Subscribe to the Bombay Chartered Accountant Journal Subscribe Now!

Month: March

Assessment — Faceless assessment — Grant of personal hearing where there is variation of income and requested by assessee — Failure to grant personal hearing requested by assessee on passing of draft assessment order — Assessment order and consequential demand and penalty notices set aside — Matter remanded to AO to grant personal hearing through video conferencing

40 Civitech Developers Pvt. Ltd. vs. ACIT [2021] 440 ITR 398 (Del) A.Y.: 2018-19; Date of order: 22nd July, 2021 Ss. 143(3), 144B(7) of ITA, 1961

Assessment — Faceless assessment — Grant of personal hearing where there is variation of income and requested by assessee — Failure to grant personal hearing requested by assessee on passing of draft assessment order — Assessment order and consequential demand and penalty notices set aside — Matter remanded to AO to grant personal hearing through video conferencing

The assessee was in real estate business. For the A.Y. 2018-19, a notice was issued against the assessee proposing to make addition to its income. The assessee filed a response and sought personal hearing through video conferencing. Another notice was served with the draft assessment order reducing the addition in response to which the assessee filed a detailed reply with documents and again sought a personal hearing through video conferencing to explain the issues which were complex in nature to the Assessing Officer in correct perspective with the layout plan, the disputed land and the towers which were incomplete. However, no personal hearing was allowed and assessment order was passed u/s 143(3) read with section 144B of the Income-tax Act, 1961 enhancing the income and consequential demand and penalty notices were issued.

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

“Section 144B(7) of the Income-tax Act, 1961 provides an opportunity for a personal hearing, if requested by the assessee. As the option to opt for personal hearing was not enabled, the assessee due to technical glitches could not request for personal hearing on the e-portal. Consequently, it could not be said that the assessee did not opt for personal hearing. Therefore, the assessment order passed u/s. 143(3) read with section 144B and the consequential demand and penalty notices were set aside.”

The matter was remanded back to the Assessing Officer to grant an opportunity of personal hearing to the assessee through video conferencing.

Section 90 of the Act; Protocol to India-Spain DTAA – Protocol containing MFN clause is an integral part of DTAA and gets imported on notification of DTAA itself and does not require separate notification. This condition of Circular is contrary to section 90(1) of the Act read with DTAA and hence not binding on the taxpayer. Also, it cannot have retroactive applicability

7 GRI Renewable Industries SL vs. ACIT  [TS – 79 – ITAT – 2022 – (Pune)] ITA No: 202/Pun/2021 A.Y.: 2016-17; Date of order: 15th February, 2022

Section 90 of the Act; Protocol to India-Spain DTAA – Protocol containing MFN clause is an integral part of DTAA and gets imported on notification of DTAA itself and does not require separate notification. This condition of Circular is contrary to section 90(1) of the Act read with DTAA and hence not binding on the taxpayer. Also, it cannot have retroactive applicability

FACTS
Assessee, a tax resident of Spain, received FTS and royalty income from India. Relying upon MFN clause in India-Spain DTAA read with Article 12 of India-Portugal DTAA assessee claimed taxation at 10% as against 20% provided in India-Spain DTAA. CIT(A) affirmed AO’s order. AO rejected the assessee’s claim on the ground that the MFN clause could not be applied automatically as section 90 requires separate notification. DRP affirmed the order of AO.

Being aggrieved, the assessee appealed to ITAT.

HELD
• India entered DTAA with Portuguese (a member of OECD Country) vide notification dated 16th June, 2020. Article 12 of India-Portuguese DTAA provides a tax rate of 10% for FTS and royalty.

•    India-Spain DTAA was signed on 8th February, 1993, entered into force on 12th January, 1995 and was notified on 21st April, 1995. Protocol containing the MFN clause was stated in DTAA to be an integral part of DTAA. It was also signed on 8th February, 1993.

•    CBDT Circular No.3/2022 dated 3rd February, 2022 mandates issuing separate notification for importing of benefits of a treaty with second State into the treaty with the first State by relying on section 90(1) of the Act.

•    This condition of Circular is contrary to section 90(1) of the Act read with DTAA, which treats protocol as an integral part of the DTAA.

•    On notifying the DTAA, all its integral parts get automatically notified. There is no need to notify the individual limbs of the DTAA again to make them operational one by one.

•    Circular issued by CBDT is binding on AO and not on the assessee.

•    Circular prescribing additional stipulation that creates disability cannot operate retrospectively to transactions taking place in any period anterior to its issuance.

Method of valuation of shares adopted by the assessee could be challenged by Assessing Officer only if it was not a recognized method of valuation as per Rule 11UA(2)

30 Him Agri Fesh (P.) Ltd. vs. ITO  [2021] 90 ITR(T) 95 (Amritsar – Trib.) ITA No.: 224 (Asr.) of 2018 A.Y.: 2014-15  Date of order: 7th July, 2021

Method of valuation of shares adopted by the assessee could be challenged by Assessing Officer only if it was not a recognized method of valuation as per Rule 11UA(2)

FACTS
In the course of assessment proceedings, the Assessing Officer doubted the quantum of the premium received on the issue of shares.

During the course of assessment proceedings, though the Assessing Officer asked the assessee to file a certificate as per Rule 11UA but, the assessee had submitted that Rule 11UA was not applicable to the case of the assessee.

Since the assessee failed to comply with provisions of Rule 11UA, the Assessing Officer calculated the Fair Market Value and made an addition on that basis, u/s 56(2)(viib). The CIT (A) dismissed the assessee’s appeal.

Consequently, the assessee filed an appeal before the ITAT.

HELD
The ITAT observed that during the course of assessment proceedings, the assessee was not able to submit the report as made by the Chartered Accountant as per Discounted Cash Flow (DCF) method due to the negligence of the counsel. However, it had filed the copy of the said valuation report with the CIT(A) but the same was neither considered by her nor any comment was given on the same.

The ITAT was of the opinion that once the assessee had opted for valuation of shares under Rule 11 UA by following the DCF method, then it was not open for the assessing officer or the CIT(A) to adopt a different method of valuation, for determining the fair market value. As per Rule 11UA, the choice is given to the assessee and not to the assessing officer. The assessing officer is duty-bound to examine the working of the DCF method but has no right to change the method of calculating the fair market value of the shares. Once an assessee had exercised its option of opting for the DCF method, then the said method is required to be applied; however that the assessing officer has the power to review the calculations and correct adoption of the parameters applied by the assessee for the purpose of arriving at valuation of the shares by applying the DCF method.

It held that the law has specifically conferred an option upon the assessee that for the purpose of section 56(2)(viib) of the Act, an assessee can adopt any of the methods mentioned u/r 11UA(2). Therefore, in the instant case also, the assessee was free to choose any of the methods mentioned u/r 11UA(2). The method of valuation could be challenged by the Assessing Officer only if it was not a recognized method of valuation (as per Rule 11UA(2)) since the very purpose of certification of DCF valuation by a merchant banker or (at the relevant time) by a chartered accountant was to ensure that the valuation is fair and reasonable.

Since, in the instant case, the CIT (A) had not examined the method adopted by the assessee, the same could not be rejected. On this reasoning, the matter was remanded back to the file of the Assessing Officer with a direction to consider the report filed by the assessee.

It was also directed that the Assessing Officer was bound by the decision rendered in the case of Innoviti Payment Solutions (P.) Ltd. vs. ITO [2019] 102 taxmann.com 59/175 ITD 10 (Bang. – Trib.) wherein it was held that the AO can scrutinize the valuation report and if the AO is not satisfied with the explanation of the assessee, he has to record the reasons and basis for not accepting the valuation report submitted by the assessee and only thereafter- he can adopt his own valuation or obtain fresh valuation report from an independent valuer and confront the assessee. But he has no power to change the method of valuation opted by the assessee if it is one of the methods recognised u/r 11UA(2).  

Expenditure incurred on a new project of starting a hotel chain for expansion of an existing business of real estate development and financing was to be considered as expenditure for the purpose of carrying on existing business and thus allowable as revenue expenditure u/s 37(1)

29 ITO vs. Blue Coast Infrastructure Development Ltd.  [2021] 90 ITR(T) 294 (Chandigarh – Trib.) ITA No.: 143 (Chd) of 2019 A.Y.: 2013-14 Date of order: 23rd July, 2021

Expenditure incurred on a new project of starting a hotel chain for expansion of an existing business of real estate development and financing was to be considered as expenditure for the purpose of carrying on existing business and thus allowable as revenue expenditure u/s 37(1)

FACTS
Assessee-company was engaged in the business of real estate development and financing. It expanded its business into starting a hotel chain. It incurred certain expenses like professional fees in connection with the said project and claimed the same u/s 37 of the Act. However, the Assessing Officer disallowed the same. The CIT (A) deleted the disallowance on the grounds that the business of the assessee was in existence and the expenses were incurred in connection with the expansion of business.

Aggrieved, the revenue filed appeal to the ITAT.

HELD
The ITAT dismissed the revenue’s appeal on the following grounds:

The ITAT observed that the CIT (A) had made findings that the assessee’s business was an existing business, whose expansion was under consideration and expenses for the same were incurred. There was no change in management, and there was interlacing of funds, and the genuineness of the expenses was not doubted. The expenses incurred were in the same line of the existing business of the assessee.

The ITAT held that the decision of the CIT (A) was based on the ratio laid down by the Delhi High Court in CIT vs. SRF Ltd. [2015] 59 taxmann.com 180/232 Taxman 727/372 ITR 425, the Mumbai ITAT in Reliance Footprint Ltd. vs. Asstt. CIT [2014] 41 taxmann.com 553/63 SOT 124 (URO) as also in decision of the co-ordinate bench in DSM Sinochem Pharmaceuticals India (P) Ltd. vs. Dy. CIT [2017] 82 taxmann.com 316 (CHD – Trib.).

In Sinochem Pharmaceuticals (supra), the ITAT relied on Calcutta High Court decision in Kesoram Industries & Cotton Mills Ltd. [1992] 196 ITR 845 (Cal.), wherein it was held that if the expenses are incurred in connection with the setting up of a new business, such expenses will be on capital account but where the setting up does not amount to starting of a new business but expansion or extension of the business already being carried on by the assessee, expenses in connection with such expansion or extension of the business must be held to be deductible as revenue expenses. In that case, the expenditure was not related to the setting up a new factory; it pertained to exploring the feasibility of expanding or extending the existing business by setting up a new factory in the same line of business. Thus, since there was an expansion or extension of the existing business of the assessee, the same was to be considered as revenue expenditure.

To conclude, since the CIT (A) relied on the cases referred to above including the decision of co-ordinate bench, the ITAT upheld the findings of the CIT (A) and dismissed the appeal of the revenue.

HOW PREVALENT IS THE CONCEPT OF DE FACTO CONTROL?

INTRODUCTION
An investor with less than a majority of the voting rights may have rights that are sufficient to give it power and the practical ability to direct the relevant activities of the investee unilaterally: typically known as ‘de facto control’. Concluding whether an entity has de facto control over another entity can at times be highly judgemental and challenging. This article considers the requirements of Ind AS 110 Consolidated Financial Statements, analyses them and lucidly summarizes the principles using live examples of de facto control applied by companies.

Extracts of Ind AS 110 Consolidated Financial Statements
B41 An investor with less than a majority of the voting rights has rights that are sufficient to give it power when the investor has the practical ability to direct the relevant activities unilaterally.

B42 When assessing whether an investor’s voting rights are sufficient to give it power, an investor considers all facts and circumstances, including:

(a) the size of the investor’s holding of voting rights relative to the size and dispersion of holdings of the other vote holders, noting that:

(i) the more voting rights an investor holds, the more likely the investor is to have existing rights that give it the current ability to direct the relevant activities;

(ii) the more voting rights an investor holds relative to other vote holders, the more likely the investor is to have existing rights that give it the current ability to direct the relevant activities;

(iii) the more parties that would need to act together to outvote the investor, the more likely the investor is to have existing rights that give it the current ability to direct the relevant activities;

(b) potential voting rights held by the investor, other vote holders or other parties;

(c) rights arising from other contractual arrangements; and

(d) any additional facts and circumstances that indicate the investor has, or does not have, the current ability to direct the relevant activities at the time that decisions need to be made, including voting patterns at previous shareholders’ meetings.

B43 When the direction of relevant activities is determined by majority vote and an investor holds significantly more voting rights than any other vote holder or organised group of vote holders, and the other shareholdings are widely dispersed, it may be clear, after considering the factors listed in paragraph B42 (a)–(c) alone, that the investor has power over the investee.

Application examples

Example 4

An
investor acquires 48 per cent of the voting rights of an investee. The
remaining voting rights are held by thousands of shareholders, none
individually holding more than 1 per cent of the voting rights. None of the
shareholders has any arrangements to consult any of the others or make
collective decisions. When assessing the proportion of voting rights to
acquire, on the basis of the relative size of the other shareholdings, the
investor determined that a 48 per cent interest would be sufficient to give
it control. In this case, on the basis of the absolute size of its holding
and the relative size of the other shareholdings, the investor concludes that
it has a sufficiently dominant voting interest to meet the power criterion
without the need to consider any other evidence of power.

 

Example 5

Investor A holds 40 per cent of the voting rights of an
investee and

twelve other investors each hold 5 per cent of the
voting rights of the

investee. A shareholder
agreement grants investor A the right to appoint, remove and set the
remuneration of management responsible for directing the relevant activities.
To change the agreement, a two- thirds majority vote of the shareholders is
required. In this case, investor A concludes that the absolute size of the
investor’s holding and the relative size of the other shareholdings alone are
not conclusive in determining whether the investor has rights sufficient to
give it power. However, investor A determines that its contractual right to
appoint, remove and set the remuneration of management is sufficient to
conclude that it has power over the investee. The fact that investor A might not
have exercised this right or the likelihood of investor A exercising its
right to select, appoint or remove management shall not be considered when
assessing whether investor A has power.

B44 In other situations, it may be clear after considering the factors listed in paragraph B42 (a)–(c) alone that an investor does not have power.

Application example

Example 6

Investor A holds 45 per cent
of the voting rights of an investee. Two other investors each hold 26 per
cent of the voting rights of the investee. The remaining voting rights are
held by three other shareholders, each holding 1 per cent. There are no other
arrangements that affect decision-making. In this case, the size of investor
A’s voting interest and its size relative to the other shareholdings are
sufficient to conclude that investor A does not have power. Only two other
investors would need to co-operate to be able to prevent investor A from
directing the relevant activities of the investee.

B45 However, the factors listed in paragraph B42 (a)–(c) alone may not be conclusive. If an investor, having considered those factors, is unclear whether it has power, it shall consider additional facts and circumstances, such as whether other shareholders are passive in nature as demonstrated by voting patterns at previous shareholders’ meetings. This includes the assessment of the factors set out in paragraph B18 and the indicators in paragraphs B19 and B20. The fewer voting rights the investor holds, and the fewer parties that would need to act together to outvote the investor, the more reliance would be placed on the additional facts and circumstances to assess whether the investor’s rights are sufficient to give it power. When the facts and circumstances in paragraphs B18–B20 are considered together with the investor’s rights, greater weight shall be given to the evidence of power in paragraph B18 than to the indicators of power in paragraphs B19 and B20.

Application example

Example 7

An investor holds 45 per cent of the voting rights of
an investee. Eleven

other shareholders each hold 5 per cent of the voting
rights of the investee. None of the shareholders has contractual arrangements
to consult any of the others or make collective decisions. In this case, the
absolute size of the investor’s holding and the relative size of the other
shareholdings alone are not conclusive in determining whether the investor
has rights sufficient to give it power over the investee. Additional facts
and circumstances that may provide evidence that the investor has, or does
not have, power shall be considered.

 

Example 8

An investor holds 35 per
cent of the voting rights of an investee. Three other shareholders each hold
5 per cent of the voting rights of the investee. The remaining voting rights
are held by numerous other shareholders, none individually holding more than
1 per cent of the voting rights. None of the shareholders has arrangements to
consult any of the others or make collective decisions. Decisions about the
relevant activities of the investee require the approval of a majority of
votes cast at relevant shareholders’ meetings—75 per cent of the voting
rights of the investee have been cast at recent relevant shareholders’
meetings. In this case, the active participation of the other shareholders at
recent shareholders’ meetings indicates that the investor would not have the
practical ability to direct the relevant activities unilaterally, regardless
of whether the investor has directed the relevant activities because a
sufficient number of other shareholders voted in the same way as the
investor.

B46 If it is not clear, having considered the factors listed in paragraph B42 (a)–(d), that the investor has power, the investor does not control the investee.

ANALYSIS OF THE DE FACTO CONTROL EXAMPLES
As can be seen from the above provisions, the requirements are set out more like principles, and there are no bright-line tests, making the decision on de facto control extremely judgemental. When it is not clear whether the investor has de facto control, the default position is that the investor does not control the investee.

The following conclusions can be drawn from the examples provided under Ind AS 110:

• In Example 4, the investor holds 48% voting rights, and the remaining 52% is widely spread. Here, the conclusion is straightforward. In practice, the starting point for determining de facto control is 45% voting rights, when the remaining 55% is widely spread. However, that does not mean that a 40% voting right with the remaining 60% voting rights widely spread will straight-away disqualify. A 40% voting right may qualify as de facto control if other facts and circumstances indicate that the investor has the practical ability to direct the relevant activities unilaterally of the other entity. For example, the investor may have some formal agreements of support from other major investors, or it may have contractual rights to appoint, remove and remunerate the key management personnel. Here, the emphasis is on contractual rights and not that the investor appoints, removes or remunerates the key management personnel, even without those contractual rights.

• In Example 5, the investor has 40% voting rights, with the remaining 60% voting rights held by 12 investors equally, i.e. 5% each. Typically, the investor in such circumstances will not have de facto control. However, in this example, the investor has contractual rights to appoint, remove and remunerate the decision-makers of the investee and therefore exercises control through a combination of 40% voting rights and contractual rights. Sometimes, contractual rights may be to appoint and remove a majority of the board of directors that drive the relevant activities of the company, which would certainly provide the investor with control. Those contractual rights may either be entered into with all other investors or embedded in the articles of association or other constitutional documents, such as the shareholder’s agreement.

• In Example 6, the investor has 45% voting rights, with two other investors having 26% voting right each. If these two investors get together, the investors voting rights of 45% will not be sufficient to trump the 52% combined voting rights of the other two investors. It does not matter whether the two investors have an agreement or not between themselves to vote against the 45% investor. However, if the 45% investor has an agreement with one of the 26% investors to act in concert, then either the 45% investor or the 26% investor would have control which will depend upon which investor has agreed to support which other investor.

• In Example 7, an investor has 45% voting rights, and the remaining voting rights are held 5% each by 11 other investors. Additionally, there are no other contractual arrangements or matters that change the fact pattern. Here, the 45% investor cannot assume that two other investors holding 5% voting rights each may co-operate with him or have co-operated with him in the past, and as a result, the 45% investor has de facto control. In this example, the 45% investor would not have de facto control, despite a significant size of the investment, absent other facts and circumstances that may change the decision. Although the 45% size is large enough, it cannot be seen in isolation. When seen in the context of the shareholding of the other investors, and the dispersion, and absent any contractual arrangements, the accounting conclusion is that the 45% investor does not have control.

• In Example 8, the investors voting rights of 35% is considered to be of a small size in the context of significant participation by other shareholders in the general body meetings, as well as the existence of three major investors holding 5% each, with which the investor does not have any contractual arrangements. It does not matter that the investor has been able to exercise his voting powers to his advantage for several years; but that alone will not mean that the investor can consolidate the investee as a subsidiary. If this example was extended such that 34% other investors vote at general body meetings, it may indicate the 35% investor exercising control (35% > 34%, total voting is 69%). However, it is highly unlikely that the investee would qualify as a subsidiary for the 35% investor, given that the size of the investment is relatively very low and the presence of other significant investors. Even if the significant investors did not exist, the 35% investor would not qualify for de facto control, unless for example, there is absolutely poor participation at the general body meeting, say other investors holding not more than 10% voting rights vote, and there is no precedence in the past, of that having exceeded 15%.

As can be seen from the above, the principles of de facto control have to be applied to each fact pattern very carefully. Just because an investor is able to exercise his voting powers to his advantage, it does not on its own suggest that the investor should treat the investee as its subsidiary.

EXAMPLES OF DE FACTO CONTROL
A perusal of the examples below suggests that the investors holding should be significant to reach the de facto threshold; in most cases, it is around 45% or more. Other facts and circumstances would have also played a critical role in deciding on de facto control. In the absence of that information, it may not be appropriate to conclude basis the examples exhibited below.

CHOLAMANDALAM
FINANCIAL HOLDINGS LIMITED

 

The Company holds 45.47% of
the total shareholding in CIFCL as at March 31, 2021 (45.50% as at March 31,
2020) and has de-facto control as per the principles of Ind AS 110 and
accordingly CIFCL has been considered as a subsidiary in Ind AS Financial
Statements.

(Source:
2020-21 Annual Report)

TATA
COMMUNICATIONS

 

Tata Sons Pvt Limited is
controlling Tata Communication by virtue of holding 48.90%.

 

On 28 May 2018, Tata Sons
Private Limited (‘TSPL’) and its wholly owned subsidiary, Panatone Finvest
Limited (‘Panatone’), increased their combined stake in the Company to 48.90%
there by gaining de-facto control as per Ind-AS. Accordingly, the Company has
classified TSPL and Panatone as “Controlling Entities” and disclosed
subsidiaries, joint ventures and associates of Controlling Entities and their
subsidiaries as the ‘Affiliates’ of the Controlling entities, effective this
date.

(Source:
2019-20 Annual Report)

 

GODREJ
INDUSTRIES LIMITED

 

During the year, Godrej
Properties Limited has allotted 25,862,068 equity shares (Previous Year:
22,629,310 equity shares) of face value of Rs 5 each through Qualified
Institutions Placement. This has resulted in the dilution of equity holding
of the Company from 49.36% to 44.76%. The Company (GIL) has power and de
facto control over Godrej Properties Limited (GPL) (even without overall
majority of shareholding and voting power). Accordingly, there is no loss of
control of GIL over GPL post the QIP and GIL continues to consolidate GPL as
a subsidiary.

(Source:
2020-21 Annual Report)

RPSG
VENTURES

 

Parent- under de facto
control as defined in Ind-AS 110

 

 

 

 

 

 

 

 

 

 

(Source:
2020-21 Annual Report)

 

BOMBAY
BURMAH TRADING CORPORATION LIMITED

 

The Company along with its
Subsidiaries holds 39.67% of the paid up Equity Share Capital of Bombay
Dyeing & Manufacturing Corporation (BMDC), a Company listed on the Bombay
Stock Exchange. Based on legal opinion and further based on internal
evaluation made by the Company, there is no de facto control of the Company
over BDMC.

(Source:
2019-20 Annual Report)

 

BRITISH
AMERICAN TOBACCO

 

Investments in associates
and joint ventures – On 30 July 2004, the Group completed the agreement to
combine the US domestic business of Brown & Williamson (B&W), one of
its subsidiaries, with R.J. Reynolds. This combination resulted in the
formation of RAI, which was 58% owned by R.J. Reynolds’ shareholders and 42%
owned by the Group. The Group has concluded that it does not have de facto
control of RAI because of the operation of the governance agreement between
the Group and RAI which ensures that the Group does not have the practical
ability to direct the relevant activities of RAI; in particular, the Group
cannot nominate more than five of the Directors (out of 13 or proportionally
less if there are less than 13 Directors) unless it owns 100% of RAI or some
other party owns more than 50%. In addition, there are no other contractual
arrangements which would give the Group the ability to direct RAI’s
operations. Manufacturing and cooperation agreements between RAI and the
Group have been agreed on an arm’s length basis.

(Source:
2015 Annual Report)

CONCLUSION
In India, several companies have significant promoter ownership, though the promoters may not hold a clear absolute majority, such as a shareholding greater than 50%. Therefore, the concept of de facto control becomes all the more important. As can be seen from the above discussion, even if a promoter is able to exercise his voting powers to his advantage, it may not be appropriate to conclude that the investee is a subsidiary with respect to that promoter unless the absolute and relative size of the holding held by the promoter is substantial, and there are other facts and circumstances including the extent of dispersion of other holdings or contractual arrangements, that suggest that the promoter has control over the investee.  

FRESH CLAIM IN A RETURN FILED IN RESPONSE TO A NOTICE ISSUED UNDER SECTION 148

ISSUE FOR CONSIDERATION
In Volume 53 of BCAJ (January, 2022), we covered the issue of the validity of a fresh claim, made otherwise than by way of revising the return of income. Such fresh claim can be in respect of any deduction, exemption etc., which has not been claimed in the return of income already filed. Yet another facet of this controversy is sought to be addressed here. When it is found that an income chargeable to tax has escaped the assessment, the Assessing Officer is empowered to reopen the case and reassess the income under Section 147. In such cases, the assessee has to be served with a notice u/s 148 requiring him to furnish his return of income. The question that frequently arises, for consideration of the courts, is as to whether the assessee can furnish a return of income in response to the notice issued u/s 148, declaring an income lesser than what has already been declared/assessed prior to issuance of the notice by making a fresh claim for an allowance or deduction therein.

In the case of CIT vs. Sun Engineering Works (P) Ltd. 198 ITR 297, the Supreme Court held that it was not open to the assessee to seek a review of the concluded item, unconnected with the escapement of income, in the reassessment proceeding. Following this decision, several High Courts, including the Madras, Bombay and Calcutta High Courts, have taken the view that the income returned in response to the notice issued u/s 148 cannot be lesser than the amount of income originally declared/assessed. However, recently, the Karnataka High Court has taken a contrary view on the issue after considering the Supreme Court’s decision in the case of Sun Engineering Works (P) Ltd. (supra).

SATYAMANGALAM AGRICULTURAL PRODUCER’S CO-OPERATIVE MARKETING SOCIETY LTD.’S CASE

The issue had earlier come up for consideration of the Madras high court in the case of Satyamangalam Agricultural Producer’s Co-operative Marketing Society Ltd. vs. ITO 40 taxmann.com 45.

The assessment years involved in this case were 1997-98, 1998-99 and 1999-2000. The assessee was dealing with the marketing of agricultural produce of members, sale of liquor and consumer goods. It had filed its returns of income for the assessment years under consideration and the returns filed were also processed u/s 143(1)(a). Later, the Assessing Officer issued notices u/s 148 on noticing that deduction u/s 80P was wrongly claimed regarding income derived from the sale of liquor. In response to the notices issued u/s 148, the assessee society filed returns of income wherein it also claimed deduction u/s 80P(2)(d) in respect of its interest income on investments with co-operative banks, which was not claimed in filing the first return of income. This being a fresh claim made by the assessee in the returns filed in response to the notice issued u/s 148, it was rejected by the Assessing Officer by relying on the decision of the Supreme Court in the case of Sun Engineering Works (P) Ltd. (supra).

The Commissioner (Appeals), as well as the ITAT, confirmed the Assessing Officer’s order. Before the High Court, the assessee contended that the claim made in response to the notice u/s 148 could not have been rejected at the threshold itself since it was never assessed earlier and their returns only processed u/s 143(1); since the proceedings were completed u/s 143(1), the claims made were never considered initially; the assessments to be made u/s 147 were required to be considered as the regular assessments under which such claims could have been made. The assessee relied upon the decision of the Supreme Court in the case ITO vs. K.L. Srihari (HUF) 250 ITR 193.

The High Court held that when there was no dispute that the claim made by the assessee about the interest income on investment was not made in the original return, and only a fresh claim was made for the first time in the return filed in pursuance of notice u/s 148, such fresh claims could not be allowed as the proceedings u/s 147 were for the benefit of the Revenue. The High Court relied upon the decision of the Supreme Court in the case of Sun Engineering Works (P) Ltd. (supra) and decided the issue against the assessee.

A similar view has been taken by the High Courts in the following cases –

• CIT vs. Caixa Economica De Goa 210 ITR 719 (Bom)

• K. Sudhakar S. Shanbhag vs. ITO 241 ITR 865 (Bom)

• CIT vs. Keshoram Industries Ltd. 144 Taxman 1 (Calcutta)

THE KARNATAKA STATE CO-OPERATIVE APEX BANK LTD.’S CASE

The issue, recently, came up for consideration before the Karnataka High Court in the case of The Karnataka State Co-Operative Apex Bank Limited vs. DCIT 130 taxmann.com 114.

In this case, for A.Y. 2007-08, the assessee had filed its return of income on 31st October,2007, declaring a total income of Rs. 40,77,27,150. No assessment u/s 143(3) was made for that year. The Assessing Officer issued a notice u/s 148 on 31st March, 2012. The assessee filed the return of income in response to the aforesaid notice on 13th September, 2012 and declared a lower income of Rs. 32,56,61,835 claiming a loss on sale of securities to the extent of Rs. 8,28,65,052, not claimed in the first return of income. Thereafter, the Assessing Officer passed an order u/s 143(3) r.w.s 147 determining the assessee’s income at Rs. 51,71,70,670 and made the following additions:

a) disallowance of contributions made to funds – Rs. 10,86,43,782; and

b) denial of set-off of loss claimed on sale of securities – Rs. 8,28,65,052.

The CIT (A) as well as tribunal did not grant relief regarding the additional claim of loss made by the assessee on account of the sale of securities on the ground that the aforesaid additional claim was not made in the original assessment proceeding. The assessee preferred the further appeal before the High Court raising the following substantial questions of law –

1) Whether the Tribunal is right in applying the ratio of the decision of the Hon’ble Supreme Court in CIT vs. Sun Engineering (P.) Ltd. 198 ITR 297 (SC) and holding that concluded issue in the original proceeding cannot be reagitated in reassessment proceedings even though the case of the appellant is distinguishable inasmuch as there was no original assessment proceedings on the facts and circumstances of the case?

2) Whether the Tribunal was justified in law in not appreciating that the notice u/s 148 of the Act was issued to “assess” the income and thus all contentions in law remained open for the appellant to agitate by filling a return in response to the notice u/s 148 of the Act on the facts and circumstances of the case?

3) Whether the Tribunal is justified in law in holding that the appellant is not entitled to make additional claim of loss incurred of Rs. 8,28,65,052/- in the reassessment proceedings under section 147 of the Act on the facts and circumstances of the case?

4) Whether the Tribunal is right in not holding that the appellant is entitled to the additional claim of actual loss incurred of Rs. 8,28,65,052/- on account of sale of government securities on the facts and circumstances of the case?

Before the High Court, the assessee submitted that there was no original assessment for the same assessment year, and only an intimation u/s 143(1) was issued to the assessee. The said intimation u/s 143(1) was not an order of assessment as held by the Supreme Court in the case of ACIT vs. Rajesh Jhaveri Stock Brokers (P.) Ltd. 291 ITR 500. Therefore, the issue of loss on sale of securities was not considered by the Assessing Officer and has not reached finality. The assessee also urged that the decision of the Supreme Court in the case of Sun Engineering Works (P) Ltd. (supra) should not be applied in its case on the ground that in that case the original order of assessment had attained finality and, therefore, it was held that the assessee could not agitate the issues in reassessment proceedings. Further, reliance was placed on the decision of the Supreme Court in the case of V. Jagan Mohan Rao vs. CIT & Excess Profit Tax 75 ITR 373 in which it was held that the original assessment got effaced upon issuance of notice of reassessment and the subsequent assessment proceedings has to be done afresh. The assessee also relied upon the decisions of the Supreme Court in ITO vs. Mewalal Dwarka Prasad 176 ITR 529 (SC) and ITO vs. K.L. Sri Hari (HUF) 250 ITR 193 (SC) as well as on the decisions of the Karnataka High Court in CIT vs. Mysore Iron & Steel Ltd. 157 ITR 531, Nitesh Bera (HUF) vs. Dy. CIT [IT Appeal No. 585 of 2016, dated 17th February, 2021] and CIT vs. Avasarala Automation Ltd. [Writ Appeal Nos. 1411-1413 of 2004, dated 5th April, 2005].

On the other hand, the revenue relied upon the decision of the Supreme Court in the case of Sun Engineering Works (P.) Ltd. (supra) and argued that it still held the field. It was submitted that Section 148 of the Act provided a remedy to the revenue and not to the assessee. If the assessee discovered any omission or any wrong statement in the original return filed after the time limit to revise u/s 139(5) expired, the only remedy which was available to the assessee was to file a return and to seek condonation of delay in filing the return u/s 119 where the time for completion of assessment was not over.

The High Court referred to the decision of a three-judge bench of the Supreme Court in the case of V Jagan Mohan Rao (supra) wherein it was held that when there was a reassessment or assessment u/s 147, the original assessment proceeding, if any, got effaced and the reassessment or assessment has to be done afresh. The High Court also referred to the decision of the Supreme Court in the case of Mewalal Dwarka Prasad (supra) in which it was held that once proceeding u/s 148 of the Act was initiated, the original order of assessment got effaced. The court noted that in Sun Engineering Works (P.) Ltd. (supra), it was held that in a proceeding for reassessment, the issues forming part of the original assessment could not be agitated, whereas, in Mewalal Dwarka Prasad (supra), it was held that once proceeding u/s 148 was initiated, original order of assessment got effaced.

The High Court further referred to the decision of the Supreme Court in the case of K.L. Srihari (HUF) (supra), in which the matter was referred to a three judges bench considering divergence of view so taken in the earlier cases. The relevant portion from the decision of the Supreme Court as reproduced in its order by the Karnataka High Court is as follows –

1. By order dated 19th November, 1996, these special leave petitions have been directed to be placed before the three-judge Bench because it was felt that dissonant views have been expressed by different Benches of this court on the scope and effect of reopening of an assessment under section 147 of the Income-tax Act, 1961. It has been pointed out before us that the matter has earlier been considered by a Bench of three judges in V. Jagan Mohan Rao vs. CIT and EPT and the observations in the said case came up for consideration before two judges’ Benches of this court in ITO vs. Mewalal Dwarka Prasad [1989] 176 ITR 529 and in CIT vs. Sun Engineering Works (P.) Ltd. [1992] 198 ITR 297 and that there is a difference in the views expressed in said later judgments.

2. We have heard Shri Ranbir Chandra, learned counsel appearing for the petitioners, and Shri Harish N. Salve, learned senior counsel appearing for the respondents. We have also perused the original assessment order dated 19th March, 1983, as well as the subsequent assessment order that was passed on 16th July, 1987, after the reopening of the assessment under section 147. On a consideration of the order dated 16th, July, 1987, we are satisfied that the said assessment order makes a fresh assessment of the entire income of the respondent-assessee and the High Court was, in our opinion, right in proceeding on the basis that the earlier assessment order had been effaced by the subsequent order. In these circumstances, we do not consider it necessary to go into the question that is raised and the same is left open. The special leave petitions are accordingly dismissed.

In view of the above, the High Court held that, in the case of the assessee, there was no original assessment order and it was only an intimation u/s 143(1), which could not be treated to be an order in view of the decision of the Supreme Court in the case of Rajesh Jhaveri (supra). Therefore, the proceeding u/s 148 was the first assessment and the same could have been done after taking into consideration all the claims of the assessee including the one made in filing the return in response to the notice u/s 148. It was held that the decision rendered by the Supreme Court in Sun Engineering Works (P.) Ltd. had no application to the fact of the case. It was also held that even if an intimation u/s 143(1) was considered to be an order of assessment, in the subsequent reassessment proceedings, the original assessment proceeding got effaced and the Assessing Officer was required to conduct the proceedings de novo and to consider the fresh claim of the assessee.

Accordingly, the High Court decided the issue in favour of the assessee and remitted the matter to the Assessing Officer for adjudication of the fresh claim made by the assessee in its return filed in response to the notice issued u/s 148.

OBSERVATIONS
The scope of assessment in a case where a notice is issued u/s 148 is governed by section 147 which provides as under (as it existed prior to its substitution by the Finance Act, 2021) –

If the Assessing Officer has reason to believe that any income chargeable to tax has escaped assessment for any assessment year, he may, subject to the provisions of sections 148 to 153, assess or reassess such income and also any other income chargeable to tax which has escaped assessment and which comes to his notice subsequently in the course of the proceedings under this section, or recompute the loss or the depreciation allowance or any other allowance, as the case may be, for the assessment year concerned (hereafter in this section and in sections 148 to 153 referred to as the relevant assessment year).

In Sun Engineering Works (P.) Ltd.’s case (supra), the Supreme Court held that the reference to ‘such income’ here would mean the income chargeable to tax which has escaped assessment as referred in the initial part of the section and, therefore, the scope of assessment u/s 147 is limited only to the income which has escaped the assessment for which the proceeding has been initiated by issuing notice u/s 148. The only other income other than such escaped income which also can be included is any other escaped income which comes to the notice of the Assessing Officer subsequently in the course of the proceeding and which is not forming part of the reasons recorded for the issuance of notice u/s 148.

In the case of V. Jaganmohan Rao (supra), the Supreme Court was dealing with the case wherein the assessment was reopened with regard to the escaped income which accrued to the assessee as a result of the decision of the Privy Council in a dispute related to title of the property. While finally assessing the income, the Assessing Officer not only taxed such escaped income accruing as a result of the decision of the Privy Council but also assessed the other portion of the income which accrued to the assessee in accordance with the judgement of the High Court. The assessee contested it on the ground that at the time when the original order of assessment was passed, the ITO could have legitimately assessed the other income which was due to be assessed as per the judgment of the High Court and that there was, therefore, an escapement only to the extent of the income accruing as a result of the decision of the Privy Council. It is in this context, the Supreme Court held as under –

Section 34 in terms states that once the Income-tax Officer decides to reopen the assessment he could do so within the period prescribed by serving on the person liable to pay tax a notice containing all or any of the requirements which may be included in a notice under section 22(2) and may proceed to assess or reassess such income, profits or gains. It is, therefore, manifest that once assessment is reopened by issuing a notice under sub-section (2) of section 22 the previous under-assessment is set aside and the whole assessment proceedings start afresh. When once valid proceedings are started under section 34(1)(b) the Income-tax Officer had not only the jurisdiction but it was his duty to levy tax on the entire income that had escaped assessment during that year (emphasis supplied).

Subsequent to this decision of the Supreme Court in the case of V. Jaganmohan Rao, several High Courts took the view that the assessee can seek relief even during the course of the reassessment proceeding by relying on the Supreme Court’s observation that the whole assessment proceeding would start afresh in case of reassessment. Later, this issue of whether the assessee can claim reliefs to his benefit during the course of the reassessment proceeding reached the Supreme Court in the case of Sun Engineering Works (P.) Ltd. (supra) in which it was held as under –

37. The principle laid down by this Court in V. Jaganmohan Rao’s case (supra) therefore, is only to the extent that once an assessment is validly reopened by issuance of notice under section 32(2) of the 1922 Act (corresponding to section 148 of the 1961 Act), the previous under-assessment is set aside and the ITO has the jurisdiction and duty to levy tax on the entire income that had escaped assessment during the previous year. What is set aside is, thus, only the previous under-assessment and not the original assessment proceedings. ………..The judgment in V. Jaganmohan Roa’s case (supra), therefore, cannot be read to imply as laying down that in the reassessment proceedings validly initiated the assessee can seek reopening of the whole assessment and claim credit in respect of items finally concluded in the original assessment. The assessee cannot claim recomputation of the income or redoing of an assessment and be allowed a claim which he either failed to make or which was otherwise rejected at the time of original assessment which has since acquired finality. Of course, in the reassessment proceedings it is open to an assessee to show that the income alleged to have escaped assessment has in truth and in fact not escaped assessment but that the same had been shown under some inappropriate head in the original return, but to read the judgment in V. Jaganmohan Roa’s case (supra) as if laying down that reassessment wipes out the original assessment and that reassessment is not only confined to ‘escaped assessment’ or ‘under-assessment’ but to the entire assessment for the year and start the assessment proceedings de novo giving right to an assessee to reagitate matters which he had lost during the original assessment proceeding, which had acquired finality, is not only erroneous but also against the phraseology of section 147 and the object of reassessment proceedings. Such an interpretation would be reading that judgment totally out of context in which the questions arose for decision in that case. It is neither desirable nor permissible to pick out a word or a sentence from the judgment of this Court, divorced from the context of the question under consideration and treat it to be the complete ‘law’ declared by this Court. The judgment must be read as a whole and the observations from the judgment have to be considered in the light of the questions which were before this Court.

