Subscribe to the Bombay Chartered Accountant Journal Subscribe Now!

Month: June

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.”

DECLARATION OF SIGNIFICANT BENEFICIAL OWNERSHIP IN A COMPANY

1. BACKGROUND

1.1
Section 90 of the Companies Act, 2013 (Act), when enacted from 01.04.2014,
provided for investigation of beneficial ownership of shares in certain cases.
This section corresponded to section 187D of the Companies Act, 1956.This
original section is replaced by a new section by the Companies (Amendment) Act,
2017 effective 13.06.2018. This new section provides that every individual or
trust having significant beneficial ownership of shares in a company (private
or public) has to file a declaration for such holding in the manner prescribed
in the Rules.

 

1.2
By a Notification dated 13.06.2018, the Companies (Significant Beneficial
Owners) Rules, 2018 were notified. These Rules came into force on 13.06.2018.
There were a lot of ambiguities about some of the provisions in these Rules.
Therefore, they were not made operative and have been amended by a Notification
dated 8.02.2019. Accordingly, the Companies (Significant Beneficial Owners)
Amendment Rules, 2019 have now come into force from 8.02.2019.

 

1.3
Section 90 has been further amended by the Companies (Amendment) Ordinance,
2018 effective 02.11.2018. Section 90 and the above Rules contain provisions
which require certain individuals having significant beneficial ownership in
shares of a company to make a declaration in the prescribed form. In this
article some of the important provisions relating to declaration of significant
beneficial ownership in a company are discussed.

 

2. DECLARATION OF BENFICIAL INTEREST IN ANY SHARE

2.1
Section 89 of the Companies Act, 2013 provides for declaration to be filed by a
shareholder in respect of beneficial interest in any shares of a company
(whether public or private). Under this section, if a shareholder of a company
has no beneficial interest in the shares of a company held by him / her, such
shareholder has to file with the company a declaration in Form No. MGT-4 giving
particulars of the beneficial owners of the shares within 30 days of acquiring
these shares. A similar declaration is also required to be filed with the
company within 30 days whenever there is a change in the particulars of the
beneficial owners. Similarly, the person having beneficial ownership in shares
of a company held in the name of any other person is required to file a
declaration in Form No. MGT-5 within 30 days of acquiring such beneficial
interest. On receipt of the above declarations, the company is required to make
a note of such declarations in the Register of Members and file Form No. MGT-6
within 30 days with the Registrar of Companies (ROC) with the prescribed filing
fees.

 

2.2 If there is default in filing the above
declarations by the shareholder or the beneficial owner of shares within time,
section 89(5) provides for levy of a fine up to Rs. 50,000. For continuing
default further fine up to
Rs. 1,000 for each day can be levied. Similarly, for default in filing Form.
No. MGT-6 in time by the company a fine will be levied on the company and every
officer in default. In this case the minimum fine will be Rs. 500 subject to
maximum of Rs. 1,000. Further, in case of continuing default by the company, a
further fine up to Rs. 1,000 per day will be levied on the company and on the
officers in default.

 

2.3 Further, if the beneficial owner does not make
the declaration u/s. 89, he / she or any person claiming through him / her
shall not be entitled to claim any right in respect of such shares. Section 89
is amended by the Companies (Amendment) Act, 2017, effective from 13.06.2018.
According to this amendment, it is provided that for the purposes of sections
89 and 90, beneficial interest in a share includes, directly or indirectly,
through any contract, arrangement or otherwise, the right or entitlement of a
person or persons to (a) exercise any or all of the rights attached to such
shares, or (b) receive or participate in any dividend or other distribution in
respect of such shares.

 

3. SIGNIFICANT BENEFICIAL OWNER

3.1 The
term “Significant Beneficial Owner” is defined in section 90(1) of the Act as
under:

(i)  This
term applies to – every individual, who acting alone or together, or through
one or more persons or trust (including a foreign trust and persons resident
outside India);

(ii)  Such
person holds beneficial interest of not less than 25%, or such other
percentage, as may be prescribed (at present the Rules prescribe 10%), in the
shares of the company;

(iii) Such person may have right to exercise or may be actually
exercising significant influence or control as defined in section 2(27) of the
Act.

 

3.2
In order to further understand who is a “Significant Beneficial Owner” we have
to refer to the Companies (Significant Beneficial Owners) Amendment Rules,
2019. This term is defined in Rule 2(h) to mean as under:

 

An individual referred to in section
90(1), who acting alone or together, or through one or more persons or trust,
possesses one or more of the following rights or entitlements in the company:

 

(i)  Holds
indirectly or together with any direct holdings not less than 10% of (a)
shares, (b) voting rights in the shares, or (c) right to receive or participate
in the total distributable dividend or any other distribution in a financial
year;

(ii)  Has
right to exercise or actively exercises significant influence or control in any
manner other than through direct holdings alone. For this purpose “Significant
Influence” is defined in Rule 2(i) to mean the power to participate, directly
or indirectly, in the financial and operating policy decisions of the company
but not control or joint control of those policies. The term “Control” includes
the right to appoint majority of the directors or to control the management or
policy decisions exercisable by a person or persons acting individually or in
concert, directly or indirectly, including by virtue of shareholding or
management rights or shareholders agreements or voting agreements or in any
other “manner”;

(iii) If an individual does not hold any right or entitlement as stated in
para 3.2(i), indirectly, he shall not be considered to be a significant
beneficial owner.

 

3.3
(i) An individual shall be considered to hold a right or entitlement, as stated
in Para 3.2(i), directly, if he / she (a) holds the shares in the company in
his own right, or (b) holds or acquires a beneficial interest in the shares of
the company as provided in section 89(2) and has made the declaration required
to be made u/s. 89;

(ii)  From
the above, it is evident that the provisions of section 90 are applicable to a
person only if he / she holds shares in the company indirectly. If he / she
holds such shares directly only, he / she has to make the declaration u/s. 89
only and not u/s. 90.

 

3.4
Explanation III to Rule 2(4) states that an individual shall be considered to
be holding a right or entitlement
in the shares of a company indirectly if he / she satisfies any of the following
criteria in respect of the member of the company:

 

(i)  Where the member of the company is a body
corporate (whether Indian or foreign), other than an LLP, and the individual
(a) holds majority stake in that member, or (b) holds majority state in the
ultimate holding company (whether Indian or foreign) of that member;

(ii)  Where the member of the company is an HUF
(through karta) then the individual who is the karta of the HUF.
This will mean that if the individual is only a member of an HUF (and not its karta),
he / she will not be considered to have indirect interest in the company;

(iii) Where the member of the company is a
partnership entity (including an LLP) and the individual is (a) a partner, (b)
holds majority stake in the body corporate which is a partner of the
partnership entity, or (c) holds majority stake in the ultimate holding company
of the above body corporate;

(iv) Where the member of the company is a trust
(through its Trustee) and the individual is (a) a Trustee in the case of a Discretionary
Trust or a Charitable Trust, (b) a beneficiary in the case of a Specific Trust,
or (c) Author or settlor in the case of a Revocable Trust. This will mean that
a settlor of an Irrevocable Trust or a beneficiary of a Discretionary Trust
will not be considered as holding indirect interest in the shares held by a
Trust;

(v) Where the member of the company is (a) A pooled
Investment Vehicle, or (b) An entity controlled by the pooled Investment
Vehicle based in Member State of the Financial Action Task Force on Money
Laundering and the Regulator of the Securities Market in such Member State is a
member of the International Organisation of Securities Commissions, and the
individual in relation to the pooled Investment Vehicle is (A) a general partner,
(B) an Investment Manager, or (C) a Chief Executive  Officer, where the Investment Manager is a
body corporate or a partnership entity. It may be noted that if the pooled
Investment Vehicle is based in a jurisdiction which does not fulfil the above
requirements, the provisions of items (i) to (iv) above will apply.

(vi) Explanation VI clarifies that any financial
instruments in the form of (a) Global Depository Receipts, (b) Compulsorily
Convertible Preference Shares, or (c) Compulsorily Convertible Debentures will
be treated as shares in the company and all the above provisions will apply to
such instruments;

(vii)
It may be noted that for the above purpose the expression “Majority Stake” is
defined in Rule 2(1)(d) to mean (a) holding more than 50% of the equity share
capital in the body corporate, (b) holding more that 50% of the voting rights
in the body corporate, or (c) having the right to receive or participate in
more than 50% of the distributable dividend or any other distribution by the
body corporate;

(viii) It may be noted that the
above provisions do not apply to the shares of the company held by the
following entities:

 

(a) The
Authority constituted u/s. 125(5), i.e., Investor Education and Protection
Fund;

(b) The
Holding Company, provided that the details of such holding company are reported
in Form No. BEN-2;

(c) The
Central Government, State Government or any Local Authority;

(d) The
Company, Body Corporate or the entity controlled by the Central Government,
State Governments or partly by Central and partly by a State Government or
Governments;

(e) SEBI-registered Investment Vehicles, Mutual
Funds, Alternative Investment Funds, Real Estate Investment Trust,
Infrastructure Investment Trusts, regulated by SEBI;

(f)  Investment
Vehicles regulated by RBI, IRDA or Pension Fund Regulatory and Development
Authority.

 

From the above discussions it is
evident that each individual will have to study the provisions of section 90
and the Rules carefully to determine whether he / she along with any other person
is holding directly and indirectly 10% or more of the specified rights or
entitlements in the shares or financial instruments such as CCPS or CCDS of the
company. This is an onerous exercise depending on the facts of each case.

 

4. DECLARATION OF SIGNIFICANT BENEFICIAL OWNERSHIP

4.1
Section 90(1) further provides that the person who has significant ownership in
shares of a company should file with the company the prescribed Form No. BEN-1,
specifying the nature of his / her interest and such other particulars as
provided in the Rules. This Form is to be filed within the prescribed time
limit as under:

 

(i)  In
respect of significant beneficial ownership existing on 08.02.2019, within 90
days from the commencement of the Rules, i.e., by 07.05.2019;

(ii)  If
the significant beneficial ownership is obtained after 08.02.2019, but before
07.05.2019, the Form should be filed within 30 days after 07.05.2019.

(iii) In all other cases within 30 days of acquiring significant
beneficial ownership or changes therein.

 

4.2
Every company has to maintain a Register of Significant Beneficial Ownership in
Form No. BEN-3 as prescribed by the Rules. This Register will be open to
inspection by every member on payment of the prescribed fees.

 

4.3 Upon
receipt of such declaration in Form BEN-1 from the person who has significant
beneficial ownership in shares, the company has to file Form No. BEN-2 with the
ROC with the prescribed fees within 30 days of the receipt of such declaration.

 

4.4
If such declaration is not received by a company, it has to give a notice in
Form No. BEN-4 to the person (whether a member of the company or not) if the
company has knowledge or has reasonable cause to believe that such person:

 

(i)  Is
a significant beneficial owner of the company;

(ii)  Is
having knowledge of the identify of a significant beneficial owner or another
person who is likely to have such knowledge; or

(iii) Has been a significant beneficial owner of the company at any time
during the three years immediately preceding the date on which the notice is
issued.

 

On receipt of this notice from the
company, such person has to give the required information to the company within
30 days of the date of the notice.

 

4.5 If no information is received by
the company from the above person or the information given by such person is
not satisfactory, the company has to apply to the National Company Law Tribunal
(NCLT) within 15 days. By this application the company can apply for directions
from NCLT that the shares in question shall be subject to restrictions,
including:

 

(i)  Restrictions
on transfer of interest attached to such shares;

(ii)  Suspension
of the right to receive dividend or any other distribution in relation to such
shares;

(iii) Suspension of voting rights in relation to such shares;

(iv) Any
other restriction on all or any of the rights attached to such shares.

 

4.6
NCLT has to give notice to all concerned parties and after hearing them pass
appropriate order within 60 days or such extended period as may be prescribed.
On receipt of the order of the NCLT, the company or the aggrieved person may
apply for modification / relaxation of the restrictions within one year from
the date of such order. If no such application is made within one year, the
shares will be transferred to the Authority appointed u/s. 125(5) of the Act
for administration of the Investor Education and Protection Fund.

 

5. PUNISHMENT FOR CONTRAVENTION OF SECTION 90

Section 90(10) to 90(12) provides
for punishment for contravention of provisions of section 90 as under:

 

(i)  If
a person required to file declaration u/s. 90(1) does not file the same he
shall be punishable with imprisonment for a term which may extend to one year
or with fine of Rs. 1 lakh which may extend to Rs. 10 lakhs, or with both. For
continuing default, there will be a further fine up to Rs. 1,000 per day till
the default continues;

(ii)  If a company required to maintain the Register
u/s. 90(2) and to file information with the ROC u/s. 90(4) fails to do so in
time or denies inspection of relevant records, the company and every officer
who is in default shall be punishable with fine which shall not be less than
Rs. 10 lakhs and may extend to Rs. 50 lakhs. In case of continuing default a
further fine up to Rs. 1,000- per day will be levied for the period of the
default;

(iii) If any person wilfully furnishes any false or incorrect information
or suppresses any material information of which he / she is aware in the
declaration filed u/s. 90, he / she shall be liable to action u/s.  447 of the Act (i.e., Punishment for Fraud).

 

6. IMPACT OF THE ABOVE PROVISIONS

Some practical issues arise from the
above provisions relating to declaration of Significant Beneficial Ownership of
shares in a company. As stated earlier, the above declaration is to be made by
the individual who has indirect beneficial interest in the shares of a company
held by any other person. Further, section 90 and the applicable Rules provide
that the company has to maintain certain records and file the declaration with
the ROC. Non-compliance with the provisions of the section and the Rules invite
stringent penalties. In view of the above, some of the practical issues are
discussed below:

(i)  If
Mr. X holds 5% of equity shares in XYZ Pvt. Ltd., but he has no beneficial
interest in such shares. Mr. M is the beneficial owner of these shares. In this
case, section 89 is applicable. Mr. X will have to file declaration in Form No.
MGT-4 within a period of 30 days from the date on which his / her name is
entered in the Register of Members of such company and Mr. M will have to file
declaration in Form No. MGT-5 with the company within 30 days after acquiring
such beneficial interest in the shares of the company. The company will have to
file the declaration with the ROC in Form No. MGT-6 within 30 days of receipt
of the Forms MGT-4 and MGT-5;           

(ii)  PB
Pvt. Ltd. is holding 8% of the equity shares of XYZ Ltd. and Mr. P is holding
4% of the equity shares in XYZ Ltd. Mr. P is also holding 51% of equity shares
of PB Pvt. Ltd. In this case, Mr. P will be deemed to be holding significant
beneficial ownership in shares of XYZ Ltd., as he is indirectly holding
interest in 8% equity shares (through PB Pvt. Ltd) and directly holding 4% of
equity shares. In this case, Mr. P will have to file declaration in Form No.
BEN-1 with XYZ Ltd.;

(iii) AB Pvt. Ltd. is holding 15% of equity shares of XYZ Ltd. Mr. A is
holding 55% of equity shares in AB Pvt. Ltd. In this case, Mr. A will be
considered as holding Significant Beneficial Ownership of more than 10% of
equity shares of XYZ Ltd. This is because Mr. A will be considered to have 15%
indirect ownership of shares of XYZ Ltd. through AB Pvt. Ltd. Therefore, Mr. A
will have to file declaration in Form No. BEN-1;

(iv) ABC
(HUF), through its karta Mr. B, is the owner of 12% equity shares of XYZ
Ltd. In this case, Mr. B will be considered as indirect owner of these shares
and he will have to file declaration in Form No. BEN-1. No other member of the
HUF has to file this declaration;

(v) Mrs.
N is a Trustee of NPS Trust. There are two beneficiaries of the trust who have
equal share. Mrs. N in her capacity of Trustee is holding 20% equity shares in
ABC Ltd. In this case, each beneficiary will be deemed to have significant
beneficial ownership in shares of ABC Ltd. Therefore, each beneficiary will
have to file declaration in Form No. BEN-1. If the trust is a discretionary
Trust, the above declaration is to be filed by the Trustee only. If the trust
is a revocable Trust, such declaration is to be filed only by the Settlor of
the Trust.

(vi) JDS
LLP is holding 25% equity shares of ABC Ltd. Mr. J, Mr. D, Mr. S and JDS Pvt.
Ltd are partners of JDS LLP. In this case Mr. J, Mr. D and Mr. S will be deemed
to be significant beneficial owners of the shares and each of them will have to
file a declaration in Form No.BEN-1. There is one Mr. R who holds 60% of equity
shares of JDS Pvt. Ltd. (one of the partners of JDS LLP).Therefore, Mr. R will
also be considered as a Significant Beneficial Owner of shares of ABC Ltd. and
he will also be required to file declaration in Form No. BEN-1.

(vii) There are the following
members in PR Ltd.:

(a)

CD Pvt. Ltd

2%

(b)

ABC (HUF) (Through Karta)

4%

(c)

PDS LLP

3%

(d)

DC (Trust) (Discretionary Trust)

5%

(e)

XYZ & Co. (Partnership Firm) (through its partner A)

8%

(f)

Others

78%

 

 

——-

 

TOTAL

100%

 

 

====

 

Mr. A holds 55% equity shares in CD
Pvt. Ltd. He is the karta of ABC (HUF). He is also a partner of PDS LLP.
and XYZ Co. and a Trustee of DC Trust. All these entities together own 22% of
equity shares in PR Ltd. Therefore, Mr. A will be treated as having Significant
Beneficial Ownership of more than 10% of equity shares of PR Ltd. and he will
have to file declaration in Form No. BEN-1.

 

7. TO SUM UP

From the analysis of the above provisions of
section 90 and the applicable Rules, it will be noticed that an onerous duty is
cast on individuals who hold indirect, together with or without direct,
interest of 10% or more in the equity shares of a company. Therefore, all
individuals who are having investments in shares of companies directly or
indirectly will have to study these provisions and file declaration in Form No.
BEN-1 within the prescribed time limit. It appears that these provisions are
made to locate persons who hold control in a company through benami
holdings. That is the reason why stringent penalties are provided in sections
89 and 90 for non-compliance by the individuals, the company and its defaulting
officers. Let us hope that these provisions will curb some unethical practices
which are at present adopted by certain individuals and companies for
exercising control over and to influence certain corporate decisions.

TDS UNDER SECTION 194A ON PAYMENT OF ‘INTEREST’ UNDER MOTOR ACCIDENT CLAIM

ISSUE FOR CONSIDERATION

Under the Motor Vehicles
Act, 1988 (MVA), a liability has been cast on the owner of the motor vehicle or
the insurer to pay compensation in the case of death or permanent disablement
due to a motor vehicle accident. This compensation is payable to the legal
heirs in case of death and to the victim in case of permanent disablement. For
the purposes of adjudicating upon claims for compensation in respect of motor
accidents, the Motor Accident Claims Tribunals (MACTs) have been established.
The MVA further provides that in case of death the claim may be preferred by
all or any of the legal representatives of the deceased. The quantum of
compensation is decided by taking into consideration the nature of injury in
case of an injured person and the age, monthly income and dependency in death
cases. The MVA contains the 2nd Schedule for compensation in fatal accidents
and injury cases claims. While awarding general damages in case of death, the
funeral expenses, loss of consortium, loss of estate and medical expenses are
also the factors that are considered.

 

The claims under the MVA may involve delay which may be due
to late filing of the compensation claim, investigation, adjudication of claim
and various other factors. A provision is made u/s. 171 of the MVA to
compensate the injured or his legal heir for the delay, which reads as under:

 

“Section 171. Award of interest where any claim is
allowed.

Where any Claims Tribunal allows a claim for compensation
made under this Act, such Tribunal may direct that in addition to the amount of
compensation, simple interest shall also be paid at such rate and from such
date not earlier than the date of making the claim as it may specify in this
behalf.”

 

CBDT circular No. 8 of 2011 requires deduction of income tax
at source on payment of the award amount and interest on deposit made under
orders of the court in motor accident claims cases. The issue has arisen before
courts as to whether tax is deductible at source u/s. 194A on such interest
awarded by the MACTs u/s. 171 of the MVA for delay.

 

While the Allahabad, Himachal Pradesh and Punjab and Haryana
High Courts have held that such payment is not income by way of interest as
defined in section 2(28A) and no tax is deductible at source u/s. 194A, the
Patna and Madras High Courts have taken a contrary view, holding that such
payment is interest on which tax is deductible at source u/s. 194A.

 

THE ORIENTAL INSURANCE CO. LTD. CASE

The issue first arose before the Allahabad High Court in the
case of CIT vs. Oriental Insurance Co. Ltd. 27 taxmann.com 28.

 

In this case, the
assessee, an insurance company, paid compensation and interest thereon under
the MVA to claimants without complying with the provisions of section 194A. The
assessing authority took a view that the assessee had failed to deduct income
tax on the amount of interest u/s. 194A and held that it was accordingly liable
to deposit the amount of short deduction of tax u/s. 201(1) along with interest
u/s. 201(1A) for a period of five assessment years. According to the assessing
officer, debt incurred included claims and interest on such claims was clearly
covered u/s. 2(28A). His reasoning was as below:

 

1. Interest paid under the MVA was a revenue receipt like
interest received on delayed payment of compensation under the Land Acquisition
Act. Since section 194A applied to interest on compensation under the Land
Acquisition Act, it also applied in respect of interest on compensation under
the MVA.

2. The interest element in a total award was different from
compensation. However, interest on such compensation was on account of delayed
payment of such compensation, and therefore it was clearly an income in the
hands of the recipient, taxable under the Income-tax Act.

3. The interest element
was different from compensation as provided in section 171 of the MVA  as that section provided that the tribunal
might direct that in addition to the amount of compensation, simple interest
should also be paid.

4. There was no exemption u/s. 194A for TDS on interest
payment by insurance companies on MACT awards.

5. The actual payer of interest was the insurance company and
the responsibility to deduct tax lay squarely on it. The provisions of section
204(iii) were very clear that the person responsible for payment meant “in the
case of credit or as the case may be, payment of any other sum chargeable under
the provisions of this Act, the payer himself, or, if the payer is a company,
the company itself including the principal officer thereof.”

6. Payment awarded under the MVA was identical to the award
under the Land Acquisition Act. Tax was deducted u/s. 194A on interest paid or
credited for late payment of compensation under the Land Acquisition Act.
Therefore, section 194A was also applicable in respect of interest paid or
credited on delayed payment of compensation under the MVA.

7. Interest under the MVA was similar to interest paid under
the Income-tax Act, as both arose by operation of law. The nature of payment
mentioned in both the Acts was “interest”. TDS on interest payment under the
Income-tax Act was not deductible in view of the specific exemption u/s. 194A(3)(viii).
Since there was no similar exemption for interest payment under the MVA, the
provisions of section 194A applied to these payments.

 

The Commissioner (Appeals) dismissed the appeal of the
assessee, confirming the action of the assessing authority and holding that the
interest payment awarded u/s. 171 of the MVA was nothing but interest, subject
to the provisions of section 194A.

 

In the second appeal before the tribunal, the Agra Tribunal
decided the issue in favour of the assessee, following its own earlier
decisions in the cases of Divisional Manager, New India Insurance Co.
Ltd., Agra vs. ITO [ITA Nos. 317 to 321/Agra/2003], which, in turn, had
followed the decision of the Delhi Tribunal in the case of Oriental
Insurance Co. Ltd. vs. ITO dated 27.9.2004, and in Oriental
Insurance Company Ltd. vs. ITO [ITA Nos. 276 & 280/Agra/2003 dated
31.1.2005].

 

It was argued before the Allahabad High Court on behalf of
the Revenue that it was the responsibility of the payer of interest to deduct
tax on such payment of interest, because section 2(28A) clearly envisaged that
interest meant interest payable in any manner in respect of moneys borrowed or
debt incurred (including a deposit, claim or other similar right / obligation)
and includes any service fee or other charges in respect of the money borrowed
or debt incurred, or in respect of any credit facility which had not been
utilised. It was argued that the Tribunal had not referred to the decision of
the Supreme Court in the case of Bikram Singh vs. Land Acquisition
Collector 224 ITR 551, in which it had been held that interest paid on
the delayed payment of compensation was a revenue receipt eligible to tax u/s.
4 of the Income-tax Act, 1961.

 

On behalf of the Revenue, reliance was placed upon the following
decisions:

 

a) The Karnataka High Court in the case of CIT vs.
United Insurance Co. Ltd. 325 ITR 231, where the court held that
interest paid above Rs. 50,000 was to be split and spread over the period from
the date interest was directed to be paid till its payment.

b) The Karnataka High Court in the case of Registrar
University of Agricultural Science vs. Fakiragowda 324 ITR 239 where
interest received on belated payment of compensation for acquisition of land
was held to be a revenue receipt chargeable to income tax on which tax was
deductible at source.

c) The Supreme Court, in the case of T.N.K. Govindaraju
Chetty vs. CIT 66 ITR 465, in the context of interest on compensation
awarded for acquisition of land, held that if the source of the obligation
imposed by the statute to pay interest arose because the claimant was kept out
of his money, the interest received was chargeable to tax as income.

d) The Supreme Court, in the case of K.S. Krishna Rao
vs. CIT 181 ITR 408, where interest paid on compensation awarded for
compulsory acquisition of land u/s. 28 of the Land Acquisition Act, 1894 was
held to be in the nature of income and not capital.

 

On behalf of the assessee, it was argued before the Allahabad
High Court that:

 

1. The interest paid on the award of compensation was not
interest as understood in general parlance and it was not an income of the
claimant.

2. The compensation
awarded by the MACT to the claimants was a capital receipt in the hands of the
recipients, not taxable under any provision of the Income-tax Act. Since the
award was not taxable in the hands of the recipient, it was not an income but
was a capital receipt.

3. Interest paid by the insurance company u/s. 171 of the MVA
was not interest as contemplated u/s. 194A, because interest that was contented
under that section was an income taxable in the hands of the recipient, whereas
interest received by the recipient u/s. 171 of the MVA was a capital receipt in
the hands of the recipient, being nothing but an enhanced compensation on account
of delay in the payment of compensation.

 

The Allahabad High Court referred to the definition of
interest u/s. 2(28A), which reads as under:

 

“ ‘interest’ means interest payable in any manner in
respect of any moneys borrowed or debt incurred (including a deposit, claim or
other similar right or obligation) and includes any service fee or other charge
in respect of the moneys borrowed or debt incurred or in respect of any credit
facility which has not been utilised.”

 

After referring to the language of section 194A, the
Allahabad High Court referred to the CBDT circular 24 of 1976 (105 ITR
24), where the concept of interest had been explained. It also referred
to clause (ix) of section 194A(3), which had been inserted by the Finance Act,
2003 with effect from 1st June, 2003, which read as under:

 

“to such income credited or paid by way of interest on the
compensation amount awarded by the Motor Accidents Claims Tribunal where the
amount of such income or, as the case may be, the aggregate of the amount of
such income credited or paid during the financial year does not exceed Rs.
50,000.”

