee, other secretarial
records, listing of all pending litigations and also obtaining
management representation (which have been referred to in the Guidance
Note). The auditor may also obtain independent confirmation from the legal counsel as to whether any such proceedings, other than those in respect of properties reflected in the books are pending, as per SA 501 – Audit Evidence – Specific Considerations for Selected Items.

d. The reporting under this clause is required only in cases where proceedings are initiated or pending against the company as ‘benamidar’
and not otherwise. Hence, even if notice is received but no proceedings
have been initiated, reporting is not warranted. The reporting is
required by the auditor of the company holding any benami property but not as an auditor of the company which is the beneficial owner.

e. Compilation of data for Intangible Assets: Since the requirement for reporting on maintenance of records for intangible assets has been newly introduced, many companies may not have a proper inventory thereof, except the details of the payments made or expenses capitalised on an individual basis. This could pose challenges to prepare a comprehensive itemised listing of all intangible assets and reconciling the same with the books. It is imperative that in such cases a one-time exercise is undertaken
to reconstruct the records and the nature of documentary evidence like
licences, agreements, internal SOPs (for internally generated
intangibles) which is available is also specified. This would also
facilitate easy identification in future. Wherever required, an
appropriate management representation should be obtained regarding the completeness of the data.

f. Awareness of the legal requirements: There
are certain situations where the auditor would have to familiarise
himself with the legal requirements. These mainly pertain to the
following:

i. The provisions of the Benami Property Transactions Act, 1988 and the related Rules.
Though relevant extracts of current regulations are given in the ICAI
Guidance Note, the auditor will have to keep abreast with the changes
therein, if any.

ii. Identifying the list of promoters of the company and their relatives:
Promoter and Relative have not been defined under the Order. However,
amended Schedule III (for disclosures related to holder of title deeds)
states that both ‘Promoter’ and ‘Relative’ will be as defined under the Companies Act, 2013.
Though a few promoters could be traced to those named in the prospectus
or identified in the annual return, the auditor will have to rely on
secretarial and other records and / or management representation to
determine those who have control over affairs of the company directly or
indirectly, whether as a director or shareholder or otherwise, or in
accordance with whose advice, directions, or instructions the Board is
accustomed to act and can be considered as promoters. In case there is
no such party, even then a specific representation should be obtained.

iii.
Ascertaining whether the requirements under the Trade Mark, Copyright,
Patents, Designs and IT Acts as well as the licensing requirements under
telecom, aviation, pharma and other similar industries have been
complied with in respect of the Intangible Assets.

iv. Being aware of the laws dealing with registration of immovable properties, including those pertaining to specific states.

In case of doubt, the auditor should seek the views of the company’s legal counsel or their own expert. This will be in line with SA 500 – Audit Evidence regarding using the Managements’ Expert
(by assessing the complexity, materiality, risk, independence,
competence, capability and objectivity, amongst other matters) and SA
620 – Using the Work of an Auditors’ Expert (by assessing the
complexity, materiality, risk, adherence to quality procedures,
competence, capability and objectivity, amongst other matters),
respectively. In either case, the requirements of SA 250 – Consideration
of Laws and Regulations in an Audit of Financial Statements should be
complied with.

g. Business combinations and acquisitions: The following matters need to be considered in case of such situations:

i.
In case a company has acquired another entity and the same is merged in
terms of an approved scheme, immovable properties of the transferee
company are considered deemed to be transferred in the name of the
acquiring company. However, till the time the acquiring company complies
with local / state-specific procedures, including payment of stamp
duty, etc., it would not be actually transferred in the name of the
acquiring company and, hence, would require factual reporting.

ii. In case of business combination as per Ind AS 103, where the acquiring company has identified intangible assets acquired as
a part of the transaction, the nature, and basis, whether or not the
same is in the books of the transferor needs to be evaluated and
recorded. Further, for intangible assets recorded on consolidated
financial statements, though there is no requirement for reporting by
the auditor, as the Order is only applicable on standalone financial
statements, it would be a good practice for the company to separately
list them in the intangible asset register.

h. Revaluation:
As per the ICAI Guidance Note, this clause is applicable only to the
entity which adopts the revaluation model. Hence, fair valuation of PPE
on first-time adoption, acquisition of assets / business on slump sale
basis or under business combination, change in ROU asset due to lease
modification as per Ind AS 116, re-measurement due to changes in foreign
exchange rates, etc., will not require reporting under this clause.
Further, impairment of PPE accounted under cost model is outside the
purview of reporting.

In case an entity adopts the revaluation model for PPE and Intangible Assets, there could be two scenarios as under:

i. Valuation by an external valuer:
In such cases, the fact should be indicated and the auditor should
check the necessary documentation as to whether he is registered under
Rule 2 of the Valuation Rules specified earlier. In such cases, the
auditor needs to ensure that the management ensured that the principles
laid down in Ind AS 113 on Fair Valuation are adhered to by the valuer.
The auditor should keep in mind the requirements under SA 500 – Audit
Evidence regarding using the Managements’ Expert, indicated earlier.
ii. Internal valuation: The
Order does not seem to mandate that a company needs to get a valuation
done by an external valuer. In such cases, the auditor will have to
exercise a greater degree of professional scepticism and review
the basis and assumptions for arriving at the revised fair value keeping
in mind the requirements of Ind  AS 113 as indicated earlier,
irrespective of the accounting framework. The requirements under SA 540 –
Auditing Accounting Estimates, Including Fair Value Accounting
Estimates and Related Disclosures (covering the extent of use of market
specific inputs and their relevance, assessment of comparable
transactions, basis and justification of unobservable inputs, amongst
others) also need to be kept in mind. In case of any doubt, the auditor should seek the assistance of their own valuation expert keeping in mind the requirements under SA 620 – Using the Work of an Auditors’ Expert, discussed earlier.

CONCLUSION

The
above changes have cast onerous responsibilities on the auditors and in
many cases the auditors would need to go beyond what is stated in the
Order because the devil lies in the details!

REGULATORY SCEPTICISM

The Reserve Bank of India (RBI) issued a Circular on 27th April, 2021. Its aim was to improve audit quality, strengthen independence and accountability. Considering the short timeline for implementation and the rigour of the guidelines, it appears that the RBI regarded these matters as critical. Therefore, the degree of urgency is justified by the necessity.

These guidelines seem to carry the scars of the IL&FS, Yes Bank, DHFL and other failures. Failures in the banking and financial services sector (BFS) need to be distinguished from other business failures. BFS functions like the veins and arteries in the human body and many institutions are the edifice on which other sectors stand. A few pillars crumbling or blockages in arteries could have an overarching spiral effect.

Audit Quality is ‘sterilised’ by Independence and gets ‘infected’ by conflicts of interest. Just as a doctor or a hospital cannot have ‘interest’ in a pharmaceutical company and a judge cannot be a partner at a law firm that litigates in the court, by the same token impaired independence weakens the objectivity of a professional. The central bank seems to have become mindful of this root cause.

Considering the above, a more stringent test for BFS in terms of number of years of appointment, number of entities that can be audited, the cooling-off period, mandatory joint audits, inclusion of NBFCs and the bar on services to group entities is only an expected response by the regulator.

The RBI has raised the bar through these guidelines by not allowing non-audit services one year prior to and after the appointment and even imposed a bar on conducting any audit/non-audit engagements with ‘group’ entities. Covering NBFCs of a certain size within the ambit of the above guidance is also a noteworthy step.

Some reports in the public domain have equated auditor eligibility norms with prescriptions of the Companies Act, 2013 and the Code of Ethics. A trade body wrote that the principles stated by the RBI are sector-agnostic and therefore must be aligned. One would think that regulations (which are practices, unlike principles) have to be dependent on context. In this case, it is hard to disregard the nature and function of BFS and the scale, spread and shock of recent failures. A concerned regulator will therefore raise the bar in display of its ‘regulatory scepticism’ about auditors. Mandatory joint audits also seem to arise from the same thought process.

Taking NBFCs into the fold is a step worth examining. The NBFCs are part of the nervous system of BFS. The IL&FS collapse and AQR findings by NFRA must have been ringing in the regulator’s mind till today. I would infer that this move is to firm up a more comprehensive monitoring of the entire BFS by the central bank.

The uproar from some circles routed through trade bodies is understandable. A ban on services to group entities and ‘take over’ of NBFCs’ auditor appointments by the RBI will have adverse commercial consequences for current incumbents. A sudden disqualification of auditors and the additional burden of fresh appointments at a short notice will be tough, but surely not impossible. Some clarifications are also wanting from RBI.

For systemically important entities, a heightened level of regulation seems necessary. The concern about this entire matter must have caused the insistent exigency in the central banker’s action. RBI is one of the finest regulators – tough, erudite and not infiltrated by vested interests. One can be reasonably sure about RBI having done its homework before rolling out these changes.

 
Raman Jokhakar
Editor

PLEDGE

In the Mahabharat and the Purans, there are many strange but interesting stories. They have some great messages for us because there is very deep thought behind them.

In the Mahabharat war, the Kauravs and Pandavs were in their respective camps one evening. In those days, there were ethics even in wars and they were strictly observed. Battles were fought only between sunrise and sunset. In the evening, there used to be friendly interaction. Even the enemies used to inquire about each other’s health, give condolences for the loss of lives and so on. Not only that, the Pandavs used to go to the Kauravs’ mother Gandhari to seek her blessings by offering ‘Namaskaar’ or ‘Pranaam’ to her and other elders. Such was their culture. There used to be strict ‘cease fire’ in the evening.

However, one evening, quite surprisingly and all of a sudden, an arrow came from the Kauravs’ camp and brushed by Yudhishthir’s ear. Everybody was shocked. Yudhishthir, taken by surprise, said to Arjun, ‘Paarth, how can you remain quiet? Didn’t you see what happened? How can you tolerate it? It means your “Gandeeva” (Arjun’s special bow) is useless!’

Arjuna got furious on hearing this and said to Yudhishthir, ‘I will kill you!’

There was a stunned silence. Arjuna continued, ‘I have taken a pledge that I will kill whosoever insults my “Gandeeva” bow!’ Everyone was taken aback and wondered how the war would proceed without Yudhishthir.

But Shrikrishna came forward and advised Arjun: ‘Paarth, I ask you to curse Yudhishthir, using bad and insulting words.’

Confusion worst confounded! Shrikrishna continued, ‘Using bad words and insulting the Gurus or elderly persons is just like killing them.’

Arjun did accordingly. Everybody thought that the matter was over. But again, Arjun stood up and said, ‘Now, I will have to kill myself.’ The confusion was at its peak.

‘Why?’ everyone asked.

‘Because, I have also taken another pledge – that I will kill any person who insults my beloved elder brother Yudhishthir. I am myself that culprit. So, I need to kill myself.’

Shrikrishna, as usual, had a solution. He stepped forward to salvage the situation and advised Arjun, ‘Paarth, you praise yourself in front of all of us since self-admiration and boasting is nothing but killing oneself!’

Let us all offer our ‘Namaskaar’ to such rich thoughts.

Words are powerful. Words carry deep meaning for those who utter them and also for those to whom they are addressed.

Vachana comes from Vac, the very root of all syllables that is pure consciousness. Therefore, respect for words, upholding promises, choosing the right words become critical for a society to thrive and flourish. India, unfortunately, has the lowest ranking when it comes to upholding contracts today when actually the entire society, rule of law and commerce, everything works on commitment to one’s pledge, to one’s word.  

Charitable purpose – Sections 2(15) and 12AA of ITA, 1961 – Registration – Cancellation of registration – Condition precedent – The assessee is hit by proviso to section 2(15) is not a ground for cancellation of registration

22. Goa Industrial Development Corporation vs. CIT [2020] 421 ITR 676 (Bom.) [2020] 116 taxmann.com 42 (Bom.) Date of order: 4th February, 2020

 

Charitable purpose – Sections 2(15) and 12AA of ITA, 1961 – Registration
– Cancellation of registration – Condition precedent – The assessee is hit by proviso
to section 2(15) is not a ground for cancellation of registration

 

The appellant is a statutory corporation established under the Goa,
Daman and Diu Industrial Development Corporation Act, 1965 (GIDC Act) with the
object of securing orderly establishment in industrial areas and industrial
estates and industries so that it results in the rapid and orderly
establishment, growth and development of industries in Goa. The appellant was
granted registration u/s 12A of the Income-tax Act, 1961 on 16th
December, 1983 and the same continued until the making of the impugned orders
in these appeals. By an order dated 27th December, 2011, the
Commissioner of Income-tax withdrew the registration granted to the appellant
by observing that it is crystal clear that the activities of the appellant are
inter-connected and inter-woven with commerce or business. The Commissioner of
Income- tax has based its decision almost entirely on the proviso to
section 2(15) of the Income-tax Act which defines ‘charitable purpose’. This proviso
was introduced with effect from 1st April, 2009.

 

The Tribunal dismissed the appeal filed by the assessee.

 

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

‘i)    The cancellation of registration has to be
initiated strictly in accordance with the provisions u/s 12AA(3) of the
Income-tax Act, 1961. The power of cancellation of registration can be
exercised by the Commissioner where the Commissioner is satisfied that the
activities of the trust or institution are not genuine or are not being carried
out in accordance with the objects of the trust or institution, as the case may
be. The powers u/s 12AA(3) cannot be exercised merely because the institution
in question may be covered under the proviso to section 2(15) after the
amendment, or that the income limit specified in the proviso is
exceeded.

 

ii)    There were no categorical
findings that the activities of the assessee were not genuine or were not in
accordance with the objects of the trust or the institution. Merely because, by
reference to the amended provisions in section 2(15), it may be possible to
contend that the activities of the assessee were covered under the proviso,
that, by itself, did not render the activities of the assessee as non-genuine
activities so as to entitle the Commissioner to exercise powers u/s 12AA(3).
The cancellation of registration was not valid.’

 

Cash credits (Bogus purchases) – Section 68 of ITA, 1961 – Assessee had declared certain purchases to be made during year and A.O. added entire quantum of purchases to income of assessee on plea that purchases were bogus purchases – Tribunal held that only reasonable profit at rate of 5% on purchases should be added back to income of assessee – Tribunal was justified in its view; A.Y.: 2010-11

21. Principal CIT vs. Rishabhdev Technocable Ltd. [2020] 115 taxmann.com 333 (Bom.) Date of order: 10th February, 2020 A.Y.: 2010-11

 

Cash credits (Bogus purchases) – Section 68 of ITA, 1961 – Assessee had
declared certain purchases to be made during year and A.O. added entire quantum
of purchases to income of assessee on plea that purchases were bogus purchases
– Tribunal held that only reasonable profit at rate of 5% on purchases should
be added back to income of assessee – Tribunal was justified in its view; A.Y.:
2010-11

 

The assessee is a company engaged in the business of manufacturing and
dealership of all kinds of industrial power controlling instrument cables and
related items. For the A.Y. 2010-11, the assessee filed return of income
declaring income of Rs. 1,35,31,757. The A.O. noticed that the Sales Tax
Department, Government of Maharashtra, had provided a list of persons who had
indulged in the unscrupulous act of providing bogus hawala entries and
purchase bills. The names of beneficiaries were also provided. The A.O. also
noticed that the assessee was one of the beneficiaries of such bogus hawala
bills. He referred to the purchases allegedly made by the assessee through four
hawala entries for the assessment year under consideration. He
disallowed the entire expenditure shown as incurred by the assessee on
purchases and made the addition.

 

The CIT(A) enhanced the quantum of such purchases from Rs. 24,18,06,385
to Rs. 65,65,30,470. The CIT(A) held that there can be no sales without
purchases. When the sales were accepted, then the corresponding purchases could
not be disallowed. Therefore, the CIT(A) held that only the profit element
embedded in the purchases would be subject to tax and not the entire purchase
amount. The CIT(A) added 2% of the purchase amount of Rs. 65,65,30,470 as
profit which worked out to Rs. 1,31,30,609 to the income of the assessee and
the balance addition was deleted. On appeal by the Revenue, the Tribunal
increased the profit element from 2% to 5% and increased the addition
accordingly.

 

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

 

‘i)     In Bholanath Polyfab
(P.) Ltd. (Supra), the Gujarat High Court was also confronted with a
similar issue. In that case the Tribunal was of the opinion that the purchases
might have been made from bogus parties but the purchases themselves were not
bogus. Considering the facts of the situation, the Tribunal was of the opinion
that not the entire amount of purchases but the profit margin embedded in such
amount would be subjected to tax. The Gujarat High Court upheld the finding of
the Tribunal. It was held that whether the purchases were bogus or whether the
parties from whom such purchases were allegedly made were bogus, was
essentially a question of fact. When the Tribunal had concluded that the
assessee did make the purchase, as a natural corollary not the entire amount
covered by such purchase but the profit element embedded therein would be
subject to tax.

 

ii)     We are in respectful
agreement with the view expressed by the Gujarat High Court.

 

iii)    Thus, we do not find any
merit in this appeal. No substantial question of law arises from the order
passed by the Tribunal. Consequently, the appeal is dismissed.’

Business expenditure – Allowability of (prior period expenses) – Section 37 of ITA, 1961 – Assessee had prior period income and prior period expenses – Assessee set off the two and offered only net amount of expenses for disallowance – A.O. disallowed the claim – Tribunal allowed the claim – No substantial question of law arose from Tribunal’s order; A.Y.: 2004-05

20. Principal CIT vs. Mazagon Dock Ltd. [2020] 116 taxmann.com 325 (Bom.) Date of order: 20th August, 2019 A.Y.: 2004-05

 

Business expenditure – Allowability of (prior period expenses) – Section
37 of ITA, 1961 – Assessee had prior period income and prior period expenses –
Assessee set off the two and offered only net amount of expenses for
disallowance – A.O. disallowed the claim – Tribunal allowed the claim – No
substantial question of law arose from Tribunal’s order; A.Y.: 2004-05

 

The assessee had prior period income and prior period expenses. The
assessee had set off the two and offered only the net amount of expenses for
disallowance. The A.O. did not accept the method of setting off of prior period
income with prior period expenses as claimed by the assessee and disallowed the
expenditure.

 

The Tribunal held that the assessee was justified in computing the
disallowance after setting off prior period income against the prior period
expenses. In fact, the Tribunal noted the fact that for the A.Y. 2007-08, the
Revenue had accepted the net income offered after set-off of prior period
income with prior period expenses. This is in that year where expenses of prior
period were less than prior period income. The Tribunal allowed the assessee’s
claim.

 

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

 

‘Whether on the facts and in the circumstances of the case and in law,
the Tribunal is correct in allowing the setting off of the prior period income
against the prior period expenditure without ascertaining the nexus between
income and expenditure?’

 

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

 

‘i)    We find that the view taken
by the Tribunal on the facts cannot be found fault with. This particularly as
the Revenue for a subsequent period accepted this practice of set-off, which
resulted in income and subjected it to tax. The basis / principles for allowing
the set-off of prior period income with prior period expenses has to be consistent
for years. Therefore, the view taken by the Tribunal cannot be faulted.

 

ii)    In view of the above, the
question as framed does not give rise to any substantial question of law. Thus,
not entertained.’

 

Business expenditure – Section 37 of ITA, 1961 – General principles – Difference between ascertained and contingent liability – Public sector undertaking – Provision for revision of pay by government committee – Liability not contingent – Provision deductible u/s 37 Income – Accrual of income – Principle of real income – Public sector undertaking – Amounts due as fees – Amounts included in accounts in accordance with directions of Comptroller and Auditor-General – Amounts had not accrued – Not assessable; A.Y.: 2007-08

19. Housing and Urban Development Corporation Ltd. vs.
Additional CIT [2020] 421 ITR 599 (Del. [2020] 115 taxmann.com 166 (Del.) Date of order: 6th February, 2020 A.Y.: 2007-08

 

Business expenditure – Section 37 of ITA, 1961 – General principles –
Difference between ascertained and contingent liability – Public sector
undertaking – Provision for revision of pay by government committee – Liability
not contingent – Provision deductible u/s 37

 

Income – Accrual of income – Principle of real income – Public sector
undertaking – Amounts due as fees – Amounts included in accounts in accordance
with directions of Comptroller and Auditor-General – Amounts had not accrued –
Not assessable; A.Y.: 2007-08

 

The assessee was a public sector undertaking. For the A.Y. 2007-08, it
claimed deduction of Rs. 1.60 crores on account of the provision for revision
of pay in its books of accounts. The deduction was made in the light of the Pay
Revision Committee appointed by the Government of India. The A.O. disallowed
the claim, holding that the expenditure was purely a provision against an
unascertained liability and could not be claimed as expenditure for the A.Y.
2007-08. The disallowance was upheld by the Tribunal.

 

The assessee was following the accrual or mercantile system of
accounting and was accounting the ‘fees’ as its revenue from the date of
signing of the loan agreement. The amount was finally realised from the loan
amount, when it was actually disbursed to the borrower. There were instances
when the loan agreement was signed and the borrower would not take the
disbursement and, accordingly, fees would not be realised. The Comptroller and
Auditor-General (CAG) objected to this on the ground that the accounting
treatment was not in accordance with the Accounting Standards issued by the
Institute of Chartered Accountants of India which provide guidance for
determination of income on accrual basis. The assessee assured the CAG that the
accounting policy was reviewed for the F.Y. 2006-07 and, accordingly, the Board
had approved the change in accounting policy in its meeting held on 27th
September, 2007. The revised accounting policy recognised the fees as on the
date of their realisation, instead of the date of signing of the loan
agreement. For the A.Y. 2007-08, the A.O. made an addition of Rs. 1.28 crores
on the ground that the change had resulted in understatement of profits and
also because the change was introduced after the closing of the financial year.
The addition was upheld by the Tribunal.

 

The Delhi High Court allowed the assessee’s appeal and held as under:

 

‘(i)   The position was that the
liability to pay revised wages had already arisen with certainty. The committee
was constituted for the purpose of wage revision. That the wages would be
revised was a foregone conclusion. Merely because the making of the report and
implementation thereof took time, it could not be said that there was no basis
for making the provision. The expenditure of Rs. 1.60 crores on account of
anticipated pay revision in the A.Y. 2007-08 was deductible.

 

(ii)   No income accrued at the
point of execution of agreement. The change in the accounting policy was a
result of the audit objection raised by the CAG. The assessee had claimed
deduction in profits in the computation of the total income and added it as
income in the subsequent assessment year, which had been accepted by the A.O.
The change was, thus, revenue-neutral. The addition of Rs. 1,28,00,000 was not
justified.’

Section 92A(2)(c) of the Act – Loan given by each enterprise should be considered independently and an enterprise can be deemed to be an AE only if loan given by it exceeds 51% of book value of total assets – Business advances cannot be construed as loan to determine AE

10. Soveresign Safeship Management Pvt. Ltd. vs.
ITO ITA No. 2070/Mum/2016 A.Y.: 2011-12 Date of order: 5th March, 2020

 

Section 92A(2)(c) of the Act – Loan given
by each enterprise should be considered independently and an enterprise can be
deemed to be an AE only if loan given by it exceeds 51% of book value of total
assets – Business advances cannot be construed as loan to determine AE

 

FACTS

The assessee was
engaged in providing ship management and consultancy services. In Form 3CEB it
had considered two group companies as AEs (Associated Enterprises) and reported
international transactions by way of advances received in the course of
business from these entities. The assessee was providing ship management and
consultancy services to one of the entities from which it had received business
advances.

 

Before the TPO, the
assessee contended that though the said entities were not AEs, it had
inadvertently disclosed them in Form 3CEB as AEs. The TPO deemed the two group
entities as AEs u/s 92A(2)(m) on the basis that there was a relationship of
mutual interest between the taxpayer and the two group entities.

 

The DRP observed
that business advances received were separately reported and included within
‘sundry creditors’. The assessee had not rendered any service to the entities
for which it had received advances. Hence, advances received by the assessee
from the said entities were to be treated as loans taken from the AEs. The DRP
further observed that since the aggregate loans taken from the two entities
exceeded 51% of the book value of the total assets of the assessee, u/s
92A(2)(c) of the Act they were AEs of the assessee.

 

Being aggrieved,
the assessee appealed before the Tribunal.

 

HELD

(A) In terms of section 92A(2)(c),
an enterprise will be deemed to be an AE if ‘loan advanced by one enterprise
to the other enterprise constitutes not less than fifty-one per cent of the
book value of the total assets of the other enterprise’. As the language of
the section is unambiguous, only lending enterprises which had advanced loan
exceeding 51% of the book value of the total assets could be deemed as AEs.

 

(B) Advances received by the assessee from one of
the entities were towards ship management and consultancy services rendered by
it to the said entity. Business advances cannot be construed as loans.
Accordingly, such advances should be excluded while determining AE
relationship.

 

(C)       The tax authority could not rely merely on
self-disclosure of AEs by the assessee in Form 3CEB when the facts in the
financial statements of the assessee were clear and the language of the statute
was unambiguous.

 

 

 

 

Article 12 of India-Korea DTAA, section 9(1)(vii) of the Act – Fees paid to foreign company for providing shortlist of candidates as per job description, were not in the nature of FTS u/s 9(1)(vii) of the Act

9. TS-141-TAT-2020 (Ind) D&H Secheron Electrodes Pvt. Ltd. vs.
ITO ITA No. 104/Ind/2018 A.Y.: 2016-17 Date of order: 6th March, 2020

 

Article 12 of India-Korea DTAA, section
9(1)(vii) of the Act – Fees paid to foreign company for providing shortlist of
candidates as per job description, were not in the nature of FTS u/s 9(1)(vii)
of the Act

 

FACTS

The assessee was
engaged in the business of manufacture of welding electrodes and was looking
for engineers for development of certain products. Hence, it entered into an
agreement with a Korean company (‘Kor Co’) for providing a list of engineers
matching the job description provided by it. On the basis of the list provided,
the assessee interviewed the candidates and recruited them if found suitable.
For its service, the assessee made payments to Kor Co without withholding tax.

 

According to the A.O., since the said services were technical in nature,
the assessee was liable to withhold tax. Therefore, the A.O. treated the
assessee as ‘assessee in default’ and initiated proceedings u/s 201 and u/s
201(1A) of the Act. The CIT(A) upheld the view of the
A.O.

 

Being aggrieved,
the assessee filed an appeal before the Tribunal.

 

HELD

(1) In the contract between the
assessee and Kor Co, the assessee had not sought any technical expertise from
the latter.

(2) The process involved in the services provided
by Kor Co was as follows:

(a) Assessee provided detailed job description to
Kor Co;

(b) After matching the job description with the
profile of candidates available in its database, Kor Co shortlisted candidates
for the assessee and had merely provided the list of such candidates to the
assessee;

(c) Kor Co had guaranteed that if the appointed
candidate were to voluntarily leave the job within the first 90 days of
employment, Kor Co would provide suitable replacement at no cost to the
assessee.

(3) The assessee had evaluated the
shortlisted candidates on its own by interviewing them and taking tests. The
decision whether the relevant candidates were suitable as per its requirements
was solely that of the assessee and Kor Co had not provided any inputs for the
same.

(4) Having regard to the nature of
the services provided by Kor Co, the payments made by the assessee to Kor Co
were not in the nature of ‘fees for technical services’ as defined in
Explanation 2 to section 9(1)(vii). Accordingly, the assessee was not required
to withhold tax from such payments.

 

Note: Apparently, though the assessee had also
referred to Article 12 of the India-Korea DTAA, the Tribunal concluded only in
the context of section 9(1)(vii) of the Act.

Section 9(1)(vi) and section 194J of the Act – Payments made to telecom operators for providing toll-free number service were in nature of ‘royalty’ u/s 9(1)(vi) and, consequently, tax was required to be withheld

8. [2020] 116
taxmann.com 250 (Bang.)(Trib.) Vidal Health
Insurance TPA (P) Ltd. vs. JCIT ITA Nos. 736 &
1213 to 1215 (Bang.) of 2018 A.Ys.: 2011-12 to
2014-15 Date of order: 26th
February, 2020

 

Section 9(1)(vi)
and section 194J of the Act – Payments made to telecom operators for providing
toll-free number service were in nature of ‘royalty’ u/s 9(1)(vi) and,
consequently, tax was required to be withheld

 

FACTS

The assessee was
licensed by IRDA for providing TPA services to insurance companies. It engaged
telecom operators (‘telcos’) for allotting toll-free numbers and providing
toll-free telephone services to policy-holders of insurance companies such that
the charges for calls made by policy-holders to the toll-free number were borne
by the assessee and not the policy-holders. The assessee did not deduct tax
from the payments made to the telcos.

 

According to the
A.O., the payments were in the nature of royalty u/s 9(1)(vi) of the Act, read
with Explanation 6 thereto. Accordingly, he disallowed the payments u/s
40(a)(ia) of the Act.

 

The CIT(A) held
that since the payments were made by the assessee for voice / data services,
they were in the nature of royalty.

 

Being aggrieved,
the assessee appealed before the Tribunal. The assessee’s principal argument
was that section 194J deals with deduction of tax from payment of ‘royalty’. As
per Explanation (ba) in section 194J, the meaning of ‘royalty’ should be
construed as per Explanation 2 to section 9(1)(vi) of the Act. Explanation 6 to
section 9(1)(vi) of the Act defines ‘process’. Since section 194J has nowhere
referred to Explanation 6 to section 9(1)(vi) of the Act, it could not be
considered.

 

HELD

Royalty
characterisation

(i)   A toll-free number involves providing
dedicated private circuit lines to the assessee.

 

(ii) The consideration paid by the assessee was
towards provision of bandwidth / telecommunication services and further, for
‘the use of’ or ‘right to use equipment’. The assessee was provided assured
bandwidth through which it was guaranteed transmission of data and voice. Such
transmission involved ‘process’, thus satisfying the definition of ‘royalty’ in
Explanation 2 to section 9(1)(vi) of the Act.

 

Royalty definition
u/s 194J

(a) Explanation 6 to section 9(1)(vi) defines the
expression ‘process’, which is included in the definition of ‘royalty’ in
Explanation 2.

 

(b) Since Explanation 2 does not define ‘process’,
the definition of ‘process’ in Explanation 6 must be read into Explanation 2 to
analyse whether a particular service comprised ‘process’ and consequently
consideration paid for the same was ‘royalty’.

 

Section 54 – Deduction in full is available to the assessee even when the new house property is purchased in the joint names of the assessee and others

6. 
Subbalakshmi Kurada vs. ACIT (Bangalore) N.V. Vasudevan (V.P.) and B.R. Baskaran
(A.M.) ITA No. 2493/Bang/2019 A.Y.: 2016-17 Date of order: 8th May, 2020 Counsel for Assessee / Revenue: V.
Srinivasan / Rajendra Chandekar

 

Section 54 –
Deduction in full is available to the assessee even when the new house property
is purchased in the joint names of the assessee and others

 

FACTS

The assessee had
sold a residential house property for a sum of Rs. 12.75 crores on 6th
November, 2015. She purchased another residential house property on 17th
February, 2016 for Rs. 11.02 crores.

 

The new house
property was purchased in the joint name of the assessee and her son. The
assessee claimed deduction of Rs. 8.47 crores u/s 54. Since the new residential
house property was purchased in the name of the assessee and her son, the A.O.
restricted the deduction u/s 54 to 50%, i.e., he allowed deduction to the extent
of Rs. 4.23 crores only. The CIT(A) also confirmed the same.

 

Before the
Tribunal, the Revenue supported the order passed by the CIT(A).

 

HELD

The Tribunal
observed that the entire consideration towards the purchase of the new
residential house had flown from the bank account of the assessee. It also
noted that the Karnataka High Court in the case of DIT (Intl.) vs. Mrs.
Jennifer Bhide (15 taxmann.com 82) had held that deduction u/s 54
should not be denied merely because the name of the assessee’s husband was
mentioned in the purchase document, when the entire purchase consideration had
flown from the assessee. Therefore, following the ratio laid down in the
said decision and the decision of the co-ordinate Bench in the case of Shri
Bhatkal Ramarao Prakash vs. ITO (ITA No. 2692/Bang/2018 dated 4th
January, 2019), the Tribunal held that the assessee was entitled to
full deduction of Rs. 8.47 crores u/s 54.

 

Sections 10(37) and 56(2)(viii) – Interest received u/s 28 of the Land Acquisition Act, 1894 treated as enhanced consideration not liable to tax

5.  Surender vs. Income-tax Officer (New Delhi) Sushma Chowla
(V.P.) and Dr. B.R.R. Kumar (A.M.) ITA No.
7589/Del/2018 A.Y.:
2013-14 Date of
order: 27th April, 2020 Counsel
for Assessee / Revenue: Sudhir Yadav / N.K. Choudhary

 

Sections 10(37) and 56(2)(viii) – Interest
received u/s 28 of the Land Acquisition Act, 1894 treated as enhanced
consideration not liable to tax

 

FACTS

The agricultural
land of the assessee was acquired by Haryana State Industrial and
Infrastructure Development Corporation Ltd. (‘HSIIDC’) u/s 4 of the Land
Acquisition Act, 1894 (‘the Acquisition Act’). The HSIIDC had not paid the
compensation at the prevailing market rate, therefore the assessee filed an
appeal before the High Court for increase in compensation. The Court enhanced
the compensation which included Rs. 1.84 crores in interest u/s 28 of the
Acquisition Act. The assessee claimed that the amount so received was enhanced
consideration, hence exempt u/s 10(37). However, according to the A.O. as well
as the CIT(A), the amount so received could not partake the character of
compensation for acquisition of agricultural land. Hence, both held that the
sum so received was interest taxable u/s 56(2)(viii).

The question before
the Tribunal was whether the amount received can be treated as enhanced
consideration u/s 28 of the Acquisition Act and hence exempt u/s 10(37) as
claimed by the assessee, or u/s 34 of the Acquisition Act and hence taxable u/s
56(2)(viii) as held by the CIT(A).

 

HELD

The Tribunal
referred to the decision of the Supreme Court in Commissioner of
Income-tax, Faridabad vs. Ghanshyam (HUF) (Civil Appeal No. 4401 of 2009
decided on 16th July, 2009). As per that decision, section
28 of the Acquisition Act empowers the Court in its discretion to award
interest on the excess amount of compensation over and above what is awarded by
the Collector. It depends upon the claim by the assessee, unlike interest u/s
34 which depends upon and is to be paid for undue delay in making the award /
payment. The Apex Court in the said decision further observed that interest
awarded could either be in the nature of an accretion in the value of the lands
acquired, or interest for undue delay in payment. According to the Court,
interest u/s 28 of the Acquisition Act is an accretion to the value of the land
and thus it forms part of the enhanced compensation or consideration. On the
other hand, interest awarded u/s 34 of the Acquisition Act is interest paid for
a delay in payment of compensation.

 

Therefore, relying
on the decision of the Apex Court referred to above, the Tribunal held that
since the compensation payable to the assessee was increased u/s 28 of the
Acquisition Act as per the order of the High Court, the amount received by the
assessee was exempt u/s 10(37).

 

Section 194C r/w/s 40(a)(ia) – Even an oral contract is good enough to invoke section 194C – Payment of hire charges made by assessee to cab owners for hiring cabs for the purpose of providing transportation services to its customers would attract section 194C – Since payment is made by the assessee, the presumption would be that there was a contract for hiring of vehicles

12.
[2020] 116 taxmann.com 230 (Bang.) Singonahalli
Chikkarevanna Gangadharaiah vs. ACIT ITA No.
785/Bang/2018 A.Y.: 2014-15 Date of
order: 24th February, 2018

 

Section 194C r/w/s 40(a)(ia) – Even an oral
contract is good enough to invoke section 194C – Payment of hire charges made
by assessee to cab owners for hiring cabs for the purpose of providing
transportation services to its customers would attract section 194C – Since
payment is made by the assessee, the presumption would be that there was a
contract for hiring of vehicles

 

FACTS

The A.O. noticed
from the Profit & Loss account of the assessee that the assessee has debited
a sum of Rs. 6,18,73,785 for vehicle hire charges paid and Rs. 2,48,39,356 for
petrol and diesel expenses paid. The assessee was asked to produce details of
TDS on expenses. However, the assessee failed to do so.

 

Subsequently, the
assessee submitted the PAN cards from cab drivers and owners to whom hire
charges were paid and said that the cab drivers and owners were all regular
income tax payers and hence, as per section 194C, no TDS was made where PAN was
provided.

 

According to the
A.O., section 194C will only apply to a contractor engaged in the  business of plying, hiring or leasing goods
carriages – and not to a contractor engaged in the business of plying passenger
vehicles. Accordingly, the A.O. held that the assessee is liable to deduct
TDS and disallowed a sum of Rs. 6,18,73,785 for vehicle hire charges u/s
40(a)(ia) of the Act.

 

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

 

HELD

Upon going through
the provisions of section 194C, the Tribunal held that there is no doubt that
the assessee in this case has made the payments of hire charges to cab owners.
As regards the contention of the assessee that the payments have not been made
in pursuance of any contract, the Tribunal held that a contract need not be in
writing; even an oral contract is good enough to invoke the provisions of
section 194C. The cab owners have received the payments from the assessee
towards the hiring charges, therefore, the presumption normally would be that
there was a contract for hiring of vehicles. Hence, if the assessee has made
the payment for hiring the vehicles, the provisions of section 194C are clearly
applicable.

 

The contract has to
be looked into party-wise, not on the basis of the individual. The Tribunal
held that all the payments made to a cab owner throughout the year are to be
aggregated to ascertain the applicability of the TDS provision as all the
payments pertain to a contract. A contract need not be in writing. It may infer
from the conduct of the parties. It may even be oral. The Tribunal also noted
that u/s 194C, sub-section (5) proviso thereto, if the aggregate amount
paid or credited to a person  exceeds Rs.
75,000, then the assessee shall be liable to deduct income tax at source.

 

The Tribunal then
discussed the amendment brought in by the Finance (No. 2) Act, 2014 with effect
from 1st April, 2015 by virtue of which only 30% of any sum payable
to a resident is to be disallowed. It noted that in the present case the
authorities below have added the entire sum of Rs. 6,18,73,785 by disallowing
the whole amount. Though the substitution in section 40 has been made effective
from 1st April, 2015, in its view the benefit of the amendment
should be given to the assessee either by directing the A.O. to confirm from
the cab owners as to whether the said parties have deposited the tax or not,
and further restrict the addition to 30% of the disallowance. The Tribunal held
that it will be tied (sic) and meet the ends of justice if the
disallowance is only restricted to 30% of the amount liable for TDS u/s 194C.
Accordingly, this issue is partly allowed.

 

Following the decision of the Calcutta High Court in IT Appeal No.
302 of 2011, GA 3200/2011, CIT vs. Virgin Creations decided on 23rd
November, 2011, the Tribunal restored the issue to the file of the A.O.
with the direction that the assessee shall provide all the details to the A.O.
with regard to the recipients of the income and the taxes paid by them. The
A.O. shall carry out necessary verification in respect of the payments made to
the cab drivers and taxes paid on the same by the cab drivers and filing of
returns by the recipients. In case the A.O. finds that the recipient has duly
paid the taxes on the income, the addition made by the A.O. shall stand
deleted.

 

The appeal filed by
the assessee was partly allowed.

I.Section 194H – Benefit extended by assessee to the distributor under an agreement for supply of mobile phones cannot be treated as commission liable for deduction of tax at source u/s 194H as the relationship between the assessee and the distributor was not of a principal and agent II.Section 37 – Expenditure incurred on Trade Price Protection to counter changes in price of handsets by competitors, life of model, etc. was incurred wholly and exclusively for the purpose of business and was an allowable expenditure u/s 37(1)

11.
[2020] 114 taxmann.com 442 (Delhi) Nokia
India (P) Ltd. vs. DCIT ITA Nos.:
5791 & 5845(Del)2015 A.Y.:
2010-11 Date of
order: 20th February, 2020

 

I.   Section 194H – Benefit extended by assessee
to the distributor under an agreement for supply of mobile phones cannot be
treated as commission liable for deduction of tax at source u/s 194H as the
relationship between the assessee and the distributor was not of a principal
and agent

 

II.  Section 37 – Expenditure
incurred on Trade Price Protection to counter changes in price of handsets by
competitors, life of model, etc. was incurred wholly and exclusively for the
purpose of business and was an allowable expenditure u/s 37(1)

 

FACTS I

The assessee
company had extended certain benefits / post-sale discounts to the
distributors. These discounts / trade offers did not form part of the agreement
between the assessee and the distributors. The A.O. disallowed the expenditure
u/s 40(a)(ia) considering the fact that no TDS u/s 194H was deducted from these
amounts.

 

HELD I

Upon perusal of the
agreement, the Tribunal observed that the relationship between the assessee and
HCL is that of principal to principal and not that of principal and agent. The
Tribunal held that the discount which was offered to distributors is given for
promotion of sales. This element cannot be treated as commission. There is
absence of  principal-agent relationship
and the benefit extended to distributors cannot be treated as commission u/s
194H of the Act.

 

As regards the applicability of section 194J, the A.O. has not given any
reasoning or finding that there is payment for technical service liable for withholding
u/s 194J. Marketing activities had been undertaken by HCL on its own. Merely
making an addition u/s 194J without the actual basis for the same on the part
of the A.O. is not just and proper.

 

As regards the
contention of the Revenue that discounts were given by way of debit notes and
the same were not adjusted or mentioned in the invoice generated upon original
sales made by the assessee, the Tribunal observed that this contention does not
seem tenable after going through the invoice and the debit notes. In fact,
there is clear mention of the discount for sales promotion.

 

The Tribunal
allowed this ground of appeal and deleted the addition made.

 

FACTS II

The assessee
company had incurred certain expenditure on Trade Price Protection which was
extended to distributors to counter changes in the price of handsets by
competitors, protect them against probable loss, etc. The A.O. had disallowed
the expenditure questioning the commercial expediency involved in incurring the
same.

 

HELD II

The Tribunal held
that the expenditure can be treated as being incurred on account of commercial
expediency considering the modern-day technological changes which are very
fast. It observed that as per the submission made before the A.O., this
expenditure had been covered in a special clause in the Trade Schemes filed.
The Tribunal further held that expenditure incurred for Trade Price Protection
was allowed as deduction since the same was considered as being incurred wholly
and exclusively for the purpose of business.

This ground of
appeal filed by the assessee was allowed.

Reopening – Beyond four years – Assessment completed u/s 143(3) – A mere bald assertion by the A.O. that the assessee has not disclosed fully and truly all the material facts is not sufficient – Reopening is not valid

6. M/s. Anand Developers vs. Asst.
Commissioner of Income Tax Circle-2(1) [Writ Petition No. 17 of 2020] Date of order: 18th February,
2020 Bombay High Court (Goa Bench)

 

Reopening –
Beyond four years – Assessment completed u/s 143(3) – A mere bald assertion by
the A.O. that the assessee has not disclosed fully and truly all the material
facts is not sufficient – Reopening is not valid

 

The petition challenged the
notice dated 29th March, 2019 issued u/s 148 of the Income-tax Act,
1961 and the order dated 17th December, 2019 disposing of the
assessee / petitioner’s objections to the reopening of the assessment in
pursuance of the notice dated 29th March, 2019.

 

The
petitioner had submitted its return of income within the prescribed period for
A.Y. 2012-13 declaring total income of Rs. 62,233. The case was selected for
scrutiny through CASS and notice was issued u/s 143(2) of the Act and served
upon the petitioner on 28th August, 2013. Based on the details
furnished by the petitioner, the A.O. passed the assessment order dated 16th
March, 2015 u/s 143(2).

 

It was the case of the
petitioner that vide its own letter dated 20th February, 2015
in the course of the assessment proceedings before the A.O., it had itself
submitted that a few flats may have been allotted to persons in violation of
Clause 10(f) of section 80IB. It was also contended that this ought not to be
regarded as any breach of the provisions of section 80IB; in any case, this
ought not to be regarded as any breach of the provisions of section 80IB in
its entirety and at the most benefit may be denied in respect of the
transfers made in breach of Clause 10(f) of section 80IB.

 

The petitioner submitted that
through this letter it had made true and complete disclosures in the course of
the assessment proceedings itself. It was upon consideration of these
disclosures that the A.O. finalised the assessment order of 16th
March, 2015 u/s 143(3). Under the circumstances, merely on the basis of a
change of opinion, the A.O. lacked jurisdiction to issue notice u/s 148 seeking
to reopen the assessment. Since there was absolutely no failure to make true
and full disclosures, there was no jurisdiction to issue such notice u/s 148
after the expiry of four years from the date of assessment.

 

The Department submitted that
since the petitioner had admitted vide its letter dated 20th
February, 2015 that it had violated the provisions of section 80IB and further
failed to make true and full disclosures, there was absolutely no
jurisdictional error in issuing the impugned notice or making the impugned
order.

 

The High Court observed that
the factum of the address of the letter dated 20th February,
2015 is indisputable because the respondents had themselves not only referred
to it but also quoted from it in the show cause notice dated 17th December,
2019 issued to the petitioner along with the impugned order of the same date by
which the objections of the petitioner to the reopening of the assessment came
to be rejected. Even the impugned order dated 17th December, 2019
rejecting the petitioner’s objections makes a specific reference to the
petitioner’s letter of 20th February, 2015 submitted during the
assessment proceedings u/s 143(3). Both the show cause notice dated 17th
December, 2019 and the impugned order of the same date specifically state that
the petitioner in the course of the assessment proceedings had furnished a list
of flat-owners to whom flats were sold in the project ‘Bay Village’.

 

The notice and the impugned
order proceed to state that upon perusal of this list, coupled with the letter
dated 20th February, 2015, it transpires that there was non-compliance
on the part of the petitioner with the provisions of section 80IB at least
insofar as some of the sales were concerned. Since it is virtually an admitted
fact that the petitioner had submitted a list of the flat-owners and vide
its letter dated 20th February, 2015 pointed out that there may be
breach insofar as the sale of some of the flats are concerned, it cannot be
said by the respondents that there was no truthful or complete disclosure on
the part of the petitioners in the course of the assessment proceedings itself.

