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S. 10B, as amended w.e.f. 1-4-2001 — Deduction to be computed w.r.t. profits of EOU unit after reducing losses of non-EOU units — Held, No

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43 2009 TIOL 53 ITAT Bang.

DCIT v. M/s Medreich Ltd.

ITA No. 632/Bang./2008

A.Y. : 2004-2005. Dated : 21-11-2008

Whether in view of the provisions of S. 10B, as amended
w.e.f. 1-4-2001, the deduction u/s.10B is to be computed with reference to
profits of EOU unit after reducing the losses of non-EOU units — Held, No.

Facts :

The assessee company, a 100% EOU, was engaged in the business
of manufacture of pharmaceutical products. The assessee company claimed
exemption u/s.10B of the Act in respect of export profits in the EOU Unit and
also the domestic profits thereon. The assessee had not claimed set-off of
business losses incurred in other units but carried them forward. The AO while
assessing the total income first set off the loss of non-EOU unit against the
entire profit of the EOU unit (domestic as well as export) and then allowed
deduction u/s.10B on the residue. As a result, the carried forward benefit
claimed by the assessee was not allowed. Aggrieved, the assessee preferred an
appeal to the CIT(A) who allowed the claim of the assessee by relying on the
decision of the Bangalore Tribunal in the case of M/s. Webspectrum Software Pvt.
Ltd. in which the Tribunal held that the deduction u/s.10A is to be allowed
without setting off brought forward and current year loss of non-10A unit.
Aggrieved, the Revenue preferred an appeal to the Tribunal.

Held :

The Tribunal did not find any infirmity in the order of the
CIT(A). It dismissed the appeal of the Revenue.

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Nirav Shah

S. 10A — Assessee owned two STP units — Whether deduction to be computed w.r.t. profits of one unit without setting off loss of other unit — Held, Yes. Whether deduction to be allowed w.r.t. profits and gains derived — Held, Yes. Whether order of CIT u/s.

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42 2009 TIOL 41 ITAT Bang.

Tata Consultancy Service Ltd. v. ACIT

ITA No. 590/Bang./2008

A.Y. : 2003-2004. Dated : 14-11-2008

S. 10A of the Income-tax Act, 1961 — A.Y. 2003-04 — Assessee
owned two STP units — During the assessment year STP Unit 1 earned profit and
STP Unit 2 suffered loss — Assessee computed deduction u/s.10A in respect of STP
Unit 1 with reference to its profits and without setting off the loss suffered
by STP Unit 2 — AO accepted the manner of computation adopted by the assessee —
CIT invoked S. 263 and directed AO to compute deduction u/s.10A in respect of
Unit 1 on the profits of Unit 1 after setting off loss of Unit 2 — Whether
deduction u/s.10A is to be computed with reference to profits of an undertaking
without setting off loss incurred by another eligible undertaking — Held, Yes.
Whether deduction u/s.10A is to be allowed with reference to profits and gains
derived by an undertaking — Held, Yes. Whether order of CIT u/s.263 needs to be
set aside — Held, Yes.

Facts :

The assessee company owned two STP units for export of
software. During the A.Y. 2003-04, STP Unit 1 earned profit, whereas STP Unit 2
suffered a loss. The assessee in its return of income claimed deduction u/s.10A
of the Act in respect of Unit 1. This deduction was computed with reference to
profits of Unit 1 without setting off the loss of STP Unit 2. No deduction
u/s.10A was claimed in respect of STP Unit 2.

The Assessing Officer (AO) while assessing the total income
of the assessee, accepted the manner of computation of deduction u/s.10A.

The CIT was of the opinion that deduction allowed u/s.10A in
respect of STP Unit 1 without setting off the loss of STP Unit 2 against income
of STP Unit 1 was not in accordance with law and that the order is prejudicial
to the interest of the Revenue. He accordingly directed the AO to modify the
order and allow deduction u/s.10A after setting off the loss from STP Unit 2
against the profit of STP Unit 1.

Aggrieved with the order of CIT u/s.263, the assessee
preferred an appeal to the Tribunal.

Held :

The Tribunal after considering various judicial precedents
and also the provisions of S. 10A(1), 10A(4), notes on clauses while introducing
amendment to S. 10A(4) by Finance Bill, 2001 held as under :

(1) In S. 10A(1), the word ‘an’ has been used before the
undertaking. Deduction is to be allowed on such profit and gains as are
derived from the undertaking. Hence, to apply the provisions of S. 10A, one
has to consider the profit and gains as derived by an undertaking. It does not
refer to profits and gains as are derived by the assessee. The assessee may be
having more than one undertaking.

(2) Deduction u/s.10A is to be computed on the basis of
profits and gains derived by an undertaking. In the instant case, STP Unit 2
was having a loss and therefore, its loss cannot be set off while ascertaining
the deduction u/s.10A for STP Unit 1.

(3) When the AO has taken one of the possible views, then
the order of the AO cannot be termed as erroneous and the CIT was having no
power to cancel that order u/s.263 of the Act.

The Tribunal cancelled the order passed by the CIT u/s.263 of
the Act. The assessee’s appeal was allowed.

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Nirav Shah

S. 143(2), S. 158BC, S. 292BB — For period prior to 1-4-2008 where notice not issued, whether block assessment order without jurisdiction — Held, Yes. Whether S. 292BB applicable to A.Y. 2008-09 and subsequent years — Held, Yes

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41 2009 TIOL 38 ITAT Del. SB

Kuber Tobacco Products (P) Ltd. v. DCIT

IT(SS)A No. 261/Del./2001

A.Ys. : 1-4-1988 to 25-1-1999. Dated : 14-1-2009

Income-tax Act, 1961 — S. 143(2), S. 158BC, S. 292BB — For a
period prior to 1-4-2008 where a notice u/s.143(2) of the Act is not issued, the
block assessment proceedings and consequential block assessment order can be
said to be without jurisdiction — Held, Yes. Whether S. 292BB is applicable to
A.Y. 2008-09 and subsequent years — Held, Yes.

Facts :

Search action u/s.132 of the Act was carried out in
the case of the assessee on 21-1-1999. The assessment order dated 29-1-2001
passed u/s.158BC of the Act was silent on the issue of notice u/s.143(2).
Neither before the Assessing Officer, nor before the CIT(A) did the assessee
contend that the assessment framed without issuance of notice u/s.143(2) was
invalid. The assessee in an additional ground before the Tribunal contended that
in the absence of issuance of mandatory legal notice u/s.143(2) of the Act the
block assessment proceedings and consequential block assessment order be held to
be without jurisdiction.

The Revenue raised a plea that in view of insertion of S.
292BB which is inserted by Finance Act, 2008 w.e.f. 1-4-2008, the assessee
cannot take the plea that assessment should be held invalid merely for the
reason that no notice u/s.143(2) was issued and the assessee is barred from
taking this plea.

In these circumstances, the question referred to the Special
Bench was whether the assessee who has participated in block assessment
proceedings is precluded from taking any objection that notice u/s.143(2) was
not served upon him or was not served upon him in time, in view of the
provisions of S. 292BB inserted by the Finance Act, 2008 w.e.f. 1-4-2008 and if
so, since when he can be said to be so precluded.

Held :

The Special Bench of the Tribunal held as follows :

(1) The scope of S. 292BB is that where any assessee has
appeared in any proceedings or has co-operated in any inquiry relating to
assessment or reassessment, then the consequences ensued will be that it will
be deemed that any notice under any provisions of the Act, which is required
to be served on an assessee has been duly served on him and it will further be
deemed to be served in time and in accordance with the provisions of the Act.
The assessee is debarred from taking the defence or raise any objection in any
proceedings or inquiry that the notice was :

(a) Not served upon him;

(b) Not served upon him in time; and

(c) Served upon him in any improper manner.

(2) The assessee has a right of being served with the
notice in case proceedings are taken against him and in case of invalid notice
the whole proceedings taken pursuant to that notice would be void ab initio
(subject to provisions of S. 292B) and will have no legal consequences. To
overcome some of the situations, S. 292BB has been brought on the statute as
explained in the Memorandum explaining the provisions as well as notes on
clauses.

(3) Applicability of S. 292BB is not strictly restricted to
issue of notice u/s.143(2), but it is in respect of other notices relating to
any provisions of the Act, which include notice to initiate re-assessment
proceedings and other proceedings also.

(4) Where the statute u/s.292BB deems service of notice, it
will always include issue of notice as service cannot be effected without
issuance thereof.

(5) Where procedural statute creates a new disability or
obligation and imposes new duties in respect of transactions already
accomplished, then the statute cannot be construed to have retrospective
effect. S. 292BB cannot be construed to have retrospective operation and it
has to be applied prospectively.

(6) S. 292BB is applicable to A.Y. 2008-09 and subsequent
years. The assessee is precluded from taking such objection for and from A.Y.
2008-09. Prior to 1-4-2008 i.e., up to 31-3-2008, as per S. 292BB, the
assessee is not precluded from taking any objection regarding invalidity of
assessment/reassessment on the ground of improper/invalid issuance/service of
a notice.

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Nirav Shah

Whether while computing book profit u/s. 115JB, lower of unabsorbed loss or depreciation as per profit and loss account of amalgamated company can be set off against profits of amalgamating company — Held, Yes.

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40 2009 TIOL 26 ITAT Bang.

VST Tillers & Tractors Ltd.
v. CIT

ITA No. 588/Bang./2008

A.Y. : 2003-2004. Dated : 21-11-2008

S. 115JB of the Income-tax Act, 1961 — A.Y. 2003-04 — Whether
while computing book profit u/s. 115JB of the Act lower of unabsorbed loss or
depreciation as per profit and loss account of the amalgamated company can be
set off against profits of an amalgamating company — Held, Yes.

Facts :

During the year ended 31-3-2003, V.S.T. Precision Components
Ltd. (‘VPCL’), a company which was subsidiary of the assessee company was
amalgamated with the assessee company. The amalgamation, approved by the
Karnataka High Court by its order dated 18th July 2003, was to be effective from
1-4-2002. The terms of amalgamation, as mentioned in paragraph 11 of the order
of the Court, inter alia stated that accumulated loss and depreciation of
VPCL shall be deemed to be the loss and depreciation of the assessee company as
provided u/s.72 of the Act.

The assessee returned an income of Rs. Nil after setting off
business loss and unabsorbed depreciation of VPCL. The assessee computed book
profit u/s.115JB by reducing from profit as per its profit & loss account the
brought forward loss as per profit & loss account of VPCL.

The book profit computed by the assessee was accepted by the
AO in the assessment u/s.143(3).

Subsequently, the CIT was of the opinion that since the
unabsorbed loss was not as per the books of account of the assessee company but
of VPCL, the same cannot be permitted to be reduced from the book profit for
purposes of S. 115JB. He, accordingly, directed the AO to modify the assessment
order by re-computing the tax liability u/s.115JB.

Aggrieved, the assessee preferred an appeal to the Tribunal.

Held :

The Tribunal noted that the effective date of amalgamation
was 1-4-2002. The Tribunal held that in view of the statutory provisions of S.
72A(1) and also the order of the High Court sanctioning the scheme, the
unabsorbed business loss and also unabsorbed depreciation of VPCL were deemed to
be loss and depreciation of the assessee company. U/s.115JB(2) lower of
unabsorbed loss or unabsorbed depreciation is to be set off against the book
profit. Since the unabsorbed loss of VPCL was lower than unabsorbed
depreciation, the assessee had rightly set off the unabsorbed loss against book
profit. The Tribunal held that the CIT was not correct in directing the AO to
compute book profit without setting off the unabsorbed loss of VPCL. The
Tribunal set aside the order of the CIT passed u/s.263 of the Act.

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Nirav Shah

Whether grant of excessive credit of TDS amounts to escapement of income — Held, No. Whether it can be construed as grant of excessive relief under sub-clause (iii) of Explanation 2(e) to S. 147 — Held, No

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39 2009 TIOL 01 ITAT Hyd.

GMR Projects Pvt. Ltd. v. ACIT

ITA No. 1014/Hyd./2007

A.Y. : 2000-2001. Dated : 26-9-2008

S. 147 of the Income-tax Act, 1961 — A.Y. 2000-01 — Whether
grant of excessive credit of TDS amounts to escapement of income — Held, No.
Whether grant of excessive credit of TDS can be construed as grant of excessive
relief under sub-clause (iii) of clause (c) of Explanation 2 to S. 147 of the
Act — Held, No.

Facts :

For A.Y. 2000-01 the assessee company filed its return of
income declaring total income of Rs.11,20,190. During the year under
consideration the assessee had in its profit & loss account admitted receipts of
Rs.3,33,87,112, but had claimed credit for TDS, amounting to Rs.56,30,970, in
respect of entire gross receipts of Rs.25,70,53,996. The Assessing Officer
completed the assessment u/s.143(3) of the Act assessing the total income to be
the same as returned income and granted credit of TDS amounting to Rs.56,27,970.

Subsequently, the AO initiated reassessment proceedings since
he was of the view that as per provisions of S. 199 of the Act credit should be
restricted to the extent of income admitted during the year. In the order passed
u/s.143(3) r.w. S. 147 of the Act, the AO restricted credit of TDS to
Rs.7,34,516.

In an appeal to the CIT(A) the assessee challenged the
reopening of assessment on the ground that grant of excessive credit of TDS
cannot be construed as escapement of income. The CIT(A) upheld the reopening and
held that grant of excess credit of TDS is a case of income being subjected to
excessive relief.

Aggrieved, the assessee preferred an appeal to the Tribunal,
wherein it challenged the reopening of the assessment.

Held :

The Tribunal noted that the words ‘income’ and ‘tax’ have
different connotations and are separately defined in the Act. The tax on income
is on the basis of charge prescribed in Chapter II of the Act. It further
observed that what needs to be assessed under the Act is the income earned by
the assessee. Chapter XIV of the Act prescribes the procedure for assessment.
Once the income is earned, returned and assessed, the collection and recovery of
tax start simultaneously at each stage as prescribed in Chapter XVII of the Act.
The Tribunal observed that as per the scheme of the Act, each stage is a
distinct stage, and each stage culminates into the next. In the present case,
the Tribunal noted that it was dealing with assessment stage.

The Tribunal observed that S. 147 is contained in Chapter XIV
of the Act and deals with income which has escaped assessment. It stated that
when one says that income has escaped assessment, it only means that such income
has escaped the tax net though it was taxable. According to the Tribunal,
granting of excess credit cannot be equated with income escaping assessment. By
granting excess credit everything revolves around correct collection and
recovery of tax. Nowhere income is in picture and if income is not in picture,
where is the question of its escapement ? The Tribunal held that the AO assumed
the jurisdiction wrongly when no income had escaped assessment.

As regards the provision of clause (c)(iii) of Explanation 2
to S. 147 of the Act, the Tribunal noted that the issue is squarely covered in
favour of the assessee by the decision of the Bombay High Court in the case of
Bombay Gas Co. Ltd.

The Tribunal quashed the order of reassessment.

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Nirav Shah

(a) Ss.(2) and (3) of S. 14A are procedural in nature and, hence, retrospective. (b) All direct and indirect expenses are disallowable u/s.14A, which have relation with income not chargeable to tax. (c) S. 14A applicable to dividend earned by assessee

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38 (2008) 26 SOT 603 (Mum.) (SB)

ITO v. Daga Capital Management (P.) Ltd.

ITA Nos. 8057 (Mum.) of 2003 and 183, 1372 and 2048 (Mum.)
of 2005

A.Ys. : 2001-02 and 2002-03. Dated : 20-10-2008

S. 14A of the Income-tax Act, 1961 :

(a) Expenses falling under any head or Section which
are otherwise deductible as business expenditure or under other respective
heads, would call for disallowance to the extent to which those expenses
have been incurred in relation to income exempt from tax.

(b) Ss.(2) and (3) of S. 14A are procedural in nature
and, hence, retrospective.

(c) For purpose of S. 14A what is relevant is to work
out expenditure in relation to exempt income and not to examine whether
expenditure incurred by assessee has resulted into exempt income or taxable
income.

(d) All direct and indirect expenses are disallowable
u/s.14A, which have any relation with income not chargeable to tax under the
Act.

(e) S. 14A would be applicable where shares are held
as stock-in-trade.

(f) Provisions of S. 14A would be applicable with
respect to dividend income earned by assessee engaged in business of dealing
in shares and securities on shares held as stock-in-trade when earning of
such dividend income was incidental to trading in shares.

The assessee-company was engaged in the business of dealing
in shares. For the relevant assessment year, the assessee had exempt dividend
income and, therefore, the Assessing Officer disallowed certain expenses in
terms of S. 14A. The CIT(A) upheld the disallowance.

The Special Bench also held in favour of the Revenue on all
the matters. The Special Bench observed as under :

1. S. 14A has an overriding effect over all other
Sections allowing deductions :

(a) The residence of this Section in the first
sub-chapter, viz., ‘Heads of income’, clearly demonstrates that it
has been made applicable to all the heads of income. If the intention of the
Legislature had been to restrict its application to the expenditure under
heads other than ‘business income’, then it would have been placed under the
relevant sub-chapter instead of the first sub-chapter, which, in turn,
refers to all the heads of income. Therefore, the expenses deductible under
the head ‘Business income’ are not immune from S. 14A.

(b) S. 14A is a special provision which deals with
disallowances of expenditure incurred by the assessee in relation to income
which does not form part of the total income under the Act. The expenses
falling under any head or Section which are otherwise deductible as business
expenditure or under other respective heads, would call for disallowance, in
view of the specific provision of S. 14A, to the extent to which those have
been incurred in relation to the income exempt from tax.

2. Ss.(2) and (3) of S. 14A are retrospective :

(a) In case of substantive provisions, the general rule
is that a provision is normally prospective in nature, unless it is given
retrospective operation expressly or can be so inferred by necessary
implication.

(b) However, in respect of
clarificatory/explanatory/procedural provisions, the date of insertion loses
its significance.

(c) S. 14A was inserted with a view to clarify the
intention of making disallowance in respect of ‘expenditure incurred by the
assessee in relation to income which does not form part of the total income
under this Act’. This Section declared the intention of the Act ‘since
inception’.

(d) When Ss.(1) itself is clarificatory and then
resultantly retrospective, it is beyond comprehension as to how Ss.(2) and
(3), providing the mechanism to do what is provided for in Ss.(1), can be
construed as substantive and, hence, prospective.

(e) A proviso has also been inserted in S. 14A for
reducing its rigor, which stipulates that no reassessment u/s.147 or
rectification u/s.154 shall be carried out by the Assessing Officer so as to
give effect to the newly inserted provision. That has been done so as not to
disturb the proceedings which have already attained finality in the period
prior to this insertion. However, assessments which are pending at any
stage, either before the Assessing Officer or the CIT(A) or the Tribunal or
the Higher Courts, would be governed by the mandate of that Section as it is
retroactive. From the above discussion, it is clear that Ss.(2) and (3) are
procedural in nature and, hence, retrospective.

3. Expenditure in relation to exempt income :

(a) The language of Ss.(1) of S. 14A clearly provides
that no deduction shall be allowed ‘in respect of expenditure incurred by
the assessee in relation to income which does not form part of the tot

Nirav Shah

(a) S. 48 — Option to avail benefit of indexation or not is with assessee. (b) S. 70 — Capital gain computed with indexation can be set off against capital gain computed without indexation.

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37 (2008) 26 SOT 380 (Mum.)

Mohanlal N. Shah HUF v. ACIT

ITA No. 789 (Mum.) of 2004

A.Y. : 2002-03. Dated : 24-9-2008

(a) S. 48 of the Income-tax Act, 1961 — Option to avail
or not to avail benefit of indexation is with the assessee.

(b) S. 70 of the Income-tax Act, 1961 — Capital loss
computed with indexation can be set off against capital gain computed without
indexation.

During the relevant assessment year, the assessee had sold
shares and units of mutual funds. In respect of shares sold, the assessee did
not claim benefit of indexation, but in respect of units sold of one mutual fund
the assessee opted for indexation. The resultant loss from the units was set off
against the gain from shares.

The Assessing Officer held that though the benefit of
indexation is a privilege allowed to the assessee as S. 48, the same could not
be availed of on a pick-and-choose basis; and that the option to offer capital
gain at the rate of 20% with indexation and at the rate of 10% without
indexation lies with the assessee as S. 112, but before that S. 70 comes into
appraisal and for setting off of any income under the same head it is but
natural that capital gain is to be calculated on the same footing. Therefore, he
disallowed the method adopted by the assessee. The CIT(A) also held against the
assessee.

The Tribunal, following the decision in the case of
Devinder Prakash Kalra v. ACIT, (2006) 151 Taxman 17 (Delhi), held in favour
of the assessee. The Tribunal noted as under :

(1) The computation of income from capital gains is
governed by S. 48. A plain reading of the said provision reveals that a
capital gain from each asset which is transferred has to be computed.
Indexation is allowable while computing the ‘capital gain’ from the transfer
of each long-term capital asset.

(2) As provided in S. 48, option is with the assessee to or
not to avail of benefit of indexation for computation of capital gains on
transfer of each of long-term capital assets.

(3) It is only after computing the capital gains as per S.
48, can it be aggregated by setting off the loss u/s.70 and it is then that
the rate of tax as provided u/s.112 is to be applied.

(4) The Delhi Bench of the Tribunal in the case of
Devinder Prakash Kalra v. ACIT, (2006) 151 Taxman 17 (Mag.), has held that
S. 112 is not only a beneficial provision, but is also mandatory provision and
if several transactions have taken place by way of sale of shares, the
assessee can avail of the benefit of indexation in a few transactions and
avail of 10% tax rate in the remaining transactions.

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Nirav Shah

S. 145A — If a change per se is forced upon assessee in valuation of closing stock, corresponding adjustment in opening stock to be carried out for consistency

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36 (2008) 26 SOT 141 (Mum.)

Dy. CIT v. Beck India Ltd.

ITA Nos. 383 and 483 (Mum.) of 2005

A.Y. : 2001-02. Dated : 11-9-2008

S. 145A of the Income-tax Act, 1961 — If on account of
application of S. 145A, a change per se is forced upon assessee in valuation of
its closing stock, a corresponding adjustment in opening stock has to be carried
out for consistency.

For the relevant assessment year, the Assessing Officer held
that the assessee was bound to follow the decision of the High Court in
Melmould Corpn. v. CIT, (1993) 202 ITR 789/71 Taxman 47 (Bom.) and that if a
change in method of accounting results in change in value of closing stock, no
corresponding adjustment would be required in opening stock, since such a change
would have the effect of disturbing the accounts leading to a chain reaction,
and, therefore, he added back MODVAT credit balance to closing stock of the
assessee. The CIT(A) directed the Assessing Officer to make corresponding
adjustments in the opening stock.

The Tribunal, relying on the decision in the case of CIT
v. Mahavir Aluminium Ltd., (2008) 297 ITR 77/ 168 Taxman 27 (Delhi), upheld
the CIT(A)’s order. The Tribunal noted as under :

1. S. 145A mentions ‘inventory’ and limiting it only to
‘closing inventory’, disregarding the opening inventory, would be not in
accordance with the plain meaning of the term ‘inventory’ used in the Section.
Inventory will necessarily include within its fold both opening as well as
closing.

2. In Melmould Corpn.’s case (supra), the assessee
had made a change in the method of valuation, which was not thrust upon the
assessee, but voluntarily selected by it. Such a change suo motu done
would definitely be different from one, which is statutory inflicted, where an
assessee per se is forced to make an adjustment to value of its
inventory.

3. However, when on account of application of S. 145A a
change per se is forced upon the assessee in the valuation of its
closing stock, a corresponding adjustment in opening stock has to be carried
out for consistency.

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Nirav Shah

S. 2(22)(e) — Amount given by company to director to purchase business premises, returned since deal could not materialise — Could not be treated as deemed dividend.

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35 (2008) 26 SOT 95 (Delhi)

Sunil Sethi v. Dy. CIT

ITA No. 2131 (Delhi) of 2007

A.Y. : 2004-05. Dated : 12-9-2008

S. 2(22)(e) of the Income-tax Act, 1961 — When amount was
given by company to its director for business purposes of company i.e., to
purchase business premises, and said amount was returned since the deal could
not materialise, such amount could not be treated as deemed dividend.

During the relevant year, the assessee, who was a director in
a company and was holding 50% of the share capital of the Company, had received
Rs.30 lacs from the Company by way of an imprest to enable him to make the
payment for a proposed office complex and as the deal could not materialise, the
same was returned to the company. The Assessing Officer and the CIT(A) held such
amount as deemed dividend.

The Tribunal, following the decision in the case of Dy.
CIT v. Lakra Bros., (2007) 162 Taxman 170 (Chd.)(Mag.), held that provisions
of S. 2(22)(e) were not applicable in the assessee’s case. The Tribunal noted as
under :

1. A sum of Rs.30 lacs was given to him for the purpose of
making advance with respect to certain land dealings which were proposed to be
entered into by the company through the assessee. The assessee was a director
in the company and could lawfully execute certain agreements on behalf of the
company. Such payment was made in pursuance of a resolution passed by the
company.

2. It was not the case of the Revenue that such resolution
did not happen or it was an afterthought story. No material had been brought
on record to suggest that what was explained by the assessee was incorrect.
The sum had been treated as deemed dividend simply for the reason that it was
given to the assessee.

3. The transaction was in the ordinary course of the
business of the company, and there was no intention on the part of the company
to give a loan or advance to the assessee for his individual benefit.

4. It had been demonstrated that in the bank account of the
assessee, in which the said amount of Rs.30 lacs was credited, was always
having balance of more than Rs.30 lacs. So even for a short period the
assessee had not derived any benefit or it could not be said that the said
amount was given to the assessee by the company for his individual benefit.
The amount was lying in the bank account of the assessee, which was not
utilised at all for any purpose.

5. The amount was paid for a very short period for a
specific purpose and there was documentary evidence on record to substantiate
the explanation of the assessee that the amount was given for the business
purposes of the company.

Thus, the said amount could not be treated as deemed dividend
in the hands of the assessee.

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Nirav Shah

S. 254(1) — Oral pronouncement during hearing not order; Tribunal has power to refix cases to prevent miscarriage of justice — Only condition is aggrieved party must get opportunity of hearing.

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34 (2008) 119 TTJ 501 (Mumbai)

Mafatlal Securities Ltd. v. Jt. CIT

ITA No. 1127 (Mum.) of 2001

A.Y. : 1996-97. Dated : 10-8-2007

S. 254(1) of the Income-tax Act, 1961 — Oral pronouncement
during the course of hearing is not an order at all; even otherwise, Tribunal
has inherent power to refix the cases to prevent miscarriage of justice or to
grant substantial justice, and the only condition which is required to be
satisfied is that the aggrieved party must be given an opportunity of hearing.

In the course of original hearing, the learned counsel for
the assessee stated that the facts of this case were identical to the facts of
another case decided by this Tribunal, wherein the Tribunal had decided in
favour of the assessee. Hence, the case was heard mainly as a covered case and
the result was pronounced during the course of the hearing itself.

Thereafter, during the course of further study of the files,
the Bench thought that certain observations in the decisions in two cases of
Mumbai Benches were relevant. Hence, the case was released for fresh hearing as
a part heard case so as to confront these two decisions to the assessee. The
learned counsel took a preliminary objection that the Tribunal had pronounced
the order, hence, if any decision was taken contrary to the decision pronounced,
it would amount to review of order and which was beyond its powers. The learned
Departmental Representative supported the approach of the Tribunal where an
adequate opportunity of hearing was given to the assessee before taking any
other view in the matter.

The Tribunal, relying on the decision of the Supreme Court in
the case of ITAT v. V. K. Agarwal, (1998) 150 CTR 513 (SC)/(1998) 101
Taxman 382 (SC), held that unless the order of the Bench was signed by all the
members of the Bench and was dated, it was not an order of the Tribunal. The
Tribunal noted as under :

1. Legally speaking, oral pronouncement during the course
of hearing is not an order at all. It is only an intimation of likely result
or prima facie conclusion expressed on the basis of the contentions
made by the parties. It is only a procedural aspect and it does not create any
statutory embargo or limitation.

2. No party can proceed further unless it receives an order
in writing and in the case of orders passed by the Tribunal, the limitation
also starts from the date when the order is served. Hence, oral pronouncement
does not give any inherent right or create any limitation with regard to
statutory rights of the parties to the disputes.

3. Even an entry to this effect, in the order sheet signed
by the Members of the Bench would not constitute an order within the meaning
of r. 34 of the ITAT Rules.

4. Even if it is presumed that oral pronouncement during
the course of hearing is an order, then the Tribunal being a Court of plenary
jurisdiction is well within its powers within the meaning of S. 254(1) to
refix it for clarifications before passing an order in writing. The Tribunal
has inherent power to refix the cases in such type of situations to prevent
miscarriage of justice or to grant substantial justice. The only condition
which is required to be satisfied is that the aggrieved party must be given an
opportunity of hearing which has been done in this case.

5. Similarly, the Tribunal before passing a written order
can refix the case suo motu for clarifications so as to appraise the
issue afresh in the light of other facts or material. There is nothing wrong
in it because principles of natural justice are equally applicable to judicial
authorities as these are applicable to the parties to the disputes.

6. Though the Tribunal is not akin to a Court but the
functions discharged by it are similar to a Court, hence, in addition to its
expressed statutory powers, it has got inherent power to pass such orders as
may be necessary for the ends of justice.

The following cases were also relied on by the Tribunal :

1. Oriental Building & Furnishing Co. v. CIT, (1952)
21 ITR 105 (Punj.)

2. Singar Singh & Sons v. CIT, (1965) 58 ITR 626
(All.)

3. CIT v. Dr. T. K. Jairaj, (2002) 172 CTR (Ker.)
584; (2002) 256 ITR 252 (Ker.)

4. Khushalchand B. Daga v. T. K. Surendran, ITO
(1972) 85 ITR 48 (Bom.)

Note : Similar decision was taken by the Pune Tribunal in
the case of CIT v. Jinendra Smelting & Rolling Mills, Misc. Application
No. 65/Pn/2007 in ITA No. 539 (Pn) 2006 reported in 119 TTJ 519.

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Nirav Shah

S. 254(1) — If decision not relied upon by parties at hearing and Bench desires to apply ratio of such decision, natural justice demands that Bench should confront parties with decision and should give opportunity to make submissions w.r.t. such decisio

New Page 1

33 (2008) 119 TTJ 433 (Jab.) (TM)

Vindhya Telelink Ltd. v. Jt. CIT

ITA No. 295 (Jab.) of 2000 and

C.O. No. 19 (Jab.) of 2002

A.Ys. : 1997-98 and 1998-99. Dated : 22-8-2008

S. 254(1) of the Income-tax Act, 1961 — If any decision is
not relied upon by the parties at the time of hearing and the Bench desires to
apply the ratio of such decision, natural justice demands that the Bench should
confront the parties with such decision and should give an opportunity to them
so that they can make their submissions with reference to such decision.

For the relevant assessment years, the Assessing Officer
disallowed 50% of the expenditure claimed by the assessee assuming that
expenditure towards foreign travel was attributable to the wife of the managing
director, who accompanied him during such visits. The CIT(A) allowed the relief
following the decision of the Kerala High Court in the case of Appollo Tyres
Ltd. [CIT v. Appollo Tyres Ltd., (1998) 149 CTR 538 (Ker.)/(1999) 237 ITR
706 (Ker.)]. The learned AM upheld the order of the CIT(A) following the same
decision of the Kerala High Court. However, the learned JM reversed the order of
the CIT(A) following various other decisions. It was contended by the assessee’s
learned counsel before the TM that the learned JM has referred to such decisions
which were not relied upon or argued on behalf of the Department.

The Third Member noted as under :

1. If any decision is not relied upon by the parties at the
time of hearing and the Bench desires to apply the ratio of such decision,
natural justice demands that the Bench should confront the parties with such
decision and should give an opportunity to them so that they can make their
submissions with reference to such decision. Admittedly, in this case this has
not been done by the Bench.

2. Therefore, since the decisions were not referred to by
any of the parties at the time of hearing, the learned JM was not justified in
relying upon the same while deciding the issue under consideration.

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Nirav Shah

Income limits for assigning cases to Deputy Commissioners/Assistant Commissioners, Income-tax officers increased, applicable with effect from 1-4-2011 — Instruction No. 1/2011, dated 31-1-2011.

New Page 2

Full texts of
relevant Notifications, Circulars and Forms are available on the BCAS website :
www.bcasonline.org

68 Income limits for assigning cases to Deputy
Commissioners/Assistant Commissioners, Income-tax officers increased, applicable
with effect from 1-4-2011 — Instruction No. 1/2011, dated 31-1-2011.

Metros charges for the
above purpose would be Ahmedabad, Bangalore, Chennai, Delhi, Kolkata,
Hyderabad, Mumbai and Pune.

Nirav Shah

Instruction No. 3/2011 (F. No. 279/MISC. 142/2007-ITJ) dated 9-2-2011 — Appeals and Revision of monetary limits for filing of appeals by the Department before Income-tax Appellate Tribunal, High Courts and Supreme Court — Section 268A of the Income-tax Ac

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Full texts of
relevant Notifications, Circulars and Forms are available on the BCAS website :
www.bcasonline.org

67 Instruction No. 3/2011 (F. No. 279/MISC. 142/2007-ITJ)
dated 9-2-2011 — Appeals and Revision of monetary limits for filing of appeals
by the Department before Income-tax Appellate Tribunal, High Courts and Supreme
Court — Section 268A of the Income-tax Act, 1961 — Measures for reducing
litigation (reproduced)

Reference is Invited to Board’s instruction No. 5/2008, dated
15-5-2008 wherein monetary limits and other conditions for filing Departmental
appeals (in income-tax matters) before the Appellate Tribunal, High Courts and
Supreme Court were specified.

2. In supersession of the above instruction, it has been
decided by the Board that Departmental appeals may be filed on merits before the
Appellate Tribunal, High Courts and Supreme Court keeping in view the monetary
limits and conditions specified below.

3. Henceforth appeals shall not be filed in cases where the
tax effect does not exceed the monetary limits given hereunder :

Sr. No.	Appeals in income-tax matters	Monetary limit (in Rs.)
1.	Appeal before Appellate Tribunal	3,00,000
2.	Appeal u/s.260A before High Court	10,00,000
3.	Appeal before Supreme Court	25,00,000

It is clarified that an appeal should not be filed merely
because the tax effect in a case exceeds the monetary limits prescribed above.
Filing of appeal in such cases is to be decided on merits of the case.

4. For this purpose, ‘tax effect’ means the difference
between the tax on the total income assessed and the tax that would have been
chargeable had such total income been reduced by the amount of income in respect
of the issues against which appeal is intended to be filed (hereinafter referred
to as ‘disputed issues’). However, the tax will not include any interest
thereon, except where chargeability of interest itself is in dispute. In case
the chargeability of interest is the issue under dispute, the amount of interest
shall be the tax effect. In cases where returned loss is reduced or assessed as
income, the tax effect would include notional tax on disputed additions. In case
of penalty orders, the tax effect will mean quantum of penalty deleted or
reduced in the order to be appealed against.

5. The Assessing Officer shall calculate the tax effect
separately for every assessment year in respect of the disputed issues in the
case of every assessee. If, in the case of an assessee, the disputed issues
arise in more than one assessment year, appeal can be filed in respect of such
assessment year or years in which the tax effect in respect of the disputed
issues exceeds the monetary limit specified in paragraph 3. No appeal shall be
filed in respect of an assessment year or years in which the tax effect is less
than the monetary limit specified in paragraph 3. In other words, henceforth,
appeals can be filed only with reference to the tax effect in the relevant
assessment year. However, in case of a composite order of any High Court or
Appellate Authority, which involves more than one assessment year and common
issues in more than one assessment year, appeal shall be filed in respect of all
such assessment years even if the ‘tax effect’ is less than the prescribed
monetary limits in any of the year(s), if it is decided to file appeal in
respect of the year(s) in which ‘tax effect’ exceeds the monetary limit
prescribed. In case where a composite order/judgment involves more than one
assessee, each assessee shall be dealt with separately.

6. In a case where an appeal before a Tribunal or a Court is
not filed only on account of the tax effect being less than the monetary limit
specified above, the Commissioner of the Income Tax shall specifically record
that “even though the decision is not acceptable, appeal is not being filed only
on the consideration that the tax effect is less than the monetary limit
specified in this instruction”. Further, in such cases, there will be no
presumption that the Income Tax Department has acquiesced in the decision on the
disputed issues. The Income Tax Department shall not be precluded from filing an
appeal against the disputed issues in the case of the same assessee for any
other assessment year, or in the case of any other assessee for the same or any
other assessment year, if the tax effect exceeds the specified monetary limits.

7. In the past, a number of instances have come to the notice
of the Board, whereby an assessee has claimed relief from the Tribunal or the
Court only on the ground that the Department has implicitly accepted the
decision of the Tribunal or Court in the case of the assessee for any other
assessment year or in the case of any other assessee for the same or any other
assessment year, by not filing an appeal on the same disputed issues. The
Departmental representatives/counsels must make every effort to bring to the
notice of the Tribunal or the Court that the appeal in such cases was not filed
or not admitted only for the reason of the tax effect being less than the
specified monetary limit and, therefore, no inference should be drawn that the
decisions rendered therein were acceptable to the Department. Accordingly, they
should impress upon the Tribunal or the Court that such cases do not have any
precedent value. As the evidence of not filing appeal due to this instruction
may have to be produced in Courts, the judicial folders in the office of CsIT
must be maintained in a systemic manner for easy retrieval.

8. Adverse judgments relating to the following issues should
be contested on merits notwithstanding that the tax effect entailed is less than
the monetary limits specified in paragraph 3 above or there is no tax effect:

a) Where the Constitutional validity of the provi-sions of an Act or Rule are under challenge, or

b) Where Board’s order, Notification, Instruction or Circular has been held to be illegal or ultra vires, or
c) Where Revenue Audit objection in the case has been accepted by the Department.

9. The proposal for filing Special Leave Petition under Article 136 of the Constitution before the Supreme Court should, in all cases, be sent to the Directorate of Income-tax (Legal & Research), New Delhi and the decision to file Special Leave Petition shall be in consultation with the Ministry of Law and Justice.

10. The monetary limits specified in paragraph 3 above shall not apply to writ matters and direct tax matters other than Income-tax, filing of appeals in other direct tax matters shall continue to be governed by relevant provisions of the statute and rules. Further, filing of appeal in cases of Income-tax, where the tax effect is not quantifiable or not involved, such as the case of registration of trusts or institutions u/s.12A of the Income-tax Act, 1961, shall not be governed by the limits specified in para 3 above and decision to file appeal in such cases may be taken on merits of a particular case.

This instruction will apply to appeals filed on or after?………?2011*. However, the cases where appeals have been filed before?…….?2011* will be governed by the instructions on this subject, operative at the time when such appeal was filed.

This issues u/s.268A(1) of the Income-tax Act,1961.

*As clarified subsequently, these instructions will apply to appeals filed on or after 9th February, 2011.

Nirav Shah

Instructions No. 2/2011 (F.No. 225/25/2010/ITA-II), dated 9-2-2011 — Processing of returns of A.Y. 2010-11 — Section 143 of the Income-tax Act, 1961 — Steps to —(reproduced)

New Page 2

Full texts of
relevant Notifications, Circulars and Forms are available on the BCAS website :
www.bcasonline.org

66 Instructions No. 2/2011 (F.No. 225/25/2010/ITA-II), dated
9-2-2011 — Processing of returns of A.Y. 2010-11 — Section 143 of the Income-tax
Act, 1961 — Steps to —
(reproduced)

The issue of processing of returns for A.Y. 2010-11 and
giving credit for TDS has been considered by the Board. In order to clear the
backlog of returns, the following decisions have been taken :

(i) In all returns (ITR-1 to ITR-6), where the difference
between the TDS claim and matching TDS amount reported in AS-26 data does not
exceed Rs.1 lakh, the TDS claim may be accepted without verification.

(ii) Where there is zero TDS matching, TDS credit shall be
allowed only after due verification. However, in case of returns of ITR-1 and
ITR-2, credit may be allowed in full, even if there is zero matching, if the
total TDS claimed is Rs. five thousand or lower.

(iii) Where there are TDS claims with invalid TAN, TDS
credit for such claims is not to be allowed.

(iv) In all other cases TDS credit shall be allowed after
due verification.

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Nirav Shah

Press Release : Central Board of Direct Taxes — No. 402/92/2006-MC (04 of 2011), dated 12-2-2011.

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Full texts of
relevant Notifications, Circulars and Forms are available on the BCAS website :
www.bcasonline.org

65 Press Release : Central Board of Direct Taxes — No.
402/92/2006-MC (04 of 2011), dated 12-2-2011.

India has entered into a Tax Information Exchange Agreement
(TIEA) with the Bahamas for sharing information, including exchange of banking
and ownership information. The Agreement was signed on 11th February 2011.

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Nirav Shah

CBDT Instructions No. F. No. 225/25/2010/ITA.II, dated 10-2-2010 regarding extension of time limit for filing ITR-V forms

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Full texts of
relevant Notifications, Circulars and Forms are available on the BCAS website :
www.bcasonline.org

64 CBDT Instructions No. F. No. 225/25/2010/ITA.II, dated
10-2-2010 regarding extension of time limit for filing ITR-V forms.

CBDT has extended the time limit for filing ITR-V forms
relating to income-tax returns for A.Y. 2010-11 filed electronically (without
digital signature) on or after 1st April, 2010. These ITR-V forms can now be
filed up to 31st July, 2011 or within a period of 120 days from the date of
uploading of the electronic return data, whichever is later.

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Nirav Shah

Set-off on Import Licences, etc. — Notification No. VAT.1510/CR.109-A/Taxation-1, dated 20-12-2010.

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Part B : INDIRECT TAXES

74 Set-off on Import Licences, etc. — Notification No.
VAT.1510/CR.109-A/Taxation-1, dated 20-12-2010.

Rule 54(f)(i) has been amended and set-off has been allowed
on Import Licences including Special Import Licences, Duty-Free Advance Licences
and any other Scrips issued under the Foreign Trade Policy, from time to time
under the Foreign Trade Development & Regulation Act, 1992 described in Entry 3
and on Export Permit or licence or quota described in Entry 4 of Notification
under Schedule Entry C-39.

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Nirav Shah

Schedule Entry C-39 to include import licences — Notification No. VAT.1510/CR.109/Taxation-1, dated 20-12-2010.

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Part B : INDIRECT TAXES

73 Schedule Entry C-39 to include import licences —
Notification No. VAT.1510/CR.109/Taxation-1, dated 20-12-2010.

Vide this Notification, Notified List in Schedule Entry C-39
for goods of incorporeal nature or intangible character, has been amended. Entry
3 has been substituted by Import Licences including Special Import Licence,
Duty-Free Advance Licence and any other Scrips issued under the Foreign Trade
Policy, from time to time under the Foreign Trade Development & Regulation Act,
1992. Entry No. 6 for credit of Duty Entitlement Pass Book, Entry No. 13 for
credit of Duty-Free Replenishment Certificate and Entry No. 14 for credits of
Duty Free Import Authorisation (DFIA) have been deleted w.e.f. 1-1-2011.

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Nirav Shah

E-payment — Notification No. VAT.1510/CR.165/Taxation-1, dated 20-12-2010.

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Part B : INDIRECT TAXES

72 E-payment — Notification No. VAT.1510/CR.165/Taxation-1,
dated 20-12-2010.

Every registered dealer liable to file six-monthly returns
shall make payment electronically w.e.f. 31-3-2011 under the MVAT Act, 2002.

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Nirav Shah

Due date for submission of Audit Report for 2009-10 extended — Trade Circular 3T of 2011, dated 31-1-2011.

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Part B : INDIRECT TAXES

MVAT UPDATE

71 Due date for submission of Audit Report for 2009-10
extended — Trade Circular 3T of 2011, dated 31-1-2011.

Due date for submission of MVAT Audit Report in Form 704 for
the period 2009-10 has been extended from 31st January, 2011 to 15th February,
2011 and due date for statement of submission of audit report in Form 704 along
with required documents would be 25th February, 2011.

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Nirav Shah

Fumigation of Export Cargo not a taxable service — Circular No. 132/1/2011-ST, dated 12-1-2011

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Part B : INDIRECT TAXES

70 Fumigation of Export Cargo not a taxable service —
Circular No. 132/1/2011-ST, dated 12-1-2011.

By this Circular, it has been clarified that Fumigation of
Export cargo is not a taxable service under ‘Cleaning Service’ as this service
does not satisfy the statutory definition of ‘Cleaning Activity’ u/s.65(24b).
Further this exclusion is also substantiated by earlier Notification No.
41/2007-ST, dated 6th October 2007 as amended by Notification No. 42/2007, dated
29th November 2007.

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Nirav Shah

Janata Personal Accident Policy not liable to service tax — Circular No. 133/2/2011-ST, dated 18-1-2011

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Part B : INDIRECT TAXES

SERVICE TAX UPDATE

69 Janata Personal Accident Policy not liable to service tax
— Circular No. 133/2/2011-ST, dated 18-1-2011.

By this Circular it has been clarified that the Janata
Personal Accident Policy is exempt from service tax as this is customised group
insurance scheme floated as per the specifications of State Government to extend
risk cover to target population and to fulfil rural or social sector obligations
prescribed by IRDA.

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Nirav Shah

Clarification by CBDT that filing of an application to the Dispute Resolution Panel is optional (reproduced hereunder for ease of reference)

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42 Clarification by CBDT that filing of an application to the
Dispute Resolution Panel is optional (reproduced hereunder for ease of
reference)

F. No. 142/22/2009-TPL (Pt. II)

20th January 2010

The Director General of Income-tax (International Taxation),

Room No. 406, Drum Shape Building,

I. P. Estate, Delhi.

Subject:

Clarification regarding
filing of Objections before Dispute Resolution Panel (DRP) – reg

A new section 144C was inserted in the Income-tax Act, 1961
vide Finance (No. 2) Act of 2009. Section 144C provides for constitution of a
Dispute Resolution Panel (DRP) to decide cases of an eligible assessee as
defined in sub-section (15) of section 144C of the Income-tax Act. The Dispute
Resolution Panel Rules were notified vide SO No. 2958 (E) dated 20th November
2009.

2. A query has been raised as to whether it is compulsory for
an assessee to file an objection before the DRP or whether he can choose to file
an appeal through the normal appellate channel of CIT (Appeals).

3. The provisions from sub-section (2) to sub-section (5) of
section 144C are quite clear that a choice has been given to the assessee either
to go before the DRP or to prefer the normal appellate channel. It is again
clarified that it is the choice of the assessee whether to file an objection
before the Dispute Resolution panel against the draft assessment order or not to
exercise this option and file an appeal later before CIT (Appeals) against the
assessment order passed by the Assessing Officer.

4. This position may also be brought to the notice of
taxpayers at large.

C. S. Kahlon,
Member (L&C).

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Nirav Shah

IS IT FAIR TO DENY REGISTRATION U/S.12AA TO CHARITABLE TRUSTS ON FLIMSY GROUNDS ?

Is It Fair

Introduction :

Under the Income-tax Act, 1961 (the Act), charitable trusts
are eligible for exemption from tax liability in terms of section 10 and section
11 to section 13. One of the pre-conditions for section 11 to
section 13 is that it should obtain registration from the Commissioner of
Income-tax u/s.12AA. Of late, there is a tendency in the Income Tax Department
to create hurdles in availing any exemption or other tax reliefs. e.g.,
exemptions/deductions u/s.10A, u/s.10B, u/s.80IA, u/s.80IB, etc. Truly speaking,
registration u/s.12AA in itself does not grant exemption. It is only a basic
procedural requirement. Yet, it is experienced that obtaining the registration
has become a task in itself.