 

The Allahabad High Court referred to the following decisions:

 

1. The Punjab and Haryana High Court in the case of CIT
vs. Chiranji Lal Multani Mal Rai Bahadur (P) Ltd. 179 ITR 157, where it
had been held that interest awarded by the court for loss suffered on account
of deprivation of property amounted to compensation and was not taxable.

2. The National Consumer Disputes Redressal Commission in Ghaziabad
Development Authority vs. Dr. N.K. Gupta 258 ITR 337, where it had been
held that if proper infrastructure facilities had not been provided to a person
who was provided with a flat and was therefore entitled to refund of the amount
paid by him along with interest at 18%, the paying authority was not entitled
to deduct income tax on the amount of interest, as it was not interest as
defined in section 2(28A), but was compensation or damages for delay in
construction or handing over possession of the property, consequential loss to
the complainant by way of escalation in the price of property, and also on
account of distress and disappointment faced by him.

3. The Himachal Pradesh High Court in the case of CIT
vs. H.P. Housing Board 340 ITR 388, where the High Court had held that
payment for delayed construction of house was not payment of interest but was
payment of damages to compensate the claimant for the delay in the construction
of the house and the harassment caused to him.

4. The Supreme Court, in the case of CIT vs. Govind
Choudhury & Sons 203 ITR 881, had held that when there were
disputes with the state government with regard to payments under the contracts,
receipt of certain amount under the arbitration award and the interest for
delay in payment of amounts due to it, such interest was attributable to and
incidental to the business carried on by it. It was also held that interest
awarded could not be separated from the other amounts granted under the awards
and could not be taxed under the head “income from other sources”.

5. The Bombay High Court decision in the case of Islamic
Investment Co. vs. Union of India 265 ITR 254, where it had been held
that there was no provision under the Income-tax Act or under the Code of Civil
Procedure to show that from the amount of interest payable under a decree, tax
was deductible from the decretal amount on the ground that it was an interest
component on which tax was liable to be deducted at source.

 

The Allahabad High Court also referred to the decisions of
the Delhi High Court in the case of CIT vs. Cargill Global Trading (P)
Ltd. 335 ITR 94 and CIT vs. Sahib Chits (Delhi) (P) Ltd. 328 ITR
342, which had analysed the meaning of the term “interest”.

 

The Allahabad High Court observed that most of the rulings
relied upon by the Revenue related to interest paid on delayed payment of
compensation awarded under the Land Acquisition Act. According to the Allahabad
High Court, an award under the Land Acquisition Act and an award under the MVA
could not be equated for the simple reason that in land acquisition cases the
payment was made regarding the price of the land and on such price the
provisions of capital gains tax were attracted. On the other hand, in motor
accident claims, the payment was made to the legal representatives of the
deceased for loss of life of their bread-earner, the recipients of awards being
poor and illiterate persons who did not even come within the ambit of the
Income-tax Act, and the amount of compensation under the MVA also did not come
within the definition of “income”.

 

According to the Allahabad High Court, the term “interest” as
defined in section 2(28A) had to be strictly construed. The necessary
ingredient was that it should be in respect of any money borrowed or debt
incurred. The award under the MVA was neither money borrowed by the insurance
company nor debt incurred by the insurance company. The word “claim” in section
2(28A) should also be regarding a deposit or other similar right or obligation.

 

The Allahabad High Court observed that the intention of the
legislature was that if the assessee had received any interest in respect of
moneys borrowed or debt incurred, including a deposit, claim or other similar
right or obligation, or any service fee or other charge in respect of moneys
borrowed or debt incurred had been received, then certainly it would come
within the definition of interest. The word “claim” used in the definition may
relate to claims under contractual liability, but certainly did not cover
claims under a statutory liability, the claim under the MVA regarding
compensation for death or injury being a statutory liability.

 

Further, the Allahabad High Court referred to the insertion
of clause (ix) to section 194A(3), stating that it showed that prior to 1st
June, 2003 the legislature had no intention to charge any tax on interest
received as compensation under the MVA. According to the High Court, there was
therefore no justification to cast a liability to deduct TDS on interest paid
on compensation under the MVA prior to 1st June, 2003.

 

The Allahabad High Court also noted that u/s. 194A(1), tax
was deductible at source if a person was responsible for paying to a resident
any income by way of interest other than interest on securities. In the opinion
of the Allahabad High Court, the award of compensation under motor accident
claims could not be regarded as income, being compensation to the legal heirs
for the loss of life of their bread-earner. Therefore, interest on such award
also could not be termed as income to the legal heirs of the deceased or the
victim himself.

 

It was noted by the Allahabad High Court that an award under
the MVA was like a decree of the court, which would not come within the
definition of income referred to in section 194A(1) read with section 2(28A) of
the Income-tax Act. According to the court, proceedings regarding claims under
the MVA were in the nature of garnishee proceedings, where the MACT had a right
to attach the judgement debt payable by the insurance company. Even in the
award, there was no direction of any court that before paying the award the
insurance company was required to deduct tax at source. As held by the Supreme
Court in the case of All India Reporter Ltd. vs. Ramachandra D. Datar 41
ITR 446, if no provision had been made in the decree for deduction of
tax before paying the debt, the insurance company could not deduct the tax at
source from the amount payable to the legal heirs of the deceased.

 

The Allahabad High Court
observed that the different High Courts in the cases of Chiranji Lal
Multani Mal Rai Bahadur (P) Ltd. (supra), Dr. N.K. Gupta (supra), H.P. Housing
Board (supra) and Sahib Chits (Delhi) (P) Ltd. (supra),
held that if interest was awarded by the court for loss suffered on account of
deprivation of property or paid for breach of contract by means of damages or
was not paid in respect of any debt incurred or money borrowed, it would not
attract the provisions of section 2(28A) read with section 194A(1). The
Allahabad High Court, therefore, held that interest paid on compensation under motor
accident claims awards was not liable to income tax.

 

A similar view has been taken by the Himachal Pradesh High
Court in the case of Court on Its Own Motion vs. H.P. State Co-operative
Bank Ltd. 228 Taxmann 151, where the High Court quashed the CBDT circular
No. 8 of 2011 which required deduction of income tax on award amount and
interest accrued on deposit made under orders of the court in motor accident
claims cases, and in the case of National Insurance Co. Ltd. vs. Indra
Devi 100 taxmann.com 160, and by the Punjab and Haryana High Court in
the case of New India Assurance Co. Ltd. vs. Sudesh Chawla 80 taxmann.com
331.

 

THE NATIONAL INSURANCE CO. LTD. CASE

The issue again came up before the Patna High Court in the
case of National Insurance Co. Ltd. vs. ACIT 59 taxmann.com 269.

 

In this case, the District Judge gave an award to the
claimant under the MVA of Rs. 3,70,000 plus interest at 6% per annum from the
date of filing of the claim. The amount was to be paid within two months of the
passing of the order, failing which the further direction was to pay interest
at 9% per annum from the date of the order till the date of final payment. The
insurance company deducted and deposited TDS of Rs. 24,715 u/s. 194A while
making the payment of the amount of the award. The claimant objected to the
deduction of TDS by filing a petition before the District Judge. The District
Judge held that the deduction of Rs. 24,175 by way of TDS was not sustainable
and directed the insurance company to disburse the amount to the claimant
without TDS. The insurance company filed a writ petition in the High Court
against this order of the District Judge for seeking permission to deduct tax
at source on payment of the interest on compensation.

 

Before the Patna High Court, on behalf of the insurance
company, reliance was placed upon the relevant provisions of the Income-tax Act
in support of the stand that the insurance company was under a statutory
liability u/s. 194A of the Act to have made deduction of the amount of TDS
while making payment by way of interest on the compensation amount awarded by
the MACT. The total interest component under the award came to a little over
Rs. 1,20,000, and therefore, the insurance company was bound under the Act to
make deduction of TDS while making payment; accordingly, an amount of Rs.
24,175 was to be deducted as TDS.

 

Reliance was also placed upon a decision of the Patna High
Court in C.W.J.C. No. 5352 of 2013, National Insurance Co. Ltd. vs. CIT,
where the court had held as under:

 

“It appears that the Tribunal below has ignored the
statutory duty conferred upon the insurer under section 194 (1) (sic) of the
Income-tax Act. Under the said provision, the insurer is obliged to deduct tax
at source from the amount of interest paid by the insurer to the claimant. The
said amount has to be deposited with the Government of India as the income tax
deducted at source. The Tribunal below has grossly erred in directing the
insurer to pay the said sum to the claimant.”

 

Reliance was further placed upon a decision of the Madras
High Court in the case of New India Assurance Co. Ltd. vs. Mani 270 ITR
394, in which it had been held as follows:

 

“A plain reading of section 194A of the IT Act would
indicate that the insurance company is bound to deduct the income tax amount on
interest, treating it as a revenue, if the amount paid during the financial
year exceeds Rs. 50,000. In this case, admittedly, when the compensation amount
has been deposited during the financial year, including interest, the interest amount
alone exceeded Rs. 50,000 and therefore the insurance company has no other
option except to deduct the income tax at source for the interest amount
exceeding Rs. 50,000, failing which they may have to face the consequences,
such as prosecution, even. In this view alone, when the execution petition was
filed for the realisation of the award amount, deducting the income tax at
source for the interest, since it exceeded Rs. 50,000, on the basis of the
above said provision, the balance alone had been deposited, for which the court
cannot find fault.”

 

It was highlighted that the Madras High Court in the said
case had relied upon the decision of the Supreme Court in the case of Bikram
Singh vs. Land Acquisition Collector 224 ITR 551, where the Supreme
Court had held that interest received on delayed payment of compensation under
the Land Acquisition Act was a revenue receipt eligible to income tax. It was
explained that the Madras High Court in the said case had further held that the
trial court had not considered the actual effect of the amendment to section
194A, which came into effect from 1st June, 2003. The Madras High
Court observed that if the claimant was not liable to pay tax, his remedy was
to approach the department concerned for refund of the amount. According to the
Madras High Court, the executing court did not have the power to direct the
insurance company not to deduct the amount and pay the entire amount, thereby
compelling the insurance company to commit an illegal act, violating the statutory
provisions.

 

The Patna High Court examined the provisions of sections
194A(1) and (3)(ix) of the Income-tax Act. According to the Patna High Court,
it was evident from the above provisions that any person responsible for paying
any income by way of interest (other than the interest on securities) was
obliged to deduct income tax thereon. The only exception was in case of income
paid by way of interest on compensation amount awarded by MACT, where the
amount of such income or the aggregate of the amounts of such income credited
or paid during the financial year did not exceed Rs. 50,000. The court was
therefore of the view that if the interest component of the payment to be made
during the financial year on the basis of award of the MACT exceeded Rs. 50,000,
then the person making the payment was obliged to deduct TDS while making
payment.

 

The Patna High Court further held that while exercising his
jurisdiction with regard to execution of the award, the District Judge had to
be conscious of the fact that any such payment would be subjected to statutory
provisions. Since there was a clear provision under the Income-tax Act with
regard to TDS, the District Judge could not have held to the contrary. The only
remedy for the claimant under such circumstances was to approach the assessing
officer u/s. 197 for a certificate for a lower rate of TDS or non-deduction of
TDS, or alternatively to approach the tax authorities for refund of the amount
in case no tax was due or payable by the claimant.

 

The Patna High Court therefore allowed the writ petition of
the company and set aside the order of the District Judge.

 

OBSERVATIONS

Section194A requires a person responsible for payment of
interest to deduct tax at source in the circumstances specified therein. Clause
(ix), inserted with effect from  1st
June, 2003 in section 194A(3) exempted income credited or paid by way of
interest on the compensation amount awarded by the MACT where the amount of
such income or the aggregate of the amounts of such income credited or paid
during the financial year did not exceed Rs. 50,000. This clause (ix) has been
substituted by clauses (ix) and (ixa) with effect from  1st June, 2015. The new clause
(ix) altogether exempts income credited by way of interest on the compensation
amount awarded by the MACT from the liability to deduct tax at source u/s.
194A, while clause (ixa) continues to provide for exemption to income paid by
way of interest on compensation amount awarded by the MACT where the amount of
such income or the aggregate of the amounts of such income paid during the
financial year does not exceed Rs. 50,000. In effect, therefore, no TDS is
deductible on interest on such compensation which is merely credited but not
paid, or on payment of interest where the amount of interest paid during the
financial year does not exceed Rs. 50,000. The issue of applicability of TDS
therefore is really relevant only to cases where there is payment of such
interest exceeding Rs. 50,000 during the year and that, too, when it was not
preceded by the credit thereof.

 

Section 2(28A) defines the term “interest” in a manner that
includes the interest payable in any manner in respect of any moneys borrowed
or debt incurred. In a motor claim award, there is obviously no borrowing of
monies. Is there any debt incurred? The “incurring” of the debt, if at
all,  may arise only on grant of the
award. Before the award of the claim, there is really no debt that can be said
to have been incurred in favour of the person receiving compensation. In fact,
till such time as a claim is awarded there is no certainty about the
eligibility to the claim, leave alone the quantum of the claim. In our
considered view, no part of the amount awarded as compensation under the MVA
till the date of award could be considered as in the nature of interest. The
amount so awarded till the time it is awarded cannot be construed as interest
even where it includes the payment of “interest” u/s. 171 of the MVA for the
reason that such “interest” cannot be construed as “‘interest” within the meaning
of section 2(28A) of the Act and as a consequence cannot be subjected to TDS
u/s. 194A of the Act.

 

If one looks at the award of “interest” u/s. 171 of the MVA,
typically in most cases, such interest is a part of the amount of compensation
awarded and is not attributable to the late payment of the compensation, but is
for the reasons mentioned in section 171 and at the best relates to the period
ending with the date of award. This “interest” u/s. 171 for the period up to
the date of award, would not fit in within the definition of interest u/s.
2(28A). Interest for the period after the date of award, if related to the
delayed payment of the awarded compensation, would fall within the definition
of interest, being interest payable in respect of debt incurred. It would only
be the interest for the period after the date of award which would be liable to
TDS u/s. 194A of the Income-tax Act provided, of course, that the amount being
paid is exceeding Rs. 50, 000 and was not otherwise credited to the payee’s
account before the payment.

 

Looked at differently, the interest up to the date of award
would also partake of the same character as the compensation awarded, being
damages for a personal loss, and would therefore not be regarded as an income
at all, opening a new possibility of contending that the provisions of section
194A may not apply to a case where the payment otherwise is not taxable in the
hands of the recipient.

 

In cases where the payment of the awarded compensation is
delayed, the ultimate amount of payment to be made may include interest for the
post-award period. In such a case, the ultimate amount will have to be
bifurcated into two parts, one towards compensation including interest for the
pre-award period, and the other being interest which may be subjected to TDS.
This need for bifurcation of interest into pre-award interest and post-award
interest, and the character of each, is supported by the decision of the
Supreme Court in the case of CIT vs. Ghanshyam (HUF) 315 ITR 1,
where the Supreme Court held as under in the context of interest on
compensation under the Land Acquisition Act:

 

“To sum up, interest is different from compensation.
However, interest paid on the excess amount under section 28 of the 1894 Act
depends upon a claim by the person whose land is acquired whereas interest
under section 34 is for delay in making payment. This vital difference needs to
be kept in mind in deciding this matter. Interest under section 28 is part of
the amount of compensation whereas interest under section 34 is only for delay
in making payment after the compensation amount is determined. Interest under
section 28 is a part of enhanced value of the land which is not the case in the
matter of payment of interest under section 34.”

 

One of the side questions is whether such interest included
in MACT compensation awarded under the MVA is chargeable to tax at all? There
is no doubt that the amount of compensation awarded is for the loss of a
personal nature and is therefore a capital receipt of a personal nature, which
is not chargeable to tax at all. The payment, though labelled “interest” u/s.
171 of the MVA, bears the same character of such compensation inasmuch as it
has no relation to the dent or the period and is nothing but a compensation to
an injured person determined on due consideration of the relevant factors,
including for the period during the date of injury to the date of award.

 

The mere fact that such income credited by way of interest on
MACT compensation awards is subjected to the provisions of section 194A and the
payer is required to deduct tax at source does not necessarily mean that such
amounts are otherwise chargeable to tax. It is important to note that section
194A, in any case, refers to a person responsible for paying to a resident “any
income” by way of interest and demands compliance only where the payment is in
the nature of income. As interpreted by the Allahabad High Court and the other
courts, such income would mean income which is chargeable to tax. If the
interest is not chargeable to tax, then the question of deduction of TDS u/s.
194A does not arise.

 

The question of chargeability to tax of such income has also
been recently considered by the Rajasthan High Court in case of Sarda
Pareek vs. ACIT 104 taxmann.com 76, where the High Court took the view
that on a plain reading of section 2(28A), though the original amount of MACT
compensation is not income but capital, the interest on the capital
(compensation) is liable to tax. The Supreme Court has admitted the special
leave petition against this order of the Rajasthan High Court in 104
taxmann.com 77. In the case of New India Assurance Company Ltd.
vs. Mani (supra) the Madras High Court held that the interest awarded
as a part of the compensation was income chargeable to tax; however, in a later
decision in the case of Managing Director, Tamil Nadu State Transport
Corpn. (Salem) Ltd. vs. Chinnadurai, 385 ITR 656, the High Court took a
contrary view and held that such interest awarded did not fall under the term
“income” as defined under the Income-tax Act. An SLP is admitted by the Supreme
Court against this decision, too. Therefore, clearly the issue of chargeability
of even the post-award interest to income tax is still a matter of dispute.

 

As observed by the Allahabad High Court, the one significant
difference between the compensation under the Land Acquisition Act and under
the MVA is that the compensation under the Land Acquisition Act may be
chargeable to tax under the head capital gains, whereas the compensation under the
MVA is not chargeable to tax at all.

 

One has to also keep in mind the provisions of section
145A(b), as applicable from assessment year 2010-11 to assessment year 2016-17,
which provided that notwithstanding anything to the contrary contained in
section 145, interest received by an assessee on compensation or on enhanced
compensation, as the case may be, shall be deemed to be the income of the year
in which it is received. With effect from assessment year 2017-18, an identical
provision is found u/s. 145B(1). However, the provisions of section 145A and
section 145B merely deal with how the income is to be computed and in which
year it is to be taxed, and do not deal with the issue of whether a particular
item of interest is chargeable to income tax or not. Therefore, these
provisions would apply only to interest on compensation which is otherwise
chargeable to income tax, and would not be applicable to interest which is not
so chargeable.

 

One also needs to refer to the provisions of section
56(2)(viii), which provides for chargeability under the head “income from other
sources” of interest received on compensation or on enhanced compensation
referred to in section 145A(b). Again, this provision merely prescribes the
head of income under which such interest would fall, provided such interest
income is chargeable to tax. It does not necessarily mean that the interest in
question is in the nature of income in the first place.

This is further clear from the fact that section 2(24), which
contains the definition of income, specifically includes receipts under various
clauses of section 56(2), such as clauses (v), (vi), (vii), (viia) and (x) –
gifts and deemed gifts, (viib) – excess premium received by a company for
shares, (ix) – forfeited advance for transfer of capital asset, and (xi) –
compensation in connection with termination or modification of terms of
employment for ensuring that such receipts so specified are treated as an
“income” for the purposes of the Act. In contrast, receipt of the nature
specified under clause (viii) of section 56(2) is not included in section 2(24)
indicating that such interest on compensation is not deemed always to be an
income.

 

One Mr. Amit Sahni has recently knocked the doors of the
Delhi High Court by filing a writ petition seeking quashing of the provision
which mandates deduction of tax on the interest on compensation awarded under
the MVA. The court, vide order dated 16th April, 2019, has directed
the CBDT to pass a reasoned order latest by 30th June, 2019 in
response to the representation made by the petitioner in this regard.

 

The better view, therefore, seems to be that of the
Allahabad, Himachal Pradesh and Punjab and Haryana High Courts, that no tax is
deductible in respect of interest awarded u/s. 171 of the Motor Vehicles Act,
even if such interest exceeds Rs. 50,000, unless such interest is (i)
attributable to the delay in payment of the awarded compensation and (ii)
pertains to the period after the date of the award and is (iii) calculated
w.r.t. the amount of the compensation awarded. This view is unaffected by the
fact of the insertion of clause (x) in section 194A(3), w.e.f. 1st
June, 2003 and the substitution thereof w.e.f. 
1st June, 2015.

 

Given this position, and since the issue involves TDS, which
is merely a procedural requirement, one hopes that the CBDT will come out with
a clarification explaining that the provisions of section 194A have a
restricted application to the cases involving payment of interest for the delay
in payment of awarded compensation, so that neither the insurance companies nor
the poor claimants have to unnecessarily suffer through unwarranted tax
deduction or litigation in this regard.

CHANGING RISK LANDSCAPE FOR AUDIT PROFESSION, WITH SPECIAL EMPHASIS ON NFRA AND OTHER RECENT DEVELOPMENTS

Mr. N.P. Sarda, Past President of the ICAI and a
well-known teacher to many in the profession, delivered a remarkable speech at
the BCAS on 9th January, 2019. BCAJ received requests from many
members to publish some of the key points of that talk. We are publishing this
summary just in time before the audit season for unlisted entities commences. A
summary cannot convey the full import of his presentation but we hope this
piece will enable the professionals to get a bird’s-eye view of the changing
landscape of the audit profession. We would recommend that you also watch the
two-hour-long talk on the BCAS You Tube channel.

 

In the last couple of years, the frequency and scale of
frauds revealed to stakeholders and the public at large has been astonishing.
Many would have thought that post-Satyam scandal lessons were learnt and proper
governance practices put in place. However, with irregularities at Punjab
National Bank (PNB), Infrastructure Leasing & Financial Services
(IL&FS), amongst others, coming to the fore, the burning questions about
loopholes in the system, accountability, risk management, etc., are again up
for debate in the corporate world.

 

In the aftermath of the scams, the National Financial
Reporting Authority (NFRA) was formed to tighten the regulatory aspects and
monitor the quality of audit. This led to issues such as overriding powers of
the NFRA over the ICAI, questioning auditors about the professional work, etc.
In this article, we provide various aspects of this development, the issues
therein and their impact. The following broad headings cover the key aspects
dwelt upon by Mr. Sarda.

 

INCREASING RISKS AND CHALLENGES

Economic and regulatory changes are taking place at a rapid
pace. We have witnessed substantive reforms, viz., the Companies Act, 2013, Ind
AS and Auditing standards that are aligned with International frameworks,
Income Computation and Disclosure Standards and Corporate Governance
requirements to enhance transparency and certainty. In the wake of these
developments across various regulations and rising incidents of frauds, the
risks and challenges in auditing are also increasing. This is on account of the
following:

 

  •   Increasing size and spread of business
    entities and groups (locations,  subsidiaries, geographies, SPVs, number of
    transactions, frauds    );
  •    Multiple investments and special purpose
    entities;
  •    Multiplicity of inter-entity transactions and
    transfer of funds;
  • Rise in the volume and amount of transactions
    and of frauds;
  •    Complex nature of business transactions (complex
    instruments and contracts    );
  •    Rapid changes and volatility (what took a
    decade now takes less than a year    );
  •    Need for valuation and making provisions
    (towards pending demands and litigations) based on estimates at year end;
  •    Stress on fair value (subjective concept) as
    against historical cost;
  •    Increasing
    component of intangible assets and challenges in valuing them (wide variation
    in methodologies; valuation may not be valid over a period of time);
  •    Various risk factors such as market risk,
    credit risk, risk due to emerging technologies;
  •    Failure of business entities / industries;
  •    Technology tools in audit becoming a priority
    – checking controls / processes designed through computers, integration of
    different business softwares of an organisation, use of data analytics;
  •    Lack of practice of reconciliation,
    confirmations and certifications of ledger balances (through internal and
    external sources);
  •    Various checks and balances built for proper
    governance and prevention of frauds (such as concurrent audits, inspections by
    regulators, Audit Committee, Risk Management Committee, whistle-blower policy)
    may fail due to neglect or oversight and ineffectiveness of respective roles,
    leaving the statutory auditor to face all the criticism and blame;
  •    Need for investigations and forensic audit
    for a wide range of frauds involving falsification or fabrication of documents
    and records, frauds by collusion, management override of controls, frauds
    perpetrated by management;
  •    Society expects the auditor to unearth all
    frauds, while the auditors believe that such expectations are unrealistic and,
    therefore, the gaps in expectations, promises and actual performance. Though
    the primary responsibility of discovering frauds lies with the governance and
    management teams, the auditors will have to upgrade their standard of
    performance to detect all the material frauds by designing suitable audit
    programmes and procedures;
  •    Every time a scam is reported, instant
    judgements are passed in media as to why auditors did not report them. Without
    proper examination of the factual situation, audit documentation, etc. (were
    any financial statements during the period of fraud certified by the auditor,
    was it bona fide error or gross negligence, was it a planned collusion?)
    there is presumption of audit failure;
  •   Other risks like unrecorded and unusual
    transactions, significant related party transactions, doubts about going
    concern assumption, revenue recognition issues, off balance sheet items;
  •    Temptation and pressure to show improved
    results vis-à-vis last quarter, lack of emphasis on long-term
    sustainability;
  •    Frauds disguised through fraudulent reporting
    and misappropriation of assets.

 

SPECIFIC INSTANCES OF FRAUDS, SCAMS AND FAILURES

There have been several
financial scams causing distress, including with famous and reputed corporates.
The list of ten biggest corporate frauds includes Enron, World Com, sub-prime
mortgage crisis, Satyam Computers, Daewoo, Fannie Mae and Freddie Mac, AIG,
Phor-Mor, Bernie Madoff and Barlow Clowes. The findings reveal that these were
management-driven frauds wherein fraudulent financial reporting was resorted
to, in order to cover misappropriation of assets or a deteriorating financial
position. This requires increased professional scepticism from audit.

Let us look at some instances of fraud and the modus
operandi followed:

1. The Harshad Mehta fraud – bank funds used to finance stock
exchange transactions using portfolio management;

2. Sub-prime mortgage crisis – the model of giving loans
solely on mortgage of immovable properties, without any requirement of
repayment of loan by borrowers, failed as the values of the mortgaged
properties declined;

3. Satyam Computers – this involved manipulation of computer
systems, generation of fake invoices, overstating figures of revenue, profits,
bank balances. To cover up, forged bank statements, deposit receipts and
confirmations were produced by the management;

4. Kingfisher Airlines – the consortium of public sector
banks lent huge amounts of money to the airlines as part of a restructuring
exercise, after the loan account was classified as a non-performing asset.
This was questioned in the backdrop of the situation wherein the company was
reporting huge losses, the absence of adequate collateral securities, etc. The
loan funds were diverted out of India through financial transactions;

5. PNB – Letter of Undertaking to secure overseas credit from
other lenders was issued without cash margin through SWIFT system that was
not linked with Core Banking Solution. Due to this loophole, the
undertakings issued remained outside the books and, thus, remained undetected;

6. IL&FS – short-term borrowings were used for financing
long-term projects resulting in liquidity crisis. Due to long recovery
period from large infrastructure projects, it defaulted in repayment of
short-term loans (asset-liability mismatch).