38. …..

39. As a result of the aforesaid discussion we find that in proceedings under section 147 the ITO may bring to charge items of income which had escaped assessment other than or in addition to that item or items which have led to the issuance of notice under section 148 and where reassessment is made under section 147 in respect of income which has escaped tax, the ITO’s jurisdiction is confined to only such income which has escaped tax or has been under-assessed and does not extend to revising, reopening or reconsidering the whole assessment or permitting the assessee to reagitate questions which had been decided in the original assessment proceedings. It is only the under-assessment which is set aside and not the entire assessment when reassessment proceedings are initiated (emphasis supplied). The ITO cannot make an order of reassessment inconsistent with the original order of assessment in respect of matters which are not the subject matter of proceedings under section 147. An assessee cannot resist validly initiated reassessment proceedings under this section merely by showing that other income which had been assessed originally was at too high a figure except in cases under section 152(2). The words ‘such income’ in section 147 clearly refer to the income which is chargeable to tax but has ‘escaped assessment’ and the ITO’s jurisdiction under the section is confined only to such income which has escaped assessment.

Keeping in view the object and purpose of the proceedings under section 147 which are for the benefit of the revenue and not an assessee, an assessee cannot be permitted to convert the reassessment proceedings as his appeal or revision, in disguise, and seek relief in respect of items earlier rejected or claim relief in respect of items not claimed in the original assessment proceedings, unless relatable to ‘escaped income’, and reagitate the concluded matters. Even in cases where the claims of the assessee during the course of reassessment proceedings related to the escaped assessment are accepted, still the allowance of such claims has to be limited to the extent to which they reduce the income to that originally assessed. The income for purposes of ‘reassessment’ cannot be reduced beyond the income originally assessed.

The Karnataka High Court, in the case of The Karnataka State Co-operative Apex Bank Ltd. (supra), observed that divergent views had been taken by the Supreme Court in these two cases i.e. Sun Engineering Works (P.) Ltd. (supra) and Mewalal Dwarka Prasad (supra). The High Court also by referring to the decisions of the Supreme Court in the case of V. Jagmohan Rao, Mewalal Dwarka Prasad and K.L. Srihari (HUF) (supra) observed that once proceeding u/s 148 was initiated, the original order of assessment got effaced.

In the case of Mewalal Dwarka Prasad (supra), the notice u/s 148 was issued for income escaping the assessment w.r.t three different cash credit entries in the assessee’s books during the year. When the assessee challenged the validity of the notice before the High Court, the High Court upheld its validity but only with respect to one of the cash credit entries, and for the balance two entries, the notice was held to be invalid. The revenue disputed these findings and argued that the High Court should not have examined the tenability of the assessee’s contention with regard to the other two transactions and that aspect should have been left to be considered by the ITO while making the reassessment as it was open to the ITO to examine not only the three items referred to in the notice but also whatever came within the legitimate ambit of an assessment proceeding. In this context, the Supreme Court held that it was not for the High Court to examine the validity of the notice u/s 148 regarding the two items if the High Court concluded that the notice was valid at least in respect of the remaining item. Whether the ITO, while making his reassessment, would take into account the other two items should have been left to be considered by the ITO in the fresh assessment proceeding.

In our respectful submission, in the case of Mewalal Dwarka Prasad (supra), the Supreme Court had dealt with the limited issue about whether the High Court should have considered the validity of notice on the basis of the other items of income when it was held to be valid at least for one of the items of escaped income. In this context, the Supreme Court referred to the decisions of several High Courts and also to its own decision in the case of V. Jaganmohan Rao wherein it was held that when a notice is issued u/s 148 based on a certain item of income that had escaped assessment, it is permissible for the income-tax authorities to include other items in the assessment, in addition to the item which had initiated and resulted in issuance notice u/s 148. As far as the decision of the Supreme Court in the case of K.L. Srihari (HUF) (supra) is concerned, in its final order dated 25th March, 1998, a reference has been made to its earlier order dated 19th November, 1996 (in the same case) whereby the SLPs have been directed to be placed before the three-judges bench on the ground that dissonant views have been expressed in the cases of Sun Engineering Works (P.) Ltd. and Mewalal Dwarka Prasad.

The Calcutta High Court in the case of Keshoram Industries Ltd. (supra) has considered the impact of the Supreme Court’s decision in the case of K.L. Srihari (HUF) (supra) and held as under:

8. True as contended by Mr. Khaitan in ITO vs. K.L. Srihari (HUF) [2001] 250 ITR 193 (SC), a three-judges Bench considered the following judgments:

(1)  CIT vs. Sun Engg. Works (P.) Ltd. [1992] 198 ITR 2971 (SC);
(2)  ITO vs. Mewalal Dwarka Prasad [1989] 176 ITR 529 (SC); and
(3)  V. Jaganmohan Rao vs. CIT and CEPT [1970] 75 ITR 373 (SC).

but observed that:

“In these circumstances we do not consider it necessary to go into the question that is raised and the same is left open…”. (p. 194)…………..

12. Having heard learned counsel for the respective parties, we are respectfully of the view that in ITO vs. K.L. Srihari (HUF) 250 ITR 193, the Supreme Court did not consider it necessary to go into the views expressed by different Benches of the Supreme Court on the scope and effect of reopening of an assessment under section 147 of the Income-tax Act. We, respectfully, are, therefore, of the view that the judgment of the Supreme Court in CIT vs. Sun Engg. Works (P.) Ltd. [1992] 198 ITR 2971 has neither been dissented from nor overruled.

13. No doubt as contended by Mr. Khaitan, the judgment in CIT vs. Sun Engg. Works (P.) Ltd.[1992] 198 ITR 297 1 (SC), is a two-judges Bench judgment. By the said judgment, the three-judges Bench judgment in V. Jaganmohan Rao vs. CIT/CEPT [1970] 75 ITR 373 (SC), has not been and could not have been overruled. As noticed supra, the Supreme Court in CIT vs. Sun Engg. Works (P.) Ltd. [1992] 198 ITR 2971 has explained the principle laid down in V. Jaganmohan Rao vs. CIT/CEPT[1970] 75 ITR 373 (SC).

The decision of the Karnataka High Court has thrown open some very pertinent and interesting issues, some of which are listed hereunder:

•    Whether an assessment made u/s 143(3) r.w.s 147 is a fresh assessment or re-assessment where it is made in pursuance of an intimation u/s 143(1) or where no assessment was made.

•    Whether there was any conflict of views between the four decisions of the Supreme Court referred to and analyzed by the Karnataka High Court.

•    Whether the three decisions of the Supreme Court, other than the decision in the case of Sun Engineering Works (supra), held that the original assessments which were made got effaced and therefore an altogether fresh assessment is to be made as per the provisions of law.

•    Whether the decision in Supreme Court, being the latest in line, and delivered by the larger bench of three judges, could be said to have laid down the law permitting an assessee to make a fresh claim, when the court confirmed the decision of the Karnataka High Court, 197 ITR 694, which had held that the interest levied u/s 139(8) and 217 in original assessment was required to be deleted.

•    Whether the proceedings for re-assessment are necessary for the benefit of revenue.

• Whether the purpose and objective of the Income Tax Act are to levy tax on real income whenever assessed under the Act.

The decision of the Karnataka High Court, by opening a new possibility for the taxpayers, has thrown a serious challenge for the revenue. It would be better for the Supreme Court to examine the issue afresh and reconcile its views in the four decisions rendered by it, over a period of time, preferably by constituting a larger bench.

S. 179 r.w.s. 264 – Non speaking order – without any reasons – Orders set aside

11 Bhavesh Mohan Lakhwani vs. Pr. Commissioner of Income Tax-12 & Anr; [W.P. No. 560 of 2021;  Date of order: 31st January, 2022 (Bombay High Court)]  

S. 179 r.w.s. 264 – Non speaking order – without any reasons – Orders set aside

The Petitioner had challenged the order dated 3rd March, 2020 passed by the Pr. CIT  u/s 264 of the Act rejecting the Petitioner’s Application filed u/s 264. The Petitioner had filed an application u/s 264 of the Act before Pr.CIT challenging the order u/s 179 of the Act dated 28th September, 2018  passed by the  Assessing Officer, against the  Petitioner for recovery of tax demand of Rs. 2,77,01,520 arising out of the assessment of M/s. Laxmi Realty & Advisory Pvt Ltd. The Petitioner being one of the directors of the said M/s. Laxmi Realty & Advisory Pvt Ltd during the relevant A.Y. 2015-16, therefore the Assessing officer had initiated and passed order u/s 179 of the Act against the Petitioner for recovery of tax demand of the said company.

The Hon. Court observed that both the orders under Section 179(1) and Section 264 of the said Act are without giving any reasons. In the order passed u/s 179(1), the Income Tax Officer simply says that there was a reply received from Petitioner, but the same is not being accepted. In the order passed under Section 264 of the said Act, the Principal Commissioner of Income Tax has not even dealt with the submissions made by the Petitioner.

In the circumstances, the Hon. Court set aside both the orders, i.e., the order dated 27th February, 2020, passed under Section 264 of the said Act and the order dated 28th September, 2018, passed under Section 179(1).

The Hon. Court further directed that the Assessing Officer  consider afresh the response filed by Petitioner and pass an order under Section 179(1) of the said Act in accordance with law and before any order is passed, the Petitioner shall be given a personal hearing, and notice of personal hearing shall be communicated to Petitioner at least two weeks in advance. If the Assessing Officer wishes to rely on any judgments or order passed by any Court or Tribunal, he shall provide a copy thereof to the Petitioner and allow him an opportunity to deal with those judgments or distinguish those judgments and those submissions of the Petitioner shall also be dealt with in the order.

Section 43CA does not apply in a situation where allotment letters are issued and part payments received prior to 1st April, 2013

28 Spenta Enterprises vs. ACIT  [TS-63-ITAT-2022(Mum.)] A.Y.: 2014-15; Date of order: 27th January, 2022 Section: 43CA

Section 43CA does not apply in a situation where allotment letters are issued and part payments received prior to 1st April, 2013

FACTS
In the course of assessment proceedings of the assessee, carrying on the business of builders, developers and realtors, the Assessing Officer (AO) noted that there was a difference between agreement value and market value in respect of some of the properties. He issued a show cause to the assessee. In response, the assessee submitted that only in two cases the stamp duty value on the date of allotment was in excess of their respective agreement values. He further submitted that since allotment letters were issued and initial amounts received prior to coming into force of section 43CA, the provisions of section 43CA did not apply even to these two cases. To substantiate, the assessee submitted ledger copies of the buyer’s accounts and bank statements showing receipt of initial amounts from the buyer. The assessee also relied upon the decision of the Mumbai Tribunal in the case of Krishna Enterprises vs. ACIT.

The AO, not being convinced by the submissions made by the assessee, added a sum of Rs. 8,26,329 to the total income of the assessee under section 43CA.

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

Aggrieved, assessee preferred an appeal to the Tribunal.

HELD
The Tribunal noted the twin contentions of the assessee, namely that since section 43CA was introduced w.e.f. 1st April, 2013 and the agreements under consideration were entered into prior to 1st April, 2013; the provisions of section 43CA do not apply and because the difference between the ready reckoner rate and sale consideration was only 5%, the same needs to be ignored on the touchstone of the decision of the Mumbai Tribunal in the case of Krishna Enterprises vs. ACIT. The Tribunal held that the assessee succeeds on both the counts. The Tribunal set aside the orders of the authorities below and decided the issue in favour of the assessee.

Sum accepted as a loan, which is found correct in principle, could not be treated as an amount received since there is a pre-condition of its return to be made to the creditor party. The fact that the creditor company’s name is subsequently struck off is contrary to the factual position in the impugned year

27 ITO vs. Hajeebu Venkata Seeta  [TS-50-ITAT-2022(Hyd.)] A.Y.: 2009-10; Date of order: 5th January, 2022 Section: 56

Sum accepted as a loan, which is found correct in principle, could not be treated as an amount received since there is a pre-condition of its return to be made to the creditor party. The fact that the creditor company’s name is subsequently struck off is contrary to the factual position in the impugned year

FACTS
During the previous year relevant to the assessment year under consideration, the assessee received a sum of Rs. 2,84,00,000 from Synchron Infotech Pvt. Ltd. The amount so received was paid to Legend Infra Homes Pvt. Ltd. The purpose of the transactions was to purchase property from Legend Infra Homes Pvt. Ltd. by Synchron Infotech Pvt. Ltd.

This position was confirmed by bank transactions and copies of ledger account in the books of Synchron Infotech Pvt. Ltd., Legend Infra Homes Pvt. Ltd. and the assessee. The entry in the case of the assessee is that the relevant sum was given to Legend Infra “towards advance for purchase of property on behalf of Synchron”. The ledger account of Legend Infra Homes Ltd. reflected the relevant sums as advances towards the purchase of property on behalf of Synchron and not in the name of the assessee.

The Assessing Officer held this sum of Rs. 2,84,00,000 to be taxable u/s 56(2)(vi) of the Act and added it to the assessee’s total income. He also observed that the name of Synchron Infotech Pvt. Ltd. had been struck off.

Aggrieved, the assessee preferred an appeal to CIT(A), who allowed the appeal filed by the assessee and held that the sum of Rs. 2,84,00,000 received by the assessee is not without consideration, and consequently, section 56(2)(vi) of the Act does not apply.

Aggrieved, revenue preferred an appeal to the Tribunal.

HELD
The Tribunal observed that the AO had not invoked section 68 of the Act in order to treat the impugned sums as unexplained cash credit on account of the assessee’s failure to prove the identity, genuineness and creditworthiness of all the parties therein. The Tribunal held that a loan sum accepted as correct in principle could not be treated as an amount received since there is a pre-condition of its return to be made to the creditor party. The Tribunal rejected the arguments on behalf of the revenue and confirmed the action of CIT(A).

AUDITOR’S REPORTING – GROUP AUDIT AND USING THE WORK OF OTHER AUDITORS

The term ‘group’ as defined in Accounting Standard 21 and Indian Accounting Standard 110 includes parent and all its subsidiaries. Consolidated financial statements are the financial statements of a group presented as those of a single enterprise which includes consolidation of financial statements of parent, subsidiaries, associates and joint ventures in accordance with applicable accounting standards. Standard on Auditing (SA) 600, ‘Using the Work of Another Auditor’ establishes standards when an auditor, reporting on the financial statements of an entity (the group—in the case of consolidated financial statements), uses the work of another auditor on the financial information/statements of one or more components included in the financial statements of the entity. ICAI has also issued a Guidance note on Consolidated Financial Statements to provide guidance on the specific issues and audit procedures to be applied to audit consolidated financial statements.

Under the International Standard on Auditing 600 issued by International Auditing and Assurance Standards Board, the group auditor is responsible for the direction, supervision, and performance of the group audit and the appropriateness of the group audit report. Where SA 600 applies and when the group auditor has to base his/her opinion on the financial information of the entity as a whole relying upon the statements and reports of the other auditors, the group auditor shall clearly state in his/her report the division of responsibility for the financial information included in a group financial statement of components audited by other auditors and that they have been included as such after performing appropriate procedures. However, it is important to note that it is not blind reliance on the work done by other auditors.

When the group auditor or principal auditor concludes that the financial information of a component is immaterial, the procedures outlined in SA 600 do not apply. Principal auditor should consider materiality portion of financial information which the principal auditor audits, degree of knowledge regarding business of the components, risk of material misstatement in financial information of the components audited by other auditor, whether principal auditor can perform additional procedures before accepting his/her position as principal auditor.

The objective of this article is to highlight some important aspects relating to group audits in India and role and responsibilities of the principal auditor or the group auditor when using the work of other auditors.

ISSUE 1 – ACCESS TO WORKING PAPERS OF COMPONENT AUDITORS
ICAI issued a clarification in May 2000 which provides that an auditor is not required to provide the client or the other auditors of the same enterprise or its related enterprise such as a parent or a subsidiary, access to his audit working papers. The main auditors of an enterprise do not have the right of access to the audit working papers of branch auditors. In the case of a company, the statutory auditor must consider the report of the branch auditor and has a right to seek clarifications and/or to visit the branch if he deems it necessary to do so for the performance of the duties as auditor. An auditor can rely on the work of another auditor without having any right of access to the audit working papers of the other auditor. For this purpose, the term ‘auditor’ includes ‘internal auditor’. The only exception is that the auditor may, at his discretion, in cases considered appropriate by him, make portions of or extracts from his working papers available to the client.

The above clarification is based on the principles of SA 230, Audit Documentation, in accordance with which audit documentation is the property of auditor and SA 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing, which provides that the auditor should respect the confidentiality of information acquired in the course of his work and should not disclose any such information to a third party without specific authority or unless there is a legal or professional duty to disclose. In addition to this, Part I of the Second Schedule to the Chartered Accountants Act, 1949 provides that “A Chartered Accountant in practice shall be deemed to be guilty of professional misconduct, if he discloses information acquired in the course of his professional engagement to any person other than his client, without the consent of his client or otherwise than as required by any law for the time being in force.”

In line with the above, under SA 600, where another auditor has been appointed for the component, the principal auditor would normally be entitled to rely upon the work of such auditor unless there are special circumstances to make it essential for him to visit the component and/or to examine the books of account and other records of the said component. However, this poses a practical limitation on the principal auditor while conducting a group audit.

ISSUE 2 – RESPONSIBILITY OF PRINCIPAL AUDITOR/GROUP AUDITOR WHILE USING WORK OF ANOTHER AUDITOR
(i) SA 600 requires that the Principal Auditor should perform the following procedures while planning to use the work of another auditor:

• Consider the professional competence of Other Auditor, if other auditor is not a member of ICAI;

•    Obtain sufficient appropriate audit evidence, that the work of other auditor is adequate for principal auditor’s purpose. For this purpose, the principal auditor should advise the other auditor of the use that is to be made of the other auditor’s work and report and make sufficient arrangements for co-ordination of their efforts at the planning stage of the audit. The principal auditor would inform the other auditor of matters such as areas requiring special consideration, procedures for the identification of inter-component transactions that may require disclosure and the timetable for completion of audit; and advise the other auditor of the significant accounting, auditing, and reporting requirements and obtain representation as to compliance with them;

• There should be sufficient liaison between the principal auditor and the other auditor. For this purpose, the principal auditor may find it necessary to issue written communication(s), i.e., group instructions to the other auditor;

• The principal auditor should share detailed group audit instructions to other auditor, which may include the following:

• Significant Risk-Group Financial Statement Level (e.g., management override of control, revenue recognition, impairment).

• Group Structure-Details of subsidiary/joint venture and % stake for current year and previous year.

• Significant accounting and auditing issues.

• Timetable of communication, contacts, communication protocols.

In addition to being asked to complete group audit questionnaires and/or provide memoranda of work performed, component auditors may be asked to report directly to group auditors in the form of an audit or review opinion on financial information i.e., the group reporting/consolidation package prepared by component management.

• Principal auditor may require another auditor to submit a detailed questionnaire with reference to the work performed by him, checklist etc.

• Consider significant findings of other auditor and perform supplement tests if necessary.

(ii) Regulation 33(8) of SEBI (Listing Obligations and Disclosure Requirements) (Regulations) 2015

SEBI Circular dated 29th March, 2019 states that the principal auditor is required to send Group Audit / Review Instructions to component auditors for audit/review of the consolidated financial statements / results. Since the audit/review report requires specific assertion on performance of procedures in accordance with the SEBI Circular, it is mandatory that component auditor should respond to the instructions and provide the requisite information.

It is important to note that the parent company management is responsible for ensuring co-ordination between the principal and other auditor to comply with the requirements of SA 600.The requirements specified in the SEBI circular seems to be mandatory for the entities whose accounts are to be consolidated with the listed entity and to the statutory auditors of entities whose accounts are to be consolidated with the listed entity.

The circular requires the principal auditor to communicate its requirements to the component auditors on a timely basis. This communication shall set out the work to be performed, the use to be made of that work, and the form and content of the component auditor communication with the principal auditor. Therefore, the principal auditor is required to send the group audit/review instructions to the component auditor, and if the component auditor does not respond to such instructions on a timely basis, then it may be considered as a non-compliance with the requirements of the circular since the audit/review report (format issued by SEBI) requires specific assertion that “we also performed procedures in accordance with the Circular issued by SEBI under Regulation 33(8) of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, as amended, to the extent applicable”.

Accordingly, if the component auditor does not respond to the questionnaire, checklist or information request sent by the principal auditor, it may be considered as a scope limitation, and the principal auditor may issue a qualified opinion/conclusion in such a situation in accordance with SA 705, Modifications to the Opinion in the Independent Auditor’s Report.

ISSUE 3 – CONSIDERATION OF MATERIALITY BY PRINCIPAL AUDITOR
The principal auditor is required to compute the materiality for the group as a whole (which is different from materiality to issue an opinion on the standalone financial statements), which should be used to assess the appropriateness of the consolidation adjustments (i.e., permanent consolidation adjustments and current period consolidation adjustments) that are made by the management in the preparation of CFS. The parent auditor can also use the materiality computed on the group level to determine whether the component’s financial statements are material to the group to determine whether they should scope in additional components and consider using the work of other auditors as applicable.

ISSUE 4 – REPORTING BY PRINCIPAL AUDITOR
SA 600 requires that the report on consolidated
financial statements and standalone financial statements (in a situation where the branch auditors are other than principal auditor), should state clearly the division of responsibility between principal auditor and other auditor. The principal auditor should express a qualified/disclaimer of opinion if:

• Principal auditor cannot use the work of other auditor and is unable to perform sufficient additional procedures as required by SA 600.

• If there is modification in another auditor’s report, then the principal auditor should consider whether the subject of the modification is of such nature and significance, in relation to the entity’s financial information and whether it requires a modification of the principal auditor’s report.
    
It is important to note the requirements in Guidance Note on Audit of Consolidated Financial Statements, which requires that while considering the observations (for instance, modification and /or emphasis of matter/other matter in accordance with SA 705/706) of the component auditor in his report on the standalone financial statements, the parent auditor should comply with the requirements of SA 600. Reference should be made to paragraph 23 of SA 600 which states, “In all circumstances, if the other auditor issues, or intends to issue, modified auditor’s report, the principal auditor should consider whether the subject of the modification is of such nature and significance, in relation to the financial information of the entity on which the principal auditor is reporting, that it requires a modification of the principal auditor’s report.”

Hence, the principal auditor needs to evaluate the observations (modification and /or emphasis of matter) in the component auditor’s report, in his auditor’s report on the CFS. For example, the considerations may include materiality and scope of the component; the assessment of risk of material misstatement for the group; the impact of the modification in light of the materiality thresholds for the group audit, etc.

The principal auditor should document how they have dealt with the qualifications or adverse remarks contained in the other auditor’s report in framing their report on the CFS of the group, considering materiality and risk assessment of the component.

The principal auditor of Consolidated Financial Statements in accordance with an ICAI announcement is required to state if certain components have been audited by other auditor and if such component/s is/ are material to the consolidated financial statements of the Group.

Where the financial statements of one or more components are unaudited, the principal auditor should consider unaudited components in evaluating a possible modification to his/her report on the consolidated financial statements. The evaluation is necessary because the auditor (or other auditors, as the case may be) has not been able to obtain sufficient appropriate audit evidence in relation to such consolidated amounts/balances. In such cases, the auditor should evaluate both qualitative and quantitative factors on the possible effect of such amounts remaining unaudited when reporting on the consolidated financial statements using the guidance provided in SA 705, Modifications to the Opinion in the Independent Auditor’s Report. If such unaudited component/s is/are not material to the consolidated financial statements of the group, the principal auditor is required to state this fact in an ‘Other Matter’ paragraph.

REPORTING ON KAM
Reporting on KAM applies to audit reports issued on consolidated financial statements of listed entities, in addition, to the report issued on standalone financial statements. The Implementation guide to SA 701 refers to SA 600 in case where the parent’s auditor is not the auditor of all the components to be included in the consolidated financial statements. It further states that the group auditor would be required to assess matters that in his professional judgement, are key audit matters from the perspective of consolidated financial statements. This needs to be done at the planning stage and updated during the performance of the audit.

Though there is no mandatory requirement in SA 701 read with SA 600 to mandatorily send group reporting instructions to the auditors (if they are different from group auditors) of unlisted subsidiaries to specifically seek a response to KAM pertaining to these subsidiaries, however, since the group auditor would be required to assess matters that in his professional judgement, are key audit matters from the perspective of
consolidated financial statements, the group auditor may seek a response from component auditor if any KAM is required to be included for that component. This can be done as part of the group audit instructions.

ISSUE 5 – RESPONSIBILITY OF THE COMPONENT AUDITOR/OTHER AUDITOR
During planning, performance or completion of the audit, component auditor/other auditors are expected to communicate with the principal auditor immediately if:

• Timing of the work creates an irresolvable problem,

• Instructions are not fully understood,

• It is necessary to vary procedures from those specified,

• Circumstances arise that may result in a qualified opinion,

• Services have been performed without the appropriate pre-approvals or consideration of the independence matters discussed in the group audit instructions,

• Local conditions are such that work cannot be done within the estimated time or fee,

• Issues are identified that may affect work performed outside their territory, or

• Other auditor become aware of events, transactions, or recent or proposed legislative changes that may have a significant impact on the component or other members of the affiliated group (e.g., instances of fraud, significant changes to the level of control reliance, illegal acts, etc.).

The principal auditor will request acknowledgement of receipt of Group Audit Instructions and confirmation of cooperation from other auditor. Other auditor will be required to comply with the Guidance Note on Independence of Auditors (Revised), Code of Ethics issued by Institute of Chartered Accountants of India and the Companies Act, 2013 in relation to the work carried out on the component.

ISSUE 6 – AUDITORS’ REPORTING ON INTERNAL FINANCIAL CONTROLS OVER FINANCIAL REPORTING IN CASE OF CONSOLIDATED FINANCIAL STATEMENTS

Section 129(4) of the 2013 Act states that the provisions of the 2013 Act applicable to the preparation, adoption and audit of the financial statements of a holding company shall, mutatis mutandis, apply to the consolidated financial statements. The parent auditor is required to report in the case of consolidated financial statements under Section 143(3)(i) of the 2013 Act on the adequacy and operating effectiveness of the Internal Financial Controls over Financial Reporting, for the components only if it is a company under the 2013 Act.

The auditors of the parent company should apply the concept of materiality and professional judgment while reporting under section 143(3)(i) on the matters relating to Internal Financial Controls over Financial Reporting that are reported by the component auditors. The auditor should also assess the impact, if any, of the subject matter of any qualification, adverse opinion or disclaimer stated by any of the component auditors in their respective components, and any remedial measures effected by the parent company to mitigate the effect of such observations in the component audit reports on the financial reporting process for the consolidated financial statements.

ISSUE 7 – AUDITOR’S REPORTING UNDER CARO 2020
There are certain new/revised clauses in CARO 2020, which are related to consideration of reports of other auditors, e.g.:

• Consideration of reports of the internal auditors
(Clause 3(xiv)),

• Consideration of the issues, objections or concerns raised by the outgoing auditors in case of resignation of auditors during the year (Clause 3 (xviii)),

• Reporting on funds taken by the company from any entity or person on account of, or to meet the obligations of its subsidiaries, associates or joint ventures
(Clause 3(ix)(e)), and

• Reporting on loans where the company has raised loans during the year on the pledge of securities held in its subsidiaries, joint ventures or associate companies and report if the company has defaulted in repayment of such loans raised (Clause 3(ix)(f)).

Additionally CARO 2020 is also applicable to audit report for consolidated financial statements for only one clause i.e. clause (xxi) of CARO requires an auditor to comment on whether there have been any qualifications or adverse remarks by the respective auditors in the Companies (Auditor’s Report) Order (CARO) reports of the companies included in the consolidated financial statements, if yes, details of the companies and the paragraph numbers of the CARO report containing the qualifications or adverse remarks need to be indicated. The following points should be noted in this regard:

• Reporting under this clause is only required for those entities included in the consolidated financial statement to whom CARO 2020 is applicable.

• CARO report is to be included as separate annexure in the audit report to the consolidated financial statements.

• Assessments of responses by component auditors as qualification/adverse remark requires application of professional judgment.

• The concept of materiality is relevant when reporting under CARO. However, if a qualification/adverse remark is given by any individual component, there is a presumption that the item is material to the component. Hence when reporting under clause 3(xxi), the auditor is not required to re-evaluate the materiality from a consolidation perspective. Hence every qualification/adverse remark made by every individual component including the parent should be included while reporting under this clause.

• Qualification/adverse remarks given in parent company’s standalone CARO report are also required to be included.

• In case the audit report of the components has not yet been issued by its auditor, then the principal auditor would include the fact in his/her report.

BOTTOM LINE
Effective two-way communication between the principal auditor and the component auditor is of essence for the group audits, the starting point for which is the clear and timely communication of the requirements by way of group audit instructions. Also, it is equally important for the group management to play an active role for high-quality group audits. Similarly, when the auditor decides to use the work of another auditor e.g., branch auditor in an audit of standalone financial statements, internal auditor or auditor’s expert, the principal auditor should adhere to the procedures prescribed in SA 600 and ensure timely planning and communication along with documentation to demonstrate performance of such procedures. Besides this, the principal auditor is required to communicate important and group-related matters to those charged with governance and group management in a timely manner.  

FUNGIBILITY OF DIRECT TAX AND INDIRECT TAX FOR INDIVIDUAL INCOME TAXPAYERS AND INCOME TAX RETURNS FILERS

Kindly refer to my article – ‘India’s Macro-Economic & Financial Problems and Some Macro-Level Solutions’, published in September, 2021 BCAJ. Some professional colleagues and friends have opined that Fungibility of Direct and Indirect Taxes is never possible. No country in the World to their knowledge has such a facility given multiple difficulties etc. I accept their worthy views with a caveat that some country has to start. Why cannot India take the lead in this matter?

Others stated that my suggestion in the article is a solution that is self-defeating. The country loses out on Tax Revenues – Direct and Indirect and nobody gains in this matter. Please see the workings later.

My listing of benefits of tax fungibility is as under (from the above-published article):
1) Possibility of increased Income Tax Returns being filed by Individuals to claim the GST refund.
2) Widening of GST net due to individual income taxpayer asking for GST invoice.
3) The individual taxpayer MUST FEEL rewarded for filing income tax returns. Ultimately, Income Tax has always been a sensitive topic, and one must make the Tax Payer feel rewarded.

So far as individual income taxpayers are concerned, Indirect Tax is apparently unfair for B2C transactions (Business-to-Consumer). In B2B transactions, the business receiving goods and services is able to take an input tax credit of the same for its business and tax payment. While in B2C, this facility is not available. My proposal is aimed at making it
available.

Working:
By the working below, I wish to dispel this argument of Revenue Loss or no net increase in Tax Revenues. Note that this is only applicable to Individual Taxpayers filing ITRs 1 – 4.

Case: Individual ‘A’ (based on the old tax regime of income tax)

1

Total annual income

Rs 22.00 lakhs

2

Taxable annual income

Rs 20.00 lakhs

3

Income tax payable

(@ 21% tax rate (slab computation)

Rs 4.20 lakhs

4

Income available for annual spending (2-3)

Rs 15.80 lakhs

5

Amount spent

(assuming 80% spend on goods and services
and balance 20% savings)

Rs 12.64 lakhs

6

GST invoices available

(on 80% of total purchases)

Rs 10.10 lakhs

7

Value of purchases

GST paid on purchases

(at 15% average GST rate)

Rs 8.80 lakhs

Rs 1.30 lakhs

When filing the Income Tax Return, the individual taxpayer MUST show the amount of GST paid Rs 1.30 lakhs and claim an applicable Income Tax Refund. It is my view that even a 100% GST setoff will not impact Income Tax Revenues but will increase Income Tax Returns filings and add to GST revenues.

Note: Lower the value and percentage of GST Invoices, lower the GST set off against income tax payable. Individual purchasers/Buyers will insist on GST Invoices.

MECHANISM
To all those who already have PAN Cards and are filing any of the above 4 types of Income Tax Returns, the Income Tax office can send out a special code that is linked to the assessee’s PAN Card Number.

Those who have not filed their returns in the past MUST do so for availing GST setoff /refund and make an application to the Income Tax Authorities for the special code.

Every time a GST invoice is collected this special code must get referenced and scanned. That is the responsibility of the purchaser to show his special code card which the seller will scan and link with the GST Invoice. This can be done with safeguards and conditions that are easy to fulfill such as payment via debit/credit card/UPI/Electronic mode and even a threshold per transaction to start with.

Through the above referenced individual code, the Income Tax authorities must capture the GST paid by the individual as they are capturing the other Income and TDS thereon.

This collated information about sellers giving GST invoice details should also go to the GST authorities. They can then find out who is filing GST Returns and who is not.  Is the GST paid by the seller in line with the Sales
Invoice details given by the purchaser? An App or other modes of technology for this purpose could also come in handy.

As stated by me in the September, 2021 BCAJ article, the Revenue authorities must do some original thinking. There is a possible solution which MOST IMPORTANTLY favours the individual income tax payer. This must not be refrigerated but be worked on for 2023-24 implementation.

The key issue we are facing is the issue of Equity for the individual income taxpayer. Already, with Agriculture income out of ambit of the Income Tax Act, there is a high sense of frustration that large landowners and wealthy agriculturists are conveniently excluded.

Note: The author wishes to thank the members of the BCAJ Editorial team for value-added interventions to the article.  

INTERNAL CONTROL CONSIDERATIONS FOR UPCOMING AUDITS

Internal controls are unique to every company and are designed according to the company’s size and structure. A robust framework of internal control protects company’s interests, promotes accountability, and enables the preparation of reliable and accurate financial information. Under the Companies Act, 2013 (‘2013 Act’), the Board of Directors of a company are required to establish internal controls that are adequate and operate effectively. An auditor reporting obligation has been prescribed under section 143(3)(i) of the 2013 Act for reporting on the adequacy and operating effectiveness of internal financial controls with reference to financial statements (‘IFCFS’). The Guidance1 Note on Audit of Internal Financial Controls Over Financial Reporting (‘Guidance Note’) guides some of the implementation challenges.

In the current environment, internal control considerations continue to remain one of the key focus areas of stakeholders. A robust internal control framework is the only tool that can cater to the increased stakeholders’ expectations. This article aims to highlight the key aspects relating to design and operating effectiveness of internal controls that the auditor should consider during the upcoming audits of financial statements prepared under the 2013 Act for F.Y. 2021 – 2022 and onwards.

PLETHORA OF NEW FINANCIAL STATEMENT DISCLOSURES AND AUDITORS REPORTING OBLIGATIONS

Schedule III to the 2013 Act and auditors reporting obligations under Companies (Auditor’s Report) Order, 2020 (‘CARO 2020’) and other2 auditors reporting obligations under the 2013 Act have been overhauled with an aim to strengthen objective decision making by the stakeholders. Though it would be expected that auditors reporting is restricted to matters disclosed in the financial statements, some of the new reporting requirements deviates from this fundamental principle. The following is a snapshot that summarizes the key financial statement disclosures and key auditors’ requirements, including the matters which are common:

New
matters which warrant disclosures in financial statements and require
reporting by auditors (Key)

 

New financial statement
disclosures (Key)

(No
specific auditors reporting obligations prescribed)

 

New auditors reporting
obligations (Key)

(No
specific disclosures in financial statements)

Schedule III and CARO 2020

•
Agreement of quarterly returns/ statements with books of accounts for
borrowings taken against security of current assets.

•
Grant of loan/ advances in the nature of loan which are repayable on
demand or granted without specifying any terms or repayment period.

•
Material uncertainty in repayment of liabilities basis assessment of
financial ratios, etc.

•
Undisclosed income.

•
Wilful defaulter.

•    Corporate
social responsibility.

Schedule III and other2
reporting matters

•
Lending and borrowings masking the ‘Ultimate Beneficiary’.

•
Granular ageing analysis of certain captions e.g., trade receivables
including ageing of disputed and undisputed receivables.

•
Accounting of scheme of arrangement and explanation for deviation, if
any, with applicable accounting standards.

•
Transactions with struck off companies.

CARO 2020:

•
Enhanced reporting of loans, investment, etc
e.g., evergreening3 of loans.

•
Internal audit.

•
Whistle blower complaints.

•
Short term funds used for long term purpose.

•     Cash
losses.

Other2
reporting matters:

•
Compliance with dividend norms.

_____________________________________________________________

1   Issued in September 2015.

2   As prescribed under Rule 11 of the Companies
(Audit and Auditors) Rules, 2014.

3   In general parlance it implies an attempt to mask
loan default by giving new loans to help delinquent borrowers to repay/adjust
principal or pay interest on old loans.

A cursory reading of some of the new auditors’ requirements (e.g. lending and borrowings masking the ‘Ultimate Beneficiary’) might give the impression that these requirements expand the boundaries of an audit engagement requiring the auditor to perform procedures that are generally performed in an investigation. However, it might be noted that these reporting obligations have been prescribed in relation to the audit of financial statements. Accordingly, the auditor should consider Standards on Auditing and other guidance in planning and performing the audit procedures to address the risk of material misstatement as stated above. Some of the considerations are as follows:

• Substance vs. legal form– Schedule III to the 2013 Act and CARO 2020 have significantly enhanced the reporting obligations relating to loans, guarantees, etc. The auditor should verify that the controls have been established to critically assess the substance of the transaction irrespective of the legal form. To illustrate – basis relevant facts and circumstances, it might be appropriate to conclude that extension of a loan (such as one day prior to the expiration of tenure) is in substance evergreening of loans even though the loan is not technically ‘overdue’ – which is the trigger for reporting under CARO 2020.

• Critical assessment of funding needs of the borrower and its utilisation of funds- Schedule III provides disclosures relating to conduit lending/ borrowing transactions, etc, masking the ‘Ultimate Beneficiary’ and related matters. Further, management must also provide representations to the auditor that there are no such transactions except for that disclosed in the financial statements. Under the Companies (Audit and Auditors) Rules, 2014, the auditor must comment whether such management representation has been obtained and whether the representation is materially misstated. The auditor should assess whether the controls have been established to evaluate the funding needs of the borrower (prior to granting of loans) and periodically obtain end-use report of the funds from the borrower.

• Efficacy of periodic book close process- The auditor should review existing book close process and assess whether reliable information is generated which enables accurate filing of quarterly returns/ statements with the lenders. Where differences exist – assess whether proper explanations for differences have been documented and approved as per the authority matrix of the company.

