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The New India We Want by Shri N. R. Narayana Murthy

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Whoever becomes the Prime Minister will be the Prime Minister for every citizen, every resident and every visitor of India. The new PM will have to heal the secular rupture that has taken place. No country can make stellar economic progress unless there is peace at its borders and harmony within. Therefore, the first duty of the new PM will be to create an environment where every dialogue, including those with our neighbours, is on a platform of civility, courtesy, harmony and facts. This is the only way to enthuse and energise Indians of all religious beliefs, political ideologies and social status.

The economy has suffered during the last four to five years. The reputation of India has taken a beating abroad during the last six to eight years. During 1999-2009, when China was mentioned three times in boardrooms abroad, India was mentioned at least once. Today, India is not mentioned even once when China is mentioned 30 times. Good governance rests on seven important attributes: equity, fairness, transparency, accountability, honesty, secularism and a robust, consistent and responsive legal system. Most public governance experts tell me that we have seen the steepest fall in these attributes during the last five years. Therefore, the first task for the new PM is to restore these attributes at least to the level they were during the 1990s.

If we want to raise the hope and confidence of the Indian youth, we have to create jobs for them — jobs with good disposable income. We have to create 150-200 million jobs during the coming decade. The only way we can spend more on social welfare programmes is by collecting more taxes that come from growth in corporate activities. The new PM has to articulate India’s commitment to the seven attributes. Our embassies, immigration and customs officials must be empowered to make the visit of every foreigner a pleasant experience. Our state governments must become active partners in this task.

A trusted and well-informed Cabinet group should visit the global capitals every three months and reiterate these messages and make sure that enough investments come in. We have excellent people to lead such groups on both sides of the aisles. These are modern, well-informed individuals who can raise the confidence of senior corporate leaders.

The new PM must accept that, at this stage of our development, jobs can be created only in urban and semi-urban areas. The need of the day is to make our cities more attractive not just for Indians but for foreigners too. We must keep our ego down and realise that the foreigners have umpteen global options for investment. The PM must make the visit and stay of foreigners hasslefree. It is amusing that the visa-on-arrival facility is not available for even one country that is among our top five trading partners in software. The PM must create a ministry of urban governance. An apolitical expert with a proven track record has to lead this ministry since this is essentially a Centre-state issue.

It is time that we made life better for our poor people. We have to focus on education, healthcare, nutrition and shelter. All programmes that provide such facilities must use Aadhaar identity to deliver services efficiently and without corruption through a voucher scheme. You cannot run any such directed schemes without strengthening Aadhaar. Therefore, the new PM must appoint a smart, modern and a results-oriented technocrat to run UIDAI. While continuing with the right to education ideology, the new government must provide full subsidy to the private sector players in these fields through vouchers without making these institutions debilitated.

Taking about education brings me to initiatives in higher education. The new PM must give top priority to pass Bills on welcoming foreign universities and starting innovation universities. Without adequate focus on research and higher education, India’s future is shaky.

Ever since the mid-1970s, population control has been given up. I have hardly seen any PM speak about it since then. It is time we resurrected this important initiative.

Peace at our borders is extremely important and the new PM must give priority to that task. We have not seen any major move with Pakistan since A B Vajpayee’s time. It is time we acted as the elder brother to Pakistan and helped that country overcome the trauma they are facing. A happy India requires a happy Pakistan.

(Source: Extracts from an article by Shri N. R. Narayana Murthy, Executive Chairman Infosys, in The Economic Times dated 29-04-2014)

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Poor Quality of Our Democracy

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This election season, in the midst of our self-congratulation over the vitality of Indian democracy, we should ask ourselves: What is the quality of our democracy? Democracy cannot simply be a plurality of parties, free elections, peaceful handovers of power, an independent judiciary, constitutional governance, and personal and group freedoms. A healthy democracy must also have and promote substantively rich debate on policy alternatives and choices.

It is striking that through the campaign there has been no debate, of any depth, on everyday policy issues. Indian politicians seemingly have neither the stomach nor the intellectual bandwidth for those kinds of debates. The media too cannot sustain any kind of sensible commentary on key policy choices facing us. You would look in vain for an analysis of hard policy tradeoffs as we confront economic and social challenges.

Nowhere is this more evident than in respect of election manifestos which promise all manner of things. Are the policies they enunciate desirable? And if desirable, are they feasible financially, socially, politically, and culturally? Our media should be trying to answer these questions. Instead, they are preoccupied with who will win the election, who did what during campaigning and what is the last thing Narendra Modi said.

The manifestos of the two major parties suggest both are agreed on a Goods and Services Tax (GST) and encouraging foreign investment. That is worth bringing to the attention of voters. Yet few in the media have bothered to do so. BJP’s opposition to allowing multibrand retailing and its espousal of simpler tax structures has had some mention. Can India repudiate its decision on multibrand retailing? How would foreign investors react to constant policy changes? And how should we simplify our tax structures?

Both parties want to do something for health. Congress wants to pass a right to health bill, increase health expenditures to 3% of GDP and create millions of jobs in that sector. How to define the right to health? How many rights-based bills can we work with (right to education, right to information, right to food)? Is 3% too much or too little, and what would we spend less on? What kinds of jobs does Congress want to create in health?

BJP wants to raise education expenditures to 6% of GDP, encourage online courses and boost vocational training. Is 6% affordable, what are the limitations of online learning and do we have the connectivity for it, and how to energies the moribund vocational sector?

Millions are migrating to towns and cities. Urban policy is therefore a huge challenge. Congress wants to build 100 urban clusters around older or emerging cities to take the pressure off existing conurbations. BJP wants to go further and create 100 completely new cities. Which way is better? Is either feasible given struggles around land rights, a new land acquisition bill and lack of supporting infrastructure?

Speaking of infrastructure, both parties want high-speed trains. Given the horrendous record of Indian railways in managing low-speed trains, how would we move to a different, more exacting system? High-speed trains require new tracks. That means dedicating a lot of land to the project. How will that be achieved when land is at such a premium? BJP thinks that we desperately need freight corridors, industrial corridors and a port-led development strategy. Has anyone weighed up what this would mean, how we would pay for it and where we would locate these installations?

We in India are obsessed with the most superficial, transitory and procedural elements of policy making and with quite a thin conception of democracy and good governance. We pat ourselves on the back for holding elections and over deep, elemental battles in our politics — the secularism debate, or human development versus growth-led development and a host of other relatively abstract, philosophical arguments. On the other hand, we shy away from hard-headed, rigorous engagement with everyday policy challenges. If we continue to neglect these everyday challenges in social and political life, we will see our bubbling democracy subside and then eventually be consigned to the dustbin of history.

(Source: An Article by Mr. Kanti Bajpai in the Times of India, dated 26-04-2014)

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Applicability of PAN requirement for Foreign Nationals

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The Ministry of Corporate Affairs has vide General Circular No. 11/2014 dated 22nd May 2014, has clarified that the PAN details are mandatory only for those foreign nationals who are required to possess “PAN” in terms of provisions of the Income Tax Act, 1961 on the date of application for incorporation while filing Form INC -7 for incorporation of Company. Where the intending Director who is a Foreign National is not required to compulsorily possess PAN, it will be sufficient for such a person to furnish his/her passport number, along with undertaking stating that provisions of mandatory applicability of PAN are not applicable to the person concerned. The form of Declaration is required to be made in the proforma given in the circular.

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Certification of forms under the Companies Act, 2013 by practicing professionals

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The Ministry of Corporate Affairs has vide General Circular No. 10 /2014 dated 7th May 2014, invited the attention of the professional bodies ( ICAI, ICSI, ICWAI) for authenticating the correctness and integrity of documents being filed by them with the MCA in electronic mode. It is required to examine e-forms or non e-forms attached and filed with general forms on MCA portal viz. to verify whether all the requirements have been complied with and all the attachment to the forms have been duly scanned and attached in accordance with the requirement of above said rules.

Where any instance of filing of documents, application or return or petition etc. containing false or misleading information or omission of material fact or incomplete information is observed, the Regional Director or the Registrar as the case may be, shall conduct a quick inquiry against the professionals who certified the form and signatory thereof including an officer in default who appears prima facie responsible for submitting false or misleading or incorrect information pursuant to requirement of above said Rules; 15 days’ notice may be given for the purpose.

The Regional Director or the Registrar will submit his/her report in respect of the inquiry initiated, irrespective of the outcome, to the Governance cell of the Ministry within 15 days of the expiry of period given for submission of an explanation with recommendation in initiating action u/s. 447 and 448 of the Companies Act, 2013 wherever applicable and also regarding referral of the matter to the concerned professional Institute for initiating disciplinary proceedings.

The E-Gov cell of the Ministry shall process each case so referred and issue necessary instructions to the Regional Director/ Registrar of Companies for initiating action u/s 448 and 449 of the Act wherever prima facie cases have been made out. The E-Gov cell will thereafter refer such cases to the concerned Institute for conducting disciplinary proceedings against the errant member as well as debar the concerned professional from filing any document on the MCA portal in future.

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Delegation of powers u/s 458 of Companies Act 2013 to the Regional Directors

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The Ministry of Corporate Affairs has vide notification dated 21st May 2014, delegated the powers and functions of the Central Govt to the Regional Directors at Mumbai, Kolkata, Chennai, Noida, Ahmedabad, Hyderabad and Shillong, for sections :

• Section 8(4)(i)(a) for alteration of Memorandum in case of conversion into another kind of Company

• Section 8(6) for revocation of license granted u/s. 8 in respect of companies with Charitable objects

• Section 13(4) and 13 (5) for shifting of registered office from one state to another

• Section 16 for rectification of name of company
• Section 87 for rectification in the register of charges • Section 111 (3) for circulation of members resolution
• Section 140 (1) for removal of auditor before the expiry of his 5 year term ;and
• Section 399 (1)(i) for inspection, production and evidence of documents filed with prospectus

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Delegation of powers u/s 153 and 154 of Companies Act, 2013 to Regional Director, Noida

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The Ministry of Corporate Affairs has vide notification dated 21st May 2014, delegated the powers and functions of the Central Government in respect of allotment of Director Identification Number (DIN) u/s.s 153 and 154 of the said Act to the Regional Director, Joint Director, Deputy Director or Assistant Director posted in the office of Regional Director at Noida.

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Delegation of Powers u/s. 458 to ROC

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The Ministry of Corporate Affairs has vide Notification dated 21st May 2014 delegated powers for the following sections of the Companies Act, 2013 to the Registrar of Companies

• Section 4(2)(a) – if the Name stated in the Memorandum is not undesirable
• Section 8(1)(b) – for Grant of License to Company on being incorporated with Charitable Objects
• Section 8(4)(i)(c) – For permission for alteration of the Memorandum and Articles of association of Companies incorporated with charitable objects etc. except for conversion into Company of other kind.
• Section 8 (5)- grant of license to existing companies for registration under this section
• Section 13(2)-for approval for change in the name of the Company

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A. P. (DIR Series) Circular No. 130 dated 16th May, 2014

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External Commercial Borrowings (ECB) from Foreign Equity Holder – Simplification of Procedure

This circular provides that, with immediate effect, approval under the Automatic Route will now be granted by the Bank of the borrower and not by RBI in the following cases where ECB has been availed of from FEH (direct holder as well as indirect holders) and group companies of FEH: –

1. ECB by companies belonging to manufacturing, infrastructure, hotels, hospitals and software sectors from indirect equity holders and group companies.

2. ECB by companies in miscellaneous services from direct/indirect equity holders and group companies. Miscellaneous services mean companies engaged in training activities (but not educational institutes), research and development activities and companies supporting infrastructure sector. Companies doing trading business, companies providing logistics services, financial services and consultancy services are, however, not covered under the facility.

3. ECB by companies belonging to manufacturing, infrastructure, hotels, hospitals and software sectors for general corporate purpose (which includes working capital financing) from direct equity holder.

4. Change of lender when the ECB is from FEH – direct/ indirect equity holder(s) and group companies.

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A. P. (DIR Series) Circular No. 129 dated 9th May, 2014

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External Commercial Borrowings (ECB) Policy – Refinance/Repayment of Rupee loans raised from domestic banking system

Presently, subject to certain terms & conditions, Indian companies are permitted to refinance/repay the Rupee loans, raised by them from the domestic banking system, by raising ECB from recognised lenders, subject to conditions.

This circular prohibits with immediate effect eligible Indian companies to raise ECB from overseas branches/ subsidiaries of Indian banks for the purpose of refinance/ repayment of the Rupee loans raised from the domestic banking system in respect of the following:

a. Scheme of take-out financing.
b. Repayment of existing Rupee loans for companies in infrastructure sector.
c. Spectrum allocation.
d. Repayment of Rupee loans.

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A. P. (DIR Series) Circular No. 128 dated 9th May, 2014

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External Commercial Borrowings (ECB) Policy: Re-schedulement of ECB – Simplification of procedure

Presently, prior approval of RBI is required for any elongation/ rollover in the maturity period of an existing ECB.

This circular now permits banks to grant elongation/ rollover of the maturity period of an existing ECB (but not FCCB) availed under the Automatic Route or the Approval Route, subject to the following conditions: –
i. Changes, if any, in all-in-cost (AIC) must only be on account of change in average maturity period (AMP) as a result of re-scheduling of ECB and post rescheduling the AIC and the AMP must be in conformity with the applicable guidelines.
ii. T here must not be any increase in the rate of interest and no additional cost (in foreign currency/Indian Rupees) must be involved due to the re-scheduling.
iii. R e-scheduling is permitted, only once, before the maturity of the ECB.
iv. I f the lender is an overseas branch of a domestic bank, prudential norms applicable on account of rescheduling have to be complied with. v. Changes on account of re-scheduling must be reported to DSIM through revised Form 83.
vi. E CB should be in compliance with all applicable guidelines related to eligible borrower, recognised lender, AIC, AMP, end-uses, etc.
vii. The borrower must not be in the default / caution list of RBI and should not be under investigation of the Directorate of Enforcement.

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A. P. (DIR Series) Circular No. 127 dated 2nd May, 2014

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Foreign Direct Investment (FDI) in India – Reporting mechanism for transfer of equity shares/fully and mandatorily convertible preference shares/fully and mandatorily convertible debentures

This circular states that: –
(a) In cases where the NR investor including an NRI, who has acquired and continues to hold control in an Indian company in accordance with SEBI (Substantial Acquisition of shares and Takeover) Regulations, acquires shares on the stock exchanges under the FDI scheme through a registered broker it is the duty of the investee company to file form FC-TRS with the bank within 60 of the transaction.

(b) Henceforth, banks have to approach the concerned Regional Office of RBI (as against the present system of approaching the Central Office of RBI) to regularise the delay in submission of form FC-TRS, beyond the prescribed period of 60 days.

(c) IBD/FED or the nodal office of the bank has to continue to submit a consolidated monthly statement in respect of all the transactions reported by their branches together with copies of the FC-TRS forms received from their branches to FED, RBI, Foreign Investment Division, Central Office, Mumbai in a soft copy (in MS- Excel).

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(2011) 38 VST 159 (P & H) M/s. Goyal Motor Parts v. State of Punjab

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Rate of tax — Sale of digital inverters with UPS facility — Information technology products — Taxable at 4% — Schedule Entry 60(27) of Punjab Vat Act, 2005 — Tribunal cannot brush aside reports of technical experts.

Facts:
The appellant sold microteck digital inverters, manufactured by M/s. Microteck International, as UPS-EB having extra facility of UPS (Uninterrupted Power Supply) to run computers and paid 4% rate of tax being covered by sub-entry (27) of entry 60 of Schedule B of the Punjab VAT Act, 2005. The designated authority held it taxable @12.5% being covered by residual entry. The Appellate Authority relying on report of certain laboratories allowed appeal, against which the Department filed appeal before the Punjab VAT Tribunal. The Tribunal allowed appeal filed by the Department and held that only such uninterrupted power supply (UPS) products which were information technology products were to fall in Entry 60 of Schedule B and any other product even if named UPS would be chargeable @12.5% tax. The appellant referred substantive question of law to the Court for determination arising out of the order passed by the Tribunal.

Held:
The product sold by the appellant is an electronic power source which stores the energy in batteries connected to it when the AC source is present and converts this energy automatically to AC power when the input AC source fails and automatically feeds so generated AC powers to load connected and returns to mains when the AC source comes back to the input side. As per certificate of IIT Delhi the product sold by the appellant is a UPS. This could be used both as inverter as well as in computers. The appellant sold the goods in the market through retailers and was not in a position to determine as to what use the goods would be put to, as the same would be entirely at the discretion of purchaser.

The Court following the decision of the Madras High Court in case of State of Tamil Nadu v. M/s. Vinyl Cable Industries, (1993) 88 STC 430 and decision of SC in case of M/s. Hindustan Poles Corporation, (2006) 145 STC 625 held that goods in question sold by the appellant fulfil all the conditions of an UPS and hence taxable at 4%. The Court further held that the Tribunal fell in error in brushing aside the reports of technical experts opining that goods in question were UPS.

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(2011) 38 VST 142 (P&H) M/s. Jaibharat Gum and Chemicals Ltd. v. State of Haryana and Others

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VAT — Quantification of refund as per appeal order — No power to consider merit of case.

Facts:
The petitioner, the manufacturer of ‘guar gum’, exported ‘guar gum’. The petitioner claimed refund of tax paid on purchase of raw material ‘guar’ which was disallowed in assessment but in appeal it was granted. Thereafter, while quantifying refund as per appeal order, the revisional authority disallowed the refund on merit. The Tribunal confirmed the order of revisional authority disallowing refund. The petitioner filed petition before the Punjab and Haryana High Court against the order passed by the Haryana Tax Tribunal.

Held:
The High Court, following its earlier order in case of Raghbar Dass Hukam Chand & Co v. State of Haryana, (2009) 25 VST 574, allowed the petition. The relevant observations of the Court in the said case are as under:

“Therefore, we are of the view that on principle as well as on precedent, it stands established that an officer exercising power of determining the amount of refund cannot exercise the power of review or appeal or revision. Such an officer has to respect the order of assessment and then is required to proceed to determine the amount of refund. The provisions of section 43 read with Rule 36 postulates limits of their power as already noticed and, therefore, the orders passed by the Deputy Excise and Taxation Commissioner are liable to be set aside.”

However, the Court made clear that this will not affect the merits of liability of the petitioner in pending appeal.

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(2011) 22 STR 56 (Tri.-Chennai) — SMP Steel Corporation v. CCE, Madurai.

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Power of revision not exercisable when an appeal is pending before the Commissioner (Appeals).

Facts:
The penalties were set aside by the Commissioner (Appeals) vide his order dated 25-2-2010. Since, a revised order was passed by the adjudicating authority in June 2010, subsequent to the order of the Commissioner (Appeals); the appellants were in appeal against the revised order.

Held:
Power of revision cannot be exercised in respect of any issue which is appealed before the Commissioner (Appeals). In the present case, the order was revised after the appeal before the Commissioner (Appeals) was decided. The revision was bad in law and appeal was allowed in favour of the appellants.

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(2011) 22 STR 20 (Tri.-Chennai) — Anil Kumar Yadav v. CCEx., Pondicherry.

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Section 80 of the Finance Act cannot be invoked to waive penalty under some sections and to impose penalty under some other sections.

Facts:
The original authority had imposed penalty u/s. 78 of the Finance Act, but had not imposed any penalty u/s. 76 and 77 of the Finance Act invoking section 80 of the Finance Act. On appeal against the order of the original authority for waiver of penalty u/s. 78, penalty amount was reduced to 25%. However, the appellant appealed that full penalty shall be waived as he had paid the entire Service tax amount along with interest, proving bona fide interest. The respondents appealed that since the penalty amount of 25% was not paid within one month, full penalty shall be imposable.

Held:
Section 80 is applicable in respect of penalties imposable u/s.s 76, 77 and 78 of the Finance Act. Once it is accepted that there was a reasonable cause for such failure to pay Service tax, penalties u/s.s 76, 77 and 78 all are to be waived. More so since the Department had not appealed against waiver of penalty u/s.s 76 and 77 r.w.s 80 of the Finance Act. Section 80 does not authorise authorities to waive the penalty under some sections and impose penalty under some other sections. Therefore, penalty imposed u/s. 78 could not be sustained.

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(2011) 22 STR 215 (Tri.-Bang.) — KPIT Cummins Infosystems Ltd. v. CCEx., Bangalore.

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Enhancement of penalty by the same authority cannot be permitted when adjudication order is already passed.

Facts:
The Commissioner issued a show-cause notice dated 18-6-2008 and after following the principle of natural justice, passed an order for enhancement of penalty. The appellants argued that the order being issued by the Commissioner, it cannot be reviewed by the Commissioner himself and the same is in violation of Appellate processes under the Finance Act. 

Held:
The Tribunal held that once an adjudication order is passed, show-cause notice issued by the same authority cannot hold good for the same issue and the Revenue should exercise other available alternative options in the statute.

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(2011) 22 STR 177 (Tri.-Mumbai) — Affinity Express India Pvt. Ltd. v. CCEx., Pune-I.

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Refund of Cenvat credit — Export of business auxiliary service — Service was taxable after May 2006 — Assessee entitled to take credit at the time of availment — Even prior to May 2006. Refund of Cenvat credit — Export of business auxiliary service — Service tax paid on local travel and medical insurance services, outdoor catering and meal coupons — Credit admissible.

Facts:
The appellants had filed a refund claim of Cenvat credit availed on input services used for export of business auxiliary service, for the period starting from April 2006. However, the claim for local travel and medical insurance was rejected by the lower authorities and the claim for outdoor canteen/meal coupons was allowed. Thereby, the appellants and the Revenue both were in appeal for disallowance and allowance of refund claim by the lower authorities.

The Revenue submitted that the services exported by the appellants had come under Service tax net with effect from 01-05-2006, therefore, any input service availed before 1-5-2006 is not eligible for credit.

However, as per the Cenvat Credit Rules, the appellants were entitled to take credit at the time of availment and not at the time of provision of service. This means that the appellants were entitled to avail the input service credit of services availed in the month of April 2006.

In support of availment of credit on local travel and medical insurance, reliance was placed on the Bombay High Court’s decision in case of Ultratech Cement, 2010 (20) STR 577 (Bom.) wherein it was held that the input service availed by the assessee in the course of business is entitled for Cenvat credit.

Apart from this, with regard to outdoor catering and meal service, the appellants stated that credit on outdoor catering service is available if the cost of food is borne by the employer. However, the appellants were denied credit on the amount recovered from employees against subsidised food.

Held:
The appeal was allowed to the appellants in respect of availment of credit for the month of April 2006 and for availment of credit of Service tax paid on local travel and medical insurance. On the other hand, the Revenue’s appeal was partly allowed by denying credit of Service tax paid on outdoor catering and meal service, for the amount which was recovered by the assessee from the employees.

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IFRS — FAULTY FRAMEWORK?

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In the UK, the House of Lords report on audit published in March this year created headlines on competition and choice in the audit market and on the audit of banks. While their Lordships made many of their remarks specifically in respect of bank auditing and bank accounting, there were criticisms that were more generic, stemming from the rules-based nature of IFRS and the evidence suggesting that IFRS was an ‘inferior system’, which limited auditors’ scope to exercise ‘prudent judgment’. They went on to recommend that the use of IFRS should not be extended until the ‘long and uncertain process’ of achieving general agreement on IFRS was complete.

Considering that all publicly-held companies in the UK are required to report using IFRS, these are damning criticisms and ones that bear wider examination. While there is a general agreement that IFRS is a theoretically sound framework for financial reporting, practice suggests that all is not well. The reality is that companies are effectively using their own individual financial reporting frameworks when they communicate with the market. GAAP measures tend not to be broadcast, but frequent reference is made to ‘adjusted (EBITDA) (Earnings Before Interest, Taxes, Depreciation and Amortisation)’. The more cynical might suggest that everyone adjusts their EBITDA to suit themselves and that it forms a sort of ‘earnings before the bad stuff’. However, many auditors insist that GAAP figures have equal prominence with non- GAAP measures, the reality is that analysts and the media reflect other measures, such as free cashflow and maintainable earnings.

There are also a number of areas where business people intuitively distrust IFRS and those tend to relate to areas where the economics implicit in accounting judgments fail to reflect the business decisions behind them.

For instance, in IFRS, the excess of the acquisition cost over the individual net tangible asset values of a business acquired represents a number of intangible assets, whereas under UK GAAP it was all bundled together as goodwill. The values attributed to brands, customer lists and other such intangible assets, all require separate valuation exercises using theoretical models and a number of variable inputs.

The resulting values can vary greatly, depending on the inputs used. I have rarely met anyone in business who ascribes values to intangible assets in such a way, when considering a business acquisition or otherwise, and it is hardly surprising that doing so for accounting purposes causes a degree of the financial reporting outputs to be distrusted.

This distrust of formal financial reporting has contributed to the annual report becoming more a document of record than a live source of information. Companies are now more sophisticated and have a number of channels through which information is given to the market. When taken in conjunction with the blandness and sheer volume of narrative reporting and disclosures in annual reports, it is little wonder that some now see them as anachronistic.

What is to be done? On IFRS, I remain convinced that it is the nearest thing to a conceptual framework that can work globally and scalably for different sizes of companies. However, there are areas where it has become overly complex and produces results that just do not make sense to people in business. These need a long hard look, particularly around asset and liability valuation, impairment, intangibles, share options and deferred taxation. It should be fundamental that an accounting framework is scalable so that we can actually have comparability between companies that have different ownership characteristics, but which might otherwise be identical. IFRS can be put in this position if its complexities are resolved and if its rebalances use fundamental principles to give weight to prudence, comparability, reliability and understandability.

If the Lords’ report can start a sensible debate around IFRS and financial reporting more generally, it will have been worthwhile, irrespective of its sharp analysis of the competitive framework of audit.

[Source : James Roberts, Accountancy, May 2011 (excerpted)]

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Harness IT, collaborate and grow !

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Information technology (IT) is a term we read,
write and hear every day, but one has to wonder whether we have truly
understood its potential. Two recent news items have got me thinking.
The first is the enormous embarrassment caused to India, when two
persons out of the ‘50 most wanted list’ submitted by us to our
neighbouring country were found to be in our own backyard. This was the
result of Indian investigating agencies not sharing information. The
consequence was a serious dent to their credibility in the eyes of the
public.

The second news item was about the judge, who permitted
the use of an iPad by an accused in the 2G scam case, to process the
85,000 pages he was expected to read, to prepare for his defence. The
learned judge was of the opinion that without the use of technology this
was impossible.

What do these two events indicate? We are ready
to accept technology which will enable the processing and disseminating
of information, but are simply not willing to share that information.
What are the reasons that compel people to withhold information and
treat it as secret? The first and the most obvious is that its
disclosure will affect or damage vested interests. Withholding
information that should rightfully be in the public domain is a crime.
This is done when the person withholding the information desires illegal
gratification or gain. To counter this, we have measures like the Right
to Information (RTI), Act. A vigilant media has already exposed a
number of scams. One hopes this will help in cleansing public life and
result in reducing, if not removing corruption.

Even more
disturbing is the mindset of bureaucrats and other public authorities.
They believe if information, however trivial, is made public, it will be
misused. This could possibly be coming from their belief, that they are
the rulers, and the public their subjects. The creators of data, the
gatherers or possessors of information, are of the view that such data
or information is their source of power, and by not sharing it they
would continue to be powerful. What they fail to realise is that by not
sharing this information, they become vulnerable to public criticism. It
is quite possible that the non-disclosure of information is not always
with the intent of making money, rather it is to do with the lack of
transparency in the system.

It is this mindset that has to
change. I am conscious that certain categories of information cannot be
shared, because they may involve national security. But such categories
would be very few. Non-disclosure of information must be an exception
and not the rule. If this is not done, information finds its way to the
public fora through unofficial channels, which can lead to
misinformation campaigns, some of them, vicious. To illustrate, one must
look at the impact of the Wikileaks cables that have been doing the
rounds in the press. Much of what is being circulated is the opinion of
the person who sent those cables. However, since those in power and in
public life have been so averse to sharing information , the public
tends to believe everything that is now appearing in the press. Thus,
non-disclosure of information at the appropriate time has caused more
damage than benefit. Those holding public office must learn to be
transparent in their dealings. It is only then that the confidence of
the public, which has been shattered by all these scams, will be
restored to some extent atleast. For this purpose the power of
technology can be harnessed.

What is true of governments is
equally true in the commercial world. In today’s world, information
which is the source of knowledge, and at times knowledge itself, will
have to be shared and placed in the public domain. This is because the
problems that face the world are of such magnitude, it will require a
global effort to solve them. In an era when corporates pay huge sums of
money to acquire intellectual property rights, and incur enormous
expenditure to protect them, readers will doubt the validity of the
statement. An illustration from the book, Macrowikinomics, by Don
Tapscott and Anthony Williams will possibly prove this point. In 2007,
after investing millions of dollars and three years to unlock the
genetic basis of type 2 diabetes, which poses one of the most costly
challenges in the industrialised world, Novartis posted its raw research
data on the internet. In the fiercely competitive world of drug
manufacturers, people wondered if the company had lost its mind. The
president of the company thought otherwise. In his words, “To translate
this study’s provocative identification of diabetes-related genes into
the invention of new medicines will require a global effort”. By placing
its data in the public domain, the company hoped to leverage the
talents of the global research community, well beyond its employees. It
should be noted that Novartis did not share everything. It did not share
its own notes or commentary, thereby retaining its lead to some extent.
It, however, felt that sharing its initial research would be more
beneficial than hoarding it behind a wall of patent protection.

There
are lessons to be learnt by our profession from the narrative in the
preceding paragraph. In times where complexities of business and
regulation are multiplying, and the expectations from the users of our
services are increasing, we need to collaborate with members from our
profession, as well as other sister professions and disciplines. With
technology being what it is, I think geography is no barrier. To use a
popular phrase, geography is now history! I find the young generation is
already using technology to communicate and interact. The growth of
networking sites is testimony to this fact. Two hurdles need to be
overcome. The first is the attitude of some who believe that protection
of their knowledge base is their ticket to prosperity. The second is the
aversion of some of the jewels in our profession, to the use of
technology to share their wisdom. If these obstacles can be overcome,
and I am sure they will, our profession has a great future!

Anil J. Sathe
Joint Editor
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Learning to work

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“The Greatest Waste in the world is the difference between what we are and what we are capable of becoming”

— Ben Herbster

Sounds strange, but all of us have to learn to work. Most of us are working far below our capacity. Our abilities and energies are underutilised. We are like an industrial organisation with the installed capacity of 1000 units, but just producing 200 units. If we can substantially reduce the gap between what we are capable of producing and what we actually are producing, we can work wonders. Sounds strange, but it is true. One is reminded of the words of Thomas Alva Edison:

“If we all did the things we are capable of doing, we would literally astound ourselves”

Why should one work?
Gandhiji has described ‘Wealth without Work’ as one of the seven deadly social sins. We do not have to look very far to see what happens, when people inherit large chunks of wealth and who, because they have much more than they need, stop doing any productive work and wile away their time. Wealth without work not only kills their desire to work, but makes them spend their money on luxuries, wine, women and what not. Therefore one has to work, and teach one’s children also to work, in spite of the wealth that one possesses.

Even Lord Krishna in the Bhagavad Gita advises Arjuna to work:

“There is nothing in the three worlds, Partha, that should be done by Me, nor anything unattained that might be attained, yet I mingle in action.”
“For if I mingled not ever in action unwearied, men all around would follow my path, son of Pritha”

Krishna in other words says: If leaders in our society, who are occupying high positions do not work, they set an example to the rest of the society. It is therefore necessary that we work, and work to our fullest capacity.

How should we work?
Having concluded that we should work, one should also learn to work efficiently. People have the tendency to spread work over available time. We should not spend the whole day on work which can be finished in a couple of hours, and feel that we have been working hard for the full day.

What should be the manner of our working?
People have to work for earning a livelihood. The question is how should one earn. Let us remember what our scriptures tell us:

“Without causing any torment to others, without going to the place of villainous people, without causing any unhappiness to your soul, even if you earn a little, that should be considered to be more than enough.”

What should be the purpose of our work?
Working hard and making an honest living is not enough. We should work with a purpose, a noble cause. There is a difference between just breaking stones and working to make a temple. Working for a good cause brings a special kind of happiness and a sense of fulfilment, a joy which is difficult to describe. If we can bring a smile to the face of the poorest of the poor, and wipe a tear from the eyes of a person undergoing pain and suffering, we would have done something worthwhile. It is this small act of kindness and grace that really matters. In the words of Mother Teresa:

“We cannot do great things on this Earth, only small things with great love.”

What should be the ultimate goal of our work?

Ultimately we have to reach a stage where we realise we are working for God, as per His wish. We must then understand that it is not we who are working, but it is God who is working through us. We are just His chosen instruments. In words of Shri Haribhai Kothari.

Let us then work, work to our fullest capacity, work for noble causes and work understanding that it is God who is working through us. It will make our lives truly worthwhile.

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(2011) 137 TTJ 508 (Coch.) F.C.I. Technology Services Ltd. v. ACIT ITA No. 616 (Coch.) of 2008 A.Y.: 2003-04. Dated: 4-6-2010

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Section 10A — While computing deduction u/s.10A of an eligible unit, loss of non-eligible and other eligible unit cannot be set off against profit of such eligible unit.

The assessee was rendering services from its three units located at Chennai, Bangalore and Kochi. It claimed exemption of Rs.58.68 lakh u/s.10A in respect of income from the Bangalore unit. The Assessing Officer held that the loss from the other two units had to be set off first against the income of the Bangalore unit and since this set-off left the assessee with no positive income, the assessee was not entitled to any exemption u/s.10A. The CIT(A) upheld the order of the Assessing Officer.

The Tribunal, following the Special Bench decision of ITAT Chennai in the case of Scientific Atlanta India Technology (P.) Ltd. v. ACIT, (2010) 129 TTJ 223 (Chennai) (SB)/(2010) 37 DTR 46 (Chennai) (SB)/(2010) 2 ITR 66 (Trib.) (Chennai) (SB), held as under:

(1) The business loss of non-eligible unit(s) cannot be set off against the profits of undertaking(s) eligible for deduction u/s.10A.

(2) Any other income, including the losses arising to the assessee from other concerns, shall be computed as per the regular provisions of the Act, and, consequently, carried forward under and in terms of the regular provisions of the Act.

(3) That the unabsorbed claim u/s.10A, i.e., the income after deduction, having arisen from an eligible unit, cannot be carried forward in the like manner as a business loss or unabsorbed depreciation and would, therefore, be subject to tax.

(4) Deductions u/s.10A and u/s.10B, and also those u/s.80HH, u/s.80HHA, u/s.80-I, u/s.80-IA, etc. are unit-specific in contradiction to being assessee-specific.

(5) There is nothing in the section that suggests aggregation of profits from two or more undertakings so that the profit derived from each is to be considered separately i.e., as if it were the only income of the assessee, for the purpose of computation of deduction thereunder.

(6) In other words, the qualifying amount and, consequently, the deduction in its respect are to be worked out on a stand-alone basis, independently for each eligible unit.

(7) Loss of any other unit is not to be set off while computing deduction u/s.10A.

(8) Income that remains after the deduction u/s. 10A or the unabsorbed claim u/s.10A would stand to be taxed as such i.e., shall not be set off against any other loss or be carried forward.

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(2011) 137 TTJ 249 (Jab.) (TM) ACIT v. Smt. Mukta Goenka IT (SS)A No. 23 (Jab.) of 2007 A.Ys.: 1-4-1996 to 12-12-2002 Dated: 28-5-2010

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Section 158BD — Satisfaction recorded u/s.158BD before initiation of block assessment proceedings of the person searched does not satisfy the requirement of law — Further, so-called satisfaction recorded by the Assessing Officer in the order sheet without even stating that undisclosed income pertaining to the assessees has been detected from the seized record of the persons searched was not in accordance with the provisions of section 158BD —Therefore, the block assessments of the assessees u/s.158BD are not valid.

During the search and seizure operations at the premises of SGL Ltd. and its director A, certain incriminating documents were found. Investigations revealed that SGL Ltd. had received large amount in the form of share capital from sister concerns through bogus shareholders and from agricultural income. Since assessee-trusts also made investment in SGL Ltd., the Assessing Officer framed block assessment u/s.158BD r.w.s 158BC. So-called satisfaction in the order sheet dated 4th September 2003 was recorded before the commencement of block assessment proceedings of the persons searched on 5th September 2003.

The assessees challenged the block assessment orders u/s.158BD before the learned CIT(A). The learned CIT(A) accepted the contention of the assessee and quashed the proceedings u/s.158BD because such notices were issued without any basis. The CIT(A) held that there is no satisfaction recorded objectively and that the same is without application of mind and, accordingly, annulled the block assessment orders u/s.158BD.

There was a difference of opinion between the members of the Tribunal. The Third Member, relying on the decisions in the following cases, upheld the CIT(A)’s order in favour of the assessee:

(a) Manish Maheshwari v. ACIT & Anr., (2007) 208 CTR 97 (SC)/(2007) 289 ITR 341 (SC)

(b) Manoj Aggarwal v. Dy. CIT, (2008) 117 TTJ 145 (Del.) (SB)/(2008) 11 DTR 1 (Del.) (SB) (Trib.)/ (2008) 113 ITD 377 (Del.) (SB).

The Tribunal noted as under:

(1) The so-called satisfaction in the order sheet dated 4th September 2003 has been recorded before the commencement of the block assessment proceedings of the persons searched on 5th September 2003. This satisfaction is not in accordance with the provisions of section 158BD. The satisfaction recorded u/s.158BD on 4th September 2003 i.e., before the initiation of block assessment proceedings of the person searched does not satisfy the requirement of law. The observation that the Assessing Officer has taken simultaneous action in the case of persons searched and in the cases of these assessee-trusts is factually incorrect, because in the cases of assessee-trusts the satisfaction was recorded on 4th September 2003, whereas the block assessment proceedings of the person searched were started subsequently on 5th September 2003.

(2) Similarly, the observation of the AM that it is immaterial whether the satisfaction was recorded in the file of the persons searched or in the case of assessee-trusts is legally incorrect and is not according to the provision of law. Similarly, the reason given by the AM that the Assessing Officer in the case of assessee-trusts and the persons searched is the same and, hence, it is immaterial whether the reasons recorded were in the file of the persons searched or in the case of assesseetrusts is incorrect and is contrary to law.

(3) Satisfaction should be recorded by the Assessing Officer of person searched as per the provisions of section 158BD. It is well-settled law that satisfaction recorded has to be objective/ judicious satisfaction and the order sheet dated 4th September 2003, in the cases of the present assessees, does not fulfil this condition, because the block assessment proceedings of the persons searched were started by issuing notice u/s.158BC on 5th September 2003 and hearing of the case of the persons searched was started on 13th October 2003.

(4) Hence, in no case, the Assessing Officer of the persons searched can examine the seized record on 4th September 2003 and ask the assessees’ explanation in respect of seized record of the persons searched.

(5) The so-called satisfaction recorded on 4th September 2003 by the Assessing Officer is based on assumption and presumption and is not based on seized record and is not a judicious satisfaction and, hence, the order sheet dated 4th September 2003 does not fulfil the requirement of section 158BD.

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IMPORTANT RECENT AMENDMENTS UNDER MVAT ACT, 2002

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While presenting the Budget for 2011-12 the Finance Minister of Maharashtra proposed certain amendments in the MVAT Act, 2002. Accordingly, L. A. Bill No. XVII of 2011, dated 8-4-2011 was introduced in the Assembly. The said Bill has become law namely, Maharashtra Tax Laws (Levy, Amendment and Validation) Act, 2011 (Mah. Act. No. XV of 2011) dated 21-4-2011. The amendments have come into operation from 1-5-2011 as Notification to that effect is issued bearing no. VAT.1511/CR-63/ Taxation 1 dated 28-4-2011. The important changes brought in by the above Amendment Act can be briefly noted as under:

1. Amendments in respect of Voluntary Registration:

As on today, the Registration under Voluntary Registration Scheme (VRS) is granted on the basis of advance payment of Rs.25,000. The said amount is adjustable against the liability which may be payable in the returns to be filed after registration.

However, now as per amendment in section 16(2) of the MVAT Act, 2002, the advance payment of Rs.25,000 will be treated as Security Deposit with the Government. It will not be allowed to be adjusted against liability. It will be refunded back after certain period, if there is no breach of any of the conditions which are laid down in this regard. As per newly inserted section 16(2A) of the MVAT Act, 2002, the Government can prescribe conditions for refund of deposit. The said conditions are prescribed by way of Rule 60A.

As per Rule 60A, it is the dealer who has to apply for refund of deposit. The application of refund can be made after 36 months from the end of month in which registration is granted but before 48 months from the said month. In case of cancellation of Registration Certificate (RC) before above period of 36 months, the application is to be made within six months from such date of cancellation. The application is to be made to registration authority and such authority should grant the refund within 90 days from receipt of application, subject to the dealer filing all returns as well as paying taxes as per the said returns.

2. Revised returns:

It is obligatory upon the dealers to file correct and complete returns by prescribed time. There are a number of events which may require correction in the original return or earlier revised returns. Therefore, the law permits dealers to file revised returns. This gives him opportunity of clearing himself of any charge of concealment or to prefer an additional claim, if any.

Up till now, there were no restrictions on the number of revised returns which can be filed by the dealers. In other words, a dealer could file more than one revised returns to correct the mistakes committed in the original returns or earlier revised returns.

However, now by the amendment a tab is put on the number of revised returns which can be filed by a dealer. As per section 20(4)(a), (b) and (c), there are three kinds of revised returns. A revised return can be filed suo motu or it can be to give the effect to VAT audit findings or it can be to give effect to findings of the business audit. The amendment seeks to allow only one revised return in each of the above categories. Though the amendment provides as above, a view can be taken that the dealer can file more than one revised returns to put up his position and in course of assessment such returns are also expected to be considered.

A dealer will now have to be very careful about filing revised return. He has to be certain that all the corrections are included in the particular one revised return. Allowing more than one revised return could not have caused any difficulty to the Department, but the curtailment will certainly cause great difficulty to the trading community.

It may be mentioned that in the category of suo motu revised return, the time limit was nine months from the end of concerned period/year. It is now enhanced to ten months.

This is an amendment about procedural law and the Department will take a view that the restriction operates from 1-5-2011. Therefore even for the returns for period prior to the above effective date, the restriction will be applied and accordingly after the above effective date the dealer may be permitted to file only one revised return relating to the said prior period.

3. No appeal against order levying interest:

The trend of amendments appears to be against the dealer community. The Government has debarred dealers from getting justice in case of levy of interest. The appeals against interest leviable u/s.30(2) and 30(4) are already prohibited by an amendment in 2010. However, appeals against interest u/s.30(1) (interest on URD) and 30(3) (differential dues) were allowed. Now section 26(5) is amended, whereby clause (c), which gave power to the Appellate Authority to deal with interest orders is deleted. Indirectly, the appeals will not be maintainable against the above interest u/s.30(1) and 30(3). Thus, one more beneficial provision is being done away with to the detriment of the dealer community. There will not be an opportunity to get justice in case of wrong levy.