 

The Court observed that
merely making of a bald statement that the assessee had not disclosed fully and
truly all the material facts is really never sufficient in such matters. In the
present case as well, apart from such a bald assertion, no details have been
disclosed as to the material which was allegedly not disclosed either truly or
fully. Rather, the record indicates that the entire list of flat-owners was
disclosed. Further, vide the same letter disclosures were made in
relation to the sale transactions and it was even suggested that some of the
transactions may not be compliant with the provisions of Clause 10(f) of
section 80IB. Clearly, therefore, the Department had failed to make out any
case that there was no true and full disclosure.

 

Further, section 147 of the
IT Act empowers the A.O. who has reason to believe that any income chargeable
to tax has escaped assessment for any A.Y. to reassess such income, no doubt
subject to the provisions of sections 148 to 153 of the Act. The proviso
to section 147, however, makes clear that where an assessment under sub-section
(3) of section 143 has been made for the relevant A.Y., no action shall be
taken u/s 147 after the expiry of four years from the end of the relevant
assessment year unless any income chargeable to tax has escaped assessment for
such assessment year by reason of failure on the part of the assessee, inter
alia ‘to disclose fully and truly all material facts necessary for its
assessment for that assessment year’. This means that normally, the limitation
period for re-assessment u/s 147 is four years. However, in a case where the
assessment has been made u/s 143(3) where, inter alia, the assessee
fails to disclose fully and truly all material facts necessary for assessment
for that assessment year, re-assessment can be made even beyond the period of
four years in terms of section 148. Therefore, in order to sustain a notice
seeking to reopen assessment beyond the normal period of four years it is
necessary for the respondents to establish, at least prima facie, that
there was failure to disclose fully and truly all material facts necessary for
the assessment for that assessment year.

 

In the present case, the
respondents have failed to establish this precondition even prima facie.
Rather, the material on record establishes that there were full and true
disclosures of all material facts necessary for the assessment for the A.Y.
2012-13. Despite this, the impugned notice seeking to reopen the assessment for
that year has been issued beyond the normal period of four years. On this short
ground, the impugned notice dated 29th March, 2019 and the impugned
order dated 17th December, 2019 were quashed and set aside. The
Court relied on the decisions of the Division Bench of this Court in the case
of Mrs. Parveen P. Bharucha [(2012) 348 ITR 325] and Zuari Foods and
Farms Pvt. Ltd. (WP No. 1001 of 2007 decided on 11th April, 2018).

 

The Court
observed that the decision in Calcutta Discount Co. Ltd. [(1961) 41 ITR
191 (SC)] in fact assists the case of the petitioner rather than the
respondents. In that decision, the Hon’ble Supreme Court has held that it is
the duty of the assessee to disclose fully and truly all primary relevant
facts, and once all primary facts are before the assessing authority, he
requires no further assistance by way of disclosure and it is for him to decide
what inference of facts can be reasonably drawn and what legal inferences have
ultimately to be drawn. However, if there are some reasonable grounds for
thinking that there had been under-assessment as regards any primary facts
which could have a material bearing on the question of under-assessment, that
would be sufficient to give jurisdiction to the ITO to issue notice for
re-assessment. In the present case, as noted earlier, there is absolutely no
reference to any alleged material facts which the petitioner failed to disclose
in the course of the assessment proceedings. Rather, the impugned notice refers
to the list as well as the letter issued by the petitioner itself which is
sought to be made the basis for the reopening of the assessment. For the
aforesaid reasons the petition is allowed and the impugned notice dated 29th
March, 2019 and the impugned order dated 17th December, 2019
are quashed and set aside. 

 

Revision – TDS – Non-resident – Shipping business – Section 263 and section 172, r/w sections 40(a)(ia), 194C and 195 of ITA, 1961 – Where assessee had paid export freight to a shipping agent of non-resident ship-owner or charter without deduction of tax at source, provisions of section 172 would be applicable and provisions of section 194C or section 195 which provide for deduction of tax at source shall not be applicable; A.Y.: 2014-15

26. Principal
CIT vs. Summit India Water Treatment and Services Ltd. [2020]
116 taxmann.com 107 (Guj.) Date
of order: 3rd February, 2020 A.Y.:
2014-15

 

Revision –
TDS – Non-resident – Shipping business – Section 263 and section 172, r/w sections
40(a)(ia), 194C and 195 of ITA, 1961 – Where assessee had paid export freight
to a shipping agent of non-resident ship-owner or charter without deduction of tax at source, provisions of section 172 would
be applicable and provisions of section 194C or section 195 which provide for
deduction of tax at source shall not be applicable; A.Y.: 2014-15

 

For the A.Y. 2013-14, the assessee filed its return of income declaring
total loss of Rs. 1,35,18,193. By an order dated 22nd March, 2016,
the A.O. finalised the assessment u/s 143(3). The Principal Commissioner of
Income-tax (‘the PCIT’) invoked the power of revision u/s 263 of the Act, 1961
on the ground that without deducting TDS on the export freight, the assessee
company had paid export freight amounting to Rs. 2,03,66,683 to Inter-Ocean
Shipping and Logistic Services. According to the PCIT, as no TDS return showing
the details of deduction of any tax in respect of the aforesaid export freight
had been filed and as the A.O. had not verified the same, the scope of
provisions of TDS on export freight, the entire amount was required to be
disallowed u/s 40(a)(ia) of the Act. By an order u/s 263 dated 21st
March, 2018, the PCIT directed the A.O. to pass a fresh assessment order after
providing an opportunity of being heard to the assessee in view of the
observations made in the order u/s 263.

 

The Tribunal
came to the conclusion that the A.O. has accepted the total loss declared by
the assessee in the return of income and passed order u/s 143(3) dated 22nd
March, 2016. The Tribunal considered the materials placed before it and found
that the respondent assessee had made payment for export freight to the Indian
Ocean Shipping and Logistics Services, which was an Indian agent acting on
behalf of the non-resident shipping company for collecting freight demurrage
and other charges and reimbursing the same to the shipping company. Therefore,
relying on the CBDT Circular No. 723 dated 19th September, 1995, the
Tribunal held that where payment is made to the shipping agents of the
non-resident ship-owner or charter, the agent steps into the shoe of the
principal, i.e. the shipping company, and according to the provisions u/s 172
of the Act, which provides for shipping business in respect of non-residents
would be applicable and the provisions of section 194C or 195 which provides
for deduction of tax at source shall not be applicable. The Tribunal,
therefore, held that the PCIT failed to consider that the assessee had
furnished the relevant materials in respect of export freight payment and it is
also not controverted by the PCIT; and therefore, it cannot be said that the
assessment order is erroneous or prejudicial to the interest of the Revenue in
any manner. The Tribunal set aside the order of the PCIT passed u/s 263 of the
Act.

 

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

 

‘i)   In view of the facts emerging
from the record and the finding of facts arrived at by the Tribunal, none of
the questions can be termed as substantial questions of law from the impugned
order passed by the Tribunal.

 

ii)   The appeal, therefore, fails
and is accordingly dismissed.’

 

Section 56 read with sections 22 and 23 – Compensation received under an agreement entered into with a tenant granting him an option to take on lease other units which belonged to the assessee is taxable under the head Income from Other Sources

10.
[2020] 116 taxmann.com 223 Redwood
IT Services (P) Ltd. vs. ITO(10)(2)(2), (Mum.) ITA No.
1309(Mum) 2018 A.Y.:
2011-12 Date of
order: 28th February, 2020

 

Section 56 read with sections 22 and 23 –
Compensation received under an agreement entered into with a tenant granting
him an option to take on lease other units which belonged to the assessee is
taxable under the head Income from Other Sources

 

FACTS

The assessee acquired an immovable property which was divided into four
units of which two units, viz. Unit Nos. 3 and 4, were let out. In terms of the
agreement entered into by the assessee with the tenant, the assessee had
granted an option to the tenant to take the other two units, viz. Units 1 and 2,
on lease. Under the option agreement, the assessee agreed to lease the property
in future and restrained itself from leasing it to any other person during the
period for which the option was granted. In consideration of such a covenant,
the assessee received from the tenant a compensation of Rs. 33,75,000 which was
offered by him under the head Income from Other Sources.

 

The A.O. considered
the two units in respect of which option was granted to be deemed let-out units
and charged tax on their market rent, and after allowing the standard deduction
taxed a sum of Rs. 76,64,328 under the head ‘Income from House Property’.

 

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

 

HELD

The Tribunal held that for income to be assessable under the head Income
from House Property, it should be out of the property let out or deemed to be
let out for the relevant period. In this case the property is neither let out
nor vacant. The compensation cannot, therefore, be assessed under the head
Income from House Property.

 

The amount received
by the assessee is in the nature of compensation for not letting out property
to any third party for a specified period. The meaning thereof is that by
entering into an option agreement, the assessee had renounced its right to let
out Unit Nos. 1 and 2 for a period of nine months from the date of the option
agreement and any amount received in pursuance of the said agreement is in the
nature of compensation which is assessable under the head Income from Other
Sources.

 

The Tribunal held
that the A.O. as well as the CIT(A) were incorrect in coming to the conclusion
that the property is deemed to be let out and income from the said property
needs to be computed u/s 22 of the Act.

 

The Tribunal directed
the A.O. to delete the additions made towards Income from House Property.

 

This ground of appeal filed by the assessee was
allowed.

Deemed income – Section 41(1) of ITA, 1961 – Section 41(1) will not apply to waiver of loan as waiver of loan does not amount to cessation of trading liability; A.Y.: 2003-04

25. Principal CIT vs. SICOM Ltd. [2020] 116 taxmann.com 410 (Bom.) Date of order: 21st January, 2020 A.Y.: 2003-04

 

Deemed income – Section 41(1) of ITA, 1961 – Section 41(1) will not
apply to waiver of loan as waiver of loan does not amount to cessation of
trading liability; A.Y.: 2003-04

In the
assessment proceedings for the A.Y. 2003-04, the A.O. considered the issue of
waiver of loan by the Government of Maharashtra and held that an amount of Rs.
114.98 crores covered by the loan given by the Government of Maharashtra is
taxable under sections 28(iv) and 41(1) of the Income-tax Act, 1961.
Accordingly, the said amount was treated as income of the assessee for the year
under consideration and added back to its total income.

 

The CIT(A)
and the Tribunal allowed the assessee’s claim and deleted the addition.

 

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

 

‘i)    The first appellate authority had followed
the decision of this Court in Mahindra & Mahindra Ltd. (Supra)
in deleting the addition made by the A.O. on account of remission of loan. The
decision of this Court in Mahindra & Mahindra (Supra) was
contested by the Revenue before the Supreme Court in Commissioner vs.
Mahindra & Mahindra Ltd. [2018] 404 ITR 1. The issue before the
Supreme Court was whether waiver of loan by the creditor is taxable as
perquisite u/s 28(iv) of the Act or taxable as remission of liability u/s 41(1)
of the Act. The Supreme Court held as under:

(a)   Section 28(iv) of the IT Act does not apply
in the present case since the receipts of Rs 57,74,064 are in the nature of
cash or money.

(b)   Section 41(1) of the IT Act does not apply
since waiver of loan does not amount to cessation of trading liability.

 

ii)    On careful examination of the matter, we are
of the considered opinion that the decision of the Supreme Court is squarely
applicable to the facts of the present case.

 

iii)    Consequently, we do not find any merit in
the appeal to warrant admission. Appeal is accordingly dismissed.’

Charitable or religious trust – Registration procedure (Deemed registration) – Sections 12AA and 13 of ITA, 1961 – Where Commissioner (Exemption) did not decide application u/s 12AA within six months from date on which matter was remitted by Tribunal, registration u/s 12AA(2) would be deemed to be granted to assessee society; A.Ys.: 2010-11 to 2014-15

24. CIT(E) vs. Gettwell Health and Education Samiti [2020] 115 taxmann.com 66 (Raj.) Date of order: 15th March, 2019 A.Ys.: 2010-11 to 2014-15

 

Charitable
or religious trust – Registration procedure (Deemed registration) – Sections
12AA and 13 of ITA, 1961 – Where Commissioner (Exemption) did not decide
application u/s 12AA within six months from date on which matter was remitted
by Tribunal, registration u/s 12AA(2) would be deemed to be granted to assessee
society; A.Ys.: 2010-11 to 2014-15

 

The assessee
is a society registered under the Rajasthan Societies Registration Act, 1958 vide
registration certificate dated 3rd January, 2008. Its main object is
to provide medical facilities in the State of Rajasthan. The assessee is
running a hospital at Sikar in the name of Gettwell Hospital & Research
Centre. The assessee filed an application in Form 10A seeking registration u/s
12AA of the Income-tax Act, 1961 on 19th January, 2010. The
Commissioner of Income Tax (Exemptions) [‘the CIT(E)’] rejected that
application by an order dated 23rd July, 2010. By an order dated 22nd
July, 2011, the Tribunal set aside the order dated 23rd July, 2010
and remanded the matter back to the CIT(E) on the ground that it had not
communicated the A.O.’s report to the assessee and therefore restored the issue
of registration back on the file of the CIT(E) with a direction that the
assessee should be given an opportunity before deciding the issue of
registration and should be confronted with all the materials which are
considered adverse to the assessee. After remand of the matter, the CIT(E)
passed a fresh order on 9th October, 2015 and rejected the
application of the assessee, holding that the assessee was running the hospital
for the benefit of the family members of Shri B.L. Ranwa and there was no
charity in it.

 

The Tribunal allowed the assessee’s appeal.

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

 

‘i)    The Tribunal also noted that once the matter
was remanded back to the CIT(E) then the limitation for passing the order /
decision cannot be more than the limitation provided for deciding the
application u/s 12AA of the Act. There is no dispute that as per the provisions
of section 12AA(2) of the Act the limitation for granting or refusing the
registration is prescribed as before the expiry of six months from the end of
the month in which the application was received. Relying on the judgment of the
Supreme Court in CIT vs. Society for the Promotion  of Education [2016] 67 taxmann.com 264/238
Taxman 330/382 ITR 6 which upheld the judgment of the Allahabad High
Court and judgment of this Court in CIT vs. Sahitya Sadawart Samiti
[2017] 88 taxmann.com 703/396 ITR 46 (Raj.), the Tribunal held that
once the limitation prescribed u/s 12AA of the Act expired and the
consequential default on the part of the CIT(E) in deciding the application,
would result in deemed grant of registration is a settled proposition.

 

ii)    Therefore, it has been held
by the Tribunal that the judgment of the CIT(E) is reversed on merits and
registration would stand granted to the assessee by prescription of law made in
section 12AA(2) of the Act. The Tribunal in this behalf relied on the judgment
of the Lucknow Bench of the Tribunal in Harshit Foundation vs. CIT [2013]
38 taxmann.com 309/60 SOT 147 (URO) in which case it was held that
where the Commissioner does not pass any order even after six months from the
receipt of the Tribunal’s order remitting the matter to him, the registration
will be deemed to have been granted.

 

iii)    This is subject to exercise
of the Commissioner’s power u/s 12AA(3) of the Act in appropriate cases.

iv)   In view of the above, we
hardly find any justification in admitting this appeal as in our considered
view it does not raise any question of law, much less substantial question of
law. The appeal is therefore dismissed.’

 

Charitable purpose – Section 2(15) r/w sub-sections 11, 12 and 13 of ITA, 1961 – Where India Habitat Centre, inter alia set up with primary aim and objective to promote habitat concept, was registered as a charitable trust, principle of mutuality for computation of its income was not required to be gone into as income was to be computed as per sections 11, 12 and 13; A.Y.: 2012-13

23. CIT (Exemption) vs. India Habitat Centre [2020] 114 taxmann.com 84 (Del.) Date of order: 27th November, 2019 A.Y.: 2012-13

 

Charitable purpose – Section 2(15) r/w sub-sections 11, 12 and 13 of
ITA, 1961 – Where India Habitat Centre, inter alia set up with primary
aim and objective to promote habitat concept, was registered as a charitable
trust, principle of mutuality for computation of its income was not required to
be gone into as income was to be computed as per sections 11, 12 and 13; A.Y.:
2012-13

 

For the A.Y.
2012-13, the assessee filed its return of income on 28th September,
2012 in the status of ‘Trust’, declaring ‘Nil income’. Its assessment was
framed u/s 143 (3) of the Income-tax Act, 1961, computing total income as Rs.
5,86,85,490 and holding that the activities of the assessee are hybrid in
nature; they were partly covered by provisions of section 11 read with section
2(15), and partly by the principle of mutuality. It was held by the A.O. that
since the assessee is not maintaining separate books of accounts, income cannot
be bifurcated under the principle of mutuality or otherwise. The entire surplus
in I&E account, amounting to Rs. 5,83,92,860, was treated as taxable income
of the assessee.

The CIT(Appeals) allowed the appeal of the assessee by relying upon the
judgment of the Delhi High Court in the assessee’s own case dated 12th
October, 2011 for A.Ys. 1988-89 to 2006-07 and the decision of the Hon’ble
Supreme Court in the case of Radha Soami Satsang vs. CIT [1992] 193 ITR
321/60 Taxman 248. The Tribunal confirmed the decision of the
CIT(Appeals).

 

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

 

‘i)    The fundamental question is
that if the assessee has taken the plea of mutuality, whether it could be
deprived of the benefit of section 2(15) of the Act. On this aspect, the A.O.
has proceeded to classify the assessee’s activities as ?hybrid”, holding that
part of the activities are covered by provisions of section 11 r/w section
2(15) and part by principle of mutuality. The CIT(A), after examining the records,
has given a categorical finding that the activities of the centre fall within
the meaning of the definition of ?charitable activities” as provided u/s 2(15)
of the Act.

 

ii)    Applying the test of profit motive, it was
held that the surpluses generated by the assessee are not being appropriated by
any individual or group of individuals. Merely because the assessee is charging
for certain goods and services it does not render such activities as commercial
activities, and the fact that the A.O. has accepted that the assessee is
promoting public interest as provided in the proviso to section 2(15),
there cannot be any doubt that the assessee should be regarded as a charitable
organisation and given the full benefit of exemption provided to such
organisations under the Act. Relying on this premise, it has been held that
since the assessee has not generated any surpluses from anyone, members or
non-members, it was not correct to say that the assessee has claimed relief
partly as charitable organisation and partly as mutual association.

 

iii)    Further, it was rightly
held that the principle of mutuality becomes superfluous in view of the fact
that the activities were held to be charitable. Applying the principle of
consistency, the CIT(A) held that there is no fundamental change in the nature of
activities of the assessee for the period prior to A.Y. 2008-09 and subsequent
years. The ITAT has confirmed the findings of the CIT(A). Though the principles
of res judicata are not applicable to the income tax proceedings,
however, at the same time, one cannot ignore the fact that there is no dispute
with respect to the consistency in the nature of activities of the assessee.
All the income tax authorities have held that the assessee is a charitable
institution and this consistent finding of fact entitles the assessee to have
its income computed under sections 11, 12 and 13 of the Act.

 

iv)   In this background, we find
no ground to disentitle the assessee to the benefits of section 2(15) of the
Act. This being the position, we find no perversity in the impugned decision
and, therefore, no question of law, much less substantial question of law,
arises for consideration. As a result, the appeal of the Revenue is dismissed.’

Section 45 – Amount received by assessee in its capacity as a partner of a firm from the other partners on account of reduction in profit-sharing ratio of the assessee, is a capital receipt not chargeable to tax

9. [2019] 116 taxmann.com 385 (Mum.) Anik Industries Ltd. vs. DCIT ITA No. 7189/Mum/2014 A.Y.: 2010-11 Date of order: 19th March, 2020

 

Section 45 – Amount received by assessee in
its capacity as a partner of a firm from the other partners on account of
reduction in profit-sharing ratio of the assessee, is a capital receipt not
chargeable to tax

 

FACTS

The assessee was a partner in a partnership firm, namely
M/s Mahakosh Property Developers (the ‘firm’). The assessee was entitled to a
30% share in the profits of the firm. During the year, the assessee received a
sum of Rs. 400 lakhs on account of surrender of 5% share of profit (from 30% to
25%.) This sum was not included in the computation of total income on the
ground that the firm was reconstituted and a right was created in favour of the
existing partners. The existing partners whose share was increased, paid
compensation of Rs. 400 lakhs to the assessee.

The assessee relied
upon the decision of the Hon’ble Madras High Court in A.K. Sharfuddin vs.
CIT (1960 39 ITR 333) for the proposition that compensation received by
a partner from another partner for relinquishing rights in the partnership firm
would be capital receipt and there would be no transfer of asset within the
meaning of section 45(4) of the Act. Reliance was placed on other decisions
also to submit that the provisions of sections 28(iv) and 41(2) shall have no application
to such receipts.

 

The A.O. held that
the said payment was nothing but consideration for intangible asset, i.e., the
loss of share of partner in the goodwill of the firm. Therefore, this amount
was to be charged as capital gains in terms of the decision of the Ahmedabad
Tribunal in Samir Suryakant Sheth vs. ACIT (ITA No. 2919 &
3092/Ahd/2002) and the decision of the Mumbai Tribunal in Shri
Sudhakar Shetty (2011 130 ITD 197). Finally, the said amount was
brought to tax as capital gains u/s 45(1).

 

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

 

Aggrieved, the
assessee preferred an appeal to the Tribunal,

 

HELD

The Tribunal
observed that the only issue that fell for its consideration was whether or not
the compensation received by an existing partner from other partners for
reduction in profit-sharing ratio would be chargeable to tax as capital gains
u/s 45(1).

 

As per the
provisions of section 45(1), any profits or gains arising from the transfer of
a capital asset effected in the previous year shall be chargeable to capital
gains tax. The Tribunal noted that the answer to the aforesaid question lies in
the decision of the Hon’ble Karnataka High Court in CIT vs. P.N.
Panjawani (356 ITR 676) wherein this question was elaborately examined
in the light of various judicial precedents.

 

The Tribunal noted
that the decision of the Karnataka High Court in P.N. Panjawani (Supra) also
takes note of the fact that the firm is not recognised as a legal entity but
the Income-tax Act recognises the firm as a distinct legally assessable entity
apart from its partners. A clear distinction has been made between the income
of the firm and the income of the partner. It is further noted that there is no
provision for levying capital gains on consideration received by the partner
for reduction in the share in the partnership firm. Upon perusal of paragraph
22 of the decision, it is quite discernible that the factual matrix is
identical in the present case. The aforesaid decision has been rendered after
considering the various case laws on the subject as rendered by the Hon’ble
Apex Court. The Tribunal found the decision to be applicable to the given
factual matrix.

 

The Tribunal held
that the compensation received by the assessee from the existing partners for
reduction in the profit-sharing ratio would not tantamount to capital gains
chargeable to tax u/s 45(1). It deleted the addition made and allowed the
appeal filed by the assessee.

POSSIBLE SOLUTION TO THE PROBLEM OF STRESSED ASSETS

The gross
Non-Performing Assets (NPAs) of all Scheduled Commercial Banks shot up from Rs.
69,300 crores in 2009 to Rs. 9,33,609 crores in 2019. The stress in the industrial
sectors such as power, roads, steel, textiles, ship-building, etc. are mainly
responsible for this huge increase. RBI has time and again come up with various
guidelines to resolve the financial stress in NPAs and reclassify them to
standard assets. The Government of India also brought the Insolvency and
Bankruptcy Code (IBC) into force in 2016 to bring about quick resolution of
NPAs. However, the results have not been very encouraging.

 

BBBB MODEL OF INFRASTRUCTURE /
PROJECT DEVELOPMENT

Infrastructure
development and financing of green field / brown field projects is generally
plagued with several issues. And it is this area that has significantly
increased the NPAs in the banking sector. Since the opening up of the economy
the nexus between the 4B’s has been at the centre of the problem. One can
term it as the ‘BBBB model’ of infrastructure development wherein the
Bureaucracy, Businessmen, Bankers and the Bench (Judiciary) have played a key
role in creating stress in the project / company and consequently leading to
non-viability of the projects and the rise in NPAs. The role played by
these 4Bs which has led to cost escalation of the projects or delays in their
implementation can be summarised as under:

 

Bureaucracy: The number of regulatory approvals creating hurdles in doing business,
delays in getting several regulatory approvals, land acquisition delays,
greasing of the palms of bureaucrats and politicians for expediting approvals,
compliance / clearances and licenses, etc.

Businessmen: Aggressive / unrealistic projections, siphoning off of funds and fund
diversion, gold plating the cost of projects, etc.

Bankers: Financing based on aggressive / unrealistic projections, lack of
project monitoring, delays in sanctioning / disbursements, phone banking /
corruption, technical and physical incapability / inefficiency for project
appraisal / analysis, etc.

Bench: The slow process of the judiciary / arbitration / claim settlement and
justice delivery system in India.

 

The above are some of
the primary reasons for delays in implementation of projects, consequently
leading to cost escalations, increase in the overall cost of the projects and
their non-viability.

 

Understanding financial stress in the
company / project

We normally hear
about ‘signs of financial stress’ like (1) the company is making losses, (2)
the net worth of the company is negative, (3) the company is not able to meet
its present payment obligations, (4) the company’s rating is downgraded, (5) it
has a high debt-to-equity ratio, (6) there is consistent over-drawl in the cash
credit account, and (7) it has a low current asset ratio.

 

These are only
‘signs’ of the financial stress in the company. Some of these signs would be
common across sectors, industries or among various companies in distress.
However, the causes of the financial stress among them would vary and could
relate to regulatory approvals, labour, reduction in demand for products /
services, land acquisition, debtors unable to pay, litigations, reduction in
revenues or prices of products or services, increase in input costs,
non-availability of inputs / raw materials, etc.

 

In order to resolve
the financial stress in companies and for resolving the NPA issue, we can
broadly categorise the solutions adopted by the regulator / government into two
kinds:

 

(1)
  Sweep the dust under the carpet:
Under this, the regulator allowed lenders to defer their interest and principal
payments, allowed lenders to provide additional funding and required promoters
to infuse more capital and provide personal and / or corporate guarantees. The
regulator even allowed regulatory forbearance (i.e., special dispensation to
lenders for not categorising these borrowers / assets as NPAs once the
restructuring plan was implemented) so that the company and existing capital
providers are given enough time to resolve the real cause of the financial
stress and the company can be revived.

 

The
problem with this approach was that the cause of the financial stress never got
resolved but the payment to lenders got postponed and the build-up of NPAs in
the system did not get reversed. Further, the lenders failed to monitor things
once the restructuring scheme got implemented whether or not the cause of
financial stress was resolved. Lenders with their short-sighted view were only
bothered that they did not have to classify the asset as an NPA or make
additional provisions immediately, and for the time being they could sweep the
dust under the carpet. This led to lenders approving restructuring schemes that
were based on aggressive business assumptions and sometimes even unrealistic
assumptions.

 

(2)   Lift the mat, show the dust to everyone and
let someone else clean it up: Under the second type of solution, the regulator
took away the regulatory forbearance (i.e., special dispensation for not
categorising the account by lenders as NPA on restructuring). The regulator
allowed the lenders to defer their interest and principal payments and required
promoters to infuse more capital and provide personal and / or corporate
guarantees. The lenders were required to reach an agreement for a restructuring
scheme within specified timelines. If the restructuring scheme was not approved
within the specified timelines, lenders either had to change the owner or
resolve the matter under the Corporate Insolvency Resolution Process (CIRP).

 

The timelines
specified by the regulator again resulted in lenders approving some of the
restructuring schemes that were based on aggressive business assumptions and
sometimes unrealistic assumptions.

 

Another issue was
that each and every decision of the lenders was viewed and reviewed with
suspicion and the sword of inquiry by various investigative agencies of the
government and its authorities was hanging on the lender’s decision. This led
to lenders not reaching any decision at all in some cases. In such situations,
lenders preferred to let the NCLT, NCLAT or the Supreme Court decide under the
IBC even at the cost of possible value destruction of the asset on referring to
these forums.

 

These solutions did
not lead to a reversal of the build-up of NPAs or resolving the real cause of
the financial stress in the company. Further, shareholders and depositors of
lenders continued to lose money under both the above methods due to various
reasons.

As
you may have noticed under the above two approaches, the government or the
regulator is only providing a solution for postponing payment of interest and
principal but has failed to provide a solution for resolving the cause of the
financial stress. Resolving the cause of financial stress has been left to the
existing lenders or promoters, and in some cases to new lenders and promoters
where the asset is sold to a new investor. In order to resolve the stress of
NPAs in the economy, the government and various regulators need to step in and
resolve the true cause behind the financial stress. At the same time, it is
virtually impossible for governments and regulators to have a customised
solution for each company for resolving its financial stress. Hence there is a
need to generalise the causes of financial stress in a company and then
government and regulators need to find a solution for resolving these issues
rather than merely postponing interest and principal payments.

 

The factors leading
to financial stress in a company can be broadly categorised as under:

 

Table 1

Sr.

Stress factor

Entity responsible

(A)

Revenue

Customers are interested in minimising
the price of the product and consequently revenue for the company

(B)

Variable cost

Raw material, labour costs, etc. directly linked to generating
revenue. Suppliers, labour are interested in maximising or increasing this component and consequently the
cost of production

(C)

Fixed cost

– Revenue-linked

Administration cost, legal, rentals, etc. (other bare minimum fixed
costs which are absolutely necessary)

(D)

Fixed cost

– Capital
provider-related

Depreciation and interest. Capital providers are interested in maximising or increasing this component
in order to maximise their return on capital

(E)

Profit

Capital providers are interested in maximising
or increasing this component in order to maximise their return on capital

 

Please note: Regulator / government will have a role in all or any of the above
factors directly or indirectly either for minimising or maximising the stress
factor. (Examples: Central Electricity and Regulatory Commission would be
keen on minimising revenue and tariff for customers. NHAI, if it delays in
land acquisition for a road project, it would push the cost of the project
and consequently fixed costs)

 

 

Financial stress in a
company can be reduced if the role of any of the above can be reduced or
eliminated. The factors stated in A, B and C above can be difficult to reduce
or eliminate. However, the factors stated in D and E can be reduced or
eliminated to make the operations of the company viable and resolve the
financial stress in the company.

 

‘Utility
Instruments’: A possible solution for resolving stress / NPAs

One of the solutions
for resolution of stressed assets and reducing the NPAs in the books of lenders
can be the issuing of ‘Utility Instruments’. A typical project which is an NPA,
especially in the infrastructure space, is funded by a mix of debt (from banks)
and equity infused by the promoters / investors in the company. What if an
instrument is introduced which replaces all the debt and equity in the company?

 

Two questions arise:

(1) Who will
subscribe to these ‘Utility Instruments’?

(2)
What will be the return on these ‘Utility Instruments’ – especially when the
project is not even able to service the interest, forget servicing of principal
and return on equity?

 

The answers to the
above questions will be explained in detail with the help of an example of a
stressed power-generating company that is an NPA asset in the books of the
bankers.

 

How it will work

A typical Power
Generation Company POGECO Ltd. has set up a coal-fired thermal power plant of
1,000 MW at Rs. 5 crores per MW with a debt-to-equity ratio of 70:30.  When the project is implemented and
operational, the balance sheet of such a company would broadly look as under:

 

Table 2

Liabilities

Rs. Cr.

Assets

Rs. Cr.

Equity

1,500

Fixed Assets

5,000

Debt

3,500

 

 

Total

5,000

Total

5,000

 

 

A typical Profit and
Loss account of POGECO Ltd would look as per Table 3, had it been
operating under normal circumstances based on certain assumptions.

 

These
assumptions are further detailed in Table 4 (for those interested in
understanding the details of calculations).

Table 3

Sr.

Particulars

Total for the year

(Amt. Rs. Cr.)

(A)

Per unit

(Amt. in Rs./Kwh)

(B)

% of Tariff (B)

(A)

Revenue

2,973

4.39

100%

(B)

Variable cost – fuel cost

1,929

2.85

65%

(C)

Fixed cost

 

 

 

i

O&M

150

0.22

5%

ii

Depreciation

200

0.30

7%

iii

Interest on long-term loan

420

0.62

14%

iv

Interest on working capital loan

48

0.07

2%

 

Total fixed cost

818

1.21

28%

(D)

Profit Before Tax (PBT)

226

0.33

7%

 

 

Cost components of
POGECO Ltd. and assumptions

 

Table 4

Sr.

Cost component

Assumption

(A)

Variable costs

 

1

Coal purchase cost

Rs. 4,000 per tonne (4,000 gross calorific value – GCV) (including
transportation up to the gate, taxes, etc.)

2

Secondary fuel purchase cost

Rs. 0.10 per kwh

(B)

Fixed cost

 

1

Operation & maintenance (O&M)

Rs. 15 lakhs per MW p.a. (including maintenance capex)

2

Depreciation on fixed assets

Rs. 200 crores p.a. assuming a 25-year plant life

3

Interest on long-term debt

12% p.a.

4

Interest on working capital

12% p.a.

5

Return on equity

15% – promoter / investor will expect some return on his investment
(or else he will not be interested in carrying out the operations). This is
generally even recovered from the consumers in the tariff in a typical PPA

(C)

Other assumptions

 

1

Plant load factor (PLF)

85%

2

Auxiliary consumption

9%

3

Station heat rate

2,500 kcal/kWh

4

Working capital requirement

1 month coal inventory and 1 month receivables

 

 

Let us critically
analyse the above cost components.

As you can see (refer
Table 3), 28% of the cost is fixed cost (in the first year). Normally, this
cost would gradually go down over the years as the debt gets paid and the
interest cost on long-term loan would gradually decrease. However, costs of
other components that are fixed will not decrease over the years and will
remain constant throughout the plant life.

 

Any investor putting
in his time, money and effort would want a normal return on his investment.
Hence, PBT of Rs. 226 crores is nothing but 15% return on Rs. 1,500 crores
equity investment. Accordingly, PBT would represent about 7% of the tariff
which will be charged to the consumers of POGECO Ltd.

 

From a consumer’s
perspective he will be paying ~ 35% (28%+7%) of the power tariff on account of
O&M, depreciation, interest and return of equity. As a consumer, he would
be interested in reducing these components to the maximum extent.

 

In India we have also
seen the issue relating to gold plating of projects or cost escalations /
overruns due to delays. In such a scenario, per MW cost of setting up the power
plant is much higher than Rs. 4 crores to Rs. 5 crores per MW (as assumed in
our example). In such an event the consumers would be paying more than 35% of
the tariff in fixed costs component.

 

To put it in a different
perspective, the stress in POGECO Ltd. will be due to the following conflicting
factors among various parties:

(1)
Consumers and regulator will want to
minimise the tariff / revenue, i.e. component A from tariff (refer
Table 3);

(2) Bankers or debt
providers will want to ensure their
interest and principal gets paid hence they will not be interested in reducing
component Cii, Ciii and Civ (i.e. depreciation and
interest) from the tariff and the Profit & Loss statement (refer Table 3).
The reason for including depreciation here is that although in the P&L it
is a non-cash item, but commensurate cash flows will be utilised to service the
principal portion of the debt.

(3) Investors /
promoters will want to maximise
their return, hence they will try to increase component Cii and D
(i.e. depreciation and PBT) (refer Table 3).

 

The
conflict among the above factors makes POGECO Ltd. unviable (the example
tariffs are too low or the cost of project is high which has increased the
fixed costs). What could be the solution for making POGECO Ltd. viable which
ensures principal payment to banks, return of investment / equity of promoter /
investor and tariff reduction for consumers?

 

The key is to
eliminate some of the components of the fixed costs which will benefit the
consumer while ensuring that the investments of the banks and investors are
returned.

 

How do we reduce the
fixed cost components?

Step 1 – Issue ‘Utility Instruments’ to
the end-consumers of the power

To make it easier to
understand, let us assume a town with 30 lakh consumers / families /
connections is consuming electricity from POGECO Ltd. Further, it is assumed
that distribution lines are already set up and cost related to distribution /
distribution losses is not involved. These consumers are directly purchasing
power from POGECO Ltd. These 30 lakh consumers on an average would consume
about 180-190 units per month which is about 6,776 million units of electricity
requirement.

 

The net generation of
the 1,000 MW power plant (assuming it operates at 85% PLF and 9% of auxiliary
consumption) would be roughly ~ 6,776 million units.

 

Hence, POGECO Ltd.
would issue ‘Utility Instruments’ to these 30 lakh consumers. Each instrument
issued by POGECO Ltd. would give the right to the consumer to purchase 10 units
of electricity from POGECO Ltd. at a discounted price per unit.

 

POGECO
Ltd. will issue 67.76 crore ‘Utility Instruments’ at Rs. 73.79 each to its
consumers. This will enable POGECO Ltd. to generate Rs. 5,000 crores from the
issuance. The calculation can be better explained in the table below:

 

Table 5

Sr.

Particulars

Quantity

(A)

POGECO Ltd. capacity

1,000 MW

(B)

Net generation @ 85% PLF and 9% auxiliary consumption

6,77,58,60,000 units

(C)

Number of ‘Instruments’ to be issued with right to purchase 10 units
(b/10)

67,75,86,000

(D)

Cost of project for setting up the power plant

Rs. 5,000 crores

(E)

Amount to be raised per ‘Instrument’ (d/c)

Rs. 73.79

 

 

Step 2 – Utilise the proceeds received
from these ‘Utility Instruments’ to pay the bankers and the investors

A Board of Trustees
can be appointed to oversee the entire process of getting the proceeds from
consumers and paying the bankers and investors (once the plant is made
operational). An O&M contractor should be appointed who will be managing
the plant and will be operating under the supervision / oversight of the Board
of Trustee and the regulator. With the proceeds from the ‘Utility Instruments’,
POGECO Ltd. will pay back the debt of Rs. 3,500 crores and the equity
investment of Rs. 1,500 crores.

 

RETURN ON INVESTMENT

The investor will
demand some return on investment up to the date he receives his money from the
‘Utility Instruments’. Further, there will also be a working capital
requirement to fund coal / fuel inventory and receivables. These additional
requirements can always be factored into the amount to be raised from the
consumers through the ‘Utility Instruments’.

 

Step
3 – Supply electricity to consumers at variable cost

The ‘Utility
Instruments’ will not carry any interest, nor will the amount paid by consumers
for purchase of the same (@ Rs. 73.79 per ‘Instrument’) be repaid to the consumers.
However, with the ‘Instruments’ the consumer has the right to purchase
electricity from POGECO Ltd. at a variable cost. Accordingly, each unit
consumed by the consumer will cost him only Rs. 3.07 per unit vs. Rs. 4.39 per
unit (that he would have otherwise paid to purchase power in our example –
refer Profit & Loss statement in Table 3 above). This is a saving of
about 30% in electricity cost for the consumer!

 

Let us do the math on
how he is getting the return on his investment of Rs. 73.79 per ‘Utility
Instrument’.

 

Assuming a family is
consuming 100 units of electricity every month, it consumes 1,200 units every
year. The consumer will need to buy 120 ‘Utility Instruments’. This will
require him to pay or invest Rs. 8,855. Against this investment he will be
saving Rs. 1.32 per unit of his consumption, or Rs. 1,584 in the first year of
investment on consumption of 1,200 units of electricity (i.e. Rs. 1.32 fixed
cost x 1,200 units). This works out to about 17.88% of the amount invested.

 

These savings would
gradually reduce (i.e. as discussed above due to the impact of the long-term
debt as it gets paid and the interest cost on long-term loan as part of fixed
cost would gradually decrease). The yearly saving gradually reduces to Rs. 861
in the 25th year of the power plant’s life. However, the Internal Rate of
Return for the consumer would still work out to be about ~ 15.5% over the
period of 25 years of the life of the plant.

 

With the above
analysis, the questions related to (1) Who will subscribe to these ‘Utility
Instruments’, and (2) What will be the return on these ‘Instruments’ are
answered.

 

Enumerable factors
such as costs related to distribution licensee, distribution and transmission
costs and losses, etc. will also play a role which would pose practical
challenges for implementing this concept. How to deal with these challenges and
issues can be a separate analysis or part of a study.

 

Applicability to
other sectors

A detailed analysis
of the concept has been presented here using the example of a power company.
However, this principal / concept can be applied to any company / sector that
is capital intensive or any public utility company, or any company having a
substantial component of operating and financial leverage and is catering to a
large number of consumers.

 

Examples:

(a) ‘Utility
Instruments’ can be issued to truck owners / transport companies / courier
companies wherein they will be paying toll limited to variable and O&M
costs for a road project.

(b) ‘Utility Instruments’
can be issued by Metro projects in urban areas such as Mumbai Metro or Delhi
Metro to its daily travellers / office-goers.

(c) Companies laying
the network of pipelines for the distribution of natural gas in urban areas can
issue ‘Utility Instruments’ to their consumers who would be using piped natural
gas.

(d) Financing for
setting up of infrastructure for charging stations in the city and providing
batteries for electric cars can be done through issuing ‘Utility Instruments’
to consumers using electric cars.

 

Implementation of the concept

We can always think
of variations to the above principle for implementation of this concept in the
current scenario with limited changes / amendments to the regulations. Let us
assume that Tata Power (i.e. a generation company) issues ‘Utility Instruments’
to the consumers in Mumbai. The proceeds will be utilised to reduce the debt
and / or equity component in their balance sheet.

 

As a consumer the
holder of a ‘Utility Instrument’ will be paying the normal electricity bill
every month as per the existing mechanism along with other consumers. At the
end of the year, Tata Power can reimburse various cost components (other than
O&M cost and variable cost) to the holders of these instruments. A
Chartered Accountant can play a role here for identifying companies wherein
this structure / concept can be implemented and give necessary advice to the
senior management to this effect.

 

Under
the current scenario there would be various regulatory challenges for issuance
of ‘Utility Instruments’. This will even require SEBI and RBI to come together
for necessary issuance and / or amendment of guidelines for enabling their
issuance. Several existing guidelines such as ICDR guidelines, the Companies
Act, 2013, etc. will also have to be amended in order to recognise these
‘Instruments’. A Chartered Accountant can play an important role here, too,
initially making necessary representations to various regulatory and industrial
bodies.

 

These
‘Utility Instruments’ can also be marketable / tradeable, i.e. if in a
given year the consumer shifts location, there is flexibility for him to sell
the same to another consumer. A Chartered Accountant / Merchant Banker can play
a critical role in the valuation of such ‘Instruments’. The
Board of Trustees will also play a key role in ensuring successful
implementation of the concept. The government will have to issue necessary
regulations for the purpose of setting up, functioning and overseeing of the
Board of Trustees in the interest of the consumers and holders of ‘Utility
Instruments’. Here, too, a Chartered Accountant can play an eminent role as a
watchdog and audit the entire process on a continuous basis.

In these unprecedented times, going forward there is going to be significant
stress in the manufacturing, industrial and infrastructure sectors. Companies
which were probably viable prior to Covid-19 may turn unviable due to lack of
demand or various other factors. We need to think of out-of-the-box solutions
in order to cope with the possible crisis. Through implementation of this
concept in sectors wherein wide numbers of consumers are being catered to, we
can attempt to eliminate the fixed costs related to investments.

 

 

GOVERNANCE & INTERNAL CONTROLS: THE TOUCHSTONE OF SUSTAINABLE BUSINESS – PART II

On 12th March, 2020 BCAS made an announcement
deferring my talk scheduled a week hence. The previous
day, WHO had labelled the novel coronavirus disease
or Covid-19 as a pandemic. As a consequence, several
precautions snowballed into locking down half the world’s
population as the deadly virus quickly infected over four
million people in 210 countries and claimed tens of
thousands of lives. Our Prime Minister asked for 22nd
March to be observed as Janata Bandh following which
we are into Lockdown 3.0 (and now 4.0 till 31st May,
2020). Some have termed this outbreak as a Black Swan
event and the biggest challenge humanity has faced
since World War II, seriously impacting lives, earnings,
economies and businesses with a whopping toll on the
markets. We still have to see a flattening of the curve
and estimates are that this will trigger a global recession
for an extended period. The trillion-dollar question…
who could have anticipated this and, more importantly,
prepared for it?

Over the last few decades we have been witness to
quite some events of tremendous gravity such as Ebola,
SARS, Bird Flu, the 2008 meltdown, the 2011 Earthquake
and Tsunami, Brexit… With these abnormal occurrences
occurring with discomforting regularity, is this the new
normal?

But what have all these got to do with internal controls (IC)?
Sound internal controls which encompass identifying and
managing risks both internal and external, are a sine qua
non for running a sustainable business. Conventionally
though, internal controls were more of the order of internal
checks and internal audit (IA). Segregation of duties,
maker-checker procedures, vouching transactions,
physical verification of cash, stocks and so on received
a lot of prominence. And internal audit was seen as a
routine albeit necessary activity, coasting alongside the
main operations in business. Within corporations, too, this
function was never the sought-after role for accounting
and finance professionals. Not so any longer. The everchanging
world in which things are turning more complex
by the day, is only making this entire process difficult and
tricky as we reflect on the Covid-19 pandemic.

INTERNAL CONTROLS

Controls function to keep things on course and internal
controls in any business or enterprise provide the
assurance that there would be no rude surprises. The
Committee of Sponsoring Organisations1 (COSO) has
defined IC as ‘a process, effected by an entity’s board of
directors, management and other personnel, designed to
provide reasonable assurance regarding the achievement
of objectives relating to operations, reporting and
compliance’. As per SIA 120 issued by the Institute of
Chartered Accountants of India2, ICs are essentially risk
mitigation steps taken to strengthen the organisation’s
systems and processes, as well as help to prevent and
detect errors and irregularities. In SA 3153 it is defined
as ‘the process designed, implemented and maintained
by those charged with governance, management and
other personnel to provide reasonable assurance about
the achievement of an entity’s objectives with regard
to reliability of financial reporting, effectiveness and
efficiency of operations, safeguarding of assets and
compliance with applicable laws and regulations’. IC
therefore encompasses entity level, financial as well as
operational controls (Figure 1).