• Competence of objectivity of management experts- Controls regarding assessing the competence and objectivity of management experts involved if any e.g., in case of revaluation of property, plant and equipment/ intangible assets, assess compliance with Companies (Registered Valuers and Valuation) Rules, 2017 to the extent applicable.

•    Avoid hindsight- Presentation of comparative information for new disclosures pursuant to the requirements of Schedule III might involve making necessary estimates and require the exercise of judgement. The auditor would need to be ensure that the estimates/ judgement involved are based on the information available as at the end of the previous year and without using hindsight information e.g., trade receivable under litigation till end of previous year has been disclosed as disputed trade receivable in the previous year even though such litigation has been disposed of by the end of the current year.

MATERIAL4 UNCERTAINTY RELATING TO GOING CONCERN
Circumstances affecting management’s assessment of going concern might change rapidly in the current environment, e.g., adverse key financial ratios or challenges in the realisation of financial assets and payment of financial liabilities may cast significant doubt on the company’s ability to continue as a going concern. As required under Standard on Auditing, 570, Going Concern, the auditor is required to report in a separate paragraph in the audit report if a material uncertainty relating to going concern exists.

•    Schedule III to the 2013 Act now requires companies to disclose:

•    Certain financial ratios in the financial statements (e.g., debt service coverage ratio) and explain any change in the ratio by more than 25% as compared to the preceding year.

•    Ageing of trade receivables and trade payables.

•    CARO 2020 requires the auditor to comment whether material uncertainty exists on the company’s ability of meeting its liabilities within a period of one year from the balance sheet date.

____________________________________________________________________

4   A
material uncertainty exists when the magnitude of its potential impact and
likelihood of occurrence is such that, in the auditor’s judgment, appropriate
disclosure of the nature and implications of the uncertainty is necessary for
the fair presentation of the financial statements (in the case of a fair
presentation financial reporting framework).

It might be noted that the going concern assessment under Standards on Auditing and reporting under CARO 2020 is not is the same – though there might be interlinkages. Under CARO 2020, the auditor’s responsibility is limited to assessing a company’s solvency i.e. material uncertainty, if any on the company’s ability to meet its liabilities; whereas going concern assessment is a much wider assessment of the entity. The auditor would need to assess whether a material uncertainty exists related to events or conditions that, individually or collectively, may cast significant doubt on the company’s ability to continue as a going concern e.g. a Company that is in the business of selling garments under a brand licensing agreement, might face a material uncertainty relating to going concern, if the license is not expected to be renewed. Another situation might be, where a company has hived off substantially all of its business and, absence of any concrete business plan, might indicate that material uncertainty relating to going concern exist.

The Guidance Note requires the auditor to make appropriate disclosures to state the inherent limitations on IFCFS and the limitations in consideration of such controls operating as at the balance sheet date for the future operations of the company. The assessment of material uncertainty relating to going concern involves judgement about inherently uncertain future or outcomes of events/ conditions. These judgements can be made only on the basis of what is known at the balance sheet date. The outcome of future operations of the company cannot be reliably predicted for all events/ conditions. In the current business and economic environment, what may be a reasonable assumption today may no longer be so, a short time later. Hence there are limitations in the operation of IFCFS for the company’s future operations. Following are examples of uncertainties that might create limitations on IFCFS operating as at the balance sheet date:

• Uncertainties around management’s ability to execute its turnaround strategy such as addressing reduced demand and to renew or replace funding especially where market value of unencumbered assets has deteriorated.

• Effect of business disruptions e.g., disruption of supply chain.

•  Effect of actions of the company on its long-term solvency e.g., deferral of payment of trade payables may affect long term solvency of the company.

• Where support letter has been provided by the Parent company – the uncertainties around the ability of the Parent company to discharge the obligations of the subsidiary as and when they fall due.

Accordingly, where a material uncertainty relating to going concern has been identified, the auditor should assess the inherent limitations on the operation of the IFCFS regarding the future operations of the company and should appropriately disclose such limitations in the audit report pursuant to requirements of the Guidance Note.

MATERIAL PRIOR PERIOD ERRORS
While auditing the financial statements for the current year, material errors in the financial statements of the previous years might be identified. Prior period errors occurs if undisclosed income of previous years is identified in the current year or due to mathematical mistakes, mistakes in applying accounting policies in respect of recognition, measurement, presentation, or disclosure, etc. Examples of prior period errors could be where due to the effects of inadequate controls on cut-offs, excess revenue was recognised in previous years. Another example could be where unaccounted cash was generated from scrap sale of previous years.

•    Schedule III to the 2013 Act requires companies to provide:

•    Details of any transaction not recorded in the books of accounts that has been surrendered/ disclosed as income during the year in the tax assessments, unless there is immunity for disclosure under any scheme. The company is also required to state whether the previously unrecorded income and related assets have been properly recorded in the books of account during the year.

•    Specific disclosures for Ind AS compliant company e.g., changes in other equity due to prior period errors.

•    CARO 2020 has also prescribed reporting obligations for auditors in case of undisclosed income.

Under the Guidance Note, errors observed in previously issued financial statements in the current financial year or restatement of previously issued financial statements to reflect the correction of a material misstatement has been included as an indicator of material weakness5. Where a material weakness in IFCFS exists, the Guidance Note requires the auditor to modify the IFCFS opinion. In determining the type of modification, i.e., qualification, disclaimer, or adverse the auditor should assess its pervasiveness of the material weakness, which might include the following:

• Manner of treatment of the prior period error in the current year’s financial statements . As per the Guidance Note, pervasive effect on the IFCFS include those matters that impacts the audit opinion on the company’s financial statements. It might be noted that under Ind AS 8, the material prior period errors are corrected by restating the comparative amounts unless such restatement is impracticable. Under AS 4, comparatives are not restated but are normally included in the determining net profit or loss for the current period.

•  The root cause which resulted in a material prior period error.

• The combination of the identified material weakness with other aspects of the financial statements, e.g., linkage with data used in management estimates or effect of the prior period error on the disclosures.

• The interaction of the control which failed to detect material misstatement with other controls, (e.g., the interaction of General IT controls, linkage to a transaction-level control or financial reporting process such as controls over the prevention and detection of fraud, significant transactions with related parties, controls over the financial statement close process).

PRIOR PERIOD ERRORS IDENTIFIED BY THE MANAGEMENT
There might be a situation where material prior period errors were identified by the management through its internal controls. Even in such case, the above mentioned considerations would be relevant to assess the consequential implications. As per the Guidance Note, the auditor should report if the company has adequate internal control systems in place and whether they were operating effectively as at the balance sheet date. It should be noted that when forming the opinion on internal financial controls, the auditor is required to test the same during the financial year under audit (and not just as at the balance sheet date) though the extent of testing at or near the balance sheet date may be higher, e.g. if the company’s revenue recognition was erroneous throughout the year but was corrected, including for matters relating to internal control that caused the error, as at the balance sheet date, the auditor is not required to report on the errors in revenue recognition during the year.

Accordingly, the auditor should assess the design and operating effectiveness of the new/ revised controls implemented by the management which aims to augment the book close process and avoid erroneous financial reporting. Where the new/ revised controls operate effectively by the balance sheet date and the auditor concludes that no material weakness exists as at the balance sheet date, the audit opinion on IFCFS would be unmodified.

EXEMPTION TO AUDITORS OF CERTAIN PRIVATE COMPANIES FROM REPORTING ON IFCFS
MCA has exempted auditors from reporting on IFCFS of a private company if such private company’s turnover is less than INR 50 crores as per latest audited financial statements and the aggregate borrowings from banks or financial institutions or anybody corporate at any point of time during the financial year is less than INR 25 crores. However, this exemption can be availed only if the private company has not committed a default in filing its financial statements under section 137 or annual return under section 92 of the 2013 Act. The assessment of the qualifying criteria poses certain challenges – some of them are discussed below:

ASSESSMENT OF TURNOVER CRITERIA
Financial statements under Schedule III do not disclose ‘Turnover’ but instead disclose ‘Revenue from operations.’ The items comprising turnover and revenue from operations are similar to a very large extent, but differences exist – as stated below:

Turnover as
defined under section 2(91) of the 2013 Act means aggregate value of the
realisation of amount made from:

 

•  Sale,
supply or distribution of goods or

•
Services rendered, or both,

 

by the company during a financial year.

Under Schedule III Revenue From
operations comprise:

 

•
Sale of products,

•
Sale of services

•
Grants or donations received (in case of section 8 companies only) and

•
Other operating revenues.

It might be noted that there is no specific reference of ‘Other operating revenues’ in the definition of turnover. ‘Other operating revenues’ include revenue arising from a company’s operating activities, i.e., either its principal or ancillary revenue-generating activities, but which is not revenue arising from the sale of products or rendering of services.

In order to derive the amount of turnover, the auditor should:

•  First, consider the amount of sale of products and sale of services as appearing in the latest audited financial statements.

•  Next, the auditor should obtain a breakup of other operating revenues to identify items, if any, that might qualify as turnover e.g., sale of manufacturing scrap would qualify as turnover as it arises during the process of manufacturing of finished goods. Similarly, government grants recognised under other operating revenues should be excluded as it is neither earned from the sale of goods nor the rendition of services.

ASSESSMENT OF BORROWING CRITERIA
One of the conditions for availing the exemption is that if ‘at any point of time’ during the financial year, prescribed borrowings are less than INR 25 crores. This seems to imply that the exemption is available even if borrowings from banks or financial institutions, or any body corporate is less than INR 25 crores in any day of the year under audit. The proposition is explained through the following illustrations:

Borrowings
from banks/financial institutions/body corporate

Exemption
available?

As at 1
April 20X1

2 April
20X1 to 31 March 20X2

Balance
as at 31 March 20X2

Nil

Borrowing
of INR 100 crores raised

INR 100
crores

Yes

INR 500
crores

? Borrowing of INR 100 crores raised on 5
April 2021

? Entire borrowing of INR 600 crores repaid
on 30 March 20X2 (i.e., one day before year end)

Nil

Yes

INR 90
crores

INR 5
crores repaid

INR 85
crores

No

Accordingly, the auditor should obtain the movement of borrowings, if any, from prescribed parties and assess whether the thresholds for availing exemption are met.

IFCFS REPORT ON CONSOLIDATED FINANCIAL STATEMENTS
The consolidated financial statements of a private company might include certain subsidiaries/ associates/ joint ventures which are exempted from obtaining auditor’s report on IFCFS at standalone level pursuant to the MCA exemption, as discussed above. This creates quite interesting situations and poses unique challenges to the auditors of the holding company while opining on IFCFS of the consolidated financial statements:

Section 129(4) of the 2013 Act states that the provisions of the 2013 Act is applicable to the preparation, adoption and audit of the financial statements of a holding company shall, mutatis mutandis, apply to the consolidated financial statements. Accordingly, all consolidated financial statements prepared under the 2013 Act should be accompanied with the auditor’s report (including annexures thereon) unless specifically exempted under the 2013 Act. Thus, in the above illustrative scenarios as well, the auditor of the Parent company would need to report on IFCFS of consolidated financial statements.

The Guidance Note provides that reporting on the adequacy of IFCFS on consolidated financial statements would be on the basis of the audit reports as submitted by the statutory auditors at the standalone level. Hence, where IFCFS report has not been provided due to the exemption, auditors of such companies are not required to separately provide an audit report on IFCFS to the auditor of the Parent Company as this would nullify the MCA exemption. Thus, basis the Guidance note, in the above scenarios, the audit report of IFCFS on consolidated financial statements should state that the IFCFS report covers only those companies on which the IFCFS report has been provided at the standalone level. The auditor may consider including a statement in the introductory paragraph of the IFCFS report in this regard as this would clearly set out the coverage and scope of the IFCFS report on consolidated financial statements. The auditor should consider consequential changes to the IFCFS report regarding references of the exempted private company.

In a nutshell

•    Considering the multitude of changes, an early dialogue with the stakeholders, including the auditors, would help mitigate implementation challenges to a large extent. For continuing requirements, auditors should reassess if any change in the audit strategy basis his experience would be necessary.
•    The auditor should consider the consequential effect of observations in IFCFS on other aspects of audit report ,e.g., Reporting on adverse effect on the functioning of the company [Section 143(3)(f)].

THE ESG AGENDA AND IMPLICATIONS FOR C-SUITE AND CORPORATE INDIA

INTRODUCTION
The topic of Environmental, Social and Governance (‘ESG’) aspects of a business has been extensively covered across the global media in the past couple of years. The focus on ESG has been particularly expedited by the Covid-19 pandemic. There is mounting pressure on businesses from all stakeholders – shareholders, investors, regulators, suppliers, customers and communities – to start thinking about their sustainability and wider ESG journey.

ESG – DEVELOPMENTS IN INDIA

The business landscape in India is catching up on the ESG agenda. There is a significant growth in ESG-linked capital markets in India, with assets under management of the top 10 ESG mutual funds growing to INR 12,000 crore during 2019-2021 – representing almost a 5x increase in just two years1. From F.Y. 2022-23, SEBI has mandated the top 1,000 listed companies by market capitalisation to disclose ESG data through Business Responsibility and Sustainability Report (BRSR). At the COP26 summit in November 2021, India announced its goal to be net-zero by 2070. It will be businesses – large and small – which will eventually have to work towards achieving the net-zero goal and key targets around the country’s energy mix and carbon emissions intensity.     

In addition to this business and regulatory imperative, environmental factors are also at play. According to Germanwatch, India is one of the top countries which will be impacted by climate change2. Chennai almost ran out of water in 2019. The year 2021 saw droughts, floods, and landslides in various states in India. The start of the year 2022 was one of the coldest winters in India. The frequency and scale of such events are predicted to only increase in the future. Combining the impacts of such natural disasters with India’s goal to be net-zero by 2070 means that businesses across industry sectors will have to start considering sustainability and ESG parameters to make their operations more resilient for a climate-informed landscape of the future.

 

1   https://economictimes.indiatimes.com/mf/mf-news/esg-fund-assets-jump-4-7-times-in-2-years-may-grow-further/articleshow/88380627.cms

2   https://www.business-standard.com/article/current-affairs/india-among-top-10-countries-most-affected-by-climate-change-germanwatch-121012500313_1.html

So, what does this ESG agenda mean for Indian companies?

I have identified three key themes and focus areas for the C-suite to consider while trying to embed ESG parameters into business operations: a) Sustainable/ESG financing, b) Operating model, and c) Stakeholder engagement.

SUSTAINABLE/ESG FINANCING

Sustainability is not an overnight success. Embarking on a sustainability journey involves potential changes to how businesses have operated historically. This requires long-term planning and resources, with capital often being the most important. Organisations that lack enough capital or need additional funds can look at Sustainable/ESG financing. There are growing sustainability-focused capital markets – in India and overseas – that Indian companies can tap into to finance their sustainable business transformations. Depending on the business needs, the funding can take the form of either of the following two mechanisms: 1) ‘Use of proceeds’ instruments (e.g., Green/sustainability bonds/loans), where funds are used to finance specific projects/initiatives with environmental or social benefits. The 2022 Finance Budget has laid out various policies, including launching Sovereign Green Bonds and other initiatives on a private-public partnership model, in order to boost the climate finance ecosystem in India. In September 2021, Adani Green Energy Limited issued green bonds worth $750 million to fund the Capex of its ongoing renewable projects3. 2) ‘ESG-linked’ instruments (e.g., ESG/sustainability-linked loans), where repayment terms are pegged to certain environmental or social performance indicators. Ultratech Cement is already linking its financial commitments with sustainable targets4.

 

3   https://www.adanigreenenergy.com/newsroom/media-releases/Adani-Green-Energy-Continues-to-Ramp-Up-Focus-On-ESG

4   https://www.business-standard.com/article/current-affairs/glasgow-cop26-how-india-inc-plans-to-meet-net-zero-targets-by-2070-121110300058_1.html

Financial institutions are increasingly moving away from funding traditional environmentally damaging assets and industry sectors. Sustainable/ESG financing can help CFOs access necessary capital as well as a greater capital pool. Additionally, such funding can potentially be at a lower cost, in turn positively impacting the bottom line. ESG/sustainability-linked loans usually involve a reduced interest rate when underlying ESG goals are met. Similarly, organisations can issue Green/sustainability bonds at lower coupon rates to investors who are willing to accept lower returns alongside achieving positive environmental and social outcomes. For organisations, sourcing cheaper Sustainable/ESG financing can help reduce the cost of capital and improve margins whilst advancing their sustainability/ESG agenda. Additionally, through embedding ESG metrics within their strategic decision-making process, an organisation can ensure that funds are utilised in activities/initiatives which can generate maximum environmental and social impact.

OPERATING MODEL – VALUE CREATION FROM ESG
Secondly, from an operating model perspective, there are opportunities for value creation as well as risk mitigation from incorporating ESG parameters into business operations. Organisations can look at value creation by assessing their product/service mix. Companies can consider launching new sustainable products to take advantage of shifting consumer trends and preferences. E.g., the plant-based protein market in India is expected to grow to $650-700 million by 20255. Similarly, the market for vegan food, recycled raw materials, electric vehicles, alternative raw materials to single-use plastics, etc., is on the rise. A global BCG research suggests that within the consumer goods sector, 70% of consumers are willing to pay a 5% price premium for more sustainably manufactured products6. India’s net-zero goals and transition to zero-carbon economy present multiple business opportunities in the areas of green hydrogen, biofuels, electric vehicles and related infrastructure, waste management, etc. Organisations can therefore achieve top-line growth through a combination of ESG/sustainability-focused new product and service launches, entering into new markets, and premium pricing. For SMEs and start-ups, it is a great opportunity to be disruptors in the sustainability domain. Through sustainable products and services, SMEs/start-ups can achieve a competitive advantage vis-à-vis large corporates which lack ESG credentials.

 

5   https://www.cnbctv18.com/environment/global-surge-in-plant-based-cultivated-meat-indian-market-sees-substantial-growth-11012762.htm

6   https://www.bcg.com/publications/2020/supply-chain-needs-sustainability-strategy

A strong focus on environmental parameters can help organisations achieve significant resource efficiencies. Through embedding circular economy principles, companies can look at reducing the usage of raw materials and resources, including reusing and recycling them, in turn driving cost savings. A global paper company managed to achieve a 10% increase in EBITDA margins through a combination of emissions costs reductions, resource efficiencies and revenue growth7. By 2030, Ambuja Cement is targeting to save 77 litres of water/tonne of cement produced8. While these ESG-focused efforts require initial investments and often involve a longer payback period, it is not always the case. A private Indian mining company that invested in a water treatment facility on their site was able to recover the investment in just under three years. Reducing greenhouse gas emissions by shifting to renewable sources of energy and less carbon-intensive methods can also drive energy savings. Ultimately, such cost savings translate to higher business valuations. The BCG research cited earlier9 also suggests that by being leaders in the ESG domain, companies across industry sectors are able to achieve significant valuation premiums (between 11-14% across consumer goods, steel and chemical sectors) over peers. Businesses can therefore look at significant value creation through a combination of multiple ESG-focused initiatives across their end-to-end value chains.

OPERATING MODEL – RISK MITIGATION BY FOCUSING ON ESG

From a risk mitigation perspective, companies need to start assessing and adapting their supply chains to account for negative impacts from climate change. Almost 5 million hectares of crop in India was affected in 2021 due to climate crisis10.  A negative impact on the agricultural sector can have a knock-on implication on multiple other industry sectors that directly or indirectly rely on agricultural produce for their raw material needs. WWF research predicts that almost 30 cities in India will face acute water crises by 205011. In addition to traditional industry sectors like agriculture, manufacturing, mining, chemicals, this can be a cause of concern for the growing technology sector in India, whose demand for water to cool their data centres will continue to rise. There is a growing sense of urgency for businesses across industry sectors to look at sustainable options and plan for raw material shortages (in India and globally) to avoid potential supply chain disruptions.

Indian companies might also face risks from regulatory changes and/or increased scrutiny. While an earlier blanket ban imposed in 2019 on single-use plastics was held off by the central government, it is now going to come into force from 1st July, 2022. New EPR rules in relation to plastic recycling and use are also coming into effect from 1st July, 202212. Corporates will have to reassess their supply chains to comply with these upcoming regulations. In November 2021, a local municipal corporation in western India, imposed a crackdown on major textile companies discharging trade effluents into the city sewage network citing environmental concerns, leading to factory closures. Proactively implementing sustainable supply chain measures can help organisations mitigate any potential disruptions (and consequential financial loss) from such regulatory changes and/or scrutiny.

 

7   https://www.bain.com/client-results/a-paper-company-takes-bold-steps-to-become-a-sustainability-leader/

8   https://www.business-standard.com/article/current-affairs/glasgow-cop26-how-india-inc-plans-to-meet-net-zero-targets-by-2070-121110300058_1.html

9   https://www.bcg.com/publications/2020/supply-chain-needs-sustainability-strategy

10 https://www.downtoearth.org.in/news/climate-change/climate-crisis-has-cost-india-5-million-hectares-of-crop-in-2021-80809

Focusing on social aspects like health and safety, employee wellbeing, impact on communities and indigenous populations is also becoming increasing important. Any instances of corruption, bribery, child-labour, human rights abuses, etc. can lead to a negative impact on brand reputation. This might also entail financial risk in the form of a decline in stock prices or reduced valuations, regulatory penalties and fines. Ensuring the right social and governance policies for increased transparency and accountability is becoming critical.

Leading Indian multinationals have already committed to various climate change and sustainability and ESG goals. The likes of the Tata group have put compliance with ESG standards as a top business priority, and more business will follow. For SMEs as well, it will be a business imperative to consider the ESG agenda – particularly where they are suppliers or customers of large Indian and global multinationals which have their own sustainability goals and targets to achieve.

 

11 https://www.downtoearth.org.in/news/water/wwf-identifies-100-cities-including-30-in-india-facing-severe-water-risk-by-2050-74058

12           https://indianexpress.com/article/india/centre-notifies-epr-norms-for-plastic-packaging-waste-7780632/

ESG AND STAKEHOLDER ENGAGEMENT
Lastly, from a stakeholder engagement perspective, the C-suite can place high importance on ESG reporting and sustainability-related disclosures. For listed companies not within the remit of the current SEBI mandate, as well as for private companies, a voluntary disclosure can help achieve a competitive advantage through improved brand credentials. Such a voluntary disclosure can be based on existing domestic requirements in India (SEBI’s BRSR) or any global frameworks (like GRI, UN SDGs, etc.) or a customised basis depending on the commercial priorities. Voluntary disclosures can also help C-suite pre-empt any potential disclosure requests and/or pressure from customers, communities, activists and investors and build more transparent and better working relationship with these stakeholders. Mandatory or voluntary disclosures that show improved performance and results on ESG metrics can help enhance ESG ratings for organisations, which can in-turn enable them to access a larger capital pool and at more favourable terms. The government of India is also looking at obtaining an ESG ranking for the upcoming Initial Public Offering of the Life Insurance Corporation of India, with the aim of attracting a larger and responsible pool of capital13.

Impact investment has gained a lot of traction in India in the past couple of years. According to data from Impact Investors Council, almost $1.2 billion were invested just in the first five months of 202114. Private equity and venture capital groups in India are also increasingly focusing on ESG parameters as part of their investments as well as launching dedicated ESG funds15. Consequently, for SMEs and start-ups, focusing on ESG can be a great catalyst for raising funds to fuel their expansion and growth journey.

CONCLUSION

All of the above three themes – Sustainable/ESG financing, Value Creation and Risk Mitigation from ESG from an Operating Model perspective and Stakeholder Engagement – are in a way interrelated. In practice, it will be difficult to isolate one theme from the other. Progress in one aspect will have a compounding impact on others. Similarly, a negative outcome in one will also mean potential revisions across other ESG initiatives. Therefore, organisations will have to undertake a robust scenario-planning analysis in choosing ESG initiatives to be implemented and engage in continuous monitoring to maximise their ESG impact.

Irrespective of the industry sector, ownership status (public vs. private), the scale of operations (start-up vs. large multinational), it is becoming clear that there are multiple business reasons for organisations to look at ESG.

Climate change is already here (the latest evidence is the unseasonal rain on 6th January, 2022 in my home city of Ahmedabad – for a minute not considering its unintended consequences for the agricultural sector). The time for the C-suite of Indian organisations to act is now. The more proactive they are, the bigger will be the benefits and opportunities for future generations in India.

 

13             https://economictimes.indiatimes.com/markets/ipos/fpos/govt-working-on-esg-ranking-for-lic-ahead-of-public-offer/articleshow/88744950.cms

14 https://www.freepressjournal.in/business/impact-investors-infused-around-12-bn-in-india-amid-the-second-wave-of-covid

15           https://www.livemint.com/companies/news/aavishkaar-capital-launches-250-mn-esg-first-fund-11643022266115.html

CARO 2020 SERIES: NEW CLAUSES AND MODIFICATIONS RESIGNATION OF STATUTORY AUDITORS AND CSR

(This is the eighth and last article in the CARO 2020 series that started in June, 2021)

PART A – RESIGNATION OF STATUTORY AUDITORS

 

BACKGROUND

There have been several instances of resignations by statutory auditors mid-way through their tenures in the recent past. Whilst that may be legally permissible, what is more important is whether there is anything which is more than what meets the eye in the resignation that the incoming auditor needs to know. Also, resignation of an auditor of a listed entity/its material subsidiary before completion of the review/audit of the financial results/statements for the year due to frivolous reasons such as pre-occupation may seriously hamper investor confidence and deny them access to reliable information for taking timely investment decisions.

SCOPE OF REPORTING

The scope of reporting pertaining to the aforesaid clause is as under:Whether there has been any resignation of the statutory auditors during the year, if so, whether the auditor has taken into consideration the issues, objections or concerns raised by the outgoing auditors. [Clause 3(xviii)]

PRACTICAL CONSIDERATIONS IN REPORTING

Before proceeding further it would be pertinent to note certain statutory requirements and professional pronouncements.SEBI Circular [CIR/CFD/CMD1/114/2019 dated 18th October, 2019]

The key requirements in respect thereof are summarised hereunder:

a) All listed entities/material subsidiaries shall ensure compliance with the following conditions while appointing/re-appointing an auditor:

• If the auditor resigns within 45 days from the end of a quarter of a financial year, then the auditor shall, before such resignation, issue the limited review/ audit report for such quarter.

• If the auditor resigns after 45 days from the end of a quarter of a financial year, then the auditor shall, before such resignation, issue the limited review/ audit report for such quarter as well as the next quarter.

• Notwithstanding the above, if the auditor has signed the limited review/ audit report for the first three quarters of a financial year, then the auditor shall, before such resignation, issue the limited review/ audit report for the last quarter of such financial year as well as the audit report for such financial year.

b) The auditor proposing to resign shall bring to the notice of the Audit Committee the reasons for his resignation including but not limited to areas where he has not been provided the necessary information / documents and explanations to matters raised during and in connections with the audit.

c) The above information has to be provided to the company in the format specified in Annexure A of the Circular, as under:

Sr.
No.

Particulars

1

Name of the listed
entity/ material subsidiary:

2

Details of the
statutory auditor:

a. Name:

b. Address:

c. Phone number:

d. Email:

3

Details
of association with the listed entity/ material subsidiary:

a.
Date on which the statutory auditor was appointed:

b.
Date on which the term of the statutory auditor was scheduled to expire:

c.
Prior to resignation, the latest audit report/limited
review report submitted by the auditor and date of its submission.

4

Detailed
reasons for resignation:

5

In
case of any concerns, efforts made by the auditor prior to resignation
(including approaching the Audit Committee/Board of Directors along with the
date of communication made to the Audit Committee/Board of Directors)

6

In
case the information requested by the auditor was not provided, then
following shall be disclosed:

a.
Whether the inability to obtain sufficient appropriate audit evidence was due
to a management-imposed limitation or circumstances beyond the control of the
management.

 

b.
Whether the lack of information would have significant impact on the
financial statements/results.

 

c.
Whether the auditor has performed alternative procedures to obtain
appropriate evidence for the purposes of audit/limited review as laid down in
SA 705 (Revised).

 

d.
Whether the lack of information was prevalent in the previous reported
financial statements/results. If yes, on what basis the previous
audit/limited review reports were issued.

7

Any other facts
relevant to the resignation:

Declaration
I/ We hereby confirm that the information given in this letter and its attachments is correct and complete.

I/ We hereby confirm that there is no other material reason other than those provided above for my resignation/ resignation of my firm.

Signature of the authorized signatory

Date:
Place:
Enclosures:

d) The listed entity / material subsidiary should cooperate in providing all the information and documents as requested by the auditor.

e) Disclosure should be made by the company as soon as possible but not later than twenty four hours of the Audit Committees’ views.

Duty of Outgoing Auditor [Section 140(2) of Companies Act, 2013]

The auditor who has resigned from a company shall file within a period of 30 days from the date of resignation a statement in Form ADT-3 with the company and the Registrar of Companies. In the case of a government company or any other company-owned or controlled by any of the governments, the auditor shall also file such a statement with the Comptroller and Auditor-General of India.

Clause 8 of Part I of First Schedule of the Chartered Accountants Act, 1949

A Chartered Accountant in practice shall be deemed to be guilty of professional misconduct, if he accepts a position as auditor previously held by another chartered accountant without first communicating with him in writing;

The underlying objective is that the member may have an opportunity to know the reasons for the change in order to be able to safeguard his own interest, the legitimate interest of the public and the independence of the existing accountant. It is not intended, in any way, to prevent or obstruct the change. When making the enquiry from the outgoing auditor, the one proposed to be appointed or already appointed should primarily find out whether there are any professional or other reasons why he should not accept the appointment.

The existence of a dispute as regards the fees would not constitute valid professional reasons on account of which an audit should not be accepted by the member to whom it is offered. However, in the case of an undisputed audit fees for carrying out the statutory audit under the Companies Act, 2013 or various other statutes having not been paid, the incoming auditor should not accept the appointment unless such fees are paid.

Implementation Guide on Resignation/ Withdrawal from an Engagement to Perform Audit of Financial Statements Issued by ICAI (the “Implementation Guide”)

In view of the increasing instances of withdrawal from audit engagements mid-way through the tenure, the ICAI has issued the above Implementation Guide that the outgoing and incoming auditors need to be aware. The Implementation Guide identifies various reasons for the resignation of auditors as under:

• SA 210 “Agreeing to the Terms of Audit Engagements” – If the auditor is unable to agree to a change in the terms of the audit engagement and is not permitted by the management to continue the original audit engagement, the auditor shall withdraw from the audit engagement.

• SA 220 “Quality Control for an Audit of Financial Statements” – If the engagement partner is unable to resolve the threat to independence with reference to the policies and procedures that apply to the audit engagement, if considered appropriate, the auditor can withdraw from the audit engagement.

• SA 240, “The Auditor’s Responsibilities relating to Fraud in an Audit of Financial Statements” – If, as a result of a misstatement resulting from fraud or suspected fraud, the auditor encounters exceptional circumstances that bring into question the auditor’s ability to perform the audit, the Standard suggests the withdrawal from the engagement as one of the options, subject to following certain procedures and measures.

• SA 315, “Identifying and Assessing the Risks of Material Misstatements Through Understanding the Entity and its Environment” – Concerns about the competence, integrity, ethical values or diligence of management, or about its commitment to or enforcement of these, may cause the auditor to conclude that the risk of management misrepresentation in the financial statements is such that an audit cannot be conducted. In such a case, the auditor may consider, where possible, withdrawing from the engagement, unless those charged with governance put in place appropriate corrective measures.

• SA 580, “Written Representations”– If the auditor is unable to obtain sufficient appropriate audit evidence, then the auditor is expected to determine the implications thereof to decide whether to qualify the opinion or to resign.

• Non-payment of auditor’s remuneration.

• Issuance of a Qualified report.

The Implementation Guide emphasises that the auditor is expected to describe the above specific circumstances, amongst others, while giving the reasons for resignation, instead of mentioning ambiguous reasons such as other preoccupation or personal reasons or administrative reasons or health reasons or mutual consent or unavoidable reasons.

Keeping in mind the above reporting requirements, the following are some of the practical considerations that could arise whilst reporting under this clause:

a) Modified Report issued by the outgoing auditor:-The nature and extent of the modification should be critically evaluated by the incoming auditor both from a qualitative and quantitative perspective. In doing so he may have to generally rely on oral discussions with the outgoing auditor since he may not be willing to part with the internal documentation and working papers, especially if it is an unlisted / non-public interest entity to which the SEBI circular mentioned earlier would not apply. In such circumstances he should advise the outgoing auditor to communicate in writing the specific reasons for withdrawal as per the Implementation Guide mentioned above to the appropriate level of management and those charged with governance and insist on a copy thereof, especially if the minutes do not reveal much. In such cases, there is no rule, written or unwritten, which would prevent an auditor from accepting the appointment in these circumstances once he has conducted proper due diligence before accepting the audit. He may also consider the attitude of the outgoing auditor and whether it was proper and justified.

b) Performing appropriate due diligence before stepping into the Outgoing Auditors shoes:- It is imperative that the incoming auditor undertakes appropriate inquiries and performs due diligence procedures as under before stepping into the shoes of the outgoing auditor who has withdrawn from the engagement:

(i) Evaluate diligently about the entity, the scope of the mandate, the resources (time, manpower and competence) available to execute the audit and then take a conscious call to accept or not to accept the engagement.

(ii) Have auditors frequently resigned from the entity in the past.

(iii) Evaluate the reasons for issuance of qualified, disclaimer opinion by the outgoing auditor.

(iv) Whether entity is regular in payment of statutory dues.

(v) Review the financial statements to ascertain any indication that the going concern basis may not be appropriate.

(vi) Check and understand accounting policies or treatment of specific transactions that cast doubt on the integrity of the financial information.

(vii) Are there issues arising from communication with the outgoing auditors, professional or otherwise, which suggest that the incoming auditor should decline the appointment.

(viii) Check whether the entity is involved in any long drawn litigation with the regulatory authorities.

(ix) Consider any other information available in the public domain.

CONCLUSION
The regulators have tightened the rules for withdrawal by statutory auditors from the engagement midway through their tenure to ensure that companies do not go scot-free and brush under the carpet any irregularities and misappropriations. The reporting responsibilities under this clause would ensure that there is a proper channel of communication between the incoming and outgoing auditors regarding any adverse matters concerning the entity.

PART B – CORPORATE SOCIAL RESPONSIBILITY (CSR)

BACKGROUND

The provisions dealing with CSR have been in force for a few years and many companies have now ingrained it as part of their DNA. Earlier, the approach of the regulators was more in the nature of ‘comply or report’. However, the emphasis is now on ensuring that companies take their CSR obligations more seriously. Earlier, there was no responsibility on auditors to comment on CSR compliance separately, and only the Board of Directors were required to report on the same. However, reporting under CARO 2020 would ensure greater accountability on companies who were not taking CSR seriously.SCOPE OF REPORTING
The scope of reporting pertaining to the aforesaid clause is as under:

a) Whether, in respect of other than ongoing projects, the company has transferred unspent amount to a Fund specified in Schedule VII to the Companies Act within a period of six months of the expiry of the financial year in compliance with second proviso to sub-section (5) of section 135 of the said Act. [Clause 3(xx)(a)]
b) Whether any amount remaining unspent under sub-section (5) of section 135 of the Companies
Act, pursuant to any ongoing project, has been transferred to special account in compliance with the provision of sub-section (6) of section 135 of the said Act. [Clause 3(xx)(b)]

PRACTICAL CONSIDERATIONS AND CHALLENGES IN REPORTING

Before proceeding further it would be pertinent to note certain statutory requirements:Additional Disclosures under amended Schedule III
While reporting under this Clause, the auditor will have to keep in the mind the amended Schedule III disclosures which are as under:

Where the company covered under section 135 of the companies act, the following shall be disclosed with regard to CSR activities in the financial statements;

1

amount
required to be spent by the company during the year,

2

amount
of expenditure incurred,

3

shortfall
at the end of the year,

4

total
of previous years shortfall,

5

reason
for shortfall,

6

nature
of CSR activities,

7

details
of related party transactions, e.g., contribution to a trust controlled by
the company in relation to CSR expenditure as per relevant Accounting
Standard/ Indian Accounting Standard,

8

where
a provision is made with respect to a liability incurred by entering into a
contractual obligation, the movements in the provision during the year should
be shown separately.

Whilst reporting, the auditor should make a cross reference to the above disclosures made in the financial statements to ensure that there are no inconsistencies.

Other Relevant Statutory Provisions

Section 135(5) and (6) of the Companies Act, 2013

Section 135(5):
The Board of Directors of every eligible company shall ensure that the Company spends in every financial year, at least 2% of the average net profits of the company during the 3 immediately preceding financial years, in pursuance of the CSR policy. The net profit shall be as computed in terms of section 198.

The expression “three immediately preceding financial years” in sub-section (5) shall be read as number of years completed by a newly incorporated company.

“Unspent amount” as referred to in sub-section (5) unless relates to an “ongoing project” shall be transferred to a fund specified in Schedule VII within 6 months of the end of the financial year.

Section 135(6):
Any amount remaining unspent under sub-section (5), pursuant to any ongoing project, fulfilling such conditions as may be prescribed, undertaken by a company in pursuance of its Corporate Social Responsibility Policy, shall be transferred by the company within a period of thirty days from the end of the financial year to a special account to be opened by the company in that behalf for that financial year in any scheduled bank to be called the Unspent Corporate Social Responsibility Account, and such amount shall be spent by the company in pursuance of its obligation towards the Corporate Social Responsibility Policy within a period of three financial years from the date of such transfer, failing which, the company shall transfer the same to a Fund specified in Schedule VII, within a period of thirty days from the date of completion of the third financial year.

Permissible CSR Activities [Schedule VII read with the Rules]:

Schedule VII prescribes the following broad heads of activities on which the prescribed classes of Companies need to spend to fulfil their CSR obligations:

Sub

Clause

Broad
Area

Projects
or Programmes related to Activities in the following areas

i)@

Hunger,

Healthcare,

Sanitation etc.

• Eradicating extreme hunger, poverty and
malnutrition 

• Promoting health care including
preventive health care and sanitation

• Contribution to the Swatch Bharat Kosh.

• Provision for aids and appliances to
differently abled persons *

i)@

(continued)

• Disaster relief in
the form of medical aid, supply of clean drinking water and food supply*

• Trauma care around
highways in case of accidents*

• Supplementing of
Government Schemes like mid-day meal by corporates through additional
nutrition*

• Enabling access to
or improving delivery of public health systems (also covered under Clause iv
below)*

• Social Business
Projects involving giving medical and legal aid to road accident victims*
(also under Clause ii below)

ii)@

Education and vocational skills

• Promotion of education including special
education and employment enhancing vocational skills amongst:

(i) children,

(ii) women,

(iii) elderly, and

(iv) differently abled.