 

NFRA

To ensure greater reliability of financial statements,
section 132 of the Companies Act, 2013 introduced the provisions relating to
NFRA. These were notified on 13th November, 2018.

 

Applicability

The classes of companies and body corporates governed by NFRA
(Rule 3) include:

(a) Companies whose
securities are listed on stock exchange in / outside India

(b) Unlisted public
companies

– paid up capital not less
than Rs. 500 crores

– annual turnover not less
than Rs. 1,000 crores

– loans, debentures,
deposits not less than Rs. 500 crores

(monetary thresholds – as
on 31st March of the preceding year)

(c) Insurance, banking,
electricity companies, etc.

(d) A subsidiary or
associate company outside India having income or net worth exceeding 20% of the
consolidated income or net worth of the Indian company.

 

Functions

The main functions of NFRA (Companies Act read with NFRA
Rules, 2018) are:

 

a. Make recommendations on Accounting and Auditing Policies
and Standards (after receiving recommendations from the ICAI);

b. Monitor and enforce compliance with Accounting Standards:

– may review financial statements of company / body corporate

– may require them to produce further information /
explanation

– may require presence of officers of company / body
corporate and its auditor

– based on inquiry, any fraud above Rs. 1 crore will be
reported to government;

c. Monitor and enforce compliance with Auditing Standards:

– may review working papers and audit communications

– may evaluate sufficiency of the quality control system and
manner of documentation

– may perform other testing of audit supervisory and quality
control procedures

– may require an auditor to report on its governance
practices and internal processes designed to promote audit quality and reduce
risk

d. Oversee the quality of service of the profession
associated with ensuring compliance with such standards and suggest measures
for improvement in quality of service; may refer cases to Quality Review Board
constituted under the Chartered Accountants’ Act and call for information, and
/ or a report from them;

e. Maintenance of details of auditors of companies specified
in Rule 3;

f. Promote awareness on compliance of accounting and auditing
standards;

g. Co-operate with national and international organisations
of independent audit regulators.

 

Powers

NFRA is entrusted with powers to investigate either suo
motu or on a reference made to it by the Central Government (for prescribed
class of companies) into matters of professional or other misconduct (as
defined in the Chartered Accountants Act). As per the Supreme Court decision in
the case of Gurvinder Singh, other misconduct will include any act that brings
disrepute to the profession, whether or not related to his professional work
and not necessarily done in his capacity as a CA. It is also provided that
where NFRA has initiated the investigation, no other institute or body can
initiate or continue any proceedings in such matters.

 

Where professional or other misconduct is proved, the
consequences are two-fold:

 

a. Penalty: For individuals – Rs. 1 lakh, may extend to 5
times the fees

For firms – Rs. 10 lakhs, may extend to 10 times the fees

b. Debarring the member or the firm from practice for a
minimum period of 6 months, not exceeding 10 years, applicable even to company
/ body corporate not governed by Rule 3.

 

NEED OF NFRA – ARGUMENTS

Several perceptions had led to the constitution of the NFRA.
We have analysed them below with valid arguments:

 

1. Frauds like Satyam and PNB – the disciplinary
mechanism of the ICAI being a creation of its own members, is ‘not independent’

The ICAI functions under the Ministry of Corporate Affairs,
the disciplinary procedure is laid down in the Act itself and government
nominees are present in every proceeding. As against the earlier practice of
involvement of Council members twice (at stages of prima facie and final
decision), after amendment to the Chartered Accountants Act in 2006, the
Director of Discipline (not a member of the Council) reports cases to the Board
of Discipline (Schedule I cases) and the Disciplinary Committee (Schedule II
cases). The government nominees are present in all the 3 bodies.

 

No allegation of bias has ever been raised – that the process
is not carried out judiciously. Rather than creating a separate body, the NFRA,
the government can appoint more nominees in the disciplinary mechanism of the
ICAI.

 

No other institute or body has taken such strict disciplinary
action against its own members as has been done by the ICAI. This is evidenced
by the fact that in the Satyam case various members have been debarred for
life, while in the PNB case the ICAI started suo motu action, without a
formal complaint. As for the member, such disciplinary proceedings are a
punishment in itself and result in loss of reputation. The ICAI has made
tremendous efforts to formulate and spread knowledge of compliance with standards
as part of CPE. QRB, FRRB and Peer Review are some other mechanisms that have
been working effectively.

 

2. Delay in disciplinary proceedings of ICAI

While this was true earlier, through amendments to the
Chartered Accountants Act in 2006, appointment of multiple Directors of
Discipline or Disciplinary Committees was allowed in order to avoid delays.

 

During the process, requests for adjournments and stay (for
proceedings ongoing with other regulatory authorities or Courts) caused delays
as this is a judicial process. Against this, the NFRA rules provide for a
summary procedure within 90 days where an opportunity for personal hearing may
or may not be given. It is important to strike a balance between the two
extremes – that the opportunity granted for hearing may be misused, but a
contrary stand can be harsh on the member.

 

3. With amounts and frequency of corporate and bank
frauds rising, the authorities had to take drastic action

It is assumed that all problems will be solved once NFRA sets
in. However, what kind of action is envisaged under it? Prevention and
detection of fraud is a very large area. NFRA provisions don’t address the
aspect of prevention of fraud; they are restricted to limited areas of action
against statutory auditors for gross misstatement in financial statements on
account of non-compliance of accounting and / or auditing standards. The
consideration is that there was something wrong in the accounting and auditing
standards and that was the reason of misconduct by the members.

 

It is presumed that if action is taken against the member,
frauds will not take place. But there are no steps for the detection of fraud
until certification of the financial statements by the auditor (exception fraud
noticed during search, later reported to government). The functions of NFRA do
not include aspects of deterrent action on perpetrators of fraud and / or other
checks and balances for prevention of fraud. In short, the focus of NFRA is
on the police and not on the thief!

 

4. Non-detection of
fraud by an auditor considered as fraudulent act and a case of professional
misconduct. Strict regulation could reduce such instances

In the backdrop of failure
to report frauds, fingers are pointed at auditors with allegations that the
auditors colluded with management and it is an intentional act involving gross
negligence. However, it is not prudent to draw any conclusion without examining
the facts. It could be a bona fide omission (not part of audit sample
selection), or an error of judgement, or that the time available to auditor was
not commensurate with the volume of business. May be, the skills of the auditor
have not kept up with those of the fraudster! The presumption that
non-detection of fraud is a fraudulent act or is professional negligence / misconduct
and that frauds can be reduced by a strict regulation like NFRA is far-fetched.

 

Importantly, enough stress has to be placed on relevant
internal controls, internal checks and balances required in the management and
governance of large entities. If they are not adequate, the statutory audit, on
its own and on a standalone basis, will not be effective. If negative
presumptions about the role of auditors continue, then new talent may hesitate
to enter the auditing profession.

 

NFRA AND OTHER REGULATORS – A TUSSLE

The question arises whether
it was necessary to have a separate disciplinary mechanism when ICAI already
has one. The ICAI had urged the Central Government against setting up the NFRA
(a legal fight is not possible because the ICAI functions under the Ministry of
Corporate Affairs). This, in fact, is the legal opinion of Mr. Mukul Rohatgi,
former Attorney General, that the NFRA encroaches on the powers of the ICAI.
Under the Constitution, if any institution has specific powers (ICAI in this case
regarding disciplinary mechanism), other institutions cannot have the same
mandate.

 

In a case filed before the
Delhi High Court by the Chartered Accountants’ Association, the Court has
granted stay on initiation of disciplinary action by NFRA. The final verdict is
pending on the matter of SEBI debarring PwC for 2 years (stay by the Supreme
Court).

 

The overlap and conflict between NFRA and other bodies gives
rise to the following issues:

 

1. Where NFRA has not initiated the proceedings, can ICAI do
it (different language in Act and Rules)?

2. Whether NFRA’s jurisdiction would apply to every act of
misconduct of a chartered accountant, or only relating to financial statements?

3. Would NFRA apply to the auditor of every branch of all
banks?

4. If an auditor is debarred by NFRA, the impact will extend
to his every audit appointment including for companies not covered by Rule 3.

5. There is no provision in the NFRA rules for complaints by
any stakeholder against Rule 3 companies. It is restricted to cases referred by
government or suo motu action. Even ICAI would not have jurisdiction to
address such complaints.

 

While the guilty must be punished, it is equally important
that innocents are not harassed.

 

ROLE OF ICAI POST-NFRA

The ICAI will make recommendations on Accounting and Auditing
Standards to NFRA. The role of Quality Review Board to oversee the quality of
audit service rendered would continue. Towards this, an effective role can be
played by having efficient structure and process of inspection. The aspect of
improving and strengthening the expertise and quality of work of internal
auditors, experts in designing and implementing internal controls, computer
controls, etc. also needs be seen.

 

There is no change in
jurisdiction and powers of ICAI over auditors, other than those of Rule 3
entities. The ICAI ought to regulate over matters not governed and administered
by NFRA provisions, as discussed above.

 

ACTION FOR AUDITORS

The change in the regulatory environment and expectations
demands that auditors develop and deliver high-quality service to reinforce the
relevance of audit. The skill sets and manner of executing audit need to
evolve. We have highlighted below the perspective for the auditors about what
they need to do.

a. Focus on upgrading
professional skills (including industry specialisation);

b. Audit firms to devise
and implement quality controls and best practices;

c. Appropriate audit
planning considering industry, client, nature of business, controls in place,
systems and procedures, accounting policies followed;

d. Undertake risk
assessment on the basis of evaluation of internal controls and computer
controls;

e. Design audit procedures
based on findings of risk assessment (e.g. special procedures may be required
for unusual transactions and evaluation of uncertainties and estimates;

f. Apply audit techniques
including computer-aided tools;

g. Develop expertise on
Accounting and Auditing Standards and strictly adhere to them;

h. Have a trained and
talented audit team for execution;

i. Stress on detailed
documentation;

j. Exercise
professional scepticism;

k. Quality control in
Audit Firms;

l. Consultation with other
experts, wherever required;

m. Constructive
discussions and communication with management and with those charged with
governance on internal controls, risk management and provide valuable insights;

n. Giving value-added
insights;

o. Appropriate reporting
of Key Audit Matters.

 

CONCLUDING REMARKS

The success of NFRA would depend upon the constitution of its
members, the experts appointed, their expertise and approach, its finance and
infrastructure, the effectiveness of coordination with ICAI in respect of
Accounting and Auditing Standards and assistance of the Quality Review Board.

 

Risks are becoming the focal point. The
responsibilities of the auditor are increasing. With public sentiment turning
negative and some lowering of confidence in the independent auditor’s work,
there is a fear that professionals may stay away from the audit domain.

UNIFIER IN CHIEF

The twenty
third day of May, 2019, saw a historic event unfold. Prime Minister Narendra
Modi showed his ability to convert hope into confidence, a rare feat in recent
Indian electoral history, and that, too, through sheer performance. This vote
of trust I hope will result in transforming the governance machinery which can
be trusted as much as the trust in a person.

 

Industrialist Anand Mahindra’s tweet hit the nail
on the head: “Size of the country (Land mass + population) X Size of the
Economy X Size of the election mandate = Leader’s Power Quotient. By the
measure of this crude formula, @narendramodi is about to become the most
powerful, democratically-elected leader in the world today…”

 

The power of
the people comes across through this mandate. Many of the 350 million people
earning Rs. 33 / day refused the promise (rather a bribe to vote) of Rs. 72,000 / year
and instead voted for leadership. It is quite clear that people have voted for
trust, integrity and decisiveness that are critical for the future of India.
Past governments, through doles and freebies, had turned people into beggars.
Rarely would you find a country where segments of society wish to get
classified as backward to seek some government entitlement. Obviously, giving
doles was the strategy of ‘deception’ of past rulers – to get votes, cover up
non-performance and continue to divide the society. This vote is a long-overdue
moment where people chose decisive, strong, trustworthy and goal-oriented
leadership. Moreover, this happened in spite of the strongly negative,
concocted and vicious atmosphere created by media and politicians.

 

There is little doubt that allegations of
corruption at high places during the last five years have been reduced to
nothing. Money and tangible government benefits reaching people are provable. A
taxi driver was telling me that he went to his village 500 km. away to vote for
Modi. Another from near Varanasi told me about dramatic changes he saw in his
village. I have been to Varanasi before 2014 and the oldest living holy city
had turned into an unpleasant place. I went there in 2018 and saw the change.
People saw that the tone at the top also translated into actual delivery.

It is
important to note who and what got defeated. Dynasts – all across – people rejected
family-owned party systems and the entitled vote-seekers who didn’t show vision
or performance and only sought power and power alone. The 21-party
power-seeking group who couldn’t give any alternative narrative (couldn’t even
give a PM face) except projecting a monster out of Modi, were rejected. The
second set of losers is Communists – the Tukde Tukde gang, the
breaking-India forces – they got ‘Azadi’ from being in the Lok Sabha! The third
set of losers is in the media – I have never seen such consistent, slimy and
vulgar stooping down. Bias without basis, propping a disproportionate one-sided
view, pelting negativity and uttering utter lies. It was shocking to see the
likes of TIME magazine and NY Times also roped into this.

 

The vote was
a buy-in for the Modi story of New India. His Articulation and Eloquence, Will
and Work, Intention and Execution, balance between Idealism and Realism, and
above all demonstrable love for the nation came across loud and clear. And so
the ‘Chowkidar’ did turn out to be a ‘Chor’ – he stole the hearts of people and
even the votes which opponents may have got if they had remained sincere and
discreet.

 

The vote is a unifying one. People seem to have overcome decades of divisions
and seem to have voted for leadership and cohesion. I hope this will see a
beginning of end of divisions and divisiveness and people seeing themselves as
Indians above all. Perhaps the winners will understand that poverty alleviation
does not need division- based benefits. For this change to come, the citizens
will have to assimilate what the victor meant when he said (and I paraphrase): There
will remain only two jaatis (segments) in the country – The poor who
want to come out of poverty and (the second will be) those who want to bring
the poor out of poverty. This is the dream we should carry.

 

Raman Jokhakar

Editor

CAESAR’S WIFE SHOULD BE ABOVE SUSPICION

BACKGROUND

On 30th April,
2019, SEBI passed orders in the matter of the National Stock Exchange. The
principal issue was the alleged preferential access accorded to some parties to
the stock market order mechanism whereby they could profit and also allegedly
giving them preference over other investors, brokers, etc. Further, there are
two other orders passed by SEBI that deserve consideration. They effectively
exhibit SEBI’s new approach to widen the scope of the liability of persons
associated with the capital market, especially of those connected with listed
companies such as directors, auditors, key executives, etc.

 

These two orders deal with
the alleged abuse of position by some people close to NSE whereby they profited
from certain data preferentially and exclusively obtained from NSE which was
used to develop products that were sold in the market. Worse, the implication
that appears to be brought out is that these products enabled the users to
profit at the cost of other investors.

 

The orders make stringent
adverse comments and issue directions against the two groups of investors. The
first group comprises those who were close to the NSE and which closeness was
used to obtain and use NSE data exclusively. The second group consists of the
exchange itself and its two key officials at the relevant time. SEBI found that
the officials did not carry out the required diligence expected of them. The
adverse directions are fairly stringent and harsh and if they acquire finality,
have the potential to harm careers and reputations, especially of the involved
key persons.

 

However, on appeal to SAT,
the operation of these orders has been stayed as regards some of the key
management persons. Despite the fact that the issues are in appeal because of
the new approach of SEBI, we are reviewing these decisions because a very
interesting approach has been taken in relation to the duties and liabilities
of key management persons. The orders have wider implications and in a manner
are cautionary for several groups who may be in a similar situation; they are,
independent directors, non-executive directors, promoter directors and other
entities associated with the capital markets. These entities often enter into
profitable associations with their companies. Key and even mid-level executives
should examine these transactions. A fairly broad level of performance is
expected from these persons, which are far beyond the literal requirements of
the law. For the purposes of this academic analysis, the statements in the SEBI
orders are taken to be true, though, on facts / law, it is possible that they
may be reversed.

 

THE ALLEGATIONS

SEBI alleged, in the first
order, that there were 5 persons (4 individuals and 1 company) close to the
NSE. This closeness arose primarily because of the closeness of one person over
a long period of time and who, it is stated, was very influential and respected
in NSE. SEBI alleged that he used his position to get certain contracts in
favour of a company associated with his extended relatives. It was alleged that
under this arrangement certain data of NSE was preferentially / exclusively
given to this company. This data was used to develop software products that
could be sold to market operators whereby they could profit and also perhaps
have an edge over other operators in the market. In view of these facts,
allegations of having violated several provisions of Securities Laws, including
those relating to fraud and unfair trade practices, were made.

 

In the second order, based
broadly on the same facts, SEBI has alleged that NSE and its two top officials
failed to exercise due diligence in relation to such contracts, especially
where the parties involved were close to the exchange.

 

THE DEFENCES OFFERED

SEBI relied on certain
emails exchanged between some of the persons covered by the order. According to
SEBI the emails record confidential information which was preferentially given
by NSE. The parties responded that the emails were being taken out of context.

 

The parties also generally
and specifically denied any wrong-doing, particularly relating to profiting
unduly from such information, and also contended that the software products did
not harm the interests of other investors.

 

NSE and its officials also
denied any wrong-doing. They, inter alia, stated that the contracts were
of such size and nature that they do not deserve close attention of the top
officials of the Exchange. They stated that the alleged effects of the
contracts were effectively inconsequential. Further, the contracts did receive
the attention and diligence they deserved.

 

CONCLUSIONS OF SEBI

SEBI rejected these
defences and described how the parties were very close to the Exchange and thus
influenced NSE’s decision-making process. Further, SEBI

 

  • brought out and emphasised the personal
    relations between some of the parties;
  • it particularly highlighted that the manner
    in which the information was provided was exclusive and hence irregular;
  • concluded that proper safeguards were not put
    in place for protecting the data from being shared;
  • SEBI also pointed out that mere disclosure by
    a party that it is interested in a contract is not sufficient and not a
    substitute for diligence by NSE’s key personnel.

 

ORDERS PASSED

Two orders have been
passed. These debar the individuals from, inter alia, holding positions
in prescribed entities. NSE has been issued several directions relating to
strengthening of its internal systems. Further, SEBI has directed legal action
against specified individuals and companies for abuse of the data, etc. As
stated above, on appeal, the operation of SEBI’s orders has been stayed.

 

IMPLICATIONS FOR INDEPENDENT DIRECTORS,
OTHER DIRECTORS AND SENIOR OFFICIALS OF VARIOUS ENTITIES ASSOCIATED WITH
CAPITAL MARKETS, AUDITORS, ETC.

The orders deal with certain
specific facts and also relate to the case of a stock exchange that has certain
duties to the market. However, the principles involved also have relevance to
other entities, for example, independent directors, executive and non-executive
directors, CFOs, key personnel such as company secretaries, lawyers, auditors,
etc.

 

It is very common, for
example, to have contracts and arrangements with directors and / or persons
connected with them. There are requirements under law whereby directors and key
management personnel have to disclose their interest in the contracts and
arrangements with the company. There are also provisions relating to
related-party transactions. However, the orders suggest that complying with
even such broad and comprehensive requirements may not be enough. As a matter
of fact, where such connection exists, arrangements with persons close to the
company ought to require a higher degree of diligence on the part of the
company, its CEO, etc. If it is found later that the contracts bestowed undue
favour or better terms than others or there is non-compliance of law, lack of
action against the party, etc., then the company, its officials and the parties
involved could face scrutiny and possibly action from SEBI.

 

The orders also deal with
confidential and valuable information about the company and the safeguards the
company and the parties who have access to the information would have to take
to ensure that there is no abuse. Conceptually, this is similar to unpublished
price-sensitive information for which there are extensive regulations relating
to insider trading. Abuse of such information may result in loss to the company
and / or loss to investors or may impact the credibility of entities in the
markets.

 

The fact that top
executives (both former Managing Directors) have been debarred from holding
office for a period of three years (though these actions have been stayed by an
appellate order) is another area of concern. The contracts in question were,
relatively speaking, of small amounts in the context of the size of NSE. There
is, I submit, validity in their defence that such contracts are largely handled
at the functional level. However this defence was not accepted.

 

SEBI has expressed that
even if the contracts are small in value, if they are with parties close to the
company, then the contracts / arrangements need a closer watch at a senior
level; because issues, especially those related to confidential data, could
have wider ramifications if abused. Hence, I now perceive that key management
executives will henceforth be expected to look at and monitor closely contracts
with persons close to the company. SEBI has alleged that NSE did not take due
action for violation because the parties who violated the contracts were close
to and influential in NSE.



The other point to
emphasise is that the usual concepts and definition of “persons interested in
contracts” have been given a broader interpretation. Hence, mere disclosure of
interest or even complying with the procedural / approval requirements may not
be enough. Further, even if a person involved is not deemed to have interest as
defined in law or is not a related party as defined in law, the management will
have to demonstrate that due “care and diligence” was carried out at the time
of entering into a contract / arrangement with such person/s.

 

To conclude, the adage Caesar’s wife should be above
suspicion applies today even more than ever.

ORDINANCE FOR CO-OPERATIVE HOUSING SOCIETIES

INTRODUCTION

The Maharashtra Government has introduced the Maharashtra
Ordinance No. IX of 2019 dated 09.03.2019 to amend the Maharashtra Co-operative
Societies Act, 1960 (“the Act”). This Ordinance would remain in
force for a period of six months, i.e., up to 8th September, 2019
after which it would lapse unless the Government comes out with an Amendment
Act or renews the Ordinance. A new Chapter, XIII-B, consisting of section 154B
to 154B-29, has been inserted in the Act specifically dealing with co-operative
housing societies.

 

One of the complaints against the Act was that it was geared
more towards general co-operative societies and did not have special provisions
for co-operative housing societies. That issue is sought to be addressed by
this new Chapter. While the Ordinance has made several amendments to the Act,
it has introduced key changes to the concepts of membership of a co-operative
society. This article examines some of the amendments made by the Ordinance in
relation to membership of a co-operative housing society.

 

NEW CATEGORIES OF MEMBERSHIP

The Ordinance has introduced new categories of membership in
a co-operative housing society. A “Member” has been defined to mean:

 

(a) a person joining in an application for the registration
of a housing society; or

(b) a person duly admitted to membership of a society after
its registration;

(c) an Associate or a Joint or a Provisional Member.

 

Thus, an Associate Member has now also been classified as a
Member. A Joint Member has also been categorised as a Member. Further, a new
category of membership called Provisional Member has been introduced. A house
construction co-operative housing society; tenant ownership housing society;
tenant co-partnership housing society; co-operative society; house mortgage
co-operative societies; premises co-operative societies, etc., are all included
in the definition of a housing society.

 

An “Associate Member” has been defined to mean any of the
specified ten relations of a Member; these are the husband, wife,
father, mother, brother, sister, son, daughter, son-in-law, daughter-in-law,
nephew or niece of a person duly admitted to membership of a housing society.
For this purpose, there must be a written recommendation of a Member for the
Associate Member to exercise his rights and duties. Further, an Associate
Member’s name would not appear in the Share Certificate issued by the society
to the Member. Hence, it is evident from this definition that only one of the ten
relatives can be inducted as an Associate Member. It is worth noting that the
Ordinance has some drafting errors in the definition of Associate Member in the
English text. However, on a reading of the Marathi version the position becomes
clearer.

 

A “Joint Member”, on the other hand, has been defined to mean
a person who either joins in an application for the registration of a housing
society or a person who is duly admitted to membership after its registration.
The Joint Member holds share, right, title and interest in the flat jointly but
whose name does not stand first in the share certificate. Thus, a Joint Member
would not be the first name holder in the share certificate but would be the
second or third name holder. Thus, the difference between an Associate Member
and a Joint Member is as follows:

 

The Act defines an Associate Member as a member who holds
jointly a share in the society but whose name does not appear first in the
share certificate. Thus, this existing definition in the Act (applicable for
co-operative societies) is a combination of the definitions for Associate and
Joint Members introduced by the Ordinance which would now be applicable for
co-operative housing societies. Further, this existing definition treats any
person as an Associate Member, whereas as per the Ordinance only ten specified
relatives can be Associate Members. The existing definition under the Act would
apply to general co-operative societies while the definitions introduced by the
Ordinance would apply only for co-operative housing societies. Thus, there
would be two separate definitions.

 

The society may admit any person as an Associate, Joint or
Provisional Member. However, this has to be read in the context of the
definition of the term Associate Member which states that only the specified
relatives of a Member can be admitted as Associate Members.

 

VOTING RIGHTS OF MEMBERS

A Member of a society shall have one vote in its affairs and
the right to vote shall be exercised personally. It is now expressly provided
that an Associate Member shall have right to vote but can do so only with the
prior written consent of the main Member.

 

In case of Joint Member, the person whose name stands first
in the share certificate has the right to vote. In his absence, the person
whose name stands second, and in the absence of both, the person whose name
stands third shall have the right to vote. However, this is provided that such
Joint Member is present at the General Body Meeting and he is not a minor.

 

Based on the above, the differences between an Associate and
a Joint Member can be enumerated as follows:

Associate Member

Joint Member

Only one of ten
specified relatives can be treated as an Associate Member

Any person can be made a
Joint Member

An Associate Member’s
name cannot be entered in the share certificate issued by the Society

A Joint Member’s name is
entered in the share certificate issued by the Society

An Associate Member can
vote only with the prior written permission of the Member. It does not state
that this can be done only if the main Member is absent. Hence, an Associate
Member can vote even if the main Member is present provided he has got his
prior written consent

A Joint Member can vote
only if the main Member is absent. 
Thus, if the main Member is present, a Joint Member cannot vote even
with the prior written permission of the main Member

 

PROVISIONAL MEMBER

One of the perennial issues
in the case of a housing society has been that of the role that a nomination
plays in the case of the demise of a Member. A nomination continues only up to
and till such time as the Will is executed. No sooner is the Will executed,
than it takes precedence over the nomination. A nomination does not confer any
permanent right upon the nominee nor does it create any legal right in his
favour. Nomination transfers no beneficial interest to the nominee. A nominee
is for all purposes a trustee of the property. He cannot claim precedence over
the legatees mentioned in the Will and take the bequests which the legatees are
entitled to under the Will. In spite of this very clear position in law,
several cases have reached the High Courts and even the Supreme Court. The
following are some of the important judicial precedents on this issue:

 

(1) The Bombay High Court in the case of Om Siddharaj
Co-operative Housing Society Limited vs. The State of Maharashtra & Others,
1998 (4) Bombay Cases, 506, has observed as follows in the context of a
nomination made in respect of a flat in a co-operative housing society:

 

“…If a person is
nominated in accordance with the rules, the society is obliged to transfer the
share and interest of the deceased member to such nominee. It is no part of the
business of the society in that case to find out the relation of the nominee
with the deceased Member or to ascertain and find out the heir or legal
representatives of the deceased Member. It is only if there is no nomination in
favour of any person that the share and interest of the deceased Member has to
be transferred to such person as may appear to the committee or the society to
be the heir or legal representative of the deceased Member.”