1. COSO Committee of Sponsoring Organisations of the Treadway Commission:
Internal Control – Integrated Framework, May, 2013
2 Standard on Internal Audit (SIA) 120 issued by the Institute of Chartered
Accountants of India
3 Standard on Auditing (SA) 315 ‘Identifying and Assessing the Risks of Material
Misstatement Through Understanding the Entity and its Environment’, issued
by ICAI effective 1st April, 2008

A number of regulatory requirements are in place in the
realm of IC. The Companies Act, 20134 requires the
statutory auditor to report on ‘whether the company has
adequate internal financial controls system in place and
the operating effectiveness of such controls’. It requires
the Board to develop and implement a risk management
policy and identify risks that may threaten the existence
of the company. It imposes overall responsibility on
the Board of Directors with regard to Internal Financial
Controls. The Directors’ Responsibility Statement has to
state that ‘the Directors, in the case of a listed company,
had laid down internal financial controls to be followed by
the company and that such internal financial controls are
adequate and were operating effectively.’ And they have
also devised a proper system to ensure compliance with
the applicable laws and that such systems are operating
effectively. SEBI5 Regulations stipulate the preparation of
a compliance report of all laws applicable to a company
and the review of the same by the Board of Directors
periodically, as well as to take steps (by the company) to
rectify instances of non-compliance and to send reports
on compliance to the stock exchanges quarterly.
Furthermore, listed companies have additional
responsibilities on Internal Controls for Financial Reporting.
A Compliance Certificate is mandated to be signed by the
CEO and CFO to indicate that ‘they accept responsibility for
establishing and maintaining internal controls for financial
reporting and that they have evaluated the effectiveness of
the internal control systems of the listed entity pertaining to
financial reporting and they have disclosed to the auditors
and the audit committee, deficiencies in the design or
operation of such internal controls, if any, of which they are
aware and the steps they have taken or propose to take
to rectify these deficiencies’. The Institute of Chartered
Accountants of India has formulated Standards on Internal
Audit which are a set of minimum requirements that need
to be complied with. Hence, the overall responsibility
for designing, assessing adequacy and maintaining the
operating effectiveness of Internal Financial Controls rests
with the Board and the management (Figure 2).

THE CONTROL S HIERARCHY

Internal Controls is a vast topic in its own right. What we
will examine in this article are the following aspects:
(i) IC in action,
(ii) M anaging Risks, and
(iii) E xcellence in Business

4 The Companies Act, 2013: Sections 134, 143, 149
5 Securities and Exchange Board of India (SEBI) (Listing Obligations and Disclosure
Requirements) Regulations, 2015

Given the enlightened readers’ expert knowledge on the
above, I will dwell on anecdotes from my experience having
been on both sides of the table (auditor as well as auditee)
which could provide perspectives for due consideration.

Internal Controls in action
First, some ground realities:
* IC is commonly perceived as a specialist domain of
auditors whereas fundamentally it is the lookout of every
person in the workforce. Every manager must realise that
s/he has the core responsibility of running operations
consciously abiding by the control parameters. As the
primary owner, every person in charge must provide
assurance that their work domain is under control through
a control self-assessment mechanism;
* IA is perceived as a statutory duty and often deprived
of the credit it deserves. The irony is that this function is
not appreciated when all is well and the first issue to be
frowned upon when something goes amiss!
* O perations get priority and IA, instead of being seen
as a guide and ally to business, is perceived to be an
adversary.

In well-run enterprises there is realisation and
understanding of the importance of IC in running and
growing a sustainable business. Here are some good
practices I have experienced which build and nurture a
healthy control culture in the enterprise.

(i) In Hindustan Unilever (HLL then) there was an
unwritten practice that accountants had to go through a stint in IA. Speaking for myself, I can candidly state that my
appreciation of enterprise-wide business processes grew
during my tenure in Unilever Corporate Audit. I bagged
my first business role to run the Seeds Business in HLL
on the strength of the exposure to various businesses and
functions while in IA. A stint in IA is invaluable in opening
up the mind to the various facets of business;

(ii) U nilever Corporate Audit always reported to the
Board of Unilever and this chain of command percolated
down. In India, we were a resource for the region. IA,
therefore, had the desired independence. Not only did it
give us working exposure in several geographies, we often
worked in teams with members from different countries.
Apart from learning best practices from different parts of
the world, I found the attitude to audit and culture quite
varied. When we came up with issues, in many countries
it would be accepted and debated purely at a professional
level, whereas in some it would be taken as a personal
assault by the auditee! Managing such conflicts by open
communication and objective fieldwork / analytics is a
valuable experience in honing leadership skills;

(iii) IA used to take on deputation team members from
other functions such as Manufacturing, Sales, QA, etc.
This provided a two-pronged advantage. As a primary
owner of controls, such functional members became the
spokespersons for demystifying IA within the organisation.
Equally, these members brought in their domain expertise
to raise the quality within IA, in particular on operational
controls. Involving and engaging team members in
different ways helps in building the control culture;

(iv) A udit always began with a meeting with the Chairman
/ MD / Business Head as the case may be. Not only
did this give a perspective to the business but it also
highlighted for the IA team the priorities and areas where
the business looked for support from IA. This would also
demonstrate the senior leadership’s commitment to IA.
Soon thereafter, we would convert this into a Letter of
Audit Scope outlining the focus areas of the particular
audit. In a sense, it was like giving out the question paper
before the exam! Open communication with the auditee
and a constructive attitude is the core of a productive
outcome.

Managing Risks

At the core of Board functioning in a company is the task
of managing risks. With change and uncertainty being
the order of the day, regulations require listed companies
to have a separate Risk Management Committee at the Board level which is often chaired by an Independent
Director. While identifying and managing financial and
operational risks can be delegated to the management,
the Board focuses on strategic or environmental risks.
A major risk which we find emerging is that of disruptions.
While the other risks which are identified or anticipated can
be reasonably managed, businesses today feel challenged
due to disruptions coming from various quarters. These
could be in the form of Regulatory disruption (e.g. FDI in
multi-brand retail), Market disruption (e- and m-commerce
congruence), Competitive disruption (Jio in the telecom
space), Change in consumer buying behaviour (leasing
or renting vs. buying) or Disruptors in the service space
(Airbnb or Uber). What businesses need to be planning
for is not just combating competition from traditional
competitors, but that coming from the outside as well.

The purport of these external risks become clear, as
pointed out by the World Economic Forum6, as global risks
– an unsettled world, risks to economic stability and social
cohesion, climate threats and accelerated biodiversity
loss, consequences of digital fragmentation, health
systems under new pressures. As for Covid-19, there
were research papers published post the SARS event
warning about such an eventuality. Stretching it further,
even films such as Contagion portrayed this. It is feared
that a number of MSMEs and startups may get seriously
throttled due to this disruption. How seriously do Boards
and managements take the cue from such pointers going
forward and, more important, prepare for such disruptions
is going to be the key in sustaining businesses.

As we learn to work differently during lockdowns, there is
a growing reliance on remote working and heightened use
of technology. Webinars, video chats, video conferences,
e-platforms and Apps have become daily routines and
add another dimension to cyber security, data protection
and data privacy.

In Rallis India Limited, it had been the practice for many
years to have an off-site meeting of the Board devoted
to discussing strategy and long-term plans. It is now
imperative that companies use such fora at a Board and
senior leadership level not only to debate annual and
long-term plans, but also scenario planning simulating
various major risks. These are necessary to strengthen
IC by crafting exhaustive disaster recovery plans not
only for operations or digital disruptions, but also for force majeure events occurring in different magnitudes
across the extended supply chain both within and
externally.

6 World Economic Forum: The Global Risks Report, 2020

Excellence in Business

In the Tata Group, in addition to instilling the Tata Code
of Conduct, all companies adopt the Tata Business
Excellence Model7 (TBEM). Based on the Malcolm
Balridge model of the USA, TBEM encourages Tata
Companies to strive for excellence in every possible
manner. Instituted by Chairman Emeritus Mr. Ratan Tata
in honour of Bharat Ratna Late J.R.D. Tata who embodied
excellence, TBEM is the glue amongst Tata Companies
to share best practices and provide a potent platform
for leadership development. Last year marked the 25th
year of its highest award called the JRD-Quality Value
Award, which was bestowed on companies that reached
a high threshold of business excellence. Rallis won the
JRD-QV Award in 2011 and I benefited hugely having
been an integral part of the TBEM process. This gave
me tremendous perspectives on managing businesses,
especially in the following areas:

(a) T BEM is a wall-to-wall model touching every aspect
of business from leadership to strategy to customer
to results. A trained team comprising members from
different backgrounds and businesses comes together
for an assessment over many man-months. While
assessment is done against a framework, this is not
in the nature of an audit. Evidence and records do not
get as much importance as interactions with people. It
is not uncommon for a team to interact with a thousand
persons connected with the company being assessed,
both workforce as well as other stakeholders. Therefore,
the smell of the company would give a perspective on
governance matters as well. Excellence assessments
is a great discipline for organisations to get an external
assurance on both governance and internal controls;

(b) U nique to TBEM is the practice of having Mentors for
every assessment. I have been privileged to be a longstanding
Mentor. The Mentor essentially assesses the
strategy of the company and also plays the crucial role of
being a bridge between the company and the assessing
team. The Mentor finally presents the assessment finding
to the Chairmen both at the company and at the Group
level. Over the years this has given me exposure to various
industries ranging from steel to battery to insurance to
coffee and retail, not to speak of connecting with scores of people within the Group and beyond. A great tool for
leadership development;

(c) T BEM uses the lens of continuous improvement
to assess businesses. Deep within lies the twin benefit
of this not only sharpening controls but also constantly
improving the effectiveness and efficiency of business
processes. The DNA of excellence in an organisation
leads every individual to keep questioning and enriching
jobs. Excellence is a journey, not a destination and a way
of doing business.

7 www.tatabex.com – About us – Tata Business Excellence Model

Bringing these together

All the three components, viz., risk management, internal
audit and business excellence acting in unison are
crucial to building and nurturing a sustainable business.
In many organisations, however, the degree of maturity
and the level of execution of each of these vary and are
rarely found to be harmoniously in motion. Embedded in
this lies the fact that each of these is driven by different
frameworks, parameters, regulations, formats, reporting systems, teams and so on. A softer aspect is that most
of this is perceived as a theoretical exercise and the
operating management having to fill in tedious forms
while running the business!

Here is an approach (Figure 3) which integrates all
of these driving similar goals and therefore avoiding
repeated exercises involving the operating teams.

The Enterprise Risk Management exercise carried out
across the organisation involving internal and external
stakeholders culminates in the identification of the
environmental, strategic, operational and financial risks
of the business. The Enterprise Process Management
model crafts all the business processes into three
levels which can be aligned and integrated with the
mitigation plans for the risks. These L1, L2 and L3
processes keep getting updated and improved annually
to drive continuous improvement as well as to enhance
controls.

The internal audit self-control checklists as well as audit
plans would be dovetailed with these mitigation plans and
processes. Such an approach will not only ensure that operations are run within the defined control framework
keeping risks within the appetite of the business, but
also strive continuously for excellence as processes
keep improving its efficiencies and effectiveness. This
integrated framework will then flow through populating the
various formats required and help the operating teams
to also address different reviews in a cohesive manner.
Above all, this brings in the desired objective of the entire
workforce viewing and putting into action the entire gamut
of the internal control framework enabling them to register
a superior performance in business.

The Late J.R.D. Tata’s quote sums this up well: ‘One
must forever strive for excellence, or even perfection, in
any task however small, and never be satisfied with the
second best.’

Driving excellence, all businesses will necessarily need
to uphold the highest standards of governance and
internal controls for long-term sustainable value creation,
committed to all stakeholders.

(This article is a sequel to Part 1 published on Page 15 in
BCAJ, March, 2020)

SPECIFIED DOMESTIC TRANSACTIONS: RETROSPECTIVE OPERABILITY OF OMISSION OF CLAUSE (i) TO SECTION 92BA(1)

Section 92BA of
the Income-tax Act, 1961 defines ‘Specified Domestic Transaction’ by providing
an exhaustive list of transactions; this section was introduced through the
Finance Act, 2012 w.e.f. 1st April, 2013. The transaction for
expenditure payable / paid to certain persons [mentioned u/s 40A(2)(b)], being
one of the specified domestic transactions, was omitted from the statute book
through the Finance Act, 2017 w.e.f. 1st April, 2017.

 

The enumeration
of a domestic transaction in section 92BA is a necessary requirement for the
reference of the same to the Transfer Pricing Officer u/s 92CA. Accordingly,
the omission of clause (i) to section 92BA(1) had the effect of restraining
reference to the Transfer Pricing Officer in case of transactions for expenditure
payable / paid to certain persons [mentioned u/s 40A(2)(b)] on and after the
date of enforcement of the omission (1st April, 2017).

 

The above said
omission and its effect was clear enough to rule out the scope for any
ambiguities, but incidentally, there exist contradictory findings / judicial
pronouncements by certain Tribunals as well as the High Courts in relation to
(A) applicability of the above said omission since 1st April, 2013,
i.e. the date of introduction of section 92(BA); (B) on holding that the clause
(i) to be believed to have never existed on the statute book; and (C) holding
the reference to the Transfer Pricing Officer in respect of clause (i)
transactions as void ab initio. Hence, this
article puts forth a synopsis of various judicial decisions on the captioned
issue.

 

MOOT QUESTION FOR
CONSIDERATION

The moot question
for consideration is whether the provisions appearing in clause (i) to
section 92BA [i.e., the clause that included expenditures relating to clause
(b) of section 40A(2), under Specified Domestic Transactions], which was
omitted vide Finance Act, 2017 with effect from 1st April,
2017, will be considered as omitted since the date on which section 92BA was
brought into force (i.e., 1st April, 2013 itself), which makes
clause 92BA(1)(i) inapplicable even in respect of the period of assessment
prior to 1st April, 2017?

 

And accordingly, whether
it is a correct and settled position of law to state that when a provision is
omitted, its impact would be to believe that the particular provision did not
ever exist on the statute book and that the said provision would also not be
applicable in the circumstances which occurred when the provision was in force
even for the prior period?

 

WHAT IS CENTRAL TO THE
ISSUE

Section 92BA, as it
stood prior to the omission of clause (i), and section 92CA are central to the
issue at stake and hence are reproduced hereunder:

 

Section
92BA(1) – For the purposes of this section
and sections 92, 92C, 92D and 92E, ‘specified domestic transaction’ in case of
an assessee means any of the following transactions, not being an international
transaction, namely,

(i) any
expenditure in respect of which payment has been made or is to be made to a
person referred to in clause (b) of sub-section (2) of section 40A;

(ii) any
transaction referred to in section 80A;

(iii) any
transfer of goods or services referred to in sub-section (8) of section 80-IA;

(iv) any
business transacted between the assessee and other person as referred to in
sub-section (10) of section 80-IA;

(v) any
transaction referred to in any other section under Chapter VI-A or section
10AA, to which provisions of sub-section (8) or sub-section (10) of section
80-IA are applicable; or

(vi) any other
transaction as may be prescribed and where the aggregate of such transactions
entered into by the assessee in the previous year exceeds a sum of [five] crore
rupees.

Section
92CA(1) – Where any person, being the
assessee, has entered into an international transaction or specified domestic
transaction in any previous year, and the Assessing Officer considers it
necessary or expedient so to do, he may, with the previous approval of the
Principal Commissioner or Commissioner, refer the computation of the arm’s
length price in relation to the said international transaction or specified
domestic transaction under section 92C to the Transfer Pricing Officer.

 

PROSPECTIVE, NOT
RETROSPECTIVE

It is pertinent to
note here that the deletion by the Finance Act, 2017 was prospective in nature
and not retrospective, either expressly or by necessary implication of the
Parliament. At this juncture, the findings of ITAT Bangalore (further
upheld by the High Court of Karnataka in ITA 392/2018) in Texport Overseas Pvt.
Ltd. vs. DCIT [IT(TP)A No. 2213/Bang/2018] are of relevance:

 

The ITAT held that ‘clause (i) of section 92BA deemed to be omitted from its
inception and that clause (i) was never part of the Act. This is due to the
reason that while omitting the clause (i) of section 92BA, nothing was
specified whether the proceeding initiated or action taken on this continue.
Therefore, the proceeding initiated or action taken under that clause would not
survive at all in the absence of any specific provisions for continuance of any
proceedings under the said provision. As a result if any proceedings have been
initiated, it would be considered or held as invalid and bad in law.’

 

WIDE ACCEPTANCE

This finding of the
ITAT Bangalore received wide acceptance all over the country and had been
followed by various Tribunals (such as ITAT Indore, Ahmedabad, Cuttack and
Bangalore).

 

The Tribunal based
its finding completely on the following judicial pronouncements pertaining to
section 6 of the General Clauses Act, 1897:

i.  Kolhapur Canesugar Works Ltd. vs. Union of
India in Appeal (Civil) 2132 of 1994 vide
judgment dated 1st February, 2000 (SC);

ii. General Finance Co. vs. Assistant Commissioner
of Income-tax 257 ITR 338 (SC);

iii. CIT vs. GE Thermometrics India Pvt. Ltd. in ITA
No. 876/2008 (Kar.).

 

Before looking into
the findings of the Hon’ble Supreme Court in this regard, which were relied
upon by the ITAT Bangalore, sections 6, 6A and 24 of the General Clauses Act,
1897 should be considered. These sections are reproduced hereunder:

Section 6:‘Where this Act, or any Central Act or Regulation made after the
commencement of this Act, repeals any enactment hitherto made or hereafter to
be made, then, unless a different intention appears, the repeal shall not –

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

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

(c) affect any
right, privilege, obligation or liability acquired, accrued or incurred under
any enactment so repealed; or

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

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

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

 

Section 6A:‘Where any Central Act or Regulation made after the commencement of
this Act repeals any enactment by which the text of any Central Act or
Regulation was amended by the express omission, insertion or substitution of
any matter, then, unless a different intention appears, the repeal shall not
affect the continuance of any such amendment made by the enactment so repealed
and in operation at the time of such repeal.’

 

Section 24: ‘Where any Central Act or Regulation is, after the commencement of
this Act, repealed and re-enacted with or without modification, then, unless it
is otherwise expressly provided, any appointment notification, order, scheme,
rule, form or bye-law, made or issued under the repealed Act or Regulation,
shall, so far as it is not inconsistent with the provisions re-enacted,
continue in force, and be deemed to have been made or issued under the provisions
so re-enacted, unless and until it is superseded by any appointment
notification, order, scheme, rule, form or bye-law, made or issued under the
provisions so re-enacted.’

 

DEEMED ORDER

The effect of
section 24 insofar as it is material is that where the repealed and re-enacted
provisions are not inconsistent with each other, any order made under the
repealed provisions are not inconsistent with each other, any order made under
the repealed provision will be deemed to be an order made under the re-enacted provisions.

Section 24 of the
General Clauses Act deals with the effect of repeal and re-enactment of an Act
and the object of the section is to preserve the continuity of the
notifications, orders, schemes, rules or bye-laws made or issued under the
repealed Act unless they are shown to be inconsistent with the provisions of
the re-enacted statute. In the light of the fact that section 24 of the General
Clauses Act is specifically applicable to the repealing and re-enacting
statute, its exclusion has to be specific and cannot be inferred by twisting
the language of the enactments – State of Punjab vs. Harnek Singh (2002)
3 SCC 481.

 

WHERE AN ACT IS
REPEALED

Section 6 applies
to repealed enactments. Section 6 of the General Clauses Act provides that
where an Act is repealed, then, unless a different intention appears, the
repeal shall not affect any right or liability acquired or incurred under the
repealed enactment or any legal proceeding in respect of such right or
liability and the legal proceeding may be continued as if the repealing Act had
not been passed.

 

As laid down by the
Apex Court in M/s Gammon India Ltd. vs. Spl. Chief Secretary & Ors.
[Appeal (Civil) 1148 of 2006] that, ‘…whenever there is a repeal of
an enactment the consequences laid down in section 6 of the General Clauses Act
will follow unless, as the section itself says, a different intention appears
in the repealing statute. In case the repeal is followed by fresh legislation
on the same subject, the court has to look to the provisions of the new Act for
the purpose of determining whether they indicate a different intention. The
question is not whether the new Act expressly keeps alive old rights and
liabilities but whether it manifests an intention to destroy them. The
application of this principle is not limited to cases where a particular form
of words is used to indicate that the earlier law has been repealed. As this
Court has said, it is both logical as well as in accordance with the principle
upon which the rule as to implied repeal rests, to attribute to that
legislature which effects a repeal by necessary implication the same intention
as that which would attend the case of an express repeal. Where an intention to
effect a repeal is attributed to a legislature then the same would attract the
incident of saving found in section 6.’

 

Section 6A is to
the effect that a repeal can be by way of an express omission, insertion or
substitution of any matter, and in such kind of repeal unless a different
intention appears, the repeal shall not affect the continuance of any such
amendment made by the enactment so repealed and in operation at the time of
such repeal.

 

Now, we examine the
observations of the Apex Court in General Finance Co. vs.
ACIT. Therein, the Apex Court has examined the issue of retrospective
operation of omissions and held that the principle underlying section 6 as
saving the right to initiate proceedings for liabilities incurred during the
currency of the Act will not apply to omission of a provision in an Act but
only to repeal, omission being different from repeal as held in different
cases. In the case before the Apex Court, a prosecution was commenced against
the appellants by the Department for offences arising from non-compliance with
section 269SS of the Income-tax Act, 1961 (punishment for non-compliance with
provisions of section 269SS was provided u/s 276DD). Section 276DD was omitted
from the Act with effect from 1st April, 1989 and the complaint u/s
276DD was filed in the Court of the Chief Judicial Magistrate, Sangrur, on 31st
March, 1989.The assessee sought for quashing of the proceedings by filing a
petition u/s 482 of the Code of Criminal Procedure and Article 227 of the
Constitution. The High Court held that the provisions of the Act under which
the appellants had been prosecuted were in force during the accounting year
relevant to the assessment year 1986-87 and they stood omitted from the statute
book only from 1st April, 1989. The High Court, therefore, took the
view that the prosecution was justified and dismissed the writ petition. But
the Apex Court did not concur with the view of the High Court and ruled that:

 

‘…the principle
underlying section 6 of the General Clauses Act as saving the right to initiate
proceedings for liabilities incurred during the currency of the Act will not
apply to omission of a provision in an Act but only to repeal, omission being
different from repeal as held in the aforesaid decisions. In the Income-tax
Act, section 276DD stood omitted from the Act but not repealed and hence, a
prosecution could not have been launched or continued by invoking section 6 of
the General Clauses Act after its omission.’

 

PRINCIPLE OF EQUITY AND
JUSTICE

It is inferable
from the findings of the Apex Court that by granting retrospective operability
to the omission of a penal provision it was merciful and did uphold the
principles of equity and justice. But the moot question here is whether the
findings of the Apex Court in respect of a penal provision can be extended
universally to all kinds of provisions present under any law in force, i.e.
substantive, procedural and machinery provisions. A situation that revolves
around this moot question was before the Karnataka High Court in CIT vs.
GE Thermometrics India Pvt. Ltd. [ITA No. 876/2008] and further in DCIT
vs. Texport Overseas Pvt. Ltd. [ITA 392/2018], which followed the ratio
laid down by the Apex Court in General Finance Co. vs. ACIT and
applied the findings in an identical manner to the cases involving omission of
the provision providing definitions.

 

The ITAT Bangalore
in Texport Overseas also relied upon the findings of the Apex
Court in Kolhapur Canesugar Works Ltd. vs. Union of India [1998 (99) ELT
198 SC], wherein the sole question before the Hon’ble Court was whether
the provisions of section 6 of the General Clauses Act can be held to be
applicable where a Rule in the Central Excise Rules is replaced by Notification
dated 6th August, 1977 issued by the Central Government in exercise
of its Rule-making power, (and) Rules 10 and 10A were substituted. The findings
of the Apex Court herein were also similar to those in General Finance
Co. vs. ACIT, as to retrospective operability of the omission.

 

Section 6A of the
General Clauses Act is central to the captioned issue; it removes the ambiguity
of whether the repeal and omission both have the same effect as retrospective
operability. ‘Repeal by implication’ has been dealt with in State of
Orissa and Anr. vs. M.A. Tulloch and Co. [(1964) 4 SCR 461] wherein the
Court considered the question as to whether the expression ‘repeal’ in section
6 r/w/s 6A of the General Clauses Act would be of sufficient amplitude to cover
cases of implied repeal. It was stated that:

 

‘The next
question is whether the application of that principle could or ought to be
limited to cases where a particular form of words is used to indicate that the
earlier law has been repealed. The entire theory underlying implied repeals is
that there is no need for the later enactment to state in express terms that an
earlier enactment has been repealed by using any particular set of words or
form of drafting but that if the legislative intent to supersede the earlier
law is manifested by the enactment of provisions as to effect such
supersession, then there is in law a repeal notwithstanding the absence of the
word “repeal” in the later statute.’

 

REPEAL VS. OMISSION

The captioned issue
in reference to the findings of the Apex Court in Kolhapur Canesugar
Works Ltd. vs. Union of India and General Finance Co. vs. ACIT
was also discussed in G.P. Singh’s ‘Principles of Statutory Interpretation’ [12th
Edition, at pages 697 and 698] wherein the learned author expressed his
criticism of the aforesaid judgments in the following terms:

 

 

‘Section 6 of
the General Clauses Act applies to all types of repeals. The section applies
whether the repeal be express or implied, entire or partial, or whether it be
repeal simpliciter or repeal accompanied by
fresh legislation. The section also applies when a temporary statute is
repealed before its expiry, but it has no application when such a statute is
not repealed but comes to an end by expiry. The section on its own terms is
limited to a repeal brought about by a Central Act or Regulation. A rule made
under an Act is not a Central Act or regulation and if a rule be repealed by
another rule, section 6 of the General Clauses Act will not be attracted. It
has been so held in two Constitution Bench decisions. The passing observation
in these cases that “section 6 only applies to repeals and not to
omissions” needs reconsideration, for omission of a provision results in
abrogation or obliteration of that provision in the same way as it happens in
repeal. The stress in these cases was on the question that a “rule” not being a
Central Act or Regulation, as defined in the General Clauses Act, omission or
repeal of a “rule” by another “rule” does not attract section 6 of the Act and
proceedings initiated under the omitted rule cannot continue unless the new rule
contains a saving clause to that effect…’

 

In a comparatively
recent case before the Apex Court, M/s Fibre Boards (P) Ltd. vs. CIT
Bangalore [(2015) 279 CTR (SC) 89], the Hon’ble Court reconsidered its
opinion as to retrospective operability of omissions and distinguished the
findings in Kolhapur Canesugar Works Ltd. vs. Union of India, General
Finance Co. vs. ACIT and other similar cases. The Apex Court held that
sections 6 and 6A of the General Clauses Act are clearly applicable on
‘omissions’ in the same manner as applicable on ‘repeals’; it also held that:

 

‘…29. A reading
of this section would show that a repeal can be by way of an express omission.
This being the case, obviously the word “repeal” in both section 6 and section
24 would, therefore, include repeals by express omission. The absence of any
reference to section 6A, therefore, again undoes the binding effect of these
two judgments on an application of the per incuriam
principle.

…31. The two
later Constitution Bench judgments also did not have the benefit of the
aforesaid exposition of the law. It is clear that even an implied repeal of a
statute would fall within the expression “repeal” in section 6 of the General
Clauses Act. This is for the reason given by the Constitution Bench in M.A. Tulloch & Co. that only the
form of repeal differs but there is no difference in intent or substance. If
even an implied repeal is covered by the expression “repeal”, it is clear that
repeals may take any form and so long as a statute or part of it is obliterated,
such obliteration would be covered by the expression “repeal” in section 6 of
the General Clauses Act.

…32. In fact,
in ‘Halsbury’s Laws of England’ Fourth Edition,
it is stated that:

“So far as
express repeal is concerned, it is not necessary that any particular form of
words should be used. [R vs. Longmead (1795) 2 Leach 694 at 696]. All that is required is that an
intention to abrogate the enactment or portion in question should be clearly
shown. (Thus, whilst the formula “is hereby repealed” is frequently
used, it is equally common for it to be provided that an enactment “shall
cease to have effect” (or, if not yet in operation, “shall not have
effect”) or that a particular portion of an enactment “shall be
omitted”).’

 

In view of the
above-mentioned judicial pronouncements and the provision of law, it can be
interpreted that insofar as ‘omission’ forms part of ‘repeal’, the omission of
clause (i) to section 92BA(1) does not have retrospective operation and the
omission will not affect the reference to the Transfer Pricing Officer in
respect of transactions u/s 92BA(1)(i) for the accounting years prior to 1st
April, 2017. But on account of varied findings in this regard by the Tribunals
as well as the High Courts, the matter is yet to be settled.

INTERNAL AUDIT ANALYTICS AND AI

INTRODUCTION

Artificial Intelligence (AI) is set to be the key driver of
transformation, disruption and competitive advantage in
today’s fast-changing economy. We have made an attempt
in this article to showcase how quickly that change is
coming, the steps that Internal Auditors need to take to get
going on the AI highway and where our Internal Audits can
expect the greatest returns backed by investments in AI.

1.0 Artificial Intelligence Defined

While there are many definitions of Artificial Intelligence
/ Machine Intelligence, the easiest to comprehend is
about creating machines to do the things that people are
traditionally better at doing. It is the automation of activity
associated with human thinking:
(A) Decision-Making,
(B) Problem-Solving, and
(C) Learning.
A more formal definition would be, ‘AI is the branch of
computer science concerned with the automation of
intelligent behaviour. Intelligence is the computational
ability to achieve goals in the world’.

1.1 Common AI Terms and Concepts

Machine Learning (ML): This is a subset of AI. Machine
Learning algorithms build a mathematical model based
on sample data, known as ‘training data’, in order to
make predictions or decisions without being explicitly
programmed to perform the task.
* Unsupervised ML – Can process information without
human feedback nor prior data exposure;
* Supervised ML – Uses experience with other datasets
and human evaluations to refine learning.

Natural Language Processing (NLP): A sub-field of
linguistics, computer science, information engineering
and artificial intelligence concerned with the interactions
between computers and human (natural) languages, in
particular how to programme computers to process and
analyse large amounts of natural language data. NLP
uses ML to ‘learn’ languages from studying large amounts
of written text. Its abilities include:

(i) Semantics – What is the meaning of words in
context?
(ii) Machine Translation – Translate from one language
to another;
(iii) Name entity recognition – Map words to proper
names, people, places, etc.;
(iv) Natural Language Generation – Create readable
human language from computer databases;
(v) Natural Language Understanding – Convert text
into correct meaning based on past experience;
(vi) Question Answering – Given a human-language
question, determine its answer;
(vii) Sentiment Analysis – Determine the degree of
positivity, neutrality or negativity in a written sentence;
(viii) Automatic Summarisation – Produce a concise
human-readable summary of a large chunk of text.

Neural Network (or Artificial Neural Network): This
is a circuit of neurons with states between -1 and 1,
representing past learning from desirable and undesirable
paths, with some similarities to human biological brains.

Deep Learning: Part of the broader family of ML methods
based on artificial neural networks with representation
learning; learning can be supervised, semi-supervised
or unsupervised. Deep Learning has been successfully
applied to many industries:
(a) Speech recognition,
(b) Image recognition and restoration,
(c) Natural Language Processing,
(d) Drug discovery and medical image analysis,
(e) Marketing / Customer relationship management.

Leading Deep Learning frameworks are PyTorch
(Facebook), TensorFlow (Google), Apache MXNet,
Chainer, Microsoft Cognitive Toolkit, Gluon, Horovod and
Keras.

1.2 AI Concepts – Context Level (Figure 1)
1.3 Artificial Intelligence Challenges

Many challenges remain for AI which need to be managed
effectively:

(1) What if we do not have good training data?
(2) The world is biased, so our data is also biased;
(3) OK with deep, narrow applications, but not with wide ones;
(4) The physical world remains a challenge for computers;
(5) Dealing with unpredictable human behaviour in the wild.

2.0 Global Developments

There has always been excitement surrounding AI. A
combination of faster computers and smarter techniques
has made AI the must-have technology of any business.
At a global scale, the main business drivers for AI are:
(i) Higher productivity, faster work,
(ii) More consistent, higher quality work,
(iii) Seeing what humans cannot see,
(iv) Predicting what humans cannot predict,
(v) Labour augmentation.

2.1 Global Progress on AI – A few examples

2.2 The Internal Audit Perspective

Robotic Process Automation (RPA) is a key business driver for AI in audit in the sense that it has the potential to achieve significant cost savings on deployment. The goal of RPA is to use computer software to automate knowledge workers’ tasks that are repetitive and timeconsuming.

The key features of RPA are:
* Use of existing systems,
* Automation of automation,
* Can mimic human behaviour,
* Non-invasive.

The tasks which are apt for RPA are tasks which are definable, standardised, rule-based, repetitive and ones involving machine-readable inputs.

Sample listing of tasks for RPA:

2.3 Case Study of Application of RPA for Accounts Payable process (Figure 2; See following page)

2.4 AI Audit Framework for Data-Driven Audits (Figure 3; See following page)

3.0 Internal Audit AI in Practice – Case Study RPA Case Study from India:

A leading automobile manufacturer had the following

environment and challenges:

(a) Millions of vendor invoices received as PDF files;

(b) Requirement for invoice automation, repository build,

duplicate pre-check;

(c) Manual efforts were fraught with errors;

(d) PDF to structured data conversion was inconsistent;

(e) Conclusion: A Generic RPA tool was needed.

The solution proposed entailed:

(1) Both audit analytics and RPA being positioned as one solution,

(2) Live feed to the PDF files from diverse vendors,

(3) Extract Transform Load jobs were scheduled for the PDF files,

(4) Duplicate pre-check metrics were built and scheduled,

(5) Potential exceptions were managed through a convenient and collaborative secure email notification management system plus dashboards,

(6) Benefit – 85% reduction in effort and 10x improvement in turnaround time.

4.0 How you can get started on using AI in your

Internal Audits

You can get started on your AI journey in Internal Audit by bringing your analytics directly into the engagement. With AI in Audit the efficiency, quality and value of decisionmaking gets significantly enhanced by analysing all data pan enterprise as one.

Some of the steps you can take to get along in your Audit AI journey are listed below:

(I) Integrate your audit process / lifecycle;

(II) Collaborate with clients on a single platform;

(III) Make every audit a data-driven audit;

(IV) Use data analytics through all phases of projects;

(V) Use RPA where manual work is an obstacle;

(VI) Use Audit Apps where process is well-defined;

(VII) Augment audits with statistical models and Machine Learning;

(VIII) Evolve to continuous monitoring and Deep Learning.

(Adapted from a lecture / presentation by Mr. Jeffery Sorensen, Industry Strategist, CaseWareIDEA Analytics, Canada, with his permission)

GST ON PAYMENTS MADE TO DIRECTORS

This article
analyses the GST implications of different payments made by companies to their
Directors. Such payments can be broadly categorised into:

(1)    Remuneration to Whole-Time Directors

(2)    Remuneration to Independent Directors

(3)    Payment towards expenses as lump sum or as
reimbursement.

Each of the above
is discussed below.

 

REMUNERATION TO WHOLE-TIME DIRECTORS

Whole-Time
Directors (who can be professionals or from the promoter group) (‘WTD’) are
those persons who are responsible for the day-to-day operations of the company
and are entitled to a remuneration. The terms of appointment for such WTDs
(including the remuneration and perquisites) are as per the limits laid down by
Schedule V to the Companies Act, 2013. The remuneration can be a fixed minimum
amount per month or a combination of fixed amount plus a commission based on a
percentage of the profits. The said terms are laid down in an agreement
approved by the Board of Directors.

 

In terms of the agreement between the company and the WTD/s, the WTD is
regarded as having a persona of not only a Director but also an employee
depending upon the nature of his work and the terms of his employment.
Moreover, in all such cases the company makes necessary deductions on account
of provident fund, profession tax and deduction of tax at source under
Income-tax law, treats these Directors as employees of the company in filings
before all statutory authorities and considers the remuneration paid to them as
a salary. Thus, the relationship of the Director vis-à-vis the company would be
that of an employer-employee.

 

If the same is
analysed from the GST point of view, Schedule III of the Central Goods and
Services Tax Act, 2017 (‘CGST Act’) provides for supplies which are to be
treated neither as a supply of goods nor a supply of services. Entry (1) of the
said Schedule reads as follows, ‘Services by an employee to the employer in
the course of or in relation to his employment’. From this it can be
inferred that the services supplied by an employee to the employer is not a
service liable to GST.


REMUNERATION TO INDEPENDENT DIRECTORS

Independent Directors (‘IDs’), on the other
hand, are not WTDs but are recommended by the Board of Directors and appointed
by the shareholders. They are normally separate and independent of the company
management. These IDs provide overall guidance and do not work under the
control and supervision of the company management and therefore, by inference,
they are not employees of the company. IDs attend the meetings of the Board or
its committees for which they are paid fees, usually referred to as sitting
fees / directors’ fees. In many cases, the Directors are also paid a percentage
of profits as commission.

Analysing these
payments to IDs from the GST perspective, 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’) provides that the ‘GST on services supplied by
a director of a company or a body corporate to the said company or the body
corporate located in taxable territory shall be paid under reverse charge
mechanism by the recipient of services’.

 

Thus, in case of
payments to IDs (whether they are located in India or domiciled outside India),
the company will have to pay GST under Reverse Charge Mechanism (‘RCM’),
albeit appropriate credit of such GST paid shall be available to the
company, subject to fulfilment of other terms and conditions of availment of
ITC.

 

PAYMENT TOWARDS EXPENSES AS LUMP SUM OR AS REIMBURSEMENT

In many companies,
Directors (whether WTDs or IDs) are also paid a lump sum amount towards
expenses, or reimbursed the actual expenses incurred by them in performing
their duties as directors, e.g. travel expenses, accommodation expenses, etc.
The same is as per the terms of appointment for WTDs or the Directors’ Expense
Reimbursement Policy of the company.

 

Regarding the
applicability of GST on such payments, the Authority on Advance Rulings (‘AAR’)
in the case of M/s Alcon Consulting Engineers (India) Private Limited,
Bengaluru (AR No. Kar ADRG 83/2019) dated 25th September, 2019,
while responding to the query, whether expenses incurred by employees and later
reimbursed by the company are liable to GST, ruled in the negative and observed
that the expenses incurred by the employees are expenses of the applicant and
therefore this amount reimbursed by the applicant to the employee later on
would not amount to consideration for the supplies received, as the services of
the employee to his employer in the course of his employment is not a supply of
goods or supply of services and hence the same is not liable to tax.

 

Therefore, any
expense reimbursement to a WTD who is treated as an employee would not be
liable to GST. However, if the reimbursement of expenses is made to an ID, who
also receives sitting fees, the same shall be treated as part of the
consideration and would be liable to GST under the RCM.

 

Analysis of
the AAR decision in Clay Craft India Private Limited

Whilst the above provisions of the GST law regarding the taxability of
payments made to the Directors were fairly settled, a recent Advance Ruling
issued by the AAR, Rajasthan in the case of Clay Craft India Private
Limited (AR No. Raj/AAR/2019-20/33) dated 20th February, 2020 held
that consideration paid to Directors by the company will attract GST on Reverse
Charge basis as it is covered under Entry 6 of the Reverse Charge Notification
issued under the CGST Act. Entry 6 of the said Notification provides that the
GST on services supplied by a Director of a company or a body corporate to the
said company or the body corporate located in the taxable territory shall be
paid under RCM by the recipient of services.

 

SERVICE SUPPLIED BY AN
EMPLOYEE

The applicant in
the above Advance Ruling had sought clarity on ‘whether payment made for
services availed from a Director, in their capacity as an employee, is also
liable to be taxed under GST on RCM basis’. The clarification was sought
keeping in mind Entry (1) of Schedule III of the CGST Act on the basis of which
the ‘Services by an employee to the employer in the course of or in
relation to his employment’ is treated neither as a supply of goods nor
a supply of services. Thus, the service supplied by an employee to the employer
is not a supply for GST purposes.

The aforesaid query
was raised by the applicant pursuant to a decision passed by the AAR, Karnataka
in the case of M/s Alcon Consulting Engineers (Supra) wherein the
Authority provided that the services provided by the Director to the company
are not covered under Schedule III Entry (1) of the CGST Act as the Director is
not an employee of the company and hence the payment made to him is liable to
GST.

 

In both the
aforesaid rulings, there is no segregation of payments / consideration paid to
the Directors for the services provided by such Directors in their capacity as
an employee or as an agent or as a Director.

 

EPF DEDUCTED FROM
DIRECTORS

It would be pertinent to note that the applicant in the Clay Craft
case (Supra) was already paying GST under RCM on any commission paid to
its Directors, who were providing services to the company in the capacity of
Director. However, payments for the services received from its Whole-Time
Directors / Managing Directors, who were supplying services in their capacity
as employees of the company, were made in the form of salary and the same were
also offered by the Directors in their personal income tax returns under
‘Income from Salary’. The company was also deducting EPF from their salaries
and all other benefits given to them were as per the policy decided by the
company for its employees.

 

However, the AAR
did not consider the above and only took note of the RCM entry under GST and
denied treating Directors as employees of the company.

 

Analysis of
the AAR decision in Anil Kumar Agrawal

In yet another
recent Advance Ruling by the AAR, Karnataka in the case of M/s Anil Kumar
Agrawal (AR No. Kar ADRG 30/2020) dated 4th May, 2020, the
Authority analysed incomes derived from various sources so as to examine
whether such income in relation to any transaction amounts to supply or not.
One such source of income examined was ‘Salary received as Director from
a Private Limited Company’.

 

The AAR, Karnataka
at paragraph 7.8 of the ruling explicitly observed that:

‘The applicant
is in receipt of certain amount termed as salary as Director of a private
limited company. Two possibilities may arise with regard to the instant issue
of amount received by the applicant. The first possibility that the applicant
is the employee of the said company (Executive Director), in which case the
services of the applicant as an employee to the employer are neither treated as
supply of goods nor as supply of services, in terms of Schedule III of CGST Act
2017.

The second
possibility that the applicant is the nominated Director (non-Executive
Director) of the company and provides the services to the said company. In this
case the remuneration paid by the company is exigible to GST in the hands of
the company under reverse charge mechanism under section 9(3) of the CGST Act
2017, in the hands of the company, under Entry No. 6 of Notification No.
13/2017-Central Tax (Rate) dated 28th June, 2017.

…….

…….

In view of the
above, the remuneration received by the applicant as Executive Director is not
includable in the aggregate turnover, as it is the value of the services
supplied by the applicant being an employee.’

 

OBSERVATIONS

Keeping in view
these contradictory rulings, it would be pertinent to have a look at some of
the observations made in the following judgments / circulars / notifications of
various authorities. Though the judgments are in respect of the erstwhile
Service Tax law, the provisions being identical can also be applied to GST.

 

(i)     Remuneration paid to the Managing Director
is to be considered as salary. A Managing Director may be regarded as having a
persona of not only a Director but also an employee or agent, depending upon
the nature of his work and the terms of the employment1.

(ii)    If an amount paid to an individual was
treated as salary by the Income-tax Department, it could not be held by the
Service Tax Department as amount paid for consultancy charges and to demand
service tax on the same2.

(iii)   If a Director is performing duties and is
working for the company, he will come within the purview of an employee3.

(iv)   Remuneration paid to four Whole-Time Directors
for managing the day-to-day affairs of the company and where the company made
necessary deductions on account of provident fund, professional tax and TDS as
applicable and declared these Directors to all statutory authorities as
employees of the company, remuneration paid to Directors was nothing but salary
and the company was not required to discharge service tax on remuneration paid
to Directors4.

(v)    The Managing Director of a company may be
executive or non-executive. A Managing Director of a company may or may not be
an ‘employee’ of the company. It was rightly held that for the purpose of ESIC
the company is the owner. The Managing Director is not the ‘owner’. Even if the
Managing Director is declared as ‘Principal Employer’ to ESIC, he can still be
an employee5.

(vi)   Payments made by a company to the Managing
Director / Directors (Whole-Time or Independent) even if termed as commission,
is not ‘commission’ that is within the scope of business auxiliary service and,
hence, service tax would not be leviable on such amount6.

(vii) The Managing Director / Directors (Whole-Time or
Independent) being part of the Board of Directors, perform management functions
and they do not perform consultancy or advisory functions…In view of the above,
it is clarified that the remunerations paid to the Managing Director /
Directors of companies whether Whole-Time or Independent when being compensated
for their performance as Managing Director / Directors, would not be liable to
service tax7.

(viii) The service tax (now GST) paid by the company
will be treated as part of remuneration to non-Whole-Time Directors and if it
exceeds the ceiling of 1% / 3%, the approval of the Central Government would be
required – Circular No. 24/2012 dated 9th August, 2012 of the
Ministry of Corporate Affairs. This entire circular is on the basis that GST is
payable on payments made to non-Whole-Time Directors only. And, as a corollary,
it can be inferred that service tax (now GST) shall not be payable on payments
made to Whole-Time Directors.

 

1 In Ram Prasad vs. CIT (1972) 2 SCC 696 dated
24th
August,
1972 bound to
cause uncertainty and unnecessary litigation.

2 In Rentworks India P Ltd. vs. CCE (2016) 43
STR 634 (Mum. – Trib.)

3 In Monitron Securities vs. Mukundlal
Khushalchand 2001 LLR 339 (Guj. HC)

4 In Allied Blenders and Distillers P Ltd. vs.
CCE & ST [2019] 101 taxmann.com 462 (Mum. –CESTAT)

5 In ESIC vs. Apex Engineering Ltd. 1997 LLR 1097

6 CBE&C Circular No. 115/09/2009-ST dated 31st July, 2009

7 CBE&C Circular No. 115/09/2009-ST dated 31st July, 2009

MAY LEAD TO NEEDLESS
LITIGATION

From the above it
can be further deduced that a Director may provide services to a company in the
capacity of a Director or agent or employee and may receive consideration /
payments in the form of sitting fees or commission or salary, depending on the
arrangement he / she has with the company. Consequently, tax would be payable
in accordance with the nature of the consideration derived by a company’s
Director providing services in his / her capacity as a Director or agent or
employee. Under such circumstances, considering all payments to Directors under
one category and imposing GST on the same is against the established principles
of law and bound to cause uncertainty and unnecessary litigation.