• Road safety awareness programmes
including drivers training, training
to enforcement personnel, traffic safety*

• Awareness of the above aspects through
print, audio and visual media*

• Setting up of Research Training and
Innovation Centres  for the benefit of
predominantly the rural community covering the following aspects:

(i) Capacity building for farmers covering best
sustainable farm management practices*

(ii) Training agricultural labour on skill development*

• Providing Consumer Protection Services
covering the following aspects:

(i) Providing effective consumer grievance redressal
mechanism*

(ii) Protecting consumer’s health and safety,
sustainable consumption, consumer service, support and complaint resolution*

(iii) Consumer rights to be mandated*

(iv) All other consumer protection programmes and
activities*

• Donations to IIMs for conservation of
buildings and renovation of classrooms (also covered under clause v below)*

• Donations to Non Academic Technopark not
located within an academic institution
but supported by the Department of Science and Technology*

• Research and case studies in the areas
specified in Schedule VII (normally under the respective areas and, if not,
under this clause)*

iii)

Gender
equality

and

empowerment
of

disadvantaged

sections

• Promoting gender equality,

• Empowering women,

• Setting up of hostels, old age homes and
hostels for women and orphans, day care centres and such other

facilities for senior citizens, and

• Measures for reducing inequalities faced
by socially and economically backward groups.

• Slum Rehabilitation Projects and EWS
Housing*

iv)

Environmental

and
ecological

sustainability
and

conservation
of

natural
resources

• Maintaining ecological balance,

• Protection of flora and fauna,

• Maintaining quality of air and water

• Contribution to the Clean Ganga Fund

• Setting up of Research Training and
Innovation Centres for the benefit of predominantly the rural community
covering the following aspects:

(i) Doing own research on the field for individual
crops to find out the most cost optimal and agri-ecological sustainable farm
practices with a focus on water management*.

(ii) To do Product Life Cycle Analysis from the solid
conservation point of view*

• Renewable energy projects*

v)

Heritage,
Art and

Culture

• Protection of natural heritage,

• Protection of art and culture,

• Restoration and maintenance of related
buildings and sites of historical importance and works of art,

• Setting up public libraries,

• Promotion and development of traditional
arts and handicrafts

vi)

Armed
Forces

Measures for the benefit of:

(i) armed forces,

(ii) veterans, and

(iii) war widows.

vii)

Sports

• Training to promote:

(i) rural sports,

(ii) nationally recognised sports,

(iii) paralympic sports, and

(iv) Olympic sports

• Any training provided outside India to
sports personnel representing any State or Union Territory at National or
International level.

viii)

Political

Contributions

• Contributions to Prime Ministers National
Relief fund or

• Contributions to other funds set up by
the Central

Government for socio economic development
and relief and for the welfare of:

(i) Scheduled Castes,

viii)

(continued)

(ii) Scheduled Tribes

(iii) other backward classes and

(iv) women

ix)

Technology

Incubators

Contributions or funds provided to
technology incubators located within academic institutions approved by the
Central Government.

x)

Rural Development Projects

Any project meant for development of rural
India will be covered*

xi)

Slum Development Projects

Any project for development of slums would
be covered

xii)

COVID -19 Related Areas

Funds may be spent for COVID-19 purposes
under the following activities/Funds:

•  Eradicating hunger, poverty and
malnutrition $

•   Disaster
Management, including relief, rehabilitation and reconstruction activities $

•   Contribution
to PM Cares Fund $

•   Contribution
to State Disaster Management Authority $

•    Ex-gratia
payment to temporary/casual/daily wage workers for the purpose of fighting
COVID-19 $

•   Spending for setting up makeshift
hospitals and temporary COVID care facilities will be eligible under items
(i) and (xii) of Schedule VII. #

•     Companies
engaged in R & D activities for new vaccines, drugs and medical devices
in the normal course of business may undertake similar new activities for
COVID-19 related matters for FYs 2020-21, 2021-22 and 2022-23 subject to the
following conditions:

a) Such
activities are carried out in collaboration with institutes or organisations
mentioned in item ix of Schedule VII

b)
Details thereof are disclosed in the Annual Report on CSR Activities

[Inserted
in the CSR Amendment Rules vide notification dated
24th August, 2020]

*As per the MCA Circular dated 18th June, 2014 providing clarifications on various aspects related to CSR activities.

@ The above referred circular provides that the items included under sub clauses (i) and (ii) above, should be interpreted liberally so as to capture their essence.
The above circular has also clarified on certain related aspects as under:

• One off events like marathons, awards, charitable concerts, sponsorship programmes etc. would not qualify as CSR expenditure.
• Only activities undertaken in project / programme mode are permissible.
• Expenses incurred in pursuance of legal obligations under Land, Labour or other laws would not quality as CSR expenditure.

$ As per MCA Circular dated 23rd March, 2020.
# As per MCA Circular dated 22nd April, 2021.

Monitoring Unspent Funds:
The provisions dealing with tracking and treatment of unspent funds, excess amounts spent and capital assets created or acquired as per the recent amendments which are crucial to reporting under this clause are tabulated and summarised hereunder:

Note:

The Funds specified under Schedule VII are as under:
• PM National Relief Fund
• Swach Bharat Kosh
• Clean Ganga Fund
• PM CARES Fund
• State Disaster Management Authority
• Skill Development Fund

Excess Amounts Spent:
As per the amended Rules, notified on 22nd January, 2021, any excess amount beyond the prescribed limit can be set off against the spending requirements in the immediately succeeding three financial years subject to the following conditions:

a) The excess amount available for set-off shall not include any surplus arising out of the CSR activities.

b) The Board of Directors shall pass a resolution specifically permitting the same.

The aforesaid carry forward shall not be allowed for excess amounts spent during any financial year ended before 22nd January, 2021.

Creation and Acquisition of Capital Assets:
As per the amended Rules, any CSR amounts may be utilised by a Company towards creation or acquisition of capital assets, only if the assets are held by any of the following:

a) A company registered under Section 8 of the Act, or a Registered Public Trust or Society having charitable objects and a CSR Registration Number; or

b) Beneficiaries of the said CSR project in the form of Self-Help Groups or Collective Entities; or

c) A public authority.

In case of any such assets existing prior to the amendment i.e. 22nd January, 2021, the same shall be transferred within 180 days from the commencement date.

Keeping in mind the above reporting as well as requirements, the following are some of the practical challenges that could arise in reporting under these clauses:

a) Reporting Issues and Challenges in the Initial Period of Applicability:- The amendments are prospective from 22nd January, 2021. Accordingly only the unspent amount for F.Y. 2020-21 in respect of other than ongoing projects needs to be transferred to the fund specified in Schedule VII within six months from the end of the financial year. This is the case even if the Company has unspent amounts in earlier years. However, if the Company has made provisions for unspent amounts of the earlier years, which remains outstanding as on 31st March, 2021 the same should be transferred to the separate bank account or Schedule VII fund as the case may be within the prescribed periods as indicated earlier. The auditors should ensure that appropriate factual disclosures are made where deemed necessary. Further, there could be several other practical issues which could be encountered in the first year of reporting, few of which are discussed hereunder together with their possible resolution by the auditors, coupled with appropriate reporting of all relevant facts as deemed necessary based on their best judgement:

Issues

Possible
Resolution

A Company has a running project that was
commenced few years back and is expected to continue for next 2 years. Can
this be considered as an Ongoing project?

Subject to the definition of ongoing
project in terms of the timeline, the Board of Directors can henceforth
consider and approve this current running project as an Ongoing Project with
reasonable justification.

A CSR project was undertaken and
subsequently abandoned by Implementing Agency due to lack of additional
funds. Can this be considered as an Ongoing project? 

Subject to the definition of ongoing
project in terms of the time line, the Board of Directors can henceforth  consider and approve the aforesaid project
as an Ongoing Project with reasonable justification.

A Company contributed a certain amount to
the Implementing Agency for the construction of a hospital. It paid the full
amount in F.Y. 2020-21, whereas the hospital is expected to be completed in
F.Y. 2022-23. Can this be considered as an Ongoing project? 

If the Company has already paid the whole
amount of its CSR obligations during F.Y. 2020-21, then it is not required to
consider it as Ongoing Project. However, it is the duty of the Board as per
Rule 4 (5) to satisfy itself that the funds so disbursed have been utilized
for the purpose and in the manner as approved by it and the CFO or the person
responsible for financial management need to certify to that effect. Hence
the Company needs to have a report from the Implementation Agency for the
spends and utilization of funds and report it in the Board Report for F.Y.
2020-21 with facts and details. Further, a mandatory impact assessment
needs to be done by a Monitoring Agency in case of companies with mandatory
spending of Rs. 10 crores or more in the three immediately preceding
financial years and for individual project outlays in excess of Rs.1 crores as
per the amended Rules.

b) Monitoring in case of Multiple Projects:– In case of companies having huge CSR budgets and financing multiple projects, both ongoing and others, a robust internal control mechanism would have to be implemented to monitor project-wise utilisation to ensure that unspent amounts are transferred on a timely basis and their subsequent utilisation in case of ongoing projects, which needs to be verified by the auditors to enable them to report compliance under Clause 3(xx)(b). Whilst there is no requirement to maintain separate special bank accounts for each project it is desirable to ensure proper monitoring and greater transparency. The Board may consider laying an appropriate policy in this regard.

c) Funds Utilised towards acquisition of Capital Assets in earlier periods:- For companies that have utilised funds in earlier periods and shown them as capital assets, it is mandatory to transfer the same within 180 days from 22nd January, 2021 to the prescribed authorities /entities as indicated earlier. Though no specific reporting is required under these clauses, it would be incumbent on the auditors to verify the same as part of their audit and in case the report is dated after the expiry of the said period, he may consider drawing attention to the same since it is a statutory requirement. Similar factual disclosure could be considered in the case where the period of 180 days has not elapsed on the date of signing, and the same are not transferred.

d) Transactions with Related Parties:- In many companies, CSR obligations are fulfilled by transferring the funds to group entities registered as NPOs under Section 8/25 of the Companies Act, 2013 / 1956. In such cases, care should be taken to ensure that the same are towards approved projects. The monitoring of the same is done in accordance with the revised guidelines on monitoring and impact assessment, including the need for involving an external agency, if required, as discussed earlier. In case of any lapses or deficiencies noticed the same should be factually reported under Clause 3(xx)(b) based on materiality and use of judgement.

CONCLUSION
The additional reporting requirements have placed very specific responsibilities on the auditors to supplement the revised regulatory landscape of CSR of “comply or pay up”, which views CSR spending more as a tax then a social obligation. As is always the case, it is the auditors who have to bell the cat!

MEASURE OF …

The measure of wealth is freedom.
The measure of health is lightness.
The measure of intellect is judgment.
The measure of wisdom is silence.
The measure of love is peace.
– Naval Ravikant

Chartered Accountants are in the profession of ‘recognition’ and ‘measurement’. Much of life, in its wider and deeper sense, needs measuring with each passing year, or in our context, at least at the end of the fiscal year.

What matters may not be in the line of sight. Contemporary wisdom measures and turns on a sharp spotlight on what matters. Wisdom articulates the reality of things with a purpose: to make us aware of the starkness of what matters, the urgency of action and the futility of much of what we believe to be important in the short term. ‘Non-recognition’ of this can be our stupidity, lethargy or even careless disregard. I have been following the writings of Naval for a while and thought of sharing them and leaving you with questions I ask myself.

The measure of wealth is freedom. We gather wealth but, for a long time, run short of freedom. Even on vacation, work chases us. How much freedom do we have on our time and actions? Wealth without freedom is futile. Freedom TO and Freedom FROM are two types of categories. While money gives us the freedom to overcome many life problems, how free do we become from other problems?

The measure of health is lightness. How much lightness do we feel in our bodies? How much space do our minds have to let ‘light’ occupy it rather than the clutter of million thoughts? Are we trading off health with time to our profession?

The measure of intellect is judgment. We often learn this over time. A lot of our work hones judgment. Naval writes: “…wisdom is knowing the long-term consequences of your actions. Wisdom applied to external problems is judgment. … knowing the long-term consequences of your actions and then making the right decision to capitalize on that.” How do I figure out the difference between direction and effort? Can I figure out what’s really stupid and then avoid it? Am I able to see beyond the immediate and look far into the future?

The measure of wisdom is silence. When wisdom is applied, the outcome is silence. The closer you are to the truth, the more silent you become inside. How much silence or evenness do we feel within? By being the way I am, am I becoming something that I would not want to?

You can reflect on the rest of Naval’s words. I wish to end this page with a conversation I had with my daughter. She told me about ellipsis. ‘…’ the three dots we sometimes use to end a sentence. I think the measure of life is an ellipsis, in the sense that it goes on, that there are no full stops. Its spirit is continuance. It is open-ended, uncertain and full of possibilities. The ellipsis holds hope in the unsaid. As we begin the new fiscal and come out of one patch of uncertain time, will it not be brave to accept the certainty of uncertainty?

 
Raman Jokhakar
Editor    

CELEBRATING 75 YEARS OF INDEPENDENCE JAGANNATH SHANKARSHETH

In the last few months, through this column, we gratefully remembered Lokmanya Tilak, Madanlal Dhingra and Ramprasad Bismil. They sacrificed everything and dedicated their lives for the freedom of our country. Today, we will try to know about a man who made a yeomen contribution to the development of Mumbai and also, in turn, our country – Shri Jagannath Shankarsheth (JSS) – popularly known as Nana Shankarsheth. His surname was ‘Murkute’. Born on the 10th of February, 1803, he passed away on the 31st of July, 1865.

He was born in a wealthy family engaged in the business of jewellery and diamonds. His reputation and credibility were so high that Arabs, Afghans and other foreign merchants preferred to place their money in the custody of JSS; rather than with banks. JSS was a prominent Indian philanthropist and educationist.

JSS took leadership in many areas of Mumbai’s civil life. He founded the School Society and the Native School of Bombay, the first of its kind in Western India. It changed names from time to time, and finally, it is known as ‘Elphinstone Educational Institute’ (Elphinstone College) today! Many leaders of our country were educated in that college. The Students’ Library and Scientific Society first opened their girls’ schools. Despite the opposition from some orthodox citizens, JSS provided funds to them. He also founded the English School, the Sanskrit Seminary and Sanskrit Library, all located in Girgaum, South Mumbai. He has also instituted a well-known scholarship in his name for the topper in the subject of Sanskrit in the SSC Board, who continues further studies in Sanskrit.

In 1845, along with Sir Jamsethjee Jeejeebhoy, JSS formed the Indian Railway Association to bring railways to India. This Association was eventually incorporated as the Great Indian Peninsula Railway (GIP), presently ‘Central Railway’. JSS and Jeejeebhoy were the only two Indian Directors of GIP Railways. He participated in India’s first train journey between Mumbai and Thane, which took about 45 minutes.

JSS, Sir George Birdwood and Dr. Bhau Daji Lad initiated some of the major reconstruction efforts of the city in 1857. They transformed the then congested city into a spacious one, with monumental buildings. JSS was first Indian member of the Legislative Council of Mumbai under the Act of 1861 and became a member of the Bombay Board of Education. He was also the first Indian member of the Asiatic Society. JSS generously donated to a school in Grant Road and also a theatre. He also helped the British Government in the banning of the inhuman custom of ‘Suttee’ (widow burning). Thanks to his efforts, Hindus got a cremation ground at Sonapur. He donated generously to many temples.

During the first war of independence in 1857, the British suspected his involvement; but acquitted him for want of evidence. Bombay Association was the first political organisation in Mumbai founded by JSS on the 26th of August, 1852.

His memorials are – a marble statue at Asiatic Society of Mumbai, then the erstwhile Girgaum road was renamed as JSS Road and Nana Chowk at Grant Road. The Government of Maharashtra has recently allotted a large plot of land in the Antop Hill area, Wadala, to build a memorial of Shri Jagannath Shankarsheth.

Let us offer our grateful Namaskaar to this great philanthropist, educationist, visionary leader of our country.

SALTY… IS IT?

There was a sugar anthill in which numerous ants lived. Each of them was leading a very happy life and, being in a sugar anthill, everything was sweet in their lives.

One day, an ant from this colony moved out and met another ant. As they started talking, the ant from the sugar anthill (let’s call it the sugar ant) was surprised to hear the sad tale of the other ant.

It so happened that the other ant lived in a salt anthill (let’s call it the salt ant). The salt ant was disappointed with salt all around. She exclaimed, ‘This life is very salty.’ She had never tasted sugar.

Hearing this, the sugar ant replied, ‘What’s wrong? Life is so beautiful and full of sweetness all around.’

This was difficult for the salt ant to digest. She responded, ‘Impossible!’

‘Come with me, I shall show you,’ so saying, the sugar ant led the salt ant to her colony at the sugar anthill. Once there, the sugar ant asked, ‘Now tell me, isn’t life sweet?’

The salt ant tasted the sugar and responded, ‘What? This is salty, too!’

The sugar ant coaxed the salt ant to try once again. The salt ant did try but gave the same response. It was difficult for the sugar ant to understand. She decided to take the salt ant to the Mother sugar ant to resolve the issue. The Mother sugar ant was also perplexed when she heard the sugar ant’s predicament.

‘How could it be?’ she wondered.

In an attempt to unravel the mystery, the Mother sugar ant asked the salt ant to take a bite of sugar and asked her to respond.

‘Salty,’ the salt ant asserted.

The Mother sugar ant thought for a while. Then she smiled and her eyes brightened like those of a child who had suddenly spotted his mother in a group of strangers.

She told the salt ant to take another bite of the sugar and the salt ant obediently did so. As the salt ant opened her mouth to consume the sugar, the Mother sugar ant said, ‘Stop! Wait for a moment. Let me see your mouth.’”

The Mother sugar ant peeped into the mouth of the salt ant and exclaimed, ‘There you are! A piece of salt is already there in your mouth. How will anything taste any different but salty?’

As professionals, many a time we may commence our work with presumptions and / or prejudices which may influence our actions and decisions. They may sour our results and relations. However, professional scepticism should not translate into distrust, cynicism and suspicion. Further, it would be dangerous to carry such scepticism into our personal lives.

Would it not be wise to always begin with the question – ‘Have I removed the piece of salt (in the form of prejudices, etc.) before I set out to see the world soaked in sugar?’

THE IMPORTANCE OF STRONG PASSWORDS

We have all been there – any website that we visit wants us to share our email id and insists that we create a userid and password. The normal tendency is to use our regular email id and password on all sites. This is the primary mistake we commit while accessing the online world.
 

At the same time, if you are a business owner and have a website of your own, you need to know the people who visit your website and have their email ids. Besides, you would not like anyone and everyone to access and nose through your website without proper authentication.

 

Unauthorised access to your digital world is a major problem for anyone who uses computers or any other devices, especially if connected to the internet. The effects for victims of these break-ins can include the loss of valuable data, including bank account information, money, or even having their identity stolen. Moreover, unauthorised users may use someone else’s computer to break the law which could put the victim in legal trouble.

 

Surprisingly, although strong passwords are the most important in keeping our information secure online, this fact is often also the most overlooked. It may surprise you to know that in 2013, 90% of all online passwords were considered vulnerable to hacking. It was also found that 70% of people do not use a unique password for each website they access and more than 33% users share their password with others!

 

Another study showed that a majority of users use passwords which are so easy to guess – e.g., 123456 or ‘password’ or 111111. Using such passwords is suicidal as they are easiest to guess and hack.

 

The following points need to be kept in mind for ensuring your password security:

* Passwords must be long and complex – never use personal information like name of self or spouse, kids, pets, birthdays, etc. They are very easy to guess. Never use common words.

* Passwords should contain at least twelve characters. It has been calculated that if a hacker generates 1 billion passwords per second, a 5-digit password can be cracked in 0.38 seconds, while a 12-digit password would take 12,386.42 years to crack!

* Passwords must have at least one upper case, one lower case, one numeric and one special character (like !@#$%^&) each.

* Never write down passwords, as that makes it easier for the passwords to be stolen and used by someone else.

* Never use the same password for two or more devices, as someone who breaks into one machine will try to use the same password to take control of the others.

* Never use the same password on multiple sites, especially banking or transactional sites.

* Try and change all your passwords periodically – preferably once in six months.

* Use a good password manager (like LastPass) to manage all your passwords, since it is impossible to remember so many passwords.

 

Passwords are undoubtedly essential to security, but they are not the only method that can or should be used to protect one’s computers and devices. In addition to creating a good password, Windows 10 allows face recognition (Hello Windows / Hello Asus / Hello HP). Facial Recognition uses the FIDO (Fast Identity Online) protocol. Many laptops have fingerprint and / or iris recognition devices also, which provide an additional layer of security for your devices.

 

SECURITY FOR MOBILE DEVICES

On mobile devices, a PIN or passcode is used. This is like a password for a computer, but it may have a minimum of four characters or digits and should be something that is not personal or easily guessable. Passcodes for devices should also be set to time out after a short period of time. On time-out, the code will then need to be re-entered. Ideally, the timeout should occur in no more than ten minutes, although shorter periods between time-outs are best. Besides, these days many cell phones allow fingerprint and face recognition options which make your device more secure.

 

2 FACTOR AUTHENTICATION (2FA)

The use of 2 Factor Authentication (2FA) adds another layer to your security. For every large / reputed site you visit, this option is always there. To enable 2FA, you need to download an app like Authy or Google Authenticator.

 

In the case of Google, for example, once you have the app installed, go to your Google / Gmail account (myaccount.google.com/security) and look for 2-Step verification. Once you enable it and link your phone to your Google account, every time you login to your account from a different device, in addition to your password, it will also ask you for the 2FA code. You will have to go to your Authenticator App, read the code there for Google and enter it when prompted on your computer. This ensures that even if your password is hacked, the hacker cannot get into your account without the 2FA code which is unique to you and your device. Similarly, for your Amazon account – go to your account, login & security, enable 2-step verification and follow the same process as prompted. Facebook has similar options in Settings & Privacy, Settings, Security & Login – Two-Factor Authorisation.

 

The online world is dangerous and unforgiving. Sensible use of passwords, face recognition, 2FA all add to your security levels and allow you to conduct your online affairs safely. Stay safe, stay protected in this hazardous world by using the above tools sensibly and effectively.

 

Happy Browsing!

CONTRADICTIONS BETWEEN COMPANIES ACT AND SECURITIES LAWS: COMPOUNDED BY ERRANT DRAFTING

BACKGROUND
A listed company is subject to dual regulation. First, by the Companies Act, 2013 which is the parent act under which it is incorporated and which lays down the basic rules about how companies should be governed. And second, the multiple regulations notified under the SEBI Act. The regulator under each of these sets of laws is also different.

It is not as if the objectives of the two laws are clearly distinct and non-overlapping. Unfortunately, however, neither regulator would like to cede to the other and agree that some areas are best regulated exclusively by the other. Thus, several areas are regulated by both the regulators. And these areas actually keep increasing. Whether the concept and requirements relating to Independent Directors, whether the issue of shares and debentures, whether the setting up of various committees, their constitution and scope, etc., each regulator makes its own set of provisions.

This article attempts to look at this overlap and the resultant consequences. It also highlights the attempts made periodically to harmonise and even cede control. It also differentiates the nature of enforcement by the two regulators.

But this article arises primarily out of a recent informal guidance issued by SEBI. In this case, not only is there dual regulation, but owing to what appears to be poor drafting, certain harsh consequences have arisen which SEBI has merely reinforced without accepting.

AREAS OF DUAL GOVERNANCE

The objectives of the Companies Act, 2013 (‘the Act’) / Rules notified therein and the Securities Laws (consisting of the SEBI Act and several regulations notified by it) do have common areas. Both have as one of their objectives the governance of companies, even if SEBI primarily regulates companies that have listed, or propose to list, their securities. Both regulate the issue of securities, even if SEBI basically regulates the issue of securities to the public.

Thus, for example, the whole area of corporate governance is regulated minutely by both the laws. The definition of ‘Independent Directors’ is enunciated elaborately and separately by each of the two regulators. The constitution of committees such as the Audit Committee and the Nomination and Remuneration Committee is similarly laid down independently by the two laws. And the manner of issue of securities is also regulated independently by each of the two sets of laws.

Both sets of laws also regulate related party transactions. However, the definition of related parties, the nature of related party transactions governed, the manner of their approval, the quantum limits beyond which special approvals are required, etc., are all framed with differences, some major and some minor.

The result obviously is many differences, big and small, which companies have to carefully navigate through.

CONSEQUENCES OF DIFFERENT PROVISIONS

What happens when the same issue has differently-worded provisions under the Act / Rules and the Securities Laws? For example, the minimum number of Independent Directors required. The Act has made a simple rule which may result in a lower number of minimum Independent Directors, while the Securities Laws (the LODR Regulations) would require more. Or, say, the definition of related party transactions. The definition of related parties under the SEBI LODR Regulations is wider and covers groups of persons who are not covered as related parties under the Act. Similarly, the definition of related party transactions under the SEBI LODR Regulations is wider. So, again, the question is how will the differences be reconciled?

Primarily, the answer is that (i) both the sets of provisions have to be complied with, and (ii) in case of overlap / difference, the narrower or stricter provision will apply. If the LODR Regulations require more Independent Directors while the Act prescribes a lower number, the LODR Regulations will apply. Similarly, the wider definition of related party transactions under the SEBI LODR Regulations will apply.

But while this may be a good basic principle, the provisions of each set of laws should be carefully examined.

ATTEMPTS TO HARMONISE AND CEDE CONTROL

It is not as if the two regulators are always deliberately confrontational and engaged in a turf war. There is actually a tendency to carefully review what the other regulator has already provided in its corresponding provisions. Indeed, from time to time reviews are carried out and attempts are made to harmonise wherever possible. However, often a fresh set of amendments is made which widens the gap further. Since the provisions governed by SEBI are generally in the Regulations which can be easily amended, SEBI is able to update the provisions to current requirements and also take care of the difficulties faced. The amendments to the Act require approval of Parliament, although, interestingly, we have also seen a series of amending acts over the years.

DUAL ENFORCEMENT ACTION

Each of the two sets of laws has differing consequences in case of violation. Even the process of enforcement can be different. A violation of the provisions in the Act may result in fine and / or prosecution and, at times, other action. SEBI, however, generally has a wider arsenal of actions. It may be in the form of levying a penalty, directing persons not to deal in securities, barring persons from accessing securities markets, disgorgement, etc.

Companies and other persons in default alleged to have violated the provisions may face dual proceedings, one by each regulator, even for substantially the same violation!

Interestingly, under section 24 of the Act, certain specified provisions of the Act relating to listed / to be listed companies are to be ‘administered’ by SEBI. Ideally, such a provision would have ensured not only that dual provisions are either eliminated or harmonised, but even the action is by a single regulator. However, the provisions of this section have a narrow scope.

MANAGERIAL REMUNERATION – DUAL PROVISIONS AND CONSEQUENCE OF POOR DRAFTING

Let us take up a specific case that provides a good example of overlapping provisions with certain anomalous results owing to poor drafting. This case relates to payment of ‘managerial remuneration’, i.e., remuneration paid to directors. Traditionally, the Act has regulated payment of managerial remuneration in fair detail. The persons who can be appointed as Managing / Wholetime Directors, the manner of their appointment, the upper limits of their remuneration, etc., are all regulated in detail. Earlier, payment of remuneration beyond the specified limits required approval of the Central Government. However, now the Act requires approval of the shareholders instead. But even the shareholders cannot grant approval for remuneration that exceeds certain limits. The Act places limits on managerial remuneration in terms of percentage of net profits (as calculated in a prescribed manner) and, in case where profits are inadequate, or there are losses, in absolute terms.

SEBI had, till recently, not provided for limits on managerial remuneration but dealt with the subject by requiring the Nomination and Remuneration Committee to recommend managerial remuneration. However, with effect from 1st April, 2019 it made several requirements relating to certain managerial remuneration. One such requirement related to Promoter Executive Directors and became an area of confusion and a company approached SEBI for an ‘informal guidance’. It may be recalled that SEBI grants ‘informal guidance’ on provisions (for a relatively small charge) which, although it has limited binding effect, often helps know the view that SEBI may generally take.

The relevant provision is Regulation 17(6)(e) of the SEBI LODR Regulations which reads as under:

(e) The fees or compensation payable to executive directors who are promoters or members of the promoter group, shall be subject to the approval of the shareholders by special resolution in general meeting, if –
(i)    the annual remuneration payable to such executive director exceeds rupees 5 crore or 2.5 per cent of the net profits of the listed entity, whichever is higher; or
(ii)    where there is more than one such director, the aggregate annual remuneration to such directors exceeds 5 per cent of the net profits of the listed entity:

Provided that the approval of the shareholders under this provision shall be valid only till the expiry of the term of such director.

Explanation. – For the purposes of this clause, net profits shall be calculated as per section 198 of the Companies Act, 2013.

As can be seen, the provision states that the upper limit on annual remuneration in case of one such Promoter Executive Director is Rs. 5 crores or 2.50% of the net profits, whichever is higher. In case there is more than one such director, the corresponding limit on the aggregate remuneration to all such directors is 5% of the net profits.

The anomaly is apparent. The limit on remuneration in case of one director is given in an absolute amount as well as in a percentage. However, in case of more than one such director, the limit is given only in percentage terms. To take an example, if the net profit is Rs. 50 crores, then the company may pay Rs. 5 crores as managerial remuneration to one such director, being the higher of Rs. 5 crores and Rs. 1.25 crores (2.50% of Rs. 50 crores). If there are two or more such directors, however, the company can pay only Rs. 2.50 crores, since in such a case the company cannot pay more than 5% of its net profits as aggregate remuneration to all such directors. Thus, even the single director, who could have otherwise received up to Rs. 5 crores, would now get a far lesser remuneration since the aggregate limit for all the directors put together is Rs. 2.50 crores! Of course, if the net profits are very large (say, beyond Rs. 100 crores), the difficulty arising out of such an anomaly would be diluted. But if the profits are less, the anomaly becomes even more glaring.

For a company that needs more than one such director, the provision creates difficulties. When SEBI was approached for an informal guidance on this, it confirmed the above view and said that the remuneration would be limited to 5% of net profits (see informal guidance dated 18th November, 2020 to Manaksia Aluminium Company Limited). Thus, the company would be required to approach the shareholders for a special resolution.

To be fair, SEBI could not have resolved a drafting anomaly through an informal guidance since this would generally require an amendment.

CONCLUSION


A careful consideration is needed whether at all there is a need for dual sets of provisions on the same subject which result in overlap, conflict and even confusion, apart from double proceedings and double punishment. A fleet-footed SEBI could be given exclusive jurisdiction over listed / to be listed companies in several areas. This will ensure that companies have a single set of provisions to apply and that there is a single regulator who will take action in case of violation and the regulator is one who has several different enforcement actions that it can take that are suited to the violation/s.

HINDU LAW: THE RIGHTS OF AN ILLEGITIMATE CHILD

INTRODUCTION
The codified and uncodified aspects of Hindu Law deal with several personal issues pertaining to a Hindu. One such issue is the rights of an illegitimate child in relation to inheritance of ancestral property, self-acquired property of his parents, right to claim maintenance, etc.

 

VOID / VOIDABLE MARRIAGE

The Hindu Marriage Act, 1955 applies to and codifies the law relating to marriages between Hindus. It states that an illegitimate child is one who is born out of a marriage which is not valid. A valid marriage is one which does not suffer from the disabilities mentioned in this Act, viz., neither partner has another spouse living at the time of the marriage; neither of them is of unsound mind / has a mental disorder / is insane; they are not under the marriageable age; the parties are not within prohibited degrees of relationship as laid down in Hindu law; the parties are not sapindas (defined common relationships) of each other. For all void marriages, the Act provides that a decree of nullity can be obtained from a court of law. Hence, the marriage is treated as null and void. Thus, if there is a marriage which suffered from any of these defects then the same would be void. Certain marriages under the Act are voidable at the option of the party who is aggrieved.

 

ILLEGITIMATE CHILD – MEANING

A child born out of such a void or voidable wedlock would have been treated as an illegitimate child prior to the amendment of the Hindu Marriage Act in 1976. From 1976, the Hindu Marriage Act has been amended to expressly deal with an illegitimate child. Section 16(1) provides that even if a marriage is null and void, any child born out of such marriage who would have been legitimate if the marriage had been valid, shall be considered to be a legitimate child. This is true whether or not such child is born before or after the commencement of the Marriage Laws (Amendment) Act, 1976. This would also be the case whether or not a decree of nullity is granted in respect of that void marriage under this Act.

 

It also provides that if a decree of nullity is granted in respect of a voidable marriage, any child begotten or conceived before the decree is made, who would have been the legitimate child of the parties to the marriage if at the date of the decree it had been dissolved instead of being annulled, shall be deemed to be their legitimate child notwithstanding the decree of nullity.

 

Hence, now all children of void / voidable marriages under the Act are treated as legitimate. The Act also provides that such children would be entitled to rights in the property of their parents.

 

The Supreme Court in Bharatha Matha & Anr. vs. R. Vijaya Renganathan, AIR 2010 SC 2685 has held that ‘it is evident that Section 16 of the Act intends to bring about social reforms, conferment of social status of legitimacy on a group of children, otherwise treated as illegitimate, as its prime object.’

 

In Jinia Keotin & Ors. vs. Kumar Sitaram Manjhi & Ors. (2003) 1 SCC 730, the Apex Court explained the meaning behind the Amendment as follows:

‘4 … Under the ordinary law, a child for being treated as legitimate must be born in lawful wedlock. … The legitimate status of the children which depended very much upon the marriage between their parents being valid or void, thus turned on the act of parents over which the innocent child had no hold or control. But for no fault of it, the innocent baby had to suffer a permanent setback in life and in the eyes of society by being treated as illegitimate. A laudable and noble act of the legislature indeed in enacting section 16 to put an end to a great social evil.’

 

In S.P.S. Balasubramanyam vs. Suruttayan @ Andali Padayachi & Ors. AIR 1992 SC 756 the Supreme Court held that if man and woman are living under the same roof and cohabiting for a number of years, there will be a presumption u/s 114 of the Evidence Act that they live as husband and wife and the children born to them will not be illegitimate. Thus, even children born out of a live-in relationship were accorded legitimacy.

 

In Rameshwari Devi vs. State of Bihar & Ors. AIR 2000 SC 735 the Supreme Court dealt with a case wherein after the death of a government employee, the children born illegitimately to the woman who had been living with the said employee, claimed a share in the pension / gratuity and other death-cum-retirement benefits along with children born out of a legal wedlock. The Court held that u/s 16 of the Act, children of a void marriage are legitimate. As the employee, a Hindu, died intestate, the children of the deceased employee born out of the void marriage were entitled to a share in the family pension, death-cum-retirement benefits and gratuity.

 

SUCCESSION TO PROPERTIES OF OTHER RELATIVES

However, the Amendment Act has also introduced an interesting caveat, that while such a child born out a void or voidable wedlock would be deemed to be legitimate, the Amendment would not be treated as conferring any rights in the property of any person other than its parents.

 

In Smt. P.E.K. Kalliani Amma & Ors. vs. K. Devi & Ors. AIR 1996 SC 1963 the Apex Court held that section 16 of the Act was not ultra vires of the Constitution of India. In view of the legal fiction contained in section 16, the illegitimate children, for all practical purposes, including succession to the properties of their parents, had to be treated as legitimate. They could not, however, succeed to the properties of any other relation on the basis of this rule which in its operation was limited to the properties of the parents.

 

Again, in Jinia Keotin & Ors. vs. Kumar Sitaram Manjhi & Ors. (2003) 1 SCC 730 the Supreme Court held that section 16 of the Act, while engrafting a rule of fiction in ordaining the children, though illegitimate, to be treated as legitimate, notwithstanding that the marriage was void or voidable, chose also to confine its application, so far as succession or inheritance by such children is concerned, to the properties of the parents only. It held that conferring any further rights upon such children would be going against the express mandate of the Legislature.

 

This view was once again endorsed by the Supreme Court in Bharatha Matha (Supra) where it held that a child born of a void or voidable marriage is not entitled to claim inheritance in ancestral coparcenary property but is entitled only to claim share in self-acquired properties, if any.

 

CONTROVERSY IN THE ISSUE

The above issue of whether illegitimate children can succeed to ancestral properties or claim a share in the HUF was given a new twist by the Supreme Court in 2011 in the case of Revanasiddappa and Anr. vs. Mallikarjun and Ors. (2011) 11 SCC 1. The question which was dealt with in that case was whether illegitimate children were entitled to a share in the coparcenary property or whether their share was limited only to the self-acquired property of their parents u/s 16(3) of the Hindu Marriage Act? It disagreed with the earlier views taken by the Supreme Court in Jinia Keotin (Supra), Bharatha Matha (Supra) and in Neelamma & Ors. vs. Sarojamma & Ors. (2006) 9 SCC 612, wherein the Court had held that illegitimate children would only be entitled to a share of the self-acquired property of the parents and not to the joint Hindu family property.

 

The Court observed that the Amendment had used the word ‘property’ and had not qualified it with either self-acquired property or ancestral property. It has been kept broad and general. It explained that if they have been declared legitimate, then they cannot be discriminated against and they will be at par with other legitimate children and be entitled to all the rights in the property of their parents, both self-acquired and ancestral. The prohibition contained in section 16(3) will apply to such children only with respect to property of any person other than their parents. Qua their parents, they can succeed to all properties. The Court held that there was a need for a progressive and dynamic interpretation of Hindu Law since the society was changing. It stressed the need to recognise the status of such children who had been legislatively declared legitimate and simultaneously recognise the rights of such children in the property of their parents. This was a law to advance the socially beneficial purpose of removing the stigma of illegitimacy on such children who were as innocent as any other children.

 

The Supreme Court also explained the modus operandi of succession to ancestral property. Such children will be entitled only to a share in their parents’ property, but they could not claim it in their own right. Logically, on the partition of an ancestral property the property falling in the share of the parents of such children would be regarded as their self-acquired and absolute property. In view of the Amendment, such illegitimate children will have a share in such property since such children were equated under the amended law with the legitimate offspring of a valid marriage. The only limitation even after the Amendment was that during the lifetime of their parents such children could not ask for partition, but they could exercise this right only after the death of their parents.

 

Hence, the Court in Revanasiddappa (Supra) concluded that it was constrained to take a view different from the one taken earlier by it in Jinia Keotin (Supra), Neelamma (Supra) and Bharatha Matha (Supra) on section 16(3) of the Act. Nevertheless, since all these decisions were of two-member Benches, it requested the Chief Justice of India that the matter should be reconsidered by a larger Bench.

 

CURRENT STATUS

It has been close to ten years since the above request for a larger Bench, but the matter has not yet been resolved. This issue once again cropped up in the Supreme Court in the case of Jitender Kumar vs. Jasbir Singh CA 18858/2019 order dated 21st October, 2019. The Supreme Court observed that since this issue has been referred to a larger Bench, the current case would be decided only after its hearing.

 

MAINTENANCE

Section 20 of the Hindu Adoptions and Maintenance Act, 1956 also needs to be noted; it provides for maintenance of children by a Hindu. A Hindu is bound, during his or her lifetime, to maintain his or her legitimate or illegitimate children during their minority. In addition, an unmarried Hindu daughter (even if illegitimate) can claim maintenance from her father till she is married relying on section 20(3) of this Act, provided that she pleads and proves that she is unable to maintain herself from her own earnings. This is also the view expressed by a three-Judge Bench of the Supreme Court in Abhilasha vs. Parkash, Cr. Appeal No. 615/2020, order dated 15th September, 2020.