 

(2)  Again, in the case of Gopal Vishnu
Ghatnekar vs. Madhukar Vishnu Ghatnekar, 1981 BCR, 1010, the Bombay
High Court has observed as follows in the context of a nomination made in
respect of a flat in a co-operative housing society:

 

“…It is very clear on the
plain reading of the Section that the intention of the Section is to provide
for who has to deal with the society on the death of a Member and not to create
a new rule of succession. The purpose of the nomination is to make certain the
person with whom the society has to deal and not to create interest in the
nominee to the exclusion of those who in law will be entitled to the estate.
The purpose is to avoid confusion in case there are disputes between the heirs
and legal representatives and to obviate the necessity of obtaining legal
representation and to avoid uncertainties as to with whom the society should
deal to get proper discharge. Though in law the society has no power to
determine as to who are the heirs or legal representatives, with a view to
obviate similar difficulty and confusion, the Section confers on the society
the right to determine who is the heir or legal representative of a deceased
Member and provides for transfer of the shares and interest of the deceased
Member’s property to such heir or legal representative.

 

Nevertheless, the persons
entitled to the estate of the deceased do not lose their right to the same…
the provision for transferring a share and interest to a nominee or to the heir
or legal representative as will be decided by the society is only meant to
provide for the interregnum between the death and the full administration of
the estate and not for the purpose of conferring any permanent right on such a
person to a property forming part of the estate of the deceased. The idea of
having this Section is to provide for a proper discharge to the society without
involving the society into unnecessary litigation which may take place as a result
of dispute between the heirs’ uncertainty as to who are the heirs or legal
representatives…

 

It is only as between the society and the nominee or heir or
legal representative that the relationship of the society and its Member are
created and this relationship continues and subsists only till the estate is
administered either by the person entitled to administer the same or by the
Court or the rights of the heirs or persons entitled to the estate are decided
in the court of law. Thereafter, the society will be bound to follow such
decision… To repeat, a society has a right to admit a nominee of a deceased
Member or an heir or legal representative of a deceased Member as chosen by the
society as the Member.”

 

(3) A single judge of the
Bombay High Court in Ramdas Shivram Sattur vs. Rameshchandra Popatlal
Shah 2009(4) Mh LJ 551 has held that a nominee has no right of
disposition of property since he is not an absolute owner. It held that the law
does not provide for a special Rule of Succession altering the Rule of
Succession laid down under the personal law.

 

(4) The position of a
nominee in a flat in a co-operative housing society was also analysed by the
Supreme Court in Indrani Wahi vs. Registrar of Co-operative Societies, CA
No. 4646 of 2006(SC).This decision was rendered in the context of the
West Bengal Co-operative Societies Act, 1983.The Supreme Court held that there
can be no doubt that the holding of a valid nomination does not ipso facto
result in the transfer of title in the flat in favour of the nominee. However,
consequent upon a valid nomination having been made, the nominee would be
entitled to possession of the flat. Further, the issue of title had to be left
open to be adjudicated upon between the contesting parties. It further held that
there can be no doubt that where a Member of a co-operative society nominates a
person, the co-operative society is mandated to transfer all the share or
interest of such Member in the name of the nominee.

 

It is also essential to
note that the rights of others on account of an inheritance or succession are a
subservient right. Only if a Member had not exercised the right of nomination,
then and then alone, the existing share or interest of the Member would devolve
by way of succession or inheritance. It clarified that transfer of share or
interest, based on a nomination in favour of the nominee, was with reference to
the co-operative society concerned and was binding on the said society. The
co-operative society had no option whatsoever, except to transfer the
membership in the name of the nominee but that would have no relevance to the
issue of title between the inheritors or successors to the property of the
deceased. The Court finally concluded that it was open to the other members of
the family of the deceased to pursue their case of succession or inheritance in
consonance with the law.

 

Taking a cue from these
cases, the Ordinance seeks to make certain changes to the Act. It has
introduced the concept of a Provisional Member. This is defined to mean a person
who is duly admitted as a Member of a society temporarily after the death
of a Member on the basis of nomination till the admission of
legal heir or heirs as the Member of the society in place of the deceased
Member. The salient features of Provisional Membership are as follows:

 

a)
It is temporary in nature;

b)  It comes into force only once the main Member
dies;

c)  It can apply on the basis of a valid
nomination;

d)  It would continue only till the legal heirs of
the deceased Member are admitted as members of the society. This could be by
way of a Will or an intestate succession.

 

Thus, the Ordinance seeks to clarify the legal position which
has been expounded by various Court judgements, i.e., the Provisional Member
would only be a stop-gap arrangement between the date of death and the
execution of the estate of the deceased. However, it proceeds on one incorrect
assumption. It states that such membership will last till such time as the
legal heirs of the deceased Member are made members. What happens in case of a
Will where the Member has bequeathed his right in favour of a beneficiary who
is not his legal heir? A legal heir is not defined under any Act. It is a term
of general description. The Law Lexicon by Ramanatha Aiyar (4th
Edition) defines it as including only next of kin or relatives by blood. It is
known that a person can make even a stranger a beneficiary under his Will. In
such an event, a strict reading of the Ordinance suggests that the Provisional
Membership would also continue since the legal heirs of the deceased have not
been taken on record.

 

However, that would be an absurd construction since once the
Will is executed, it is the beneficiary under the Will who should become the
Member. Hence, it is submitted that this definition needs redrafting. The
position has been correctly stated in the proviso to section 154B-13
also introduced by the Ordinance. This correctly states that the society shall
admit a nominee as a Provisional Member after the death of a Member till the
legal heirs or person who is entitled to the flat and shares in accordance with
succession law or under Will or testamentary document are admitted as Member in
place of such deceased Member. Hence, this recognises the fact that a person
other than legal heirs can also be added as a Member.

 

The Ordinance also provides for the contingency of what
happens if there is no nomination. In such cases, the society must admit such
person as Provisional Member as may appear to the Managing Committee to be the heir
/ legal representative of the deceased Member. It further states that a
Provisional Member shall have right to vote.

 

PROCEDURE ON THE DEATH OF A
MEMBER

Normally, in the case of a housing society, any transfer of
share or interest of a Member is not effective unless the dues of the society
have been paid and the transferee applies and acquires membership of the
co-operative housing society. However, this provision does not apply to the
transfer of a Member’s interest to his heir or to his nominee.

 

The Ordinance introduces
section 154B-11 which states that on the death of a Member of a society, the
society is required to transfer the share, right, title and interest in the
property of the deceased Member in the society to any person on the basis of:

 

  • Testamentary documents, i.e., a Will;
  • Succession certificate / legal heirship
    certificate – in case of intestate succession;
  • Document of family arrangement executed by
    the persons who are entitled to inherit the property of the deceased Member; or
  • Nominees.

 

This is the first time that
a document of family arrangement has been given statutory recognition. The
amendment equates a Memorandum of Family Arrangement to be at par with a
testamentary or intestamentary succession document. Scores of Supreme Court
judgements, such as Ram Charan Das vs. Girja Nandini Devi (1955) 2 SCWR
837; Tek Bahadur Bhujil vs. Debi Singh Bhujil, (1966) 2 SCJ 290; K. V.
Narayanan vs. K. V. Ranganadhan, AIR 1976 SC 1715, etc., have held that
a family arrangement does not amount to a transfer and hence there is no need
for registration of a Family Settlement MOU. In spite of this, in several cases
the Registration Authorities are reluctant to mutate the rights in the Property
Card or the Record of Rights based on an unregistered Family Settlement MOU. In
several cases, even co-operative societies do not agree to transfer the share
certificates based on the Family Settlement MOU unless it is registered and
stamped.

 

The Ordinance now provides that the society must transfer the
flat based on a Document of Family Arrangement executed by the persons who are
entitled to inherit the property of the deceased Member. However, this has
restricted the transfer only to those persons who are entitled to inherit the
property of the deceased. For instance, in the case of an intestate Hindu male,
his Class I heirs, Class II heirs, agnates and cognates are entitled to inherit
his property. Thus, a document signed between any of these relatives should be
covered under this provision.

 

CONCLUSION

The Ordinance has made
significant changes for co-operative housing societies especially in the area
of Membership. The concept of Provisional Member is also a welcome amendment.
However, one feels that the Ordinance has been drafted in a hurry resulting in
some drafting errors. It would be desirable that these are rectified when the
Amendment Bill is tabled by the Government.

Sections 2(28A), 10(23G), 36(1)(viia)(c) and 36(1)(viii) – Exemption u/s. 10(23G) – Assessee providing long-term finance for infrastructure projects and facilities – Exemption of interest – Definition of “interest” – Borrowers liable to pay “liquidated damages” at 2.10% in case of default in redemption or payment of interest and other moneys on due dates, for period of default – Liquidated damages fall within purview of word “interest” – Assessee entitled to exemption

21

Infrastructure Development Finance
Co. Ltd. vs. ACIT; 412 ITR 115 (Mad)

Date of order: 1st March,
2019

A.Y.: 2002-03

 

Sections
2(28A), 10(23G), 36(1)(viia)(c) and 36(1)(viii) – Exemption u/s. 10(23G) –
Assessee providing long-term finance for infrastructure projects and facilities
– Exemption of interest – Definition of “interest” – Borrowers liable to pay
“liquidated damages” at 2.10% in case of default in redemption or payment of
interest and other moneys on due dates, for period of default – Liquidated
damages fall within purview of word “interest” – Assessee entitled to exemption

 

Business
expenditure – Provision for bad and doubtful debts – Deduction u/s. 36(1)(viii)
and section 36(1)(viia)(c) to be allowed independently

 

The
assessee provided long-term finance to enterprises which developed, maintained
and operated infrastructure projects and facilities. For the A.Y. 2002-03 the
assessee claimed exemption u/s. 10(23G) of the Income-tax Act, 1961 in respect
of the interest earned by it from the long-term finance provided and the
liquidated damages received from the borrowers on account of default on their
part in making payments according to the terms of the loan agreements. The
assessee also claimed deductions u/s. 36(1)(viia)(c) and independently u/s.
36(1)(viii) in respect of provision made for bad and doubtful debts.

 

The A.O. rejected the claim for exemption u/s.
10(23G) on the ground that the amounts earned by the assessee did not
constitute “interest” as defined u/s. 2(28A). He further held that the claim
for deduction u/s. 36(1)(viia)(c) was allowable only after reducing from the
assessee’s income, the deduction allowable u/s. 36(1)(viii) and that deduction
could not be granted independent of each provision.

 

The Commissioner (Appeals) and the Tribunal
affirmed the order 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
liquidated damages earned by the assessee were admittedly on account of
defaults committed by the borrowers. According to the terms of the agreement
with the borrowers, in case of default in redemption or payment of interest and
all other money (except liquidated damages) on their respective due dates,
liquidated damages at the rate of 2.10% per annum were levied and payable by
the borrowers for the period of default. Though the term “liquidated damages”
was used in the agreement, it actually signified the interest claimed by the
assessee. This term “interest” would come within the word “charge” as provided
under the definition of interest.

 

ii)   It was
an admitted fact that the assessee fell within the definition of a “specified
entity” and it carried on “eligible business” as provided u/s. 36(1)(viii).
Clauses (i) to (ix) of section 36(1) did not imply that those deductions
depended on one another. If an assessee was entitled to the benefit under
clause (i) of section 36(1), he could not be deprived of the benefits of the
other clauses. This is how the provision was arrayed. The computation of amount
of deduction under both these clauses had to be independently made without
reducing the total income by deduction u/s. 36(1)(viii).

 

iii)   Accordingly,
both the questions of law are answered in favour of the appellant assessee.”

Return of income – Delay of 1232 days in filing return – Condonation of delay – Assessee – NRI filed an application for condonation of delay of 1232 days in filing return on ground she was not in a position to file her returns on time due to severe financial crisis in United States of America and injuries sustained by her in an accident, enclosing a medical report in support of claim – Said application was rejected by CBDT on ground that medical certificate did not support case of assessee and that assessee had professional advisor available to her and, thus, required returns ought to have been filed within stipulated period – Though there was some lapse on part of assessee, that by itself would not be a factor to turn out plea for filing of return, when explanation offered was acceptable and genuine hardship was established – Delay to be condoned

26.  Smt. Dr. Sudha Krishnaswamy vs. CCIT; [2018]
92 taxmann.com 306 (Karn):

Date of order: 27th
March, 2018

A. Ys.: 2010-11 to 2012-13

Sections 119 and 139 of I. T.
Act 1961

 

Return of income – Delay of
1232 days in filing return – Condonation of delay – Assessee – NRI filed an
application for condonation of delay of 1232 days in filing return on ground
she was not in a position to file her returns on time due to severe financial
crisis in United States of America and injuries sustained by her in an
accident, enclosing a medical report in support of claim – Said application was
rejected by CBDT on ground that medical certificate did not support case of
assessee and that assessee had professional advisor available to her and, thus,
required returns ought to have been filed within stipulated period – Though there
was some lapse on part of assessee, that by itself would not be a factor to
turn out plea for filing of return, when explanation offered was acceptable and
genuine hardship was established – Delay to be condoned

 

The assessee, a non-resident,
had filed a petition for condonation of delay u/s. 119(2)(b) of the Income-tax
Act, 1961 before Commissioner of Income Tax. She contended that she sold one
vacant site and being non-resident, purchaser of property had deducted income
tax as per provisions of section 195, which had resulted in a refund for A. Y.
2012-13. As regards A. Ys. 2010-11 and 2011-12, it was submitted that she had
no taxable income and claimed that entire refund was relating to TDS from
interest and bank deposits. Accordingly, she requested to condone delay on
ground that she was not in a position to file her returns on time due to severe
financial crisis in United States of America and injuries sustained by her in
an accident, enclosing a medical report in support of the claim and direct
Assessing Officer to accept returns for aforesaid 3 years and process return of
income on merits and issue refund orders. Said application was rejected on
ground that assessee had professional advisor available to her and required returns
ought to have been filed within a stipulated period and, accordingly, rejected
the application relating to the three assessment years in question. The
assessee filed writ petitions challenging the orders of the Commissioner.

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

 

“i)  It is not the case of the assessee that she is avoiding any
scrutiny of the returns. On the other hand, it is the case of the assessee that
she is entitled for refund, being a non-resident owing to the recession at U.S.
and the accidental injuries suffered, no returns were filed within the period
prescribed. In the circumstances, it cannot be held that the
assessee-petitioner has obtained any undue advantage of the delay in filing the
income tax returns.

 

ii)   It is trite law that rendering substantial justice shall be
paramount consideration of the Courts as well as the Authorities rather than
rejecting on hyper-technicalities. It may be true that there was some lapse on
the part of assessee, that itself would not be a factor to turn out the plea
for filing of the return, when the explanation offered was acceptable and
genuine hardship was established. Sufficient cause shown by the petitioner for
condoning the delay is acceptable and the same cannot be rejected out-rightly
on technicalities.

 

iii)  Considering the overall circumstances, the delay of 1232 days in
filing the returns for the relevant assessment years in question is condoned
subject to denial of interest for the delayed period if found to be entitled
for refund.”

Recovery of tax – Provisional attachment – Certain transactions to be void – Powers of TRO – Petitioner purchased a property belonging to a deceased person through his legal representative – Same was declared void as it was under attachment proceedings for recovery of tax dues of said deceased person – Petitioner contended that he was a bona fide purchaser of property for adequate consideration and was not aware of attachment of property for recovery of tax of its owner – TRO could not declare a transaction of transfer as null and void u/s. 281 and if department wanted to have transactions of transfer nullified u/s. 281, it must go to civil court under rule 11(6) of Second Schedule to have transfer declared void u/s. 281

25.  Agasthiya Holdings (P.) Ltd. vs. CIT; [2018]
93 taxmann.com 81 (Mad):

Date of Order: 13th April,
2018

Section 281 r.w.s. 222 and
rule 11 of second schedule of I. T. Act 1961

 

Recovery of tax – Provisional
attachment – Certain transactions to be void – Powers of TRO – Petitioner
purchased a property belonging to a deceased person through his legal
representative – Same was declared void as it was under attachment proceedings
for recovery of tax dues of said deceased person – Petitioner contended that he
was a bona fide purchaser of property for adequate consideration and was
not aware of attachment of property for recovery of tax of its owner – TRO
could not declare a transaction of transfer as null and void u/s. 281 and if
department wanted to have transactions of transfer nullified u/s. 281, it must
go to civil court under rule 11(6) of Second Schedule to have transfer declared
void u/s. 281

 

The appellant/writ petitioner
company, engaged in real estate business, purchased a property through the
legal representatives of one deceased ‘PJ’. Before purchasing property the
petitioner got legal opinion from its Advocate and also by verifying the
encumbrances through encumbrance certificate which showed no encumbrance. After
a search of original assessee’s house after two years, four months and two
days, the Revenue found about the sale of the said property in favour of the
petitioner and registration on the file of the Joint Sub-Registrar, Tuticorin.
The Tax Recovery Officer, Tuticorin held that the legal representatives of the
original assessee had illegally transferred the attached property in favour of
the appellant.

 

On appeal before the
Commissioner (Appeal), the assessee contended that the Tax Recovery Officer had
acted outside his jurisdiction Madurai. The Commissioner (Appeals), noted that
on a perusal of the Assessing Officer’s and the Tax Recovery Officer’s report
and other evidence, the attachment of the said property was made on 18/12/1987
and it was duly intimated to the Sub-Registrar’s Office by the Tax Recovery
Officer on 28/09/2007 and it was served on 03/10/2007 and only after the said
information, the transfer of property had taken place and in the light of the
rule 16(1)(2) of the Second Schedule, the defaulter or his legal representative
not competent to alienate any property except with the permission of the Tax
Recovery Officer and since the Tax Recovery Officer had acted within his
jurisdiction in the light of the said rule, the representation/petition
submitted by them was to be rejected and accordingly, the same was rejected on
the ground of no merits. On appeal, the Tribunal also upheld the order of the
Commissioner (Appeals).

 

The petitioner filed appeal as
well as writ petition challenging the order. The petitioner contended that it
was for the department to move the civil court to declare the transaction in
the form of sale in their favour u/s. 281 as null and void. It further claimed
that assessee was the bona fide purchasers for value and consideration without
any notice of pre-encumbrance and therefore, the property was liable to be
released from attachment.

 

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

 

“i)  The Tax Recovery Officer, Tuticorin, had sent a communication to
the legal representatives of the original assessee by pointing out that they
had illegally transferred the attached property, which was, as per proceedings
dated 18/12/1987, attached on 06/01/1988 in favour of the appellant in writ
appeal in W.A. (MD) No. 1186 of 2017/writ petitioner and they are calling upon
to show cause as to why the illegal transaction made by them should not be
declared as null and void as per rule 16(1) of the Second Schedule.



ii)   The appellant/writ petitioner submitted a representation to the
Commissioner, Madurai, narrating the events that had happened and claimed that
they are innocent and bona fide purchasers for valid and consideration
without any notice of prior encumbrance and therefore, prayed for appropriate
direction to direct the Assessing Officer to drop any further proceedings
pertaining to the said property and raise the attachment and also enclosed the
supporting documents.

 

iii)  The Commissioner, Madurai, has taken into consideration the said
representation and noted that on a perusal of the Assessing Officer’s and the
Tax Recovery Officer’s report and other evidence, the attachment of the said
property was made on 18/12/1987 and it was duly intimated to the
Sub-Registrar’s Office by the Tax Recovery Officer on 28/09/2007 and it was
served on 03/10/2007 and only after the said information, the transfer of
property had taken place and in the light of the rule 16(1)(2) of the Second Schedule,
the defaulter or his legal representative is not competent to alienate any
property except with the permission of the Tax Recovery Officer and since the
Tax Recovery Officer has acted within his jurisdiction in the light of the said
rule, the representation/petition submitted by them is to be rejected and
accordingly, the same is rejected on the ground of no merits.

 

iv)  As already pointed out, the Tax Recovery Officer has noted that the
property has been illegally transferred by way of a registered sale deed dated
18/06/2008 and since it has been sold after service of the demand notice, it
has to be declared as null and void as per the provisions of the Income-tax
Act.

 

v)   The facts projected would also lead to the incidental question as
to whether the sale by the legal representatives of the deceased in favour of
the appellant/writ petitioner was done with a view to defraud the revenue. It
is the categorical case of the appellant/writ petitioner that before purchasing
the property, they got the legal opinion and also obtained encumbrance
certificates and any entries therein have not declared any succeeding
encumbrance including the attachment of the said property by the Income Tax
Department.

 

vi)  Now, coming to the facts of the case, the order of attachment was
made on 18/12/1987 and as per the additional affidavit of the second appellant,
dated 12/12/2011, filed in writ petition, the intimation was sent to the Joint
Sub-Registrar, Tuticorin, on 28/09/2007 and it was acknowledged by him on
03/10/2007 and notice for settling a sale proclamation u/s. 53 of the Second
Schedule of the Income-tax Act was served on the legal heirs of the original
assessee as such the sale of the property to the writ petitioner was to be held
as null and void on 09/08/2011 which was the subject matter of challenge in the
writ petition.

 

vii) In the light of the ratio laid down by the Supreme Court of India in
TRO vs. Gangadhar Vishwanath Ranade [1998] 100 Taxman 236, it is not
open to the Tax Recovery Officer to declare the said sale as null and void. The
above said decision also held that ‘the Tax Recovery Officer is required to
examine whether the possession of the third party is of a claimant in his own
right or in trust for the assessee or on account of the assessee. If he comes
to a conclusion that the transferee is in possession in his or her own right,
he will have to raise the attachment. If the department desires to have the
transaction of transfer declared void u/s. 281, the department being in the
position of a creditor, will have to file a suit for a declaration that the
transaction of transfer is void u/s. 281.’

 

viii)      In the light of the ratio laid down in the
above cited decision, it is not open to the Tax Recovery Officer to declare the
said transfer/alienation as null and void as per the provisions of the
Income-tax Act. It is also brought to the knowledge of this Court by the
appellant/writ petitioner that he also sought information under the Right to
Information Act, from the Public Information Officer – the Joint Sub-Registrar,
Tuticorin, as to the order of attachment by the Income Tax Officer in respect
of the property concerned. The said official informed that no such document is
available on file. Therefore, this Court is of the considered view that it is for
the Income Tax Department, to file a suit to hold the transaction declared as
null and void as per the ratio laid down by the Supreme Court of India
Gangadhar Vishwanath Ranade case (supra).

 

ix)  The writ petition is partly allowed and the order of the Judge in
granting liberty to the writ petitioner to move the Tax Recovery Officer under
rule 11 of the Second Schedule seeking adjudication of his claim is set aside
and the revenue is granted liberty to file a civil suit to declare the sale
transaction/sale deed in favour of the writ petitioner as null and void.”

Offences and prosecution – Principal Officer – Assessee was a Non-Executive Chairman of Board of Directors of company based in Delhi/NCR region – AO passed an order u/s. 2(35) with respect to TDS default of company treating assessee as Principal Officer of company and launched prosecution proceedings against the assessee u/s. 276B – Where there was no material to establish that assessee was in-charge of day-to-day affairs, management, and administration of his company, AO could not have named him as Principal Officer and accordingly he could not have been prosecuted u/s. 276B for TDS default committed by his company

24.  Kalanithi Maran vs.
UOI; [2018] 92 taxmann.com 308 (Mad): Date of Order:
28th March, 2018: F. Ys. 
2013-14 and 2014-15

Sections 2(35) and 276B of I.
T. Act, 1961

 

Offences and prosecution –
Principal Officer – Assessee was a Non-Executive Chairman of Board of Directors
of company based in Delhi/NCR region – AO passed an order u/s. 2(35) with
respect to TDS default of company treating assessee as Principal Officer of
company and launched prosecution proceedings against the assessee u/s. 276B –
Where there was no material to establish that assessee was in-charge of
day-to-day affairs, management, and administration of his company, AO could not
have named him as Principal Officer and accordingly he could not have been
prosecuted u/s. 276B for TDS default committed by his company

 

The assessee was a
Non-Executive Chairman of the Board of Directors of company Spice Jet Limited
based in Delhi /NCR region. The company was engaged in the business of
operation of scheduled low cost air transport services under the brand name
‘Spice Jet’. The assessee was residing and carrying on business at Chennai and
was not receiving any remuneration whatsoever from the company. The assessee
was full time Executive Chairman of Sun TV Network Ltd., which is a public
limited company, from which he drew remuneration as per the provisions of the
Companies Act. There was failure on part of Spice Jet Limited to deposit tax
deducted at source from amounts paid/payable to third parties for F.Ys. 2013-14
to 2014-15. The Assessing Officer passed an order dated 03/11/2014 u/s. 2(35)
of the Income-tax Act, 1961 with respect to TDS default of Spice Jet to the
tune of Rs. 90 crore treating the assessee as the Principal Officer of the
Company within the meaning of section 2(35). By the impugned order, while
naming the assessee as the Principal officer, the Assessing Officer also held
that the assessee was liable for prosecution u/s. 276B for the Tax Deducted at
Source default committed by the company. The assesse filed writ petition
chalanging the said order of the Assessing Officer.

 

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

 

“i)  The assessee was a Non-Executive Chairman of the Board of Directors
of the Company. Admittedly, the corporate office of the company is at Delhi. It
is not in dispute that the assessee is residing at Chennai and the impugned order
dated 03/11/2014 naming the assessee as the Principal Officer was served on the
assessee at Chennai at his residential address. It is also pertinent to note
that the show-cause notice dated 01/9/2014 was served on the assessee at his
residential address at Chennai. When the assessee had taken a stand that he is
not involved in the day-to-day affairs of the company and was also not drawing
any salary from the company, it cannot be stated that the assessee cannot file
the writ petition at the place where he received the show-cause notice as well
as the impugned order.

 

ii)   In the instant case, admittedly the assessee is challenging the
order treating him as the Principal Officer, which was received by him at
Chennai and was brought to his knowledge only at Chennai. Though the authority
is at Delhi, it is clear that part of cause of action had arisen at Chennai. As
per article 226(2) of the Constitution of India, the writ petition is
maintainable before a High Court within which the cause of action wholly or in
part, arises for the exercise of such power, notwithstanding that the seat of
such Government or authority or the residence of such person is not within
those territories. That apart, though the company’s registered corporate office
is at Delhi and the TAN number is at Delhi assessment, the assessee in this
writ petition has not challenged the assessment order, but, has challenged only
the impugned order naming him as the Principal Officer. In these circumstances,
this Court has jurisdiction to entertain the writ petition.