 

 

The AAR seems to have erred in delivering the rulings under the Clay
Craft and the M/s Alcon Consulting Engineers cases (Supra)
and by obvious inadvertence or oversight failed to reconcile the aforesaid
issue with that of some previously pronounced judgments of co-equal or higher
authorities. It also appears that the AAR wanted to differ from the precedents;
however, it was not open to the AAR to completely ignore the previous decisions
on illogical and unintelligible grounds. Regrettably, the ruling delivered by
the AAR without referring to the aforesaid precedents and without consciously
apprising itself of the context of such judgments on similar issues, is per
incuriam, meaning a judgment given through inadvertence or want of
care, and therefore requires reconsideration. Per incuriam judgments are
not binding judgments. Needless to say, the AAR is only binding on the
applicant but carries some reference and, therefore, nuisance value and should
be appealed before the higher forum.

 

CONCLUSION

While the AARs are not binding on anyone other than the applicants, the
companies may revisit their payments to Directors on which GST is not being
currently paid by them under RCM. Such payments should be analysed on the basis
of the contract / agreement with the Directors and the payment / non-payment of
GST under RCM against such payments to Directors be decided and documented.

 

There is also an
immediate need for a Central Appellate Authority for Advance Rulings since
contradictory rulings given by different state authorities, and sometimes even
by the same state authority as in the case discussed above (by the AAR,
Karnataka) can result in unnecessary confusion and avoidable litigation.

 

OFFICE SUITES FOR PRODUCTIVITY

Office Suites are suites of personal
productivity products for primarily creating documents, spreadsheets and
presentations. Of late, the trend has been to move away from installed,
licensed software products towards online products that are accessed over the
Internet and are paid via a monthly or annual subscription, with free updates
during the period of subscription. In earlier days, we all started our
computers with Wordstar and Lotus 1-2-3. Office Suites have ‘graduated’ since
then, with additional features and extended capabilities which are barely used
in our day-to-day working. But we cannot do without them either. Here, we take
an overview of some major leading Office Suites for productivity at the
workplace.

 

MICROSOFT OFFICE

Microsoft Office is the king of Office
Suites comprising a complete collection of Word, Excel, PowerPoint, OneDrive,
Outlook, OneNote, Skype and Calendar. If you are comfortable and used to the
Microsoft eco-system (who isn’t?) this is the best choice for you. Microsoft
365 Family (originally Office 365) and the allied range is the latest online
version of the Suite, is quite affordable, auto-upgradable and allows you to
backup and store your documents online with a whopping online storage of up to
1 TB per user, for multiple devices. You can work online and offline and the
.docx, .xlsx and .pptx formats are the gold standard for office suites. The
entire suite encompasses a plethora of features and you can utilise them as you
grow your proficiency in handling them. They also have Android and iOS versions
which work seamlessly on your mobile phones.

 

G-SUITE / GOOGLE DOCS

G-Suite is the office suite from another
online giant – Google. It offers Gmail, Docs (including docs, sheets,
presentations, forms, drawings), Drive and Calendar for business – all that you
need to do your best work, together in one package that works seamlessly from
your computer, phone or tablet. The pricing per user is very attractive in
India. You can use either the online or the offline mode as per your convenience.
Of course, it has Android and iOS versions also, which makes it easy to use the
suite from any device you own.

 

Google Docs is the free version of G-Suite
with the same powerful features, but with scaled-down capabilities and reduced
storage online.

 

Most of the features of Microsoft Office for
day-to-day use are found in G-Suite. Of course, being a Google product, the
search function is very powerful and innovative. If you are comfortable with
the Google environment, G-Suite is the best choice for you.

 

LIBREOFFICE

LibreOffice is a powerful and free office
suite, a successor to OpenOffice (.org), used by millions of people around the
world. Its clean interface and feature-rich tools help you unleash your
creativity and enhance your productivity. LibreOffice includes several
applications that make it the most versatile free and open source office suite
on the market: Writer (word processing), Calc (spreadsheets), Impress
(presentations), Draw (vector graphics and flowcharts), Base (databases) and Math
(formula editing).

 

LibreOffice is free and gets updated
regularly. It is compatible with a wide range of document formats such as
Microsoft® Word (.doc, .docx), Excel (.xls, .xlsx), PowerPoint (.ppt, .pptx)
and Publisher. But LibreOffice goes much further with its native support for a
modern and open standard, the Open Document Format (ODF). With LibreOffice, you
have maximum control over your data and content – and you can export your work
in many different formats, including PDF.

 

WPS OFFICE

WPS Office is a complete, free office suite
with a PDF editor. It is available across platforms and can be used on Mac, PC,
Android, iOS, Linux and also online. It includes many useful templates (just
like Microsoft and Google offerings) which help you to start creating excellent
documents right from the word go.

The documents created have high level of
compatibility with Microsoft Office, Google Docs and Adobe PDF. The entire
package is ultra-light with an ultra-small installation and ultra-fast startup
speed. It is available off the shelf with 8 languages for PC and 46 languages
for Android. So if you have a lot of multilingual correspondence with
international clients, this would be the best option for you.

 

With PDF, Cloud, OCR, file repair and other
powerful tools, WPS Office is quickly becoming more and more people’s first
choice in office software.

 

SMARTOFFICE

SmartOffice lets you view and edit Microsoft
Office files and also PDFs on the go. It is an intuitive, easy-to-use document
editing app with a sleek design inspired by the familiar UI of a desktop Office
document. Users can view, edit, create, present and share MS Office documents
directly on or from their mobile devices. Word, Excel, PowerPoint, PDF are also
supported. Besides, you can print wirelessly directly from the App to a host of
printers which are WiFi-enabled.

 

Documents can be saved in original file
formats or quickly converted to PDFs. All editing and formatting functions are
supported. Support is available even for password-protected documents. Full
Cloud Synchronisation is available and you can open and save documents to the
Cloud with effortless ease with Box, Dropbox and Google Drive.

 

A must-have tool in your suite of apps for
productivity on the go.

 

So now you have many options, many of
them free – just choose the one best for you and go right ahead with improving
your productivity at work. Best wishes!

SHARING INSIDE INFORMATION THROUGH WhatsApp – SEBI LEVIES PENALTY

BACKGROUND

On 29th April,
2020, SEBI passed two orders (‘the orders’) levying stiff penalties on two
persons who allegedly shared price-sensitive information. The information they
shared was the financial results of listed companies before these were
officially published.

 

About two years back, there
were reports in the media that the financial results of leading companies had
been leaked and shared on WhatsApp before they were formally released. It was
also alleged that heavy trading took place based on such leaked information.
These orders are, thus, the culmination of the investigation that SEBI
conducted in the matter. It is not clear whether these are the only cases or
whether more orders will be passed, considering that leakage was alleged in
respect of several companies. (The two orders dated 29th April, 2020
relate to the circulation of information concerning Ambuja Cements Limited and
Bajaj Auto Limited.)

 

Insider trading is an issue
of serious concern globally. Leakage of price-sensitive information to select
people results in loss of credibility of the securities markets. However, the
nature of insider trading is such that it is often difficult to prove that it
did happen. This is particularly so because such acts are often committed by
people with a level of financial and other sophistication. Hence, the
regulations relating to insider trading provide for several deeming provisions
whereby certain relations, acts, etc. are presumed to be true. As we will see,
in the present cases the order essentially was passed on the basis of some of
these deeming provisions. However, as we will also see, the application of such
deeming provisions in the context of social media apps like WhatsApp can
actually create difficulties for many persons who may be using them for
constant informal communication.

 

WHAT
ALLEGEDLY HAPPENED?

There were media reports that
the financial results of certain leading companies were leaked in some WhatsApp
groups well before they were formally approved and published by the companies.
Financial results are by definition deemed to be price-sensitive information,
meaning that their release can be expected to have a material impact on the
price of the shares of such companies in the stock market. In the two companies
considered in the present cases, it was alleged that there was a sharp rise in
the volumes of trade after the leakage.

 

It was found that two persons
– NA and SV – had shared the results through WhatsApp in respect of the two
companies. NA shared the information with SV and SV passed it on to two other
persons. SEBI carried out extensive raids and collected mobile phones and
documents. But it could not trace back how the information got leaked from the
companies to these persons in the first place and whether it was passed on to
even more people. In both the cases it was found that the information that was
leaked and shared matched with the actual results later released formally by
the companies.

 

Thus, it was alleged that NA
and SV shared UPSI in contravention with the applicable law. NA and SV were
stated to be working with entities associated with the capital markets.

 

WHAT
IS THE LAW RELATING TO INSIDER TRADING?

While the SEBI Act, 1992
contains certain broad provisions prohibiting insider trading, the detailed
provisions are contained in the SEBI (Prohibition of Insider Trading)
Regulations, 2015 (‘the Regulations’). These elaborately define several terms
including what constitutes insider trading, who is an insider, what is
unpublished price-sensitive information (‘UPSI’), etc. For the present
purposes, it is seen that financial results are deemed to be UPSI. Further, and
even more importantly in the present context, the term insider includes a
person in possession of UPSI. The offence of insider trading includes sharing
of UPSI with any other person. Thus, if a person is in possession of UPSI and
shares it with another person, he would be deemed guilty of insider trading.

 

It is not necessary that such
person may be connected with the company to which the UPSI relates. Mere
possession of UPSI, by whatever means, makes him an insider and the law
prohibits him from sharing it with any other person. This thus casts the net
very wide. In principle, even a person who finds a piece of paper containing
financial results on the road would be deemed to be an insider and cannot share
such information with anyone!

 

WHAT
DID THE PARTIES ARGUE IN THEIR DEFENCE AND HOW DID SEBI DEAL WITH THEM?

The parties placed several
arguments to contend that they could not be held to have violated the
regulations.

 

They claimed that they were
not aware that these were confirmed financial results and pointed out that
globally there was a common practice to discuss and even share gossip, rumours,
estimates by analysts, etc. relating to companies. There were even columns like
‘Heard on the Street’ which shared such rumours. They received such information
regularly and forwarded it to people. They pointed out that there were many
other bits of information that they shared which were later found to be not
accurate / true. But SEBI had cherry-picked this particular item. As far as
they were concerned, these WhatsApp forwards were rumours / analysts’
estimates, etc. like any other and were thus expected to be given that level of
credibility.

 

SEBI, however, rejected this
claim for two major reasons. Firstly, it was shown that the information shared
was near accurate and matched with the actual results later released by the
companies. Secondly, the law was clear that being in possession of UPSI and
sharing it made it a violation. It was also pointed out that the claim that
these were analysts’ estimates was not substantiated.

 

The parties also pointed out
that they were not connected with the companies. Further, no link was
established with anyone in the companies and the information received by them.
But SEBI held that because mere possession of UPSI made a person an insider, no
link was required to be shown between the parties or the source of information
and the companies.

 

It was also pointed out that
they had not traded on the basis of such information. Here, too, SEBI said that
mere sharing of UPSI itself was an offence. Further, SEBI said that it was also
not possible to determine due to technical reasons who were the other persons
with whom the information may have been shared and whether anyone had traded on
the basis of such information.

 

There were other contentions,
too, but SEBI rejected all of them and held that the core ingredients of the
offence were established.

 

ORDER
OF SEBI

SEBI levied in each of the
orders on each of the parties a penalty of Rs. 15 lakhs. Thus, in all, a total
penalty of Rs. 60 lakhs was levied on the two. SEBI pointed out that it was not
possible to determine what were the benefits gained and other implications of
the sharing of information. However, it said that an appropriate penalty was
required to be levied to discourage such actions in the markets.

 

CRITIQUE
OF THE ORDERS

Insider trading, as mentioned
earlier, is looked at very harshly by laws globally and strong deterrent
punishment is expected on the perpetrators. However, there are certain aspects
of these orders that are of concern and there are also some general lessons.

 

The core point made in the
orders is that mere possession of UPSI is enough to make a person an insider.
There is certainly a rationale behind such a deeming provision. It is often
very difficult to prove links between a company and its officials with a person
in possession of inside information. A company is expected to take due steps to
prevent leakage of information by laying down proper systems and safeguards.
If, despite this, information is leaked, then the person in possession is
likely to have got it through some links. Further, where a person is in
possession of such information, even if accidentally, it would be expected of
him to act responsibly and not to trade on it or share it with others. In the
present case, SEBI held that the parties were having the UPSI and they should
not have shared it with others.

 

However, there are certain
points worth considering here, in the opinion of the author. The parties have
claimed that they have been sharing many other items which were not confirmed
or authentic information but merely what was ‘heard on the street’. The persons
who received it would also treat such information with the same level of
scepticism. If, say, 24 items were shared which were mere rumours and then one
such item was shared without any further tag to it, the fair question then
would be whether it should really be treated as UPSI, or even ‘information’? SEBI
has not alleged or recorded a finding that there was any special mention that
these bits of information were unique and authentic.

 

SEBI has stated that the
parties should have noted later, when the results were formally declared, that
the information was confirmed to be authentic. The question again is whether it
can be expected of a person, if, assuming this was so, he or she is sharing
hundreds of such forwards, to check whether any such item was found later to be
true?

 

SEBI has insisted that (i) it
was shown that the information was authentic, (ii) it was deemed to be
price-sensitive, (iii) it was not published, (iv) the parties were in
possession of it, and (v) they shared it. Hence, the technical requirements for
the offence were complete and thus it levied the penalty. It is also relevant
to note that the same two parties were found to have shared UPSI in two
different companies and to the same persons.

 

Be that
as it may, this is an important lesson for people associated with the capital
markets. Social media messages are proliferating. People chat endlessly on such
apps and forward / share information. We have earlier seen cases where
connections on social media were considered as a factor for establishing
connections between people. The lesson then is that, at least in the interim,
people connected with the capital market and even others would need to err on
the side of caution and not share any such items. Just as people are
increasingly advised to be careful about sharing information received on WhatsApp
and the like which could be fake news, such caution may be advised for such
items, too. The difference is that in the former case it is to safeguard
against fake news and in the latter it is to safeguard against authentic news!

 

At the same time, it is
submitted that a relook is needed at the deeming provisions and their
interpretation and exceptions may need to be made. Sharing of guesses, gossip,
estimates, etc. ought not to be wholly banned as they too have their productive
uses. Considering the proliferating nature of such apps and their productive
uses, it may not be possible or fair to expect that people will not discuss or
share gossip and things that are ‘heard on the street’. Something more should
be required to be established to hold a person as guilty than the mere ticking
off of the technical requirements of an offence.

 

 

ANAND YATRA: IN THE PURSUIT OF HAPPINESS

Anand yatra
means a happiness tour. All of us want to be happy in life and that, too,
forever. But let’s not forget that one doesn’t really need any reason to be
happy. On the other hand, one needs a reason to be unhappy!

 

Laughter and smiles manifest
happiness, while tears signify unhappiness. A wide, genuine smile reflects
happiness. Anandashru (tears of joy) are the tears that flow on happy
occasions. At any marriage there are tears in the eyes of the bride and her
family. These could be partly anandashru on the new beginning in her
life and partly sadness due to her vidai from the family. We have also
read that ‘A curve of a smile can straighten many issues’.

 

Happiness arises through
possession of tangible things such as money, property, jewellery and so on.
Happy moments are felt and experienced out of sound health and good
relationships. Sadly, tangible objects provide happiness for a short and
limited time. It could, perhaps, be worthwhile spending resources on
experiences. A bank of fantastic experiences brings happiness and joy when
those cherished memories unfold. One can re-live, refresh and share such
memories, time and again, bringing joy to ourselves and the people around us.

 

Health and happiness are also
closely related. Short-term diseases can affect happiness temporarily. Chronic
ailments can bring long-term misery. To be healthy and happy one can embrace
regular meditation, have adequate sleep, adopt an exercise pattern and change
to healthy food habits. However, one has to accept the fact that one can take
all precautions to be healthy, but hereditary family health parameters are
beyond one’s control and one may have to learn to happily accept them and live
with them. Generally, happiness brings along health.

 

Happiness is an attitude, a
habit. It is more inner than outer. A person with all physical comforts and
facilities may still be unhappy. On the other hand, a person with just the
basic comforts may be happier. In this anand yatra, contentment and
control play a crucial role in achieving happiness. A person caught in the
vicious cycle of craving more and more may never be happy with his / her
achievements.

 

Many times we feel we should
search for happiness and joy in small things. The best example of this could be
a little child finding happiness in playing with all kinds of pots, pans and
cutlery in the kitchen, leaving aside costly toys. In religious and
philosophical parlance, Namasmaran (chanting of God’s name) gives
peace of mind with ultimate happiness of an enduring nature.

 

Happiness makes a person more
creative, productive and efficient. A positive state of mind can bring success
with ease and comfort. While we may think success will bring us happiness, the
lab-validated truth is that happiness brings us more success. Change could
result in happiness or misery. A person who adapts to change is happy, and vice
versa.

 

Nowadays, among the elderly
and the middle-aged people laughter clubs have become quite popular. They
generate intentional laughter to bring happiness among the participants. In
this commercial world there are also workshops conducted to teach happiness and
the joys of life. The well-known Marathi writer, the late P.L. Deshpande, had
an amazing and unique talent to generate ‘Hasuaniaasu’, meaning laughter
and tears, at the same time.

 

In sum, instead of the
pursuit of happiness, let us live life as an expression of happiness. Happiness
without doubt multiplies with sharing and the journey of life is an opportunity
to share happiness. Let’s undertake the anand yatra of life as a true yatrekaru
(pilgrim).  

 

A CA’s HAPPINESS QUOTIENT!

I deplore the Hon’ble Minister of Finance for
snatching away from the Chartered Accountants’ community a particular moment of
happiness which they long for every year. What is that moment? I will come to
it in another moment.

 

A fox once woke up in a desert. He saw his
shadow which was very long. He thought to himself, ‘Oh! What a long shadow I
have! I must find a shelter for myself which will accommodate this long shadow
of mine!’

 

So he began to hunt for such a shelter in the
desert. He walked miles and miles but could not find a shelter befitting his
shadow. He was tired, sweating, hungry and thirsty. He was frustrated. Soon it
was high noon.

 

Tired and perspiring, he again looked at his
own shadow for which he was on this mission. When he saw it, he exclaimed to
himself, ‘Ah! What a fool I am! For such a small shadow I toiled for such a
long time unnecessarily’. So he found a small shelter and happily stayed there.

 

This is typical of a man who is very ambitious
in his youth. He wants to change the world. But later he realises that the
world is very ruthless and the going gets really tough. Then he derives
happiness even with the very little success which is much less than what he deserves,
and much within his ability.

 

When one passes one’s CA, one has a lot of
dreams. One feels that one will perform wonders in the financial world, or one
will perform one’s audit function very effectively and not tolerate nonsense in
accounts. One feels that one can win tax litigations purely on merits, on one’s
knowledge and presentation skills. But soon one realises that the means of
achieving success are totally different. If one does not want to compromise
with one’s conscience and ethics, one remains complacent with whatever little
one gets.

 

Thus, a common man’s happiness lies in getting
a good window seat in a local train!

 

But I was on the happy moment in a CA’s life
that occurs every year. Through the months of July to September, a CA is obsessed
with only one thought – Whether the due date of filing income tax returns will
be extended. He begs for it, dreams about it and prays for it. And once the
extension is announced by the Finance Minister, his joy is limitless.

 

But, alas! This year, in
the process of extending the Corona – Covid-19 lockdown period, the Government
(perhaps inadvertently, or maybe sensibly, for a change) on its own extended
the due date. It was a pleasant surprise that there were no representations, no
struggles, no appeals, no litigations and no writ petitions required for this.
It’s really a bounty!

 

So friends, relax during this lockdown period
and gather strength to beg for further extension of the tax filing date!

 

Good luck to all CAs.  

 

THE DOCTRINE OF ‘FORCE MAJEURE’

INTRODUCTION

Force majeure is a French
term which, at some point or other, we have all come across when reading a
contract. It is a small, solitary clause lurking somewhere at the end which has
the effect of discharging all the parties from their obligations under the
contract! What does this clause actually mean and how does one interpret it in
the light of the present pandemic? Would a contract hit by non-performance due
to Covid-19 fall under the force majeure scenario? Let us
try and answer some of these questions.

 

MEANING

The Black’s
Law Dictionary, 6th edition, defines the term force majeure
as ‘An event or effect that can be neither anticipated nor controlled.’ The
events of force majeure could be acts of God such as earthquakes,
floods, famine, other natural disasters and manmade occurrences such as wars,
bandhs, blackouts, sabotage, fire, arson, riots, strikes, theft, etc. Even
major changes in government regulations could be a part of this clause. In
short, any act that was outside the realm of contemplation at the time when the
contract was executed but which now has manifested and has had a major impact
on the contract. It is necessary that such acts should not be committed
voluntarily by either party, i.e., they are out of the control of the parties
which are rendered mere spectators to the consequences. For example, a sample force
majeure clause found in a real estate development contract could be as
follows:

 

‘The
obligations undertaken by the parties hereto under this Agreement shall be
subject to the force majeure conditions, i.e., (i) non-availability of
steel, cement and other building material (which may be under Government
Control), water and electric supply, (ii) war, civil commotion, strike, civil
unrest, riots, arson, acts of God such as earthquake, tsunami, storm, floods,
cyclone, fire, etc., (iii) any notice, order, rule, notification of the
Government and / or other public or competent authority, (iv) any other
condition / reason beyond the control of the Developer.’


INDIAN CONTRACT LAW

The Indian Contract Act, 1872
governs the law relating to contracts in India. The edifice of almost all
contracts and agreements lies in this Contract Law. In the event that a
contract does not explicitly provide for a force majeure clause, then
section 56 of the Act steps in. This section deals with the frustration
of contracts. The consequences of a force majeure event
are provided for u/s 56 of the Act which states that on the occurrence of an
event which renders the performance impossible, the contract becomes void
thereafter. A contract to do an act which, after the contract is made, becomes
impossible or, by reason of some event which the promisor could not prevent,
becomes unlawful is treated as void when the act becomes impossible or
unlawful. Thus, if the parties or one of the parties to the contract is
prevented from carrying out his obligation under the contract, then the
contract is said to be frustrated.

 

When the act
contracted for becomes impossible, then u/s 56 the parties are exempted from
further performance and the contract becomes void. The Supreme Court in Satyabrata
Ghose vs. Mugneeram Bangur & Co., AIR 1954 SC 44 has held that a
change in event or circumstance which is so fundamental as to strike at the
very root of the contract as a whole, would be regarded as frustrating the
contract. It held:

 

‘In deciding
cases in India the only doctrine that we have to go by is that of supervening
impossibility or illegality as laid down in section 56 of the Contract Act,
taking the word “impossible” in its practical and not literal sense. It must be
borne in mind, however, that section 56 lays down a rule of positive law and
does not leave the matter to be determined according to the intention of the
parties.’

 

The Supreme
Court went on to hold that if and when there is frustration, the dissolution of
the contract occurs automatically. It does not depend on the choice or election
of either party. What happens generally in such cases is that one party claims
that the contract has been frustrated while the other party denies it. The
issue has got to be decided by the courts on the actual facts and circumstances
of the case.

 

The Supreme Court has, in South East Asia Marine Engineering and
Constructions Ltd. (SEAMEC Ltd.) vs. Oil India Ltd., CA No. 673/2012, order
dated 11th May, 2020, clarified that the parties may instead
choose the consequences that would flow on the occurrence of an uncertain
future event u/s 32 of the Contract Act. This section provides that contingent
contracts to do or not to do anything if an uncertain future event occurs,
cannot be enforced by law unless and until that event has occurred. If the
event becomes impossible, such contracts become void.

 

The English
Common Law has also dealt with several such cases. The consequence of such
frustration had fallen on the party that sustained a loss before the
frustrating event. For example, in Chandler vs. Webster, [1904] 1 KB 493,
one Mr. Chandler rented space from a Mr. Webster for viewing the coronation
procession of King Edward VII. Mr. Chandler had paid part consideration for the
same. However, due to the King falling ill, the coronation was postponed. Mr.
Webster insisted on payment of his consideration. The Court of Appeals rejected
the claims of both Mr. Chandler as well as Mr. Webster. The essence of the
ruling was that once frustration of a contract took place, there could not
be any enforcement and the loss fell on the person who sustained it before the force
majeure event occurred.

 

The above
Common Law doctrine has been modified in India. The Supreme Court in the SEAMEC
case (Supra) has held that in India the Contract Act had already
recognised the harsh consequences of such frustration to some extent and had
provided for a limited mechanism to improve the same u/s 65 of the Contract
Act. Section 65 provides for the obligation of any person who has received
advantage under a void agreement or a contract that becomes void. It states
that when a contract becomes void, any person who has received any advantage
under such agreement or contract is bound to restore it, or to make
compensation for it to the person from whom he received it. Under Indian
contract law, the effect of the doctrine of frustration is that it discharges
all the parties from future obligations.

 

For example,
a convention was scheduled to be held in a banquet hall. The city goes into
lockdown due to Covid and all movement of people comes to a halt and the
convention has to be cancelled. Any advance paid to the banquet hall for this
purpose would have to be refunded by the hall owners. In this respect, the
Supreme Court in Satyabratha’s case has held that if the parties
to a contract do contemplate the possibility of an intervening circumstance
which might affect the performance of the contract but expressly stipulate that
the contract would stand despite such circumstances, then there can be no case
of frustration because the basis of the contract being to demand performance
despite the occurrence of a particular event, performance cannot disappear when
that event takes place.

 

COVID-19 AS A ‘FORCE MAJEURE’

Is Covid-19
an Act of God; is a typical force majeure clause wide enough to
include a lockdown as a result of Covid-19? These are some of the questions
which our courts would grapple with in the months to come. However, some Indian
companies have started invoking Covid and the related lockdown as a force
majeure clause. For example, Adani Ports and SEZ Ltd., in
a notice to the trade dated 24th March, 2020, has stated that in
view of the Covid-19 pandemic the Mundra Port has notified a ‘force
majeure event’. Accordingly, it will not be responsible for any claims,
damages, charges, etc., whatsoever arising out of and / or connected to the
above force majeure event, either directly or indirectly. This
would include vessel demurrage due, inter alia, to pre-berthing or any
other delays of whatsoever nature and, accordingly, the discharge rate
guaranteed under the agreement shall also not be applicable for all vessels to
be handled at the port for any delay or disturbance in the port services during
the force majeure period.

 

CONCLUSION

Indian businesses would have to take a deep look at their contracts and
determine whether there is a force majeure clause and, if yes,
what are its ramifications. In cases where there is no such clause, they should
consider taking shelter u/s 56 of the Indian Contract Act. This is one area
where they could renegotiate and, if required, even litigate or go in for arbitration.
It would be very interesting to see how Indian Courts interpret the issue of
Covid acting as a force majeure clause. However, it must be
remembered that force majeure cannot be invoked at the mere drop
of a hat. The facts and circumstances must actually prove that it was
impossible to carry out the contract. What steps did the parties take to meet
this uncertain event would also carry heft with the Courts in deciding whether
or not to excuse performance of the contract.  

RESIDENTIAL STATUS OF NRIs AS AMENDED BY THE FINANCE ACT, 2020

1.0  BACKGROUND

The
government presented the Union Budget 2020 in the month of February this year
in the midst of an economic slowdown. The Budget was based on the twin pillars
of social and economic reforms to boost the Indian economy. The Finance Bill,
2020 got the President’s assent on 27th March, 2020, getting
converted into the Finance Act, 2020 which has brought in a lot of structural
changes such as (a) giving an option to the taxpayers to shift to the new slabs
of income-tax; (b) introducing the Vivad se Vishvas scheme; (c) reducing
the corporate tax rate; and (d) changes in taxation of dividends and many other
proposals.

 

Apart from
the above, one of the significant amendments made by the Finance Act, 2020
pertains to a change in the rules for determining the residential status of an
individual.

 

Let us study
these amendments in detail. It may be noted that the amendments to section 6 of
the Income-tax Act, 1961 (the Act) are applicable with effect from 1st
April, 2020 corresponding to the A.Y. 2020-21 onwards.

 

2.0  SIGNIFICANCE OF RESIDENTIAL STATUS

A person is
taxed in a jurisdiction based on ‘residence’ link or a ‘source’ link. However,
the comprehensive tax liability is invariably linked to the residential status,
barring a few exceptions such as taxation based on citizenship (e.g., USA) or
in case of territorial tax regimes (such as Hong Kong).

 

In India,
section 6 of the Act determines the residential status of a person. Section 5
defines the scope of total income and section 9 expands the scope of total
income in case of non-residents by certain deeming provisions.

 

Along with
the incidence of tax, residential status is also important to claim relief
under a particular tax treaty, as being a resident of either of the contracting
states is a prerequisite for the same. Therefore, Article 4 on ‘Residence’ is
considered to be the gateway to the tax treaty. Once a person is a resident of
a contracting state, he gets a Tax Residency Certificate which enables him to
claim treaty benefits.

 

3.0  PROVISIONS OF SECTION 6 OF THE ACT POST
AMENDMENT

The highlighted
portion is the insertion by the Finance Act, 2020. The provisions relating
to residential status under the Act are as follows:

 

Residence in
India

‘6.
For the purposes of this Act,

(1)
An individual is said to be resident in India in any previous year, if he

(a)
is in India in that year for a period or periods amounting in all to one
hundred and eighty-two days or more; or

(b)
[***]

(c)
having within the four years preceding that year been in India for a period or
periods amounting in all to three hundred and sixty-five days or more, is in
India for a period or periods amounting in all to sixty days or more in that
year.

 

Explanation
1 – In the case of an individual,

(a)
being a citizen of India, who leaves India in any previous year as a member of
the crew of an Indian ship as defined in clause (18) of section 3 of the
Merchant Shipping Act, 1958 (44 of 1958), or for the purposes of employment
outside India, the provisions of sub-clause (c) shall apply in relation
to that year as if for the words ‘sixty days’ occurring therein, the words ‘one
hundred and eighty-two days’ had been substituted;

(b)
being a citizen of India, or a person of Indian origin within the meaning of Explanation
to clause (e) of section 115C who, being outside India, comes on a visit
to India in any previous year, the provisions of sub-clause (c) shall
apply in relation to that year as if for the words ‘sixty days’, occurring
therein, the words ‘one hundred and eighty-two days’ had been substituted
and in case of the citizen or person of Indian origin having total income,
other than the income from foreign sources, exceeding fifteen lakh rupees
during the previous year, for the words ‘sixty days’, occurring therein, the
words ‘one hundred and twenty days’.

     

Clause (1A)
of Section 6

(1A)
Notwithstanding anything contained in clause (1), an individual, being a
citizen of India, having total income, other than the income from foreign
sources, exceeding fifteen lakh rupees during the previous year, shall be
deemed to be resident in India in that previous year, if he is not liable to
tax in any other country or territory by reason of his domicile or residence or
any other criteria of similar nature.

 

Explanation
2 – For the purposes of this clause, in the case of an individual,
being a citizen of India and a member of the crew of a foreign-bound ship
leaving India, the period or periods of stay in India shall, in respect of such
voyage, be determined in the manner and subject to such conditions as may be
prescribed.

 

(2) A
Hindu undivided family, firm or other association of persons is said to be
resident in India in any previous year in every case except where during that
year the control and management of its affairs is situated wholly outside
India.

 

(3) A
company is said to be a resident in India in any previous year if—

(i)
it is an Indian company; or

(ii)
its place of effective management, in that year, is in India.

 

Explanation
– For the purposes of this clause ‘place of effective management’ means a place
where key management and commercial decisions that are necessary for the
conduct of business of an entity as a whole are in substance made.

 

(4)
Every other person is said to be resident in India in any previous year in
every case, except where during that year the control and management of his
affairs is situated wholly outside India.

 

(5)
If a person is resident in India in a previous year relevant to an assessment
year in respect of any source of income, he shall be deemed to be resident in
India in the previous year relevant to the assessment year in respect of each
of his other sources of income.

 

(6) A
person is said to be ‘not ordinarily resident’ in India in any previous year if
such person is,

(a)
an individual who has been a non-resident in India in nine out of the ten
previous years preceding that year, or has during the seven previous years
preceding that year been in India for a period of, or periods amounting in all
to, seven hundred and twenty-nine days or less; or

(b) a
Hindu undivided family whose manager has been a non-resident in India in nine
out of the ten previous years preceding that year, or has during the seven
previous years preceding that year been in India for a period of, or periods
amounting in all to, seven hundred and twenty-nine days or less, or

(c)
a citizen of India, or a person of Indian origin, having total income, other
than the income from foreign sources, exceeding fifteen lakh rupees during the
previous year, as referred to in clause (b) of Explanation 1 to clause (1), who
has been in India for a period or periods amounting in all to one hundred and
twenty days or more but less than one hundred and eighty-two days; or

(d)
a citizen of India who is deemed to be resident in India under clause (1A).

Explanation
– For the purposes of this section, the expression ‘income from foreign
sources’ means income which accrues or arises outside India (except income
derived from a business controlled in or a profession set up in India).

 

4.0  DETERMINING THE SCOPE OF TAXABILITY (SECTION
5)

All over the world an individual is categorised as either a Resident or
a Non-resident. However, India has an intermediary status known as ‘Resident
but Not Ordinarily Resident’ (RNOR). This status provides breathing space to a
person from being taxed on a worldwide income, in that such a person is not
subjected to Indian tax on passive foreign income, i.e. foreign-sourced income
earned without business controlled from or a profession set up in India.

 

Thus, an
individual is subjected to worldwide taxation in India only if he is ‘Resident
and Ordinarily Resident’ (ROR).

 

Therefore,
an individual who is a resident of India is further classified into (a) ROR and
(b) RNOR (Refer paragraph 3 herein above).

The scope of
total income, based on the residential status, is defined in section 5 of the
Act which can be summarised as follows:

 

 

Sources of Income

ROR

RNOR

NR

i

Income received or is deemed to be received
in India

Taxable

Taxable

Taxable

ii

Income accrues or arises or is deemed to accrue
or arise in India

Taxable

Taxable

Taxable

iii

Income accrues or arises outside India, but it is
derived from a business controlled in or a profession set up in India

Taxable

Taxable

Not Taxable

iv

Income accrues or arises outside India other than
derived from a business controlled in or a profession set up in India

Taxable

Not Taxable

Not Taxable

 

 

5.0  NON-RESIDENT

According to
section 2(30) of the Act, ‘non-resident means a person who is not a
“resident”, and for the purposes of sections 92, 93 and 168 includes
a person who is not ordinarily resident within the meaning of clause (6)
of section 6.’

 

Section 92
deals with transfer pricing, section 93 deals with avoidance of income tax by
transactions resulting in transfer of income to non-residents and section 168
deals with residency of executors of the estate of a deceased person.
‘Executor’ for the purposes of section 168 includes an administrator or other
person administering the estate of a deceased person.

 

Thus, in
view of the amendments in section 6, a change in the classification of
residential status from that of a non-resident to an RNOR may lead to change in
the scope of taxability in respect of the above sections, viz., 92, 93 and 168.

 

6.0  RATIONALE FOR CHANGE IN THE DEFINITION OF
RESIDENTIAL STATUS

Clause (c)
of section 6(1) provides that an individual who is in India in any previous
year for a period of 60 days or more, coupled with 365 days or more in the
immediately preceding four years to that previous year, then he would be
considered a resident of India. The period of 60 days is very short, therefore
Indians staying abroad demanded some relaxations. The government also
acknowledged the fact that Indian citizens or Persons of Indian Origin (PIO)
who stay outside India often maintain strong ties with India and visit India to
take care of their assets, families or for a variety of other reasons.
Therefore, relaxation has been provided to Indian citizens / PIOs, allowing
them to visit India for longer a duration of 182 days since 1995, without losing
their non-resident status.

 

However, it
was found that this relaxation was misused by many visiting Indian citizens or
PIOs, by carrying on substantial economic activities in India and yet not
paying any tax in India. They managed to stay in India almost for a year by
splitting their stay in two financial years and yet escape from taxation in
India, even if their global affairs / businesses were controlled from India. In
order to prevent such misuse, the Finance Act, 2020 has reduced the period of stay
in India from 182 days to 120 days in case of those individuals whose
Indian-sourced income1 
exceeds Rs. 15 lakhs.

 

There is no
change in case of a person whose Indian-sourced income is less than Rs. 15
lakhs.

 

7.0 IMPACT OF THE AMENDMENTS

7.1  Residential status of Indian citizens / PIOs
on a visit to India

The amended
provision of section 6(1)(c) read with clause (b) of Explanation 1 now
provides as follows:

 

An Indian
citizen or a Person of Indian Origin, having total income other than income from
foreign sources exceeding Rs. 15 lakhs, who being outside India comes on a
visit to India, shall be deemed to be resident in India in a financial year if…

(i)    he is in India for 182 days or more during
the year; or

(ii)   he has been in India for 365 days or more
during the four immediately preceding previous years and for 120 days or more
during that previous year.

 

7.2  Amendment to the definition of
R but NOR u/s 6(6)

As mentioned
earlier, section 6(6) provides an intermediary status to an individual (even
HUF through its manager) returning to India, namely, RNOR.

 

Clause (d)
is inserted in section 6(6) to provide that an Indian citizen / PIO who becomes
a resident of India by virtue of clause (c) to section 6(1) with the 120 days’
rule (as mentioned above) will always be treated as an RNOR. The impact is that
their foreign passive income would not be taxed in India.

_______________________________________________________________

1   The amendment uses the term ‘Income from
foreign sources’ which means income which accrues or arises outside India
(except income derived from a business controlled in or a profession set up in
India). In this Article, the term ‘Indian-sourced income’ is used as a synonym
for the term ‘income other than income from foreign sources’.

 

 

Let us
understand the conditions of residential status with the help of a flowchart (as
depicted below).

 

Assuming
that an Indian citizen has satisfied one of the two conditions of clause (c) to
section 6(1), namely, stay of 365 days in India during the preceding four
financial years, the following are the possible outcomes:

 

It may be noted that a person becoming a resident by virtue of the 120
days’ criterion would automatically be regarded as an RNOR, whereas a person
becoming resident by virtue of the 182 days’ criterion would become an RNOR
only if he further satisfies one of the additional conditions prescribed in
clause (a) of section 6(6) of the Act, namely, that he has been a non-resident
in nine out of the ten years preceding the relevant previous year, or he was in
India for a period or periods in aggregate of 729 days or less in seven years
preceding the relevant previous year.

 

The impact
of the amendment is that an individual who is on a visit to India may become a
resident by virtue of the reduced number of days criterion, but would still be
regarded as an RNOR, which gives much-needed relief as he would not be taxed on
foreign income, unless it is earned from a business or profession controlled /
set up in India.

 

8.0  DEEMED RESIDENTIAL STATUS FOR INDIAN CITIZENS

Traditionally,
in India income tax is levied based on the residential status of the
individual. It was felt that in the residence-based scheme of taxation there
was scope for abuse of the provisions. It was possible for a high net-worth
individual to arrange his affairs in a manner whereby he is not considered as a
resident of any country of the world for tax purposes. In order to prevent such
abuse a new Clause 1A has been inserted to section 6 of the Act vide the
Finance Act, 2020 whereby an individual being a citizen of India having total
income, other than the income from foreign sources, exceeding fifteen lakh
rupees during the previous year, shall be deemed to be resident in India in
that previous year, if he is not liable to tax in any other country or
territory by reason of his domicile or residence, or any other criterion of
similar nature. However, this provision is not applicable to Overseas Citizens
of India (OCI) card-holders as they are not the citizens of India.

 

In other
words, an individual is deemed to be a resident of India only if all the
following conditions are satisfied:

(i)    He is a citizen of India;

(ii)   His Indian-sourced total income exceeds Rs. 15
lakhs; and

(iii) He is not liable to tax in any other country or
territory by reason of his domicile or residence or any other criterion of
similar nature.

 

By virtue of the above deemed residential status, many NRIs living
abroad and possessing Indian citizenship could have been taxed in India on their
worldwide income. In order to provide relief, clause (d) has been inserted in
section 6(6) to provide that a citizen who is deemed a resident of India by
virtue of clause 1A to section 6 of the Act, would be regarded as an RNOR. The
advantage of this provision is that his foreign passive income would not be
taxed in India.

 

The above
amendment can be presented in the form of a flow chart (Refer Flow Chart 2,
on the next page):

 

 9.0 ISSUES

9.1  What is the meaning of the term ‘liable to
tax’ in the context of determination of ‘deemed residential status’?

 

 

As per the
amended provision of section 6(1A) of the Act, an Indian citizen who is not
liable to tax in any country or territory by reason of his domicile or
residence or any other criterion of similar nature would be regarded as deemed
resident of India. However, the term ‘liable to tax’ is not defined in the Act.
This term has been a matter of debate for many years. Contrary decisions are in
place in respect of residents of the UAE where there is no income tax for
individuals.

 

Whether liability to tax includes ‘potential liability to tax’, in that
the individuals are today exempt from tax in the UAE by way of a decree2
, but they can be brought to tax any time. For that matter, any sovereign
country which is not levying tax on individuals at present always has an
inherent right to tax its citizens. Therefore,
can one say that residents of any country are always potentially liable to tax
by reason of their residence or domicile, etc.?

 

In the M.A.
Rafik case, In re [1995] 213 ITR 317, the AAR held that ‘liability to
tax’ includes potential liability to tax and, therefore, benefit of the
India-UAE Tax Treaty was available to a UAE resident. However, in the case of Cyril
Pereira the AAR held otherwise and refused to grant the benefit of the
India-UAE DTAA as there was no tax in the UAE. The Hon’ble Supreme Court, in
the case of Azadi Bachao Andolan [2003] 263 ITR 706, after
referring to the ruling of Cyril Pereira and after elaborate
discussions on the various aspects of this issue, concluded that ‘it is… not
possible for us to accept the contentions so strenuously urged by the
respondents that the avoidance of double taxation can arise only when tax is
actually paid in one of the contracting states.’

 

_______________________________________________________________

2   The UAE federal government has exclusive
jurisdiction to legislate in relation to UAE taxes. However, no federal tax
laws have been established to date. Instead, most of the Emirates enacted their
own general income ‘tax decrees’ in the late 1960s. In practice, however, the
tax decrees have not been enforced to date for personal taxation. [Source:
https://oxfordbusinessgroup.com/overview/full-disclosure-summary-general-and-new-tax-regulations]

 

 

The Hon’ble
Supreme Court in this case (Azadi Bachao Andolan, Supra), further
quoted excerpts from Prof. Klaus Vogel’s commentary on ‘Double Taxation’, where
it is clearly mentioned that ‘Thus, it is said that the treaty prevents not
only “current” but also merely “potential” double taxation.’

 

In Green
Emirate Shipping & Travels [2006] 100 ITD 203 (Mum.), the Mumbai
Tribunal after refusing to be persuaded by the decision of the AAR in the case
of Abdul Razak A. Menon, In re [2005] 276 ITR 306 held that
‘being “liable to tax” in the contracting state does not necessarily imply that
the person should actually be liable to tax in that contracting state by virtue
of an existing legal provision but would also cover the cases where that other
contracting state has the right to tax such persons – irrespective of whether
or not such a right is exercised by the contracting state. In our humble
understanding, this is the legal position emerging out of Hon’ble Supreme
Court’s judgment in Azadi Bachao Andolan case.’

 

In ITO (IT) vs. Rameshkumar Goenka, 39 SOT 132, the Mumbai
Tribunal, following the decision in Green Emirates (Supra), held
that the ‘expression “liable to tax” in that contracting state as used in
Article 4(1) of the Indo-UAE DTAA does not necessarily imply that the person
should actually be liable to tax in that contracting state and that it is
enough if the other contracting state has the right to tax such person, whether
or not such a right is exercised.’

 

In the case
of DDIT vs. Mushtaq Ahmad Vakil, the Delhi Tribunal, relying on the
decisions of Green Emirates (Supra), Meera Bhatia, Mumbai ITAT, 38 SOT 95,
and Ramesh Kumar Goenka (Supra) ruled in favour of the assessee
to give the benefit of the India-UAE Tax Treaty.

 

Thus, we
find that various judicial precedents in India are in favour of granting tax
treaty benefits to the residents of even those contracting states where there
is no actual liability to tax at present. Therefore, one may take a view that
in the context of Indian tax treaties ‘liability to tax’ includes ‘potential liability
to tax’, except where there is an express provision to the contrary in the tax
treaty concerned.

 

9.2  Can a deemed resident person avail treaty
benefit?

The benefit
of a tax treaty is available to a person who is a resident of either of the
contracting states which are party to the said treaty. Article 3 of the tax
treaties defines ‘person’ to include the individual who is treated as a taxable
entity in the respective contracting state (e.g. India’s tax treaties with the
USA and the UK). However, Article 4 of the India-UK Tax Treaty dealing with
‘Fiscal Domicile’ provides that the term ‘resident of a contracting state’
means any person who, under the law of that state, is liable to taxation
therein by reason of his domicile, residence, place of management or any other
criterion of a similar nature. This provision is similar in both the
UN and the OECD Model Conventions as well as most of the Indian tax treaties.
Here the question arises as to whether a person who is a deemed resident of
India (by virtue of clause 1A to section 6 of the Act), will be able to access
a treaty based on the wordings of Article 4? Article 4 requires him to be a
resident of a contracting state based on the criteria of domicile, residence or
any other criterion of similar nature, which does not include citizenship.
Although citizenship is one of the decisive criteria while applying
tie-breaking tests mentioned in paragraph 2 of Article 4, but first one must
enter the treaty by virtue of paragraph 1.

 

When we look
at the provisions of the India-US Tax Treaty, we find that citizenship is one
of the criteria mentioned in paragraph 1 of Article 4 on residence as mentioned
below:

 

‘ARTICLE 4 –
Residence – 1. For the purposes of this Convention, the term “resident of a
Contracting State” means any person who, under the laws of that State, is
liable to tax therein by reason of his domicile, residence, citizenship,
place of management, place of incorporation, or any other criterion of a
similar nature.’