It may be noted that appeals against orders levying interest u/s.30(1) and 30(3) themselves are not debarred. Therefore, it is possible to argue that the said appeals can be filed and the Appellate Authority can decide the matter under clause (d) of section 26(5) which covers appeal against any other order. Therefore, it appears that the dealers can still take an opportunity u/s.26(5)(d).

4. New taxation scheme for liquors:

Uptill now the liquors were taxed as per normal VAT chain. Every dealer was getting set-off and was liable to tax on sales.

Now from 1-5-2011 the system is changed. Wine is continued to be taxed as per the old system. Change is brought in taxation of IMFL, foreign liquors and country liquors by issue of Notification dated 30-4-2011 as per newly inserted section 41(5). The brief features of the new system can be noted as under:

(a) Manufacturer of liquors holding licence in PLL, BR-L and CL-I will be liable to tax @ 50% of sale price subject to limit of tax amount calculated as per Formula MRP x 25/125. They will be required to mention MRP on sale bills.

(b) Wholesalers holding licence in FL I, CL II will be exempt from tax if liquor is purchased from registered dealer in Maharashtra. No set-off is available to a wholesaler. If wholesaler has imported liquor from other State/country he will be required to discharge tax liability like a manufacture i.e., 50% of sale prices subject to limit of tax calculated as per formula MRP x 25/125.

(c) Retailer holding licence in FL IT, FL-BR-H, CL/ FL/TOD-III and CL-III will also be exempt from tax if liquor is purchased from registered dealers in Maharashtra. No set-off to them.

(d) Hotel, bars, restaurants and clubs (3-star and below):

Bars, restaurants and clubs holding licence in FL-III or FL-IV or E with grading of 3-star and below will be required to pay tax at 5% on the actual sale price of liquor which is purchased from registered dealers within the State and on which tax is paid or has become payable at earlier stage.

They can collect tax separately. No set-off is available on purchases.

(e) Hotels, bars, restaurants and clubs (4-star and above):

Hotels, bars and restaurants with grading of 4-star and above will be required to pay tax at 20% of their actual sale price, if the liquor is purchased from registered dealers within the State and on which tax is paid or has become payable at earlier stage.

If liquor is imported from other States or from outside the country, then in addition to 20% as above, they will be required to pay tax at Schedule rate subject to the limit of MRP x 25/125 of such liquor sold.
They can collect tax in the sale bills. No set-off is available on purchases of liquor.

(f) Taxation of stock as on 30-4-2011:

The tax on sale of liquors in stock as on 30-4-2011 will be as per the new system, discussed above i.e., at 50% of sale price limited to calculation made as per formula of MRP x 25/125. Hotels/ bars, in addition to the above, will be required to pay 5% or 20% as the case may be. In this case set-off will remain available on stock subject to submission of stock statement.

All the dealers, except manufacturers, shall furnish a statement of closing stock of goods mentioned in Entry 1, 2 and 3 of Schedule D to the MVAT Act, 2002 as on 30th April, 2011, in the Proforma appended to the Notification by 31st May, 2011.

5.    Refunds — Unwarranted and unreasonable curtailment:

Section 51 of the MVAT Act deals with refunds as per returns. Few important changes can be noted as under:

(a)    At present there is time limit on the Department to call for additional information. That could be called within one month of filing of the application.

However the time limit of one month is deleted by present amendment to section 51(2)(a). The result is that the Department will have open ground to call for additional information at any time.

(b)    Refund to newly registered dealer:

Clause 51(2)(b) provides that the newly registered dealer can apply for refund after expiry of one year from the end of first year. This provision is sought to be deleted with the effect that they will be able to claim the refund on expiry of year, as any other normal dealer. This can be said to be beneficial to the newly registered dealers.

(c)    Inter-state seller — Removal from preferred category:
With a view to give early refunds to the dealers involved in inter-state sales, they were put in preferred category by way of section 51(3)(a)(iv)    . Therefore, these dealers could file refund applications as per return period and had not to wait till the end of full year. Now this category is removed with the result that such dealers will be required to claim refunds after the end of year. This will delay refund claims for them.

(d)    Exporter — Defined:

Preferred category u/s.51(3)(a) includes exporter. They can file refund application as per the return period. However, the term ‘Exporter’ was not defined and hence a dealer having one export transaction could also file application as exporter. This liberal provision is now sought to be tight-ened. The term ‘Exporter’ is defined by inserting the following explanation.

“Explanation — For the purposes of sub-clause (i), the expression ‘Exporter’ shall mean a registered dealer whose turnover of exports during such period as may be prescribed, is not less than such percentage of the total turnover of his sales as may be prescribed in this behalf.”

The said percentage is prescribed by insertion of Rule 55A(3). According to the said Rule, if export turnover is not less then 50% in previous year or in concerned return period, then the dealer will be considered to be exporter.

(e)    Bank guarantee:

Section 51(3)(b) provides for requirement of bank guarantee for granting refund. It also gave power to call for additional information. The clause for calling additional information is deleted and calling for bank guarantee is retained.

(f)    Period for grant of refund — Extended:

Section 51(4) provides time limit for grant of refund. At present the limit is six months from the month of receipt of refund application. The said limit is extended to 18 months from the end of the month in which application is received. At present the dealer can get interest u/s.53(1) for delay in grant of refund after expiry of the above time limit of six months. Now this can take place after 18 months. Thus more time to retain the dealer’s money without interest.

The proviso to section 51(4) provides time limit for disposal of applications pending at present. It is sought to be provided that the applications filed up to 31-3-2011 for period up to 31-3-2010 will be disposed of by 30-9-2011. The applications filed up to 31-3 -2011 for period from 1-4-2010 to 31-3-2011 will be disposed of by 30-6-2012.

(g)    Time limit for filing refund application — Section 53(7):

As per section 53(7) refund application can be filed within three years from the end of concerned year. Now the time limit is reduced to 18 months. Thus one more curtailment of the dealer’s right. Whereas time for grant of refunds by the Department is enhanced to 18 months from six months, the time limit for dealer is curtailed. This cannot be said to be a fair treatment. There will be many adverse effects on dealers.

The above provision will apply from 2009-10 and the refund applications for 2009-2010 will be required to be filed before 30-9-2011.

6.    VAT Audit report — heavy ‘weight’ on dealers:

VAT Audit provision is becoming more and more stringent for dealers. Up till now there is penalty for late filing of report, to be calculated at 0.1% of turnover.

Now section 61(1) is amended to provide that the audit report should be ‘complete’ report.

By Explanation it is provided that the audit report will be deemed to be complete, if all items, certifications, tables, schedules and annexures are filed appropriately and are arithmetically self-consistent. If the report is found to be incomplete, then dealer will be subject to penalty at 0.1% of turnover, as per section 61(2A).

7.    Prosecution for false tax invoice:

Sub-sections (1A)(i) and (ii) are inserted in section 74 to provide punishment by way of imprisonment for two years for issuing/producing false tax invoice to defraud revenue. The provision is extended to person who abates aforesaid offence.

In addition to above, there are changes in rate of taxes, few changes in composition schemes, etc. The same are not referred to here for sake of brevity.

(2011) 38 VST 168 (Bom.) M/s. Zenith Computers Ltd. v. State of Maharashtra

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Sales Tax — Power of Appellate Authority — Penalty — Cannot be levied for the first time by Appellate Authorities — Section 36(2)(C), 55 and 57 of BST Act — Section 9(2A) of CST Act.

Facts:
The appellant, manufacturer of computers, was assessed for the period from 1st May, 1986 to April 30, 1987 under the CST Act, 1956. The appellant filed appeal against the assessment order before the Deputy Commissioner of Sales Tax (Appeal) who allowed the appeal partly and imposed penalty u/s.9(2A) of the CST Act r.w.s. 36(2)(C), Explanation (2) of the BST Act, after giving opportunity of hearing to the appellant, for failure to file returns in time, by passing separate order. The appellant filed appeal before the Tribunal against such penalty order. The Tribunal confirmed the order of penalty passed by the DC (Appeal). The Tribunal, at the instance of the appellant and as per direction of the Court, referred substantial question of law before the Bombay High Court.

Held:
The High Court, considering provisions of section 36(2)(C) and section 55 of the Act, held that as per section 55(6)(a) and (b) of the Act, the Appellate Authority concerned did not have any power of imposing penalty for the first time and expression ‘confer or cancel such order or very it, so as to either enhance or to reduce the penalty’ employed in section 55(6)(b), neither covered the power to impose a fresh penalty for the first time nor did it confer any power upon the Appellate Authority to pass any order of penalty while deciding the appeal. Further it held that on the correct interpretation of section 36(2)(c) of the Act the Tribunal was not justified in holding that the DC (Appeal) in exercise of Appellate power had jurisdiction to initiate action for imposing penalty for the first time.

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(2011) 137 TTJ 188 (Mumbai) Inter Gold (India) P. Ltd. v. JCIT ITA No. 441 (Mum.) of 2004. A.Y.: 1998-99. Dated: 5-1-2010

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Sections 4 and 28(i) of the Income-tax Act, 1961 — Compensation received for loss of goodwill/ reputation is a capital receipt.

The assessee received a sum of Rs.41.58 lakh from Union Bank of Switzerland (UBS) towards loss of reputation and goodwill and claimed the same as capital receipt not chargeable to tax. The Assessing Officer and the CIT(A) held the said amount as revenue receipt chargeable to tax.

The Tribunal, relying on the decision of the ITAT Pune in the case of Serum Institute of India Ltd. v. Dy. CIT, (2007) 12 TTJ (Pune) 174/111 ITD 259 (Pune), upheld the assessee’s claim.

The Tribunal noted as under:

(1) It is evident that the compensation was awarded to the assessee ‘against loss of reputation and goodwill’. It was not on account of the failure on the part of UBS to supply the quantity ordered or some loss caused to the assessee in a particular trading transaction.

(2) It was on account of injury caused to the reputation of the assessee, albeit such injury was caused due to some business transaction.

(3) Had the amount been awarded to make good the loss caused due to excess or short supply of the material or some other trading deficiency, it would certainly have been regarded as a revenue receipt.

(4) Since the nexus of the compensation is with reputation and goodwill and not with the trading operations, it cannot be held to be a revenue receipt.

(5) The main criterion to judge as to whether the compensation is capital or revenue is to ascertain the purpose for which such compensation is awarded. If the compensation is to recoup the loss suffered by the assessee in its business activity, then it will be a revenue receipt. If, however, the purpose is unrelated to the trading activity of the assessee, it will be in the nature of a capital receipt.

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(2011) 128 ITD 108/ (2010) 8 taxmann.com 209 (Delhi) Escorts Heart Institute & Research Centre Ltd. v. ACIT A.Y.: 2005-06. Dated: 9-10-2009

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Section 37(1) — Key personnel, on whose life keyman insurance policy is taken must include, not only the person responsible for the turnover of the business (Chief Cardiac Surgeon), but also the person responsible for managing the business and to make the same profitable (Chairman and Managing Director). Accordingly the premium paid on their policy is allowable.

Facts:
The assessee was a super-specialty hospital dealing with cardiac and cardio vascular diseases. It had taken insurance policies on life of its key personnel — Chief Surgeon, Chairman and Managing Director, the premium on which was claimed as deduction.

The Assessing Officer disallowed the deduction on grounds that the benefit of policy was assigned to key personnel and therefore was not incurred wholly for business purpose.

On appeal, the learned CIT(A) held that since the surgeon had the requisite skill and knowledge of the field, therefore he was responsible for the turnover of the company and accordingly only the premium paid on his policy is deductible and that on the policy of the Chairman and the Managing Director is not.

Held:
(1) The assessee’s activity cannot be said to be solely depending on the surgeon. Though, he may be responsible for the turnover of the company, he may not be responsible for the profits of the company, due to lack of competence necessary for a businessman.

(2) Further, since the business is carried on with the ultimate motive of earning profits, it cannot be said that profits could not be taken as guiding factor to analyse the business.

(3) It was also not argued that the salaries paid to these persons were not allowable.

(4) Further, on their resignation in the subsequent year, the profits of the assessee reduced substantially.

(5) All the above factors led to the conclusion that the Chairman and the Managing Director were key personnel and accordingly the premium paid on their policy is allowed.

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Anil G. Puranik v. ITO ITAT ‘A’ Bench, Mumbai Before R. S. Syal (AM) and R. S. Padvekar (JM) ITA No. 3051/Mum./2010 A.Y.: 2006-07. Decided on: 13-5-2011 Counsel for assessee/revenue: Soli Dastur/ Rajeev Agarwal

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Section 49(1), section 50C — Once a particular amount is considered as full value of consideration at the time of its purchase, the same shall automatically become the cost of acquisition at the time when such capital asset is subsequently transferred — Section 50C applies to a capital asset being ‘land or building or both’ and not to ‘any right in land or building or both’ — Leasehold rights in plot of land is not ‘land or building or both’ — Section 50C does not apply to leasehold rights.

Facts:
On 16-8-2004, the assessee was allotted leasehold rights in a plot of land for a period of 60 years under ‘12.50% Gaothan Expansion Scheme’. The allotment was in lieu of agricultural land owned by the assessee’s father which land was acquired by the Government of Maharashtra. The lease agreement, in favour of the assessee, was executed on 8-8-2005. On 25-8-2005, the assessee transferred its rights in the said plot for a consideration of Rs.2.50 crore. In the return of income, the assessee took the stand that since the plot which was transferred by the assessee was received in consideration for agricultural land which was not a capital asset, this plot is also not a capital asset and hence gain on its transfer is not chargeable u/s.45 of the Act. Alternatively, it was contended that the market value of the plot on the date of its allotment to the assessee be taken to be its cost of acquisition. The Assessing Officer (AO) held that though the original land was agricultural, the allotted land was not agricultural and therefore the land transferred was capital asset. He held that by virtue of section 49, the cost of acquisition of original land in the hands of the assessee’s father has to be regarded as the cost of acquisition of the land transferred by the assessee. Also, he invoked the provisions of section 50C and considered the market value of land as per stamp valuation authorities to be full value of consideration.

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

Aggrieved, the assessee preferred an appeal to the Tribunal.

Held:
(1) There were two distinct transactions — the first was the acquisition by the Government of land belonging to the assessee’s father, against which the assessee, as legal heir, was given lease of plot on 16-8-2004. This transaction got completed when the assessee got the leasehold rights viz. on 16-8-2004. The second transaction was transferring, on 25-8-2005, leasehold rights in the plot for a consideration of Rs.2.50 crores. The second asset i.e., leasehold rights in the plot cannot be categorised as agricultural land within the meaning of section 2(14)(iii) of the Act.

(2) The sole criteria for considering whether the asset transferred is capital asset u/s.2(14) or not is to consider the nature of asset so transferred in the previous year and not the origin or the source from which such asset came to be acquired. The second asset i.e., the leasehold rights in the plot cannot be categorised as agricultural land within the meaning of section 2(14)(iii) of the Act. Hence, gains arising on transfer of leasehold rights were chargeable to tax u/s.45 of the Act.

(3) Section 49(1) provides that where a capital asset becomes the property of the assessee by any of the modes specified in clauses (i) to (iv), such as gift or will, succession, inheritance or devolution, etc., the cost of acquisition of such capital asset in the hands of the assessee receiving such capital asset shall be deemed to be the cost for which it was acquired by the person transferring such capital asset in the prescribed modes. In order to apply the mandate of section 49(1), it is a sine qua non that the capital asset acquired by the assessee in any of the modes prescribed in clauses (i) to (iv) should become the subject matter of transfer and only in such a situation where such capital asset is subsequently transferred, the cost to the previous owner is deemed as the cost of acquisition of the asset. Once such capital asset is transferred and another capital asset is acquired, there is no applicability of section 49(1) to such converted asset. The lower authorities erred in applying the provisions of section 49(1) to transfer of leasehold rights.

(4) Since the market value of the leasehold rights, on the date of allotment, constituted full value of consideration for transfer of lands belonging to the assessee’s father, the cost of acquisition of leasehold rights will be its market value on the date of allotment. Once a particular amount is considered as full value of consideration at the time of its purchase, the same shall automatically become the cost of acquisition at the time when such capital asset is subsequently transferred.

(5) Section 50C is a deeming provision which extends only to land or building or both. Deeming provision can be applied only in respect of the situation specifically given and hence cannot go beyond the explicit mandate of the section. The distinction between a capital asset being ‘land or building or both’ and any right in land or building or both is well recognised under the Income-tax Act. The deeming fiction in section 50C applies only to a capital asset being land or building or both, it cannot be made applicable to lease rights in land. As the assessee had transferred lease rights for sixty years in the plot and not land itself, the provisions of section 50C cannot be invoked.

The appeal filed by the assessee was allowed.

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ITO v. Radha Birju Patel ITAT ‘D’ Bench, Mumbai Before N. V. Vasudevan (JM) and Pramod Kumar (AM) ITA No. 5382/Mum./2009 A.Y.: 2006-07. Decided: 30-11-2010 Counsel for revenue/assessee: Jitendra Yadav/Shalin S. Divatia

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Section 14 — Heads of income — Income out of investments in shares of listed companies through Portfolio Management Scheme —Whether the AO was justified in taxing income under the head business income — Held that the income was taxable as capital gains.

Facts:
The assessee had made investment in shares through the Portfolio Management Scheme. She had disclosed a short-term capital gain of Rs.11.61 lakh and short-term capital loss of Rs.0.5 lakh in respect of purchase and sales of shares of various companies. According to the AO based on CBDT Circular No. 4 of 2007, dated 15-6-2007, the case of the assessee falls in the case of trading in shares. A reference was also made to the Supreme Court decision in the case of G. Venkataswami Naidu & Co v. CIT, (35 ITR 594), wherein the had laid down a principle that where purchases had been made solely and exclusively with intention to resell at a profit and the purchaser had no intention of holding property for himself or otherwise enjoying or using it, presence of such an intention was a relevant factor and unless it was offset by presence of other factors, it would raise a strong presumption that the transaction was in the nature of trade. He also noted that dividend earned during the year amounted to Rs.0.94 lakh, which according to him indicated that the intention of the assessee was to hold shares only for such period as may enable her encashing the appreciation in its value. On appeal by the assessee, the CIT(A) held in favour of the assessee. Being aggrieved, the Revenue appealed before the Tribunal and relied on the order of the AO.

Held:
The Tribunal noted that the assessee was doing investment activities through the Portfolio Manager. Such activities were for maximisation of wealth rather than encashment of profits on appreciation in value of shares. It further noted that the very nature of the Portfolio Management Scheme was such that the investments made by the assessee were protected and enhanced. Therefore, according to it, in such a circumstance, it cannot be said that Portfolio Management was a scheme of trading in shares and stock. Accordingly, it upheld the order of the CIT(A).

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(2011) 52 DTR (Jab.) (TM) (Trib.) 346 DCIT v. Vishwanath Prasad Gupta A.Y.: 2004-05. Dated: 15-6-2010

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Merely on the basis of non-maintenance of stock register it cannot be inferred that the account books are false — Also mere low Gross Profit (GP) rate by itself cannot justify an addition. Gifts received by cheques which have been confirmed by the donors in affidavits and disclosed in their respective returns could not be treated as non-genuine gifts.

Facts:
The assessee derives income from sale of motor parts, tractor parts, tyres, etc. The assessee had shown GP at 10.84% which was less than previous year GP of 14.17%. To support the reduction in GP, the assessee submitted regular books of accounts which were audited. As no quantitative details of  purchases, sales, closing stock, etc. were maintained, the book results were rejected by the AO applying provisions of section 145. The AO thereafter added an estimated amount of Rs.50,000 to total income.

Held:
The assessee had maintained inventory of opening and closing stock and vouchers for purchases and sales which were also audited. Mere non-maintenance of stock register cannot mean that the books of accounts maintained are false. Also, low GP may justify an enquiry but cannot justify an addition to the profit shown. In the present case, the AO had not shown any mistake in books of accounts. Furthermore, rate of GP in a particular year depends on many factors and the same need not be constant from year to year. Therefore addition to income is not justified.

Facts:
The assessee received gift from two parties vide cheques. To prove the gifts are genuine, the assessee submitted affidavits of donors. However, the assessee’s claim was rejected as the AO was also not satisfied with the relationship between donor and donee. Further the AO observed that the assessee did not produce donors for verification and also did not prove financial capacity. The CIT(A), however, upheld the contention of the assessee.

On Revenue’s appeal, there was a difference of opinion between the members, and the matter was referred to the Third Member.

Held II:
The gifts received by the assessee were to be considered genuine as the gift was made through cheque and also disclosed in the books of accounts of the donees. Also the donees have admitted the gift given in their respective affidavits and hence there was no reason in disbelieving the genuineness of the gift.

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(2011) TIOL 266 ITAT Mum.-SB ITO v. United Marine Academy ITA No. 968/Mum./2007 A.Y.: 2003-2004. Dated: 25-4-2011

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Sections 48, 50, 50C, Circular 8 of 2002 — Provisions of section 50C can be invoked in case of depreciable assets where the provisions of section 50 are applicable.

Facts:
The assessee, a partnership firm, engaged in business of running a marine training institute, filed its return of income declaring the total income of Rs.1,86,466. During the previous year relevant to the assessment year under consideration the assessee sold a building, on which depreciation was claimed in earlier years, for a consideration of Rs.49,43,525. Since the amount of consideration was the same as its WDV, the assessee did not offer short-term capital gains on sale of the building. The value of this building as per stamp valuation authorities was Rs.76,49,000. The Assessing Officer (AO) was of the view that one of the office building i.e., office No. 101 having a WDV of Rs.13,14,425 was not sold by the assessee during the year under consideration. The Assessing Officer (AO) held that in view of the provisions of section 50 r.w.s 50C, the value of the building adopted by the stamp valuation authorities needs to be taken as full value of consideration. He, accordingly, made an addition of Rs.20,44,900, being the difference between value of the office sold (excluding office No. 101) as per stamp valuation authorities (Rs.56,74,000) and the WDV of the said office (Rs.36,29,100), to the total income of the assessee.

Aggrieved the assessee preferred an appeal to the CIT(A), where it contended that the provisions of section 50C cannot be invoked in the case of an assessee wherein section 50 is applicable. It contended that it is not permissible to impose a supposition on a supposition of law. The CIT(A) held that the deeming provisions of section 50C could not apply to depreciable assets. He also held that the block of assets had ceased to exist. He deleted the addition made by the AO.

Aggrieved the Revenue preferred an appeal to the Tribunal.

The President, ITAT constituted a Special Bench to consider the following question:

“On a proper interpretation of sections 48, 50 and 50C of the Income-tax Act, 1961, was the Assessing Officer right in law in applying section 50C to capital assets covered by section 50 (depreciable assets) and in computing the capital gains on the sale of depreciable assets by adopting the stamp duty valuation?”

Held:
(1) There are two deeming fictions created in section 50 and section 50C. The first deeming fiction modifies the term ‘cost of acquisition’ used in section 48 for the purpose of computing the capital gains arising from transfer of depreciable assets, whereas the deeming fiction created in section 50C modifies the term ‘full value of the consideration received or accruing as a result of transfer of the capital asset’ used in section 48 for the purpose of computing the capital gains arising from the transfer of capital asset being land or building or both.

(2) The deeming fiction created in section 50C operates in a specific field which is different from the field in which section 50 is applicable. It is not a case where a supposition has been sought to be imposed on other supposition of law. Going by the legislative intentions to create the said fictions, the same operate in different fields.

(3) The harmonious interpretation of the relevant provisions makes it clear that there is no exclusion of applicability of one fiction in a case where other fiction is applicable.

(4) The assessee’s alternate argument that as the AO had held that the block of asset had not ceased to exist in the year and was in existence, section 50C could not apply as held in Roger Pereira Communications 34 SOT 64 was not acceptable, since the assessee itself had considered the entire block of buildings as having been sold/transferred during the year and the same was upheld by the CIT(A). The assessee is not entitled to take a stand with regard to facts, inconsistent with the stand that he had taken before the Revenue Authorities to obtain a decision in his favour. He cannot be heard to say that the stand on facts so taken by him is not correct just to raise a new legal plea.

The question referred to the Special Bench was answered in the affirmative i.e., in favour of the Revenue and against the assessee. The appeal filed by the Revenue was allowed.

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(2011) TIOL 262 ITAT-Mum. Purvez A. Poonawalla v. ITO ITA No. 6476/Mum./2009 A.Y.: 2006-07. Dated: 9-3-2011

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Section 56(2)(v) — ‘Consideration’ referred to in the provisions of section 56(2)(v) has to be understood as per the definition of consideration as given in section 2(d) of The Indian Contract Act, 1872 — Amount received in consideration of the assessee abstaining from contesting the will is not covered by section 56(2)(v).

Facts:
One Mrs. Mani Cawas Bamji (the deceased) was a childless widow who died in Mumbai on 6-1-2001. She possessed considerable movable properties in the form of shares, debentures and fixed deposits and immovable property known as Avasia House in her sole name at Nepean Sea Road, Mumbai. During her lifetime, she had allegedly executed a will dated 2-5- 1997. The only legal heirs entitled to her property in the event of her intestacy were the assessee, being the son of a pre-deceased sister of the deceased, and Mr. Dinshaw Jamshedji Mistry, being brother of the deceased. Under her will dated 2-5-1997, the deceased had bequeathed all her properties to her brother Mr. Dinshaw Jamshedji Mistry (DJM), who was also appointed as one of the executors in the will. There were three executors to the will but the other two (other than Mr. Dinshaw Mistry) renounced their executorship. DJM filed a petition before the Bombay High Court for grant of probate of the last will of the deceased. The assessee, as a legal heir of the deceased, received a citation from the Bombay High Court in the petition for grant of probate in respect of the last will of the deceased. The assessee filed a caveat against the grant of probate in respect of the last will of the deceased. In the affidavit filed in support of the caveat the assessee set out reasons as to why the alleged will was not valid. On such objection, the petition for grant of probate was converted into a testamentary suit. The Bombay High Court restrained DJM from dealing with the properties of the deceased. On 28-9-2002, DJM died leaving behind his will dated 29-10-2001 appointing Mr. Rajesh K. Bhavsar (RKB) as the sole executor and legatee. RKB got himself impeded as plaintiff in place of DJM in the testamentary suit for grant of probate of the last will of the deceased.

RKB and the assessee entered into a compromise agreement dated 22-11-2002, whereby the assessee agreed to receive a sum of Rs.5,08,80,000 in consideration for agreeing to the Court granting probate in respect of the last will of the deceased. This sum of Rs.5,08,80,000 was later reduced by Rs.30,00,000 and the sum of Rs.4,78,80,000 was received by the assessee in the following manner:

F.Y. 2003-04 : Rs.1,04,77,032 by various cheques
F.Y. 2005-06 : Rs.3,73,95,335 by various cheques
F.Y. 2006-07 : Rs.7,633 by cash

RKB and the assessee had on 12-12-2002 signed consent terms which consent terms were identical to the agreement dated 22-11-2002. The Court recorded the consent terms and modified the earlier order restraining DJM from alienating any part of the estate of deceased and permitted RKB to alienate some of the properties to enable him to raise funds to discharge the obligation to pay the assessee. The assessee on receipt of the agreed sum was to withdraw his caveat to enable issue of letters of administration with the Will annexed in respect of the estate of the deceased.

The assessee did not offer these amounts for taxation in the A.Y. 2006-07. The AO taxed on substantive basis the sum of Rs.3,73,95,335 (in the year of receipt) and the sum of Rs.1,04,77,032 (received in previous year relevant to A.Y. 2004-05 on a protective basis).

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

Aggrieved the assessee preferred an appeal to the Tribunal.

Held:
The Tribunal noted section 56(2)(v) has been introduced w.e.f. 1-9-2004. Thus, prior to 1-9-2004, receipts of any sum of money would not be income u/s.56(2)(v). A sum of Rs.1,04,77,032 was received between 3-4-2003 to 14-10-2003. Therefore, these receipts could not be taxed as income u/s.56(2)(v). As regards the sum of Rs.3,73,95,334, the Tribunal held that the sum in question was received by the assessee in consideration of giving up his rights to contest the will of late Mrs. Mani Cawas Bamji. The consideration referred to in the provisions of section 56(2)(v) of the Act have to be understood as per the definition of consideration as given in the Indian Contract Act, 1872 in section 2(d). The assessee has abstained from contesting the will and this constitutes the consideration for payment by RKB to the assessee. Thus, the amount received by the assessee is not without any consideration. Therefore the provisions of section 56(2)(v) were not applicable. The additions made by the AO were directed to be deleted.

The appeal filed by the assessee was allowed.

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(2011) TIOL 251 ITAT-Mum. Capgemini Business Services (India) Ltd. v. DCIT ITA No. 1164/Mum./2010 A.Y.: 2006-07. Dated: 26-11-2010

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Section 246A — The expression ‘amount of tax
determined’ in section 246A(1)(a) refers also to the determination of
the sum finally payable by the assessee and not merely to calculation of
incometax on the amount of total income by applying the rates of tax.

Facts:
The
assessee company, engaged in the business of providing IT-enabled
services and BPO services, e-filed its return of income declaring total
income of Rs.98,90,146 and claiming therein a refund of Rs.22,76,152.
The Assessing Officer in an order passed u/s.143(3) assessed the total
income to be Rs.98,90,146. While calculating the amount of tax payable
by the assessee/refund due to it, the AO in form ITNS 150A granted
credit for TDS and advance tax as claimed by the assessee, but did not
grant credit of Rs.8,38,764 claimed by the assessee u/s.90 and u/s.91 of
the Act.

Aggrieved, the assessee preferred an appeal to the
CIT(A) who held that the appeal was not maintainable since he was of the
view that section 246A did not permit such issues within its ambit.
Referring to the provisions of section 246A(1) (a), he held that the
reference to ‘tax’ is only for calculation of tax on total income and
not beyond that. He also made a reference to the definition of ‘tax’
u/s.2(43) and held that since the assessee was not challenging the
calculation of tax on total income, the grounds raised were several
steps beyond this calculation. He held that the issue of granting of
credit for advance tax or TDS could not be agitated in an appeal.

Aggrieved, the assessee preferred an appeal to the Tribunal.

Held:
The
Tribunal noted that the AO had in form ITNS 150A not granted credit of
withholding tax of Rs.8,38,764 u/s.90/91 and also that he had left the
column 18 of ITNS-150A, which specifically provides for DIT relief
u/s.90/91, blank. Upon going through the provisions of section
246A(1)(a) of the Act, the Tribunal observed that the assessee’s case
can be considered only under the second part of section 246A(1)(a) viz.
‘to the amount of tax determined’ and not under the remaining parts as
non-granting of benefit in respect of withholding tax u/s.90 /91 can
neither be considered as ‘the income assessed’, nor ‘the loss computed’,
nor ‘the status under which he is assessed’. Having so observed the
Tribunal proceeded to examine whether non-granting of refund in respect
of withholding tax u/s.90/91 can be considered under the expression
‘amount of tax determined’ and held:

(1) From the ratio
decidendi of the decisions of SC, in the case of Auto and Metal
Engineers and Others v. Union of India and Others, 229 ITR 399 (SC) and
Kalyankumar Ray v. CIT, 191 ITR 634 (SC), it is discernible that the
‘determination of tax’ refers to finding out the amount finally payable
by the assessee for which notice of demand is issued.

(2) The
expression ‘amount of tax determined’ in section 246A(1)(a) also refers
to the determination fo the sum finally payable by the assessee. Not
only the calculation of tax on the total income but also the adjustment
of taxes paid by or on behalf of the assessee is also covered within the
determination of sum payable by the assessee u/s.156 of the Act.

(3)
The expression ‘amount of tax determined’ as employed in section
246A(1)(a) encompasses not only the determination of the amount of tax
on the total income but also any other thing which has the effect of
reducing or enhancing the total amount payable by the assessee. As the
question of not allowing relief in respect of withholding tax u/s.90/91,
has the direct effect of reducing the refund or enhancing the amount of
tax payable, such an issue is squarely covered within the ambit of
section 246A(1)(a).

(4) Accepting the view-point of the CIT(A)
that the appeal is not maintainable in respect of non-allowing of relief
for tax withheld u/s.90/ 91 would amount to violating the language of
section 246A, which has otherwise given the right to the assessee to
appeal broadly against on any aspect of the ‘amount of tax determined’.

(5)
The CIT(A) was not justified in dismissing the appeal of the assessee
as not maintainable on the aspect of not allowing of credit by the AO of
tax withheld on behalf of the assessee u/s.90 and 91. The AO was
directed to modify ITNS 150A and grant the consequential refund due,
which has not been allowed.

The appeal filed by the assessee was allowed.

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(2011) 137 TTJ 741 (Del.) ACIT v. Bulls & Bears Portfolios Ltd. ITA No. 2727 (Del.) of 2008 A.Y.: 2005-06. Dated: 28-1-2011

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Sections 28(i) and 45 of the Income-tax Act, 1961 — If the assessee has maintained the investment portfolio separately and income from which was offered as capital gains and was also assessed as capital gains in successive assessments, then the income will be assessed as capital gains and not as business income.

For the assessment years 2005-06 and 2006-07, the Assessing Officer treated income from sale of shares as business income as against income from capital gains. The CIT(A) held in favour of the assessee.

The Tribunal also held in favour of the assessee. The Tribunal noted as under:

(1) The assessee is a broker as well as an investor. It has maintained the investment portfolio separately, income from which was liable to be taxed as capital gains, since the intention in respect of this was to hold the investment as investment only and was shown as such in the books of account and income therefrom was shown and treated as capital gains in the successive assessments.

(2) The schedule of investments was duly appended in the balance sheet.

(3) The assessee has also maintained separate D-mat accounts for investment and for trading. Therefore, the assessee has distinctly maintained investment account and trading account.

(4) The assessee was holding certain stock for the purpose of doing business of buying and selling and at the same time it was holding other shares as its capital for the purpose of dividend income.

Therefore, the CIT(A) has rightly held that the income is to be treated as capital gains and not as business income.

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(2011) 137 TTJ 573 (Mumbai) ACIT v. Safe Enterprises Misc. Application No. 413 (Mum.) of 2010 in ITA No. 2278 (Mum.) of 2009 A.Y.: 2005-06. Dated: 4-11-2010

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Section 254(2) of the Income-tax Act, 1961 — Where the Tribunal specifically observed that it was in agreement with the reasons given by CIT(A), mere non-production of the reasons and the conclusions of the CIT(A) in the body of the order of the Tribunal does not give rise either to a mistake of law or fact, nor can it be considered as an irregular order for being rectified u/s.254(2).

For the relevant assessment year, certain additions were made by the Assessing Officer against which the assessee filed an appeal. The CIT(A) considered the issue in great detail and passed an elaborate order in favour of the assessee. Aggrieved by this, the Department preferred an appeal before the Tribunal. The Tribunal passed a short order since it was in agreement with the CIT(A)’s order.

The Department filed a miscellaneous application on the ground that the Tribunal was not justified in passing a short order without elaborating on the issues and, thus, it gives rise to a ‘mistake apparent from record’ since it has to be presumed that the Tribunal has not applied its mind on the contentions and issues raised by the Department. In this regard, the applicant has taken a support from para 11 of the guidelines issued by the then President of the Tribunal.

Rejecting the miscellaneous application, the Tribunal observed as under:

(1) Internal guidelines issued by the then President were only to prod the Members to give detailed reasons, as far as practicable, implying thereby that whenever an order of the lower forum is based on two reasons out of which an Appellate Authority agrees only with one reason which would ultimately have an effect of upholding the order of the lower authority, it is the duty of the Tribunal to give detailed reasons to satisfy as to the basis for coming to such conclusion. In a given case, where the appellant raises some additional issues and relies upon some additional case laws which were not considered by the lower authority, even though they are not applicable to the facts of the instant case, the Tribunal may have to give its reasons rejecting such arguments while upholding the order of the CIT (A).

(2) However, when the facts and circumstances are not disputed before the Tribunal and no additional arguments were advanced by the learned Departmental Representative and, in addition to that, when the Tribunal is fully agreeing with the reasons given by the learned CIT(A), as rightly observed by the Apex Court in the case of K. Y. Pilliah & Sons (1967) 63 ITR 411 (SC), it may not be necessary to repeat the reasons given by the first Appellate Authority and an order passed by the Tribunal under such circumstances cannot be said to be illegal.

(3) In para 3 of the order of the Tribunal this Bench has specifically observed that it was in agreement with the reasons given by the CIT (A). Thus, mere non-production of the reasons and the conclusions of the CIT(A) in the body of the order of the Tribunal do not give rise either to a mistake of law or fact, nor can it be considered as an irregular order.

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(2011) 22 STR 201 (Tri.-Del.) — Amity Thermosets Pvt. Ltd. v. CCEx., Vapi.

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Use of incorrect form — Rebate claim filed in form ASTR 2 in respect of GTA service which is an input service and not exports of service — Rebate claim wrongly filed instead of refund claim — Error rectifiable — Case remanded.

Facts:
The appellants had filed rebate claims under the Export of Service Rules, claiming rebate of Service tax paid on input service used for export of GTA service. The claims were rejected since the rebate was claimed on GTA service which was an input service and there was no export of any service. The appellants contended that they had inadvertently filed rebate claim instead of refund claim for Service tax paid on input services used in relation to export of goods. The appellants agreed that the refund claim was filed in wrong form.

Held:

During the period when the rebate claim was filed by the appellants there was no form prescribed for filing the refund claim. Therefore, filing of a letter with relevant details would have been sufficient. Thus, the appellants have made a clerical error which is a rectifiable error. Therefore, appeal was allowed.

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(2011) 22 STR 253 (Tri.-Bang.) — Kunj Behari Dye Chem Pvt. Ltd. v. CCE (Appeals II), Bangalore.

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Refund of pre-deposit — On a favourable decision pre-deposit should be refunded suo motu by the Department without much delay — Time limit for claiming refund not to apply for refund of pre-deposit — Appeal allowed.

Facts:
The appellants were entitled for refund of predeposit amount of Rs.50,000 in view of favourable order of the Commissioner(A). The refund accrued in the year 2001 but the appellants filed a refund claim in the year 2007. Hence, by applying the law of limitation, the refund claim was rejected.

The appellants relied on Board’s Circular dated 2-1-2002, wherein it was clarified that claim for refund of pre-deposit is not required to be filed by appellants and a mere letter would be sufficient. Apart from this, time limit u/s. 11B of Central Excise Act for claiming refund was held inapplicable to refund of pre-deposit implying that the Revenue ought to have suo motu refunded the same.

Held:
Refund claim of pre-deposited amount cannot be rejected by applying the General Limitation Act. The pre-deposit amount should be refunded by the Department suo motu without much delay.

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(2011) 22 STR 252 (Tri.-Ahmd.) — Bock India Pvt. Ltd. v. CCEx, Vadodara

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Refund of pre-deposit on a favourable decision suo motu credit taken by appellants under intimation to Revenue — No objection can be raised by Revenue — Appeal allowed.

Facts:
The appellants had deposited an amount of Rs.40,000 in terms of stay order passed by the Tribunal. At a later stage, the same was refundable to them as the order was passed in favour of the appellants. Consequently, the appellants took the credit suo motu by intimating the Revenue.

However, proceedings were initiated against the appellants on the argument that they should have applied for refund instead of taking credit suo moto. As a result, penalty of Rs.5,000 in addition to the amount mentioned supra was confirmed against the appellants.

Held:
Refund of pre-deposit accrued to the appellants immediately on passing of the Tribunal’s order allowing the appeal. It was held that Revenue cannot raise any objection for granting of Cenvat credit since the same was intimated to the Revenue and provisions of unjust enrichment do not apply to such refund of pre-deposit. Hence, appeal was allowed in favour of the appellants.

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(2011) 22 STR 41 (Tri.-Ahmd.) — Aditya Birla Nuvo Ltd. v. CCEx., Vadodara.

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Marketing of goods manufactured by client — Taxable under business auxiliary service — Not a commission agent, therefore not entitled for exemption.

Demand and penalty — Time-barred for part period — As bona fide intention proved — Matter remanded for quantification.

Facts:
The appellants had entered into a ‘Marketing agreement’ with its joint venture to sell, distribute, market, advertise and promote the products of joint venture. The appellants had a belief that the services rendered by them during the period 1-7-2003 to 8-7-2004 were of a commission agent and were fully exempt under Notification No. 13/2003-S.T., dated 20-6-2003. Therefore, they did not pay any Service tax on the services rendered by them. However, the said Notification was withdrawn w.e.f. 9-7-2004 and as a consequence of which the appellants got themselves registered with the Service Tax Department in August 2004.

The Revenue contended that the services provided by the appellants were taxable under business auxiliary service and benefit of exemption Notification cannot be availed as the appellants were not the commission agents. Commission agent meant a person who causes sale or purchase of goods on behalf of another person for a consideration. The commission agents usually charge a fixed percentage of sale price, but the appellants were not charging a fixed percentage. Additionally, the scope of activities undertaken by the appellants is far beyond the activities of commission agent and fall within the purview of definition of business auxiliary service.

The extended period of limitation was invoked. However, the appellants contended that the limitation of five years cannot be invoked as the intention of the appellants was bona fide since they had immediately registered themselves when the relevant exemption Notification was withdrawn.

Held:
The services were to be taxable under business auxiliary service. However, due to reasonable cause for failure to pay Service tax, the penalties levied on the appellants were set aside. Further, the matter was remanded for quantification of demand within the period of limitation.

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(2011) 22 STR 203 (Tri.-Delhi) CCEx, Ludhiana v. Deluxe Enterprises.

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Cash found in business premises as unaccounted income — Treated as receipts towards business auxiliary service as no other activity except for sale of sim cards and recharge coupons of mobile phone service provider was undertaken by the respondent — Evidence not sufficient — Appeal dismissed.

Facts:
The respondents were in the business of selling sim cards, recharge coupons, mobile phones, etc. On 17-10-2003, they declared unaccounted income, to the Income-tax Officers on survey, of Rs.4,00,000. Since the respondents were engaged in providing business auxiliary services, the unaccounted income was treated to be income from business auxiliary services.

The respondents contended that the entire income of Rs.4,00,000 cannot be attributed to business auxiliary service since the service had become taxable from 1-7-2003, whereas the visit of survey team was on 17-10-2003. Moreover, for generating income of Rs.4,00,000 during the period of three months, a turnover of Rs.2,50,00,000 would be required, which is practically not possible for a small business man. Apart from this, no inquiry was made with the respondent for ascertaining the source of unaccounted income. In absence of any evidence, the income cannot be attributed to taxable services provided by them.

Held:
Since no inquiry was undertaken by the Department as to whether the respondent’s turnover during the period of three months was to the tune of Rs.2,50,00,000 plus the evidence gathered by the Department was insufficient to establish even the prevalence of probability, the Revenue’s appeal was dismissed.