 

GUARDIANSHIP

Who would be the natural guardian of such an illegitimate child is another interesting question. The Hindu Minority and Guardianship Act, 1956 states that a natural guardian of a Hindu minor (if he is a boy or an unmarried girl) and / or his property, is the father and after him the mother. In case the minor is below the age of five years, the child’s custody ordinarily vests with the mother. However, the Act provides an exception to this Rule that in the case of an illegitimate boy or an illegitimate unmarried girl, the mother would be the natural guardian and only after her can the father be the natural guardian. Recently, the Bombay High Court in Dharmesh Vasantrai Shah vs. Renuka Prakash Tiwari, 2020 SCC OnLine Bom 697, reiterated that in case of an illegitimate child it is only the mother who can be the natural guardian under Hindu Law. The only exception is if the mother has renounced the world by becoming a hermit or has ceased to be a Hindu. The Court held that since it was the father’s own case that the child was an illegitimate child, it was difficult to see how he could claim the custody of the child over the biological mother. The Supreme Court has taken a similar view in the case of the guardianship of an illegitimate Christian child in the case of ABC vs. State of Delhi (NCT) (2015) 10 SCC 1.

 

CONCLUSION

The issue relating to various rights of illegitimate children has been quite contentious and litigation prone. One eagerly awaits the constitution of the larger Supreme Court Bench. Clearly, it is high time for a comprehensive legislation dealing with all issues pertaining to such children. In the words of the Apex Court, ‘they are as innocent as any other children!’  

 

STIGMA OF ATTACHMENT(S)

Lord Dunedin famously quoted in Whitney vs. IRC [LR 1926 AC 37, 51 (HL): 10 TC 79, 110: (1924) 2 KB 602] – ‘Now, there are three stages in the imposition of a tax: there is the declaration of liability, that is the part of the statute which determines what persons in respect of what property are liable. Next, there is the assessment. Liability does not depend on assessment. That, ex hypothesi, has already been fixed. But assessment particularises the exact sum which a person liable has to pay. Lastly, come the methods of recovery, if the person taxed does not voluntarily pay.’
 

In this era of digitisation, self-assessment, self-compliance, self-policing and self-vigilance, recovery provisions of taxes are directed to act as deterrence tools rather than being tyrannical. In a democratic set-up with a progressive vision of nation-building, these provisions are considered as a measure of last resort, adopted only in extreme cases. Yet, in the GST scheme of things attachment provisions have been invoked on multiple occasions and the taxpayers have faced the wrath of this power, especially in cases of fake invoicing. This article discusses the attachment provisions under GST with specific reference to attachments of bank accounts and debtors of tax defaulters.

 

CONSTITUTIONAL BACKGROUND

The recovery provisions have a Constitutional background in terms of Articles 265 and 300-A. Article 265 sets out the cardinal rule that no taxes can be levied or collected except under authority of law. Recovery provisions fall under the powers of collection by the Executive of the state. On similar lines, Article 300-A protects the right of ownership of the property of the citizen except under authority of law. These articles when applied together frame two important principles under recovery: (a) Taxes recoverable should be under authority of law; and (b) Recovery process infringes ownership rights and should be backed by legal provisions. In District Mining Officer vs. Tata Iron & Steel Co. and Anr. (2001) 7 SCC 3581 , the three-judge Bench observed that not only should the levy of taxes have the authority of law but also its recovery should be under due authority of law. It is in this backdrop that recovery provisions under the GST law should be understood and applied by Revenue authorities.

 

–––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––—————————————————————————————————————————————-

1 This
decision has been referred to the larger Bench in Asst. Director of Mines
and Geology vs. Deccan Cements (2008) 3 SCC 451


SUMMARY OF GST PROVISIONS ON RECOVERY

Chapter 15 of the CGST / SGST enactments provide for demands and recovery of taxes. Recovery proceedings can be initiated under the following circumstances:

(i) Taxes not paid, short paid or erroneously refunded,

(ii) Ineligible availment or utilisation of input tax credit,

(iii) Taxes which are not due but collected on supplies,

(iv) Admitted taxes (including turnover reported in GSTR1)2,

(v) Disputed taxes (to the extent of mandatory pre-deposit),

(vi)   Disputed taxes to the extent stay is not obtained, and

(vii) Interest and penalties on all or any of the above.

 

Section 78 provides that recovery proceedings can be initiated at any time after three months from the date of service of the demand order. This time limit coincides with the maximum time limit of three months to file an appeal before the appellate forums. In effect, if the assessee fails to utilise the time to file an appeal within the prescribed limit, it is generally presumed that the matter is not being agitated and powers are thrust on the Revenue to proceed for recovery of taxes due to the Government. As an exception, section 78 permits the proper officer to advance the recovery actions where the circumstances warrant that the collection of taxes may be adversely affected if the entire duration of three months is permitted to the assessee, such as disposal of assets, diversion of funds, etc.

 

Section 79 provides for various methods of recovery of taxes such as:

(1) Adjustment of refunds held by the said proper officer or any other specified officer,

(2) Sale of goods under detention by the above authorities,

(3) Garnishee proceedings (evaluated below),

(4) Distraint and sale of any movable or immovable property,

(5) Recovery as land revenue, and

(6) Recovery of any amount under bond or security executed before the officer.

 

Garnishee powers u/s 79 enable the proper officer to serve upon the taxpayer’s debtors (banks, trade debtors / receivables, etc.) a notice (in DRC-14) directing them to deposit the amount specified to the account of the Government and such deposit would be treated as a sufficient discharge of their debt to the taxpayer. Although the Revenue has powers to recover taxes from other assets of the taxpayer, the circumstances may warrant that Revenue would have to protect its interest before the assets are alienated by the taxpayer. In such cases, Revenue would resort to attachments of the properties of the taxpayer in anticipation of a demand to be recovered in future.

 

––––––––––––––––––––––

2 Amendment proposed by Finance Bill, 2021

RECOVERY POWERS ARE NOT SEQUENTIAL

The CGST Act provides multiple alternatives to the Revenue officials for recovery of taxes which include attachment of properties (refer above). Are Revenue officials required to exhaust the remedies sequentially prior to proceeding for attachment of properties? Section 79 itself states that recovery can be performed by ‘one or more of the following modes’. This implies that the choice of modes of recovery is purely with the Revenue and it cannot be insisted that each mode has to be exhausted prior to proceeding with an alternative mode of recovery3. Revenue can simultaneously invoke recovery from multiple debtors / assets as long as the overall recovery is capped to the tax arrears.

 

ATTACHMENT AS A PRECURSOR TO RECOVERY

Attachments of property of the tax defaulter can be a prelude to subsequent recovery of tax arrears. ‘Attachment’ in this context refers to prohibition of transfer, conversion, disposition or movement of property by an order issued under law. It is used to hold the property for the payment of debt [Kerala State Financial Enterprises vs. Official Liquidator (2006) 10 SCC 709]. It is also well established that attachment creates no charge or lien upon the attached property. It only confers a right on the holder to have the attached property kept in custodia legis for being dealt with by the Court in accordance with law. It merely prevents and avoids private alienations; it does not confer any title on the attaching creditors. The objective is to protect the interest of Revenue until completion of proceedings and enforcing realisation of taxes in arrears to the debtor. On the other hand, the process of recovery involves the actual realisation / liquidation of the property for meeting the tax dues either from assets already under attachment or other properties of the tax defaulter.

 

–––––––––––––––––––––––––––––––––––––––

3 2000 (126) E.L.T. 222 (A.P.) G.
Lourdha Reddy vs. District Collector, Warangal


Attachment of fixed deposits before the maturity date

Disputes have emerged whether Revenue can attach and recover fixed deposits prior to their maturity. In Vysya Bank Ltd. vs. Jt. CIT [2000] 109 Taxman 106/241 ITR 178 (Kar.), the Court held that fixed deposits which are lying with banks can be encashed even before their maturity since the Department steps into the shoes of the tax defaulter and can invoke pre-closure of such deposits. On the other hand, rents which are not yet due from the landlord cannot be subjected to attachment or recovery from the debtor.

 

Attachment of Overdraft / Cash Credit accounts

Overdraft / Cash Credit facilities do not create a debt by the third party in favour of the tax defaulter. Therefore, unutilised overdraft or cash credit facilities cannot be attached by the Revenue for realisation of tax dues. In a recent decision, the Court went a step further and stated that future credits after attachment would also not be subjected to the freeze contemplated in law [2020 (5) TMI 193 – RCI Industries & Technologies Ltd. vs. DGGSTI] – ‘6. In the circumstances, we dispose of this petition with a direction that the attachment would be limited to the amounts which were lying to the credit of the petitioner in CC A/c at the time of freezing and any further credit which may come would not be under attachment.’

 

Provisional attachment of property

As an exception to the regular course of attachment after confirmation of tax demands, section 83 enables provisional attachment of any property, including bank accounts, of the taxable person for a maximum period of one year during pendency of adjudication / assessment proceedings (as per extant provisions). Rule 159 provides the procedure for provisional attachment of any property, including bank accounts, as follows:

* Commissioner shall pass an order in DRC-22 to that effect mentioning therein the details of the property which is proposed to be provisionally attached,

* Commissioner shall send a copy of the order of attachment to the authority concerned to place encumbrance on the said movable or immovable property, which shall be removed only on the written instructions from the Commissioner to that effect,

* In case of perishable or hazardous goods, the taxable person can obtain an immediate release of the goods on payment of the market price. In case of failure of payment, such goods may be disposed of and adjusted with the recoverable dues, and

* Any objection to attachment should be filed within seven days of attachment and the Commissioner may release the property after hearing the aggrieved.

 

Drastic nature of provisional attachment

The power of provisional attachment has been held to be drastic in the sense that such actions infringe the liberty of the taxpayer in running its business operations and is to be exercised before any judgement or decision is made. The authority exercising this power should have strong compelling reasons for this extraordinary action with the objective of protecting the interest of Revenue. Generally, taxpayers who have a compliant track record and tangible asset base without any indication of diversion of funds should not be saddled with such drastic actions. The High Court in 2019 (30) GSTL 396 (Guj.) Pranit Hem Desai vs. ADGGI made very assertive observations about the use / misuse of the power of provisional attachment. Though section 83 does not provide any safeguards against misuse of powers (except the approval of a Commissioner, which is generally a routine exercise), the Court stated that the very nature of action warrants circumspection and extreme care and not (its use as) a routine tool for harassment:

 

‘Further, the orders of provisional attachment must be in writing. There must be some material on record to indicate that the Assessing Authority had formed an opinion on the basis thereof that it was necessary to attach the property in order to protect the interest of the Revenue. The provisional attachment provided under section 83 is more like an attachment before judgment under the Code of Civil Procedure. It is a liability on the property. However, the power conferred upon the Assessing Authority under section 83 is a very drastic, far-reaching power and that power has to be used sparingly and only on substantive, weighty grounds and for valid reasons. To ensure that this power is not misused, no safeguards have been provided in section 83. One thing is clear, that this power should be exercised by the Authority only if there is a reasonable apprehension that the assessee may default the ultimate collection of the demand that is likely to be raised on completion of the assessment. It should, therefore, be exercised with extreme care and circumspection. It should not be exercised unless there is sufficient material on record to justify the satisfaction that the assessee is about to dispose of the whole or any part of his property with a view to thwarting the ultimate collection of the demand. Moreover, attachment should be made of the properties and to the extent it is required to achieve the above object. It should neither be used as a tool to harass the assessee nor should it be used in a manner which may have an irreversible detrimental effect on the business of the assessee.’

 

POWER OF PROVISIONAL ATTACHMENT IS NOT ABSOLUTE

The power of the Commissioner in attaching any property including bank accounts is not absolute. In Bindal Smelting Pvt. Ltd. vs. ADGGI [2020 (1) TMI 569 – P&H] the Court held that the expression ‘is of the opinion’ or ‘has reason to believe’ is of the same connotation and is indicative of subjective satisfaction of the Commissioner which depends upon the facts and circumstances of each case. It is settled law that the opinion must have a rational connection with or relevant bearing on the formation of the opinion. Rational connection postulates that there must be a direct nexus or live link between the protection of interest and available property which might not be available at the time of recovery of taxes and after final adjudication of the dispute. The opinion must be formed in good faith and should not be a mere pretence. The Courts are entitled to determine whether the formation of opinion is arbitrary, capricious or whimsical. In Valerius Industries vs. Union of India 2019 (9) TMI 618 Gujarat High Court, the Court held the following:

 

* The order of provisional attachment before the assessment order is made may be justified if the assessing authority or any authority empowered in law is of the opinion that it is necessarily to protect the interest of Revenue. A finding to the effect should be recorded prior to pursuing this remedy.

* The above subjective satisfaction should be based on some credible materials or information and should also be supported by some supervening factor.

* The power u/s 83 of the Act could be termed as a very drastic and far-reaching power. Such power should be used sparingly and only on substantive weighty grounds and reasons.

* Such power should be exercised only if there is a reasonable apprehension that the assessee may default the ultimate collection of the demand that is likely to be raised on completion of the assessment. It should, therefore, be exercised with extreme care and caution.

* This power should neither be used as a tool to harass the assessee nor should it be used in a manner which may have an irreversible detrimental effect on the business of the assessee.

* The attachment of bank accounts and trading assets should be resorted to only as a last resort or measure. The provisional attachment u/s 83 should not be equated with the attachment in the course of the recovery proceedings.

* The authority before exercising power u/s 83 for provisional assessment should take into consideration two things,

a) Whether it is a revenue-neutral situation, and

b) The statement of ‘output liability or input tax credit’.

* Having regard to the amount paid by reversing the input tax credit if the interest of the Revenue is sufficiently secured, then the authority may not be justified in invoking such power for the purpose of provisional attachment.

 

Similar views were voiced in Automark Industries (I) Ltd. vs. State of Gujarat [2016] 88 VST 274 (Guj.) where such provisions were held to be drastic and extraordinary in nature. These decisions consistently hold that these powers should be used sparingly and not as a matter of routine practice.

 

PROVISIONAL ATTACHMENT OF ENTIRE BUSINESS PREMISES

Revenue authorities were performing attachment of business premises u/s 71 at the time of their visit on the ground of tax evasion. Section 83 is applicable only in specified sections and since section 71 does not form part of the list therein, it does not permit Revenue to invoke attachment of assets on a visit of premises. In Proex Fashion Private Limited [2021 (1) TMI 365], the Court held that attachment pursuant to visit to business premises u/s 71 is not permissible.

 

This limitation of section 83 is sought to be overcome by the proposed substitution of section 83 (vide Finance Bill, 2021) which encompasses all the sections under Chapters XII, XIV and XV of the CGST Act for invoking provisional attachment. Under the amended section 83, officers would be empowered to provisionally attach the business premises at the time of visit, inspection or search rather than waiting for adjudication of the tax demands.

 

DISCLOSURE OF REASONS / CIRCUMSTANCES FOR PROVISIONAL ATTACHMENT

Section 83 does not require that the necessary circumstances be communicated to the taxpayer prior to invoking provisional attachment. But such formation of belief can be examined by the Court on being questioned by the tax defaulter. The Court can examine the materials to find out whether an honest and reasonable person can base his reasonable belief upon such materials although the sufficiency of the reasons for the belief cannot be investigated by the Court (Sheonath Singh’s case [AIR 1971 SC 2451]).

 

Continuation of attachment after one year

Pendency of proceedings is a sine qua non for provisional attachment of any property. Where the provisional attachment has been initiated, the conclusion of the proceedings warrants that the provisional attachment should be lifted and cannot be continued. Revenue authorities would have to lift the encumbrance over the property and invoke other recovery provisions based on the outcome of the adjudication / assessment.

 

In UFV India Global Education vs. UOI 2020 (43) GSTL 472 (P&H), the Court held that provisional attachments are not valid after completion of the proceedings on the basis of which attachments were initiated. In other words, where the attachment was initiated on the basis of an inspection u/s 67, the attachment would cease to operate on the completion of the proceedings under the said section. As a corollary, where the inspection proceedings migrate to adjudication under sections 73 or 74, a fresh provisional attachment is required to be initiated during the pendency of such adjudication proceedings. However, this position in law is also undergoing alteration by substitution of section 83 where the provisional attachment has been sought to be extended until the conclusion of proceedings of adjudication or one year, whichever is earlier.

 

Renewal of provisional attachment

In Amazonite Steel Pvt. Ltd. vs. UOI 2020 (36) GSTL 184 (Cal.), the Court reprimanded officers who failed to withdraw the provisional attachment of the property beyond the time limit of one year and imposed heavy costs on the officials concerned. But this does not mean that the Commissioner is not empowered to renew the provisional attachment after the expiry of one year. In Shrimati Priti vs. State of Gujarat [2011 SCC Online Guj. 1869], the Court interpreted the scope of section 45 of the Gujarat Value Added Tax Act, 2003 (similar to section 83) and held that on the one hand section 45 requires the competent officer to review the situation compulsorily at least upon completion of the period, while so doing, it does not limit his discretion to exercise such powers again if the situation so arises. Other things remaining the same, the Court also held that there is nothing in the express wording of section 83 which prohibits the Commissioner from issuing a fresh order for provisional attachment on expiry of one year. Therefore, as long as there is pendency of proceedings under a specified section, Commissioners can form an opinion and renew the provisional attachment of the property. In the context of Income-tax law, the provisional attachment has been specifically stated as not being extendable beyond two years. It is in this context that the Delhi High Court in VLS Finance Ltd. vs. ACIT [2011] 331 ITR 131 (Delhi) held that attachment of property cannot extend the limit specified in law and hence distinguishable from the position under GST.

 

Though in theory these provisions are held to be extreme actions, it is not unknown that Revenue officers have used this tool to arm-twist taxpayers in recovery of taxes. Apprehension of business breakdown compels enterprises to succumb to such demands. Despite their bona fides being proved during investigations, certain taxpayers also find the removal of attachment to be a herculean task. The tool of deterrence has in certain instances become a tool of harassment. Indeed, with great power comes great responsibility!

TAXATION OF DIGITISED ECONOMY – SIGNIFICANT ECONOMIC PRESENCE AND EXTENDED SOURCE RULE

In our earlier articles of January and May, 2020, we had covered the proposals discussed between the countries participating in the Inclusive Framework to tax the digitised economy. Closer home, India has introduced several provisions to bring into the tax net the income of the digitised economy – Equalisation Levy (EL), Significant Economic Presence (SEP) and Extended Source Rule for business activities undertaken in or with India.

This article seeks to analyse the provisions introduced in the Income-tax Act, 1961 (the Act) to tax the income in the digitised economy era – Explanation 2A, i.e., SEP, and Explanation 3A, i.e., the extended source rule, to section 9(1)(i). While there are other measures and provisions relating to taxation of the digitalised economy, such as EL and provisions related to deduction and collection of taxes, this article does not deal with such provisions.

1. BACKGROUND

Taxation of the digitised economy has been one of the hotly debated topics in the international tax arena in the recent past, not just amongst tax practitioners and academicians but also amongst governments and revenue officials. The existing tax rules are not sufficient to tax the income earned in the digital economy era. The existing rules of allocation of taxing rights in DTAAs between countries rely on physical presence of a business in a source country to tax income. However, with the advent of technology, the way businesses are conducted is different from that a few years ago. Today, it is possible to undertake business in a country without requiring any physical presence, thereby leading to no tax liability in the country in which such business is undertaken.

The urgency and importance of this topic became evident when OECD included taxation of the digital economy as the first Action Plan out of 15 in the BEPS Project. More than 130 countries, as part of the Inclusive Framework of the OECD, have been seeking to arrive at a consensus-based solution to tax the transactions in the digitised economy era for the past few years. In this regard, a two-pillar Unified Approach has been developed and the blueprints for both the Pillars were released for public comments in October, 2020.

While countries in the Inclusive Framework are hopeful of arriving at a consensus amongst all members this year, there are various policy considerations which need to be taken into account. Further, the UN Committee of Experts on International Co-operation in Tax Matters has also tabled a proposal seeking to insert a new article in the UN Model Double Tax Convention to tax the digitised economy.

India has been a key player in the global discussions to tax the digitised economy. While BEPS Action Plan 1 dealing with taxation of the digital economy did not provide a recommendation in the Final Report released in October, 2015 on account of the lack of consensus amongst the participating countries, the Report analysed (without recommending) three options for countries until consensus was arrived at – withholding tax, a digital permanent establishment in the form of SEP, or equalisation levy. It was also concluded that member countries would continue to work on a consensus-based solution to be arrived at at the earliest.

DEVELOPMENTS IN INDIA

India was one of the first countries to enact a law in this regard and EL was introduced as a part of the Finance Act, 2016. The EL applicable to online advertisement services was not a part of the Act and therefore, arguably, not restricted by tax treaties. The Finance Act, 2018 introduced the SEP provisions in the Act. Further, the scope of ‘income attributable to operations carried out in India’ was extended by the Finance Act, 2020. While introducing the extended scope, the Finance Act, 2020 also amended the SEP provisions and postponed the application of these provisions till the F.Y. 2021-22. Further, the Finance Act, 2020 also expanded the scope of the EL provisions.

Unlike the EL provisions, SEP by insertion of Explanation 2A to section 9(1)(i) and the Extended Source Rule by insertion of Explanation 3A to section 9(1)(i), were introduced in the Act itself and hence the taxation of income covered under these provisions may be subject to the beneficial provisions of the tax treaties.

In other words, the application of these provisions would be required in a scenario where the non-resident is from a jurisdiction which does not have a DTAA with India, or where the non-resident is not eligible to claim benefits of a DTAA, say on account of application of the MLI provisions, or due to the non-availability of a Tax Residency Certificate (TRC).

In addition to scenarios where benefit of the DTAA is not available, it is important to note that one of the possible methods for implementation of Pillar 1 of the Unified Approach is the modification of the existing DTAAs through another multilateral instrument (MLI 2.0) to provide for a nexus and the amount to be taxed in the Country of Source or Country of Market. Therefore, the reason for introduction of these provisions in the Act is to enable India to tax such transactions once the treaties are modified because without charge of taxation in the domestic tax law, mere right provided by a tax treaty may not be sufficient.

2. EXPLANATION 2A TO SECTION 9(1)(I) (SEP)

The SEP provisions were introduced by way of insertion of Explanation 2A to section 9(1)(i) of the Act. It reads as follows:

‘Explanation 2A. – For the removal of doubts, it is hereby declared that the significant economic presence of a non-resident in India shall constitute “business connection” in India and “significant economic presence” for this purpose, shall mean –
(a) transaction in respect of any goods, services or property carried out by a non-resident with any person in India, including provision of download of data or software in India, if the aggregate of payments arising from such transaction or transactions during the previous year exceeds such amount as may be prescribed; or
(b) systematic and continuous soliciting of business activities or engaging in interaction with such number of users in India, as may be prescribed:

Provided that the transactions or activities shall constitute significant economic presence in India, whether or not –
(i) the agreement for such transactions or activities is entered in India; or
(ii) the non-resident has a residence or place of business in India; or
(iii) the non-resident renders services in India:
Provided further that only so much of income as is attributable to the transactions or activities referred to in clause (a) or clause (b) shall be deemed to accrue or arise in India.’

Therefore, Explanation 2A seeks to extend the definition of ‘business connection’ to certain transactions where the business is undertaken ‘with’ India as against the traditional method of creating a business connection only in cases of transactions undertaken ‘in’ India.

The thresholds in respect of the amount of payment for goods and services and in respect of the number of users have not yet been prescribed, therefore the provisions of SEP, although applicable from A.Y. 2022-23, are not yet operative.

2.1 Whether SEP would apply only in case of digital transactions
It is important to note that under Explanation 2A, the definition of SEP is an exhaustive one and therefore a transaction which does not satisfy the above criteria would not be considered as constituting an SEP.

It is also important to note that the definition of SEP is not restricted to only digital transactions but seeks to cover all transactions which are undertaken with a person in India. This is in line with the proposed provisions of Pillar 1 of the Unified Approach and the discussion of the same in the Inclusive Framework. Pillar 1 of the Unified Approach seeks to bring to tax automated digital businesses as well as consumer-facing businesses. On the other end of the spectrum, the proposed Article 12B in the UN Model Tax Convention seeks to tax only automated digital businesses and does not cover consumer-facing businesses.

Further, at the time of introduction of the SEP provisions in the Finance Act, 2018, the Memorandum explaining the provisions of the Finance Bill (Memorandum) referred to taxation of digitalised businesses and thus the intention seems to be to tax transactions undertaken only through digital means. However, the language of the section does not suggest the taxation only of digital transactions. This is also evident in the CBDT Circular dated 13th July, 2018 (2018) 407 ITR 5 (St.) inviting comments from the general public and stakeholders, specifically comments on revenue threshold for transactions in respect of physical goods.

Further, with regard to clause (a) what needs to be prescribed is the threshold for the amount of payment and not the type of transactions covered. Therefore, even a transaction undertaken through non-digital means would constitute an SEP in India and hence a business connection in India if the aggregate transaction value during the year exceeds the prescribed amount.

An example of a transaction which may possibly be covered subject to the threshold could be the service provided by a commission agent in respect of export sales, wherein no part of the service of such agent is undertaken in India. Various judicial precedents have held that export sales commission is neither attributable to a business connection in India in such a scenario, nor does it constitute ‘fees for technical services’ u/s 9(1)(vii) of the Act. However, now the activities of such an agent, providing services to a person residing in India (the seller), could possibly constitute an SEP in India.

Further, clause (b) above refers to systematic and continuous soliciting of business or engaging in interaction with a prescribed number of users. At the time of the introduction of the SEP provisions by the Finance Act, 2018, this activity was required to be undertaken ‘through digital means’ in order to constitute an SEP. This additional condition of the activity being undertaken ‘through digital means’ was removed by the Finance Act, 2020. Accordingly, any activity which is considered
as soliciting business or engaging with a prescribed number of users could result in the constitution of an SEP in India.

For example, a call centre of a bank outside India which deals with a number of Indian customers could result in the entity owning the call centre to be considered as having an SEP in India if the number of customers solicited exceeds the prescribed threshold.

Accordingly, every type of transaction undertaken with India may be covered as constituting an SEP in India, not in accordance with what is provided in the Memorandum.

2.2 Transaction in respect of any goods, services or property carried out by a non-resident with any person in India
The first condition for constitution of an SEP is a transaction in respect of any goods, services or property carried out by a non-resident with any person in India, the payments for which exceed the prescribed threshold.

The term ‘goods’ has not been defined in the Act. While one may be able to import the definition of the term from the Sale of Goods Act, 1930, it may not be of much relevance as the SEP provisions also apply to transactions in respect of ‘property’. Therefore, all assets, tangible as well as intangible, would be covered under this clause subject to the discussion below regarding SEP covering only transactions whose income is taxed as business profits.

Thus, offshore sale of goods to a person in India may now be covered under the SEP provisions (subject to the fulfilment of the threshold limit). Interestingly, the Supreme Court in the case of Ishikawajima-Harima Heavy Industries Ltd. vs. DIT [2007] 288 ITR 408, held that income from sale of goods by a non-resident concluded outside India would not be considered as income accruing or arising in India. The SEP provisions, specifically covering such transactions, could now override the decision of the Apex Court in cases where the SEP provisions are triggered.

Another question that arises is whether a transaction of sale of shares is covered. Let us take as an example the sale of shares of a US Company by a US resident to a person in India. Such a sale, not being sale of shares of an Indian company, assuming that the US Company does not have an Indian subsidiary to trigger indirect transfer provisions, was not considered as accruing or arising in India and therefore is not taxable in India.

In the present case, one may be able to argue that even if the transaction value exceeds the threshold limit, the SEP provisions would not be triggered if the sale is not a part of the business of the US resident seller. This would be so as the constitution of an SEP results in the constitution of a business connection. Therefore, for SEP to be constituted, the transaction needs to be in respect of business income and not in respect of a capital asset. Section 9(1)(i) clearly differentiates between business connection and an asset situated in India.

In other words, SEP would only apply to transactions, the income from which would constitute business income. Accordingly, income from sale of shares, not being the business income of the US resident seller, would not trigger SEP provisions.
It is important to highlight that what is sought to be covered under the SEP provisions is business income and a transaction of sale of property which is not a part of the business of the non-resident seller may not be covered. However, this does not mean that a single transaction is outside the scope of SEP provisions. Let us take the example of a heavy machinery manufacturer in Germany who sells his machines globally. If the price of a single machine exceeds the threshold value, a single sale by the German manufacturer to a person in India may trigger the SEP provisions as the income from such sale is a part of his business income. While the Supreme Court in the case of CIT vs. R.D. Aggarwal & Co., (1965) (56 ITR 20, 24), held that a stray or isolated transaction is normally not to be regarded as a business connection, this position may no longer hold good for transactions triggering SEP as the SEP provisions require fulfilment of subjective conditions.

But then, what is meant by a ‘person in India’? While most of the sections in the Act refer to a ‘person resident in India’, Explanation 3A refers to a ‘person who resides in India’. Given the intention to tax a non-resident on account of the economic connection with India, there needs to be a semblance of permanent connection of the transaction with India. This permanent connection may not be satisfied in the case of a person who is visiting India for a short visit and is, say, availing the services from the non-resident. Therefore, one may argue that a person in India in Explanation 2A would mean a person resident in India. Further, the term ‘resides’ may connote a continuous form of residence and, therefore, in such a scenario also, one may be able to argue that the term refers to a person resident in India.

2.3 Systematic and continuous soliciting of business activities or engaging in interaction with such number of users in India
The second condition for the constitution of an SEP is systematic and continuous soliciting of business activities or engaging in interaction with a prescribed number of users in India.

There are two types of transactions which would be covered under the condition (subject to the fulfilment of the number of users in India threshold):
a) Systematic and continuous soliciting of business activities; and
b) Engaging in interaction.

There is ambiguity as to what constitutes ‘users’, ‘soliciting’ as well as ‘engaging in interaction’. As highlighted earlier, while the conditions required the above activities to be undertaken through digital means at the time SEP provisions were introduced by the Finance Act, 2018, the Finance Act, 2020 removed the requirement of digital means, thereby possibly expanding the scope of the transactions covered.

We need to wait and see how the threshold limits along with conditions, if any, are prescribed.

Some of the activities which may be covered under this condition would be social media companies, support services which engage with multiple users in India, online advertisement services, etc.

2.4 Profits attributable to SEP
The second proviso to Explanation 2A provides that only so much of income as is attributable to the transactions or activities referred to in clause (a) or clause (b) shall be deemed to accrue or arise in India. Explanation 1(a) to section 9(1)(i), on the other hand, seeks to cover income attributable to operations carried out in India.

Given the peculiar language used in the 2nd proviso to Explanation 2A, this may result in a scenario where the entire income arising out of a transaction or activity would be considered as accruing or arising in India.

Let us take an example to understand the impact and such a possible absurd outcome in detail. A non-resident who manufactures certain goods outside India sells such goods in India under two scenarios – through a sales office in India and directly without any physical presence in India. Assuming that in both scenarios the sale of the goods is concluded outside India, in the first scenario the activities undertaken by the sales office could result in the constitution of business connection under Explanation 2 if the employees in the sales office habitually play a principal role in the conclusion of contracts of the non-resident in India. In such a scenario, Explanation 3 provides that only the income as is attributable to the activities of the sales office would be deemed to accrue or arise in India. Therefore, only a part of the profits of the non-resident, which represents the amount attributable to the activities of the sales office, let us say xx% on the basis of various judicial precedents, would be taxable in India.

However, in the second scenario, assuming that the threshold as prescribed in Explanation 2A is met, the transaction of the sale of goods to a person resident in India could constitute an SEP in India. In such a scenario, the moot question that arises for consideration is whether on a literal reading of the 2nd proviso to Explanation 2A, it can be said that in such a transaction the entire income is attributable to the ‘transaction’ and shall be deemed to accrue or arise in India?

In other words, if a business connection is constituted on account of operations carried out in India, only part of the profits would be taxed in India, whereas if the business connection is constituted on account of the SEP in India, it is open to question as to whether the entire income of the non-resident could be attributed and deemed to accrue or arise in India.

Similarly, the entire income of a social media company outside India engaging with a large number of users in India could be taxed in India if the number of users exceeds the threshold and results in the constitution of an SEP in India.

Such a view, on a literal interpretation of the amended provisions, would not be in consonance with the global discussion on the subject currently in progress at various international fora.

Such a view would also not be in line with the discussion contained in the BEPS Action Plan 1 Report which provides:
‘Consideration must therefore be given to what changes to profit attribution rules would need to be made if the significant economic presence option were adopted, while ensuring parity to the extent possible between enterprises that are subject to tax due to physical presence in the market country (i.e., local subsidiary or traditional PE) and those that are taxable only due to the application of the option.’

Further, the BEPS Action Plan 1 Report analyses three options while attributing profits to the SEP:
a) Replacing functional analysis with an analysis based on game theory that would allocate profits by analogy with a bargaining process within a joint venture. However, the Report appreciates that this method would mean a substantial departure from the existing standard for allocation of profits on the basis of functions, assets and risks and, therefore, unless there is a substantial rewrite of the rules for the attribution of profits, alternative methods would need to be considered;
b) The fractional apportionment method wherein the profits of the whole enterprise relating to the digital presence would be apportioned either on the basis of a predetermined formula or on the basis of variable allocation factors determined on a case-by-case basis. However, this method is not pursued further as it would mean a departure from the existing international standard of attributing profits on the basis of separate books of the PE;
c) The deemed profit method wherein the SEP for each industry has a deemed net income by applying a ratio of the presumed expenses to the taxpayer’s revenue derived in the country. While this option is relatively easier to administer, it has its own set of challenges, such as, if the entity on a global level has incurred a loss, would the deemed profit method still allocate a notional profit to the SEP?

Similarly, the draft Directive, introduced by the European Commission on ‘significant digital presence’, provided for a modified profit-split as the method to attribute the profits to the SEP. The draft Directive, introduced in 2018, was not enacted due to lack of consensus amongst the members of the European Union.

In both the examples above, in the context of profits attributable to the SEP, one may be able to argue that taxing activities undertaken outside India result in extra-territorial taxation by India and, therefore, go beyond the sovereign right of the country to tax such income.

The CBDT has recognised this need to provide clarity for profit attribution to the SEP and has included a chapter on the same in its draft report on Profit Attribution to Permanent Establishments (CBDT Press Release F 500/33/2017-FTD.I dated 18th April, 2019) (draft report).

The draft report provides that in the case of an SEP, in addition to the traditional equal weightage given to assets, employees and sales, one can consider giving weightage to users as well in the case of digitised businesses depending on the level of user intensity. The draft report proposes the weight of 10% to users in business models involving low / medium user intensity and 20% in business models involving high user intensity.

It is important to note that the report, when finalised and notified, would be forming a part of the Rules and in the absence of any reference to attribution of profits to the SEP in Explanation 2A, one may need to further analyse the application on finalisation of the rules.

2.5 Summary of SEP provisions
The SEP provisions have been summarised below:

3. EXPLANATION 3A TO SECTION 9(1)(i) (EXTENDED SOURCE RULE)
Following global discussions, the Finance Act, 2020 extended the source rule for income attributable to operations carried out in India by inserting Explanation 3A to section 9(1)(i), which reads as under:
‘Explanation 3A. – For the removal of doubts, it is hereby declared that the income attributable to the operations carried out in India, as referred to in Explanation 1, shall include income from –
(i)    such advertisement which targets a customer who resides in India or a customer who accesses the advertisement through an internet protocol address located in India;
(ii)    sale of data collected from a person who resides in India or from a person who uses an internet protocol address located in India; and
(iii)    sale of goods or services using data collected from a person who resides in India or from a person who uses an internet protocol address located in India.’

The following proviso has been inserted in Explanation 3A to clause (i) of sub-section (1) of section 9 by the Finance Act, 2020 w.e.f. 1st April, 2022:
‘Provided that the provisions contained in this Explanation shall also apply to the income attributable to the transactions or activities referred to in Explanation 2A.’

3.1 Whether Explanation 3A creates nexus?
Unlike Explanation 2A, which equates SEP to a business connection, the language used in Explanation 3A is different.

Explanation 3A to section 9(1)(i) provides,
‘For the removal of doubts, it is hereby declared that the income attributable to the operations carried out in India, as referred to in Explanation 1, shall include….’

Explanation 1 provides that in the case of a business of which all the operations are not carried out in India, only part of the income as is reasonably attributable to the operations carried out in India shall be deemed to accrue or arise in India.

Further, the nexus for income deemed to accrue or arise in India in the form of business connection in India or property in India or source of income in India, etc., is provided in the main section 9(1)(i).

Now, the question arises whether Explanation 1 can be applied without a nexus in section 9(1)(i)? One may argue that having established a nexus in the form of business connection, asset or source of income in India, Explanation 1 merely provides the amount of income attributable to the said nexus and, therefore, in the absence of a nexus u/s 9(1)(i), Explanation 1 cannot be applied.

In this regard, the role of ‘Explanation’ in a tax statute has been explained by the Karnataka High Court in the case of N. Govindraju vs. ITO (2015) (377 ITR 243) in the context of Explanation vs. proviso, wherein it was held,
‘37. Insertion of “Explanation” in a section of an Act is for a different purpose than insertion of a “proviso”. “Explanation” gives a reason or justification and explains the contents of the main section, whereas “proviso” puts a condition on the contents of the main section or qualifies the same. “Proviso” is generally intended to restrain the enacting clause, whereas “Explanation” explains or clarifies the main section. Meaning, thereby, “proviso”’ limits the scope of the enactment as it puts a condition, whereas “Explanation” clarifies the enactment as it explains and is useful for settling a matter or controversy.
38. Orthodox function of an “Explanation” is to explain the meaning and effect of the main provision. It is different in nature from a “proviso” as the latter excepts, excludes or restricts, while the former explains or clarifies and does not restrict the operation of the main provision. It is true that an “Explanation” may not enlarge the scope of the section but it also does not restrict the operation of the main provision. Its purpose is to clear the cobwebs which may make the meaning of the main provision blurred. Ordinarily, the purpose of insertion of an “Explanation” to a section is not to limit the scope of the main provision but to explain or clarify and to clear the doubt or ambiguity in it.’

The above decision lends weight to the argument that in the absence of a nexus in section 9(1)(i), Explanation 1 cannot apply. Having taken such a view, one may therefore possibly conclude that as Explanation 1 does not create a nexus and as Explanation 3A merely extends the scope of Explanation 1 in terms of income as is attributable to the operations carried out in India, Explanation 3A shall not apply unless the non-resident has a business connection. In other words, Explanation 3A merely acts like a ‘force of attraction’ provision in the Act and does not create a nexus by itself.

It may be highlighted that the above view that in the absence of a nexus u/s 9(1)(i), Explanation 1 shall not apply, is not free from doubt. Another possible view is that Explanation 1 refers to the income which is deemed to accrue or arise in India and therefore creates a nexus by itself irrespective of the fact as to whether or not there exists a business connection. One will have to wait for the judicial interpretation in this regard to see whether the judiciary reads down the extended source rule in Explanation 3A.

3.2  What is sought to be taxed through Explanation 3A
Explanation 3A seeks to extend the scope of income attributable to operations carried out in India in the case of three scenarios:
a) Sale of advertisement;
b) Sale of data; and
c) Sale of goods or services using data.

In respect of (a) and (b) above, the same is also covered by the extended EL provisions as applicable to e-commerce supply or services. Further, section 10(50) of the Act, as proposed to be amended by the Finance Bill, 2021, provides that income other than royalty or fees for technical services shall be exempt under the Act if the said transaction is subject to EL. Therefore, in respect of transactions covered under (a) or (b), the provisions of EL would apply and Explanation 3A may not be applicable.

Therefore, only the provisions of (c) have been analysed.