 

iii)  U/s. 2(35)(b), the Assessing Officer can serve notice only to
persons who are connected with the management or administration of the company
to treat them as Principal Officer. Section 278B clearly states that it shall
not render any such person liable to any punishment, if he proves that offence
was committed without his knowledge.

 

iv)  In the instant case, the assessee has stated that he was not
involved in the day-to-day affairs of the company and that he is only a
Non-Executive Chairman and not involved in the management and administration of
the company. Whereas, the Managing Director, himself has specifically stated
that he is the person in-charge of the day-to-day affairs of the company.

 

v)   The Assessing Officer, while passing the impugned order naming the
assessee as the Principal Officer, has not given any reason for rejecting the
contention of the Managing Director. When the Managing Director himself has
stated that he is the person who is in-charge of the day-to-day affairs of the
management and administration of the company and that the petitioner is not so,
the Assessing Officer without any reason has named the assessee as the
Principal Officer. Merely because the assessee is the Non-Executive Chairman,
it cannot be stated that he is in-charge of the day-to-day affairs, management
and administration of the company. The Assessing Officer should have given the
reasons for not accepting the case of the Managing Director as well as the
assessee in their respective reply. The conclusion of the Assessing Officer
that the assessee being a Chairman and major decisions are taken in the company
under his administration is not supported by any material evidence or any
legally sustainable reasons.

 

vi)  It is clear that the assessee was not involved in the management,
administration and the day-to-day affairs of the company, therefore, the
assessee cannot be treated as Principal Officer. In these circumstances, the
impugned order dated 03/11/2014 is liable to be set aside. Accordingly, the
same is set aside. The writ petition is allowed.”

Export oriented undertaking (Manufacture) – Exemption u/s. 10B – Assessee firm was engaged in mining and export of iron ore – It outsourced work of processing of iron ore to another company which operated plant and machinery outside custom bonded area – Assessee’s claim for exemption u/s. 10B was rejected by AO – Tribunal took a view that mere processing of iron ore in a plant and machinery located outside customs bonded area would not disentitle assessee from claiming exemption u/s. 10B where iron ore was excavated from mining area belonging to an export oriented unit – Accordingly, Tribunal allowed assessee’s claim – No substantial question of law arose

23.  Pr. CIT vs.
Lakshminarayana Mining Co.;
[2018] 93 taxmann.com 142 (Karn):

Date of Order: 6th
April, 2018

A. Ys.: 2009-10 to 2011-12

Section 10B of I. T. Act, 1961

 

Export oriented undertaking
(Manufacture) – Exemption u/s. 10B – Assessee firm was engaged in mining and
export of iron ore – It outsourced work of processing of iron ore to another
company which operated plant and machinery outside custom bonded area –
Assessee’s claim for exemption u/s. 10B was rejected by AO – Tribunal took a
view that mere processing of iron ore in a plant and machinery located outside
customs bonded area would not disentitle assessee from claiming exemption u/s.
10B where iron ore was excavated from mining area belonging to an export
oriented unit – Accordingly, Tribunal allowed assessee’s claim – No substantial
question of law arose

 

The assessee was a firm in the
business of mining and export of iron ore. It had entered into an operation and
maintenance agreement with NAPC Ltd., which operated the plants and machineries
installed in the Export Oriented Unit (hereinafter referred to as ‘EOU’) and
non-EOU both belonging to the assessee-firm. The EOU had started production on
23/09/2006 and accordingly deduction u/s. 10B of the Income-tax Act, 1961 on
the profits derived from the production of iron ore from the EOU was claimed.
The Assessing Officer disallowed the claim for deduction u/s. 10B with respect
to production of iron ore said to have been outsourced by the EOU to the
non-EOU and restricted the claim to the profits derived by the EOU from its
production.

 

The Commissioner (Appeals)
confirmed the order of the Assessing Authority holding that the claim for
deduction u/s.10B was not allowable in respect of production of non-EOU. The
Tribunal held that customs bonding was not a condition precedent for granting
exemption u/s. 10B. It was thus concluded that mere processing of the iron ore
in a plant and machinery located outside customs bonded area  would 
not  disentitle  the 
assessee  from  deduction u/s.10B where the iron ore was
excavated from the mining area belonging to an export oriented unit. The
Tribunal allowed the assesee’s claim.

 

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

 

“i)  In the instant appeal, primary contention advanced by the revenue
is to the effect that profits that have been derived by the assessee must be
pursuant to excavation and processing activity of the assessee in a customs
bonded area. It is further contended that as the ‘production’ has not been
carried out in the EOU and, contribution to the finished product by the
assessee being almost absent, deduction u/s. 10B cannot be permitted.

 

ii)   Insofar as factual aspects are concerned, the authorities have
clearly held that there has been outsourcing of processing of iron ore to
evidence which the profit and loss account and the ledger account for the
relevant year have been relied upon. The assertions to the contrary by the
revenue warrants no acceptance.

 

iii)  As regards the contention that the processing by ‘SESA plant’ which
is a plant situated outside the customs bonded area and disentitles the
assessee from claiming deduction u/s. 10B is concerned, the same can be
answered as follows:

 

(a) The processing of the iron ore in a plant belonging to the assessee
being in the nature of job work is not prohibited and forms an integral part of
the activity of the EOU;

 

(b) The mere fact that the ‘SESA Plant’ is situated outside the bonded
area is of no legal significance as the benefit of customs bonding is only for
the limited purpose of granting benefit as regards customs and excise duty. The
entitlement of deduction under the Act is to be looked into independently and
said benefit would stand or fall on the applicability of section 10B.

 

iv)  The judgement in the case of CIT vs. Caritor (India) (P.) Ltd.
[2015] 55 taxmann.com 473/230 Taxman 411/[2014] 369 ITR 463 though arises in
the context of deduction u/s. 10A which is different from deduction u/s. 10B
insofar as section 10A provides for the location of the unit in the ‘Special
Economic Zone’ such locational restriction is absent in case of section 10B,
however, the principle that benefit of customs and excise duty is independent
of the entitlement of deduction under the Act is applicable in the instant case
also. From the discussion above, it is held that no substantial question of law
arises for consideration.”

Educational institution – Exemption u/s. 10(23C)(vi) – Where assessee society was set up with object of imparting education and it had entered into franchise agreements with satellite schools and also used gains arising out of these agreements in form of franchisee fees for furtherance of educational purposes, it fulfilled requirements to qualify for exemption u/s. 10(23C)(vi)

22.  DIT (Exemption) vs. Delhi Public School
Society; 403 ITR 49 (Del); [2018] 92 taxmann.com 132 (Del): Date of Order: 3th
April, 2018

A. Y.: 2008-09

Sections 2(15), 10(23C) and 11
of I. T. Act, 1961

 

Educational institution –
Exemption u/s. 10(23C)(vi) – Where assessee society was set up with object of
imparting education and it had entered into franchise agreements with satellite
schools and also used gains arising out of these agreements in form of franchisee
fees for furtherance of educational purposes, it fulfilled requirements to
qualify for exemption u/s. 10(23C)(vi)

 

The assessee a society
registered with the Registrar of Societies, Delhi had established 11 schools
and had also permitted societies/organisations/trusts with similar objects to
open schools under the name of ‘Delhi Public School’, in and outside India. As
on date, 120 schools were functioning under that name in and outside India. The
main objective of assessee society was to establish progressive schools or
other educational institutions in Delhi or outside Delhi, open to all without
any distinction of race or creed or caste or special status with a view to
impart sound and liberal education to boys and girls during their impressionable
years. The assessee had been enjoying exemption, in respect of its income u/s.
10(22) of the Income-tax Act, 1961 since A. Y. 1977-78 till A. Y. 2007-08. In
view of the change in law, section 10(22) was substituted by section 10(23C)(vi)
with effect from 01/04/1999, the assessee applied in (Form 56D) requesting for
approval of exemption, u/s. 10(23C)(vi) on 16/04/2007 for A. Y. 2008-09
onwards. The Additional Director of Income Tax, by order dated 30/04/2008,
rejected the assessee’s application u/s. 10(23C)(vi) seeking exemption,
on the grounds that, inter alia, the franchisee fee received by it from
the satellite schools in lieu of its name, logo and motto amounts to a
‘business activity’ with a profit motive and no separate books of account were
maintained by assessee for business activity as required u/s. 11(4A). The
assessee filed writ petition challenging the order.

 

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

 

“i)  There is a multitude of authorities that have surveyed and analysed
the exemption permitted u/s. 10(23C)(vi), which broadly conclude that if the
educational institution merely acquires a profit surplus from running its
institution, that alone would not belie its larger education purpose. For
instance, in Queen’s Educational Society vs. CIT [2015] 372 ITR 699/231
Taxman 286/55 taxmann.com 255 (SC), the Supreme Court focused on the
requirements that were germane to qualify for exemption under the erstwhile
section 10(22) and the subsequent section 10(23C)(vi), namely that: the
activities of the educational institution should be incidental to the
attainment of its objectives and separate books of account should be maintained
by it in respect of such business; primarily to highlight that even if an
educational institution indulges in a profit making activity, that does not
necessarily subsume the larger educational/charitable purpose of the
organisation. The determining test to qualify for exemption u/s. 10(23C)(vi),
hence, lies in the final motivation on which the institution functions,
regardless of what extraneous profit it may accrue in the pursuit of the same.

 

ii)   This critical test therefore has a conspicuous qualitative value;
the objectives of the organisation are to be determined not merely by the
memorandum of objectives of the institution, but, also from the design of how
the profits are being directed and utilised and if such application of profits
uphold the ‘charitable purpose’ of the organisation (as postulated in section
2(15)) or if the objectives are marred by a profit making motive that emerges
more as a business activity rather than an educational purpose. Section
10(23C)(vi) while guiding the manner of this determination also,
provides a certain amount of discretion to the authority assessing the
compliance to these conditions for ascertaining whether the requirements of the
provision are met with. Such scrutiny is to be carried out every year,
irrespective of any preceding pattern in the assessment of the previous years.

 

iii)  As can be seen from the present income tax
appeals, the prescribed authority has examined the assessee’s application for
exemption u/s. 10(23C)(vi) in light of the recent audits of the assessee’s
accounts. Although assessee society, in the earlier years had been granted
exemption u/s. 10(23C)(vi), that itself does not cause for a res judicata
principle, as examination of the assessee’s audited accounts may be done afresh
by the prescribed authority, corresponding to the specific assessment year, as
prescribed in the second proviso to section 10(23C)(vi).

 

iv)  Despite this stipulation, the prescribed
authority will still have to apply the determinative test of assessing whether
the business is incidental to the attainment of the objectives of the entity
and whether separate books of account are being maintained in respect of such
business, even if the profits received by the assessee as such increase
exponentially, if the assessee qualifies this test, they will still be eligible
for exemption u/s. 10(23C)(vi).

 

v)   In light of the decisive test for determining eligibility for
exemption u/s. 10(23C)(vi), it is apparent that the assertion of the
DGIT that the assessee’s activities including charging a franchisee fee could
not be regarded as a charitable activity within the meaning of section 2(15),
and thus, inapplicable for exemption u/s. 10(23C)(vi), has not been
adequately substantiated, despite examination of the assessee’s audited
accounts. The DGIT asserted that the assessee is carrying out a business
activity for profit motives by entering into franchise agreements, whereby, it
has opened and is running around 120 schools, and that these charges were
received by the assessee for using the name of Delhi Public School by the
satellite schools in and outside India and no separate books of account were
maintained by the assessee for the business activity as required under section
11(4A). This is prima facie not correct, because the assessee has
maintained, accounts audited in detail for financial years 2000-2001, 2003-04,
2004-05 and 2005-06. That aspect has been found by the Tribunal for those
assessment years. Such accounts have been maintained in compliance to what is
required under the seventh proviso to section 10(23C)(vi) and section
11(4A).

 

vi)  Furthermore, the memorandum of association of assessee society, as
well as the joint venture agreements entered into by assessee society with the
satellite schools validate the motive of an educational purpose that the
assessee aims through its business activities and substantiate its contentions
in that regard. On review of the assessee’s audited accounts, it can be
observed that the surpluses accrued by assessee society are being fed back into
the maintenance and management of the assessee schools themselves. This,
reaffirms the assessee’s argument that the usage of the gains arising out of
its agreements are incidental to its educational purpose outlined by its
objective of the assessee.

 

vii) The authorities also reiterate that a mere incurrence of (surplus)
profit does not automatically presuppose a business activity that invalidates
the exemption under section 10(23C)(vi); the same has to be tested on
whether such profits are being utilised within the meaning of the larger
charitable purpose as defined in section 2(15) or not. On scrutiny, it can be
observed that the accounts
marked the heading ‘Secretary’s Account’, detail the heads of income and
expenditure that cater to the various requirements of running and maintaining
the satellite schools. Thus, arguendo if it were held that the objected
activity were indeed commercial in nature, nevertheless, the realisation of
profit by the assessee is through an activity incidental to the dominant
educational purpose that its memorandum of association sets out, and is in turn
being channelled back into the maintenance and management of the same schools,
thus, fulfilling the objectives the assessee has set out in its memorandum of
objectives.

viii)      In view of the above analysis, it is concluded that the
assessee fulfilled the requirements u/s. 10(23C)(vi) to qualify for
exemption; assessee society is maintaining its eleven schools and the 120
satellite schools in furtherance of the education joint venture agreements with
an educational purpose that also qualifies as a ‘charitable purpose’ within the
meaning of section 2(15) and is not in contravention of section 11(4A).

 

ix)  It is felt by this court that section 10(23C)(vi) ought to
be interpreted meticulously, on a case-to-case basis. This is because, the
larger objective of an educational/charitable purpose of the institution and
its manifestation can only be subjectively adjudged; for instance, in the present
situation, the balance sheets of the assessee demonstrate how the profits are
utilised for the growth and maintenance of the very schools they are accrued
from, thus, subscribing to a charitable motive. However, the educational
institutions may take more creative steps to qualify their objectives as an
‘educational purpose’ that is more universal than the individual objectives set
out in the memoranda of objectives of such institutions. For instance, a
percentage of profits earned from a business activity indulged in by such an
educational institution may be mandated towards fructifying the implementation
the provisions of the Right to Education Act, 2009, particularly, to create a
more sensitive learning environment for children with disabilities in implementation
of the provisions in the Persons with Disabilities (Equal Opportunities,
Protection of Rights and Full Participation) Act, 1995, or have a system to
analyse the ratio of inflow of money over progressive assessment years as
opposed to how much of this money is channelled back into the growth and
maintenance of such educational purpose, in order to put in place a visible
system of accountability. This is an observation, to ensure that the purpose
for which section 10(23C)(vi) was introduced, is adequately fulfilled and not
disadvantageously circumvented by vested parties.

 

x)   For the foregoing reasons, the writ petition has to succeed.
Accordingly, the assessee’s writ petition is allowed.”

Company – Recovery of tax from director – Notice to directors – Condition precedent – Furnishing of particulars to directors of steps taken to recover dues from company and failure thereof – Condition not satisfied – Order u/s. 179(1) set aside

21.  Madhavi Ketkar vs. ACIT; 403 ITR 157 (Bom);
Date of Order:  5th January,
2018

A. Ys.: 2006-07 to 2011-12

Section 179(1) of ITA 1961;
Art. 226 of Constitution of India

 

Company – Recovery of tax from
director – Notice to directors – Condition precedent – Furnishing of
particulars to directors of steps taken to recover dues from company and
failure thereof – Condition not satisfied – Order u/s. 179(1) set aside

 

The   petitioner  
was   a   director  
of   a   company.  
For A. Ys. 2006-07 to 2011-12, the
Assessing Officer of the company passed an order u/s. 179(1) of the Income-tax
Act, 1961 against the petitioner for recovery of the tax dues of the company.
The petitioner filed a writ petition in the High Court and challenged the
order. The petitioner contended that section 179(1) conferred jurisdiction on
the authority to proceed against the directors of a private limited company to
recover the tax dues from the directors only where the tax dues could not be
recovered from the company and that no effort was made by the authorities to
recover the tax dues from the defaulting company.

 

The Bombay High Court allowed
the writ petition, quashed the order passed u/s. 179(1) of the Act, and held as
under:

 

“i)  The notice issued u/s. 179(1) to the directors of a private limited
company must indicate, albeit briefly, the steps taken by the Department to
recover the tax dues from the company and failure thereof. Where the notice
does not indicate this and the directors raise objections of jurisdiction on
the above account, they must be informed of the basis of the Assessing Officer
exercising the jurisdiction and the directors response, if any, should be
considered in the order passed u/s. 179(1).

 

ii)   The Department acquired or got jurisdiction to proceed against the
directors of a private limited company, only after it had failed to recover the
dues from the company. It was a condition precedent for the Assessing Officer
to exercise jurisdiction u/s. 179(1) against the director of the company. The
jurisdictional requirement was not satisfied by a mere statement in the order
that recovery proceedings had been conducted against the defaulting company but
it had failed to recover its dues. Such a statement should be supported by
mentioning briefly the types of efforts made and the results.

 

iii)  The notice u/s. 179(1) did not indicate or give any particulars in
respect of the steps taken by the Department to recover the tax dues of the
defaulting company and failure thereof. In the letter sent in response to the
notice, questioning the jurisdiction of the Department, the petitioner had
sought details of the steps taken by the Department and had pointed out that
the defaulting company had assets of over Rs. 100 crores.

 

iv)  Admittedly, no particulars of steps taken to recover the dues from
the defaulting company were communicated to the petitioner nor indicated in the
order. At no time had the petitioner been given a chance to meet the
Department’s case that it had taken steps to recover the amount from the
defaulting company so as to meet the jurisdictional condition precedent before
passing an order u/s. 179(1).

 

v)   The order was set aside since the condition precedent was not
satisfied. However, the attachment order would be continued till the passing of
a final order by the Assessing Officer u/s. 179(1)”

                  

Co-operative society – Special deduction u/s. 80P – No deduction where banking business is carried on – No evidence of banking business – Mere inclusion of name originally and object in bye-laws of society not conclusive – Assessee entitled to special deduction u/s. 80P

20.  ELURU Co-operative House Mortgage Society
Ltd. vs. ITO; 403 ITR 172 (T&AP)

Date of Order: 13th
September, 2017

A. Ys.: 2007-08, 2008-09 and
2009-10

Section 80P of ITA 1961

 

Co-operative society – Special
deduction u/s. 80P – No deduction where banking business is carried on – No
evidence of banking business – Mere inclusion of name originally and object in
bye-laws of society not conclusive – Assessee entitled to special deduction u/s.
80P

 

The assessee was a
co-operative society, established in the year 1963. Originally, the assessee
was registered as the Eluru Co-operative House Mortgage Bank Ltd. But the
Reserve Bank of India as well as the Co-operative Department of the State
refused to accord permission to the assessee to carry on the business of
banking under that name. Therefore the word “Bank” was deleted from the name of
the assessee w.e.f. 19/02/2009. The assessee claimed that it was not a bank
within the meaning of section 80P(4) of the Income-tax Act, 1961.

 

For the A.Ys. 2007-08, 2008-09
and 2009-10, the assessee filed returns of income declaring “nil” income
claiming deduction u/s. 80P(2), on the ground that it was running on the
principle of mutuality, dealing only with its own members. The Assessing
Officer rejected the claim for deduction.

 

The Tribunal upheld the
disallowance.

 

On appeal by the assessee, the
Telangana and Andhra Pradesh High Court reversed the decision of the Tribunal
and held as under:

 

“i)  The entitlement of an assessee to the benefit of deduction u/s.
80P(2) does not depend upon either the name of the assessee or the objects for
which the assessee was established. The entitlement to deduction under the
provision would depend upon the actual carrying on of the business activity,
viz., banking. The fact that all co-operative banks would necessarily be
co-operative societies cannot lead to the presumption that all co-operative
societies are also co-operative banks. There are different types of co-operative
societies, many of whom may not be transacting any banking business.

 

ii)   Without reference to a single transaction that the assessee had
with any non-member, the Tribunal upheld the findings of the Assessing Officer
merely on the basis of the name of the assessee and one of the objects clauses
in the bye-laws of the assessee. Therefore, the finding of the Tribunal was
obviously perverse and such a finding could not have been recorded on the basis
of the material available on record.

 

iii)  The assessee was entitled to the special deduction u/s. 80P for the
A. Ys. 2007-08, 2008-09 and 2009-10.”

 

Business – Adventure in nature of trade – Assessee holding immovable property from 1965 – Agreement for developing property in 1994, supplementary agreement in 1997 and memorandum of understanding in 2002 – Transaction not an adventure in nature of trade – Gains from sale of flats not assessable as business income

19.  Pr. CIT vs. Rungta Properties Pvt. Ltd.; 403
ITR 234 (Cal); Date of Order: 8th May, 2017

A. Ys.: 2003-04, 2004-05 and
2006-07

Section 28 of ITA 1961

 

Business – Adventure in nature
of trade – Assessee holding immovable property from 1965 – Agreement for
developing property in 1994, supplementary agreement in 1997 and memorandum of
understanding in 2002 – Transaction not an adventure in nature of trade – Gains
from sale of flats not assessable as business income

 

The
assessee was holding immovable property since the year 1965. It entered into a
development agreement dated 28/01/1994 in relation to the property with another
company TRAL. The development agreement was followed by a supplementary
agreement dated 19/02/1997 and a memorandum of understanding dated 18/09/2002.
The arrangement between the assessee and TRAL was that a new structure was to
come up in place of the existing one at the cost of the developer and the
assessee was to get 49.29% of the developed property along with an undivided
share of the land in the same proportion, the rest going to the developer. The
Assessing Officer held that the transaction was an adventure in the nature of
trade and the income arising thereon is business income as against the claim of
the assessee that it is a capital gain.

 

The Commissioner (Appeals) and
the Tribunal reversed the decision of the Assessing Officer and allowed the
claim of the assessee.

 

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

 

“i)  The assessee’s arrangement with the developer was not a joint
venture agreement and there was no profit or loss sharing arrangement. In the
absence of any evidence that the assessee undertook the business of property
development, the object clause in the memorandum could not be treated to be the
determining factor to conclude that this was a part of the assessee’s regular
business.

 

ii)   On the same reasoning, reference to property in the corporate name
of the assessee could not make the assessee a property development company.

 

iii)  The Tribunal as well as the Commissioner (Appeals) had concurrently
found that the transactions of sale of flats did not constitute an adventure in
the nature of trade. The finding was justified.”

TDS On Provision For Expenses Made At Year-End

Issue for Consideration

Many
of the provisions casting obligation to deduct tax at source (‘TDS’) under
Chapter XVII-B require tax  deduction at
the time of credit of the specified income or sum to the account of the payee
or at the time of payment, whichever is earlier.

 

Each
of the relevant provisions of TDS, by way of a deeming fiction, under an
Explanation, provide  that when the
income or sum is credited to any account by any name in the books of account of
the person liable to pay it, such crediting shall be deemed to be credit of
such income or sum to the account of the payee and the provisions of the
relevant section shall apply accordingly[1].

 

 

A
question often arises as to whether tax is required to be deducted at the time
of making provision, in the books of account, 
for several expenses at the end of the accounting year under the
mercantile system of accounting.  While
a  view has been taken in some cases that
tax is not required to be deducted at source where the payee is not
identifiable,  there has arisen one more  controversy even in respect of ad-hoc or
interim provisions made, in respect of liability payable to identified payees
in future. The issue that has arisen is, whether crediting the amount to the
provision account, in such cases,  be
deemed to be credit to the account of the concerned payee attracting the
liability to TDS. The incidental issue also arises as to whether the reversal
of such provision in the subsequent period has any bearing in determining
applicability of TDS. Conflicting decisions have been rendered by the Bangalore
bench of Tribunal on this subject.


[1] 
Refer to Explanations to Section 193, 
Section 194A, Section 194C, 
Section 194H,  Section 194-I,  Section 194J.


IBM
INDIA (P) LTD.’S CASE

The
issue first came up before the Bangalore bench of the Tribunal in the case of IBM
India (P) Ltd vs. ITO 154 ITD 497.

 

In this case, pertaining to assessment years 2005-06 to
2009-10, the assessee,  a wholly owned
subsidiary of a U.S. based company, was following the mercantile system of
accounting. As a part of the global group accounting policy, the assessee had
to quantify its expenses every quarter, within 3 days of the end of each
quarter. The assessee made a provision in the books of account for expenses, on
such quantification,  in respect of which
service/work had been provided/performed by the vendors in the relevant quarter  but for which the invoices had not been
furnished or in respect of which the payments had not fallen due, recognising
the liability incurred. On the basis of scientific methodology, the assessee
estimated such expenses and created a provision for such expenses every quarter
within 3 days of the end of the quarter. At the time of creation of provision,
in this manner, it was not possible for the assessee to identify parties, or if
parties were identified, to arrive at the exact sum on which TDS was to be
deducted.

 

The
expenses were debited to the profit and loss account and the provisions were
credited to a provision account, and not to the vendor accounts, as those had
not fallen due for payment. In the subsequent financial year, the provision
entries were reversed and on receipt of invoices in respect of the respective
expenses, the same were recorded as liabilities due to the respective parties,
at which point of time taxes were deducted 
at source. The provision so made was disallowed by the assessee itself
in terms of section 40(a)(i) and 40(a)(ia) while filing its return of income.

 

According
to the Assessing Officer, in respect of the provision so created by the
assessee in the books of account, tax was deductible at source and the assessee
by not deducting the tax has been in default and was liable to deposit the tax
and also for interest and penalty. In response to the show cause notice issued
u/s. 201(1) & 201(1A), the assessee submitted that invoices were not
received in respect of the underlying expenses, and therefore there was neither
accrual of expenditure nor was the payee identified, as the amount was not
credited to the account of the payee, but to a suspense account. There was no
accrual of expenditure in accordance with the mercantile system of accounting,
and therefore there was no obligation on its part to deduct tax at source. The
assessee took a stand that, though  the
relevant provisions of law in Chapter XVII-B, did provide for the situation
where  an amount was credited to a
“Suspense Account”, there should be a legal liability to pay, and the
payee should be known, and only then the obligation to deduct tax at source
arose. The Assessee also submitted that the provision entries were reversed in
the subsequent financial year(s) and necessary taxes were withheld at source at
the time of actual payment (when legal liability to pay arose and the identity
of the party was known).