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(2011) 22 STR 126 (Tri.-Bang.) — CCEx., Visakhapatnam v. Andhra Pradesh Paper Mills Ltd.

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Cenvat credit of service tax paid on rent-a-cab service, telephone service and professional service of Chartered Accountant is admissible.

Facts:
The respondents had availed credit of Service tax paid on rent-a-cab service which was used by officials of the company for timely completion of their jobs, telephone service as landline phones were installed at residences of officials and bills were paid by the respondents, and professional service of Chartered Accountant which was directly related to the business of the respondents.

The Revenue was in appeal against allowance of credit on above-mentioned service as it contended that conveyance offered to officials was for their personal comfort and welfare purpose which was in no way connected to the respondent’s business activity.

Held:
By relying on various judgments, issue regarding eligibility of Cenvat credit on rent-a-cab service, telephone service and professional service of Chartered Accountant was settled in favour of the respondents as the services were connected with their business activity and accordingly the Revenue’s appeal was rejected.

Comment:
With the recent changes in the CENVAT Credit Rules, taking credit on such items could be a challenge.

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(2011) 22 STR 89 (Tri.-Mumbai) — L’oreal India Pvt. Ltd. v. CCE, Pune-I.

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Cenvat credit of Service tax paid on house-keeping of guest-house, factory, garden maintenance and jungle cutting admissible — Service tax paid on picnic service for employees not admissible.

Facts:
The appellants were denied credit on outdoor catering service availed in guest-house, garden maintenance; house-keeping at guest-house, house-keeping at factory, picnic and jungle cutting services availed by them. The credit was denied on the ground that those services had no nexus with the business of the appellants.

The appellants expressed that services of garden maintenance, outdoor catering and house-keeping were related to the manufacturing activity undertaken by the appellants. Jungle cutting services were also related to the business of the appellants as the service was availed to keep the final product bacteria free. Apart from this, picnic service was availed to boost the employees for efficient working.

Held: The appellants were entitled for credit availed on outdoor catering service and house-keeping service except for the portion of service recovered from persons staying in guest-house. However, the credit on house-keeping services of factory, garden maintenance and jungle cutting services was fully allowed to the appellants. However, credit was fully denied on picnic services availed as it had no nexus with the business activity of the appellant.

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(2011) 22 STR 201 (Tri.-Del.) — Fiamm India Automotive Ltd. v. CCEx., Delhi.

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Cenvat credit of Service tax paid on group insurance policy taken for employees, CHA service, rent-a-cab service, general insurance service relating to export goods — Credit eligible — Appeal allowed.

Facts:
(a) The appellants contended that credit of Service tax paid on group insurance policy for employees who are not covered by ESI cannot be disallowed on the ground that it is not connected with the business activity, as company is required to pay compensation to employees who are not covered by ESI, in the event of accident.

(b) The appellants had availed CHA service for supply of goods for export on FOB basis, which implies that ownership of goods lies with the appellants till the delivery of goods on board the ship. The Department had challenged the availment of credit on CHA service. Reference was made to Board’s Circular dated 23-8-2007, which made it apparent that in case where sale is on FOB basis, place of removal shall be the load port only. Therefore, any service availed up to the place of removal shall be treated as input service and accordingly, credit shall be availed of Service tax paid on such input service.

(c) With respect to rent-a-cab service, appeal was filed by the Department against order of Commissioner (Appeals) allowing credit of Service tax paid on the said service. The Department had contended that rent-a-cab service was utilised for transporting vendors and clients from guest-house to factory and vice versa which is not related to business activities. Thus, credit shall not be admissible.

(d) With respect to general insurance service for export of goods, appeal was filed by the Department against order of the Commissioner (Appeals) allowing credit of Service tax paid on the said service. The Department had contended that the activity had no nexus with the manufacture or clearance of export of goods.

Held:

(a) Taking a group insurance is clearly in course of business activities and hence, is an eligible input service for claiming Cenvat credit.

(b) CHA service availed up to the load port shall be considered as an input service and Cenvat credit shall be allowed on the same.

(c) The activity of transportation of vendors and clients was indirectly related to business activity as vendors were the suppliers of raw materials required for final products and clients were the ultimate consumer of final products. Therefore, credit cannot be denied.

(d) Since the export of goods was on FOB basis, credit of Service tax paid on general insurance service was allowed.

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(2011) 22 STR 159 (Tri.-Mum.) — Rubita Gidwani v. Commissioner of Service Tax, Mumbai.

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Liability of sub-contractor — Writing contents of advertising material for advertising agency — Not liable since Service tax paid by advertising agency — Certificate produced to show payment of tax by principal was not considered — Matter remanded.

Facts:
The appellants were engaged in work related to conceptualisation and writing contents of advertisement such as advertising films, print-ads, which was used by another service provider for production of final advertisement material. The period involved was May, 2001 to June, 2003 for which the Department had confirmed recovery of service tax from the appellants as advertisement consultant.

The appellant referred to Board’s Circular dated 23-8-2007, wherein it stated that a taxable service which is intended for use by another service provider does not alter the taxability of service provided. However, even if the appellant is held to be liable, liability would arise only from the date when Circular was issued. Apart from this, she further stated that service tax was required to be paid only when sub-contracting was for a different service category. However, the appellants were not providing any such service. Additionally, she had also produced a certificate that the tax had been paid by the service provider; however, the same was overlooked by the lower authorities.

The Revenue argued that the appellant was working on retainership basis and the relationship between service provider and the appellant was that of principal-to-principal. Moreover, the definition of advertising agency which is an inclusive definition also covers advertising consultants within the ambit.

Held:
In case the appellant was required to pay service tax, it would amount to taxing the same service twice. Furthermore, liability to pay tax lies with the service provider who actually provides the service and not with the sub-consultant. Thus, the case was remanded to the lower authorities in order to reconsider the certificate produced by the appellant.

Note:
On the same lines, the Mumbai Tribunal passed the same order on similar facts in the case of (2011) 22 STR 161 (Tri.-Mumbai) — Neil Enterprises v. Commissioner of Service Tax, Mumbai.

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(2011) 22 STR 15 (Tri.-Delhi) — Kedia Castle Delleon Industries Ltd. v. CCEx., Raipur.

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Packaging activity on manufacture of non-excisable goods falls within the ambit of Central Excise Act — Not liable to Service tax.

Facts:
The appellants were engaged in activity of bottling, labelling, affixing the hologram sticker and sealing of glass bottles of country liquor manufactured by them. They contended that the packaging activity undertaken by them amounts to manufacture and does not attract Service Tax. Furthermore, the definition of packaging activity as per the Finance Act, specifically excludes packaging activity amounting to manufacture as per the Central Excise Act.

The respondents stated that liquor manufactured by the appellants was not excisable goods as liquor was not mentioned in the Central Excise Tariff Act. This implies that activity was not covered by definition of manufacture as per the Central Excise Act and the activity was covered under ‘Packaging activity services’ under the Finance Act. Additionally, they relied on MP High Court’s judgment in the case of Vindhyachal Distilleries Pvt. Ltd. v. State of MP, 2006 (3) STR 723 (MP) in which it was held that bottlers are required to pay Service tax.

Held:
The decision which was relied upon by the respondents was overruled by the larger Bench judgment of the MP High Court in which it was held that packaging and bottling of liquor is covered by definition of manufacture. Accordingly, no Service tax was chargeable. Thus appeal was allowed in favour of the appellants.

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(2011) 22 STR 129 (Mad.) — Kasturi & Sons Ltd. v. Union of India.

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Software maintenance liable to Service tax with
effect from 1-6-2007 only and CBEC Circular dated 7-10-2005 holding
software to be goods and maintenance thereof liable to Service Tax prior
to 1-6-2007 is ultra vires Finance Act.

Facts:
The
Department had issued a Circular dated 17-12-2003 clarifying that
software services were out of the purview of Service tax and section
65(19) defining ‘Business Auxiliary Services’ specifically excluded
information technology services. However, the Supreme Court’s judgment
in case of Tata Consultancy Services v. State of Andhra Pradesh, (2005) 1
SCC 308; (2004) 178 ELT 22 considered canned software as ‘goods’.
Therefore, the Department issued another Circular dated 7-10-2005,
holding software to be ‘goods’ and maintenance thereof leviable to
Service tax.

The petitioners argued that the Circular dated
7-10-2005 was ultra vires section 83 of the Finance Act read with
section 37B of Central Excise Act and 65 (19) of the Finance Act.

The
Revenue contended that section 65(19) excluded only designing and
developing of computer software, and maintenance of software was not
excluded therefrom and the Circular only explained the scope of services
and interpretation of law and did not override the legal provisions.

Held:
The
definition of ‘Business Auxiliary Services’ excluded maintenance of
software specifically till introduction of the Finance Act, 2007. The
amendment made through the Finance Act, 2007 was not with retrospective
effect. Moreover, computer software was included in the definition of
‘goods’ only with effect from 1-6-2007 under the Finance Act. Therefore,
the Circular was held to be overriding the statutory provisions and
software maintenance was held to be liable to Service tax only with
effect from 1-6-2007.

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POINT OF TAXATION RULES, 2011

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1. Background:

1.1 Point of Taxation Rules, 2011 (POT Rules) were notified vide Notification No. 18/2011-ST, dated 1-3-2011 and were amended before they came into force vide Notification No. 25/2011-ST, dated 31-3-2011. Therefore, in order to avoid confusion, only the amended rules are analysed and discussed. In all, there is a set of nine rules. While introducing the POT Rules, the Ministry of Finance, in its Instruction D.O.F. No. 334/3/2011-TRU, dated 28-2-2011 stated as under:

“These rules determine the point in time when the services shall be deemed to be provided.

The general rule will be that the time of provision of service will be the earliest of the following dates:

  • Date on which service is provided or to be provided
  • Date of invoice
  • Date of payment.”

The Service Tax Rules, 1994 (ST Rules) are also correspondingly amended consequent upon introduction of POT Rules to align the provisions and to alter the payment from receipt to the point when services are deemed to be provided.

1.2 Hitherto, Service tax was payable into the Government treasury only at the point of time and to the extent of actual receipt towards value of taxable service. There is a paradigm shift in this well-settled modus operandi of collection of the levy vide the introduction of the POT Rules and accrual is expected to be the new order of the levy with the exception of tax payable on advances also. At the outset, it may be noted that although POT Rules came into force from 1-4-2011, an option is provided in Rule 9 of POT Rules to pay Service tax on receipt basis till 30-6-2011. Essentially, the introduction of POT Rules is claimed as a transitionary action to align the system of payment of taxes on goods and services in the forthcoming GST Regime.

2. Whether POT Rules determine ‘taxable event’ or point of time for manner of collection?

2.1 Prelude to the POT Rules provides that the said rules have been made for the purpose of collection of Service tax and determination of rate of Service tax. However, Rule 2 defining a few terms, its clause (e) defines point of taxation as; “ ‘Point of taxation’ means the point in time when a service shall be deemed to have been provided”. Thus a deeming fiction is created and different times have been laid down when a service shall be deemed to be provided. Does this mean that this set of rules determines the ‘taxable event’? In any law, the charging section determines the taxable event. Section 66 of the Finance Act, 1994 (Act) reads as under:

“there shall be levied a tax (hereinafter referred to as Service tax) at the rate of . . . percent of the value of taxable services referred to in section 65(105) . . . and collected in such manner as may be prescribed.”

2.2 The Supreme Court in the case of Association of Leasing and Financial Services Companies v. UOI, (2010) 20 STR 417 (SC) observed that the taxable event is the rendition of service. The Gujarat High Court in the case of CCE&C v. Reliance Industries Ltd., (2010) 19 STR 807 (Guj.) held that “in our view, substantive provision of the Act would clearly indicate the relevant date is the date of entry in service and not the date of billing.” The Tribunal in the case of CCE v. Krishna Coaching Institute, (2009) 14 STR 18 (Tri.-Del.) held that even though value has been received prior to the date of levy of Service tax, Service tax shall be leviable once the service has been rendered after the date of levy of Service tax. Similarly, in the case of Hindustan Colas Ltd. v. CCE, (2010) 19 STR 845 (Tri.-Mum.) it was held that levy of Service tax is with reference to taxable event and if that has taken place prior to the introduction of levy of a particular service, Service tax cannot be levied on the amount/consideration received for the said service. In the context of excise law in the case of Wallace Flour Mills Company Ltd. v. CCE, (1989) 44 ELT 598 (SC), the goods were exempted from duty at the time of manufacture. However, at the time of clearance after the budget, the duty was levied. The Court held that although when taxable event of manufacture occurred, the goods were exempt, the duty is collected at a later date for administrative convenience. The authorities were competent to collect the duty at the rate applicable at the time of clearance on the goods excisable at Nil rate at the time of taxable event of manufacture. Later in the case of CCE, v. Vazir Sultan Tobacco Co. Ltd., (1996) 83 ELT 3 (SC), the Court held that once the levy is not there at the time of manufacture, it cannot be levied at the time of removal of goods. Thus the law laid down through the above cases is that under the central excise law, the taxable event is manufacture or production of goods and collection of duty is at the point of removal and exempted goods under a notification are excisable goods. However, when they are outside the purview of the excise law at the time of manufacture, no duty can be levied at the time of clearance on the goods manufactured before the introduction of levy and removed after the imposition of levy.

2.3 Thus the charging section levies a tax at prescribed rate on the value of taxable service and specifies that the manner of collection shall be as prescribed. Accordingly, the amended Rule 6 of the ST Rules prescribes that Service tax is to be paid by 6th/5th of the month as the case may be immediately following the calendar month in which the service is deemed to be provided as per POT Rules. In other words, ST Rules read with POT Rules determine the manner of collection of Service tax. Therefore POT Rules do not determine the ‘taxable event’ viz. the provision of service, on the happening of which, the levy of Service tax is triggered. In the backdrop of this analysis, a question arises as to whether Rule 2(e) of the POT Rules defining point of taxation as point in time when service is deemed to be provided is appropriate? The object and purpose laid down while introducing POT Rules indicate that POT Rules are prescribed to provide a deeming fiction for the point in time to determine the manner of collection of Service tax and not taxable event of provision of service. In effect, Rule 6 of the Rules read with POT Rules determines the manner of collection of Service tax. Amidst this legal controversy, the provisions of POT Rules, are discussed hereafter.

3. Determination of point of taxation:

Rule 3 to Rule 8 deal with different situations for determining point of taxation.

3.1 General Rule (Rule 3):
The basic rule set out in Rule 3 is that earlier of the following three events is the point at which Service tax is required to be paid:

  • The date on which an invoice is issued for a service provided or to be provided.
  • If no invoice is issued within 14 days of completion of service, the date on which provision of a service is completed.
  • The date on which any advance by whatever name known is received.

The Government’s letter F. No. 341/34/2010-TRU, dated 31-3-2011 in para 2 has provided a following illustrative table:

The above indicates that point of taxation is hybrid or multiple with a condition of whichever is earlier. If the stated objective is mere alignment with GST, then whether resorting to multiple points was required is a question. Further, and as it also exists since 2005, if advance payment is also a point of taxation under deeming fiction, there is another question arising as to whether or not uniformity will be achieved in the indirect tax system. Under the excise law, the time of manufacture is the taxable event, but the duty is levied at the point of clearance and thus there is a single taxation point. Under the VAT laws, the tax is payable when sale is made.

3.2    When effective rate of Service tax is changed (Rule 4):

Notwithstanding anything in Rule 3 of POT Rules as discussed in para 3.1 above when the effective rate of Service tax changes, provision of this Rule 4 relating to change in effective rate of Service tax is applicable. The rate of Service tax for this purpose also includes abated rate under any exemption or a specific rate under any rule. For instance, there is a lower effective rate of tax by virtue of exemption of 75% in value in case of service of transportation of goods by road, exempted value on various services vide Notification No. 1/06-ST, dated 1-3-2006 or there is a composition rate prescribed in case of works contract service or options available of specific rates for services of air travel agents, life insurance business, purchase or sale of foreign currency including money changing, etc. under Rule 6(7), (7A) and (7B), respectively of ST Rules. Determination of point of taxation under the said Rule 4 for services provided before the change in rate and after the said change is provided as follows:

(a)    When taxable service is provided before the change in effective rate of tax:

  •  If both, issuing invoice and receipt of payment are after the date of change of effective rate of tax, whichever accrues earlier is the point of taxation. The changed rate would apply here.

  •     However, when the invoice is issued prior to the change in effective rate of tax, but the payment is received after the said change, the date of invoice is the point at which tax is payable and accordingly the old rate would apply.
  •     As against the above, when the payment is received prior to the change in effective rate of tax, but the invoice is issued after the date of change of the rate, the date of payment is the point of taxation. As such, in this case also the old rate of tax would be applicable.

(b)    When a taxable service is provided after the change in effective rate of Service tax:

  •  If the invoice is issued prior to the change in the effective rate of tax, but the payment is received after the said change, the date of receipt of payment is the point of taxation and despite the issue of invoice earlier, in deviation from the general rule, the changed rate would be applicable.

  •  However, when both, issuing invoice and receipt of payment have occurred prior to the change in the effective rate of tax, the earlier event out of the two occurrences is the point of taxation. The old rate would be applicable in this situation.

  •  When the payment is received prior to the change in the effective rate of Service tax, but the invoice is issued after the said change, the date of invoice is the point of taxation. The changed rate would be applicable here again in deviation from the general rule.

The broad principle in the above six situations is that the tax rate is determined based on when two events have occurred at a point of time i.e., either provision of service and issue of invoice or provision of service and payment.

3.3    When a new service is introduced in the law:
(Rule 5):

3.3.1 When any service (other than a service which is considered in continuous supply and accordingly covered by Rule 6) which was not taxable earlier and for the first time it is made taxable from a specific date, Service tax is not payable:

(a)    when the invoice is issued and payment is received for such service before such service became taxable;
(b)    when the payment is received prior to the service becoming taxable, but the invoice is issued after the service becoming taxable, if the invoice is issued within fourteen days from the date of completion of service as laid down in Rule 4A of the ST Rules.

3.3.2 This rule appears to defy the basic legality that when there is no ‘taxable event’ under the law, there cannot be levied Service tax as emerging from the provision of section 66 of the Act as well as various rulings, some of which are cited in para 2 earlier. From the conditions laid in (a) above, it appears that in a case when both, issue of invoice and payment have occurred prior to the date of introduction of the levy, but if a service as a matter of fact is provided after the introduction of levy, no Service tax is payable. Conversely, in terms of (b) above, if the service is provided prior to the effective date of the new levy, payment also is received prior to such date, but if no invoice is issued within 14 days, Service tax liability would arise. The question arises is whether the condition of issuing invoice within 14 days in terms of Rule 4A of the ST Rules can be applied to the period prior to the effective date of the levy? Does such rule get authority of law? It appears that if the Rule is not amended, considerable litigation may surface on this issue in addition to the hardship expected to be faced by a large number of service providers.

3.4 Continuous supply of service: (Rule 6):
3.4.1 Continuous supply of service as defined by Rule 2(c) of POT Rules means any service provided or to be provided continuously under a contract for a period exceeding three months or where the Central Government notifies a particular service to be a continuous supply of service with or without any condition.

The Government in accordance with the provisions of the said Rule 2(c) of POT Rules vide Notification 28/11-ST, dated 1-4-2011 notified the following services to be constituted in the nature of continuous supply, notwithstanding the period for which they are provided or agreed to be provided:

  •     Telecommunication service [65(105)(zzzx)]
  •     Commercial or industrial construction [65(105)(zzq)]
  •     Construction of residential complex [65(105)(zzzh)]
  •     Internet telecommunication service [65(105)(zzzu)]
  •    Works contract service [65(105)(zzzza)]

3.4.2 The conditions mentioned in sub-clauses (a) and(b) of Rule 6 are aligned with Rule 3, viz. the general rule discussed in para 3.1 earlier. Nevertheless, Rule 6 for services held to be in continuous supply is in primacy over Rules 3 and 4 discussed in paras 3.1 and 3.2 earlier and Rule 8 discussed in 3.9 hereafter. The earlier event of the date of invoice or the date of receipt of advance is the point of taxation. Like the general rule, in case of continuous supply of service also, if the invoice is issued within 14 days of completion of service, the date of completion of service would be the point of taxation. However, in case where the terms of the contract for the service provided that on the completion of a specific event or a milestone, certain payment is required to be made by the recipient of the service to the provider thereof, the date of completion of each such event or milestone as provided in the contract would be deemed to be completion of part or whole of such service, as the case may be. In this context, the following clarification of the Finance Ministry made vide para 5 of letter F. No. 341/34/2011-TRU of 31-3-2011 is relevant:

“5. Rule 6 relating to continuous supply of service has been aligned with the revised Rule 3 and the date of completion of continuous service has been defined within the rule. This date shall be the date of completion of the specified event stated in the contract which obligates payment in part or whole for the contract. For example, in the case of construction services if the payments are linked to stage-by-stage completion of construction, the provision of service shall be deemed to be completed in part when each such stage of construction is completed. Moreover, it has been provided that this rule will have primacy over Rules 3, 4 and 8.”

3.4.3 Briefly stated, so far as this Rule 6 is concerned, ordinarily, once a service is determined as one in continuous supply, the date of the completion of the event stated in the contract is the point of taxation. However, if an invoice is raised or payment is received before this date, point of taxation shifts accordingly.

3.5 When services are exported: Rule 7(a):

When the services are held as exported in terms of the Export of Services Rules, 2005, there does not arise a liability to pay Service tax. However, technically until the payment for the service is received in convertible foreign exchange, the service would not constitute export, because the condition of receipt in foreign exchange does not stand fulfilled. Rule 7(a) and the proviso in this regard provide that if payment for exported service is made within the period specified by the Reserve Bank of India (RBI) which is usually 12 months (except in certain cases, a longer period is allowable), the date of payment is considered the point of taxation. However, if it is not received within the period specified by RBI, the point of taxation would be determined as if this rule is absent and therefore in accordance with Rules 4, 5 or 6 discussed above or Rule 8 discussed hereafter in para 3.9, as the case may be. To summarise, if the payment for the exported service is not made within the time prescribed by RBI, the Service tax liability would emerge and the liability would arise from the point of taxation as determinable under the rules without having benefit of considering the date of receipt and therefore the interest for delayed payment also would arise as the point of taxation would shift to a much earlier date like the date of invoice or the date of completion of service, or as the case may be. The clarification of the Finance Ministry in para 9 of the letter F. No. 341/34/11-TRU of 31-3-2011 is reproduced below:

“9. Export of services is exempt subject, inter alia, to the condition that the payment should be received in convertible foreign exchange. Until the payment is received, the provision of service, even if all other conditions are met, would not constitute export. In order to remove the hard-ship that will be caused due to accrual method, the point of taxation has been changed to the date of payment. However, if the payment is not received within the period prescribed by RBI, the point of taxation shall be determined in the absence of this rule.”

3.6    When Service tax is payable under reverse charge mechanism: Rule 7(b):

In case of services like insurance agents and mutual fund agents, goods transport agencies or when taxable services are provided from outside India, the liability of Service tax is on recipient of the services u/s.68(2) of the Act. In such cases, like in case of exported services, the Rule 7(b) provides for point of taxation on the date of actual payment to the service provider. However, this is subject to the condition that the payment is made within six months of the date of the invoice. If the payment is not made within 6 months of the date of invoice, point of taxation is determined in the absence of this rule i.e., in accordance with the applicable rule, be it Rule 3, 4, 5, 6 or 8, as the case may be. Like in the case of export of services discussed in 3.5 earlier, interest for the delayed payment would arise as the point of taxation would shift to the date of invoice or the date of completion of service, etc. The clarification of the Finance Ministry vide para 10 of the letter dated 31-3-2011 is as follows:

“10. In case of services where the recipient is obligated to pay Service tax under Rule 2 (1)(d) of the Service Tax Rules i.e., on reverse charge basis, the point of taxation shall be the date of making the payment. However, if the payment is not made within six months of the date of invoice, the point of taxation shall be determined as if this rule does not exist. Moreover, in case of associated enterprises, when the service provider is outside India, the point of taxation will be the earlier of the date of credit in the books of account of the service receiver or the date of making the payment.”

3.7    Certain professionals to continue to pay Service tax on receipt basis: Rule 7(c):

Rule 7(c) has carved out an exception for the following professional service providers when services are provided as individuals, proprietary firms or partnership firms and provided for the date on which payment for a service is received or made as the point of taxation and accordingly has maintained a status quo for these assessees. The list is as follows:

  •     Architect [Section 65(105) (p)]
  •    Chartered Accountant [Section 65(105) (s)]
  •     Cost Accountant [Section 65(105) (t)]
  •     Company Secretary [Section 65(105) (u)]
  •     Interior Decorator [Section 65(105) (q)
  •     Legal Consultant [Section 65(105) (zzzzm)]
  •     Scientific and Technical Consultant [Section 65 (105) (za)]

Thus, the above categories of persons continue to pay Service tax on receipt basis even after 1-7-2011. In this list, professions of consulting engineers and management consultants are conspicuously missing. In this context, the clarification vide para 8(iii) of the Finance Ministry letter of 31-3-2011 is relevant to note:

“8(iii) Individuals, proprietorships and partnership firms providing specified services (Chartered Accountant, Cost Accountant, Company Secretary, Architect, Interior Decorator, Legal, Scientific and Technical consultancy services). The benefit shall not be available in case of any other service also supplied by the person concerned along with the specified services.” (emphasis supplied)

It is required to note here that the above rider is not mentioned in the applicable rule, but finds place in the Government clarification in the above words.

3.8 Associated enterprises:

In case of associated enterprises, when the service provider is outside India and the Service tax is pay-able in respect thereof under reverse charge, the earlier of the date of credit in the books of account of the receiver of service or the date of payment is considered the point of taxation. When any associated enterprise is situated in India, no provision is made for it in POT Rules. The earlier proviso in this regard in Rule 6 of the ST Rules is also omitted with effect from 1-4-2011. The clarification in para 7 of the Finance Ministry letter of 31-3-2011 explains this point as follows:

“7. Rule 7 relating to associated enterprises has been deleted. Now that the date of completion of the provision of service is an important criterion in the determination of point of taxation, it shall take care of most of the dealings between the associated enterprises. Thus in case of failure to issue the invoice within the prescribed period, the date of completion of provision of service shall come into effect even if payment is not made.”

3.9    Royalty payments: Intellectual property rights:
(Rule 8):

It is provided that in respect of royalties and payments towards copyrights, trademarks, designs or patents, when the whole amount of consideration is not ascertainable at the time of provision of service, the service shall be deemed to have been provided each time the payment in respect of the use or the benefit is received by the provider of trademark, copyright, patent, etc. or at the time the invoice is issued by the service provider, whichever is earlier.

4.    Services completed or invoice issued before POT Rules became effective:

Transitional provision is made in the POT Rules whereby for the service provision completed prior to 30-6-2011 or invoices issued till 30-6-2011, an assessee at his option can pay Service tax at the point when payment is received or made, as the case may be. In short, an assessee can continue to pay service tax on receipt basis for the invoices issued till 30-6-2011 or he may pay on accrual if so opts from 1-4-2011.

5.    When invoice is not paid partly or wholly by the recipient of service:

Most assessees under the Service tax law, except the seven categories of professionals as discussed in para 3.7 earlier, face the challenge of payment of service tax based on the invoice in the post — July 01, 2011 scenario and not receiving full/part payment towards the service, leave aside non-receipt of amount of service tax charged in the said invoice. Therefore, non-payment or short payment may occur on account of various reasons such as dispute as to delayed service, quality of deliverables, cash-flow difficulty of the recipient of service, breach of terms of service, etc. With the onset of POT Rules, corresponding changes are made in the ST Rules. The amended Rule 6(3) of the ST Rules provides that:

  •     If the service is wholly or partly not provided for any reason; or

  •     Where the amount of invoice is renegotiated due to inadequate or poor quality of service, the service provider or the assessee can refund the amount to the receiver of service with Service tax or issue a credit note suitably.

After such refund of amount or issue of credit note, the assessee may himself adjust the excess payment of Service tax against his Service tax li-ability for the subsequent period. However, when no invoice is paid for at all by the service receiver and if the assessee does not issue a credit note, no provision is made in the POT Rules or ST Rules for adjustment of bad debts. Refer to para 11(ii) of the Finance Ministry letter of 31-3-2011 explaining the position as follows:

“11(ii) If the amount of invoice is renegotiated due to deficient provision or in any other way changed in terms of conditions of the contract (e.g., con-tingent on the happening or non-happening of a future event), the tax will be payable on the revised amount provided the excess amount is either refunded or a suitable credit note is issued to the service receiver. However, concession is not available for bad debts.”

6.    CENVAT credit available on receipt of invoice:

Rule 4(7) of the CENVAT Credit Rules, 2004 is simultaneously amended to align with POT Rules to provide that CENVAT credit of Service tax is available immediately on receipt of invoice issued on or after 1-4-2011, except when service tax is payable under reverse charge mechanism. However, if the invoice is not paid within three months of the date of invoice, the credit is required to be reversed. The credit can be taken again after the invoice is paid. (Readers may refer to Service tax feature in May 2011 Issue of BCAJ for detailed analysis of this at para 5 under ‘Significant Amendments in CENVAT Credit’).

7.    Some issues:

7.1 Mr. A, an assessee under the Service tax law received advance payment on 25th February for his services agreed to be provided 1st June onwards. The rate of Service tax was revised from 10.3% to 12.36% from May 2011. Considering the POT Rules in operation, on the receipt of advance payment, Service tax @10.3% was paid by Mr. A on 5th March i.e., in the following month of the receipt on the receipt of advance is the earliest event. Whether Mr. A would be required to pay service tax at higher rate of tax on the amount of advance received on 25th February, if:

(a)    he issues an invoice on March 10 for the said advance

(b)    he issues an invoice on June 01 when service commences

(c)    he issues an invoice on 31st March.

Mr. A seeks advice.

7.1    (a) When the rate of Service tax changes, ordi-narily one is governed by the provisions of Rule 4 of POT Rules. Accordingly, when services are provided after the change in the rate, but if advance is received prior to such change and if the invoice is also issued prior to such change, the point of taxation is earlier event of the two occurrences, therefore payment on 5th March @10.3% is in order as the invoice is also issued prior to the date of change in the rate.

(b)    If the invoice is not issued by Mr. A till June 01, he will be required to pay service tax @12.36% as his point of taxation would be June 01 in this case and the liability to pay Service tax arises on 5th July. (Here the default under Rule 4A of STR is also made as no invoice is issued within 14 days of the receipt of the advance.)

(c)    In this situation also, the point of taxation would be 25th February and therefore the payment of tax on 5th March @10.3% was proper notwith-standing the default in issuing of invoice later than 14 days of the receipt of the advance.

Mr. A is advised to issue the invoice within 14 days of the receipt of advance as in (a) above in order to avoid a controversy.

7.2 Mr. X provides a service which was hitherto not taxable. However, the service is introduced in the law from a prospective date for the first time, say, from July 01. For certain services provided till 30th June, Mr. X had already issued two invoices, however no payment was received by Mr. X till 30th June. Whether Service tax would be payable in any case by Mr. X if he receives the payment for both the two invoices in August and December, respectively.

7.2    Rule 5 of POT Rules provides for point of taxation when a new service is introduced in the law for the first time. However, the above situation is not envisaged by the said rule. Therefore Rule 3(a) being a general rule would be applicable. Accordingly, no Service tax would be payable as the date of invoice is the point of taxation and at such time the service was not taxable. Further, in principle, in the absence of or prior to the introduction of POT Rules when the provisions of service occurred, the service was not taxable and therefore no Service tax would have to be paid. Taxable event under the service tax law is rendering of taxable service as discussed and decided in cases cited in para 2 earlier and also by the Gujarat High Court in CCE&C v. Schott Glass India (P) Ltd., (2009) 14 STR 146 (Guj) held that taxable event in relation to Service tax is admittedly the rendering of taxable service. Many disputes have arisen on the issue of whether Service tax is payable in respect of services provided prior to the introduction of levy on it and payment for which is received later. In the case of Lumax Samlip Industries

v.    CST, (2007) 6 STR 417 (Tri.-Chennai) it was held that for determination of Service tax liability, the relevant date is the date on which the service was received by the appellant. If the service was received before the applicability of Service tax on that service, Service tax cannot be levied.

7.3 ABC & Co is a partnership firm of CAs which is registered with the Service Tax Dept. under the following service categories:

  •     Chartered Accountant
  •     Management or Business Consultant
  •     Business Support

They are in the process of converting into LLP in due course of time. ABC & Co seeks advice as to implications of POT Rules before/after conversion into LLP.

7.3A    According to the provisions of Rule 7(b) of POT Rules, relaxation is applicable only in the following circumstances/situations:

  • Service provider is an individual, proprietary firm or partnership firm
  • Specified service is provided by a service provider.

Hence, the following position emerges:

(a)    Prior to LLP conversion, relaxation under POT Rules, would be available only in regard to taxable Services provided under ‘Chartered Ac-countant’ category [Section 65(105) (s)]

(b)    Post LLP conversion, relaxation under Rule 7(b) of POT Rules, would not be available to ABC & Co.

ITO v. Chheda Construction Co. (Joint Venture) ITAT ‘C’ Bench, Mumbai Before R. S. Padvekar (JM) and Rajendra Singh (AM) ITA No. 2764/Mum./2009 A.Y.: 2005-06. Decided on: 27-4-2011 Counsel for revenue/assessee: Ajit Kumar Sinha/K. Shivram

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Section 80IB(10) — Amendment to section 80IB(10) w.e.f. A.Y. 2005-06 restricting the commercial area to 5% is not applicable to projects commenced prior to 1-4-2005.

Facts:
The assessee, a builder and land developer, had entered into an agreement to develop and construct a building project on land situated at Mira Taluka, Dist. Thane. For A.Y. 2005-06, the assessee filed a return of income in which it claimed deduction u/s.80IB(10) of the Act. The AO noted that the housing project which consisted of 94,255 sq. ft had shopping area to the extent of 7,935 sq. ft. The AO denied the deduction on the ground that in view of the amendment to section 80IB(10) w.e.f. 1-4- 2005, the assessee was not entitled to deduction u/s.80IB(10) of the Act.

Aggrieved the assessee preferred an appeal to CIT(A) who allowed the appeal.

Aggrieved by the order passed by the CIT(A) the Revenue preferred an appeal to the Tribunal.

Held:
The Tribunal noted that the assessee’s project had commenced prior to 1-4-2005. It also noted that in the case of Brahma Associates, the High Court has held that the amendment to section 80IB is prospective in operation. Since the assessee’s project had commenced in December 2003, the Tribunal held the amendment to be not applicable to the assessee’s case.

The Tribunal dismissed the appeal filed by the Revenue.

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Pyare Mohan Mathur HUF v. ITO ITAT Agra Bench Before P. K. Bansal (AM) and H. S. Sidhu (JM) ITA No. 471/Agra/2009 A.Y.: 2005-06. Decided on: 21-4-2011 Counsel for assessee/revenue: Rajendra Sharma/ Vinod Kumar

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Section 2(22B), section 50C, section 55(2)(b)(i) — Cost of acquisition of the property u/s.55(2) (b)(i) will be its fair market value as on 1-4-1981 as determined by the registered valuer and not the circle rate.

Facts:
The assessee sold property acquired by him prior to 1-4-1981. The assessee computed capital gains by considering fair market value of the property on 1-4-1981 to be its cost of acquisition. The fair market value adopted by the assessee was on the basis of a valuation report of a registered valuer. The Assessing Officer (AO), on the basis of Inspector’s Report, took circle rate list dated 8-6-1981 and valued the land on 1-4-1981 on the basis of circle rate and regarded this value to be the fair market value to be considered as cost of acquisition for computing capital gains.

Aggrieved, the assessee preferred an appeal to the CIT(A) who confirmed the order passed by the AO.

Aggrieved, by the order of the CIT(A), the assessee preferred an appeal to the Tribunal.

Held:
The Tribunal noted that the term ‘fair market value’ is defined in section 2(22B) and no rules have been made for purpose of determining fair market value. The assessee had relied on the valuation report which he obtained from the registered valuer who is technical person and duly approved by the Department, whereas the AO had deputed the Inspector who brought the circle rate of the village where the land was situated and had adopted the circle rate to be fair market value. There is no provision under the chapter relating to capital gains which states that circle rate will be treated as cost of acquisition. Circle rates are notified by the State Government for levy of stamp duty for registration of sale deeds. The circle rates are deemed to be full value of consideration received or accruing as a result of transfer u/s.50C. But this section nowhere states that circle rates as notified will be the fair market value. The Tribunal held that in view of the provisions of section 55A once the assessee has submitted the necessary evidence by way of valuation report made by the Registered Valuer, the onus gets shifted on the AO to contradict the report of the Registered Valuer. The registered valuation officer is a technical expert and the opinion of an expert cannot be thrown out without bringing any material to the contrary on record. In case the AO was not agreeable with the report of the Registered Valuer, he was duty bound to refer the matter to the DVO for determining the fair market value of the land as on 1-4-1981 which he failed to do so. The Tribunal held that the Revenue has not discharged the onus but merely rejected the fair market value taken by the assessee. It set aside the order of the CIT(A) and directed the AO to re-compute the capital gain after taking the fair market value of the land as on 1-4-1981, as claimed by the assessee.

This ground of appeal filed by the assessee was allowed.

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Income: Capital or revenue: Refund of excise duty under subsidy scheme and interest subsidy, etc.,: Capital receipts and not taxable.

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[M/s. Shri Balaji Alloys v. CIT, 333 ITR 335 (J&K)]

Pursuant to the new industrial policy announced by the State of J&K the assessee received excise refund and interest subsidy, etc. The assessee claimed it to be capital receipt. Alternatively, the assessee claimed that the subsidy amount was eligible for deduction u/s.80-IB. The Assessing Officer, CIT(A) and the Tribunal rejected the assessee’s claim and held that the receipt was a revenue receipt on the ground that (i) the subsidy was for established industry and not to set up a new one, (ii) it was available after commercial production, (iii) it was recurring in nature, (iv) it was not for purchasing capital assets, and (v) it was for running the business profitably.

On appeal by the assessee, the Jummu and Kashmir High Court reversed the decision of the Tribunal and held as under:

“(i) The ratio of Sahney Steel, 228 ITR 253 (SC), Ponni Sugar 306 ITR 392 (SC) and Mepco Industries, 319 ITR 208 (SC) is that to determine whether incentives and subsidies are revenue or capital receipts, the purpose underlying the incentives is the determinative test. If the object of the subsidy scheme is to enable the assessee to run the business more profitably, then the receipt is on revenue account. On the other hand, if the object of the subsidy scheme is to enable the assessee to set up a new unit or to expand the existing unit, then the receipt of the subsidy is on capital account. It is the object for which the subsidy/assistance is given which determines the nature of the incentive subsidy. The form or mechanism through which the subsidy is given is irrelevant.

(ii) On facts, the object of the subsidy scheme was (a) to accelerate industrial development in J&K, and (b) generate employment in J&K. Such incentives, designed to achieve a public purpose, cannot, by any stretch of reasoning, be construed as production or operational incentives for the benefit of the assessee alone. It cannot be construed as mere production or trade incentives.

(iii) The fact that the incentives were available only after commencement of commercial production cannot be viewed in isolation. The other factors which weighed with the Tribunal are also not decisive to determine the character of the incentive subsidies in view of the stated objects of the subsidy scheme.

(iv) The finding of the Tribunal that the incentives were revenue receipt is, accordingly, set aside, holding the incentives to be capital receipt in the hands of the assessee.”

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Appeal to Tribunal: Appeal by Department against order of CIT(A): Department seeking adjournment to file paper book: Tribunal allowing appeal without paper book: Order of Tribunal set aside: Assessee to be given opportunity to submit paper book.

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[Krishan Kumar Sethi v. CIT, 333 ITR 16 (Del.)]

The addition of cash credit made by the Assessing Officer u/s.68 was deleted by the CIT(A). The Revenue filed appeal before the Tribunal against the said deletion. At the time of hearing, the Department sought adjournment for filing paper book. On the adjourned date, paper book was not filed by the Department, but the Tribunal heard and allowed the appeal without the paper book.

The assessee filed appeal before the Delhi High Court and contended that even if the Department had not filed the paper book, in those circumstances a chance should have been given to the assessee to file a paper book. The Delhi High Court allowed the appeal and held as under:

“(i) There was substance in the submission of the assessee. The order of the Tribunal was to be set aside giving liberty to the assessee to file the paper book containing the documents on which the appellant wanted to rely in support of his submissions.

(ii) The Tribunal to hear the parties afresh and take into consideration the material to decide the issue again.”

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(2011) 128 ITD 24/ (2010) 8 taxmann.com 286 (Mum.) Ms. Nita A. Patel v. ITO A.Y.: 2004-05. Dated: 15-7-2009

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Section 48 — (i) Indexed cost of acquisition of a property has to be calculated with reference to date when assessee acquires ownership rights over property and physical possession of property is not relevant — (ii) Amount paid to tenant for getting the possession of the property can be taken as cost of improvement and accordingly indexation can be applied.

Facts:
The assessee sold a property, being a flat, for consideration of Rs.1.68 crore. The assessee acquired the property at Rs.46.38 lakh on 27- 12-1990. However, he got the possession of the property only on 6-1-1992 and that too after paying the tenant Rs. 18,00,000 to vacate the same.

The Assessing Officer was of the view that since the assessee got possession only on 6-1-1992, it could be said that the assessee held the property from that date in view of section 48. The AO, accordingly, calculated the indexed cost of acquisition and capital gains. AO also disallowed the payment made to the tenant for vacating the property which was claimed by the assessee as indexed cost of improvement.

On appeal, the CIT(A) upheld the assessment order.

Held:
(1) Assets which are referred under the capital gains include not only the property which is tangible, but also intangible rights whose physical possession cannot be taken. The word ‘held’ used in the Explanation (iii) to section 48 does not mean physical ownership or physical possession of the property, but it refers to ownership rights only.

(2) The ownership has been passed by virtue of the agreement. Possession of property was delayed only due to the adverse possession of a tenant which subsequently got vacated and so, the assessee was deemed to be holding the property with effect from the agreement date. Accordingly claim of indexation from 27-12-1990 was correct.

(3) Further the assessee was entitled to consider the amount paid to the tenant as cost of improvement.

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(2011) 128 ITD 1 (Delhi) ITO v. Dharamshila Cancer Foundation and Research Centre A.Y.: 2002-03. Dated: 27-3-2009

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Section 2(15) — Quantum of profit is no test in itself for determining the charitable nature of a society and that too after finding the facts that the profits were applied for charitable purpose only.

Facts:

(1) The assessee was a society registered u/s.12A, established with the main object of carrying out research and to run the hospital and care centres with special emphasis on cancer detection and cure and general public welfare.

(2) The assessee had filed NIL return, claiming exemption u/s.11.