While Explanation 2A seeks to cover a transaction of a non-resident with a person residing in India, Explanation 3A does not require such conditions. In other words, even transactions between two non-residents may be subject to tax under Explanation 3A if the transaction:
a)    In the case of sale of advertisement, targets a customer residing in India;
b)    In the case of sale of data, is in respect of data collected from a person residing in India; or
c) In the case of sale of goods or services, is using data collected from a person residing in India.

For example, ABC, a foreign company owning a social media platform having various users all over the world, including India, is engaged by FCo, a foreign company engaged in the business of apparels, to provide data analytics services to enable FCo to understand the consumption pattern in Asia in order to enable it to target customers in Europe. It is assumed that the data analytics service is undertaken outside India.

In this scenario, as ABC is providing a service to FCo, both non-residents, using data collected from persons residing in India in addition to other countries, Explanation 3A may apply and, therefore, deem the income from sale of services to be accruing or arising in India. While, arguably, only the portion of the income which relates to the data collected from India should be taxed in India, it may be practically difficult, if not impossible, in such a scenario to bifurcate such income on the basis of data collected from every country.

Moreover, as this would be a transaction between two non-residents, the question of extra-territoriality as well as the practical difficulty of implementing the taxation of such transactions may need to be evaluated in detail.

The issues relating to the attribution of income – whether the entire income is deemed to accrue or arise in India or is only a part of the income (and if so, how is the same to be computed) is to be taxed, as explained above in the context of SEP would equally apply here as well. In fact, as the CBDT draft report on profit attribution to PE was released before the Finance Act, 2020, there is no guidance available to provide clarity in this matter.

4. CONCLUSION


Currently, the provisions of SEP are not yet operative as the thresholds have not yet been prescribed. Further, the SEP provisions as well as those related to extended scope have limited application due to the benefit available in the DTAAs. However, with treaty eligibility being questioned in various transactions in the recent past and with the application of the MLI, these provisions may be of greater significance. Therefore, it is imperative that some of the aforementioned ambiguities, such as the amount of income attributable to the SEP and extended scope, be clarified at the earliest by the authorities.

RATE OF TAX ON DEEMED SHORT-TERM CAPITAL GAINS U/S 50

ISSUE FOR CONSIDERATION
Section 50 of the Income-Tax Act, 1961 provides for the manner of computation of capital gains arising on sale of depreciable assets forming part of a block of assets and for deeming such gains as the one on transfer of the short-term capital assets. The section reads as under:

‘Special provision for computation of capital gains in case of depreciable assets

50. Notwithstanding anything contained in clause (42A) of section 2, where the capital asset is an asset forming part of a block of assets in respect of which depreciation has been allowed under this Act or under the Indian Income-tax Act, 1922 (11 of 1922), the provisions of sections 48 and 49 shall be subject to the following modifications: –

(1) where the full value of the consideration received or accruing as a result of the transfer of the asset together with the full value of such consideration received or accruing as a result of the transfer of any other capital asset falling within the block of the assets during the previous year, exceeds the aggregate of the following amounts, namely: –
(i) expenditure incurred wholly and exclusively in connection with such transfer or transfers;
(ii) the written down value of the block of assets at the beginning of the previous year; and
(iii) the actual cost of any asset falling within the block of assets acquired during the previous year,

such excess shall be deemed to be the capital gains arising from the transfer of short-term capital assets;

(2) where any block of assets ceases to exist as such, for the reason that all the assets in that block are transferred during the previous year, the cost of acquisition of the block of assets shall be the written down value of the block of assets at the beginning of the previous year, as increased by the actual cost of any asset falling within that block of assets, acquired by the assessee during the previous year and the income received or accruing as a result of such transfer or transfers shall be deemed to be the capital gains arising from the transfer of short-term capital assets.’

In a situation where an asset which is otherwise held for more than three years but is deemed short-term capital asset, on application of section 50, for the reason such an asset forming part of the block of assets and depreciated is transferred, the issue has arisen as to the rate of tax applicable to the gains on transfer of such assets – whether such gains would be taxable in the manner prescribed u/s 112 at a concessional rate of 20%, or at the regular rates prescribed for the total income. While a few benches of the Tribunal have held that the rate applicable would be the regular rate applicable to total income including the short-term capital gains, in a number of decisions various benches of the Tribunal have taken the view that the rate applicable on such deemed short-term capital gains would be the rate applicable to long-term capital gains, i.e., the rate of 20% prescribed u/s 112. This controversy has been discussed in the BCAJ Vol. 48-B, November, 2016, Page 51, but the latest decision in Voltas Ltd. has added a new dimension to the conflict and some fresh thoughts on the subject are shared herein.

THE RATHI BROTHERS’ CASE

The issue had come up before the Pune bench of the Tribunal in the case of Rathi Brothers (Madras) Ltd. vs. ACIT, ITA No. 707/PN/2013 dated 30th October, 2014.

During the previous year relevant to A.Y. 2008-09, the assessee sold its office premises for Rs. 98,37,000. Since depreciation had been claimed on such asset in the past, the assessee computed its capital gains u/s 50 at Rs. 93,40,796, disclosed such capital gains as short-term capital gains but computed tax thereon at the rate of 20%.

It was contended before the A.O. that the tax rate u/s 112 was being applied on the gains treating the gains as long-term capital gains, though the resultant capital gains were in the nature of short-term capital gains as per the provisions of section 50 based on the decision of the Bombay High Court in CIT vs. Ace Builders (P) Ltd. 281 ITR 210. The assessee also placed reliance on the decision of the Mumbai Tribunal in the case of P.D. Kunte & Co. vs. ACIT (ITA No. 4437/Mum/05 dated 10th April, 2008).

However, the A.O. observed that the said ITAT decision was in the context of eligibility of exemption u/s 54EC in respect of capital gains computed u/s 50 on transfer of an asset held for more than three years. It was pointed out to the A.O. that in response to a miscellaneous application filed in that case the order was modified to hold that on the reasoning of the Bombay High Court in the case of Ace Builders (Supra), it naturally followed that even the tax rate applicable while bringing capital gain to tax would be as per the provisions of section 112.

However, attempting to distinguish this interpretation, the A.O. stated that section 50 was a special provision inserted to compute capital gains in respect of depreciable assets with an intention to prevent dual concession to the assessee in the form of depreciation as well as concessional rate of tax. It was also emphasised by the A.O. that even in the case decided by the Bombay High Court, the larger issue involved was the eligibility to claim deduction u/s 54E against capital gains arising on transfer of an asset on which depreciation was being claimed, even if such gains were to be computed in accordance with the provisions of section 50.

The A.O. accordingly taxed the capital gain as short-term capital gain and declined to apply the tax rate prescribed u/s 112.

The Commissioner (Appeals) dismissed the assessee’s appeal, holding that section 50 was enacted with the objective of denying multiple benefits to the owners of assets. According to him, the rationale behind enacting such a deeming provision u/s 50 was that the assessee had already availed benefits in the form of depreciation in case of depreciable assets, and it was not equitable to extend dual benefit of depreciation as well as concessional tax rate of 20% to capital gains arising on transfer of depreciable assets.

On behalf of the assessee it was argued before the Tribunal that since the asset was held for more than three years, it was a long-term capital asset as defined in section 2(14), and capital gain computed even u/s 50 is to be treated as long-term capital gain. The Bombay High Court in Ace Builders (Supra) had held that section 50 is a deeming provision, hence the same is to be interpreted to the extent to achieve the object of the said provision. Reliance was also placed by the assessee on the Mumbai Tribunal decision in the case of P.D. Kunte & Co. (Supra).

The Tribunal refused to accept the argument that in case of Ace Builders the Bombay High Court had held that even capital gain computed u/s 50 is to be treated as long-term capital gain. According to the Tribunal, the High Court had explained that if the capital gain was computed as provided u/s 50, then the capital gains tax would be charged as if such capital gain had arisen out of a short-term capital asset. The Tribunal also did not follow the Mumbai Tribunal decision in the case of P.D. Kunte & Co. on the ground that this ground had remained to be adjudicated in that case.

The Tribunal therefore held that such capital gains was not eligible for the 20% rate of tax applicable to long-term capital gains u/s 112.

A similar view has been taken by the Mumbai bench of the Tribunal in the cases of ACIT vs. SKF Bearings India Ltd. (ITA No. 616/Mum/2006 dated 29th December, 2011), SKF India Ltd. vs. Addl. CIT (ITA No. 6461/Mum/2009 dated 24th February, 2012) and Reckitt Benckiser (India) Ltd. vs. ACIT, 181 TTJ 384 (Kol.).

THE VOLTAS CASE

The issue came up again recently before the Mumbai bench of the Tribunal in the case of DCIT vs. Voltas Ltd. TS-566-ITAT-2020(Mum).

In this case, the assessee had sold buildings which were held for more than three years. The assessee claimed that the capital gains on the sale of the buildings should be taxed at 20% u/s 112 instead of at 30%, the rate applicable to short-term capital gains.

It was argued on behalf of the assessee before the Tribunal that the issue was covered in favour of the assessee by the Mumbai Tribunal decision in the case of Smita Conductors Ltd. vs. DCIT 152 ITD 417. Reliance was also placed on the decision of the Bombay High Court (actually of the Supreme Court, affirming the decision of the Bombay High Court) in the case of CIT vs. V.S. Dempo Company Ltd. 387 ITR 354 and the decision of the Supreme Court (actually of the Bombay High Court) in the case of CIT vs. Manali Investment [219 Taxman 113 (Bombay)(Mag.)] and it was argued that both Courts had held that the deeming provision of the section could not be extended beyond the method of computation of the cost of acquisition involved.

It was argued on behalf of the Revenue that section 50, being a special provision for computation of capital gains in case of depreciable assets, specifically provides in the concluding paragraph that the income accrued or arising as a result of such transfer shall be deemed to be income from transfer of a short-term capital asset. It was submitted that the language of the Act was very clear and unambiguous. It was argued that there would have been scope for ambiguity only if the term ‘short term’ was not used. It was submitted that when the Act provides that such gain would be gain arising from short term capital asset, there was no reason why the term ‘short term’ appearing in that provision should be regarded as superfluous. It was argued that when the Act was so clear there could not be any dispute about the rate of tax applicable for short-term capital gain.

The Tribunal analysed the provisions of section 50 and the decisions in the cases of V.S. Dempo (Supra) and Manali Investment (Supra). It noted the observations of the Bombay High Court (actually the Supreme Court) that section 50 is only restricted for the purpose of sections 48 and 49 as specifically stated therein, and the fictions created in sub-sections (1) and (2) have limited application only in the context of the mode of computation of capital gains contained in sections 48 and 49. The fictions have nothing to do with exemption that is provided in a totally different provision, viz., section 54EC. The Tribunal cited with approval the observations of the Bombay High Court in the case of Ace Builders (Supra) and noted that the Gujarat and Gauhati High Courts had taken a similar view in the cases of CIT vs. Polestar Industries 221 Taxman 423 and CIT vs. Assam Petroleum Industries (P) Ltd. 262 ITR 587, respectively. It also noted the Supreme Court (Bombay High Court) decision in the case of Manali Investment where the Supreme Court (Bombay High Court) permitted set-off of brought forward long-term capital loss against gains computed u/s 50 on sale of an asset which had been held for more than three years.

The Tribunal observed that the higher Courts had held that the deeming fiction of section 50 was limited and could not be extended beyond the method of computation of capital gain and that the distinction between long-term and short-term capital gains was not obliterated by this section. The Tribunal, therefore, allowed the appeal of the assessee on this ground.

A similar view has been taken by the Tribunal in the cases of Smita Conductors vs. DCIT 152 ITD 417 (Mum.), Poddar Brothers Investments Pvt. Ltd. vs. DCIT [ITA 1114/Mum/2013 dated 25th March, 2015), Castrol India Ltd. vs. DCIT [ITA 195/Mum/2012 dated 18th October, 2016], Yeshwant Engineering Pvt. Ltd. vs. ITO [ITA 782/Pun/2015 dated 9th October, 2017], DCIT vs. Eveready Industries Ltd. [ITA 159/Kol/2016 dated 18th October, 2017], BMC Software India Pvt. Ltd. vs. DCIT (ITA 1722/Pun/2017 dated 12th March, 2020), Mahindra Freight Carriers vs. DCIT, 139 TTJ 422 and Prabodh Investment & Trading Company vs. ITO (ITA No. 6557/Mum/2008). In most of these cases, the view taken by the Tribunal in the case of Smita Conductors (Supra) has been followed.

OBSERVATIONS

Section 50 provides for modification to provisions of sections 48 and 49, while giving the mode of computation as well as stating that such excess shall be deemed to be the capital gains arising from the transfer of short-term capital assets. Both sections 48 and 49 are computation provisions and therefore section 50 really only modifies the manner of computation of capital gains.

This aspect has been clarified by various Courts as under:

In Ace Builders (Supra), the Bombay High Court has observed:
‘21. On perusal of the aforesaid provisions, it is seen that section 45 is a charging section, and sections 48 and 49 are the machinery sections for computation of capital gains. However, section 50 carves out an exception in respect of depreciable assets and provides that where depreciation has been claimed and allowed on the asset, then, the computation of capital gain on transfer of such asset under sections 48 and 49 shall be as modified under section 50. In other words, section 50 provides a different method for computation of capital gain in the case of capital assets on which depreciation has been allowed.

22. Under the machinery sections the capital gains are computed by deducting from the consideration received on transfer of a capital asset, the cost of acquisition, the cost of improvement and the expenditure incurred in connection with the transfer. The meanings of the expressions “cost of improvement” and “cost of acquisition” used in sections 48 and 49 are given in section 55. As the depreciable capital assets have also availed depreciation allowance under section 32, section 50 provides for a special procedure for computation of capital gains in the case of depreciable assets. Section 50(1) deals with the cases where any block of depreciable assets do not cease to exist on account of transfer and section 50(2) deals with cases where the block of depreciable assets cease to exist in that block on account of transfer during the previous year. In the present case, on transfer of depreciable capital asset the entire block of assets has ceased to exist and, therefore, section 50(2) is attracted. The effect of section 50(2) is that where the consideration received on transfer of all the depreciable assets in the block exceeds the written down value of the block, then the excess is taxable as a deemed short-term capital gain. In other words, even though the entire block of assets transferred are long-term capital assets and the consideration received on such transfer exceeds the written down value, the said excess is liable to be treated as capital gain arising out of a short-term capital asset and taxed accordingly.
…………………………

25. In our opinion, the assessee cannot be denied exemption under section 54E because, firstly, there is nothing in section 50 to suggest that the fiction created in section 50 is not only restricted to sections 48 and 49 but also applies to other provisions. On the contrary, section 50 makes it explicitly clear that the deemed fiction created in sub-section (1) and (2) of section 50 is restricted only to the mode of computation of capital gains contained in sections 48 and 49. Secondly, it is well established in law that a fiction created by the Legislature has to be confined to the purpose for which it is created. In this connection, we may refer to the decision of the Apex Court in the case of State Bank of India vs. D. Hanumantha Rao 1998 (6) SCC 183. In that case, the Service Rules framed by the bank provided for granting extension of service to those appointed prior to 19th July, 1969. The respondent therein who had joined the bank on 1st July, 1972 claimed extension of service because he was deemed to be appointed in the bank with effect from 26th October, 1965 for the purpose of seniority, pay and pension on account of his past service in the army as Short Service Commissioned Officer. In that context, the Apex Court has held that the legal fiction created for the limited purpose of seniority, pay and pension cannot be extended for other purposes. Applying the ratio of the said judgment, we are of the opinion that the fiction created under section 50 is confined to the computation of capital gains only and cannot be extended beyond that.’

These observations of the Bombay High Court in paragraph 25 of the Ace Builder’s decision have been reproduced and approved of by the Supreme Court in the V.S. Dempo case, thereby confirming that the fiction of section 50 is confined to the computation of capital gains only and cannot be extended beyond that.

However, in paragraph 26, the Bombay High Court has observed:
‘26. It is true that section 50 is enacted with the object of denying multiple benefits to the owners of depreciable assets. However, that restriction is limited to the computation of capital gains and not to the exemption provisions. In other words, where the long-term capital asset has availed depreciation, then the capital gain has to be computed in the manner prescribed under section 50 and the capital gains tax will be charged as if such capital gain has arisen out of a short-term capital asset, but if such capital gain is invested in the manner prescribed in section 54E, then the capital gain shall not be charged under section 45 of the Income-tax Act.’

The Mumbai bench of the Tribunal in the SKF cases as well as the Pune bench of the Tribunal in the Rathi Brothers case has relied on these observations for holding against the assessee. However, since the issue before the Bombay High Court was regarding the availability of the exemption u/s 54E, the observations regarding charge of capital gains tax should be regarded as the obiter dicta. Further, the Tribunal in these cases did not have the benefit of the Supreme Court’s decision in the V.S. Dempo case, where it had approved of the fact that the applicability of section 50 is confined to the computation of capital gains only.

The observations of the Gauhati High Court, which had also been approved by the Supreme Court in the V.S. Dempo case, can also be referred to:

‘7. Section 2(42A) defines “short-term capital asset” which means a capital asset held by an assessee for not more than thirty-six months immediately preceding the date of its transfer. Thus the assets, which have been already held for more than 36 months before it is transferred, would not be short-term capital assets. Section 2(29A) defines “long-term capital asset” means a capital asset which is not short-term capital asset. Therefore, the asset, which has been held for more than 36 months before the transfer, would be long-term capital asset. Section 2(29B) provides for “long- term capital gain”, which means capital gain arising from the transfer of a long-term capital asset.

8. All capital gains on the transfer of the capital asset whether short-term capital asset or long-term capital asset except otherwise provided in mentioned sections in section 45 of the Income-tax Act are chargeable to income-tax. How the capital gains shall be computed is laid under sections 48 and 49 of the Income-tax Act, 1961. The capital gain arising from the transfer of short-term assets under section 48 (as it stands at the relevant time) are wholly assessable to be as ordinary income after deduction as provided under section 48(1)(e) whereas the capital gain arising from the transfer of long-term capital assets are partially assessable as provided under section 48(b), which reads:

“(b) where the capital gain arises from the transfer of a long-term capital asset (hereinafter in this section referred to, respectively, as long-term capital gain and long-term capital asset) by making the further deductions specified in sub-section (2).”

9. Thus by virtue of this section, long-term capital assets would be entitled for further deduction as provided in sub-section (2) of section 48. Section 49 is a provision whereunder the general principle is laid down for computing capital gains and certain exceptions are engrafted in the section. Thus, sections 48 and 49 provide for the principles on which the capital gains shall be computed and the benefit which can be given for transfer of long-term capital assets while calculating the capital gain by virtue of sub-section (2) of section 48 wherein the assessee transferring long-term capital assets can claim further deduction as specified under sub-section (2). Section 50…….

10. By virtue of this section, notwithstanding anything contained in clause (42A) of section 2, where the short-term capital asset has been defined, if the depreciation is allowed, the procedure for computing the capital gain as provided under sections 48 and 49 would be modified and shall be substituted as mentioned in section 50. Section 50 only provides that if the depreciation has been allowed under the Act on the capital asset then the assessee’s computation of capital gain would not be under sections 48 and 49 of the Income-tax Act and it would be with modification as provided under section 50. Section 54E is the section which has nothing to do with sections 48 and 49 or with section 50 of the Income-tax Act, 1961 wherein the mode of computation of capital gain is provided.
…………………..

12. Section 50 is a special provision where the mode of computation of capital gains is substituted if the assessee has claimed the depreciation on capital assets. Section 50 nowhere says that depreciated asset shall be treated as short-term assets, whereas section 54E has an application where long-term capital asset is transferred and the amount received is invested or deposited in the specified assets as required under section 54E.’

The observations of the Madras High Court in the case of M. Raghavan vs. Asst. CIT 266 ITR 145, in the context of the purpose of section 50, are also relevant:

‘22. It would appear that the object of introducing section 50 in order to provide different method of computation of capital gain for depreciable assets was to disentitle the owners of such depreciable assets from claiming the benefit of indexing, as if indexing were to be applied, there would be no capital gain available in most cases for being brought to taxation. The value of depreciable asset in most cases comes down over a period of time, although there are cases where the sale value of a depreciated asset exceeds the cost of acquisition. The result of allowing indexing, if it were to be allowed, is to regard the cost of acquisition as being very much higher than what it actually is, to the assessee. If such boosted cost of acquisition is required to be deducted from the amount realised on sale, in most cases it would result in a negative figure, resulting in the assessee being enabled to claim a capital loss. Clearly, it could not have been the legislative intent to confer such multiple benefits to the assessees selling depreciable assets.’

Therefore, from the above it is clear that the deeming fiction of section 50 is for the limited purpose of computation in case of sale of depreciable assets where the computation has to be in the same manner as that applicable to short-term capital assets, i.e., without indexation of cost and with substituted cost of acquisition, being the written down value of the block of assets. The deeming of short-term capital gains can therefore be viewed in the context of the manner of computation of the capital gains, i.e., without the indexation of cost available u/s 48.

It may also be noted that one of the factors that weighed with the Pune bench of the Tribunal in Rathi Brothers for not following the Mumbai Tribunal decision in the P.D. Kunte & Co. case (which was the first case on the issue) was that this issue had not been decided in the P.D. Kunte & Co. case. However, the Tribunal failed to take note of the order in the Miscellaneous Application in the P.D. Kunte & Co. case (MA 394/Mum/2008 dated 6th August, 2008), where the Tribunal had allowed this ground by observing as under:

‘On the reasoning of the Hon’ble Bombay High Court in the case of Ace Builders (P) Ltd. (Supra), it naturally follows that even the tax rate applicable while bringing capital gain to tax will be as per the provisions of section 112 of the Act. The Assessing Officer is directed to apply the same’.
 
The decision of the Pune bench of the Tribunal in the said case would have been different had the amended decision delivered in the Miscellaneous Application been brought to its notice.

The better view of the matter therefore is the view taken by the Tribunal in the cases of P.D. Kunte & Co., Smita Conductors, etc., that the provisions of section 50 do not take away the benefit of the concessional rate of tax, where available, for the capital gains based on its period of holding.

[DCIT vs. S.R.A. Systems Ltd.; ITA Nos. 1497 to 1499/Mds/2009, A.Y. 2000-01 to 2001-02 (Mds.) ITAT] Section 234D – Levy of interest u/s 234D came into force from 1st June, 2003 – Prospective nature – After the commencement of the assessment year – Interest could be levied only from 1st April, 2004, i.e., from the A.Y. 2004-05 – The law to be applied is the law as on the date of commencement of the assessment year and not the change in law amended subsequent to that date Deduction u/s 10B – Undertaking – Not be formed by splitting up or reconstruction of a business already in existence – Merely by shifting business from one place to another and keeping some of the plant and machinery as those were bearing charge of financial institution – Clauses (ii) and (iii) of sub-clause (2) to section 10A were not violated

8. Commissioner of Income Tax, Chennai vs. S.R.A. Systems Ltd. [T.C. Appeal Nos. 1470 to 1472 of 2010, dated 19th January, 2021 (Bom.)]

[DCIT vs. S.R.A. Systems Ltd.; ITA Nos. 1497 to 1499/Mds/2009, A.Y. 2000-01 to 2001-02 (Mds.) ITAT]

Section 234D – Levy of interest u/s 234D came into force from 1st June, 2003 – Prospective nature – After the commencement of the assessment year – Interest could be levied only from 1st April, 2004, i.e., from the A.Y. 2004-05 – The law to be applied is the law as on the date of commencement of the assessment year and not the change in law amended subsequent to that date

Deduction u/s 10B – Undertaking – Not be formed by splitting up or reconstruction of a business already in existence – Merely by shifting business from one place to another and keeping some of the plant and machinery as those were bearing charge of financial institution – Clauses (ii) and (iii) of sub-clause (2) to section 10A were not violated

For the A.Y. 2000-01, the assessee had filed its return of income on 29th November, 2000. The assessee claimed that it was eligible for deduction u/s 10B. The return was processed on 28th March, 2002. Subsequently, the A.O. had reason to believe that income chargeable to tax had escaped assessment on account of the assessee company being ineligible for deduction u/s 10A. A notice dated 22nd March, 2007 was issued u/s 148 disallowing the entire claim of deduction u/s 10B. Further, the expenditure incurred for the renovation and repairs of the rented premises of the assessee company was disallowed by the A.O. on the ground that such expenses were in the nature of capital expenditure. The A.O. in his reassessment order noted that in terms of section 10B(ii) an undertaking in order to be eligible for deduction u/s 10B must not be formed by splitting up or reconstruction of a business already in existence. Further, he held that deduction u/s 10B was not available to the assessee in view of the provisions of section 10B(iii) which stipulate that eligible business is not formed by transfer to a new business of plant and machinery previously used for any purpose. The A.O. found that the assessee had not complied with both these conditions, hence it was not entitled to any deduction u/s 10B.

While completing the assessment u/s 143(3) r/w/s 147 for the A.Ys. 2000-01 and 2001-02, the A.O. disallowed the claim of deduction made by the assessee under sections 10A and 10B on the ground that an undertaking was formed by splitting up / reconstruction of the business already in existence. Similar disallowance was made in A.Y 2002-03 while passing an order u/s 143(3) r/w/s 263. The A.O. levied interest u/s 234D.

For the A.Y. 2002-03, on challenge the Tribunal set aside the order of the CIT after taking into consideration the decision of the Apex Court reported in 107 ITR 195 [Textile Machinery Corporation Limited vs. CIT] that held as follows:

‘… This is not a case of setting up of a new business, but only transfer of business place of existing business to a new place located in STPI area and thereafter, getting the approval from the authorities, the assessee becomes entitled to deduction u/s 10A. Merely because by shifting the business from one place to another and keeping some of the plant and machinery as those are bearing charge of financial institution, does not violate clauses (ii) and (iii) of sub clause (2) to section 10A.’

The order passed by the Income-tax Appellate Tribunal was challenged by the Department in T.C.A. No. 1916 of 2008 and the Division Bench of this Court by its judgment dated 26th October, 2018 confirmed the order of the ITAT dated 16th May, 2008 made in I.T.A. No. 2255/Mds/06 for the A.Y. 2002-03 and dismissed the appeal.

Aggrieved by the assessment order for the A.Ys. 2000-01 and 2001-02, the assessee filed appeals before the CIT(A). The Appellate Authority allowed the appeals by following the order of the Tribunal for A.Y. 2002-03. The Appellate Authority, while dealing with the levy of interest u/s 234D, held that the said section comes into effect only after the commencement of the assessment year and interest could be levied only for the A.Y. 2004-05, and therefore deleted the interest for the A.Ys. 2000-01, 2001-02 and 2002-03.

Aggrieved over the order of the CIT(A), the Department filed appeals before the Appellate Tribunal which confirmed the CIT(A) order and dismissed the appeals. While dismissing the appeals, the Tribunal held that interest u/s 234D cannot be levied for the A.Ys. 2000-01, 2001-02 and 2002-03. Further, while dismissing the appeals, the Tribunal followed the order in I.T.A. No. 2255/Mds/06 dated 16th May, 2008.

Still aggrieved, the Department filed the appeals before the High Court. The Court held that, in view of the judgment of the Division Bench of this Court, it is clear that the applicability of clauses (ii) and (iii) of sub-clause (2) to section 10B, the impugned order passed by the ITAT is proper. In view of the order passed by the ITAT of 16th May, 2008 in I.T.A. No. 2255/Mds/06 and the judgment passed by the Division Bench of this Court on 26th October, 2018 in Tax Case Appeal No. 1916 of 2008, the assessee company would be entitled to deduction u/s 10A and the disallowance made by the A.O. was not correct. For A.Y. 2002-03, since the order passed u/s 263 itself had been set aside, the cause of action for reassessment does not survive.

So far as the levy of interest u/s 234D is concerned, the Court held that the section came to be inserted by the Finance Act, 2003 with effect from 1st June, 2003. Prior to that, no interest was payable on refund in the event of an order for refund being set aside and the assessee is made to pay the same from the date of rectification order or the orders passed by the Appellate Authorities. A reading of the provisions of section 234D makes it clear that there is no indication in the language employed in the entire section that the Parliament intended to make this levy of tax on excess refund retrospective. On the contrary, after inserting this provision in the Act it is specifically stated that it comes into effect from 1st June, 2003. Though the amendment is by insertion, the Parliament has expressly stated that the amendment comes into effect from 1st June, 2003. Parliament has made its intention clear and unambiguous. In other words, it is not retrospective. Merely because the order of assessment was passed subsequent to the insertion of the said provision in the Act, would not make the said provision retrospective. The provision providing imposition of interest is a substantive provision. It is settled law that in the absence of any express words used in the provision making levy of interest retrospective, it can only be prospective (i.e.) from the date on which it came into force, viz., 1st June, 2003.

The Constitution Bench of the Apex Court in the case of Karimthuravi Tea Estate Ltd. vs. State of Kerala reported in 1966 60 ITR 262 SC held as follows:

‘…It is well settled that the Income-tax Act as it stands amended on the first day of April of any financial year must apply to the assessments of that year. Any amendments in the Act which come into force after the first day of April of a financial year would not apply to the assessment for that year even if the assessment is actually made after the amendments come into force.’

The amended provision shall come into force only after the commencement of the assessment year and cannot be applied retrospectively unless it is specifically mentioned. Therefore, the law to be applied is the law as on the date of commencement of the assessment year and not the change in law amended subsequent to that date. Section 234D having come into force only on 1st June, 2003, i.e., after the commencement of the assessment year, interest could be levied only from 1st April, 2004, that is, from the A.Y. 2004-05, and no interest u/s 234D could be chargeable prior to the A.Y. 2004-05. Since all the three assessment years are prior to the A.Y. 2004-05, the provisions of section 234D cannot be applied. Accordingly, the Revenue appeals were dismissed.

CSR – WHETHER A DAY 1 OBLIGATION?

BACKGROUND
The main provisions of section 135 of the Companies Act, 2013 as amended can be summarised as under:
* Certain specified companies are required to spend 2% of the average net profit made in the immediately preceding three years on CSR activities as specified in the relevant schedule;
* Earlier, in case of unspent CSR amounts, Boards were required to specify the reasons for not spending the amount in the Board report;
* On the basis of the recent amendment notified in the Official Gazette, in case of unspent CSR amounts, the companies are required to transfer these to a separate government fund within six months of the expiry of the financial year, unless that unspent amount pertains to ongoing CSR projects;
* In case of unspent CSR amounts pertaining to ongoing CSR projects, the companies are required to transfer such amounts within a period of thirty days from the end of the financial year to a special account opened
with a scheduled bank and to be called ‘Unspent Corporate Social Responsibility Account’; such amount shall be spent by the company within a period of three financial years from the date of such transfer, failing which they are required to transfer the unspent CSR amount in a separate government fund;
* Further, if the company spends an amount in excess of its obligation in a year, the excess amount so incurred can be set off against the CSR obligation of the immediately succeeding three financial years subject to certain conditions.

QUESTION

On the basis of this amendment, the company has a clear statutory obligation as at balance sheet date to transfer the unspent amount to the government fund / special account; accordingly, a liability for unspent amount needs to be recognised in the financial statements. If the company decides to adjust such excess incurred amount against future obligation, then to the extent of such excess an asset as prepaid expense needs to be recognised in the financial statements.

How should the amount required to be spent on CSR in a financial year be accounted for? Can it be recognised evenly over the four quarters or on an as-incurred basis, or should the obligation be provided for on Day 1 of the financial year?

RESPONSE

The following references in Ind AS 37, Provisions, Contingent Liabilities and Contingent Assets are relevant for the purpose of responding to the question.

Definitions under Paragraph 10

A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.

An obligating event is an event that creates a legal or constructive obligation that results in an entity having no realistic alternative to settling that obligation.

Appendix C Levies

1. A government may impose a levy on an entity. An issue arises when to recognise a liability to pay a levy that is accounted for in accordance with Ind AS 37, Provisions, Contingent Liabilities and Contingent Assets.

4. For the purposes of this Appendix, a levy is an outflow of resources embodying economic benefits that is imposed by governments on entities in accordance with legislation (i.e. laws and / or regulations), other than:
a)    those outflows of resources that are within the scope of other Standards (such as income taxes that are within the scope of Ind AS 12, Income Taxes); and
b)    fines or other penalties that are imposed for breaches of the legislation.

8. The obligating event that gives rise to a liability to pay a levy is the activity that triggers the payment of the levy, as identified by the legislation. For example, if the activity that triggers the payment of the levy is the generation of revenue in the current period and the calculation of that levy is based on the revenue that was generated in a previous period, the obligating event for that levy is the generation of revenue in the current period. The generation of revenue in the previous period is necessary, but not sufficient, to create a present obligation.
    
11. The liability to pay a levy is recognised progressively if the obligating event occurs over a period of time (i.e., if the activity that triggers the payment of the levy, as identified by the legislation, occurs over a period of time). For example, if the obligating event is the generation of revenue over a period of time, the corresponding liability is recognised as the entity generates that revenue.

ANALYSIS

On the basis of paragraph 4, Appendix C Levies, CSR liability is a levy. The obligating event for incurring CSR expenditure occurs on Day 1 of the financial year, because if the company is in existence on that day and had an average net profit in the preceding three financial years, the liability is crystallised. The company is liable to incur the CSR expenditure, even if later during the financial year it was wound up or merged with another company or incurred heavy losses.

Accordingly, although the CSR expenditure would be incurred throughout the financial year, the obligating event that gives rise to the CSR liability isthe existence of the company on Day 1 of the financial year, and the average net profit of the preceding three financial years of the Company should be a positive number. This analysis is clear from a combined reading of Paragraphs 8 and 11 of Appendix C Levies.

The expenditure on the CSR liability may occur evenly or unevenly throughout the financial year. That is of no relevance to the recognition of the liability. The liability will be recognised on Day 1 of the financial year. The actual expenditure is the adjustment of the already crystallised CSR liability.

Even if a company does not incur the expenditure in the financial year, it will have to transfer the unspent amount to an ‘Unspent CSR’ account. Such amount shall be spent by the company in pursuance of its obligation towards the CSR policy within a period of three financial years from the date of such transfer, failing which, the company shall transfer the same to a Fund specified in Schedule VII within a period of thirty days from the date of completion of the third financial year.

CONCLUSION


Currently there appears to be a mixed practice on when a CSR liability is recognised. Some listed companies recognise the liability on Day 1, whereas others recognise the liability over four quarterly periods. This has to change, and the CSR liability should be recognised on Day 1 of the financial year. For companies that are not listed and do not present quarterly accounts, this issue will be largely theoretical.  

Reassessment – Validity – Sections 147 and 148 – Failure to furnish reasons recorded by A.O. – Furnishing of reasons while matter pending before Tribunal to cure default in first instance – Order of Tribunal remanding matter and subsequent assessment and demand notice set aside

47. New Era Shipping Ltd. vs. CIT [2020] 430 ITR 431 (Bom.) Date of order: 27th October, 2020 A.Y.: 2004-05

Reassessment – Validity – Sections 147 and 148 – Failure to furnish reasons recorded by A.O. – Furnishing of reasons while matter pending before Tribunal to cure default in first instance – Order of Tribunal remanding matter and subsequent assessment and demand notice set aside

Upon receipt of notice u/s 148 for the A.Y. 2004-05, the assessee requested for the reasons for the notice. No reasons were furnished and the A.O. passed a reassessment order u/s 147. The reasons were ultimately furnished to the assessee before the Tribunal which remanded the matter to the A.O.

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

‘i) It was not open to the A.O. to refuse to furnish the reasons for issuing notice u/s 148. By such refusal, the assessee was deprived of the valuable opportunity of filing objections to the reopening of the assessment u/s 147. The approach of the A.O. was contrary to the law laid down by the Supreme Court.

ii) On the facts, the furnishing of reasons for reopening of the assessment at the stage when the matter was pending before the Tribunal could not cure the default in the first instance. The remand ordered by the Tribunal and the consequential assessment order and demand notice issued on the basis thereof were set aside.’

Loss – Set-off – Deduction u/s 10B – Scope of sections 10B and 70 – Assessee having three industrial units two of which export-oriented – Assessee not claiming deduction u/s 10B – Deduction cannot be thrust on it – Assessee entitled to set off losses from export-oriented units against profits of domestic tariff area unit

46. Karle International Pvt. Ltd. vs. ACIT [2020] 430 ITR 74 (Karn.) Date of order: 7th September, 2020 A.Y.: 2008-09

 

Loss – Set-off – Deduction u/s 10B – Scope of sections 10B and 70 – Assessee having three industrial units two of which export-oriented – Assessee not claiming deduction u/s 10B – Deduction cannot be thrust on it – Assessee entitled to set off losses from export-oriented units against profits of domestic tariff area unit

 

The assessee was a private limited company engaged in the business of manufacture and export of readymade garments. For the A.Y. 2008-09 the assessee filed the return of income declaring total income of Rs.12,89,760. The assessee had three units, two of which were export-oriented, and showed profit and loss from all of them. The assessee had set off losses of the units against the profits of the unit making profits and offered the balance to tax under the head ‘Income from business’. The A.O., inter alia, held that losses of the export-oriented units could not be allowed to be set off against the profits of unit No. I.

 

The Commissioner (Appeals) and the Tribunal upheld the decision of the A.O.

 

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

 

‘i) It is a well-settled legal proposition that where the assessee does not want the benefit of deduction from the taxable income, it cannot be thrust upon the assessee. Section 10B is not a provision in the nature of an exemption but provides for a deduction of such profit and gains as are derived by 100% export-oriented undertakings from the export of articles or things or computer software.

 

ii) Section 10B does not contain any prohibition that prevents an assessee from setting off losses from one source against income from another source under the same head of income as prescribed u/s 70. Section 10B(6)(ii) restricts the carrying forward and setting off of loss under sections 72 and 74 but does not provide anything regarding intra-head set-off u/s 70 and inter-head set-off u/s 71. The business income can be computed only after setting off business loss against the business income in the year in accordance with the provisions of section 70.

 

iii) Section 10A is a code by itself and section 10A(6)(ii) does not preclude the operation of sections 70 and 71. Paragraph 5.2 of the Circular issued by the Central Board of Direct Taxes dated 16th July, 2013 [(2013) 356 ITR (St.) 7] clearly provides that income or loss from various sources, i. e., eligible and ineligible units under the same head, are aggregated in accordance with the provisions of section 70.

 

iv) The assessee was entitled to set off the loss from the export-oriented unit against the income earned in the domestic tariff area unit in accordance with section 70.’

Housing project – Special deduction u/s 80-IB(10) – Principle of proportionality – Projects comprising eligible and ineligible units – Assessee can be given special deduction proportionate to units fulfilling conditions laid down in section 80-IB(10)

45. Devashri Nirman LLP vs. ACIT [2020] 429 ITR 597 (Bom.) Date of order: 26th November, 2020 A.Ys.: 2007-08 to 2011-12

Housing project – Special deduction u/s 80-IB(10) – Principle of proportionality – Projects comprising eligible and ineligible units – Assessee can be given special deduction proportionate to units fulfilling conditions laid down in section 80-IB(10)

The assessee’s housing projects DG and VV comprised 105 and 90 residential units, respectively. The assessee was denied the deduction u/s 80-IB by the A.O. on the ground that the area of five residential units in DG and three residential units in VV exceeded 1,500 square feet which was in breach of the conditions prescribed in clause (c) of section 80-IB(10).

The Commissioner (Appeals) directed the A.O. to allow deduction u/s 80-IB(10) on a proportionate basis. The Tribunal dismissed the appeals filed by both the assessee and the Department.