 

Therefore,
in case of the India-US Tax Treaty there is no doubt about the availability of
tax benefits to an individual who is deemed to be a resident of India because
of his citizenship.

 

9.3  What is the status of Indian workers working
in UAE who are invariably citizens of India?

Article 4 of
the India-UAE Tax Treaty reads as follows:

 

ARTICLE 4 RESIDENT

1.    For the purposes of this Agreement the
term ‘resident of a Contracting State’ means:

(a) ?in the case of India: any person who, under
the laws of India, is liable to tax therein by reason of his domicile,
residence, place of management or any other criterion of a similar nature. This
term, however, does not include any person who is liable to tax in India in
respect only of income from sources in India; and

(b) in the case of the United Arab Emirates: an
individual who is present in the UAE for a period or periods totalling in the
aggregate at least 183 days in the calendar year concerned, and a company which
is incorporated in the UAE and which is managed and controlled wholly in UAE.’

 

As per the
above provision, a person who stays in the UAE for 183 days or more in a
calendar year would be regarded as a resident of the UAE and therefore eligible
to get the treaty benefit.

 

The CBDT
issued a Press Release on 2nd February, 2020 clarifying that ‘the
new provision is not intended to include in tax net those Indian citizens who
are bona fide workers in other countries. In some sections of the media
the new provision is being interpreted to create an impression that those
Indians who are bona fide workers in other countries, including in
Middle East, and who are not liable to tax in these countries,
will be taxed in India on the income that they have earned there. This
interpretation is not correct.

 

In order to
avoid any misinterpretation, it is clarified that in case of an Indian citizen
who becomes deemed resident of India under this proposed provision, income
earned outside India by him shall not be taxed in India unless it is derived
from an Indian business or profession.’ (Emphasis supplied.)

 

The above
clarification is significant as it clearly provides that even though Indian
citizens in the UAE or in other countries are not liable to tax therein, their
foreign-sourced income will not be taxed in India unless it is derived from an
Indian business or profession.

 

However,
this clarification does not change the position for determination of deemed
residential status of such workers. In other words, all workers in the UAE or
other countries who are citizens of India may be still be regarded as deemed
residents of India if their Indian-sourced income exceeds Rs. 15 lakhs in a year.
The Press Release only says that their foreign income may not be taxed in
India, if the conditions are satisfied.

 

9.4  What is the impact of Covid-19 on
determination of residential status?

The CBDT
Circular No. 11 of 2020 dated 8th May, 2020 grants relief to
taxpayers by excluding the period of their forced stay in India from the 22nd
to the 31st of March, 2020 in computation of their residential
status in India for Financial Year 2019-20. The relevant extract of the said
Circular is reproduced below:

 

‘3. In
order to avoid genuine hardship in such cases, the Board, in exercise of powers
conferred under section 119 of the Act, has decided that for the purpose of
determining the residential status under section 6 of the Act during the
previous year 2019-20 in respect of an individual who has come to India on a
visit before 22nd March, 2020 and:

(a) has been
unable to leave India on or before 31st March, 2020, his period of
stay in India from 22nd March, 2020 to 31st March, 2020
shall not be taken into account; or

(b) has been quarantined in India on account of Novel Corona Virus
(Covid-19) on or after 1st March, 2020 and has departed on an
evacuation flight on or before 31st March, 2020 or has been unable
to leave India on or before 31st March, 2020, his period of stay
from the beginning of his quarantine to his date of departure or 31st
March, 2020, as the case may be, shall not be taken into account; or

(c) has departed on an evacuation flight on or before 31st
March, 2020, his period of stay in India from 22nd March, 2020 to
his date of departure shall not be taken into account.’

The above
Circular deals with the period up to 31st March, 2020. The Finance
Minister has assured similar relief for the Financial Year 2020-21. As the
operations on international flights have not resumed fully, a suitable
relaxation may be announced in future when the situation normalises.

 

10.0 EPILOGUE

The
amendments to section 6 are in the nature of anti-abuse provisions. However, in
view of the pandemic Covid-19, it is desirable that these amendments are
deferred for at least two to three years. More than half of the world is under
lockdown. India is also under lockdown for over two months now. International
flights are still not operative. Only Air India is operating international
flights under the ‘Vande Bharat’ mission to bring back or take out the
stranded passengers. This is an unprecedented situation which calls for
unprecedented measures. Today, India is considered safer than many other
countries in the world and therefore many NRIs may like to spend more time with
their families in their motherland. Under the circumstances, the amendment
relating to reduction of the number of days’ stay from 182 to 120 should be
reconsidered.

 

 

COVID-19 AND PRESENTATION OF ‘EXCEPTIONAL ITEMS’

This article
provides guidance on the presentation and disclosure of exceptional items in
the financial statements arising due to Covid-19. Firstly, it is important to
look at the requirements of various authoritative guidances which are given
below:

 

(1)  Schedule III to the Companies Act, 2013
specifically requires a line item for ‘exceptional items’ on the face of the
statement of Profit and Loss (P&L).

(2)  The Securities and Exchange Board of India
Circular dated 5th July, 2016 requires that listed entities shall
follow the Schedule III to the Companies Act, 2013 format for purposes of
presenting the financial results.

(3)  The term ‘exceptional items’ is neither
defined in Schedule III nor in any Ind AS.

(4) Paragraphs 9, 85, 86, 97 and 98 of Ind AS 1 Presentation
of Financial Statements are set out below:

 

9    ‘The objective of financial statements is to
provide information about the financial position, financial performance and
cash flows of an entity that is useful to a wide range of users in making economic
decisions… This information, along with other information in the notes,
assists users of financial statements in predicting the entity’s future
cash flows and, in particular, their timing and certainty.’

85   An entity shall present additional line items
(including by disaggregating the line items listed in paragraph 82), headings
and subtotals in the statement of profit and loss, when such presentation is
relevant to an understanding of the entity’s financial performance.

86   Because the effects of an entity’s various
activities, transactions and other events differ in frequency, potential for
gain or loss and predictability, disclosing the components of financial
performance assists users in understanding the financial performance achieved
and in making projections of future financial performance. An entity includes
additional line items in the statement of profit and loss, and it amends the
descriptions used and the ordering of items when this is necessary to explain
the elements of financial performance. An entity considers factors including
materiality and the nature and function of the items of income and expense. For
example, a financial institution may amend the descriptions to provide
information that is relevant to the operations of a financial institution. An
entity does not offset income and expense items unless the criteria in
paragraph 32 are met.

97   When items of income or expense are material,
an entity shall disclose their nature and amount separately.

     

98   Circumstances that would give rise to the
separate disclosure of items of income and expense include:

(a) write-downs of inventories to net realisable
value or of property, plant and equipment to recoverable amount, as well as
reversals of such write-downs;

(b) restructurings of the activities of an entity
and reversals of any provisions for the costs of restructuring;

(c)   disposals of items of property, plant and
equipment;

(d) disposals of investments;

(e) discontinued operations;

(f)   litigation settlements; and

(g) other reversals of provisions.

 

(5) In December, 2019 IASB issued
an Exposure Draft General Presentation and Disclosures (ED) that, once
finalised, would replace IAS 1 and eventually Ind AS 1. The deadline for
submitting comments is 30th September, 2020. The ED proposes
introducing a definition of ‘unusual income and expenses’ and requiring all
entities to disclose unusual income and expenses in a single note.

 

(6) As per the ED: ‘Unusual income and expenses
are income and expenses with limited predictive value. Income and
expenses have limited predictive value when it is reasonable to expect that
income or expenses that are similar in type and amount will not arise for
several future annual reporting periods.’

 

(7) Paragraph B67-B75 of the application guidance
to the ED provides further explanation of the nature of ‘unusual’ items. In
particular, the following extracts may be noted:

 

‘In
determining whether income or expenses are unusual, an entity shall consider
both the type of the income or expense and its amount. For example, an
impairment loss resulting from a fire at an entity’s factory is normally an
unusual type of expense and hence would be classified as an unusual expense
because in the absence of other indicators of impairment, another similar
expense would not reasonably be expected to recur for several future annual
reporting periods.

 

Income and expenses that are not unusual by type may be unusual in
amount. Whether an item of income or expense is unusual in amount is determined
by the range of outcomes reasonably expected to arise for that income or
expense in several future annual reporting periods. For example, an entity that
incurs regular litigation costs that are all of a similar amount would not
generally classify those litigation expenses as unusual. However, if in one
reporting period that entity incurred higher litigation costs than reasonably
expected because of a particular action, it would classify the costs from that
action as unusual if litigation costs in several future annual reporting
periods were not expected to be of a similar amount. The higher litigation
costs are outside the range of reasonably expected outcomes and not predictive
of future litigation costs.’

 

(8) The ED also supports the conceptual concerns
raised by certain stakeholders about the presentation of exceptional items as a
separate line item in the P&L statement rather than in the notes. The
following may be particularly noted:

 

The Board
proposes that information about unusual income and expenses should be disclosed
in the notes rather than presented in the statement(s) of financial
performance. The Board concluded that disclosure in the notes would enable
entities to provide a more complete description and analysis of such income and
expenses. Disclosure in the notes also provides users of financial statements
with a single location to find information about such income and expenses and
addresses some stakeholders’ concerns that unusual income and expenses may be
given more prominence than other information in the statement(s) of financial
performance.

 

Some
stakeholders suggested that, given the importance some users of financial
statements attach to the disclosure of unusual income and expenses, operating
profit before unusual income and expenses should be added to the list of
subtotals specified by IFRS Standards and the requirements relating to analysis
of operating expenses by function or by nature adjusted accordingly. In their
view, no longer being able to present an operating profit subtotal before
unusual items would be a significant step back from current practice. The Board
has not proposed adding this subtotal because, in some cases, presentation of
an operating profit before unusual income and expenses subtotal could result in
a presentation that mixes natural and functional line items. Users have told
the Board that they do not find mixed presentation useful and want to see all
operating expenses analysed by one characteristic (nature or function).

 

AUTHOR’S ANALYSIS AND CONCLUSIONS

The two
fundamental questions that need to be answered are as follows:

(i)   What items are included as exceptional items?

(ii)   Whether an exceptional item is presented as a
separate line item in the P&L or only described in the notes?

 

Before we start
addressing the above questions, the following points may be kept in mind:

(a) Exceptional items may arise from Covid or
non-Covid factors or a combination of both. For example, the fall in oil prices
may be due to Covid as well as trade wars between oil-producing countries.

(b) The separate presentation of exceptional item
in the P&L is required by both SEBI and Schedule III.

(c)   The two factors / tests that dominate whether
an item is exceptional are the size of the item (‘materiality test’) and the
predictive value (‘predictability test’). For example, by presenting a non-recurring
item as exceptional, investors can exclude those exceptional items in making
future projections of the performance. This aspect is also clear in the IASB’s
ED. At this point in time, the pandemic should be considered to be unusual and
non-recurring and will meet the test in the ED.

 

(d) Whilst Schedule III and SEBI require separate
presentation of exceptional items, there are a few anomalies which are listed
below:

(i)   The presentation of exceptional item as a
separate line item results in a mixed presentation. For example, presentation
of losses on inventory due to marking them down to net realisable value as
exceptional item results in cost of sales division into two separate line
items.

(ii)   An item of expense or loss may be caused by
both exceptional and non-exceptional factors. Segregating between what is
exceptional and what is not exceptional may be challenging. For example,
consider that the value of investment in an equity mutual fund at December-end
was Rs. 100. Prior to the outbreak / lockdown the value had gone up to Rs. 110.
On 31st  March, 2020 the value
had fallen to Rs. 85. Consequently, a net loss of Rs. 15 is included in the
P&L for the last quarter. This theoretically may be represented in two
ways, (a) Rs. 15 is an exceptional item, or (b) Rs. 25 is an exceptional item
and Rs. 10 is income from normal gains. Putting it simply, determining what is
exceptional can be very arbitrary in this case, because it involves determining
an arbitrary cut-off date. It also results in a mixed presentation when one
item is segregated into two different components. In this given case, the
author believes that Rs. 15 should be considered as an exceptional item and the
segregation was done to merely illustrate the point.

 

(e)   Given the specific
requirement of SEBI and Schedule III, it may not be incorrect to disclose a
material and non-recurring item as exceptional on the face of the P&L.
However, a better option would be not to present an exceptional item in the
P&L because it results in a mixed presentation and arbitrariness in
segregating an item as exceptional and not exceptional. Rather, exceptional
items may be more elaborately described in the notes to accounts.

 

Table
1

 

Expenditure

Author’s evaluation of exceptional and
non-exceptional

Impairment

For many enterprises, impairment is
non-recurring. Therefore, the same may be presented as exceptional items if
those are material, irrespective of whether they are caused due to Covid or
non-Covid factors

Incremental costs
due to Covid

If the costs are incremental to costs incurred
prior to the Covid outbreak and not expected to recur once the crisis has
subsided and operations return to normal, and clearly separable from normal
operations, they may be presented as an exceptional item. Temporary premium
payments to compensate employees for performing their normal duties at
increased personal risk, charges for cleaning and disinfecting facilities
more thoroughly and / or more frequently, termination fees or penalties for
terminated contracts or compliance with contractual provisions invoked
directly due to the events of the pandemic, may be both incrementally
incurred as a result of the coronavirus outbreak and separable from normal
operations. On the other hand, payments to employees for idle time, rent and
other recurring expense (e.g., security, utilities insurance and maintenance)
related to temporarily idle facilities, excess capacity costs expensed in the
period due to lower production, paying employees for increased hours required
to perform their normal duties and paying more for routine inventory costs
(e.g., shipping costs) will generally not be incremental and separable and
should not be presented as exceptional items

Provision for
doubtful debts

Provisions for doubtful debts are determined using
the expected credit loss method (ECL). The forward-looking projections in the
ECL model may be adjusted to reflect the post-Covid economic situation.
Generally, it will be difficult to segregate the overall ECL between those
that are Covid-caused and others. Besides, a higher ECL may be expected, on a
go forward basis, because Ind AS 109 specifically requires the ECL model to
be adjusted for forward-looking information. Consequently, it is difficult to
argue that a higher ECL provision will be a non-recurring feature. Therefore,
the provisions should not be identified as an exceptional item

Suspension of capitalisation of borrowing cost
due to Covid lockdown

There can be two views on this matter. Due to
suspension, the borrowing costs incurred during construction of an asset may
be expensed rather than capitalised. Consequently, the expense will impact
the P&L all at once. Had the interest expenditure been capitalised, had
there been no Covid, the expense would have been reflected by way of future
depreciation charge. As a result, since the expenditure is in any case
incurred, there is no exceptional item. The alternative view is that because
of the lockdown the interest expenditure is impacting the P&L all at
once. Since such expenditure is non-recurring the same may be presented as an
exceptional item

Litigation costs

Is the litigation caused due to Covid? For
example, there is clear evidence that the contract delay was due to Covid and
the customer is litigating on the same? Legal costs incurred to defend the
entity’s position may be presented as an exceptional item. Similarly, advice
from counsel on force majeure clauses in contracts may be considered
to be exceptional. These items may be presented as an exceptional item

Write-off / write-down
of inventories

If this meets the materiality test and the
predictability test, it may be presented as an exceptional item

Losses due to fall in NAV of investments made in
mutual
funds (MF)

If this meets the materiality test and the
predictability test, it may be presented as an exceptional item

Restructuring costs

Costs incurred on downscaling of operations if
caused due to Covid may be presented as an exceptional item

Onerous contracts

If this meets the materiality test and the
predictability test, it may be presented as an exceptional item

Severance pay for premature termination of
employment

Normal salary cost paid for lockdown period will
generally not pass the tests because salary is a recurring cost. However,
severance pay may be non-recurring in nature, whether caused due to Covid or
otherwise, and hence may be presented as an exceptional item

 

 

For the
purposes of providing additional guidance, the following indicative list of
expenditures is evaluated from the perspective of whether those are
exceptional, from the prism of the principles described above. The assumption
is that the items discussed in Table 1 (on the previous page) are
material to the specific entity.

 

The fundamental challenge in
identifying an exceptional item is that it results in arbitrariness due to
segregating an item into two separate components and a mixed presentation. Therefore,
it is suggested that the items discussed above which are identified as
exceptional items may be presented as such with an elaborate description in the
notes to the accounts.

 

It is not uncommon for
entities to supplement the EPS figures required by Ind AS 33 by voluntarily
presenting additional amounts per share, for example, profits before and after
exceptional items. For additional earnings per share amounts, the standard
requires:

(I)    that the denominator used should be that
required by Ind AS 33;

(II)   that basic and diluted amounts be disclosed
with equal prominence and presented in the notes;

(III) an indication of the basis on which the
numerator is determined, including whether amounts per share are before or
after tax; and

(IV) if the numerator is not reported as a line item
in the statement of comprehensive income or separate statement of P&L, a
reconciliation to be provided between it and a line item that is reported in
the statement of comprehensive income [Ind AS 33.74].

 

Alternative EPS figures may
be presented on the face of the P&L as well as in the notes.  

 

PREPARING FOR ‘THE NEW NORMAL’

My Dear Members,

 

This is the third consecutive
month that I am writing to you from the confines of my home. It is almost
unbelievable that the lockdown was announced more than 70 days ago. Who ever imagined
that 2020 would be such a nightmare of a year for the entire planet? On an
individual level there has been pain of loneliness, illness, fatigue, mental,
financial and emotional stress for many victims of the virus and their family
members. We must remain optimistic that these dark days will end sooner rather
than later and we will be allowed to open up in a phased manner. However, one
thing is very clear – life as we knew it till just a few months ago will change
for the foreseeable future. We will all have to get used to what is being
called ‘The New Normal’. As we all look at reopening our offices, social
distancing, wearing of masks, increased emphasis on good hygiene practices,
building our immunity and avoiding physical interaction will be of utmost
importance. This highly contagious but not so fatal virus is not going to be
beaten in a hurry; the onus is on us to protect ourselves and our loved ones by
changing our habits and following certain rules.

 

INDIA TO UNLOCK AND BOUNCE BACK

With each passing day of the
lockdown, the Indian economy is being dragged deeper towards a recession.
Recently, two rating agencies cut India’s GDP for the current year to minus 5%,
equalling the dubious record low achieved 40 years ago. It is indeed a worrying
situation and we are staring at difficult times. There is a global slowdown and
we are amongst many countries facing a recession. India seems to be in a spot
of bother because the structure of this recession is different and not
comparable to anything we have seen in the past. India is facing a
pandemic-induced recession, where the medical infrastructure is under severe
strain with huge shortage of hospital beds and medical facilities. Some sectors
are facing huge shortage of demand, such as hospitality, air travel, etc. So we
need to handle the situation differently.

 

What is worrying is that in
spite of the total lockdown for more than 70 days, our number of infected cases
are not flattening or coming down; on the contrary, they are rising. It seems
that the continuous total lockdown has impacted the economy very, very
adversely. Has the lockdown been effective? Has it worked the way we wanted it?
It seems it has not had the effect we were wishing for. What has happened due
to the lockdown is that our economy has crumbled and has been almost crushed.
In my view, the government has now taken the correct decision to open up and
unlock the activities in a phased manner. We need to do the right things in the
days to come and the government should shift the focus to creating awareness on
hygiene and how to live with this virus. This virus is not likely to go away in
a hurry and has to be managed without panic and hysteria.

 

I remain very optimistic
about our capabilities, abilities and power to bounce back. Our recovery rate
is rising and mortality rate due to Covid-19 remains very low as compared to
other countries. We are a resilient and self-reliant nation and I am sure that
once we reboot our economy, both domestic and global investors and capital will
flow back into our economy. Let us also play our part in restarting the economy
in whatever way we can.Let us start our economic activities in earnest because
little drops of water make a mighty ocean. If we start consuming, demand will
go up, exchange of money will lead to rolling of working capital which, in
turn, will lead to investment and overall growth will return. In these times,
the sheer size of our population and our domestic demand has the capability to
inject the much-needed stimulus into our economy.

 

Let us stand up once again on
our feet, not overreact to fear and at the same time learn how to live in the
changed environment.

 

Take care, stay safe and go
digital!

 

 

 

CA Manish Sampat

President

UNPACKING THE PACKAGE FROM TAXPAYER PERSPECTIVE

As we battle our way
out of four lockdowns, we are grateful to the honest and courageous frontline
workers. We are pained by the affliction caused to those at the bottom of our
societal pyramid – the daily-wage earners and those moving back to their homes.
Each day we hear news that we don’t want to hear and also see news showing acts
of courage, selflessness and service.


In India we say that
one can tell how good the roads are when monsoon comes. We see how good our
financial, health and social infrastructure is when disaster strikes. This
disaster has shown that we still have a very long way to go.


The Atmanirbhar
Bharat announcements included some truly effective measures and some
half-hearted ones. There is no clarity about the quantum of the stimuli, the
cash outflow from government, the conditions imposed and the actual amount that
will reach the hands that will spend and translate into demand. One hopes the
next few rounds of ‘packages’ would cover what this one didn’t.


The easiest looking
part was hardest to understand – reduction of 25% in the TDS rate. We are told
this rate reduction will increase liquidity of Rs. 50,000 crores from 14th
May, 2020 to 31st March, 2021. Now if you had to be paid fees of Rs.
10 lakhs and Rs. 1 lakh is TDS, then instead of Rs. 1 lakh, the TDS deducted is
Rs. 75,000. But if you were making a loss in FYE 2021 – that Rs. 75,000 is
blocked and this 25% idea is useless! If you are profit-making you will have to
pay advance tax in that very quarter and shell out that 25%. One wonders what
is the liquidity infusion and for how long. Allowing loss-making entities to
claim refund of the TDS deducted, fast NIL deduction certificates, waiver of
first quarter advance tax and elimination of TDS entirely for six months
subject to review in December, 2020 would have brought cash in the hands when
businesses need them the most.


Many entities will
benefit from EPF paid by the government. In other cases, the employer and
employee contributions reduced from 12% to 10% for three months may not be
effective. The fundamental question is – When people don’t have money, where
is the question of compulsory saving for retirement? Salary payment without
deduction from the employee and postponement of employer’s contribution could
have brought money in the hands of both. Add to this a condition that such
scheme would be available if the employer didn’t retrench the employees for
6-12 months and after 3-6 months both employer and employee can decide to make
their respective contributions. This would have given job security and more
cash, both to the employer and the employee.


Most
government actions – even in times of need – seem half-hearted. I can only
think of two reasons for this: (1) They didn’t think about it, or (2) They did
think about it, but didn’t do it. Both situations are scary and mock taxpayer
and citizen groups. Simple and effective approaches are not difficult if
Neta-cracy and Babu-cracy are kept in check.

The Modi Government’s
performance in the field of finance has been discouraging, especially its
response. After the IL&FS and Punjab and Maharashtra Bank bust, the
Franklin Templeton case (six schemes worth more than Rs. 25,000 crores) and the
Yes Bank write-off tell a tale. In Yes Bank, the write-off of investment in
additional tier-one bonds (a quasi capital) under approval of the RBI
gave a wrong signal that investments in the capital of banks could fail. About
Rs. 8,415 crores of MF schemes and savings of tax-paid money are gone.


Today, both taxpayers
and beneficiaries of taxes are in the same boat. As a taxpayer – whether she
pays Rs. 1 lakh, Rs. 10 lakhs or Rs. 50 lakhs – she may not be able to get an
ambulance or a hospital bed in case Covid-19 strikes. I am not sure where the
taxpayer stands in the big picture! The taxpayer needs to rise and question
where her taxes are going and what does she get in return.

 

 

 

Raman
Jokhakar

Editor

 

SPECIFIC TRANSACTIONS IN INCOME TAX & GST

In continuation of the article
published in the April, 2020 issue of this Journal, we have detailed certain
other areas of comparison between the Income tax and the GST laws

 

REVISION IN
PRICE OF SUPPLY – ACCRUAL OF INCOME VS. SUPPLY OF SERVICE

The time of supply
and the accrual of income are generally synchronous with one another. The
earlier article discussed that the supply aspect of a contract generally
precedes the claim of consideration from the contract. In most contracts, the
right to receive consideration starts immediately on completion of supply
resulting in co-existence of supply and income in a reporting period. Yet, in
certain cases the occurrence of supply and the consequential income therefrom
may spread over different tax periods. This concept of timing can be understood
from the perspective of tax treatments over retrospective enhancement of price
/ income. Income tax awaits the right to receive the enhanced income but excise
retraces any additional consideration back to the date of removal and is not
guided by the timing of its accrual.

 

Under the Excise law, there was
considerable debate on the imposition of interest on account of revision of the
transaction value subsequent to removal of excisable goods. The Supreme Court
through a three-judge Bench in Steel Authority of India Ltd. vs. CCE,
Raipur (CA 2150, 2562 of 2012 & 599, 600 & 1522-23 of 2013) was
deciding a reference in the light of decisions in CCE vs. SKF India Ltd.
[2009] 21 STT 429 (SC) and CCE vs. International Auto Ltd. [2010]
24 STT 586 (SC) wherein the question for consideration was the due date
of payment of the excise duty component on subsequent enhancement of a
tentative price. In other words, whether the date of removal of goods would be
relevant in case of a subsequent enhancement of price with retrospective
effect. The Court, after analysing the provisions of sections 11A, 11AB, etc.
held that the date of removal was the only relevant date for collection of tax
and the transaction value would be the value on the date of removal. Even
though the price of the transaction was not fixed on the date of removal,
subsequent fixation of price would relate back to the date of removal and
interest would be applicable on the additional price collected despite the
event taking place after the removal.

 

In service tax, the taxable event was
the rendition of service [Association of Leasing & Financial Service
Companies vs. UOI; 2010 (20) STR 417 (SC)]. Rule 6 of the Service Tax
Rules r/w the Point of Taxation Rules provides for payment of service tax based
on the invoice raised for rendition of service. In case of regular services,
the invoice was considered as a sufficient trigger for taxation, while in the case
of continuous services the right to claim consideration was considered as the
appropriate point of time when tax would be applicable. The said rules seem to
be the source of the provisions contained in the GST law, especially for
services. Where provision of service is the point of taxation, the principles
as made applicable to removal under the Excise law would also be applicable to
service tax laws.

 

In sales tax law, the term turnover
(and sales price) was defined on the basis of amounts receivable by the dealer
towards sale of goods. The Supreme Court in Kedarnath Jute Manufacturing
Co. Ltd. [1971] 82 ITR 363 (SC) stated that the liability to pay sales
tax would arise the moment the sale was effected. In the case of EID
Parry vs. Asst. CCT (2005) 141 STC 12 (SC), the Court was examining
whether interest was payable on short payment of purchase tax on account of
enhanced purchase consideration payable after fixation of the statutory minimum
price of sugar under the Government Order. The Supreme Court held that no
interest was payable on such enhanced consideration and any tax paid earlier
was a tax paid in advance. In fact, the Court went a step further stating that
the amount paid towards the provisional price fixed by the government is not
the price until finalised by the government for the transaction of sale.

 

Now under the GST law, tax on supply of
goods / services is payable on the invoice for the supply, i.e. typically on or
before the removal of goods or the provision of service. From the perspective
of supply of goods, the collection of taxes under GST has blended the sales tax
concept (relying on invoice) and the excise concept (relying on removal).
However, there is a clear absence of a condition of ‘right to receive’
the consideration from the recipient while assessing the supply of goods.

 

One probable reason would be that the
legislature has presumed an invoice as evidence of the supplier completing its
obligation under the contract, resulting in a right to receive the
consideration. The other reason could be that the legislature is fixing its tax
at the earliest point in time (which it is entitled to do), i.e. when the
outward aspect of a contractual obligation takes place and is not really
concerned with the timing of its realisation. Both reach the same conclusion,
that while income tax stresses on ‘right to receive’,
GST latches onto the transaction immediately on ‘completion of obligation to
supply’ and does not await realisation
of consideration to establish taxing rights. In effect, the time of supply for
GST may in many cases be triggered even before the income accrues to the
taxpayer and as a consequence creating a timing difference between both laws.
Therefore, even if prices are tentative, it may be quite possible to tax the
transaction and subsequent fixation of prices of supply of goods or services
would not assist the taxpayer in claiming that the point of tax liability is
the point of fixation of the price.

 

One caveat would be that in case of services
the law does not have any tangible substance to trace its origin and
completion, and hence as a subordinate test adopts receipt of consideration as
the basis of the supply (of service) having been complete (both in the case of
regular and continuous supply of service). But this is a matter of legislative
convenience of collection rather than a conceptual point for analysis.

 

DEPRECIATION
COMPONENT ON CAPITAL ASSETS

The GST law prohibits the claim of
Input Tax Credit (ITC) if such component has been capitalised in the written
down value (WDV) of the block of assets under the Income-tax Act [section 16(4)
of CGST]. This is introduced to prohibit persons from availing a dual benefit:
(1) a deduction from taxable profits under income tax; and (2) a deduction from
output taxes. Taxpayers generally opt to avail ITC and refrain from taking
depreciation on such tax components. In case a taxpayer (erroneously or
consciously) avails depreciation on the ITC component of capital goods without
claiming the credit under GST, does the window to relinquish its claim of
depreciation and re-avail ITC continue to remain open?

 

We can take the case of motor vehicles
which was originally considered as ineligible for ITC becoming eligible for the
same if the taxable person decides to sell the asset during the course of
business. The answer could be a ‘possible’ yes (of course, with some practical
challenges). Section 41(1) of the Income-tax Act permits an assessee to offer
any benefit arising from a previously claimed allowance / deduction as income
in the year of its credit. Through this provision the assessee may be in a
position to reverse the depreciation effect and state that there is no
depreciation claim on the ITC component of the asset. We may recall that the
Supreme Court in Chandrapur Magnet Wires (P) Ltd. vs. CCE 1996 (81) ELT 3
SC had in the context of MODVAT stated that if the assessee reverses a
wrongly-claimed credit, it would be treated as not having availed credit. This
analogy can serve well in this case, too, on the principle of revenue
neutrality. But the contention of revenue neutrality becomes questionable where
there is any change in law, in tax rates, etc.

 

However, the
reverse scenario, i.e. giving up the ITC claim and availing depreciation, may
not be as smooth. While there may not be an issue under the GST law, the
Income-tax Act follows a strict ‘block of assets method’ and alterations to
such blocks, except through enabling provisions, are not permissible. The block
of assets method only permits alterations to the block in case of acquisition,
sale, destruction, etc. of assets and does not provide for retrospective change
in the actual cost of the asset. The only alternative is to file a revised
return before the close of the assessment year in which the acquisition takes
place by enhancing the actual cost, or file a revised block of assets during
the course of assessment proceedings.

 

ASSESSMENT VS.
ADJUDICATION OR BOTH

The Privy Council in Badridas
Daga vs. CIT (17 ITR 209) stated that the words ‘assess’ and
‘assessment’ refer to the procedure adopted to compute taxes and ‘assessee’
refers primarily to the person on whom such computation would be performed
(also held in Central Excise vs., National Tobacco Co. of India Ltd. 1972
AIR 2563). While adjudication and assessment are both comprised in the
wider subject to ‘assessment’, the procedure for assessment under income tax is
distinct from the assessment systems under the Excise / GST laws.

Income tax follows the concept of
previous year and assessment year, i.e. incomes which are earned in a financial
year (previous year) are assessed to tax in the immediately succeeding year
(assessment year). Consequently, income tax liability arises at the end of the
previous year and is liable for payment during the assessment year. The
taxpayer is required to compute the net income arising during the previous year
and discharge its liability after the close of the previous year as part the
self-assessment scheme. The unit of assessment is a year comprising of twelve
months. On the other hand, the liability towards GST is fixed the moment the
transaction of supply takes place with the collection being deferred to a later
date through a self-assessment mechanism, i.e. the 20th of the
subsequent calendar month (tax period).

 

The assessment of income under income
tax takes place in multiple stages. The return filed u/s 139 is examined
through a process popularly called summary assessment, the scope of which involves
examination of mathematical accuracy, apparent errors (such as conflicting or
deficient data in the return), incorrect claims based on external data sources
with Income tax authorities (such as TDS, TCS, Annual Information Reports,
etc.) [section 143(1)]. Based on a Computer-Aided Selection System, a return
may be selected for detailed scrutiny assessment on the legal and factual
aspects involving information gathering, examination, application and final
conclusion through an assessment order [sections 143(2) and (3)]. One
assessment year is subjected to a single scrutiny assessment. Once this takes
place, such an assessment cannot be altered other than by a re-assessment. The
re-assessment provisions u/s 147 provide for assessment of escaped income (either
arising after self-assessment or scrutiny assessment) which can be initiated
within a stipulated time frame in cases of escaped incomes. Income tax has
defined time limits for initiation and completion of such scrutiny and
re-assessments.

 

The Excise and service tax laws follow
a system of adjudication rather than a scheme of assessment. This probably is
on account of the physical administration system adopted by Excise authorities
during the 1900s. The Excise law has bifurcated the administrative function
into two stages, (a) audit / verification function (information collation), and
(b) adjudication function (legal application). These functions are not
necessarily performed by the same authority. The audit function was not
codified in law but guided by administrative instructions. It involved
site-cum-desk activity wherein the authorities performed the information
collection and issued an exception-based report on the identified issues. After
this, the adjudicating authority prepares a tax proposal, referred to as a show
cause notice, giving its interpretation over a subject with the evidence
collected for this purpose. The adjudicating authority would complete the
adjudication after due opportunities and confirm / drop the proposal by
issuance of an adjudication order. The Excise law provided for time limits on
issuance of the show cause notice but did not provide an outer limit to its
completion.

 

The critical difference between the two
systems can be examined from these parameters:

(1)        Source
and scope – Scrutiny assessments are currently selected through a computer-aided
selection process. Though administrative instructions limited the assessments
to identified issues, the officer had the liberty to expand the scope in cases
where under-reporting of taxes is identified. The statute does not limit the
scope of the scrutiny proceedings. Adjudication commences after internal audit
/ verification / inspection reports but not through any random sampling
methodology. The scope of the adjudication is clearly defined and the entire
proceeding only hovers around the issue which is defined in the notice.

 

(2)        Methodology – Income tax
assessments involve both fact-finding and legal application. The onus is on the
officer to seek the facts required and arrive at a legal conclusion, but the
stress is initially on the facts of the case. The diameter of an ideal
adjudication process is driven by application of law and the presumption is
that the adjudicating officer has concluded the fact-finding exercise thoroughly;
however, in practice any deficiency in facts can be made good by seeking an
internal verification report or submission from the taxpayer. In adjudication,
the fact-finding authority and the decision-making authority may not
necessarily be the same, unlike in income tax assessments.

 

(3)        Adversarial
character – Adjudication is slightly adversarial in nature, in the sense that the
notice commences with a proposal of tax demand leaving the taxpayer to provide
all the legal and factual contentions against the proposal. Revenue and
taxpayers are considered as opposing parties to the issue identified.
Assessments do not acquire an adversarial character until the Revenue officer
reaches a conclusion that there is under-payment of taxes.

 

(4)        Multiplicity
and parallel proceedings – Scrutiny proceedings are undertaken only once for a particular
assessment year. Multiple scrutiny proceedings are not permissible for the same
assessment year even on matters escaping attention during the scrutiny
proceedings. Multiple adjudications by different authorities (in ranking /
function) are permissible for a particular tax period, though the issues may
not necessarily overlap with each other. As regards periodicity, there would be
one income tax assessment in force for a particular assessment year but there
can be multiple adjudication orders in force for the tax period. The period
under adjudication is not limited by tax periods or financial years, except for
the overall time limit of adjudication.

 

(5)        Revenue’s
remedy – In income tax, Revenue does not have the right to appeal against the
assessment order of the A.O. Where orders are ‘erroneous’, the Commissioner can
exercise his revisionary powers. Adjudications being adversarial in nature are
orders against which both the taxpayer and the Revenue have the right of
appeal. Revision proceedings are limited in scope in comparison to appellate
proceedings where Revenue is under appeal – for example, revision proceedings
cannot be initiated where the A.O. adopts one of the two possible views (order
would not be erroneous) but the appellate proceedings would be permissible even
in cases where the Commissioner differs from the view adopted by the
subordinate. At the first appellate forum, the Commissioner of Income Tax (Appeals)
[CIT(A)] is permitted to wear the A.O.’s hat and enhance the assessment during
the course of the proceedings. Under Excise, the Commissioner of Central Excise
(Appeals) [CCE(A)] proposing enhancement of tax would have to necessarily
operate as an adjudicating officer assuming original jurisdiction and following
the time limits and restrictions as applicable to the original adjudication
proceedings – for example, the CIT(A) can enhance the assessment of an order
under appeal even if the time limit for assessment has expired, but a CCE(A)
would not be permitted to issue a show cause notice for enhancement after the
time permissible to issue a show cause notice.

 

(6)        Demands
and refunds – Income tax assessments could result in a positive demand or a refund
to the taxpayer. The net result of the computation of income would have to be
acted upon by the A.O. without any further proceeding. Excise adjudications,
being issue-specific, can only result in tax demand or dropping of the
proceedings – but cannot result in refunds. The taxpayer is required to
initiate the refund process through independent proceedings. Consequently,
excess tax paid in respect of capital gains income can be adjusted with short
tax paid on business income. On the other hand, excess tax paid on a
manufactured product cannot be adjusted with short tax paid on any other
product – both these aspects are to be independently adjudicated and the
process of adjustment can only take place through a specific right of
adjustment under recovery procedures.

 

(7)        Time
limits – Income tax has defined the time limits for initiation and completion
of proceedings, including re-assessment, etc. Excise laws are not time-bound on
the completion of the adjudication, though Courts have directed that the validity
of a notice can be questioned where there is unreasonable delay in completion
of the adjudication.

 

(8)        Finality – Assessment orders
under income tax are final for the assessment year under consideration and no
issue for that assessment year can be re-opened or revised except by statutory
provisions under law. Adjudication orders are final only with respect to the
issue under consideration and Excise authorities are permitted to adjudicate other
issues within the statutory time limit. Therefore, multiple adjudication orders
for one tax period are permissible under the Excise law.

 

(9)        Effect
orders – Appellate proceedings are with reference to specific issues and on
the completion of such proceedings the income tax authority is required to
modify the assessment order after taking into consideration the conclusion over
the disputed matter. An adjudication proceeding is itself issue-driven and
hence the appellate orders generally do not require any further implementation
by the adjudication officer unless directed by the appellate authority.

 

The GST law has adopted a hybrid system
of adjudication and assessment – adjudication seems to be inherited largely
from the Excise law and the assessment scheme has been borrowed from the Sales
Tax law. While sections 59-66 represent the assessment function, section 73/74
performs the adjudication over the issues gathered through assessment activity.
The consequence of having this dual functionality would be:

 

(a)        All
assessments resulting in demand of taxes would necessarily have to culminate in
adjudication without which the demand would not be enforceable under law, even
though it may be liable. Where the assessment results in a refund of taxes, the
Revenue may not proceed further and would leave it to the assessee to claim a
refund under separate provisions, i.e. section 54. This is quite unlike in
income tax where refunds computed under the Act are necessarily required to be
paid and need not be sought by the assessee through a refund application.

 

(b)        Under
sales tax, self-assessment was considered as a deemed assessment in the sense
that the return filed was considered as accepted unless reopened by Revenue
authorities. The assessment order modifies the self-assessment (i.e. return)
and no further adjudication is required to complete the assessment. GST also
treats the return filed as a self-assessment of income. In some cases where
assessments are to be made (best judgement assessment, scrutiny assessment,
etc.), the assessments are interim until final adjudication of the demand
arising therefrom. Though adjudication necessarily succeeds assessments (to
enforce demands), assessment need not necessarily precede adjudication.

 

(c)        Revenue
authorities now have appellate and revision remedies for assessing escaped
taxes. Appellate rights have been granted to both the assessee and to Revenue
against the orders passed under sections 73 / 74 and revision rights have been
granted to the Commissioner to revise the said adjudication order (sections 107
and 108). In effect, Revenue has the option to either appeal or revise the
adjudication order (though in limited cases). This seems to be a concern given
the fact that adjudicating officers are expected to be independent authorities.
With multiple review powers by senior administrative offices on a suo motu
basis, any possibility of reopening of adjudication orders may impair the
quality and fairness of adjudication.

 

(d)        GST
has for the first time introduced an overall time limit for completion of
adjudication and, in effect, capped the time limit for its commencement (three
months from the statutory time limit of completion). This is unlike the Excise
law where time limits of adjudication proceedings are not capped. The enactment
has also rectified an anomaly in the income tax law by stating that notices for
adjudication should be issued at least three months prior to the expiry of the
time limit for adjudication.

 

To sum up, the GST law seems to have a
blend of both, resulting in wide latitude of powers to the tax authorities and
one should tread cautiously while representing before the tax authorities by
ensuring robust documentation.

 

UNEXPLAINED
CREDITS – UNACCOUNTED SALES / CLANDESTINE REMOVALS

Income tax contains specific provisions
deeming unexplained credits / moneys or expenditure (assets or income which
cannot be identified to a source). In income tax the said credits are deemed as
income and aggregated to the total income without the need to examine the head
under which they are taxable. Unlike income tax where tax is imposed on a
single figure, i.e. the total income of the assessee for the assessment year,
GST is applicable on individual transactions and identification of the
transaction is of critical importance.

 

In the recent past there have been
circumstances where inspection proceedings have resulted in detection of
unaccounted assets (such as cash). The practice of the Revenue has been to
allege that unaccounted assets are an outcome of the supply of particular
product / service and liable to tax under GST. This is being done even in the
absence of a parallel provision under GST to deem unaccounted assets as a
supply from a taxable activity. This approach suffers some deficiencies on
account of various reasons: (a) deeming fiction over incomes cannot be directly
attributable to a taxable supply; (b) the levy is dependent on certain factors
such as exemptions, classification, rates, etc. and such facts cannot be left
to best judgement; (c) a defendant cannot be asked to prove the negative (i.e.
prove that he / she has NOT generated the asset from a supply); (d)
presumptions of the existence of a transaction cannot be made without having
reasonable evidence on time, value and place of supply. The provisions of best
judgement u/s 62, too, do not provide wide latitude in powers and are
restricted to cases of non-filers of returns. In the absence of a document
trail or factual evidence, it would be inappropriate for the Revenue to allege
suppression of turnover and impose GST on such deemed incomes under income tax.

 

In the context of Excise, demands based
on income tax reports have all along been struck down on the ground that such
reports are merely presumptions and cannot by themselves substitute evidence of
manufacture and removal. In Commissioner vs. Patran Pipes (P) Ltd. – 2013
(290) ELT A88 (P&H) it was held that cash seized by income tax
authorities cannot form cogent evidence showing manufacture and clandestine
removal of such goods. The larger Bench in SRJ Peety Steel Pvt. Ltd. vs.
CCE 2015 (327) E.L.T. 737 (Tri.–Mum.) held that the charge of
clandestine removal cannot sustain merely on electricity calculations. In
service tax, too, in CCE vs. Bindra Tent Service (17) S.T.R. 470 (Tri .-
Del.) and CCE vs. Mayfair Resorts (22) S.T.R. 263 (P & H)
2010 it was held by the Courts that surrender of income before income
tax authorities would not be considered as an admission under the Service Tax
law. These precedents are likely to apply to the GST enactment as well, and
unless thorough investigation of these unexplained incomes is performed, tax
liability cannot be affixed to unexplained credits.

 

TAX AVOIDANCE
PROVISION SECTION 271AAD OF INCOME TAX ACT

By the recent Finance Act, 2020 the
Central Government has introduced a specific penal provision in the Income-tax
Act in terms of section 271AAD. The said section has been introduced to address
the racket of fake invoices – the income tax law has been empowered to impose a
penalty to the extent of the ‘value’ of the fake invoice. The
section is applicable (a) where there is a false entry in the books generally
represented through a fake input invoice (being a case where the supplier is a
bogus dealer, there is no supply of goods / services at all, invoice is fake /
forged); or (b) where a person has participated in such falsification – such as
supplier, agent, etc.

 

The GST law also contains provisions
u/s 122 to impose a penalty on the supplier to the extent of tax evaded in case
of bogus supplies. A recipient of such supplies is also liable for penalty to
the same extent. Therefore, apart from the basic payment of tax and interest, a
recipient and / or supplier would be liable to an aggregate penalty under both
laws which would exceed the value of the fake invoice, including the GST
component. This is apart from other penalties and consequences of prosecution
and de-registration. The presence of such stringent provisions would pave the
way to both income tax and GST authorities to jointly clean up the system of
this menace and share such information with each other for effective
enforcement. This provision is another step in integration of income tax and
GST laws.

 

The above instances (which are selected as examples) clearly convey the
need for industry to view any transaction from both perspectives at a
conceptual and reporting level. With the advent of GST, additional
responsibilities would be placed on taxpayers to provide suitable
reconciliation between GST and income tax laws. GST authorities would be
interested in identifying those incomes that were not offered to tax and income
tax authorities would be interested in identifying those supplies which have
not been reported as income. The taxpayer has to survive this tussle and stamp
his claim to the respective authorities.

 

DOUBLE DEDUCTION FOR INTEREST UNDER SECTIONS 24 AND 48

ISSUE FOR CONSIDERATION

Section 24
of the Income-tax Act grants a deduction for interest payable on the borrowed capital
for acquisition, etc. of a house property in computing the income under the
head  ‘Income from House Property’. This
deduction is allowed for interest for the pre-acquisition period in five equal
annual instalments from the year of acquisition, and for the period
post-acquisition, annually in full, subject, however, to the limits specified
in section 24.

 

Section 48
of the Act grants a deduction for the cost of acquisition and improvement of a
capital asset in computing the income under the head ‘Capital Gains’. That for
the purposes of section 48 interest paid or payable on borrowings made for the
acquisition of a capital asset is includible in such a cost and is allowable as
a deduction in computing the capital gains, is a settled position in law.