(3) The Assessing Officer denied the benefits u/s. 11 and u/s.12 on two grounds, namely:

(a) Hospital charges were on higher side and were comparable to hospitals run on commercial basis, and

(b) The alleged subsidised treatment was only given to doctors, relatives/friends of the doctors and employees of the hospital.

(4) On appeal, the assessee proved the facts to the satisfaction of the CIT(A) that its charges were in line with those hospitals who were claiming benefits of sections 11 and 12 and also that the patients have come from farflung areas and that the second ground was altogether baseless. Consequently the CIT(A) set aside the order passed by the AO. Thereupon the Revenue went into second appeal.

Held:

(1) Profitability is not the sole criterion to assess the charitable nature of a society. Charitable activity can also result in profits and that does not conclude that the activity carried on was not charitable in nature.

(2) Further, profits accruing to the society were utilised for charitable purpose only, which was also affirmed by the AO.

(3) Thus, the appeal of the Revenue was dismissed.

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Search and seizure: Block assessment: Assessment of third person: Limitation: Section 158BC, section 158BD and section 158BE(2)(b) of Income-tax Act, 1961: Notice issued u/s.158BC: Later fresh notice issued u/s.158BD: Time for making assessment to be reconed from first notice.

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[CIT v. K. M. Ganesan, 333 ITR 562 (Mad.)]

Pursuant
to a search, notice u/s.158BC was issued to the assessee on 27-7-1999.
After noticing that the warrant was not issued in the name of the
assessee, a fresh notice u/s.158BC r/w.s. 158BD was issued on the
assessee on 7-2-2001. The assessee filed the block return on 29-1-2003
admitting ‘nil’ undisclosed income. The assessment was made on
27-2-2003. The assessee claimed that the assessment is invalid being
made beyond the period of limitation of two years from the date of
issuance of notice on 27-7-1999. The CIT(A) and the Tribunal accepted
the assessee’s claim.

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

“(i)
The assessee knew very well the purpose for which the notice was issued
on 27-7-1999. The warrant was not issued in the name of the assessee
was admitted. In the circumstances, notice issued u/s.158BC was in
accordance with the requirement of section 158BD.

(ii)
Non-mentioning of section 158BD would not ipso facto invalidate the
earlier notice. Therefore, the assessment made against the assessee was
beyond the period prescribed u/s. 158BE(2)(b).”

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Industrial undertaking: Deduction u/s.80-IB of Income-tax Act, 1961: A.Y. 2004-05: Assessee not claiming deduction for initial years: Does not disentitle the assessee to claim benefit for remaining years if conditions are satisfied.

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[Praveen Soni v. CIT, 333 ITR 324 (Del)]

The assessee was engaged in the business of manufacturing and exports of readymade garments. For the first time the assessee claimed deduction u/s. 80-IB in the A.Y. 2004-05 pleading that even if he had not claimed the benefit for the past years, it should be allowed to him from A.Y. 2004-05 for the remaining period of 10 years, i.e., up to A.Y. 2007-08. The Assessing Officer denied the benefit on the ground that the assessee had not availed the deduction in the first year in question, i.e., A.Y. 1998-99. The Assessing Officer also held that since the assessee was not registered as a small-scale industry under the provisions of the Industries (Development and Regulation) Act, 1951 the assessee was not entitled to claim the benefit u/s.80-IB of the Act. The Tribunal upheld the decision of the Assessing Officer.

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

“(i) Merely because though the assessee was eligible to claim the benefit, he did not claim it in that year that would not mean that he would be deprived from claiming this benefit till the A.Y. 2007-08, which was the period for which his entitlement would accrue. The provisions contained in section 80-IB of the Act nowhere stipulated any condition that such a claim had to be made in that first year, failing which there would be forfeiture of such claim in the remaining years.

(ii) It was not the case of the assessee that he should be allowed to avail of the claim for 10 years from A.Y. 2004-05. The assessee had realised his mistake in not claiming the benefit from the first assessment year, i.e., A.Y. 1998-99. At the same time, the assessee forwent the claim up to the A.Y. 2003-04 and was making the claim only for the remaining period. There was no reason not to give the benefit of the claim to the assessee if the conditions stipulated u/s.80-IB of the Act were fulfilled.

(iii) The registration under the 1951 Act would be of no consequence for availing of the benefit u/s.80-IB of the Act. Clause (g) of sub-section (14) of section 80-IB of the Act only mandates that such an industrial undertaking should be regarded as small-scale industrial undertaking u/s.11B of the 1951 Act.

(iv) Thus, insofar as extending the provisions of section 80-IB of the Act was concerned, the only aspect which was relevant was whether the conditions stipulated under Notification issued u/s.11B of the 1951 Act for regarding it as small-scale industrial undertaking were fulfilled or not. There was no dispute that the assessee fulfilled the eligibility conditions prescribed u/s.80-IB of the Act and was to be regarded as small-scale industrial undertaking.

(v) The Assessing Officer was directed to give the benefit of deduction claimed by the assessee u/s.80-IB of the Act for the A.Y. 2004-05.”

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Business expenditure: Disallowance u/s. 40(a)(iii) A.Y. 2002-03: Salary paid to nonresidents outside India in Netharlands: Not chargeable to tax in India: Not liable for TDS: Disallowance u/s.40(a)(iii) not justified.

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[Mother Dairy Fruit, Vegetable (P) Ltd. v. CIT, 240 CTR 40 (Del.)]

The assessee-company has a marketing office in Rotterdam in the Netherlands to support its export business in India. It remits funds in foreign currency to its Netherlands office to meet the expenses of that office. During the previous year relevant to the A.Y. 2002-03, the aggregate of the amount of salaries paid to the employees of that office was Rs.19,29,632. The employees were non-residents and were subject to tax in the Netherlands as per DTAA between India and the Netherlands. As such tax was not deducted at source on such salary payment. The Assessing Officer disallowed the claim for deduction of the said amount of Rs. 19,29,632 relying on the provisions of section 40(a)(iii) on the ground that tax was not deducted at source on such salary payment. The CIT(A) allowed the assessee’s appeal and deleted the addition. The Tribunal reversed the decision of the CIT(A) and restored that of the Assessing Officer.

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

“Salary to non-resident employees of the assessee paid in the Netherlands was not chargeable to tax in India as per section 5(2) and section 9(1)(ii) as also as per Article 15 of DTAA between India and the Netherlands and therefore, provisions of section 40(a)(iii) were not applicable for non-deduction of tax at source.”

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Export profit: Deduction u/s.80HHC of Income-tax Act, 1961: A.Y. 1994-95: Assesseecompany in business of manufacture and sale of automobile parts: Amount received as fees for development work from foreign party: 90% of such amount not to be excluded under Expln. (baa) to section 80HHC for computing profits of the business.

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[CIT v. Motor Industries Co. Ltd., 239 CTR 541 (Kar.)]

The assessee-company was in the business of manufacture of automobile parts. For the A.Y. 1994-95, the assessee had received an amount of Rs.64,75,373 as fees towards developmental work from M/s. Robert Bosch, Germany. In respect of this amount, the assessee had claimed deduction u/s.80-O of the Income-tax Act, 1961, which was granted. For the purpose of computing the amount deductible u/s.80HHC of the Act, the Assessing Officer excluded 90% of the above amount for computing the profits of the business by applying Explanation (baa) to section 80HHC. The assessee objected to such exclusion. The Tribunal accepted the assessee’s claim.

In appeal, the Revenue contended that the assessee had already availed the benefit of the said income u/s.80-O of the Act and accordingly that the said income is in the nature of ‘charges’ as contemplated under clause (i) of Explanation (baa) to section 80HHC. The Karnataka High Court upheld the decision of the Tribunal and held as under:

“(i) It is clear that such incomes which have no direct nexus with the export turnover are liable to be deducted in arriving at the profits of the business. It was only when the assessee has an independent income which has no nexus with the income derived from export, which is in the nature of brokerage, commission, interest, rent or charges, and by inclusion of that income to the profits of the business, results in distortion, then, such income should be excluded.

(ii) In the instant case, it is not in dispute that the assessee is in the business of export of goods and merchandise. The disputed income is earned by the assessee for his fees towards developmental work from RB. The developmental work is intimately connected with the business of manufacturing and sale of goods by the assessee. There is immediate nexus between the activity of export and the developmental work.

(iii) Admittedly, for the services rendered by way of these developmental work, the assessee has been given the benefit of deduction u/s. 80-O. The receipt of consideration from the foreign enterprise is not in dispute. From the very same business that the assessee is carrying on, he is having an income under two heads and therefore, it is not a case of any independent income unrelated to or unconnected with the business carried on by the assessee is sought to be included in the profits of the business.

(iv) In these circumstances, the Tribunal was justified in holding that the said consideration received for developmental work is not liable to be deducted under clause (baa) in computing the profits of the business.”

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Scheme of Amalgamation — Sanction of Court — Companies Act, section 391(2), 394.

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[Sesa Industries Ltd. v. Krishna H. Bajaj & Ors., AIR 2011 SC 1070]

A resolution was passed by the Board of Directors of SIL to amalgamate SIL with SGL, effective from 1st April, 2005. In pursuance thereof, SIL and SGL filed respective company applications in the Bombay High Court seeking the Court’s permission to convene a general body meeting. In the year 2006 the High Court allowed SIL and SGL to convene meetings for seeking approval of shareholders. The shareholders of SIL & SGL by 99% majority approved the scheme of amalgamation. Only the respondent No. 1 was the sole shareholder who had objected. Petitions were filed in the High Court for according approval to the scheme. Official Liquidator also filed his report. The objection of report were dismissed and subsequent appeals against the same were dismissed. Thereafter the Company Judge sanctioned the scheme of amalgamation. Aggrieved by the above order the Respondent No. 1 filed an appeal whereby the Division Bench set aside the Company Judge order. Hence the appeals were filed by SLP before the Apex Court.

The Court observed that when a scheme of amalgamation/ merger of a company is placed before the Court for its sanction, in the first instance the Court has to direct holding of meetings in the manner stipulated in section 391 of the Act. Thereafter before sanctioning such a scheme, even though approved by a majority of the concerned members or creditors, the Court has to be satisfied that the company or any other person moving such an application for sanction under sub-section (2) of section 391 has disclosed all the relevant matters mentioned in the proviso to the said sub-section. First proviso to section 394 of the Act stipulates that no scheme of amalgamation of a company, which is being wound up, with any other company, shall be sanctioned by the Court unless the Court has received a report from the Company Law Board or the Registrar to the effect that the affairs of the company have not been conducted in a manner prejudicial to the interests of its members or to public interest. Similarly, second proviso to the said section provides that no order for the dissolution of any transferor company under clause (iv) of subsection (1) of section 394 of the Act shall be made unless the official liquidator has, on scrutiny of the books and papers of the company, made a report to the Court that the affairs of the company have not been conducted in a manner prejudicial to the interests of its members or to public interest. Thus, section 394 of the Act casts an obligation on the Court to be satisfied that the scheme of amalgamation or merger is not prejudicial to the interest of its members or to public interest.

Therefore, while it is trite to say that the Court called upon to sanction a scheme of amalgamation would not act as a court of appeal and sit in judgment over the informed view of the concerned parties to the scheme, as the same is best left to the corporate and commercial wisdom of the parties concerned, yet it is clearly discernible from a conjoint reading of the aforesaid provisions that the Court before whom the scheme is placed, is not expected to put its seal of approval on the scheme merely because the majority of the shareholders have voted in favour of the scheme. Since the scheme which gets sanctioned by the Court would be binding on the dissenting minority shareholders or creditors, the Court is obliged to examine the scheme in its proper perspective together with its various manifestations and ramifications with a view to finding out whether the scheme is fair, just and reasonable to the concerned members and is not contrary to any law or public policy.

An Official Liquidator acts as a watchdog of the Company Court, is reposed with the duty of satisfying the Court that the affairs of the company, being dissolved, have not been carried out in a manner prejudicial to the interests of its members and the interest of the public at large. It, therefore, follows that for examining the questions as to why the transferor-company came into existence; for what purpose it was set up; who were its promoters; who were controlling it; what object was sought to be achieved by dissolving it and merging with another company, by way of a scheme of amalgamation, the report of an official liquidator is of seminal importance and in fact facilitates the Company Judge to record its satisfaction as to whether or not the affairs of the transferor company had been carried on in a manner prejudicial to the interest of the minority and to the public interest.

In the instant case concurrent finding of fact was recorded that information supplied was sufficient. However, the official liquidator failed to incorporate contents of inspection report u/s.209A in his affidavit. The official liquidator thereby failed to discharge the statutory burden placed on him under the second proviso to section 394(1) of the Act.

However the sanction of scheme cannot be held up merely because the conduct of official liquidator is blameworthy. In the instant case the findings in the report u/s.209A of the Act were placed before the Company Judge, and he had considered the same while sanctioning the scheme of amalgamation. Therefore, in the facts and circumstances of the instant case, the Company Judge had, before him, all material facts which had a direct bearing on the sanction of the amalgamation scheme, despite the aforestated lapse on the part of the Official Liquidator. The Company Judge, having examined all material facts, was justified in sanctioning the scheme of amalgamation.

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Powers of Attorney — Right of audience before Court — Power of Attorney Act, 1882, section 2.

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[Varsha A. Maheshwari (Mrs) v. M/s. Bhushan Steel Ltd. & Anr., AIR 2011 Bombay 58.]

Shri Ajay Maheshwari, holding the power of attorney on behalf of the appellant Mrs. Varsha Maheshwari, his wife, claimed to be heard on her behalf. Shri Maheshwari asserted his right to be heard by the Court on the basis of the power of attorney executed by his wife. His contention was that since the Power of Attorney empowered him ‘to act and appear’ on behalf of his wife, it conferred a right of audience before the Court.

Shri Maheshwari, holder of power of attorney, relied upon the judgment of the Supreme Court in the case of Janki Vashdeo Bhojwani & Anr. v. Indusind Bank Ltd., reported at 2005 SCC 439, where the Supreme Court held that the right of power of attorney is to appear, plead and act on behalf of the party and can state on oath whatever knowledge he has about the case, but he cannot become a witness on behalf of the party. He can only appear in his personal capacity.

As to the circumstances in which a person may be permitted by the Court to appear, act and plead, the Bombay High Court referred to a judgment of the Supreme Court delivered by Justice V. R. Krishna Iyer, in the case of Harishankar Rastogi v. Girdhari Sharma & Anr., reported at AIR 1978 SC 1019, wherein the Supreme Court held that a private person who was not an advocate, has no right to barge into the Court and claim to argue for a party. He must get the prior permission of the Court for which the motion must come from the party himself.

In the later judgment in the case of T. C. Mathai v. District & Sessions Judge, reported at (1999) 3 SCC 614, the Supreme Court had followed the view in Harishankar Rastogi v. Girdhari Sharma & Anr., (supra) and upheld it.

The Court held that a person holding a power of attorney on behalf of a party authorising him to appear, act or plead for him before a Court of law is not entitled to a right of audience before a Court of law and cannot be heard as a representative of the party unless specifically permitted by the Court to do so upon a proper application moved by the party himself. As regards the application of the appellant Mrs. Varsha Ajay Maheshwari was concerned, having regard to the fact that the person seeking to represent her was her husband who was well versed with the circumstances of the case and being a person who had entered into all transactions relevant for the decision of the present dispute, he was permitted to address the Court in the matter.

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Doctrine of merger — Precedent — Maintainability of review petition before High Court — When SLP dismissed by Apex Court against the main judgment of High Court — Constitution of India, Article 136.

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[Gangadhara Palo v. Revenue Divisional Officer, (2011) (266) ELT 3 (SC)]

The main judgment of the High Court was dated 19th June, 2001 dismissing the writ petition of the appellant herein, the appellant thereafter filed a special leave petition to the Apex Court which was dismissed on 17th September, 2001.

The order of the Apex Court dismissing the special leave petition simply states “The special leave petition is dismissed”. Thus, the order gives no reasons.

Thereafter a review petition was filed before the High Court. The question arose as regards the maintainability of the review petition. The review petition was dismissed by the High Court.

On appeal to Supreme Court it was observed that it will make no difference whether the review petition was filed in the High Court before the dismissal of the special leave petition or after the dismissal of the special leave petition. The important question really was whether the judgment of the High Court has merged into the judgment of the Supreme Court by the doctrine of merger or not.

When the Apex Court dismisses a special leave petition by giving some reasons, however meagre (it can be even of just one sentence), there will be a merger of the judgment of the High Court into the order of the Supreme Court dismissing the special leave petition. According to the doctrine of merger, the judgment of the Lower Court merges in to the judgment of the Higher Court. Hence, if some reasons, however meager, are given by the Apex Court while dismissing the special leave petition, then by the doctrine of merger, the judgment of the High Court merges into the judgment of the Apex Court and after merger there is no judgment of the High Court. Hence, there can be no review of a judgment which does not even exist.

The situation is totally different where a special leave petition is dismissed without giving any reasons whatsoever. It is well settled that special leave under Article 136 of the Constitution of India is a discretionary remedy, and hence a special leave petition can be dismissed for a variety of reasons and not necessarily on merits. One cannot say what was in the mind of the Court while dismissing the special leave petition without giving any reasons. Hence, when a special leave petition is dismissed without giving any reasons, there is no merger of the judgment of the High Court with the order of this Court. Hence, the judgment of the High Court can be reviewed since it continues to exist, though the scope of the review petition is limited to errors apparent on the face of the record. If, on the other hand, a special leave petition is dismissed with reasons, however meagre (it can be even of just one sentence), there is a merger of the judgment of the High Court in the order of the Supreme Court.

A judgment which continues to exist can obviously be reviewed, though of course the scope of the review is limited to errors apparent on the face of the record, but it cannot be said that the review petition is not maintainable at all.

A precedent is a decision which lays down some principle of law. A mere stray observation of the Court, would not amount to a precedent. Thus, a stray observation of the Court while dismissing the SLP was not a precedent.

The power of review cannot be taken away as that has been conferred by the statute or the Constitution. The review petition was remanded back to the High Court to decide on merits in accordance with law.

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Inherent powers of Court — Every procedure is permissible for a Court for doing justice unless express prohibited — CPC section 151.

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[Rajendra Prasad Gupta v. Prakash Chandra Mishra and Others, (2011) 2 SCC 705]

The appellant was the plaintiff in a suit filed before the Court of the Civil Judge, Varanasi. He filed an application to withdraw the said suit. Subsequently he changed his mind and before an order could be passed in the withdrawal application he filed an application praying for withdrawal of the earlier withdrawal application. The second application was dismissed and that order was upheld by the High Court.

The Supreme Court held that rules of procedure are handmaids of justice. Section 151 of the Code of Code of Civil Procedure gives inherent powers to the Court to do justice. That provision has to be interpreted to mean that every procedure is permitted to the Court for doing justice unless expressly prohibited, and not that every procedure is prohibited unless expressly permitted. Courts are not to act upon the principle that every procedure is to be taken as prohibited unless it is expressly provided for by the Code, but on the converse principle that every procedure is to be understood as permissible till it is shown to be prohibited by the law. As a matter of general principle prohibition cannot be presumed. There is no express bar in filing an application for withdrawal of the withdrawal application.

The application praying for withdrawal of the withdrawal application was maintainable.

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Clough Engineering Ltd. v. ACIT ITA No. 4771 & 4986 (Del.)/(2007) (SB) Article 5, 7, 11 of India-Australia DTAA A.Y.: 2003-04. Dated: 6-5-2011

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  • Interest earned by foreign company on tax refund is not effectively connected with PE in India based on ‘asset-test’ or ‘activity-test’. The ‘indebtedness’ in respect of which interest arose is not ‘effectively connected’ with PE as ‘payment of tax’ is primarily the liability of a foreign company and not PE.
  • The Interest on income tax refund is taxable in terms of Article 11(2) on gross basis (@ 15%) in the hands of foreign company and not on net basis (full rate) under Article 7 r.w. Article 11(4).

Facts:

  • The taxpayer, an Australian company, had a PE in India. PE was carrying out designing, engineering, procuring, fabricating, installing, laying pipelines, testing and pre-commissioning of off-shore platforms on contractual basis.
  • The taxpayer received tax refund along with interest in respect of excess TDS which was deducted from contract receipts of the PE. The taxpayer claimed that such interest income was taxable at the rate of 15% on gross basis as per Article 11(2) of the DTAA.
  • The Tax Authority held that the interest income was received on refund of the tax deducted at source made from business receipts and was directly connected with the business receipts of PE in India and hence the same was chargeable as profits of the PE under Article 7 r.w. Article 11(4) of the DTAA.
  • The CIT(A) accepted the contentions of the Tax Authority. The matter was carried to the Tribunal and in view of conflicting decisions rendered by different Benches of the Tribunal3, a Special Bench was constituted to address the matter.

Ruling:
The ITAT rejected the contentions of the Tax Authority and held as under:

  • For determining taxation of interest under DTAA, what is relevant to determine is whether or not the indebtedness is effectively connected with the PE.
  • If debt is effectively connected with the PE as contemplated by Article 11(4), income would become taxable under Article 7 as business profits.
  • The fact that interest income is not business income is not determinative of whether income is assessable under Article 7. For taxation under Article 7, effective connection with the PE is relevant.
  • Interest income does not have to be necessarily business income in nature for establishing the effective connection with the PE, since it would render provision contained in Article 11(4) of DTAA redundant.
  • In the present case, income is connected with the PE in the sense that it has arisen on account of TDS from the receipts of the PE. However, payment of tax is the responsibility of FCO. Tax liability is determined after computation of income. Tax is not expenditure but appropriation of profit. Thus, though the debt is connected with receipts of the PE, it cannot be regarded as effectively connected with such receipts as primary responsibility is that of FCO and such liability crystallise on the last day of the previous year. In fact, FCO is entitled to pay taxes from any sources.
  • Merely because taxes are collected at source, it will not create effective connection of the indebtedness with the PE, as tax is only the appropriation of profit.
  • In the circumstances such interest is not effectively connected with the PE. Hence, it is liable to tax in terms of Article 11 (on gross basis) and not in terms of Article 7 (on net basis).
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Goodyear Tire and Rubber Company (2011) (AAR No. 1006 & 1031 of 2010) Sections 45, 48, 56(2)(viia), 195 of Incometax Act Dated: 2-5-2011

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  • Transfer of shares held in an Indian company, by one foreign company to its foreign subsidiary would not be chargeable to capital gains and such receipt cannot be considered as income in the hands of the recipient foreign company.
  • In terms of section 45 r.w.s. 48, transfer of shares without consideration is not chargeable to tax under the head capital gains.
  • In an international transaction, transfer pricing provisions can apply only when income is chargeable to tax in India.
  • If transaction is not liable to tax in India, withholding tax implications u/s.195 do not arise.

Facts:
USCO holds 74% shares in Indian listed company (ICO). USCO also holds 100% shares of an operating company in Singapore (SingCo) which managed natural rubber purchases, delivery finances and treasury operations of various entities in the Group. As part of USCO’s global strategy, USCO contemplated restructuring of its Indian investment. For this purpose, USCO voluntarily contributed entire 74% stake in ICO to Singco without any consideration. The contribution deed made it clear that SingCo was not liable to compensate USCO for contribution of shares at any time and there was no obligation on the part of Singco to takeover any liability of USCO.

The proposed transaction is pictorially depicted as given on next page.

Application was filed by USCO and Singco raising issues regarding taxability of contribution in the hands of USCO. Consequentially, questions were also raised about applicability of TDS obligation of Singco as also applicability of transfer pricing provisions to the transaction.

Before AAR, it was contended that:

  • Proposed transfer of shares of ICO to USCO to SingCo is without consideration in money or money’s worth.
  • As consideration for transfer is incapable of being valued in definite monetary terms, the mechanism to charge capital gains u/s.45 r.w.s. 48 of Income-tax Act would fail.
  • Contribution is in the form of gift and would therefore not amount to transfer u/s.45 r.w.s. 47(iii) of the Act.

The Tax Department put forth the following contentions:

  • Proposed transfer is for creation of a better business environment, which itself is a consideration. Hence, the transaction cannot be regarded as a gift or as a voluntary contribution without consideration.
  • The transfer of shares, is an attempt of case of ‘treaty shopping’ for avoidance of capital gains tax at a future date, since in case transferee company gifts/sells these shares to another entity, the transaction will not be taxable in India in view of India-Singapore DTAA, which otherwise would not be the case in the context of India-USA DTAA.
  • The bar under proviso to section 245R(2) of the Act relating to the transaction designed for avoidance of tax covers both present and future scenarios.

AAR held:

  • Computation mechanism is integral and fundamental to the scheme of taxation.
  • Capital gain needs to be calculated after taking into account full value of consideration. There is distinction between ‘full value of consideration’ and ‘fair market value of capital asset transferred’.
  • Having regard to the earlier rulings in case of Amiantit International Holding and Dana Corporation2, the transferor cannot be regarded as having derived any profit or made any gain if transfer without consideration is made in favour of 100% subsidiary. If the transfer is without consideration and is incapable of being valued in definite monetary terms, the same is unascertainable and cannot form the basis of taxation u/s. 48.
  • As there are no tax implications within the realm of sections 45 and 48 of the Act, applicability of section 47(iii) is academic.
  • ICO, being a listed entity, any gains arising on transfer of its shares, being a long-term capital asset, is otherwise exempt u/s. 10(38) of the Act. Hence, the transaction cannot be said to be designed for avoidance of tax through treaty shopping.
  • ICO is a company in which public are substantially interested. Hence, the provisions of section 56(2)(viia) of the Act would not be attracted on proposed transfer of its shares.
  • Transfer pricing provisions u/s. 92 to 92F of the Act would not be applicable in the absence of liability to pay tax.
  • As income is not chargeable to tax, the question of withholding tax by GTRC/GOCPL u/s. 195 does not arise.
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Standard Chartered Bank v. DDIT ITA No. 3827/Mum./2006 Article 7, 12 of India Singapore DTAA Section 195 of Income-tax Act A.Y.: 2004-05. Dated: 11-5-2011

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  • Data processing charges do not constitute ‘royalty’ under the Income-tax Act as also India-Singapore DTAA. Payments are made for use of a facility and not for any process/use of equipment and hence it is not royalty.
  • In the absence of control or physical access to any equipment, it cannot be said that the payment was made for any ‘use’ or ‘right to use’ the equipment.

Facts:

  • The taxpayer (SCB), a non-resident company, is engaged in the banking business in India through various branches. It entered into an agreement with a Singapore company (SingCo) for providing data processing support from outside India. The agreement required SingCo to make available disc storage capacity in its data centre for exclusive use of SCB.
  • The arrangement involved electronic transmission of raw data by SCB and electronic processing of such data by SingCo as per SCB’s requirements. Processed data is electronically transmitted back to India in the form of reports as per specifications of SCB.
  • SCB claimed that (i) charges paid to SingCo did not amount to royalty under the IT Act as well as under Article 12 of DTAA (ii) Payments were in the nature of business profits which, in absence of PE in India, were not taxable.
  • In response to SCB’s application for ‘nil’ tax withholding, the Tax Authority held that the payment constituted ‘royalty’ under Incometax Act as well as DTAA.
  • On appeal, the first Appellant Authority upheld the Tax Authority’s order and concluded that the payments were made (a) for use of ‘process’ provided by SingCo through its computer facility for data processing; or (b) for use of ‘scientific equipment’ since the arrangement was for renting out disc space in the hardware system, over which SCB exercised constructive control over infrastructure facilities and such facilities were for exclusive use of SCB.

Held:

  • For the following reasons, the ITAT held that the payment was not for use or right touse ‘any process’ within the meaning of Article 12(3)(a) of India-Singapore DTAA.
  • There was no use or right to use any process of SingCo by SCB at any of the stages, i.e., transmission of raw data, processing of data by SingCo staff and electronic transmission of duly processed output data by SingCo to SCB.
  • The consideration paid by SCB cannot be said to be for the software embedded in the mainframe computer of SingCo.
  • In Kotak Mahindra Primus Ltd. v. DCIT, (105 TTJ 578), Mumbai, the ITAT had held that payments made for specialised data processing of raw data using mainframe computers located abroad is not liable to tax as royalty since there was no control over the actual processing of data and there was no physical access or control over themainframe computer. This decision squarely applied to the facts of the case.
  • The payment was for a facility which was available to any person willing to use it.
  • For the following reasons, the ITAT held that the payment was not royalty for equipment hire as there was no use or right to use any equipment.
  • Earmarking a space segment capacity of the equipment does not result in possession (actual or constructive) of the equipment being provided.
  • The context and collocation of the two expressions ‘use’ and ‘right to use’ followed by the word ‘equipment’ indicate that there must be some positive act of utilisation, application or employment of equipment for the desired purpose.
  • If an advantage was taken from sophisticated equipment installed and provided by another, it could not be said that the recipient/customer used the equipment as such.
  • What was contemplated by the word ‘use’ in royalty definition was that the customer came face to face with the equipment, operated it or controlled its functions in some manner. Availing services which involved use of infrastructure is not royalty.
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M/s. Wheels India Ltd. v. ITO ITA No. 1793/Mds./2006 (Chennai) Article 12(4) of India-US DTAA; Sections 9(1)(vii), 210, 201(1A) Income-tax Act A.Y.: 2005-06. Dated: 19-4-2011

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In terms of Article 12(4) of India-US tax treaty, payment made to US companies for ‘developing tooling’ and ‘validating new process for manufacture’ of wheels for commercial vehicles is ‘fees for included services’. 

Facts:

  • The taxpayer (WIL), an Indian company, is engaged in the manufacture of steel wheels for commercial vehicles, passenger cars, utility vehicles, earthmoving and construction equipments, agricultural tractors and defence vehicles.
  • WIL developed a new process for manufacturing steel wheels for trucks out of a single piece of steel material. The new design and concept was intended to result in reduction of input material and improvement in the strength of the wheel by elimination of welding process. WIL applied for registering patents in India with Indian Government Patent authorities in respect of the wheels which it intended to manufacture.
  • However, WIL did not have requisite knowhow for designing the machine capable of manufacturing the product as per patented processes.
  • WIL approached two US companies (USCOs), which had the required machine/tooling capability with them for validating the process conceptualised by WIL. In terms of the agreements, WIL got the validation done through USCOs. However, after receipt of initial report, WIL did not pursue the agreement with USCOs as the validation reports did not meet WIL’s requirement.
  • After discontinuation of the agreement, WIL began manufacturing the item/articles in their own in-house facility, after importing requisite machinery from other parties in Germany and US.
  • WIL did not deduct tax at source in respect of advance payments made to USCOs, on the premise that the entire services under the agreement were rendered by USCOs outside India and no income was chargeable to tax in India. And, in any case, in terms of the treaty no amount was chargeable as no technology was made available by USCOs as its services were essentially for validating the new process which was actually developed by WIL.

The Tax Authority rejected the contention of WIL and concluded that the services provided by both foreign companies would come under the purview of ‘fees for technical services’ liable to tax in terms of section 9(1)(vii) of the Income-tax Act and under ‘fees for included services’ under Article 12(4) of India-US DTAA. On this basis, the Tax Department proceeded to treat WIL as assessee in default u/s.201 for not withholding tax on payments made to USCOs.

Held:
ITAT accepted the contentions of the Tax Authority and held that:

  • The term ‘fees for technical services’ and ‘make available’ in the context of DTAA is generally understood by Courts1 as under:
  • Mere rendering of specific technical services is not sufficient to attract definition of ‘fees for technical services’. The services rendered should make available technical knowledge, experience, skill, know-how, etc.
  • To fit into ‘make available’, the technology, the technical knowledge, skills, etc. must remain with the person receiving the services even after the particular contract comes to an end.
  • It is not enough that the services offered are the product of intense technological effort and that a lot of technical knowledge and experience of the service provider have gone into it. The technical knowledge or skills of the provider should be imparted to and absorbed by the receiver so that the receiver can deploy similar technology or techniques in future without depending upon the provider.
  • WIL got validation done through USCOs and thereafter it began manufacturing items/articles. Necessary tooling was developed in-house with CAD and CAM techniques available with WIL. Furthermore, extensive process trials were conductedat WIL. This directly supports the fact that WIL was ‘made available’ with technical know-how making it able to carry out in-house manufacturing activities.
  • The fact that WIL got the test for validation done and thereafter got the manufacturing of tooling done raises a strong presumption that the technical know-how involved in the process was made available. It is not the case of WIL that the know-how was obtained from some other party and/or that the manufacturing was abandoned. The fact that the toolings were developed in-house by WIL support that the know-how was passed on to WIL and hence the services made available requisite know-how.
  • The payments made to USCO’s, were liable to tax in India, and hence WIL was required to deduct tax at source.
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Digest of Recent Important Foreign Decisions on Cross- Border Taxation — part II

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In the first part of the Article published in May, 2011 some of the Recent Important Foreign Decisions on Cross-Border Taxation were covered. In this part, the remaining decisions are being covered.

13. Thailand: Royalty


Supreme Court — Marketing fee paid pursuant to international franchise agreement constitutes ‘royalty’

The Supreme Court recently issued a judgment that the marketing fee paid by a Thai franchisee would be subject to Thai withholding tax as the fee constituted royalty income.

In a typical international franchise scheme, the foreign franchisor would charge the Thai franchisee a franchise fee, which typically consists of a royalty for the intellectual property and a marketing fee. It is common practice for the franchisor to ensure that any marketing activity undertaken by the franchisee is in line with the franchise’s international standards, and for the marketing fee to be computed based on net sales.

From a tax perspective, there remains no question that the franchise fee is categorised as royalty income, which would be subject to Thai withholding tax at the rate of 15% u/s. 70 of the Revenue Code. However, the marketing fee incurred by the Thai franchisee via payments made to Thai advertising companies had largely gone unnoticed for Thai withholding tax purposes.

The Supreme Court has now held that marketing fees paid in Thailand to Thai advertising firms would be subject to 15% Thai withholding tax as royalty, as if it had been paid to the foreign franchisor. The Court based the judgment on the following:

— the fee is deemed to be the additional income of the franchisor, as it directly, or indirectly, benefits the brand as well as the trademark of the franchisor;

— the franchisor effectively has control over the advertising activities; and

— this fee is calculated in a similar manner to franchise fee, i.e., based on sales.

It appears that the Court has ruled in this manner so as to prevent tax planning by a foreign company (which was not carrying on any business in Thailand) from avoiding withholding tax u/s. 70 of the Revenue Code.

This judgment is expected to have a huge impact on audits carried out by revenue officers with revenue officers raising more assessments on the franchisee in Thailand for past payments.

14. United Kingdom: Determination of residence for individuals


Court of Appeal rules on HMRC’s interpretation of IR20

On 16th February 2010, the Court of Appeal dismissed applications for judicial review in the cases of R (oao Davies and anor) v. CRC; R (oao Gaines- Cooper) v. CRC.

The taxpayers sought judicial review of HMRC’s determination that they were resident and ordinarily resident in the United Kingdom.

(a) Facts and legal background. The issue centred on guidance published by HMRC on residence and ordinary residence of individuals, known as IR20.

Paragraph 2.2 of IR20 provided that a taxpayer would be treated as non-resident and non-ordinarily resident if:

— he left the UK for the purposes of full-time employment abroad;

— he remained abroad for at least a whole tax year, and

— his visits to the UK totalled less than 183 days in any tax year, and averaged less than 91 days per tax year.

Paragraphs 2.7 to 2.9 of IR20 dealt with ‘Leaving the UK permanently or indefinitely’. Thereunder, HMRC reiterated the 91-day rule mentioned above. That section also stated that HMRC might request evidence of permanent abode outside the UK.

The taxpayers had left the United Kingdom, but not for the purposes of employment abroad. As such, their situation fell under IR20 paras 2.7.-2.9, and not IR20 para 2.2.

HMRC issued a determination that the taxpayers were resident in the United Kingdom, on the basis that they had not made a ‘distinct break’ from ties in the United Kingdom. Thus, it was not sufficient for the taxpayers simply to meet the 91-day rule.

The taxpayers argued that the ‘distinct break’ requirement was contrary to the guidance in IR20. They argued further that even if the requirement were found to be in line with the guidance, HMRC had, in practice, previously not insisted on this requirement. The fact that HMRC only began to require such evidence in 2004-05 amounted to a change in approach, and this breached their legitimate expectations.

(b) Issue. The issues were:

— whether, in requiring evidence of a distinct break, HMRC had departed from the terms of IR20, and

— even if HMRC had not so departed, whether HMRC had changed their approach, leading to a breach of the taxpayers’ legitimate expectations.

(c) Decision. IR20 para 2.2. dealt with leaving the United Kingdom for the purposes of full-time employment abroad. Under this paragraph, there was no requirement for a ‘distinct break’. Thus, for individuals who came within the terms of that paragraph, there was no need for HMRC to look into any persisting social or family ties in the UK.

The Court rejected the taxpayers’ argument that this interpretation should also apply to IR20 paras 2.7-2.9. According to the Court, because IR20 paras 2.7-2.9 deal with leaving the United Kingdom ‘permanently or indefinitely’, these words are crucial in terms of construing those paragraphs. It is therefore important to consider the extent to which the taxpayer has retained social and family ties within the United Kingdom.

There is therefore a clear distinction between the determination of residence for individuals who have left the UK for full-time employment abroad, and those who have left the UK permanently or indefinitely.

The taxpayers fell within IR20 paras 2.7-2.9, and therefore HMRC was entitled to request from them evidence of having left the United Kingdom ‘permanently or indefinitely’, and this included evidence of a ‘distinct break’.

On the change of approach point, Moses LJ stated that there was no public law obligation of fairness that prevents HMRC from increasing, without warning, the intensity or scrutiny of claims by taxpayers to be non-resident. Indeed, the absence of warning might be a powerful tool to deploy, to ensure that taxpayers provide frank disclosure. Nevertheless, the Court held that HMRC’s rejection of the taxpayers’ claim was not as a result of a changed approach. The appeals were dismissed.

Ward LJ, while agreeing with the decision, nevertheless, expressed some sympathy for the taxpayers. He understood the taxpayers’ suspicions that HMRC had indeed changed their policy. However, he was persuaded that what has been construed to be a change in HMRC policy was actually the effect of a closer and more rigorous scrutiny and policing of a growing number of claims. This is permissible for HMRC to undertake, and is not a root-and-branch change in policy.

Note: In 2009, IR20 was withdrawn and replaced by new guidance document, HMRC6.

15. France: Administrative Supreme Court clarifies notion of domicile for individuals

On 27 January 2010, the Supreme Administrative Court gave its decision in the case of SCP Vier (No. 294784) concerning the domestic notion of fiscal domicile. Details of the decision are summarised below.

(a) Legal background. Domestic law treats individual taxpayers as residents for tax purposes when they have their fiscal domicile in France. The definition of fiscal domicile, provided by Article 4B of the Code Général des Impôts (CGI), is based on three alternative criteria:

— personal: the home or principal place of residence; or

— professional: performance of a trade, business or professional activity; or

— economic: the centre of the economic interests.

Under the economic criterion, an individual is considered to have the centre of his economic interests in France, if the individual:

—  has made major investments;

— has a main office or effective place of management; or

—  derives most of his income in France.

(b)    Facts. The taxpayer possessed immovable and movable assets situated in France, while his regular income was derived from an employment in Greece. After a tax investigation, the French tax authorities decided to assess the taxpayer as a French resident on his worldwide income. They took the position that due to the location of his assets, the taxpayer met the economic criteria provided by Article 4B1(c) of the CGI: the ‘centre of its economic interests’. The taxpayer claimed not to be a resident and, thus, only liable to French source income.
    
(c)    Issue. The issue was whether the notion of ‘centre of economic interests’ should be considered as (i) the place where the individual has made major investments, regardless of their profitable nature; or (ii) the place where the individual derives most of his actual income.

(d)    Decision. The Administrative Supreme Court ruled in favour of the taxpayer and held that the notion of ‘centre of economic interests’ refers primarily to the place where an individual derives most of his income. Thus, the location of the assets must be regarded as a secondary criterion in the definition of ‘centre of its economic interests’.


16.    United States: Transfer Pricing:

US Court of Appeals withdraws decision in Xilinx transfer pricing case

The US Court of Appeals for the Ninth Circuit has withdrawn its decision in the case of Xilinx Inc. and Consolidated Subsidiaries v. Commissioner of Internal Revenue, (Docket No. 06-74246). See TNS:2009-06-05:US-1.

The decision was issued 27th May 2009 and held that the specific rules for cost-sharing agreements (CSAs) in the US Treasury Regulations issued u/s. 482 of the US Internal Revenue Code prevailed over the general arm’s-length standard.

As a result, the value of stock options granted by Xilinx in connection with a CSA were required to be included in the pool of costs to be shared under the CSA even when the facts indicated that companies operating at arm’s length would not do so. The Court of Appeals also determined that this result did not violate the provisions of the 1997 US-Ireland income tax treaty due to the saving clause in Article 1(4).

The decision of the Court of Appeals, which was by a 2:1 majority of a three-member judicial panel, proved controversial, and the taxpayer petitioned the Court for re-hearing (see TNS:2009-08-18:US-1) . The Court’s Order withdrawing the decision is dated 13th January 2010. It does not indicate the next step to be taken in the proceeding.

17.    Spain: Substance v. Form

Treaty between Spain and US-Spanish Supreme Court takes substance over form in approach applying treaty

The Supreme Court gave its decision on 25th September 2009 in the case of the sale of shares of the Spanish company La Cruz del Campo, S.A. owned by US Stroh Brewery Company to Guinness Plc (Recurso de Casación 3545/2003). Details of the decision are summarised below.

(a)    Facts. The appellant, Stroh Company, held shares representing 28.45% of the capital of La Cruz del Campo, S.A. In January 1991, Stroh accepted the offer by Guinness Plc to buy those shares. It also told the buyer that it would exercise the transfer in several steps. At the time of the offer, the shares were deposited in the United States. In January 1991, Stroh transferred part of the shares to its US subsidiary, Victors Company, in exchange for 17 shares in the latter. Victors Company sold the shares to Guinness Plc for the same price as that for which it had acquired them. In May 1991, Stroh transferred the remaining shares in La Cruz del Campo S.A. to another US subsidiary, Hoya Ventures, in exchange of 100% in the latter’s capital. These shares represented less than 25% of the capital in La Cruz del Campo, S.A. The shares were sold by Hoya Ventures to Guinness Plc in February 1992 for the same price as that for which it had acquired them. The tax administration and the decision of the First Instance Court considered that the capital gain of the sale was obtained by Stroh, and was therefore taxable in Spain.

(b)    Issue. Spanish corporate income tax legislation at the time of transactions considered income derived from securities issued by Spanish resident companies to be taxable in Spain, but the law only expressly taxed capital gains derived from assets located in Spain. Therefore, the appellant claimed that Spain did not have taxing rights on the transaction.

Article 13(4) of the USA-Spain tax treaty states that gains derived from the alienation of stock in the capital of a company resident in a contracting state may be taxed in this state if the recipient of the gain during the 12 -month period preceding the alienation had a participation, directly or indirectly, of at least 25% of the capital. Item 10(c) of the protocol to the treaty establishes an exception to the taxation of an alienation when the alienations are contributions between companies of the same group, and the consideration thereof consists of a participation in the capital of the acquiring company.