 

The
Assessing Officer rejected the assessee’s arguments on the grounds that:

 

1.  The
assessee did not explain as to how the expenses had been quantified;

 

2.  When
no invoices were received, the booking of such expenses in the accounts and
claiming them as expenditure of the previous year was erroneous; and

 

3.  The
procedure followed by the assessee, of reversing the entries and recording the liability
in its books of account when invoices were received, was contrary to the
accounting policy, because once expenditure was booked in the profit and loss
account, it could not be reversed;

 

4.  There
was no clarification as to whether tax 
was deducted on the whole of the provisional entries, so as to allow the
amount that was disallowed  u/s.
40(a)(ia), in the year in which tax  was
deducted and paid ;

 

5.  The
procedure followed by the assessee might 
have led to the allowing of the expenditure one year prior to the
incurring of the actual expenses;

 

6.  The
details of the TDS made on such provisions made at the end of the year was also
provided by the assessee on sample basis, contending that the number of entries
were huge and hence could not be provided in full within a limited period;
giving rise to non-verification of deductions claimed.

 

The Assessing Officer treated the assessee
as an assessee in default for  the taxes
not deducted at source, in respect of provision for expenses made in the books
of account, and also levied consequential interest.

 

The orders passed u/s. 201(1) and 201(1A)
were upheld by the CIT (A) for the following reasons:

 

1.  Under
mercantile system of accounting, accrual of liability for any expenditure was
not dependent on receipt of invoice from the person to whom payment for
expenditure had to be made. The accounting practice followed by the assessee
was contrary to the mercantile system of accounting.

 

2.  The
claim of the assessee that it created provision in the books of account on an
estimated basis in some cases, on a historical basis in one set of cases  and by using some sort of arithmetical or
geometric progression in other cases, was not acceptable. The assessee had not
established its plea with concrete evidence. The assessee had full knowledge of
what was due to its vendors, sub-contractors, commission agents etc. Therefore,
there was no necessity to create provisions.

 

3.  The
argument regarding chargeability to tax in the hands of the payee or the time
at which the payee recognised income in respect of the payment received from
the assessee was irrelevant.

 

Before the Tribunal, the assessee
contended that:

 

1.  When
payee was not identified there could  be
no charge u/s. 4(1) and therefore there could 
be no obligation to deduct tax at source;

 

2.  The
returns of TDS to be filed under the Income Tax Rules, 1962 contemplated
furnishing of names of payees.



3.  Judicial
decisions recognise that there could be no TDS obligation in the absence of
payee.

 

4.  If there was no income chargeable to tax in
the hands of the payee, there could  be
no TDS obligation. TDS obligations arose only when there was
“Income”. TDS obligations did not arise on the basis of mere payment,
without there being income and corresponding liability of the person receiving
payment from the assessee to pay tax.

 

5.  The
Assessee relied on CBDT Circular No. 3/2010 dated 2.3.2010, issued in the
context of the provisions of section 194A of the Act dealing with TDS
obligation of banks at the time of provision of monthly interest liability
under the Core Banking Solution software, where the CBDT had clarified that TDS
was not applicable at the time of such monthly provisioning.

 

6.  Reliance
was also placed by the assessee on the Delhi High Court decision in the case of
UCO Bank vs. Union of India [2014] 369 ITR 335, where the Delhi High
Court had held that no tax was deductible on deposits kept by the Registrar
General of the High Court, since the ultimate payee was not known.

 

The Revenue argued that:

 

1.  The
assessee on its own had disallowed the expenditure in question u/s. 40(a)(i)
& 40(a)(ia). Such disallowance arose only when there existed a liability to
deduct tax at source in terms of Chapter-XVII-B of the Act. The assessee having
on its own disallowed expenditure u/s. 40(a)(i) & 40(a)(ia), could not
later on  turn around and say that there
was no obligation to deduct tax at source.

 

2.  The
assessee did not account for expenditure on accrual basis but on receipt of
invoice  which could not  be the point of time at which accrual of
expenditure could  be said to have
happened. The system of accounting followed by the assessee was not in tune
with the mercantile system of accounting.

 

3.  When
the assessee credited suspense account for payments due to various persons,
such credit itself was treated as credit to the account of the payee by a
deeming fiction in the various provisions of Income tax Act. The assessee could
not therefore say that the payee was not identified. Even in such a situation,
the assessee had to comply with the TDS provisions.

 

4.  The
method of accounting followed by the Assessee resulted in postponement of time
at which tax had to be remitted to the credit of the Government. It  could be seen from the fact that the
assessee, in some cases, was liable to charge of interest u/s. 201(1A) for
about 84 months. The question whether the Assessee was indulging in a
deliberate exercise in this regard was irrelevant. The fact that the revenue
was put to loss by reason of the system of accounting followed by the assessee
and the fact that otherwise the money should have reached the coffers of the
revenue much earlier, was sufficient to uphold the levy of interest u/s.
201(1A) of the Act.

 

5.  When
the Assessee argued that the payees were not identified, it was not open to the
assessee to also contend that there was no accrual of income in the hands of
the payee or that the payment was not chargeable to tax in the hands of the
payee in India.

 

6.  The
CBDT circular No. 3/2010 was in the context of banks crediting interest on
fixed deposits of customers. The decisions rendered by the judicial forums
based on those circulars were  not
relevant, as they were relevant only in the case of Banks and could not be
pressed into service in other cases, such as the case of the Assessee.

 

The Tribunal deleted the demand for
payment of taxes raised u/s. 201(1) as the tax that was deducted  subsequently when the actual liability was
booked, was paid. However, it upheld the applicability of the provisions of TDS
at the time of making provision and the obligation to deduct tax thereon and
accordingly,  levy of interest u/s.
201(1A) on account of delay  on the part
of the assessee in complying with the TDS provisions. On the facts of the case,
the Tribunal noted that the assessee was fully aware of the payee, but
postponed credit to its account for want of receipt of invoice. Proceeding on
the basis that payees were known to the assessee, regarding applicability of
TDS on provision, the Tribunal held as under:

 

1.  Once
the assessee had offered disallowance in respect of provision u/s. 40(a)(i) and
40(a)(ia), it was not possible to argue that there was no liability to deduct
tax at source on the same provision. The disability u/s. 40(a)(i) &
40(a)(ia), and the liability u/s. 201(1) could not be different and they arose
out of the same default;

 

2.  The
liability to deduct tax at source existed when the amount in question was
credited to a “Suspense Account” or any other account by whatever
name called, which would also include a “Provision” created in the
books of account;

 

3.  Since
the assessee had not established with concrete evidence that provision was made
on an estimated basis, it had full knowledge of amounts payable to vendors,
sub-contractors, commission agents, etc., and there was no necessity to
create a provision;

 

4.  The
statutory provisions clearly envisaged collection at source de hors the
charge u/s. 4(1).

 

5.  The
argument that TDS provisions operated on income and not on payment, in the
facts and circumstances of the  case, was
erroneous. Section 194C & 194J used the expression “sum” and not
“income”. Further, section 194H & 194-I did not use the expression
“chargeable to tax”.

 

6.  The
Tribunal further held the decision of the Bangalore bench in the case of DCIT
vs. Telco Construction Equipment Co. Ltd. ITA No. 478/Bang/2012 to be sub
silentio, and, therefore, not binding. The Delhi High Court decision in the
case of UCO Bank (supra)  was also
distinguished on the ground that the assessee was fully aware of the payee in
the case before the Tribunal.

 

The Tribunal therefore confirmed the levy
of interest u/s. 201(1A).

 

BOSCH
LTD.’S CASE

The issue again came up before the
Bangalore bench of the Tribunal in the case of Bosch Ltd vs. ITO
TS-116-ITAT-2016.

 

This was a case relating to assessment
year 2012-13. The facts of this case were almost identical to the facts of
IBM’s case. The assessee was a company engaged in the business of manufacture
and sale of injection equipments, auto electric items, portable electric power tools, etc.

 

In respect of expenses amounting to  Rs.1,96,84,115, a provision was created by
the company in its books and the same was disallowed under the provisions of section
40(a)(i)(ia) in computation of total income filed for the assessment year
2012-13. Out of Rs.1,96,84,115, no invoices were received for an amount of
Rs.1,79,36,713 and the said  amount was
reversed in the beginning of the next accounting year. The assessee contended
that no tax was required to be deducted in respect of such amount for which no
invoices were received.

 

The contention of the assessee was not
accepted by the Assessing Officer by holding that the system of accounting
followed by the assessee was faulty and did not enable any verification. He
held that since the assessee company was following mercantile system of
accounting, tax should have been deducted on the provisions made. Accordingly,
the Assessing  Officer held that the
assessee to be an ‘assessee in default’ u/s. 201(1) of the IT Act and demanded
tax  and interest thereon.

 

The CIT (A) confirmed the action of the
Assessing Officer by holding that suo-moto disallowance under the
provisions of section 40(a)(ia) did not absolve the assessee from its
responsibility of deducting tax at source. However, the CIT (A) directed the
Assessing  Officer to exclude those
amounts in respect of which TDS had been made on the dates on which invoices
had been raised. 

 

Before the Tribunal, the assessee
submitted that, as regards the expenses for which the service provider or
vendor had not raised any invoices nor were they acknowledged by the assessee
company, it made a provision for such expenses on a scientific basis and such
provision was debited to its P&L account, in conformity with the provisions
of Accounting Standard 29- Provisions, Contingent Liabilities and Contingent
Assets (AS 29) issued by the Institute of Chartered Accountants of India
(ICAI). Such provision, which was mandatory as per AS 29, was reversed in the
beginning of the next accounting year.

 

It was argued that:

 

a.  No
income had accrued to the payees and a mere provision was made in the books of
account at the year end. The very fact that the provision was reversed in the
beginning of the next accounting year showed that no income had accrued to the
payee and therefore, there was no liability to deduct TDS on the basis of mere
provision.



b.  The
payees as well as the exact amount payable to them were not identifiable and
therefore, there was no liability to deduct tax at source.

 

c.  The
existence/accrual of income in the hands of payee was a pre-condition to fasten
the liability of TDS in the hands of the payer;

 

d.  The
provisions of section 195 stipulated that the payer had to deduct tax at source
at an earlier point of time, either at the time of crediting to the payee’s
account or at the time of payment of income to the payee. The phrase “whichever
is earlier” would mean that both the events i.e crediting the amount to the
account of payee and payment to the assessee must necessarily occur. Therefore,
when there was no payment made the question of deducting TDS at the time of
crediting did not arise.

 

Reliance was also placed on the CBDT’s
Instruction No.1215 (F.No.385/61/78 IT(B) dated 08-11-1978.

 

On behalf of the revenue, it was argued
that on a plain reading of section 195, the liability to deduct tax at source
had arisen the moment the amount was credited in the books of account,
irrespective of fact whether the amount was paid or not. It was  further submitted that the provision of
taxing statutes should be construed strictly so that there was no place for any
inference.

 

The Tribunal took a view that the liability
to deduct tax at source arose only when there was accrual of income in the
hands of the payee. It relied upon the decision of Supreme Court in the case of
GE India Technology Centre P. Ltd. vs. CIT 327 ITR 456. According to the
Tribunal, the fact that the provisions made at the year-end were reversed in
the beginning of the next accounting year showed that there was no income
accrued. The Tribunal observed that mere entries in the books of account did
not establish the accrual of income in the hands of the payee, as held by the
Hon’ble Supreme Court in the case of CIT vs. Shoorji Vallabhdas & Co. 46
ITR 144.

 

The Tribunal
accordingly concluded that there was no liability in the hands of the assessee
company to deduct tax at source, merely on the provisions made at the year end.

 

This order of the
Tribunal has been followed by the Bangalore bench of the Tribunal in the case
of TE Connectivity India Pvt Ltd vs. ITO (ITA 3/Bang/2015 dated 25.5.2016).

 

OBSERVATIONS

The objective  of inserting the Explanation has been stated
in Circular No. 3/2010 dated 2-3-2010. The relevant portion of this circular is
reproduced below:

 

Explanation to section 194A was introduced
with effect from 1-4-1987 by the Finance Act, 1987 to plug the loophole of
avoiding deduction of tax at source by crediting interest in the books of
account under accounting heads ‘interest payable account’ or ‘suspense account’
instead of to the depositor’s/payee’s account. (emphasis added)

 

It is gathered  from the above that, the Explanation applies
where   the interest (or any other amount
to which other provisions of TDS applies) is otherwise required to be credited
to the payee’s account and in order to avoid deduction of tax at source, it has
been credited to some other account, and not to the payee’s account.

 

A provision for an expense, by its very
nature, can not, in accountancy, be credited to any particular payee’s account;
it is rather to be credited to the Provision Account. The sum which cannot be
credited to the payee’s account as per the accounting principles cannot be
brought within the purview of Explanation so as to  deem to have been credited to the payee’s
account. The possibility to have credited a sum to the payee’s account should
first exist in order to invoke the Explanation. There is a stronger case for
non application of the  Explanation  in cases where the payee is not known in
comparision to the  cases where the payee
is known. Mere non-receipt of an invoice by the assessee cannot result in
claiming that the amount has not accrued to the service provider, particularly
when the contractual terms are also known to the assessee. The TDS provisions
in the later circumstances may be construed to have been avoided or  defeated by crediting an expenditure   to a provision account, instead of to the
payee’s account.

 

One view that the Explanation is intended
to apply only when the liability to pay that amount has become due is on
account of the language of the Explanation itself. The relevant provision of
section 194C [earlier it was present in the form of an Explanation II to s/s.
(2) but re-enacted as s/s. (2) with effect from 1-10-2009] is reproduced below:

 

Where any sum referred to in sub-section
(1) is credited to any account, whether called “Suspense account” or
by any other name, in the books of account of the person liable to
pay such income,
such crediting shall be deemed to be credit of such income to the account of
the payee and the provisions of this section shall apply accordingly. (emphasis
added)

 

The words used in the Explanation are
“person liable to pay such income” in contrast to the “person responsible for
paying” as used in the main provision. Therefore, as per this view, the person
should have become liable to pay the income on which tax is required to be withheld
in order to get covered by the Explanation. 
This view perhaps has a better appeal in cases of section 195 which
bases the obligation on ‘chargeability’ in the hands of the payee.
However, this view may not hold water, when one appreciates that the term
“liable to pay such income” merely qualifies the person who is required to
deduct tax, and not the point of time of deduction of tax. 

 

As far as disallowance u/s. 40(a)(ia) is
concerned, offering disallowance u/s. 40(a)(ia) cannot absolve the assessee
from his liability u/s. 201(1). Both the provisions, one for disallowance u/s.
40(a)(i) or 40(a)(ia) and the other for treatment of  the assessee as an assessee in default can
co-exist. The Second Proviso to section 40(a)(ia) envisages such a possibility whereby
the assessee can be proceeded against under the provisions of section 201,
apart from disallowing the relevant expenditure on account of his default in
complying with the TDS provisions.

 

But then, the incidental issue would be as
to whether the provision created in the books of account, for which a view is
taken that tax is not deductible on it, can be subjected  to the disallowance provisions of section
40(a)(i) or 40(a)(ia) or not. These provisions of section 40(a) apply to any sum payable
and on which tax is deductible at source under Chapter XVII-B. It is not the
case that the tax is not deductible at all from the provisions for expenses. It
is only the point of time at which tax is required to be deducted that is in
dispute. Therefore, it would be difficult to take a view that  the claim based on such provisions cannot be
disallowed u/s. 40(a)(i) or 40(a)(ia) merely because tax is not deductible at
present but in future. Otherwise, it would result into granting of deduction in
the year of making provision and making disallowance provision otiose in the
subsequent year in the absence of any claim for its deduction. However,
difficulties would certainly arise in a case where the provision is made for
liability towards unidentified payees. In such case, neither payee is known nor
his residential status is known.

 

One may however take notice of the
decision of the Mumbai Tribunal in the case of Pranik Shipping &
Services Ltd. vs. ACIT [2012] 135 ITD 233 wherein a view was taken that the
provision of section 40(a) would not apply in cases where the expenditure in
question was claimed in the return of income but was neither credited to the
account of payee nor provided for in the books.

 

If one looks at the plain reading of the
tax deduction sections, they require tax deduction at source on payment of any
income of specified nature (except in case of section 194C, which requires
payment of any sum). The chargeability to tax of such income is not a
prerequisite, except in case of section 195, which specifically requires such
sum to be chargeable to tax. Therefore, one can distinguish the provisions of
section 195 from the other tax deduction provisions, which do not specify that
such amounts have to be chargeable to tax. The reliance by the Tribunal on GE
Technology Centre’s decision (supra) in Bosch’s case, in relation to 
section 195, may be a good law and may be debatable for provisions other
than section 195.    

 

The assessees are advised, in the interest of
mitigating litigation to deduct tax at source 
in cases where the services are rendered and the payee is known, even
while making the provisions for expenses on an estimated basis or otherwise.

Section 92B and section 271AA of the Act –Penalty cannot be levied for failure to disclose share issue transaction in Form 3CEB filed before the 2012 amendment to the definition of international transaction.

13.
[2018] 93 taxmann.com 87 (Delhi)

ITO vs.
Nihon Parkerizing (India) (P.) Ltd.

ITA No. :
6409/Del/2015

A.Y:
2011-12

Date of
Order: 10th April, 2018

 

Section 92B and section 271AA of the Act –Penalty cannot
be levied for failure to disclose share issue transaction in Form 3CEB filed
before the 2012 amendment to the definition of international transaction.

 

Facts

Taxpayer, an Indian company, had received certain sum as
share capital from its associated enterprise (AE) during FY 2010-11. Taxpayer
furnished the transfer pricing report in Form 3CEB disclosing other
international transactions u/s. 92E. However, Taxpayer did not report the share capital transaction in
Form 3CEB.

 

AO contended that due to retrospective amendment to
section 92B in the year 2012, share issue transaction qualifies as an
international transaction with retrospective effect. AO imposed penalty for
non-disclosure of the transaction of share capital issue in the Form 3CEB.
Taxpayer argued that the amendment to the definition of international
transaction was made by the Finance Act 2012 with retrospective effect, whereas
the report in Form 3CEB was filed by the Taxpayer much before the enactment of
the amendment. Taxpayer contended that as on the date of filing Form 3CEB,
there was no requirement to report the share issue transaction and hence
penalty cannot be levied.

 

Aggrieved by the order of AO, taxpayer appealed before
CIT(A). The CIT(A) deleted the penalty holding that that as on the date of
filing of Form 3CEB by the Taxpayer, there was no requirement to report the
share issue transaction and hence, no penalty was leviable. Aggrieved, AO
appealed before the Tribunal.

 

Held

– Section 92B of the Act was amended
by the Finance Act 2012 with retrospective effect from 01st April
2002 to cover capital financing, including any type of long-term or short-term
borrowing, lending or guarantee, purchase of sale of marketable securities or
any type of advance, payments or deferred payments or receivable or any other
debt arising during the course of the business as international transaction.

 

– However, Form 3CEB disclosing
international transactions for the relevant year was filed by the Taxpayer
prior to such amendment and at that time the Taxpayer was not aware that there
would be retrospective amendment wherein the transaction of issue of shares
would be required to be reported in Form 3CEB.

 

– It is an established law that, for
imposition of penalty, the law in force at the time of filing Form 3CEB would
be applicable.

– It is true that issue of share
capital is an international transaction. However, as on the date of filing of
Form 3CEB in the above year, Taxpayer was not required to disclose the said
transaction. Since the law was later amended, though, with retrospective
effect, the issue had no clarity prior to amendment. Thus, there was a
reasonable cause for not disclosing the share capital issue as an international
transaction in the Form 3CEB by the Taxpayer and hence, penalty is to be
deleted.  

5 Section 133A – Returned income as against declared income during survey accepted.

5.  Amod Shivlal Shah vs. ACIT

Members:  G.S. Pannu (A. M.) and Pawan Singh (J. M.)

ITA No.: 795/MUM/2015  

A.Y.: 2006-07                                                                                               

Dated: 23rd  February, 2018

Counsel for Assessee /
Revenue:  Dr. K. Shivaram &  Rahul Hakani / Rajesh Kumar Yadav

 

Section
133A – Returned income as against declared income during survey accepted.

 

FACTS

The
assessee was engaged in carrying out business activity as a builder and
developer. On 12.03.2007, a survey action u/s. 133A was carried out at the
business premises of the assessee. At the time of survey, it was noted that the
return of income for the assessment year under consideration as well as for
Assessment Years 2004-05 and 2005-06 were not filed. It was found that the
development work of residential building situated at Bandra, Mumbai was
complete in view of the Occupancy Certificate issued by the Municipal
Corporation on 31.10.2005. In the statement recorded, the assessee declared the
income of Rs. 1 crore based on the work-in-progress declared for Assessment
Year 2003-04 and in the answer at the time of survey, the working thereof was
also enumerated. 

 

Subsequently,
the assessee filed a return of income for assessment year 2006-07 on 29.03.2007
declaring an income of Rs.25.36 lakh, which was accompanied by the audited
Balance-sheet and the Profit & Loss Account.  The response of the assessee was that
subsequent to the survey, it compiled its accounts, which were got audited
and   it  
 showed    that   
the    estimation     made      
at  Rs.1 crore was incorrect.
During the course of assessment, assessee also furnished the reconciliation
between income declared during survey and the returned income.  In sum and substance, the stand of the
assessee was that the income declared at the time of survey was a rough
estimate, whereas the return of income was on the basis of audited accounts
compiled with reference to the corresponding evidences, material, etc.

 

The
AO did not accept the explanation furnished as according to him, the
declaration made at the time of survey was binding on the assessee and the same
could not be retracted. The CIT(A) also affirmed the addition made by the
AO. 

 

Before
the Tribunal, the revenue supported the orders of the lower authorities and
relied upon the decision of the Mumbai Tribunal in the case of Hiralal
Maganlal and Co. vs. DCIT, (2005) 97 TTJ Mum 377.  

 

HELD

The
Tribunal noted that the income declared during the survey was entirely based on
the estimation of the value of the WIP as appearing on 31.03.2003 and the
expenses estimated for Assessment Years 2004-05 to 2006-07.  Thus, the income offered at the time of
survey was on an estimate basis.  The
Tribunal also noted that the assessee had explained the basis on which the
income was drawn-up at the time of filing of return and the reasons for the
difference between the income offered at the time of survey and that declared
in the return of income. 

 

To
a question, whether the AO was justified in making the addition merely for the
reason that assessee had offered a higher amount of income at the time of
survey – the Tribunal relied to the decision of the Supreme Court in the case
of Pullangode Rubber Produce Co. Ltd. vs. State of Kerala & Anr. (91 ITR
18) where the court had observed that the admission made on an anterior
date, which was not based on correct state of facts, was not conclusive to hold
the issue against the assessee. 

 

According
to the Tribunal, the stand of the assessee was much more convincing since the
original declaration itself was not based on any books of account or supporting
documents, but was merely an estimate, whereas the return of income had been
filed on the basis of audited accounts and the principal areas of differences,
namely, the amount of sale proceeds and the expenditure were duly supported by
relevant documents.

 

As
regards reliance placed by the revenue on the decision of the Tribunal in the
case of Hiralal Maganlal and Co., the Tribunal noted that the said decision was
dealing with a statement recorded u/s. 132(4) of the Act at the time of search,
whereas the present case was dealing with a statement recorded u/s. 133A of the
Act at the time of survey.  The Tribunal
pointed out that the Supreme Court in the case of CIT vs. S. Khader Khan
Sons, 352 ITR 480 had upheld the judgment of the Madras High Court in the
case reported in 300 ITR 157, wherein the difference between sections 133A and
132(4) of the Act was noted and it was held that the statement u/s. 133A of the
Act would not have any evidentiary value. The Tribunal also referred to the
CBDT Circular no. 286/2/2003 (Inv.) II dated 10.03.2003, wherein it has been
observed that the assessments ought not to be based merely on the confession
obtained at the time of search and seizure and survey operations, but should be
based on the evidences/material gathered during the course of search/survey
operations or thereafter, while framing the relevant assessments. 

 

Accordingly,
the Tribunal set-aside the order of the CIT(A) and directed the AO to delete
the addition.

Section 115JB – For computing book profits u/s. 115JB, no adjustment can be made in respect of depreciation provided at a rate higher than that prescribed under Schedule XIV of Companies Act provided the assessee shows how and on what basis the specified period and the higher rate of depreciation was arrived at.

9. [2018] 93 taxmann.com 215
(Chennai)

Indus Finance Corporation Ltd
vs. DCIT

ITA No. : 1348/Chennai/2017

A.Y.: 2012-13  

Dated: 03rd May,
2018

 

Section 115JB – For computing book profits u/s. 115JB, no
adjustment can be made in respect of depreciation provided at a rate higher
than that prescribed under Schedule XIV of Companies Act provided the assessee
shows how and on what basis the specified period and the higher rate of
depreciation was arrived at.

           

FACTS

The
assessee, engaged in the business of providing non-banking financial services,
charged depreciation on wind mills at 80% as against 5.28% prescribed under
Schedule XIV of the Companies Act, 1956. The notes to the accounts mentioned
that depreciation on wind mill has been provided at the rates prescribed by the
Income-tax Act. For the purposes of computing book profits u/s. 115JB of the Act, the Assessing Officer (AO) sought to disallow the amount
of depreciation in excess of the amount computed by applying the rate
prescribed by Schedule XIV of the Companies Act, 1956. In the course of
assessment proceedings, it was submitted by the assessee that the rate of
depreciation given in Schedule XIV of the Companies Act was only the minimum
rate that had to be charged and the assessee was at a liberty to claim excess
depreciation when situation warranted. The AO, not being satisfied with the
contention of the assessee computed book profits by allowing depreciation on windmills
at the rate prescribed in Schedule XIV of the Companies Act, 1956.

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

 

Aggrieved,
the assessee preferred an appeal to the Tribunal where on behalf of the assessee
it was contended that the wind mills had not performed to the level expected
and therefore assessee was constrained to charge depreciation, above the rate
prescribed under Companies Act and reliance was placed on the decision of
co-ordinate bench in the case of DCIT vs. Indowind Energy Ltd, (ITA
No.1854/2015, dated 25.10.2016).

 

HELD   

The
Tribunal noted that the assessee can, at its option, choose to provide
depreciation at a rate higher than that prescribed under Schedule of the
Companies Act.  However, in doing so, the
assessee must justify that the depreciation so computed, is in accordance with
section 205(2)(b) of the Companies Act which provides that depreciation can be
provided by dividing ninety-five per cent of the original cost thereof to the
company by the specified period in respect of such asset. It observed that
except for the note in the annual accounts, nothing was brought on record to
show how and on what basis the specified period and the higher rate of
depreciation was arrived by the assessee. In absence of justification by the
assessee on the basis of depreciation arrived by it, the Tribunal held that,
for the purposes of computing book profits u/s. 115JB, lower authorities were
justified in allowing depreciation based on the rates prescribed in the
Schedule. The Tribunal distinguished the decision relied upon by the assessee
by holding that the said decision was based on realistic facts.

Section 37(1) – Premium paid on keyman insurance policy, under which in the event of death of the directors assured sum had to be received by the assessee, is allowable expenditure u/s. 37(1) of the Act.