Grounds for rejection :

The objections being currently raised by the CITs are
difficult to comprehend, let alone justify. Some of the objections raised are
discussed below:

It is common that people settled in Mumbai, hailing from a
common village place have an affinity towards their native place. They may want
to set up a school or a hospital in that village. The source of funds is
obviously in cities like Mumbai. It is convenient to register and administer the
trust in Mumbai although the actual activity i.e., construction of
school/hospital, etc., is at a distant place.

The CIT’s objection is, how can be monitor the activity !
Needless to state that the Charity Commissioner has registered the trust with
the complete information on the record. Strictly speaking, the Charity
Commissioner is the regulating authority. How is the CIT concerned with
subsequent regulation/monitoring? Ultimately, the Department will always be in
a position to examine the accounts and records.

In this regard, reference can be drawn to the Karnataka High
Court decision in the case of DIT v. Garden City Education Trust, (191
Taxman 238) wherein it was held that at the time of granting registration, the
CIT is not concerned with the manner of application of funds. He is only required to examine the nature and objects of
the trust as deduced in the trust deed. The question of application of funds is
to be decided by the AO while granting exemption u/s.11.

Sometimes, the CIT refuses to register the trust unless there
is some activity! It is like a chicken and egg syndrome.

One of the objections was as to what is the evidence that it
is meant truly for the public ? i.e., how the activities are publicised ?

Another common question is how will the multiple objects of
the trust be achieved with a meagre initial corpus ! The explanation is quite
obvious. The institution first gets registered with a small amount. After it
obtains approval u/s.80G, only then the donations would flow in.

Possible reasons for negative attitude :

I visualise the following probable reasons :

(a) First and foremost, the typical bureaucratic attitude
is negative thinking.

(b) Ego or other interests.

(d) Fear that good and positive attitude may be
misconstrued in the Department itself.

(e) Genuine experience about misuse of exemptions and
concessions. This gives rise to prejudices.

(f) Since the requirement of renewal of approval u/s.80G
has been done away with, extra caution while granting it for the first time.

Conclusion :

Instructions may be issued for a soft and liberal approach.
It may be noted that the Special Bench (Delhi) in the case of Bhagwad Swarup
Shri Shri Devraha Baba Memorial Shri Hari Parmarth Dham Trust v. CIT, has
held that in a case where the CIT does not pass the order granting or refusing
registration of trust within the period laid down in section 12AA(2)
registration would be deemed to have been granted to the trust or institution
automatically on expiry of the period specified in section 12AA(2) of the Act.

Returns for first two to three years may be scrutinised to ensure that the
functioning is on a desired track.

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Nirav Shah

Is it fair to deny TDS credit on account of mismatch of data?

Is It Fair

Introduction:

The Income Tax Department is undergoing computerisation with
an undue haste and in the process creating chaotic situations for honest
taxpayers. Initially, with effect from 1st April, 2005 the transition from
manual to computerised system was planned with respect to TDS credit. The
Finance (No.2) Act, 2004 had amended the provisions to dispense with the
requirement of issuing TDS certificates by the deductors, the requirement of
submitting TDS certificates along with returns, and provide for the issuance of
Annual Tax Statement (Form 26AS), etc. Then, the implementation of these
proposals was postponed, the last postponement being made to 1st April, 2010 by
the Finance Act, 2008 — for the reason that the information technology
infrastructure of the Income-tax Department was not yet operational at the
national level. Therefore, at the time when the Finance Bill, 2008 was presented
before parliament, it was hoped that the department would be able to make its
information technology infrastructure ready by 1st April, 2010. However,
immediately thereafter, Rule 37BA was introduced with effect from 1st April,
2009 to provide that TDS credit shall be given on the basis of information
relating to deduction of tax furnished by the deductor. Therefore, it seems that
by virtue of some miracle what could not be achieved in spite of the combined
efforts of more than four years, has been achieved in just one year! The
implementation, therefore, has now been preponed by one year in an indirect
form.

The unfairness

In almost all the cases, while processing returns u/s.
143(1), for A.Y. 2007-08 & 2008-09, TDS credit has been denied either in part or
in full for the assumed reason that the information furnished by the assessee is
not matching with the information available with the department.

First of all, it needs to be examined whether the Assessing
Officer has a power to deny credit of TDS for such a reason, particularly for
A.Y. 2007-08 & 2008-09. Section 199, as it existed prior to its substitution by
the Finance Act 2008 with effect from 1st April 2008, provides for the credit of
TDS on the basis of production of the TDS certificate. Credit for TDS on the
basis of Annual Tax Statement in Form 26AS was only for the deduction of TDS
made on or after 1st April, 2008. Therefore, for A.Y. 2007-08 & 2008-09, TDS
credit should have been granted on the production of TDS certificates.

Although it was mandatory on the part of the assessee to
attach proof of TDS claim along with the return, as per provisions of
Explanation to Section 139(9), Rule 12(2) read with section 139C, has
specifically exempted assessees from submitting proof of TDS claimed along with
the return. However, it was required to be produced before the Assessing Officer
if demanded, as specifically spelt out in section 139C.

Therefore, if at all TDS credit was not matching with the
data available with the department, it was obligatory on the part of the
Assessing Officer to call for the proof of the TDS claim in the form of a TDS
certificate, and to allow the credit if the claim was found to be proper. This
view is further supported by Instruction No.6/2008, dated 18th June, 2008
whereby Assessing Officers were instructed that where the aggregate TDS claim
does not exceed Rs 5 lakh, and where the refund computed does not exceed Rs
25,000, the TDS claim of the taxpayer should be accepted at the time of
processing of returns; and in all remaining returns, the Assessing Officer shall
verify the TDS claim from the deductor or assessee, as the case may be, before
processing the return (Instruction was applicable for A.Y. 2007-08).

Without considering the legal position, the Assessing
Officers have resorted to denial of TDS credit wherever there was a mismatch and
that too even without explaining as to which TDS claim is not matching as per
their database!

The problem will be further aggravated for A.Y. 2009-10 and
subsequent years where the new section 199, read with Rule 37BA, will empower
Assessing Officers to deny credit wherever there is mismatch. Even without any
mistake on the part of the assessee, the credit will be denied — may be due to
some error on the part of the deductors in filing the relevant statements or on
the part of the banks in uploading the information on the challans.

There are many practical issues other than those caused by
the errors of the deductors or banks, which the department is not geared up yet
to tackle. For example, it has been experienced that the department has sent TDS
data verification report by email to the e-filer of the returns of A.Y. 2009-10
in which the credit has not been granted even on account of the differences in
Assessment Year, i.e., if the assessee has claimed the TDS credit pertaining to
an earlier Assessment Year on account of his cash system of accounting, the
difference has been reported to that extent in such reports sent by the
department. Therefore, in such cases, even without any mistake on the part of
any of the parties, the assessees have had to suffer only due to the technical
problems of the department.

As a result of denial of TDS credit, either the refund is not
granted to the assessee or the demand is raised with interest. In cases where
the demand has been raised due to such denial of TDS credit, the assessee can
take recourse to section 205 which provides that where tax is deductible at the
source, the assessee shall not be called upon to pay the tax himself to the
extent to which tax has been deducted. Therefore, at least in such cases where
the demand is arising due to the denial of TDS credit, the assessee should be
given an opportunity to prove that TDS has been deducted from his income. If it
is proved so by the assessee, the demand should not be enforced against the
assessee or refunds should not be adjusted against such demands automatically.

Conclusion

In a scenario where it has been accepted that the system is
not yet fully operational, and therefore, it has been made mandatory for the
deductor to issue TDS certificates till 31st March 2010, it is unfair to make
provisions at the same time to provide TDS credit merely on the basis of data
available in the system, ignoring TDS certificates. Necessary instructions
should be issued by CBDT to ensure that credit of TDS is given on production of
a certificate by the ‘Deductor’.

levitra

Nirav Shah

Is it fair To infer ‘Concealment’ without giving opportunity to disclose ? [S. 271(1)(c) of Income-tax Act, 1961]

Is It Fair

1. Introduction :

Of late, there has been a storm over conflicting decisions of
the Apex Court on ‘mens rea’ as an essential element of penalty for
‘concealment of income or furnishing inaccurate particulars of income ? The two
conflicting decisions particularly under reference are

— Dilip Shroff’s case 291 ITR 519 and Dharmendra Textiles
case 306 ITR 227.

The January 2009 issue of BCAJ carries an article on the
judicial analysis of these decisions. The purpose of the present article is to
bring out certain practical aspects occasioned by the e-regime.

2. As readers are aware, the process of submission of returns
has undergone a structural change in the last couple of years. Firstly,
corporate and other large entities like firms with tax audit are required to
file an on-line return. One has to fill in only what is prescribed in the form.
There is no room to furnish any explanation.

Secondly, others who file paper returns, can submit only the
return-form without any enclosures; not even a statement of income.

Now, under Income Tax, there are innumerable issues which are
debatable; many claims which are arguable. Assessees may have bona fide
claims e.g., on S. 14A; 40(a)(ia) — rate of deduction; 50C, 2(22)(e) and
so on. One may want to make a claim by placing on record the relevant facts,
reasoning and case law, if any relied on to be transparent. But he is deprived
of this opportunity and is permitted to submit only the arithmetic calculation.
This is unfair. In this context all these decisions now need to be reconsidered.

3. ‘Mens rea’ — a viewpoint. Admittedly, words like
‘deliberately’ or ‘wilfully’ are missing before the expression — ‘concealed or
furnished.’ However, one view is that the expressions ‘concealed’, ‘furnished
inaccurate particulars’, and tax ‘sought to be evaded’ — essentially connote
some deliberate or conscious act. Thus, the concept of ‘mens rea’ is
embedded in these three expressions without there being a need for separate
words like ‘deliberate’ or ‘wilful’. So also, in the two recent decisions cited
earlier, there is an issue as to whether an ‘obiter dicta’ can prevail
over the ‘ratio’.

4. It is unfortunate that on the one hand, there is chaotic
ambiguity in the provisions of law; on the other hand, there is no opportunity
to disclose your viewpoint proactively. This is aggravated by the ill-motivated
administration. Further, conflicting judicial decisions also make the life of an
assessee difficult. In the environment an assessee could suffer about 68%
outgoing in terms of tax and penalty, apart from interest.

5. Is it then fair to :

try to punish honest taxpayers ?

make all lawful remedies ill-affordable ?

force an assessee to yield to unlawful demands ?

To make the law fair :

penalty and interest should not be levied unless there exists ‘mens rea’.

an assessee should have the opportunity of giving reasons for a claim for
deduction or an expenditure.

levitra

Nirav Shah

Decision of the Court

Right to Information

Disclosure of assets of the judges of the Supreme Court

The full bench of the Delhi High Court, in the judgment
pronounced on 12.01.2010 upholding the single bench’s order, has held that the
Chief Justice of India comes within the purview of the Right to Information Act,
and that details of judges’ assets must be disclosed under the RTI Act. It has
gone to the extent of stating that even income-tax returns and medical records
of judges needed to be disclosed, if they serve public interest.

Two clauses of section 8(1) which are dealt with in this
order are: Clause (e) – whether information is held by the Chief Justice of
India in his fiduciary capacity and Clause (j) – whether the information is
personal to be exempt.

The Court held:

The CJI cannot be a fiduciary vis-à-vis the judges of the
Supreme Court. The judges of the Supreme Court hold independent office, and
there is no hierarchy in their judicial functions which places them on a
different plane than the CJI. The declarations are not furnished to the CJI in a
private relationship or as a trust, but in discharge of the constitutional
obligation to maintain higher standards and probity of judicial life, and are in
the larger public interest. In these circumstances, it cannot be held that the
assets information shared with the CJI by the judges of the Supreme Court, is
held by him in a fiduciary capacity, which if directed to be revealed, would
result in breach of such duty.

Accordingly, the court has held that section 8(1)(e) does not
cover asset declarations made by judges of the Supreme Court and held by the CJI.
The CJI does not hold such declarations in a fiduciary capacity or relationship.

In the present case, the particulars sought by the respondent
do not justify or warrant protection under section 8(1)(j), inasmuch as the only
information the applicant sought was whether the1997 Resolution was complied
with. That kind of innocuous

information does not warrant the protection granted by section 8(1)(j). The full
bench concurred with the view of the learned single judge that the contents of
asset declarations, pursuant to the 1997 Resolution, are entitled to be treated
as personal information, and may be accessed in accordance with the procedure
prescribed under section 8(1)(j); and that they are not otherwise subject to
disclosure. Therefore, as regards the contents of the declarations, whenever
applicants approach the authorities under the Act, they would have to satisfy
themselves under section 8(1)(j) that such disclosure is warranted in “larger
public interest”.

Some interesting excerpts from the judgement:

‘The subject matter in
hand involves questions of great importance concerning balance of rights of
individuals and equities against the backdrop of paradigm changes brought
about by the legislature through the Act ushering in an era of transparency,
probity and accountability as also the increasing expectation of the civil
society that the judicial organ, like all other public institutions, will also
offer itself for public scrutiny.

‘Information is the
currency that every citizen requires to participate in life and the governance
of society. In any democratic polity, greater the access, greater will be the
responsiveness, and greater the restrictions, greater the feeling of
powerlessness and alienation. Information is a basis for knowledge, which
provokes thought, and without thinking process, there is no expression.
“Knowledge” said James Madison, “will forever govern ignorance and people who
mean to be their own governors must arm themselves with the power knowledge
gives. A popular government without popular information or the means of
obtaining it is but a prologue to farce or tragedy or perhaps both”. The
citizens’ right to know the facts, the true facts, about the administration of
the country is thus one of the pillars of a democratic State. And that is why
the demand for openness in the government is increasingly growing in different
parts of the world.

‘The source of right to
information does not emanate from the Right to Information Act. It is the
right that emerges from the constitutional guarantees under Article 19(1)(a)
as held by the Supreme Court in a catena of decisions. The Right to
Information Act is not repository of the right to information. Its repository
is the constitutional rights guaranteed under Article 19(1)(a). The Act is
merely an instrument that lays down statutory procedure in the exercise of
this right. Its overreaching purpose is to facilitate democracy by helping to
ensure that citizens have the information required to participate meaningfully
in the democratic process and to help the governors accountable to the
governed. In construing such a statute the Court ought to give it the widest
operation which its language will permit. The Court will also not readily read
words which are not there and the introduction of which will restrict the
rights of citizens for whose benefit the statute is intended.

‘Having posed the question
whether judicial ethics exist as such, Justice J.B Thomas had stated:
“We form a particular
group in the community. We comprise a select part of an honourable profession.
We are entrusted, day after day, with the exercise of considerable power. Its
exercise has dramatic effects upon the lives and fortunes of those who come
before us. Citizens cannot be sure that they or their fortunes will not some
day depend upon our judgment. They will not wish such power to be reposed in
anyone whose honesty, ability or personal standards are questionable. It is
necessary for the continuity of the system of law as we know it, that there be
standards of conduct, both in and out of court, which are designed to maintain
confidence in those expectations.” (Judicial Ethics in Australia, Sydney, Law
Book Company, 1988)

‘The right to information often collides with the right to privacy. The government stores a lot of information about individuals in its dossiers supplied by individuals in applications made for obtaining various licenses, permissions including passports, or through disclosures such as income tax returns or for census data. When an applicant seeks access to government records containing personal information concerning identifiable individuals, it is obvious that these two rights are capable of generating conflict. In some cases, this will involve disclosure of information pertaining to public officials. In others, it will involve disclosure of information concerning ordinary citizens. In each instance, the subject of the information can plausibly raise a privacy pro-tection concern. As one American writer said: one man’s freedom of information is another man’s invasion of privacy.
- ‘It was Edmund Burke who observed that “All persons possessing a portion of power ought to be strongly and awfully impressed with an idea that they act in trust and that they are to account for their conduct in that trust.” Accountability of the Judiciary cannot be seen in isolation. It must be viewed in the context of a general trend to render governors answerable to the people in ways that are transparent, accessible and effective. Behind this notion is a concept that the wielders of power – legislative, executive and judicial – are entrusted to perform their functions on condition that they account for their stewardship to the people who authorise them to exercise such power. Well defined and publicly known standards and procedures complement, rather than diminish, the notion of judicial independence. Democracy expects openness and openness is concomitant of free society. Sunlight is the best disinfectant.’
[Secretary General, Supreme Court of India vs Subhash Chandra Agarwal: LPA No 501/ 2009: judgment pro-nounced on 12.01 2010: Delhi High Court FB]

Part B: The RTI Act

   Public Cause Research Foundation (PCRF) Report:

PCRF (A Parivartan Initiative) is a public trust started by some RTI activists to encourage public information officers to think and act positively while dealing with RTI requests.

If the PIO denies information under the RTI Act because he has done something wrong and wants to hide something, it is understandable. However, a large number of officers are rejecting informa-tion, not because they have something to hide, but because they are culturally oriented to say “No”. Often, one comes across officers who would say, “Why should I give information to him? Why is he asking for information? What will he do with this information? Who is he to question me?” These questions are reflective of a mindset with which our bureaucracy has been working for decades. They are simply not used to being questioned by the public.

Likewise, RTI Awards seek to comparatively assess the performance of all information commissioners, so that the best practices could be highlighted. During 2009, PCRF studied 51,128 orders passed by various information commissions during the calendar year 2008 and received feedback from 8,400 appellants. The performance of each com-missioner was studied in great detail in term of disposals and pendencies, pro-disclosure attitude, compliance to his orders, deterrence impact and satisfaction ratio.

The awards have been instituted in three categories: Information Commissioner (to felicitate an information commissioner who has enabled access to correct and complete information to maximum appellants and strictly enforced the RTI Act); Public Information Officer (to felicitate information officers who have provided complete and correct information with maximum number of RTI applications within the prescribed time limit); and citizens (to felicitate those citizens who created maximum public impact by using the RTI Act).

The following is the executive summary of this awards exercise:

The Right to Information (RTI) Awards was instituted in the year 2009. One of its objectives was to comparatively assess the performance of all information commissioners. For this purpose, the performance of each commissioner was studied in great detail. The study revealed a highly uneven implementation of the RTI Act across the country. It also highlighted the best practices which some commissioners may like to emulate.

   1. Methodology: For the purpose of this study, orders passed in 51,128 cases during 2008, by 72 Information Commissioners and 14 combined benches from 25 Information Commissions (barring Uttar Pradesh, Tamil Nadu and Sik-kim), were analyzed. We found that in 35,930 cases (i.e., 68% cases), orders were passed in favour of disclosure. We wrote letters to these 35,930 appellants. We also interviewed many of them on phone. We asked all of them one question: Did they finally get information after approaching the Information Commission? Finally, we received feedback from 8,400 appellants who shared with us their experiences with the Commission.

   2. Orders in Favour of Disclosures: Nationally, for every 100 appeals and complaints filed in Information Commissions, orders in favour of disclosure were passed in 68 cases. Information was denied in 22% of the cases and 10% of the cases were remanded back. Mr. Anil Joshi of Chhattisgarh, Mrs. Gangotri Kujur of Jharkhand, and the combined benches of Chhattisgarh passed 100% of the orders in favour of disclosures. A total of 34 commissioners passed more than 90% of the orders in favour of disclosures. Among the states, Assam, Chhattisgarh, Arunachal Pradesh, Punjab and Karnataka passed more than 90% of the orders in favour of disclosure. However, 10 commissioners and four states passed less than 50% of the orders in favour of disclosures, Mr. Naveen Kumar from Maharashtra and Mr. C D Arha from Andhra Pradesh were at the bottom of the list, with less than 20% of the orders in favour of disclosures.

   3. Compliance of Orders: However, a favourable order from the Information Commissioner does not translate into information. Nationally, just 38% of the pro-disclosure orders could actually be implemented. In the balance 62% cases, the people did not get information despite a favourable order. Arunachal Pradesh has done quite well on this score. They could get more than 90% of their orders implemented. In addition to Arunachal Pradesh, Mr. A Venkatratnam of Goa, Mrs. Gangotri Kujur of Jharkhand and the combined benches of Assam and Nagaland could get more than 70% of their orders implemented. However, on the lower side, 44 commissioners could get less than 40% of their orders implemented. Mr. R Dileep Reddy and Mr. C D Arha of Andhra Pradesh, Mr. M R Ranga of Haryana and Mr. M M Ansari, Mr. M L Sharma and Mr. S N Mishra of CIC could get less than 20% of their pro-disclosure orders complied with.

   4. Non-compliance: Many commissioners close a case after passing orders in favour of disclo-sure— without ensuring compliance thereof. The appellant has to struggle with the concerned public authority for a few months to get the order implemented. After writing several letters and making several visits to the public authority, when the order is still not complied with, he makes a complaint to the commission. Many appellants get tired and do not file complaints again. Even when a complaint is filed, the same comes up for hearing in its due course after a few months, because most of the commissions have huge pendencies, thus causing hardships to appellants. Mostly, the complaint is disposed of without a hearing and with a letter to the public authority to comply with the Commission’s earlier order. The public authority still does not obey the order. Even if a hearing takes place in the Commission, the case is again closed with directions to the officer to provide information rather than taking any penal action. Mostly, the order is again not complied with.

   5. Continuing Mandamus: Some states follow the practice of “continuing mandamus”. They do not close a case after passing orders, but post hearings subsequently for compliance thereof. The case is not closed till the appellant reports satisfaction. These are Punjab, Uttarakhand, Bihar, Orissa, Karnataka, Arunachal Pradesh, Gujarat and some commissioners like Mrs. Gangotri Kujur of Jharkhand, etc. Their compliance rates are better than other Commissioners and Commissions. However, the problem with most of them is that barring a few, they have been quite soft with officers. Repeated non-compliance is ignored. As a result, in some cases, several hearings take place spanning over several months which leads to attrition and tires out the appellants. When the appel-lant stops coming, the cases are closed with the assumption that the appellant might have received all information. Therefore, continuing mandamus needs to be coupled with strict enforcement.

   6. Arrest Warrants: Arunachal Pradesh is the first and the only Information Commission in the country to have issued bailable arrest warrants under section 18(3) of the RTI Act for non-compliance of the Commission’s orders. Non-compliance of their orders is treated as a complaint under section 18 of the RTI Act. Section 18(3) of the RTI Act empowers the Commission to issue bailable arrest warrants and seek production of documents. Arunachal Pradesh has used this section quite effectively to get its orders implemented. Other commissions across the country may also like to invoke their powers under this section to improve compliance.

   7. Disposals: Mr. Vijay Baburao Borge and Mr. Naveen Kumar have disposed the maximum number of cases: 383 and 333 respectively, per month. However, they achieved this disposal by rejecting or remanding back almost 80% of their cases without hearings. Mr. Shailesh Gandhi stood out by disposing 270 cases per month, in the first few months, and more than 400 cases per month later. He could bring down his pendency from 12 months to less than 2 months. At the lower end are the north-eastern states, who disposed very few cases, because they get few appeals. However, there are some commissioners who disposed very few cases despite huge pendencies. Commissioners who disposed less than 10 cases per month, despite huge pendencies, are Mr. Dileep Reddy of Andhra Pradesh, Mr. Arun Kumar Bhattacharya of West Bengal, late Shri G G Kambli of Goa and Mr. R K Angousana Singh of Manipur.

   8. Imposition of Penalties: The RTI Act mandates that every violation of the Act “shall” be penalised unless there was a reasonable cause on the part of the PIO. The penalty amount has to be deducted from the PIO’s salary. However, just 2.4% of the recorded violations across the country were penalised. In 74% cases of recorded vio-lations, the Hon’ble Information Commissioners did not even question the PIO as to whether there was a “reasonable cause” or not. The PIOs were questioned in just 26% cases through show cause notices. However, as many as 65% of these show cause notices remained pending at the end of the year. Some 23% notices were dropped because the Commissioners found the explanations and excuses presented by PIOs in these cases as “reasonable”. The combined benches of Orissa imposed penalties in almost 30% of pro-disclosure cases. As an individual Commissioner, Mr. D N Padhi of Orissa was at the top, even though he imposed penalties on less than 11% of pro-disclosure cases. There are six Commissioners who imposed penalties in more than 10% of pro-disclosure cases. Nearly 50 Commissioners and 11 Commissions, including the CIC, imposed penalties in less than 2% pro-disclosure cases. What was alarming was the fact that there were 29 Commissioners and three Commissions who did not impose even a single penalty despite thousands of recorded violations.

   9. Pendencies: Huge pendencies have become such a severe problem in some states that it takes more than a year for a case to come up for hearing if it were filed today. Some urgent steps need to be taken to address mounting pendencies. States with more than a year’s pendency are Orissa, Madhya Pradesh, Maharashtra, UP and some of the Commissioners at CIC. Strict imposition of penalties will have a direct bearing on the number of appeals re-ceived at the Commission. When the RTI Act came into effect, officers were scared of violating it because of its strong penal provisions. But when they saw that the penal provisions were not being strictly enforced, they started taking RTI lightly. If PIOs do not take RTI Act seriously, the number of appeals at Commissions will increase exponentially. Therefore, the inflow of cases to the Commission can be reduced with strict enforcement of penal provisions.

   10. State of Records: In many Commissions, the state of records is not very healthy. Many Commissions do not even know for sure how many cases they disposed. At different times, they gave us different figures of disposals. Many Commissions do not have copies of all orders. Uttar Pradesh claimed to have passed 22,658 orders during 2008. However, they said that they do not maintain copies of all orders. Tamil Nadu said they had passed more than 40,000 orders but provided us with only 900 orders.

   11. Missing Records: The trend of PIOs reporting records to be missing or lost seems to be on the rise. In many cases, this is treated as a legitimate excuse for denial of information. However, in some parts of the country, when the Commissioners threatened police action, suddenly these ‘missing’ records came out, which means that “missing records” was merely an excuse given by the PIOs to deny information. Mr. Vijay Kuvalekar of Maharashtra has been very successful in forcing PIOs to trace out records in many cases when he threatened police action.

   12. Arbitrary Commissioner Strength: Commissioners seem to be appointed by state governments without reference to the pendency of that Commission. On one hand, we came across states like Arunachal Pradesh that has five Commissioners for 43 appeals, and on the other hand, we have Gujarat that has one Commissioner for a pendency of almost 5,000 cases. It is important to formulate some guidelines that state how much pendency a Commissioner should be appointed.

Part C: Others News

Important Pronouncement by the Commission:

(Continuing from January 2010)

When Shailesh Gandhi, CIC, was in the BCAS office addressing RTI activists and journalists, he distributed a compilation of eight important and profound pronouncements by the Central Information Commission.

3. Reasons For Claiming Exemptions

Since Right to Information is a fundamental right of citizens, denial has to be only on the basis of the exemptions under section 8(1); and it is necessary to carefully explain the reasons of how any of the exemptions apply, when a PIO wishes to deny information on the basis of the exemptions. Merely quoting the subsection of section 8 is not adequate. Giving information is the rule and denial is an exception.

In the absence of any reasoning, the exemption under any clause of section 8(1) is held to have been applied without any basis.

4. Fiduciary

The traditional definition of ‘fiduciary’ implies that a person occupies a position of trust in relation to someone else, therefore, requiring him to act for the latter’s benefit within the scope of that relationship. In business or law, we generally mean someone who has specific duties, such as those that attend a particular profession or role, e.g., a financial analyst or trustee. The information must be given by the holder of information when there is a choice – as when a litigant goes to a particular lawyer, or a patient goes to particular doctor. It is also necessary that the principal character of the relationship is the trust placed by the provider of information in the person to whom the information is given. An equally important characteristic for the relation-ship to qualify as a fiduciary relationship is that the provider of information gives the information for using it for his benefit. When a committee is formed to give a report, the information provided by it in the report cannot be said to be given in a fiduciary relationship. All relationships usually have an element of trust, but all of them cannot be classified as fiduciary.

University Grant Commissioner to be penalised!

In a wake of the deemed university controversy, the Central Information Commission has slammed the University Grants Commission (UGC) for lack of transparency in information on deemed universities.

Ruling that the UGC appeared to act as if the RTI Act did not apply to it, the information watchdog has awarded a compensation of Rs. 2,000 to an applicant and issued a show cause notice to the UGC for not responding within the stipulated 30-day period.

The Commission noted: “It is a very sad state of affairs that the UGC appears to be operating with-out any understanding of what is happening. The Commission has earlier also directed the UGC to put up various information under its section 4 obligations. The UGC has failed to comply with it.”

President’s Foreign Tours

President Pratibha Patil managed to pull-off quite an austerity drive! She managed state visits to eight countries on a ridiculous expenditure of just Rs. 1.95 lakh. In response to the RTI application, the reply reveals that on state visits to Brazil-Mexico-Chile, Bhutan, Vietnam-Indonesia and Spain-Poland, Patil spent Rs. 12,878, Rs. 32,670, Rs. 66,364 and Rs. 83,339 respectively. This comes to a total of Rs. 1,95,251. The document said the expenses were incurred under the budget head “tour expenses”.

Chetan Kothari, the applicant, believes that the infor-mation provided is incomplete, false and malafide, and he has lodged a complaint with CIC against the PIO of Rashtrapati Bhavan.

Padma Bhushan Award Challenged

Media persons Pritish Nandy and Vir Sanghvi have filed a RTI application with regard to the inclusion of Sant Singh Chatwal’s name for the Padma Bhushan award.

Freedom of Information (FOI) Act, USA

ABC News filed a FOI application with the National Institute of Standards and Technology (NIST), USA which had investigated the collapse of the World Trade Centre Towers on 9/11, to get aerial photos of the dramatic collapse. The images were taken from a police helicopter — the only photographers allowed in the space near the towers on September 11, 2001. ABC said the NIST gave 2779 pictures on nine CDs. The photos are the core to understanding the visual phenomena of what was happening. ABC Network has posted 12 photos on its website.

Advertisements by DAVP

The Directorate of Visual Publicity (DAVP) has issued 1,231 advertisements over January 1, 2008 to September 28, 2009, costing over Rs. 217 crores on behalf of ministries and government departments.

In a move that could further expose misuse of public funds by politicians for personal publicity, the Central Information Commission (CIC) has allowed disclosure of advertisements issued by the government over one year. The panel has allowed disclosure of details related to the number and cost of advertisements and those that have photographs of politicians.

Nirav Shah

MVAT Audit — Some important issues

Lecture Meeting

Subject : MVAT Audit — Some important issues

Speaker : Govind Goyal, C.A.

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

Date : 21st January 2009

(1) While introducing the subject, the speaker said that
Notification of October 2008, introduced new Form No. 704 being Report of the
Auditor. The Commissioner of Sales Tax issued a Circular stating that all
Reports submitted after 10th November 2008 shall be in new Form No. 704 and not
in old Form.

(2) After studying the new Form, the WIRC of the Institute
made representation to the Commissioner of Sales Tax (CST) that certain clauses
in the new Form need to be changed, since they cannot be certified by Chartered
Accountants and are inconsistent with provisions of law. After discussion, the
Commissioner agreed that those clauses need to be changed. Another Circular was
issued in December 2008 clarifying that for year 2007-2008, the Auditor will
have an option to submit his Report either in the old Form or in the new Form
No. 704 and the same should be submitted before 31st January 2009.

(3) In Part-I of old Form No. 704, there were 9 statements to
be certified by the Auditor. This number is now increased to 15 certificates. He
has now to certify that he has read and understood the instructions given in the
new Form. He has also to certify that the dealer was carrying on his business
activity from the principal place and additional places registered with the
Sales Tax Department. It is difficult for the Auditor to issue such certificate.
His duty is to audit books with the supportings. Similarly, the new Form
requires him to certify that all transactions recorded in the books of accounts
are reflected in bank statements. This is not possible particularly when the
dealer followed mercantile system.

(4) In Part-II, general information about business of auditee
is required to be given. Now certain ratios are to be reported and they are :

à
Net turnover to total turnover

à
Cash Sales to Total Sales

à
Cash Purchases to Total Purchases

However, neither the MVAT Act nor the Central Sales Tax Act
defines Cash Sales or Cash Purchases. It is not clear whether they include
cheques, or credit card.

(5) The auditor has to certify details of purchases over
Rs.5,00,000 from new local suppliers. The term new local suppliers means persons
from whom no purchases were made in preceding year. This casts additional
responsibility to find out the position for preceding year also. This makes the
Auditor’s duty onerous.

(6) Part-III of Report contains schedules :

In one schedule, the Auditor has to certify figures of
Sales/Purchases per returns, the figure determined from books and
re-conciliation of differences with reasons.

(7) In reporting, the Auditor has to give details of the
Auditor who has certified the accounts statements under the Income-tax Act. The
speaker observed that this is again inconsistent because there may be cases
where audit is conducted under the Companies Act or Co-op Societies Act or Trust
Act; but those may not be required under the Income-tax Act.

(8) Determination of Gross Turnover of Sales and Purchases :

Turnover means aggregate of Sale Price or Purchase Price of
transactions effected during the year. Sales/Purchase includes not only
Sale/Purchases of goods traded or manufactured by the dealer, but also covers
spares, components, packing materials, fuel. It also includes Capital goods. Net
turnover will not include taxes collected or paid. However, the gross turnover
of Sales/Purchase will include tax collection. Labour charges are to be excluded
since they are not sale of goods. Deduction should also be made of goods
returned within 6 months from the date of sale. While determining the turnover
the Auditor must take note of sale/purchase of scrap, sale/purchase of capital
goods like plant and machinery and miscellaneous purchases included in printing
& stationery, in repairs and maintenance charges, and in sales promotion
expenses. The Auditor must keep in mind the accounting standards, and the
guidance note of the Institute states that taxes collected by dealer as well as
excise duty shall not form part of income. If any portion of collection of tax
and duty has remained unpaid, the same should be shown as liability.

(9) For determining turnover of inter-State sales, deduction
is also to be made of freight and transport charges included in sale price.
Thereafter for Gross turnover of sales, the taxes collected and excise duty is
to be added.

For quantifying taxable sales in Maharashtra, deduction is to
be made of inter state sales, exempt sales, labour charges and taxes and excise
duty collected, to arrive at net taxable turnover liable for MVAT.

Computation of Tax : The taxable turnover is to be
bifurcated into five Schedules according to their categories. The tax rates are
NIL for Sch. A (exempt goods), 1% for Sch. B Goods, 4% for Sch. C and specified
rate for petroleum and liquor referred in Sch. D and for residuary goods in Sch.
E the rate is 12.5%. The Auditor will determine and state net taxable sale under
each schedule giving entry No. and tax rate. If the dealer has collected excess
tax, the same stands forfeited in favour of Government.

(10) In turnover of purchases after necessary deductions, the
Auditor has to verify taxes paid on purchases for determining set-off or input
tax credit.

Conditions for allowance of set-off :

a) Goods purchased should be from registered dealers.

b) The entries in the register should be supported by tax invoices.

c) The purchase register and tax invoice should give the date, invoice No., name and address of supplier, registration No., net purchase price and VAT charged separately. The provisions of Rules 52, 53 and 54 dealing with set-off working should .be borne in mind. If the VAT charged is not mentioned separately, set-off will not be granted. The aggregate amount of set-off is subject to statutory deduction per Rule 53 and negative list per Rule 54.

11) Tax on purchase of goods and packing materials used for manufacture and packing of tax-free goods is not allowed for set-off.

12) Where there is difference in tax due or set-off claimable per working by Auditor and per returns of dealer, the auditee should be advised to file revised return and pay the difference before finalising and submitting Form No 704. A note should be taken of revised return. In the said report, the auditor should also state the period for which further set-off is due and resultant refund due.

13) Works contracts:

In works contracts, determination of taxable quantum of sale forming part of Final Bill and the tax rate applicable thereon is the most complicated region in M-VAT Audit.

14) Whether a particular contract is a works contract or a sale simpliciter is a matter of controversy. Judgments of the Apex Court on works contracts of almost similar nature vary from each other. Assuming a particular contract is a works contract, determination of sale component is equally challenging. The gross amount of bill is a composite figure involving sale of material and sale of services. Tax is not leviable on service element under MVAT. Rule 58 prescribes mode of determination of sale price. From gross amount of bill eight items of deduction are to be made; some of which are:

i) Architect’s or designer’s fees

ii) Labour and service charges in respect of contract

iii) Water charges

iv) Profit margin of dealer in respect of Labour/ service charges. The balance constitutes sale price on which tax is payable @4% or @12.5% (general rate) or @ 8% under the composition scheme, depending on category of goods involved.

15) In actual practice, dealers undertaking works contracts are reluctant to disclose items like expenses on services, architects fees and their profit margin. To overcome this, the State Government has evolved a table for various types of contracts, such as construction contract, fabrication, painting, air conditioning, repairing and annual maintenance contract. The rate of deduction for component of services are mentioned against each category of con-tract. To illustrate, in building construction contract the value of services will be taken” at 30% and the balance of 70% will be treated as sale of material liable to VAT.

16) In Practice, it was found that contractors felt that in spite of prescribed table, it is not possible for them to make invoice. A representation was made to design a scheme akin to composition scheme. So u/s.42 of the MVAT Act, composition scheme is designed providing 8% of total contract value will be regarded as MVAT payable. Another representation was made requesting for reduction of rate of 8% on construction contract which was reduced to 5% from 20th June 2006.

If construction contractor is opting for composition, then their set-off on purchases is reduced.

17) Where composition is not opted, the normal set-off as per Rule is permitted. If, it is opted, the set-off claim is scaled down, if composition is un-der 8% scheme, set-off amount will be reduced by 36%. If composition is under 5% scheme, set-off clause will be reduced by an amount being 4% of total purchase price. The normal composition rate is 8% applicable to all works contracts, whereas building contractors can opt for 5% for construction contract and 8% for contract other than construction contract. The set-off on works contract other than construction contract is to be scaled down by 3% of purchase amount and for construction contract this scaling down is by 4%.

18) Unlike the composition scheme applicable to hoteliers or retailers where entire turnover is required to be considered, construction contractors can opt composition @ 5% qua contract. Similarly, under other composition scheme the dealer is not permitted to collect tax from customers. But under the works contract composition scheme, the dealer can collect tax. These aspects must be kept in mind while determining gross turnover and net turnover. While going through profit & loss account, the Auditor should verify whether hire charges are credited to profit & loss account. These may be in respect of leasing of goods. Earlier there was a separate Act-‘Right to use goods Act’. All amounts received for leasing of goods, machinery, furniture were liable to MVAT atapplicable rates which are 12.5% for leasing of machinery, furniture and 4% for computers. So these receipts should be considered in determining gross and net turnovers.

19) Provisions applicable to mandap decorators, hotel industries, 2nd-hand car dealers, retailers and bakary dealers:

Though the composition scheme to mandap decorators was announced in 2007, the same was made applicable from 1-4-2005. All these dealers can discharge their tax liability by paying 1.5% tax on total turnover.

In case of dealers in hotel industries, second-hand car trade, retailers and bakery dealers, the Auditor should verify weather they have applied for in prescribed form to the Revenue authorities for coming under the composition scheme. Application has to be made either at the time of registration or at the beginning of financial years. Once the dealer opts for the scheme, he cannot come out of the scheme till the end of that financial year. Similarly these dealers are not permitted to collect tax from customers. This is a pre-condition. Therefore, sale price will not be treated as inclusive of tax. The tax @ 8% will be payable on entire sale price. In case of hotels charging rent for rooms, since rooms are immovable property, the rent earning is not liable to MYAT tax.

Where room hire charges are inclusive of breakfast or breakfast & lunch or breakfast, lunch & dinner, the charges attributable to these facilities are determined by applying the following table to gross rent collection, viz. :

For breakfast        – 5% of total rent
For breakfast & lunch    – 10%
For breakfast, lunch & dinner   – 15%

The amount worked out at applicable rate to gross room rent will have to be considered for arriving at taxable sale price.

20) Determination of taxable turnover in case of C.F.I. Units located in backward area:

Where units are enjoying incentives whereby they do not have to pay any tax on turnover of sales, turnover of sales and purchases are determined in normal manner but set-off on purchases will not be allowed, but they are entitled to claim refund of taxes paid on purchase including tax paid on capital goods.

CFI unit in backward area, similar deduction is to be made. From final bill, the payment is made to CFI units for purchase of goods used in works contract. The remaining amount will be liable to tax @ 4% or 12.5% as the case may be.

21) As regards refunds till March 2007, the refunds due per return up to March 2007 were allowed to be carried forward. But refunds due for 2007-2008 cannot be carried forward. Refund due as per return or revised return for March 2008 or due as per Audit Report cannot be carried forward.

22) Re : Medicine dealers if pharmacies:

Till June 2007, turnover was determined as per MRP Scheme. From July 2007 the determination is to be made as done in normal dealers. Till June 2007 tax was collected from manufacturers on basis of MRP. The said scheme is discontinued. All medicine dealers had to submit stock statement as on 30-6-2007.

23) MVAT applicable to liquor licence dealers: S. 61:

Turnover limit of Rs.40 lakhs applicable to normal dealers does not apply to liquor licence dealers.

The dealer may permit other dealer to use his licence for liquor trading. The person using the licence has also to get his accounts audited, irrespective of the amount of turnover.

24) As regards Kirana merchants, they can opt for the composition scheme. If they have opted for the composition scheme, the tax rate will be 5% or 8%. If they have not opted, difficultly arises in determination of turnover of various categories of goods liable for different rates e.g., sugar, wheat, pulses are tax free, whereas on items like toothpaste, tax is 5% and on sale of dry fruit the rate is 4%. Very often he makes one cash memo for all these items, so also he does not make cash memo but records sales in his diary. As per Circular of the Commissioner and guidance note of WIRC, in all such cases, the turn-over of sales is to be determined in ratio of turnover of purchases as per purchase register. By applying above ratio, the sales turnover is determined.

25) Textile processors:

Till 31st March 2005, they were exempt from tax. This was withdrawn under the MVAT Act. Processing is a works contract. On basis of purchases of chemicals and other materials, the taxable turnover is determined. In response to representation of Textile Processors Associations, the Finance Minister in Budget speech, assured that textile processing will not be treated as works contract and their trade will be exempt. Notification was then issued granting exemption to textile processors. Set-off will not be allowed on taxes paid on purchase of materials and capital goods. However, per Notification of 23rd October 2008 as per Rule 53(10) they will be entitled to claim set-off on purchases of capital goods and taxes on material used for processing. The exemption being applicable from 1-4-2005, those textile processors who have paid VAT as works contractors, can revise their returns and claim refund of taxes paid.

The revised Audit Report will have to be submitted giving reasons for revision. Revised Report should be filed only after the revised returns are filed by the dealer.

26) Verification of CST Returns:

S. 5(1) to S. 5(3) describe three different categories of inter-State sale, export sale & export sale without taking delivery of import. In such cases the ultimate consumer should pay charges of Bill of Entry, Customs duty and forwarding charges. Otherwise claim u/ s.5(2) may get disallowed.

S. 5(3) deals with transaction where the sale is effected to actual exporter. Such dealer should furnish declaration Form H which can be given for inter-State purchases as well as local purchases. Sale on Form 11 is treated as inter-State sale even if exporter is located within Maharashtra.

Export of goods without taking delivery through negotiation of Railway receipt or lorry receipt. The movement of goods should not be broken, if the claim of inter-State sale is to be proved. Secondly all dealers in the transaction must be registered dealers. Under CST, it is also necessary to collect Form E-1 from the selling dealer and Form ‘C’ from the purchasing dealer. In the event the dealer negotiating the documents fails to collect Form E-1, but collects only Form C, then such transaction will be treated as inter-State transaction liable to CST. The dealer negotiating Railway or lorry receipt has to issue Form E-2 to the purchasing dealer.

S. 6A of the CST Act deals with branch consignment transfer.

(27) Branch transfer and consignment sales:

Where movement of goods from one State to another State is otherwise than under contract of sale, then it is to be considered as branch transfer or consignment transfer. The conditions for falling under category of branch transfer are:

a) Sale is not under contract of sale

b) The consignee or branch should furnish declaration in Form F.

The Auditor should make note of missing Form C and Form F, and if the same are expected to be received, tax difference need not be paid. The revised return also need not be filed if dealer is confident of receiving missing forms. Suffice if the Auditor clarifies his stand in final report on chances of receiving missing forms.

(28) Time limit for submitting Audit Report:

As regards due date for submitting Audit Report in Form-704 it is 31st January 2009; the speaker informed that representation is made to the Commissioner for extending the date up to 31st March 2009. The speaker advised that without waiting for such extension, the Auditor should file report by 31st January 2009.

The learned speaker then replied queries raised by some members. The meeting terminated with a vote of thanks to the learned speaker.

Nirav Shah

Taxability of profits from purchase of goods from India

International Taxation

Attribution of profits to a Permanent Establishment/Business
Connection is an evergreen controversial subject. Article on ‘Business Profits’
in a tax treaty and S. 9 of the Income-tax Act, 1961 deal with this subject.
However, many a time activities of an enterprise in the source State are
restricted to purchase of goods. In such a scenario, whether the same results in
any tax liability or not, is discussed in this Article.

1.0 Introduction :

Many a time, activities of a foreign enterprise are
restricted to purchase of goods from India. As per the provisions of the Foreign
Exchange Management Act, 1999 (FEMA), a branch or a liaison office in India of a
foreign enterprise is permitted to carry out limited activities only. In
Rahim v. CIT, (1949) 17 ITR 256 (Orissa) and CIT v. Rodriguez, (1951)
20 ITR 247 (Mad.), it was held that a part of profits may be attributed to the
buying activities. However, the Supreme Court, in case of Anglo-French Textile
Co. Ltd., (1954) 25 ITR 27 (SC), held that if the act of buying is negligible,
it may not justify the allocation of any portion of the profits to that
activity. In CIT v. Ahmedbhai Umarbhai, (1950) 18 ITR 472 (SC), the Apex
Court held that “when considering the place of accrual of profits u/s.5, in
cases where the assessee carries on both manufacturing and selling operations,
the whole of the profits should not be considered as accruing from the sale or
at the place of sale, but a part of the profits should be held to accrue at the
place where the goods are manufactured.” Thus, it can be interpreted here that
profits accrue not only on final sale of the product but at every stage, right
from buying, manufacturing, processing and final selling. The complexities arise
where the above activities take place in two or more countries. How the
resultant profits are to be attributed to various activities, is a major area of
concern and controversy worldwide. Let us understand the position from the
perspective of the Indian tax law.

2.0 Domestic Tax Law
Provisions :

2.1 Provisions under the Income-tax Act, 1961 :

The relevant provisions under the Income-tax Act, 1961 are S.
5 and S. 9. S. 5 provides that income of a non-resident is taxed in India if it
is received or is deemed to be received or if it accrues or arises or is deemed
to accrue or arise to him in India. Relevant extracts from S. 9 which deals with
income deemed to accrue or arise in India in respect of a non-resident assessee
are as follows :

“S. 9 : Income deemed to accrue or arise in India

(1) The following income shall be deemed to accrue or
arise in India :

(i) all income accruing or arising, whether directly or
indirectly, through or from any business connection in India, or through
or from any property in India, or through or from any asset or source of
income in India, or through the transfer of a capital asset situate in
India.

Explanation 1 : For the purposes of this Clause :

(a) in the case of a business of which all the operations
are not carried out in India, the income of the business deemed under this
clause to accrue or arise in India shall be only such part of the income as
is reasonably attributable to the operations carried out in India;

(b) in the case of a non-resident, no income shall be
deemed to accrue or arise in India to him through or from operations which
are confined to the purchase of goods in India for the purpose of export;

From Clause (a) mentioned above, it is clear that even in
case where the business connection in India is established, only the profits
which are attributable to such business connection would be taxable in India.
Clause (b) clearly provides that if the non-resident’s activities in India are
confined to purchase of goods for the purpose of exports, then no income shall
be deemed to accrue or arise in India.

2.2 CBDT Circulars :

CBDT Circular No. 23, dated 23-7-1969 provides that
maintaining a branch office in India for the purchase of goods or appointing an
agent in India for the systematic and regular purchase of raw materials or other
commodities would tantamount to business connection in India.