On appeals by the assessee and the Department, the Bombay High Court held as under:

‘i) Clause (c) of section 80-IB(10) does not exclude the principle of proportionality in any manner.

ii) The Tribunal was justified in holding that the assessee was entitled to deduction u/s. 80-IB(10) on proportionate basis. The view taken by the Commissioner (Appeals) and the Tribunal need not be interfered with.’

Exempt income – Disallowance u/s 14A – Disallowance of expenditure incurred to earn exempt income – No evidence of such expenditure – Failure by A.O. to record dissatisfaction – No disallowance could be made u/s 14A

44. CIT vs. Brigade Enterprises Ltd. (No. 2) [2020] 429 ITR 615 (Karn.) Date of order: 22nd October, 2020 A.Y.: 2009-10

Exempt income – Disallowance u/s 14A – Disallowance of expenditure incurred to earn exempt income – No evidence of such expenditure – Failure by A.O. to record dissatisfaction – No disallowance could be made u/s 14A

The assessee was engaged in the business of real estate development. For the A.Y. 2009-10 the A.O. made a disallowance u/s 14A.

The Commissioner (Appeals) sustained the disallowance of the interest disallowed u/s 14A read with Rule 8D of the Income-tax Rules, 1962, to the extent of Rs. 1,09,99,962 u/s 14A read with Rule 8D(2)(iii) and deleted the disallowance of interest u/s 14A read with Rule 8D(2)(ii) to the extent of Rs. 15,27,310. The Tribunal, inter alia, held that there was no material on record to substantiate that overdraft account was utilised for making tax-free investments and the investment proceeds were from the public issue of shares. Therefore, it could not be held that funds from the overdraft account from which interest had been paid had been invested in mutual funds which yielded income exempt from tax. Thus, deletion of disallowance u/s 14A read with Rule 8D(2)(ii) to the tune of Rs. 15,27,310 was upheld.

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

‘i) The A.O. had not rendered any finding with regard to the incorrectness of the claim of the assessee either with regard to its accounts or that he was not satisfied with the claim of the assessee in respect of such expenditure in relation to exempt income as is required in accordance with section 14A(2) for making a disallowance under Rule 8D.

ii) Thus, the Tribunal had rightly concluded that the A.O. had not recorded the satisfaction with regard to the claim of the assessee for disallowance u/s 14A read with Rule 8D(2). Section 14A was not applicable.’

Business expenditure – Deduction u/s 37 – Company – Discount on employees stock option plan – Deductible

43. CIT (LTU) vs. Biocon Ltd. [2020] 430 ITR 151 (Karn.) Date of order: 11th November, 2020 A.Y.: 2004-05

Business expenditure – Deduction u/s 37 – Company – Discount on employees stock option plan – Deductible

The following question of law was raised before the Karnataka High Court:

‘Whether on the facts and in the circumstances of the case and in law the Tribunal was right in holding that the discount on issue of Employees Stock Option Plan (ESOP) is allowable deduction in computing the income under the head profits and gains of the business?’

The High Court held as under:

‘i) From a perusal of section 37(1) it is evident that the provision permits deduction of expenditure laid out or expended and does not contain a requirement that there has to be a pay-out. If an expenditure has been incurred, section 37(1) would be attracted. Section 37 does not envisage incurrence of expenditure in cash.

ii) An assessee is entitled to claim deduction under the provision if the expenditure has been incurred. It is well settled in law that if a business liability has arisen in the accounting year, it is permissible as deduction even though the liability may have to be quantified and discharged at a future date.

iii) Section 2(15A) of the Companies Act, 1956 defines “employees stock option” to mean option given to whole-time directors, officers or the employees of the company, which gives such directors, officers or employees the benefit or right to purchase or subscribe at a future date to securities offered by the company at a pre-determined price. In an employees stock option plan, a company undertakes to issue shares to its employees at a future date at a price lower than the current market price. The employees are given stock options at a discount and the same amount of discount represents the difference between the market price of shares at the time of grant of option and the offer price. In order to be eligible for acquiring shares under the scheme, the employees are under an obligation to render their services to the company during the vesting period as provided in the scheme. On completion of the vesting period in the service of the company, the option vests with the employees.

iv) The expression “expenditure” also includes a loss and therefore, issuance of shares at a discount where the assessee absorbs the difference between the price at which they are issued and the market value of the shares would be expenditure incurred for the purposes of section 37(1). The primary object of the exercise is not to waste capital but to earn profits by securing consistent services of the employees and, therefore, it cannot be construed as short receipt of capital.

v) The deduction of the discount on the employees stock option plan over the vesting period was in accordance with the accounting in the books of accounts, which had been prepared in accordance with the Securities and Exchange Board of India (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999. For A.Y. 2009-10 onwards, the A.O. had permitted the deduction of the employees stock option plan expenses. The Revenue could not be permitted to take a different stand with regard to the A.Y. 2004-05. The expenses were deductible.’

Appeal to ITAT – Duty of Tribunal to consider issue on merits – Document not filed due to mistake of counsel for assessee – Dismissal of appeal not justified – Appeal should have been decided on merits

42. Swetha Realmart LLP vs. CIT [2020] 430 ITR 159 (Karn.) Date of order: 3rd November, 2020 A.Y.: 2016-17

Appeal to ITAT – Duty of Tribunal to consider issue on merits – Document not filed due to mistake of counsel for assessee – Dismissal of appeal not justified – Appeal should have been decided on merits

 

For the A.Y. 2016-17, the assessee had filed an appeal before the Income-tax Appellate Tribunal against the order of the Commissioner (Appeals). The Tribunal, by an order dated 29th May, 2020, dismissed the appeal inter alia on the ground that in the absence of documentary evidence in support of the assessee’s claim that the property sold in question was not a depreciable asset, no ground is made out to interfere with the order passed by the Commissioner (Appeals).

 

The assessee filed an appeal before the High Court against this order of the Tribunal. The following question was raised:

 

‘Whether, in the facts and circumstances of the case, the Tribunal is right in law in dismissing the appeal instead of disposing the matter on its merits.’

 

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

 

‘i) It is trite law that for the fault committed by counsel, a party should not be penalised.

 

ii) Due to inadvertence, the senior chartered accountant engaged by the assessee could not comply with the directions of the Tribunal to file documents. The Tribunal, in fact, should have adjudicated the matter on the merits instead of summarily dismissing it. The order of dismissal was not valid.

 

iii) The substantial question of law framed by this Court is answered in favour of the assessee and against the Revenue.

 

iv) In the result, the order passed by the Tribunal is quashed. The matter is remitted to the Tribunal. Needless to state that the assessee shall file the audited accounts and computation of income as directed by the Tribunal within a period of four weeks from the date of receipt of the certified copy of the order passed today before the Tribunal. Thereupon, the Tribunal shall proceed to adjudicate the appeal on its merits.’

Appeal to Commissioner (Appeals) – Powers of Commissioner (Appeals) – Sections 246 and 251 of ITA, 1961 – Commissioner (Appeals) has power to consider claim not raised in return or revised return

41. Sesa Goa Ltd. vs. Addl. CIT [2020] 430 ITR 114 (Bom.) Date of order: 12th March, 2020 A.Y.: 2005-06


 
Appeal to Commissioner (Appeals) – Powers of Commissioner (Appeals) – Sections 246 and 251 of ITA, 1961 – Commissioner (Appeals) has power to consider claim not raised in return or revised return

 

The Bombay High Court held as under:

 

‘i) Appellate authorities under the Income-tax Act, 1961 have very wide powers while considering an appeal which may be filed by the assessee. The appellate authorities may confirm, reduce, enhance or annul the assessment or remand the case to the Assessing Officer. This is because, unlike an ordinary appeal, the basic purpose of a tax appeal is to ascertain the correct tax liability of the assessee in accordance with law.

 

ii) The Commissioner (Appeals) has undoubted power to consider a claim for deduction not raised in the return or revised return.’

 

Sections 9(1)(vi) and 44BB – As source of income is the place where income-generating activity takes place, hire charges paid under bare-boat charter agreement were deemed to accrue and arise in India and were liable to tax in India – On facts, fixed place PE of vessel providers was constituted in India – Since vessel was used in connection with prospecting of mineral oil, payment was covered u/s 44BB and hence could not be treated as royalty

11. [2021] 124 taxmann.com 56 (AAR-New Delhi) SeaBird Exploration FZ LLC, In re
A.A.R. Nos. 1284 and 1285 of 2012 Date of order: 14th January, 2021

Sections 9(1)(vi) and 44BB – As source of income is the place where income-generating activity takes place, hire charges paid under bare-boat charter agreement were deemed to accrue and arise in India and were liable to tax in India – On facts, fixed place PE of vessel providers was constituted in India – Since vessel was used in connection with prospecting of mineral oil, payment was covered u/s 44BB and hence could not be treated as royalty

FACTS

The applicant was a company incorporated in the UAE and was also a tax resident of UAE. It was engaged in the business of rendering geophysical services to the oil and gas exploration industry which involved seismic data acquisition and processing. The applicant was providing such offshore services to oil companies in India. For performing its services, the applicant required seismic survey vessels, or vessels fitted with a special kind of equipment. Accordingly, the applicant entered into a bare-boat charter agreement (BBC agreement) with two different vessel-providing companies (VPCs) for hire of two seismic survey vessels on global usage basis. The BBC agreements were neither location specific nor utilisation specific and the applicant was free to use them in any part of the world. It was required to pay hire charges irrespective of whether or not the vessels were in use. Under the BBC agreement, the vessel owner makes the ship available to the charterer and then it is for the latter to maintain and operate it in the manner it desires. The vessel owner has no role to play either in navigation or any other day-to-day operations of the ship which is at the complete disposal of the charterer. The Masters, officers and crew of the vessel are to be ‘servants’, with all operational expenses to be borne by the hirer.

The applicant contended before the AAR that the source of income can be in India only if income-generating activity was contingent upon use in India. However, in this case the source of income was connected to delivering and transferring control of the vessel to the applicant and not its subsequent utilisation in India. Since the vessels were given on hire outside India, there was no source of income in India and no income could be said to accrue or arise or deem to accrue or arise in India under the Act. Further, even if it was held that income arising from the global BBC agreement was taxable in India, income should be computed in accordance with the provisions of section 44BB. And, since section 44BB applies, income cannot be taxed as ‘royalty’ u/s 9(1)(vi).

HELD


VPCs derive income from hiring of the seismic vessels which are used for marine acquisition of seismic data and are in the nature of scientific equipment. Any consideration received for use or right to use such scientific equipment would be in the nature of royalty unless the consideration was covered under the provisions of section 44BB.

Section 44BB(2)(a) of the Act provides that: the amount paid or payable (whether in or out of India) to the assessee or to any person on his behalf on account of the provision of services and facilities in connection with, or supply of plant and machinery on hire used, or to be used, in the prospecting for, or extraction or production of, mineral oils in India. Plant includes ship and since the vessel was used in connection with prospecting of mineral oil, hire charges were covered u/s 44BB. Therefore, they could not be treated as royalty in view of specific exclusion under Explanation 2(iva), to section 9(1)(vi). Once payment was covered u/s 44BB, it could not be brought within the purview of section 9(1)(vi). Accordingly, the income of the VPCs was not in the nature of royalty. The issue considered in the present case is identical with that discussed in Wavefield Inseis ASA, In re [2010] 230 CTR 106 (AAR) and, therefore, ruling of that decision is squarely applicable.

Source of income is the place where income-generating activity takes place. In case of business income, it is the place where business is conducted. The business activity of seismic vessel can only be at the place where it is utilised for acquisition of seismic data and not at the place where the contract for hiring was signed or where the ship was delivered. Deciding accrual of business income on the basis of the place of delivery may result in an anomalous situation.

In the case of a seismic vessel, the business is not conducted by the Master, crew or manpower on board but by scientific equipment on the vessel which emits seismic waves and recaptures them. Hence, to decide the place of business of seismic vessels it is not relevant whether the agreement is for time charter or for BBC.

In GVK Industries vs. ITO (371 ITR 453) (SC), the Supreme Court held that the ‘source state taxation’ rule confers primacy to right to tax on a particular income or transaction to the state / nation where the source of the said income is located. Relying on this decision, the appellant submitted that to apply the source rule it was necessary to establish nexus with taxable territory. The source rule was in consonance with the nexus theory and did not fall foul on the ground of extra-territorial operation. Source was the country where income or wealth was physically or economically produced.

The payer (i.e., the applicant) was executing the contract in the Indian territory. The services of the seismic vessels were utilised within Indian territory. Thus, all the parameters of the ‘source rule’ as explained by the Supreme Court were fulfilled and, hence, the business activity of the VPCs had a clear nexus with the Indian territory. There was existence of a close, real, intimate relationship and commonality of interest between non-resident VPCs and the applicant, which satisfied the requirements for ‘business connection’ and ‘territorial nexus’. Since the business of the VPCs was carried out through the seismic vessels deployed in Indian territory, the fixed place PE of the VPCs was constituted in India.

Section 14A – Even suo motu disallowance made by an assessee u/s 14A needs to be restricted to the extent of exempt income

16. Chalet Hotels Ltd. vs. DCIT Mahavir Singh (V.P.) and Rajesh Kumar (A.M.) ITA No. 3747/Mum/2019 A.Y.: 2015-16 Date of order: 11th January, 2021 Counsel for Assessee / Revenue:Madhur Agarwal / V. Sreekar


 

Section 14A – Even suo motu disallowance made by an assessee u/s 14A needs to be restricted to the extent of exempt income

 

FACTS

The A.O., while assessing the total income of the assessee, invoked the provisions of section 14A read with Rule 8D and disallowed a sum of Rs. 27,15,12,687 and of Rs. 2,14,47,136 under Rule 8D(2)(iii). Thereby, he disallowed a total sum of Rs. 29,29,59,823 u/s 14A.

 

Aggrieved, the assessee preferred an appeal to the CIT(A) where, in the course of the proceedings it claimed that the assessee has earned exempt income only to the extent of Rs. 13,17,233 and the same may be adopted for making disallowance under Rule 8D(2)(iii).

 

The CIT(A) deleted the disallowance made by the A.O. under Rule 8D(2)(ii), i.e., interest expenditure amounting to Rs. 27,15,12,687, but confirmed the disallowance under Rule 8D(2)(iii) being administrative expenses at Rs. 5,86,52,973 as against the exempt income claimed by the assessee at Rs. 13,17,233. The CIT(A) restricted the disallowance to the amount suo motu computed by the assessee at Rs. 5,86,52,973.

 

Aggrieved, the assessee preferred an appeal to the Tribunal.

 

HELD

The Tribunal noted that the short point of dispute is whether the disallowance under Rule 8D(2)(iii) is to be restricted to the extent of exempt income, i.e., dividend income earned by the assessee at Rs. 13,17,233 or the disallowance as suo motu computed by the assessee at Rs. 5,86,52,973.

Having gone through the decision of the Supreme Court in the case of Maxopp Investments Ltd. (Supra) wherein the Supreme Court has categorically held that the disallowance cannot exceed the exempt income the Tribunal deleted the suo motu disallowance made by the assessee at Rs. 5,86,52,973 and restricted the disallowance to the extent of the exempt income claimed by the assessee at Rs. 13,17,233.

Sections 43CA and 263 – In a case where the A.O. has taken a possible view after inquiring into the matter and appreciating the facts and documents filed by the assessee, the PCIT has no jurisdiction to set aside the assessment

15. Ranjana Construction Pvt. Ltd. vs. PCIT George George K. (J.M.) and B.R. Baskaran (A.M.) ITA No. 4308/Mum/2019 A.Y.: 2014-15 Date of order: 11th January, 2021 Counsel for Assessee / Revenue: N.R. Agrawal / Bharat Andhle

Sections 43CA and 263 – In a case where the A.O. has taken a possible view after inquiring into the matter and appreciating the facts and documents filed by the assessee, the PCIT has no jurisdiction to set aside the assessment

FACTS

The assessee e-filed its return of income for A.Y. 2014-15 declaring a total income of Rs. 1,60,260.

Vide an allotment letter dated 12th June, 2010, the assessee agreed to sell to Mr. Vasant Kumar Pujari, the buyer, Flat No. A-302 in Kailash Heights for a consideration of Rs. 36,65,000. He (the assessee) received an account payee cheque for Rs. 2,50,000 dated 22nd June, 2010 as token advance. Thereafter, he received Rs. 18,32,500 up to 20th December, 2012. The sale agreement was registered on 26th June, 2013. On the date of registration, the stamp duty value of the said flat was Rs. 57,48,160 which was reflected in the AIR on the Department website. In the course of assessment proceedings, a notice was issued u/s 142(1) asking the assessee to furnish the date of property purchased / sold details. (These were contained in the AIR information generated by the Department from the ITES.)

The assessment of total income of the assessee was completed u/s 143(3) and an order dated 8th September, 2016 was passed u/s 143(3) accepting the returned income.

Subsequently, the PCIT, after issuing a show cause notice to the assessee and rejecting its contentions, set aside the order passed u/s 263 and directed the A.O. to examine the issue after giving sufficient opportunity of being heard to the assessee. The PCIT held that:
i) the agreement does not mention allotment of the flat vide allotment letter dated 12th June, 2010;
ii) allotment letter is not forming part of the registered agreement;
iii) the assessee has not filed any evidence of having filed the allotment letter with the Stamp Duty Authority;
iv) the agreement does not mention about booking amount claimed to have been paid by the assessee vide the allotment letter;
v) the agreement mentions that the purchaser has perused the commencement certificate, plans and other documents and has approached the promoters for allotment of the flat. The allotment letter is dated 12th June, 2010 and the commencement certificate is dated 28th June, 2010 which contradicts the clauses in the agreement.

Aggrieved, the assessee preferred an appeal to the Tribunal.

HELD


The Tribunal observed that according to the learned PCIT, the business income should have been computed by taking the deemed consideration as on the date of registration and not on the date of agreement to sell as per the observations in the revisionary order. Besides, the Tribunal also found that this issue has been specifically raised by the A.O. in the notice issued u/s 142(1) wherein a copy of the AIR as generated by the ITES was attached and the assessee was called upon to reconcile the entries appearing therein. The assessee had duly filed reconciliation vide letter dated 24th August, 2016 submitting a copy of the sale agreement and also the necessary details of the said deal. The A.O., after examining such details, accepted the business income of the assessee based on the stamp value as on the date of the agreement to sell.

The Tribunal held that the A.O. has taken a possible view after inquiring into the matter and appreciating the facts and documents filed by the assessee. Since the A.O. took a possible view, the PCIT has no jurisdiction to set aside the assessment. The Tribunal found itself inclined to quash the revisionary proceeding on this count alone.

On merits, the Tribunal held that the assessee has a fool-proof case as the income has been assessed pursuant to sections 43CA(3) and (4) which clearly provide that if the date of agreement and the date of registration are not the same, the stamp value as on the date of agreement shall be taken for the purpose of computing the income of the assessee and not the date of registration.

The Tribunal allowed the appeal of the assessee by setting aside the order of the PCIT.

Sections 45, 48 and 50CA – There is no provision in the Act authorising the A.O. to refer valuation of shares transferred for the purpose of calculating capital gains – Sale consideration disclosed in the share purchase agreement ought to be adopted for calculating the long-term capital gains in the case of transfer of shares – Section 50CA of the Act inserted w.e.f. 1st April, 2018 clearly indicates that prior to that date there was no provision under the Act authorising the A.O. to refer for valuation of shares for the purpose of calculating capital gains

14. ACIT vs. Manoj Arjun Menda George George K. (J.M.) and B.R. Baskaran (A.M.) ITA No. 1710/Bang/2016 A.Y.: 2012-13 Date of order: 4th January, 2021 Counsel for Revenue / Assessee:  Rajesh Kumar Jha / V. Srinivasan

Sections 45, 48 and 50CA – There is no provision in the Act authorising the A.O. to refer valuation of shares transferred for the purpose of calculating capital gains – Sale consideration disclosed in the share purchase agreement ought to be adopted for calculating the long-term capital gains in the case of transfer of shares – Section 50CA of the Act inserted w.e.f. 1st April, 2018 clearly indicates that prior to that date there was no provision under the Act authorising the A.O. to refer for valuation of shares for the purpose of calculating capital gains

FACTS

The assessee, an individual, filed his return of income for A.Y. 2012-13 declaring a total income of Rs. 7,22,25,230. Vide Share Purchase Agreement dated 20th October, 2011, the assessee along with other shareholders sold their entire shareholding in Millennia Realtors Private Limited (MRPL) to Ambuja Housing & Urban Infrastructure Company Limited (AHUIC) for a consideration of Rs. 66.81 crores. The purchasers also agreed to pay Rs. 17.76 crores as accrued interest on debentures. Thus, the total amount payable by AHUIC to the shareholders of MRPL worked out to Rs. 84.58 crores. The assessee held 13.29% of the shareholding in MRPL and hence received Rs. 11.24 crores for his portion of the shares sold. In his return of income, he computed long-term capital loss and carried forward the same.

In the course of the assessment proceedings, the assessee submitted copies of the share purchase agreement and the valuation report dated 20th October, 2011 referred to in the share purchase agreement. The A.O., based on the information sought by him u/s 133(6) from Oriental Bank of Commerce, the bankers of MRPL, and also the property consultant who facilitated the transfer of shares of MRPL, came to the conclusion that the fair market value of the shares of MRPL disclosed in the share purchase agreement was on the lower side. Therefore, he held that to arrive at the correct FMV the shares need to be valued and said that the most appropriate way to value them is the Net Asset Valuation method (NAV).

After adopting valuation under the NAV method, the A.O. held that the sale consideration of the shares transferred by the assessee and the other shareholders has to be taken as Rs. 166.72 crores against Rs. 66.81 crores as agreed upon in the sale / purchase agreement dated 20th October, 2011 and the assessee’s share in the consideration works out to Rs.24.52 crores against Rs. 11.24 crores. Accordingly, the A.O. arrived at the long-term capital gain of Rs. 3,33,23,661 as against the loss of Rs. 9,94,59,651 as calculated by the assessee.

Aggrieved, the assessee preferred an appeal to the CIT(A) who, following the judgment of the Apex Court in the case of George Henderson & Co. Limited [66 ITR 622 (SC)] and other judicial pronouncements, held that there is no provision under the Income-tax Act empowering the A.O. to refer a matter for valuation in relation to the transfer of a capital asset, being transfer of shares. The CIT(A) allowed the appeal of the assessee.

But the aggrieved Revenue preferred an appeal to the Tribunal where, on behalf of the assessee, it was contended that the issue in question is squarely covered by the decision of the Tribunal in the case of another shareholder, viz., Raj Arjun Menda, in ITA No. 1720/Bang/2016 (order dated 20th February, 2020).

HELD

The Tribunal observed that the co-ordinate bench in the case of Raj Arjun Menda (Supra) has decided an identical issue in favour of the assessee. The Tribunal held that the transfer of the assets being the shares of a company, there is no provision under the Act for referring the matter for valuation. Accordingly, the Tribunal in that case confirmed the order of the CIT(A) and held that the consideration disclosed in the share purchase agreement dated 20th October, 2011 should be adopted for the purpose of computation of long term-capital gains on the sale of shares.

Following the decision in the same case, viz., Raj Arjun Menda (Supra), the Tribunal held that the CIT(A) is justified in holding that the sale consideration disclosed in the sale purchase agreement ought to be adopted for calculating the long-term capital gains in the case of transfer of shares. It also mentioned that section 50CA inserted w.e.f. 1st April, 2018 would have no application to the instant case since it was dealing with A.Y. 2012-2013. In other words, section 50CA inserted w.e.f. 1st April, 2018 clearly indicates that prior to that date there was no provision authorising the A.O. to refer the shares for valuation for the purpose of calculating capital gains.

Whereas a part of a composite itinerary, the employee of the assessee employer availing LTC has travelled to a foreign sector along with destination in India, the assessee employer cannot be faulted for not deducting tax at source from LTC allowed to employee, given that such amount was no longer exempt to the employee u/s 10(5)

29. 124 taxmann.com 354 State Bank of India vs. ACIT, TDS IT Appeal No. 1717 (Mum.) of 2019 A.Y.: 2012-13 Date of order: 27th January, 2021

 

Whereas a part of a composite itinerary, the employee of the assessee employer availing LTC has travelled to a foreign sector along with destination in India, the assessee employer cannot be faulted for not deducting tax at source from LTC allowed to employee, given that such amount was no longer exempt to the employee u/s 10(5)

 

FACTS

During the course of a survey u/s 133A it was found that certain employees of the assessee have claimed LTC (Leave Travel Concession) facility wherein ‘travel to places outside India was involved’. It was noted that some of the employees had taken a very circuitous route, involving travel abroad to one or more domestic destinations. The A.O. noted that the admissible LTC in these cases was treated as tax-exempt u/s 10(5) and that such exemption was not available in cases where the employee travels out of India. The A.O. contended that to that extent, the assessee was in error in not deducting tax at source in respect of such payment of the LTC facility. The A.O. also noted that ‘the employees travelled to the Indian destinations not by the direct and shortest route but by a circuitous route, including a foreign journey. Thus, the A.O. held that the LTC payment should have been included in the income of the employees concerned while deducting tax at source from the salaries, and the assessee is required to be treated as an assessee in default for not deducting the related tax at source. The assessee carried the matter in appeal before the CIT(A) who upheld the A.O.’s contention.

 

Aggrieved, the assessee preferred an appeal before the Tribunal.

 

HELD

There is no specific bar in the law on travel eligible for exemption u/s 10(5), involving a sector of overseas travel, and in the absence of such a bar the assessee employer cannot be faulted for not inferring such a bar. The reimbursement is restricted to airfare, on the national carrier, by the shortest route as is the mandate of rule 2B. The employee has travelled, as a part of that composite itinerary involving a foreign sector as well, to the destination in India. The guidance available to the assessee employer indicates that in such a situation the exemption u/s 10(5) is available to the employee, though to the extent of farthest Indian destination by the shortest route, and that is what the assessee employer has allowed.

 

Due to the position with respect to taxability of such LTC in the hands of the employee, the assessee employer cannot be faulted for not deducting tax at source from the LTC facility allowed by him to the employees. Once the estimation of income in the hands of the employee under the head ‘income from salaries’ by the employer was bona fide and reasonable, the assessee employer cannot be held to be in default.

 

The appeal of the assessee employer was allowed.

Sections 143(2) and 143(3) – Assessment order passed by a jurisdictional officer in a case where the notice u/s 143(2) was not issued by him but by a non-jurisdictional officer is bad in law and void ab initio

28. [2021] 123 taxmann.com 395 (Luck.)(Trib.) ITO vs. Arti Securities & Services Ltd. A.Y.: 2014-15 Date of order: 6th November, 2020

Sections 143(2) and 143(3) – Assessment order passed by a jurisdictional officer in a case where the notice u/s 143(2) was not issued by him but by a non-jurisdictional officer is bad in law and void ab initio

FACTS

In an appeal filed by the Revenue, the assessee filed an application under Rule 27 of the ITAT Rules and raised two issues – one related to limited scrutiny and another related to jurisdiction. The Tribunal admitted the application of the assessee and heard and decided the jurisdictional ground.

The assessee had e-filed return of income on 26th September, 2014 declaring income of Rs. 11,11,750 and the case was selected for scrutiny u/s 143(2) vide notice issued by DCIT, Circle-4, Kanpur and DCIT-6, Kanpur on the same date, i.e., 3rd September, 2015. As per assessment order dated 29th December, 2016 read with transfer memo dated 16th May, 2016, the case was transferred from DCIT-6, Kanpur to Income-tax Officer-6(1), Kanpur on the ground of monetary limit vide order dated 28th April, 2016 passed by the Pr. CIT-2, Kanpur. The jurisdictional Income-tax Officer, Kanpur did not issue any notice u/s 143(2) and completed the assessment without issuing any notice u/s 143(2).

The jurisdictional A.O. started the proceedings from 18th May, 2016 by mentioning that case records were received from DCIT-6, Kanpur because of change of monetary limit.

In the course of appellate proceedings, it was submitted on behalf of the assessee that on this copy of the order sheet there is no mention of issue of notice u/s 143(2), nor is there any mention of any order passed by the Commissioner u/s 127. Besides, when the first notice u/s 143(2) was issued on 3rd September, 2015, Revenue was aware of the fact that as per monetary limit for ITR of Rs. 11,11,750, the competent A.O. to issue notice u/s 143(2) was the Income-tax Officer-6(1), Kanpur.

HELD

The Tribunal noted that
i) The assessee filed return of income declaring income of Rs.11,11,750;
ii) The jurisdictional A.O. was the Income-tax Officer, Ward-6, Kanpur (as per CBDT instruction No. 1/2011);
iii) Two notices u/s 143(2) were issued by DCIT-4, Kanpur and DCIT-6, Kanpur on the same date, i.e., 3rd September, 2015;
iv) The statutory notice u/s 143(2) has not been issued by the jurisdictional A.O.;
v) No order u/s 127 has been passed by the CIT transferring the case from DCIT-6 to Income-tax Officer-6, Kanpur.

Considering the ratio of the decisions of the Tribunal in the case of Krishnendu Chowdhury vs. ITO [2017] 78 taxmann.com 89 (Kol.); Sukumar Chandra Sahoo vs. Asst. CIT [IT Appeal No. 2073 (Kol.) of 2016, dated 27th September, 2017] and Bajrang Bali Industries vs. ACIT [IT Appeal No. 724 (LKW) of 2017, dated 30th November, 2018], the Tribunal allowed the jurisdictional ground taken by the assessee and held that the notice u/s 143(2) was not issued by an officer having jurisdiction on the assessee and who had passed the assessment order, therefore in view of non-issue of statutory notice u/s 143(2), the assessment order is bad in law and void ab initio and hence all further proceedings including the order passed by the learned CIT(A) is bad in law and, therefore, the appeal filed by Revenue against the order of the CIT(A) does not stand and is dismissed.

The appeal of the Revenue was dismissed by allowing one of the grounds of the assessee raised under Rule 27 of the ITAT Rules.

Section 45 – In a case where notional income has been received by the assessee as per development agreement and no real income has been received as the developer vanished and there was neither any development nor any area received by the assessee, capital gains will not be chargeable to tax if the possession is taken back by the assessee and there was no development

27. [2020] 122 taxmann.com 169 (Hyd.)(Trib.) Santosh Kumar Subbani vs. ITO
A.Y.: 2007-08 Date of order: 13th November, 2020

Section 45 – In a case where notional income has been received by the assessee as per development agreement and no real income has been received as the developer vanished and there was neither any development nor any area received by the assessee, capital gains will not be chargeable to tax if the possession is taken back by the assessee and there was no development

FACTS

For A.Y. 2007-08, the assessee had not filed his original return of income. The A.O., having received information with regard to transfer of property by the assessee through a sale-cum-development-agreement-cum-GPA with M/s 21st Century Investments & Properties Ltd., vide document No. 5126/2007 dated 26th March, 2007, issued a notice u/s 148, in response to which the assessee filed the return of income admitting to total income of Rs. 74,380 from other sources and agricultural income of Rs. 1,65,340.

As per the information received by the A.O., under the development-agreement-cum-GPA, the assessee transferred the land, admeasuring 0.15 guntas, at Nizampet. The agreement provided that the developer has to complete the development within 24 months and the assessee has to receive 5,000 square feet built-up area.

The assessee submitted before the A.O. that the developer did not perform the construction activity and argued that there is no case of capital gains. The A.O. conducted inquiries through an Inspector and found that no development had taken place on the said land. However, since, the assessee has handed over the property as per the agreement dated 26th March, 2007 to the developer, in the view of the A.O.  it was hit by section 2(47)(v) and accordingly he assessed the SRO value of Rs. 11,89,883 as sale consideration and determined a short-term capital gain of Rs. 4,38,029.

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

HELD


The Tribunal noted that after entering into the agreement, the developer has vanished and no real development took place till date as verified and confirmed by the A.O. through the Departmental Inspector and hence no developed area was received by the assessee. It is clear that there was no real income except notional income as per the development agreement which has never been received by the assessee. According to the Tribunal, the issue which decides the taxability of capital gains is whether the possession is lying with the developer or taken over by the assessee. During the course of appeal proceedings, upon inquiry by the Tribunal, the AR submitted that till date the development agreement was not cancelled and no public notice was issued by the assessee for cancellation of the same.

The Tribunal held that the issue is required to be remitted back to the file of the A.O. with a direction to decide the capital gains after verifying whether or not the possession is taken back by the assessee and whether the assessee has cancelled the development agreement. In case the possession is taken back by the assessee and there has been no development, the assessee succeeds in the appeal.

CSR RULES AMENDMENT – AN ANALYSIS

1. BACKGROUND
Corporate Social Responsibility (CSR) can be defined as a company’s sense of responsibility towards the community and environment (both ecological and social) in which it operates. Companies can fulfil this responsibility through waste and pollution reduction processes, by contributing educational and social programmes, by being environmentally friendly and by undertaking activities of similar nature. CSR is not charity or mere donations. CSR is a way of conducting business by which corporate entities visibly contribute to the social good.

The Companies Act, 2013 has formulated section 135, Companies (Corporate Social Responsibility) Rules, 2014 and Schedule VII which prescribe mandatory provisions for companies to fulfil their CSR. This article aims to analyse these provisions (including all the amendments therein).

Applicability of CSR provisions
o On every company including its holding or subsidiary having:
* Net worth of Rs. 500 crores or more, or
* Turnover of Rs. 1,000 crores or more, or
* Net profit of Rs. 5 crores or more
o during the immediately preceding financial year, and
* A foreign company having its branch office or project office in India, which fulfils the criteria specified above.

However, if a company ceases to meet the above criteria for three consecutive financial years then it is not required to comply with CSR provisions till such time as it meets the specified criteria.

The Ministry of Corporate Affairs, vide Notification dated 22nd January, 2021 in exercise of the powers conferred by section 135 and sub-sections (1) and (2) of section 469 of the Companies Act, 2013 (18 of 2013), notified rules to further amend the Companies (Corporate Social Responsibility Policy) Rules, 2014. These rules are to be called the Companies (Corporate Social Responsibility Policy) Amendment Rules, 2021.

They shall come into force on the date of their publication in the Official Gazette. As per the Notification, section 21 of the Companies (Amendment) Act, 2019 has come into force with effect from 22nd January, 2021.

2. The top ten points relating to changes in CSR rules are as follows
CSR expenditure
(i) Surplus from CSR activities to be ploughed back in same project or transferred to Unspent CSR Account and spent as per policy and annual action plan, or transferred to Fund within 6 months of the end of the financial year.
(ii) Excess amount spent shall be set off within three succeeding financial years subject to conditions (i.e., surplus arising out of CSR activities shall not be considered and the Board of the company shall pass a resolution to that effect).
(iii) CSR amount may be spent for creation / acquisition of capital asset to be held in the manner prescribed.
(iv) Specific exclusion of sponsorship activities for deriving market benefits from the scope of CSR activities.

Governance
(v) Eligible implementing entities through which a company shall undertake CSR activities will be required to register themselves with the Central Government w.e.f. 1st April, 2021.
(vi) Responsibility of the Board to ensure that the funds so disbursed have been utilised for the purposes and in the manner as approved by it and the CFO or the person responsible for financial management shall certify to the effect.
(vii) CSR Committee to formulate Annual Action Plan for CSR activities.
(viii) Companies with average CSR obligation of Rs. 10 crores or more in three preceding years to undertake impact assessment through an independent agency for projects of Rs. 1 crore or more which have been completed not less than one year before the impact study and the report to be placed before the Board and in the Annual Report of CSR.

Reporting
(ix) Earlier, only the contents of the CSR policy were required to be disclosed on the company’s website. Now, composition of CSR Committee, CSR Policy and projects approved by the Board are required to be disclosed.
(x) New format inserted for disclosure to be included in the Board’s Report.

3. The provisions relating to amendment of the Companies Act are tabulated below:

Section

Description

Amendment

Earlier
provision

Implication

135(5)

CSR spending

If the company has not completed 3
years since incorporation, then 2% of average net profit during such
immediately preceding financial year

The Board to ensure that the company
spends at least 2% of the average net profit made during 3 immediately
preceding financial years

This provision is to rationalise the
method of computation of net profit for the purpose of CSR

In case of newly-incorporated entities,
the amount of CSR expenditure will be increased

135(5)

2nd proviso

Unspent amount not relating to an
ongoing project

The unspent amount not relating to an
ongoing project shall be transferred to a Fund specified in Schedule
VII within 6 months of the end of the financial year

If the company fails to spend the
amount, the Board is required to specify the reasons for not spending

This is a welcome step and the
corporates will be benefited

In case the amount cannot be spent, it
can be transferred to a Fund, avoiding non-compliance

135(6)

Unspent amount relating to an ongoing
project

The company is required to transfer the
amount to a special ‘Unspent CSR Account’ within 30 days from
end of financial year and spend it within 3 financial years from date
of such transfer

No corresponding provision

This is a welcome step and the corporates
will be benefited

This will enable corporates to plan
their cash flows and park the excess amount in ‘Unspent CSR Account’ to be
utilised within next 3 F.Y.s

135(7)

Contravention w.r.t. sections 135(5) and
135(6)

Fine equal to:

In case of company – 2X of the amount required to be
transferred, or Rs. 1 crore, whichever is less

In case of officers – 1/10th of the amount
required to be transferred, or Rs. 2 lakhs, whichever is less

No corresponding provision

Provision for fine introduced

4. The provisions relating to amended CSR Rules as per the Companies (Corporate Social Responsibility Policy) Amendment Rules, 2021 are tabulated below:

Rule

Description

Amendment

Earlier
provision

Implication

4

CSR implementation

Eligible implementing entities through
which a company shall undertake CSR will require to register themselves
with Central Government w.e.f. 1st April, 2021

No corresponding provision

Welcome step from the point of view of
governance

Responsibility of the Board to ensure that the funds so disbursed
have been utilised for the purposes and in the manner as approved by
it and the CFO or the person responsible for financial management shall certify
to the effect

5(2)

CSR Committee

Committee to formulate annual action
plan for CSR activities

Institute transparent monitoring
mechanism for implementation of projects

This is a new provision

Shall help in formulation of
Board-governed annual plan. This would lead to good governance

Board may alter such plan based
on recommendation of CSR Committee

7

CSR expenditure

Board to ensure administrative overheads
not to exceed 5% of total CSR expenditure for financial year

Contribution to corpus, expenditure on
CSR projects approved by Board on recommendation of CSR Committee, excluding
items not falling under Schedule VII

New provisions and welcome ones

This was required as corporates
necessarily need to incur some administrative expenses

Surplus from CSR activities not to be treated as business profit and
be ploughed back in same project or transferred to Unspent CSR
Account and spent as per policy and annual action plan or transfer to
Fund within 6 months from the end of financial year

New provision

Shall benefit the corporates in
smoothening their cash flow and also compliance of the CSR provision

Excess amount spent shall be set off within 3
succeeding financial years subject to conditions (i.e., surplus
arising out of CSR activities shall not be considered and Board of the
company shall pass a resolution to that effect)

New provision

Shall benefit the corporates in
smoothening their cash flow and also compliance of the CSR provision

CSR amount may be spent for creation
/ acquisition of capital asset to be held in the manner prescribed

 

8

CSR reporting

Companies with average CSR
obligation of Rs. 10 crores or more in 3 preceding years to undertake impact
assessment through an independent agency for projects of Rs. 1 crore or
more which have been completed not less than 1 year before the impact study

No corresponding provision

New provision

Will lead to good governance

The report to be placed before the
Board and in the Annual Report of CSR

Company may book the expenditure
towards CSR which shall not exceed 5% of total CSR expenditure or Rs. 50
lakhs, whichever is less

9

Display of CSR activities on website

Company to disclose composition of CSR Committee,
CSR Policy and projects approved by the Board

Company to disclose the contents of the
CSR policy

 

10

Format for Annual Report on CSR

New format inserted for disclosure to be included in the Board’s
Report

No corresponding provision

Procedural, to clarify the definitions
and meanings

2(b)

Meaning of administrative overheads

General management and administrative
expenditure, excluding direct expenses towards a particular project

No corresponding provision

2(d)

Meaning of CSR activities

Excludes sponsorship activities for deriving market benefits for its
products

As per Schedule VII

2(f)

Meaning of CSR Policy

Definition amended to widen the scope
of Committee to recommend formulation of annual action plan

2(g)

Meaning of international Org.