8. [2018] 93 taxmann.com 188
(Mumbai)

Arcadia Share & Stock
Brokers (P.) Ltd. vs. ACIT

ITA Nos. : 5854 &
5855/Mum/2016

A.Ys.: 2011-12 &
2012-13 

Dated: 25th April,
2018

 

Section
37(1) – Premium paid on keyman insurance policy, under which in the event of
death of the directors assured sum had to be received by the assessee, is
allowable expenditure u/s. 37(1) of the Act.

 

FACTS

The
assessee, a private limited company, engaged in the business of share and stock
broking, claimed deduction on account of premium paid towards keyman insurance
policy taken in the name of two of its directors. In course of assessment
proceedings, the Assessing Officer (AO) called upon the assessee to furnish
necessary details. After verifying the details furnished by the assessee and
referring to the characteristic of keyman insurance, the AO called upon the
assessee to justify the deduction claimed. The assessment order stated that the
assessee submitted some literatures of keyman insurance policy, but did not
furnish any document to prove that the policies taken are keyman insurance
policy. The AO held the premium paid to be on life insurance policy and not on
keyman insurance policy. Accordingly, he held that the premium paid by the
assessee cannot be allowed as business expenditure and disallowed the amount of
premia paid. 

 

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

 

Aggrieved,
the assessee preferred an appeal to the Tribunal.

 

HELD

The
Tribunal noted that the assessee had claimed deduction of the premium paid in
respect of such Insurance policy in assessment years 2005-06, 2006-07 and
2007-08. While completing assessments for these years
u/s. 143(3) of the Act, the AO after examining assessee’s claim, allowed
deduction in respect of premium paid. The Tribunal held that when it is a fact
on record that the Insurance policies are continuing from the year 2004 and in
the preceding assessment years assessee’s claim of deduction in respect of
premium paid have been allowed by the AO in scrutiny assessments, in the
absence of any material change in facts the deduction claimed in respect of
premium paid cannot be disallowed in the impugned assessment year, as the rule
of consistency must be applied.  

 

It
observed that except stating that in the preceding assessment years the AO has
not properly examined the issue no material change was pointed which could have
influenced the AO to take a different view in the impugned assessment year
departing from the view taken in the preceding assessment years.

 

The
Tribunal noted that the keyman insurance policies were taken in the name of
directors in pursuance to resolution dated 24th February 2004 of
board of directors and the sum assured under the insurance policy as per the
terms and conditions will come back to the assessee on the death of policy
holders. Accordingly, the Tribunal allowed assessee’s claim of deduction of
premium paid in both the assessment years.

 

The appeals filed by
the assessee were allowed.

Section 254 (2) : Appellate Tribunal – Rectification of mistakes – Issue is debatable in view of contradictory judgements–order cannot be rectified

12. Procter & Gamble Home
Products Pvt. Ltd. vs. ITAT & Others. [Writ Petition no. 2738 of 2017 dated
: 09th March, 2018 (Bombay High Court)]. 

[Procter & Gamble Home
Products Pvt. Ltd. vs. DCIT [ MA  order
dt. 28/7/2017 (reversed) ; arising out of ITA No. 3531/Mum/2014; Bench : K ;
AY:   Dated 06th June, 2016 ;
Mum.  ITAT ]]

 

Section 254 (2) : Appellate
Tribunal – Rectification of mistakes – Issue is debatable in view of
contradictory judgements–order cannot be rectified

 

The
assessee had entered into an agreement with its sister concern for sharing of
certain common facilities and not for renting of the premises in favour of the
sister concern. However, the AO treated the amount received by assessee as
income from house property. The provision in the agreement for charge at Rs.90
per sq.ft. for the built-up area occupied from time to time was, in terms of the
understanding of the party, not implemented. Instead, as intended by the
parties all along, the cost of common facilities shared by the companies was
pooled and borne by the parties in the ratio of respective net sales. In terms
of this arrangement, the assessee in fact had paid Rs.7.63 crore to the said
sister concern such amount being net of the recoveries from such sister concern
in respect of its share of common expenses, full break-up of which was
furnished by the assessee during the assessment proceedings. Therefore, there
was no scope for arriving at any other artificial rent or any other amount
received/receivable by the assessee under the agreement. The impugned amount
considered taxable in the hands of the assessee has not been considered by the A.O
as an allowable expense in the hands of the sister concern in its assessment,
thereby resulting into double taxation of the said amount.

 

The Tribunal allowed the
Revenue appeal u/s.  254(1) of the Act by
holding that the amount received by it as rent/ compensation from its sister
concern for utilisation of a part of its premises is to be classified as ‘income
from other sources‘. This was after negative the alternate contention of
the assessee that rent/ compensation should be classifiable under the head ‘business
income‘ as also Revenue’s contention that it is classifiable under the head
‘income from the house property‘. The Tribunal did by following the
order of its coordinate bench (on identical facts) in the case of M/s. Procter
& Gamble Hygiene & Healthcare Ltd., (sister concern) for the Assessment
Years 1996-97 to 2000-01. In all the aforesaid cases, on identical facts it has
been held that the rent/compensation received has to be taxed under the head ‘income
from other sources’.

 

The Revenue had filed
Miscellaneous Application, seeking to rectify the order dated 6th June,
2016. This essentially on the following grounds:(a) the order dated 6th June,
2016 was passed without considering the written submission which were filed on
behalf of the Revenue; and (b) the order dated 6th June, 2016 had
erred in relying upon   the   orders  
passed  in the sister concern case
for AY: 1996-97 to 2000-01 to allow the appeal.

 

This was in view of the fact
that all of them proceeded on a fundamentally wrong basis namely – that the
issue stands concluded by an order passed by the Tribunal for AY: 1995-96 in
respect of the sister concern. This was not so as in fact, as it did not
consider the claim of the Revenue that rent/ compensation is chargeable to tax
under the head ‘income from the house property‘ while holding it to the
taxable as ‘income from other sources‘.

 

The MA  order of the Tribunal dated 28th July,
2017 does recall its order dated 6th June, 2016 only on the second
ground that the reliance by the Tribunal on its earlier order in respect of the
sister concern was not correct. As those orders in turn it relied upon an
earlier order for A.Y 1995-96 of the Tribunal which did not have any occasion
to deal with submission regarding the classification of  the rent/compensation under the head ‘income
from house property’.

 

Being aggrieved, the assessee
filed an Writ petition to the High Court challenging the order passed in MA .
The High Court observed that the order of the Tribunal dated 6th June,
2016 while allowing Petitioner’s appeal, had relied upon the sister concern’s
order passed by the Tribunal in respect of A.Y 1996-97 to 2000-01. Admittedly,
all the orders of the Petitioner’s sister concern relied upon by the order
dated 6th June, 2016 had an issue with regard to the classification of
rent/compensation being received on letting of property under the head ‘income
from the house property’ or ‘income from other sources’. Therefore, it
followed the same. The order of the Tribunal in respect of its sister concern
for A.Y. 1995-96 was also before the Tribunal while passing the order dated 6th
June, 2016. Therefore, the rectification application of the Revenue calls
upon the Court to reappreciate its understanding of the order passed by the
Tribunal in the case of its sister concern for A.Y 1996-97 to 2000-01. This was
on the ground that the earlier orders did not correctly understand/ interpret the
order passed by the Tribunal in respect of A.Y 1995-96 in the case of
Petitioner’s sister concern. This itself would in effect amount to Review.
Therefore, outside the scope of rectification. Besides, it seeks to sit in
appeal over order passed by its Coordinate Bench for Assessment Years 1996-97
to 2000-01. This was not permissible. Moreover, the Revenue has filed appeals
in the sister concern case for the A.Y. 1996-97 to 2000-01 u/s. 260A of the Act
to this Court. The question raised therein is on the issue of appropriate
classification of the rent/ compensation under the head ‘income from the
other sources‘ or under the head ‘income from the house property‘.
The aforesaid appeals have been admitted and are awaiting consideration for
final disposal. Till such time, as the orders of the Tribunal of its Coordinate
Bench in respect of the A.Y 1996-97 to 2000-01 are set aside or are stayed
pending the final disposal, its ratio would, prima facie, continue to be
binding. Therefore, even if the Revenue seek to contend to the contrary it
would be a debatable issue. This cannot be a subject matter of rectification.
Therefore, MA order dated 28th July, 2017 of the Tribunal to the
extent it allowed the Revenue’s application for rectification of the order
dated 6th June, 2016 of the Tribunal was set aside. Accordingly, Petition was
allowed.  

Section 43A : Foreign exchange fluctuation : on loan liability being notional as no actual payment was made – section 43A of the Act as amended w.e.f. 1st April, 2003 – would not require any adjustment in the cost of the fixed assets.

11. Pr.CIT vs.  Spicer India Ltd. [ Income tax Appeal no.
1129 of 2015 dated: 18th April, 2018 (Bombay High Court)].  [Affirmed DCIT vs. Spicer India Ltd. [ITA No.
1886/PN/2013; AY: 2003-04;   Dated: 20th
October, 2014 ; Pune.  ITAT]

 

Section
43A : Foreign exchange fluctuation : on loan liability being notional as no
actual payment was made –  section 43A of
the Act as amended w.e.f. 1st April, 2003 – would not require any
adjustment in the cost of the fixed assets.

 

The assessee is engaged in
manufacturing of axles and propeller shafts and assemblies. On 31st
March, 2006, the assessment was completed u/s. 143(3) of the Act for the
A.Y.2003-04. Thereafter, the A.O reopened the assessment for the subject AY on
the ground that gain on foreign exchange conversion of loan liabilities, would
require corresponding change in the value of the fixed assets. This not having
been done, has resulted in the assessee claiming excess depreciation.

 

Consequent to the above
reopening, the A.O passed an order u/s. 
143(3) of the Act r.w.s 147 of the Act, adding the excess depreciation
which has been disallowed to the assessee’s income.

 

Being aggrieved, the assessee
filed an appeal to the CIT(A). The CIT(A) 
observed that section 43A of the Act deals with the increase or
reduction in the liability of the assessee as expressed in India currency on
account of changes in the rate of exchange of currency. Section 43A of the Act
has been amended w.e.f. 01.04.2013 i.e. from A.Y. 2003-04 to prescribe that the
adjustment of foreign currency fluctuations in respect of foreign currency
borrowings taken for acquiring fixed assets is to be made to the cost or the
WDV of fixed assets only at the time of making payment i.e. on cash basis and
not on accrual basis for the purposes of income tax. In the present case, the
impugned gain on foreign currency fluctuations is a notional gain in as much as
it has resulted on account of translation of foreign loan liability at the end
of the year on accrual basis.

 

The foreign exchange gain is
not as a result of actual payment made by the assessee. Therefore, the
aforesaid gain cannot be adjusted towards the cost of the fixed assets.
Accordingly, there is no justification for the A.O to have reduced the
depreciation allowance corresponding to the aforesaid exchange gains.

 

The Revenue being aggrieved, filed an appeal before the Tribunal.
The Tribunal by the dismissed the Revenue’s appeal by inter alia holding
on merits that in view of amended section 43A of the Act, the gain / loss in
the foreign exchange fluctuation on loan liability being notional as no actual
payment was made, section 43A of the Act as amended w.e.f. 1st
April, 2003 would not require any adjustment in the cost of the fixed assets.
This is so as no actual payment has been made by the assessee during the
previous year relevant to the subject AY. Further, places reliance upon the
decision in Commissioner of Income Tax vs. Woodward Governor India P. India,
(2009) 312 ITR 254.

 

Being aggrieved, the Revenue
filed an appeal to the High Court. The High Court observed that no payment was
made during the previous year relevant to the subject AY.  The Apex Court in Woodward Governor India
P. India, (supra) while dealing with the amended provisions of section 43A
of the Act has held that “…. with effect from 1st April, 2003 such
actual payment of the decreased/ enhanced liability is a condition precedent
for making adjustment in the carrying amount of the fixed asset.”

 

The aforesaid observation of
the Apex Court apply to the facts of the present case. Accordingly, the revenue
appeal was dismissed.

Section 147 : Reassessment – Reopening on basis of same set of facts – change of opinion – power not to correct mistakes – reassessment was held to be invalid [Section 148 ]

10.  Pr. CIT  vs. Century Textiles and Industries Ltd.

[ Income tax Appeal no 1367 of 2015 ; dated :
03rd April, 2018 (Bombay High Court)].  [Affirmed DCIT vs. Century Textiles and
Industries Ltd.   [ITA No.
2036/Mum/2013;  Dated:
22nd August, 2014 ; AY : 2007-08; 
Mum.  ITAT ]

 

Section 147 : Reassessment –
Reopening on basis of same set of facts – change of opinion – power not to
correct mistakes – reassessment was held to be invalid [Section 148 ]

 

Assessee is engaged in
manufacture of cotton piece goods, denim, yarn, caustic soda, salt, pulp and
paper, etc. The assessee had in its return of income claimed deduction
of Rs.33.67 crore u/s. 80IC of the Act in relation to its paper and pulp unit
on the basis of audit report in Form 10CCA.

 

During the scrutiny
proceedings, the A.O raised specific queries with regard to above claim u/s.
80IC of the Act which was responded. The A.O after considering the entire
material on record disallowed the assessee’s claim to the extent of Rs.11.49
crore out of total claim of Rs.33.67 crore u/s. 80IC of the Act while passing
assessment order u/s. 143(3).

 

Thereafter, a notice u/s. 148
of the Act was issued seeking to reopen assessment. Reasons in support of the
notice as communicated to the Assessee that “the income chargeable to tax to
the extent of Rs.4.99 crore has escaped assessment. Issue notice u/s. 148 for
A.Y.2007-08”

 

Assessee objected to the
reopening of the notice on the ground that the same amounts to change of
opinion and therefore without jurisdiction. However, the A.O rejected the
objection and proceeded to complete the assessment u/s. 143(3) r.w.s 147 of the
Act. The A.O disallowed the claim of deduction u/s. 80IC of the Act by further
amount of Rs.4.99 crore.

 

Being aggrieved, the assessee
carried the issue in appeal to the CIT(A). The CIT(A) rejected the assessee’s
appeal on the issue of reopening of assessment and confirmed the assessment
order.

 

Being aggrieved, the assessee
carried the issue in appeal to the ITAT. The Tribunal allowed the assessee’s
appeal, interalia holding that the assessee’s claim for deduction u/s.  80IC of the Act in respect of its paper and
pulp unit duly supported by audit report u/s. 10CCA of the Act was a subject
matter of enquiry by the A.O in the regular assessment proceedings. This is
evident from the fact that queries with regard to the claim of deduction
u/s.  80IC of the Act were specifically
raised by the A.O and the same were responded to by the assessee. Thus, the Tribunal
held that there was a view taken/opinion formed during the regular assessment
proceedings. Therefore, this is a case of change of opinion on the part of the
A.O in issuing notice and seeking to reopen assessment. The ITAT relied on the
decision of  Supreme Court in CIT vs.
Kelvinator of India Ltd. [2010] 320 ITR 561 that “reasons to believe” do
not empower the A.O to reopen an assessment when there is change in opinion.
Power to reopen assessment as observed by the Supreme Court is only a power to
reassess not to review the order already passed.

 

Being aggrieved, the revenue
carried the issue in appeal to the High Court. 
The Revenue in support of the appeal states that reopening notice was
not on account any change of opinion, as no opinion/view was taken in regular
assessment proceedings in respect of the receipts/income not derived directly
from the paper and pulp unit.

 

The Hon. High Court observed
that the reasons in support of the impugned notice is that during the regular
assessment proceedings on account of omission by the A.O the above income was
not excluded from the claim for deduction. This is different from non application
of mind to claim for deduction u/s. 80IC of the Act. As held by this Court in Hindustan
Lever vs. Wadkar (2004) 268 ITR 339, the reasons in support of the
reopening notice has to be read as it is. No additions and/or inferences are
permissible. Moreover, the power u/s. 147/148 of the Act is not to be exercised
to correct mistakes made during the regular assessment proceedings. In the
above facts, the view taken by the 
Tribunal is a view in accordance with the decision of the Apex Court in
Kelvinator India (Supra).

 

The decision of this Court in
Export Credit Guarantee Corporation of India [2013] 350 ITR  651 relied by the Dept. was distinquished. It
was also found as a fact in the above case of Export Credit Guarantee
Corporation of India (Supra) that no query was raised during the course of
the regular assessment proceedings. Thus, the occasion for the A.O to apply his
mind to the claim by the assessee in that case, did not arise.  Accordingly, the revenue Appeal was
dismissed.

Section 68: Cash credits – Bogus loan – The proviso to section 68 inserted with effect from 01.04.2013, does not have retrospective effect – If the AO regards the loan as bogus, he has to assess the lender but cannot assess as unexplained cash credit

9.  Pr.CIT – vs.  Veedhata Tower Pvt. Ltd.

[Income tax Appeal no. 819 of 2015
dated: 17th April , 2018 (Bombay High Court)]. [Affirmed Veedhata
Tower Pvt. Ltd vs. I.T.O-9(3)(3) [ITA No.7070/Mum/2014;  Bench : H ; AY:  2010-11 ; Dated: 21st January,
2015 ; Mum.  ITAT]

 

Section 68: Cash credits –
Bogus loan – The proviso to section 68 inserted with effect from 01.04.2013,
does not have retrospective effect – If the AO regards the loan as bogus, he
has to assess the lender but cannot assess as unexplained cash credit 

 

The assessee had obtained a
loan from M/s. Lorraine Finance Pvt. Ltd (LFPL). The A.O. held that the
assessee was unable to establish the genuineness of the loan transaction
received in the name of LFPL nor able to prove the credit worthiness/the real
source of the fund. This led to the addition of the loan as unexplained cash
credit u/s. 68 of the Act.

 

In appeal, the view of the
A.O. was upheld by the CIT(A).

 

On further appeal, the
Tribunal while allowing the assessee’s appeal records on facts that, it is undisputed
that the loan was taken from LFPL. It is also undisputed that the lender had
confirmed giving of the loan through loan confirmations, personal appearance
and also attempted to explain the source of its funds. It also records the fact
that the sum of Rs.64.25 lakh had already been returned to LFPL through account
payee cheques and the balance outstanding was Rs.1 crore and 75 lakh. Besides,
it records that the source of source also stands explained by the fact that the
director of the creditor had accepted his giving a loan to the assessee’s
lender.

 

In view of the above fact, it
is the Revenue’s case that the source of source, the assessee is unable to
explain. The requirement of explaining the source of the source of receipts
came into the statute book by amendment to section 68 of the Act on 1st
April, 2013 i.e. effective from A.Y. 2013-14 onwards. Therefore, during the
subject assessment year, there was no requirement to explain the source of the
source. The Tribunal held that the assessee had discharged the onus placed upon
it u/s. 68 of the Act by filing confirmation letters, the Affidavits, the full
address and pan numbers of the creditors. Therefore, the Revenue had all the
details available with it to proceed against the persons whose source of funds
were alleged to be not genuine as held by the Apex Court in CIT vs. Lovely
Exports (P.) Ltd. [2009] 319 ITR (St.) 5 (SC).

 

Being aggrieved, the
revenue  filed an appeal to the High
Court. The grievance of the Revenue is that, even in the absence of the
amendment to section 68 of the Act, it is for the assessee to explain the
source of the source of the funds received by an assessee. It is submitted that
the assessee has not able to explain the source of the funds in the hands of
M/s. LFPL .

 

The High Court observed that
the Bombay Court in CIT vs. Gangadeep Infrastructure Pvt. Ltd, 394 ITR 680
has held that the proviso to section 68 of the Act has been introduced by the
Finance Act, 2012 w.e.f. 1st April, 2013 and therefore it would be
effective only from A.Y 2013-14 onwards and not for the earlier assessment
years. In the above decision, reliance was placed upon the decision of the Apex
Court in Lovely Exports (supra) in the context of the pre-amended
section 68 of the Act. In the above case, the Apex Court while dismissing the
Revenue’s Appeal from the Delhi High Court had observed that, where the Revenue
urges that the money has been received from bogus shareholders then it is for
the Revenue to proceed against them in accordance with law. This would not
entitle the Revenue to invoke section 68 of the Act while assessing the
assessee for not explaining the source of its source. In present case the
assessee had discharged the onus which is cast upon it in terms of the
pre-amended section 68 of the Act by filing the necessary confirmation letters
of the creditors, their Affidavits, their full address and their pan. In any
event, the question as proposed in law of the obligation to explain the source
of the source prior to 1st April, 2013, A.Y 2013-14, stands
concluded against the Revenue by the decision of this Court in Gangadeep
Infrastructure (supra). Accordingly, the 
revenue appeal is dismissed.

A. P. (DIR Series) Circular No. 70 dated May 19, 2016

fiogf49gjkf0d

Money Transfer Service Scheme – Submission of statement/returns under XBRL

This circular states that all Authorized Persons, who are Indian Agents under Money Transfer Service Scheme (MTSS) have to submit the statement on quantum of remittances from the quarter ending June 2016 in eXtensible Business Reporting Language (XBRL) system which can be accessed at https://secweb.rbi.org.in/orfsxbrl/.

A. P. (DIR Series) Circular No. 69[(1)/22(R)] dated May 12, 2016

fiogf49gjkf0d

Notification No. FEMA 22 (R)/2016-RB dated March 31, 2016

Establishment of Branch Office (BO)/ Liaison Office (LO) / Project Office (PO) in India by foreign entities – procedural guidelines

This Notification repeals and replaces the earlier Notification No. FEMA 22/2000-RB dated May 3, 2000 pertaining to Foreign Exchange Management (Establishment in India of branch or office or other place of business) Regulations, 2000. 

A. P. (DIR Series) Circular No. 68[(1)/23(R)] dated May 12, 2016

fiogf49gjkf0d

Notification No. FEMA 23 (R)/2015-RB dated January 12, 2016

Foreign Exchange Management (Exports of Goods and Services) Regulations, 2015

This Notification repeals and replaces the earlier Notification No. FEMA 23/2000-RB dated May 3, 2000 pertaining to Foreign Exchange Management (Export of Goods and Services) Regulations, 2000.

A. P. (DIR Series) Circular No. 67/2015- 16[(1)/23(R)] dated May 02, 2016

fiogf49gjkf0d

Notification No. FEMA 5 (R)/2016-RB dated April 01, 2016

Foreign Exchange Management (Deposit) Regulations, 2016

This Notification repeals and replaces the earlier Notification No. FEMA 5/2000-RB dated May 3, 2000 pertaining to Foreign Exchange Management (Deposit) Regulations, 2000.

A. P. (DIR Series) Circular No. 66 dated April 28, 2016

fiogf49gjkf0d

Opening and Maintenance of Rupee / Foreign Currency Vostro Accounts of Non- Resident Exchange Houses: Rupee Drawing Arrangement

Presently, Exchanges Houses are required to maintain a collateral equivalent to one day’s estimated drawings under Rupee Drawing Arrangement with respect to Vostro Accounts.

This circular has done away with the requirement of mandatorily maintaining a collateral by Exchange Houses under Rupee Drawing Arrangement with respect to Vostro Accounts. However, banks are free to frame their own policies and decide whether to request for a collateral or not from Exchange Houses.

A. P. (DIR Series) Circular No. 65 dated April 28, 2016

fiogf49gjkf0d

Import of Goods: Import Data Processing and Monitoring System (IDPMS )

This circular states that an Import Data Processing and Monitoring System (IDPMS) on the lines of Export Data Processing and Monitoring System (EDPMS) is to be developed. For this purpose Customs will modify the Bill of Entry format and non-EDI (manual) ports will be upgraded to EDI Ports.

This circular also contains guidelines to be following once the IDPMS system becomes operational. The guidelines pertain to: –

1. Write off of import bills due to discounts, fluctuation in exchange rates, change in the amount of freight, insurance, quality issues; short shipment or destruction of goods by the port / Customs / health authorities, etc.

2. Extension of Time for settlement of import dues

3. Follow-up for Evidence of Import.

A. P. (DIR Series) Circular No. 64/2015-16 [(1)/13(R)] dated April 28, 2016

fiogf49gjkf0d

Notification No. FEMA 13 (R)/2016-RB dated April 01, 2016

Foreign Exchange Management (Remittance of Assets) Regulations, 2016

This Notification repeals and replaces the earlier Notification No. FEMA 13/2000-RB dated May 3, 2000 pertaining to Foreign Exchange Management (Remittance of Assets) Regulations, 2000.

A. P. (DIR Series) Circular No. 63 dated April 21, 2016

fiogf49gjkf0d
Foreign Investment in units issued by Real Estate Investment Trusts, Infrastructure Investment Trusts and Alternative Investment Funds governed by SEBI regulations

This circular now permits foreign investment (acquire, purchase, sell, transfer) in units of Investment Vehicles registered and regulated by SEBI or any other competent authority, subject to compliance with the applicable terms and conditions. For the purpose of investment under these Regulations: –

1. foreign investment in units of REITs registered and regulated under the SEBI (REITs) Regulations, 2014 will not be included in “real estate business”

2. Presently, an Investment Vehicle will mean: –

a. Real Estate Investment Trusts (REITs) registered and regulated under the SEBI (REITs) Regulations 2014;

b. Infrastructure Investment Trusts (InvITs) registered and regulated under the SEBI (InvITs) Regulations, 2014;

c. Alternative Investment Funds (AIFs) registered and regulated under the SEBI (AIFs) Regulations 2012.

3. Unit will mean beneficial interest of an investor in the Investment Vehicle and will include shares or partnership interests.

4. A person resident outside India will include a Registered Foreign Portfolio Investor (RFPI) and a Non-Resident Indian (NRI).

5. Payment for the units must be by way inward remittance or by debit to an NRE or an FCNR account.

SEBI Order Now Enables Investors To Recover Losses From Fraudsters In The Securities Markets

fiogf49gjkf0d
Can the Securities and Exchange Board of India make a fraudster or other wrong doer in the securities markets compensate the wronged persons? The answer, generally, is that SEBI cannot do so. This question is important because the parties are normally required to approach other forums which could include courts, Consumer Protection Forums, etc. However, a recent order of SEBI, following an order by the Securities Appellate Tribunal, has opened the door to this aspect to a little extent. This order is significant for several reasons. SEBI is an expert body in the securities markets with fairly broad powers. It has a huge infrastructure at its command to investigate, adjudicate and punish. The groundwork for determining whether a person has committed such a fraud, etc. would be laid down by SEBI through such orders. SEBI also has, as we will see later, the powers to disgorge gains made by wrongdoers. In some cases, such as in the alleged scams in initial public offerings, SEBI even went the extra mile and made arrangements for distribution of these illegal gains to those at whose cost such gains were made. The next logical step ought be to allow such things on a general basis and perhaps even allow persons who have suffered losses to approach SEBI.