However, Paragraph 3(5) of the said Circular further
clarifies that a non-resident will not be liable to tax in India on any income
attributable to operations confined to purchase of goods in India for export,
even though the non-resident has an office or an agency in India for this
purpose. Where a resident person acts in the ordinary course of his business in
making purchases for a non-resident party, he would not normally be regarded as
an agent of the non-resident u/s.163. But where the resident person is closely
connected with the non-resident purchaser and the course of business between
them is so arranged that the resident person gets no profits or less than the
ordinary profits which might be expected to arise in that business, the
Income-tax Officer is empowered to determine the amount of profits which may
reasonably be deemed to have been derived by the resident person from that
business and include such amount in the total income of the resident person.

The Circular further provides that the taxability of the
apportionment of any income under Explanation (a) to S. 9(1)(i) to an agent of a
non-resident in India will be subject to the exemption provided in Clause (b) of
the said Explanation.

CBDT Circular No. 163, dated 29-5-1975 further clarifies that lithe correct legal position is that in the case of a non-resident, no income shall be deemed to accrue or arise in India through or from operations which are confined to purchase of goods in India for the purpose of export. Accordingly, the mere existence of an agency established by a non-resident in India will not be sufficient to make the non-resident liable to tax, if the sole function of the agency is to purchase goods for export”.

In view of these CBDT Circulars and provisions of law, it is clear that even though the activities of purchase of goods in India for the purpose of exports in case of non-residents are effectively connected to a business connection, no income is attributable to it.

In spite of these clear legal provisions, the matter has come up for judicial interpretation in some cases. In the following paragraphs the same are discussed.

3.0 Judicial Rulings:

3.1 In CIT v. N. K. lain, (1994) 206 ITR 692 (Del.), it was held that no income could be deemed to have accrued to the non-resident assessee in India where, on his instructions, his agent purchased dress material, got it stitched into garments and exported such garments to him abroad.

3.2 The AAR in the case of Angel Garments Ltd., (2006) 287 ITR 341 (AAR) had occasion to decide a similar issue, the facts of which are given below.

Angel Garments Ltd., which was incorporated in Hong Kong, proposed to set up liaison office in India. The proposed activities of the liaison office were as follows:

a) Collecting information and samples of various garments and textiles from various manufacturers, traders and exporters;

b) Passing on information with regard to various garments and textiles products available in India to the applicant’s head office at Hong Kong;

c) Co-ordinate and act as the channel of communication between the applicant and the Indian exporters; and

d) Follow up with the Indian exporters for timely export of goods ordered by the applicant.

Angel Garments applied for an advance ruling seeking determination of taxability or otherwise of the above transactions in India.

Usually, Article 5 of a tax treaty provides that the maintenance of a fixed place of business solely for the purpose of purchase of goods or merchandise or of collecting information for the enterprise does not constitute a permanent establishment. However, since M/ s. Angel Garments Ltd. was incorporated ~ in Hong Kong with which India does not have a tax treaty, the Advance Ruling Authority examined the issue under the provisions of the Income-tax Act, 1961. The Authority concluded that u/s.9 of the Act, lino income shall be deemed to accrue or arise in India to him through or from operations which are confined to the purchase of goods in India for the purpose of exports”. The Authority further held that Explanation to S. 9(1)(i) does not specify that the export should be made to the country of which the applicant is the tax resident (in the instant case it was Hong Kong). Exports can be made to any country.

3.3 Ikea Trading (Hong Kong) Ltd. (2009) 308 ITR 422 (AAR):

In this case also the AAR reached identical conclusions. Brief facts of the case were as follows:

The applicant set up a liaison office in India to carry out the following activities:

i) Enquiry into and consideration of potential suppliers for the IKEA product range.

ii) Collecting information and samples of various home-furnishing items from manufacturers and passing on information with regard to various textiles, rugs & carpets and other material (such as plastics, metals and lighting products) available in India.

iii) Doing quality check of the various products at labs to see whether they adhere to the costing and quality parameters as prescribed by IKEA group.

iv) Coordinating and acting as the channel of communication between the applicant and the Indian exporters.

v) Follow up with the Indian exporters for timely export of goods ordered by the applicant and supervising the inland logistics.

vi) Doing social audit of the suppliers to ensure that they adhere to various environmental and other regulations.

The applicant shared the office with Ikea Trading (India) Pvt. Ltd., a Group company. The items purchased by the applicant were to be invoiced by the Indian suppliers directly to the applicant who in turn would sell the same to the wholesale companies outside India and the sale price would be received by the applicant outside India and no revenue-generating activities would take place in India. In this case, the consignee was different from the buyer as with a view to save freight, travel and other expenses, the Indian suppliers had been requested to deliver the goods directly to Ikea Group distribu-tion outlets at Belgium and other countries. Further, the export remittances were made to Indian suppli-ers by Ikea Switzerland (and not by the Ikea Hong Kong on whose names invoices were raised) as the said company in Switzerland carried out the function of ‘Central treasury’.

The AAR in this case held that “no income can be attributed to the purchase operations in India by resorting to the deeming fiction u/s.9(1)(i) because the Explanation clearly excludes such attribution. In the case of Mushtaq Ahmed (2008) 307 ITR 401 (AAR), this Authority had noted that Clause (b) of Explanation 1 acts as an embargo against attributing any income to the purchase operations carried out in India, if such purchases are for the purpose of export”.

3.4 Nike Inc. v. ACIT, (2008 TIOL 255 ITATBang.) :

3.4.1 Recently, the Bangalore Tribunal had occasion to consider similar facts in the above case.

3.4.2 Facts of the case:

i) Nike Inc (the assessee) set up a liaison office in India with the approval of the Reserve Bank of India (RBI) to act as a communication channel between manufacturers in India, the assessee and affiliates of the assessee.

ii) The activities of the Indian liaison office, amongst others, included:

Liaisoning between the manufacturers and the assessee;
Giving opinion on reasonability of prices;
Ensuring the quality of goods exported;
Tracking delivery dates;
Shipment tracking

iii) The assessee as a buying agent for its affiliates, directly entered into an agreement with manu-facturers in India for procurement of goods from India. The goods would be directly shipped to the affiliate’s location by the manufacturers. The assessee earned a commission for performing the buying agency services.

3.4.3 The Tax Authorities contended that:

i) The assessee is not purchasing goods from the manufacturer and does not take title to the goods which are directly exported to the affiliates.

ii) The exclusion to business connection in respect of purchase of goods by a non-resident for the purpose of export would not apply to the assessee.

iii) The activities of liaison office are beyond its activities as approved by RBI as the staff of the liaison office trained factories, evaluated samples, certified auditors, etc.

iv) Nike Inc has a business connection/Permanent Establishment in India and is chargeable to tax to the extent of income which is attributable to the activities carried out in India or accruing or arising in India.

v) 5% of the FOB value of exports could be reasonably considered as income attributable to Ind!a operation.

The Commissioner of Income-tax (Appeals) upheld the view of the Assessing Officer as regards the taxability of sourcing operations carried on by the liaison office in India.

3.4.4 The assessee contended that:

i) The Revenue authorities cannot travel beyond the Income-tax Act. Violation if any from RBI approval could only be examined by RBI authorities.

ii) The assessee is a one-window procurement agency for distribution and sale by its affiliates.

iii) The assessee is performing the role of an agent for its various affiliates in respect of procurement of goods.

iv) Assessee acting as an agent and assessee acting on its own are more or less parallel to one another, since both end up only in purchase.

v) All the activities performed by the liaison office are within the ambit of purchase function.

vi) Exclusion to business connection under Explanation (l)(b) to S. 9(1)(i) of the Act is clearly attracted because it is export in the course of purchase. Hence no income accrues or arises in India.

3.4.5 The Tribunal held in favour of the assessee as follows:

The assessee is a purchasing agent of the various affiliates. The liaison office was clearly not floating tenders, placing purchase orders and taking physical delivery of the goods, since it was only an agency office of the assessee. It merely ensured that various affiliates receive the goods they require and the quality they expect.

There are three ways to purchase:

1) Purchase of goods and receipt of goods at the same time at one place where the office of the assessee is located.

2) Purchase information sent by the assessee, but goods despatched to its various sales outlets.

3) The assessee as an agent of the buyers indicates to the manufacturers the rate at which the goods will be supplied, the names and addresses of the buyers where the goods have to be sent.

The Tribunal observed that situations 2 and 3 are more or less similar. In the present case which is similar to 3, the affiliates have purchased the goods with the help of the agent. Irrespective of whether the purchase is by the principal directly or through an agent, so long as the purchase is for the purpose of export, the activity would be excluded from the gamut of business connection.

The Tribunal also observed that the assessee is not in anyway representing the manufacturer and is not an agent of the manufacturer but of the affiliates. The liaison office only ensures and supervises the manufacturing activity as an agent of the affiliates. The manufacturer does not receive any services from the liaison office or the assessee. The activities of the liaison office are well within the limits pre-scribed by RBI.

4.0 Provisions under a Tax Treaty :

Normally Paragraph 4 of Article 5 of a tax treaty contains specific exclusions from the definition of the term ‘Permanent Establishment’. Paragraph 4 of Article 5 of the United Nation’s Model Convention reads as follows:

“4. Notwithstanding the preceding provisions of this Article, the term ‘permanent establishment’ shall be deemed not to include:

a) the use of facilities solely for the purposes of storage or display of goods or merchandise belonging to the enterprise;

b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage or display;

c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise;

d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise;

e) the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character.”

Clause (d) of Paragraph 4 of Article (5) relevant to our discussions, of the OECD Model is similarly worded.

From the above provisions, it is clear that maintenance of a fixed place of business solely for the purpose of purchase of goods or merchandise or of collecting information for the enterprise does not constitute a permanent establishment in the source country.

5.0 Conclusion:

From the above discussion, the following principles emerge in respect of exclusion provided under clause (b) of the Explanation to S. 9(1)(i) of the Act:

i) Goods may be exported to any country and not necessarily to the country of the concerned non-resident entity whose activities in India are under question;

ii) Goods may be exported directly by Indian suppliers / exporters;

iii) Delivery of goods may be made to a country different from the country of the concerned non-resident entity i.e., consignee may be different from the buyer;

iv) Payment may be made from a group company from a third country.

Nirav Shah

Credit Rating Risk : Risk Management — Case study

Risk

A credit rating estimates the credit worthiness of an entity,
be it a corporation, company, individual, public corporation or a
non-governmental organisation or even a country!

Credit rating involves evaluation of the potential borrower’s
credit worthiness in terms of borrowing capacity and the ability to repay,
including the ability to service the debt in terms of repayment of interest and
principale.

Credit rating primarily is of two types. The first is a
personal credit rating or the credit rating of an individual borrower.
Generally, the factors that influence this rating are: the ability of the
individual to repay the loan; the rate of interest; the relative use of credit
vis-à-vis his/her own capital; the saving and investment pattern; the purpose of
the loan; the spending pattern; background credit account enquiries; the
duration of credit history; activity and wealth; the nature and type of debt,
etc.

The other is corporate credit rating which is more of an
indicator to potential investors about the standard and rating of the entity
issuing the debt security.

The credit ratings of corporate entities take into account
the issuers’ credit worthiness, that is, the ability to repay the loan, interest
rate, credit scores depending on track record, profile, history, proposed usage,
capital structure, industry analysis and other factors.

Some of the prominent credit rating agencies abroad and in
India are: S & P (Standards and Poor), Moody’s, and Fitch Ratings
(International); and CRISIL and ICRA (in India), etc.

Generally credit rating agencies for corporate debt offerings
issue ratings like AAA+, AAA, BBB, CCC right down to D, E, F & S, etc. These
indicate ‘rating status’ indicating borrowing strength of the corporate. In the
case of individual borrowers, an assessment is done of the borrower’s ability to
repay. In case of corporates, the rating is at the request of the borrower; and
in case of individual borrowing, the rating is generally done at the instance of
the lender, though normally at the cost of the borrower.

The risk associated with credit rating is that of rating an
entity better than its real standing, resulting in an increased exposure of the
investor/lender. This is probably what led to the Global financial crisis.

Credit rating agencies have been under a cloud and their role
and relevance is being questioned. In India, the credit rating agencies had
failed to downgrade Satyam’s ratings and did so only when the scam was out in
the open — after the event!

The criticism of rating agencies stems from:

1. The nexus that they have with the market, analysts, the
market players and the corporate management.

2. Rating agencies are often wiser after the event.

3. Ratings affect interest rates and borrowing capacity

4. A premature negative rating can trigger corporate
failure.

5. Agencies go more by formulae and lack business acumen.

6. Agencies lack expertise in evaluating ‘green field’
projects.

Services of ‘rating agencies’ are critical in
evaluating risk where

(1) Companies that do not have a credit history or new
companies.

(3) Existing companies are undertaking diversification.

(4) Market risk – where commodities are
involved.

(5) Predicting specific business cycles.

Case study of the Month:

DuPont is a multinational which has a presence in the agro,
nutrition, energy utilities, consumer, government and healthcare sectors,
offering a bouquet of products like flooring materials, lubricants, coatings
like Teflon and a host of other products. Currently it has a net worth of around
7.2 billion US dollars, a long-term debt of 9.5 billion US dollars and a total
debt of 11 billion US dollars.

DuPont up to the 1960’s was known for its financial stability
and low debt to equity ratio and this protected the company from financial
constraints.

Competition increased post 1970, forcing the company to go in
for inorganic growth through acquisitions, and it had to deviate from a zero /
low debt company and start borrowing.

Debt financing resulted in dividend cuts, but with the use of
internal accruals for funding projects, the company managed to maintain a AAA
bond rating.

However, as time passed, the company stopped reducing debt
and went on borrowing, especially for M & A activity.

Increase in debt downgraded the rating to AA. The current
debt rating is lower, being A by Fitch, A2 by Moody’s and A by S & P. The
company is thus faced with a credit rating risk, with the outlook assessment of
all three rating companies being negative.

As a risk management consultant, you are asked for your
inputs and advice in this given situation.

Solution to the Case Study:

The risk manager’s advice is:

(1) Dupont should adopt a conservative capital structure for
the future which will help restore confidence and give the firm greater
financial freedom to fund research projects and diversification and pursue new
projects.

(2) In the interregnum raise the debt equity ratio to 2 to 1
by issue of convertible bonds for a period of 2 to 3 years – conversion at 10%
discount over market price on the date of conversion. This is suggested that the
increased leverage will adversely impact earnings before Tax and also PAT but it
will grant stability in cash flow.

(3) With consolidation and better performance PAT and PE will
increase over a period of 3 years. This is based on the Business plan and profit
projections given by the company and evaluated by the ‘risk manager’.

(4) In the current scenario a better option would be to move
to a higher leveraged position with more debt issued (the company easily can go
up to a debt equity ratio of 2.5 or 3:1. This way it can take advantage of the
tax shield and the revival phase of the economy and manage by issuing much
lesser debt at better rates to finance further activity.

(The case study and solution are not intended to be in the nature of
comments on the functioning or management of the companies but represent one of
the possible approaches selected by the author for demonstrating the concept
and issues of risk management)

Nirav Shah

FDI’s free fall

New Page 1

The existentialist dilemma before Indian democracy is stark :
it cannot co-exist with financial honesty. It does not matter if you are
personally incorruptible; you have to be institutionally corrupt in order to
engage in the business of democracy. The moral code of elections is
uncomplicated : Don’t ask. Don’t tell. And for God’s sake don’t get caught.

— M. J. Akbar
in India Today, dated 10-1-2011

59 FDI’s free fall

Falling FDI in both absolute and relative terms indicates a
lack of investor confidence. It should jolt politicians back to governance and
building on the 1991 reforms. A UN report on FDI in 2010 makes this point
sharply. Though global FDI flows increased by a percentage point over the last
year, developing economies’ share jumped 10%. For the first time ever, more than
half of global FDI travelled to emerging markets. However, FDI inflows into
India declined by a whopping 31.5%. And that’s not in relative but in absolute
terms. In other words, it’s not just that India is getting a smaller share of a
bigger pie — indicating its relative uncompetitiveness among emerging markets.
It’s that the size of the pie itself has shrunk for India – by almost a third.
That ought to be enough to set alarm bells clanging for our economic managers.

(Source : The Times of India, dated 25-1-2011)

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Nirav Shah

Infosys Plans to Stem MBA-MTECH Attrition

New Page 1

— M. J. Akbar
in India Today, dated 10-1-2011

58 Infosys plans to stem MBA-MTECH attrition

Infosys, the country’s second largest information technology
services firm, is aggressively planning to increase the number of its business
consultants by re-skilling many of its engineers.

“Every quarter, a lot of people leave us for higher courses
like MBA and MTech. We have seen a rise in the interest level of our employees
for consulting work. To tame this and provide growth opportunity for engineers,
we are planning to introduce a new initiative as part of our iRace (Infosys Role
and Career Enhancement) programme,” said Mohandas Pai.

In-house CAT : In-house engineers with over two years of
experience can opt for this programme. The company is expected to do a pilot
test soon and to implement the programme next year. “We will conduct a test for
the employees and if they pass the test, they can join our consulting team,” Pai
added.

(Source : Business Standard, dated 21-1-2011)

(Comment : Our profession needs a similar programme)

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Nirav Shah

RBI promises parity if foreign banks form arms

New Page 1

— M. J. Akbar
in India Today, dated 10-1-2011

57 RBI promises parity if foreign banks form arms

The Reserve Bank of India (RBI) is dangling the carrot of
near level-playing field to foreign banks such as Citigroup and HSBC, if they
convert into wholly-owned subsidiaries which is essential for systemic safety,
instead of functioning as parents’ branches, leaving room for instability.

MNC banks would be allowed to set up branches at their will
in smaller cities, barring some security-sensitive regions, and list their
shares on stock exchanges with at least 25% Indian holding, said a central bank
discussion paper on Presence of Foreign Banks in India.

Global banks would have a minimum capital adequacy ratio of
10% and lower priority sector lending target than domestic private peers.

There are 34 foreign banks operating in India as branches,
accounting for 7.65% of total banking assets as on March 31, 2010, up from 9.03%
a year ago. If credit equivalent of off-balance sheet assets are included, their
share was 10.52%. The share of top five foreign banks alone was 7.12%.

(Source : The Economic Times, dated 22-1-2011)

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Nirav Shah

SC blames own verdicts for declining standards

New Page 1

— M. J. Akbar
in India Today, dated 10-1-2011

56 SC blames own verdicts for declining standards

The Supreme Court reprimanded governments for abuse of
discretionary land allotment powers before turning reflective and admitting that
some of its judgments have contributed to the all-round falling standards.

The Bench’s remarks came during the hearing of a petition,
which accused the Madhya Pradesh Government of allotting 20 acres of prime land
at a throwaway price to the Kushabhau Thakre Trust, which has BJP leaders L. K.
Advani and Venkaiah Naidu as trustees. Before reserving verdict, the Court said
: “Discretionary power was to be used in public good. In the last 50 years, this
is exercised just for the opposite. The man who abides by law feels he is a
fool. Every state, not only Madhya Pradesh, who has got discretionary power has
abused it.

(Source : The Times of India, dated 19-1-2011)

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Nirav Shah

Political governance — End the drift

New Page 1

— M. J. Akbar
in India Today, dated 10-1-2011

55 Political governance — End the drift

Decision-making isn’t a synonym for governance. Even so, it’s
a good pointer to a ruling dispensation’s ability to be on its toes. On that
score, data shows UPA-II fared badly in 2010. The cabinet’s record on number of
decisions taken in 2010 compared to earlier was below par. Between 2005-08
during the Congress-led coalition’s first tenure, the cabinet took an average of
242.5 decisions yearly. The annual average since 2005 is 183. In 2010, however,
the Cabinet managed consensus on just 112 decisions, the lowest single-year
figure since the UPA came to power. Amazingly, decision-making actually
decelerated post-2009, when the Left was no longer around to ambush it !

(Source : The Times of India, dated 18-1-2011)

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Nirav Shah

Fuel Pricing — Death by policy

New Page 1

— M. J. Akbar
in India Today, dated 10-1-2011

54 Fuel Pricing — Death by policy

The new Union minister for petroleum and natural gas Jaipal
Reddy can implement the brightest ideas from the smartest bureaucrats and yet
the root of the problem that resulted in the murder of Mr. Yashwant Sonawane, a
district official in Maharashtra who sought to curb the adulteration of petrol
by the kerosene mixing mafia, will not be touched unless India’s fuel pricing
policy is shaped by the logic of simple economics. Various estimates have been
provided in the past few days of the size of the domestic black market in
kerosene. Some put it upwards of Rs.16,000 crore annually. This is a huge amount
of money that can finance large and even globally powerful mafias, not to
mention two-bit gangsters like the ones who killed Mr. Sonawane. There was a
time when Mumbai was in the grip of smugglers. With some simple policy steps
like lower tariffs, liberalisation of gold imports and such like these
all-powerful mafias were marginalised and largely confined to Bollywood movies.
In the case of kerosene and diesel an export smugglers mafia has been created
with India’s lower priced fuels smuggled to Nepal and Bangladesh.

The only way in which mafias get eliminated is by the
elimination of the economic basis for their existence. It is not prohibition
that finally ended the power and wealth of bootleggers and illicit liquor mafia,
but a liberal policy that allowed the sale of properly priced alcohol.

As a first step, the Government must reduce the price
differential between diesel, kerosene and petrol. This will not only have the
positive effect of reducing the fiscal burden of the humungous oil subsidy, but
also encourage a more rational use of both diesel and kerosene. The
under-pricing of these two fuels has encouraged the growth of highly
energy-inefficient and environmentally dangerous means of power generation and
fuel utilisation. Moreover, for an import-dependent country like India
subsidised fuel increases the trade deficit and contributes to external payments
problems.

(Source : Business Standard, dated 31-1-2011)

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Nirav Shah

SC : No govt. wants a strong judiciary

New Page 1

— M. J. Akbar
in India Today, dated 10-1-2011

(Source : Business Standard, dated 15-2-2011)

53 SC : No govt. wants a strong judiciary

The Supreme Court said no government wants a strong judiciary
and added that meagre budgetary allocations by the Centre and states came in the
way of setting up of courts and infrastructure to speed up the justice delivery
system.

It said : “No government wants a strong judiciary . . .
Budgetary allocation to judiciary is less than 1% by the governments. This shows
their commitment towards judiciary.” The remark from a Bench of Justices G. S.
Singhvi and A. K. Ganguly came when it was told that only one witness has been
examined in the last four years in the Amar Singh phone-tapping case, which has
been marred by adjournments.

(Source : The Times of India, dated 12-2-2011)

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Nirav Shah

Taxing wealth — Has the time come for the super-rich to pay more taxes ?

New Page 1

— M. J. Akbar
in India Today, dated 10-1-2011

52 Taxing wealth — Has the time come for the super-rich to
pay more taxes ?

One of the high points of economic and fiscal reform in India
in the past two decades has been the progressive moderation of direct tax rates.
Thanks to this, the ratio of direct to indirect taxes has risen, a sign of
greater progressiveness and equity in India’s taxation system. Direct taxes are
not easily passed on, as indirect taxes tend to be, and so their incidence is
more directly on the individual or firm paying the tax. While this has been a
positive trend, the ratio of total tax revenues to national income has, in fact,
come down in recent years and remains below 12%. India has a very low tax/GDP
ratio by world standards. Apart from widespread tax evasion and avoidance, the
complete exemption of certain types of income from taxation, like agricultural
income, has made it that much more difficult for the tax authorities to capture
all taxable incomes.

The wealth of just 657 BS billionaires has been estimated to
be Rs.16 lakh crore. Taxing away just 0.1% of that would yield a revenue of
Rs.16,000 crore. A 10% long-term capital gains tax, with the securities
transactions tax dumped, and a death duty or inheritance tax can easily generate
another Rs.10,000 crore, netting a cool Rs.26,000 crore of additional direct tax
revenue, without hurting the middle class. Not only would this help Mr.
Mukherjee in his fiscal house-keeping but it would give his party a talking
point at a time when it is being accused of corruption and currying favour with
corporates. Some, including the stock market, would cry foul and the Government
must factor that negative response in. But many would cheer a Government dipping
into the deep pockets of the super-rich.

(Source : Business Standard, dated 15-2-2011)

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Nirav Shah

Trade mark Law: ‘Parody’

IPR LAWS

An interesting debate arises in light of the recent
controversy between the Tata Group and Greenpeace, India (‘Greenpeace’). The
facts leading to the controversy and a recent judgment of the Delhi High Court
were that Greenpeace, a non-profit organisation that seeks to promote
environmental causes, had started a campaign protesting the building of a port
in the Bhadruk District in Orissa. It was Greenpeace’s view, that the building
of the port would dishouse the Olive Ridley turtles found in the area as also
disturb the marine life in the vicinity. The Tata Group resisted the said
campaigning and asserted that they had already secured all necessary approvals
and permissions. Hence, in order to raise awareness about the plight of the
turtles, Greenpeace India, inter alia, hosted a game on their website known as
‘Turtle v. Tata¹.’ The game is a pac man style game wherein
the role of the pac man is portrayed by a turtle and the demons are the symbol
of Tata chasing the turtle. It was in this context that Tata filed a claim in
the Delhi High Court on two grounds, firstly that the acts of Greenpeace were
defamatory in nature; and secondly, that by using the name Tata and the symbol
of Tata, Greenpeace had infringed the registered trade marks of Tata.

For the purposes of the present article, we are concerned
only with the second aspect of the claim, i.e., trade mark infringement and
whether such ‘parodic’ use of a trade mark would amount to infringement thereof.
The issue is a delicate one since it involves the balancing of two competing
private rights as also two competing public interests. The private rights are
obvious, one being the right to free speech and the other being the right in
property of the trade mark owner. The public interests, though may not be
evident immediately, do exist. The right to free speech is a fundamental right
guaranteed to every citizen under Article 19 of the Constitution of India, and
it is imperative in public interest that this fundamental right is not
restricted except to the limited extent as envisaged under the said Article
itself. On the other hand trade mark law apart from protecting the rights of an
individual in his property, does a more important function that of preventing
public confusion. Trade mark law seeks to protect the general public from the
confusion that may arise in case identical and/or deceptively similar marks are
used by different traders upon their goods in the market. Such confusion, if not
protected against, could lead to disastrous consequences — for example, where a
medicine for lowering blood pressure and a medicine for increasing blood
pressure are sold under identical and/or deceptively similar trade marks. Public
confusion in such a case could even be fatal.

It is in light of the above, that I propose to examine the
law relating to use of trade marks in parodies and to what extent can a
citizen’s right to free speech be extended, can it be allowed even if it
violates someone else’s property rights or must it be curtailed as being a
reasonable restriction and/or to put it differently does a trade mark
registration prevent all further usage of the trade mark by any other person.

In order to examine this issue, reference may be made to
Article 19 of the Constitution of India and section 29 of the Trade marks Act,
1999, each of which, inter alia, provide as under:

Constitution :

“19. Protection of certain rights regarding freedom of
speech, etc.

(1) All citizens shall have the right

(a) to freedom of speech and expression;

(b) – (g) xxxxxx

(2) Nothing in sub-clause (a) of clause (1) shall affect
the operation of any existing law, or prevent the State from making any law,
in-so-far as such law imposes reasonable restrictions on the exercise of the
right conferred by the said sub-clause in the interests of the sovereignty
and integrity of India, the security of the State, friendly relations with
foreign States, public order, decency or morality or in relation to contempt
of court, defamation or incitement to an offence.”

Trade marks Act, 1999:

“29. Infringement of registered trade marks. —

(1) A registered trade mark is infringed by a person who,
not being a registered proprietor or a person using by way of permitted use,
uses in the course of trade, a mark which is identical with, or deceptively
similar to, the trade mark in relation to goods or services in respect of
which the trade mark is registered, and in such manner as to render the use
of the mark likely to be taken as being used as a trade mark.

(4) A registered trade mark is infringed by
a person who, not being a registered proprietor or a person using by way of
permitted use, uses in the course of trade, a mark which —

(a) is identical with or similar to the registered
trade mark; and

(b) is used in relation to goods or services which are
not similar to those for which the trade mark is registered; and

(c) the registered trade mark has a reputation in India
and the use of the mark without due cause, takes unfair advantage of or is
detrimental to, the distinctive character or repute of the registered
trade mark.”

A bare reading of section 29 would show that use of a
registered trade mark as a trade mark by any person other than the registered
proprietor of a trade mark without the consent of the owner would amount to an
infringement thereof. Hence, in the instant case, it was argued by the Tata
Group that use of their registered trade mark and symbol by Greenpeace was in
violation of their rights and amounted to infringement of registered trade
marks. Greenpeace took the defence that the use of the trade marks was merely in
a parodic sense and not for any other purpose. Greenpeace urged that the use of
a trade mark in a parody would fall within section 29(4) of the Trade marks Act,
1999 and hence, would not amount to an infringement. Greenpeace contended that
their use was not ‘without due cause’ and hence, they had not infringed the
registered trade marks.

At this juncture, before alluding to the ratio decidendi of
the Delhi High Court in the above matter, I would like to, as a background,
explain what is a parody and draw attention to a few judgments of the American
Courts, wherein the issue of use of a trade mark in a parodic sense has been
considered and dealt with.

It may be appreciated that in the USA the right to freedom of speech guaranteed under the First Amendment to the American Constitution is absolute as compared to the conditional right to freedom of speech granted under the Indian Constitution2. Hence, the considerations weighing with the American Courts vis-à-vis the freedom of speech would not be entirely analogous.

A parody as defined by Wikipedia is “is a work created to mock, comment on, or make fun at an original work, its subject, author, style, or some other target, by means of humorous, satiric or ironic imitation.3”

The Second Circuit has in the case of Cliff Notes Inc. v. Bantam Doubleday Dell Publishing Group Inc.4 succinctly explained the purpose of a parody as being “A parody must convey two simultaneous and contradictory messages: that it is the original but also that it is not the original and is instead a parody.” The Second Circuit also pointed out that if a parody which only performed the first function, it would be subject to trade mark law since it could lead to consumer confusion. The Court held that the principal issue that ought to be decided in such a case was how to strike a balance between the two competing considerations of allowing artistic expression and preventing consumer confusion.

Music International5, the Ninth Circuit dealt with a claim by Mattel for the use of its trade mark ‘Barbie’ by the music group Aqua in their song entitled ‘Barbie Girl.’ The lyrics of the song made references to the trade mark ‘Barbie’ and it was this use of the trade mark ‘Barbie’ which was considered, inter alia, an infringement by Mattel. The Ninth Circuit, after considering the manner of use and the nature of the use of the trade mark in the song, held that there was no infringement. The Ninth Circuit made several interesting observations with respect to the conflict between the rights granted under the First Amendment (right to free speech) and to the rights of a trade mark owner. The Ninth Circuit observed, inter alia, as under:

“The First Amendment may offer little protection for a competitor who labels its commercial goods with a confusingly similar mark, but trade mark rights do not entitle the owner to quash an unauthorised use of the mark by another who is communicating ideas or expressing points of view. Were we to ignore the expressive value that some marks assume, trade mark rights would grow to encroach upon the zone protected by the First Amendment. When unauthorised use of another’s mark is part of a communicative message and not a source identifier, the First Amendment is implicated in opposition to the trade mark right. Simply put, the trade mark owner does not have the right to control public discourse whenever the public imbues his mark with a meaning beyond its source identifying function. It is the source identifying function which trade mark law protects, and nothing more.”

The Ninth Circuit, in order to adjudicate the dis-pute, applied the test as to whether the use of the trade mark was misleading to the source or content of the work or did it have artistic relevance to the underlying work. The Court held that the use of ‘Barbie’ by the defendants was not misleading as to the source and hence, no case for infringement was made out.

One more interesting judgment of the American Courts in this regard is the case of Mutual of Omaha Insurance Co. v. Novak6 wherein the alleged infringing acts were the use by Novak of the trade marks of Mutual of Omaha Insurance Co. on T-shirts. The registered trade mark of the Mutual of Omaha Co. was ‘Mutual of Omaha’, used in respect of its insurance services. Novak started using a similar design with the trade mark ‘Mutant of Omaha’ and a sign below that which read as ‘Nuclear Holocaust Insurance.’ In this case, the defence of parodic use was negated by the majority on the grounds that the protection af-forded by the First Amendment does not give a licence to infringe someone else’s property rights; and that since there were several other avenues of communication available to Novak, such as an editorial parody in a book, magazine or film, such use in violation of the rights of Mutual of Omaha Insurance Co. must be injuncted. Justice Heaney, however, dissented and considered that the majority judgment had failed to recognise and protect the rights of Novak under the First Amendment.

In India, on the other hand, there have not been too many judicial pronouncements on parody as a defence in a trade mark infringement action. One of the few earlier judgments is in the case of Pepsico Inc v. Hindustan Coca Cola Ltd.7, wherein the Delhi High Court recognised in passing that a parody would not be an infringement and held that, “Similarly, use of the phrase in the commer-cial advertisement “Yeh Dil Mange No More” can at best be mocking or parodying in the context it is used, but does not amount to infringement of trade mark of the appellant.”

However, now Justice Ravindra Bhat has in his judgment in Tata Sons Ltd. v. Greenpeace 8 dealt with and discussed the subject of parodies in some detail. Justice Bhat based his judgment primarily on the judgment of the South African Constitutional Court in case of Laugh It off Promotions CC v. Freedom of Expression Institute9, which was a case where the Defendant had sought to market T-shirts bearing parodied images of trade marks of several corporate giants. This was objected to by South African Breweries, one of the corporate giants whose trade marks had been parodied upon on the defendant’s T-shirts. It was in these facts that the Court was pleased to hold as under:

“76. Parody is inherently paradoxical. Good parody is both original and parasitic, simultaneously creative and derivative. The relationship between the trade mark and the parody is that if the parody does not take enough from the original trade mark, the audience will not be able to recognise the trade mark and therefore, not be able to understand the humour. Conversely, if the parody takes too much it could be considered infringing based upon the fact that there is too much theft and too little originality, regardless of how funny the parody is.

Parody is appropriation and imitation, but of a kind involving a deliberate dislocation. Above all, parody presumes the authority and currency of the object work or form. It keeps the image of the original in the eye of the beholder and relies on the ability of the audience to recognise, with whatever degree of precision, the parodied work or text, and to interpret or ‘decode’ the allusion; in this sense the audience shares in a variety of ways the creation of the parody with the parodist. Unlike the plagiarist whose intention is to deceive, the parodist relies on the audience’s awareness of the target work or genre; in turn, the complicity of the audience is a sine qua non of its enjoyment.

The question to be asked is whether, looking at the facts as a whole, and analysing them in their specific context, an independent observer who is sensitive to both the free speech values of the Constitution and the property protection objectives of trade mark law, would say that the harm done by the parody to the property interests of the trade mark owner outweighs the free speech interests involved. The balancing of interests must be based on the evidence on record, supplemented by such knowledge of how the world works as every judge may be presumed to have. Furthermore, although the parody will be evaluated in the austere atmosphere of the Court, the text concerned (whether visual or verbal or both) should be analysed in terms of its significance and impact it had (or was likely to have), in the actual setting in which it was communicated.

It seems to me that what is in issue is not the limitation of a right, but the balancing of competing rights. The present case does not require us to make any determinations on that matter. But it would appear once all the relevant facts are established, it should not make any difference in principle whether the case is seen as a property rights limitation on free speech, or a free speech limitation on property rights. At the end of the day this will be an area where nuanced and proportionate balancing in a context specific and fact-sensitive character will be decisive, and not formal classification based on bright lines.

In sum, while a defendant’s use of a parody as a mark does not support a ‘fair se’ defence, it may be considered in determining whether the Plaintiff-owner of a famous mark has proved its claim that the defendant’s use of a parody mark is likely to impair the distinctiveness of the famous mark.”

It was based on the above reasoning and in light of the facts that Justice Bhat was pleased to hold that Greenpeace’s actions did not amount to an infringement and held, inter alia, as under:

“42. The above analysis would show that the use of a trade mark, as the object of a critical comment, or even attack, does not necessarily result in infringement. Sometimes the same mark may be used, as in Esso; sometimes it may be a parody (like in Laugh it Off and Louis Vuitton). If the user’s intention is to focus on some activity of the trade mark owners, and is ‘denominative’, drawing attention of the reader or viewer to the activity, such use can prima facie constitute ‘due cause’ u/s.29(4), which would disentitle the Plaintiff to a temporary injunction, as in this case. The use of TATA, and the `T’ device or logo, is clearly denominative. Similarly, describing the Tatas as having demonic attributes is hyperbolic and parodic. Through the medium of the game, the defendants seek to convey their concern and criticism of the project and its perceived impact on the turtles habitat. The Court cannot annoint itself as a literary critic, to judge the efficacy of use of such medium, nor can it don the robes of a censor. It merely patrols the boundaries of free speech, and in exceptional cases, issues injunctions by applying Bonnard principle.”

I firmly believe that Justice Bhat’s judgment is a step forward in the right direction. However, each case would have to be judged on its own merits. A perusal of the above judgments reveals as to how Courts have so far sought to balance the two competing interests in cases of parodies involving registered trade marks. In my opinion, this is a very sensitive matter and the line of distinction very fine between the two competing public interests. Courts will need to exercise their judicial discretion in every case to determine whether the use of a trade mark in a parody is promoting public interest in terms of establishing free speech or would it be reasonable to restrict the same since it is in fact harming public interest by causing public confusion as also violating the rights of an individual trade mark owner.

One cannot overemphasise the importance and relevance of the present issue, since it involves a balancing act between two competing public interests and not just private interests. Admittedly, the case when filed by a trade mark owner would be to protect his own private interest in property but the underlying fact is that Courts will be called upon to consider and/or must consider the public interests involved. The freedom of speech as against the disastrous consequences which could arise out of public confusion need to be assessed and balanced in each case. Hence, it is essential that an effective rule and/or law is developed to guide the Courts in such matters. An official recognition to parodies would also be beneficial. The Copyright Act, 1957 does protect work published for the purpose of fair comment and criticism. I think it would be advisable to introduce a suitably moulded provision in the Trade marks Act, 1999 as well.

Nirav Shah

Know your A.O.

LIGHT ELEMENTS

‘Know your judge before you know law’ it sounds very simple.
Obviously, it has direct relevance to legal proceedings. It deals with the
mindset of the person in the chair of judge. My friend Herambha Shastri once
elaborated this adage when we were deliberating an income-tax case. Let me share
with you Herambha’s interesting musings over this issue.

‘First we should make an ‘amendment’ to this maxim for the
purpose of proceedings under the income tax law as ‘Know your Assessing Officer
before you know Income-tax law’. You know the facts. You know the law. You know
the case law. But alas! If you don’t know the AO, then you suffer.

How do you know the AO? For that matter first you should
imagine and be in the AO’s shoes. Given the discretionary powers under the
Income Tax Act, think how you can exercise those powers ‘irrationally and
illogically’. It is said that ‘facts come first and law comes next’. But mind
you, under the income-tax proceedings the discretionary powers of the AO come
first, facts come next and then the law follows (if at all, by the time you
reach the Appellate stage).

Never show that you know the income-tax law more than the AO,
since there is ‘a deeming fiction’, though unwritten, that the AO is always
well-versed with the law he implements. His knowledge about case laws is
state-of-the-art as if he has delivered all those judgments. So please don’t
flaunt your knowledge of law and the case law. This is all about what you should
have in mind before you enter the AO’s office.

The moment you knock the door to enter the cabin be careful
about observing the protocol established in the British era (say, ‘May I come in
Sir, I am so sorry to bother you’ etc. ). A slight mistake may vitiate the
atmosphere and hence the proceedings even before they begin.

Having entered the cabin, don’t occupy the chair till the AO
asks you to sit. Normally, he lets you in but will not attend to you till you
feel awkward and uneasy. You keep looking around aimlessly. What you find is a
medium-size dusty framed photograph of Mahatma Gandhi on the wall, then a
calendar, obviously given by one of the taxpayers (maybe wanting to impress the
AO), a shelf stacked with files and papers full of dust, a steel cupboard with
topped with bundles of some more files in red cloth, a ceiling fan rattling over
the head of the AO along with humming of the air-conditioner and old books on
Income-tax Act and Rules, and ready reckoners which appears never to have been
touched.

Give the AO sufficient time to complete his conversation on
the phone if he happens to be on the line with the higher-ups or some friend.
Don’t stretch your hand for a shake-hand for your introduction. Unfortunately,
this British cutom is somewhat despised in the Income-tax Department. I don’t
know why? When the AO finishes his conversation or his work on hand, he will
stare at you and wave at you with his hand indicating you to sit (as if he is
very considerate to you). When you settle in the chair, don’t bother to
introduce yourself, that is of no consequence till it is time to sign the order
sheet. Only indicate the assessee’s name.

The AO would then become active and start the search for the
file on the ‘hit list’. Normally, he finds it instantly in that mess if he wants
to. I wonder how? But unfortunately he can never locate the copy of the notice
sent by him. His assistant also fails in that pursuit. This is the first
opportunity to begin co-operating with the Department, don’t lose it, so take
out the copy of the notice from your file and hand it over to the AO but be
placid. The AO would just chuckle.

Consider the AO as a dormant volcano. Sometimes he would
place in your hand a printed questionnaire or dictate questions orally depending
upon the stakes (obviously government’s stake) involved in and his homework of
the case. Normally, he starts his ‘homework’ after your submissions. Thereafter,
you start feeling the ‘heat’ of his discretionary powers till your position
becomes vulnerable and non-negotiable. You become paranoid about what would be
the AO’s perspective. If the AO is a direct recruit he will be more stern,
studious and innovative about the compliance of tax laws. If he is promoted as
an AO from within the Department he will be more concerned about procedural
matters. If he is on the verge of retirement he will be lenient and
understanding, compared to a younger AO. A lady AO will, probably, be more
professional.

Here my friend Herambha stopped his elaboration. But he made
a very subtle remark, ‘Keep in mind, there is no penalty for ‘concealment of
satisfaction’ by the AO under the income-tax law’. May be CPE programmes should
have a course in psychology as well.

levitra

Nirav Shah

CA certificates under I-T Dept scanner

New Page 1

43 CA certificates under I-T Dept scanner

After the Satyam scam, the role of chartered accountants (CAs)
has come into focus again. This time the Income Tax (I-T) Department has found
that CAs have given false certificates, enabling Non-Resident Indians (NRIs) and
foreign nationals to evade taxes in India. The government agency has informed
the Institute of Chartered Accountants of India (ICAI), which regulates the
chartered accounting profession in the country, of the fraud. ICAI has powers to
take disciplinary action against errant members. Calling the fraud ‘a massive
violation of the law’, the Central Board of Direct Taxes (CBDT) Member Saroj
Bala (in charge of revenue) said, “A large number of such payments are outright
tax deductible in India and taxable in India, but are not taxed because CAs have
certified them not taxable. The ‘CBDT’ administers all direct tax issues in the
country, but the tip-off on this method of tax evasion came from a CA. Under the
Income-tax Act, a CA certificate can be obtained saying no tax needs to be
deducted while remitting money overseas, after which the Reserve Bank of India
permits the transfer of money. Bala said the department receives numerous such
certificates involving ‘thousands of crore of rupees’. A firm estimate of
revenue loss is not yet available as investigations are still on. The payments
that are under the I-T Department’s scanner are interest on overseas loans,
payments for contractual work by foreign firms in India and capital gains from
sale of assets (similar to the Vodafone-Hutch transaction). For instance, if an
Indian firm borrows from a foreign bank, under normal circumstances tax will
have to be deducted on the subsequent interest payment. But no tax is payable if
a CA certifies that the overseas entity that receives the interest payment is
not a tax resident of India. The I-T Department’s investigations have found that
the non-tax residency is not necessarily the case. “Some verifications and
inspections of certificates have been carried out and many defaulters found. We
are contemplating action against this false certification by CAs,” Bala said.
Indian tax rules also require tax to be deducted on payments from any income
earned by a company that has a permanent establishment (PE) in India.
Verification of many such CA certificates revealed that the foreign recipients
had PEs in India, but escaped the tax net. Investigations found that both small
and large accountancy firms are into this practice. “Normally, many CAs do not
apply their mind. They issue the certificate and make money,” she said, adding
that when confronted, some CAs claimed they were not aware of the tax
provisions.

(Source : Business Standard, 2-2-2009)

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Nirav Shah

Centre forms task force to curb misuse of subsidies

New Page 1

— M. J. Akbar
in India Today, dated 10-1-2011

51 Centre forms task force to curb misuse of subsidies

To curb the misuse of subsidised kerosene, cooking gas (LPG)
and fertilisers, the Centre has constituted an inter-ministerial task force
under Unique Identification Authority of India (UIDAI) Chairman Nandan Nilekani.

The team of experts will work to evolve a mechanism for
direct subsidy transfer and give its interim report within four months. Several
Government committees in the past, including the Kirit Parikh committee, had
recommended direct transfer of subsidies. States such as Haryana and Madhya
Pradesh are close to implementing a direct subsidy transfer for grains.

The Government had formed the task force in light of the
‘overwhelming evidence’ that the present policy of giving subsidy on kerosene
was resulting in ‘waste, leakage, adulteration and inefficiency’, the statement
said. The Government provides kerosene at subsidised prices to below-poverty
line families under the Public Distribution System. “Therefore, it is imperative
that the system of delivering the subsidised kerosene be reformed urgently,” it
added.

“Similarly, the system of provision and delivery of
subsidised LPG to intended beneficiaries needs to be reformed. The current
subsidy on kerosene is Rs.20.56 per litre while the same on domestic LPG is
Rs.356 per cylinder. This leaves a massive scope for black marketing in these
essential commodities,” the statement said.

(Source : Business Standard, dated 15-2-2011)

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Nirav Shah

ICSI told to suggest changes in LLP Structure:

New Page 1

74 ICSI told to suggest
changes in LLP Structure:

The
Ministry of Corporate Affairs has asked the Institute of Company Secretaries of
India (ICSI) to suggest changes to make the limited liability partnership (LLP)
model more suitable for the small and medium sector enterprises in the country.

Converting to an LLP structure will also help SME units get easier access to
credit from banks, the official said. LLP’s registrations were opened in April
last year but the response has been very poor, with only 677 entities being
registered till date. The official further points out that the present number
mainly comprises big consulting groups and law firms, with a relatively small
portion of small-sized entities and new entrants showing interest. “This (LLP
form of business) is a fantastic new opportunity and will inevitably give a
whole new profile to the MSME sector.

It will
be possible for the sector to reach out to venture capital. This can be the
stepping stone for partners becoming much larger industrialists and logging
bigger growth,” Minister for Corporate Affairs Salman Khurshid had earlier said,
on the advantages for SMEs to leverage out from the LLP model. The report of the
task force on SMEs, which was recently presented to Prime Minister Manmohan
Singh, had highlighted the need for giving wide publicity to the LLP model,
which it said will provide SMEs an interim solution to move from the informal to
the formal economy.

(Source:
The Economic
Times dated 06.02.2009)

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Nirav Shah

Top-level vacancies frustrating tax targets: CBDT

New Page 1

73 Top-level vacancies frustrating tax targets: CBDT

Three
weeks to go before presentation of India’s national budget and the finance
ministry called for urgent steps to fill top-level vacancies in the direct tax
administration as delays were affecting the realisation of targets.

Central
Board of Direct Taxes (CBDT) Chairman S.S.N. Moorthy has even written to the
chairman of Union Public Service Commission requesting an urgent meeting of what
is called the departmental promotion committee for filling up the vacancies.

In the
letter, Moorthy says after the recent promotion of some officials to the grade
of chief commissioners, the vacancies in the posts of commissioners of income
tax had gone up to as high as 71.

Some of
these vacancies are in key circles of the tax administration in large metros
such as Mumbai, New Delhi and Chennai, which account for the bulk of the
country’s direct tax collections.

“Needless to say, this is adversely affecting the efforts of the department in
meeting the revenue collection targets,” the tax board chief says in the letter
to Union Public Service Commission Chairman D.P. Agarwal.