 

The above
understandings, otherwise settled, encounter difficulty in cases where an
assessee, after having claimed a deduction over a period of years, for the same
interest u/s 24 in computing the income from house property, claims a deduction
for such interest, in aggregate, paid or payable over a period of the
borrowings again u/s 48, in computing the capital gains. It is here that the
Revenue authorities reject the claim for deduction u/s 48 on the ground that
such an interest has already been allowed u/s 24 and interest once allowed
cannot be allowed again in computing the total income.

 

The issue of
double deduction for interest, discussed above, has been the subject matter
of  conflicting decisions of  different benches of the Income Tax Appellate
Tribunal some of which are examined here and their implications analysed for a
better understanding of the subject.

 

THE C. RAMABRAHMAM CASE

The issue was first examined by the Chennai Bench of the Appellate
Tribunal in the case of ACIT vs. C. Ramabrahmam, 57 SOT 130 (Mds).
In that case the assessee, an individual, had purchased a house property with
interest-bearing borrowed funds at T. Nagar, Chennai on 20th
January, 2003 for an aggregate cost of Rs. 37,03,926. An amount of Rs. 4,82,042
in aggregate was paid as interest on the housing loan taken in 2003 for
purchasing the property which was claimed as deduction u/s 24(b) in the A.Ys.
2004-05 to 2006-07. He sold the property on 20th April, 2006 for Rs.
26.00 lakhs and in computing the capital gains, he claimed the deduction for
the said interest u/s 48 of the Act. The A.O. disallowed the claim for
deduction of interest u/s 48 since interest in question on the housing loan had
already been claimed as deduction u/s 24(b) in the A.Ys. 2004-05 to 2006-07,
and the same could not be taken into consideration for computation u/s 48
inasmuch as the legislative provision of section 48 did not permit inclusion of
the amount of deduction allowed u/s 24(b) of the Act. The A.O. added back the
interest amount to the income of the assessee from short-term capital gains vide
the assessment order dated 24th November, 2009.

 

The assessee
preferred an appeal against the assessment order, wherein the addition made by
the A.O. was deleted by the CIT(A) on the ground that the assessee was entitled
to include the interest amount for computation u/s 48, despite the fact that
the same had been claimed u/s 24(b) while computing income from house property.
The Revenue challenged the CIT(A)’s order in an appeal before the Tribunal.

 

Before the
Tribunal, the Revenue prayed for restoring the additions made by the A.O. on
the ground that once the assessee had availed deduction u/s 24(b), he could not
include the very same amount for the purpose of computing capital gains u/s 48.
On the other hand, the assessee sought to place reliance on the CIT(A)’s order
as well as the findings contained therein, and in the light thereof, prayed for
upholding his order and sought dismissal of the Revenue’s appeal.

On due
consideration of the rival submissions of both the parties at length and the
orders of the authorities on the issue of capital gains, the Tribunal noted
that there was hardly any dispute that the assessee had availed the loan for
purchasing the property in question and had declared the income under the head
‘house property’ after claiming deduction u/s 24(b) and that there was no
quarrel that the assessee’s claim of deduction was under the statutory
provisions of the Act and, therefore, he succeeded in getting the deduction.
The Tribunal also noted that after the property was sold, the assessee also
chose to include the said interest amount in the cost while computing capital
gains u/s 48.

 

The Tribunal
observed that deductions u/s 24(b) and u/s 48 were covered by different heads
of income, i.e., ‘income from house property’ and  ‘capital gains’, respectively; that a perusal
of both the provisions made it unambiguous that none of them excluded the
operation of the other; in other words, a deduction u/s 24(b) was claimed when
the assessee concerned declared income from house property, whereas the cost of
the same asset was taken into consideration when it was sold and capital gains
was computed u/s 48; that there was not even the slightest doubt that the
interest in question was indeed an expenditure in acquiring the asset.

 

The Tribunal
proceeded to hold that since both provisions were altogether different, the
assessee in the instant case was certainly entitled to include the interest
amount at the time of computing capital gains u/s 48 and, therefore, the CIT(A)
had rightly accepted the assessee’s contention and deleted the addition made by
the A.O. The Tribunal, qua the ground, upheld the order of the CIT(A).

 

The decision
of the Chennai Bench has since been referred to with approval in the following
decisions to either allow the double deduction of interest on the borrowed
capital, and in some cases to allow the deduction u/s 48 where no deduction was
claimed u/s 24: Ashok Kumar Shahi, ITA No. 5155/Del/2018 (SMC)(Delhi);
Gayatri Maheshwari, 187 TTJ 33 (UO)(Jodhpur); Subhash Bana, ITA 147/Del/2015
(Delhi); and R. Aishwarya, ITA 1120/Mds/2016 (Chennai).

 

CAPT. B.L. LINGARAJU’S CASE

The issue
came up for consideration before the Bangalore Bench of the Tribunal in the
case of Capt. B.L. Lingaraju vs. ACIT, ITA No. 906/Bang/2014. The
facts as gathered from the notings of the Tribunal are that in this case the
total income computed by the assessee, an individual, included income from
house property of Rs. 1,09,924, which meant that the interest expenditure on
the housing loan was already allowed. A revised computation submitted during
the assessment by the assessee before the A.O. along with the return of income,
recomputed the income at Rs. 2,59,924. The assessee had claimed deduction for
housing loan interest restricted to Rs. 1.50 lakhs because the house property
in question was self-occupied and the deduction on account of interest was
restricted to Rs. 1.50 lakhs as per the provisions of section 24(b) of the I.T.
Act. The assessee appears to have sold the house property during the year and
the capital gains thereon, computed after claiming the aggregate interest of
Rs. 13,24,841 u/s 48, was included in the total income returned for the A.Y.
2009-10. The A.O. seems to have disallowed the claim of interest in assessing
the capital gains u/s 48 of the Act and the CIT(Appeals), vide his order
dated 1st April, 2014 
confirmed the action of the A.O.

 

The
assessee, aggrieved by the orders, had filed an appeal before the Tribunal
raising the following grounds:

 

‘1. The order of the Learned Assessing Officer is
not justified in disallowing capitalisation of interest for computing short
term capital gains.

2.  The Learned CIT(A) II has wrongly interpreted
the term cost of acquisition under sections 48, 49 and section 55(2). The
Learned CIT(A) II is of the opinion that the cost of acquisition cannot be
fluctuating, but it should be fixed, except in circumstances when the law permits
substitution. Learned CIT(A) II has disallowed the interest paid on loan
amounting to Rs. l3,24,841 in his order without considering the facts of the
case and the CIT and ITO has ignored the decision in the case of CIT
vs. Hariram Hotels (P) Ltd. (2010) 229 CTR 455 (Kar) which
is in favour of appellant.

3.
……………………………………….

On the basis
of above grounds and other grounds which may be urged at the time of hearing,
it is prayed that relief sought be granted.’

 

The Tribunal
has noted that the appeal was earlier fixed for hearing on 14th
January, 2016 and on that date the hearing was adjourned at the request of the
AR of the assessee and the next date of hearing was fixed on 21st April,
2016; the new date of hearing was intimated to the AR of the assessee at the
time of hearing on 14th January, 2016. None appeared on behalf of
the assessee on 21st April, 2016 and there was no request for
adjournment. Under the facts, the Tribunal proceeded to decide the appeal of
the assessee ex parte qua the assessee after considering the written
submissions of the AR of the assessee which were available on pages 1 to 8 of
the Paper Book. The Revenue supported the orders of the authorities below.

 

The
Tribunal, on due consideration of the written submissions filed by the AR of
the assessee and the submissions of the Revenue and the orders of the
authorities below, found that  the
assessee had placed reliance on the judgments of the jurisdictional High Court
rendered in the case of CIT & Anr. vs. Sri Hariram Hotels (P) Ltd.,
229 ITR 455 (Kar) and CIT vs. Maithreyi Pai, 152 ITR 247 (Kar). It
noted the fact that the judgment rendered in the case of Sri Hariram
Hotels (P) Ltd. (Supra) had followed the earlier judgment of the
jurisdictional High Court rendered in the case of Maithreyi Pai (Supra).
The assessee had also placed reliance on the judgments of the Delhi High Court
and the Madras High Court and several Tribunal orders which were not found to
be relevant as the Tribunal had decided to follow the orders of the
jurisdictional High Court.

 

While examining the applicability of the judgments of the jurisdictional
High Court, it was found that the Court in the case of Maithreyi Pai
(Supra), had held that the interest paid on borrowing for the
acquisition of capital asset must fall for deduction u/s 48, but if the same
was already the subject matter of deduction under other heads like those u/s
57, it was not understandable as to how it could find a place again for the
purpose of computation u/s 48 because no assessee under the scheme of the Act
could be allowed a deduction of the same amount twice over; in the present
case, as per the facts noted by the A.O. on page 2 of the assessment order,
interest in question was paid on home loan and it was not in dispute that
deduction on account of interest on housing loan / home loan was allowable
while computing income under the head ?income from house property’; as per the
judgment of the jurisdictional High Court, if interest expenditure was
allowable under different sections including section 57, then the same could
not be again considered for cost of acquisition u/s 48.

 

In the
Tribunal’s considered opinion, in the present case interest on housing loan was
definitely allowable while computing income under the head ?house property’
and, therefore, even if the same was not actually claimed or allowed, it could
not result into allowing addition in the cost of acquisition.

 

The Tribunal
further noted that it was not the case of the assessee that the housing loan
interest in dispute was for any property used for letting out or used for
business purposes, and even if that be a claim, the interest could be claimed
u/s 24 or 36(1)(iii) but not as cost of acquisition u/s 48; it was seen that
interest expenditure was allowed as deduction u/s 24 to the extent claimed and,
therefore, interest on housing loan could not be considered again for the
purpose of addition in the cost of acquisition as per the judgment of the High
Court of Karnataka cited by the assessee in the grounds of appeal and by the AR
of the assessee in his written submissions. The Tribunal, in the facts of the
case, respectfully following the judgment of the High Court of Karnataka, held
that the claim of the assessee for deduction of interest u/s 48 in computing
the capital gains was not allowable.

 

OBSERVATIONS

The relevant
part of section 24 which grants deduction for interest payable on the borrowed
capital reads as: ‘(b) where the property has been acquired, constructed,
repaired, renewed or reconstructed with borrowed capital, the amount of any
interest payable on such capital…’

 

Likewise,
the part relevant for deduction of cost u/s 48 reads as: ‘the income
chargeable under the head “capital gains” shall be computed, by
deducting from the full value of the consideration received or accruing as a
result of the transfer of the capital asset the following amounts, namely: (i)
expenditure incurred wholly and exclusively in connection with such transfer;
(ii) the cost of acquisition of the asset and the cost of any improvement
thereto:’

 

Apparently,
section 24 grants a specific deduction for interest in express terms subject to
certain conditions and ceilings. While section 48 does not explicitly grant a
deduction for interest, the position that such interest is a part of the cost
for section 48 and is deductible is settled by the decisions of various Courts
in favour of the allowance of the claim for deduction. There is nothing
explicit or implicit in the respective provisions of sections 24 and 48 that
prohibits the deduction under one of the two where a deduction is allowable or
allowed under the other. One routinely comes across situations where it is
possible to claim a deduction under more than one provision but dual claims are
not attempted or entertained due to the express pre-emption by the several
statutory provisions which provide for denial of double deductions. These
provisions in express terms lay down that no deduction under the provision
concerned would be allowable where a deduction is already claimed under any
other provisions of the Act. The Act is full of such provisions, for example,
in section 35 in its various alphabets and chapter VIA.

In the
circumstances, it is tempting to conclude that in the absence of an express
prohibition, the deductions allowable under different provisions of the statute
should be given full effect to, more so in computing the income under different
heads of income. It is this logic and understanding of the law that has
persuaded the different benches of the Tribunal to permit the double deduction
in respect of the same expenditure, first u/s 24 and later u/s 48. For the
record it may be noted that most of the decisions have followed the decision in
the case of C. Ramabhramam (Supra). In fact, some of them have
followed this decision to support the claim of deduction u/s 48 even in cases
where they were not asked to deal with the issue of double deduction.

 

Having noted
this wisdom behind the allowance for double deduction, it is perhaps
appropriate to examine whether such deduction, under the overall scheme of the
Act, is ever permissible. One view of the matter is that under the scheme of
taxation of income, net of the expenditure, there cannot be any license to
claim a double deduction of the same expenditure unless such a dual deduction
is permissible by express language of the provisions. Under this view, a double
deduction is not a rule of law but can be an exception in exceptional
circumstances. A prohibition in the rule underlying the overall scheme of the
taxation of income and all the provisions of the Act is not required to
expressly contain a provision that prohibits a double deduction.

 

This view
finds direct favour from the ruling of the Supreme Court in the case of Escorts
Ltd. 199 ITR 43. The relevant parts in paragraphs 18 and 19 read as
follows: ‘In our view, it is impossible to conceive of the Legislature
having envisaged a double deduction in respect of the same expenditure, even
though it is true that the two heads of deduction do not completely overlap and
there is some difference in the rationale of the two deductions under
consideration. On behalf of the assessees, reliance is placed on the following
circumstances to support the contention that the statute did not intend one
deduction to preclude the other: …We think that all misconceptions will vanish
and all the provisions will fall into place if we bear in mind a fundamental,
though unwritten, axiom that no Legislature could have at all intended a double
deduction in regard to the same business outgoing; and, if it is intended, it
will be clearly expressed. In other words, in the absence of clear statutory
indication to the contrary, the statute should not be read so as to permit an
assessee two deductions, both under section 10(2)(vi) and section 10(2)(xiv) of
the 1922 Act, or under section 32(1)(ii) and section 35(2)(iv) of the 1961 Act qua
the same expenditure. Is then the use of the words “in respect of the same
previous year” in cl. (d) of the proviso to section 10(2)(xiv) of
the 1922 Act and section 35(2)(iv) of the 1961 Act a contra-indication which
permits a disallowance of depreciation only in the previous years in which the
other allowance is actually allowed? We think the answer is an emphatic
“no” and that the purpose of the words above referred to is totally
different.’

 

The position
laid down by the Apex Court continues with force till date. It is also
important to take note of the fact that none of the decisions of the Tribunal
have examined the ratio and the implication of this decision and,
therefore, in our respectful opinion, cannot be said to be laying down the
final law on the subject and have to be read with caution.

 

It is most
appropriate to support a claim for deduction u/s 48 for treating the interest
as a part of the cost with the two famous decisions of the Karnataka High Court
in the cases of Maithreyi Pai and Sri Hariram Hotels
(Supra). At the same time it is important to note that the same
Karnataka High Court in the very decisions has observed that the double
deduction was not permissible in law and in cases where deduction was already
allowed under one provision of the Act, no deduction again of the same
expenditure under another provision of the Act was possible, even where there
was no provision to prohibit such a deduction. The relevant part of the
decision of the High Court in the Maithreyi Pai case reads as
under:

 

‘8.
Mr. Bhat, however, submitted that section 48 should be examined independently
without reference to section 57. Section 48 provides for deducting from the
full value of consideration received, the cost of acquisition of the capital
asset and the cost of improvement, if any. The interest paid on the borrowings
for the acquisition of capital asset must fall for deduction under section 48.
But, if the same sum is already the subject-matter of deduction under other
heads like under section 57, we cannot understand how it could find a place
again for the purpose of computation under section 48. No assessee under the
scheme of Income-tax Act could be allowed deduction of the same amount twice
over. We are firmly of the opinion that if an amount is already allowed under
section 57, while computing the income of the assessee, the same cannot be
allowed as deduction for the purpose of computing the “capital gains” under
section 48.

9.
The statement of law thus being made clear, it is not possible to answer the
question one way or the other, since there is no finding recorded by the
Tribunal in regard to the contention raised by the Department that it would
amount to double deduction. We, therefore, decline to answer the question for
want of a required finding and remit the matter to the Tribunal for fresh
disposal in the light of observations made.’

 

This being
the decision of the High Court directly on the subject of double deduction, judicial
discipline demands that due respect is given to the findings therein in
deciding any claim for double deduction. In that case, the Karnataka High Court
was pleased to allow the deduction u/s 48 of the interest on capital borrowed
for acquisition of the capital asset being shares of a company, that was
transferred and the gain thereon was being brought to tax under the head
capital gains. The Court, however, pointed out, as highlighted here before,
that such a deduction would not have been possible if such an interest was
allowed as a deduction u/s 57 in computing the dividend income.

 

The view
that the deduction u/s 48 is not possible at all once a deduction was allowable
under any other provision of law, for example, u/s 24, even where no such deduction
was claimed thereunder, is incorrect and requires to be avoided. We do not
concur with such an extreme view and do not find any support from any of the
Court decisions to confirm such a view.

 

A note is
required to be taken of the decision of the Ahmedabad bench in the case of Pushpaben
Wadhwani, 16 ITD 704, wherein the Tribunal held that it
was not possible to allow a deduction u/s 48 for interest in cases where a
deduction u/s 24 for such an interest was allowed. The Tribunal, in the final
analysis, allowed the deduction u/s 48 after confirming that the assessee was
not allowed any deduction in the past of the same interest. In that case the
Tribunal in paragraph 6 while allowing the claim u/s 48, in principle, held:

 

‘In the case of Maithreyi
Pai (Supra), the Hon’ble High Court has held that the interest paid on
the borrowed capital for the purposes of purchase of shares should form part of
“the cost of acquisition” provided the assessee has not got deduction in
respect of such interest payment in earlier years. In the instant case, from
the order of the ITO it is not clear as to when the assessee acquired the flat
in question and whether she was allowed deduction of interest payments in
computing the income from the said flat under the head “Income from house
property” in earlier years. If that be so, then the interest paid on the loan
cannot be treated as part of “the cost of acquisition”. However, if the
assessee has not been allowed such deduction in earlier years, then in view of
the decision in the case of Maithreyi Pai (Supra), the interest
should form part of “the cost of acquisition” of the asset sold by her. Since
this aspect of the matter requires investigation, I set aside the orders of the
income-tax authorities on this point and restore the case once more to the file
of the ITO with a direction to give his decision afresh keeping in mind the
observations made in this order and after giving an opportunity of being heard
to the assessee in this regard.’

 

However, two views on the subject
are not ruled out as is made apparently clear by the conflicting decisions of
the different benches of the Tribunal; it is possible to contend that a view
favourable to the taxpayer be adopted till the time the issue is settled. The
case for double deduction is surely on better footing in a case where the
deduction is being claimed in computing the income under different heads of
income and in different assessment years

 

ACCOUNTING OF E-WASTE OBLIGATION

The E-waste (Management) Rules, 2016 (“Rules”), as amended,
impose e-waste obligations on manufacturers of electrical and electronic goods
who have placed any goods in the market in the current financial year. The
collection, storage, transportation, segregation, refurbishment, dismantling,
recycling and disposal of e-waste shall be in accordance with the guidelines
published by the Central Pollution Control Board.

 

The purpose of this article is not to dive deep into the
legislation, but to explain the accounting consequences with a simplified
example.

 

Consider a refrigerator manufacturer that has been in
manufacturing for many years; it has the following e-waste obligations under
the Rules:

Obligation for financial year

(the measurement period)

Quantum of
e-waste obligation

Expected cost (Rs. million)

2018-19

10% of
refrigerators sold in 2008-09

50

2019-20

20% of
refrigerators sold in 2009-10

110

2020-21

30% of
refrigerators sold in 2010-11

200

2021-22

40% of
refrigerators sold in 2011-12

310

2022-23

50% of
refrigerators sold in 2012-13

415

2023-24

60% of
refrigerators sold in 2013-14

550

2024-25

70% of
refrigerators sold in 2014-15

690

2025-26

70% of
refrigerators sold in 2015-16

750

2026-27

70% of
refrigerators sold in 2016-17

850

2027-28

70% of
refrigerators sold in 2017-18

990

 

 

4,915

 

If the manufacturer participated in the market in the current
financial year (2018-19), its obligation is determined with reference to 10% of
the refrigerators sold in the preceding 10th year (2008-09) and the
cost is estimated at Rs. 50 million. As can be seen from the above table, the
liability increases substantially over the years due to volume increases (i.e.,
the number of refrigerators sold each year keeps increasing) and the percentage
applied under the Rules also increases steeply. The question that arises is, is
a provision of Rs. 4,915 million required for the year end 2018-19?

 

The main argument for supporting a provision of Rs. 50
million is that the obligating event is the participation in the market for the
financial year 2018-19 (the measurement period), and the cost of fulfilling the
obligation is determined by reference to the year 2008-09 under the Rules. On
this basis, the cost of obligation is Rs. 50 million, and should be provided
for, unless it has already been expended and charged to P&L.

 

The main argument for supporting a provision of Rs. 4,915
million is that the obligating event is all the sales made in the past, rather
than participation in the market for the current financial year. A provision of
Rs. 4,915 million will ensure that cost related to all previous years’ sales
are provided for. Accordingly, any costs including future costs for sales
already made are recognised. Consequently, the sales and the accompanying cost
of those sales are matched and recognised in the same period, thereby ensuring
that matching principles are followed.

 

Appendix B, Liabilities arising from Participating in a
Specific Market – Waste Electrical and Electronic Equipment of Ind AS 37 Provisions,
Contingent Liabilities and Contingent Assets deals with the accounting and
is discussed below. At a global level this issue was discussed and led to
issuance of IFRIC 6 Liabilities arising from Participating in a Specific
Market – Waste Electrical and Electronic Equipment, on the basis of which
Appendix B was developed.

 

What constitutes the obligating event in accordance with
paragraph 14(a) of Ind AS 37 for the recognition of a provision for waste
management costs:

  • the manufacture or sale of the
    historical household equipment?
  • participation in the market
    during the measurement period?
  • the incurrence of costs in the
    performance of waste management activities?

 

Paragraph 17 of Ind AS 37 specifies that an obligating
event is a past event that leads to a present obligation that an entity has no
realistic alternative to settling. Paragraph 19 of Ind AS 37 states that
provisions are recognised only for “obligations arising from past events
existing independently of an entity’s future actions”.

 

Participation in the market during the measurement period is
the obligating event in accordance with paragraph 14(a) of Ind AS 37. As a consequence, a liability for waste
management costs for historical household equipment does not arise as the
products are manufactured or sold. Since the obligation for historical
household equipment is linked to participation in the market during the
measurement period, rather than to production or sale of the items to be
disposed of, there is no obligation unless and until a market share exists
during the measurement period.

 

The International Financial Reporting Interpretations
Committee (IFRIC) considered an argument that manufacturing or selling products
constitutes a past event that gives rise to a constructive obligation.
Supporters of this argument emphasise the definition of a constructive
obligation in paragraph 10 of IAS 37 and point out that in determining whether
past actions of an entity give rise to an obligation, it is necessary to
consider whether a change in practice is a realistic alternative. These
respondents believed that when it would be necessary for an entity to take some
unrealistic action in order to avoid the obligation then a constructive
obligation exists and should be accounted for.

 

The IFRIC rejected this
argument, concluding that a stated intention to participate in a market during
a future measurement period does not create a constructive obligation for
future waste management costs. IFRIC felt that in accordance with paragraph 19
of Ind AS 37, a provision can be recognised only in respect of an obligation
that arises independently of the entity’s future actions. If an entity has no
market share in a measurement period, it has no obligation for the waste
management costs relating to the products of that type which it had previously
manufactured or sold and which otherwise would have created an obligation in
that measurement period. This differentiates waste management costs, for
example, from warranties, which represent a legal obligation even if the entity
exits the market. Consequently, no obligation exists for the future waste
management costs until the entity participates in the market during the
measurement period.

 

Some constituents asked
the IFRIC to consider the effect of the following possible national
legislation: the waste management costs for which a producer is responsible
because of its participation in the market during a specified period (for
example, 20X6) are not based on the market share of the producer during that period but on the producer’s
participation in the market during a previous period (for example, 20X5). The
IFRIC noted that this affects only the measurement of the liability and that
the obligating event is still participation in the market during 20X6.

 

The IFRIC considered whether its conclusion is undermined by
the principle that the entity will continue to operate as a going concern. If
the entity will continue to operate in the future, it treats the costs of doing
so as future costs. For these future costs, paragraph 18 of Ind AS 37
emphasises that financial statements deal with the financial position of an
entity at the end of its reporting period and not its possible position in the
future. Therefore, no provision is recognised for costs that need to be
incurred to operate in the future.

 

On the basis of the above discussions, under Appendix B of
Ind AS 37, a provision of only Rs. 50 million is required in 2018-19 (unless
the amount is already expended), which should be charged to the P&L.

SETTING UP THE INTERNAL AUDIT FUNCTION

Internal Audit is an important function within an
organisation. In the present context of increasing emphasis on good governance,
the need for well-defined risks and controls framework, the focus on prevention
rather than detection and desire for a strong compliance culture, there is an
urgent need to ensure that the Internal Audit function has been set up with due
thought process.

 

This article highlights some of the key areas that require
attention while setting up the Internal Audit function in an organisation.
For organisations that already have such a function, there may be a need to
revisit the manner in which it has been set up and make suitable changes to
ensure that the Internal Audit function is engineered to perform effectively.

 

The management of the company while setting up the Internal
Audit function has to take a few key decisions:

 

  • Organisational placement: Who will IA
    report to?
  • Structure: Will IA be an in-house
    function, a totally outsourced function or a co-sourced function?
  • Team composition and location: What
    skill sets will be required for the IA team? How should the team be selected /
    sourced?
  • Scope: How will the scope of IA be
    determined? What will be kept out of the scope?
  • Budget and resources: What is a
    reasonable budget and what resources need to be made available to IA?

 

ORGANISATIONAL PLACEMENT

The audit committee of the
Board (“ACB”) is required to take primary responsibility for ensuring an effective
Internal Audit function. In an ideal situation, internal auditors functionally
report to the ACB and administratively to the CEO. In organisations that do not
require to have an ACB, the responsibility for setting up and overseeing the
Internal Audit function rests with the Board or an equivalent Governing Body,
in case of non-corporate bodies.

 

In reality, in a large
number of cases, the Internal Audit function reports to the CFO, both
administratively and functionally. Even where it does not report to the CFO,
the CFO wields strong influence on the Internal Audit function. The word
“audit” is so strongly associated with the financial reporting process that it
is often wrongly presumed that anything to do with audit, including internal
audit, must have a dotted or a solid line to the CFO.

 

In the absence of a clear understanding of the important role
assigned to the Internal Audit function in the corporate governance framework,
the function is more often than not organisationally misplaced, thereby undermining
its very role.

 

There are also organisations where Internal Audit technically
reports to the ACB, but for all practical purposes that is only on paper. In
these cases, the Audit Committee plays virtually no role in ensuring the
effectiveness of the Internal Audit function, often spending minimal time on
Internal Audit matters. All decisions, such as appointment of internal
auditors, scope determination, access rights and budget for Internal Audit are
taken unilaterally by the CEO or the CFO.

 

It has been my experience that an effective Internal Audit
function has two levels of reporting lines:

 

  • For operational audits, the first level of
    reporting may be to the CEO or a committee comprising of senior executive
    management. However, the key issues arising or areas of difference of opinions
    from such audits need to be presented to the ACB periodically.
  • For organisation-wide audits dealing with
    governance matters (such as effectiveness of whistle-blower mechanism, related
    party process audit and compliance function review) or for audits of functions
    directly headed by the CEO, the reporting has to be to the ACB.

     

For Internal Audit function to play a meaningful role in
an organisation, the first step is to ensure correct organisational placement and
to provide meaningful access to those charged with governance, in this case the
ACB

 

IA Structure: In-house, Outsourced or Co-sourced? Or, is
there a fourth option?

 

                 

A decision that requires deliberation by the management is
the structure of the Internal Audit Department. For a long time, discussions on
the structure have been limited to the three obvious options – that the
Internal Audit function be entirely an in-house function, or the entire
function be outsourced to an external agency, or the Internal Audit function be
partly in-house and partly outsourced.

 

What drives this decision? For some industries, the
regulators have mandated the structure. e.g., a bank is not allowed to
outsource its Internal Audit function, whereas an insurance company above a
certain size is mandatorily required to engage an external agency to perform
its internal and concurrent audit. For large corporate conglomerates and
multinational companies, there is often a Central Internal Audit team headed by
a “Group Head – Internal Audit”. This central team is supported either by a
team large enough to perform all internal audits across all group entities or
is supported by one or more professional firms, each one assigned to perform
internal audit of specific entities of the group or specific areas within
select entities. Increasingly, it is observed that large listed companies or
corporate conglomerates assign the position of “Chief Internal Auditor” to an
in-house person and the management, along with the Chief Internal Auditor,
determines the structure of the IA function.

 

Ideally, the management of the company, with guidance from
the members of the ACB, and in consultation with the Chief Internal Auditor,
should decide upon the structure of Internal Audit function in a manner that:

  • Ensures transparency and fair reporting on the
    status of risks and controls, and on the effectiveness of risk management
    processes and governance processes;
  • Encourages good talent and specialised skills,
    as required, to be available to the Internal Audit function;
  • Ensures that Internal Audit function remains a
    relevant and focused function within the organisation, providing early alerts
    and timely warnings where needed;
  • Accelerates the use of technology for making
    the Internal Audit function efficient and time-sensitive;
  • Allows the organisation to optimise the costs,
    e.g., by appointing local audit firms for remote / decentralised units, while
    retaining the centralised function audits in-house.

 

Unfortunately, in many cases, the structure of the Internal
Audit function is selected in a casual manner based on past practices, without
much deliberation and with the primary objective of cost optimisation. This
needs to change significantly – so that the determination of the structure of
Internal Audit function is a conscious decision backed by serious thinking.

 

In the present dynamic
times, there is the emergence of a fourth option – multi-sourced internal audit
where, in addition to selecting one of the three basic structures described
above, specialist skills are brought in as team members on a need basis,
typically for areas very specific to the industry, or new emerging areas such
as blockchain, cyber security, data privacy, social media audits, etc. With a
fast increasing gig economy on the one hand and a fast changing world on the
other, Internal Audit function cannot be served well with static skills – hence
the emerging trend of seeking the support of specialists to supplement the
internal audit team, for select areas / activities. An effective Internal
Audit function can be designed based on a fine play between in-house talent,
outsourced support on a regular, recurring basis and specialised skills sourced
on a need basis.

 

Decisions for taking support through outsourcing must be
based on strategic thinking as to what is driving the outsourcing decisions –
(a) is it the need to have additional people, (b) the inability to recruit the
right talent, (c) the need for having people in the right geography, (d) the
need for specialised skills that are not available in-house, (e) the need to
bring in lateral experience of the outsourced firm, or (f) the need to optimise
cost as outsourced resources are cheaper than adding team members in-house? If
the structure is strategically decided and the rationale for outsourcing is
clearly understood, the selection of outsourcing partners would be far better
and more effective.

 

To summarise, while setting up the Internal Audit
Function, its structure must be determined based on serious, strategic thinking
and the decision must be revisited periodically to ensure that the structure
continues to be relevant.

 

TEAM COMPOSITION AND LOCATION

Once the decision about the structure of the Internal Audit
function is taken, next is the selection of the team leader, the team members
and / or the outsourcing partners. A good mix of competencies and qualities
needs to be brought together for an effective internal audit. The team leader
should have a clear vision, strong people skills, deep understanding of risks
and controls and of the business being audited, breadth of knowledge about the
external economic and competitive environment, and much more. The past practice
of appointing a “minister without a portfolio” as the Head of Internal Audit
must stop – the Head of Internal Audit must be committed and passionate about
the function and be able to inspire the team to think out of the box and
deliver beyond expectations.

 

 

Careful determination of the size, mix and composition of the
IA team and the identification of competencies and qualities required goes a
long way in selecting the right outsourcing partners. Gone are the days when
internal audit teams would comprise largely of chartered accountants. The
present-day IA team needs to come from different academic and experience
backgrounds – a good IA team for a large company or a corporate group would
include, in addition to finance and accounting persons, specialists in the
industry being audited, some functional specialists such as IT specialists,
engineers, legal and tax specialists and forensic experts.

In case of a multi-locational organisation it is important to
decide the location where the members of the IA team are to be stationed and to
ensure adequate infrastructure at such locations. With advance of technology, it
is not the mere physical location but the decision as to centralisation /
decentralisation of Internal Audit function that becomes relevant.

 

The management may devise suitable policies to encourage flow
of talent into the Internal Audit function – many organisations follow the
policy of placing new entrants first for a stint in internal audit and then
rotate them out based on demonstrated capabilities and interest. Similarly, at
the time of considering promotions from mid-management to senior level, organisations
give due weightage to those who have spent time as part of the internal audit
team for a certain tenure. These considerations, at an early stage, make the
internal audit teams vibrant, with a good mix of young entrants and experienced
functional experts.

 

IA SCOPE DETERMINATION

There has been a lot of
talk about “risk-based internal audit”, where the risk assessment of the
organisation should form the primary basis for scope determination. This is all
very well for organisations that have gone through a rigorous process of risk
assessment and make efforts to keep the same updated to reflect dynamic risks.
For such organisations, the internal audit scope would be determined by the
management in consultation with the internal auditors, based on the identified
risks and their severity after considering the impact of mitigating controls.

 

Many organisations,
however, do not have a mature Risk Management Function and their documented
Risk Management Framework is sketchy and not reflective of the real risks
comprehensively. In such cases, the determination of scope becomes an intuitive
exercise, driven by the areas covered in the past 2-3 years and by the areas
and risks that are apparent and significant. Many finer areas that merit
inclusion in the audit scope remain outside the purview. For internal audit
scope to be meaningful, there is a need for the Risk Management framework of
the organisation to be comprehensive and updated on a dynamic basis. An
internal audit scope designed based on a well-defined Risk Management framework
and after seeking inputs from senior executive management, audit committee
members and statutory auditors tends to be comprehensive and relevant.If
there is one area that needs to be overhauled, it is the manner of fixing the
scope of internal audit – in most cases, there is little creativity, hardly any
dynamism and no clear link between key risks and audit areas included in the
scope.

 

For a meaningful internal audit, the scope must reflect
the dynamic reality and the real concern areas of the organisation, it must
cover adequate ground for proving reasonable assurance on the effectiveness of
controls, and it must have flexibility to modify / enhance the scope to
accommodate newly-identified risks / activities that require attention.

 

IA BUDGET AND RESOURCES

Internal audit is an important management function that
requires a plan, a budget and a commitment for resources, just like any other
function. Management may do well to establish a comprehensive budget detailing
the various heads under which the IA function will need to spend and the
resources and infrastructural support that it would require.

 

The budget and resource planning needs to include:

  •  People cost for the in-house team;
  • Outsourcing cost for the audits proposed to be
    outsourced;
  • Specialist cost;
  • Training needs for skill upgradation of the IA
    team;
  • Technology tools and equipment;
  • Allocation for proper space and infrastructure
    – access to work stations, meeting rooms, video conferencing and communication facilities,
    etc.;
  • Provision of support for development of IT
    utilities and reports required for audit, administrative support, etc.

 

In this dynamic environment, very often the internal audit
budgets are static and the kind of resources allotted are outdated. The
investment made in training and upgrading the skills and knowledge of the IA
team leaves much to be desired and all this inevitably leads to an impoverished
IA function trying hard to “live within the budget”.

 

An effective IA function needs to be empowered with a
healthy budget for efficient execution and skill enhancement, the latest IT
tools and infrastructure and adequate resources for partnering with appropriate
outsourcing agencies and specialists. Expectations from internal audit need to
be aligned to the budget and resources provided for internal audit.

 

CONCLUDING REMARKS

Internal audit is one of the pillars of corporate governance
– lack of planning or mindless cost-cutting in building this pillar can bring
down the superstructure of corporate governance. The tone at the top where the
function is respected as a value adder and not merely as a statutory obligation
will help sustain a great Internal Audit function.

 

Many of the thoughts
expressed in this article may appear to be academic or theoretical – but these
are fundamental to the establishment of a robust Internal Audit function in any
organisation. Just as “well begun is half done”, in the case of Internal Audit
function – “Ill-begun is almost totally lost.”

 

In the present times, when Internal Audit function is
expected to perform audit at the speed of risk, ensuring that the foundation on
which the Internal Audit function is standing is strong and periodically
reinforced to stand the test of time is critical.

WORKS CONTRACT VIS-A-VIS VALUE OF TAXABLE TURNOVER

INTRODUCTION

The taxation of a works
contract under sales tax has been the subject of much debate in the pre-GST
era. The issues arising therefrom are manifold. One such issue is the valuation
of taxable turnover under a works contract.

 

A ‘Works Contract’ is a
composite contract involving both goods and labour. As per the statutory
provisions only value relating to goods can be taxed under sales tax laws. But
determining the value of goods has remained mired in controversy.

 

GOODS USED BUT NOT
GETTING TRANSFERRED

This is one of the issues
being hotly discussed. The case of Commissioner of Sales Tax vs.
Matushree Textiles Limited (132 STC 539)(Bom) is, amongst others, one
of the earliest judgements, laying down that even if goods are not getting
transferred physically but their effect gets transferred, it will be considered
a works contract.

 

In this case, dyes and
chemicals were used for dyeing of cloth. And one of the arguments was that
since the dyes /chemicals are washed away there is no transfer of property in
goods for it to become a part of a works contract.

 

But the Bombay High Court
turned down this argument, holding that even passing on of colour, in the form
of a colour shade on cloth, is transfer of property in goods, and thus it comes
under a works contract. However, valuation was not discussed in this judgement.

 

A case where the issue of valuation arose was that of Enviro
Chemicals vs. State of Kerala (39 VST 434)(Ker). The activity
involved here was the treatment of effluent water. The dealer used chemicals to
purify water and such purified water was then allowed to flow into a river. The
argument was that since there is no transfer of property to the employer in any
form, there is no taxable value as the use of materials is only as consumables.

 

The High Court, by a
majority, rejected the argument and held that the value of goods used, though
not actually transferred to the employer, is taxable.

 

In the recent case of A.P.
Processors vs. State of Haryana (57 GSTR 491)(P&H), the
facts relevant to the judgement are noted as under by the High Court:

 

“3. A few facts relevant
for the decision of the controversy involved as narrated in VATAP No. 32 of
2017 may be noticed. The appellant-assessee is a dealer duly registered under
the provisions of the Haryana Value Added Tax Act, 2003 (HVAT Act) and the
Central Sales Tax Act, 1956 (the CST Act). The assessee is a textile processor
and is engaged in the execution of job works. The grey fabric comes to the
processors and after due processing/manufacturing, the finished product is sent
back, raising an invoice on which Basic Excise Duty (BED) and Additional Excise
Duty (AED) is also leviable, although the rate of duty is nil, and as per the
valuation prescribed in the relevant Act considering the cost of grey fabric,
processing charges and other incidental charges, etc.

 

The assessing authority
concluded the assessment on the basis of observations and findings that all the
dyes and chemicals used in the execution of the job work of bleaching and
dyeing are transferred in physical form or as their inherent properties. Therefore,
the property in goods passed on in the process of execution of the job work
should be taxed; the assessing officer raised a tax demand of Rs. 5,34,516 vide
order dated 20.3.2007 (Annexure A.1). Reliance was placed on the decision of
the Bombay High Court in Commissioner of Sales Tax vs. Matushree Textiles
Limited, (2003) 132 STC 539.

 

Still not satisfied, the
assessee filed an appeal before the Tribunal, inter alia canvassing that
tax on value of chemicals consumed during the process of dyeing and job work
was not to be included for the purpose of levy of VAT under the HVAT Act/CST
Act. It was also argued that even the dye used in the process would not be
entirely taxable because a substantial portion of the same is not transferred
to the principal eventually. The assessee also submitted a book containing the
reports and technical certificates issued by various competent authorities
justifying the stand of the assessee that chemicals are wasted during the
process of dyeing of textiles and that only a part of the colour is made part
of the final product sent to the principal. Vide impugned order dated 17.3.2017
(Annexure A.5), the Tribunal dismissed the appeal upholding the levy of tax on
the entire value of the chemicals and dyes used in the process irrespective of
the fact whether property in goods had been transferred or not. Hence the
instant appeal by the appellant-assessee.”

 

The Hon’ble High Court
thereafter examined the process in detail. The processes like washing,
watering, dyeing and softening, etc. are carried out. After examining the scope
of such processes and the technical reports submitted on behalf of the
assessee, the Hon. High Court held as under:

 

“21. In other words, the
bleaching and dyeing is a multi-level process in which chemicals are used
initially and are mandatorily washed out before the cloth becomes conducive for
the process of dyeing. After undertaking dyeing, the fabric is sent to the
principal. Initially, the fabric indicates washing with the help of caustic
soda, desizer, soda ash, hydrogen peroxide, HCL, potassium permanganate, oxalic
acid, sodium sulphate and acetic acid. The said process would be akin to
washing clothes at home with the help of washing powder. The effect of washing
is to ensure that the portion of elements and dirt attached to the cloth is
removed before any further process is carried out. It was also claimed that in
this process, the weight of the cloth is reduced which shows that no chemical
gets stuck to the cloth. The property of such chemicals, if held to be absorbed
in the fabric and transferred, (is that) the fabric would not remain fit for
wearing. The dyeing work undertaken by the appellant on cotton fabrics
manufactured by them is the final act, but prior to this act of dyeing various
processes are undertaken for making the fabric fit for dyeing. The processes
normally undertaken are as follows: (1) desizing, (2) scouring, (3) bleaching,
(4) mercerizing and (5) dyeing and finishing.

 

While the textile
undergoes the aforesaid treatment, certain chemicals are used which are
consumables and which do not hold on to the cotton fabrics. After completion of
the aforesaid processes, dyeing is undertaken which holds on to the cotton
fabric giving a lasting impression and ultimately converts the grey fabric into
printed fabric, which is then marketed. In the act of dyeing, as also in
printing, certain amount of chemicals, dyes and colours are washed out and they
do not remain embedded on the textile or fabric. Thus, the benefit of
chemicals, dyes and colours which get washed out to this extent would be
extended to the assessee-appellant. In Gannon Dunkerley & Co. [AIR
1954 Mad 1130] it has been specifically laid down that while permitting
deductions, the consumables are required to be deducted from the total gross
turnover of an assessee for arriving at actual taxable turnover and the dyes
and chemicals in the present case, a certain percentage thereof being
consumables, are required to be excluded.

 

22. Thus, it would be
pertinent to observe that what is taxable under the HVAT and CST Act is the
value of the goods which get transferred to the customer in the execution of
the works contract either as goods or in any other form and not the value of
goods used or consumed in the execution of the works contract, if such user or
consumption does not result in transfer of property in those goods in any form
to the customer. The tax on the entire value of chemicals consumed during the
process of dyeing and job work are not to be included for the purpose of levy
of VAT as substantial portion of the same is not transferred to the principal
eventually.”

 

Thus, the Hon’ble High
court has arrived at the scope of consumables in relation to a works contract.
The judgement is laying down a sound principle though there are also some
contrary judgements. The actual extent of transfer of property depends upon the
facts of each case.

 

CONCLUSION

The judgement will be
useful for guiding the assessee /authorities in deciding the controversial
issue of valuation of goods for the purpose of levy of tax in works contracts.
The judgement will also apply to many such day-to-day transactions like laundry
activities or only cleaning activity, etc. It is expected that the assessee
will give technical / relevant data to determine the value and the authorities will
look at it in a fair and businesslike manner to avoid further disputes in all
such contracts executed up to 30th June, 2017.

 

It may be noted that under
GST laws, w.e.f. 1st July, 2017, such contracts are to be treated as
labour contracts. Thus, the entire value of transaction (including value of
material as well as services) shall be liable to tax as ‘service contract’ and
tax thereon shall be levied accordingly.

AN ASSESSMENT OF ASSESSMENT PROVISIONS


Tax
laws are structured on three key pillars – levy, assessment and collection.
Assessment is the link between levy and collection of taxes. Assessment
provisions under indirect tax laws, especially excise law, have evolved from
the era of officer control and assessment to self-assessment.

 

With
its introduction in 2017, GST law is now about to change gears and enter the
phase of ‘Assessments’. This phase operates as a litmus test over the extent of
percolation of the law into the system both at the Government’s and the tax
payer’s end. Tax payers are about to experience challenges on the front of
assessments, audits and adjudications and this article examines some of the
issues involved.

 

ASSESSMENT – AUDIT – ADJUDICATION

Though
the above terms are used inter-changeably, they represent distinct activities
in any legal enforcement. The GST law has made specific provisions towards each
of these aspects under its machinery provisions, i.e., Chapter XII –
Assessment; Chapter XIII – Audit; and Chapter XV – Demands & Recovery.

 

Assessment
has been defined u/s. 2(11) as any ‘determination of tax liability’. Advanced
Law lexicon explains assessment as ‘determination of rate or amount of
something such as tax, damages, imposition of something such as tax or fine
according to an established rate’.

 

Audit
u/s. 2(13) involves an elaborate exercise of examination of records, returns
and other documents maintained to verify correctness of taxes paid / refunded
and assess compliance under the Act.

 

Adjudication
has not been defined but the term ‘Adjudication authority’ has been defined as
an authority that ‘passes any order or decision under the Act’. Advanced
Law lexicon explains adjudication as the process of ‘trying and determining
a case judicially’.

Assessment
essentially means computation of the taxes under the law. Audit, on the other
hand, is a special procedure involving desk and / or on-site review of records.
Adjudication involves a judicious process of deciding the questions of law
which emerge from the assessment and audit processes. Assessment and audit are
the processes which lead to the adjudication function and these three functions
come under the overall umbrella of ‘Assessment’ in a tax law.