However, this has not happened mainly because of certain inherent limitations on SEBI under the law. SEBI is not an adjudicator of disputes. It would surely punish fraudsters. It may debar them from markets. It may make them pay penalty, though such penalty goes in government coffers and not to help those who lost monies. It may prosecute such persons too. It also orders parties who have illegally collected monies to refund them , with interest. However, an aggrieved person could not approach SEBI and require it to make a wrongdoer compensate the loss he had suffered. Indeed, till recently, it was a little uncertain whether SEBI had powers even to disgorge illegitimate gains. A clarificatory amendment was however made in 2014 to explicitly give such powers to SEBI.

However, compensating loss caused by fraudsters continued to remain out of SEBI’s legal powers. The investors were thus forced to approach the long drawn procedures in courts. An investor may get some satisfaction when such fraudsters are punished, but he still would remain short of his hard earned monies. However, thanks to persistent efforts of an investor who lost money to a company and its Promoters through fraud, there is a glimmer of hope that SEBI may be required to do broader justice in such matters. By a recent decision of SEBI, which indeed was following the directions of the Securities Appellate Tribunal (“SAT “), SEBI has acknowledged such responsibility. A final order is awaited, since calculation of ill-gotten monies is in progress. While it would be interesting to see the legal reasoning SEBI provides for passing such final order and also see its fate in appeals, if any, it would be worth to consider this decision.

SEBI’s decision

The decision was in case of the applicants Harishchandra and Ramkishori Gupta (“the Applicants”) in the matter of Vital Communications Limited (“Vital”)(SEBI Order dated 1st April 2016).

To summarise from the facts as narrated in the Order, Vital, a listed company, had made a preferential issue of equity shares to certain parties. SEBI found that a significant portion of the funding for such preferential issue was made by Vital itself. Many of the preferential allottees were also found to be connected to Vital/its Promoters. Thereafter, a spate of catchy advertisements were issued of proposed buyback of shares at a high price, preferential issue at even higher price, and for issue bonus shares. None of this actually took place in the manner described in the advertisements.However, along with such advertisements, certain preferential allottees sold a substantial quantity of shares. Effectively thus, the advertisements helped the parties to sell equity shares at a high price to unsuspecting investors. Since the ruling price then was much lower than the price that could be expected if the promises as per the advertisements had actually been carried out, investors rushed in and bought the shares. SEBI investigated and uncovered the facts and took action against the parties by debarring them, etc.

However, this left the investors with losses. The Applicants approached SEBI praying that their losses should be compensated. SEBI refused to do claiming that it had no powers under SEBI Act to order the company and/or its directors to compensate the Applicants. The Applicants filed an appeal to the SAT. SAT ordered that if SEBI found Vital guilty of fraud, “…it may consider directing the concerned entity or Vital to refund the actual amount spent by the applicants on purchasing the shares in question and with appropriate interest”.

SEBI undertook final investigation and did find wrongdoing and fraud. SEBI passed various directions against the parties. However, still, it did not pass orders providing for compensation to the investors who were duped into making investments. The Applicants once again appealed to SAT . SAT once again passed an order asking SEBI to do the needful. SEBI then passed an order that it will look into quantification of ill gotten gains and thereafter pass orders for disgorgement and restitution. It then thus finally gave a proper hearing to the Applicants on the issue of compensation. However, on review, SEBI found that its own orders/investigation had not made a proper calculation of the ill gotten gains by the Company/ Promoters. Accordingly, finally SEBI undertook vide this recent and latest order to determine the amount of ill gotten gains to take the matter to its next and final step of ordering such parties to return (i.e., effectively compensate) the gains made to the Applicants, who suffered losses. Interestingly, while the original fraudulent advertisement & sale of shares took place in 2002, it is only in 2016, after several petitions and appeals by the Applicants that SEBI has initiated action. It will still be some time before the amount of ill gotten gains would be calculated, then hopefully recovered from the parties and paid to the Applicants who have suffered losses.

Disgorgement – a history of uncertainties

Disgorgement, simply stated, is taking away ill-gotten gains from the wrong doer. A person may, for example, make gains from insider trading in violation of the applicable Regulations. SEBI may order such person to disgorge such gains and pay them over to SEBI. Till very recently, whether SEBI could, in law, order disgorgement was debated. However, the SEBI Act was amended vide the SEBI (Amendment) Act, 2014, with effect from 18th July 2013, specifically giving it power to disgorge gains made in violation of specified provisions of law. However, even these amendments expressly permit only disgorgement. The objective is only to ensure that the wrong doers do not keep their ill gotten gains. They do not specifically expressly provide for payment of these disgorged amounts to those who were at the losing end (though SEBI has passed some orders of such type). Further, it was still unclear law whether an investor can initiate such action. Now, this order creates a precedent that SEBI can undertake such exercise of disgorging such ill-gotten gains and then reimburse them to those whom they belonged.

Limitations

An important distinction to be made here is that this case is no precedent for investors being able to approach SEBI to get general disputes resolved and get the whole of their losses recovered. It only means that SEBI will disgorge gains made from acts/omissions in violation of specified securities laws. And that only such gains will go back to the hands of investors. The investors may have suffered a higher loss, but if its flow cannot be traced to the pockets of such wrong doers, then there may be nothing to recover to that extent. Thus, the investor may not get the whole of their losses compensated.

In any case, if SEBI cannot recover such monies as for example when the fraudsters do not have sufficient assets, the investors would still have lesser amounts to receive.

However, SEBI/SAT has ordered that interest shall also be disgorged and paid, irrespective of whether the fraudster had earned such interest or not. This, though an extension of the power of disgorgement, does give relief for the time element.

There is another type of situation where there may be fraud but the amount of gains made by the fraudster may not match with the losses of the investor. For example, a broker/adviser may give wrongful/fraudulent advice to gain commission fees. The investor may invest monies and then end up losing a large sum of money. However, disgorgement permits forfeiture of ill-gotten gains. In such a case would include only the brokerage/fees, which would be a small fraction of the loss. A purely contractual or similar dispute will not be covered. These continue to remain within the domain of civil courts, stock exchanges, etc.

Scope of disgorgement

As the amended Section 11B makes it clear, disgorgement is of all gains made from violations of SEBI Act and Regulations. Thus, gains made not just from fraud but from any violation of specified securities laws. Thus, even though the decision in this case related to a fraud, the principle would clearly extend to gains from any other violation of Securities Laws. And thus, those who suffer on account of violation of Securities Laws may get compensated.

Conclusion

A fresh, even if hesitant and incomplete, chapter has opened in the history of Securities Laws. While it is too early to draw final conclusions, investors now do have a better measure to recover their losses that is formal, speedier and effective. However, much depends on the final order, the manner in which losses are determined and recovered and also the legal reasoning SEBI adopts for such order. It will also have to be seen whether such orders are appealed against and what appellate Tribunal/ courts decide. The fact that the orders of SAT and SEBI both talk of restitution to be “considered in accordance with the provisions of the SEBI Act, 1992 …and the regulations framed thereunder” is also interesting since there could still be some legal uncertainties about the whole process

ETHICS, GOVERNANCE & ACCOUNTABILITY

fiogf49gjkf0d
ACCOUNTABILITY

In ethics and governance, accountability is answerability, blameworthiness, liability and the expectation of accountgiving. As an aspect of governance, it has been central to discussions related to problems in the public sector, non-profit and private (corporate) and individual contexts Political accountability is the accountability of the government, civil servants and politicians to the public and to legislative bodies such as a congress or a parliament.

Within an organization, the principles and practices of ethical accountability aim to improve both the internal standard of individual and group conduct as well as external factors, such as sustainable economic and ecologic strategies. Also, ethical accountability plays a progressively important role in academic fields, such as laboratory experiments and field research.

Internal rules and norms as well as some independent commission are mechanisms to hold civil servants within the administration of government accountable. Within department or ministry, firstly, behavior is bound by rules and regulations; secondly, civil servants are subordinates in a hierarchy and accountable to superiors. Nonetheless, there are independent “watchdog” units to scrutinize and hold departments accountable; legitimacy of these commissions is built upon their independence, as it avoids any conflicts of interests. The accountability is defined as an element which is part of a unique responsibility and which represents an obligation of an actor to achieve the goal, or to perform the procedure of a task, and the justification that it is done to someone else, under threat of sanction.

RTI Clinic in June 2016: 2nd, 3rd, 4th Saturday, i.e. 11th, 18th and 25th, 11.00 to 13.00 at BCAS premises.

2 States: The Story of Mergers and Stamp Duty

fiogf49gjkf0d
Introduction

Just when one thought that the burning issue of stamp duty on merger schemes has been settled once and for all, a Bombay High Court decision has stoked the fire some more! To refresh, the Supreme Court and several High Court decisions have held that the order of High Court u/s.394 of the Companies Act sanctioning an amalgamation was a conveyance within the meaning of the term conveyance and was liable to stamp duty. A Transfer under a merger is a voluntary act of parties and it has all the trappings of a Sale. The Scheme sanctioned by Court is an instrument and the State has power to levy duty on a merger. Even in States where there is no express provision levying duty as on a merger, Courts have held that stamp duty is payable as on a conveyance.

Recently, the Full Bench of the Bombay High Court in the case of  The Chief Controlling Revenue Authority vs. M/s. Reliance Industries Ltd, Civil Reference No. 1/2007 was faced with an interesting issue of stamp duty payable on an inter-state merger. In a case where a company registered in Gujarat merged with a company registered in Maharashtra would stamp duty be payable once or twice was the moot question?

Background to the Case

Reliance Petroleum Ltd, a Gujarat based company had merged into Reliance Industries Ltd, a Mumbai based company. The Stamp Acts of both Maharashtra and Gujarat had a specific provision levying duty on a Court Order sanctioning a Scheme of merger. In Maharashtra, the maximum duty on a Scheme of merger is Rs. 25 crore. Pursuant to the merger, Reliance Industries Ltd had paid a stamp duty of Rs. 10 crores in Gujarat and hence, paid only the balance of Rs. 15 crore in Maharashtra. Thus, it claimed that it was eligible for a set off of the duty paid in one State against the duty payable in another State. For this, it relied upon section 19 of the Maharashtra Stamp Act, 1958 (“the Act”) which provides that where any instrument described in Schedule-I to the Act and relating to any property situate or to any matter or thing done or to be done in Maharashtra is executed out of Maharashtra subsequently such an instrument / its copy is received in Maharashtra the amount of duty chargeable on such instrument / its copy shall be the amount of duty chargeable under Schedule-I less the duty, if any, already paid in any other State. Thus, similar to a double tax avoidance agreement, a credit is available for the duty already paid. It may be recalled that under the Act, stamp duty is leviable on an every instrument(not a transaction) mentioned in Schedule I to the Maharashtra Stamp Act, 1958 at rates mentioned in that Schedule – LIC vs. Dinannath mahade Tembhekar AIR 1976 Bom 395. If there is no instrument then there is no duty is the golden rule one must always keep in mind. An English decision in the case of The Commissioner of Inland Revenue vs. G. Anous & Co. (1891) Vol. XXIII Queen’s Bench Division 579 has held that held that the thing, which is made liable to stamp duty is the “instrument”. It is the “instrument” whereby any property upon the sale thereof is legally or equitably transferred and the taxation is confined only to the instrument whereby the property is transferred. This decision was cited by the Supreme Court in the case of Hindustan Lever Ltd vs. State of Maharashtra, (2004) 9 SCC 438. Hence, if no instrument is executed, there would not be any liability to stamp duty.

In Reliance’s case, the Revenue Department argued that it was the Court Order and not the Scheme which was liable for duty. Since there were two separate Court Orders, the duty paid on the Gujarat High Court’s Order was not eligible for set off against the duty payable on the Bombay High Court’s Order. These two Orders were not the same instrument and hence, no credit was available. On the other hand, the Company argued that it was the Scheme which was the instrument and not the Court Orders. Accordingly, since there was only one Scheme, a credit was available. Since both the transferor and the transferee company were required to secure sanctions separately, the Scheme and the Order of the Bombay High Court sanctioning the Scheme would not constitute an instrument or a conveyance, unless and until the Gujarat High Court had sanctioned the Scheme. This is because the Scheme would become effective and operative and the property would stand transferred and vested from the transferor to the transferee, only on the Gujarat High Court making the second order sanctioning the Scheme. In fact if the Gujarat High Court had not sanctioned the Scheme, the same would not have become operative and there would be no transfer or vesting of property in the transferee company. Accordingly on such sanction being granted by the Gujarat High Court, the parties were liable to pay stamp duty on the sanctioned scheme in Gujarat and then to pay stamp duty in Maharashtra subject to a rebate u/s. 19 for the duty already paid in Gujarat.

Court’s Order

The Bombay High Court upheld the stand of the Department and negated Reliance’s plea. It held that the duty is payable on a Court Order and not a Scheme. The Court relied upon the decision of the Supreme Court in Hindustan Lever vs. State of Maharashtra (2004) 9 SCC 438 which held that the transfer is effected by an order of the Court and the order of the Court sanctioning the scheme of amalgamation is an instrument which transfers the properties and would fall within the definition of section 2(l) of the Act, which includes every document by which any right or liability is transferred. In Hindustan Lever’s case, it was held that the point as to whether the stamp duty was leviable on the Court order sanctioning the scheme of amalgamation was considered at length in Sun Alliance Insurance Ltd. vs. Inland Revenue Commissioners 1971 (1) All England Law Reports 135. There it was observed that the order of the court was liable to stamp duty as it resulted in transferring the property and that the order of the court which results in transfer of the property would be an instrument liable to be stamped. The Bombay High Court further held that it was the settled position of law that in terms of the Act, stamp duty is charged on ‘the instrument’ and not on ‘the transaction’ effected by ‘the instrument’.

The Bombay High Court Order dated 7.6.2002 which sanctioned the merger would be the instrument and that was executed in Mumbai, i.e., in Maharashtra. The instrument was chargeable to duty and not the transaction and therefore even if the Scheme may be the same, i.e., transaction being the same, if the Scheme was given effect by a document signed in the State of Maharashtra it was chargeable to duty as per the Act. As per the Act, the taxable event was the execution of the instrument and not the transaction. If a transaction was not supported by execution of an instrument, there could not be a liability to pay duty. Therefore, essentially the duty was leviable on the instrument and not the transaction. Although the Scheme may be same, the Order dated 7.6.2002 being a conveyance and it being an instrument signed in State of Maharashtra, the same was chargeable to duty so far as State of Maharashtra was concerned. It further held that although there were two orders of two different High Courts pertaining to the same Scheme they were independently different instruments and could not be said to be same document especially when the two orders of different High Courts were upon two different Petitions by two different companies. When the scheme of the Act was based on chargeability on an instrument and not on transaction, it was immaterial whether it was pertaining to one and the same transaction. The instrument, which effected the transfer, was the Order of the Court issued u/s. 394(1) that sanctioned the Scheme and not the Scheme of amalgamation itself. It accordingly held that the transfer would take effect from the date the Gujarat High Court passed an order sanctioning the Scheme. In other words, after the Gujarat High Court passed an order sanctioning the Scheme on account of the order of the Bombay Hon’ble Court, the transfer in issue took place. It negated the contention that only a document, which ‘created right or obligation’ alone constituted an ‘instrument’ since the definition of the term ‘instrument’ was an inclusive and not an exhaustive definition. Thus, the term ‘instrument’ also included a document, which merely recorded any right or liability.

It thus concluded that section 19 of the Act providing double-duty relief was not applicable. The Order of the Bombay High Court related to property situated within Maharashtra and was also passed in Maharashtra and hence, a fundamental requirement of section 19, i.e., the instrument must be executed outside the State, was not fulfilled. While paying duty on the Bombay High Court Order dated 7.6.2002 rebate cannot be claimed for the duty paid on Gujarat High Court’s Order by invoking section 19 of the Act.

Repercussions of the judgment

This judgment of the Bombay High Court will have several far reaching consequences on the spate of cross-country business restructuring. Emboldened by this decision, other States would also start demanding stamp duty on mergers involving companies from more than one state Companies would now have to factor an additional cost while considering mergers. The same would be the position in the case of a demerger. An interesting scenario arises if instead of a merger, one considers a slump sale of a business involving companies located in two states. In such an event if a conveyance is executed for any property, then there would only be one instrument. Here it is very clear that section 19 would apply and the duty paid in one state would be allowed as a set off in the other. Thus, depending upon the mode of restructuring the duty would vary. Is that a fair proposition? Also, while companies located in the same state would get away with a single point taxation, those in two or more states suffer an additional burden. Does this not throw up an arbitrage opportunity of having the registered offices of all companies party to the merger in the same state as opposed to having separate registered offices? Would that not lead to a larger loss of revenue for the state from which the office is shifted out as compared to the small gains it would have made from the stamp duty on merger. One wishes that the law is implemented and interpreted in a manner that does not encourage such manoeuvring.

Conclusion

One can only submit that the decision of the Bombay High Court needs a reconsideration otherwise the entire pace of mergers and demergers would be retarded in the Country. With mergers being neutral from an income tax as well as indirect tax perspective, stamp duty is the single biggest transaction cost. This decision would see a huge increase in the duty costs.

Writ – Power of attorney – A writ petition under Article 226 of the Constitution can be filed by a power of attorney holder subject to certain safeguards [Constitution Of India – Art. 226]

fiogf49gjkf0d
Syed Wasif Husain Rizvi vs. Hasan Raza Khan AIR2016All52 (HC)

The issue before the Full Bench of the Allahabad High Court was “Whether a writ petition under Article 226 of the Constitution can be filed by a power of attorney holder.” The High Court held that when a writ petition under Article 226 of the Constitution is instituted through a power of attorney holder, the holder of the power of attorney does not espouse a right or claim personal to him but acts as an agent of the donor of the instrument. The petition which is instituted, is always instituted in the name of the principal who is the donor of the power of attorney and through whom the donee acts as his agent. In other words, the petition which is instituted under Article, 226 of the Constitution is not by the power of attorney holder independently for himself but as an agent acting for and on behalf of the principal in whose name the writ proceedings are instituted before the Court. Hence, the issue was decided in the affirmative.

The High Court further emphasised the necessity of observing adequate safeguards where a writ petition is filed through the holder of a power of attorney. These safeguards should necessarily include the following:

(1) The power of attorney by which the donor authorises the donee, must be brought on the record and must be filed together with the petition/application;

(2) The affidavit which is executed by the holder of a power of attorney must contain a statement that the donor is alive and specify the reasons for the inability of the donor to remain present before the Court to swear the affidavit; and

(3) The donee must be confined to those acts which he is 15 authorised by the power of attorney to discharge.

Mohammedan Law – Will – Challenge – Limitation of three years starts from date author of Will expires – Bequest to heir is not valid unless consent of all other legal heirs is obtained. [Limitation Act Art 137 and Mohammedan Law – Rule 192].

fiogf49gjkf0d
Smt Munawar Begum vs. Asif Ali and Ors. AIR 2016 (NOC) 259 (Cal)(HC).

Saira Begum, the mother of the appellant had executed Will in the year 1995. She expired on 18th January, 2003. The appellant filed the suit on 12th November, 2003 for cancellation of the Will. The short point was from which date limitation is to be counted i.e. from 1995 or from 18th January, 2003. There is no dispute that a Will is a legal declaration of the intention of the testatrix with respect to her property and takes effect after her death. A Will is a voluntary posthumous disposition of property. Since a Will takes effect after death, the argument that the appellant was aware of the same in the year 1995 is of no significance. In the instant case, the author of the Will, the mother, expired on 18th January, 2003. The right to sue begins to run from 18th January, 2003 and the period of limitation is three years. The suit was filed on 12th November, 2003. Therefore, it was held that the suit was filed within the period of limitation.

The other issue was regarding the validity of the Will, submission was though a Will under the Mohammedan Law, in order to be valid and enforceable in law, it has to fulfill certain conditions under Rule 192. In the instant case, however, the Will of Saira Begum, the mother of the appellant falls short of the requirements stipulated therein since the Appellant had not given consent. It was held that as far as the consent of the appellant is concerned, under Rule 192, a bequest to an heir is not valid unless the other heirs consent. It appears from the Will dated 28th September, 1995, which was registered subsequently in 1998, that the signature of the appellant, an heir, is absent. Therefore, as the consent of the appellant is missing, the Will or the testamentary disposition is invalid. Though it was emphasised on behalf of the respondent that the Will in question speaks that “I further declare voluntarily that I do not wish to give any part of my said property to my any other children or relatives and I make this Will with the consent of all my other children and without any objection from any of them”, the same is of little significance as though the Will contains the signature of other heirs, it does not bear the signature of the appellant. The said sentence in the Will, as noted, could have been of some significance if other heirs had not put their signature. Since the signature of the appellant was absent, it was held that the Will was not valid under Rule 192 and not binding on the appellant.

FIRM – Appointment of Arbitrator – Unregistered firm cannot enforce arbitration clause in a partnership deed. [Indian Partnership Act, 9132 – Section 69(3)].

fiogf49gjkf0d
C.M. Makhija vs. Chairman South Eastern Coalfields Ltd. AIR 2016 CHHATTISGARH 63 (HC).

An application was filed in the High Court under section 11(6) of the Arbitration & Conciliation Act, 1996 whereby the applicant sought to enforce an arbitral agreement and prayed for appointment of an Arbitrator. The application was objected to on the ground that the applicant was not a registered partnership firm having registration number from the Register of Firms & Societies and section 69 of the Indian Partnership Act, 1932, prohibits filing of a proceeding by an unregistered firm.

The High Court held that section 69, speaking generally, bars certain suits and proceedings as a consequence of non-registration of firms. Sub-section (1) prohibits the institution of a suit between partners inter se or between partners and the firm for the purpose of enforcing a right arising from a contract or right conferred by the Partnership Act unless the firm is registered and the person suing is or has been shown in the Register of Firms as a partner in the firm. Sub-section (2) similarly prohibits a suit by or on behalf of the firm against a third party for the purpose of enforcing rights arising from a contract unless the firm is registered and the person suing is or has been shown in the Register of Firms as a partner in the firm. In the third sub-section a claim of set-off which is in the nature of a counter-claim is barred as also the s/s. (3) takes within its sweep the word “other proceedings”. The words “other proceedings” in sub-section (3) whether should be construed as ejusdem generis with “a claim of set-off”, was subject of conflicting decisions. Finally, the conflict was resolved by the Supreme Court in the case of Jagdish Chandra Gupta vs. Kajaria Traders (India) Ltd. AIR 1964 SC 1882 wherein the Court held the rule ejusdem generis did not apply to an unregistered firm and unregistered firm could not enforce an arbitration clause in the partnership deed. Hence, the application for appointment of Arbitrator cannot be gone into for the bar created u/s. 69(3) of the Indian Partnership Act, 1932.

Fixed Deposits – Renewal of fixed deposits cannot be made in the name of different constituent other than original depositor. [Banking Regulation Act – Section 45ZB].

fiogf49gjkf0d
The Canara Bank vs. Sheo Prakash Maskara AIR 2016 PATNA 58 (HC).

Father, mother and son had different Kamdhenu Deposits made in the year 1996. These deposits were cumulative deposits i.e. the interest accruing is ploughed back and upon maturity, the entire cumulative amount is paid. They were to mature for payment at the end of one year i.e. in 1997. None of the three parties approached the Bank for either renewal or encashment of the said deposit certificates, it lay with the Bank. In other words, the money remained with the Bank. For the first time in the year 2002, the parties approached the Bank for renewal of the deposit receipts. This time the Bank refused to renew the receipts with effect from the date of its original maturity, though they were agreeable to renew the same for the matured amount from the date when they applied for renewal in 2002. However, the head office of the Bank examined the matter and directed the Bank to renew the certificates in relation to the son with effect from the date of its maturity on rate of interest prevailing in that period, but when it came to father and mother the Bank took a stand that it will not give the same treatment.

The Division bench of the High Court held that there is no plausible explanation why in case of the son the Bank agreed to renew for five years retrospectively and grant interest at the then prevailing rates, but when it came to his father and mother why the Bank took a different stand. Therefore, the Court held that the direction of the learned single Judge which is virtually directing that same treatment has to be given to the parents cannot be faulted with, but there was a problem i.e. due to subsequent events. It is not in dispute that during pendency of the writ petition, mother had died on 13-10-2010. Thus, renewal could only be up to that period and not beyond that. There cannot be a renewal in name of a different constituent, than the original applicant, as that would be a fresh deposit. To accept or not to accept fresh deposit is Bank’s discretion and that would also depend upon the claimants upon death, establishing their rights in absence of nomination. Father died on 17-9-1998, and it is for the first time in 2002 that renewal was sought by one of the sons. There could be no renewal in his name. To that extent, we are of the view that after the death of father, the K.D.R. receipt could not be renewed as there is no proof of the fact that renewal or maturity claim was led by all the heirs completing all formalities. The Court further held that if all the heirs claim payment consequent to encashment, Bank would pay the same as per their joint claim in the shares they desire.

Daughters – Daughters in tribal areas in the State of Himachal Pradesh will inherit property in accordance with Hindu Succession Act 1956 and not as per custom and usage. [Hindu Succession Act, 1956 – Section 2(2), 4]

fiogf49gjkf0d
Bahadur vs. Bratiya and ors AIR 2016 HIMACHAL PRADESH 58 (HC).

 A suit for declaration to the effect that father of plaintiff Rasalu was Gaddi, therefore, belonged to Scheduled Tribe community. The parties were governed by custom, according to which, the daughters do not inherit the property of their father

Sub-section (2) of section 2 of the Hindu Succession Act (the Act) reads as under:-

“(2) Notwithstanding anything contained in s/s. (1), nothing contained in this Act shall apply to the members of any Scheduled Tribe within the meaning of clause (255) of Article 366 of the Constitution unless the Central Government, by notification in the official Gazette, otherwise directs.”

The High Court held that in few of the judgments of the Senior Sub Judge and District Judge, it is held that in the community of Gaddi, property devolves only upon the sons and it does not devolve upon the daughters, but in few of the judgments, it is held that property amongst Gaddi community would devolve upon sons and daughters equally. There is no consistency in the judgments cited to prove the custom amongst the Gaddies that sons alone would inherit the property. The plaintiff had not even placed on record copy of Riwaj-i-aam to prove that there is a custom prevalent in the Gaddi community that after the death of male collateral, the property devolves upon sons only and not upon daughters. In the copy of Pariwar register produced by the plaintiff, expression “Rajput Gaddi” has been mentioned. It further strengthens the case of the defendants that parties were Rajput and not Gaddi.

Even if it is hypothetically held that the parties were Gaddi, still the plaintiff has failed to prove that there was any custom whereby the girls were excluded from succeeding to the property of their father. According to the plain language of section 4 of the Hindu Succession Act, 1956, any text, rule or interpretation of Hindu Law or any custom or usage as part of that law in force immediately before the commencement of the Act shall cease to have effect with respect to any matter for which provision is made in the Act. In view of this, though there is no conclusive evidence that the custom is prevailing in the Gaddi community that the daughters would have no rights in the property but even if it is hypothetically assumed that this custom does exist, the same would be in derogation of section 4 of the Hindu Succession Act, 1956.