The appellant considered that there was a breach of the tax treaty since the tax administration and the First Instance Court decision qualified as ‘sales’ the transactions that were non-monetary contributions to the capital of the subsidiaries, which were excluded from taxation by the protocol. In addition, the interpretation of an international convention could not be undertaken unilaterally by one of the parties. Moreover, the second transaction entailed less than 25% of the capital, so it could have only been taxable in the United States. Furthermore, in case the transactions were subject to tax in Spain, the taxable capital gains should be those obtained by the subsidiaries from the difference between the selling price and the acquisition cost. In this case, there was no difference between the two.

(c)    Decision. The Supreme Court held that as the company issuing the shares was resident in Spain and the shareholder’s rights should be exercised in Spain, the shares should be considered as being located in Spain independently of where the shares were deposited. Therefore, the capital gain was subject to tax in Spain.

The Court stated that the person applying the law must qualify any act or transaction in accordance with its real juridical nature, bearing in mind its content, consideration and legal effects, without following the forms or names given by the parties. Therefore, both the tax administration and the Court of First Instance were allowed to qualify the transactions when those transactions did not correspond to the true legal nature of the considerations.

At the time of acceptance of the offer, Stroh fulfilled the two requirements established in Article 13(4) of the treaty, which allow the transaction to be taxed in Spain. The purpose of the subsequent share transactions with the subsidiaries was not for restructuring reasons. When examining the transactions involved as a whole, it appeared
that the intention of the appellant was not the one that is usually assigned to these types of transactions.

Therefore, there was a relative contractual simulation that occurs when there is an (unwanted) fictitious transaction aimed at disguising the real transaction (that was made in breach of the law). The effect of the law is to reveal the legal implications that the parties had tried to avoid. Therefore, the Court concluded that the tax administration was correct in its assessment.

18.    Australia: Foreign Tax Credit

ATO Interpretative Decision ATO ID 2010/175 — FTC for foreign tax paid in respect of gain not fully assessable in Australia

On 8 October 2010, the Australian Taxation Office (ATO) issued an Interpretative Decisions (ATO ID).

ATO ID 2010/175 deals with the entitlement to a foreign income tax offset (i.e., foreign tax credit) for a foreign tax paid in respect of a gain where the gain is not fully assessable in Australia. The ATO reached a decision that based on the wording of the legislation, only a proportion of the foreign tax should be available as a credit. Interestingly, the ATO ID notes a statement in Explanatory Memorandum to the Bill implementing the new foreign tax credit rules that seems to suggest that a full credit should be available. The ATO expressed its view that the statement is inconsistent with the words and purpose of the legislation and should be disregarded.

19.    United States; France: Foreign Tax Credit

Treaty between US and France-US Tax Court: income earned in or over foreign countries; US or international airspace (saving clause, foreign earned income exclusion, FTC)

The US Tax Court has decided on the availability of the foreign -earned income exclusion and foreign tax credit with regard to a flight attendant’s income. Savary v. Commissioner of Internal Revenue, T.C. Summary Opinion 2010-150, Docket No. 6839-09S (6 October 2010).

The case involved a taxpayer who was a US citizen but resident of France. She worked as a flight attendant on flights between France and the United States:

— 38.2% of her income was earned in or over for-eign countries (the ‘foreign income’); and

— the remaining portion was earned while in the United States or in international airspace (the ‘US/international airspace income’).

US-France tax treaty

The first issue was whether the United States was precluded from taxing her income by Article 15(3) of the treaty between the United States and France signed on 31st August 1994 (the ‘Treaty’), which provides that income from employment as a crew member of a ship or aircraft operated in international traffic is taxable only by the country of which the taxpayer is a resident.

The Tax Court held that the saving clause in Article 29(2) of the Treaty, which provides that the United States may tax its citizens and residents as if the Treaty had not come into effect, took precedence and thus her income was taxable under the Internal Revenue Code (IRC).

Foreign earned income exclusion

The second issue was whether the taxpayer was entitled to claim the foreign-earned income exclusion under IRC section 911.

The Tax Court concluded that the ‘US/international airspace income’ was US source income and not foreign-earned income, noting that international airspace is not a foreign country for purposes of IRC section 911.    Accordingly, the taxpayer was not entitled to claim the foreign-earned income exclusion.

On the other hand, the taxpayer was allowed to exclude the ‘foreign income’.

FTC:

The third issue was whether the taxpayer was entitled to a foreign tax credit in the United States under Article 24 of the Treaty and IRC section 901 for the taxes paid to France.

The Tax Court denied a US credit for US tax payable on the ‘foreign income’, on the ground that the taxpayer was already allowed a US exclusion of such foreign source income under IRC section 911.

Further, the Tax Court disallowed a US credit for French tax paid on the ‘US/international airspace income’, explaining that the United States consented in Article 24 only to provide a FTC on income attributable to sources in France, as determined under the source of income rules of the IRC, and not to US source income. The Tax Court stated that a credit in France would be the only treaty relief from double taxation. The Tax Court noted that the French tax authorities had already denied the credit on the basis of Article 15(3) of the Treaty. The Tax Court was of the view, however, that the French tax authorities had erred in this regard, and that the taxpayer could seek reconsideration from the French authorities or, as a last resort, competent authority relief under Article 26 of the Treaty.

Accuracy-related penalty:

The fourth and final issue was whether the tax-payer was liable for the accuracy-related penalty under IRC section 6662.

The Tax Court declined to impose the penalty be-cause it was not demonstrated that the taxpayer’s underpayment was attributable to her negligence or disregard of rules or regulations.

20.    Italy: Beneficial Owner

Treaty between Italy and Luxembourg — Italian decision on interpretation of term ‘beneficial owner’

On 19 October 2010, the Lower Tax Court of Piemonte (Commissione tributaria provinciale del Piemonte/Torino) issued decision no. 124 regarding the interpretation of the term ‘beneficial owner’ contained in Article 12 (Royalties) of the tax treaty between Italy and Luxemburg (the Treaty). Details of the decision are summarised below.

(a)    Facts.
The taxpayer is an Italian company that signed an agreement for the use of a trademark owned by a Luxemburg company (Luxco). Luxco is wholly owned by a company resident in Bermuda.

On the royalties paid by the Italian taxpayer to Luxco, the reduced withholding tax (10%) provided for by Article 12 of the Treaty was withheld instead of the domestic withholding tax of 30%.

The Italian tax authorities claimed that Luxco was not the beneficial owner of the royalty’s payment; therefore, it cannot benefit from the reduced with-holding tax provided for by the Treaty.

(c)    Decision. The taxpayer asserted that Luxco was the beneficial owner of the royalties payments based on the following grounds:

— Luxco was the owner of the trademark, which was accounted for in Luxco’s annual balance sheet;

— the trademark was properly registered in Luxemburg;

— the use of the trademark was granted by a proper licence agreement between the Italian taxpayer and Luxco;

— the income generated by the licence agree-ment was properly accounted for in Luxco’s profit and loss accounts.

The Court noted that the arguments put forward by the taxpayer only prove that Luxco was the formal owner of the trademark and that it formally received the royalty payments, but not that Luxco was the beneficial owner. Therefore, the Court rejected the arguments of the taxpayer, giving the following reasons:

— The beneficial owner must have an autonomous organisation to provide services and must bear the entrepreneurial risks of such activity. This was not the case in respect to Luxco. Indeed, Luxco acquired the trademark free of charge and it has no costs related to such trademark; moreover, Luxco had a very small operative organisation (no movable properties, low employment costs). In this respect, Luxco is acting without any entre-preneurial risks.

—  Luxco was wholly owned by a sole shareholder (resident in Bermuda).

21.    Finland: Transfer Pricing

Supreme Administrative Court rules on interest rate on intra-group loan

The Supreme Administrative Court of Finland (Korkein hallinto-oikeus, KHO) gave its decision on 3 November 2010 in the case of KHO:2010:73. Details of the decision are summarised below.

(a)    Facts. As part of restructuring the financial structure of a group, the taxpayer, Finnish company A Oy, paid back two loans taken from a third party and took a corresponding loan from a Swedish company B AB, which was acting as the group financing company. The loans taken from the third party carried interest at the rates between 3.135% and 3.25%, whereas the interest rate on the intra-group loan was set to 9.5% based on the average group interest rate. The average group interest rate was determined by interest rates applied on loans that the group had taken from third parties and loans from its shareholders.

(b)    Legal background. Affiliated companies are required to observe the arm’s-length principle. If the tax authorities conclude, based on section 31 of the Law on Tax Procedure, that the arm’s-length principle has not been observed in transactions between group companies, the taxation may be corrected and reassessment may be made to re-flect the arm’s-length conditions.

(c)    Issue. The issue was whether the interest rate set on the intra-group loan, 9.5%, was at arm’s length, considering that the loans taken from a third party had been subject to interest rates of 3.135% and 3.25%.

(d)    Decision.
The Court emphasised that the interest rate on an intra-group loan cannot be based on an average group interest rate in circumstances (e.g., the company’s good creditworthiness) where financing could have been obtained from a non-related party at a substantially lower interest rate than the average group interest rate. The Court pointed out that the taxpayer’s financing needs did not substantially change in the refinancing and it had not received any financial services from B AB which may have influenced the interest rate.
The Court held that the interest rate on the intra-group loan was not at arm’s length and increased the taxpayer’s taxable income by the amount of non-deductible interest which was the difference between the interest rate on intra-group loan (9.5%) and the interest rate of 3.25%.

United States: Residency

USVI District Court denies residency for lack of intent to become USVI residents

The US District Court of the United States Virgin Islands (USVI) has determined that five family members were not bona fide residents of the USVI on the ground that they failed to demonstrate their genuine intent to become USVI residents. VI Derivatives, LLC v. United States, Case No. 3:06-CV-12 (18 February 2011).

This case involved five members of the Vento family — Richard Vento (husband), Lana Vento (wife), Nicole Mollison (daughter), Gail Vento (daughter), and Renee Vento (daughter). They filed their income tax returns with the USVI Bureau of Internal Revenue (BIR) in 2001. Both the BIR and the US Internal Revenue Service (IRS) issued Notices of Deficiency to the Vento family. Each Vento family member filed a petition to determine their income tax liability for 2001 and their petitions were con-solidated into this case.

The Vento family took the position that they were exempt from US taxation on the income reported in the USVI u/s. 932 of the US Internal Revenue Code (IRC) because they were present in the USVI on the last day of 2001 with intent to become residents. The BIR contended that the petitioners’ pattern of repeated travel to the USVI and their development of a residential property was sufficient to establish USVI residency. The IRS argued that the petitioners were not bona fide residents of the USVI, because they did not take sufficient action to demonstrate an intent to become USVI residents and did not abandon their prior residences by the end of 2001.

The District Court stated that under IRC section 932, as applied in 2001, a taxpayer who was a bona fide resident of the USVI at the end of a year generally was exempt from filing a US federal income tax return or paying income taxes to the United States for that year. The District Court further stated that IRC section 932, however, drew a distinction between a bona fide residents and mere transients or sojourners, and required the latter to file a tax return with both the IRS and the BIR for income received from the USVI.

The District Court noted that both parties agreed the standard set forth in Sochurek v. Commissioner, 300 F.2.d 34 (7th Cir. 1962) should be applied in deciding whether the Vento family members were bona fide USVI residents at the end of 2001.

The District Court further noted that while the abandonment of a prior residence is not required to claim residency elsewhere, a court may consider whether a taxpayer maintains strong ties to a location other than the claimed residence.

The District Court stated that the subjective Sochurek factors — whether the petitioners intended to be USVI residents at the end of 2001 or whether they travelled to the USVI for the purpose of avoiding US income taxes — had particular relevance, given the suspicious timing of the family’s decision to ‘move’ to the USVI. The District Court noted that in early 2001, the family realised a gain of USD 180 million from the sale of their shares in a technology business (Objective Systems Integrators, Inc.), of which Richard Vento was a founder, and that the USVI residency for 2001 would allow them tax savings of more than USD 9 million.

The District Court held that the Vento family’s testimony that they intended to become USVI residents by the end of 2001 was undermined by the objective facts:

— the house they purchased in the USVI was not liveable by the end of 2001, despite efforts to renovate it as quickly as possible;

— the house was not fully furnished by the end of 2001;
—  none of the family’s furniture or valuable personal possessions were brought to the house;

—  the family spent very little time in the USVI during 2001 and 2002 and primarily engaged in vacation-type activities when in the USVI;

— the family did not have a bank account in the USVI in 2001;

— neither of the two businesses Richard Vento was starting in the USVI was up and running by the end of 2001;

— there is no evidence that Richard and Lana Ventos were involved in community activities in the USVI or had assimilated into its culture in 2001;

—  the family’s office remained in Nevada;

— Richard and Lana Ventos purchased property in Nevada in May 2001 with a plan to construct a mansion on the property;

— Nicole Mollison’s children were enrolled in school in Nevada in 2001; and

—  in 2001, Gail Vento was attending college in Colorado, and Renee Vento had a clear goal of obtaining a master’s degree in California.

After applying the relevant Sochurek factors, the District Court concluded that no member of the Vento family was a bona fide resident of the USVI at the end of 2001.

Acknowledgment/Source

We have compiled the above summary of decisions from the Tax News Service of the IBFD for the period April, 2010 to March, 2011.

Notification No. 36/2011 and 37/2011, dated 25-4-2011.

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The taxable service provided by a restaurant having facility of air-conditioning and has licence to serve alcoholic beverages and accommodation services provided by a hotel, inn, guest-house, etc. shall be treated as export, in case such restaurant or hotel is situated outside India and shall be treated as received in India in case the restaurant or hotel is situated in India.
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Notification No. 35/2011, dated 25-4-2011.

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By this Notification, the optional scheme available in Rule 6(7A) of the Service Tax Rules, 1994 has been amended, so that the insurer carrying Life Insurance business will have the option to pay tax on that portion of the premium which is not invested, when such break-up is given to the policyholder. Where the break-up is not so provided, tax amount shall be 1.5% of the gross premium. However, where the entire premium is only for the risk portion, the same shall constitute the taxable value of the service.
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Notification No. 34/2011, dated 25-4- 2011.

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By this Notification, Notification No. 1/2006-ST, dated 1st March, 2006 has been amended to the effect that:

(a) Services provided by restaurant having facility of AC and having licence to serve alcoholic beverages shall be exempt from the service tax leviable thereon as is in excess of the service tax calculated @ 30% of the gross amount charged for providing such services.

(b) Services provided by hotel, inn, guest-house, club or camp-site shall be exempt from service tax leviable thereon as is in excess of the service tax calculated @ 50% of the gross amount charged for providing such services.

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Notification No. 33/2011, dated 25-4-2011.

Notification No. 33/2011, dated 25-4-2011.

Notification No. 32/2011, dated 25-4-2011.

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By this Notification, Notification No. 25/2006- ST, dated 13-7-2006, which provided exemption to services provided by CA/CS/CWA in his professional capacity relating to representing the clients before any statutory authority in the course of proceedings initiated under any law for the time being in force has been rescinded.
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Notification No. 31/2011, dated 25-4-2011.

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With effect from 1-5-2011 services provided by a hotel, inn, guest-house, club or camp-site in relation to providing of accommodation for a continuous period of less than three months are exempted where the declared tariff for providing of such accommodation is less that Rs.1000 per day. It is clarified that the declared tariff includes charges for all amenities, but excludes any discount offered on the published charges for such unit.
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Notification No. 30/2011, dated 25-4- 2011.

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With effect from 1st May 2011, services provided by hospital, nursing home or multi-speciality clinic to an employee of business entity in relation to health check-up or to any person covered by health insurance scheme for any health check-up or treatment are exempted.
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Notification No. 29/2011, dated 25-4-2011.

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Provisions of the Finance Act, 2011 would come into force 1st day of May 2011.
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Notification No. 28/2011, dated 1-4-2011.

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It has been notified that the following services shall be treated as continuous supply of services for the purpose of Point of Taxation Rules:

(a) Construction in respect of commercial or industrial buildings;

(b) Construction service of residential complex;

(c) Telecommunication services;

(d) Internet telecommunication services;

(e) Works contract services.

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Circular No. 137/6/2011, dated 20-4-2011.

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It has been clarified that the service provided by a visa facilitator, in the form of assistance to individuals directly, to obtain a visa, does not fall under any of the taxable services u/s. 65(105) of the Finance Act, 1994. Hence service tax is not attracted.
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Speculation loss: Section 43(5): A.Y. 2003-04: Loss from trading derivatives is speculative loss: Clause (d) inserted to the proviso to section 43(5) w.e.f. 1-4-2006 is prospective and not retrospective.

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[CIT v. Shri Bharat R. Ruia (HUF) (Bom.), ITA No. 1539 of 2010, dated 18-4-2011]

In the A.Y. 2003-04, the assessee had entered into certain transactions in exchange-traded derivatives which resulted in loss amounting to Rs.28,37,707. The assessee claimed the loss as business loss. The Assessing Officer held that the loss is speculation loss covered u/s.43(5). The Tribunal allowed the assessee’s claim. Following the decision of a Coordinate Bench, the Tribunal held that clause (d) to the proviso to section 43(5) of the Act being retrospective in nature, the losses incurred from the derivative transactions could not be treated as speculation losses incurred by the assessee in the A.Y. 2003-04.

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

“(i) Clause (d) inserted to the proviso to section 43(5) w.e.f. 1-4-2006 is prospective and not retrospective.

(ii) The futures contract being an article of trade created by an authority under the 1956 Act, the transactions in futures contracts would constitute transaction in commodity u/s.43(5) of the Act. In the result, we hold that the exchange-traded derivative transactions carried on by the assessee during the A.Y. 2003-04 are speculative transactions u/s.43(5) of the Act and the loss incurred in those transactions are liable to be treated as speculative loss and not business loss.”

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Salary: Interest u/s.234B: Employee is not liable to pay interest u/s.234B for failure to pay advance tax on salary.

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[DIT v. M/s. Maersk Co. Ltd. (Uttarakhand) (FB), ITA No. 26 of 2009, dated 7-4-2011]

Pursuant
to an agreement with ONGC, the assessee, a foreign company, had
supplied technicians to ONGC. The Assessing Officer treated the assessee
as an agent of the technician-employees and assessed their income under
the head salaries. Interest u/s.234B, was levied on the ground that the
employees had not paid advance tax. The Tribunal allowed the assessee’s
claim that employees were not liable to pay advance tax as the tax was
deductible at source u/s.192, and accordingly set aside the levy of
interest.

On appeal by the Revenue, the issue was referred to
the Full Bench. The Full Bench of the Uttarakhand High Court upheld the
decision of the Tribunal and held as under:

“(i) Advance tax on
the salary of an employee is not payable u/s.208 of the Act by the said
assessee inasmuch as the obligation to deduct tax at source is upon the
employer u/s.192 of the Act. The assessee cannot foresee that the tax
deductible under a statutory duty imposed upon the employer would not be
so deducted. The employee-assessee proceeds on an assumption that the
deduction of tax at source has statutorily been made or would be made
and a certificate to that effect would be issued to him. Consequently,
the liability to pay interest in respect of such deductible amount is
therefore clearly excluded to that extent.

(ii) The statute has
taken care of the liability to pay tax by the assessee u/s.191 of the
Act directly if the tax has not been deducted at source. The assessee
only became liable to pay the tax directly u/s.191 of the Act since it
was not deducted at source. The stage of making payment of tax could
only arise at the stage of self-assessment which is to be made in a
later assessment year.

(iii) The liability to pay interest
u/s.234B of the Act is different and distinct inasmuch as the interest
could only be imposed on the person who had defaulted, which in the
present case is the employer for not making deduction of tax at source
as required u/s.192 of the Act.

(iv) The assessee-employee would
not be liable to pay interest u/s.234B of the Act since he was not
liable to pay advance tax u/s.208 of the Act.”

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Deemed dividend: Section 2(22)(e): Advance or loan received by the assessee from a company is not to be assessed as ‘deemed dividend’ u/s.2(22)(e) if the recipient is not a shareholder.

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[CIT v. Ankitech Pvt. Ltd. (Del.), ITA No. 462 of 2009, dated 11-5-2011]

The assessee-company received advances of Rs. 6.32 crore by way of book entry from Jackson Generators Pvt. Ltd, a closely-held company. The shareholders having substantial interest in the assessee-company were also having 10% of the voting power in Jackson Generators Pvt. Ltd. The Assessing Officer assessed the said advance of Rs. 6.32 crore as deemed dividend u/s.2(22)(e) in the hands of the assessee-company. The Tribunal deleted the addition and held that though the amount received by the assessee was ‘deemed dividend’ u/s.2(22)(e), it was not assessable in the hands of the assesseecompany as it was not a shareholder of Jackson Generators Pvt. Ltd.

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

“(i) U/s.2(22)(e), any payment by a closely-held company by way of advance or loan to a concern in which a substantial shareholder is a member holding a substantial interest is deemed to be ‘dividend’ on the presumption that the loans or advances would ultimately be made available to the shareholders of the company giving the loan or advance. The legal fiction in section 2(22)(e) enlarges the definition of dividend but does not extend to, or broaden the concept of, a ‘shareholder’. As the assessee was not a shareholder of the paying company, the dividend was not assessable in its hands.

(ii) As the condition stipulated in section 2(22) (e) treating the loan or advance as deemed dividend are established, it is open to the Revenue to take corrective measure by treating this dividend income at the hands of the shareholders and tax them accordingly.”

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The power of parliament to make law with respect to extra-territorial aspects or causes — Part i

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1.1 Article 245 of the Constitution of India deals with the extent of laws made by the Parliament and by the Legislatures of States. Clause (1) of the said Article, inter alia, provides that subject to the provisions of the Constitution, the Parliament may make laws ‘for’ the whole or any part of the territory of India. Clause (2) of the said Article further provides that no law made by the Parliament shall be deemed to be invalid on the ground that it would have extra-territorial operation.

1.2 Section 9(1) of the Income-tax Act, 1961 (the Act) provides a deeming fiction to effectively treat foreign income of an assessee as deemed to accrue or arise in India under certain circumstances in the situations provided therein. Technically, section 9 applies to resident as well as the non-resident assessees. However, applicability thereof to a resident is not of much relevance in the context of taxability of income in India, except in case of an assessee, who is not ordinarily resident. Where income actually accrues or arises in India, such a fiction is not needed to create a situation which exists in reality and therefore, in such cases, this fiction has no relevance. This also effectively does not apply to the income received in India, as such income are chargeable u/s. 5 in case of resident as well as non-resident assessees irrespective of the place of accrual of income. Therefore, effectively, a foreign income of a non-resident assessee, which is not received in India would not be chargeable to tax under the Act, unless it accrues or is deemed to accrue in India.

1.3 Clauses (i) to (iv) of section 9 provide for such deeming fiction in respect of certain income under the circumstances specified therein, such as income accruing or arising, directly or indirectly, through or from any business connection in India or from any property in India, etc. These provisions are considered valid as varieties of nexus set out therein are based on sufficient and real territorial connection. This is mainly based on the general principle that once there is a sufficient territorial connection or nexus between the persons sought to be taxed and the country seeking to tax, the income-tax may appropriately be levied on that person in respect of his foreign income. Primarily, we are not concerned with these provisions in this write-up, though they have continued in section 9(1) with some changes even after introduction of clauses (v) to (vii).

1.4 Clauses (v) to (vii) were inserted by the Finance Act, 1976 (w.e.f. 1-6-1976) deeming interest, royalty and Fees for Technical Services (FTS) to accrue or arise in India effectively making the non-resident recipient of such income chargeable to tax in cases where such non-resident had no tax liability in respect of such income under the pre-existing provisions (hereinafter income specified in these clauses is referred to as the Specified Income). Under these provisions, the law also seeks to charge a non-resident in respect of his income outside India merely because the payment thereof is made by Indian resident with some exceptions. Accordingly, the residential status of the payer became relevant to detriment the situs of income. Further, under these provisions, the law also seeks to charge Specified Income arising from transactions between two non-residents outside India under certain circumstances and so on. This had raised doubts as to the validity of these provisions which came up for consideration before the Courts in India, mainly in the context of provisions relating to FTS.

1.5 In the context of taxability of FTS under clause (vii)(b) of section 9(1), a new dimension was given by the Apex Court in the case of Ishikawajima- Harima Heavy Industries Ltd. (288 ITR 408) wherein while dealing with the taxability of income from offshore services, the Court, inter alia, held that for such income to be regarded as accruing or arising in India, it is necessary that services not only are utilised within India, but also are rendered in India. Such a condition for taxability of such income was by and large not considered as relevant prior to this judgment and the same was also found against the very object for which these provisions were introduced by the Finance Act, 1976. Accordingly, Explanation to section 9 has been inserted/sustituted by the Finance Act, 2010 with retrospective effect from 1-6-1976 to overcome the possible effect of the position emerging from this part of the judgment of the Apex Court. Some doubts have also been raised with regard to validity of this new Explanation.

1.6 In the context of validity of the provisions contained in clauses (v) to (vii) of section 9(1), the debate continued with regard to extent of the Parliament’s powers to enact a law having extra-territorial operations.

1.7 Recently, the Constitution Bench of the Apex Court has dealt with this issue and decided the scope of powers of the Parliament to enact a law having extra-territorial operations. In this context, this has settled the general principle in this regard. This judgment will have implications not only with regard to the Income-tax Act, but also with regard to other laws enacted by the Parliament. In this write-up, we are only concerned with the effect of this judgment in the context of the above-referred deeming fiction provided in the Act in respect of the Specified Income.

Electronics Corporation of India Ltd., (ECIL) v. CIT & Anr. — 183 ITR 44 (SC):

2.1 The issue referred to in para 1.6 above came up before the Andhra Pradesh in the context of section 9(1)(vii). In this case, the brief facts were:

The assessee company (ECIL) had entered into an agreement with Norwegian Co. (NC) under which, for the agreed consideration, the N.C. was to provide technical services including facilities for training of personnel of the ECIL in connection with the manufacture of computers by ECIL. For the purpose of remitting the amount payable to NC, the ECIL had approached the Income Tax Officer (ITO) for grant of No Objection Certificate (NOC) as contemplated in section 195(2) of the Act for remittance without deduction of tax at source (TDS). When ITO expressed inability to issue such NOC, the ECIL approached the Commissioner of Income Tax (CIT) for directing ITO to issue the NOC. The CIT declined to issue such direction as according to him, the said payment was income which is deemed to accrue or arise in India u/s.9(1)(vii) and was liable to TDS u/s.195. Against this, ECIL had filed a writ petition before the High Court.

2.2 Before the High Court, various contentions were raised including validity of provisions of section 9(1)(vii) on the ground that it has extraterritorial operation without any nexus between the persons sought to be taxed (i.e., NC) and the country (i.e., India) seeking to tax under a fiction of deemed income arising in India. In this write-up, we are not concerned with the other contentions raised in this case. For the purpose of deciding the issue, the Court referred to historical background of the Income-tax Act and noted that the Indian Income-tax Act, 1922 was passed by the Indian Legislature in exercise of its powers conferred by the British Parliament under the Government of India Act, 1915-1919 which was replaced by the Government of India Act, 1935. The Court then noted that section 99 of the Government of India Act, 1935, inter alia, empowered the Federal Legislatures to make law for the whole or any part of British India. Comparing these provisions with provisions of Article 245 of the Constitution, the Court noted that there was no provision like Article 245(2) in the Government of India Act. The Court then pointed out that the Income-tax Act, 1961 is a post-Constitution law made by the Parliament.

2.3 It was contended on behalf of the ECIL that the NC does not have any Office in India, nor does it have any business activity in this country. The Parliament is not competent to enact section 9(1)(vii)    as it has extra-territorial operation by creating a fiction of income accruing in India without any nexus between the NC and India. For this, reliance was placed on various judgments including the judgment of the Apex Court in the case of Carborandum Co. (108 ITR 335) as well on the commentary given in the book (i.e., Law and Practice of Income Tax) written by the learned authors Kanga & Palkhivala.

2.4 For the purpose of deciding the issue, the Court stated that various judgments relied on by the counsel of the petitioner were rendered under the Indian Income-tax Act, 1922. The Court also noted that the facts of the case under consideration show that the payment is made by an Indian company to a foreign company for FTS and know-how, which is to be used by the Indian company in its business in India. For the purpose of the Income-tax Act, the fiction of income deemed to arise in the country where tax is levied is not uncommon. The narrow test of territorial nexus evolved by the courts in England may not be suitable for application by a developing country like India in the developments which are taking place. The language and spirit of Article 245(2) of the Constitution is clear. The Court will be slow in striking down the law made by the Parliament merely on the ground of extra-territorial operation. India has entered into agreements with several other nations providing for double taxation relief and if there is a real apprehension of deterrence to foreign collaborations as contended on behalf of the petitioner, it will be expected that the Government will take suitable action. Finally, the Court did not agree with the contention of the petitioner that the impugned provisions are beyond the legislative competence of the Parliament.

2.5 When the above judgment of the High Court came up for consideration before the Apex Court, the Court noted that the Revenue is proceeding on the basis that the NC is liable to tax and therefore, the ECIL is obliged to deduct tax at source while making the payment. The case of the Revenue rests on section 9(1)(vii)(b) of the Act and the question is whether, on the terms in which the provision is couched, it is ultra vires.

2.5.1 To decide the issue, the Court noted the constitutional scheme to make laws which operate extra-territorially and referred to the provisions contained in Article 245 and stated that considering provisions of Article 245(2), which provides that no law made by the Parliament shall be deemed to be invalid on the ground that it will have extra-territorial operation, a Parliamentary statute having extra-territorial operation cannot be ruled out from contemplation. Therefore, according to the Court, the operation of the law can extend to persons, things and acts outside the territory of India and for this purpose, the Court also noted the judgment of the Privy Council in the case of British Colombia Electric Railway Co. Ltd. wherein it was held that the problem of inability to enforce the law outside the territory cannot be a ground to hold such law invalid. The nation enacting a law can order that the law requiring any extra-territorial operation be implemented to the extent possible with the machinery available. This principle clearly falls within the ambit of pro-visions of Article 245(2). The Court then observed as under (page 55):

“In other words, while the enforcement of the law cannot be contemplated in foreign State, it can, none the less, be enforced by the courts of the enacting State to the degree that is permissible with the machinery available to them. They will not be regarded by such courts as invalid on the ground of such extra-territoriality.”

Accordingly, the Court drew the distinction between the power to ‘make Laws’ and ‘operation’ of laws. The Court also took the view that the operation of the law enacted by the Parliament can extend to persons, things and acts outside the territory of India.

2.5.2 Finally, the Court felt that the issue should be decided by the Constitution Bench considering its implications and held as under (page 55):

“But the question is whether a nexus with some-thing in India is necessary. It seems to us that, unless such nexus exists, the Parliament will have no competence to make the law. It will be noted that Article 245(1) empowers the Parliament to enact laws for the whole or any part of the territory of India. The provocation for the law must be found within India itself. Such a law may have extra-territorial operation in order to subserve the object and that object must be related to something in India. It is inconceivable that a law should be made by the Parliament in India which has no relationship with anything in India. The only question then is whether the ingredients, in terms of the impugned provision, indicate a nexus. The question is one of substantial importance, specially as it concerns collaboration agreements with foreign companies and other such arrangements for the better development of industry and commerce in India. In view of the great public importance of the question, we think it desirable to refer these cases to a Constitution Bench, and we do so order.”

2.5.3 From the above, it would appear that the Court held the view that the Parliament does not have power to make extra-territorial law unless a nexus exists with something in India. In the context of Article 245(1), the observations of the Court that the provocation for the law must be found within India itself and the object for which the law having extra -territorial operation is made must be related to something in India, raised an issue as to whether this could mean that such provocation and object must arise only within India.

2.5.4 It seems that the petitioner (i.e., ECIL) did to pursue the above matter further and hence the issue remained to be decided by the Constitution Bench.

REINVESTMENT IN OVERSEAS PREMISES

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1. Issue for consideration:

1.1 Section 54 of the Income-tax Act grants an exemption from payment of tax on capital gains, arising on transfer of a residential house on fulfilment of the conditions specified therein. One of the conditions requires an assessee to re-invest the capital gains in purchasing or constructing a residential house within the prescribed period.

1.2 Section 54F of the Act grants a similar exemption from payment of tax on capital gains, arising on transfer of a capital asset other than a residential house on fulfilment of the conditions specified therein. This Section also amongst other conditions requires an assessee to re-invest the net consideration in purchasing or constructing a residential house within the prescribed period.

1.3 Both these provisions restrict the benefit of exemption to individuals and Hindu Undivided Families and grant exemption, irrespective of the residential status of the assessees. These provisions do not confer or deny the exemptions for tax on the basis of the location of the residential house.

1.4 In the advent of the globalisation, it is not uncommon, that the new residential house is acquired by an assesse at a place located outside India. Such overseas acquisitions have, in turn, triggered a controversy in taxation involving the eligibility of an assessee for exemption based on re-investment of capital gains outside India.

2. Leena J. Shah’s case:

2.1 The issue arose in the case of Smt. Leena J. Shah v. ACIT, 6 SOT 721 (Ahd.) where an assessee perhaps for the first time, contested the action of the CIT(A) in confirming the denial of exemption u/s.54F of the Income-tax Act, 1961 inter alia on the ground that the investment was made by the assessee in purchasing the residential house outside India.

2.2 The assessee, a non-resident sold some plots of land located in India for a total consideration of Rs.44,92,170 and earned the capital gains of Rs.43,80,454 after reducing the indexed cost of Rs.1,11,760. She claimed an exemption for investment in residential house and purchased a residential house in the USA, outside India. The AO denied the exemption by observing that the sale proceeds of the plot of land had not been utilised in acquiring the residential house in India and moreover, the residential house purchased/ constructed in the USA is not subject to tax in India within the meaning of section 54 of the Act. The AO therefore, did not allow the claim of deduction of Rs. 43,80,454 and brought the said amount to tax.

2.3 The CIT(A) confirmed the action of the AO by holding that section 54F was introduced in the Act by the Finance Bill, 1982 and the Memorandum explaining the provisions of the Finance Bill, 1982 explained that the exemption u/s.54F was granted with a view to encourage the construction of the house which naturally meant that the house was constructed in India and not outside India.

2.4 The assessee submitted before the Tribunal that; section 54F which was similar to section 54 did not make any distinction between a resident and a non-resident unlike several other sections in which the benefit was clearly and unambiguously denied to a non-resident; the benefit of section 54 and section 54F was intended to be available to both the categories of assessees without any discrimination; any interpretation which militated against the basic principle would not be a just and fair interpretation of the statute and would amount to doing injustice to all nonresidents in general and the appellant in particular who had invested the net consideration in a residential house, though outside India.

2.5 It was further explained that; there was no such stipulation u/s.54F that the new residential house must be located in India; wherever the Legislature found requirement of such stipulation, the same was provided in that section; the language of section was clear, the same was to be read accordingly. The decisions in the case of Padmasundra Rao v. State of Tamil Nadu, Kishore B. Setalvad v. CWT, and Orissa State Warehouseing Corpn. v. CIT were relied upon.

2.6 The honourable Tribunal concurred with the view that the legislative intent behind introduction of section 54F was to be gathered form the Notes, Memorandum and the Circular which in the Tribunal’s view provided that the investment was to be in the residential house located in India. The Tribunal cited several decisions in support of the view that the external aids like Notes, etc. were available for interpretation of the law and the meaning of the provision of section 54F could be gathered from such aids. In the light of the above settled rulings of interpretation of tax statutes, the Tribunal found appropriate that a residential house purchased/constructed must be in India and not outside India, in the USA. It noted that the interpretation put forth by it was strongly supported by the marginal note to section 54F.

3. Prema P. Shah’s case:

3.1 The issue again arose in the case of Prema P. Shah v. ITO, 100 ITD 60 (Mum.) where the question before the Tribunal was whether the exemption contemplated u/s.54(1) could be extended to the capital gains that was reinvested in a residential house purchased in a foreign country on selling the property that was situated in India.

3.2 In that case the brief facts available are that the assessee sold a jointly held residential property located in India for Rs.60 lakh on 4-4-1992 which was purchased for Rs.14 lakh on 29-3-1983. The capital gains was reinvested in purchasing residential house outside India, in London, the UK. The assessee claimed exemption u/s.54, showing long-term capital gains as Nil. The AO denied the exemption claimed on a few grounds including for the fact that the property was located outside India and in his opinion the same was required to be located in India for a valid claim of exemption from taxation.

3.3 The CIT(A) upheld the action of the AO and did not approve the view canvassed by the assessee. While disallowing the assessee’s claim, the CIT(A) observed:

(a) the assessee had taken loan from Barclays Bank and used the assessee’s foreign earning to purchase/lease the property. In other words, the receipts which gave rise to capital gains, were not utilised for the purchase of the property,

(b) the assessee had not purchased the property in India and the Income-tax Act extended to the ‘whole of India’ only,

(c) The lease for 150 years, though perpetual, the benefit of long-term lease obtained in the UK could not be treated as purchase under the Indian laws for the purpose of income taxation.

3.4 The assessee before the Tribunal contended that there was nothing in the statute to show that the property purchased should exist in India so as to claim the benefit contemplated under the Act; that the only stipulation for a valid claim of exemption was that the income should have arisen in India and it was not necessary that it should also be invested in India. For the above proposition, the assessee drew the attention to section 11 of the Income-tax Act, 1961 and it was further submitted that if the Legislature had such an intention, it would have been definitely and specifically mentioned, as it had been mentioned in section 11 which provided that any income from property held for charitable or religious purposes was exempt from tax u/s.11(1)(a) only to the extent it applied it to such purposes in India; if the Legislature wanted investment of the capital gains in India itself for exemption, the Legislature would have specifically stated so in the section itself.

3.5 The Tribunal on consideration of the submissions made by the parties was of the considered view that the assessee was entitled to the benefit of exemption form taxation under the Act which did not exclude the right of the assessee to claim the property purchased in a foreign country. The Tribunal held that if all other conditions laid down in the section were satisfied, merely because the property acquired was located in a foreign country, the exemption claimed would not be denied.

4.    Girish M. Shah’s case:

4.1 The issue recently arose in the case of ITO v. Dr. Girish M. Shah, ITA No. 3582/M/ 2009 before ‘G’ Bench of ITAT, Mumbai. In that case, the assessee, non-resident Indian settled in Canada since 1994, sold his flat in Mumbai in 2003, for Rs.16 lakh, that was purchased in April, 1984, for Rs.1,31,401. The assessee claimed the benefit of indexation and reported a net capital gain of Rs.797,801. The entire sale consideration was repatriated to Montreal for a joint purchase of a house for Rs.64.75 lakh. The benefit of section 54 was claimed on the ground that sale proceeds were utilised for purchasing property.

4.2 The AO held that the provisions of the Act were applicable to India only. When a non-resident could not be taxed in India in respect of income received outside India, deduction could in the AO’s view could not be granted in respect of an activity outside India. He also noted that there was no undertaking that capital gains would be paid should the new property be disposed of. The AO, placing reliance on the decision of the Ahmedabad Tribunal in the case of Leena J. Shah v. ACIT in ITA No. 2467 (Ahm.) (supra), denied the benefit of section 54 to the assessee and recomputed the long-term capital gains at Rs.13,51,803.

4.3 On appeal the CIT(A) found that the entire sale proceeds had been utilised in the purchase of the new asset and hence capital gains was not chargeable u/s.54 of the Act. He also held that section 54F did not specify that the new as-set should be situated in India. As there was no specific restriction on location of new asset, the benefit of section 54F could not be denied to the assessee who had satisfied all other conditions, observed the CIT(A). The CIT(A) relied on the decision of the jurisdictional Tribunal in the case of Mrs. Prema P. Shah v. ITO (supra) for allowing the exemption that was claimed by the assessee.

4.4 The Tribunal vide order dated 17-2-2010 relying on the decision in the cases of Mrs. Prema P. Shah and Sanjiv P. Shah v. ITO (supra) upheld the action of the CIT(A) by holding as follows: “In short, we are of the considered view, for the reasons stated hereinabove, that the assessee is entitled to the benefit u/s.54 of the Act. It does not exclude the right of the assessee to claim the property purchased in a foreign country, if all other conditions laid down in the section are satisfied, merely because the property acquired is in a foreign country”. The Tribunal noted that the jurisdictional High Court had dismissed the Revenue’s appeal against the above order of the Tribunal in the case of Prema P. Shah and Sanjeev P. Shah on account of the tax effect being less than Rs.4 lakh.

4.5 The Tribunal noted that in Leena J. Shah’s case, the issue was for the claim u/s.54F, while in the case before them, it was section 54. It noted that the decision of the jurisdictional Tribunal had a greater binding effect.

4.6 Lastly, the Tribunal observed that it was the settled law that if there were two views, the Court had to adopt the interpretation that favoured the assessee.

5.    Observations:

5.1 A bare reading of the provisions of sections 54 and 54F make it abundantly clear that there are no express conditions that require that the capital gains or the net consideration is reinvested in a residential house located in India. There are several provisions of the Income-tax Act which specifically require an investment to be made in India or for an act to be carried out in India. In the circumstances, for denying the claim of exemption, one will have to read the location-based condition in to these provisions, so as to insist on the new house being in India.

5.2 Section 54F was introduced by the Finance Act, 1982 for the purpose of conferring exemption from tax on capital gains in certain cases on investment of the consideration in residential premises. The said provision nowhere mandates that the exemption is conditional and is subjected to investment in residential premises located in India. The language of the law is very clear and does not leave any scope for ambiguity or misunderstanding.

5.3 It is the settled position in law that nothing is to be read in the provisions of the Act or added thereto where the language of the law is clear. In case of section 54 and section 54F the language in the context of location of the premises is clear and unambiguous leaving no scope for application of any external aids of interpretation like, FM’s speech or Notes to clauses or Memorandum explaining the provisions and the Circular explaining the same. It is significant to note that even the Circular, heavily relied upon by the learned AO, at no point or place requires that the construction of residential premises should be in India before an exemption u/s.54F is granted.

5.4 The main plank for denying the exemption is based on the Notes to Clauses, 134 ITR 106 (St.) Memorandum to the Finance Act, 1982, 134 ITR 128 (St) and the Circular of the CBDT bearing Circular No. 346, dated 30-6-1982 issued on introduction of section 54F by the Finance Act, 1982 The relevant paragraph of the Circular is reproduced as under:

“20.1 Under the existing provisions of the IT Act, any profits and gains arising from the transfer of a long-term capital asset are charged to tax on a concessional basis. For this purpose, a capital asset which is held by an assessee for a period of more than 36 months is treated as a ‘long-term’ capital asset.