 

ASSESSMENT SCHEME

Chapter
XII of the GST law provides for specific instances where an assessment would be
performed:

Type (Section)

Scenarios

Outer
time-limit

Self-assessment (59)

Assessment of the tax dues by the
assessee himself through returns in GSTR-3B & 1

Due dates of filing return

Provisional assessment (60)

Assessment by the officer on specific
request by the assessee in cases of difficulty in ascertainment of the tax
liability

Six months (extendable to 4 years) from application

Scrutiny assessment (61)

Scrutiny of the data reported in returns
on a frequent basis for any visible discrepancies culminating into a demand
u/s. 73 or 74

Within 3 / 5 years from due date of annual return

Assessment of non-filers (62)

Best judgement assessment in case of
non-filing of returns within prescribed time limits

5 years from due date of annual return

Assessment of unregistered persons (63)

Best judgement assessment in case of
unregistered persons which are required to be registered

5 years from due date of annual return

Summary assessment (64)

Assessment in order to protect interest
of Revenue and culminating into a demand u/s. 73 or 74

Within 3 / 5 years from due date of annual return

 

 

Any
assessment initiated under these sections would have to meet the prerequisites
of the section and the authority would have to operate within the confines of
these sections while exercising its powers. For example, scrutiny assessment of
the returns u/s. 61 can be initiated only to verify the correctness of the
returns filed and examine the discrepancies noticed therein. The assessing
authority is under an obligation to provide the reasons for invoking section 61
and such reasons should emerge from the returns filed for the period under
consideration. It cannot be initiated for conducting a detailed audit of the
books of accounts of the assessee. Such powers rest within the domain of
sections 65 and 66 only. Similarly, an assessing authority can invoke section
62 only for the months for which the returns are not filed and cannot spread
the assessment for other periods.

 

Further,
the provisions only provide the circumstances under which assessments can be
initiated. The provisions are not a complete code for enforcement of the demand
and its recovery. Once the assessments are duly initiated and the examination
of records report a discrepancy, the officer would have to enter adjudication
provisions u/s. 73 / 74 for the recovery of tax dues. Where the officer
concludes that the taxes are duly reported and paid, adjudication need not be
invoked and an assessment order confirming the conclusions would be sufficient.

 

AUDIT SCHEME

Chapter
XIII provides for conducting a regular audit (65) or a special audit (66).
Going by earlier experience where audit provisions in the rules were
challenged, the legislature has introduced these powers in the main enactment
itself allaying any doubts over the jurisdiction to conduct audits. There is no
time limit to conduct an audit of an assessee. However, any demands arising
from these audits would have to follow the process u/s. 73 and 74 which have an
outer time limit of 3 and 5 years, respectively. The key features of regular
and special audit are as follows:

Regular Audit (65)

Special Audit (66)

Performed by authorised officers either on periodical or
selection basis

Performed by appointed chartered accountants / cost
accountants at the specific instance of the Revenue officer on selection
basis only

Audit can be a desk review or an on-site review

Audit would generally be performed on-site

Audit report would record the findings of any tax short
payment / non-payment

Audit report would address specific points defined in the
scope of the audit for further action by the Revenue officers

Proceedings u/s. 73 / 74 would be initiated in case of any
demand

Proceedings u/s. 73 / 74 would be initiated in case of any
demand

Initiated before any adjudication proceeding

Can be initiated during adjudication proceedings

 

While
powers of audit are much wider in scope in comparison with assessment
provisions, they, too, are not unfettered powers. Audit officers cannot, in the
garb of audit, perform an inspection of the assessee’s premises. The audit
officers would have to restrict themselves to the transactions recorded in the
books of accounts and their conformity with the returns filed. For example, an
audit officer visiting the premises cannot perform a physical verification of
the stocks and its comparison with books of accounts; an officer cannot perform
seizure of stocks, records, etc., and does not possess powers equivalent to the
Cr.P.C., 1973 which are conferred upon inspecting officers. Where such
discrepancies are identified, the audit officer can at the most report the same
internally for necessary action by the empowered officers. Like assessment
provisions, where the audit officers conclude that demand of taxes has arisen,
it would have to initiate proceedings u/s. 73 or 74 as appropriate.

 

ADJUDICATION SCHEME

It
is evident that any assessment / audit (except section 62 / 63) involving a
demand would culminate into an adjudication proceeding u/s. 73 or 74. The said
sections provide for issuance of a show cause notice proposing a demand and are
followed by an adjudication proceeding over the issue involved. The section can
be invoked under the following instances as tabulated below:

Instances

Explanation

Examples

Tax not paid or short paid

Output taxes which are legally payable are not paid wholly or
partly

Sale of fixed asset not offered to output tax, etc.

Tax erroneously refunded

Refund sanctioned but on incorrect grounds u/s. 54

Refund in excess of the prescribed formula, etc.

Input tax credit wrongly availed

Credit availed on inputs / input services or capital goods
which are specifically blocked or not available u/s. 16-18

Credit on motor vehicles, rent a cab, etc.

Input tax credit wrongly utilised

Credit rightly availed but utilised incorrectly against
output taxes in terms of section 49

CGST credit utilised for SGST output, etc.

 

 

The
key features of sections 73 and 74 are as follows:

  • While section 73 covers cases where the
    reasons for non-payment are bona fide, section 74 can be invoked where
    the reasons are on account of fraud, wilful misstatement, and / or suppression
    of facts to evade tax payment (fraud cases).
  • The person from whom such amounts appear to
    be recoverable should be put to notice (popularly called show cause notice) as
    to why said amounts are not recoverable from him along with interest or
    penalty. The adjudication officer has to make out a case in the SCN and offer
    the assessee the opportunity to defend itself against the facts and law laid
    down before it.
  • Once the proceedings are initiated, they are
    subjected to an outer time limit of 5 years (extended period in fraud cases)
    and 3 years (normal period in bona fide cases) for its completion. The
    proper officer should initiate the proceedings at least 3 months (6 months in
    fraud cases) prior to the time limit for completion of adjudication. The said
    time limit is to be calculated from the due date of filing annual return or
    date of erroneous refund.
  • As a dispute resolution measure, the
    assessee is provided an option to pay the complete tax and interest (penalty of
    15% in fraud cases) before the issuance of the SCN on the basis of its own
    ascertainment or the ascertainment of the proper officer. As a second level of
    dispute resolution, the assessee is also provided the option to pay the
    complete tax and interest (penalty of 25% in fraud cases) within 30 days of the
    issuance of the SCN.
  • Once an SCN is issued for an initial period,
    a detailed SCN for a subsequent period need not be issued. A statement
    computing taxes payable would be deemed to be an SCN, provided the grounds are
    identical to the initial period. Section 74(3) provides that the allegation of
    fraud cannot be made in periodical SCNs for subsequent periods.
  • The proper officer would determine the tax,
    interest and penalty (10% in bona fide cases, 100% in fraud cases) by
    way of an adjudication order. Where the assessee waives its right of appeal and
    pays the tax, interest and penalty (of 50%), the proceedings are deemed to be
    concluded.

 

The above scheme is substantially
similar to section 11A of the Central Excise Act and section 73 of the Finance
Act. The critical difference is with respect to time limitation. While the
erstwhile laws provided for a time limit of initiation of adjudication
proceedings and no outer time limit for its completion, the GST law provides
for the time limit over the conclusion of the said proceedings. The
adjudication proceedings are deemed to be concluded where the order is not
issued within 3 / 5 years.

 

The
other critical difference is with respect to recovery of erroneous input tax
credit which was contained in rule 14 of the erstwhile rules. Consequent to
inclusion of input tax credit provisions in the Act itself, sections 73 / 74
provide for recovery of input tax credits wrongly availed / utilised. Input tax
credit which has been wrongly availed and not utilised is also recoverable from
the assessee. Whether interest is applicable on such recovery is a different
aspect and needs to be viewed u/s. 50.

 

OTHER MISCELLANEOUS ADJUDICATION PROVISIONS (SECTION 75)

The
law-makers have scripted many settled legislative principles in this provision.
Most of the provisions have their roots in settled principles of natural
justice, fairness, double jeopardy, speaking orders, etc.

 

  • The computation of limitation of 3 / 5 years
    is subject to any stay over proceedings by any Court / Tribunal and the period
    of stay would stand excluded for such computation. A new provision has been
    inserted which extends the period for subsequent years where the Revenue is
    under appeal on a similar issue before an appellate forum. The purpose of this
    insertion was to enable the tax authority to transfer matters to a ‘call book’
    maintained as a practice in the erstwhile regime and keep them pending until
    disposal of the appeal. It is unclear whether the specific issue would be kept
    pending or all proceedings, including other issues which are not under appeal,
    would be subjected to this extension. Cross objections filed by the Revenue are
    equivalent to cross appeals and hence can extend the period of limitation.
  • In cases where the appellate authority or
    Tribunal or Court concludes that the grounds on fraud are not sustainable, the
    proceedings would continue to be valid for the normal period (of 3 years)
    despite such conclusion. Demand for the normal period would have to be adjudged
    on its merits in spite of the SCN being set aside for the extended period.
  • The decision of the adjudicating authority
    should confine itself to the grounds specified in the SCN and should not be in
    excess of the amounts specified in the notice. The officer is required to pass
    a speaking order detailing the facts and provisions leading to the conclusion.
  • Personal hearing is required to be granted
    in case it is specifically requested or the decision contemplated is adverse.
    Adjournments are allowed to be granted up to a maximum of three hearings.
    Courts have frowned upon the practice of officers providing three alternative
    dates for personal hearing in the same notice.
  • Taxes self-assessed and reported in the
    returns remaining unpaid would be recovered without issuance of any SCN in
    terms of section 79.
  • Interest on tax short paid or not paid would
    be payable irrespective of whether the same is specified in the adjudication
    order.
  • In cases where penalty is imposed u/s. 73 /
    74, no other penalty can be imposed on the same assessee under any other
    provision.
  • In case of any remand or direction by
    appellate forums to issue an order, such orders are required to be issued
    within 2 years from the communication of such direction.

 

PRINCIPLES ON ISSUANCE OF SCN

An
SCN is the first step taken by the Revenue to recover any tax demands. It is
the basic and most crucial document in the entire adjudication process. Certain
settled principles of adjudication under the Excise and Service Tax law would
have applicability even under the GST regime:

 

  • Issue of a show cause notice is condition
    precedent to a demand proceeding. The Supreme Court in various instances held
    that any demand can be confirmed only by way of an issuance of a show cause
    notice [Gokak Patel Volkart Limited vs. CCE 1987 28 ELT 53 (SC)].
    This principle would continue to hold good even under the GST scheme as the
    assessment and audit provisions direct that any demand should be recovered
    through the mechanism u/s. 73 / 74.
  • A mere letter of communication cannot be
    equated to a show cause notice. The show cause notice should specify the
    allegations and the basis for it to be sustainable under law [Metal
    Forgings vs. UOI 2002 146 ELT 241 (SC)    ].     Prejudged SCNs have been
    struck down by the Courts as being tainted with bias.
  • An SCN must contain all the essential
    details and relied-upon documents. A show cause is the foundation of the entire
    proceeding and the allegations should be clear and supported legally [CCE
    vs. Brindavan Beverages (P) Ltd. 2007 213 ELT 487 (SC)    ].
  • SCNs on assumptions / presumptions, without
    any material evidence and based only on inferences, are not valid in law [Oudh
    Sugar Mills Ltd. vs. UOI 1978 2 ELT J172 (SC)    ].
  • Show cause notices issued under a wrong
    section cannot be invalidated as long as the powers of the SCN are traceable to
    the statute [BSE Brokers Forum vs. SEBI 2001 AIR SCW 628 (SC)].
  • Corrigenda issued to the SCN are valid as long
    as they rectify apparent mistakes in the notice and do not enlarge its scope [CCE
    vs. SAIL 2008 225 ELT A130 (SC)    ].     However, the corrigenda can be issued
    any time before completion of the adjudication proceeding and may not be bound
    by the time limit.

 

PRINCIPLES FOR DIFFERENTIATING FRAUD AND NON-FRAUD CASES

Wilful
Misstatement, Suppression and Fraud

These
terms have been a matter of considerable litigation since failure of the
Revenue to meet the situations contemplated under these terms invalidated the
entire proceedings irrespective of the merits of the case. While Revenue has
applied these terms mechanically, the assessee has banked upon these terms to
defendits case.

 

In
Cosmic Dye Chemicals vs. CCE (1995) 75 ELT 721 (SC), the
Supreme Court explained these terms as follows:

 

Fraud
and collusion – as far as fraud or collusion are concerned, it is evident that
intent to evade duty is built into these very words.

 

Misstatement
or suppression – so far as misstatement or suppression of facts are concerned,
they are clearly qualified by the word wilful, preceding the words misstatement
or suppression of facts, which mean intent to evade duty.

 

The
Supreme Court in CCE vs. Chemphar Drugs & Liniments 1989 (40) ELT 276
(SC) observed that fraud, etc., is essentially a question of fact
emerging from a positive act. Non-declaration of any information in the returns
without any deliberate intention does not amount to suppression. Similarly, the
Supreme Court in Padmini Products vs. CCE 1989 (43) ELT 795 (SC)
held that mere inaction or non-reporting does not amount to suppression of
facts.

 

Suppression
has now been defined in Explanation 2 to section 74 which states that any
failure to report facts or information required to be disclosed in returns,
statements or reports would amount to suppression of facts. This definition has
implicitly removed the requirement that suppression should be wilful and
consequently any failure to report required information would amount to
suppression. However, if one observes section 74, suppression should be
accompanied with intention to evade payment of tax and it appears that despite
its open-ended definition, Revenue has to still establish tax evasion in cases
of suppression.

 

In
Tamil Nadu Housing Board vs. CCE 1991 (74) ELT 9 (SC), the
Court stated that an intention to evade would be present only in cases where
the assessee has deliberately avoided the tax payment. Cases involving
ambiguity in law or multiple interpretations in laws were not cases of tax
evasion.

 

The
burden of proof that circumstances of the case warrant invocation of extended
period of limitation is on the Revenue and these circumstances should be
discernible from the records of proceedings against the assessee.

 

PRINCIPLES IN ADJUDICATION

Adjudicating
officers are quasi judicial officers and have to follow settled legal
disciplines in the process of adjudication. Some of the principles to be
followed are:

 

  • Res judicata – the Latin term res
    judicata     means a thing which is already adjudged, has attained finality and
    cannot be reconsidered. Since each tax period is different, the said principle
    does not apply directly across tax periods unless underlying assumptions like
    law and facts remain the same.
  • Adjudicating authorities are creatures of
    statute and hence vires of a section or entire Act itself cannot be put
    to question before such authority. These questions can only be placed before
    the High Court under its Writ jurisdiction.
  • Adjudicating authorities would have to act
    on fairness and such proceedings cannot be impaired by instructions, directions
    or clarifications from senior officers.
  • The authorities are bound by the principle
    of judicial discipline and should either follow or clearly distinguish
    decisions of higher appellate forums while adjudging a matter.
  • The officer who has heard the assessee
    should only pass the order. An incoming officer would have to conduct fresh
    hearings prior to passing any order.
  • Questions on jurisdiction to issue the
    notice, order or communication should be made at the first available instance.
    In terms of section 160(1) no person can question the proceedings at a later
    stage if he / she has acted upon such notice, order or communication.

 

FIXATION OF MONETARY LIMITS FOR ADJUDICATION

CBEC
in its Circular No. 31/05/2018-GST dated 09.02.2018 has prescribed monetary
limits for optimal distribution of work relating to issuance of SCNs.  The following table provides the monetary
limits for adjudication:

Sl. No.

Officer of Central Tax

CGST Limit

IGST Limit

1

Superintendent

Up to Rs. 10 lakhs

Rs. 20 lakhs

2

Dy / Asst. Commissioner

Rs. 10 lakhs –
Rs. 1 crore

Rs. 20 lakhs –
Rs. 2 crores

3

Addln / Jt Commissioner

Above Rs. 1 crore

Above Rs. 2 crores

 

The
Supreme Court in Pahwa Chemicals (P) Ltd. vs. CCE – 2005 (181) ELT 339
(SC), held that administrative directions of the board
allocating different works to various classes of officers cannot cut down the
jurisdiction vested in them by statute and may be followed by them at best as a
matter of propriety. Issuance of SCN or adjudication contrary to such
directions cannot be set aside for want of jurisdiction, especially as no
prejudice is caused thereby to assessee.

 

CRITICAL MATTERS IN ADJUDICATION (SECTIONS 73 AND 74)

A)  Whether reversal of input tax credit is
recoverable u/s. 73 and 74?

As
the recovery provisions are limited to four scenarios, any recovery outside the
scope of the above terms is without any authority. The Supreme Court in CCE
vs. Raghuvar (India) Ltd. 2000 (118) E.L.T. 311 (S.C.) held that
section 11A is not an omnibus provision to cover any and every action to be
taken under the Act. The said section will apply only when the circumstances
specified therein are triggered.

 

A
typical example would be the case of reversal of common input tax credit
required in terms of section 17(1)/(2). Strictly speaking, provisions of
section 17(1)/(2) do not place a bar on availing input tax credit. Instead,
these provisions provide for a reversal of input tax credit in excess of what
is attributable to taxable supplies. Non-reversal does not amount to input tax
credits ‘wrongly availed’ or ‘wrongly utilised’. Hence there could be a
challenge on whether the Revenue has powers to invoke sections 73 / 74 to
recover input tax credit reversals under the said provisions. In the context of
Rule 57CC (parallel to Rule 6 of Cenvat Credit Rules and Rule 42 / 43 of GST
rules) which governed common inputs, the Tribunal in Pushpaman Forgings
vs. CCE Mumbai 2002 (149) E.L.T. 490 (Tri.-Mumbai)1  held that payment of an amount is NOT ‘duty
or credit’ and in the absence of a specific provision to recover the same, the
proceedings are invalid.

 

B)  Whether reversal of transition credit is
recoverable u/s. 73 and 74?

The primary challenge for invoking
sections 73 and 74 for recovery of transition credit arises on account of the
definition of input tax credit u/s. 2(62) r/w 2(63) of the CGST Act. Recovery
of transitional credit could be on account of two reasons, (a) not meeting
erstwhile law conditions (e.g. not an input service, input or capital goods in
terms of Cenvat Rules, etc); and / or (b) not meeting transitional conditions
(e.g. not eligible duties defined under GST, first time credits to traders,
etc). There should be no doubt on the recovery of the former as the
non-compliance emerges under the Cenvat Rules and hence is governed by recovery
provisions of the said rules which are saved under the GST law. Once the said
amount is regularised under the erstwhile law, the transition claim stays
intact in terms of section 142. The latter, however, poses some challenge on
the recovery front.

 

Sections
73 / 74 can be invoked only for recovery of wrongfully availing / utilisation
of ‘input tax credit’. Input tax credit, by definition, is limited to the taxes
which are charged and paid under the IGST / CGST Acts only. The transition
provisions are a separate code by itself under Chapter XX and cannot be equated
to the input tax credit provisions under Chapter V. Transition credit is
directly credited to the electronic credit ledger and available towards discharge
of tax liabilities unlike input tax credits which have to pass the tests
prescribed in sections 17 and 18 of the GST law.

 

Now
Rule 121 of the transition provisions provides for recovery of such credit in
terms of sections 73 and 74 of the CGST Act. The parent provisions u/s. 140
delegate its powers to rules only for the limited purpose of prescribing the
manner of availing. The parent provisions do not authorise the Government to
prescribe the recovery provisions. Unlike the Cenvat Rules where availing of
input tax credit was itself in a delegated legislation, transitional credit is
contained in the enactment and cannot be recovered through a subordinate
legislation.

 

CBEC
Circular No. 42/16/2018-GST dated 13.04.2018 provides that Cenvat credit and erstwhile recovery of arrears of taxes
are recoverable as Central taxes in terms of section 142 of the CGST law. In
one case the Circular prescribes that one may invoke section 79 (such as
garnishee orders, etc.) for recovery, clearly bypassing the step of adjudication.
Circular 58/32/2018-GST dated 04.09.2018 has gone a step further and
stated that the same may be reversed as input tax credit while filing GSTR-3B.
The genesis of these conclusions appears to be hazy and the backdoor entry of
Rule 121 is open for challenge in the Courts.

 

C)  Whether an SCN can be issued where taxes are
fully paid prior to its issuance?

Sections
73 / 74 state that an SCN would be issued where taxes are ‘not paid’ or ‘short
paid’. While section 73 provides for waiver of the penalty, there is no such
waiver in cases covered u/s. 74. In many cases, the assessee discharges the
taxes prior to issuance of the SCN and the taxes are completely paid on the
date of issuance of the SCN. We also observe from the said section that the
notice should specify why the amount specified is not ‘payable’. Section 73(7)
also specifies that in case of any short payment, the SCN should be issued only
to the extent of the short payment. All these provisions indicate that an SCN
cannot be issued where taxes are fully paid prior to its issuance.

 

Historically,
the Revenue officers would raise the SCN proposing a demand and provide for an
appropriation of the tax already paid by the assessee against the proposed
demand. This practice would keep the demand outstanding until the appropriation
at the time of conclusion of the adjudication proceedings. Whether a similar
practice can be continued given that the provisions are borrowed from the
Central Excise law is a matter of detailed examination.

 

D)  Whether an SCN can be issued only towards
interest or penalty?

In
many cases, the assessee deposits the taxes but fails to compute the interest
on account of delayed payment of taxes. It has been held by various Courts that
interest is an automatic levy and does not require specific notice for its
recovery. Section 75(12) provides that in case of self-assessed tax, the amount
of interest remaining unpaid would be recoverable directly in terms of section
79 without issuance of a show cause notice. Therefore, there is no requirement
of any SCN proceeding to recover interest.

 

In
cases of fraud where taxes have been completely paid, the Revenue may invoke
adjudication proceedings u/s. 74 for recovery of penalty. As discussed above,
the said section provides only for four instances where the proceedings can be
initiated. It is only when the above conditions are satisfied that penalty can
be proposed against the assessee. Where taxes have been completely paid, none
of the four instances applies and there is a possibility to take a view that an
SCN cannot be issued merely for recovery of penalty. Whether the officer can
then directly invoke section 122(1) may be a matter of examination.

 

E)  What happens where multiple issues are
involved and some issues fall in the fraudulent basket while others fall in the
non-fraudulent basket?

The
examination of a case falling u/s. 73 / 74 has to be performed for each issue
on hand and not in its entirety. There could occur circumstances where some
issues genuinely arise on account of interpretation of law and some issues on
account of evasive acts. The time limitation of 3 / 5 years would have to be
examined for each issue on hand depending on which basket they fall into. The
officer cannot paint all issues with one brush and apply the time limit of 5
years for the proceedings as a whole. Once the issues are segregated, the
proceedings would be governed by the respective sections.

 

F)  Can parallel proceedings be conducted by two
officers either by Central / State workforce?

Section
6(2) of the GST law provides that any proceeding issued on a subject matter by
any officer would not be duplicated with another proceeding of an officer of
parallel rank. This provision is specific to the issue under examination. The
parallel administration can certainly raise other issues provided they have
jurisdiction to assess these in terms of the work allocation between the Centre
and the State administrations.

 

G)  Whether disclosure to Central officer still
results in suppression before the State officer and vice versa?

In
case prior disclosure of information is made to a Central authority, an issue
arises whether the State authorities can allege suppression of information. The
terms are merely an expression of the state of mind of the tax payer. Where the
tax payer has established bona fide in reporting the issue to the
jurisdictional officer, it can certainly pray that the case does not involve a
fraudulent act. Unless the assessee has specifically withheld information being
sought from a particular officer, it can claim itself to be excluded from the
above terms. In fact, it may be interesting for one to even examine whether
reporting of information in one State would amount to sufficient bona fide
in assessments of other States. These are issues which would emerge on account
of State-wise assessments and cross empowerment of administration under the
law.

 

H)  Tax experts are requested for their opinion on
the status of litigation as on balance sheet date in the context of
provisioning in terms of GAAP?

Departmental
audits / assessments are only inquiry proceedings over the tax dues reported by
the assessee and until a specific issue is red-flagged, such proceedings may
not fall within the domain of provisioning / contingency. But where the issue
is ascertained and adjudication proceedings are initiated by way of an SCN, the
tests of provisioning (enlisted below) would have to be performed for the
company:

 

  • An entity has
    a present obligation (legal or constructive) as a result of past events;
  • It is probable
    that the obligation may entail an economic outflow; and
  • A reliable
    estimate can be made of such outflow.

 

The
term present obligation has been defined as an obligation whose existence as on
the balance sheet date is probable. Though an SCN is a mere
proposal, the term present obligation requires one to test the probability of
the demand in view of the SCN as on balance sheet date. An SCN is an indication
of a potential demand and the tax expert would have to weigh the issue for its
merits and judicial precedents for concluding on the probable exposure to the
company.

 

Going by the overall
architecture of the GST law and the work allocation, it appears that audit
would be conducted based on statistical sampling of the assessee, assessments
would be performed on case-specific non-compliance reports and both these
functions would then channel into adjudication proceedings for recovery of tax
dues from the assessee. The GST topography poses multiple hurdles in assessment
of tax payers. Cross empowerment and maintenance of uniformity in State level
assessments would be a game changer. Being a new turf, tax payers and Revenue
would have to traverse the path of assessments cautiously.

Yoga karmasu kaushalam. This is a message from the
Geeta – Chapter 2.50. And this is perhaps one of the most valuable and
practical messages given by anyone to mankind. Its plain meaning is:
yoga is ‘skill in performing any action / task.’ Skill could mean
excellence and total immersion in the work at hand. Skill also means
being detached from the fruit of action while being completely involved
in the work at hand. In the words of Ralph Waldo Emerson – The reward of
a thing well done is to have done it. Krishna propagates three kinds of
yogas to achieve salvation – Dnyana (knowledge), Bhakti (devotion) and
Karma (work). Yoga literally means being in communion, for it comes from
the word Yuj.
Many
great personalities were inspired by this message. Lokmanya Tilak, one
of the early freedom fighters, gave stress to ‘Karma’ i.e. action. In
our fight for independence this was necessary. The entire verse is even
more poignant. It reads thus – One who is equipped with equanimity in
this life discards both merit and sin. Therefore, remain established in
yoga; yoga results in perfect action.
Krishna
says that the Chaturvarnas (four categories) in the society were
created by HIM based on the qualities and nature of activity of an
individual. Hence, Brahmanas were concerned with knowledge; Kshatriyas
with security, governance and war; Vaishyas with trade and industry; and
Shudras with the remaining services. In Indian scriptures, we have
references that two brothers could belong to different professions or
‘Varnas’. Therefore, ‘varnas’ were not attached to birth but to the
predisposition of each individual. Interestingly, Krishna Himself
performed all these functions Himself at once:
  • when giving knowledge to Arjuna, He was Brahmana,
  • killing demons like Kans and Shishupal, He was a Kshatriya or warrior,
  • trading in dairy products in Mathura, Krishna was a Vaishya; and
  • as charioteer (sarathi) of Arjuna, He maintained horses – the work of shudras.
Every
role that He performed, He performed it with dexterity. At the same
time, He was completely detached from the fruit of His action. This is
the lesson to be learnt from these words of counsel.
At
the end of the Geeta, Krishna tells Arjuna that he has the liberty of
choosing his course of action. This implies that once a person has
grasped the full purport of equanimity, he is endowed with the
capability to make right choices.
I would conclude: in Yoga an individual has:
  • the liberty to choose his field of operation,
  •  perform his work as duty with detachment, with
  • no control over the fruits of his action.
Hence,
as professionals to have success, peace and happiness, let us inculcate
and develop this attitude, especially of being detached and enjoy
stress-free work. In short, be fully involved and yet be detached from
the fruits of action.

21st June is International Yoga Day.

Section 5(2)(a) and section 15 of the Income-tax Act, 1961 – salary remitted to NRE account in India for services rendered in Nigeria is not taxable in India on receipt basis

11

TS-220-ITAT-2019(Kol)

Deepak Kumar Todi vs. DDIT

ITA No. 1918/Kol/2017

A.Y.: 2011-12

Dated: 16th April, 2019

 

Section 5(2)(a) and section
15 of the Income-tax Act, 1961 – salary remitted to NRE account in India for
services rendered in Nigeria is not taxable in India on receipt basis

 

FACTS

The
assessee, a non-resident individual, was employed in Nigeria. For the relevant
year under consideration, the Assessee received foreign inward remittances in
his NRE account maintained in India on account of salary for the services
rendered in Nigeria. The assessee contended that such salary amount was
transferred by the employer only under due instructions of the assessee. Thus,
the constructive receipt of such salary is out of India and the money received
in the NRE account of the assessee is mere remittance which cannot constitute income
‘received or deemed to be received in India’ within the meaning of section
5(2)(a) of the Act.

 

The AO,
however, was of the view that receipt of salary in India by way of direct
remittance by the foreign employer to the assessee’s bank account in India
would amount to first receipt in India. Further, as the income has not been
taxed in Nigeria, non-taxation of such amount in India would amount to double
non-taxation. Consequently, the AO taxed such amount as salary income under the
Act.

 

Aggrieved,
the assessee appealed before the CIT(A) who upheld the AO’s order. Still
aggrieved, the assessee appealed before the tribunal.

 

HELD

  •      The tribunal
    observed that tax had been duly withheld by the foreign employer on the salary
    income of the assessee. It was, therefore, not a case of double non-taxation of
    income. Thus, the AO’s observation that the income had neither been taxed in
    Nigeria nor in India, was incorrect to this extent.
  •      Reliance was
    placed on the Calcutta HC ruling in Utanka Roy vs. DIT, International Tax
    (390 ITR 109)     to hold that the salary income for services rendered
    outside India had to be considered as income accruing outside India and, hence,
    not taxable in India.

Sections 9(1)(vi), 9(1)(vii) and Article 12 of the India-Germany DTAA – subscription fees received for access to online database does not qualify as FTS or royalty

10

TS-215-ITAT-2019(Mum)

Elsevier Information Systems GmbH vs.
DCIT

ITA No.1683/Mum/2015

A.Y.: 2011-12

Dated: 15th April, 2019

 

Sections 9(1)(vi), 9(1)(vii)
and Article 12 of the India-Germany DTAA – subscription fees received for
access to online database does not qualify as FTS or royalty

 

FACTS

The
assessee is a tax resident of Germany and is engaged in the business of
providing access to online database pertaining to chemical information
consisting of articles on the subject of chemistry, substance data and inputs
on preparation and reaction methods as experimentally validated. The assessee
earned subscription fees by providing access to the online database from
customers worldwide, including India.

 

The
assessee, contended that subscription fee received from the customers is not in
the nature of royalty or fee for technical services (FTS). Further, in the
absence of a PE in India, such income is not taxable in India.

 

But the AO
noted that the database was akin to a well-equipped library which provided
users with the desired result without much effort. Further, the AO concluded
that the data was in relation to a technical subject collated from various
researchers and journals involving technical expertise, which would not have
been possible without technical expertise and human element. Hence, he treated
the subscription fees as FTS under the Act as well as the DTAA. Further, the AO
also held that the online database was in the nature of a literary work which
amounts to right to use copyright and hence it qualifies as royalty under
section 9(1)(vi) of the Act as well as the DTAA.

 

HELD

  •      The database
    maintained by the assessee consisted of chemical information which the users
    could access for their own benefit. The data contained in the online database
    was collated by the assessee from articles printed in various journals on
    similar topics which were otherwise available to the public on subscription
    basis. The collated data was stored on the online database in a structured and
    user-friendly manner and was made accessible through regular web browsers,
    without any use of a designated software or hardware.
  •      Examination
    of the subscription agreement between the assessee and the customer revealed
    the following aspects:

(a)  The assessee granted non-exclusive and
non-transferrable right to the subscriber to access, search the browser and
view the search results and print or make copies of such information for its
exclusive use.

(b)  Upon termination of the subscription
agreement, the subscriber was required to delete all such stored data.

(c)  All rights and interests in the subscribed
products and data remained with the assessee and the users were prohibited from
making any unauthorised use of such data.

  •      Thus, the
    assessee merely provided access to the database without conferring any
    exclusive or transferrable right to the users. The intellectual property in the
    data / product remained with the assessee. There is no material on record to
    show that the assessee had transferred its right to use the copyright of any
    literary, artistic or scientific work to the subscribers while providing them
    with access to the database.
  •      Hence, the subscription fee does not qualify as
    royalty. Reliance in this regard was placed on the AAR ruling in the case of Dun
    & Bradstreet Espana SA (272 ITR 99)    , the Ahmedabad Tribunal ruling
    in the case of ITO vs. Cedilla Healthcare Ltd. (77 Taxmann.com 309)
    and DCIT vs. Welspun Corporation Ltd. (77 Taxmann.com 165).
  •      The assessee
    had neither employed any technical / skilled person to provide any managerial
    or technical service, nor was there any direct interaction between the
    subscriber of the database and the employees of the assessee. Further, there
    was no material on record to show that there was human intervention in
    providing access to the database. Thus, in the absence of human intervention,
    the subscription fee did not qualify as FTS under the Act as well as the DTAA.
    Reliance in this regard was placed on SC decisions in the cases of CIT
    vs. Bharati Cellular Ltd. (193 Taxman 97)     and DIT vs. A.P. Moller
    Maersk A.S. (392 ITR 186).

Article 12 and Article 5 read with Article 7(3) of the India–Russia DTAA – consideration received by a member of a consortium qualifies as business income; as the income is attributable to the assessee’s PE in India, it is taxable in India

9

TS-212-ITAT-2019(Del)

PJSC Stroytransgaz vs. DDIT

ITA No. 2842/Del/2010 [A.Y.: 2004-05]

ITA No. 2843/Del/2010 [A.Y.: 2005-06]

ITA No. 6029/Del/2012 [A.Y.: 2006-07]

ITA No. 3821/Del/2010 [A.Y.: 2004-05]

ITA No. 3822/Del/2010 [A.Y.: 2005-06]

A.Y.s: 2004-05 & 2005-06

Dated: 15th April, 2019

 

Article 12 and Article 5
read with Article 7(3) of the India–Russia DTAA – consideration received by a
member of a consortium qualifies as business income; as the income is
attributable to the assessee’s PE in India, it is taxable in India

 

FACTS

The
assessee is a company incorporated in Russia with expertise in implementation
of oil and gas industry projects. During the year under consideration, the
assessee entered into a consortium with an Indian company to execute certain
oil and gas projects for customers in India.

 

As agreed
between the parties to the consortium and the customer, the assessee was
required to (i) depute specialised manpower in India to undertake project
management and execution to the satisfaction of the customers for a specified
monthly consideration, and (ii) to prepare the technical bid to be provided to
the customer on the basis of its technical expertise and knowhow.

 

The
project management and execution work was performed by the branch office (BO)
of the assessee in India. On the other hand, the preparation of the technical
bids was undertaken by the assessee outside India.

 

There was
no dispute on the fact that the BO constituted the permanent establishment (PE)
of the assessee in India. The income from project management and execution
rendered by the BO was offered to tax as fee for technical services on gross
basis and the income from the supply of technical design and knowhow by the HO
was offered to tax as royalty on gross basis under Article 12 of the
India-Russia DTAA.

 

The
assessing officer (AO) contended that since the assessee had a PE in India,
Article 12 of the India–Russia DTAA was not applicable and the entire payment
received by the assessee had to be taxed on net basis as business profits.

 

HELD

  •      A close
    reading of the agreements indicates that the assessee was one of the members of
    the consortium. The consideration received by the assessee from the project
    execution is nothing but its business profits from the execution of the
    project.

 

  •     Being a
    member of the consortium, the assessee cannot pay royalty to itself and,
    therefore, the share received from the execution of the projects is nothing but
    business profits. Even in a case where services are rendered in India by the HO
    and not by the BO, the consideration received by the assessee cannot be
    bifurcated as royalty and business income.

 

  •      Since the
    assessee had a PE in India and the income from both manpower supply and the
    technical bid carried out outside India was attributable to the PE in India,
    the total income earned from the project is taxable as business income in
    India.

Article 5(2)(k)(i) of India–UK DTAA – multiple counting of employee in a single day is impermissible for computing service PE threshold; period of stay during which employee is on vacation in India is also to be excluded for determination of service PE

8

TS-210-ITAT-2019(Mum)

Linklaters vs. DDIT

ITA No. 3250/Mum/2006

A.Y.: 2002-03

Dated: 16th April, 2014

 

Article 5(2)(k)(i) of
India–UK DTAA – multiple counting of employee in a single day is impermissible
for computing service PE threshold; period of stay during which employee is on
vacation in India is also to be excluded for determination of service PE

FACTS

The
assessee, a UK resident partnership firm, was engaged in the business of
practising law. During the year under consideration, the assessee was appointed
to provide legal consultancy services to Indian clients, in respect of which it
received consultancy fees. The assessee contended that the fee received was in
the nature of business income and, in the absence of PE, such income was not
taxable in India.

 

The AO,
however, was of the view that the employees / other personnel of the assessee
rendered services in India for a period of more than 90 days and, hence, the
assessee had a service PE in India under Article 5(2)(k)(i) of the India–UK
DTAA. He, therefore, held that the income earned from rendering legal
consultancy services was taxable in India.

 

However, the assessee argued that one of its
employees present in India was on a vacation here and during such stay the
employee did not render any services in India. Consequently, such period has to
be excluded for the purpose of computing the threshold of 90 days for
determination of service PE. Further, the assessee argued that the period of
stay of employees in India has to be taken cumulatively and not individually.
On the above basis, the total presence of employees in India was only for 87
days. Hence, service PE in India was not triggered.

 

On appeal,
the CIT (A) held that the assessee had a service PE in India. Aggrieved, the
assessee appealed before the tribunal.

 

HELD

  •      As per
    Article 5(2)(k)(i) of the India-UK DTAA, the assessee shall constitute a
    service PE in India only if the presence of its employees for rendering
    services in India exceeds 90 days in any 12-month period.

 

  •      Various
    documentary evidences furnished by the assessee, such as leave register of the
    employer, the log of work maintained by the employee and invoice raised on the
    client, etc., indicated that one of the employees of the assessee was on a
    vacation to India and had not rendered any services in India during such leave
    period. Further, during such period, no other employee of the assessee was
    rendering services in India. Hence, such leave period had to be excluded for
    computing the period of 90 days.

 

  •      Further, for
    computation of the 90-day threshold, stay of employees in India on a particular
    day has to be taken cumulatively and not independently. Thus, multiple counting
    of an employee in a single day is impermissible under Article 5(2)(k)(i) of the
    India–UK DTAA. Reliance in this regard was placed on the ruling of Mumbai ITAT
    in the case of Clifford Chance (82 ITD 106).

 

  •      Since the
    aggregate period of stay of the assessee’s employees in India accounted to only
    87 days, there was no service PE of the assessee in India.

Section 56(2)(viib) – Fair market value determined on the basis of NAV method accepted since the assessee was able to substantiate the value

6

India Today
Online Pvt. Ltd. vs. ITO (New Delhi)

Members: Amit
Shukla (J.M.) and L. P. Sahu (A.M.)

ITA Nos. 6453
& 6454/Del/2018

A.Y.s: 2013-14
& 2014-15

Dated: 15th
March, 2019

Counsel for
Assessee / Revenue: Salil Aggarwal and Shailesh Gupta / A.K. Mishra

 

Section 56(2)(viib) – Fair market
value determined on the basis of NAV method accepted since the assessee was
able to substantiate the value

 

FACTS

The assessee company was engaged in
the business of development, design and maintenance of website and sale and
purchase of shares. While assessing income for A.Y. 2013-14, the A.O. noted
that the assessee company had received share application money from Living
Media India Ltd., an investor, as under:

Year of receipt

Rs. in crores

No. of shares issued /
(Year of issue)

FY 2010-11

21.35

 

FY 2011-12

50.90

 

Sub-total

72. 25

2,40,83,333 (08/09/2012)

FY 2012-13

135.42

5,07,94,056 (FY 2013-14)

 

The above shares were issued @ Rs.
30 per share, i.e., face value of Rs. 10 and premium of Rs. 20 based on the
valuation report of a chartered accountant. As per the said valuation report,
the fair market value (FMV) of the share of the assessee company was Rs. 77.06
which was determined on the basis of the NAV method. One of the major assets
held by the assessee was investment of Rs. 112.01 crores (book value) in a
subsidiary, viz., Mail Today News Paper Private Limited. As per the report of
the independent valuer, the FMV of the subsidiary’s share was Rs. 40. This
valuation was done applying DCF method. Based on this report, the chartered
accountant valued the investment held by the assessee in the subsidiary at Rs.
286.17 crores, as against the book value of Rs. 112.01 crores.

 

The A.O. did not tinker with the
valuation except for holding that the assessee had taken the percentage of
shareholding of the subsidiary at 67%, whereas it was 64% as per the audit
report of the subsidiary. Based on this, he valued the share at Rs. 27.75.
Thus, according to him, since the assessee company had issued 5,07,94,056
shares at a premium of Rs. 20, the excess amount of Rs. 11.43 crores,
calculated @ Rs. 2.25 per share, was taxable as income from other sources u/s.
56(2)(viib).

 

On appeal by
the assessee, the CIT(A) held that the addition u/s. 56(2)(viib) should be made
in the year of issue of shares irrespective of the year of receipt of the share
application money. Secondly, he noted that the net worth of the subsidiary
company was completely eroded as reported by its auditor. Therefore, according
to him, while computing the FMV of the shares of the assessee, the FMV of
shares of its subsidiary at the most can be taken at face value, i.e. Rs. 10
per share as against Rs. 40 per share considered by the assessee. After
substituting the FMV of the share of the subsidiary at Rs. 10, the FMV of the
share of the assessee company came to negative.

 

Therefore, he held that the
assessee received the sum of Rs. 48.17 crores in excess of the FMV of
2,40,83,333 shares issued during F.Y. 2012-13 corresponding to A.Y. 2013-14.
Accordingly, he held that the same was taxable as income from other sources
u/s. 56(2)(viib). According to him, since 5,07,94,056 shares were allotted in
the financial year pertaining to the next assessment year, he deleted the
addition of Rs. 11.43 crores made by the A.O.

 

HELD

As per the provisions of clause (a)
of Explanation to section 56(2)(viib), FMV is the value determined in
accordance with the method prescribed in the Rules 11U and 11UA [sub-clause
(i)] or the value which is substantiated by the company to the satisfaction of
the A.O. [sub-clause (ii)], whichever is higher. The tribunal further noted that
the assessee had exercised the option under sub-clause (ii), viz., to
substantiate the value. Secondly, it was also noted that there were no
prescribed methods under Rules 11U and 11UA for the purpose of determination of
FMV on the date of issue of shares on 8.09.2012 as the methods were notified
only on 29.11.2012.

 

Therefore, according to the
tribunal, it would not be fair to make any kind of enhancement or addition
based on the provision of Rule 11UA. The Tribunal further noted that the
assessee had been able to substantiate the FMV which was based on the valuation
report of a chartered accountant. Further, the assessee also gave following
instances to substantiate the value of its share:

 

  • the fair market value of the shares of the subsidiary from which
    the assessee company derives its value had been accepted by the A.O. in the
    assessment order of the subsidiary in the assessment years 2013-14 and 2014-15
    at Rs. 40;
  • the subsidiary company
    had also issued its shares to a non-resident entity at Rs. 43.29;
  • In the earlier
    assessment year, i.e., 2011-12, the assessee company had sold 40,302 shares
    held by it in the subsidiary company at Rs. 43.29 per share and the same was
    accepted by the Revenue in the order passed u/s. 143(3).

 

The tribunal
also noted that as per the valuation report, the value per share was determined
at Rs. 77.06, which was far more than the price at which the assessee had
issued shares, i.e. Rs. 30. Further, it noted that the A.O. had also accepted
the valuation of the share of the assessee, except for the factors stated
above. According to the tribunal, the report of the valuer of the assessee
company based on NAV method cannot be rejected on the ground that the Rules of 11U/11UA
do not recognise the said method, when the assessee has not exercised the
option under sub-clause (i) of Explanation (a) to section 56(2)(viib).

 

As regards the objection of the CIT(A) as to the
valuation of shares of the subsidiary company, the tribunal observed that the
DCF method is a recognised method of valuation. The same has to be accepted
unless specific discrepancies in the figures or the factors taken into account
are found. The tribunal also rejected the CIT(A)’s contention that the chartered
accountant who has given the valuation report was not a competent person in
terms of Rule 11U, as according to it, the same would only be relevant when the
valuer has done the valuation in the manner prescribed in 11U and 11UA, because
such condition is prescribed in Rule 11. If the assessee has not opted for 11U
& 11UA, then, according to the tribunal, all those guidelines and formulas
given therein would not apply.

Section 201 – Payments to non-residents without deduction of tax at source – Order passed u/s. 201 (1) beyond one year from the end of the financial year in which the proceedings u/s. 201 were initiated is void ab initio

5

Atlas Copco (India) Limited vs. DCIT (Pune)

Members:
R.S. Syal (V.P.) and Vikas Awasthy (J.M.)

ITA Nos. 1669, 1670 &
1671/PUN/2014, 1685 to 1688/PUN/2014 and CO No. 60/PUN/2018

A.Y.s: 2008-09 to 2011-12

Dated: 5th April,
2019

Counsel for Assessee /
Revenue: R. Murlidhar / Pankaj Garg

 

Section 201 – Payments to
non-residents without deduction of tax at source – Order passed u/s. 201 (1)
beyond one year from the end of the financial year in which the proceedings
u/s. 201 were initiated is void ab initio

 

FACTS

During the financial years 2007-08
to 2010-11, the assessee made payments to various foreign entities towards
procurement of software licence, software maintenance charges, testing charges,
website maintenance charges, personal management charges, software expenses,
reimbursement of internet charges, etc. The assessee did not deduct tax at
source from these payments. The A.O. issued show cause notice to the assessee
on 27.01.2012 u/s. 201(1) and 201(1A). After considering the submission of the
assessee, the A.O. vide order dated 06.02.2014 held that the aforesaid payments
were in the nature of royalty / fee for technical services (FTS) u/s. 9(1)(vi)
and 9(1)(vii), respectively. Hence, it was mandatory for the assessee to deduct
tax at source on such payments. For its failure, he deemed the assessee as
assessee in default and raised a demand of Rs. 1.81 crores.

 

Against this, the assessee filed an
appeal before the CIT(A). Except for demand raised in respect of payments for
software maintenance charges, testing charges and towards personal management
fees, the CIT(A) confirmed the A.O.’s order. Aggrieved by the order of the
CIT(A), the assessee filed appeals for assessment years 2008-09 to 2010-11 and
the Revenue filed cross appeals. On its part, Revenue filed appeal for the
assessment year 2011-12.