The
letter also comes against the backdrop of Finance Minister Pranab Mukherjee
directing the Income Tax Department to make all efforts to achieve the revised
collection target of Rs.4,000 billion by the end of this fiscal.

India’s
direct tax collections have been just Rs.2,500 billion in the first nine months
of this fiscal, growing at 8.5 per cent over the corresponding period of the
previous year. In fact, personal income tax has actually seen a decline of 0.41
per cent. This has obviously made the tax administration jittery.

Senior
officials said one of the main ways to enhance tax collections would be by
regular sharing of information among the commissionerates and developing a
common database. But vacancies at the top slots are frustrating such efforts.

Revenue
Secretary Sunil Mitra is also holding an urgent meeting with 18 chief
commissioners of income tax here to review the shortfall in tax collections and
find ways to make it up.

(Source:
www.topnews.in dated 05.02.2010)

(Compiler’s
Note:
Revenue collection will increase when taxpayers are treated with respect and
trust due to a worthy customer. Today, an honest tax payer is the most harassed
lot as he finds himself unable to deal with the corrupt officials and has to
face time consuming and costly litigation. A dishonest taxpayer has the money to
smoothen his way. The FM should inculcate the habit amongst his officers to
treat the taxpayer with trust and respect. Otherwise, he will be killing the
goose which lays the golden egg!!!)

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Nirav Shah

S&P threatens to downgrade Japan’s rating:

New Page 171 S&P threatens to
downgrade Japan’s rating:

S&P
threatened to downgrade Japan’s rating unless the world’s second-largest economy
took more steps to rein in its mounting public debt.

The
warning by Standard & Poor’s, which cut its outlook for Japan’s sovereign rating
for the first time since 2002, reflected concerns that the government’s efforts
to trim its mounting public debt were proceeding too slowly.

S&P
retained its long-term credit rating for Japan of AA, defined by the agency as a
very strong capacity to meet financial commitments, but said it had revised the
outlook associated with that rating from stable to negative. The AA rating puts
Japan in the same category as Slovenia, Chile and Ireland, according to S&P’s
website.

(Source:
The Times of India dated 28.01.2010)

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Nirav Shah

Learn technology in your language:

New Page 1

72 Learn technology in your
language:

Spoken
Tutorials, a technology that explains software applications in your mother
tongue, will be launched by the Indian Institute of Technology – Bombay.

Nowadays, software applications find use in everyday living. For example, to
book a train ticket online one can log on to www.spoken-tutorial.org and get a
demonstration on steps to book an e-ticket with a commentary in a language of
one’s choice.

The
technology developed by IIT-B will now allow non-English speakers to negotiate
the information highway.

The
technology will soon be introduced in educational institutions across the
country by the National Mission on Education through Information and
Communication Technology (NMEICT), an initiative of the Human Resource
Development Ministry.

(Source:
Hindustan Times dated 26.01.2010)

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Nirav Shah

SMEs to be exempt from IFRS:

New Page 1

70 SMEs to be exempt from IFRS:

Small
and medium enterprises (SMEs) in the country will not have to prepare their
accounts as per the International Financial Reporting Standards (IFRS) from
April 1, 2011, saving them significant cost of switching to the more rigorous
accounting standards. A government-constituted core panel on IFRS has decided to
exempt SMEs from the first phase of convergence falling due in 2011.

Convergence to IFRS is a costly exercise which includes an overhaul of
operational and IT processes apart from training costs. A small enterprise, for
this exemption, is likely to be one where the investment in plant and machinery
is more than Rs 25,00,000 but does not exceed Rs 5 crore.

A medium
enterprise is one where investment in plant and machinery is more than Rs 5
crore but does not exceed Rs 10 crore.

Recently, a core committee of the government finalised the road map for IFRS
convergence in India. The ICAI has said that all entities having net worth in
excess of Rs 1,000 crore will have to follow IFRS. The list also includes all
NSE and BSE listed companies, entities having foreign borrowings of more than Rs
500 crore, insurance entities, mutual funds, venture capital funds and all
scheduled banks having operations outside India.

(Source:
The Economic
Times dated 25.01.2010)

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Nirav Shah

CBDT seeks report on Mumbai I-T refund scam:

New Page 1

69 CBDT seeks report on Mumbai
I-T refund scam:

The
Central Board of Direct Taxes (CBDT) has sought a detailed report from the field
formation in Mumbai over the reported “income- tax refund scam” in that
jurisdiction. No insider of the Income-Tax Department has been identified in any
wrong doing. “It looks as if some external people were involved, but we have to
wait for the complete information,” official sources said. Indications are that
the findings of the report, once obtained, will be placed before the Finance
Minister. CBDT also maintained that the amount involved was not as high as Rs 41
crore as reported in certain sections of the media. Meanwhile, a CBI spokesman
said that the matter has come to the notice of the investigation agency.
However, no case has been registered as yet. “Only if a case is registered can
an investigation begin. More details can be shared only if a case is
registered,” the spokesman added.

(Source:
The Hindu Business Line Newspaper dated 25.01.2010)

(Compiler’s
Note: The issue
arises: Can we trust the safety and security of confidential financial data
which assessees upload on the Department’s website, if the Department cannot
protect its own interest?)

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Nirav Shah

RCom wants action against its special auditor:

New Page 1

68 RCom wants action against
its special auditor:

Reliance
Communications (RCom) has asked the Department of Telecommunications (DoT) to
take action against its special auditor, Parakh & Co, for alleged breach of
confidentiality and misconduct. It has also asked DoT to scrap Parakh’s report,
saying the conclusions are incorrect, unilateral and biased.

The
audit report, commissioned by the DoT, had alleged that RCom had hidden revenues
of Rs 2,799 crore for the financial years 2006-07 and 2007-08, costing the
government Rs 315 crore in licence and spectrum fees that are charged as a
percentage of revenue.

The
auditor also said RCom inflated wireless revenue by 23 per cent or Rs 2,915
crore, to Rs 15,213 crore in the report to shareholders in 2007-08.

The
terms of reference did not require the auditor to make observations on
consolidated financial statements. Moreover, they have finalised the report
without any discussion or communication with us, the company said.

(Source:
Internet & Media Reports dated 25.01.2010)

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Nirav Shah

Licences of Entities Would Be Revoked If TheyzSource Funds From India –Mauritius:

New Page 1

67 Licences of Entities Would
Be Revoked If TheyzSource Funds From India –Mauritius:

The Financial Services Commission of Mauritius has imposed a
stringent set of conditions on Mauritius-based companies investing in India in a
bid to allay fears about round-tripping of funds. The Mauritian government has
also warned that licences of entities investing in India would be revoked if
they source funds from India. The move provides a new turn to the lingering
debate over allegations of Indian corporates using the Mauritius route to escape
capital gains tax. Mauritius is the top source of foreign direct investment (FDI)
flowing into India. During the first seven months of the current financial year,
nearly $8 billion of the $18 billion FDI flowing into India came from Mauritius.
An annual audit of Mauritius-based entities investing in India has been made
mandatory, said Milan J N Meetrabhan, chief executive of the Financial Services
Commission of Mauritius. The Indian side has been apprised of the steps taken to
check round-tripping, and Mauritius hopes that this will take care of the
concerns about tax evasion.

The move is significant since it comes at a time when the
government is planning to review all double taxation avoidance treaties to plug
loopholes. Also, the direct taxes code which is to replace the I-T Act next year
proposes a number of changes in the country’s tax laws, including some that will
nix the capital gains tax exemption enjoyed by investing through havens.

A Mauritian team headed by Dr Rama Sithanen, Vice Prime
Minister and Minister of Finance and Economic Empowerment, met FM Pranab
Mukherjee. Mr. Sithanen said that FDI was flowing into India through Mauritius
not because of the tax benefit only. There are a number of other countries with
more attractive tax treaties with India, but so much investment is not flowing
through them. Mauritius is preferred because we have a transparent regulatory
system and a sound financial sector, he emphasised.

(Source:
Economic Times, dated 20.01.2010)

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Nirav Shah

Get up, sitting for long can kill you – Even Exercising Won’t Help If You Spend Hrs At Office Desk Or Watching TV:

New Page 1

65 Get up, sitting for long
can kill you – Even Exercising Won’t Help If You Spend Hrs At Office Desk Or
Watching TV:

Here’s a
new warning from health experts: Sitting is deadly. Scientists are increasingly
warning that sitting for prolonged periods — even if you exercise regularly —
could be bad for your health. And it doesn’t matter where the sitting takes
place — at office, at school, in the car or before a computer or TV — just the
number of hours it occurs.

In an
editorial published this week in the
British Journal of
Sports Medicine,
Elin Ekblom-Bak of the Swedish School of Sport and Health Sciences suggested
that authorities rethink how they
define physical activity to highlight the dangers of
sitting.

“After
four hours of sitting, the body starts to send harmful signals,” Ekblom-Bak
said. She explained that genes regulating the amount of glucose and fat in the
body start to shut down.

(Source: The Times of India dated 22.10.2010)

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Nirav Shah

ICAI finds Haribhakti & Co guilty of negligence – As Karvy auditor:

New Page 1

66 ICAI finds Haribhakti & Co
guilty of negligence – As Karvy auditor:

The accounting regulator is finally swinging into action in
the multiple demat account scam that was detected over three years ago.

The disciplinary committee of the Institute of Chartered
Accountants of India (ICAI) has found the internal auditors — Haribhakti & Co —
guilty of negligence, while checking the books of Karvy Depository Participant.

ICAI’s disciplinary committee has found one audit partner and
an audit manager of Haribhakti guilty.

But sources said of the three charges that were framed,
Haribhakti has been found guilty on only one charge.

Shailesh Haribhakti, a senior partner of the chartered
accountancy firm, refused to comment, saying “it would be premature”. The
central council of ICAI, which is the highest decision-making body of ICAI, will
now either ratify or overrule the report of the disciplinary committee. The
central council is likely to decide the fate of the two auditors next month. To
give a brief background of the case, the Securities and Exchange Board of India
had unearthed a multiple demat accounts scam in the year 2006.

A person named Roopalben Panchal opened thousands of demat
accounts and illegally cornered shares in various IPOs.

Sebi, in its April 2006 order, among others, faulted the
internal auditors of Karvy – Haribhakti, for failing to detect thousands of
demat accounts being opened with the same address.

(Source:
www.taguru.in & www.bloombergtv.com
dated 19.01.2010)

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Nirav Shah

Politicos, money bags own ‘doomed varsities’

New Page 164 Politicos, money bags
own ‘doomed varsities’

Politicians, property dealers and industrialists-turned-politicians dominate the
list of those who owned the 44 deemed universities that are set to lose ‘deemed’
status in the coming days.

D Y
Patil, Governor of Tripura, is an old Congress hand and runs an education empire
in Maharashtra. Only one of his institutes — D Y Patil Medical
College, Kolhapur — will lose deemed status.

Then,
there is S Jagatharakshakan of DMK, Minister of State, Information &
Broadcasting, whose Bharath Institute of Higher Education & Research will lose
deemed status. BIHER has six constituent institutions involved in teaching
medical and dental science, nursing, physiotherapy and engineering.

Another
one from DMK stable is former Union minister M Thambidurai who runs St Peter’s
Institute of Higher Education and Research in Chennai. It has 1,051 students
enrolled in engineering, computer science, electronics and IT at
undergraduate/postgraduate level and also research. AIADMK leader A C Shanmugham
runs Dr MGR Educational and Research Institute and has dental and engineering
colleges affiliated to it with more than 6,000 students on its rolls.

Santosh
University in Ghaziabad is run by P Mahalingam, personal physician to BSP
founder Kanshi Ram. It has 800 students on its rolls and claims to have three
colleges teaching medical, dental and paramedical sciences. BLDE University,
Bijapur, Karnataka is run by Congress MLA M V Patil. It has a medical college
named after Patil’s father late B M Patil and has nearly 400 students on its
rolls. Former Congress MP R L Jalappa is at the helm of Sri Devraj Urs Academy
of Higher Education & Research, Kolar in Karnataka. Industrialist M A M
Ramaswamy, a member of Rajya Sabha and belonging to JD(S), runs Chettinad
Academy of Research and Education. It has two constituent institutes, a hospital
and research institute and a nursing college.

If it’s
Haryana, it has to be a property dealer. No wonder Maharishi Markendeshwar
University, Mullana, with a host of engineering and medical colleges as its
constituents, is run by Tarsem Garg who started as a property dealer and
graduated to become education entrepreneur.

(Source: The
Times of India dated 20.01.2010)

(Compiler’s Note:
The above is an incomplete
list. The remaining must also be owned/controlled/managed by vested interests.
In such a situation, is policy reform or corrective action possible?)

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Nirav Shah

Deemed Below Par: India’s university education system needs an overhaul

New Page 1

63 Deemed Below Par: India’s
university education system needs an overhaul

We have an acute paucity of quality colleges and universities
in this country. Those already established can barely meet the growing demand
for higher education. Given this situation, government must welcome private
investors who could lend muscle to efforts to scale up the higher education
sector. But such a move would not suit many of our politicians who have a
substantial stake in perpetuating the licence raj in this sector. They often use
their clout to flout norms and unfairly profit from the business of higher
education, arm twisting governing bodies that are meant to be unbiased and independent to do
their bidding. Competition from genuinely interested parties is thus viewed as a
threat by our netas.

The concept of a deemed university itself is a questionable
category and must be done away with. Either a university is autonomous or is
state-run – there is no need for a nebulous in-between category. The
inconsistencies marking deemed universities are there for all to see: They have
the freedom to make profits but are also given huge central government and UGC
grants. Universities and colleges must be given the freedom to run their own
affairs if they are not funded by the union or state exchequers. Instead of
doling out large sums of money, which may go unaccounted for, the government
would do well to make it easier for those seeking to enter the education sector
establish themselves. This could be done by, for instance, allocating land
speedily and eliminating red tape.

(Source: The
Times of India dated 21.01.2010)

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Nirav Shah

Disgruntled Junior Ministers open their heart to the PM: Complain of Lack of Work, Powerful Babus

New Page 162 Disgruntled Junior
Ministers open their heart to the PM: Complain of Lack of Work, Powerful Babus

PM
Manmohan Singh called junior ministers for a rare interaction. Within minutes,
however, he realised he was face to face with a band of unemployed workers. By
the end of the 45-minute session, he had promised to take up their case with the
Cabinet ministers who were in the line of fire.

The
interaction was a long sob story with MoS after MoS lamenting that their seniors
were not giving them enough work, that ‘babus’ were more powerful and that they
wanted more. The PM called junior ministers the energy pool, asking them to
focus on flagship schemes and use technology to improve governance.

The
juniors have been a perennially disgruntled lot, saddled with insufficient work
or unacceptable quality of it. This was true of both the NDA rule and UPA-1. The
story does not appear to have changed in UPA-2. The aggrieved ministers said
that as they do not go to the Planning Commission or attend Cabinet meetings,
they be allowed to give inputs in policy-making and, at least, be informed about
decisions.

The PM
looked grim when told that many ministers don’t even get to see official files.
Panabaka Lakshmi, it is learnt, said she had seen just one solitary file in
eight months. An exasperated MoS asked why could he not be trusted with a file.
The case of the Trinamool underlined an irony. E Ahmed and K H Muniappa, both
deputy to party chief Mamata Banerjee in the Rail Ministry expressed their
unhappiness.

(Source: The
Times of India dated 20.01.2010)

(Compiler’s Note:
The situation in various
States is no better. No wonder the pace of reforms and implementation is so
slow!)

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Nirav Shah

Bar councils under RTI Act purview: CIC

New Page 1

61 Bar councils under RTI Act
purview: CIC

The bar councils are open to public scrutiny under the Right
To Information (RTI) Act and should set-up a mechanism to facilitate processing
of applications directed to them under the transparency law, the Central
Information Commission has held.

The Bar Council of India and Bar Council of Punjab and
Haryana had rejected several RTI applications saying though they were set-up
under the Advocates Act, 1961 they did not get direct or indirect funding from
the government, hence are out of the purview of the RTI Act.

However, the commission in a recent order held that the
councils might not have been financed by the central or state governments but
they were setup under an Act passed by Parliament and hence they are covered by
the RTI act.

(Source:
www.dnaindia.com, dated 19.01.2010)

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Nirav Shah

RBI notifies relaxation in remittance norms

New Page 1

60 RBI notifies
relaxation in remittance norms

The Reserve Bank of India has notified relaxation
in remittance norms regarding salary earned by foreign nationals employed in
India by a foreign company or an Indian citizen employed by a foreign company
outside India. These individuals, according to the RBI, may open, hold and
maintain a foreign currency account with a bank outside India and receive the
whole salary payable to him for the services rendered to the
office/branch/subsidiary/joint venture in India of such foreign company, by
credit to such account, provided that income-tax chargeable under the Income-tax
Act, 1961, is paid on the entire salary as accrued in India. Hitherto, the
amount that could be credited to the foreign currency account with a bank
outside India could not exceed 75 per cent of the salary accrued to or received
by the expatriate or Indian national from the foreign company. Further, the RBI
said that a citizen of a foreign State resident in India employed with a company
incorporated in India may open, hold and maintain a foreign currency account
with a bank outside India and remit the whole salary received in India in Indian
rupees, to such account, for the services rendered to the Indian company,
provided that income-tax chargeable under the Income-tax Act, 1961 is paid on
the entire salary accrued in India. The relaxation in the remittance norm by the
RBI follows the Government notifying the same through a Gazette notification.

(Source:
The Hindu Business Line
Paper
dated 19.01.2010)

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Nirav Shah

Another law, more trouble

New Page 1

59 Another law, more trouble

When governments say they want to protect wages, they often
end up killing employment. They, of course, deny that, but that is what minimum
wages and legalized job security imply. The Union Labour Ministry plans to amend
the Contract Labour (Regulation and Abolition) Act, 1970. This amendment will
allow Labour Commissioners and other officials to fix minimum wages for seasonal
workers. You may say that a law that prescribes minimum wages will only make
people get their due. Instead, it leads to incentives that are detrimental to
the workers.

It will permit appointed officials to harass employers.
Worse, it will permit collusion between firms and officials. If you take the law
and the officials out of the equation, then wages are set by the market. A firm
requiring labourers will have to pay market wages if it wants to get workers.
But with officials in the picture, as the new amendment will ensure, chances are
that they will pay much less. Official collusion and loopholes will ensure that.

(Source:
Mint Newspaper
dated 19.01.2010)

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Nirav Shah

Perceptives

New Page 1

54 Perceptives

“Start by listening, because all too often the United States
starts by dictating.”

— U.S. President Barack Obama, speaking to Al Arabiya news
channel in his first interview with a foreign news outlet, on his instructions
to his new Middle-East envoy.

“That’s cheap for what I do . . . . You’ve got to whet my
appetite to get me onboard.”

— Thomas Taylor, a member of Britain’s House of Lords,
caught on tape telling undercover reporters (posing as lobbyist) that
companies will pay him more than $ 140,000 a year to amend legislation.

“All nations have found themselves in the same boat.”

— Russian Prime Minister Vladimir Putin, exhorting his
colleagues at the davos “economic egotism” because of the economic crisis.

“We have been in business for 300 years. We were hit by the
phylloxera insect in the 19th century that destroyed our vines. . . . we have
faced two world wars. I see the crisis as a challenging but constructive event.”

— Dominique
Heriard Dubreuil, Chairman of the Remy Cointreau Group – the producer of Remy
Martin cognac and Piper-Heidsieck champagne — taking the long view on the
current economic malaise.

(Source : Newsweek,
26-1-2009 and 9-2-2009)

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Nirav Shah

Govt. to allow foreign MNCs to impose annual service fee

New Page 1

52 Govt. to allow foreign MNCs to impose
annual service fee

The Government is considering a proposal to allow foreign
multinationals to impose an ‘annual service fee’ on their Indian subsidiary for
providing management services. The foreign direct investment (FDI) policy, while
allowing payment of royalty, licence fee and technical know-how fee, does not
provide for payment of annual service fee by Indian subsidiaries.

If allowed, this may become another important source of
income for foreign multinational companies from their Indian arms. The issue
came up in the last meeting of foreign investment promotion board (FIPB), when
it took up the proposal of Canada-based potato and French-fry major McCain Foods
for removal of restriction on payment of service fees by McCain India, a major
supplier of cut-potatoes to fast food giants like McDonalds and KFC in India.

The board deferred its decision on the proposal and referred
it to the Reserve Bank of India (RBI) as it has foreign exchange implications.
Mc Cain Canada has a management fee arrangement with group
companies/subsidiaries in order to facilitate the operations of its group
companies and to cover the cost of providing general management services.

McCain India has not made any payment so far in respect of
services provided to it by McCain Canada in view of restriction imposed by the
Government in 1995 in their original approval. “The approval was subject to the
condition that no service fee shall be paid by the Indian subsidiary company,”
an official in the Department of Industrial Policy and Promotion said.

The board’s decision on the company’s request for allowing
payment of service fee to parent company is being watched closely by the
industry, since it will set a precedent for other multinational companies that
charge such fees from subsidiaries in other countries. Arguing its case, the
foreign food processing firm has pointed out that the condition was imposed in
1995 when there were strict foreign exchange control regulations.

A senior official in the DIPP said that the RBI will have to
take a final view on whether an annual service charge could be allowed under
regulations of Foreign Exchange Management Act (FEMA). “If the fee is in the
form of royalty or technical know-how fee, then it can be allowed. Because, in
the present environment, there are no restrictions under the FEMA for companies
intending to make payments towards constancy or services.

FEMA also permits payments towards service fee/ consultancy
fees of up to $ 1 million per project without apex bank’s prior approval,” the
DIPP official said. He also said that introduction of annual service fee in FEMA
may require the RBI to increase the limit of remittances payable to foreign
companies. The various forms of management services provided by international
parent companies to their subsidiaries in various countries include corporate
secretarial services, insurance services, legal advice, pension plan management,
engineering services and other corporate information services. McCain Canada
calculates the quantum of service fee chargeable to the subsidiary based on
actual expenses incurred by it on managing its international operations.

(Source : The Economic Times, 27-1-2009)

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Nirav Shah

Offshore tax shelters much too inviting

New Page 1

53 Offshore tax shelters much too inviting

American companies, especially those receiving federal aid,
should be expected to pay a fair share of U.S. taxes.

Pretty well buried under all the hoopla of President Barack
Obama’s inaugural was a report last week that could help the U.S. Treasury tame
its way-out-of-whack balance sheet. The Government Accountability Office report
looked at U.S. companies that stash money in foreign countries to shelter them
from U.S. taxes.

U.S. Sen. Carl Levin, D-Mich., who requested the report along
with fellow Democratic Sen. Byron Dorgan of North Dakota, estimates that such
companies are avoiding $ 100 billion in U.S. taxes. And many of them — including
Bank of America and Citigroup — have lately been on the receiving end of
billions of dollars in federal bailout money or fat federal government
contracts.

Now, $ 100 billion may seem like pocket change when you’re
running a trillion-dollar budget deficit and carrying a $ 10.4-trillion national
debt. But you know, every billion counts when you are trying to spend your way
out of a recession. Unfortunately, this offshoring of taxable assets is entirely
legal, which Levin and Dorgan hope to do something about.

Common sense, not to mention common decency, would seem to
dictate that if you take tax dollars you also pay your full share of tax bills.

According to the report by the GAO, which is the
congressional watchdog agency on government programmes and spending, 83 of the
100 largest publicly traded U.S. corporations and 63 of the 100 largest publicly
traded companies with government contracts have subsidiaries in places that are
regarded as tax havens. There is no official definition of such places, but they
have common characteristics, such as no or low local taxes, political stability,
laws that keep financial dealings secret, and a tendency to promote themselves
in the right circles as great places to keep your money out of reach of Uncle
Sam or other tax-grabbing governments.

Bermuda, for example, has no income tax on foreign earnings
and allows foreign companies to incorporate there under an ‘exempt’ status. Plus
the island is not a bad place to have to go to visit your money. The British
Virgin Islands, the Cayman Islands, Switzerland and Luxembourg are among other
places that attract extraordinary amounts of foreign corporate capital. None of
the countries identified in the GAO report as tax havens appears to have much in
the way of a military or other things that take a lot of tax dollars. When they
have emergencies, they probably just call us.

To be fair, the GAO report says some companies have
legitimate business reasons to operate in places that also happen to have
favorable tax and privacy laws.

But does insurance giant AIG, for example, recipient of $ 85
billion in federal bailout money, really need five subsidiaries in Bermuda and
three in Switzerland, as listed in the GAO report ? Does Boeing need six in
Bermuda and 16 in the U.S. Virgin Islands ? The report shows Midland-based Dow
Chemical with 35 subsidiary operations in countries identified as tax havens,
Ford with two, General Motors with 11, and GMAC — in which the U.S. Treasury now
has a $ 5-billion stake — with two, one in Bermuda and the other in Switzerland.
How many car loans can you make in such places ?

There are those who will say that if the United States had
more reasonable tax laws, Uncle Sam wouldn’t be driving all this money into
offshore shelters. But there are those, too, who will say that no business will
pass up an opportunity to cut its own taxes.

Back in 2007, when Levin first started raising this issue
through the permanent sub-committee on investigations that he chairs, he had an
ally in the Senate behind legislation to at least make the companies disclose
their financial offshoring, which could have had an impact on their ability to
secure federal help. Levin’s bill was cosponsored by the junior Senator from
Illinois, a Democrat named Barack Obama.

So something tells that while the GAO report didn’t make much
of a splash, it will not be the last word on this issue.

(Source : Internet, 25-1-2009)

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Nirav Shah

Cooking oils fail health test

New Page 1

51 Cooking oils fail health test

Trans fat, a known trigger for heart attacks, causing
thousands of premature deaths globally every year, has been found in
tremendously high quantities in almost all popular Indian cooking oils.

Laboratory tests conducted by Delhi-based Centre for Science
and Environment (CSE) on seven vanaspati brands, 21 different brands of
vegetable oils (soyabean, sunflower, groundnut, mustard, coconut, olive, sesame
and palm), desi ghee and butter available in Indian markets found that trans fat
levels were five to 12 times higher than the world’s recommended standards in
all vanaspati brands.

According to the latest recommendations, trans fat in oil
should not exceed 2% of the total oil. However, the study found trans fat levels
to be as high as 23.7% in the case of Panghat vanaspati brand and 23.31% in the
case of Raag vanaspati. Rath vanaspati had 15.9% trans fat, Gagan had 14.8%,
Jindal had 13.7% while Gemini had 12.7% trans fat content.

Interestingly, the lowest trans fats level was found in desi
ghee and in Amul butter — 5.3% and 3.73%, respectively.

Trans fat occurs when liquid oils solidify by partial
hydrogenation, a process that stretches food shelf life and changes safe
unsaturated fat into a killer. It is known to increase bad LDL cholesterol,
triglycerides and insulin levels and reduces beneficial HDL cholesterol. Trans
fats also trigger cancer, diabetes, immune dysfunction, obesity and reproductive
problems.

In 2005, all restaurants in California went trans fat free
voluntarily. In 2008, the US government made it mandatory. The following year,
even New York banned trans fat. Scientists say an increase of 5 gm of trans fat
a day is equivalent to a 25% increased risk of cardiovascular diseases.

Shockingly, say CSE researchers, even while Indian food
regulators have accepted trans fat as a serious health concern, they are
delaying setting the standard, presumably under pressure from the edible oil
industry. As a result, India has no regulation to check the content of trans fat
in oil.

In 2004, the Health Ministry’s oils and fats sub-committee,
under the Central Committee for Food Standards, begun discussions on a standard
for trans fat. In January 2008, the sub-committee forwarded its recommendations
to the Central Committee for Standards. But the Central Committee is still
awaiting more data and information.

(Source : The Times of India, 4-2-2009)

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Nirav Shah

AGRICULTURAL LAND LAWS : BTALA, 1948

Laws and Business

(In this Article, we continue with our study of the
Bombay Tenancy and Agricultural Lands Act, 1948 (‘Act’) which deals with
certain aspects of the law relating to agricultural lands in the State of
Maharashtra.)

Transfers to non-agriculturists :

U/s.63 of the Act, any transfer, i.e., sale, gift,
exchange, lease, mortgage with possession of agricultural land in favour of any
non-agriculturist is not be valid unless it is in accordance with the provisions
of the Act. The terms sale, gift, exchange and mortgage are not defined in this
Act and hence, the definitions given under the Transfer of Property Act, 1882
would apply.

This section could be regarded as one of the most vital
provisions of this Act since it regulates transactions of agricultural land
involving non-agriculturists. Even if a person is an agriculturist of another
State, say Punjab, and he wishes to buy agricultural land in Maharashtra, then
section 63 would apply. An important exception to the provisions of section 63
would be in the case of succession to agricultural land by a non-agriculturist.
Thus, if the legal heirs of an agriculturist are non-agriculturists or if the
legatees under his will are non-agriculturists, even then the succession/bequest
in their favour would be valid. In law, succession to property cannot lie in a
vacuum and the BTALA would not override succession laws [refer Ghanshyambhai
v. State of Gujarat, (1999) 2 Guj. LR 1061].

Similarly, any transfer in favour of an agriculturist of any
land exceeding the ceilings fixed under the Maharashtra Agricultural Lands
(Ceiling on Holdings) Act, 1961 (which we would be examining in subsequent
Articles) is not valid unless it is in accordance with the provisions of the
Act.

The above transfers can be done with the prior permission of
the Collector, subject to such conditions as he deems fit. However, he would not
grant such a permission if the buyer is a non-agriculturist and his income from
other sources is more than Rs.5,000 per year.

Some of the conditions under which the Collector would grant
permission for the transfer of an agricultural land are as follows :

(i) the land is required for non-agricultural purposes; or

(ii) the land is required for the benefit of an
industrial/commercial/educational/charitable undertaking; or

(iii) the land is being sold in execution of a decree of a
Civil Court for arrears of land revenue; or

(iv) the land is being gifted by way of a trust or
otherwise bona fide by the owner in favour of his family member.

Once the permission has been granted by the Collector it must
be acted upon within one year, unless extended by the Collector up to a maximum
period of five years.

If a land is transferred in violation of section 63, then
u/s.84C the transfer becomes invalid on an Order so made by the Mamlatdar. If
the parties give an undertaking that they would restore the land to its original
position within three months, then the transfer does not become invalid.

Once such an Order is passed by the Mamlatdar, the land vests
in the State Government. The amount received by the transferor for selling the
land shall be deemed to be forfeited in favour of the State. Further, the
Mamlatdar would determine the reasonable price of the land and grant the land on
a new tenure on payment of occupancy price equal to the reasonable price so
determined. The reasonable price would not be lower than 20 times the land
assessment and not more than 200 times the land assessment. Further, it would
include, the value of any structures, wells, permanent fixtures, etc., on the
land.

Transfer of land to non-agriculturists for bona fide
industrial use :

U/s.63-1A of the Act, transfer of land in favour of a
non-agriculturist without the Collector’s permission is permissible in the
following two cases :

(i) it is for a bona fide industrial use; or

(ii) it is for a special township project.

The other conditions for the above are that :

(a) the Development Control Regulations permits such an
industrial use; or

(b) the land is located within an industrial zone under
any plan prepared under the Maharashtra Regional & Town Planning Act, 1966
or any other applicable similar law; or

In case the total area of the land so proposed to be used
exceeds 10 hectares/25 acres, then the prior permission of the Development
Commissioner (Industries) would be required. Thus, if the purchaser of the
agricultural land is a company which desires to undertake a special township
project and it wants Foreign Direct Investment (FDI) for the same, then it would
have to ensure that the size of the plot is 25 acres or more. In such a case, it
would need the prior approval of the Development Commissioner of Industries for
first acquiring such an agricultural land.

The purchaser of the land for the above purposes must put it
to the industrial use within 15 years from the date of purchase or else the
seller has the right to repurchase the land at the price at which he sold it.
Till 2004, the limit was five years and it was extended to 15 years by the
Maharashtra Tenancy and Agricultural Laws (Amendment) Act, 2004. If the
purchaser was holding the land in 2004 and had failed to put it to use within
five years of purchase, then he can put it to industrial use within the
remaining period out of 15 years, subject to payment of certain non-agricultural
tax.

Bona fide industrial use :

Agricultural land can be purchased without approval if it is
for a bona fide industrial use which has been defined under the Act to
mean the following :

activity of manufacturing,

processing of goods,

handicrafts,

activity of industrial business or enterprise,

tourism activity within notified tourist places/hill stations,

construction of industrial building

construction of industrial buildings used for manufacturing process or power projects or ancillary industrial use, such as R&D, godown, canteens, providing housing to workers of industry,

establishment of an industrial estate/co-operative industrial estate/service industry/ cottage industry units.

Special township project:

Agricultural land can also be purchased without the approval of the Collector if it is for constructing a special township project as per the Rules framed under the Maharashtra Regional and Town Planning Act, 1966. Although, in such cases apart from the permission of the Collector, special township projects require a host of other regulatory clearances, as high as 30- 35 approvals. Some of the key requirements for a special township project are as follows:

It should be an integrated township

The minimum area to be developed must be 100 acres for which norms and standards are to be followed as per the local byelaws. If there are no such local byelaws, then a minimum of 2,000 dwelling units for 10,000 people must be developed. The housing component must constitute at least 60% of the total area.

The township must provide for a school, shopping, community centres, medical services, etc. Around 20% of the area must be designated for recreational spaces and an additional 5% for amenities.

The developer must provide for basic infrastructure and public utilities. There must be a water provision of 140 litres per person.

Construction and real estate development other than what is specified above is not covered. Thus, the Collector’s permission would be required for the same.

A special township project is eligible for various sops and benefits under the Maharashtra Housing Policy. Some of the benefits are as follows:

Non-agricultural permission is automatic.

Government land falling under the township area shall be leased out to the developer at the current market rate.

The condition that only agriculturists will be eligible to buy agricultural land is not applicable within the special township area.

There is no ceiling limit for holding agricultural land by the developer of such special township project.

Floating FSI is available within the township. Thus, the unused FSI of one plot can be used anywhere in the whole project.

A stamp duty concession is available compared to the prevailing rate.

It is partially exempted from payment of scrutiny fee while processing the development proposal.

It is eligible for a 50% concession in payment of development charges.

In addition, special township projects are also eligible for external commercial borrowings under the FEMA Regulations.

Significance of Act:

This Act is very important to industry at large since it lays down the circumstances under which company/non-agriculturist can buy agricultural land. The management of companies dealing with or in agricultural land would be well advised to pay heed to the provisions of this Act or else they face the risk of losing the land altogether.

Nirav Shah

Real Estate Laws: Recent Developments-II

Laws and BusinessI. Stamp Duty Ready Reckoner 2010

1.1 The State Government has issued the Ready Reckoner for
computing the Fair Market Values for immovable property in Maharashtra for the
year 2010. As expected, the property rates in Mumbai have been increased by
10-20% compared to last year. The state government expects to mobilise Rs.
5,075 crore as revenue through stamp duty and registration fee by the end of
2009-10 and hence, it has hiked the rates to achieve its target. Stamp duty is
only second to VAT in terms of revenue earners for the State of Maharashtra.
Even though on one hand, the State has reduced the peak duty rate to 5% when
compared to other States, it has on the other hand, consistently increased the
Reckoner rates which have more than compensated for the fall in duty rates.
Thus, the State has been able to increase its Stamp Duty revenue year after
year. Readers may be interested to know that as far back as in 1993, the State
Government had given an undertaking before the Bombay High Court in the case
of Ashok Bansilal Mutha v State of Maharashtra & Ors. (Contempt Petition No.
28 of 1993), that it will not use the Ready Reckoner for calculating stamp
duty. In spite of this, the Sub-registrars always insist upon payment of duty
as per the Reckoner.

1.2 There are no changes in the Valuation Guidelines. The
rates mentioned in the Reckoner are on a per square metre of built-up area
basis, i.e., the same as previous years. There were news reports that the
Reckoner would be aligned with the amendment to the Maharashtra Ownership Flat
Act and that henceforth the property rates would be on a carpet area basis.
This would have enabled parity between the Flat Ownership Agreement and the
Reckoner rates. However, the 2010 Reckoner continues with the built-up area
pricing only. All other valuation parameters are the same as before.

1.3 When one considers the hike in the registration fee
along with the hike in the Reckoner rates, it is a double whammy for property
buyers. It is high time that the Ministry of Urban Development, along with the
Ministry of Housing and Urban Poverty Alleviation crack the whip by
threatening to refuse disbursement of funds to the State under the Jawaharlal
Nehru National Urban Renewal Mission (JNNURM). Only then can we expect some
relief and rationalisation of stamp duty rates and /or property values.

II.
Property Tax Calculation

2.1 Currently, the BMC levies a property tax based on the
Rateable Value of flats. Under the rateable value system, property tax is
based on the expected rent which a property can fetch. In the case of owner
occupied properties, the rateable value is arrived at on the basis of a
schedule of rates prepared by the BMC for different buildings. In these rates,
what is noteworthy is that newer buildings have a higher rateable value as
compared to older buildings. Accordingly, newer buildings, no matter where
located, would pay a higher tax as compared to older buildings, no matter
where located. Accordingly, a new building in Dahisar would pay higher
property tax as compared to an old building in Cuffe Parade.

2.2 To rectify this anomaly and in a bid to earn more
revenue, the BMC has devised the Capital Value System of levying property tax.
This new method is to be implemented from the next financial year, i.e., from
1st April, 2010. Under the Capital Value taxation, property tax will be levied
based on the current market value of the property and not on the basis of the
erstwhile rateable value.

2.2.1 To arrive at the market value, the rates given in the
Stamp Duty Ready Reckoner are sought to be used. Once the market value is
determined on this basis, it would remain frozen for 5 years. Thus, if the
Reckoner Rates for 2010 are adopted on 1st April 2010, then they would
continue till 31st March 2015.

2.2.2 The rate of property tax would be decided every year
by the BMC in its Annual Budget. It is expected to be 0.30% to 0.45% of the
Capital Value of the Property. for example, if the Capital value of a flat at
Churchgate is Rs. 2,00,00,000, then the property tax @ 0.45% will be Rs.
90,000 per annum.

2.2.3 In computing the property tax, various factors need
to be borne in mind, such as, carpet area, use of the property, etc. In a
subsequent Article, we will examine the Capital Value System in greater depth.

2.2.4 After an increase in Reckoner Rates, removal of the
cap on registration fees, flat buyers / owners in Mumbai have been gifted one
more exploitive tax by the Government in 2010. The New Year could not have
gotten off to a better start for the real estate sector!

III. Stamp Duty on Agreements not provided for

3.1 A few years ago, Schedule I to the Bombay Stamp Act was
amended to introduce Art. 5(h) (A) which provides for a duty on any Agreement
not otherwise provided for under the Schedule and creating any obligation,
right or interest and having a monetary value. The duty was 0.1%.

Thus, all Agreements which created a monetary obligation or
an interest and which were not otherwise covered under the Act were chargeable
with duty under this Article. These included Share Subscription Agreements for
PE Funding, etc.

3.2 The 2009 Amendment Act has increased the duty under
this Article. Accordingly, the stamp duty would be 0.1% in case the value of
the agreement is Rs. 10 lakhs or less. In the case of an agreement which
exceeds Rs. 10 lakhs in value, the duty would now be @ 0.2% of the amount
agreed in the contract. E.g., in case a real estate fund agrees to invest Rs.
100 crores in a real estate project, the Share Subscription Agreement would
now be stamped with a duty of Rs. 20 lakhs.

Nirav Shah

Accounting Frauds : Prosecution under IPC

Laws and Business

1. Introduction :

1.1 Accounting frauds and scams, from being rare, are
becoming a norm. India has also had its share of frauds. Corporate India is yet
reeling from the recent case of Satyam Computers, an instance where the
promoters, CFO and auditors have been taken into ‘custody’. At a time like this,
it is relevant to consider penalties prescribed under the Indian laws for such
frauds.

1.2 Punishment for offences relating to accounting fraud,
forgery, etc., in case of companies are prescribed under two Statutes — the
Companies Act, 1956 and the Indian Penal Code, 1860 (‘the Code’).
Criminal Law in India is mainly governed by two major Acts : the Indian Penal
Code, 1860 and the Criminal Procedure Code, 1973. While the Indian Penal Code
deals with what can be considered as an offence and the punishment for various
offences, the Criminal Procedure Code, 1973 prescribes procedures and
formalities which must be followed in trying an offence.

1.3 As chartered accountants we rarely bother about criminal
law . . . However, Satyam’s case indicates that sometimes willingly or
unwillingly, we may become a party to criminal proceedings. Hence, it becomes
necessary to at least have a fair understanding about the basics of criminal
law. Further, even in cases of economic offences, criminal cases may be
initiated against companies, its officers and businessmen. In such an event it
would be of great assistance if we have some knowledge of criminal law. This
article examines some of the punishments prescribed under the Code for
accounting frauds. Some of the sections herein examined are those which form
part of the chargesheet filed by the Police in Satyam’s case.

2. Falsification of Accounts (S. 477-A) :

2.1 S. 477-A of the Code expressly deals with
Falsification of Accounts. It makes falsification of books and accounts
punishable. It also makes the act of making false entries or
omitting or altering any false entry punishable.

2.2 S. 477-A deals with the following two types of distinct
offences :

à
Falsification of accounts

à
Making of false entries

2.3
Falsification of Accounts :

à
The offender must be a clerk, officer or a servant.

à
He must have acted willfully and with an intent to defraud.

à
He must either destroy, alter, mutilate, falsify any book, electronic record,
paper, writing, valuable security, or account.

à
The above-mentioned documents must be of his employer.

2.4
Making False Entries :

à
The offender must be a clerk, officer or a servant.

à
He must have acted willfully and with an intent to defraud

à
He makes/abets any false entry or omits/ alters/abets the making of any
entry from any book, electronic record, paper, writing, valuable security, or
account.

2.5 The punishment for both the above-mentioned type of
offences is an imprisonment up to 7 years and/or a fine. The offence is a
non-cognisable offence under the Criminal Procedure Code. A non-cognisable
offence would mean one where the police can arrest only on the basis of a
warrant issued by a Magistrate. The police cannot arrest an accused merely on
the basis of a complaint, etc., like they can in the case of grievous crimes,
such as murder. The accused can get a bail against this offence.

2.6 For a charge u/s.477-A, it is not necessary to
show the following evidence that :

à
any particular person was defrauded. A general intent to defraud is enough.

à
any specific sum of money was involved.

à
the offence was committed on a particular date.

2.7 The person charged of the offence — the offender — must
be either a clerk, officer or a servant. Any other person is not covered by S.
477-A. The person must be employed by the employer in either of three
capacities. There must be an employer-employee relationship — Hari
Prasad v. State of UP, 1953 Cr. Lj 1496 (All). It has been held that
if a partner of a firm also has dual responsibilities to manage the business, or
write up the firm’s accounts, then he would be covered under this Section and
can be prosecuted for any such offence. A working director/managing director
would be a servant of his employer, i.e., the company.

2.8 Intention to defraud is essential to attract this
Section. Thus, something which is not true must be passed off as true with an
intention to cause some kind of injury to property. Two essential elements are,
deceit and injury. Hence, either there must be a suppression of the
truth or there must be a suggestion of a lie.

2.9 An important principle to note is that the sanction of the Company Court is not needed for prosecuting the managing director of a company in liquidation for an offence u/s.477-A of the Code. The Companies Act does not impact proceedings instituted by the Liquidator – C. Hanumantha Rao v. T. S. Rama Rao, AIR 1961 AP 493.

3. Forgery (S. 465) :

3.1 S. 465 punishes an act of forgery with a term of up to 2 years and/ or fine.

3.2 The term forgery is defined in S. 463 to mean:

the act of making a false document or part I thereof

with an intent to :

cause damage or injury to a person or to the public
support any claim or title
cause any person to part with any property
cause any person to enter into any contract
commit fraud

3.3 Forgery takes place only when a false document is made with an intent of causing damage or injury to any person. A false document is one where the person making it does so with the intention that it appears to have been made by another person.

4. Forgery of a Valuable Security (S. 467) :

4.1 S. 467 of the Code deals with an offence of a forgery of a valuable security. The important facets of this Section are as follows:

there must be a forgery.

it must be in respect of a valuable security, or must give authority to a person to make or transfer a valuable security or to receive principal, interest or dividend thereon. A valuable security is a document whereby any legal rights are created, extended, transferred, extinguished, released, etc. In Hari Prasad v. State of UP, 1953 Cr. Lj 1496 (All), it was held that account books containing entries which are not signed by any party are not valuable security.

it could also be in respect of a document acknowledging the payment or money or a receipt.

4.2 The punishment for the offence is imprisonment for life or with imprisonment for a term of up to 10 years. It also attracts a fine.

5. Forgery for Cheating (S. 468) :

5.1 S. 468 punishes a ‘forgery’ which is done for the purposes of cheating. It covers a forgery of a document or an electronic record which is done with the intention that such document/record shall be used for cheating. Falsification of books of accounts for the purposes of cheating are covered under this Section – Banessur Biswas (1872) 18 WR (Cr) 46.

5.2 S.415 definesthe term ‘cheating’ as follows:

There must be a deceit of a person by fraudulent or dishonest means.

As a result of such deceit, the other person must either:

deliver property to another person; or
consent to retention of property by another person; or
do or omit to do anything which he would not do

The above act or omission must cause damage or harm to mind, body, reputation or property of the person.

In the above case, the offender who deceives is said to cheat the other person.

5.3 It is noteworthy that the Section states the of-fender must have an intention of cheating while committing the forgery. Actual cheating or the fact that someone has indeed been cheated is not material to attract this Section. It is required to prove that the document has been forged by the accused and the accused did so with an intention of cheating.

5.4 The punishment prescribed for such an offence u/s.417 is imprisonment of up to 7 years and also fine. This offence is also a non-cognisable offence punishable by a Magistrate.

6. Using a Forged Document as a Genuine Document (5. 471) :

6.1 According to the provisions of S. 471, if any person fraudulently or dishonestly uses any document or an electronic record as genuine when he knows or believes that the same is actually a forged document/record, then he is punishable as if he had actually forged the same.

6.2 This Section does not prescribe any penalty for the offence, but treats it as a case of a forgery. Thus, it is essential to first see whether the document is indeed a forged document. If yes, then S. 471 can be applied. The onus is on the prosecution to demonstrate that the document is forged and that the offender knew about the forgery and yet used the same as an original document in either a fraudulent or dishonest manner.

7. Cheating to cause wrongful loss (5. 418) :

7.1 S. 418 of the Code is attracted if the following conditions are satisfied:

the offender was under an obligation imposed by law or legal contract to protect the interest of a person.

the offender actually cheated a person.

the offender cheated with the knowledge that he is likely to cause wrongful loss to the person cheated.

7.2 S. 418 applies to people who are entrusted with the responsibility of protecting other’s interest under a legal/contractual obligation. These include, bankers, trustees, advocates, etc. In one case the directors and accountant were accused of preparing a false balance sheet to mislead the public to induce them to deposit money with the bank. They were held to be liable of an offence under this Section. In the very old case of Giles Seddon v. S. J. Loane, (1910) 11 CrLj 624, the Madras High Court held that the mere fact that the balance sheet was false was not adequate to attract the provisions of this Section. The guilty knowledge of the director cannot be presumed from the mere fact that he authorised the issue of a balance sheet containing false entries but must be decided on a consideration of all the facts and circumstances, e.g., the nature of the false statements, the materiality of the amounts involved in the false entries, the ease or difficulty with which their truth or falsity could be ascertained, the course of business of the company, the position, individual standing of the directors, etc. The Court further held that mere mistakes in the classification of a debt as doubtful or bad is a matter on which experts might differ and that by itself does not warrant a case for cheating. There must exist some other corroborative evidence to show that all this was intended to be a part of a larger scheme of things conceived to deceive and cheat people. The same would even apply to a misrepresentation by way of an omission. In this case, debts due by directors were not dis-closed separately.

This is a very old judgment, almost 100 years old, and one wonders how the Courts of today would view the principles enunciated therein ?