20.2 With a view to encouraging house construction, the Finance Act, 1982, has inserted a new section 54F to provide that where any capital gain arises from the transfer of any long-term capital asset, other than a residential house, and the assessee purchases within one year before or after the date on which the transfer took place or constructs within a period of three years after the date of transfer, a residential house, the capital gains arising from the transfer will be treated in a concessional manner as under ……”

5.5 The Finance Minister’s speech on introduction of the Finance Act of 1982, 134 ITR (St.) 23, does not prescribe any such condition for exemption based on the location of the new asset-neither the speech suggest that the provision is introduced for promotion of the construction of houses, leave alone in India. The Circular No. 346 appears to have supplied the legislative intent without being authorised to do so.

5.6 Such an ‘Indian’ insistence by the authorities appears to be misplaced, more so when the language of these provisions is clear and leave no room for ambiguity. Even the Circular relied upon by the authorities does not mandate that the construction of houses sought to be promoted is India-specific. Significantly, even the analogy based on the said Circular is not available for rejecting the claim for exemption u/s.54 which provision surely is not handicapped by any Circular explain-ing the alleged intention behind its introduction.

5.7 The law undoubtedly overrides the Circular where the language of the law is clear. The unambiguous language of the law i.e., sections 54 and 54F does not restrict its scope based on the location of the asset. It is a sheer fallacy to read the condition of investment in India in the provisions and assume that exemption u/s.54F from capital gains is intended to give a boost to the construction of residential houses in the country and this objective will not be achieved if the property is acquired or constructed in a foreign country. It is clear that the Circular has presumed that section 54F is introduced for construction of house. Assuming that such presumption of the board is right, it nowhere requires that the house construction should be in India.

5.8 Section 54F is introduced mainly for facilitating purchase of house by the people on sale of other assets. Therefore the exemption at best can be said to be introduced to enable the purchase of house by an individual or HUF without payment of tax. Had it been for the promotion of construction industry, the exemption would have been conferred on all assessees and would not have been restricted to individual and HUF.

5.9 The decision in the case of Leena J. Shah, has been delivered without detailed reasons, in one paragraph, after citing several decisions of the courts to suggest that in interpretation of the law, it is permissible to rely on the external aids of interpretation including the Notes, Memorandum and the Circular. While there cannot be two opinions on this wisdom, what is perhaps overlooked, with full respect, is the established position in law which requires and permits the use of external aids only in cases where the language of the law is unclear and ambiguous and as noted the language here is clear. It is for this reason that the subsequent decisions of the Tribunal have chosen to not follow the ratio of the said decision in Leena J. Shah’s case and have proceeded to allow the exemption in cases of overseas investment. Moreover, the later decisions of the Mumbai Tribunal, being the latest shall prevail over Leena J. Shah’ decision, more so because the said decisions have not only considered the ratio of Leena J. Shah’s decision but have also analysed the law in detail in concluding that the benefit of exemption is available for overseas investment.

5.10 A resident assessee is entitled to and is not denied exemption u/s.54F on purchase of residential premises anywhere in the world. If that is so, in the absence of any specific or implied prohibition, such an investment any-where in the world by a non-resident cannot be denied.

5.11 Once the Income-tax Act, 1961 assumes the power to tax the Income of a non-resident, then the logical consequence of such a power is to confer upon such a person all the benefits that flow from the provisions of the Act unless specifically prohibited.

5.12 The Income-tax Act, wherever required has specifically stipulated in writing that the investment should be made in India, like in sections 10(20A) and 10(20B) 10(22) and 10(24), 10(26) and section 11(1)(a) which reads as under:

“11. (1) Subject to the provisions of sections 60 to 63, the following income shall not be included in the total income of the previous year of the person in receipt of the income —

(a)    income derived from property held under trust wholly for charitable or religious purposes, to the extent to which such income is applied to such purposes in India; and, where any such income is accumulated or set apart for application to such purposes in India, to the extent to which the income so accumulated or set apart is not in excess of 15% of the income from such property; ……”

5.13 Likewise even Chapter XIIA, vide section 115C(f), clearly provides that the investment should be in specified asset of Indian company or Central Government for a person to claim exemption u/s. 54F. Similarly, section 54E to 54ED requires investment in Indian assets for claiming exemption.

5.14 In American Hotel and Lodging Association Educational Institute, 301 ITR 86 (SC), the Court confirmed that the words ‘in India’ could not be read into section 10(23C)(vi). Again, the Supreme Court in the case of Oxford University Press, 247 ITR 658 (SC), wherein the Court was required to examine whether for claiming exemption, it was necessary to carry out any activity in India, in the context, held that it was impermissible to read in the Act, the words ‘in India’ into section 10(22) of the Income-tax Act.

5.15 Article 26 of the Model Convention provide for non-discrimination. According to the said Article, persons who are non-residents of India, residing in the other contracting state, shall not be subjected to taxation provisions that are different or more burdensome than the provisions applicable to residents of India. It is clear that a non-resident Indian being resident of other state should not be discriminated while being taxed in India and should be conferred with the same benefits including of sections 54 and 54F as are available to a resident while being taxed in India under the Income-tax Act, 1961.

5.16 In cases where two views are possible, the benefit of doubt should be given to the assessee. sections 54 and 54F, being a beneficial provision, the Court has to adopt the interpretation that favours the assessee importantly where these provisions are incentive provisions.

DEDUCTIBILITY OF FEES PAID FOR CAPITAL EXPANSION TO BE USED FOR WORKING CAPITAL PURPOSES — AN ANALYSIS— Part II

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In the first part of this article we had discussed why fees paid to a syndicating agency for assisting capital expansion for the purpose of working capital needs would be allowed as a revenue expenditure in the hands of a companyassessee. In this part, we are discussing why the decisions of the Supreme Court in Punjab Industrial Development Corporation’s case 225 ITR 792 and Brooke Bond India’s case 225 ITR 798 are distinguishable where expenditure has been incurred for the purpose of working capital needs in connection with capital expansion.

Decisions in Punjab Industrial Development Corporation Ltd. and Brooke Bond India are distinguishable:

It is a trite law that a judgment has to be read in the context of a particular case. A judgment cannot be applied in a mechanical manner. A decision is a precedent on its own facts. In State of Orissa v. Md. Illiyas, AIR 2006 SC 258, the Supreme Court explained this principle in the following words:

“. . . . . Reliance on the decision without looking into the factual background of the case before it, is clearly impermissible. A decision is a precedent on its own facts. Each case presents its own features.”

In Goodyear India Ltd v. State of Haryana, 188 ITR 402, the Supreme Court held that a precedent is an authority only for what it actually decides and not what may remotely or even logically follow from it. The Supreme Court further held that a decision on a question which has not been argued cannot be treated as a precedent.

In CIT v. Sun Engineering Works P. Ltd., 198 ITR 297, the Supreme Court held as under:

“It is neither desirable nor permissible to pick out a word or a sentence from the judgment of this Court, divorced from the context of the question under consideration and treat it to be the complete ‘law’ declared by this Court. The judgment must be read as a whole and the observations from the judgment have to be considered in the light of the questions which were before this Court. A decision of this Court takes its colour from the questions involved in the case in which it is rendered and while applying the decision to a latter case, the Courts must carefully try to ascertain the true principle laid down by the decision of this Court and not to pick out words or sentences from the judgment, divorced from the context of the questions under consideration by this Court, to support their reasonings. In H.H. Maharajadhiraja Madhav Rao Jiwaji Rao Scindia Bahadur v. Union of India, (1971) 3 SCR 9, this Court cautioned:

“It is not proper to regard a word, a clause or a sentence occurring in a judgment of the Supreme Court, divorced from its context, as containing a full exposition of the law on a question when the question did not even fall to be answered in that judgment.”

In Bharat Petroleum Corporation Ltd. v. N. R. Vairamani, 8 SCC 579, the Supreme Court held that “Courts should not place reliance on decisions, without discussing as to how the factual situation fits in with the fact situation of the decision on which reliance is placed. Observations of Courts are neither to be read as Elucid’s theorems nor as provisions of a statute and that too taken out of their context. These observations must be read in the context in which they appear to have been stated. Judgments of Courts are not be construed as statutes.” The Supreme Court quoted the following observations of Lord Morris in Herrington v. British Railways Board, 2 WLR 537 with approval:

“There is always peril in treating the words of a speech or a judgment as though they were words in a legislative enactment, and it is to be remembered that judicial utterances made in the setting of the facts a particular case.

11. Circumstantial flexibility, one additional or different fact may make a world of difference between conclusions of two cases. Disposal of cases by blindly placing reliance on a decision is not proper.

12. The following words of Lord Denning in the matter of applying precedents have become locus classicus:

“Each case depends on its own facts and a close similarity between one case and another is not enough because even a single significant detail may alter the entire aspect, in deciding such cases, one should avoid the temptation to decide cases (as said by Cardozo) by matching the colour of one case against the colour of another. To decide therefore, on which side of the line a case falls, the broad resemblance to another case is not at all decisive.” . . . . .

Precedent should be followed only so far as it marks the path of justice, but you must cut the dead wood and trim off the side branches, else you will find yourself lost in thickets and branches. My plea is to keep the path to justice clear of obstructions which could impede it.”

The Full Bench of the Delhi Court recently in L.D. Bhatia Hingwala (P.) Ltd v. ACIT, 330 ITR 243 after quoting the above decisions of the Supreme Court held as under:

“From the aforesaid authorities, it is luculent that a judgment has to be read in the context, and discerning of factual background is necessary to understand the statement of principles laid down therein. It is obligatory to ascertain the true principle laid down in the decision and it is inappropriate to expand the principle to include what has not been stated therein.”

In Punjab Industrial Development Corporation Ltd. case and Brooke Bond India’s case, the question before the Supreme Court was whether filling fees paid to the Registrar of Companies for enhancement of capital constituted revenue expenditure? The Supreme Court was not concerned with a case where the object of capital expansion was to have working funds for carrying on business activities. In the former case, after quoting various contrary decisions of the High Courts, the Supreme Court held as under:

“We do not consider it necessary to examine all the decisions in extenso because we are of the opinion that the fee paid to the Registrar for expansion of the capital base of the company was directly related to the capital expenditure incurred by the company and although incidentally that would certainly help in the business of the company and may also help in profit-making, it still retains the character of a capital expenditure since the expenditure was directly related to the expansion of the capital base of the company. We are, therefore, of the opinion that the view taken by the different High Courts in favour of the Revenue in this behalf is the preferable view as compared to the view based on the decision of the Madras High Court in Kisenchand Chellaram (India) (P.) Ltd.’s case (supra). We, therefore, answer the question raised for our determination in the affirmative, i.e., in favour of the Revenue and against the assessee.”

In the latter case, viz., Brooke Bond India’s case, the Supreme Court placed reliance on its decision in Punjab Industrial Development Corporation Ltd. case to reiterate that fees paid to the Registrar of Companies for enhancement of capital constitutes capital expenditure. In this case the counsel raised an argument that the case of the assessee is not covered by the decision in Punjab Industrial Development Corporation Ltd. case as the object of capital expansion was to have more working funds for the assessee to carry on its business and to earn more profits. The Supreme Court while dealing with the said argument held that it is unable to accept the said argument for the reason that the statement of case sent by the Tribunal does not indicate a factual finding in that connection. The relevant portion of the decision is as under:

“Dr. Pal has, however, submitted that this decision does not cover a case, like the present case, where the object of enhancement of the capital was to have more working funds for the assessee to carry on its business and to earn more profit and that in such a case the expenditure that is incurred in connection with issuing of shares to increase the capital has to be treated as revenue expenditure. In this connection, Dr. Pal has invited our attention to the submissions that were urged by learned counsel for the assessee before the Appellate Assistant Commissioner as well as before the Tribunal. It is no doubt true that before the Appellate Assistant Commissioner as well as before the Tribunal it was submitted on behalf of the assessee that the increase in the capital was to meet the need for working funds for the assessee-company.

But the statement of case sent by the Tribunal does not indicate, that a finding was recorded to the effect that the expansion of the capital was undertaken by the assessee in order to meet the need for more working funds for the assessee. We, therefore, cannot proceed on the basis that the expansion of the capital was undertaken by the assessee for the purpose of meeting the need for working funds for the assessee to carry on its business. In any event, the above-quoted observations of this Court in Punjab State Industrial Development Corpn. Ltd.’s case (supra) clearly indicate that though the increase in the capital results in expansion of the capital base of the company and incidentally that would help in the business of the company and may also help in the profit-making, the expenses incurred in that connection still retain the character of a capital expenditure since the expenditure is directly related to the expansion of the capital base of the company.” (emphasis supplied)

The decision of the Supreme Court in Brooke Bond India’s case (wherein principle laid down in Punjab Industrial Development Corporation Ltd. case has been reiterated), has to be seen in the light of the context and questions involved. It is a settled proposition that a decision takes colour from the questions involved in the case in which it is rendered. [Refer among others Prakash Amichand Shah v. State of Gujarat, AIR 1986 SC 468 (SC), Union of India v. Dhanwanti Devi, (1996) 6 SCC 44] The question before the Supreme Court was whether fees paid to the Registrar of Companies in relation to expansion of capital base is in the nature of revenue expenditure? The Supreme Court was called upon to render its verdict without an occasion to consider the aim or object for which the expenditure had to be incurred. In fact, the Supreme Court was concerned with the fees paid to the Registrar of Companies for increasing the authorised capital as a prelude to infusion of funds. There was no actual receipt of funds during the year. The expenditure towards the increased ability to raise capital was in these circumstances held to be capital. The Supreme Court had no occasion to examine the ‘two stages’ of deployment of funds. In fact the Supreme Court was concerned with a stage anterior to both the stages as funds had not yet been raised/received; such a potential only had been created. The decision of the Supreme Court therefore has to be seen in that context and cannot be extended beyond.

One may note that the Supreme Court in these decisions had not referred to its earlier decisions wherein principles with respect to characterisation of an expenditure into revenue or capital have been outlined. Some of the decisions are of larger Bench viz., Assam Bengal Cement’s case 27 ITR 34 etc. In such circumstances, it is the principles laid down by the larger Bench of Supreme Court which have to be kept in mind while characterising the nature of any expenditure into revenue or capital. The ratio of the decisions of the Supreme Court in Punjab Industrial Corporation Ltd.’s case and Brooke Bond India’s case should therefore be limited to facts similar as in these two cases.

In Lakshmi Auto Ltd. v. DCIT, 101 ITD 209, the Chennai Tribunal had an occasion to explain the scope of the decision in Brooke Bond India’s case; especially the observations made by the Supreme Court in the context of the argument made by Dr. Pal. In the case before the Chennai Tribunal, the assessee claimed deduction u/s. 37(1) towards expenditure on issuance of right shares. The Assessing Officer processed the return u/s. 143(1)(a). The assessee’s claim was disallowed on the grounds that the said expenditure was capital in nature. On appeal to the Commissioner (Appeals), the assessee raised a specific plea that expenses incurred on rights issue was for raising working capital. The Commissioner (Appeals) held that the decision of the Supreme Court in Brooke Bond (India) Ltd. v. CIT (supra) squarely applied to the case of the assessee and, therefore, the prima facie adjustment was held to be valid.

On further appeal to the Tribunal, the Judicial Member held that the Supreme Court in Brooke Bond India Ltd.’s case (supra) had not decided the issue as regards the expenditure incurred on increase of capital to meet the need for more working funds. The Judicial Member further held that the Assessing Officer was not correct in making prima facie adjustment on the grounds that the expenditure was capital in nature as no facts were available on record as to whether the assessee required the funds to increase capital to meet the need of work-ing capital or not. Not agreeing with the conclusions and findings of the Judicial Member, the Accountant Member held that the Assessing Officer was within his jurisdiction to make adjustment as no debate was involved after pronouncement of the decision in case of Brooke Bond (India) Ltd. (supra). The third Member on reference concurred with the views of the Judicial Member. The relevant observations of the third Member are as under:

“9. Having heard both the parties on the point and after perusing the various precedents relied upon, I find that the issue in question is a debatable issue. It is not directly covered by the decision of the Apex Court rendered in the case of Brooke Bond (India) Ltd. v. CIT, (1997) 225 ITR 798.    In this case the Supreme Court has held that expenditure incurred by a company in connection with issue of shares, with a view to increase its share capital, is directly related to the expansion of the capital base of the company, and is capital expenditure, even though it may incidentally help in the business of the company and in the profit-making. It was contended before the Supreme Court that where the enhancement was to have more working funds for the assessee to carry on its business and to earn more profit and that in such a case the expenditure that is incurred in connection with issuing of shares to increase the capital has to be treated as revenue expenditure. On this the Supreme Court has held that the statement of case sent by the Tribunal did not record the finding to the effect that the expansion of the capital was undertaken by the assessee for the purpose of meeting the need for more working funds for the assessee to carry on its business.

From this it can be concluded that if the expansion of capital is in order to meet the need for more working funds, in that eventuality the expenditure could partake the nature of revenue expenditure. De hors examination in this regard, it is not possible to apply the ratio.

Each case depends on its own facts, and a close similarity between one case and another is not enough, because even a single significant detail may alter the entire aspect. In deciding such cases, one should avoid the temptation as said by Cordozo by matching the colour of one case against the colour of another. I am reminded of Heraclitus who said “you never go down the same river twice”. What the great philosopher said about time and flux can relate to law as well. It is trite that a ruling of superior Court is binding law. It is not of scriptural sanctity, but is of ratiowise luminosity within the edifice of facts where the judicial lamp plays the legal flame. Beyond those walls and de hors the milieu we cannot impart eternal vernal value to the decision, exalting the doctrine of precedents into a prison house of bigotry, regardless of varying circumstances and myriad developments. Realism dictates that a judgment has to be read subject to the facts directly presented for consideration.

I have considered the entire conspectus of the case. In my opinion, the decision of the Apex Court in the case of Brooke Bond (India) Ltd. (supra) can be applied only after examining the object of the capital enhancement. This decision is not applicable if enhancement of the capital was made for gearing up funds for working capital. The object of gearing up of the capital was not looked into. Total amount was disallowed without examining the details. Even applicability of section 35D was not considered. In my opinion, this is not correct. I have gone through the reasoning adduced by the ld. Judicial Member. In my opinion he took a correct view in the matter. I concur with his decision on this issue.” (emphasis supplied)

In view of all the above, one may argue that the expenditure incurred in connection with issuance of shares for augmenting working capital needs should be allowed as deduction u/s. 37(1) of the Act. The decisions of the Supreme Court in Punjab Industrial Corporation case and Brooke Bond India case (supra) would not be applicable to cases where the object of enhancement of the capital expansion is to have more working funds. As a result, fees paid to XY bank by ABCL in the present case should be allowed as revenue expenditure u/s. 37(1) of the Act.

Partner’s interest — On capital:

Interest paid on partner’s capital by a partnership firm is allowed as a business deduction subject to the limit specified u/s. 40(b) of the Act. Under the Act, a partnership firm is regarded as a taxable entity distinct and separate from partners constituting it. Interest paid is deducted while computing the total income of the firm. Such deduction is admissible, irrespective of whether the capital is used for acquiring an asset or for working capital purposes. The admissibility of interest on partner’s capital account is in one sense a measure of avoiding double taxation on the same income. It is also an acknowledgement of separate existence of the firm and the partners.

A company is also regarded as a separate and distinct person from its shareholders. A company and a partnership firm thus stand on the same pedestal on this count. If in the eyes of Legislature expenditure connected with capital of a firm (viz., interest on capital introduced by a partner into a partnership firm) is allowable as a business deduction, it would be unreasonable to disallow expenditure incurred by a company in connection with share capital of a company. This is especially in view of the fact that there are no specific provisions in the Act restricting the admissibility of such an expenditure; the disallowance only being sustained on the premise of it being a capital expenditure u/s. 37.

What could be/is ‘working capital/funds’:

In Advance Law Lexicon 3rd edition 2005, the term ‘working capital’ is defined as ‘the funds available for conducting day-to-day operations of an enterprise; the money in circulation, acquired through cash balances, daily cash sales or short-term borrowings and used to run day-to-day affairs of a business organisation; capital available for day-to-day running of a company, used to pay expenses such as salaries, purchases, etc.’. The word web defines it as assets available for use in the production of further assets. In CIT v. IBM World Trade Corporation, 161 ITR 673, the Bombay High Court held that working capital is that which is utilised in a business and is another expression for circulating capital. In CIT v. Modern Theatres Ltd., 50 ITR 548, the Madras High Court held that circulating capital is a capital which is turned over and in the process of being turned over yields profit or loss. The Kerala High Court in Kerala Small Industries Development Corporation Ltd. v. CIT, 270 ITR 452 held that ‘Circulating capital’ means capital employed in the trading operations of the business and the dealings with it comprise trading receipts and trading disbursement. The term ‘working capital’ thus implies funds which an organisation must have to finance its day-to-day business operations. It is that part of the total capital which is employed in the trading/current assets.

What could be a trading/current asset for a particular business may be a fixed/capital asset for another business. There are no fixed rules with regard to characterisation of assets into current asset and fixed asset. One has to determine under what circumstances the asset has been acquired? What is the purpose for which the assets are acquired? If the asset is related to day-to-day business operations, then it would be regarded as current asset. It would be part of the circulating capital. Expenses incurred in connection with such acquisitions are to be allowed as business deduction. In this connection one may refer to the decision of the Supreme Court in Bombay Steam Navigation Co. v. CIT (supra). In the said decision, the Supreme Court held that if transaction of acquisition of the asset is closely related to carrying on of the assessee’s business, the expenditure incurred in connection therewith is to be regarded as revenue expenditure. The Supreme Court in CIT v. Bombay Dyeing and Mfg. Co. Ltd., 219 ITR 521 applying the ratio of Bombay Steam Navigation Co. v. CIT (supra) held that ex-penses incurred in connection with amalgamation of companies could be characterised as revenue expenditure if amalgamation is essential for smooth and efficient conduct of business.

The expense under discussion (viz., fees paid to XY bank) is incurred in connection with raising of funds for working capital purposes and for securing distribution rights, licences and brands in European, African and Asia-pacific countries. Securing distribution rights, licences and brands are essential for running business in such countries. ABCL acquires these intangibles for smooth and efficient conduct of business in such countries. It is on such rationale [and following rationale of the Supreme Court’s decision in Bombay Dyeing and Mfg Co.’s case (supra)] that associated expenses may be argued to be revenue in nature. Otherwise, it would be argued that licences, brands, etc. are intangible assets (see the definition of ‘block of assets’) necessitating the branding of associated expense as capital in nature.

Circular No. 136/5/2011, dated 20-4-2011.

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By this Circular, Accounting Codes have been allotted for the new taxable services introduced vide the Finance Act, 2011.
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Circular No. 134/3/2011, dated 8-4-2011.

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By this Circular, it has been clarified that when whole of service tax is exempt, the same applies to education cess & secondary and higher education cess as well. Since education cess is levied and collected as percentage of service tax, when and wherever service tax is Nil by virtue of exemption, education cess would also be Nil.
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SAT directs Mutual Fund to compensate unitholders — for loss in NAV on account of changes to Scheme

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The essential issue raised recently was, if a mutual fund raises money under certain terms and then it changes them, what is the recourse available to the investor? What do the SEBI (Mutual Funds) Regulations, 1996 (‘the Regulations’) provide for this? When do such changes amount to change in ‘fundamental attributes’ which would require giving exit to the unit holder at the prevailing NAV? Can SEBI limit and define by a circular what are ‘fundamental attributes’? What are the implications of SEBI’s circular explaining what are ‘fundamental attributes’? If the mutual fund changes ‘fundamental attributes’ without following the prescribed procedure, what relief does the law provide to the investor? What if the mutual fund does not provide such relief? Is the only recourse available to investors to file a civil suit to obtain relief? These and other issues are dealt with in the recent decision of the Securities Appellate Tribunal (‘SAT’) in (Appeal No. 111 of 2010, decision dated 3rd May 2011, unreported but available on SEBI’s website).

The primary facts of this case as detailed by SAT are as follows. The appellants (husband and wife) had invested almost the whole of their life’s savings (about Rs.2.50 crores) in an open-ended Gilt scheme (called the ‘HSBC Gilt Fund’ or ‘the Scheme’) of the HSBC Mutual Fund (‘the Fund’). The appellants had chosen to invest in the Short- Term Plan which the offer document stated was suitable for investors seeking to obtain returns from a plan investing in gilts (including treasury bills) across the yield curve with the average maturity of the portfolio normally not exceeding seven years and modified duration of the portfolio normally not exceeding five years. The investment was made between October 2008 and November 2008.

In around February 2009, on receipt of the statement from the fund, they found that the Net Asset Value (NAV) had inexplicably and substantially depreciated by 10% and that too (as they later came to know) within a span of three days. On further inquiries, they came to know that the fund had wound up its ‘Long-Term Plan’ and modified the ‘Short-Term Plan’ by increasing the existing time frame of five to seven years to not exceeding 15 years. The benchmark index was also changed.

The appellants complained that these changes were changes in ‘fundamental attributes’ of the Scheme and were made without following the Regulations, which require informing the unit holders and, more importantly, giving them a chance to exit at the prevailing NAV before the proposed change. The relevant clause (5A) of Regulation 18 of the Regulations provides as follows:

“18. (15A) The trustees shall ensure that no change in the fundamental attributes of any scheme or the trust or fees and expenses payable or any other change which would modify the scheme and affects the interest of unitholders, shall be carried out unless, —

(i) a written communication about the proposed change is sent to each unit holder and an advertisement is given in one English daily newspaper having nationwide circulation as well as in a newspaper published in the language of region where the Head Office of the mutual fund is situated; and

(ii) the unit holders are given an option to exit at the prevailing NAV without any exit load.”

The unit holders were not informed through direct communication or through advertisement, nor were they given an option to exit at the prevailing NAV without any exit load.

The appellants, who feared further depreciation in the NAV, exited the Scheme and lodged complaints with the distributor, the fund, etc. and the Securities and Exchange Board of India (SEBI).

SEBI investigated the matter and passed an Order. Though the Order does refer to the complaints made by unit holders, the unit holders were not given an opportunity to be parties to the proceedings. Of course, the allegations made were violations of the Regulations and hence SEBI can proceed independently and directly against the person who allegedly violated them. However, this is emphasised, because when the appellants appealed against this Order of SEBI, the respondents — and even SEBI — claimed that the appellants did not have any locus standi to appeal!! Of course, SAT rejected this contention (as discussed later), but it is strange that even SEBI raised such a technical objection.

SEBI investigated the matter and heard the fund and its related parties. SEBI did find that there were substantial changes adversely affecting the unit holders. However, strangely, it took a stand that since it had issued a circular in 1998 explaining what fundamental attributes are and even gave a list of them, the fund is not guilty since the changes were not given in that list. This aspect is discussed in more detail later.

SEBI, however, did find the fund guilty on certain other charges and issued a warning to the fund, etc. to strictly comply with the law. This obviously left the appellants without any relief from their loss.

The appellants appealed against the Order of SEBI before the SAT. The fund — and even SEBI — as per the SAT Order, first raised a preliminary objection that the appellants had no locus standi to appeal. The SAT rejected these contentions firmly. I find it strange and even unjust that SEBI, after not having granting relief to the unitholders who suffered from the changes made to the Scheme, and after having passed such Order without directly hearing them, raises this technical objection that the appellants could not appeal against such Order! I wonder then who, if at all, would appeal against such Order?

Anyway, the more substantive issue was whether the changes made in the Scheme were changes to the ‘fundamental attributes’ of the Scheme. Also, even if they were, whether the changes can be limited only to those specified in a clarification by SEBI.

The term ‘fundamental attributes’ has not been defined in the Regulations. SEBI, however, had issued a circular dated 4th February 1998. In the circular, certain changes were specified as ‘fundamental attributes’, but apparently the changes made to the Scheme as per the facts in the present case were not specifically covered.

The SAT held that the changes made to the Scheme as discussed earlier were indeed changes to the fundamental attributes observing as follows:

“10. Having regard to the changes made in the scheme by which the duration of the investments therein was altered from five to seven years to a period not exceeding 15 years, we are of the considered opinion that this change is one which affects the fundamental attributes of the scheme and also modifies the same affecting the interest of the unit holders. The words ‘fundamental attributes’ have not been defined in the regulations and, therefore, they have to be understood according to their ordinary dictionary meaning. Fundamental is something which is basic or serves as a foundation or goes to the root of the matter. In the context of an investment scheme, one of the important factors that an investor looks at is the duration for which the investments are going to be made in that scheme. In this sense, the duration of the investment constitutes one of the fundamental attributes thereof. In the instant case when the scheme was launched it had two plans — short-term plan and long-term plan the duration of both was different and the investors took an informed decision in investing in one or the other plan . ….what respondents 2 to 5 did was…. they increased the duration of the short-term plan to a long-term without informing the investors. This was most unfair. Since the duration of the investments was substantially increased, we have no doubt in our mind that one of the fundamental attributes of the scheme was altered. Even the whole-time Member has recorded a finding in the impugned order that the change in the duration virtually modified the short-term plan into a long-term plan and this is what he has observed:

“The sudden change in investing substantial funds of the scheme in long-term gilt instruments from short-term instruments had in turn changed the average maturity and the modified duration of the scheme portfolio, drasti-cally varying them, so as to modify the scheme virtually into a Long-Term Plan.”

Interestingly, note also the following observations of the SAT with regard to the findings of SEBI itself in its Order:

“The whole-time Member himself has recorded a finding that the changes affect the interest of the unit holders of the scheme. It is pertinent to refer to this finding in his own words:

“The change in the duration of the scheme is a change which certainly affects the interest of the unit holders of the scheme. Any fund house making any changes so as to modify the scheme which affects the interests of the unit holders would be liable for the contravention of Regulation 18(15A) of the Mutual Funds Regulations, if they had effected such changes without complying with the procedure mentioned therein.”

Can SEBI limit the list of changes that amount to ‘fundamental attributes’ by means of a Circular? In any case, does the Circular limits the list? The SAT observed and held as follows:

“Having recorded the aforesaid findings, the whole-time Member holds that the aforesaid changes in the scheme did not alter its fundamental attributes merely because they did not fall within the clarifications issued by the Board as per its Circular of 4th February, 1998. We cannot agree with him. The Circular was issued giving clarifications in regard to some of the fundamental attributes of a scheme. What is elaborated therein is only illustrative and in the very nature of things it cannot be exhaustive. Apart from the attributes referred to in the Circular, there could be other fundamental attributes of a scheme like the duration of a scheme as in the present case. We agree with the learned senior counsel for the respondents that if the nature of the investments were to change, the fundamental attributes of a scheme would get altered. He was right in contending that if investments were to be made in equity or money market instruments instead of Government securities as originally stipulated, the fundamental attributes of a scheme would undergo a change. But those could not be the only fundamental attributes of a scheme. As already observed, there could be other attributes as well, depending upon the nature of the scheme.

11. We are really amazed that the whole-time Member after recording a finding that respondents 2 to 5 had changed the scheme which affected the interest of the unit holders without complying with Regulation 18(15A) of the Regulations failed to issue directions to these respondents for complying with the provision. The finding recorded in this regard has already been reproduced above and we agree with the whole-time Member that respondents 2 to 5 had brought about changes in the scheme which affected the interest of the unit holders. This being so they were obliged to comply with the provisions of Regulation 18(15A) which they have not and the grievance of the appellants is justified that the Board failed to issue appropriate directions in this regard.”

SEBI had also held that adverse directions against the fund could not be passed since, according to SEBI, no such allegation was made in the show-cause notice issued to the respondents. SAT, however, found otherwise and held as follows:

“The reason given by the whole-time Member for not issuing the necessary directions is that there was no such allegation in the show-cause notice dated 7th August, 2009 that was issued to the respondents. This reason, to say the least, is most untenable. The details of the changes made in the scheme have been elaborated in the show-cause notice and there is a clear allegation in para 16 thereof that the respondents had violated, among others, Regulation 18(15A) of the Regulations. It is this Regulation which required the respondents to give an exit route to all those who were the unit holders on the date of the change including the appellants. We are satisfied that the whole-time Member grossly erred in not issuing the appropriate directions in this regard.”

The final contention was that the disclosure was made in the offer document that the fund manager could make changes as market conditions warrant. The SAT held that such a disclosure does not permit making of fundamental attributes without following the prescribed procedure and giving the prescribed relief under the Regulations.

Accordingly, the SAT set aside the Order of SEBI and directed that, subject to due verification, etc. that the appellants be compensated for the loss suffered by them for the amount being the difference between the relevant NAV and the sale price of their units.

In my view, it is also sad though that no costs were given and the investors were merely restored to the NAV which they were otherwise entitled to. The investors had of course at stake a large loss of around Rs.25 lakh and could fight till SAT for relief. However, though their claims were clearly upheld, they had to bear the costs out of their pockets. The issue is: Is this fair?

Port Trust Land

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Introduction:

One of the largest landlords in the island city of Mumbai is the Board of Trustees of the Port of Mumbai or the Bombay Port Trust or the BPT as it is popularly known. BPT had let out large parcels of land (e.g., the Ballard Estate area of South Mumbai) on a rental basis. The area of land leased out by BPT is around 300 hectares. However, since the past few years, with real estate becoming a very scarce commodity in the city of Mumbai, there has been a spate of litigation between BPT as a landlord and the tenants on the other hand. In this scenario, it is important to understand the nature of the lease arrangement with BPT and the consequences of the same.

Nature of BPT:
The Bombay Port Trust was first constituted under the Bombay Port Trust Acts of 1873 and 1879. BPT is an Authority constituted for the administration, control and management of the port in Mumbai (which was and is a major port of India). Subsequently, a nationwide Act, called the Major Port Trusts Act, 1963 (‘the Act’) was enacted for all the major ports of India. This Act was made applicable to the Bombay Port Trust in the year 1975. Hence, now BPT is governed by the Major Port Trusts Act. The property owned by BPT absolutely vests in the Board by virtue of the provisions of the Act.

BPT is a State within the meaning of Article 12 of the Constitution of India and hence, it cannot act in an arbitrary or unjust manner. Its actions must be reasonable and always taken in public interest. This principle has been laid down by a host of Supreme Court decisions, such as, Dwarkadas Marfatia v. Board of Trustees of the Port of Bombay, (1989) 3 SCC 293, Maneka Gandhi v. UOI, (1978) 1 SCC 248, etc.

Land leased out by BPT:
As discussed earlier, BPT is involved in several disputes where it wants tenants to vacate in cases where lease is expiring or has expired. A majority of the disputes pertain to: whether BPT is bound to renew leases which have expired since it is a State and hence, it must act in public interest. Further, whether or not BPT can increase the rent significantly also forms a part of this dispute.

The decision of the Bombay High Court in the case of Omprakash Tulsiram Aggarwal, 1993 Mh LJ 1725 is significant in this respect. In this case, the renewal of the lease was refused by BPT. The lessees filed a writ stating that such a refusal was an arbitrary and unilateral decision of BPT and was not keeping with the conduct expected from a State. The High Court dismissed the writ petition and held that since BPT genuinely required the land for its own use, as was evident from its correspondences and it had also passed a resolution to that effect, there were ample reasons for refusal to renew the lease. Further, the acquisition was just fair and reasonable and did not suffer from the vice of Article 14, i.e., an arbitrary and unjust action. This judgment was subsequently affirmed by the Apex Court in Kumari Shri Lekha Vidyarthi v. State of UP, AIR 1991 SC 537.

In the case of Jayantilal Dharamsey, 2001 (1) Bom CR 44 it was held that BPT cannot act capriciously and arbitrarily and would have to fix the lease rent in accordance with fairness and reasonableness. This was a very path-breaking decision and ultimately went to the Supreme Court.

The Supreme Court in the case of Jamshed Hormusji Wadia v. BPT, 2004 (3) SCC 214 had an occasion to consider Jayantilal’s decision and a bunch of other cases, all of which dealt with the issue of whether or not BPT can increase the rent significantly and terminate leases in the case of illegal sub-letting by lessees. This famous decision of the Supreme Court laid down the all-important compromise proposal in this respect. BPT proposed a compromise formula to tide over the litigation and the same was accepted by the Supreme Court with some modifications. The important principles laid down by this decision were:

(a) After 1-4-1994, revision in rents shall be @ 10% for non-residential uses and @ 8% for residential uses; Interest chargeable by the Board of Trustees of the Port of Mumbai in respect of arrears of rent for the period commencing 1-4-1994 up to the date of actual payment shall be calculated @ 6% per annum.

(b) In the case of expired leases, fresh lease on new terms shall be at the sole discretion of the Board. The grant of fresh leases may be considered taking into account restructuring requirements for the City’s Development Plan, BPT’s Master Plan and the Development Control Regulations.

(c) Where a fresh lease is granted, arrears may be recovered in the form of premium at the applicable letting rate for respective use with simple interest at 15% per annum from the date of expiry of lease till grant of fresh lease.

(d) In the case of expired leases without a renewal clause, additional premium may be recovered at 12 months’ rent at the applicable letting rate.

(e) In the case of subsisting leases, assignments and consequent grant of lease on new terms would be at the prevailing letting rate at the relevant time and in relation to use. Where the lessee is already paying rent at the prevailing letting rate, assignment would be permitted on a levy of revised rent at 25% over the applicable letting rate or on levy of premium at 12 months’ rent at the applicable letting rate as may be desired by the lessee/tenant.

(f) Subletting, change of user, transfer, occupation through an irrevocable power of attorney and any other breaches may be regularised by levy of revised rent at the applicable letting rate at the time of such breach from the date of breach. Where the lessee/tenant is already paying rent at the prevailing letting rate, such regularisation be permitted on levy of revised rent at 25% over the applicable letting rate or a levy of premium at 12 months’ rent at the applicable letting rate as may be desired by the lessee/tenant.

(g) The Bombay Port Trust is an instrumentality of State and hence an ‘authority’ within the meaning of Article 12 of the Constitution. It is amenable to writ jurisdiction of the Court. The consequence which follows is that in all its actions, it must be governed by Article 14 of the Constitution. It cannot afford to act with arbitrariness or capriciousness. It must act within the four corners of the statute which has created and governs it. All its actions must be for the public good, achieving the objects for which it exists, and accompanied by reason and not whim or caprice.

(h) In the field of contracts, the State and its instrumentalities ought to so design their activities as would ensure fair competition and non-discrimination. They can augment their resources but the object should be to serve the public cause and to do public good by resorting to fair and reasonable methods. The State and its instrumentalities, as the landlords, have the liberty of revising the rates of rent so as to compensate themselves against loss caused by inflationary tendencies. They can and rather must also save themselves from negative balances caused by the cost of maintenance, and payment of taxes and costs of administration. The State, as landlord, need not necessarily be a benevolent and good charitable samaritan. However, the State cannot be seen to be indulging in rack renting, profiteering and indulging in whimsical or unreasonable evictions or bargains.

(i) The ‘Compromise Proposals’ so modified shall bind the parties and all the lessees, even if not parties to the proceedings before the Supreme Court.

Consequent to the above Supreme Court decision, the Estate Department of BPT issued a Circular in November 2006 which laid down the following important provisions:

(a)    It is obligatory on the part of lessees/tenants to obtain prior consent in writing of BPT for any assignment/transfer, subletting, under letting in any manner or parting with possession of the premises or any part thereof whether on leave and licence basis or otherwise.

(b)    Further, BPT was not bound to accord its sanction to a proposal for the above breaches which take place without its prior consent and if they proceed any further with such breaches, they shall be doing so at their own risk, cost and consequences.

(c)    It fixed 10-3-2004 as the cut-off date for the purpose of regularising past breaches, subletting, etc. Breaches committed after 10-3-2004 would attract application of revised rent/compensation prospectively i.e., from 1-9-2006 calculated based on 6% per annum return on the rates prescribed in the Stamp Duty Ready Reckoner for the year 2006 with 4% per annum increase every October, pro rata to the area of breach.

(d)    It was also decided by the Board that in future, changes in lease terms like additional construction, change of user, etc. should be with prior approval.

(e)    In case of subletting/assignment without prior approval, the Board reserves the right to resume possession and failure to obtain prior approval will attract, in addition to revised rent/compensation, a penalty of 12 months’ rent/compensation at the revised rates for every year of delay without prejudice to the Board’s rights and remedies including eviction and recovery of arrears, etc.

Even after the above-mentioned Supreme Court decision, several lessees are yet locked in a fierce battle with BPT, since not all issues have been resolved. A very famous club in Mumbai is currently locked in a fierce litigation with BPT which may threaten its very existence if BPT wins the ultimate battle. Its lease expired in 1990. BPT has been demanding possession of the land and premises constructed thereon. Several lessees of South Mumbai have filed an appeal in the City Civil Court which is pending. By virtue of this appeal, BPT’s order demanding possession has been stayed. It is also challenging the levy of rent from 2006 to 2010 on the grounds that it tantamount to an exorbitant enhancement of rent.

Applicability of other laws:

Another  issue  which  arises  is  whether  the provisions of the Maharashtra Rent Control Act, 1999 apply to land leased by BPT?

In the case of Jamshed Hormusji Wadia v. BPT, 2004 (3) SCC 214, the Court held that the issue as to the applicability of the Maharashtra Rent Control Act, 1999 to the Port of Mumbai and the property held by it is left open to be decided in appropriate proceedings.

Section 3(1) of this Act provides that it does not apply to any premises belonging to the Government or a local authority. Under the previous Rent Control Act of 1947, the definition of local authority was not given in the Act and hence, various decisions such as Ram Ugrah Singh, (1983) Mah LJ 815 had held that the BPT is a local author-ity. However, now Section 7(6) of the 1999 Rent Act expressly defines the term local authority in an exhaustive manner and does not include BPT within its definition. Hence, now BPT is not a local authority and accordingly, it is not exempt from the provisions of the Rent Act.

The Public Premises (Eviction of Unauthorised Occupants) Act, 1971 would also apply to property held by BPT — Ashoka Marketing Ltd. v. PNB, AIR 1991 SC 855.

Auditor’s duty:

The Auditor should enquire of the auditee, in case the auditee is dealing in property which is under lease from the BPT, whether the covenants of the lease deed, such as rent increases, renewal, etc. have been duly complied. Non-compliance with this could have serious repercussions for the buyer/lessee.

By broadening his peripheral knowledge, the Auditor can make intelligent enquiries and thereby add value to his services. He can caution the auditee of likely unpleasant consequences which might arise. It needs to be repeated and noted that the audit is basically under the relevant law applicable to an entity and an auditor is not an expert on all laws relevant to business operations of an entity. All that is required of him is exercise of ‘due care’.

SHARES WITH DIFFERENTIAL VOTING RIGHTS — A USER’S PERSPECTIVE

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Concept:
Shares with differential voting rights (DVR shares) are like ordinary equity shares but with differential voting rights. They are listed and traded in the same manner as ordinary equity shares. However, they mostly trade at a discount as they provide fewer voting rights compared to ordinary equity shares. Companies generally compensate DVR investors with a higher dividend.