 

The assessee filed cross objections
for assessment year 2011-12. But the assessee’s cross objection was time barred
by 878 days. However, taking into consideration the facts of the case, the law
laid down by the Supreme Court in the case of Ram Nath Sao and Ram Nath
Sahu and Others vs. Gobardhan Sao and Others (2002 AIR 1201) and the
reasons furnished by the assessee, the delay of 878 days in filing of cross
objections was condoned by the Tribunal.

 

Before the Tribunal, the assessee
submitted that in the impugned assessment years, show cause notice u/s. 201(1)
and 201(1A) was issued on 27.01.2012. But the order u/s. 201(1) and 201(1A) for
all the impugned assessment years was passed by the A.O. on 6.02.2014. It was
contended that, as per the decision of the Special Bench of Tribunal in the
case of Mahindra & Mahindra Ltd. vs. DCIT (122 TTJ 577),
which was affirmed by the Bombay High Court (365 ITR 560), the
A.O. was required to pass the order within one year from the end of the
financial year in which the proceedings u/s. 201 were initiated, i.e., on or
before 31.03.2013. Since the order passed was beyond the period of limitation,
the same was void ab initio and the subsequent proceedings arising
therefrom were vitiated.

 

In reply, the Revenue contended
that as per the provisions of section 201(3), the order u/s. 201(1) could have
been passed at any time after the expiry of six years from the end of the
financial year in which payment was made or credited. According to the Revenue,
the case laws relied on by the assessee were distinguishable on facts. The
Special Bench decision was rendered in 2009, whereas the provisions of section
201(3) were inserted by the Finance Act, 2009 w.e.f. 01.04.2010.

 

HELD

According to the tribunal, a bare
perusal of sub-section (3) as referred to by the Revenue shows that reference
is to the payments made without deduction of tax at source to ‘person resident
in India’. The sub-section (3) is silent about the limitation period for
passing the order u/s. 201 where the payments are made without deduction of tax
at source to non-resident / overseas entities.

 

In the present
case, the tribunal noted that the assessee had made payments to non-residents.
Therefore, it held that the provisions of section 201(3) do not get attracted.
According to the tribunal, where the payments are made to entities / persons,
other than those specified in sub-section (3), the limitation period of one
year from the end of the financial year in which the proceedings u/s. 201 were
initiated, as laid down by the Special Bench of Tribunal and affirmed by the
Bombay High Court, would apply.

 

Since
the order u/s. 201 was passed much after the lapse of the one-year period from
the end of the financial year in which proceedings u/s. 201 were initiated, the
tribunal held that the order u/s. 201 in the impugned assessment years was void
ab initio. Accordingly, the appeals filed by the assessee were allowed.

Section 54 – Investment, for purchase of new residential house, made up to date of filing of revised return of income qualifies for exemption u/s. 54

15

[2019] 104 taxmann.com 303 (Mum.)

Rajendra Pal Verma vs. ACIT

ITA No. 6814/Mum/2016

A.Y.: 2013-14

Dated: 12th March, 2019

 

Section 54 – Investment, for
purchase of new residential house, made up to date of filing of revised return
of income qualifies for exemption u/s. 54

 

FACTS

The
assessee e-filed his return of income for A.Y. 2013-14 on 31.03.2013.
Thereafter, he revised his return on 15.11.2014. In the course of assessment
proceedings, the A.O. observed that the assessee had sold a residential flat
and had claimed the entire long term capital gain of Rs. 1.75 crores as exempt
us. 54 of the Act.

 

The A.O.
observed that the assessee entered into an agreement dated 29.12.2014 with the
builder for the purchase of a new residential house. The agreement provided
that the construction of the house would be completed by September, 2017. The
A.O. also observed that the assessee had 
neither invested the capital gains in the purchase of a new house, nor
had he deposited the amount in a capital gains account as required by section
54(2). Accordingly, the A.O. disallowed the claim for exemption u/s. 54 of the
Act.

 

Aggrieved,
the assessee preferred an appeal before the CIT(A) who allowed the exemption to
the extent of investment made for purchase of new residential house up to the
due date of filing of the return of income as envisaged u/s. 139(1). He
restricted the claim of exemption to Rs. 83.72 lakhs. Still aggrieved, the
assessee preferred an appeal to the Tribunal.

 

HELD

The
Tribunal, on examining the provisions of section 54, observed that on a plain
and literal interpretation of section 54(2), it can be gathered that the
conscious, purposive and intentional wording provided by the legislature of
“date of furnishing the return of income u/s. 139” cannot be
substituted and narrowed down to section 139(1) of the Act. It held that the
date of furnishing the return of income u/s. 139 would safely encompass within
its sweep the time limit provided for filing the “return of income” by the
assessee u/s. 139(4) as well as the revised return filed by him u/s. 139(5).

 

The
Tribunal noted that the question as to whether an assessee would be eligible to
claim exemption u/s. 54 to the extent he had invested in the new residential
property up to the date on which he had filed the revised return of income had
been looked into by a co-ordinate bench of the Tribunal in the case of ITO
vs. Pamela Pritam Ghosh [ITA No. 5644(Mum.) of 2016, dated 27.06.2018].
The Tribunal in that case had observed that the due date for furnishing the
return of income according to section 139(1) was subject to the extended period
provided under sub-section (4) of section 139.

 

The Tribunal held that the assessee was entitled to claim exemption u/s.
54 to the extent he had invested towards purchase of new residential property
up to the date of filing revised return u/s. 139(5) [on 15.11.201]. As the
assessee had invested Rs. 2.49 crores towards purchase of the new residential
house up to that date (date of filing of revised return u/s. 139(5)) which is
in excess of long term capital gain, the entire long term capital gain was held
to be exempt u/s. 54. The appeal filed by the assessee was allowed.

Corrigendum:  In
the March 2019 issue of BCAJ, in the feature Tribunal News – Part A, the line “The
appeal filed by the Revenue was dismissed by the Tribunal” appearing on
page 56 in the decision at Serial No. 31 – should correctly read as “This
ground of appeal filed by the revenue was allowed by the Tribunal.”

Section 263 – If a matter is examined by the Assessing Officer during the course of assessment and consciously accepts the plea of the assessee, the order can still be subjected to revision u/s. 263 of the Act if the view adopted by the A.O. is unsustainable in law

14

[2019] 104 taxmann.com 155 (Ahmedabad)

Babulal S. Solanki vs. ITO

ITA No. 3943/Mum/2016

A.Y.: 2012-13

Dated: 4th March, 2019

 

Section 263 – If a matter is
examined by the Assessing Officer during the course of assessment and
consciously accepts the plea of the assessee, the order can still be subjected
to revision u/s. 263 of the Act if the view adopted by the A.O. is
unsustainable in law

 

FACTS

The
Commissioner, on verification of assessment records of the assessee, observed
that while computing capital gains from transfer of land by the assessee, sale
consideration was taken instead of the jantri value, which was higher,
and therefore the difference between the jantri value and sale
consideration remained untaxed. He opined that the assessment order passed by
the A.O. was erroneous and prejudicial to the interest of the Revenue.

 

The
assessee, however, submitted that this aspect was specifically examined by the
A.O. and his claim was allowed after due verification of the records and
details pertaining to the sale of land.

 

The Commissioner
did not accept the contention of the assessee and held that since there was no
mention by the A.O. as to why the stamp duty value was not adopted as full
value of consideration, the matter was not examined and thus he directed the
revision of the assessment order u/s. 263 of the Act. Aggrieved, the assessee
preferred an appeal to the Tribunal.

 

HELD

The
Tribunal noted the decision of the Supreme Court in the case of Malabar
Industrial Co. Ltd. vs. CIT (243 ITR 83) wherein it was held that where
two views are possible and the ITO has taken one view with which the
Commissioner does not agree, it cannot be treated as an erroneous order
prejudicial to the interests of the Revenue unless the view taken by the ITO is
unsustainable in law.

 

The
Tribunal held that even if the matter was examined by the A.O. and it was his
conscious call to accept the plea of the assessee, such a situation would not
take the matter outside the purview of section 263 as the view adopted by the
A.O. in the present case was clearly unsustainable in law.

 

Further,
the Tribunal observed that the Commissioner had directed examination of the
claim on merits and therefore the revision order of the Commissioner did not
call for any interference.

 

The appeal filed by the assessee was dismissed.

Section 80-IA – Deduction u/s. 80-IA – Industrial undertaking – Generation of power – Assessee owning three units and claiming deduction in respect of one (eligible) unit – Losses of earlier years of other two units cannot be notionally brought forward and set off against profits of eligible unit – Unit entitled to deduction u/s. 80-IA to be treated as an independent unitSection 80-IA – Deduction u/s. 80-IA – Industrial undertaking – Generation of power – Assessee owning three units and claiming deduction in respect of one (eligible) unit – Losses of earlier years of other two units cannot be notionally brought forward and set off against profits of eligible unit – Unit entitled to deduction u/s. 80-IA to be treated as an independent unit

20

CIT vs. Bannari Amman Sugars Ltd.;
412 ITR 69 (Mad)

Date of order: 28th
January, 2019

A.Y.: 2004-05

 

Section
80-IA – Deduction u/s. 80-IA – Industrial undertaking – Generation of power –
Assessee owning three units and claiming deduction in respect of one (eligible)
unit – Losses of earlier years of other two units cannot be notionally brought
forward and set off against profits of eligible unit – Unit entitled to
deduction u/s. 80-IA to be treated as an independent unit

 

The
assessee manufactured and sold sugar. It operated three power generation units,
two in Karnataka and one in Tamil Nadu with a capacity of 16, 20 and 20
megawatts, respectively. For the A.Y. 2004-05, the assessee claimed deduction
u/s. 80-IA of the Income-tax Act, 1961 for the first time in respect of its 16
megawatts unit in Karnataka. The A.O. set off the losses suffered by the units
in Karnataka and Tamil Nadu against the profits earned by the eligible unit and
held that the assessee had no positive profits after such set-off and hence no
deduction was liable to be granted u/s. 80-IA.

 

The Tribunal found that independent power purchase
agreements were entered into by the assessee which contained different and
distinct terms and conditions. It held that the provisions of section 80-IA
were attracted only in the case of the specific unit which claimed deduction
and that consolidating the profit and loss of the three units of the assessee
by the lower authorities was untenable.

 

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

 

“i)   Section
80-IA(5) provides that in determining the quantum of deduction u/s. 80-IA, the
eligible business shall be treated as the only source of income of the assessee
during the previous year relevant to the initial assessment year and to every
subsequent assessment year up to and including the assessment year for which
the determination is to be made. Thus, each unit, including a captive power
plant, has to be seen independently as separate and distinct from each other
and as units for the purpose of grant of deduction u/s. 80-IA.

 

ii)   The mere
fact that a consolidated balance sheet and profit and loss account had been
prepared for the entire business would not disentitle the assessee to claim
deduction u/s. 80-IA in respect of only one undertaking of its choice. The
assessee had maintained separate statements and had filed before the
Commissioner (Appeals) detailing separate project cost and source of finance in
respect of each unit. The assessee had exercised its claim before the A.O. for
deduction u/s. 80-IA in respect of only the 16-megawatts unit at Karnataka.
Each unit, including a captive power plant, had to be seen independently as
separate and distinct from each other and as units for the purpose of grant of
deduction u/s. 80-IA.

 

iii)   In the light of the above discussion, the
questions of law are answered in favour of the assessee and against the Revenue
and the tax case (appeal) is dismissed.”

Section 119 – CBDT – Power to issue directions – Any directives by CBDT which give additional incentive for an order that Commissioner (Appeals) may pass having regard to its implication, necessarily transgresses on Commissioner’s exercise of discretionary quasi judicial powers. Interference or controlling of discretion of a statutory authority in exercise of powers from an outside agency or source, may even be superior authority, is wholly impermissible

19

Chamber of Tax Consultants vs. CBDT;
[2019] 104 taxmann.com 397 (Bom)

Date of order: 11th April,
2019

 

Section
119 – CBDT – Power to issue directions – Any directives by CBDT which give
additional incentive for an order that Commissioner (Appeals) may pass having
regard to its implication, necessarily transgresses on Commissioner’s exercise
of discretionary quasi judicial powers. Interference or controlling of
discretion of a statutory authority in exercise of powers from an outside
agency or source, may even be superior authority, is wholly impermissible

 

The
Chamber of Tax Consultants challenged a portion of the Central Action by the
CBDT which provided incentives to Commissioner (Appeals) for passing orders in
certain manner. The Bombay High Court allowed the writ petition and held as
under:

 

“i)   In terms of the provisions contained in
sub-section (1) of section 119, the Board may, from time to time, issue such
orders, instructions and directions to other income tax authorities as it may
deem fit for proper administration of the Act and such authorities shall
observe and follow the orders, instructions and directions of the Board. While
granting such wide powers to the CBDT under sub-section (1) of section 119, the
proviso thereto provides that no such orders, instructions or directions shall
be issued so as to require any income tax authority to make a particular assessment
or to dispose of a particular case in a particular manner.

ii)   When the CBDT guidelines provide greater
weightage for disposal of an appeal by the Appellate Commissioner in a
particular manner, this proviso of sub-section (1) of section 119, would surely
be breached.

 

iii)   Thus, the portion of the Central Action Plan
prepared by CBDT which gives higher weightage for disposal of appeals by
quality orders, i.e., where order passed by Commissioner (Appeals) is in favour
of Revenue, was to be set aside.”

Sections 2(47) and 45(4) – Capital gains – Where retiring partners were paid sums on reconstitution of assessee-partnership firm in proportion to their share in partnership business / asset, no transfer of assets having taken place, no capital gains would arise

18

Principal CIT vs. Electroplast
Engineers; [2019] 104 taxmann.com 444 (Bom)

Date of order: 26th March,
2019

A.Y.: 2010-11

 

Sections
2(47) and 45(4) – Capital gains – Where retiring partners were paid sums on
reconstitution of assessee-partnership firm in proportion to their share in
partnership business / asset, no transfer of assets having taken place, no
capital gains would arise

 

Under a
Deed of Retirement cum Reconstitution of the Partnership, the original two
partners retired from the firm and three new partners redistributed their
share. Goodwill was evaluated and the retiring partners were paid a certain sum
for their share of goodwill in proportion to their share in the partnership.
The assessee-partnership firm filed return of income. The A.O. was of the
opinion that the goodwill credited by the assessee-partnership firm to its
retiring partners was capital gain arising on distribution of the capital asset
by way of dissolution of the firm or otherwise. Thus, the assessee-partnership
firm had to pay short-term capital gain tax in terms of section 45(4) of the
Income-tax Act, 1961.

 

The
Commissioner (Appeals) agreed with the contention of the assessee-partnership
firm that there was neither dissolution of the firm nor was the firm
discontinued. He held that the rights and interests in the assets of the firm
were transferred to the new members and in this manner amounted to transfer of
capital asset. Thus, section 45(4) would apply. The Tribunal held that section
45(4) would apply only in a case where there has been dissolution of the firm
and, thus, the conditions required for applying section 45(4) were not
satisfied.

 

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

 

“i)   As per the provision of section 45(4),
profits or gains arising from transfer of capital asset by way of distribution
of capital asset on dissolution of firm or otherwise shall be chargeable to tax
as income of the firm. For the application of this provision, thus, transfer of
capital asset is necessary.

 

ii)   In the
case of CIT vs. Dynamic Enterprises [2014] 223 Taxman 331/[2013] 40
taxmann.com 318/359 ITR 83, the full bench of the Karnataka High Court
has held that after the retirement of the partners, the partnership continued
and the business was also carried on by the remaining partners. There was,
thus, no dissolution of the firm and there was no distribution of capital
asset. What was given to the retiring partners was money representing the value
of their share in the partnership. No capital asset was transferred on the date
of retirement. In the absence of distribution of capital asset and in the
absence of transfer of capital asset in favour of the retiring partners, no
profit or gain arose in the hands of the partnership firm.

 

iii)   In the instant case, admittedly, there was no
transfer of capital asset upon reconstitution of the firm. All that happened
was that the firm’s assets were evaluated and the retiring partners were paid
their share of the partnership asset. There was clearly no transfer of capital
asset.”

Section 37(1) – Business expenditure – Compensation paid by assessee developer to allottees of flats for surrendering their rights was to be allowed as business expenditure

17

Gopal Das Estates & Housing (P)
Ltd. vs. CIT; [2019] 103 taxmann.com 334 (Delhi)

Date of order: 20th March,
2019

 

Section
37(1) – Business expenditure – Compensation paid by assessee developer to
allottees of flats for surrendering their rights was to be allowed as business
expenditure

 

The
assessee was engaged in the business of construction and sale of commercial
space. The assessee developed a 17-storeyed building known as GDB in New Delhi.
It followed the Completed Contract Method (CCM) as compared to the Percentage
Completion Method (PCM). It booked flats to various persons after receiving
periodical amounts as advance. Some of the allottees of the flats refused to
take them for completion since the New Delhi Municipal Council (NDMC) changed
the usage of the Lower Ground Floor (LGF). The assessee then started
negotiating with the relevant flat buyers and persuaded them to surrender their
ownership and allotment letters. The assessee repaid advance money received
from these flat owners and also paid compensation in lieu of surrender
of their rights in the flats. This expenditure was claimed by the assessee as
‘revenue in nature’ and was charged to the profit and loss account (P&L
Account).

 

The A.O.
observed that the assessee had paid compensation amount ‘once and for all to
repurchase the property’ and this was ‘in fact a sale consideration and could
not be allowed as business expenditure.’ He observed further that flat owners
had shown the amount received from the assessee as capital gains in their books
of account as well as income tax returns after indexation of the cost of
acquisition. Accordingly, the payment of compensation towards ‘repurchase of
the flat’ was disallowed by holding that it was ‘a capital expenditure’. The
said amount was added back to the income of the assessee.

     

The
Commissioner (Appeals) directed that compensation paid to the allottees of the
flats for surrendering the rights therein be allowed as business expenditure of
the assessee. But the Tribunal set aside the order of the Commissioner
(Appeals) and restored the order of the A.O.

 

On appeal
by the assessee, the Delhi High Court reversed the decision of the Tribunal and
held as under:

 

“i)   In the instant case, the assessee has a
plausible explanation for making such payment of compensation to protect its
‘business interests.’ While it is true that there was no ‘contractual obligation’
to make the payment, it is plain that the assessee was also looking to build
its own reputation in the real estate market.

 

ii)   Further, the mere fact that the recipients
treated the said payment as ‘capital gains’ in their hands in their returns
would not be relevant in deciding the issue whether the payment by the assessee
should be treated as ‘business expenditure.’ It is the point of view of the
payer which is relevant.

 

iii)   The payment made by the assessee to the
allottees of the flats for surrendering the rights therein should be allowed as
business expenditure of the assessee.”

Section 37(1) and Rule 9A of ITR 1962 – Business expenditure – Where assessee was engaged in business of production and distribution of films, cost of prints as well as publicity and advertisements incurred after production as well as their certification by Censor Board, the same would not be governed by Rule 9A, they would be allowable as business expenditure u/s. 37(1)

16

CIT vs. Dharma Productions Ltd.;
[2019] 104 taxmann.com 211 (Bom)

Date of order: 19th March,
2019

A.Y.s: 2006-07 and 2009-10

 

Section
37(1) and Rule 9A of ITR 1962 – Business expenditure – Where assessee was
engaged in business of production and distribution of films, cost of prints as
well as publicity and advertisements incurred after production as well as their
certification by Censor Board, the same would not be governed by Rule 9A, they
would be allowable as business expenditure u/s. 37(1)

 

The
assessee was engaged in the business of production and distribution of feature
films. The assessee claimed expenditure incurred for positive prints of feature
films and further expenditure on account of advertisements. The A.O. noticed
that these expenditures were incurred by the assessee after issuance of
certificate by the Censor Board and, hence, he disallowed the assessee’s claim
holding that such expenditure was not allowable deduction in terms of Rule 9A
and Rule 9B.

 

The Commissioner (Appeals), confirmed the
disallowance stating that any expenditure which was not allowable under Rule 9A
could not be granted in terms of section 37; thus, he held that the expenditure
on the prints and publicity expenses are neither allowable under Rule 9A nor
u/s. 37. However, 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)   Sub-rule
(1) of rule 9A provides that in computing the profits and gains of the business
of production of feature films, the deduction in respect of the cost of
production of a feature film certified for release by the Board of Film Censors
in a previous year would be allowed in accordance with the provisions of
sub-rule (2) to sub-rule (4).

 

ii)   Clause (ii) of Explanation to sub-rule
(1) explains the term ‘cost of production’ in relation to a feature film as to
mean expenditure incurred for preparation of the film but excluding (a)
expenditure incurred in preparing positive prints, and (b) expenditure
incurred in connection with advertisement of the film after it is certified for
release by the Board of Film Censors. The sub-rules (2) to (4) of rule 9A make
special provisions for deduction in respect of profits and gains of the
business of production of feature films. For example, in terms of sub-rule (2)
of rule 9A, where a feature film is certified for release by the Board of Film
Censors in any previous year and in such previous year, the film producer sells
all rights of exhibition of the film, the entire cost of production of the film
shall be allowed as a deduction in computing the profits and gains of such
previous year. However, if the film producer either himself exhibits the film
on a commercial basis or sells the rights of exhibition of the film in respect
of some of the areas, or he himself exhibits the film in certain areas and sells
the rights in the rest and the film is released for exhibition at least 90 days
before the end of such previous year, the cost of production of the feature
film will be allowed as a deduction in computing the profits and gains of such
previous year. As per sub-rule (3) of rule 9A, if the feature film is not
released for exhibition on a commercial basis at least 90 days before the end
of previous year, a different formula for allowing the cost of production would
apply. These provisions thus make a special scheme for deduction for cost of
production in relation to the business of production of feature films. One
thing to be noted is that no part of the cost of production as defined in
clause (ii) of Explanation to sub-rule (1) is to be denied to the
assessee permanently. It is only to be deferred to the next assessment year
under certain circumstances.

 

iii)   All these provisions would necessarily be
applied in relation to the cost of production of a feature film. In other
words, if a certain expenditure is claimed by the assessee by way of business
expenditure, which does not form part of cost of production of a feature film,
rule 9A would have no applicability. In such a situation, the assessee’s claim
of expenditure would be governed by the provisions of the Act. If the assessee
satisfies the requirements of section 37, there is no reason why such
expenditure should not be allowed as business expenditure. To put it
differently, the expenditure that would be governed by rule 9A of the Rules
would only be that which is in respect of the production of the feature film.

 

iv)  In the instant case, the cost of the print and
the cost of publicity and advertisement (which was incurred after the
production and certification of the film by the Censor Board) are under consideration.
These costs fail to satisfy the description ‘expenditure in respect of cost of
production of feature film’. The term ‘cost of production’ defined for the
purpose of this rule specifically excludes the expenditure for positive print
and cost of advertisement incurred after certification by the Board of Film
Censors. What would, therefore, be governed by the formula provided under rule
9A is the cost of production minus these costs. The Legislature never intended
that those costs which are in the nature of business expenditure but are not
governed by rule 9A due to the definition of cost of production are not to be
granted as business expenditure. In other words, if the cost is cost of
production of the feature film, it would be governed by rule 9A. If it is not,
it would be governed by the provisions of the Act. The Commissioner was,
therefore, wholly wrong in holding that the expenditures in question were
covered under rule 9A and therefore not allowable. The Tribunal was correct in
coming to the conclusion that such expenditure did not fall within the purview
of rule 9A and, therefore, the assessee’s claim of deduction was governed by
section 37.”

Section 37 – Business expenditure – Capital or revenue – Test to be applied – Pre-operative expenditure of new line of business abandoned subsequently – Deductible revenue expenditure

15

Chemplast Sanmar Ltd.
vs. ACIT; 412 ITR 323 (Mad)

Date of order: 7th August,
2018

A.Y.: 2000-01

 

Section
37 – Business expenditure – Capital or revenue – Test to be applied –
Pre-operative expenditure of new line of business abandoned subsequently –
Deductible revenue expenditure

 

The
assessee was engaged in the business of manufacture of polyvinyl chloride,
caustic soda and shipping. For the A.Y. 2000-01, the A.O. disallowed the
expenditure incurred by the assessee on account of a textile project which it
had later abandoned. The A.O. held that the textile project, which the assessee
intended to start, being a totally new project distinguished from the
manufacture of polyvinyl chloride and caustic soda and the business of
shipping, in which the assessee was currently engaged, the entire expenditure
had to be treated as a capital expenditure.

 

The
Commissioner (Appeals) and the Tribunal upheld the decision of the A.O.

 

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

 

“i)   The proper test to be applied was not the
nature of the new line of business which was commenced by the assessee, but
unity of control, management and common fund. This issue was never disputed by
the A.O. or the appellate authorities.

 

ii)   The authorities had concurrently held that it
was the assessee who had commenced the business and the assessee would mean the
assessee-company as a whole and not a different entity. Therefore, when there
was commonality of control, management and fund, those would be the decisive
factors to take into consideration and not the new line of business, namely,
the textile business.

 

iii)   Before the Commissioner (Appeals) a specific
ground had been raised stating that the A.O. ought to have appreciated that the
decisive factors for allowance were unity of control, management,
interconnection, interlacing, inter-dependence, common fund, etc., and if the
above factors were fulfilled, then the expenditure should be allowed even if
the project was a new one. The Commissioner (Appeals) did not give any finding
on such a ground raised by the assessee. Therefore, it was incorrect on the
part of the department to contend that such a question was never raised before
the appellate authorities.”

Section 54F r.w.s. 45, 2(29B) and 2(42B) – Assessee having acquired rights in a flat vide allotment letter dated 26.02.2008 issued by the builder which was an unconditional allotment, and since the agreement to sell executed by the builder in assessee’s favour subsequently on 25.03.2010 was mere improvement in assessee’s existing rights to acquire a specific property, the gains arising on the sale of the said flat on 04.04.2012 were long term capital gains; assessee was entitled to exemption u/s. 54F

13
[2019]
199 TTJ (Mumbai) 388

ACIT vs. Keyur Hemant Shah

ITA No. 6710/Mum/2017

A.Y.: 
2013-14

Dated: 2nd April, 2019

 

Section 54F r.w.s. 45,
2(29B) and 2(42B) – Assessee having acquired rights in a flat vide allotment
letter dated 26.02.2008 issued by the builder which was an unconditional
allotment, and since the agreement to sell executed by the builder in
assessee’s favour subsequently on 25.03.2010 was mere improvement in assessee’s
existing rights to acquire a specific property, the gains arising on the sale
of the said flat on 04.04.2012 were long term capital gains; assessee was
entitled to exemption u/s. 54F

 

FACTS

The
assessee filed return of income on 31.07.2013 declaring income of Rs. 185.33
lakhs. During the assessment proceedings it was found by the A.O. that the
assessee had sold a flat for a consideration of Rs. 1.20 crores in which he had
a 50% share. The long term capital gain was computed at Rs. 288.73 lakhs out
which Rs. 109.4 lakhs was claimed exempt u/s. 54F and the balance was offered
to tax. It was observed by the A.O. that the agreement for purchase of the flat
was executed on 25.03.2010 and was sold subsequently on 04.04.2012. Hence the
period of holding for the original property was less than 36 months and hence
the capital gains arising out of the same cannot be claimed for exemption u/s.
54F.

 

The
assessee defended the claim by submitting the letter of allotment of the flat
dated 26.02.2008 and asserted that substantial payments for the flat were made by that time and therefore the
period of holding exceeds the required period of 36 months to classify the flat
as long term capital asset.

 

Aggrieved,
the assessee preferred an appeal to the CIT(A). The CIT(A) allowed exemption of
Rs. 109.40 lakhs u/s. 54F as claimed by the assessee.

 

HELD

The Tribunal held that on perusal of the facts of
the case, it emerged that the assessee had acquired rights in the flat on
26.02.2008. The letter of allotment was not conditional and did not envisage
cancellation of the allotted property. The agreement of sale was executed on
25.03.2010 which was nothing but a mere improvement of the assessee’s right
over the same transaction.

 

There was
nothing to suggest that the construction scheme promised by the builder was
materially different from the terms of allotment. Considering the same, it
confirmed that the resultant gains were long term capital gains in nature. The
assessee had made payments for the new property within the stipulated time and
obtained the new property by 14.04.2012.

 

Therefore,
all conditions of section 54F were fulfilled. There was no reason to deny
benefit of section 54F in this case.

Section 194C, r.w.s. 194-I – Deduction of tax at source – Contractors payment to – Payment was made to agencies towards lounging and catering services provided to customers of airlines as a part of single arrangement – Same would fall under generalised contractual category u/s. 194C

9

CIT (ITD)-1 vs. Jet Airways (India)
Ltd. [Income-tax Appeal No. 628 of 2018; (Bombay High Court) Dated 23rd
April, 2019]

 

[ACIT vs. Jet Airways
(India) Ltd.; Mum ITAT]

 

Section
194C, r.w.s. 194-I – Deduction of tax at source – Contractors payment to –
Payment was made to agencies towards lounging and catering services provided to
customers of airlines as a part of single arrangement – Same would fall under
generalised contractual category u/s. 194C

 

The assessee is an airlines company. As part of
its business, the assessee would provide lounge services to select customers at
various airports. In a typical case, a lounge would be rented out by an agency,
in the nature of an intermediary from the airport authority. The assessee
airlines company and other airlines as well as, in some cases, credit card
companies, would provide the lounge facility to premier class customers. As is
well known, a lounge is an exclusive secluded hall or a place at the airport
where a comfortable sitting arrangement and washrooms are provided to the
flying customers. Most of these lounges would have basic refreshments for which
no separate charge would be levied. According to the assessee, the assessee
would pay the agency for use of such lounge space by its customers as per
pre-agreed terms. While making such payment, the assessee used to deduct tax at
source in terms of section 194C of the Act, treating it as a payment to a
contractor for performance of a work.

 

The
Revenue contends that the assessee had paid rent to the agency and, therefore,
while paying such rental charges, tax at source u/s. 194-I of the Act should
have been deducted.

 

The
Tribunal by the impugned judgement referred to and relied upon a decision of
the coordinate Bench in the case of ACIT vs. Qantas Airways Ltd.,
reported in (2015) 152 ITD 434 and held that the department was not
right in insisting on deduction of tax at source u/s. 194-I of the Act.

 

Being aggrieved with the ITAT order, the Revenue
filed an appeal to the High Court. The Court held that the A.O. in the present
case had placed reliance on a decision of the Delhi High Court in the case of Japan
Airlines Ltd., reported in (2009) 325 ITR 298 and United Airlines
(2006) 287 ITR 281. The Court, however, noted that the Supreme Court in
the case of Japan Airlines Company Limited reported in (2015) 377 ITR 372
had overruled such decision of the Delhi High Court. The Supreme Court approved
the view of the Madras High Court in the case of CIT vs. Singapore
Airlines Ltd. reported in (2013) 358 ITR 237.

 

The issue
before the Supreme Court was regarding the nature of payments made by the
international airlines to the Airport Authority of India for availing the
services for the purpose of landing and take-off of aircrafts. The Revenue was
of the opinion that the charges paid for such purposes were in the nature of
rent for use of land, a view which was accepted by the Delhi High Court in the
above-noted judgment. The Supreme Court, in the judgement in case of Japan
Airlines (supra), held that the charges paid by the international
airlines for landing and take-off services, as also for parking of aircrafts
are in substance not for use of the land but for various other facilities such
as providing of air traffic services, ground safety services, aeronautical
communication facilities, etc. The Court, therefore, held that the payment of
such charges did not invite section 194-I of the Act. The Court observed that
this decision of the Supreme Court does not automatically answer the question
at hand.

 

Reference
to this decision was made for two purposes. Firstly, to record that the
reliance placed by the A.O. on the decision of the Delhi High Court is no longer
valid. Secondly, for the purpose of drawing an analogy that the payment for
certain services need not be seen in isolation. The real character of the
service provided and for which the payment is made would have to be judged. In
the present case, as noted, the assessee would enter into an agreement with the
agency which has rented out the lounge space at the airport from the Airport
Authority. Under such agreement, the assessee would pay committed charges be it
on a lump sum basis or on the basis of customer flow to such an agency. This,
in turn, would enable the passengers of the airlines to utilise the lounge
facilities while in transit.

 

The Court accepted the suggestion of Revenue
that service of providing beverages and refreshments was not the dominant part
of the service. It may only be incidental to providing a quiet, comfortable and
clean place for customers to spend some spare time. However, the Court did not
see any element of rent being paid by the assessee to the agency. The assessee
did not rent out the premises. The assessee did not have exclusive use to the
lounge for its customers. The customers of the airlines, along with customers
of other airlines of specified categories, would be allowed to use all such
facilities. Section 194-I of the Act governs the situation where a person is
responsible for paying any rent. In such a situation, deduction of tax at
source while making such payment is obligated. The Revenue wrongly invoked
section 194-I of the Act. In the result, the appeal was dismissed. 

Section 271(1)(c) – Penalty – Filing inaccurate particulars of income – Revised income filed voluntarily – before detection – Reason stated: accountant error – Human error – Bona fide mistake – penalty not leviable

8

Pr. CIT-18 vs. Padmini Trust [ITA No.
424 of 2017; (Bombay High Court) Dated 30th April, 2019]

 

[Padmini Trust vs.
ITO-14(1)(4); Bench: C; Mum TAT ITA No. 5188/Mum/2013]

Dated 28th
January, 2016;

A.Y. 2009-10.

 

Section
271(1)(c) – Penalty – Filing inaccurate particulars of income – Revised income
filed voluntarily – before detection – Reason stated: accountant error –  Human error – Bona fide mistake –
penalty not leviable

 

The assessee
is a Trust. The assessee had filed a return of income for the A.Y. 2009-10. The
return was taken for scrutiny by the A.O. by issuing notice of scrutiny
assessment on 27.09.2010. When the assessment proceedings were pending, the
assessee tried to rectify the return by making a declaration and enlarging
certain liability. Commensurate additional income tax of Rs. 99,05,738 was also
paid on 26.09.2011. This was conveyed to the A.O. by letter dated 15.11.2011.
While completing the assessment, the A.O. held that the revised return was not
acceptable since it was filed after the last day for filing such a revised
return. He, however, made no further additions over and above the declaration
made by the assessee in the return. On the ground that the assessee had not
disclosed the income in the original return, he initiated the penalty
proceedings. He imposed a penalty which was confirmed by the CIT(A).

 

Being
aggrieved with the CIT(A) order, the assessee filed an appeal to the ITAT. The
Tribunal held that there is wrong categorisation of capital gains and loss and
the same are evident from the papers filed. It is a case of wrong
categorisation of the income under the wrong head. The revised computation of
income basically corrects the mistake in such wrong categorisation. It is a
case where the assessee paid taxes on the extra income computed by virtue of
the revised computation along with the statutory interest u/s. 234A, 234B and
234C as the case may be. It is a settled issue that penalty cannot be excisable
in a case where the income was disclosed but under the wrong head of income.
Accordingly, levy of penalty u/s. 271(1)(c) of the Act was deleted.

 

The Revenue was aggrieved with the ITAT order and
hence filed an appeal to the High Court. The Revenue submitted that the
assessee had filed a false declaration in the original return. But after the
return was taken in scrutiny, he attempted to revise the return. Such attempt
would not give immunity to the assessee from the penalty. The counsel relied on
the decision of the Supreme Court in the case of Union of India and Ors.
vs. Dharmendra Textiles Processors and Ors. (2008) 306 ITR 277 (SC) to
contend that mens rea is not necessary for imposition of the penalty and
the penalty is a civil consequence. He also relied on the decision of the Delhi
High Court in the case of CIT vs. Zoom Communication (P) Limited (2010)
327 ITR 510 (Delhi) in which, highlighting the fact that very few
returns filed by assessees are taken in scrutiny, the Court held that merely
because the assessee had later on surrendered the income to tax would not mean
that the penalty should not be initiated, failing which the deterrent effect of
the penalty would disappear.

 

The assessee opposed the appeal contending that
there was a bona fide error in claiming short-term capital gain as
dividend income. This error was committed by the accountant of the assessee.
All such errors were corrected, whether the returns were taken in scrutiny or
not, demonstrating bona fide on the part of the assessee. He pointed out
that the tax on the additional income was paid even before the A.O. issued
specific queries in relation to the return filed. He relied on the decision of
the Supreme Court in the case of Price Waterhouse Coopers (P) Ltd. vs.
CIT, Kolkata to contend that mere bona fide error in claiming
reduced tax liability would not give rise to penalty proceedings.

 

The Court agreed with the submission of Revenue
that once the assessee is served with a notice of scrutiny assessment,
corrections to the declaration of his income would not grant immunity from
penalty. Especially in a case where the assessee during such scrutiny
assessment is confronted with a legally unsustainable claim which he thereafter
forgoes, may not be a ground to delete penalty. However, in the present case
the facts are glaring. The assessee made a fresh declaration of revised income
voluntarily before he was confronted with the incorrect claim. The assessee had
blamed the accountant for an error in filing the return. An affidavit of the accountant
was also filed. As stated by the counsel, such error was committed by other
group assessees also. Some of them corrected the error even before the scrutiny
notices. In view of such facts, the Court agreed with the conclusion of the
Tribunal that the original declaration of income suffered from a bona fide
unintended error. The Income-tax appeal was dismissed.

Section 28 r.w.s. 37(1) – Business loss – Advance payment for booking commercial space – Deal failed and could not get refund – Object clause of the assessee covered this as business activities – Allowable as deduction

7

Pr. CIT-6 vs. Khyati Realtors Pvt.
Ltd. [Income-tax Appeal No. 291 of 2017; (Bombay High Court)

Dated 30th April, 2019]

 

[Khyati Realtors Pvt. Ltd.
vs. ACIT-6(2); Bench: “A”; ITA. No. 129/Mum/2014, Mum ITAT]

Dated 4th
March, 2016;

A.Y. 2009-10.

 

Section
28 r.w.s. 37(1) – Business loss – Advance payment for booking commercial space
– Deal failed and could not get refund – Object clause of the assessee covered
this as business activities – Allowable as deduction

 

The assessee,
who is a private limited company, had advanced a sum of Rs. 10 crore to one
Bhansali Developers for booking commercial space in an upcoming construction
project. For some reason, the deal failed. The assessee, despite full efforts,
could not get refund of the said advance amount. In the return of income for
the A.Y. 2009-2010, the assessee had claimed the said sum of Rs. 10 crore as a
bad debt. The A.O. disallowed the same saying that the amount could not be
claimed by way of business loss because buying and selling commercial space was
not the business of the assessee.

 

On
appeal, the CIT(A) confirmed the disallowance. The assessee suggested before
the CIT(A) an alternate plea, that deduction should be allowed u/s. 37 of the
Act if the write-off of the advance did not fall u/s. 36(2) of the Act. But the
CIT(A) declined the assessee’s claim u/s. 36(2) on the plea that the assessee
did not have a money-lending licence or an NBFC licence; therefore, the
assessee was covered by explanation to section 37(1) of the Act. The CIT(A)
also declined the claim of the assessee u/s. 37 on the plea that the claim of
bad debts fell u/s. 30 to 36 of the Act.

 

Aggrieved
with the CIT(A) order, the assessee filed an appeal to the ITAT. The Tribunal
held that it is not in dispute that the expenditure claimed by the assessee is
not covered by any of the provisions of sections 30 to 36 of the Act and being
neither a capital nor personal expenditure, and having been incurred for the
purpose of carrying on of business, is eligible for deduction u/s. 37(1) of the
Act. The amount so advanced was not in the nature of capital expenditure or
personal expenses of the assessee, but was in the nature of advance given for
reserving / booking of commercial premises in the ordinary course of the
assessee’s business of real estate development and which could not be
recovered; therefore, there is no reason to decline the assessee’s claim as a
business loss u/s. 37(1) r.w.s. 28 of the I.T. Act. Accordingly, the claim was
allowed as a business loss.

 

Being
aggrieved with the ITAT order, the Revenue filed an appeal to the High Court.
The Court held that the assessee was engaged in the business of real estate and
financing. The object clause for incorporation of the company reads as under:

 

“1. To
carry on the business of contractors, erectors, constructors of buildings,
houses, apartments, structures for residential, office, industrial,
institutional or commercial purposes and developers of co-operative housing
societies, developers of housing schemes, townships, holiday resorts, hotels,
motels, farms, holiday homes, clubs, recreation centres and in particular
preparing of building sites, constructing, reconstructing, erecting, altering,
improving, enlarging, developing, decorating, furnishing and maintenance of
structures and other properties of any tenure and any interest therein and
purchase, sale and dealing in freehold and leasehold land to carry on business
as developers of land, buildings, immovable properties and real estate by
constructing, reconstructing, altering, improving, decorating, furnishing and
maintaining offices, flats, houses, factories, warehouses, shops, wharves,
buildings, works and conveniences and by consolidating, connecting and
sub-dividing immovable properties and by leasing and disposing off the same.”

 

This clause is thus widely
worded and would cover within its fold a range of activities such as erection,
construction of buildings and houses, as also purchase, sale and dealing in
freehold and leasehold land to carry on business as developers of land,
buildings, and immovable properties. It was in furtherance of such an object
that the assessee had entered into a commercial venture by booking commercial
space with a developer in the upcoming construction of the commercial building,
the payment being an advance for the booking. The sum was not refunded. This
was thus clearly a business loss. It was also noticed that later when, due to
continued efforts, the assessee recovered a part of the said sum, the same was
offered as business income. In the result, the Revenue’s appeal was dismissed.

Sections 2(15), 10(20), 11, 251 and 263 – Revision – Powers of Commissioner – No jurisdiction to consider matters considered by CIT(A) in appeal – Claim for exemption rejected by A.O. on ground that assessee is not a local authority u/s. 10(20) – CIT(A) granting exemption – Principle of merger – Commissioner has no jurisdiction to revise original assessment order on ground A.O. did not consider definition in section 2(15)

22

CIT vs. Slum Rehabilitation
Authority; 412 ITR 521 (Bom)

Date of order: 26th March,
2019

A.Y.: 2009-10

 

Sections
2(15), 10(20), 11, 251 and 263 – Revision – Powers of Commissioner – No
jurisdiction to consider matters considered by CIT(A) in appeal – Claim for
exemption rejected by A.O. on ground that assessee is not a local authority
u/s. 10(20) – CIT(A) granting exemption – Principle of merger – Commissioner
has no jurisdiction to revise original assessment order on ground A.O. did not
consider definition in section 2(15)

 

The assessee, the Slum Rehabilitation Authority,
claimed benefit u/s. 11 of the Income-tax Act, 1961. The A.O. disallowed the
claim and held that the assessee was not a local authority within the meaning
of section 10(20) and that in view of the nature of activities carried out by
it and its legal status, its claim could not be allowed. The Commissioner
(Appeals) allowed the assessee’s appeal and granted the benefit of exemption.
The Commissioner in suo motu revision u/s. 263 took the view that the
activities of the assessee could not be considered as for “charitable purpose”
as defined u/s. 2(15) and directed the assessment to be made afresh
accordingly.

 

The Tribunal allowed the appeal filed by the
assessee on the ground of merger as well as on the ground that the order of
assessment was not prejudicial to the interest of the Revenue.

 

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

 

“i)   The
Commissioner in exercise of revisional powers u/s. 263 could not initiate a
fresh inquiry about the same claim made by the assessee on the ground that one
of the aspects of such claim was not considered by the Assessing Officer.

 

ii)   Once
the claim of the assessee for exemption u/s. 11 was before the Commissioner
(Appeals), he had the powers and jurisdiction to examine all the aspects of
such claim. If the Department was of the opinion that the assessment order
could not have been sustained as the assessee did not fall within the ambit of
section 10(20) the ground on which the Assessing Officer had rejected the claim
and the other legal ground of section 2(15), it should have contended before
the Commissioner (Appeals) to reject the assessee’s claim on such legal ground.

iii)    The
Tribunal did not commit any error in setting aside the revision order.”

Section 40A(3) r.w.r. 6DD of ITR 1962 – Business expenditure – Disallowance u/s. 40A(3) – Payments in cash in excess of specified limit – Exceptions u/r. 6DD – Payment to producer of meat – Condition stipulated u/r. 6DD satisfied – Further condition provided in CBDT circular of certification by veterinary doctor cannot be imposed – Payment allowable as deduction

14

Principal CIT vs. GeeSquare Exports;
411 ITR 661 (Bom)

Date of order: 13th March,
2018

A.Y.: 2009-10

 

Section
40A(3) r.w.r. 6DD of ITR 1962 – Business expenditure – Disallowance u/s. 40A(3)
– Payments in cash in excess of specified limit – Exceptions u/r. 6DD – Payment
to producer of meat – Condition stipulated u/r. 6DD satisfied – Further
condition provided in CBDT circular of certification by veterinary doctor
cannot be imposed – Payment allowable as deduction

 

The
assessee exported meat. It purchased raw meat paying cash. Payments made in
cash in excess of Rs. 20,000 were disallowed u/s. 40A(3) of the Income-tax Act,
1961 on the ground that in view of Circular No. 8 of 2006 issued by the CBDT
for failure to comply with the condition for grant of benefit u/r. 6DD of the
Income-tax Rules, 1962 requiring certification from a veterinary doctor that
the person issued the certificate was a producer of meat and slaughtering was
done under his supervision.

 

The
Tribunal allowed the assessee’s appeal. It held that section 40A(3) provided
that no disallowance thereunder should be made if the payment in cash was made
in the manner prescribed u/r. 6DD. The Tribunal held that the payment made to
the producer of meat in cash satisfied such requirement and that neither the
Act nor the Rules provided that the benefit would be available only if further
conditions set out by the CBDT were complied with. The Tribunal further held
that the scope of Rule 6DD could not be restricted or fettered by the circular.

 

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

 

“i)   The assessee having satisfied the
requirements u/r. 6DD could not be subjected to the disallowance of the
deduction of expenditure on purchases in cash of meat u/s. 40A(3).

ii)     The
CBDT circular could not put in new conditions not provided either in the Act or
in the Rules.”