8. Cheating to induce delivery of property (S. 420):

8.1 If cheating is done with an intention of dishonestly inducing the person deceived to deliver any property to any person, or to make alter or destroy a valuable security, then it is punishable u/s.420 of the Code. S. 420 of the Code is one of the more popular Sections of the IPC and one which is known even by laymen. What is necessary is that the act of cheating (as defined in S. 415) must be done to induce the person cheated to part with his property.

8.2 S. 420 is different in its application from S. 417 simple cheating. In the case of a simple cheating, there is no delivery of property, whereas it is an essential ingredient of S. 420.

8.3 An act of issuing a cheque when there are insufficient funds in the payer’s bank account would also constitute an offence punishable u/ s.420 if it can be demonstrated that the cheque caused deception from inception. In such a case, the act would be punishable under the Negotiable Instruments Act as well as S. 420 of the IPC.

8.4 This offence is punishable with an imprisonment of a term which extends up to 7 years and also fine.

9. Criminal Breach of Trust (5. 409) :

9.1 Certain categories of people are guilty of an offence u/ s.409 of criminal breach of trust if they being entrusted with any property have committed a criminal breach of trust in respect of the same. The categories covered includes 7 classes – public servants, bankers, brokers, factors, merchants, attorneys and agents. Such people are considered to be men of trust in whose control people entrust property. If they commit a criminal breach of trust, they are guilty u/s.409. A criminal breach of trust happens when a custodian of a property converts it to his own use or misappropriates the same for his use or dishonestly uses that property in violation of any law or contract. For example, an agent who is entrusted with his principal’s funds with instructions to only invest them in mutual funds, invests the funds in his family companies, he is guilty of criminal breach of trust. Similarly, if an advocate is an escrow account holder for a transaction and instead of investing the money in instruments instructed by the party, he invests them in his own firm, he would be guilty under this Section.

9.2 A question which arises is whether a director can be covered under this section, i.e., can he be treated as an agent of the company and covered by S. 409 if he misappropriates the property? In the case of R. K. Dalmia v. Delhi Administration, 32 Comp Cas 699 (SC), the Supreme Court held that funds which a company has in its bank account are property of the company within the meaning of the Code and persons having power to operate on that account will be guilty of criminal breach of trust if by operating on that account funds are misappropriated. Further, a director is an agent as well as a trustee of a company within the meaning of S. 409 of the Code and thus, if a director has misappropriated the company’s property, then he too can be covered by this Section.

10. Directors’ responsibilities:

10.1 The number of prosecution cases involving companies has increased recently. There is an increasing need for directors, including independent directors to be aware of the prosecution possible under Criminal Law.

10.2 Being aware of consequences under the law would make them more diligent and vigilant in the discharge of their duties.

Nirav Shah

Recession ignites unrest People worlwide take to streets as economies crash

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50 Recession ignites unrest People worlwide
take to streets as economies crash

In the grand sweep of the current financial crisis, a few
riots here and there may not seem to add up to much. But it is a sign of things
to come : a new age of rebellion. The financial meltdown has become part of the
real economy and is now beginning to shape real politics. More and more citizens
on the edge of the global crisis are taking to the streets. Bulgaria has been
gripped this month by its worst riots since 1997 when street power helped to
topple a Socialist government. Now Socialists are at the helm again and are
having to fend off popular protests about government incompetence and
corruption.

Iceland, Bulgaria, Latvia : these are not natural protest
cultures. Something is going amiss. The LSE economist Robert Wade recently
warned the world was approaching a new tipping point. Starting from March-May
2009, we can expect large-scale civil unrest, he said. “It will be caused by the
rise of general awareness throughout Europe, America and Asia that hundreds of
millions of people in rich and poor countries are experiencing rapidly falling
consumption standards; that the crisis is getting worse not better; and that it
has escaped the control of public authorities, national and international.”

Governments have so far managed to deflect attention from
their role in the crash, their slipshod monitoring, by declaring themselves to
be indispensable to the solution. This may save the skins of politicians in
wealthier countries who can expensively try to prop up banks and sickly
industries. But it does not work in countries that are heavily indebted, with
bloated and exposed financial sectors.

(Source : The Times of India, 2-2-2009)

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Nirav Shah

Personal touch : Name cow to get more milk

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49 Personal touch : Name cow to get more
milk

By just giving a cow a name and treating it as an individual,
farmers can increase their milk yield substantially. The study by Catherine
Douglas and Peter Rowlinson of Newcastle University found that when each cow was
called by name on farms, the overall milk yield was higher than where they were
herded in a group.

“Just as people respond better to the personal touch, cows
also feel happier and more relaxed if they are given a bit more one-to-one
attention,” explained Douglas, who works at the Newcastle School of Agriculture,
Food and Rural Development.

“What our study shows is what many good, caring farmers have
long since believed. By placing more importance on the individual, such as
calling a cow by its name or interacting with the animal more as it grows up, we
can not only improve the animal’s welfare and her perception of humans, but also
increase milk production.”

Douglas and Rowlinson questioned 516 British dairy farmers
about how they believed humans could affect the productivity, behaviour and
welfare of dairy cattle. Almost half or 46% said the cows on their farm were
called by name. Those that called their cows by name had a 258 litre higher milk
yield than those who did not, said a Newcastle release.

Sixty-six percent of farmers said they “knew all the cows in
the herd” and 48% agreed that positive human contact was more likely to produce
cows with a good milking temperament. Almost 10% said that a fear of humans
resulted in a poor milking temperament.

(Source : The Times of India, 29-1-2009)

(Compiler’s remark — This is practised in India since
ancient times.)

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Nirav Shah

CBI seeks HC nod to prosecute judge

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47 CBI seeks HC nod to prosecute judge

The CBI has sought approval to prosecute a Punjab and Haryana
HC judge, Justice Nirmal Yadav, in the cash-at-Judge’s-door scam which came to
light in August last year. The agency said it has completed investigations in
the case and sent a report to the Union Government and the SC.

The Judge, Nirmal Yadav is accused of taking money from a
Delhi-based hotelier. Sources said that a report had been sent also to the DoPT
by the agency because the allegations against the Judge have been substantiated
by enough evidence and it now needs the approval to prosecute the Judge. In this
case the go ahead can be provided by President Pratibha Patil in consultation
with CJI K. G. Balakrishnan.

(Source : The Times of India, 24-1-2009)

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Nirav Shah

US infrastructure on shaky ground America’s roads, dams, bridges, schools are in dire straits, according to a report by the American Society of Civil Engineers, which assigned an overall ‘d’ grade to the nation’s infrastructure

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48 US infrastructure on shaky ground
America’s roads, dams, bridges, schools are in dire straits, according to a
report by the American Society of Civil Engineers, which assigned an overall ‘d’
grade to the nation’s infrastructure

America’s roads, public transit and aviation have gotten
worse in the past four years. Water and sewage systems are dreadful. The basic
physical backbone of American society is barely above failing, a report by top
engineers says. It’ll cost $ 2.2 trillion to fix America’s ailing
infrastructure, according to highlights of a report being released early, just
as the House of Representatives readies its first vote on President Barack
Obama’s call for a massive economic stimulus spending package. The country’s
roads, dumps, dams, bridges, schools and rail systems need lots of that money,
say the engineers, who would get a piece of the pie in working on the repairs.
Government officials are already aiming billions of dollars at those physical
needs as part of a $ 825 billion economic stimulus package. But the engineers
say that’s not enough. Overall, the American Society of Civil Engineers gives
the US physical backbone for everything from schools and parks to dams and
levees a D. That’s the same overall grade as the last time the group gave a
report, in 2005, but it really is slipping from a ‘high D’ to a ‘low D’, said
report chairman Andrew Herrmann.

(Source : The Times of India, 29-1-2009)

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Nirav Shah

Core Investment Companies — large promoter holding companies now require registration and compliance

Securities Laws

Promoters of listed companies may have cause both for some
relief and some worry with the recent and almost quiet notification of the
directions relating to Core Investment Companies (CICs) by the Reserve Bank of
India. Essentially, investment companies fulfilling certain conditions of size
and outside borrowings are now specifically required to be registered as
non-banking financial companies (NBFCs).

It is worth discussing first a short background here.
Promoters of listed companies (and even others) often hold shares of such listed
companies through investment companies for various reasons. In 1997, the Reserve
Bank of India Act was amended and it was required that NBFCs, as defined, should
be registered. There have been two views whether pure investment companies,
which just hold securities and do not deal in them, were also required to be
registered. Thus, several such companies did not register on this ground.
Further, on a case-to-case basis, several such companies were even exempted by
the Reserve Bank of India. On the other hand, numerous investment companies, it
appears, just neglected or defaulted in applying for registration. Now, the
Reserve Bank of India has defined such investment companies as Core Investment
Companies, and requires them to be registered even if they were earlier granted
exemption by the Reserve Bank of India.

The Core Investment Companies (Reserve Bank) Directions, 2011
were notified on 5th January 2011. Certain related notifications were also
issued. Important provisions of these Directions are discussed in the following
paragraphs.

What are CICs ?

The Directions define CICs. CICs are essentially companies
that carry on the business of acquiring securities and further satisfy certain
conditions. Firstly, at least 90% of their total assets should consist of
shares, debentures, loans, etc., in ‘group companies’. Secondly of the total
assets, at least 60% should consist of either equity shares or debentures,
compulsorily convertible into equity shares within 10 years of issue, of ‘group
companies’. Thirdly such companies should not trade in securities except through
block sales of securities in the specified manner. Finally, they should not
carry on any other financial activity except investment in bank deposits, money
market instruments, etc.

Which CICs are required to be registered ?

A CIC is required to be registered if, firstly, it has total
assets of at least Rs. 100 crores. Secondly, it should have raised or should be
holding ‘public funds’. Public funds are inclusively defined and particularly
include debentures, public deposits, inter-corporate deposits and bank finance.
However, debentures compulsorily convertible into equity shares within 10 years
of issue are not included. Such CICs are called systemically important CICs
(referred to herein as CICs only).

It is important to note that even the separate assets of
other ‘companies in the group’, as defined, are to be considered while
determining whether the CIC has the required minimum Rs.100 crores of total
assets or not. Thus, effectively, the aggregate assets of group companies are to
be counted to determine whether the concerned investment company is a CIC or
not.

Separate category of such CICs:

Such CICs are known by a separate category now, viz.,
CIC-ND-SI.

When is application for such registration required to be made ?

Existing CICs are required to apply within a period of six
months from the date of notification of the Directions. Till their applications
are disposed of by the Reserve Bank of India, they can continue to carry on
their business as CIC. Companies that become CICs after the date of the
Directions are required to apply within three months of becoming a CIC.

Minimum net owned funds :

NBFCs are required to have and maintain a minimum amount of
net owned funds as defined in the Reserve Bank of India Act. However, the
formula for calculation of net owned funds (NOF) is such that for holding
investment companies, the NOF often cannot be attained. This is particularly
because of an inherent feature of such investment companies that they, by
definition, invest in ‘group companies’, while the formula for calculating net
owned funds require deduction of most part of such group investments from the
‘net owned funds’. In fact, it is often found that by this calculation, even a
high positive net worth company has negative ‘net owned funds’. It is now
notified and clarified that such CICs shall not be required to have the NOF.

Minimum capital requirements :

An important reason for bringing even
non-deposit-accepting large NBFCs into the requirement of registration and
supervision is that such companies should not leverage too much and put
themselves and perhaps the market at risk. Thus, a minimum capital adequacy
requirement has been prescribed. As regards CICs, it is required that they
should have a minimum adjusted net worth that is at least 30% of the
risk-weighted on-balance sheet and specified off-balance sheet assets.

The definition of terms such as ‘adjusted net worth’ and the
formula for calculation of risk-weighted assets have been prescribed.
Essentially, the adjusted net worth includes the ‘owned funds’ but adjusted by
100% of unrealised depreciation/50% of unrealised appreciation in the book value
of quoted investments calculated in the specified manner.

Maximum debt-equity ratio :

CICs are required to have and maintain a maximum debt-equity
ratio of 2.5 as calculated in the specified manner. Essentially stated, this is
the ratio of outside liabilities to adjusted net worth, both terms as
elaborately defined in the Directions.

Outside liabilities for this purpose mean the total
liabilities appearing on the liabilities side of the balance sheet, but exclude
the following :

(i) Paid up capital

(ii) Reserves and surplus

(iii) Instruments compulsorily convertible into equity
shares within a period not exceeding 10 years from the date of issue.

However, it is to be noted that all forms of debt and
obligations having the characteristics of debt are included. In particular,
guarantees issued, whether appearing on the balance sheet or not, are also
included.

This term is thus to be contrasted with the other similar
term, though used for a different purpose, and that is ‘public funds’.

Annual auditors’ compliance certificate :

CICs are required to submit annually a certificate from their
statutory auditors of compliance with the Directions. This certificate has to be
submitted within one month of the finalisation of the balance sheet of the CIC.

What are group companies?

As stated earlier, the assets of companies in the group are also to be considered for determining whether the minimum size of total assets of Rs. 100 crores has been reached or not. The term ‘companies in the group’ has been very widely defined and thus includes the following:
i) Subsidiary-parent (defined in terms of AS-21)

ii) Joint ventures (defined in terms of AS-27)

iii) Associates (defined in terms of AS-23)

iv) Promoter-promotee [as provided in the SEBI (Acquisition of Shares and Takeover) Regulations, 1997] for listed companies,
v) related parties (defined in terms of AS-18)

vi) Companies having common brand name

vii) Having investment in equity shares of 20% and above.

Some areas requiring clarity:

There are several questions that need clearer answers and some of these are as follows:
1. What is the status of a holding investment company that does not have the minimum assets, calculated in the prescribed manner, of Rs.100 crores??

Whether such company, if not yet registered, is not required to be registered?

The Reserve Bank of India has issued simultaneous notifications giving certain exemptions, but a more express and clear exemption would clarify such issues with greater finality.

2. What would be the implications if a CIC is not in complying with the various requirements such as minimum capital adequacy, debt-equity ratio, etc. of these newly notified Directions?? By what time will it be required to be in compliance with such conditions?

3. A question related to the earlier one is whether the requirements relating to, say, having minimum 90% investments in group companies mandatory for registration or mandatory conditions after registration. The intention appears to be that if a CIC is required to be registered, then they should ensure that their asset profile consists investments in group companies only as per the specified formula. One will have to see in practiced, how the Reserve Bank of India deals with such matter.

4. It is seen that many of the related directions, circulars, etc., are presently prescribed, keeping in mind the regular categories of NBFCs such as loan, investment, etc. The CIC-ND-SI is clearly a separate category of NBFCs and hence these other directions would have to be amended to ensure coverage of such CICs as well, of course with suitable modifications where required. For example, the Directions to Auditors of 2008 would need appropriate amendments to cover such CICs.

5. Can existing registered holding companies shift to this new category? As discussed earlier, many existing holding investment companies may be finding it difficult to maintain capital adequacy and other ratios. However, they may be already registered as investment companies, but surely they would like to obtain the benefit of the diluted requirements if they otherwise qualify for being registered as CICs. The Directions do not provide for shifting of registration from being an ordinary registered investment company to a CIC. It is hoped that in keeping with the spirit of these Directions, the Reserve Bank of India allows shifting of such registration.

Conclusion:

These new Directions will require several promoter groups, particularly of listed companies, to check whether their holding companies need compliance of these Directions in the form for registration. Further, they will need to make a plan of restructuring the capital and finances of such companies to ensure that they fall within the framework of the new Directions.

Nirav Shah

Promoter – to be or not to be? – the identity crisis of Promoters resolved partly by a recent SAT decision

Securities Laws

This series of articles, introducing securities laws for
listed companies to the lay reader continues…

When is a person a Promoter of a listed company? When is he
not? What are the liabilities and disabilities of a Promoter that a person
connected with a listed company should know? Would a mere executive director
be a Promoter? Would a financial or strategic investor be a Promoter? Would
relatives of an existing Promoter be considered as Promoters? Would a
significant shareholding be the deciding factor? Would holding more shares
than the Promoter make a person a Promoter? These issues are of general
interest but they have come into sharper focus in the light of a recent
decision of the Securities Appellate Tribunal (“the SAT”) in the case of
Subhkam Ventures (I) Private Limited v. SEBI – Appeal No, 8 of 2009, order
dated 15th January 2010. In this decision, the SAT has considered a situation
where the issue was whether a private equity investor holding significant
quantity of shares and having certain rights was a ‘Promoter’.

Being a Promoter is a status that, in recent times, creates
more obligations than rights or advantages. The term Promoter, as we will see
in more detail later on, is really a result of being in control of a company.
However, it is a result and the fact that a person may be a promoter does not
give any right of control. Once a person is a Promoter, he faces several
handicaps – for example:-

1. if shares are allotted to him on a preferential basis,
lock-in period is higher.

2. he cannot increase his holding beyond a general
percentage (this restriction is for any significant shareholder but in
practice, would apply mainly to Promoters).

3. he cannot be granted ESOPs.

4. he will be counted for restriction on the number of
non-independent directors.

In addition, there are many disclosure requirements of his
holdings, his share pledges, etc. The irony is that though the Promoter in
India is in de facto and generally de jure control of a company, there are no
specific provisions holding the Promoter directly responsible. However, there
is a general provision holding a ‘person in control’ responsible for violation
by companies but it is a general provision and there is nothing specific
holding Promoters responsible for non-compliance or violation of laws.

Thus, there are sound reasons for a person to be hesitant
at being classified as a Promoter. Non-executive independent directors would
by definition not be Promoters and thus, they can avoid this categorisation.
The problem may be difficult for other non-executive directors, particularly
those who are nominees of the Promoters though not part of the Promoter Group.

There is a unique category of persons who are ex-promoters.
These include persons who have handed over control of the company to a new
Promoter but continue to hold significant shares. A category that is also not
infrequent is when a Promoter Group partitions and one branch gets control of
the company while the other holds shares but does not participate in control.
In an old case involving the Modi family/Modipon Limited
(Appeal No. 34/2001),
the Securities Appellate Tribunal held on the facts that a brother and his
group who were originally part of the Promoter Group were no more part of the
current Promoter Group, since they had separated and did not participate in
control.

However, recently, a more significant problem is faced by
persons who are significant investors in a company such as private equity
investors or similar financial investors. The category of ex-promoters may, on
facts, also fall in this group since they often retain significant holding and
also have certain contractual rights of representation and share decision
making power.

Would such persons be deemed to be in “control” of a
company or in joint control with the “main” Promoters?

The SAT had to consider a typical case and thus, we now
have the benefit of fairly detailed principles that have been laid down in
this decision. It must be clarified that SAT, in this case, had to decide
whether a person had acquired “control” and it can be seen that this issue is
substantially identical in determining ‘whether a person is a Promoter’. This
is because a person becomes a Promoter if he acquires “control”.

The facts of the case were that Subhkam, that has been
described as a private equity investor (“the PE Investor”), took a significant
24.26% stake in a listed company. As required under the Takeover Regulations,
for a person taking a 15% or higher stake, it made an open offer for another
20% shares. The terms of acquisition of shares by the PE Investor in the
listed company were that the PE Investor had certain rights. The significant
ones worth highlighting include the right to nominate a director, right of
consultation for appointment of certain senior officials, and a veto power in
the taking of certain specified acquired decisions. The issue was whether, by
virtue of such rights, the PE Investor had control and was thereby a Promoter.

Interestingly, the agreement giving the PE Investor such
rights specifically stated that the PE Investor was not a Promoter or in
control of the company.

The issue arose in a peculiar context. Subhkam had made an
open offer and in the draft letter of offer, it had specified itself only as a
financial investor. It specifically did not make an open offer under
Regulation 12 of the Takeover Regulations, which is attracted when a person
acquires control. However, SEBI, after much discussions, directed it to make
an open offer under Regulation 12 also. This direction was the subject matter
of appeal.

Incidentally, Regulation 12 requires open offer to be made by a person acquiring control in a listed company, irrespective of any acquisition of shares by him.

The SAT meticulously analysed important provisions of the agreement and also in the process, laid down important principles of determination of when a person is said to be in control of a listed company.

It is worth considering the exact wording of the definition of “control” under the SEBI Takeover Regulations:-

“control” shall include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner;

The SAT considered the above definition and observed:-

“This definition is an inclusive one and not exhaustive and it has two distinct and separate features: i) the right to appoint majority of directors or, ii) the ability to control the management or policy decisions by various means referred to in the definition. This control of management or policy decisions could be by virtue of shareholding or management rights or shareholders agreement or voting agreements or in any other manner.” Having considered the above, the SAT then went on to give a detailed description of what constitutes control and under what circumstances:-

“Control, according to the definition, is a pro-active and not a reactive power. It is a power by which an acquirer can command the target company to do what he wants it to do. Control really means creating or controlling a situation by taking the initiative. Power by which an acquirer can only prevent a company from doing what the latter wants to do is by itself not control. In that event, the acquirer is only reacting rather than taking the initiative. It is a positive power and not a negative power. In a board managed company, it is the board of directors that is in control. If an acquirer were to have power to appoint a majority of directors, it is obvious that he would be in control of the company but that is not the only way to be in control. If an acquirer were to control the management or policy decisions of a company, he would be in control. This could happen by virtue of his shareholding or management rights or by reason of shareholders agreements or voting agreements or in any other manner. The test really is whether the acquirer is in the driving seat. To extend the metaphor further, the question would be whether he controls the steering, accelerator, the gears and the brakes. If the answer to these questions is in the affirmative, then he alone would be in control of the company. In other words, the question to be asked in each case would be whether the acquirer is the driving force behind the company and whether he is the one providing motion to the organization. If yes, he is in control but not otherwise. In short, control means effective control.”

Having laid down what constitutes control, it examined the rights of the PE Investor in light of the agreement. It particularly stated that grant of rights to a significant investor can be expected since he would be likely to safeguard his investment. It held that having one nominee on the Board does not amount to having control.

The SAT analysed the provisions that give “veto rights” under certain circumstances to the PE Investor. If the company proposed to take certain acts as described in the agreement, which are typically significant and out of the normal course of business, the affirmative vote of the PE Investor was necessary. Would such a right mean that the PE Investor had acquired control? The SAT held that it did not. It observed:-

“The list of matters provided in clauses 9(a) to 9(o) are not in the nature of day to day operational control over the business of the target company. So also, they are not in the nature of control over either the management or policy decisions of the target company. These provisions merely enable the acquirer to oppose a proposal and not carry any proposal on its bidding… The mere fact that any such amendment requires an affirmative vote from the appellant is again indicative of the fact that it wants to protect its investment and that the basic structure of the company is not altered without its knowledge and approval. By no stretch of logic, can such an affirmative vote confer control over the day to day working of the company.”

Accordingly, the SAT held that the PE Investor had not acquired control and therefore was not required to make an open offer under Regulation 12. Curiously, the PE Investor would have held, if the open offer to acquire 20% was wholly successful, 44.26% shares, that would have been far more than the holding of the Promoters.

The decision was of course on facts. Often, depending upon situations, resulting also from the bargaining power of the investee company, the rights obtained may be more or less. The answer may be different. However, the general principles laid down by SAT can surely help in resolving situations such as these that are relatively quite common.

Nirav Shah

Pledge of shares by promoters

Securities Laws

This series of articles introducing securities laws for
listed companies to the lay reader continues . . .

(1) SEBI has recently made disclosure of shares pledged by
Promoters compulsory. The requirements have come into effect from 28th January
2009 but the disclosures are to be made in stages/events and actually in more
than one way. As it is a new and continuing requirement it is important to
discuss the same. I expect these requirements to continuously evolve in the near
future. The impact on the market value of some scripts where promoters have
pledged a part of their holding has been negative.

(2) While SEBI has not stated the reason for introducing this
amendment, it perhaps does not need to, considering the heated discussion in the
press on the Satyam episode where the Promoters had pledged their shares which
in turn were sold by pledgees on invocation of the pledge and/or failure of the
promoter to provide additional margin. Most of such sales were made long before
the disclosure of the alleged scam when the prices were still high. The common
investor in India normally considers the stake of the Promoters in a company as
an important factor. The investors were outraged not only because the Promoters
had effectively encashed their holdings, but also by the consequent crash in the
price of shares.

(3) SEBI has acted in haste to prevent more Satyams, by
introducing disclosure requirements. It is a fact that this new requirement is
definitely useful and some rightfully argue that it was long overdue.

(4) Let us now examine the actual wording of the requirement.
I repeat that while earlier there was no requirement to disclose pledge of
shares by promoters, now the requirements are multiple overlapping and even at
times inconsistent. Let us first summarise the regulatory provisions :

(a) A new Regulation 8A has been inserted in the SEBI
Takeover Regulations. This regulation requires promoters to disclose to the
Company the details of shares pledged by them and the Company is required in
turn to intimate the same to the stock exchanges.

(b) Clause 35 of the Listing Agreement that requires
disclosure of shareholding pattern to be
intimated to the stock exchange has been amended
to include disclosure of shares held by Promoters that are pledged or
otherwise encumbered.

(c) Similarly, Clause 41 which requires publishing of
periodical results has been amended to also include the details of shares
pledged/encumbered by Promoters.

(5) These amendments though are stated to be with immediate
effect, have effectively differing applicability dates in terms of individual
requirements. However, before we go into these individual requirements, let us
consider some terms :

(a) Disclosure is to be made by Promoters and persons
belonging to the Promoter Group. For this purpose, it has been stated that
the definition under Clause 40A of the Listing Agreement is to be followed.
This clause, in turn, refers to the definition of these terms under the SEBI
DIP Guidelines, but modifies that definition a little. For this article, the
collective term ‘Promoters’ is used to cover all of them.

(b) Disclosure is required of shares pledged. These
refer to shares of the listed company and not shares of any investment or
holding company through which the Promoters may hold shares. This is seen
as a loophole that results in an incomplete picture of the effective
encumbrance of Promoters’ holding. Having said that, it is also true that in
many cases, lenders typically prefer pledge of shares of the listed company
itself as they can be easily sold and monies realised, instead of shares of
the holding company for which the process may be longer. Thus, the loophole in
reality, to a large extent is non-existent.

(c) Disclosure is to be of shares that are pledged
or otherwise encumbered. There is an inconsistency in the scheme of the
different provisions whereby for one set of provisions, the disclosure is to
be made of shares ‘pledged’ and for others, disclosure is also required of
shares ‘otherwise encumbered’ or just ‘encumbered’. These terms being common
legal terms are relatively easily understood, but if one goes into a detailed
analysis, which space constraints do not permit, there are indeed
complexities. For example, shares can be in paper form and dematerialised form
and the pledge of either of them can be in different manner. Also, shares can
be ‘encumbered’ in many ways and indeed there can be many ways in which
restrictions can be placed on the shares that may amount to encumbrance.

(6) Disclosure under the takeover regulations :

(a) A new Regulation 8A has been inserted to require
disclosure of ‘shares pledged’.

(b) There is a transitional requirement to cover pledges
existing on the date when the amendment came into effect. There is some
controversy as to when can the amendment be said to have come into effect, but
the conservative view is that the regulation has come into effect from 28th
January 2009. This date is important for the initial period of disclosure. It
is unfortunate that SEBI has not been more specific about the effective date.

(c) The Promoters have to intimate the details of the
pledged shares, in the prescribed format, to the listed Company within 7
working days of the amendment. The Company, in turn, has to inform the stock
exchanges where the shares of the Company are listed, within 7 working days of
receipt of information from promoters. However, this is to be done only if
during a calendar quarter, the cumulative quantity of shares pledged is at
least 25000 or 1% of the total shareholding/voting rights.

(d) For further pledges, the Promoters have to inform
within 7 working days of creation or invocation of pledge. The Company, in the
manner similar to the above, informs the stock exchanges of such further
pledges or invocation of the pledge.

7) Disclosure under amended Clauses 35/41 of the Listing Agreement:

a) These amended Clauses require disclosures of Promoters’ shares that are pledged or otherwise encumbered. Suitable formats have been provided for this.

b) The disclosures will be on a quarterly basis starting from the quarter ending March 2009.

c) Regulation 8A of the Takeover Regulations requires disclosure of pledged shares only by the Promoters of the company. How will the company then know what shares are ‘encumbered’ ? This may sound to be a lacuna, but perhaps a better view is upholding the spirit and that the Promoters should still inform of shares that are ‘encumbered’ also. The Promoters are in control of the company. The requirement is on the company to disclose the shares encumbered by the Promoters. The Promoters cannot claim that, on the one hand they are in control of the company and, on the other hand the company is a separate entity that should be treated as an entity independent for this purpose. Of course, SEBI could clarify the requirements to avoid confusion.

8) In conclusion, recollect the oft-quoted comment of Warren Buffet that:

“You only find out who is swimming naked when the tide goes out”.

When Promoters pledge a substantial portion of their shares, they expose themselves and the company they control (and thereby the shareholders) to serious risks especially when there is a downturn.

The disclosures pursuant to these amendments will :

help bringing out more clearly the holding of Promoters at risk.
bring in more transparency in the corporate world.

There is considerable discussion in the media that SEBI should mandate disclosure of end use of funds raised by pledge of shares. This information, in the opinion of the author, could be very relevant and indica te the risks being taken by the promoters which could impact the operations of the company whose shares have been ‘pledged’ or ‘encumbered’.

Nirav Shah

Destiny

Namaskaar

“The fault, dear Brutus, is not in our stars, but in ourselves
that we are underlings.”

Julius Caesar–

Shakespeare

What is destiny? What role does it play in our lives? How
much of what happens to us is pre-ordained? Is everything in our life
predetermined? If everything that is going to happen is already decided in
advance, what is the role of self effort? Why should we work and struggle at
all? Can destiny never be changed? What should we do? Should we sit with folded
hands and leave everything to destiny?

We Asians, particularly Indians are accused (and sometimes
rightly) of being fatalist and believing too much in ‘fate’. But this is not
true! Our wisdom and literature teaches us otherwise. The
Bhagwad Gita
tells us that we have ‘the right to work and not to the fruits of action’,
meaning that one must do one’s best and act and not get attached to the results.
The results have to be accepted. This is succinctly borne out by the following
excerpt from the
Bhagwad Gita, where Lord Krishna has
explained it thus:

“What the outstanding person does, others will try to do. The
standards such people create will be followed by the whole world.”

“O Parth, there is nothing in the three worlds for me to
gain, nor is there anything I do not have. I continue to act, but am not driven
by any need of my own.

If I ever refrained from this continuous work, everyone would
immediately follow my example.

If I ever stopped working, I would be the cause of cosmic
chaos, and finally of the destruction of this world and these people.”

In
Yoga Vasistha,
sage Vasistha explains destiny to Rama as follows:

“If an astrologer predicts that a young man would become a
great scholar, does that young man become a scholar without study? No. Then why
do we believe in destiny? Sage Vishamitra became a Brahmarishi by self effort;
all of us have attained self knowledge by self effort alone. Hence renounce
fatalism and apply yourself to self effort.

The concept of fate has been concocted to give momentary
relief to people of low intellect during periods of grief.”

We have to learn that we must work — and build our own
destiny by our own efforts…as has been so clearly expressed by an Urdu couplet
that translates as follows:

“Make yourself so great that God Himself asks you before
granting your destiny as to what thy desire is.

We also learn from Karna in
Mahabharat
when he says, “I may be a charioteer or a charioteer’s son. Where one is born,
is in the hands of God; but what one does in one’s life, is very much in one’s
own hands.”

A Gujarati poet explains further:

We have, therefore, to understand that most of our destiny is
the result of our own efforts during this very lifetime. And what passes off as
‘destiny’ is the result of the efforts and karmas of earlier lives…

It has been aptly stated thus: “Perhaps one can think of
‘destiny’ as two different things.” The accidents that may befall us, the death
of a close relative or a dear friend, natural calamities like earthquakes and
tsunamis, and man-made disasters like riots — all fall in one category. These
are happenings over which we have no control and which have no relevance to self
effort. These have to be accepted. But for things over which we have control or
are the fallouts of our actions/inactions, we have to own full responsibility
and not blame destiny or fate for them. We cannot absolve ourselves by passing
on the buck to fate. In all such matters we have to ask ourselves, “Have I done
my best?”

In the ultimate analysis, one comes to the conclusion that
‘destiny’ comes into the picture only after events have occurred; it is relevant
only to the past and should never come in our way when we plan to reach great
heights. One cannot achieve great goals by merely banking on destiny. We have to
take charge of our lives.

I believe, destiny is the result of action.

“Over the same sea, on the same winds,

A ship sails in one direction.

Another in the opposite,

It is not the wind that decides

In which direction the ship goes;

It’s the sails: how they are tied and how they are
manoeuvered…

Similarly, it is not fate that decides where

Your life is going —

It is all about how you take life,

And where you take it.”

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Nirav Shah

Goals, Targets, Deadlines . . . . .

Namaskaar

“There’s no reason to be the richest man in the cemetery. You
can’t do any business from there.”

— Colonel Sanders

In the highly readable book ‘Tuesdays with Morrie’, a true
story by Mitch Albom, ailing Morrie in his final days of life says, “Everyone
knows they are going to die but nobody believes it. If we did, we would do
things differently. To know you are going to die, and to be prepared for it at
any time, that’s better. That way you can actually be more involved in your life
while you are living.”

What has life and death to do with CAs ? We are a party to
the creation, preservation and liquidation of companies. We are very much
present in all the cycles a company passes through. When it comes to our own
life, where do we stand ? Targets, goals, due dates and deadlines till one is
dead.

Take a typical day of a CFO of a company. The day begins in
the car replying to emails and reading business dailies. More emails and,
therefore, more replies after one reaches the office. Review of the work with
the colleagues in the department, attending interdepartmental meetings,
strategy/budget/budget review sessions. Unexpected work comes regularly — Income
Tax assessment order where the assessing officer shows his immense knowledge of
the Income-tax Act, legal issues arising out of termination of an employee and
so on. Added to this is the need to comply with the requirements of SEBI, stock
exchanges and the board of directors. The day is not over yet. On his way back
home he has to catch up on the latest judgment on transfer pricing, IFRS and
that highly recommended article that appeared in the latest Harvard Business
Review.

Being from the industry, I have narrated a typical day of the
CA in the industry. It is no different for the practising CA who has to endure
more at home too — phone calls from clients, chairman of the co-operative
society about the problems they are facing, et cetera.

Where is the time to do what one wanted to do when one was
young ? Where is the time to pursue one’s passion ? Where is the time for near
and dear ones ? My mother’s recent passing away triggered these thoughts. I
could not help the feeling that I had taken for granted the constant help
received from my parents. Did I express gratitude ? Would have, but not as
profusely as one would do with one’s bankers or customers. After all, we are
looking for repeat orders from the customers. Memories started flowing of the
many times my mother would wake me up in the night druing preparation for my CA
exams, or check to see whether I was sleeping and, if so, prepare a cup of tea,
kept everything ready as one came back from exams.

Numerous promises one made, some fulfilled and some just
remained as promises. Three of them still remain in my mind and guilt is
unlikely to go away during my lifetime. The promises to take her to the temple
of our family deity in the southern part of Tamil Nadu, darshan of
Shankaracharya of Sringeri Mutt, visit to Varanasi and dip in the Ganga. The
time required for all these trips would not have been more than a week. But one
kept postponing. Parents do not demand, nor do they remind you of the promises
made. I had the excuse of paucity of time. One does not postpone visit to a
multiplex or a restaurant or a sports stadium.

We are not saints to ignore worldly duties. We cannot be
selfless to nip our self interest. We are paid to do our work. We have to take
care of our clients. The professional firms and organisations we run have to go
on. It is not just our livelihood but the livelihood of many who depend on our
organisations. At the same time can’t we look at life not as a sprint but as a
marathon, as Prof. Raghunathan wrote in his book, “Don’t sprint the marathon”.

The belated lesson I learnt and which I wish to share with
the fellow members of our profession is not to postpone what one wanted to do in
one’s personal life. As Morrie said, “We are too involved in materialistic
things and they do not satisfy us. The loving relationships we have, the
universe around us, we take these things for granted”.

When Clayton Christensen (Innovation guru and author of
management bestsellers like “The Innovator’s Dilemma” and “The Innovator’s
Solution”) was asked last year to address the students of MBA in Harvard, he
ended his speech with the following :

“This past year I was diagnosed with cancer and faced the
possibility that my life would end sooner than I had planned. Thankfully, it
now looks as if I will be spared. But the experience has given me important
insight into my life. I have a pretty clear idea of how my ideas have
generated enormous revenue for the companies that have used my research; I
know I have had a substantial impact. But as I have confronted this disease,
it has been interesting to see how unimportant that impact is to me now. I
have concluded that the metric by which God will assess my life, isn’t dollars
but the individual people whose lives I have touched”.

Wise words indeed.

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Nirav Shah

O death, You must listen

Namaskaar

We say ‘Death’ is certain, but exactly where is it ?
Nobody knows except HE. How to travel the distance between life and the death ?
A poet aptly states in Marathi :

Translated into English, it means that the distance between
life and death is only ‘one breath’. How to travel that distance is always a
question. French novelist Albert Camus says that we live only awaiting
death. However I do not agree with Albert Camus and in fact all of us should say
with one voice that “we should live making life meaningful till death”.

Recently a Marathi movie is announced advocating that we
should have the right to end our life instead of living a life in agony. Many
others must have commented on this topic; but there does not appear to be any
unanimity on the concept of ‘right to die’. I strongly advocate a view that one
should have a ‘right to die’. Jainism advocates and celebrates it. Marathi Saint
Dnyaneshwar had also taken ‘Samadhi’.

We celebrate festival and at the same time sorrow. We believe
in life. We refuse to accept death. We love life and hate to think of death. A
slight knock by ‘death’ at the door sends shivers down our spine. Death is an
unwelcome guest. We neither have the will nor the courage to face the death. We
make all efforts to delay ‘death’, but some times we are caught unawares. He
gives a big knock at the door. If we don’t open, he breaks the door and stands
in front of us with his cruel face. He captures us and takes his toll and
vanishes in the wilderness. His shadows widen and make us fearful. But . . . .

Why should we fear ?

Because he is everywhere ?

He is in plane and train ?

He is on a boat, car, zhopadpatti and also in star hotel ?

He is on table and in a chair and on a bed ?

Middle of the road and even on footpath ?

He is in hospital, railway station and in dispensaries ?

He is here and there where “I” am.

I therefore recognise death and say

Your presence is noted.

I am however not fearful be highlighted.

His presence gives rise to innumerable brain teasers

His presence compels one to spare,

At least some valuable carpet area for “Devghar”

His presence makes authors and poets to write.

His presence makes philosophers assemble at least to fight.

His presence makes a man define and achieve a goal

His presence keeps one’s name and fame even in one’s absence

Giving everyone a motivation to do something in present.

His presence makes a small little leaf to duck under

His little movement enables leaf to take a big sky jump

And let him remember, I am not alone.

Plural of “I” becomes “we”

We shall give a good fight to him

And not run away or flee.

11/09 or 26/11 makes no difference

We always have some cross reference

We are neither afraid nor coward.

We are sending a prayer forward

Oh, ALMIGHTY, give us a right

to end our life at our will

When we have settled our important bills

And our contribution to the cause of this world is “NIL”

And also a wisdom to recognise HIS will.

I believe, death being a certainty should be treated by us as a friend. So
let us welcome the friend with a smile.

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Nirav Shah

Withdrawal of registration u/s. 12-A of the Income Tax Act, 1961

Representation

Representation

February 8, 2010

The Chairman

Central Board of Direct Taxes

Department of Revenue

Ministry of Finance

Government of India

North Block

Delhi-110 001

Dear Sir,

Sub:
Withdrawal of registration
u/s. 12-A of the Income Tax Act, 1961

Brief Background:
Section 11 of the Income Tax Act 1961 (Act) grants exemption in respect of
income applied by any person, (normally a trust or an institution) for any
charitable or religious purpose. In order to avail of an exemption u/s. 11, such
a trust or institution is required to be registered u/s. 12A of the Act. Such an
application is to be made within a period of one year from the date of creation
of the trust or establishment of the institution and the exemption would be
available in respect of the year in which such an application for registration
was made.

Up to 1st June 2007, the registering authority, which is
either the Commissioner or Director of Income Tax (Exemptions) had a power to
condone the delay in making such an application. Finance Act 2007 has withdrawn
that power from the date aforesaid.

Section 12AA of the Act prescribes the procedure for
registration, under which, the registering authority is required to be satisfied
about the genuineness of activities of the trust or institution. The section was
inserted from 1.04.1997.

The registration procedure is prescribed by rule 17A and the
form in which the application is to be furnished is Form 10A. Form 10A, contains
an undertaking by the applicant as follows:

"I undertake to communicate forth with any alteration in the
terms of the trust or in the rules governing the institution made at any time
hereafter."

However neither the governing sections nor the rules contain
any similar condition or the consequence of the non-furnishing of such a change.

Withdrawal of 12A registration in case of change in objects

As stated aforesaid, the governing sections and the rules are
silent about the intimation in change of objects / rules being given to the
registering authority. Prior to 1997, even the certificate issued in response to
the application did not contain any such condition.

We have been informed by our members that the assessing
officers are now calling for details of any change in objects and rules and in
case of such a change and the absence of intimation thereof to the registering
authority, proceeding to deny exemption under section 11. The view being taken
is that on such a change occurring and the same not being intimated to the
registering authority, the registration is treated as withdrawn.

For this we understand that reliance is being placed on the
following three decisions.

Allahabad Agricultural Institute & Another Vs. Union of India
291 ITR 116 (All)

Sakthi Charities
Vs CIT 182 ITR
483 (Mad)

Sakthi Charities
149 ITR 624 (Mad)

We now understand that, such a stand is being taken by the
registering authority in Mumbai i.e. Director of Income Tax (Exemptions). In
some cases, a communication is being sent that the registration is treated as
withdrawn while in some cases, show cause notices are being issued with similar
result.

Without going into the rationale of these decisions, merits
thereof, and the peculiar facts on the basis of which they have been rendered,
we submit that the stand taken by the Department will cause untold hardship.

It must be borne in mind that many registrations under
section 12A are more than three decades old and without any specific provision
or rule, it is virtually impossible that trustees or persons in management of
these charitable institutions would have been aware of the existence of such an
undertaking which was given at the time of application. This must be viewed in
light of the fact that most charitable institutions are run by persons working
on an honorary basis, and they rarely have professional help on a regular basis.
In any event, even those professionals would not be aware of the undertakings,
particularly when there is no express provision.

If the assessing officers deny exemption under section 11,
based on the interpretation aforesaid (many have already completed that
process), genuine charitable trusts / institutions will face huge tax arrears,
and the work of charity will suffer substantially. Moreover, even if these
trusts apply for registration again, such a registration will, be available only
from the year in which the application is made (the power of condonation having
been withdrawn)

We appreciate that it is necessary to ensure that the
exemption is granted to only deserving institutions. It is also accepted that
institutions claiming these exemptions must submit themselves to the scrutiny of
the registering authority, in case of change in objects. However, relying on a
technical interpretation to deny an exemption of this nature should be avoided.

We therefore feel that-

a) In case of change in objects being noticed, the trust /
institution be issued a show cause notice.

b) The trust be asked to explain the rationale behind the
change and if the objects are still charitable, the registration be continued.

c) If the objects are not charitable then the registration be
withdrawn by a specific order, so that the remedy of appeal is available to the
trust / institution by way of an appeal to the tribunal.

d) During the time that the proceedings in which the impact
of the change is being verified by the D.I.(Exemptions) / Commissioner, the
assessing authority be restrained from assuming / presuming that the 12A
registration is cancelled.

e) This fact of 12A registration being conditional, and the
fact of change of objects being required to be intimated to the registering
authority be given widest publicity

f) A suitable amendment be recommended in the Act, so that in
future, the trusts are suitably forewarned.

We hope quick action is taken in this regard so that genuine
trusts do not suffer on account of technical lapses. If any assistance is
required from the Bombay Chartered Accountants Society, we will be glad to
provide the same.

Yours faithfully,

Nirav Shah

CIC raps govt. on Himachal CJ posting ‘Why was he promoted despite then prez Kalam’s objection’

New Page 1

46 CIC raps govt. on Himachal CJ posting
‘Why was he promoted despite then prez Kalam’s objection’

In a further setback to the judicial secrecy, The Central
Information Commission has ordered the Centre to disclose how Jagdish Bhalla
could become Chief Justice of Himachal Pradesh even after he had been found
unfit to head another High Court by the then President, A. P. J. Abdul Kalam.

The order directing disclosure of documents related to
Justice Bhalla’s promotion came on an appeal filed by RTI activist Subhash
Chandra Agrawal, the very same activist at whose instance the CIC had already
told the SC to give out information related to declaration of assets by judges.

CIC member A. N. Tiwari asked the Justice Department to
disclose within four weeks ‘the file, records or documents germane’ to Bhalla’s
appointment as Chief Justice of the Himachal Pradesh HC in February 2008.

His promotion was unusual as just a year before, President
Kalam had returned the proposal to appoint Bhalla, as Chief Justice of the
Kerala HC. Justice Bhalla was then in the Allahabad HC and Kalam’s reservations
were on account of the Uttar Pradesh Revenue Department’s report that a land
mafia embroiled in litigation had sold the Judge’s wife a 7,200 sq.metre plot in
Noida for no more than Rs.5 lakh (as against the then prevailing market value of
Rs.7 crore.)

Justice Bhalla could still make it to the top judicial job in
Shimla because after Kalam’s retirement, the SC collegium (committee of senior
Judges) made a fresh recommendation for his promotion. At the time of his
promotion, Bhalla happened to be serving as Acting Chief Justice of the
Chattisgarh HC on account of a discretionary power exercised by Law Minister H.
R. Bhardwaj. The order of the CIC requires the Justice Department to disclose
the correspondence between the Law Minister and the CJI along with the file —
notings made by various authorities, including Kalam’s observations. If this
order is implemented, it could lay bare for the first time the manner in which
Judges appoint themselves under the existing system in which the judiciary
wrested primacy from the executive in the
name of protecting the independence of the judiciary.

(Source : The Times of India, 24-1-2009)

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Nirav Shah

How many bad eggs ?

New Page 1

45 How many bad eggs ?

The terrorist attacks on Mumbai in November and in past years
have showed up the weaknesses of India’s internal security system, but also laid
bare the fact that security failures are linked inextricably to broader issues
of governance and corruption (policemen who allow smuggling of commercial
contraband also allow RDX to come in). In the same way, the Satyam scandal
points to the dirty underbelly of India’s corporate world, and of its regulatory
and legal framework. The fact is that Satyam would not have happened without the
failure of the company’s independent directors, auditors and bankers, not to
mention senior executives not linked to the guilty promoters. Such broad-based
failures do not come together by accident; they have to be pointers to broader,
systemic failures.

In the Satyam case itself, the valuation of one of the Maytas
firms for purposes of the aborted merger was done by a leading accounting firm
on the promise of secrecy — an unheard of procedure that the independent
directors accepted without demur. Evidence of broader systemic problems has also
surfaced, with news reports pointing to the pathetic record so far of the
Serious Fraud Investigation Office (virtually no convictions till date) and of
the Institute of Chartered Accounts of India (which has a poor record of
penalising guilty accountants, and has not yet taken action in the auditing case
involving Global Trust Bank, despite the lapse of four years).

Everyone knows that business is not a morality play. There
are always good and bad eggs. The question is, what is the mixture, and is it
palatable ? When the World Bank is pointing fingers at even marquee corporate
names, does anyone recall that Transparency International polled international
businessmen to come up with the finding that Indian businessmen are the No. 1
bribe-payers abroad ?

We can respond to a scandal by brushing uncomfortable
questions under the carpet, and hope that business can go on as usual. But that
would be the worst possible way to deal with the problem. If we want to clean up
rather than simply wait for the next scandal to erupt, we had better start
looking for systemic correctives.