Background:
In India since 2001, issue of DVR shares has been allowed. These can be used to thwart hostile takeovers, as for all practical purposes, they decouple economic interest and voting rights. Shares with DVR are mainly targeted at passive investors. In most cases, small or retail investors hardly exercise their voting rights, nor do they have an understanding of corporate affairs to an extent that they can influence corporate actions. They invest in shares only for economic returns. Therefore, they give away their voting rights in favour of those investors who run the company and have management control. Thus, this mode offers investors an avenue to acquire shares at lower prices with prospects of higher dividends in return for surrendering their voting rights.

Importance:
DVR shares offer investors an opportunity to earn better returns in lieu of surrendering their voting rights and also allow a company to dilute its equity without matching dilution in the promoters’ stake. At times companies issue DVR shares to fund new large projects. This also helps strategic investors who do not want control but are looking at a reasonably big investment in a company.

Legal requirement:
Section 86 of the Companies Act permits the issue of equity shares with DVRs, subject to conditions prescribed under the Companies (Issue of Share Capital with Differential Voting Rights) Rules, 2002.

Conditions:
Rule 3 provides that every company limited by shares may issue shares with differential rights as to dividend, voting or otherwise, if apart from specified procedural compliances, it conforms to the following:

  • It has distributable profits in terms of section 205 of the Companies Act, 1956 for three financial years preceding the year in which it was decided to issue such shares.
  • It has not defaulted in filing annual accounts and annual returns for three financial years immediately preceding the financial year in which it was decided to issue such shares.
  • The issue of such shares cannot exceed 25% of the total issued share capital of the company.

Global perspective:
A large number of global giants have raised funds through DVR issues, prominent among them are Google, NewsCorp and Berkshire Hathaway.

Indian scenario:
While DVR is a well-accepted instrument used by blue-chip companies in international markets to raise funds, even after a decade of the government’s Notification, the concept is yet to gain wide currency in India.

Pantaloons Retail India Ltd. Bonus Issue:
In July 2008, PRIL, India’s leading retailer, was the first to issue bonus shares with a DVR option. The company made a bonus issue of 1: 10 shares with differential voting rights and 5% additional dividends as well. Although there is no fund-raising involved in a bonus issue of shares, the idea was to get the markets familiar with such instruments and create another alternative to raise funds in the future. “Differential voting rights (DVR) has become a widely used innovative instrument in global markets and by coupling a bonus issue with a DVR, we believe in enhancing alternatives for our shareholders,” Kishore Biyani, MD of PRIL had stated in a press release.

Gujarat NRE Coke Ltd. DVR:
In September 2009, the company issued B Equity Shares of the Company with Differential Voting Rights (DVR Shares) with lower voting rights (1/100th of the voting right of ordinary equity share). The same were issued as bonus shares in the ratio of 1 B equity shares for every 10 equity shares held.

The above illustrates the past one year relative performance of the ordinary equity share (512579) vis-à-vis the DVR share (GUJNREDVR) and the broader markets (BSE Sensex). We find that while both the ordinary as well as the DVR share have moved in a direction opposite to the BSE and have witnessed reduced share prices; the magnitude of the fall for DVR (29%) is less than that of the ordinary share (39%).

(Source: Google Finance)

Tata Motors DVR:

In October 2008, Tata Motors became the first Indian company to make a rights issue of shares carrying differential voting rights (DVR) (issue size: Rs.1960.42 crores). DVR shares have 1/10th of voting rights of ordinary shares and offer a 5% higher rate of dividend over the normal shares. It issued these shares at Rs.305 i.e., about 10% lower than the issue of normal rights at Rs.340.

The diagram shown alongside illustrates the past one year relative performance of the ordinary equity share (500570) vis-à-vis the DVR share (TATAMTRDVR) and the broader markets (BSE Sensex). We find that while both the ordinary as well as the DVR

share have outperformed the BSE; the magnitude of the gain for DVR (39%) is less than that of the ordinary share (48%).

(Source: Google Finance)

Conclusion:
For an investor, who believes in being a part of the company’s decision processes, DVR shares are not attractive due to limited voting rights.

However, if one is a minority investor and isn’t concerned much with voting rights per se, then investing in the DVR would certainly be an attractive proposition. DVRs mostly trade at a discount, largely due to the fewer voting rights they enjoy. However, at times, the gap between DVR and ordinary shares is large, providing good opportunity to investors. (Globally, the discount between shares with DVRs and ordinary shares is about 10%.) Not only does an investor stand to gain from capital appreciation in a scenario where the price difference between the ordinary and the DVR share reduces over a period as a result of rising awareness about the product, he will also be entitled to higher dividends. Furthermore, he can always invest back in ordinary shares by exiting DVRs once the differential narrows. Thus, the riskreward ratio of investing in DVRs looks somewhat skewed towards the latter. The only caveat is that before investing in a DVR, investors need comfort about the company’s fundamentals and prospects, and more importantly, its management.

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The basics of cloud computing

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Part 3

About this article:
In the previous write-up on this issue we discussed certain important aspects about cloud computing including key terminology and some offerings. This write-up focusses on certain issues which would require consideration before one decides to opt for cloud services.

Background:
Cloud computing basically refers to providing the means through which everything i.e., from computing power to computing infrastructure, applications, business processes to personal collaboration, can be delivered to you as a service wherever and whenever you need. This model is fast emerging as the choice of several large and small businesses. The choice is quite natural considering the (assured) cost savings. Such savings can be either in the form of lower capital expenditure on hardware, software licence, infrastructure or in the form of lower operational expenditure i.e., operation and maintenance expense or reducing idle time, downtime, etc. (refer to the write-up titled Cloud computing basics — part I published in BCAJ April 2011 issue).

Businesses, large and small, have several options, between whether to opt for private or public or hybrid clouds (refer to the write-up titled Cloud computing basics — part II published in BCAJ May 2011 issue). Having several options itself, sometimes, becomes a hurdle while making strategic investments. Cloud computing also brings to the fore certain unique concerns, concerns which are more significant from the ‘enterprise’ point of view.

Primary objective of moving to the cloud:
As organisations evaluate how cloud computing can achieve these advantages, they are faced with numerous choices. While moving to the cloud has definite advantages such as — improving business agility, reducing management complexity and controlling costs, etc., one needs to appreciate that simply moving towards a service-oriented cloud computing model does not automatically deliver benefits. To derive maximum benefit and Return on Investment (ROI), cloud computing needs to be considered as part of a larger move towards more effective management and integration. Needless to say inadequate planning and half-baked cloud computing solutions may add complexities rather than reduce them.

Some myths and some clarifications:
While there are several myths and misconceptions associated with the topic of cloud computing, the ones that the readers of this journal are more likely to identify with are:

Myth 1:

Data security: Will the cloud service provider guarantee security?

One common concern amongst businesses looking to move to cloud computing is data security. Primarily, moving to the cloud entails — parking your data with the service provider, this can be a discomforting thought. The very possibility of threat to confidentiality and security of the data is the source of discomfort.

From a practical standpoint, public cloud datacentres are amongst the most secure premises on the planet. Yet, at the logical level, a cloud provider with every security certification still can’t guarantee the integrity of specific servers, applications, and networks, if your applications are poorly written, set up and secured. Similarly, all the security practices of a cloud provider are meaningless if a customer organisation’s security practices are weak.

The key take-away here is that there are several layers of security to protect your data, but there is always a possibility of chinks in the armour.

Myth 2:

Data control: My organisation will be locked into one vendor and lose control of its data, if it moves to the cloud:

Almost every organisation would acknowledge that businesses need to store shared files securely. This would assume more importance when the organisation is engaged in providing medical, legal and financial services. These organisations are subject to strict local laws.

If one believes that the best way to keep your data a secret is to manage it yourself, then the moot question would be why stash your precious data offsite?

It is relevant to point out that the essence of cloud services is ‘flexibility’. One application may call another on a different cloud service, and data may be stored anywhere, including your own network, but still be accessible to cloud applications. No cloud provider offers a service that completely takes control of your environment. The best cloud solutions will be a combination of on and offpremise services.

The key take-away is that while the service provider may control the infrastructure, the data is not entirely in his control. Sure!!! he controls your access to your own data, but his primary interest is merely optimal utilisation of his resources (just like you).

Myth 3:

Cost savings: An organisation must move all its applications to a cloud service to be able to benefit fully from cloud computing:

Moving an entire datacenter to the cloud is a tall task. Practically, no cloud provider would recommend this, at least not at one go (if you ask me — you are inviting trouble). Ideally, one should adopt a step-by-step approach. One should start by identifying applications in his pipeline that can benefit his organisation by being in the cloud. Look for applications where resources are used intensely for a short period each month then left idle for the rest of the time, or applications where a moderate level of resources are used continuously, but experience ‘periods’ of very high activity.

Such applications are ideal cloud candidates. This is so, because the cloud can scale up and down resources on demand. The cloud is built for flexible access to resources that can be allocated to other applications, or even other customers, when idle.

The key take-away is that one should do a cost benefit analysis of all activities undertaken and gauge the advantages/disadvantages of shifting to the cloud. A proper evaluation would also ensure that you minimise disruptions and costs associated thereto. Who knows, the sum of all parts may be greater than the whole.

Myth 4:

IT role changes: Do I still need an IT administrator?

The role of the Exchange Administrator does not become obsolete due to the cloud. There are still many tasks that remain on-premise. You still have to manage your users and their mailboxes. Industry-specific data retention compliance, as well as implementing custom workflows, is still your responsibility. While some tasks may no longer reside on-premise, managed cloud services free up your time to engage in more strategic roles, providing you with new opportunities.

Apart from patching those servers and physically maintaining them, all other aspects of managing applications remain in the IT administrator’s hands. Monitoring, updating, integration with services such as Active Directory, security and network monitoring — these task are still required within organisations utilising cloud services.

The key take-away is that the all powerful IT administrator’s role is impacted, but the role does not get diminished. The IT administrator’s role will evolve as the availability of compute cycles and networked storage increase — that is a given, just as the IT role has evolved in the past. The question IT administrators must ask themselves is, ‘Am I prepared to play a more strategic role in my organisation?’

Myth 5:

Getting started: All you need is your credit card to start cloud computing:

You can begin using cloud computing services with just a credit card. This is a good way to get experience with this new frontier of services, in fact some of the basic services may be available free. Most cloud services provide an environment designed for getting started and developing applications.

It is important that one gets used to the concept and gain comfort. Post this one may evaluate the advantages/disadvantages of moving to the cloud.

The key take-away is take small, measured steps. Learn from experience before betting it all.

In summary:

There are pros and there are cons, also there are hyped stories of success and spiced-up stories of failure. Readers may well be cautioned to do their own research and allay their fears of this emerging service. While the service provider may promise you the moon, one should pare his expectations and make investments only upon realising measured benefits. In short, look before you leap!!!!!!!

Computer-Assisted Audit Tools (CAATs) — Use of CAATs for Ope rational Rev iew of Plant Maintenance

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Preface:

Nancy is Director — Analytics with GRC Analytics Inc. GRC Analytics Inc. are market leaders in the field of governance, risk management and control analytics for the last decade and pioneers in the implementation of audit process and data analytical tools. In a short span of time this bellwether firm had managed to establish a footprint in the accounting, finance and business assurance segment which were the erstwhile arena for large accounting and audit majors. This fast-paced growth was fuelled by a group of techno-finance professionals who delivered consistent value propositions to all their clients by riding on the backbone of contemporary assurance technology.

GRC Analytics Inc. leveraged audit technology like general audit softwares, data mining tools, work paper administration tools, reporting applications, enterprise continuous control monitoring applications and enterprise risk management applications to deliver value-added, high-return valuefor- money results to all the clients from retail to manufacturing, to information technology and healthcare.

GRC Analytics Inc. was solely responsible for overseeing all data analytic projects and applied knowledge management research projects for the firm.

In a recent Internal Audit — Engineering & Technology conclave, Nancy was presenting on the role of ‘Use of CAATs for Operational Audits and Assurance’.

Introduction:
Nancy began by providing the backdrop to the use of CAATs for the operational review of central plant maintenance activities at an engineering industry.

The Central Maintenance Cell (CMC) of a manufacturing company was entrusted with breakdown maintenance and preventive maintenance for ten plant centres in the company. The COO of the company was interested in studying and reviewing problem areas and potential threats in the maintenance process. He instructed the Head-CMC, to provide Nancy and her team with maintenance data for undertaking specialised business analysis.

The Head-CMC in turn provided Nancy with an electronic dump containing the following file layout:

Presentation on operational review of plant maintenance through CAATs:

Nancy wanted to drive home the efficacy of general audit tools to the conclave of participants comprising internal auditors, technical auditors, investigators, risk managers, IT security professionals and more. She decided to help the participants visualise the utility of audit tools (GAS) through a few live plant maintenance case studies and discussions. These case studies served as a primer for a general awareness and appreciation amongst the participants.

Case studies presented were:

(a) Plants experiencing frequent Breakdown Maintenance (BM):

Nancy summarised the electronic dump on the plant code and plant description along with filtered criteria to extract all maintenance codes containing ‘BM’.

She performed this summarisation to arrive at count of breakdown maintenance instances for each plant centre.

With the summarisation file in place she finally performed a top records filter to capture the ‘Top 5’ plant centres by highest frequency of breakdown maintenance.

Armed with this information, the Head-CMC was able to investigate and diagnose the reasons for high breakdowns on specific plant centres by looking at the age, usage, history of maintenance, nature of maintenance, plant output quality and allied details.

(b) Plants experiencing Breakdown Maintenance (BM) immediately after Preventive Maintenance (PM) in the same month:

Nancy appended a new field to the electronic dump and captured the month of maintenance against each maintenance transaction activity.

She then went on to perform a duplicate (exclusion) test on the plant code, plant description and month with the field that must be different being maintenance code.

The resultant report provided a listing of plants being halted for ‘BM’ immediately after ‘PM’ in the same month.

With the instances generated, the Head-CMC was able to investigate and diagnose the reasons for sudden breakdowns after preventive maintenance by studying the nature of preventive maintenance undertaken and the quality of maintenance spares used.

(c) Plants halted for Breakdown Maintenance (BM) beyond 24 hours:

Nancy appended a new field to the electronic dump and captured the time taken to complete each maintenance activity by simply arriving at the difference between the ‘Maintenance start time’ and ‘Maintenance end time’.

She then applied a filter to list plants under ‘BM’ for more than 24 hours.

Finally Nancy converted the filtered report of ‘Above 24 Hour BM cases’ into a frequency distribution as below:

This frequency distribution allowed the Head-CMC to focus on pain areas in the plant maintenance process.

Conclusion:
Nancy culminated her presentation by reiterating that general audit tools are time-tested, stable, robust, powerful, internationally acclaimed and user-friendly applications designed by auditors for auditors.

She added that no tool is a ready substitute for the internal and technical auditor’s acumen and judgment, but is a powerful, cost-effective facilitator.

She encouraged all the internal and technical auditors present to embrace tools and reap the benefits of an idea whose time has come.

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Need for optimal choice of accounting policies under Ind-AS

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With its press release dated 25th February 2011, the Ministry of Corporate Affairs (MCA) notified 35 Indian Accounting Standards converged with IFRS (Ind-AS), thereby eliminating the speculation on the contents of the final standards. However, the press release does not contain the date of implementation of the converged standards. The MCA has clarified that the date of implementation shall be notified at a later date.

The final standards notified by the MCA are substantially similar to the current IFRS standards. However, there are certain changes made to the Ind-AS standards as part of the convergence (rather than adoption) process to make them suitable to the Indian environment. These changes can be classified into the following categories:

  • Mandatory differences as compared to IFRS;
  • Removal of accounting policy choices available under IFRS;
  • Additional accounting policy options provided, which are not in compliance with IFRS requirements;
  • Certain IFRS guidance to be adopted with separate (deferred) implementation dates.

Our previous article explained the first category of carve-outs i.e., mandatory differences with IFRS and their impact on the financial statements. This article attempts to cover the other categories of carve-outs, whose primary focus is on accounting policies.

I. Removal of accounting policy choices available under IFRS:

This category of carve-outs pertain to several areas where IFRS offers multiple policy choices while Ind- AS restricts these policy choices.

This category of carve-outs do not result in deviations from IFRS, as they represent permitted policy choices. However, while following the policies prescribed under Ind AS will result in conformity with IFRS, these carve-outs could pose a challenge for Indian companies, if global peers follow other alternative policies (such as fair value model for investment property); if such companies are a part of a global group that follows other alternative policies; or if the Indian company has previously followed other alternative policies for IFRS reporting to overseas stakeholders.

Presentation of profit and loss account based on single statement or two-statement approach:

Position under IFRS:

IFRS provides entities with an accounting policy choice in relation to the presentation of income statement. The reporting entity can present comprehensive income as:

  • a single statement of comprehensive income (which includes all components of profit or loss and other comprehensive income); or
  • in the form of two statements i.e., an income statement (which displays components of profit or loss) followed immediately by a separate ‘statement of comprehensive income’ (which begins with profit or loss as reported in the income statement and discloses components of other comprehensive income aggregating to total comprehensive income for the period).

Position under Ind-AS:

Ind-AS requires entities to present the profit and loss account based on the single-statement approach. The two-statement approach is not permitted under Ind-AS.

Presentation of expenses based on nature or function:

Position under IFRS:
Expenses in the profit and loss account are classified according to their nature or function.

When expenses are classified according to function, expenses are generally allocated to cost of sales, selling, administrative or any other functions of the reporting entity.

There is no guidance in IFRS on how specific expenses are allocated to functions. An entity establishes its own definitions of functions such as cost of sales, selling and administrative activities, and applies these definitions consistently. Additional information based on the nature of expenses (e.g., depreciation, amortisation and staff costs) is disclosed in the notes to the financial statements.

When classification by nature is used, expenses are aggregated according to their nature (e.g., purchases of materials, transport costs, depreciation and amortisation, staff costs and advertising costs).

Position under Ind-AS:

Ind-AS permits presentation of expenses based on the nature of expenses only. As such, presentation of expenses based on function is not permitted.

Presentation of dividend/interest received and paid in the cash flow statement:

Position under IFRS:

Interest paid/received and dividends received are usually classified as operating cash flows for a financial institution. For other entities, IFRS provides entities with an accounting policy choice whereby:

  • Interest paid and interest and dividends received may be classified as operating cash flows, because they enter into the determination of profit or loss.
  • Alternatively, interest paid and interest and dividends received may be classified as financing cash flows and investing cash flows, respectively, because they are costs of obtaining financial resources or returns on investments.

Position under Ind-AS:

Ind-AS requires interest paid and interest and dividends received to be classified as financing cash flows and investing cash flows, respectively.

Investment property: Cost model and fair value model:

Position under IFRS:

All investment properties are initially measured at cost. Subsequent to initial recognition, an entity chooses an accounting policy to be applied consistently, either to:

  • measure all investment property using the fair value model; or
  • measure all investment property using the cost model.

Where an entity has adopted a fair value model, all changes in fair value subsequent to initial recognition are recognised in the profit and loss account.

Position under Ind-AS:

Ind-AS prohibits use of fair value model for investment property.

Actuarial gains and losses:

Position under IFRS:

Under IFRS, actuarial gains and losses on defined benefit plans can be recognised using various acceptable policy choices. Thus, such actuarial gains or losses can either be recognised in other comprehensive income; or recognised immediately in the profit and loss account; or amortised into the profit and loss account using the corridor approach (or any other systematic method which results in faster recognition than the corridor approach).

Position under Ind-AS:

Ind-AS does not permit immediate recognition of actuarial gains or losses in the profit and loss account or amortisation through the profit and loss account. It requires actuarial gains or losses to be recognised directly in other comprehensive income.

Presentation of government grants related to assets:

Position under IFRS: Two methods of presentation in financial statements of grants related to assets are regarded as acceptable alternatives:

  • grants presented as deferred income and recognised in profit or loss on a systematic basis over the useful life of the asset.
  • grants adjusted against the carrying value of the asset. The grant is recognised in profit or loss over the life of a depreciable asset as a reduced depreciation expense.

Position under Ind-AS:

Ind-AS requires government grants related to assets to be presented in the balance sheet by setting up the grant as deferred income. Recognition as a reduction from the asset is not permitted.

Measurement of non-monetary grants:

Position under IFRS:

A government grant may take the form of a transfer of a non-monetary asset, such as land or other resources, for the use of the entity. If a government grant is in the form of a non-monetary asset, then an entity chooses an accounting policy, to be applied consistently, to recognise the asset and grant at either the fair value of the non-monetary asset or at the nominal amount paid.

Position under Ind-AS:

In case of non-monetary grants, the fair value of the non-monetary asset is assessed and both the grant and the asset are accounted for at that fair value.

II.    Additional accounting policy choices:

This category of carve-outs represent an area where a company can either elect to follow policies aligned to IFRS, or alternate policies that diverge from IFRS.

This category of carve-outs represents an area where each individual company needs to apply careful thought and consideration. Thus, if companies want to achieve full compliance with IFRS, they would need to elect accounting policies that are aligned to IFRS. On the other hand, if compliance with IFRS is not relevant for the company, it may elect other policies that are divergent with IFRS. While assessing these policy choices, companies need to evaluate not just their current environment, but future plans (for instance, plans for a future overseas listing or fund-raising).

Such carve-outs include the following:

Exchange differences on long-term foreign currency monetary items:

Position under IFRS:

Foreign exchange gains and losses generally are recognised in the profit or loss.

Position under Ind-AS:

Ind-AS has retained the above position under IFRS. Additionally, it has provided an option to recognise unrealised exchange differences on long-term monetary assets and liabilities to be recognised directly in equity and accumulated in a separate component of equity. The amount so accumulated shall be transferred to profit or loss over the period of maturity of such long-term monetary items in an appropriate manner.

Deemed cost exemption for Property, Plant and Equipment (PPE):

Position under IFRS:

On transition to IFRS, an entity has the following choices with respect to PPE for computing deemed cost under IFRS:

  •    Revalue individual, some or all items of PPE to its fair value as at the transition date.

  •     In case assets are revalued under the previous GAAP, then those revalued amounts can be considered as a deemed cost, provided that that revalued amounts are broadly comparable (i) to the fair values as at the date of revaluation, or (ii) cost or depreciated cost in accordance with IFRS adjusted to reflect, for instance, the changes in the general or specific price index.

  •     Event-driven (such as on account of IPO or Privatisation) fair values may be considered as deemed cost.

Position under Ind-AS:

Apart from the options provided under IFRS, Ind-AS provides an additional option to continue Indian GAAP carrying values of all items of PPE as at the transition date without any modification, except for recognising asset retirement obligations. This exemption, if exercised, is required to be applied to all items of PPE without exception.

III.    Certain guidance to be adopted with separate (deferred) implementation dates:

The Ind-AS standards currently notified defer the application of guidance on accounting for embedded lease arrangements and service concession arrangements. It is expected that such guidance will become mandatory at a later date.

Similarly, the Ind-AS on accounting for exploration and evaluation of mineral resources shall be notified at a later date.

Summary:

While Ind-AS financial statements presented for the first transition period cannot be fully compliant with IFRS (since comparatives would not be presented), Ind-AS financial statements for subsequent years can be made fully compliant with IFRS, if a company chooses optimal accounting policies and does not adopt the diluted alternatives available under Ind-AS. This is assuming that a company is not impacted by the mandatory deviations.

It is advisable for the companies to continue the process of estimating the exact impact of the convergence on their business, especially in the light of mandatory carve-outs and other non-mandatory differences with IFRS that are now clear on account of the notification of the final standards. Companies that otherwise need to fully comply with IFRS issued by the IASB (for example, because their securities are listed in overseas markets that require IFRS) need to carefully evaluate the impact of such carve-outs.

Independent assurance statement

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Infosys Technologies Ltd. — (31-3-2010)

Introduction:
Det Norske Veritas AS (DNV) has been commissioned by the management of Infosys Technologies Limited (Infosys) to carry out an assurance engagement on the Infosys Sustainability Report 2009-10 (the Report). This engagement focussed on qualitative and quantitative information provided in the report, and underlying management and reporting processes. It was carried out in accordance with the DNV protocol for Verification of Sustainability Reporting (VeriSustain).

The intended users of this assurance statement are the readers of the Infosys 2009-2010 Sustainability Report. The Management of Infosys is responsible for all information provided in the Report as well as the processes for collecting, analysing and reporting that information. DNV’s responsibility regarding this verification is to Infosys only, in accordance with the scope of work carried out. DNV disclaims any liability or responsibility to a third party for decisions, whether investment or otherwise, based on this Assurance Statement.

Scope of assurance:
The scope of work agreed upon with Infosys included the verification of the content, focus and quality of the information presented in the report, against the moderate level assurance requirements in VeriSustain, covering the period April 2009 to March 2010. In particular, this assurance engagement included:

  • Review of the policies, initiatives and practices described in the Report as well as references made in the Report to the Annual Report and corporate website;
  • Review of the Report against Global Reporting Initiative Sustainability Reporting Guidelines Version 3.0 (GRI G3) and confirmation of the Application Level;
  • Review of the processes for defining the focus and content of the report;
  • Verification of the reliability of information and performance data presented in the Report;
  • Visits to the Infosys’ head-office in Bangalore and development centres in Bangalore, Mysore and Chennai, India.

Verification methodology:
This engagement was carried out between August and September 2010 by a multidisciplinary team of qualified and experienced DNV sustainability report assurance professionals. DNV states its independence and impartiality with regards to this engagement. DNV confirms that throughout the reporting period there were no services provided which could impair our independence and objectivity and also maintained complete impartiality towards people interviewed during the assignment.

The Report has been evaluated against the principles of Materiality, Stakeholder Inclusiveness, Completeness, Responsiveness, Reliability and Neutrality, as set out in VeriSustain, and the GRI G3 Application Levels.

During the assurance engagement, DNV has taken a risk-based approach, meaning that we concentrated our verification efforts on the issues of high material relevance to Infosys’ business and stakeholders. As part of the engagement we have challenged the sustainability-related statements and claims made in the Report and assessed the robustness of the underlying data management system, information flow and controls. For example, we have:

  • Examined and reviewed documents, data and other information made available to DNV by Infosys;
  • Conducted interviews with three members of the board including Chairman of the board and Chief Operating Officer;
  • Conducted interviews with 39 representatives of the Company (including members of the Infosys Sustainability Council, data owners and representatives from different divisions and functions);
  • Performed sample-based reviews of the mechanisms for implementing the Company’s own sustainability-related policies and stakeholder engagements as described in the Report, and for determining material issues to be included in the Report;
  • Performed sample-based audits of the processes for generating, gathering and managing the quantitative and qualitative data included in the Report;
  • Reviewed the process of acquiring information and economic-financial data from the 2009-10 certified consolidated balance sheet.

Conclusions:
In our opinion, the Report is an appropriate and reliable representation of the Infosys sustainability- related policies, management systems and performance for the period 2009-10. The Report, along with the referenced information in the Annual Report and on the Company website, meets the general content and quality requirements of the GRI G3, and DNV confirms that the GRI requirements for Application Level ‘A+’ have been met. We have evaluated the Report’s adherence to the following principles on a scale of ‘Good’, ‘Acceptable’ and ‘Needs Improvement’:

Materiality: Acceptable. Infosys has strengthened the materiality determination process with the identified three key focus areas of Social Contract, Resource Efficiency and Green Innovation. But the process needs to be implemented across each division and location with due consideration of short, medium and long-term impacts.

Stakeholder Inclusiveness: Good. The Company has established a process of collating inputs from various stakeholders. A multi-stakeholder based, objective-oriented engagement approach is also evident in the field of adoption of cleaner energy and higher education.

Completeness: Acceptable. The reporting boundary is limited for many parameters (page 9) and does not cover the entirety of Infosys. Infosys shall incrementally improve to aid reporting to reflect the global organisation’s footprint. But within the reporting boundary defined by Infosys, we do not believe that the Report omits relevant information that would influence stakeholder assessments or decisions.

Responsiveness: Acceptable. Infosys has responded to the material issues and to its stakeholders through its policies, management systems and processes. However, this can be improved by expanding the goal setting process to cover more material issues and appropriate performance indicators.

Reliability: Good. No systematic or material errors have been detected for data and information verified. The identified minor discrepancies were corrected. However, there is scope for improving the process to reduce potential for errors.

Neutrality: Acceptable. The information contained in the Report is presented in a balanced manner, in terms of content and tone. Overall the Report is transparent, but can be further improved by more detailed disclosures in the employee sections.

Recommendations:
In addition to the improvement opportunities stated above, DNV recommends that Infosys:

  • Identifies sustainability indicators beyond those available in the GRI, drawing from the materiality process and incorporating them with measurable targets in future reports to remain in line with international practices.
  • Formalises the functioning of the Sustainability Council and integrates the same to existing and relating governance mechanisms.
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GapS in GAAP — Accounting for Jointly Controlled Entities that have Minority Interest

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Background:

Entities A, B and C have equal ownership (33.33%) in Entity D, which they all account for as an interest in an associate (commonly known as equity method). Now A and B, enter into an arrangement under which they will form a Newco (a newly formed shell company), in which they will each have a 50% interest in return for contributing their shares in Entity D. Consequently, after completion of the transaction, Newco has a 66.7% controlling interest in Entity D and, in its consolidated financial statements (CFS), will record minority interest for investor C’s interest in Entity D.

Entities A and B when exchanging their shares in Entity D for shares in Newco, also enter into a contract which results in them having joint control (as defined in AS-27 ‘Financial Reporting of Interests in Joint Ventures’) over Newco. A and B both apply proportionate consolidation for Jointly Controlled Entities (JCE) in the CFS.

Question:
In the CFS of A and B, should the proportionate consolidation be restricted to the effective interests (33.33%) that Entities A and B each have in Entity D, or to 50% of all line items in Newco’s financial statements (including the minority interest) ?

View 1:
Entities A and B will recognise only their effective interests (33.33%) in Entity D. Proponents of this view use the definition of proportionate consolidation to support the argument. As per AS-27 Proportionate consolidation “is a method of accounting and reporting whereby a venturer’s share of each of the assets, liabilities, income and expenses of a jointly controlled entity is reported as separate line items in the venturer’s financial statements.” This definition refers only to the venturer’s share of each of the assets, liabilities, income and expenses of a JCE, and that minority interest does not meet the definition of any of these items. Further, paragraph 30 of AS-27 may also support this view, “When reporting an interest in a jointly controlled entity in consolidated financial statements, it is essential that a venturer reflects the substance and economic reality of the arrangement, rather than the joint venture’s particular structure or form. In a jointly controlled entity, a venturer has control over its share of future economic benefits through its share of the assets and liabilities of the venture. This substance and economic reality is reflected in the consolidated financial statements of the venturer when the venturer reports its interests in the assets, liabilities, income and expenses of the jointly controlled entity by using proportionate consolidation.”

View 2:
Proponents of view 2 (50% proportionate consolidation) point out to paragraph 31 of AS-27 ‘. . . . Many of the procedures appropriate for the application of proportionate consolidation are similar to the procedures for the consolidation of investments in subsidiaries, which are set out in AS-21 Consolidated Financial Statements’. Therefore, it is considered that this results in a requirement for the inclusion of all line items, including those relating to minority interest, for the purposes of proportionate consolidation.

View 3:
Entities A and B have an accounting policy choice, as the accounting guidance is not definitive.

Author’s view:
If the formation of Newco has no substance other than to house the JV and to achieve a gross-up presentation in the CFS of Entity A and B that includes minority interest, then view 1 (33% consolidation) may be a more appropriate accounting treatment. If however, the Newco did have substance (for example, it may be planned to raise funds or list NewCo) then view 2 (50% consolidation) could be favorably argued. In other words, substance over form should prevail.

Nevertheless, this is an issue that ultimately the standard-setters should resolve.

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Section A : Audit Report isued under SA 700 (Revised ), SA 705 and SA 706

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Compiler’s Note

  • The Institute of Chartered Accountants of India (ICAI) had issued Standards on Auditing (SA): SA 700 (revised) Forming an Opinion and Reporting on Financial Statements,
  •  SA 705 Modifications to the Opinion in the Independent Auditor’s Report,
  • SA 706 Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report

These standards were effective for audits of financial statements for periods beginning on or after 1st April, 2011. Following these 3 SAs would change the format in which audit reports were to be issued.

ICAI vide an announcement dated 17th April 2012, however, postponed the application of these standards to audits of financial statements for periods beginning on or after 1st April, 2012. The reason for the postponement as mentioned in the ICAI announcement was that regular CPE and other programmes to familiarise the practising members with the requirements of the new standards were necessary and only after ensuring adequate education, publicity and familiarisation, the said standards would be made mandatory.

Some companies, however, had already adopted financial statements before the date of the ICAI postponement and in such cases the statutory auditors had already issued their report in terms of SA 700, SA 705 and SA 706.

Given below is an audit report dated 13th April 2012, issued using the new SAs.

 Independent Auditor’s Report

To the Board of Directors of Infosys Limited (formerly Infosys Technologies Limited)

Report on the Financial Statements

We have audited the accompanying financial statements of Infosys Limited (‘the Company’), which comprise the Balance Sheet as at 31 March 2012, the Statement of Profit and Loss of the Company for the quarter and year then ended, the Cash Flow Statement of the Company for the year then ended and a summary of significant accounting policies and other explanatory information.

Management’s responsibility for the Financial Statements

Management is responsible for the preparation of these financial statements that give a true and fair view of the financial position, financial performance and cash flows of the Company in accordance with the Accounting Standards referred to in s.s (3C) of section 211 of the Companies Act, 1956 (‘the Act’). This responsibility includes the design, implementation and maintenance of internal control relevant to the preparation and presentation of the financial statements that give a true and fair view and are free from material misstatement, whether due to fraud or error.

Auditor’s responsibility

Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with the Standards on Auditing issued by the Institute of Chartered Accountants of India. Those Standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the Company’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of the accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

Opinion

In our opinion and to the best of our information and according to the explanations given to us, the financial statements give the information required by the Act in the manner so required and give a true and fair view in conformity with the accounting principles generally accepted in India:

(i) in the case of the Balance Sheet, of the state of affairs of the Company as at 31st March 2012;

(ii) in the case of the Statement of Profit and Loss, of the profit for the quarter and year ended on that date; and

(iii) in the case of the Cash Flow Statement, of the cash flows for the year ended on that date.

Report on Other Legal and Regulatory Requirements As required by section 227(3) of the Act, we report that:

(a) we have obtained all the information and explanations which to the best of our knowledge and belief were necessary for the purpose of our audit;

 (b) in our opinion proper books of account as required by law have been kept by the Company so far as appears from our examination of those books;

(c) the Balance Sheet, Statement of Profit and Loss and Cash Flow Statement dealt with by this Report are in agreement with the books of account; and

(d) in our opinion, the Balance Sheet, Statement of Profit and Loss and Cash Flow Statement comply with the Accounting Standards referred to in s.s (3C) of section 211 of the Companies Act, 1956. n

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GAPs in GAAP — FAQs on Revised Schedule VI

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The issuance of Revised Schedule VI to the Companies Act applicable from 1-4-2011 was a landmark event in financial reporting in India. As could be expected, there were numerous interpretation issues that arose. To address them the Institute of Chartered Accountants of India (ICAI) issued the Guidance Note on the Revised Schedule VI to the Companies Act, 1956 (GNRVI). Further, in May 2011 Frequently Asked Questions FAQ — Revised Schedule VI was posted on the ICAI website to provide further guidance. At the time of writing this article, none of the following was clear with respect to the FAQ’s — (a) the unit of ICAI that issued the FAQ’s (b) the review process — whether the Accounting Standard Board or the Technical Directorate of the ICAI reviewed the FAQ’s, and most importantly (c) the authority attached to the FAQ’s.

 In this article, we take a look at some of the contentious FAQ’s.

A company, having December year-end, will prepare its first revised Schedule VI financial statements for statutory purposes for the period 1 January to 31 December 2012. Whether such a company needs to prepare its tax financial statements for the period from 1 April 2011 to 31 March 2012 in accordance with revised Schedule VI or pre-revised Schedule VI?

Response in FAQ

It is only proper that accounts for tax filing purposes are also prepared in the Revised Schedule VI format for the year ended 31 March 2012.

Author’s view with respect to companies to which MAT is applicable

S.s (2) of section 115JB states as follows “Every assessee, being a company, shall, for the purposes of this section, prepare its profit and loss account for the relevant previous year in accordance with the provisions of Part II and III of Schedule VI to the Companies Act 1956 . . . . . . ” The Finance Act, 2012, enacted recently, has removed reference to part III from section 115JB of the Income-tax Act. This amendment is applicable for A.Y. 2013-14, i.e., for tax financial year 2012-13.

From the above amendment to section 115JB, it is clear that a company will use revised Schedule VI format for preparing its tax financial statements for the tax financial year 2012-13 (i.e., 1 April 2012 to 31 March 2013). For preparing tax financial statements for the tax financial year 2011-12 (i.e. 1 April 2011 to 31 March 2012), the fact that the Finance Act removes reference to part III of schedule VI only for previous year beginning 1 April 2012 suggests that the company may need to prepare its tax financial statements for the period 1 April 2011 to 31 March 2012 in accordance with pre-revised Schedule VI. This appears to be a straight forward interpretation of the amendment to the Income-tax Act.

Note: Generally in determining the tax liability, it should not matter whether the accounts are prepared in accordance with pre-revised Schedule VI or revised Schedule VI. However, in certain situations it may have a significant impact, for example, where the company has to pay MAT . The P&L account in pre-revised Schedule VI had the P&L appropriation account. Therefore typically certain adjustments to reserves (e.g., debenture redemption reserve) would appear in the P&L appropriation account, and the net balance would be added to the retained earnings in the balance sheet. In the revised Schedule VI, the P&L ends with PAT (profit after tax) and all the appropriations are carried out under the caption ‘Reserves’ in the balance sheet. For determining the book profits under 115JB, and consequently the MAT liability, one would achieve different results if one were to start with PAT (under revised Schedule VI) or start with the net appropriated P&L (under pre-revised Schedule VI) and treat debenture redemption reserve as an allowable expenditure (in accordance with certain favourable judicial precedents) for determining book profits for MAT purposes.

There is a breach of major debt covenant as on the balance sheet date relating to long-term borrowing. This allows the lender to demand immediate repayment of loan; however, the lender has not demanded repayment till the authorisation of financial statements for issue. Can the company continue to classify the loan as current? Will the classification be different if the lender has waived the breach before authorisation of financial statements for issue?

Response in FAQ

As per the Guidance Note on the Revised Schedule VI, a breach is considered to impact the noncurrent nature of the loan only if the loan has been irrevocably recalled. Hence, in the Indian context, long-term loans, which have a minor or major breach in terms, will be considered as current only if the loans have been irrevocably recalled before authorisation of the financial statements for issue.

Author’s view

In accordance with revised Schedule VI, a liability is classified as non-current if and only if the borrower has unconditional right to defer its payment for atleast 12 months at the reporting date. GNRVI clarifies that if a term loan becomes repayable on demand because of violation of a minor debt covenant (for e.g., submission of quarterly financial information), the company can continue to classify the same as non-current unless the lender has demanded repayment before approval of financial statements.

GNRVI does not clarify the classification where a company has violated a major debt covenant as on the reporting date. However, a reading of GNRVI suggests that the exemption is given only with regard to violation of minor debt covenants and not for violation of major covenants. Thus, if major debt covenant is violated, there can be three situations — (a) the banker has asked for repayment before approval of financial statements, (b) the banker has not asked for repayment and has not forgiven the violation before approval of financial statements, and (c) the banker has forgiven the violation before the approval of financial statements. In situations (a) and (b), the author believes that the loan should be classified as current liability. In situation (c), where the banker has actually forgiven the violation before approval of financial statements, one may argue that the intention of the ICAI is that a company should continue to classify the loan as non-current, if the possibility of loan being recalled is negligible. Subsequent waiver of breach confirms this aspect and therefore the company may continue to classify the loan as non-current.

Thus, there is a difference in view, with respect to situation (b). In the author’s view and based on the GNRVI, the same would be treated as current. However, as per the FAQ’s, the same would be treated as non-current.

How would rollover/refinance arrangement entered for a loan, which was otherwise required to be repaid in six months, impact current/non-current classification of the loan? Consider three scenarios: (a) rollover is with the same lender on the same terms, (b) rollover is with the same lender but on substantially different terms, and (c) rollover is with a different lender on similar/different terms? In all three cases, the rollover is for non-current period.

Response in FAQ

In general, the classification of the loan will be based on the tenure of the loan. Thus, in all the above cases, if the original term of the loan is short term, the loan would be treated as only current, irrespective of the rollover/refinance arrangement. However, in exceptional cases, there may be a need to apply significant judgment on substance over form. In such cases, categorisation could vary as appropriate.

Author’s view

If the rollover arrangements are with the same lender at the same or similar terms, the company will continue to classify the loan as non-current, provided that the rollover arrangement was in existence at the balance sheet date. If the rollover arrangement has been entered into with a different lender either on similar or different terms, the arrangement is more akin to extinguishment of the original loan and refinancing the same with a new loan. Hence, in such cases, the existing loan should be classified as current liability. If the rollover arrangement is entered into with the same lender but on substantially different terms, the position is not clear. We understand that the matter is under debate at the IASB level and mixed practices are being followed globally as well. Keeping this in view, one may argue that it can classify the loan as non-current, provided that the rollover arrangement was in existence at the balance sheet date.

The author believes that view taken in the ICAI FAQ is technically flawed, since rollover of loan with the same lender on the same terms for non-current period clearly results in non-current classification. This is because it is not due to be settled within the 12 months after the reporting date and the company has an unconditional right to defer settlement of the liability for atleast 12 months after the reporting date.

The company has received security deposit from its customers/dealers. Either the company or the dealer can terminate the agreement by giving 2 months’ notice. The deposits are refundable within one month of the termination. However, based on past experience, it is noted that deposits refunded in a year are not material, i.e., 1% to 2% of amount outstanding. The intention of the company is to continue long term relationship with their dealers. Can the company classify such security deposits as non-current liability?

Response in FAQ

As per Revised Schedule VI, a liability is classified as current if the company does not have an unconditional right to defer its settlement for at least 12 months after the reporting date. This will apply generally. However, in specific cases, based on the commercial practice, say for example electricity deposit collected by the department, though stated on paper to be payable on demand, the company’s records would show otherwise as these are generally not claimed in short term. Treating them as non-current may be appropriate and may have to be considered accordingly. A similar criterion will apply to other deposits received, for example, under cancellable leases.

Author’s view

As per revised Schedule VI, a liability is classified as current if the company does not have an unconditional right to defer its settlement for at least 12 months after the reporting date. In the given case, the company does not have such right since the customer/dealer can terminate the agreement by giving 2 months notice and deposit has to be refunded within 1 month of termination. Hence, the security deposit should be classified as current liability. The intention of the company to not terminate the agreement or past experience is not relevant.

In case of provision for gratuity and leave encashment, can current and non-current portions be bifurcated on the basis of actuarial valuation?

Response in FAQ

The actuary should be specifically requested to indicate the current and non-current portions, based on which the disclosure is to be made.

Author’s view

Paragraph 7.3(b) of GNRVI states as below:

“In case of accumulated leave outstanding as on the reporting date, the employees have already earned the right to avail the leave and they are normally entitled to avail the leave at any time during the year. To the extent, the employee has unconditional right to avail the leave, the same needs to be classified as ‘current’ even though the same is measured as ‘other long-term employee benefit’ as per AS-15. However, whether the right to defer the employee’s leave is available unconditionally with the company needs to be evaluated on a case to case basis — based on the terms of Employee Contract and Leave Policy, Employer’s right to postpone/ deny the leave, restriction to avail leave in the next year for a maximum number of days, etc. In case of such complexities the amount of Non-current and Current portions of leave obligation should normally be determined by a qualified Actuary.”

The author believes that ICAI FAQ needs to be read with GNRVI and it cannot override paragraph 7.3(b) of GNRVI. Hence, there is no question of any part of leave liability being classified as non-current liability, if a company does not have a right to postpone/ deny the leave for 12 months. In other words, if an actuary is appointed to do this classification, he or she should apply the principles set out in paragraph 7.3(b) of GNRVI.

Conclusion

In light of the above arguments, the author would request the ICAI to reconsider and reissue some of the FAQ’s.

The Concept of Propriety’— Dynamics & Challenges for Auditors

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Introduction

There is a saying that “we take propriety to encompass not only financial rectitude, but a sense of the appropriate values and behaviour”. Though the concept of propriety is generally associated with public sector activities, the time has now come to apply this concept even in the private sector due to the enhanced application of the ‘Agency Theory’ which requires an eloquent demonstration of the roles and responsibilities of the professional management running a company to all the stakeholders. With the changing environment, the expectations of the society have also changed and as a result, there is a greater emphasis on conformance with prescribed values, customs, procedures and practices, keeping in mind the public interest and greater application of prudence. This has resulted in an expectation of applying the concept of propriety in all the transactions carried out by the corporates and an endorsement of the same by an independent person. Consequently, the Statutory Auditors of the company, being independent, are expected to fill this vacuum. However, the Statutory Auditors focus more on the true and fair view of the financial statements and generally do not deal with the propriety aspects in depth due to various limitations and challenges. Whilst the auditors can certainly consider this emerging expectation as part of their audit process to the extent the same is significant and impacts the financial statements, there are certain practical challenges in dealing with the same. This article focusses on the concept of propriety along with its relevance for audits, propriety expectations from the auditors, responsibilities of the auditors in general, practical challenges in application of the concept of propriety in audits, audit defense to propriety concerns and the nuances of reporting propriety concerns by the auditors. This article is not intended to elucidate the responsibilities of the auditors regarding the frauds, if any, committed by the management.

What is Propriety?

In general, there is no fixed definition of the term ‘propriety’ which keeps changing, reflecting the changing expectations of society. The literal dictionary meaning of the term propriety encompasses ‘appropriateness’, ‘rightness’, ‘correctness in behaviour or morals’, ‘conformity with convention in conduct’, ‘the standards of behaviour considered correct by polite society’.

The core principles of the concept of propriety could be summarised as under:

  • Integrity
  • Openness
  • Objectivity
  • Honesty
  • Selflessness

The concept of propriety can be related to various other concepts which are commonly known. To list a few:

  • Accountability
  • Legality
  • Probity
  • Value for money
  • Fraud & Corruption
  • Governance
  • lInternal Control Environment

Practically, there is also a reasonable degree of overlap amongst application of these concepts and all the above can be analysed from the broad umbrella of propriety.

Propriety expectations from Auditors in India

Whenever the auditors carry out a Propriety Audit, they not only evaluate the underlying evidence, but also attempt to examine the regularity, reasonability, prudence and impact of various acts. In India, the audits performed by the Comptroller & Auditor General (C&AG) focus more on the propriety aspects and check the conformity with the established financial propriety standards.

Though the expectations of the statutory audit conducted under the provisions of the Companies Act, 1956 do not necessarily mandate a propriety focus on the part of the auditors, various amendments made to the Companies Act, 1956, specifically on the reporting requirements in the Auditors’ Report under the Companies (Auditor’s Report) Order, 2003 over a period of time indicate move in that direction. Certain illustrative instances of the same are given below:

  • Auditors’ responsibility to inquire on the terms and conditions of the loans and advances to identify whether they are prejudicial to the interests of the company and its members.
  • Reporting on transactions of the company which are represented merely by book entries and are prejudicial to the interests of the Company.
  • Reporting on whether personal expenses have been charged to the revenue account.
  • Reporting on reasonability of the pricing mechanism on transactions where directors are interested.
  • Reporting on preferential allotment of shares to interested parties and the impact of the pricing on the interests of the entity.
  • Reporting on the disqualification of the directors u/s.274(1)(g) of the Companies Act, 1956.
  • Reporting on the frauds by or on the company.

In addition to the aforesaid reporting requirements, propriety expectations are also embedded in the Accounting Standards such as reporting requirements related to the Related Party Transactions in accordance with the AS-18. Needless to add, the Companies Act, 1956 contains several provisions relating to propriety elements such as greater level of monitoring/approval for transactions with directors/other interested parties, remuneration paid to directors, etc.

Responsibility of the Auditors

The Statutory Auditors who conduct their audit in accordance with the Auditing Standards for reporting on the true and fair view of the financial statements may not necessarily be in a position to meet the propriety expectations of society in totality due to their role/legal boundaries. In this regard, it is worth noting that propriety challenges would invariably result in fraud on the company or by the company which needs to be reported and considered by the Auditors. As per the Generally Accepted Auditing Standards in India, the Auditors should always conduct the engagement with a mindset that recognises the possibility that a material misstatement due to fraud could be present, regardless of any past experiences with the entity and regardless of their belief about the management’s honesty and integrity.

  • The relevant/specific Auditing Standards which need to be considered by the Auditors in responding to the propriety challenges are as under: SA 240 — The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements
  •  SA 250 — Consideration of Laws and Regulations in an Audit of Financial Statements ? SA 260 — Communication with those in charge of Governance
  • SA 265 — Communicating Deficiencies in internal control to those charged with Governance and Management
  • SA 315 — Identifying and Assessing the Risk of Material Misstatement Through Understanding the Entity and its Environment
  • SA 330 — The Auditor’s Responses to Assessed Risks.

The primary responsibility for prevention and detection of fraud and error rests with both those charged with governance and the management of an entity. The objective of an audit of financial statements prepared in accordance with the framework of recognised accounting policies and practices and relevant statutory requirements, if any, is to enable the auditors to express an opinion on them. An audit conducted in accordance with the Generally Accepted Auditing Standards in India is designed to provide reasonable assurance that the financial statements taken as a whole are free from material misstatements, whether caused by fraud or error. The fact that an audit is carried out may act as a deterrent, but the auditors are not and cannot be held responsible for prevention and detection of fraud and error.

A Financial Statement Audit conducted in accordance with the applicable auditing framework does not guarantee that all material misstatements will be detected because of such factors as the use of judgment, the use of testing, the inherent limitations of internal controls and the fact that much of the evidence available to the auditors is persuasive rather than conclusive in nature. For these reasons, the Auditors are able to obtain only a reasonable assurance that material misstatements in the financial statements will be detected.

In view of the above, the responsibility of the Statutory Auditors towards the propriety aspects would be more limited and focussed on specific aspects of reporting and need not necessarily extend to the entire gamut of the transactions carried out by a company. However, propriety concerns, if any, noticed by the Auditors during their audit process should be given adequate importance and should not be overlooked. They should consider the same as part of assessing the risk associated with the entity and the environment in which it functions, and should deal with the same appropriately, including reporting to those in charge of governance, wherever required.

Propriety challenges for Auditors

Propriety is concerned with compliance with expectations of conduct and behaviour, which although not written into legislation or regulations, are generally accepted as being central to the management of the affairs of an entity. Acts of impropriety will be concerned with specific misconduct, knowingly perpetrated for personal or political gain. Similar acts, undertaken with lack of knowledge and motivation, are on the other hand, omissions of propriety. The effects on an entity are often the same but the auditors may need to bear this distinction in mind. Whether an act constitutes improper behaviour within the generally accepted standards of conduct expected in business is often a matter of interpretation and professional judgment. Invariably, the question of proving the propriety element would depend on facts and circumstances of the case. The availability of the proof and its adequacy is a matter of personal judgment of the Auditor.

Root cause for propriety issues
Propriety issues arise in entities due to the following:

  •     Corporate culture
  •     Poorly designed or operated internal controls

  •     Ignorance of the rules or expectations of proper behaviour, especially in small and medium-sized entities

  •     Urge to achieve targets/results in the short-term

  •     Greed

Symptoms for propriety issues
The propriety challenges for the auditors could take different dimensions depending on the nature of the entity and the activities carried out by it. The symptoms of propriety concerns could arise from various matters such as:

  •     Absence of business rationale for significant transactions
  •     Lack of transparency in awarding contracts

  •     Liberal/flexible arrangements with contractors

  •     Transactions without written contracts

  •     Entering into side agreements/arrangements with contracting parties

  •     Avoidance of proper tendering procedures

  •     Excessive involvement of agencies/ third parties

  •     Having an overriding authority with few individuals for allowing exceptions

  •     Situations where there is a conflict of interest

  •    Large infructuous expenses triggering propriety concerns

  •     Abnormally high hospitality expenses

  •     Lack of conclusive evidence regarding the ultimate usage of funds

  •     Weak Audit Committee/Board Members who are silent spectators

  •     Absence of appropriate disclosures in the financial statements

  •     Lack of sanctity for the Internal Audit/other audit observations.

Acts of impropriety
By studying the symptoms carefully, the Auditor may identify transactions where there are propriety concerns for the entity. Though the acts of propriety may vary from entity to entity depending on the nature, environment, etc., instances of the acts of impropriety could take any of the following dimensions:

  •     Facilitation payments, bribes, speed money paid for expediting clearances, getting things done fast which are coloured differently.

  •     Awarding contracts at a price lower than the expected value.
  •    Exorbitant service charges which are not commensurate with the services rendered.

  •     Excessive remuneration to promoters/directors which does not commensurate with the services rendered.

  •     Preferential treatment in making appointments either of contractors or of staff.

  •     Misuse of office for personal purposes.

  •     Foreign travel by senior management and board members without proper justification or clear benefit to the entity.

  •     Inflating the payments to vendors for services rendered/goods delivered where the vendors make certain improper payments on behalf of the entity which triggers propriety issues.

  •     Disposal of scrap at a value much lower than its realisable value.

  •     Selling shares held by a company to another company at a consideration above cost but substantially below the market value.

  •     Structuring the transactions with group companies which are de facto related parties in a manner that does not apparently fit into the definition of related party.

  •     Recruitment of employees based on recommendations of authorities as a quid pro quo for consideration received.

Though the propriety concerns could be factored in by the Auditors as part of their audit process, there are a number of factors that significantly limit the extent to which an audit of financial statements can be expected to identify impropriety, including:

  •     Multiple versions of the concept of propriety and its meaning

  •     Absence of adequate evidence of conducting the business

  •     Concealment and collusion

  •     Difficulties in identification of impropriety elements by an outsider

  •     Application of the concept of materiality by the auditors

  •     Actual/Perceived scope limitation on the part of the audit process

  •     Skills required on the part of the auditors for identifying transactions involving impropriety

  •     Lack of clarity in the statutory provisions dealing with the roles and responsibilities of the auditors.

In view of the various challenges listed above, it may not be possible for the Statutory Auditors to confirm propriety aspects of all the transactions entered into by the entity as part of his audit. Hence, subsequent discovery of acts of impropriety by the entity audited may not imply inadequate/ improper audit.

Audit Defense for Propriety Concerns
Whilst external Auditors of companies are not required to perform specific procedures for the purpose of identifying improprieties as part of their audit of the financial statements, they should remain alert to instances of significant possible or actual non-compliance with general standards of public conduct. In particular, the Auditors may develop a general appreciation of the framework of governance and standards of conduct within which the company conducts its activities during the course of their audit to gain an understanding of the overall internal control environment. This can be an important potential source of information on any impropriety.

As part of the Auditor’s responsibility to assess the overall internal control environment, the Auditor is required to assess inherent risk, taking account of factors relevant to the entity as a whole. In this regard, the Statutory Auditors could:

  •     Familiarise themselves with the general regulations, rules and other guidance relating to the conduct of the company’s business.

  •     A thorough understanding of the company and its business and a review of its financial control environment.

  •     Enquire of the management about the company’s policies and procedures regarding the implementation of code of conduct and instructions, while having regard to whether the policies and procedures are comprehensive and up to date.

  •     Discuss with the management and internal auditors the policies or procedures adopted for promulgating and monitoring compliance with relevant codes and instructions.

  •     Read minutes of the board and management meetings to pick up matters of propriety concern.

  •     Read the newspaper articles related to the company.

  •     Review the arrangements for whistle-blowing.

  •     Discuss with client staff in various departments including operations.

  •     Focus on areas, if any, which have not been reviewed by them for a number of years.

  •     Introduce surprise elements in the audit process.

The Auditors may also discuss their plan to perform the stipulated audit procedures to identify any propriety concerns with the Audit Committee/ those in charge of governance. This by itself could create moral pressure on the environment as well as on the management. In the process of identifying the propriety concerns, the Auditors should not go overboard and over audit the entity which may not be warranted.

The Auditors may also closely assess the following to form their opinion regarding the entity’s response towards propriety challenges:

  •     Tone at the top in dealing with the matters of impropriety.
  •     Extent of evangelism of the principles of propriety amongst the employees by the management through code of conduct/ ethical training, etc.

  •     Process of obtaining compliance declarations from the management to confirm the propriety elements for all the contracts/transactions entered into by the company.

  •     Extent of interference by the promoters with the professional management personnel.

  •     Sanctity given to various processes and procedures.

Reporting by the Auditors
If there are impropriety symptoms identified in the course of enquiry/discussion or verification by the Auditors, it is appropriate for them to report the same to the management or even to those in charge of governance and to consider their impact on audit risk. When the Auditors become aware of any failure of propriety, they should aim to understand its nature and the circumstances under which it has occurred and sufficient additional information should be obtained to evaluate the possible impropriety. If the Auditors consider that the impropriety could be significant, they may perform appropriate additional procedures and document the results.

The extent of additional procedures the auditors decide to perform in response to impropriety is a matter of professional judgment and depends on:

  •     Its impact on the financial statements
  •     Nature of the impropriety

  •     Persons involved

  •    Likelihood that the impropriety may have led to loss of funds

  •     Likelihood that the suspected impropriety involves fraud

  •     Extent to which further procedures can be expected to clarify the situation

  •     Extent to which the impropriety indicates that other impropriety or mismanagement may be present

  •     Likelihood of the need to report.

Where there is suspicion of impropriety but an absence of evidence, the Auditors may consider drawing the management’s attention to the possibility of introducing procedures that would generate evidence were the suspicion to be well founded.

To explain this concept further with an example, if the management has entered into a contract for disposing of the scrap for a value which is less than its actual realisable value for benefiting somebody, the amount received and recorded as per the books and pursuant to the contract, duly approved by an appropriate authority, need not necessarily pose an accounting challenge; however, the real value of the transaction has not been reflected in the books of account due to an act of impropriety which would definitely trigger an audit concern. This has to be investigated further and the same has to be appropriately dealt with.

Significant matters of impropriety would require appropriate reporting by the Auditors not only in their Audit Report but also communication to those in charge of governance. At the earliest suitable opportunity, the Auditors should discuss their findings at an appropriate level of management whom they do not suspect of involvement with the impropriety. Wherever there is an Audit Committee, the auditors should also discuss their findings with them.
    
If the auditors consider that impropriety may have or has occurred, they may need to reconsider their assessments of audit risk and the validity of the management’s representations. For example, a series of suspected or actual instances of impropriety that are not significant financially may be symptomatic of the management’s general disregard for proper conduct and hence may cast doubt on the general integrity of the management.

The method of reporting on audit work relating to propriety will vary depending on the nature of the work undertaken and its results. The auditors may also consider communicating the propriety concerns, if any, primarily due to internal control lapses to the management through a management letter. The auditors should also request the managements to place the management letters along with the management’s responses before the Audit Committee.

Conclusion
Impropriety is considered as one of the serious evils in all the countries and in particular in the developing countries. Governments in various countries are attempting to enact/strengthen various laws to combat impropriety. They are aware of the fact that the first stage in the dynamics of the rule of law is the framing of effective rules and laws, which are equipped to hinder the ever-rising escalation of the impropriety graph. There is nothing in this world which can guarantee high standards of propriety but appropriate safeguards can be put in place to minimise the risk of impropriety occurring or remaining undetected. These safeguards include:

  •     Clear expectations of standards of individual behavior.

  •     Appropriate internal controls to provide checks and balances against individual misconduct.

  •     External supervision to hold the organisation accountable.

Above all, such safeguards help to create a climate and culture in which high standards of propriety is valued.

In India, the proposed Companies Bill, 2011 contains various provisions relating to propriety aspects, including a provision of direct reporting of frauds by the Auditors to the appropriate authority which would enhance the role and the responsibilities of the Auditors considerably and is in the direction of thrusting propriety principles as part of the audit expectation. The Auditors should be cognizant of propriety concerns and the expectations of society in discharging their professional duties within the legal framework which would go a long way in setting the standards for audit excellence.

Reference material

  •     Indian Auditing Standards

  •     Report of the Public Audit Forum, UK

  •     Nolan Committee Report, UK

  •     Various Research Reports on Audit process available for General public.

Subscription fees received by FCO for providing social media monitoring services for market intelligence constitutes royalty u/s.9(1)(vi) of Income-tax Act and Article 12(3) of India- Singapore DTAA.

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ThoughtBuzz Pvt. Ltd.
AAR No. 1036 of 2010
explanation 2 to section 9(1)(vi),
article 12(3) of India-Singapore DTAA
Dated: 7-4-2012
Justice P. K. Balasubramanyan (Chairman)
Present for the appellant: None
Present for the respondent: P. Selvaganesh

Subscription fees received by FCO for providing social media monitoring services for market intelligence constitutes royalty u/s.9(1)(vi)   of  income-tax  act and  article 12(3) of  india-Singapore DTAA.


Facts:

  •  Taxpayer, a Singapore company (FCO), is engaged in providing social media monitoring service for a company, brand or product. The service is a platform for users to hear and engage with their customers, brand ambassadors, etc. on the Internet. The clients who subscribed, for a subscription fee, could login to the website and search on what is being spoken about various brands.

  • The system operated by FCO generated a report of analytics with inputs provided by clients. FCO obtained information, for generating report, from various external sources by using its own crawlers (computer program that gather and categorise information on the Internet).

  •  FCO approached AAR on taxability of subscription fee received from Indian subscribers under the Income-tax Act and also India-Singapore DTAA.

  • Tax Department contended that the subscription fee was in the nature of royalty as the basic mechanism of providing service was through a computer program (crawler) which was owned by FCO. Hence, subscription fee could not be disassociated from the user of computer system and it constituted fee paid for equipment use as also for imparting technical, commercial or scientific knowledge under Income-tax Act and India-Singapore DTAA

.

  • FCO contended that the subscription fee received from the Indian customers was not royalty u/s.9(1) (vi) or under India-Singapore DTAA as no exclusive right or copyright was given to its customers. There was no control of software and they did not have any possessory rights in relation to the equipments. Also, information passed on to its clients was not its own knowledge, experience or skill.

  • As FCO had no PE in India, the income was only taxable in Singapore under Article 7 of the DTAA.

AAR Ruling:

  • AAR upheld the Tax Department’s contentions and held that subscription fee received by FCO constitutes royalty for the following reasons:

  • As FCO was in business of gathering collating and making available or imparting information concerning industrial and commercial knowledge, experience and skill, the subscription fee would be covered under clause (iv) of Explanation 2 to section 9(1)(vi) of Income-tax Act.

  •  Payment received by FCO would constitute royalty under Article 12(3)4 of the DTAA, as it represents consideration for use of or right to use the process or information concerning industrial, commercial or scientific experience.

  • As subscription fee received by FCO is taxable under the Income-tax Act as also India-Singapore DTAA, tax is required to be deducted at source u/s.195 of the Income-tax Act.
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Income from inspection, verification, testing and certification services (IVTC) provided by FCO in India qualifies as Fees for Technical Services (FTS) under Income-tax Act. IVTC does not qualify as FTS under treaties containing a ‘make available’ clause, as services cannot be independently applied by service recipient. Under treaties having a Most Favoured Nation (MFN) clause, benefit of a restricted meaning of FTS in terms of make available clause is available. Income from IVTC qualifies as ‘<

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XYZ (a.a.r. Nos. 886 to 911, 913 to 924, 927, 929 and 930 of 2010)
Section 9(1)(vii) 139, 195, 245 of ITA,
article 7, 22 of india-US DTAA
Dated: 19-3-2012
Justice P. K. Balasubramanyan (Chairman)
V. K. Shridhar (Member)
Present for the applicant: G and others
Present for the Department: Mahesh Shah, Ashish Heliwal

Income from inspection, verification, testing and certification services (IVTC) provided by FCO in india qualifies as Fees for Technical Services (FTS) under income-tax act.

IVTC does not qualify as FTS under treaties containing a ‘make available’ clause, as services cannot be independently applied by service recipient.

Under treaties having a Most Favoured Nation (MFN) clause, benefit of a restricted meaning of FTS in terms of make available clause is available.

Income from IVTC qualifies as ‘other income’ under treaties not having specific FTS article.


Facts:

  • X group of companies is engaged in the business of inspection, verification, testing and certification (IVTC) services. Taxpayer, part of X group and a non-resident in India (FCO), provides IVTC services directly to Indian customers from outside India and payments are also made outside India.

  • FCO provides services, issues an analysis reports and raises invoices on ICO or directly on Indian customers.

  • FCO approached the AAR for determining the taxability in India of its income from IVTC services. Questions were also raised about the taxability of recovered costs, withholding obligations of the payers and obligation of FCO to file ROI in India.

  • The above questions were also raised, before AAR, by various entities of X group belonging to different countries.


AAR examined the position separately under the Income-tax Act/DTAAs:

FTS under Income-tax Act

  • IVTC services are in the nature of technical services and taxable as FTS under the Income-tax Act.

  • The exclusion in respect of services to be utilised in businesses carried on by residents outside India or earning income from a source outside India does not apply to facts of the case.


Under the DTAA with ‘make available’ clause:

  • Services did not ‘make available’ technical know-how, experience, skill, know-how or process to the Indian customers as:

  • Utility of services came to an end soon after its rendition.

  • There was no system in place which equipped ICO to carry on IVTC services independently.


AAR also held:

  • MFN clause extended ‘make available’ benefit in suitable cases even though the treaty was on FTS.

  • In absence of FTS Article, services would get covered by other Income Article.

  • Reimbursement of expenses partook the character of FTS. FCO obligated to file return of income if non-taxability is based on treaty entitlement.
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PART A : Decision of the C.I.C.

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Sub: Section 8(1)(j) of the RTI Act

Following was the information sought by the Appllicant and the reply given by the PIO.

The PIO has refused to give the information claiming exemption under Section 8(1)(j) of the RTI Act. An appeal was filed. The PIO (the respondent) stated that third party information could not be disclosed without taking the views of the third party and relied upon the case of Suhash Chakma vs. CIC in W.P.(C) No. 9118 of 2009. The respondent also stated that the present whereabouts of the third parties are not maintained by the Ministry.

The Commission ruled that if the third party’s address could not be located it did not mean the citizen’s right to information would disappear. Section 11 is a procedural requirement that gives third party an opportunity to voice an objection in releasing the information.

The Commission then held that in section 11(1) it is clearly stated that submission of third party shall be kept in view while taking a decision about disclosure of information. Section 11(1) dealt with the information ‘which relates to or has been supplied by a third party and has been treated as confidential by that third party’. Thus the procedure of Section 11 comes into effect if the PIO believes that the information exists and is not exempt, and the third party has treated it as confidential. The PIO must send a letter to the third party within 5 days of receipt of the RTI application. It only gives the third party an opportunity to voice its objections to disclosing information. The PIO has to keep these objections in mind and the denial of information can only be on the basis of exemption under Section 8(1) of the RTI act. As per Section 11(3), the PIO has to determine whether the information is exempt or not and inform the appellant and the third party of his decision. If the third party wishes to appeal against the decision of the PIO, he can file an appeal under Section 19 of the Act as per the provision of Section 11(4).

The Commission then explained whether the information sought was exempt u/s 8(1)(j). As per the Commission, two points need to be satisfied for the information to qualify for exemption:

(i) It must be Personal Information.

The phrase ‘disclosure of which has no relationship to any public activity or interest’ means that the information must have been given in the course of a public activity.
Various Public authorities in performing their functions routinely ask for ‘personal’ information from citizens, and this is clearly a public activity. When a person applies for a job, or gives information about himself to a Public authority as an employee, or asks for a permission, licence or authorisation or passport, all these are public activities. Also, when a citizen provides information in discharge of a statutory obligation, that too is a public activity.

(ii) To check ‘whether the State invades the privacy of an individual’.

According to the Commission, where the State routinely obtains information from citizens, this information is in relationship to a public activity and will not be an intrusion on privacy.

The Commission noted that the Parliament has not codified the right to privacy so far, hence in balancing the Right to Information of citizens and the individual’s Right to Privacy the citizen’s Right to Information would be given greater weightage. The Supreme Court of India has ruled that citizens have a right to know about charges against candidates for elections as well as details of their assets, since they desire to offer themselves for public service. It is obvious then that those who are public servants cannot claim exemption from disclosure of charges against them or details of their assets. Given our dismal record of mis-governance and rampant corruption which colludes to deny Citizens their essential rights and dignity, it is in the fitness of things that the Citizen’s Right to Information is given greater primacy with regard to privacy.

 In view of above, the Commission did not accept the PIO’s contention that information provided by an applicant when applying for passport was exempt under Section 8(1)(j) of the RTI Act. [Mr. Anand Narayan Devghare vs. PIO, Regional Passport Office, Mumbai: CIC/SG/ A/2012/000794/18743 dated 4th May 2012.]

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Hindu Adoption Act

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Introduction

The Hindu Adoptions and
Maintenance Act, 1956 (‘the Act’) is not a commercial or corporate
legislation, but its importance in today’s business world is being felt
because of succession issues, family separations and family feuds
becoming the order of the day. With an increasing number of families
adopting children, the question often arises as to whether the adopted
child is entitled to succeed the father in the business, property, etc.
In several cases, questions, such as whether the adoption was valid,
what happens if the adopted father has subsequently a natural child,
etc., are raised. Hence, it becomes essential to examine this Act. This
is all the more true in a country such as India where a great number of
businesses are family owned or controlled.

 Although a great deal
of the Hindu Law is based on customs and usages, certain portions have
been codified. The Act is one such instance of codified law. It would
hence, overrule any text, custom, usage of Hindu Law.

Application

The Act applies to:

(i) Any person who is a Hindu, Jain, Sikh or Buddhist by religion.

(ii) Any person who is not a Muslim, Christian, Parsi or a Jew.

(iii) Any person who becomes a Hindu, Jain, Sikh or Buddhist by conversion or reconversion.

(iv)
A legitimate/Illegitimate child whose one or both parents is a Hindu,
Jain, Sikh or Buddhist by religion. However, in case only one parent is a
Hindu, Jain, Sikh or Buddhist by religion, then the child must be
brought up by such parent as a member of his community, family, etc.

(v)
Any child, legitimate or illegitimate, who has been abandoned both by
his father and mother or whose parentage is not known and who in either
case is brought up as Hindu, Buddhist, Jain or Sikh. This is a very
important clause which was added by the Amendment Act of 1945. The
reason for this Amendment was that only a Hindu can be adopted. As the
religion of an abandoned child or of a child whose parentage is not
known or cannot be ascertained, the explanation to section 2(1) of the
Act was amended to the effect that a child, legitimate or illegitimate
who has been abandoned by both of his parents or whose religion is not
known, but who in either case is brought up as a Hindu, will be a Hindu
by religion.

The Act does not apply to members of Scheduled
Tribes unless the Government so directs. Manner of making adoption Any
adoption by or to a Hindu must be made in accordance with the provisions
of the Act. It is interesting to note that in case the adoption is not
in accordance with the Act, then it shall be void. The consequences of a
void adoption are:

(a) it does not create any rights in the adoptive family in favour of the adopted child; and

(b) his rights in the family of his natural birth also subsist and continue.

Thus,
in a case of a void adoption, the adopted child would not be entitled
to any inheritance or succession benefits in his adopted family. The
pre-requisites of a valid adoption u/s.6 are as follows:

 (a) the adopter is capable of and has a right of adopting under the Act;

(b) the adoptee is capable of being taken in adoption under the Act;

(c) the person giving the adoptee is capable of doing so under the Act; and

 (d) all other conditions specified under the Act have been fulfilled.

Capacity of adopter

A male Hindu is capable of adopting a son or daughter:

(a) if he is of sound mind;

 (b) if he is a major, i.e., he is above 18 years of age;

(c)
if he has a wife, he shall not adopt except with the consent of his
wife, unless she has renounced the world or ceased to be a Hindu or has
been declared to be of unsound mind. If he has more than one wife, then
the consent of all wives is required.

The wife’s consent must be
obtained before the adoption and not after it. The proviso mandates the
consent as a condition precedent to adoption and hence subsequent
consent cannot validate the adoption.

In Kashibai W/O Lachiram
v. Parwatibai W/O Lachiram 1995 SCC (6) 213, has held that the wording
is mandatory and an adoption without wife’s consent would therefore be
void.

Now a Hindu can adopt a son or a daughter. Under the old
law, adoption of a daughter was invalid except where it was customarily
accepted among certain parts of India.

A female Hindu is capable of adopting a son or daughter:

 (a) if she is of sound mind;

(b) if she is a major, i.e., above 18 years of age;

 (c)
if she either is not married or her husband is dead or has been
declared of unsound mind or has renounced the world or has ceased to be a
Hindu or her marriage has been dissolved.

Thus, a Hindu married
woman whose husband does not suffer from any of the disabilities
specified above would not be able to adopt a child on her own even with
her husband’s consent. This is a unique position and a departure from
the earlier position under the uncodified Hindu Law. This principle has
also been laid down by the Bombay High Court in the case of Dasharath
Ramachandra Khairnar v Pandu Khairnar, (1977) 79 Bom LR 426.
The Court
held that elaborate provisions are made in the Act setting out
circumstances under which a wife could have a capacity to adopt and the
consent of the husband to enable the wife to adopt is not one of the
enabling circumstances under the provisions.

Capacity of adoptee

A person may be adopted if:

(a) he is a Hindu;

(b) he has not been already adopted;

(c) he has not been already married, unless a custom or usage permits married people to be adopted; and

(d)
he must be below 15 years of age, unless a custom or usage permits
persons above 15 years to be adopted. The above conditions equally apply
to females. One of the most relevant conditions to be borne in mind is
that the adoptee must be below 15 years of age.

Capacity of person giving in adoption

The person giving the child in adoption can do so if he fulfils the following conditions:

(a) Only the natural father or mother or the guardian of a child can give him in adoption.

(b) The natural guardian can give consent for adoption to any person including himself, under the following situations:

(i) the natural father and mother are dead, have renounced the world, abandoned the child, been declared of unsound mind, etc.;

(ii) the City Civil Court has granted permission for the same

(iii) before granting permission the Court will have to be satisfied about the welfare of the child and other factors.

Conditions for a valid adoption

The additional conditions for a valid adoption are as follows:

(i)
If the adoption is of a son/daughter, the adoptive father or mother by
whom the adoption is made must not have a Hindu son/daughter,
grandson/granddaughter or great grandson/ granddaughter (whether by
legitimate blood relationship or by adoption) living at the time of
adoption; (where there is a child, adoption cannot be done even with the
consent of the child.)

(ii) If the adoption is by a male and
the person to be adopted is a female, the adoptive father is at least 21
years older than the person adopted;

(iii) If the adoption is
by a female and the person to be adopted is a male, the adoptive mother
is at least 21 years older than the person to be adopted;

(iv) The same child may not be adopted simultaneously by two or more persons;

(v)    The child to be adopted must be actually given and taken in adoption by the parents or guardians concerned or under their authority with intent to transfer the child from the family of its birth or in the case of an abandoned child or a child whose parentage is not known, from the place or family where it has been brought up, to the family of its adoption.

Effect of adoption

From the date of adoption the child will be considered to be the natural child of the adoptive family and all the ties with the original family are severed. The three exceptions to this Rule are:

(i)    The child cannot marry any person whom he could not have married had he continued in the original family of his birth;

(ii)    The adopted child is not deprived of the estate vested in him or her prior to his/her adoption when he/she lived in his/her natural family, subject to any obligations arising from such vesting of the estate; and

(iii)    The adopted child shall not divest any persons in the adoptive family of any estate vested in that person prior to the date of adoption. For instance, a Hindu widow absolutely inherits property on her husband’s death. Thereafter, she adopts a son. He cannot challenge the alienation made by the widow on the grounds that now he has an interest in such property since the property had already vested in the widow and the adoption does not relate back — Joti v. Mankubai, AIR 1988 Bom. 348/ Banabai v. Wasudeo, (1980) 82 Bom. LR 388.

(iv)    A valid adoption by a Hindu female operates as a valid adoption even by her husband. The principle has been laid down in Sawan Ram v Kala Wanti, 1967 AIR 1761 (SC). The Supreme Court held that “it is well-recognized that, after a female is married, she belongs to the family of her husband. The child adopted by her must also, therefore, belong to the same family. On adoption by a widow, therefore, the adopted son is to be deemed to be a member of the family of the deceased husband of the widow. ………… thus, itself makes it clear that, on adoption by a Hindu female who has ‘been married, the adopted son will, in effect, be the adopted son of her husband also.”

A valid adoption once made cannot be cancelled by the adoptive father or mother or any other person. Further, the adopted child also cannot renounce his adopted parents and return back to his natural family. If the adoption process has been properly followed, the consequences of the same cannot be undone and then the motive of the adoption has no relevance — Devgonda Patil v. Shamgonda Patil, AIR 1992 Bom. 189.

In the case of Chandan Bilasini v. Aftabuddin Khan, (1996) 7 SCC 13, the legal effects of an adoption have been well summarised:

“Section 12 of the Hindu Adoptions and Maintenance Act clearly provides that an adopted child shall be deemed to be the child of his adoptive father or mother for all purposes with effect from the date of the adoption and from such date all ties of the child in the family of his or her birth shall be deemed to be severed and replaced by those created by the adoption in the adoptive family. As a consequence, when a widow adopts a child, the child not merely acquires an adoptive mother but also acquires other relationships in the adoptive family, unless there is anything to the contrary in the Hindu Adoptions and Maintenance Act.

This position is reinforced by section 14(4) which sets out that where a widow or an unmarried woman adopts a child, any husband whom she marries subsequently shall be deemed to be the step-father of the adopted child. In other words, the family relationship gets crystalised as at the date of adoption. The child will be deemed to be the child of the parent who adopts the child and the existing or deceased spouse of that parent (as the case may be), if any, will be considered the child’s father or mother. A spouse subsequently acquired by the adoptive parent becomes the step-parent of the adopted child. The adopted child, however, cannot divest any person of any property already vested in that person [section 12(c)].”

The Supreme Court in Smt. Sitabai v. Ramchandra, AIR 1970 SC 343, referred to the scheme of the Hindu Adoptions and Maintenance Act and held:

“………. the child adopted is tied with the relationship of sonship with the deceased husband of the widow. The other collateral relations of the husband would be connected with the child through that deceased husband of the widow. For instance, the husband’s brother would necessarily be the uncle of the adopted child. The daughter of the adoptive mother (and father) would necessarily be the sister of the adopted son, and in this way, the adopted son would become a member of the widow’s family, with the ties of relationship with the deceased husband of the widow as his adoptive father.”

The Act also empowers the adoptive parents to dispose of their property either by way of sale, gift, exchange, etc., or by way of a will. Thus, merely because they have made an adoption that by itself is no bar on them from disposing of their properties in any manner as they deem fit.

Adoption and other Acts

Under the Income-tax Act, 1961, the definition of a child expressly includes an adopted child. Hence, clubbing provisions applicable to a minor child would also apply to an adopted child. An interesting issue would arise u/s.56(2)(vii), viz. would a gift of money/ property received by an adopted child from his or her parents be exempt? Would an adopted child be a lineal descendant of an adoptive parent? The Andhra Pradesh High Court had an occasion to consider a similar issue in the context of the Estate Duty Act, 1953, in the case of Estate of Nuli Lakshminarayana, 116 ITR 739 (AP). The Court held that the expression ‘lineal descendant’ takes in an ‘adopted son’. It is submitted that the ratio of this decision should be extended to section 56(2)(vii) also.

Section 6 and Schedule IA to the Companies Act, 1956 define the term relatives. The Schedule states that the term ‘son’ includes a step-son. However, it is silent as to whether an adopted son is included. The Department of Company Affairs in a clarification given at a meeting with Chamber of Commerce has stated that on adoption a person cannot be regarded as a relative of the persons who are relatives in his natural family. A corollary to this should mean that an adopted son is a son for Schedule IA.

The Bombay Stamp Act, 1958 provides a concessional rate of stamp duty @ 2% in case of a gift to any lineal ascendant/descendant of the donor. Again the term ‘lineal ascendant/descendant’ has not been defined. It is submitted that reliance may be placed on the decision of the Andhra Pradesh High Court explained above for concessional duty in case of a gift to/by an adopted child.

The definition of the term ‘immediate relative’ in the SEBI (Issue of Capital & Disclosure Requirement) Regulations and the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 state that the term includes the child of a person. However, it does not expressly state whether an adopted child is included. It is submitted that in the light of the above discussion, an adopted child should also be treated as an immediate relative of a person.

How can a CA help?

Normally, an Auditor/CA is not directly involved with succession issues. Nevertheless, he can provide a lot of value -added services to his clients if he is aware of the law in this respect. Disputes on inheritance impact the operations of a corporation even in case of listed companies, especially, where an adopted child is to become the successor to the business/properties. A CA can be of great assistance to his clients in cases of such family feuds and on succession planning.

Remedies for breach of contract — Damages — Measure/quantification of damages — Contract Act 1872, sections 73 and 74.

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[ MSK Projects India (JV) Ltd. v. State of Rajasthan & Ors., (2011) 10 SCC 573]

The Public Works Department of the State of Rajasthan (‘PWD’) decided in September 1997 to construct the Bharatpur bye-pass for the road from Bharatpur to Mathura, which passed through a busy market of the city of Bharatpur. After having pre-bid conference/meeting and completing the required formalities, it was agreed between the tenderers and PWD that compensation would be worked out on the basis of investment made by the concerned entrepreneur. Concession agreement dated 19-8-1998 was entered into between the parties authorising collection of toll fee by MSK-Appellant. According to this agreement, period of concession had been 111 months including the period of construction. The said period was to end on 6-4-2008. The State issued Notification preventing the entry of vehicles into Bharatpur city stipulating its operation with effect from 1-10-2000. MSK-Appellant invoked arbitration clause raising the dispute with respect to delay in issuance of notification.

The Arbitral Award was made in favour of MSKAppellant, according to which there had been delay on the part of the State of Rajasthan in issuing the Notification and the State failed to implement the same and the contractor was entitled to collect toll fee even from the vehicles using Bharatpur-Deeg part of the road. The State of Rajasthan was directed to pay a sum of Rs. 990.52 lac to appellant as loss due up to 31-12- 2003 with 18% interest from 31-12-2003 onwards.

The District Judge set aside the award and held that appellant MSK was not entitled to any monetary compensation. The appeal was allowed by the Rajasthan High Court. The issue arose for consideration before the Supreme Court as to measure/quantification of damages. Damages was claimed for loss of expected profit. The Court observed that in common parlance, ‘reimbursement’ means and implies restoration of an equivalent for something paid or expended. Similarly, ‘compensation’ means anything given to make the equivalent.

 The Court further observed that while interpreting the provisions of section 73 of the Indian Contract Act, 1872, the Courts have held that damages can be claimed by a contractor where the government is proved to have committed breach by improperly rescinding the contract and for estimating the amount of damages, the Court should make a broad evaluation instead of going into minute details. It was specifically held that where in the works contract, the party entrusting the work committed breach of contract, the contractor is entitled to claim the damages for loss of profit which he expected to earn by undertaking the works contract. Claim of expected profits is legally admissible on proof of the breach of contract by the erring party. But that there shall be a reasonable expectation of profit is implicit in a works contract and its loss has to be compensated by way of damages if the other party to the contract is guilty of breach of contract. Section 74 emphasises that in case of breach of contract, the party complaining of the breach is entitled to receive reasonable compensation, whether or not actual loss is proved to have been caused by such breach.

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Partition — Right of pre-emption against stranger purchaser — Transfer of Property Act, Section 44.

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[ Bulu Sarkhel v. Kali Prasad Basu & Ors., AIR 2012 Calcutta 67 (High Court)]

One Shri Kali Prasad Basu and Shri Goutam Basu filed a title suit alleging that Manorama Bose, mother of present plaintiffs and defendants No. 1-4 was owner of a two-storeyed building and that on her death on 19th of October, 1974 the plaintiffs and defendant Nos. 1-4 inherited the said property each having 1/6th share in said undivided two-storeyed building having four flats, two in each row. It is stated that on 5th of September, 1976 the defendant No. 1 produced a typed paper for signature of other brothers and sisters for the proposal of construction of the said flat by the defendant No. 1 for accommodation of his family members. Other co-sharers signed in the said paper in good faith, but later on the defendant No. 1 illegally sold out the said flat to an outsider (defendant No. 5) though the said flat was an accretion to said joint property. The defendant No. 1 had no right to sell out a part of the joint dwelling house to a stranger (defendant No. 5) as there was oral agreement between the co-sharers that before selling to an outsider by a co-sharer, other cosharers should be approached first for purchase. Accordingly the plaintiffs filed suit for partition as well as for purchase of the flat sold to an outsider (defendant No. 5) by invoking section 4 of the Partition Act. The Trial Court decreed the suit and allowed the prayer of plaintiff and the defendant No. 2 for purchase of the property.

The Court observed that a mere assertion of a claim to a share without demanding separation and possession (by the outsider) is not enough to give other co-shares a right of pre-emption. In the case in hand admittedly the defendant No. 5 being stranger purchaser did not claim any partition. As such, section 4 of Partition Act had no application in the facts and circumstances of this case. It is true that the stranger purchaser (defendant No. 5) was put into possession of his vendor’s (defendant No. 1) flat since her purchase in 1990, and other co-sharers of the said dwelling house including the plaintiffs had a right to resist the said possession u/s.44 of the Transfer of Property Act, 1882. But that does not mean other co-sharers can exercise their right of pre-emption u/s.4 of the Property Act when the precondition of application of the said right as mentioned in the said Section was absent. The appeal filed by the defendant No. 5 (stranger purchaser) was allowed.

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