(Source : Business Standard, 17-1-2009)

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Nirav Shah

Taxation of Software — Recent Developments

Service Tax

Preliminary:

The Information Technology/Software Industry in India is
subjected to multiple indirect taxes like Excise Duty (ED)/Countervailing Duty (CVD)
and Service tax by the Centre and VAT by the States. Apart from incidence of
multiple taxation, what is affecting the industry most is the uncertainty over
the correct applicability of a particular tax on its activities and the
confusion is in the minds of the taxing authorities — both the Central and the
States. This results in divergent practices being followed and dual taxation as
a precautionary measure.

An attempt is made to discuss some important recent
developments in regard to this complex subject.

Background:

Information Technology Software Service (ITSS) was
comprehensively brought under the levy of service tax through the insertion of
the sub-clause (zzzze) in clause (105) of section 65 of the Finance Act, 1994
(FA) w.e.f. 16-5-2008.

Since March, 2006, ED was already being levied on ‘Packaged
Software’ manufactured in India and sold off the shelf. Such ‘Packaged Software’
has been treated as ‘goods’ and classified under Tariff Item 8523 80 20 of the
Central Excise Tariff. [It needs to be noted that the issue as to whether or not
the concept of ‘manufacture’ can be applied to ‘software’ or not, is pending
before a larger Bench of the Supreme Court. However, in the context of income
tax it has been held in CIT v. Oracle Software India Ltd., (2010) 250 ELT
161 (SC), that the process of software replication which renders a commodity or
article fit for use which otherwise is not so, would fall within ‘manufacture’.

Though basic customs duty is not payable on Imports of IT
software, CVD under customs became payable on such imports due to levy of ED on
it.

W.e.f. 16-5-2008, the ‘Licence to use the IT software’ has
been subjected to levy of service tax. However, the levy was confined to the
services in relation to IT software for use for commercial exploitation. It is a
matter of common knowledge that in case of supply of software, two cost
components are usually involved viz. :

the
value of the media and the cost of recording of software thereon; and

the
value of the licence to use the software representing the consideration towards
intellectual property.

On the other hand, based on the ruling of the Supreme Court
in Tata Consultancy Services v. State of A.P., (2004) 178 ELT 22 (SC)
many States have imposed VAT or WCT on software classifying it as ‘goods’ or
‘works contract’ under respective VAT legislations. For example, under the
Maha-rashtra Value Added Tax Act, 2002 (MVAT), intangible goods are covered by
entry C-39 and liable to tax. ‘Software packages’ are notified under entry C-39
and hence, are liable to VAT.

Hence, in the context of software taxation, it becomes very
important to determine whether ‘software’ is sold as ‘goods’, and is liable to
VAT or provided as ‘service’, so as to attract levy of service tax under the FA.

Further, pursuant to the 46th Amendment of the Constitution
of India by the Constitution (Amendment) Act, 1982, the tax-base underwent a
sea-change due to the insertion of clause (29A) in Article 366. The States
acquired the powers to levy sales tax on certain types of ‘deemed sale’. As a
consequence of this constitutional amendment, all the states have made changes
in their respective VAT Legislation in this regard. One such ‘deemed sale’ that
can be subjected to levy of VAT/sales tax is transfer of the right to use any
goods for any purpose (whether or not for a specified period) for cash, deferred
payment or other valuable consideration. Thus, States have been levying or
attempting to levy VAT/sales tax on such activity of ‘providing licence to use
IT software’.

The IT/Software Industry was slapped with the demands raised
by the authorities either for customs duties i.e., CVD or for service tax. Even
though CVD was paid on the licence value, service tax was being demanded thereon
and vice versa. Even simultaneous demands under customs and service tax have
been raised in many cases.

It would appear that it was never the legislative intent that
the value addition in the form of software licence should be taxed more than
once. It should either be taxed by way of ED/CVD or by way of service tax.

Information Technology Software Service (ITSS):

IT/Software Services were comprehensively brought under the
service tax ambit w.e.f. 16-5-2008 through introduction of a specific entry viz.
section 65(105)(zzzze) in the FA.

Relevant extracts from the Ministry’s Circular/Letter DOF No.
334/1/2008-TRU, dated 29-2-2008 clarifying the scope of service are as under :

4.1.1

Information Technology (IT) software service includes:

Development (study, analysis, design and programming) of software.

Adaptation, upgradation, enhancement, implementation and
other similar services in relation to IT software.

Provision of advice and assistance on matter related to IT
software, including :

Conducting feasibility studies on the implementation of a system,

Providing guidance and assistance during the start-up phase of a new system,

Providing specifications to secure a database,

Providing advice on proprietary IT software

Acquiring (substituted by ‘providing’ by the Finance Act, 2009) the right to
use, :

IT
software for commercial exploitation including right to reproduce, distribute
and sell,

Software components for the creation of and inclusion in other IT software
products,

IT
software supplied electronically.

“4.1.2

Software consists of carrier medium such as CD, floppy and coded data. Softwares are categorised as ‘normal software’ and ‘specific software’. Normalised software is a mass market product generally available in packaged form, off the shelf in retail outlets. Specific software is tailored to the specific requirement of the customer and is known as ‘customised software.’

“4.1.3

Packaged software sold off the shelf, being treated as goods, is leviable to excise duty @ 896. In this Budget, it has been increased from 8% to 12% vide Notification No. 12/2008-CE, dated 1-3-2008. Number of IT services and IT-enabled services (ITeS) are already leviable to service tax under various taxable services.”

“4.1.5

Software and upgrades of software are also supplied electronically known as digital delivery. Taxation is to be neutral and should not depend on forms of delivery. Such supply of IT software electronically shall be covered within the scope of the proposed service.”

Software downloaded from Internet:

a) The Finance Minister in his Budget Speech on 28-2-2006 observed as under:

“Para 138

I propose to impose an 8% excise duty on pack-aged software sold over the counter. Customised software and software packages downloaded from the internet will be exempt from this levy.

In cases where the software is made available only through the medium of the Internet, there is no express, exclusion in Entry 27 stated above. However, the Explanatory Notes, which form part of the Budget papers read as under:

“Excise duty of 8% is being imposed on packaged software is also known as canned software on electronic media (software downloaded from the internet and customised software will not attract duty). [Serial 27 of Notification No. 6/2006)]”.

b) The Central Excise Rules, 2002 contemplate payment of excise duty at the time of removal of excisable goods from the factory and at the rates prevalent on the date of removal from the factory. Where a customised software solution is sold to the customer through the medium of Internet, the transaction can be considered as an e-commerce transaction and there is no physical removal of goods in a tangible form from the factory gate, which is the requirement of levy of excise duty. Further, the software is not available in any medium for it to be considered as goods as per the rationale of the Supreme Court in TCS case.

c) The following judicial rulings need to be noted:

i) In Digital Equipment (India) Ltd. v. CC, (2001) 135 ELT 962, the Tribunal has held that information transmitted via e-mail cannot be akin to import of record media in 85.23. In an e-mail transfer, no media as a movable article is crossing the international boundaries and there is no movable property movement involved. Therefore, transfer of information or idea or knowledge on e-mail transfer would not be covered within the ambit of goods under the Customs Act. If they are not goods, then they cannot be subject to any duty.

ii) The Supreme Court in the case of Associated Cement Company v. CC, (2001) 128 ELT 21 had held that where any drawings or designs or technical materials are put in any media or paper, it becomes goods. Hence only if an intellectual property is put in a media, it is to be regarded as an article or goods.

iii) In Multi Media Frontiers v. CCE, (2003) 156 ELT 272, the Tribunal has observed that a software cannot exist by itself and for it to be put to use it has to necessarily exist on some suitable media such has floppy disc, tape or CD.

iv) In Pantex Geebee Fluide Power Ltd. v. CC, (2003) 160 ELT 514 (Tri), it has been held that a transfer of intellectual property by intangible means like e-mail would not be liable to customs duty.

d) The Geneva Ministerial Declaration on Global Electronic Commerce Document WT/MIN (98) DEC/ 2, dated 25-5-1998 which is a declaration of an intent by members of WTO that they would continue their current practice of not imposing customs duty on electronic declaration.

e) MVAT does not contain specific provisions to tax supply of software electronically.

f) Providing the rights to use information technology software supplied electronically is specifically covered under the scope of ITSS[section 65(105) (zzzze)(vi) of FA.]

Amendments by the Union Budget for 2009-10/Clarification regarding packaged or canned software:

Relevant Extracts of Ministry’s Circular Letter D.O.F. No. 334/13/2009-TRU, dated 6-7-2009 are as under:

I.3 — Packaged or canned software:

Partial exemption from excise duty has been provided to packaged or canned software so that the duty payable on that portion of the value which represents the consideration for the transfer of the right to use such software, is exempted. The benefit of the exemption is available to the manufacturer of such software when he declares to the Central Excise authorities that the right to use is transferred for commercial exploitation and fulfilment of some other conditions. The details are contained in Notification No. 22/2009 — Central Excise, dated 7th July, 2009. On the portion of the value which is exempted from excise duty, service tax will be leviable under the ‘Information Technology Software Service’.

II.9 — IT Software:

On packaged or canned software, CVD exemption has been provided on the portion of the value which represents the consideration for transfer of the right to use such software, subject to specified conditions. This portion of the value is leviable to service tax as ‘Information Technology Software Service’. Although, the CVD exemption has not been made conditional upon the payment of service tax, it is requested that a mechanism be put in place to ensure regular exchange of information on details of importers availing of the exemption between the customs and service tax formations so that, where necessary, action for recovery of service tax may be taken.

Amendments by the Union Budget for 2010-2011:

a) Realising the difficulties faced by the IT/Software Industry, few steps were taken to address the same, as under:

Vide Notification No. 17/10-CE, dated 27-2-2010, the condition that the transfer of right to use shall be for a commercial exploitation has been removed and Notification No. 22/09-CE has been superseded.

Similarly, the Notification No. 80/09-Cus has been superseded vide Notification. No. 31/10-Cus and the condition relating to ‘commercial exploitation’ has been dispensed with.

Also, vide Notification No. 2/10-ST, dated 27-2-2010, the exemption from payment of whole of the service tax has been granted to ‘packaged or canned software’, intended for single use and packed accordingly subject to fulfilment of the prescribed conditions including the condition that the benefit of Notification 17/10-CE is not availed of.

Exemption from payment of service tax vide Notification Nos. 2/10-ST and 17/10-ST, both dated 27-2-2010 is granted in respect of ‘packaged or canned software’, intended for single use and packed accordingly.

(b) The following needs to be noted :

The exemption is restricted to shrink-wrapped single-user software licence and does not apply in case in ‘multi-user software licence’.

The issue of liability to pay service tax under ‘reverse charge in terms of section 66A of FA could arise in regard to the remittances towards licence fee made by the licensee based in India to the overseas software company. In such cases, there could be issues as to whether the exemption granted vide the above Notifications would be applicable or not.

a) Important Ruling of Madras High Court:

The Madras High Court, in a landmark ruling in Infotech Software Dealers Association v. UOI, (2010) 20 STR 289 (ISODA), has upheld the constitutional validity of section 65(105)(zzzze) of the FA, introduced with effect from 16-5-2008.

b) The writ petition filed by ISODA had raised the following issues, in particular:

Whether software is ‘goods’ ?

Whether, the transfer/supply of software, in terms of the end-user licence agreements en-tered into by the members of the ISODA would amount to a service, especially in the light of the fact that this transaction is treated as a sale?

Whether, the Parliament has the legislative competency to levy service tax u/s.65(105) (zzzze) of the Act?

c) During the course of hearing, ISODA had submitted that its members are re-selling software products under the three categories, viz.,

shrinkwrapped software,

multiple user software/paper licence and

Internet downloads.

ISODA also submitted that the transactions entered into by its members are only a sale of software being goods and that no element of service is present and that only the State Governments are empowered to levy tax in terms of Entry 54 of List II of Schedule VII of the Constitution and con-sequently, the Parliament has no legislative compe-tence to levy service tax on the same transaction u/s.65(105)(zzzze) of the FA.

d) Some of the important contentions of Department were as under:

The amendment would fall under Entry 97 of List I of Schedule VII of the Constitution of India and that the challenge to the legislative competency of the Parliament cannot be sustained. Standardised software licence is available across the shelf or is downloaded from Internet, and by itself, it is not a finished product inasmuch as updates are given by the original manufacturer to the end user for an agreed period. At no stage, does an end user who runs the software becomes the absolute owner of the software.

The right to use the software excludes certain rights, particularly the right to modify, right to work on the software and the right to commercially exploit the software and that each transaction should be considered individually to find out whether it is a sale or service. ‘service element’ is clearly discernible in the case of customised software which is liable for service tax.

e) The Madras High Court made the following important observations:

When the legislative competency of a taxing statute is considered, the nature of transaction and the dominant intention would be relevant.

Goods can be tangible or intangible property and the Indian law does not distinguish between the two.

Software, whether packaged or customised is goods within the meaning of Article 366(12) of the Constitution, in terms of the rulings of the Supreme Court in TCS case, the Karnataka High Court ruling in Antrix Corporation (2010) TIOL 515 HC KAR and the Madras High Court ruling in Infosys (2008) 233 ELT 56 (Mad.). The legal position that software is goods is no longer res integra.

The copyright in a software transaction is protected and always remains the property of the creators/developer and what is sold is the right to use the software. When the sale is with a condition for exclusive use of the software by the customer at the exclusion of others, it gives absolute possession and control to the user of the right to use the software.

When a developer does not sell the software (packaged or customised) as such, the transaction between the resellers and the end users cannot be a sale of software as such but only the contents of the data stored in the software, which would only amount to a service.

If the software is sold through the medium of Internet which is downloadable, it does not fit into the ambit of ‘IT software of any media’ and consequently, it is possible to hold that when an access control is given through an Internet medium with a username and password and when there is no CD or other storage media for the item, it does not satisfy the requirement of being ‘goods’.

f) The Madras High Court dismissed the writ petition of ISODA and held as under:

Though software is ‘goods’, the transaction may not amount to a sale in all cases and it may vary depending upon the end-user licence agreement. The transaction between the members of ISODA with its customers is not of sale of the software as such, but the contents of data stored in the software would amount to only service.

The Parliament has the legislative competency to enact law to include certain services provided or to be provided in terms of ‘ITSS’, the residuary Entry 97 of List I of Schedule VII. The constitutional validity of the amended provision cannot be questioned so long as the residuary power is available.

The question as to whether a transaction would amount to sale or service depends upon the individual transaction and on that ground, the vires of a provision cannot be questioned.

g) Some of the important issues arising from the aforesaid landmark ruling of the Madras High Court are as under:

The ruling makes a distinction between ‘soft-ware’ and ‘contents of data stored in the software’.

The ruling has given a new dimension to the taxation of the transfer of right to use goods, by the States. The following observations, in particular, need to be noted:

Para 31

“….the dominant intention of the parties would show that the developer or the creator keeps back the copyright of each software, be it canned, packaged or customised, and what is transferred to the network subscriber, namely, the members of the association, is only the right to use with copyright protection. By that agreement, even the developer does not sell the software as such. By that Master End-User Licence Agreement, the members of petitioner — association again enter into an end-user licence agreement for marketing the software as per the conditions stipulated therein. In common parlance, end user is a person who uses a product or utilises the service. An end user of a computer software is one who does not have any significant contact with the developer/ creator/designer of the software. According to Webster’s New World Tele-com dictionary, an end user is “the ultimate user of a product or service, especially of a computer system, application or network.” On a careful reading of the above, we are of the considered view that. “…. when a transaction takes place between the members of ISODA with its customers, it is not the sale of the software as such, but only the contents of the data stored in the software which would amount to only service. To bring the deemed sale under Article 366(29A)(d) of the Constitution of India, there must be a transfer of right to use any goods and when the goods as such is not transferred, the question of deeming sale of goods does not arise and in that sense, the transaction would be only a service and not a sale.”

It is a settled law that for a tax to be levied by the States on the transfer of right to use goods, there is no need for goods, as such, to be transferred. The above observations of the Madras High Court appear to unsettle the settled law.

The decision seems to distinguish between trans-actions entered into by developers of software products and re-sellers of software products. Most domestic software product players directly sell software licences to their customers. While, most re-sellers operate in the area of re-sale of imported software licences, a distinction is sought to be made between selling of a licence by a developer and that by a reseller.

The decision does not seem to distinguish between ordinary re-sellers and value added re-sellers. In a latter case there is possibility of service element.

The Court has also significantly observed that electronic import of software licences is a service, as the software (being goods) is not transferred. This observation could significantly impact the import of software licences by the Indian resellers and large business houses, a major portion of which happens through the electronic mode.

MRP levy introduced for packaged software — Recent Notifications:

In an important development, the Government has brought the entire packaged software industry, under the MRP-based excise levy by issuing Notification Nos. 30/10-CE and 53/10-Service Tax, both dated 21-12-2010.

In terms of the Notification No. 30/10 CE, Notification No. 49/08 CE, dated 24-12-2008 has been amended, providing for an abatement of 15% of what has been given on the MRP of the packaged software based on which the central excise duty will have to be paid by the manufacturer and CVD to be paid by the importer. In terms of Notification No. 53/10-ST, dated 21-12-2010 no service tax shall be payable on the licence value in terms of section 65(105)(zzzze)(v) of FA.

Some of the more important implications that arise from the Notifications are as under:

a) MRP-based levy would be applicable only for the physical mode used for licensing of the pack-aged software licences as contrasted to the electronic mode of transfer. Hence electronic transfer of licences for packaged software would continue to be taxed under service tax in terms of specific provisions u/s.65(105)(zzzze) of the FA.

b) Importers of packaged software licences would have the choice of either importing the licences in the electronic mode, or in the physical mode. Up-till now importers were either paying CVD on the physical imports or service tax on the electronic imports on the transaction values. Now with the MRP-based levy for CVD on physical imports, it is possible that importers could be better off, shifting to the electronic import, as the value-added margins for imports could be much higher.

c) The local manufacturers may find it better to shift to the electronic mode of transfer of software licences, as paying service tax at 10.3% on the transaction value could be cheaper as compared to paying central excise duty at 10.3% on MRP less 15% abatement.

d) In terms of Notification No. 49/08-CE, dated 24-12-2008 (as amended) ‘retail sale price’ means the maximum price at which the excisable goods in packaged form may be sold to the ultimate consumer and includes all taxes local or otherwise, freight, transport charges commission payable to dealers, and all charges, towards advertisement, delivery, packing forwarding and the like as the case may be, and the price is the sole consideration for such sale.

Notifications issued could result in practical difficul-ties for the importers. To illustrate:

i) In many cases the concept of MRP may not work for imported packaged software products. In such cases, issues would arise as to whether the customs authorities can treat the ultimate selling price charged by the importer, as the MRP where there is no MRP for the software product imported/ or would the authorities go by the retail prices published by the foreign suppliers of software packages which could be substantially higher than the price at which these are sold in India.

ii) MRP regime may not be practically workable inasmuch as a large number of transactions get conducted through contracts entered into between the parties. A software player holding valid IPR can transfer licences to various customers at varyingprice arising out of customisation etc. In such cases, how can MRP-based duty be computed.

e) In cases of imports at significantly reduced special price (e.g., non-profit bodies), the same could get covered under the MRP levy, resulting in higher overall costs.

f) The new MRP-based levy would also affect importers of software licences for their internal purposes at discounted prices. Such importers would have to pay CVD on the MRP less 15% abatement, which could mean increase the overall costs.

g) By issuing these Notifications, the Government seems to be confirming that packaged software is nothing but goods. However the electronic transfer of software licence would be service in terms of clause (vi) of section 65 (105)(zzzze) of FA. Hence, the same product can be ‘goods’ or ‘service’ depending upon the mode of delivery.

Nirav Shah

Mentoring of Articled Students – the Need of the Hour

Mentoring

What is meant by Mentoring?

Mentoring, as defined by the Encarta Encyclopedia, means
“serving as a guide, counselor and teacher for another person, usually in an
academic or occupational capacity”. Some professions have “mentoring programs”
in which newcomers are paired with more experienced persons who advise them and
serve as examples as they advance. Schools sometimes offer mentoring programs to
new students or students having difficulties. Mentorship refers to a
developmental relationship in which a more experienced or more knowledgeable
person helps a less experienced or less knowledgeable person — someone who can
be referred to as a protégé, or a mentee — to develop in a specified capacity.

The term ‘mentoring’ is, therefore, wider than training or
teaching; it entails providing guidance and direction at a personal level that
is often missed out in the Indian scheme of education, but is so critical for
higher levels of education and development! “Mentoring is a process for the
informal transmission of knowledge, social capital and the psychosocial support
perceived by the recipient as relevant to work, career or professional
development; mentoring entails informal communication, usually face-to-face and
during a sustained period of time, between a person who is perceived to have
greater relevant knowledge, wisdom or experience (the mentor) and a person who
is perceived to have less (the protégé).” (Bozeman, Feeney, 2007).

How is mentoring relevant to the CA profession?

The CA
profession provides a unique opportunity to its members to nurture budding
professionals, usually referred to as ‘articled students’. Articled students
generally venture into the world of Chartered Accountancy at a tender,
impressionable age, generally between 18 to 21 years. For most, this is their
first introduction to work and to some extent, ‘real life’. The experiences and
values that they imbibe during these years of articleship stay with them for the
rest of their lives. It is also their first exposure to the real world, where
they apply their knowledge to real life situations in a significant manner.

In recent years, the lives of articled students in Mumbai
have become stressful because of a variety of reasons ranging from long
commutes, long hours of work, balancing between the regime of coaching classes
and the demands of work, college attendance and examinations and an all-round
pressure to perform in exams and at work. The relationship between the student
and the principal has also changed from the ‘guru-shishya’ relationship to the
‘employer-employee’ relationship, with the principals using the articled
students as cheap resource. The principals, at times, forget their role of
grooming the students who work under them for three years to become
professionals. The ‘me first’ attitude of the current world, manifested in both
the principal and the student is also not conducive to a healthy
principal-student relationship.

It is in this context that mentoring gains relevance for the
CA profession; effective mentoring would lead to well rounded professionals,
greater respect for the principals and also enhancement to the image of the
profession by ensuring that the new entrants are professionally nurtured.

Where does BCAS come into the picture?

BCAS as an Enabler for Effective Mentoring

BCAS has always been an incubator of new ideas and an
initiator of novel initiatives. In the context of mentoring, BCAS has decided to
launch a unique initiative: Mentoring Articled Students. The objective of this
initiative is to build bridges where there are walls — to help members to start
thinking of articled students not as their workers but as a responsibility and a
privilege. This initiative entails creating a framework for mentoring articled
students that will lead to grooming and nurturing young minds beyond the
technical skills required for the profession — in the areas of communication,
self management, purposeful living and constant learning. It also entails
providing support to members who wish to ‘mentor’ their articled students by
providing a ready-to-use framework by organizing mentoring sessions in areas
where specialized guidance is required, and compiling a ‘mentoring guide’ for
use by the members.

The objective of this initiative may be summarized as:

§
Creating awareness amongst the members for the need to ‘mentor’ articled
students.

§
Preparing a ‘Framework for
Mentoring’ that can be implemented by an interested principal.

§
Creating awareness among
articled students to focus on holistic development during articleship that
stretches beyond technical training, such as developing inter-personal
communication and presentation skills, inculcating habits of reading, engaging
in purposeful activities and becoming a life-long learner.

This initiative envisages that while mentoring will be an
internal process between the principal and the student, BCAS will complement
individual efforts by providing a framework for mentoring and periodic updates
to the principals, and also by arranging group sessions for the students where
leading professionals from different fields will be invited to share their
experiences and knowledge with the students.

An Invitation to Participate
in this Unique Initiative

Recognizing that mentoring of articled students is the need
of the hour, BCAS commits itself to be a catalyst in this area and becomes an
enabler in promoting this noble cause — for the students of today are the
Chartered Accountants of tomorrow, and the Chartered Accountants of tomorrow are
the future of our profession.

So, come join us, to pioneer a mentoring movement for the students of our
profession.

Nirav Shah

Discounted Cash Flow

1 Introduction

Discounted Cash Flow (DCF) is a widely used method in the value analysis of any business. The value of an asset is the present value of expected cash flows from an asset. In this context, all the valuation methods including Net Asset Value (NAV),Profit Earning Capacity Value (PECV) and market price endeavour to determine the economic value of an asset but by using different approaches.

The relevance of Net Asset Value (NAV) derived from accounting books continues to diminish as self-generated intangible assets, which are key value drivers of modern corporations, are not recorded under accounting conventions. In PECV, profitability, sales and other relevant multiples derived from the market price of a comparable business is used as the metrics to arrive at the value of the subject business. It is assumed that market participants have paid for the expected future cash flows (FCF) from the asset when price under free market conditions is considered as indicative of value.

Though DCF is the application of the Net Present Value (NPV) rule, which in essence could be reduced to two variables – discount rate and cash flows, the application of DCF could be challenging as cash flows are impacted by several variables and the appropriate discounting rate is always a matter of debate. Several adjustments are also required to derive a finely calibrated value estimate. This article aims to provide an overview of the application of the DCF method in a practical context and the underlying theoretical concepts.

Description

The DCF method values a business based on the projected cash flows the subject business is expected to generate over a given period of time. The expected cash flows are discounted at an appropriate discount rate to determine its present value and thus the time value of money is provided for. A business is assumed to have a perpetual existence and DCF value is the summation of the present values of the cash flows expected in the projected horizon and estimated for perpetuity beyond the horizon.

Future cash flow (FCF) projections are the basic requirement for application of DCF. FCF usually forms part of the projected financial statements or may be derived from the projected income statements and the balance sheets. The FCF could be at the firm level available to the financiers of the business (both debt [D] and equity [E]) or to the equity holders. Generally the FCF to the Firm (FCFF), which represent business related cash flows available for distribution to both the owners (equity holders) of and the lenders to the business, is used in DCF . FCFF is equal to Profit before Interest, Tax, Depreciation and Amortisation (PBITDA) less Capital Expenditure (Capex), Taxes and adjustment for working capital changes. From the foregoing, it is evident that the FCFF is not impacted by the financing pattern of the enterprise. Conceptually, therefore, the value outcomes should not change whether the FCFF is used or Free Cash flow to equity (FCFE) is used.

Projections

The valuation estimate which is the output of a DCF model is only as good as the projections, which are built on subjective assumptions both at the macro level concerning the overall economy and business environment and at the micro level specific to the enterprise. In other words, integrity of the valuation output is largely determined by the thoroughness of the projections and its underlying assumptions. Projections review, therefore, entails a through understanding of the overall economy and the market in which the subject enterprise operates.

Common size statements, ratio analysis, peer group comparisons are analytical techniques employed in projections review. Inflationary expectations, currency movements, tariff levels are among the key macro assumptions. Business specific assumptions include pricing policy, salary levels and capital expenditure, which need to be consistent with the overall macro trends that are being projected. For example, it may not be realistic to assume a commodity would fetch prices higher than ruling market prices or to assume that raw material can be procured at lower than ruling market prices. In fact, it is likely that the prices may be influenced by the entry of other competitors prompting the incumbents to counter competition by reducing prices and influence the overall market.

At the micro level specific to the enterprise, working capital assumptions such as number of days of receivables and payables, inventories, trade advances and deposits will need to be estimated. Reasonableness of capex estimate may be ascertained through quotations/ orders placed for machinery and equipment. In this connection, it must be noted that maintenance capex should also be provided for in the projections. However, interest cost, if any, capitalized for accounting purposes is not be considered as capex for determining the FCFF.

Actual tax outflow must also to be projected with reference to the tax laws. Tax deduction on account of interest is to be ignored for computing the FCFF as the tax benefit on interest cost is captured in the discounting rate formula. Though the future FCF is derived from the accounting statements, it is the timing of the cash flows that is important and not the accounting distinction between revenue and balance sheet items. To illustrate- accounting of deferred tax does not impact cash flows but the actual outflow on payment of tax will affect the same.

2 A business entity under ordinary circumstances is expected to have a perpetual existence. But, projections are usually for a finite period. In a DCF model, the estimate of cash flows beyond the horizon is based on the cash flows generated in the last year of the horizon after appropriate adjustments. In order to fit the cash flow projections in a DCF model, the projections need to be at least up to the year in which the business is expected to achieve stable cash flows as the cash flows for perpetuity are based on the cash flows of the last year of the horizon after suitable adjustments. Conceptually the length of the forecast period should not impact value outcome.

It is important to note that it is not possible to forecast the behaviour variables with certainty and projected numbers may be considered as the outcome derived from various possibilities and the probability of their occurrence. In this context, a sensitivity analysis to assess the impact on cash flows by changes in the behaviour of variables is a necessary part of a value analysis exercise.

Theoretical Concepts

There are various theoretical concepts underlying the application of the DCF method. These are explained below:

Discount rate is the return expected by investors after taking into consideration the risk associated with the business. The investor raises return expectations when there appears to be an increase in risk.

Measurement of risk is at the heart of finance and we rely on theoretical insights and certain statistical concepts to arrive at the discount rate. In 1952, Harry Markowitz formulated the Portfolio Theory in a paper entitled “Portfolio Selection” wherein the principle of creation of the frontier of invest-ment portfolios is such that each of them had the highest expected return, given the level of risk that was set out and thus gave formal expression to the intuitive idea that diversification reduces risk. In Markwitz’s formula, Standard deviation (s) of the return on the security is considered as the risk. An investor is concerned with the risk of the portfolio which is the variance (s2) of the portfolio. A well diversified portfolio would encompass all securities in the market and would react to the general market movement and market risk.

Capital Asset Pricing Model (CAPM) is a theory about pricing assets in relation to the risks, which was independently formulated by John Lintner , Jan Mossin and William Sharpe in the 1960s. CAPM continues to be widely used although alternates such as Arbitrage Pricing Theory (APT) and Fama-French Three-Factor Model have been developed subsequently. Among other assumptions, CAPM assumes that all the investors employing Harry Markowitz theory are holding portfolios that are efficient and will maximize return at a given level of risk. An individual is concerned with the risk attached to the final portfolio and thus the risk of the individual asset will be assessed on the basis of the contribution to the variance of the portfolio.

Beta (b), which is the measure of sensitivity of a security in relation to the market as a whole, is the measure of risk. The statistical formula for Beta of a particular security is b = sim / s m2 where sim is the co-variance between the return of the particular security and the market return and s m2 is the variance of the market return.

Treasury bills/ government securities returns are assured and considered risk free thus assumed have a beta of 0. The aforementioned assumption is widely used although it is strictly not correct since only the nominal returns are assured while the real returns (inflation adjusted ) are not unless the security is inflation protected. An investor in a portfolio of well diversified stocks would require a premium for the market risk and this premium is the market risk premium.

Market risk premium = Market returns ( rm ) – Return from treasury/ government securities (rf).

A firm is exposed to business risk and financial risk. The value of a firm and business risk is dependent on its investment decisions and not by how the investments are funded. The theory that capital structure is irrelevant to the value of a firm is a proposition of Franco Modigliani and MH Miller. From a balance sheet perspective of an accountant, the value of the enterprise on the asset side is in-dependent of the ratios of debt and equity on the liability side. Leverage determines the financial risk. Cost of debt is lower than that of equity since debt holders claim ranks before that of equity holders. Increase in debt, however, increases the financial risk and thus the returns expectation of the equity holders (who are the residual claimants) would increase and the overall return expectations may not change. Equity holders have a limited liability and increase in debt may prompt the debt holder to demand a return closer to that of equity to cover the possibility of failure of debt repayment. In the real world, companies operating in sectors such as technology that have high degree of business risk and probability of failure do not have debt or have very low leverage so that the overall risk does not become unsustainable. In contrast utilities which have stable cash flows and thus lower business risks can afford to assume financial risk.

Usually the estimate of beta of the business that is valued is derived from the beta of a comparable company listed on the exchange. The leverage of the comparable company may be different from the leverage the target company has or intends to have. Under the circumstances the observed beta is to be unlevered to derive the asset beta and re-levered based on the firm’s targeted debt equity ratio. While the business risk exposure is reflected in the asset beta the financial risk element is captured on re-levering the beta. Levered beta increases as the proportion of debt increases to reflect the risk of volatility in earnings available to equity holders after providing for interest. It is assumed in practice that debt has a beta of 0. The equation bL = ba (1+(1-t)(D/E)) can be used for levering and re-levering the beta (wherein bL is the levered beta observed in the market, ba is the asset beta (unlevered beta), t is the tax rate and the tax shield on interest payments, D is the market value of debt and E is the market equity value).

Discount rate

It is important to link the discount rate to the as-sumptions underlying the FCF projections and also the expectations of the investor class who are the claimants of the cash flow. Real cash flows without inflation are to be discounted by the rate without inflation, while nominal cash flows, which have inflationary impact, are discounted using nominal rates. FCFE is to be discounted by the return expec-tations of equity holders while FCFF is discounted by the Weighted Average Cost of Capital (WACC). The WACC represents the returns required by the investors of both debt and equity weighted for their relative funding in the entity. WACC is de-rived based on the principles set out in the earlier paragraph.

WACC = Cost of equity (rE)* [E/ (D+E)] + Post tax cost of debt (rD)* [D / (E + D)]

rE = (rf )+ b * (market risk premium)

rD = Interest rate on debt* ( 1- tax rate)

The equity and debt ratios are based on the mar-ket values and not book values. In practice, book value of debt may be considered its market value if it can be retired with minimum cost or has been contracted recently or can be called on by the lender. Exceptions such as sales tax deferral loan (which does not carry interest) may need to be valued suitably. Equity value may need to be obtained by an iterative process because of the interdependence between cost of equity (due to leverage) and the resultant value.

Thus, the WACC formula clearly illustrates the relationship between return expectations and assumption of risk. Risk that can be diversified away is not rewarded while non-diversifiable risk is compensated in the formula. The minimum re-turn, which is the risk free rate, and market risk are common to all companies. A Beta of 1 means the firm is as risky as the market or a well diver-sified portfolio. Beta of 1.5 means the firms return expectation is 50% more volatile than the market and thus the risk premium increases by 50% over the market risk premium. A firm’s beta of 0.5 would reduce the return expectation to 50% of the market risk premium as the firm is less volatile than the market and its addition to the portfolio reduces the volatility of the portfolio. The building blocks of discounting rate are very clearly visible in the WACC formula.

The WACC formula also implies that unlisted shares, which do not have an exit mechanism that a listed security affords, may have a higher return expecta-tion from investors because of their lack of market-ability. similarly, in certain cases the project may not be complete and the asset beta of a completed project would not capture the project completion risk. The WACC may have to be appropriately adjusted up to compensate for the aforementioned factors.

The formula for discounting factor to be applied for each period is 1/( 1+WACC)n where n is the year in which the cash flow occurs. In a business, cash flows are distributed through the year and do not occur as a lump sum at the year end. Therefore n is corrected for midyear (on an average).

Perpetuity value

A business is expected to have perpetual life though it is usual to have a financial projection for a limited time horizon. The value of business beyond the horizon is captured in the perpetuity value. Perpetuity value usually accounts for a large part of the business value and needs to be estimated with care.

Usually the starting point for estimating the FCF

for perpetuity is PBITDA in the terminal year of the horizon period. Capex/ incremental working capital requirement for perpetuity are to be linked to assumed growth and depreciation. In case full plant utilization has already been achieved in the horizon, growth is not possible without capex invest-ment. Tax is a major outflow and is to be modeled carefully. Tax depreciation benefit is not available unless there is capex. The depreciation benefit may be equated to the capex though the tax benefit is spread over a longer period and its present value is usually lower.

Additional working capital requirement may be estimated by applying the growth percentage to the net working capital available at the end of the horizon. Year on year growth in cash flows for per-petuity is assumed after considering factors such as the competitive environment of the business, stage of growth of the overall economy, actual growth achieved and expected in the horizon etc. Typically companies in a mature economy grow at a lower rate as compared to entities in a developing economy. The cash flow is capitalized at the rate (WACC – g ) where g is the % growth assumed. The value is discounted for the present using the appropriate discount factor.

Other adjustments

The entity being valued may have non -operating assets on the valuation date, the income streams of which do not form part of the cash flows. The market value of such assets (net of taxes and expenses on realization ) is to be added to the business value. Treasury investments, land holdings (surplus) are examples of non- operating assets. Contingent li-abilities on the valuation date needs to be adjusted after considering the probability of materialisation and notional tax relief on the same. Arrears of divi-dend on cumulative preference shares not recoded in books are to be adjusted, if necessary.

Merits and Limitations of DCF

DCF explicitly uses forecast of cash flow genera-tion while other methods use proxies to get to the present value of cash flows. DCF unbundles key value drivers and the sources of risk with a great deal of clarity, thus facilitating value analysis and informed decision making much more effectively as compared to other methods. In an acquisition scenario, the synergy benefits and costs can be mapped in the model and its valuation implica-tions clearly understood through a DCF analysis. PECV, for example, captures the risk related return and growth in a single number. Given the forego-ing, DCF is indispensable as a tool to understand value drivers and facilitate value discovery from a corporate finance perspective. To value a finite life project, DCF may be the better alternate as multiples of comparable companies usually factor in perpetual existence.

The various data parameters used in building the WACC appears objective. On a closer examination, however, each of the parameters is open to chal-lenge and interpretation. Beta estimate of a traded company varies with the time period which is used to obtain the estimate. Risk free rate is strictly not risk free and impacted by several factors. There are theoretical issues with market risk premium. The parameters based on historical data are used to discount future cash flows and there is no assurance that the future will be a repetition of the past (extensive theoretical literature giving the dimensions of the issues involved is outside the scope of this overview).

In sum, DCF value is as good as the projections it is based on. Any bias in the projections would impact the value. The reasonableness of value and the projections necessarily needs to be tested with market prices of comparable companies. In case the value outcome under DCF is at significant variance with the value derived from market comparables, it would be necessary to inter alia reassess the reasonableness of the projections / market benchmarks applied to attempt to reconcile the values under both the approaches.

Considering the high level of subjectivity, DCF is seldom used in isolation and market benchmarks are important sanity checks to assess the reasonableness of the value outcome as the fair value is defined as the “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date”. Under various accounting standards, the projections being unobservable inputs are lower in the hierarchy as compared to market based inputs such as multiples. Thus DCF may have a limited application for pure value measurement required for financial reporting, statutory purposes.

Practical application (in the Indian context)

As already discussed application of CAPM in its pure form may not be very challenging particularly in the Indian context. Apart from subscription based data services, stock exchange websites (NSE, BSE) are rich sources of data an d qualitative information and are freely available. The return on 10 year Government of India security may be considered as the rf. A well diversified index (in India– BSE 100, NIFTY, Sensex) is considered as a proxy for the market. The return from the index may be used to derive an estimate of market risk premium. The beta estimate of a particular security (used as a comparable) can be derived from the historical data of the prices and the indices by applying the statistical formula. Betas of the shares that are part of the index are readily available on the websites of the exchanges. An illustrative DCF computation is set out in the annexure.

Balance Sheet
Position as at 1Jan 2010	INR
Share capital	100.00

Reserves and surplus	200.00

Loans	400.00

Total funds employed	700.00

Fixed assets	400.00

Investments ( treasury)	100.00

Net current assets	200.00

Total application of funds	700.00

Notes:

Fixed assets include land not used for business which has book value of INR 100 and market value of INR 300.

The market value of Investments is INR 90 Excise duty claim of INR 25 is matter of legal dispute. Legal counsel has opined the probability of materialisation of the claim is ~ 25%.

Income Statements							INR

	Actual			Projected

Particulars for the year	2009	2010	2011	2012	2013	2014	2015
ended 31 December

Sales	500.00	550.00	600.00	650.00	700.00	750.00	800.00

Investment Income	10.00	12.00	12.00	12.00	12.00	12.00	12.00

Less:

Rawmaterials	200.00	220.00	240.00	260.00	280.00	300.00	320.00

Employee costs	100.00	104.00	108.16	112.49	116.99	121.67	126.53

Sales and administration	100.00	103.00	106.09	109.27	112.55	115.93	119.41

Profit before Interest,	110.00	135.00	157.75	180.24	202.46	224.41	246.06
Tax Depreciation and
Amortisation( PBITDA)

Depreciation	25.00	23.00	23.00	22.00	20.00	19.00	19.00

Profit before Interest)	85.00	112.00	134.75	158.24	182.46	205.41	227.06
and Tax (PBIT

Interest	45.00	40.00	40.00	30.00	20.00	10.00	8.00

Profit before Tax (PBT)	40.00	72.00	94.75	128.24	162.46	195.41	219.06

Tax	14.00	25.20	33.16	44.88	56.86	68.39	76.67

Profit after Tax (PAT)	26.00	46.80	61.59	83.36	105.60	127.01	142.39


IDCF Computation

Valuation Date : 1 Jan 2010							INR

PBITDA		135.00	157.75	180.24	202.46	224.41	246.06

Less

Investment income		12.00	12.00	12.00	12.00	12.00	12.00

Operational EBITDA		123.00	145.75	168.24	190.46	212.41	234.06

Taxes ( Refer Note 1)		35.00	42.96	51.18	59.66	67.69	75.27

Capex		10.00	15.00	15.00	15.00	15.00	15.00

Working capital requirements		12.00	12.00	12.00	12.00	12.00	12.00

FCFF		66.00	75.79	90.06	103.80	117.71	131.79

Discounting Factor ( Note 2)		0.9395	0.8292	0.7318	0.6459	0.5701	0.5031
Present Value of FCFF		62.00	62.84	65.91	67.05	67.11	66.31

Perpetuity value	INR	Remarks

PBITDA of terminal year	234.06

Less Depreciation	20.00	equalised to perpetuity capex

PBIT	214.06

Less : Taxes	74.92

Add: Depreciation	20.00

Less:

Capex	20.00	based on requirements conidering growth,
		depreciation etc.

Additional Working capital	5.44	2% ( growth rate) of NWC at the end of horizon

Net cash flow	133.70

Add Growth in cash flow	2.67

Cash flow for 2016	136.37

Capitalised at ( WACC- g)	11.30%

Capitalised value	1,206.64

Discount rate	0.5031

Perpetuity Value	607.12

Valuation Summary

Particulars	INR	Remarks
Present Value of free cashflows
– Horizon period (upto 2015 )	391.21
– Perpetuity( 2016 and beyond)	607.12
	998.33
Less:
Contingent Liabililities	4.06	after adjusting for probability of materialisation
		and net of taxes
Business Value of Enterprise	994.27	and net of taxes
Business Value of Enterprise	994.27
Add:
Investments	90.00	at realisable value
Land	230.00	net of tax on appreciation @35%

Enterprise Value	1,314.27

Borrowings	400.00

Equity value	914.27

Business WACC				Remarks
Debt weightage	40.0%			assuming book value equal to market value and
				debt is for funding business

Equity weightage	60.0%			based on equity value ( surplus assets and invest
				ments funded by equity )

Cost of Debt	7.8%			Post tax cost of debt after tax shield

Cost of debt	12.00%			Interest rate		contracted with lenders

Average Tax Rate	35.00%

Cost of Equity	17.0%

Risk Free Rate	7.87%			Yield on		10 year		Government of		India
				Security

Market Premium	7.00%			Estimate based on surveys and market returns

Beta	1.30			Unlevered		and relevered beta; asset beta
				obtained from market price of comparable
				and index movement

WACC	13.30%

Discount rate to be used	13.30%

Growth in perpetuity assumed	2%


Capex requirements			10		15		15	15	15	15

Additional working captal			12		12		12	12	12	12
requirements

NWC position	200		212		224		236	248	260	272

Taxes

PBT			72.00		94.75		128.24	162.46	195.41	219.06

Add: Interest			40.00		40.00		30.00	20.00	10.00	8.00

Less : Investment Income			12.00		12.00		12.00	12.00	12.00	12.00

PBT		100.00			122.75		146.24	170.46	193.41	215.06

Taxes	35%		35.00		42.96		51.18	59.66	67.69	75.27

Suggested Reading / References:

Damodaran on Valuation ( 2nd Edition) by Aswath Damodaran; Published by John Wiley and Sons, Inc.

Principles of Corporate Finance (6th Edition) by Richard Brearley and Stewart C Myers; Published by Tata McGraw- Hill Publishing Company Limited.

Valuation – Measuring and Managing the Value of Companies ( 4th Edition) by Tim Koeller, Mark Goedhart and David Wessels; Published by John Wiley and Sons, Inc.

Nirav Shah

Banking Revenue Assurance using CAATs

Internal Audit

Introduction :

The Banking Regulation Act, 1949 requires the auditor of a
banking company to state whether the profit and loss account shows a true
balance of profit and loss for the period covered by such account.

The profit and loss account as set out in Form B of the Third
Schedule to the Act has three broad heads : income, expenditure and
appropriations.

Interest/discount on advances/bills and interest on deposits
form a valuable component of income.

The auditor should, on a systematic sample basis, check the
rates of interest, etc., with sanctions and agreements and physical existence of
collateral security.

He should examine with the aid of Computer Assisted Audit
Tools (CAATs) — General Audit Software whether :

Interest has been
charged on all performing accounts up to the date of the balance sheet.
According to the guidelines for income recognition, asset classification,
etc., issued by the Reserve Bank of India, a bank cannot take to income
unrealised interest on any non-performing advance;
Discount on bills
outstanding on the date of the balance sheet has been properly apportioned
between the current year and the following year;
Interest on
inter-branch balances has been eliminated in the consolidated profit and loss
account of the bank; and
Any interest
subsidy received (or receivable) from the Reserve Bank of India in respect of
advances made at a concessional rates of interest is correctly computed.

The CAAT auditor may also co-relate the interest on
advances/deposits with the amount of outstanding advances/deposits outstanding
using advanced statistical functions like correlation.

Practical case studies on use of CAATs — Illustrations on
banking revenue assurance :

Account maintenance :

Control objective : Non-recovery of service charges on
non-maintenance of minimum balance in saving and current accounts.

Control objective description : Saving and current
account holders need to mandatorily maintain a minimum quarterly balance in
their accounts.

The minimum balance to be maintained depends upon the type of
account (Saving general, current etc.), type of customer (Individual, staff,
pensioner, corporate salary account, etc.), cheque book issue status (issued,
not issued) and type of branch (urban, rural, etc.).

The minimum balance required to be maintained by each account
holder is entered in the core banking system by the branch under the field
‘minimum balance required’, in the CASA Master. Since this activity is performed
at the branch level and not the central IT level, it may be subject to branch
errors of commission.

Non-maintenance of the required minimum balance attracts a
system-levied service charge. Once again this service charge may be waived with
due permission (in case of dormant accounts for instance) or possibly with
certain mal-intentions at the account level by the branch by applying a flag ‘N’
in the field ‘SC MIN BAL FLAG’ in the CASA Master.

The bank auditor must verify the accuracy of both the
‘minimum balance required’ and ‘SC MIN BAL’ to be maintained in the CASA Master.

Procedure within GENERAL AUDIT SOFTWARE?:

Open the CASA Master file within GENERAL AUDIT SOFTWARE.
SAVING ACCOUNT WITH CHEQUE BOOK AND INCORRECT MIN BALANCE REQUIRED TO BE MAINTAINED — Perform data — Direct extraction on the CASA Master by applying the command?:

[@list(product code, “SB GEN”) .AND. cheque-book issued flag = “Y” .AND. @nomatch(customer type code, “STAFF”, ‘EX STAFF”, “PENSIONER”)

.AND. minimum balance required <> 1000].

This report will provide a list all saving accounts (other than NRE), who are not STAFF, EX-STAFF, PENSIONER, having a cheque-book facility and where minimum balance required to be maintained in the account as per the system is other than

Rs.1000. Rs.1000 is defined by the bank policy.

SAVING ACCOUNT WITHOUT CHEQUE-BOOK AND INCORRECT MIN BALANCE REQUIRED TO BE MAINTAINED — Perform data — Direct extraction on the CASA Master by applying the command?:

[@list(product code, “SB GEN”) .AND. chequebook issued flag = “N” .AND. @ nomatch(customer type code, “STAFF”, ‘EX STAFF”, “PENSIONER”) .AND. minimum balance required <> 500].

This report will provide a list all saving accounts (other than NRE), who are not STAFF, EX-STAFF, PENSIONER, having no cheque book facility and where minimum balance required to be maintained in the account as per the system is other than Rs.500. Rs.500 is defined by the bank policy.

CURRENT ACCOUNT WITH CHEQUE BOOK AND INCORRECT MIN BALANCE REQUIRED TO BE MAINTAINED — Perform data — Direct ex-traction on the CASA Master by applying the command?:

[@list(product code, “CURRENT”) .AND. chequebook issued flag = “Y” .AND. minimum balance required <> 5000].
This report will provide a list of all current accounts, having a cheque-book facility and where minimum balance required to be maintained in the account as per the system is other than Rs.5000. Rs.5000 is defined by the bank policy.

Transaction maintenance:

Control objective: Non-recovery of folio charges on saving accounts.

Control objective description: Folio charges are to be recovered in case of saving accounts having withdrawals in excess of 50 numbers/lines per half year. The charges per withdrawal in excess of 50 may differ from bank to bank and the type of saving account.

Procedure within GENERAL AUDIT SOFTWARE:

1. Open the CASA Ledger within GENERAL AUDIT SOFTWARE.

2. SAVING ACCOUNT WITH WITHDRAWALS FOR HALF YEAR — Perform data — Direct extraction on the CASA Ledger by applying the command:

[@isini(“SAVING”, product name) .AND. @ list(tran code, 1001, 6101, 1006, 1013) .AND. @betweendate(tran date, “20080401”, “20080930”)]

This intermediate report will provide a list of all withdrawals through cash (1001), cheque (6101), debit funds transfer (1006) for all Saving accounts for the half-year transaction period April 2008 to September 2008.

3. SAVING ACCOUNTS WITH CUMULATIVE WITH- DRAWALS FOR HALF YEAR — Perform Analysis — Summarisation on the above intermediate report. “Fields to Summarise” to be selected from drop down field list as “account number”. This intermediate report will provide an account wise summary of all withdrawals — cash, cheque, debit funds transfer for all SAVING accounts for the transaction period 8th April to 8th September 08 along with the number of withdrawals (i.e., entries).

4. COMPUTATION OF SERVICE CHARGES — Perform — Data — Field manipulation — Append
— Virtual numeric field having name “Service Charges” to the intermediate report generated at Step 3 above. Enter the command no_of_recs

* 1 in the parameter. This new field will provide service charges (folio charges) to be recovered from the account holder towards excess with-drawals over 50 entries.

5. IDENTIFYING SAVING ACCOUNTS WITH WITH-DRAWALS IN EXCESS OF 50 — Perform data — Direct extraction on the intermediate report generated at step 4 above by applying the command:

(no_of_recs > 50)

This final report will provide all SAVINGS ac-counts where half-yearly withdrawals are greater than 50 entries along with service charges to be recovered.

These cases can be checked physically with the Statement of Accounts for the relevant saving accounts in the final report for recovery of folio charges and the accuracy of charges recovered.

Cheque maintenance:

Control objective: Non-recovery of cheque-book issue charges on saving accounts.

Control objective description: Cheque-book issue charges are to be recovered in case of saving accounts, having a cheque leaves issued in excess of 60 numbers per year. The charges per cheque leaf issued in excess of 60 may differ from bank to bank and type of saving account.

Procedure within General Audit Software:

1. Open the Cheque Report within the General Audit Software.

2. SAVING ACCOUNTS WITH CHEQUES ISSUED DURING ANY YEAR — Perform data — Direct extraction on the Cheque Report by applying the command:

[@isini(“SAVING”, product name) .AND. @ betweendate(cheque issue date, “20080101”, “20081231”) .AND. cheque leaves > 60 .AND. .NOT. @isini( “staff”, product name)]

This intermediate report will provide a list all cheque leaves issued in excess of 60 leaves for SAVING NON STAFF accounts in the transaction period of January 2008 to December 2008.

3. COMPUTATION OF CHEQUE ISSUE CHARGES — Perform — Data — Field Manipulation — Append — Virtual numeric field having name “Cheque Issue Charges Savings” to the intermediate report generated at step 2 above. Enter the command (cheque leaves-60) * 2. This new field will provide cheque issue charges to be recovered from the account holder.

4. CHEQUE-BOOK ISSUE CHARGES RECOVERED DURING ANY YEAR — Perform data — Direct Extraction on the CASA Ledger by applying the command:

[tran descp = “SC For Cheque-Book Issue” .AND. @isini(“SAVING”, product name)]

This intermediate report will provide a list of transactions on SAVING accounts where service charges for cheque-book delivery have been recovered.

5. CHEQUE-BOOK ISSUE CHARGES NOT RECOV-ERED DURING ANY YEAR — Perform — File —Join — select the intermediate report generated in step 2 above as the Primary File. Select the intermediate report generated in Step 4 above as the Secondary File. Click on Match. Match the two files on matching key — “account number” in Primary file and “account number” in Secondary file. Use the Join condition “Records with no Secondary Match”.

This final report will provide a list of saving accounts where cheque leaves issued in any year are more than 60 (annual free cheque leaves entitlement) and cheque-book issue charges have not been recovered.

Temporary Overdraft Interest Charges:
Non-recovery of interest on Temporary Overdrafts (TODs) granted to saving accounts.

Introduction:

TODs are granted by the bank to an account holder when the account holder is short of available balance to meet specific payments on his account. The TOD is granted under the assurance by the account holder that the temporary overdraft would be made good through incoming funds in transit. TODs can be System TODs or Adhoc TODs. An account holder should normally not be granted multiple TODs, until earlier TODs are regularised. TODs which are not regularised within the limit end date should be specially taken up for scrutiny. Consistent delay in regularisations on few accounts should be dealt with strictly through punitive action.

Method within General Audit Software:
1. Open CASA TOD Ledger within the General Audit Software.

2. SAVING ACCOUNT TOD INSTANCES GRANTED — Perform data — Direct extraction on the CASA TOD Ledger by applying the command — (product name = “SAVING”)

3. Open CASA ledger within GENERAL AUDIT SOFTWARE.

4. INTEREST CHARGED on SAVING ACCOUNT TOD INSTANCES — Perform data — Direct extraction on the CASA Ledger by applying the command– (tran code = 5002 .AND. product code = 101)

Tran code 5002 stands for INTEREST DEBITS and PRODUCT CODE 101 stands for SAVING GENERAL accounts.

5. ACCOUNT SUMMARY LIST OF SAVING TODs – Perform Analysis — Summarisation on the intermediate report generated at Step 2. Select ‘account number’ as Fields to Summarise.

6. ACCOUNT SUMMARY LIST OF INTEREST CHARGED ON SAVING TODs — Perform Analysis — Summarisation on the intermediate report generated at Step 4. Select ‘account number’ as Fields to Summarise.

7. INTEREST NOT CHARGED ON SAVINGS TODs GRANTED — Perform — File — Join — select the intermediate report generated in Step 5 above as the Primary file. Select the intermediate report generated in step 6 above as the Secondary file. Click on Match. Match the two files on matching key — “account number” in Primary file and “account number” in Secondary file. Use the Join condition “Records With No Secondary Match”.

Conclusion:
General Audit Software Programmes are time-tested, stable, robust, powerful, internationally acclaimed and user-friendly applications designed by auditors for auditors. No tool is a ready substitute for the Auditors acumen and judgment, but tools are a powerful, cost-effective facilitator to large-scale electronic data analysis running into millions of records.

Revenue assurance in the banking sector can be made convenient and effective through the use of such tools.

Under a more evolved Enterprise Wide Continuous Monitoring Framework, General Audit Software Programmes can be used to automate the process of exception generation, issue escalation, resolution, feedback and learning for the business process handling Revenue Assurance.

Nirav Shah

Using Computer-Assisted Audit Tools (CAATs) for IT Audits

Nirav Shah

Internal Audit Planning – A Case Study

Background

An external audit firm is conducting internal audit in an engineering company since the last two years. The audit committee chairman had a one to one meeting with the partner–in-charge for a review of the present internal audit reports and the internal audit process. During the discussions, the chairman asked the internal auditor to present an annual internal audit plan that takes into account the bigger picture rather than smaller issues and really adds value to the business. Based on recent corporate events and the Board’s responsibilities in the matter of Transparency and Control, the Audit Committee Chairperson enquired with the – Chief Audit Executive – CAE, the status of implementation of Standards of Internal Audit of ICAI.

The CAE highlighted that a Risk Based Audit Planning process is being currently followed. However, the process has not been benchmarked against the Standards. The CAE affirmed that the entire activity will be aligned with Indian Standards and a report presented in the next Audit Committee.

Methodology

The internal audit function has a five member team. The internal auditor therefore has to select projects (areas) with high risk to the organisation and direct the limited resources towards such projects. Frequency of high risk areas needs to be high – maybe twice a year whereas in cases of low risk or almost zero risk areas, the frequency may be once in three years and so on.

A benchmark against the standard was carried out by the team to identify further areas for improvement.

Opportunities for Improvement

Overall, the Standard sought to address Audit Planning from 2 dimensions –

1. Overall Annual Audit Plan

2. Audit engagement or each specific audit project

For the Overall Annual Audit Plan, the areas identified were –

1. The existing Audit Charter adequately explained the ‘purpose, authority and responsibility’ of the Internal Audit function. The Audit Charter designed earlier had not been reviewed and revised for the last two years. During the last two years, the auditee had implemented an ERP and adopted a Balanced Scorecard strategy for evaluating performance. Efforts of Cost Reduction have rationalised middle level management.

a. The CAE and the team felt that the focus of audit needed to be revised through use of Audit Tools and the possibility of taking on a leading role in implementing Continuous Auditing.

b. One of the overall objectives that the standard expects the Internal Audit to achieve is to “strengthen overall governance, particularly strategic risk management”. The Audit Charter had not mentioned any specific responsibility for this objective. The audit team appreciated the following fact however with this objective that:

i. When strategic risks are taken, there is no audit involvement.

ii. The operating management does not perceive any specific role of the internal auditors in strategic risk management.

iii. The Internal Auditor is expected not to be a part of the decision. In this way, he/she retains their independence. If he is a part of this process, it may be a barrier to his independence at a later date, when the decision might not achieve the desired objectives. The Internal Auditor’s role as an assurance provider may get compromised if the internal auditor is involved in decision making.

One of the internal audit team members pointed out however that if he gets additional information at a later date, should he not then advise review of the decision rather than wait for issuance of the report?

This change was therefore sought to be introduced and highlighted specifically for discussion. The CAE took a stand that while the Internal Auditor could be a part of the Strategic Risk Management process, it should be seen as a ‘facilitator role’ and not as member of the decision making team.

2. While the Audit Plan was provided to the Audit Committee for approval, there was hardly any debate on the same and it was approved. The CAE thought that in the current practice, they were not really benefiting from the experience and knowledge of the Audit Committee Members. He therefore thought it fit to arrange for meetings with each of the Audit Committee Members to gain individual input prior to the next Audit Committee Meeting, where his first report would be presented. These meetings helped the CAE improve the audit plan.

3. The Risk Based Audit Planning process as currently implemented ( Refer article of BCAJ IAS article in March/April, 2003) was generally found to be robust. The process included the following –

a. Identify the Audit Universe (comprehensive list of Audit Areas),

b. Established weights and ranks for criteria which will form the basis of ranking the audit areas and cut off score

c. Applying criteria to the various audit areas

d. Arrive at scores for each area

e. Applying the Cut off criteria and shortlisting the areas of audit for the year. This forms a part of the Annual Audit Plan.

4. The revised Annual Audit Plan was also reviewed alongwith the first report. In order to ensure continuing relevance of the audit plan, a process of a half yearly review of the audit plan with the Audit Committee was suggested and approved.

For the Audit Engagement or Each Specific Audit Project –

A brainstorming on the issues and difficulties faced by the Audit Team Members in Audit Engagements was undertaken. A few of the difficulties that came up from all members was –

the general appreciation of raising the right business issues in the audit reports,

the adequacy of time for performance of the audit – at times, key areas of audit were left out given the demands of completing the report.

the team members voiced their concern that the response that the CAE gets from officials was not the same as that received by them. They felt that the auditees employees did not give the required seriousness, which resulted in avoidable delays.

The team thought of the options that the Standard provided towards overcoming these difficulties. The following were the guidelines that they felt could overcome the difficulties –

1. Preliminary Review – A visit by the CAE along with the audit team members of the audit area was planned to be conducted 15 days prior to the actual start date. This audit visit was to understand the business process area and operational realities within which the team performs, the expectations of the auditee and the auditor are discussed and firmed up, the data and time requirements from the auditees are discussed and the JOINT objectives of the audit process are laid down. The auditee’s person-in-charge is made aware of the audit objectives, methodology and the ways that risk and control needs to be looked at within the Risk Management Framework implemented. Apprehensions of the Auditee team are laid to rest in these interactions. This meeting is also sought to be used as a means to improve auditee’s person-in-charge responses.

2. Audit Engagement Planning – The Prelimi-nary Review meeting was also to be used to study past reports . The larger participa-tion of all team members in identification of potential risk and control focus in each area was scheduled for at least once a fortnight in such a way that no area is taken up without the inputs received from all team members.

These measures would also ensure that the issues that are relevant to the organisation and the auditee team are addressed. This will also ensure that there is an ongoing value addition out of the audit process.

3. The CAE decided to improve the following areas –

a. Resource allocation in line with the scope

The knowledge and skills required for each audit was sought to be formally identified and matched with the ability of the team members. In case there was a mismatch, the CAE considered the option of training a team member in the area in advance and also involving an outside professional for the specific aspect of audit as part of the on the job training for the team. The option of including a guest auditor from within the organisation also was considered.

b. Detailed Audit Programme with specific priority for audit checks

Normally the Audit Programmes were packed with all possible tests to be con-ducted during an audit for all identified risks and controls. The team decided to identify which controls significantly mitigate the risk (Key Control). Single control mitigating multiple risks were also sought to be specifically identified in a list of controls. The audit priority was focused on key controls. This focus improved audit effectiveness.

Conclusions

These measures were implemented in the quarter and some significant improvements were observed. The gaps identified vis a vis the standard and the measures already taken and thus impact were shared with the Audit Committee. The initia-tives taken were highly appreciated by the Audit Committee members.

All the action of CAE were based on Internal audit standard issued by the Institute of Chartered Accountant of India.

EXHIBIT 1 – Standards of Internal Audit – 1 of The Institute of Chartered Accountants of India The internal auditor should, in consultation with those charged with governance, including the audit commit-tee, develop and document a plan for each internal audit engagement to help him conduct the engagement in an efficient and timely manner.

The internal audit plan should be comprehensive enough to ensure that it helps in achieving of the above overall objectives of an internal audit. The internal audit plan should, generally, also be consistent with the goals and objectives of the internal audit function as listed out in the internal audit charter as well as the goals and objectives of the organisation. An internal audit charter is an important document defining the position of the internal audit vis a vis the organisation. The internal audit charter also outlines the scope of internal audit as well as the duties, responsibilities and powers of the internal auditor(s). In case the entire internal audit or the particular internal audit engagement has been out-sourced, the internal auditor should also ensure that the plan is consistent with the terms of engagement.

A plan once prepared should be continuously reviewed by the internal auditor to identify any modifications required to bring the same in line with the changes, if any, in the audit environment. However, any major modification to the internal audit plan should be done in consultation with those charged with governance. Further, the internal auditor should also document the changes to the internal audit plan.

Internal audit plan should cover areas such as:

Obtaining the knowledge of the legal and regulatory framework within which the entity operates.

Obtaining the knowledge of the entity’s accounting and internal control systems and policies.

Determining the effectiveness of the internal control procedures adopted by the entity.

Determining the nature, timing and extent of procedures to be performed.

Identifying the activities warranting special focus based on the materiality and criticality of such activities, and their overall effect on operations of the entity.

Identifying and allocating staff to the different activities to be undertaken.

Setting the time budget for each of the activities.

Identifying the reporting responsibilities.

The internal audit plan should also identify the benchmarks against which the actual results of the activities, the actual time spent, the cost incurred would be measured.

The internal auditor should obtain a level of knowledge of the entity sufficient to enable him to identify events, transactions, policies and practices that may have a significant effect on the financial information.

The audit universe and the related audit plan should also reflect changes in the management’s course of action, corporate objectives, etc. The internal auditor should periodically, say half yearly, review the audit universe to identify any changes therein and make necessary amendments, to make the audit plan responsive to those changes.

The establishment of such objectives should be based on the auditor’s knowledge of the client’s business, especially a preliminary understanding and review of the risks and controls associated with the activities forming the subject matter of the internal audit engagement.

The internal auditor should also document the results of his preliminary review so conducted.

For this purpose, the internal auditor should prepare an audit work schedule, detailing aspects such as:

activities/ procedures to be performed;

engagement team responsible for performing these activities/ procedures and

time allocated to each of these activities/ procedures.

18. While preparing the work schedule, the internal auditor should have regard to aspects such as:

any significant changes to the entity’s missions and objectives, business processes, and management’s strategies to counter these changes, for example, changes in the entity’s controls structure or changes in the risk assessment and management structures

any changes or proposed changes to the governance structure of the entity. The engagement work schedule should, however, be flexible enough to accommodate any unanticipated changes as well as professional judgment of the engagement team in the components of the audit universe as discussed above. The work schedule should also reflect the internal auditor’s assessment of risks associated with various areas covered by the particular internal audit engagement and the priority attached thereto.

19. The internal auditor should also prepare a formal internal audit programme listing the procedures essential for meeting the objective of the internal audit plan. Though the form and content of the audit programme and the extent of its details would vary with the circumstances of each case, yet the internal audit programme should be so designed as to achieve the objectives of the engagement and also provide assurance that the internal audit is carried out in accordance with the Standards on Internal Audit.

Nirav Shah

ICAI must assert itself

New Page 1

44 ICAI must assert itself

The complicity of statutory auditors Price Waterhouse in the
fudging of books by Satyam Computer Services is yet to be proven, although
prima facie they appear to have been negligent in exercising oversight. But
Satyam is not the first case of accounting fraud, many hundreds of companies are
known to have resorted to cooking their books. In most of these instances,
accountants and auditors who are members of the Institute of Chartered
Accountants of India (ICAI) have extended more than a helping hand. Yet, guilty
accountants/auditors usually get away with a reprimand, and in more serious
cases, with a fine of up to Rs.1 lakh or three months suspension for their
professional misconduct. Clearly, the law is not deterrent enough. Just about a
dozen or so members are known to have been handed out suspensions ranging up to
five years or even life and fined Rs.5 lakh. This would then mean that the ICAI
may be found wanting in taking disciplinary action or perhaps regulation does
not figure high in the priorities. That defeats the purpose of conferring the
institute the status of a self-regulating organisation.

The ICAI needs to assume the role of an independent regulator
more seriously, ensuring adoption of best practices by its members. It must
avoid succumbing to pressures from its members to go soft on disciplinary
measures. Implementation of the decision for compulsory rotation of auditors —
taken by its Central Council in July 2003 and being held in abeyance due to
pressures from large firms — must be expedited. Joint audits for companies with
turnover above a certain threshold has to be introduced to ensure company
accounts become more credible. The quality review board, with members nominated
by the ICAI Council and the Centre, too needs to begin work earnestly to raise
the quality of accounting and auditing, including services provided by the
internal auditors and accountants. Finally, the Centre needs to take a fresh
look at whether the existing structure of ICAI, as well as others such as
Institute of Company Secretaries of India (ICSI), really encourage independent
and impartial regulation and disciplinary action.

(Source : The Economic Times, 13-1-2009)

levitra

Nirav Shah

Section 14A and its Applicability to Cases of Stock-in-trade

1. Issue for Consideration

One of the major controversies, revolving around disallowance u/s. 14A, that has remained unresolved, is about the possibility of disallowance of an expenditure in the hands of a dealer in shares and securities, who holds such shares and securities as stock-in-trade. With the passage of time and examination of the issue by the courts, the issue has become more and more controversial.

Section 14A provides that no deduction shall be allowed in respect of an expenditure, incurred by the assessee, in relation to an income which does not form part of the total income.

A dealer in shares and securities is a person who ordinarily receives income from transfer of shares i.e., taxable under the head ‘Profits and gains of business or profession’. In addition, he receives income from dividend i.e., exempt from taxation as it does not form part of the total income under the Act. The expenditure incurred by such a person for carrying on the business of dealing in shares and securities, like any other business, is of varied nature that comprises of interest on borrowed funds to administration expenses and also depreciation.

The questions that arise for consideration in the case of a dealer in shares are – Whether any part of his expenditure could be said to have been incurred in relation to earning an exempt income? Can such an expenditure be treated as incurred in relation to earning the dividend income that is not taxable? Can a part of the expenditure at least be considered as related to earning an exempt income and therefore be disallowed? Can one apply the provision of Rule 8D for giving effect to the legislative intent expressed in section 14A? Can one contend that no expenditure is incurred at all for the purposes of earning dividend?

The Special Bench of the ITAT in the case of Daga Capital & Investment, 117ITD129 (SB)(Mum.) had held that the provisions of section 14A applied to the case of a person who was a dealer in shares. The ratio of the said decision to the extent relevant here is recently approved by a decision of the Delhi High Court, reported recently. The said decision of the court is in conflict with the decisions of the Karnataka and the Kerala High Courts. The appellate tribunals in the meanwhile have taken conflicting stands on the subject, throwing the issue wide open.

2. Maxopp Investment’s Decisions

The issue came for consideration in the case of Maxopp Investment Ltd. vs. CIT before the Delhi High Court reported in 347 ITR 272. The assessment years under consideration were A.Y. 1998-99 to A.Y. 2005-06. In the said case,the assessee company was engaged in the business of dealing in shares and securities. It held part of the shares as trading assets for the purpose of acquiring and retaining control over its group companies and the profit from sale of such shares, held as trading assets, was offered to tax as the business income. An amount of Rs. 1.61 crore was claimed as business expenditure u/s. 36(1)(iii), being interest paid on the funds borrowed from investment in shares held as trading assets. The company had a profit on sale of shares of Rs. 1,49,285/- and had received a dividend of Rs. 49,90,860/-.

The A.O. held that the interest claimed by the company was disallowable u/s. 14A. However, he restricted the disallowance to the amount of dividend. The CIT(A) and the ITAT following the Special Bench’s decision in the Daga Capital’s case (supra) upheld the action of the A.O.

In an appeal by the assesseee company to the High Court, on behalf of the company, an emphasis was laid on the expressions “incurred” and “in relation to” for contending that the word “incurred” must be taken literally in the sense that the expenditure must have actually taken place and that the expenditure must also have taken place in relation to income which did not form part of the total income. It was contended that the expression “in relation to” implied that there must be a direct and proximate connection with the subject matter and only that actual expenditure which was made directly and for the object of earning exempt income, i.e., the dividend income could be disallowed u/s. 14A. It was submitted that if the dominant and main objective of spending was not the earning of ‘exempt’ income, then the expenditure could not be disallowed u/s. 14A, provided it was otherwise allowable u/s. 15 to 59 of the said Act. It was also emphasised that the expenditure must be actual and could not be computed on the basis of some formula as stipulated under Rule 8D read with s/s. (2) & (3) of section 14A.

The Delhi High Court did not agree with the submissions of the assessee company that a narrow meaning ought to be ascribed to the expression “in relation to” appearing in section 14A as the context did not suggest that a narrow meaning ought to be given to the said expression. The court observed that the provision was inserted by virtue of the Finance Act, 2001 with retrospective effect from 1-4-1962 confirming the intention of the Parliament that it should appear in the statute book, from its inception that expenditure incurred in connection with income which did not form part of total income ought not to be allowed as a deduction; the factum of making the said provision retrospective made it clear that the Parliament wanted that it should be understood by all that from the very beginning, such expenditure was not allowable as a deduction; the Supreme Court in CIT vs. Walfort Share and Stock Brokers P Ltd: 326 ITR 1 (SC), held that the basic principle of taxation was to tax the net income, i.e., gross income minus the expenditure and on the same analogy the exemption was also in respect of net income; in other words, where the gross income would not form part of total income, it’s associated or related expenditure would also not be permitted to be debited against other taxable income.

The court noted that accepting the submission made on behalf of the assessees, then s/s. (1) would have to be read as follows:-“For the purposes of computing the total income under this Chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee with the main object of earning income which does not form part of the total income under this Act.” It observed that such rereading was certainly not the purport of the said provision; the expression “in relation to”did not have any embedded object and simply meant “in connection with” or “pertaining to”; if the expenditure in question had a relation or connection with or pertained to the exempt income, it could not be allowed as a deduction even if it otherwise qualified under the other provisions of the said Act; in Walfort (supra), the Supreme Court made it very clear that the permissible deductions enumerated in sections 15 to 59 were now to be allowed only with reference to income which was brought under one of the heads of income and was chargeable to tax and that if an income like dividend income was not part of the total income, the expenditure/deduction related to such income, though of the nature specified in sections 15 to 59, could not be allowed against other income which was includible in the total income for the purpose of chargeability to tax.

In deciding that the provisions of section 14A applied in the case of receipt of dividend by a dealer in shares, against the asseessee, the Delhi High Court took note of the law prevailing before insertion of section 14A in the Act with retrospective effect, as was explained by the Supreme Court in the cases of CIT vs. Maharashtra Sugar Mills Ltd: 82 ITR 452 (SC) and Rajasthan State Warehousing Corporation vs. CIT: 242 ITR 450 (SC). The court also took note of the Memorandum explaining the provisions of section 14A and also extensively relied upon the decision of the Supreme court, delivered after introduction of section 14A, in the case of Walfort (supra) where the apex court stated that the insertion of section 14A with retrospective effect, reflected the serious attempt on the part of Parliament not to allow deduction in respect of any expenditure incurred by the assessee in relation to income, which did not form part of the total income against the taxable income. The High Court observed that the apex court in that case, clearly held that in the case of an income like dividend income which did not form part of the total income, any expenditure/deduction relatable to such (exempt or non-taxable) income, even if it was of the nature specified in sections 15 to 59 of the said Act, could not be allowed against any other income which was includible in the total income.

3. CCI Ltd’s Case

The issue recently came up for consideration of the Karnataka High Court in the case of CCI Ltd vs. JCIT reported in 250 CTR 291. In that case, the assessee company, a dealer in shares & securities, had acquired 93% of shares of Kurl-on Ltd., by availing an interest free loan with the help of a broker who had been paid an amount of Rs.28,00,000/- as brokerage. The assessee company had received a dividend of Rs.46,67,190/- which dividend was exempt from taxation. The assessee company had claimed the brokerage of Rs.28,00,000/- as deduction in computing the business income from dealing in shares & securities. The A.O. in assessing the total income of Assessment year 2007-08 treated the said brokerage expenditure as directly attributable to earning the dividend income and disallowed the same besides disallowing a part of the other business expenditure. The CIT (Appeals) confirmed the said order of the A.O. and the tribunal upheld the action of the A.O in part by directing him to prorate the said expenses over the dividend and the business income.

In an appeal to the Karnataka High Court, the assessee company raised the following question of law:“Whether the provisions of section 14A of the Act are applicable to the expenses incurred by the assessee in the course of its business merely because the assessee is also having dividend income when there was no material brought to show that the assessee had incurred expenditure for earning dividend income which is exempted from taxation?”

The assessee company contended before the High Court that the assessee had incurred an expenditure for purchasing shares and a part of such shares so purchased were sold and the income derived therefrom was offered to tax as business income and the remaining unsold shares yielded dividend; that the assessee had not incurred any expenditure to earn the said dividend income and therefore, no expenditure could be attributed to the said dividend income and the said expenditure could not be disallowed and the assessee was entitled to the benefit of deduction of the entire expenditure incurred in respect of purchase of shares.

On behalf of the Revenue,it was pointed out to the court that when shares retained by the assessee had yielded dividend, when the dividend income was exempted from payment of income tax, the expenditure incurred in acquiring that dividend also should be excluded from amount of expenditure that qualified for allowance and in that view of the matter, the orders passed by the authorities were legal and valid.

The High Court observed that when no expenditure was incurred by the assessee in earning the dividend income, no notional expenditure could be deducted from the said income; that it was not the case of the assessee retaining any shares so as to have the benefit of dividend; 63% of the shares, which were purchased, were sold and the income derived therefrom was offered to tax as business income; the remaining 37% of the shares were retained and had remained unsold with the assessee which unsold shares had yielded dividend, for which, the assessee had not incurred any expenditure at all. It further noted that though the dividend income was exempted from payment of tax, if any expenditure was incurred in earning the said income, the said expenditure also could not be deducted but in the case, when the assessee had not retained shares with the intention of earning dividend income and the dividend income was incidental to his business of sale of shares, which remained unsold by the assessee, it could not be said that the expenditure incurred in acquiring the shares had to be apportioned to the extent of dividend income and that should be disallowed from deductions.

The High Court held that the approach of the authorities, in disallowing a part of the expenditure, was not in conformity with the statutory provisions contained in section 14A of the Act. The orders were held to be not sustainable in law and were set aside.

4. Observations

Section 14A(1) stipulates that for the purposes of computing the total income under Chapter IV, no deduction shall be allowed in respect of an expenditure “incurred” by the assessee “in relation to” an income which does not form part of the total income under the Income tax Act.

The position in law in respect of the expenditure incurred for earning an income, a part of which was exempt from taxation, prior to the introduction of section 14A, was governed by the ratio of the decisions in the cases of CIT vs. Maharashtra Sugar Mills Ltd: 82 ITR 452 (SC) and Rajasthan State Warehousing Corporation vs. CIT: 242 ITR 450 (SC). It was held therein that no part of expenditure could be disallowed where the expenditure was incurred in earning an income a part of which was taxable and the balance was exempted from taxation.

The object behind the insertion of section 14A is stated in the Memorandum explaining the provisions of the Finance Bill, 2001 :-“Certain incomes are not includible while computing the total income as these are exempt under various provisions of the Act. There have been cases where deductions have been claimed in respect of such exempt income. This in effect means that the tax incentive given by way of exemptions to certain categories of income is being used to reduce also the tax payable on the nonexempt income by debiting the expenses incurred to earn the exempt income against taxable income. This is against the basic principles of taxation whereby only the net income, i.e., gross income minus the expenditure is taxed. On the same analogy, the exemption is also in respect of the net income. Expenses incurred can be allowed only to the extent they are relatable to the earning of taxable income. It is proposed to insert a new section 14A so as to clarify the intention of the Legislature since the inception of the Income Tax Act, 1961 that no deduction shall be made in respect of any expenditure incurred by the assessee in relation to income which does not form part of the total income under the Income-tax Act.The proposed amendment will take effect retrospectively from 1st April, 1962 and will accordingly; apply in relation to the assessment year 1962-63 and subsequent assessment years.”

The law of section 14A has been sought to be explained by the Supreme Court in the case of CIT vs. Walfort Share and Stock Brokers P Ltd: 326 ITR 1 (SC),as under:-“Further, section 14 specifies five heads of income which are chargeable to tax. In order to be chargeable, an income has to be brought under one of the five heads. Sections 15 to 59 lay down the rules for computing income for the purpose of chargeability to tax under those heads. Sections 15 to 59 quantify the total income chargeable to tax. The permissible deductions enumerated in sections 15 to 59 are now to be allowed only with reference to income which is brought under one of the above heads and is chargeable to tax. If an income like dividend income is not a part of the total income, the expenditure/ deduction though of the nature specified in sections 15 to 59 but related to the income not forming part of the total income could not be allowed against other income includible in the total income for the purpose of chargeability to tax. The theory of apportionment of expenditure between taxable and non-taxable has, in principle, been now widened u/s. 14 A.”

The issue veers down to examining whether any disallowance is possible in cases where the income that is exempted from taxation is incidental to the main objective of expenditure and that the expenditure has no direct or proximate connection to the income that has been exempted from taxation. The issue is best exemplified with the case of a dealer in shares who incurs expenditure primarily for earning a taxable income from dealing in shares and received an exempt income from dividend as an incidence of his business of dealing in shares.

It is the assessee’s case that only such expenditure that can be disallowed that has been incurred directly in earning an exempt income and that an expenditure which has the distant effect of earning such an income cannot be disallowed where the income that was taxed has a proximate connection to such an expenditure. The revenue on the other hand is of the view that the language of section 14A does not provide for an exclusion, from operation of section 14A, of an expenditure which incidentally results in earning an exempt income; the provision for prorating of an expenditure under Rule 8D rather confirms that at least a part of the expenditure shall stand disallowed in all the cases; the relationship of some part of the expenditure, for earning an exempt income cannot be altogether denied.

The Income Tax Act, 1961 is replete with expressions like ‘in relation to’ and ‘relating to’, for example, sections 28, 35 and 36. While it is true that the terms carry a meaning which is wider than the one provided by the term wholly and exclusively incurred or for the purposes of, it nonetheless cannot be so wide as to include an expenditure with a remote or a distant connection to an exempt income.

Obviously for a dealer in shares, the dominant or the immediate objective is making profit on sale of shares. Earning dividend income cannot be the domi-nant objective and the dividend at the most may represent an incidental objective, unless it is held that earning dividend is also a dominant objective and there is a proximate link with such objective, the expenditure in question cannot be considered as having been incurred in relation to .

In our considered view the A.O., for a valid disallowance, should establish two important things. One that the expenditure incurred has a proximate link with the income that is exempt from taxation and the second that the purchase of shares was made with the main or dominant objective of earning an exempt income. Unless both of these facts are established by the A.O., no expenditure or part thereof should be disallowed u/s. 14A in computing the total income of a person who is a dealer in shares in respect of shares held as stock in trade.

The Kerala High Court in CIT vs. Leena Ramachandran, 339 ITR 296 held that no disallowance of interest claimed u/s. 36(1)(iii) should be made, u/s. 14A, in case of a dealer in shares who purchased shares out of the borrowed funds and held the same as stock-in-trade.

The issue has been sharply brought in focus by the decisions of the tribunal, delivered after considering the decisions of the Kerala High Court in Leena Ramachandran’s case (supra) and of the Karnataka High Court in the case of CCI Ltd. (supra) in the following cases;

In American Express Bank Ltd. ITA No. 5904 & 6022 /Mum/2000 dated 8-8- 2012, it was held that a prorated disallowance of an expenditure must be made u/s. 14A in the case of an assesseee engaged in the business of dealing in shares earning dividend income which is exempted from taxation in his hands. The tribunal distinguished the decision in Leena Ramachandran’s case (supra) by stating that the said decision rather supported the case of disallowance and the observations of the court in relation to shares held as stock-in-trade were to be treated as an obiter dicta and not the ratio decidendi which was to disallow the interest and that was upheld by the court.

In GanjamTrading Co. Pvt. Ltd. ITA No. 3724/ Mum/2005 dated 20-7-2012, the decision of the Special Bench in Daga Capital (supra) was distinguished to hold that the provisions of section 14A did not apply to the case of dealer in receipt of dividend income that was incidental to the dominant income from dealing in shares that was taxable by relying on the decision of the Karnataka High Court in CCI Ltd.’ s case (supra).

Similarly in India Advantage Securities Ltd. ITA No. 6711/Mum/2011 dated 20-7-2012, it was held that the provisions of section 14A did not apply to the case of dealer in receipt of dividend income that was incidental to the dominant income from dealing in shares that was taxable by relying on the decision of the Karnataka High Court in CCI Ltd.’ s case(supra). In this case, the decision of the tribunal in the case of American Express Bank Ltd(supra) was considered and was not followed.

Likewise, in Prakash K. Shah Securities Pvt. Ltd. ITA No. 3339/Mum/2012, the tribunal held that the provisions of section 14A did not apply to the case of dealer in receipt of dividend income that was incidental to the dominant income from dealing in shares that was taxable by relying on the decision of the Karnataka High Court in CCI Ltd.’ s case(supra).

The issue that was thought to be settled by the special bench decision has been sharply brought back in focus by the conflicting decisions discussed above. The correctness of the decision of the special bench decision was always under a scanner as was clear from the dissenting decision of Shri K.C. Singhal, the Accountant Member, in the context of the income from shares held as stock-in-trade. Even the part that held that Rule 8D was retrospective in its operation has not been accepted by the High Court in the case of Godrej & Boyce Ltd. vs. CIT, 328 ITR 081(Bom), which found the said rule to be prospective in its effect.

The Karnataka High Court in CCI’s case (supra) has relied on the intention of the dealer behind incurring the expenditure and proceeded to hold that no disallowance shall take place where the intention was clearly to earn business income by incurring an expenditure. It favoured ignoring the incidental income behind such an expenditure. This approach of the court charts out a new course by examining the proximity of the expenditure to the income and while doing so, takes into consideration the intention of the legislature stated in the memorandum to nullify the effect of the Supreme court decisions in the cases of Rajasthan Warehousing Co. and Maharashtra Sugar Millls (supra). Such an approach is desirable and is equitable and has the salutary effect of reducing the frivolous litigation in cases where the expenditure incidentally produces some exempt income. Accepting this approach also helps the revenue in avoiding an undesired expenditure on litigation in which the outcome is more likely to favour an assessee. Even the language of section 14A does seem to favour the assesssee.

The meaning of the term ‘in relation to’ can be gathered by referring to the ratio of the decision of the 11 judges bench of the Supreme court in the case of H.H.M. Madhavao Jivajirao Scindia ,Bahadur of Gwalior vs. Union of India, 1971, 1 SCC 85 wherein the court while interpreting the meaning of the term ‘relating to’ by a majority decision held that the term meant a dominant and immediate connection. A reference may also be made to Law Lexicon which states the term ‘in relation to’ requires elimination of the remote connection and indicates nearness or proximity.

The case of the revenue seems to largely hang on rule 8D that provides for the proration of an expenditure. This part of rule 8D cannot override the provisions of section 14A which does not mandate such proration at least in cases where the expenditure is not found to be incurred in relation to an exempt income. It is an accepted position in law that a rule cannot expand the scope of a legislative provision. It is true that s/s. (2) provides for determination of expenditure in accordance with Rule 8D. However, the said Rule while providing the methodology for calculation cannot extend the meaning of the term, ‘in relation to’ by including such expenditure that cannot be construed as having been incurred in relation to an exempt income.

There is one more angle to the issue that is provided by the language of clause (ii) of sub-Rule (2) of Rule 8D when it provides for a calculation with reference to the ‘value of investment’. This language again supports the case that no disallowance is envisaged in respect of shares held as stock in trade.

In cases where the dealer holds the shares as an investor for the purposes of earning dividend income, the disallowance u/s. 14A shall hold water.

Nirav Shah

Copyright – The Need for Registration?

To be registered or not to be registered, that is the question1.

The Copyright Act, 1957 (hereinafter referred to as “the Act”) deals with the law relating to copyright and the works in which copyright subsists, the rights of a copyright owner, the remedies of a copyright owner in case of infringement, registration of copyright etc. Now, whilst in the case of trade mark law and the law relating to patents, the respective statutes are explicitly clear that infringement can only be of a registered trade mark and of a patent granted under the Patents Act, 1970 respectively2, the Act does not so clarify in express terms. This aspect of registration of copyright and whether or not the same is mandatory in order to avail the benefits of copyright and the remedies provided under the Act has been the subject matter of several judgments, some of which will be discussed in this article. This question has now come to the fore in the light of a recent judgment3 of the Bombay High Court, which has held that registration of copyright is necessary to avail of the remedies provided under the Act.

Hence, in order to address this question, I would like to draw attention to the broad scheme of the Act and the relevant provisions thereof, followed by some judgments on the issue and thereafter, my thoughts on the law as prevailing currently and on the said recent judgment of the Bombay High Court.

Statutory provisions

The Act was enacted to amend and consolidate the law relating to copyright. The Act comprises of 79 sections spread subjectwise over 15 Chapters. For the purposes of addressing the query at hand, it would be necessary to consider the provisions of Chapter III, Chapter X and Chapter XI of the Act. Chapter III of the Act deals with works in which copyright subsists and nature of rights therein. In this regard, reference may be had in particular to section 13 of the Act which provides for, inter alia, works in which works copyright subsists as also in which works copyright does not subsist. Section 14 provides that copyright means the exclusive rights stated therein whilst section 16 provides, inter alia, that no person shall be entitled to copyright or any similar right in any work otherwise than and in accordance with the Act.

The subject of registration of copyright is dealt with in Chapter X of the Act. Section 44 provides that there shall be kept at the Copyright Office a register to be called the Register of Copyrights in which may be entered the names or titles of works and such other particulars as may be prescribed. Section 48 provides that the Register of Copyrights shall be prima facie evidence of the particulars entered therein. Section 50A provides that every entry made in the Register of Copyrights shall be published.

It may also be relevant to note that Chapter XI deals with infringement of copyright and section 51 provides, inter alia, that doing of any act by any person, the exclusive right to do which is conferred by the Act upon the owner, without the licence of the owner would be an infringement of copyright. Copyright is also infringed by allowing for profit any place to be utilised for communication of a work (which is infringing) to the public. Copyright is also infringed when a person offers for sale etc. an infringing copy of the work.

Thus, on a plain reading of the statute, it would be evident that u/s. 13 of the Act, copyright subsists in certain works. Section 13 of the Act makes no qualification as to the need for registration for a copyright to subsist. Similarly, section 51 of the Act does not talk of infringement of a registered copyright but only lays down that if any person without licence does any of the acts which only the owner of the copyright is granted the exclusive right to do, then such person would infringe the copyright.

At this juncture, it may also be relevant to point out that under the Berne Convention for the Protection of Literary and Artistic Works, to which India is a signatory, a provision is made that enjoyment and the exercise of the rights recognised therein shall not be subject to any formality4. This clause was one of the foremost reasons why the United States which has traditionally required registration of copyright did not become a signatory to the said Berne Convention for a very long time. It may be noted that even today, several countries continue to have certain formalities imposed within their legal framework but in such a manner so as to avoid falling foul of their treaty obligations.

Case law

In the light of the aforesaid statutory background, attention is invited to two contradictory judgments of the Bombay High Court on this issue. Both judgments have been passed by bench comprising of a single judge.

The first judgment is in the case of Asian Paints vs. Jaikishan Paints and Allied Products reported in 2002 (4) MhLJ 536 wherein His Lordship the Honourable Mr. Justice Vazifdar has inter alia, held as under,

“Registration under the Copyright Act is optional and not compulsory. Registration is not necessary to claim a copyright. Registration under the Copyright Act merely raises a prima-facie presumption in respect of the particulars entered in the Register of Copyright. The presumption is however not conclusive. Copyright subsists as soon as the work is created and given a material form even if it is not registered (See Buroughs (I) Ltd. vs. Uni Soni Ltd. 1997 (3) Mh.L.J. 914). Thus even if the plaintiffs work was not registered, the plaintiff having established that it had created the same prior to the defendant, mere registration by the defendant of its work cannot defeat the plaintiff’s claim.”

En suite, attention is invited to a recent judgment of His Lordship the Honourable Mr. Justice A. B. Chaudhary in the case of Dhiraj Dharamdas Dewani vs. M/s Sonal Info Systems Pvt. Ltd. reported in 2012 (3) MhLJ 888, wherein it has, inter alia, been held as under,

“Perusal of section 51 clearly shows that it shall be deemed that there shall be infringement of the copyright when any person does anything, the exclusive right to do is conferred upon the owner of the copyright by the Copyright Act or any person makes sale of copies of such work by infringement of the copyright in the said work. It is thus clear from the reading of section 51 that infringement shall be deemed when exclusive right to do of the owner of the copyright is utilized by some other person viz. the infringer. Now unless such person (the infringer) knows that there is any particular owner of the copyright in India or that such owner of copyright has registered his work u/s. 44 of the Act before he did, attributing infringement by him or on his part intentionally or unintentionally, would be preposterous. Such a person who is infringing the copyright in a work must be deemed to have knowledge about the owner of the copyright and such knowledge cannot be attributed unless the provisions of Chapter 10 regarding registration of copyright, publication thereof etc. are complied with. Otherwise a person who is innocent can in that event be easily brought in the net of infringement under civil law or criminally, which can never be the intention of the legislature. Thus, reading of section 51 which defines infringement of right conferred by this Act, with section 45(1) and the word ‘may’ therein to my mind means; if owner of a copyright wants to invoke the provisions of this Act for enforcing civil and criminal nature of remedies before the special forum, namely the District Judge rather than a normal civil Court, he must have the registration….

25. Thus careful survey of the above provisions of the Copyright Act, 1957 to my mind clearly denotes that in the absence of registration u/s. 44 of the Copyright Act by the owner of the copyright it would be impossible to enforce the remedies under the provisions of the Copyright Act against the infringer for any infringement u/s. 51 of the Copyright Act. Thus, I answer point No. 1 in the affirmative.”

Thus, as on date, there are two contradictory views of co-ordinate benches of the Bombay High Court. It must, however, be appreciated that the second judgment has been passed in ignorance of the first in as much as Justice Chaudhary records in his judgment that there does not appear to be a Bombay judgment on the issue and hence, he is required to answer the same. Had the earlier judgment been brought to his notice, he would have been bound by the earlier judgment and even then if he had disagreed with the view, the right course would have been to refer the judgment to a larger bench of the High Court5.

It would also be relevant to note that since the earlier judgment in the case of Asian Paints6 was not brought to the notice of the later Bench, it could be urged that the judgment in Dhiraj Dewani’s7 case is per incuriam and hence, not a binding precedent. The Supreme Court has explained that “Incuria” literally means “carelessness” and that in practice per incuriam is taken to mean per ignoratium8.

Concluding remarks

Even though the Bombay High Court has recently held that registration of copyright is compulsory, it may be appreciated that the High Courts of Delhi9, Calcutta10, Madras11, Kerala12, Allahabad13 and Madhya Pradesh14 have respectively held that registration of copyright is not compulsory or mandatory. The Orissa High Court15 appears to be the only other Court which has taken the view that registration of copyright is compulsory.

Thus, it would be evident that the question of compulsory registration of copyright appears to be a vexed issue on which different High Courts seem to have taken different views over the years.

Without addressing the views already taken by the various High Courts, I would like to address the aspect of whether or not there ought to be a need for registration of copyright generally. It may be appreciated that copyright (taking the view of majority High Courts) is a form of intellectual property that subsists from the moment it is created and requires no registration or formal notice. This is different from the procedure either under trade mark law or law relating to patents or law relating to geographical indications etc. all of which require registration in order to enable their owner to claim statutory remedies.

The idea behind registration is the aspect of notice. Registration tends to amount to notice to the world at large, since if something is noted in a register, it would be possible for people to inspect the same and learn of the different rights being claimed by people. However, with respect to copyright law such a system appears to be optional (taking the view of majority High Courts). Thus, as has been high-lighted in the recent judgment in Dhiraj Dewani’s16 case, there could be instances where the alleged infringer may not even be aware of the rights of a person claiming copyright in his work.

A possible answer to this issue lies in the fact that, at a very basic level, copyright law seeks to prevent copying. The Act grants certain exclusive rights to an owner with respect to his work for example in case of a literary work, the owner has the exclusive right to reproduce the work, issue copies, perform the work etc. Hence, in order for infringement to be established, it would be necessary to show that the work being complained of is a colourable imitation or substantial reproduction of the original work. On the other hand, if there has been no copying even if there be similarities, there cannot be an infringement17. Thus, a person who seeks to copy a work must make due enquiry before doing so. Of course, even in such a situation where a person is bona fide interested in copying a work and is even willing to take a licence, if required, in the absence of the details being entered in an official register, it may not be possible for him to know whether the copyright protection for the work has expired or the details of the owner whom he may wish to approach for a licence etc.

This aspect of details of a work being unknown is even more acute in today’s modern era of cyberspace. Articles and other materials are regularly sourced over the internet but often these articles are not identified as to which is their country of origin or whether they are the subject matter of copyright or who is the owner thereof etc. Hence, in such cases even if a person were willing to bona fide approach a copyright owner for a licence, there could be no means for ascertaining the details of the owner. Some of the works available online may also have expired their term of copyright, but in the absence of a database such as a Register where all such details can be verified, it is almost impossible for people to even bona fide use such works. This results in the non-dissemination or non-communication of works, on account of lack of relevant material, which is against the public good.

Copyright law whilst protecting authors and owners must also recognise the rights of the general public to access such work and hence, must make provisions whereby adequate knowledge of the status of works and their owners is available to the general public, to enable them to access the work and/or obtain appropriate licences as may be necessary.

Hence, it may be necessary considering the advances in technology and the vast materials now available, to consider some amendment to the legal system to ensure the maintenance of proper details with regard to copyrighted works. In this regard, my suggestion would be a hybrid of the present system where under copyright subsists as soon as the work is created, but that the same must be compulsorily registered thereafter so as to provide adequate notice to all concerned.

1    Based on the famous opening phrase of the soliloquy in William Shakespeare’s play Hamlet

2    Section 27 of the Trade Marks Act, 1999 and section 48 of the Patents Act, 1970

3    Dhiraj Dharamdas Dewani vs. M/s Sonal Info Systems Pvt. Ltd. 2012 (3) MhLJ 888

4    Article 5 of the Berne Convention for the Protection of Literary and Artistic Works

5    Uttar Pradesh Gram Panchayat Adhikari Sangh vs. Daya Ram Saroj 2007 (2) SCC 138 “Judicial discipline is self discipline. It is an inbuilt mechanism in the system itself. Judicial discipline demands that when the decision of a co-ordinate Bench of the same High Court is brought to the notice of the Bench, it is respected and is binding, subject of course, to the right to take a different view or to doubt the correctness of the decision and the permissible course then often is to refer the question or the case to a larger Bench. This is the minimum discipline and decorum to be maintained by judicial fraternity.”

6    Asian Paints vs. Jaikishan Paints and Allied Products 2002 (4) MhLj 536

7    Dhiraj Dharamdas Dewani vs. M/s. Sonal Info Systems Pvt. Ltd. 2012 (3) MhLJ 888

8    Mayuram Srinivasan vs. C.B.I. 2006 (5) SCC 752

9    Rajesh Masrani vs. Tahiliani Design Pvt. Ltd. AIR 2009 Del 44

10    Satsang & Anr. vs. Kiron Mukhopadhyay AIR 1972 Cal 533

11    Manojah Cine Productions vs. A. Sundaresan AIR 1976 Mad 22

12    R. Madhavan vs. S.K. Nayar AIR 1988 Ker 39

13    Nav Sahitya Prakash vs. Anand Kumar AIR 1981 All 200

14    K. C. Bokadia vs. Dinesh Dubey 1999 (1) M.P. L.J. 33

15    Brundaban Sahu vs. Rajendra Subudhi AIR 1986 Ori 210

16    Dhiraj Dharamdas Dewani vs. M/s Sonal Info Systems Pvt. Ltd. 2012 (3) MhLJ 888

17 Feist Publications, Inc. vs.Rural Telephone Service Company (1991) 499 U.S. 340 wherein the United States Supreme Court, inter alia, held that “To establish infringement, two elements must be proven (1) ownership of valid copyright, and (2) copying of constituent elements of the work that are original.”

Nirav Shah

Ind AS 102 – Share Based Payments

Background

Currently, the accounting guidance under Indian GAAP for Employee Share Based Payment Plans (ESOPs) is contained in the Guidance Note on Accounting for Employee Share-based Payments. In the case of listed companies, guidance is also provided in the Securities and Exchange Board of India (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999. There is no specific guidance currently under Indian GAAP for options granted to non-employees (for example, vendors or customers). Ind AS 102 deals with all types of share based payments, including share based payments made to non-employees.

Objective, scope and definitions

Ind AS 102 provides guidance with respect to the financial reporting by an entity, when it undertakes a share-based payment transaction. Ind AS 102 specifically excludes the below-mentioned share-based payment transactions from its scope, as the relevant guidance relating to these transactions are covered under other accounting standards:

• Share-based consideration paid in a business combination (Ind AS 103 – Business Combination)

• Certain contracts falling within the scope of Ind AS 32 “Financial Instruments: Presentation” or Ind AS 39 “Financial Instruments: Recognition and Measurement”.

Type of share based payment transactions

Under Ind AS 102, share based payment transactions are classified as follows:

Equity-settled share-based payment transactions. Under this the entity receives goods or services as Jamil Khatri Akeel Master Chartered Accountants IFRS consideration for equity instruments of the entity or another group entity. Cash-settled share-based payment transactions. Under this the entity acquires goods or services by incurring liabilities to the supplier of those goods or services for amounts that are based on the price (or value) of the entity’s shares or other equity instruments of the entity. Transactions with cash alternatives. Under this the entity receives or acquires goods or services and the terms of the arrangement, provide either the entity or the supplier of those goods or services with a choice of whether the entity settles the transaction in cash (or other assets) or by issuing equity instruments.

Measurement

Equity settled share based payment transactions Equity settled share based payment transactions are measured with reference to the fair value at the grant date (where options are granted to employees) or with reference to the fair value at the date at which the entity obtains the goods or receives the services (where options are granted to non-employees).

The measurement is at the fair value of the goods or services received, unless that fair value cannot be estimated reliably. If the fair value of the goods or services received cannot be estimated reliably, the entity shall measure the fair value by reference to the fair value of the equity instruments granted.

Typically, in the case of employees, fair value of equity instrument is considered since it is not possible to estimate reliably the fair value of the services received. However, in case of transactions with parties other than employees, there is a rebuttable presumption that the fair value of the goods or services can be estimated reliably.

The fair value of the instruments granted can generally be measured using the market prices (if available) or using a valuation technique (for example, option pricing models).

Example

Entity P grants 100 share options to each of its 200 employees which are conditional upon completing three years of service. Estimated fair value of each option on grant date is INR 10.

Year 1
Cumulative expense (100* 200* 10*1/3) = Rs. 66,667 Expense for the current period = Rs. 66,667 Entry – Expense Dr 66,667 To Equity 66,667

Year 2
Cumulative expense (100* 200* 10*2/3) = Rs. 133,333 Expense for the current period = Rs. 66,667 (133,333 – 66,667) Entry – Expense Dr 66,667 To Equity 66,667

Year 3

Cumulative expense (100* 200* 10*3/3) = Rs. 200,000 Expense for the current period = Rs. 66,667 (200,000-133,333) Entry – Expense Dr 66,667 To Equity 66,667

Cash settled transactions

Cash-settled share-based payment transactions are measured at the fair value of the liability. Further, at each reporting date, and ultimately at the settlement date, the fair value of the recognised liability is remeasured with any changes in the fair value recognised in the profit or loss account. It is to be noted that equity settled share based payment transactions are not required to be remeasured.

Example

Entity A granted 60 Share Appreciation Rights (SAR) to each of its 200 employees with three years service condition. The SAR will be ultimately settled by Entity A making cash payments to the employees based on the value of the SAR. Fair value of options at the end of: Year 1 – Rs. 15 Year 2 – Rs. 20 Year 3 – Rs. 22

At the end of Year 1

Cumulative expense (60* 200* 15*1/3) = Rs. 60,000 Expense for the current period = Rs. 60,000 Entry – Expense Dr 60,000 To Liability 60,000

At the end of Year 2

Cumulative expense (60* 200* 20*2/3) = Rs. 160,000 Expense for the current period = Rs. 100,000 (160,000 – 60,000) Entry – Expense Dr 100,000 To Liability 100,000

At the end of Year 3

Cumulative expense (60 * 200* 22 *3/3) = Rs. 264,000

Expense for the current period = Rs. 104,000 (264,000-160,000)

Entry – Expense Dr 104,000

To Liability 104,000

Conditions affecting the recognition and fair value

Conditions that determine whether the counterparty receives the share-based payment are separated into vesting conditions and non-vesting conditions.

Service conditions are those conditions which require counterparty to complete specified period of service, whereas performance conditions require the counterparty to meet specified performance targets in addition to service conditions. Performance conditions could either be market conditions where vesting is related to the market price of entity’s equity instruments or nonmarket performance conditions where vesting is related to specific performance targets unrelated to market price (for example, specified increase in sales, net profit or EPS).

Service conditions and non-market performance conditions are not reflected in the grant date fair valuation and a true up is required for failure to satisfy such condition. Market conditions and non-vesting conditions are reflected in grant date fair valuation and no true up is required subsequently for failure to satisfy such conditions.

Accordingly, no charge is recognised for goods or services received if the equity instruments granted do not vest because of failure to satisfy a service condition/non-market performance condition. On the other hand, in the case of grants of equity instruments with market conditions, the entity shall recognise the charge for goods or services received from a counterparty who satisfies all other vesting conditions (for example, services received from an employee who remains in service for the specified period of service), irrespective of whether that market condition is satisfied.

In other words, market conditions are reflected as an adjustment to the initial estimate of fair value at grant date of the instrument to be received and no adjustments are made as a result of differences between estimated and actual vesting due to market conditions.

Non-vesting conditions

Non-vesting conditions are similar to market conditions and are reflected in measuring the grant-date fair value of the share-based payment. No adjustment is made for any differences between expected and actual outcome of non-vesting conditions.

Therefore, if all service and non-market performance conditions are met, then the entity will recognise the share-based payment as a cost even if the counter-party does not receive the share-based payment due to a failure to meet a non-vesting condition.

In practice, most Indian ESOP plans have service vesting conditions, while some plans may contain performance conditions. Non-vesting conditions are rare.

Forfeiture

A grant is forfeited when the vesting conditions are not satisfied.

The amount recognised for goods or services received during the vesting period shall be based on the number of share options expected to vest considering options estimated to be forfeited.

When the goods or services received are recognised with a corresponding increase in equity, then entity shall not make any adjustment to total equity after the vesting date. An entity shall not subsequently reverse the amount recognised for services received from an employee if the vested equity instruments are later forfeited or, in the case of share options, the options are not exercised.

Estimated share-based payment cost is trued up for forfeitures or estimated forfeitures on account of an employee failing to provide the required service.

Group share-based payment arrangements

A share-based payment in which the receiving entity and the settling entity are in the same group from the perspective of the ultimate parent and which is settled either by an entity in that group or by an external shareholder of any entity in that group is a group share-based payment transaction from the perspective of the receiving and the settling entities.

In a group share -based payment transaction in which the parent grants a share-based payment to the employees of its subsidiary, the share-based payment is recognised in the consolidated financial statements of the parent, in the separate financial statements of the parent and in the financial statements of the subsidiary.

Examples

Parent P grants its own equity instruments or a cash payment based on its own equity instruments to the employees of Subsidiary S as a consideration for the services provided to S, wherein P has an obligation towards the employees of S; or

Subsidiary S grants equity instruments of Parent P or a cash payment based on the equity instruments to its own employees as a consideration for the services provided to S. Here S has an obligation towards its employees.

Let us understand the accounting treatment in case of group share based payment.

Accounting by subsidiary, when parent grants shares to the employees/counter party of its subsidiary

Here a subsidiary has no obligation to settle the transaction with the counterparty. However, subsidiary is receiving service/goods and hence recognises an expense/asset and an increase in its equity for the contribution received from the parent.

Accounting by a subsidiary who grants rights to equity instruments of its parent to its employees

The subsidiary shall account for the transaction with its employees as cash-settled. This requirement applies irrespective of how the subsidiary obtains the equity instruments to satisfy its obligations to its employees.

Accounting by parent that settles the share-based payment directly

When a parent grants rights to its equity instruments to employees of a subsidiary, the parent receives goods or services indirectly through the subsidiary in the form of an increased investment in the subsidiary, i.e. the subsidiary receives services from employees that are paid for by the parent, thereby increasing the value of the subsidiary.

Therefore, the parent should recognise in equity the equity-settled share-based payment with a correspond-ing increase in its investment in the subsidiary in its financial statements. The amount recognised as an additional investment is based on the grant-date fair value of the share-based payment. An increase in investment and corresponding increase in equity for the equity-settled share-based payment should be recognised by the parent over the vesting period of the share-based payment.

In consolidated financial statements, the investment in the subsidiary mentioned above would be eliminated against equity contribution recognised by subsidiary in its standalone financial statements and accordingly, employee compensation expense would be recognised with corresponding credit to either equity or liability.

Treasury shares

Under Ind AS, a trust formed for administering an employee stock option plan generally meets the definition of a Special Purpose Entity, and hence is consolidated with the entity. Under this approach, cost will be recognised for all grants through the trust; shares held by the Trust will be considered as treasury shares of the company; and any loan given by the company to the trust will be eliminated on consolidation. As a result of this accounting treatment, cost of any shares bought by the Trust from the open market will be reduced from the reserves of the company. Any subsequent sales by b the trust (either to the employee or third parties) will result in an increase in the reserves.

Exit Mechanism

Sometimes, an award requires an exit event (e.g. sale of the business) as either a vesting or exercise condition. The requirement for an exit event affects share-based payments in different ways, depending on how the condition is expressed. If the condition is required to occur during the service period, then it would be a performance condition.

For example, a grant of share options has a three-year service condition. However, the options cannot be exercised until an IPO occurs.

If employees leaving the entity after the service period but before the IPO retain the options, then the condition of an IPO is a non-vesting condition.

If employees leaving the entity before an exit event are required to surrender the ‘vested’ options (or sell them back at a nominal amount) then the exit condition is in substance a vesting condition.

Let us take another example. If the options do not vest until an IPO occurs and employees leaving before the IPO forfeit the options, then this is an award that contains both a service condition and a non-market performance condition, assuming that there is no minimum IPO price. Such an arrangement should be accounted for as a grant with a variable vesting period (i.e. the length of the vesting period) varies depending on when a performance condition is satisfied, based on a non-market performance condition. Because the IPO has no minimum price and therefore is not a market condition, the condition would not be reflected in the grant-date measurement of fair value and the cost would be recognised over the expected vesting period and trued up to the actual vesting period and the actual number of equity instruments granted.

Conclusion

The accounting for share based payment under Ind AS 102 is much wider in scope as compared to the existing guidance. The guidance on accounting for group share based payment should be carefully evaluated to determine the appropriate accounting treatment for group entities. Ind AS 102 provides guidance on accounting for share based payments and mandates use of fair value for recognition of share based payments (intrinsic method is permitted only in very rare circumstances). This is likely to impact the employee compensation expense of many Indian companies who have issued stock options to employees and currently use intrinsic value method to account for these options. The use of fair value method to recognise share based payment would provide a more accurate picture to all stakeholders with respect to the true compensation cost. However, this will also bring in challenges since compensation cost will be recorded, based on a calculated ‘fair value’ of the option on the grant date, which in most situations will be significantly different from the actual gain (or no gain) for the employee at the time of the vesting/exercise.

Nirav Shah

Bombay Chartered Accountant’s Society

13th February, 2013
The Chief Commissioner of Income-Tax,
Aayakar Bhavan,
Maharshi Karve Road,
Mumbai – 400 020

Dear Sir,

We refer to your above letter and thank you for providing us with an opportunity to give our suggestions on various issues relating to Foreign Tax Credits. Annexed to this letter are the issues commonly faced while trying to obtain credit for taxes paid/ deducted abroad along with suggestions for mitigating the hardships that taxpayers may face while claiming credit for the same. We hope you will find the suggestions useful. If you need any further information/clarification in respect of the above we shall be glad to provide the same.

Yours truly,
For Bombay Chartered Accountants’ Society

Deepak R.Shah Kishor B. Karia Rajesh S. Kothari
President Chairman Co-Chairman

International Taxation Committee

Bombay Chartered Accountant’s Society

Representation on “Foreign Tax Credit Rules”

1. Proof of Payment

Many times it is noticed that difficulties arise as to the acceptability of proof of payment of taxes in the source country due to various reasons.

Suggestion

FTC Rules can provide various documents that can be accepted as proof for granting credits for taxes paid / deducted overseas. Some such proofs may be: –

(i) Confirmation from the Revenue Authorities;

(ii) Certificate from the Employer in case of TDS on salaries;

(iii) Acknowledgement of Payment in case of online payment or payment across the Bank counter; and

(iv) Where appropriate proof is not available based on the domestic law of the source country than the Officer processing the return must be empowered to grant credit on being satisfied that the taxes are paid / deducted in the source country.

2. Timing Difference

More often than not the tax assessment year in India is different than it is in the foreign tax jurisdiction. For example: An assessee in India has to follow tax year from April-March whereas in US it is based on the calendar year which results in timing difference and overlapping period.

Suggestion

The FTC Rules should provide for granting proportionate tax credit based on the quantum of income falling within the previous year in line with section 199 i.e. credit for foreign taxes must be granted in the assessment year in which the income is taxed in India.

3. Unilateral Credits even where DTAA exists if payment is as per domestic tax law of the Source Country

Section 90(2) grants an option to a non-resident earning income from sources in India to either opt to be governed by the provisions of the DTAA (in case there is a DTAA between India and the country of residence of the non-resident) or opt to be governed by the provisions of the Domestic Tax Law of India, whichever is more beneficial. However, a similar choice is not available to a resident who receives income from sources outside India. He has to be governed by the provisions of the DTAA (in case there is a DTAA between India and the country from which income is sourced) and where there is no DTAA to be governed by the provisions of section 91 relating to unilateral tax credit. Many times a situation may arise when a person would not like to opt for DTAA provisions (inspite of there being a DTAA) and chooses to be governed by the provisions of domestic tax laws of the source country if they are more beneficial to him.

Suggestion

FTC Rules may provide an option to claim credit based on the rate at which taxes have been actually withheld / paid in the source country i.e. either as per DTAA or Domestic Tax Code of the source country.

4. Exchange Rate for conversion of Foreign Taxes

Since Foreign Taxes are paid in the local currency of the concerned State, an issue arises as to which of the following rate to be applied for conversion to arrive at their rupee equivalent.

(i) Exchange rate on the date on which the taxes are paid / deducted;

(ii) Exchange rate on the date on which the income is recognised in the Indian books;

(iii) Exchange rate on the date on which income accrues in India;

(iv) Exchange rate on the date of remittance of income to India;

Suggestion

Where income is recognized by the recipient in India on accrual basis on a particular date, FTC Rules should provide that the RBI Reference Rate as prevalent on that date should be considered as the rate of exchange. When income is booked on receipt basis at the time of its remittance to India during the previous year the actual rate of exchange should be taken as the rate of conversion for FTC.

5. Corresponding Adjustments on completion of Assessment

Taxes paid in foreign jurisdiction may be increased or reduced depending upon the tax liability after regular tax assessment. An issue may arise whether India should consider such changes in tax demand or refund while giving tax credit?

Suggestion

It would be fair to provide a mechanism for Corresponding Adjustments on increase or decrease of tax liability upon completion of assessment in the source country.

6. Underlying Tax Credit (UTC)

Taxation of dividends invariably results in economic double taxation. In order to encourage declaration of dividends by foreign subsidiaries of Indian companies, Section 115BBD provides for concessional rate of tax. This is indeed a welcome step. However, underlying tax credit is the only solution to mitigate economic double taxation. Unfortunately very few Indian Treaties provide for UTC.

Suggestion

FTC Rules should provide for unilateral UTC. This will further encourage Indian MNCs to bring back precious foreign exchange to the country by declaring dividends. UTC will be imperative if the Govt. is thinking of introducing Controlled Foreign Companies Regulations (CFC). However, as a safeguard against possible misuse a minimum direct shareholding % may be prescribed for availing UTC.

7. FTC in case of a Tax Sparing situation

Many Indian Tax Treaties provide for tax sparing clauses where by India will give deemed credit for taxes on exempt income in the source country. Issue may arise as to determination of the credit amount in absence of proof of payment.

Suggestion

FTC Rules may provide for acceptance of certificate issued by the Auditor’s or tax authorities to determine the tax relief for giving FTC in cases of tax sparing.

8. FTC in case India becomes country of residence under a tie-breaking test

Worldwide major issue of debate or challenge is determination of the place of “Source” of income and place of residence of a tax payer. In a Jurisdictional tax system, taxes are levied on “Residence” link as well as on a “Source” link. Under this system the tax payer is taxed on his worldwide income in the State of residence and the credit is given for the taxes paid / deducted in the source State.

A problem arises when a tax payer is held to be resident of two contracting states based on different criteria / due to timing difference. (For example a US Citizen present in India for more than 182 days would be regarded as resident of both States). Although DTAA provide for series of tie-breaking tests to determine the State of residence and State of source difficulties will arise in claiming FTC.

Suggestion

FTC Rules must provide clear guidance for claiming tax credit in cases of dual residency of individuals.

Nirav Shah

Moneys of client to be kept in a separate bank account (Clause 10 of Part I of Second Schedule)

Shrikrishna (S) – Hello, Arjun, you are looking in a good mood today, Any major fees received?

Arjun (A) – No. I am not that lucky. My last September’s bill will be received next September.

S – Then what is the secret of your smiling face today?

A – I just booked a foreign tour for my family in the coming vacation.

S – Great! But you go on vacation every year. What is special this year?

A – My son Abhimanyu is in the 10th SSC. Due to his classes and studies, we did not go anywhere for the last three years.

S – Where are you going?

A – Europe tour. But don’t tell Draupadi and Subhadra. I want to keep it as a secret.

S – But you said your clients don’t pay in time. You always crib about money, especially in March.

A – True. Fortunately, one of my clients went abroad for six months and he has kept a sizeable amount with me for his tax pay ments – Advance tax and self assessment.

S – Oh!

A – Another client has also given some amount to be invested in PPF next month. He is also touring for a long time.

S – Then what do you do with that money?

A – It came in handy to me for paying for the foreign trip. Sometimes, I also use it for my investments or share dealings.

S – Don’t you keep it separate?

A – Why? I will pay the tax or put in PPF at the appropriate time. I do it quite often.

S – But it is client’s money!

A – So what? He has entrusted it to me.

S – But there are restrictions. It is not permissible.

A – Why should there be any bar? If the client has no objection, where is the problem?

S – Dear Partha, please read clause 10 – Second Schedule – in Part I.

A – Whatever I do, you always find some fault with it. My friends are also doing the same thing as I do and they deal with huge sums.

S – See, dear. So long as it is going smoothly, there will not be any problem. But basically, it is not ethical. You are using client’s money for your personal things.

A – But what is the logic?

S – There were instances where the CAs never paid the taxes of the clients. They also did not make investments as directed by the clients.

A – Many times, clients pay us for making Government payments. Stamp duty, registration fees and so on. Can we not deposit that amount in our accounts?

S – See, if it is to be expended in a short time, you may keep it. But if it is a long time, then you need to open a separate bank account for clients’ money.

A – This is strange!

S – Yes. It has also happened that CAs were tempted to play with others’ money. Some times, they lost it in the share market or entered into wrong deals.

A – This is alarming. I know one such instance. Fortunately, he could recover with the help of his friends. Otherwise, he had a tough time.

S – That is the wisdom to be learnt. Your Council does not want it to happen to other members.

A – You mean to say, I should not deposit the clients’ money in my account at all? There are no exceptions?

S – Not necessarily. The Council has already thought of practical situations. For exam ple, if an advance fee is received, it need not be deposited in a separate account. It is your money.

A – Good! Sounds sensible.

S – If some payments are to be made on behalf of clients in a short time, then it can be routed through your normal account.

A – Can I put it in short term deposits?

S – Ideally speaking, No. You are not supposed to use that money for personal benefit. You cannot earn out of it.

A – What do you mean by short time?

S – Council has used the expression ‘reasonably short time’. That depends on facts and circumstances of each case.

A – I have heard that lawyers are also required to keep separate account for clients’ money. They receive huge amounts – for court fees, stamp duty and even as stake-holders – as escrow money.

S – Yes. Same principle applies here. Another thing, whatever you receive in your capacity as a trustee, executor or liquidator, you must put it in a separate account.

A – Oh! I need to be cautious now.

S – What is really objectionable is using it for personal benefit. CAs have gone to the extent of even depositing client’s income tax refund order in their account.

A – That is criminal. It is a fraud.

S – But apart from the fraud, he was held guilty under this clause only.

A – You have opened my eyes. I feel like can celling the tour tickets.

S – You need not go that far. But make sure that whatever obligation of your client you have undertaken, fulfill those, please don’t let him down. Faith and credibility are your greatest assets and you can’t afford to lose those. After all, you are a trustee.

A – I agree. Om Shanti! The above dialogue is with reference to Clause 10 of Part I of the Second Schedule which reads as under:

Clause 10: fails to keep moneys of his client other than fees or remuneration or money meant to be expended in a separate banking account or to use such moneys for purposes for which they are intended within a reasonable time. Further, readers may also refer pages 286 – 289 of ICAI’s publication on Code of Ethics, January 2009 edition (reprinted in May 2009).

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Nirav Shah

Extension of Time Limit for Filing Cost Audit Reports and Compliance Reports for the year 2011-12

The Cost Audit Branch of Ministry of Corporate Affairs Vide Circular No. 2/2013 has decided that all cost auditors and the companies concerned are allowed to file their Cost Audit Reports and Compliance Reports for the year 2011-12 [including the overdue reports relating to any previous year(s)] with the Central Government in the XBRL mode, without any penalty, within 180 days from the close of the company’s financial year to which the report relates or by 28th February, 2013, whichever is later.

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Nirav Shah

Extension of Time Limit for Filing Form 23AC/ACA XBRL

The Ministry of Corporate Affairs Vide Circular No 05/2013 dated 12th February 2013 has extended the time limit for filing of Form 23 AC – ACA XBRL to 28th February 2013 or within 30 days from the due date of AGM of the Company, whichever is later for the financial year commencing on or after 1-4-2011.

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Nirav Shah

Relaxation of Additional Fees and Extension of the last date of filing various forms with the Registrar of Companies.

The Ministry of Corporate Affairs has vide Circular No 03/2013 dated 8th February, 2013 relaxed the Additional Fees and extended the last date of filing various forms with the Registrar of Companies.

• The payment of Additional fees has been relaxed on Forms which ought to have been filed post the transition of MCA 21 from TCS to Infosys, but could not be filed due to technical issues in the system.

• Documents which have expired on or after 17th January 2013 due to non submission/resubmission PUCL may be restored.

• All the cases related to filing of court orders/ competent authority where the due date/date of filing was falling on or after 17th January is extended without payment of additional fees

• Name availability which expired due to nonsubmission of incorporation documents will be made available for filing of the same.

• For documents regarding registration of charges, the due date is to be extended by the Regional Director on case to case basis for due dates on or after 17-1-2013. Due dates in these cases is extended till 28-2-2013 based on request received by the RD/ROC and examined on case to case basis without levying of additional fee – the request should be made by the Company/Professional by e-mail/post along with the supporting documents. A ticket will be raised on examining the application and on being resolved, the user will be accordingly informed for filing within the time given in the e-mail. However, stakeholders who are able to file the documents by date of this circular are not eligible for fees relaxation or extension nor refund.

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Nirav Shah

Foreign Exchange Management Act, 1999 – Import of precious and semi precious stones – Clarification

This circular clarifies that, with immediate effect, Suppliers’ and Buyers’ Credit (trade credit) including the usance period of Letters of Credit opened for import of precious stones and semi-precious stones should not exceed 90 days from the date of shipment.

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Nirav Shah

Opening of NRO accounts by individuals of Bangladesh Nationality.

Presently, Nationals of Bangladesh are permitted to open Non-Resident Ordinary (NRO) accounts in India only after obtaining RBI approval.

This circular permits Nationals of Bangladesh who hold a valid visa and a valid residential permit issued by Foreigner Registration Office (FRO) / Foreigner Regional Registration Office (FRRO) concerned to open a NRO account without obtaining RBI permission. However, entities of Bangladeshi ownership will continue to require RBI permission for opening Bank accounts in India.

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Nirav Shah

Foreign investment in India by SEBI registered FIIs in Government securities and corporate debt

SEBI has revised the guidelines relating to investment in Government Securities & Corporate Debts by FII, Sovereign Wealth Funds (SWF), Multilateral Agencies, Endowment Funds, Insurance Funds, Pension Funds and Foreign Central Banks as under:

Nirav Shah

Exchange Earner’s Foreign Currency (EEFC) Account, Diamond Dollar Account (DDA) & Resident Foreign Currency (RFC) Domestic Account

Presently, EEFC, RFC (Domestic) and Diamond Dollar account holders can access the foreign exchange market for purchasing foreign exchange only after utilizing fully the available balances in their foreign currency account. This circular has removed the said restriction. Hence, EEFC, RFC (Domestic) and Diamond Dollar account holders can now access the foreign exchange market for purchasing foreign exchange without fully utilizing the available balances in their foreign currency account.

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Nirav Shah

SEBI Investment Advisers Regulations — Formal Birth of a New Profession

SEBI has notified the Investment Advisers Regulations, 2013 on 21st January 2013. The objective is to require persons engaged in the business of advising on investments to get registered with SEBI and be subject to fairly elaborate regulations. The intention seems to create/recognise a separate category of advisers rendering investment advice and who are not affected by biases of distributors. Such Advisers would thus ideally advise clients on which investment mix is best suited to the clients’ needs and risks and get paid by the client for such advice.

Presently, there are certain concerns in respect of persons providing services in investments. Often, they are not paid by the clients to whom they render services, but are paid by the entities whose products they deal in. Even if they are paid by clients, they may get commissions and other amounts from entities whose products they recommend or distribute. Thus, there is an inherent conflict of interest. Further, even otherwise, if an adviser is paid in other manner such as the quantity of stock in which the client has traded or similar criteria, he faces other types of conflict of interest such as making the client trade more, etc. By such conflicts which over a period the client also understands and realises, the concept and field of investment advice itself is brought to disrepute. Some of those engaged in investment advice have been known not to follow a wholly ethical and professional practice. The advice may be without doing due diligence of the client of his risks and objectives. The advice may even be malafide in the sense that the adviser may himself trade in the opposite direction, while advising the client to take a particular direction.

Thus, there was a need for creating such a separate category of advisers who are engaged almost exclusively in rendering such advice, who take fees from the clients and who make due disclosures about the fees he receives and the trades he himself carries out and so on. It appears that the intention was also to either prohibit the adviser from distributing products himself or making due disclosures of that, particularly of the fact of the consideration he receives if the client buys products that he advises. These Regulations are intended to carry out such objectives. However, the intention also seems to exclude several categories of persons who are otherwise regulated by other regulators such as IRDA, by other professional organisations or even by SEBI itself. Important features of these Regulations are explained as follows.

All Investment Advisers will be required to register with SEBI as a pre-condition to carry on the business of rendering investment advice. The term “investment advice” is broadly framed and includes advice on dealing in investment related products. The Investment Advisers will need to have certain basic relevant qualification and also obtain specialised training/certification. The process of registration is elaborate. They are subject to a detailed code of conduct. The requirements of documentation for clients and in particular the advice given are quite detailed. However, these requirements are perhaps impractical or infeasible particularly for small advisers, though they do set a high benchmark of standards of ethics and good business practices.

The Regulations are dated 21st January 2013 and will come into effect from the ninetieth day of their notification. An existing Investment Advisers is required to apply for registration within six months of their coming into effect and if he has done so may to carry on the activity continue till disposal of his application. New Investment Advisers will have to first apply and obtain registration before commencing such activity.

Investment Adviser is a person who is engaged in the business of rendering investment advice to clients or other persons for a consideration. Thus, persons giving free advice/tips are not covered. Having said that, the business need not be the main business (though see later exemptions for certain categories). Investment advice is broadly defined. It essentially means, advice relating to dealing in securities or investment products. It is not clear whether this would exclude products like gold, real estate, etc. since these are investment products too, though the scheme of the Regulations seem to indicate that they may not be intended to be covered. Even otherwise, it is arguable whether SEBI has jurisdiction over investments in gold, real estate, etc. But even then, a large variety of products would be covered, such as shares, derivatives, mutual fund and other units, shares of unlisted companies, company deposits (even bank deposits), insurance policies/products, small savings like national savings certificates, public provident fund, etc. Viewed even in this way, the impression would be that it would cover almost every agent/ broker dealing in financial products. However, since the requirement is that the Investment Adviser should be rendering advise for consideration, and if one takes a view that the consideration should flow from the clients, then many distributors who earn purely through commissions and the like may not get covered.

There are certain specific exclusions and thus the Regulations will not apply to such excluded persons. Insurance agents/brokers registered with IRDA, who offer investment advice solely in insurance products are excluded. So are pension advisers registered with PFRDA advising solely in pension products. Question is whether advisers who advise on multitude of products (subject, of course, to restrictions by the Regulator) would also need registration.

Distributors of mutual funds registered with specified bodies and registered stock-brokers/sub-brokers who render investment advice to their clients incidental to their primary activity are also excluded.

Professionals like Chartered Accountants, Company Secretaries, lawyers, etc. find a special mention. They too are excluded if they provide advice incidental to their professional service/legal practice. However, the wording is ambiguous. For example, Chartered Accountants are excluded if they provide “investment advice to their clients, incidental to his professional service”. There are Chartered Accountants who, for example, as part of their tax advice, also advice on investments. However, there are Chartered Accountants for whom rendering of financial advice is the main and not incidental professional service they render. It is not clear whether the intention is to exclude all practicing professionals or only those whose principle professional service is other than investment advice.

Thus, if giving such advice is not merely incidental to their professional activity, they too may require registration, irrespective of the fact that they may be regulated by their parent body. It is possible that some of such professionals may thus be covered. Entities such as individuals, firms, corporates, etc. are all covered. The Investment Adviser needs to have formal qualification. The recognised qualifications include professional qualification/post-graduate degree/diploma in finance, accountancy, etc. from recognised institutions, etc. Alternatively, the person may be a graduate in any discipline with at least five years’ experience in areas such as advice in financial products, securities, etc. Individuals and representatives of Investment Advisers need to have – in addition to such qualification it appears – a certification in financial planning from recognised institutions.

Corporate Investment Advisers need to have a minimum net worth of at least Rs. 25 lakh. Individuals and firms need to have net tangible assets of at least Rs. 1 lakh. Elaborate responsibilities and code of conduct have been provided. In particular, stress is given on not placing oneself in conflict of interest.

More important to highlight are the elaborate documentation requirements expected of Investment Advisers. Extensive disclosures relating to the Investment Advisers to the clients need to be made. Significant information has also to be collected of the client. A formal process has to be laid down to assess and analyse the client data from various perspectives including risk profiling. There has to be a documented process for selecting investments based on the client’s investment objectives and financial situation. Know Your Client records of the client’s need to be maintained by the Investment Advisers.

Curiously, the investment advice provided, written or oral, and even its rationale, has to be recorded. This innocuous and even well intended requirement can have serious practical and legal consequences. It is interesting that professionals like CAs, lawyers, etc. need not record or render every professional advice they offer in writing, but Investment Advisers are being required to so record. This may be impractical and cumbersome where clients are numerous and amounts of investments involved small, as they often are. Of course, in case of advising high net worth clients and the like, recording such advice makes sense. No specific requirement is made to take acknowledgement of the client of having received such advice and in such a case, the one-sided recording does not make sense.

The Investment Advisers are required to carry out a yearly audit of compliance of the Regulations by a Chartered Accountant or Company Secretary. Moreover, an Investment Adviser, other than an individual, is required to appoint a Compliance Officer for monitoring the compliance of the Act, Regulations, etc.

The scheme of the Regulations has a few puzzling as-pects. Whom do the Regulations really intend to cover and what types of activities? Is the intention to cover only those Investment Advisers who are not otherwise regulated by SEBI or other bodies? Is the intention not to cover mere distribution of investment products? Or is the intention to cover only those people who carry out investment advice business as their primary activity? The Regulations are not wholly clear and it is just possible that any person who carries out, wholly or partly, the business of giving investment advice would be covered. Thus, there will be multiple and even overlapping regulation.

However, in the other extreme, if the intention is to totally exclude persons already regulated by other bodies or totally exclude distributors of investment products, then the scope of the Regulations may be too narrow and the ills sought to be cured by Regulations will remain only partially touched.

There is yet another confusing area. Is the intention to cover only those Investment Advisers who are compensated by the clients and not by the issuer of the products? The Regulations seem to suggest that the Investment Advisers may receive consideration for advice from any source and not merely the client. In such a case too, intentionally or otherwise, the scope of the Regulations is broadened.

In any case, there are many types of investment products where there are thousands of small investment advisers/agents. These include, for example, agents of public provident funds, small savings, etc. It is arguable that though these too render “investment advice”, SEBI may not have jurisdiction over such products/advice. It will also be cumbersome and expensive for such agents to register themselves and difficult for them to maintain the type of records expected of them, apart from other compliances. SEBI could specifically clarify – since this seems to be the intention also – that unless they receive consideration directly from the client, the Regulations should not apply.

Another concern is of multi -service financial companies. It appears that the intention is to create chinese walls between product distribution department and investment advice department and only the latter would come under the purview of these Regulations. However, in practice, these chinese walls can be expected to be porous and this will thus make a mockery of the Regulations.

SEBI needs to relook at the Regulations to consider the difficulties highlighted above and have a dialogue with the industry and its participants, before bringing the Regulations into effect.

Nirav Shah

Consolidated Financial Statements vs. Companies Bill

Currently, listing agreement mandates listed companies to prepare Consolidated Financial Statements (CFS). Neither the existing Companies Act nor AS 21 requires companies to prepare CFS. Under the Companies Bill, 2012 (Bill) all companies, including unlisted companies and private companies that have a subsidiary will need to prepare CFS.

Unlike IAS 27, the Bill does not exempt an intermediate unlisted parent company from preparing CFS. Under IAS 27 an unlisted intermediate parent is exempt from preparing CFS if and only if:

a)the parent is itself a wholly-owned subsidiary, or is a partially-owned subsidiary of another entity and its other owners, including those not otherwise entitled to vote, have been informed about, and do not object to, the parent not presenting CFS;

b)the parent’s debt or equity instruments are not traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local and regional markets);

c)the parent did not file, nor is it in the process of filing, its financial statements with a securities commission or other regulatory organisation for the purpose of issuing any class of instruments in a public market; and

d)the ultimate or any intermediate parent of the parent produces CFS available for public use that comply with International Financial Reporting Standards.

Preparation of CFS at each intermediate parent level is likely to increase compliance cost. The Ministry of Corporate Affairs may look into the matter, and provide an exemption on the above similar lines. The said exemption may be incorporated in the rules.

For all companies, CFS should comply with notified Accounting Standards (AS) . Notified AS currently means the Indian GAAP. In the future, it may include Ind-AS for specified entities. This will impact companies that are currently preparing CFS according to IFRS, based on option given in the listing agreement. These companies will have to mandatorily prepare Indian GAAP CFS (Ind-AS in the future), and may choose to continue preparing IFRS CFS on a voluntary basis or stop preparing the same. The Ministry of Corporate Affairs may look into the matter and allow companies to continue preparing CFS using IASB IFRS instead of Indian GAAP or Ind-AS.

There seems to be some confusion with respect to associates and joint ventures. The explanation, to the section 129 of the Bill states that “the word subsidiary includes associate company and joint venture.” Apparently, the following two views seem possible:

(i)a company needs to consolidate associates and joint ventures in accordance with the notified AS using equity/proportionate consolidation method. In other words, CFS is prepared only when the group has at least one subsidiary para

(ii)a company needs to apply equity method/ proportionate consolidation to its associates and joint ventures even if it does not have any subsidiary. In other words, CFS will be prepared when the company has an associate or joint venture, even though it does not have any subsidiary.

The first view seems more aligned to the requirements of notified AS and the current practice. The second view can be supported if the intention of the lawmaker was to require a company to apply equity method/proportionate consolidation method to its associates and joint ventures even if it does not have any subsidiary. ICAI and MCA should provide clarification on this issue. It would be appropriate if the clarification maintains status quo with current requirement, which is essentially view (i).

The definition of control, subsidiary and significant influence as provided in the Bill and the accounting standards are quite different. If the companies to be consolidated under the Bill and the accounting standards are different, because of the differences in the definition, it would create a lot of confusion and difficulty. A comparison of the definitions is given in the Table.

Apparently, the definition of “control” given in the Bill is broader than the notion of “control” envisaged in the definition of the term “subsidiary.” In accordance with definition of “subsidiary,” only board control and control over share capital is considered. However, the definition of the “control”, suggests that a company may control other company through other mechanism also, say, management rights or voting agreements. Further, the definition of “subsidiary”, refers to control over more than one-half of the total share capital, without differ-entiating between voting and non -voting shares. This could lead to a situation where a company is a subsidiary under AS-21, but on which the parent has no control as defined in the Bill. Consider a simple example of a company, which has a share capital of Rs. 100, comprising 40% equity with voting rights held by A and 60% preference shares with no voting rights, held by B. In accordance with AS, A would consolidate the company but in accordance with the Bill, B would consolidate the company. The Bill seems to provide an unacceptable response, where the lender rather than the equity holder would consolidate the company.

There seems to be similar confusion with respect to associates. In accordance with the explanation in the Bill, the term “significant influence” means control over 20% of business decisions. Control over business decisions is an indicator of subsidiary, rather than associate. It appears that the definition in the Bill “controls 20% of business decisions” is wrongly described. The right way to describe it would have been “has significant influence over all critical business decisions”, and “significant influence is evidenced by 20% voting power, representation on the board, or through other means.” The other issue is that the 20% under the standard works as an indicative threshold. In other words, even a lesser percentage may give significant influence and a higher percentage need not necessarily give significant influence. However, under the Bill the 20% requirement works like a rule, rather than a rebuttable presumption.

To resolve all these anomalies, the MCA may clarify that the definitions in the Bill are relevant for legal/ regulatory purposes. For accounting purposes including preparation of CFS, definitions according to the notified AS should be used.

Nirav Shah

Social Networking – Be Careful Out There – II

About this Article

This write up is Part 2 of the three part series on the topic. The previous write-up was aimed at creating awareness about some of the myths and misconceptions related to the use of social networking sites.

While the recent events have had the effect of an eye opener for some people, there are many others who throw wind to caution

This article highlights some simple steps and safe practices which may help in making your experience a safe one rather than a sorry one.

Background

The previous write up briefly discussed some of the myths and misconceptions related to the use of social networking sites. It also focussed on the complete lack of awareness on how personal information is stored, accessed and made available on the internet. The more shocking revelation being that the information is, more often than not, revealed with or without the permission of the person who was most likely to be affected by such a revelation.

The key takeaways from the previous write up were:

• Social networking sites aren’t responsible for your privacy…. you are!!!

• Default settings on the site, may or may not provide adequate protection.

• When social networking sites change their privacy policy, they may or may not tell you about the changes made, more importantly they may not tell you how your “personal” information is about to become a more public.

• The privacy policy of the social networking site does not extend to its partners (i.e. app and other third party service providers).

• When something is provided to you free of cost, it doesn’t mean that there is no cost attached. On the contrary, it means that someone else is footing the bill. And that ‘someone’ is going to extract something of value (like your private info) in return.

• Social networking is a paradox – you are posting data meant to be private on a medium which is meant to be public.

Risks

Very recently, Facebook acknowledged that their servers were hacked. While the company said that there was no data loss/damage done, there is no way of knowing for sure whether that was a fact. This may come as a surprise to some people, however, for others it was something that they always expected to happen.

Given the nature and amount of data collected and stored by some of the social networking sites, it was obvious that sooner or later, they would be targets of cyber criminals.

A curious person would ask what does the social networking site have that may be of interest to anyone other than the users? Or the information posted by me is harmless, what damage can the hacker do to me?

A short list of the risks involved is as under:

• All your private information, either about yourself or your friends, their likes or dislikes will be compromised.

• Someone could use this information to bully you or cyber-stalk you or your friends.

• The information may be used for inappropriate or illegal purposes including phishing, cyber frauds, hacking someone else’s account, etc.

• It is also possible that your ‘views’ about someone or something may be disclosed to the very person and there would be consequences.

• Your name, details may be used to spread viruses, spam, malware, etc

• Someone may hijack your email account or Facebook page and post some damaging information.

Steps to Safe Social Networking Experience

It is important to remind the readers that there is very little we can do against a prolific hacking attack or a skilled scamster. After all, considering that the networking sites with all their resources couldn’t do much, can you do any better? It is therefore imperative that you take steps to reduce the impact of any damage that may be caused. Listed below are a few ‘counter measures’ that may be useful:

Don’t succumb to peer pressure:

Peer pressure is like a double edged sword, at times it forces you to excel and then there are times when you succumb to it and in that moment of weakness, sometimes, it leads to disastrous consequences.

Don’t let peer pressure or what other people are doing on these sites convince you to do something you are not comfortable with. Stay within your limits. Remember, just like the spoken words cannot be taken back, what you post on these site cannot be erased (not very easily). It will remain in the system no matter what.

Keep personal information out:

Generally people have a tendency to post personal information like their phone number, photos of their home or their work place, school or date of birth, etc.

Just stop for a minute and think about it. This is the same information that a hacker would be need to access your bank account, your credit card, etc. Do you really want to leave this information out in the open?

Keep your profile closed, allow only your friends to view the profile. Else, for a skilled hacker or a scamster, you would be a sitting duck, ripe for the kill.

Mask your identity:

Be very wary of posting any personal data. If possible use a nick name or an alias (commonly referred as a ‘handle’).
It’s very easy to set up a separate email account to register and receive information from the site.

The advantage being that should you even feel the need to close the account or stop using the social networking site, you needn’t stop using your primary mail account.

Use strong passwords:

Remember, the password is the weakest link in the chain. Birthdates, location, nicknames are too common, you don’t need to be a super computer to figure out these types of passwords. The hacker will have a look at your profile and the information will be sitting right in front of his eyes.

Make sure that you use a combination of upper and lower case plus numbers and special characters. It doesn’t have to be very difficult.

Common daily use sentences like ‘I travel by western railway’ can also be converted in to a unique password by making use of a combination of upper and lower case characters along with symbols. Something as obvious as BCAS 2013 can be written as ‘8©@S2013’ and it would be become 10 times more difficult to guess or hack, yet easy for you to remember.

Social networking vs. venting out

Social networking and venting out are two seperate things. Remember that what goes online stays online.

Don’t say anything or publish pictures that may cause you or someone else embarrassment.

Never post comments that are abusive, or those that may cause offence to either individuals or groups of society.

Recently, many companies have started (re)viewing current and prospective employees’ social networking pages. The slightest indiscretion and you are likely to be on your way out.

What you say can and will be used against you

Who actually owns and who controls “your” intellectual content that you post is not as clear as you might think. This also raises the question: If you don’t own it, can you really control it?

Terms of usage vary with every social networking service. It is more likely, that as soon as you sign up, you give up control of how your content may be used.

Be careful in choosing your friends:

It’s an age old advice. Be that as it may, it applies to your offline as well as online friends. Be wary about who you invite or accept invitations from. Be aware of what friends post about you or reply to your posts, particularly about your personal details and activities.

Never disclose private information when social networking. Most importantly be careful of clicking on links on an email or social networking post, even if its from your friend (in some cases specially if its from your ‘friend’)

One of the biggest mistakes you can make is to accept friend requests from people you don’t know. When you do that, you are inviting people you know nothing about to share your personal information.

When your friends share information about you on their networks that you’d rather keep private, contact them and request them to remove the damaging information. Some sites may also permit you to remove any tags that your friends use to identify you in their posts

Guard against phishing:

Be guarded about who you let join your network. Use the privacy network to restrict strangers from accessing your profile. Be on guard against phishing scams, including fake friend requests and posts from individuals or companies inviting you to visit other pages or sites. If you do get caught in a scam, make sure you remove any corresponding likes and app permissions from your account.

Don’t be afraid to block specific users or set individual privacy settings for certain sensitive posts and information.

While all of the above discussed ‘counter measure’ may not offer complete protection, you may be saved from a total disaster. After all, prevention is always better than the cure.

The next write up (the third and concluding part) will deal with the specific issue of changing your privacy settings (i.e. location) and some basic steps on what to do if your account is hacked.

Nirav Shah

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