As defined u/s 3 of UN (Privileges and
Immunities) Act

No corresponding provision

2(i)

Meaning of ongoing project

Project already commenced, multi-year
project, i.e., not less than 1 year but not exceeding 3 years

No corresponding provision

2(j)

Meaning of public authority

As defined under the RTI Act

No corresponding provision

6

CSR Policy

Omitted

List of CSR projects which a company
plans to undertake and monitoring process

This provision was omitted as the
provision relating to annual plan has been introduced

5. Impact Analysis
(I) The new rules will give the corporates thenecessary flexibility in spending in case of ongoing projects.
(II) Those corporates that are unable to spend for any reason will be able to comply with the rules if they transfer the amount to a special Fund
(III) The new rules will bring in more transparency and will involve experts in impact analysis.
(IV) The quality of governance through the Board will be a notch higher
(V) The reporting and disclosure will improve.

ERRATA
We regret that in the BCAJ issue dated January, 2021 (Vol. 52-B, Part 4), certain inadvertent errors have crept in on three different pages. In all cases, lines / cross-headings that should have been deleted have appeared with a ruling line across them. On Page 5, the lines ‘Since we all try to avoid… feel negative emotions’, have a ruling line across them. Similarly, one line on Page 30 and six lines on Page 31 also have ruling lines across them.
The errors are sincerely regretted

STRATEGY: THE HEART OF BUSINESS – PART I

Every business, every entity designs and pursues a strategy or multiple strategies to deliver its purpose. Crafting and, more importantly, successfully executing strategies is at the heart of running and growing great businesses. Strategy is the path to winning. In this two-part series, I will share some key approaches and methods which helped me over the years in accomplishing this critical aspect of a CEO’s role and mission, i.e., delivering sustainable long-term value for all stakeholders.

The broad elements of establishing a successful enterprise are depicted below (Figure 1):

At the core is setting the Vision and Strategy. The delivery mechanism is enabled through a robust process framework. This will need to encompass many critical dimensions such as being customer-driven, innovation-led, focusing on environment, health and safety, as well as upholding sustainability. A customer-focused entity strives to understand and meet the current and future needs. While delighting customers is the goal, the business should also endeavour not to dissatisfy patrons. Innovation can come through new technologies on products or in processes or people-oriented or even in the business model. The organisation will need to embed a culture of continuously improving all its activities challenging the status quo relentlessly. Sustainability and EHS should feature at the centre of all its actions. Above all, these are made possible by the people and hence talent management is important.

Each of these is an important subject in its own right. In this article I will explore some key elements pertaining to the two critical components of strategy, (i) Strategy Planning, and (ii) Strategy Deployment, and share some points on the planning dimension.

Any enterprise is guided by its Vision, Mission and Values (VMV). The first crucial framework which needs to be in place is this VMV which the enterprise stands for and lives by. VMV is articulated and communicated extensively so that not only are the employees clear about the direction of the organisation, but all the external stakeholders also know the fundamental purpose of the enterprise that they are engaging with.

Setting the VMV:
The Vision and Mission convey the raison d’être or the purpose of the enterprise. The Values are the fundamental tenets around which the enterprise conducts its affairs and are expected to be upheld at all times. While evaluating core partnerships or even acquisitions, VMV, therefore, is often the first parameter to be assessed in terms of compatibility between the conducting units. In Figure 2, a method of creating the VMV is depicted in a self-explanatory manner:

Some of the advantages that I have experienced in adopting this process are as follows:

(1)    Seeking inputs from all stakeholders gives different perspectives about their views of the business as well as expectations from the enterprise. Not only does this give a 360-degree view but also helps in eliminating blind spots which can be there in an internal exercise;

(2)    Doing a brainstorming session with the senior leadership team as well as middle management is a valuable exercise. In such intense sessions, often there is introspection of the opportunities and competencies of the enterprise which gives leads on the direction to take. Seeking external expert assistance to hold such sessions is fruitful to make the discussions even more extensive;

(3)    Sharing the initial output across the units in a capsulated form can engage the team from across the enterprise. Inputs received can be evaluated at the centre and necessary modifications can be made enhancing the quality of the output. This also has immense value in making the VMV a co-created exercise;

(4)    Finally, once the VMV is approved by the Board, a detailed communication programme is essential. Every word in the VMV is explained and the whole thrust of the organisation is shared and clarified to every team member.

The VMV once set may not change frequently, but it is not cast in stone. Such a comprehensive exercise is undertaken periodically, say once in three or four years, to incorporate the dynamic nature of business.

Strategy Planning Process:
Flowing from the VMV will be the next critical task of setting the Strategic Goal or Target, and crafting the Strategy. The strategy planning process (SPP) can be with both short and long-term perspectives. In the short term this is also aligned to the year’s business and operating plan or budget. The elements in building the SPP are diagrammatically represented in Figure 3 (right).

A word on each of the key steps:
a)    The approach is to blend both the outside-in and the inside-out outlooks of the business. So inputs are sought from the various stakeholders on the different aspects of the business as well as their needs and expectations of performance;

b) Environment scanning using PESTLE dimensions of political, economic, social, technological, legal and environmental outlooks is performed to judge the context for the strategy;

c) Coupled with this is the internal assessment of SWOT in terms of strengths, weaknesses, opportunities and threats. The enterprise also judges its core competencies so as to play from a position of power;

d) Put together, the above leads to a definition of the opportunity and throws up both strategic challenges and strategic advantages as well. A good way is to encapsulate the strategic target in terms of a quantified crisp goal or an inspiring statement. This helps immensely in communicating the strategic objective to the team and for a common engagement to go for an aligned purpose. For example, the call for a ‘5 trillion economy by 25’, ‘India Shining’, etc.

e) At this juncture, it is also important to specify the customer segments or markets which are targeted. The analysis of SWOT, core competencies and competitive positions will also lead to what would be the offering or the customer value proposition which brings about a differentiation in the marketplace. This is at the crux of strategy planning – the decision of what we want to be and equally what we do not want to be. Strategy is all about making a choice;

f) Thereafter strategic initiatives are thought out clubbing two of these elements. For example, SO – how do we leverage our strengths to tap into the opportunities, etc. (vide Figure 4; next page);

g) From these lists the next step would be to prioritise the ones to be taken up in terms of time dimensions and ease of execution;

h) These can be woven into the four perspectives to form a balanced scorecard;

i) A Strategy Map1 can be prepared which encapsulates the entire strategy flow across the perspectives and highlights the strategic actions as well;

j) This will lead to individual projects both at the company level as also at individual or functional levels2.

Creating the connect:
For any strategy or plan to succeed, the most critical element is to get across the connect with people. It is important that every team member not only knows his or her work plan but also is clear on how this connects with the larger goal of the function / department as well as that of the enterprise. This is fundamental to get a high engagement of each employee who will approach work with great interest as the significance of the tasks becomes clear.

A great way to bring in a structured connect is by using the Strategy Deployment Matrix (SDM). A pictorial representation of SDM is given in Figure 5 (at right). The SDM provides a link between the enterprise priorities and the individual department’s goals or actions. Furthermore,it brings together the department goals with thedifferent projects planned to deliver those goals. Alongside, the projects are connected with the team members who are part of the different projects. This also facilitates the time planning for each team member who is associated with the projects. With these, the SDM provides a fine alignment of the individual’s tasks / time with the projects designed to deliver departmental goals which itself is aligned to the enterprise priorities. So the SDM in a single matrix provides a clear picture of how all of it is well aligned to move in an integrated, coordinated manner.

Strategy, the dominant success factor:
A strategic approach is essential for a structured delivery of growth in business. It is important that the strategy flows from the larger aspirations of the enterprise and is also carved out in time dimensions of short and long term. While a strategy construct emanates from having a normal view of things, the environment now is volatile and ever changing. A number of disruptors, too, can emerge in a short span of time3. It is therefore necessary that strategies are also prepared to meet different contexts. A scenario planning exercise with appropriate strategies is also necessary.

The strategic plan is created to seize opportunities and its execution is important as well. This equation is pictorially represented in Figure 6.

Finally, a good Strategy is the heart of running and changing a winning business.

References

  1. Strategy Maps: Robert S. Kaplan and David P. Norton
  2. Excel in what you do: Pg. 20,BCAJ, August, 2020
  3. Governance & Internal Controls: The Touchstone of Sustainable Business – Part II: Disruptions Pg. 13,BCAJ, June, 2020

PODCASTING – THE NOVEL MODE OF STORYTELLING FOR YOUR PROFESSIONAL BRAND

When it comes to knowledge-sharing by professionals, we have three options at present:

1)    Written form: Books, articles, etc.,
2)    Video form: YouTube channels, preparing videos that give information, and
3)    Audio form: Podcasting, pre-recorded messages.

While the first two forms are quite common, Audio Form Podcasting has been gaining in popularity of late. Writing articles is not easy but the more difficult part in today’s time is to find people who read! Videos have an edge over the written form but the creation of videos can be quite expensive and time-consuming. Further, in videos the focus has to be on the appearance of the person, lights, backgrounds, animation and so on. This is the reason why the third alternative, Podcasting, is gaining ground in knowledge-sharing. With ‘Smart Speakers’ like Alexa, Google Home, Apple Homepod, etc., finding their way into our day-to-day lives, Podcasts are gaining acceptance in the same way that FM radio did in the 2000s.

A human voice speaks louder and adds much more meaning through tone and inflection than the printed form. The journey from radio to Podcasts has marked a full circle. The radio was superseded by television, television by cable, cable by internet videos and, with technological advancement, internet videos are now at par with Podcasts. Podcasting, thus, represents a new platform for story-telling.

According to survey reports by Stitcher, an average Podcast listener stays connected for 22 minutes daily. This is one reason why including Podcasting in your digital branding strategy will prove to be beneficial. Podcasts give you an opportunity to build a deep, personalised and rich relationship with your target audience. With smart speakers, the music apps supporting and aiding Podcasts, people prefer to listen to Podcasts quite frequently while doing other work instead of holding a phone in their hands or sitting in front of their screens to watch a video – or holding a book and reading it. Of course, videos and books have their own advantages, but Podcasting is creating and filling a niche.

UNDERSTANDING WHAT IS PODCASTING

When you search for it on Wikipedia, this is what it says, ‘A Podcast is an episodic series of spoken word digital audio files that a user can download to a personal device for easy listening’. Streaming applications and Podcasting services provide a convenient and integrated way to manage a personal consumption queue across many Podcast sources and playback devices.

When we talk about our profession, the most commonly accepted meaning of Podcast is a collection of audio calls or audio messages. It’s as simple as it sounds. A consultant / professional generally answers clients’ calls every now and then, explaining various concepts without clients’ queries and interruptions. To make life easier and to save on time and energy, the recorded version of such explanations / advisories can be converted to Podcasts and uploaded.

Now imagine someone calls you and asks, what is ‘Seamless ITC’ under GST? All you need to do is share the link to the Podcast uploaded by you and ask them to clarify their doubts. This also does some branding for you because the person may share it with others who may have the same query. Podcasts have an edge over videos and books because these can be heard while travelling by train or driving a car. One may not have to take out special time for the same.

HOW TO START A PODCAST

Podcasting in general terms is simple – recording an audio and uploading it on some platform which can be accessed by a subscriber of that particular service. For example, JioSaavn Music, Gaana and other music apps have started their Podcast services, too. The most commonly used hosts these days are Spotify and Anchor FM.

The following quick steps may help you to plan your Podcast:
* Come up with a concept (a topic, name, format and target length for each episode; for example, you can start with a series of topics on GST);
* Design an artwork and write a description to ‘brand’ your Podcast;
* Record and edit your audio files (such as MP3s). A microphone is recommended;
* Find a place to host them (as mentioned above, you may begin with Spotify); and
* Upload your Podcast on these platforms and the rest will be taken care of.

Now that we know what is Podcasting, let us deep-dive into some FAQs:

(1) What are the equipments / software required for a podcast?

As a beginner, you can start even with the mobile phone record option. Find a place where there is no external noise and disturbance and keep your mobile on ‘Airplane Mode’ so that your recording is not disturbed by calls / notifications.

Nevertheless, this may not suffice if you want to start recording at a professional level. For that we recommend that you use the following tools to the extent possible:

Microphone

The foremost piece of equipment you’ll require is a microphone. You may opt for a set that includes the microphone, a durable steel housing and a broadcast arm that keeps the mic off the table, etc. The good news is that apart from the normal recorder, Playstore, IOS stores and web browsers also have special recording applications / websites (Spreaker Studio, Anchor, Podbean, SoundCloud) which may assist you in having a really good Podcast recorded using a very basic mic (maybe the mic of your headphone). You may choose either of these at the beginner level. Having tried both, we can vouch that both work well provided you pick a quiet place for recording.

Headphones

A set of noise-cancelling headphones is advisable instead of normal headphones once you start recording regularly. A successful Podcast is less about pricey equipment and more about the experience you provide to your listeners. So we do not recommend higher spending on these equipments to start with, but once you are a regular, noise-cancelling headphones will help in better hearing and can help you provide better sound quality for upload.

Recording and editing software

Most of the Podcast creators use Garageband (for Mac Users) or Audacity (for Windows), which turn your laptop or tablet into a full-fledged recording studio. Both these companies offer free versions of their software which lets you record live audio, edit files, change the speed / pitch of your recordings, cut and splice, and output your Podcast to a digital sound file. You need good software as Podcasts cannot be like a normal phone call where you just start speaking on content and end after 30 to 60 minutes. When you start recording, you will realise that there will be a need for Intro Music, Background noise editing, lots of cuts and retakes. Good software ensures that all these things are mixed in a way that a Podcast sounds like an uninterrupted recording.

(2) How long should your Podcast be?

This question may arise to everyone planning to begin Podcasting. To answer this, we did reach out to people and also had surveys; and what we concluded was: Podcasts should be as long as they need to be! But since this doesn’t answer the basic FAQ, here are a few tips that you may keep in mind while considering the length of your Podcast. The length should ideally depend on the frequency of uploading. So here is a tip that we wish to share:
(i) If you plan to Podcast once or twice a week or month, the length can be 60 minutes or more; and
(ii) If you plan to Podcast daily, the length should be between five and 15 minutes.

However, the ideal length that a normal user may want to listen to a Podcast will be 20 to 25 minutes. Remember the 30-minute daily soap operas on TV? They used to run on the same psychology and that’s why there used to be a lot of series that used to run for half an hour daily.

(3) What should be the structure of the Podcast?

All Podcasts no matter what they are about, who makes them, how they are made or their length, follow three structures:

(a) Interview or Q&A structure:

This is by far the most popular structure of Podcasts. This is as simple as it sounds and requires less time for preparation. All you need to do is start interviews on specific topics or have a candid chat with industry leaders in a Q&A format. We have seen people calling leaders on Podcasts while they ask them candid questions like – what made you think you wish to practice GST, what advice would you like to give our fellow professionals, etc. A tip to share here – you may also consider having an interview with someone who can guide fellow professionals on the importance of mental and physical health.

This structure works as a branding for both the interviewer and the interviewee.

(b) Educational structure:

This is a series of Podcasts where you cover a topic which educates the listeners. The topic could be technical or non-technical. To begin with, you may consider having a series of educational Podcasts on Ind AS covering all the Ind AS’s in different segments. For this structure, some time and efforts have to be put in for preparing the content.

(c) Entertaining structure:
Again, this is a kind of series which is slowly gaining ground. In such a series, you may just call people from the same profession and talk about something which may entertain the listeners. You may have a series where you cover ‘Financial Lessons to be learnt from Bollywood Movies!’ or something like ‘Management Lessons to be learnt from Mahabharat!’ You may also just want to call people and explore their hidden talent and reveal to the listeners how fellow professionals could also be singers or comedians.

Irrespective of the structure that you choose, there are still some basics that you should cover in every Podcast: An intro, one key takeaway from the Podcast, a call to action, a thank you or a shout-out and closing remarks.

(4) What are the basic steps in publishing a Podcast?

Have a Podcast cover art design
While this may sound bizarre, a cover art will make a difference to listeners. We have often read and been taught ‘Don’t Judge A Book By Its Cover’. But it’s crazy how we always judge a book by its cover! So think about it – there are a series of Podcasts shown when someone searches, say, Podcasts by CAs; but one factor because of which a listener may choose your Podcast is your cover art. Here are some quick tips to consider while designing the cover art for your Podcast – 1/4th text, originality, lovely colour schemes and images that speak about the topic.

How to publish your podcast on Apple, Spotify, Google, etc.
This is the most interesting part about Podcasting. Unlike YouTube or Instagram, where you can directly upload a video or go live and have your content on its channel, Podcasting works differently. Currently, Google, Apple Podcasts or even Apps like JioSaavn, etc., do have a space for Podcasts but they do not allow users to upload content directly. You need a Host for your Podcast, for example, Anchor.fm, when you upload your Podcast the same will be published on the platform and from the Host it will be distributed to all the Podcast providers and based on its AI and other aspects, they will show it on their platforms.

(5) What after the Podcast is published?

Once the Podcast is published, you may consider sending a link of the same to your newsletters list, update it on your social media accounts like Twitter / LinkedIn, send a broadcast on WhatsApp, attach the link in your email signature and, lastly, ask your colleagues to share it. You can also get regular subscribers to your post on Podcasting and you can interact with them.

So far we have seen how and why Podcasting is needed to expand your professional brand, but if you are still not convinced, the following benefits may convince you to start your series:

The benefits of Podcasting


There are a variety of reasons for firms to Podcast regularly these days. The most common motivation is generating awareness about the firm, engagement and thought leadership. There are more altruistic reasons as well, which may include sharing information / insights or creating an online community. Regardless of your motivation or objective, Podcasting can provide reliable results to expand a brand for your firm. An important point to note here is that there is no violation of the Code of Ethics since we are not in any way targeting to solicit clients. Our aim in Podcasting our series should be knowledge-sharing and expanding the brand value for the firm.

If you’re still unsure whether Podcasting is right for your firm, answer the following questions:
* Are you looking to build a relationship between your firm and your audience?
* Do you have valuable information to share?
* Are you able and willing to talk about your expertise on a regular basis?
* Do you want your firm to have recognition worldwide?

If you answered yes to one or more of the above questions, then Podcasting is something that you may just want to begin.

DAUGHTER’S RIGHT IN COPARCENARY – PART VI

I am overwhelmed that my articles on the subject have evinced considerable interest. The amendment to the Hindu Succession Act, 1956 (‘the Act’) by the Hindu Succession Amendment Act, 2005 (‘the Amendment Act’) and the issue of daughters’ right in coparcenary property have now been the subject matter of substantial litigation all over the country. Through my articles published in the BCAJ in January, 2009; May, 2010; November, 2011; February, 2016; and May, 2018, I made an attempt to analyse and explain the legal position as per the various cases decided by several High Courts and by the Supreme Court of India.

It cannot be disputed that the amendments were beneficial to society and a step towards ensuring equality between males and females in an HUF. However, in view of the imprecise language of the Amendment Act and lack of clarity about what exactly was intended by the Legislature, the amendment was the subject matter of a plethora of court cases all over the country and ultimately some cases went up to the Supreme Court.

In view of the cases decided by the Supreme Court till then, my article published in February, 2016 expressed a hope that the legal position then explained was final. Unfortunately, further decisions came from the Supreme Court. I say unfortunately because as explained in my last article published in May, 2018, confusion was created by two different decisions of the Supreme Court and I had to end the article with the fervent hope that the Apex Court would review its decisions to resolve the conflict.

I am glad to note that the Supreme Court has now tried to resolve the conflict in its recent decision in the case of Vineeta Sharma vs. Rakesh Sharma and others, reported in (2020) 9 SCC 1.

The confusion created by the Supreme Court can be explained in brief as under:

‘The Supreme Court in the case of Sheela Devi vs. Lal Chand [(2006), 8 SCC 581] held that the Amendment Act would have no application in a case where succession was opened in 1989, when the father had passed away. In the case of Eramma vs. Veerupana (AIR 1966 SC 1880), the Supreme Court held that the succession is considered to have opened on the death of a person. Following that principle in the case of Sheela Devi (Supra), the father passed away in 1989 and it was held that the Amendment Act which came into force in September, 2005 would have no application’.

Based on this, the Madras High Court applied the decision to other cases.

Even in the case of Prakash vs. Phulavati (2016) 2 SCC 36 which was decided in 2016, the Supreme Court held that ‘the rights under the Amendment Act are applicable to living daughters of living coparceners as on 9th September, 2005 irrespective of when such daughters are born’.

Thus, there is a plethora of cases deciding that the father of the claiming daughter should be alive if the daughter makes a claim in the coparcenary property. Moreover, it is necessary that the male Hindu should have been alive on the date of coming into force of the Amendment Act. Thus, at that stage the legal position was that the rights of a daughter under the Amendment Act are applicable to living daughters of living coparceners as on 9th September, 2005 irrespective of when such daughters are born. Consequently, I closed my February, 2016 article with the hope that this final legal position would prevail without any further complications.

Unfortunately, this did not happen and in the case of Danamma vs. Amar (2018) 3 SCC 342 the Supreme Court held differently. The principle laid down in earlier cases was not followed and (without considering its own decision in the case of Sheela Devi) it was held that a daughter would have a share even if her father was not alive on the date of coming into force of the Amendment Act. This decision caused confusion. In my June, 2018 article I could end only by expressing the fervent hope that the Apex Court would review its decision in the Danamma case so that the apparent conflict is resolved without resulting in further litigation. Both these decisions were re-ordered by a Bench of two judges. Later, it was decided to refer the issue to a larger Bench.

Therefore, it is heartening to note that the larger Bench of the Supreme Court, after considering all previous decisions, including some High Court cases, has now taken a view which possibly settles all the confusion created earlier and lays down the law which is now final and binding on all. In the recent case of Vineeta Sharma (Supra), the Supreme Court has overruled its earlier decision in the cases of Prakash vs. Phulavati and partly overruled the Danamma decision of interpretation of the Amendment Act.

The final legal position as emerging from this decision can be summarised as follows:
(i) A daughter of a coparcener who is living as on9th September, 2005 shall by birth become a coparcener in her own right in the same manner as a son and have the same rights in the coparcenary property as she would have had if she would have been a son;
(ii) This position applies regardless of when such daughter is born;
(iii) It is not necessary that the father on account of whom a daughter gets a right should be alive.

Hopefully, this closes the chapter of controversies regarding the interpretation of the Amendment Act. I can only express the wish that the legal ingenuity of lawyers does not extend to raising any new issues and allows the final legal position to stand.

IS BIG TECH CARTELISING AGAINST INDIVIDUAL SOVEREIGNTY?

Few weeks back, WhatsApp called out users to either accept their new policy or get bumped off. A while ago, the sitting US President was de-platformed from Twitter, YouTube and Facebook. Around the same time, Amazon servers took off websites that they felt violated their policies. Google and Apple took the Parler app off their platform.
Big tech companies are monopolies, or rather megapolies (if one can coin that word to include size). Governments and users consent to and tolerate mega techs to get away with privacy and security issues. Politicians benefit from these platforms, shareholders make money from them and users fall for free services.
In the case of POTUS, the de-platforming is not an issue but permanent de-platforming is. No right to appeal is an issue. The lack of identity of these companies is a problem. (Google calls itself a marketing company, like the Big Four firms call themselves audit firms as and when it suits them!) Hiding identity and masquerading makes it all the more difficult to put a finger on wrongdoing.
Big tech today has the power to decide who has the right to assemble digitally and who has the right to speak digitally and what they can say. But when tech companies act together – either explicitly or sequentially and ‘embolden each other’ – it seems more like a cartel. Imagine if all these companies had converted free services into paid, people would have been up in arms, but not so when it concerns our civil liberties. What happened in the last few months is a kind of signalling.
More important was the subject matter – free speech and its control. We are made to believe that these are private companies. Well, if you get bumped out of one service provider, you can go elsewhere. But can free speech be privatised in a global townhall? Big tech normally talks big about freedom of speech and the like. In practice it’s not so! Add to it the leftist bias amongst those who farm the content, as already admitted by a tech honcho. This bias makes platforms more spacious for only one type of ideology. Effectively, if a cartel takes a coordinated decision, it is like a government decision and you just can’t contest it.
Free markets and capitalism have a wild and wicked side on which monopolies thrive. And the winner takes all. Can private companies disconnect your phone? Can they censor your speech? There is a difference between being a platform / medium and having editorial rights. I remember one government handle blocked me for voicing my opposing views and concerns. But do I have effective free speech rights on private platforms against a government handle? No!
Today, there is little one can do to protect these issues from monopolistic practices and especially from a free speech protection perspective. Even America doesn’t have much in its legal framework.
Big tech has taken over much of the competition. There are very few options to choose from. Should some of these services be treated as essential services and be paid for? Should there be an unbiased redressal mechanism? Do we need laws to deal with a specific situation like India just announced last week?
Tech corporations want people to live by rules and standards or community guidelines. But whose standard should be ‘the standard’? We don’t know! However, we do know that an individual and his civil liberties alone can be the centre point. An Individual is and should remain the sovereign. The time has come for an Online Bill of Rights so that no one can decide for us. What we have now is a situation where so many aspects of our lives are taken over by tech oligarchies without any rights!
 

Raman Jokhakar
Editor

Section 147 – Reassessment – Oversight, inadvertence or mistake of A.O. or error discovered by him on reconsideration of same material is mere change of opinion and does not give him power to reopen a concluded assessment

7. Dell India (P) Ltd. vs. Joint Commissioner of Income Tax, Bangalore [Writ Appeal No. 1145 of 2015, dated 27th January, 2021 (Karnataka High Court)(FB)]

Section 147 – Reassessment – Oversight, inadvertence or mistake of A.O. or error discovered by him on reconsideration of same material is mere change of opinion and does not give him power to reopen a concluded assessment

By the order dated 2nd September, 2015, a Division Bench of the Court directed that this writ appeal should be placed before the Chief Justice for considering the issue of referring the following three questions to a larger Bench. The said three questions are as under:

‘1.        Whether the Division Bench judgment in the case of Commissioner of Income-tax vs. Rinku Chakraborthy [2011] 242 ITR 425 lays down good law?

2.        Whether the judgment in Rinku Chakraborthy (Supra) is per incurium in view of the fact that it relies upon the judgment of the Apex Court in the case of Kalyanji Mavji & Co. vs. Commissioner of Income-tax 1976 CTR 85, which has been specifically overruled by the Apex Court in the case of Indian & Eastern Newspaper Society vs. Commissioner of Income-tax [1979] 110 ITR 996?

3.        Whether “reason to believe” in the context of section 147 of the Income-tax Act can be based on mere “change of opinion” of the A.O.?’

The scope of the adjudication is limited to deciding the three questions of law framed by the Division Bench.

The assessee company manufactures and sells computer hardware and other related products. It provides warranty services to the customers and the price of the standard warranty period is covered by the sale price of the computer hardware and other products. The assessee company also provides extended or upsell warranty which covers the period beyond the standard warranty. It charges an additional amount as consideration for this. Although the assessee company recovers the consideration for extended warranty with the price of the products along with sales tax or service tax, as the case may be, the revenue in connection with extended warranty is recognised and offered to income-tax proportionately over the period of the service contract, which spreads beyond the financial year in which the sale in relation to the product concerned is made. The assessee has adopted the ‘deferred revenue’ system under the mercantile system of accounting.

During the assessment proceedings, the A.O. examined the issue of deferred revenue by calling for details from the assessee. He agreed with the accounting system followed by the assessee as regards accounting of the consideration for extended warranty.

A notice u/s 148 was issued to the assessee. While arriving at the net revenue of Rs. 31,10,85,96,000 for the A.Y. 2009-10, reduction of Rs. 2,16,89,00,773 was made as smart debits deferred revenue account. It is alleged in the reasons that the said income of Rs. 2,16,89,00,773 had escaped assessment for the A.Y. 2009-10.

The assessee replied to the notice u/s 148 and objected to the reasons recorded. It submitted that the reasons recorded for reopening the assessment for the A.Y. 2009-10 are based on mere change of opinion and hence cannot be termed as valid reasons. It was submitted that as the A.O. has taken a different view for different assessment years, it amounts to merely a change of opinion. The Joint Commissioner of Income-tax, by a letter dated 24th February, 2015, rejected the objections raised by the assessee and directed it to appear for the reassessment proceedings for the A.Y. 2009-10.

Being aggrieved by the said notice u/s 148 and the rejection of its preliminary objections to the said notice, a writ petition was filed before the learned single Judge of the High Court. The Judge rejected the petition on the ground that there was no error in initiation of the proceedings u/s 148.

The assessee submitted that in the case Rinku Chakraborthy [2011] 242 CTR 425 the Division Bench had concluded that where an A.O. erroneously fails to tax a part of the assessable income, there is an income escaping assessment and, accordingly, the A.O. has jurisdiction u/s 147 to reopen the assessment. In doing so, it relied on the observations of the Apex Court in the case of Kalyanji Mavji and Company [1976] 1 SCC 985. It is further submitted that the observations made in the case of Kalyanji Mavji and Company (Supra) are no longer good law in their entirety, in the light of the subsequent decision of the Apex Court in the case of Indian and Eastern Newspaper Society [1979] 4 SCC 248 where the Apex Court held that those particular observations in Kalyanji Mavji and Company did not lay down the correct position of law. In the light of the observations of the Apex Court in the case of Indian and Eastern Newspaper Society, it is clear that a mistake, oversight or inadvertence in assessing any income would not give the power to an A.O. to reopen the assessment by exercise of powers u/s 147. That would amount to a review, which is outside the scope of section 147.

The subsequent judgment of the Apex Court in the case of Indian and Eastern Newspaper Society was not brought to the notice of this Court in the case of Rinku Chakraborthy. He urged that there are specific provisions in the Act for correcting errors / mistakes such as the power of rectification u/s 154 and one cannot resort to section 147 to correct errors or to review an earlier order.

The Division Bench held that the decision in the case of Rinku Chakraborthy is based only on what is held in clause (2) of paragraph 13 of the decision in the case of Kalyanji Mavji and Company. The decision rendered in the latter case was by a Bench of two Judges. Subsequently, a larger Bench of three Judges in the case of Indian and Eastern Newspaper Society has clearly held that oversight, inadvertence or mistake of the A.O. or error discovered by him on the reconsideration of the same material does not give him power to reopen a concluded assessment. It was expressly held that the decision in the case of Kalyanji Mavji and Company on this aspect does not lay down the correct law. The decision in the case of Rinku Chakraborthy is based solely on the decision of the Apex Court in the case of Kalyanji Mavji and Company and in particular what is held in clause (2) of paragraph 13. The said part is held as not a good law by a subsequent decision of the Apex Court in the case of Indian and Eastern Newspaper Society.

The second question was answered in the affirmative, in view of the consistent decisions of the Apex Court holding that ‘reason to believe’ in the context of section 147 cannot be based on mere change of opinion of the A.O.

The third question was answered in the negative. The Court observed that in view of settled law, framing of question No. 3 was not warranted at all.

BLAST FROM THE PAST

Here is a rare nugget from the archives of veteran Uday Chitale. This photograph was clicked in 1951-52 (about 70 years ago when the BCAS was just three years old!). The occasion was the visit of Mr. J.S. Seidman, the then President of the American Institute of CPAs, when he visited and interacted with members of the BCAS. He is seated third from left, holding a bouquet of flowers.

Those seated in the front row are, from left, N.M. Shah, R.B. Sheth, G.M. Kapadia, C.N. Sanghavi, R.P. Dalal and M.L. Bhatt.

Standing (from left to right), H.S. Banaji, D.L. Bhatt, R.S. Phadke, M.P. Chitale, D.P. Vora, M.H. Contractor, B.D. Jokhakar, S.N. Desai, S.V. Ghatalia, E.C. Pavri, A.S. Thakkar and A.H. Dalal.

OECD’S PILLAR ONE PROPOSAL – A SOLUTION TRAPPED IN A WEB OF COMPLEXITIES

1. TAXATION OF DIGITAL ECONOMY (DE) – A GLOBAL CONCERN
The
digital revolution has improved business processes and bolstered
innovation across all sectors of the economy. With technological
advancements, businesses can operate in multiple countries remotely,
without any physical presence. However, the current international tax
system, which dates back to the 1920s, is primarily driven by physical
presence and hence is obsolete and incapable of effectively taxing the
DE1.

In the absence of efficient tax rules, taxation of DE has
become a key Base Erosion and Profit Shifting (BEPS) concern all over
the world. While the Organisation for Economic Co-operation and
Development’s (OECD) BEPS 1.0 project resolved several issues, the
project could not iron out the concerns of taxation of the DE. Hence,
OECD and G20 launched the BEPS 2.0 project wherein OECD along with 135
countries is working towards a global consensus-based solution under the
ambitious ‘Pillar One’ project.

2. BLUEPRINT OF PILLAR ONE PROPOSAL – A DISCUSSION DRAFT TO BE WORKED FURTHER
OECD’s
Pillar One project proposes to modify existing profit allocation rules
in such a way that a portion of the profits earned by a Multinational
Enterprise (MNE) group is re-allocated to market jurisdictions (even if
the MNE group does not have any physical presence in such market
jurisdictions), thereby expanding the taxing rights of market
jurisdictions over MNEs’ profits.

As part of the Pillar One
project, a report titled ‘Tax Challenges Arising from Digitalisation –
Report on the Pillar One Blueprint’ (referred to as ‘Blueprint’ or
report hereafter) was released in October, 2020 which represents the
extensive technical work done by OECD along with members of the BEPS
inclusive framework (BEPS IF)2 on Pillar One.

Being a Blueprint,
it is more in the nature of a discussion draft. It does not reflect
agreement of BEPS IF members who participated in the discussion on
Pillar One proposals and there are many political and technical issues
which still need to be resolved. However, this Blueprint will act as a
solid basis for future discussions. Further, BEPS IF members have agreed
to keep working on Pillar One proposals reflected in the Blueprint with
a view to bring the process to a successful conclusion by mid-2021.

 

1   https://www.europarl.europa.eu/RegData/etudes/STUD/2016/579002/IPOL_STU(2016)579002_EN.pdf

3.  EVENTUAL IMPLEMENTATION OF PILLAR ONE REPORT – A CHALLENGING TASK

The
implementation of Pillar One proposals, if and when concluded, will
require modification of domestic law provisions by member countries, as
also the treaties signed by them. The proposal is to implement ‘a new
multilateral convention’ which would co-exist with the existing tax
treaty network. However, the architecture of the proposed multilateral
convention is still being developed by OECD and is not discussed in this
Blueprint.

4. OVERVIEW OF PILLAR ONE REPORT

The Pillar One report primarily focuses on three proposals:

(a) Amount A – New taxing right:
To recollect, Pillar One aims to allocate certain minimum taxing rights
to market jurisdictions where MNEs earn revenues by selling their goods
/ services either physically or remotely. In this regard, new profit
allocation rules are proposed wherein a portion of the MNEs’ book
profits would be allocated to market jurisdictions on formulary basis.
The intent is to necessarily allocate a certain portion of MNE profits
to a market jurisdiction even if sales are completed remotely. Such
portion of MNE profit recommended by Pillar One to be allocated to
market jurisdictions is termed as ‘Amount A’.

(b) Amount B – Safe harbour for routine marketing and distribution activities:
Arm’s length pricing (ALP) of distribution arrangements has been a key
area of concern in transfer pricing (TP) amongst tax authorities as well
as taxpayers. In order to enhance tax certainty, reduce controversy,
simplify administration under TP laws and reduce compliance costs, the
framework of Amount B is proposed. ‘Amount B’ is a fixed return for
related party distributors that perform routine marketing and
distribution activities. Unlike Amount A which can allocate profits even
if sales are carried out remotely, Amount B is applicable only when an
MNE group has some form of physical presence carrying out marketing and
distribution functions in the market jurisdiction. Currently, the report
suggests that Amount B would work independent of Amount A and there is
no discussion on the inter-play of the two amounts in the report.
Besides, even if Amount A is inapplicable to an MNE group (for reasons
discussed below), the MNE group may still need to comply with Amount B.

(c) Dispute prevention and resolution mechanism:
The report recognises that it would be impractical if tax
administrations of all affected market jurisdictions assess and audit an
MNE’s calculation and allocation of Amount A. It is also unlikely that
all disputes concerning Amount A rules could be resolved by existing
bilateral dispute resolution tools such as Mutual Agreement Procedure
(MAP) and Advanced Pricing Agreement (APA). To remove uncertainty, a
clear and administrable mandatory binding dispute prevention process is
proposed in the report to prevent and resolve disputes specifically
related to Amount A. Under this process, a detailed consultation would
take place amongst taxpayers and tax authorities of market jurisdictions
before tax adjustments are made to the MNE’s assessment.

Considering
that Amount A is the heart of the Pillar One report, this article
focuses on the concept, computation and taxation of Amount A.

 

2              BEPS
IF was formed by OECD in January, 2016 wherein more than 135 countries
participate on equal footing in developing standards on BEPS-related issues and
reviewing and monitoring its consistent implementation


5. CONDITIONS FOR APPLICABILITY OF AMOUNT A TO MNE GROUP – IMPACT OF MATERIALITY
To
recollect, Amount A represents the amount recommended by the Pillar One
report to be allocated, for the purpose of taxability, to market
jurisdictions even if, as per existing taxation rules, no amount may be
allocable to the market jurisdiction. Some fundamental conditions are
proposed on the applicability of Amount A and subject to these
conditions alone Pillar One recommends allocation of MNE profits of a
group to market jurisdictions.

Each of the following conditions
needs to be satisfied by the MNE group for triggering of Amount A
allocation. Non-compliance with any of the conditions may result in
complete non-trigger of allocation:
a) MNEs having consolidated
global revenues (from all businesses) exceeding €750mn as per
consolidated financial statement (CFS) prepared at the parent entity
level under the applicable accounting standards;
b) MNEs engaged in ‘Automated digital service’ (ADS) and ‘Consumer-facing business’ (CFB);
c)
MNEs earning revenues of more than €250mn from ADS and CFB activities
carried out outside their home jurisdiction. The definition of an MNE’s
home jurisdiction is still being developed. For instance, one option
being explored is where the group is headquartered or where the ultimate
parent entity is a tax resident; and
d) MNEs earning more than routine profits.

Some further comments / elaborations of the conditions enumerated above are as under:

Pre-condition
for allocation of Amount A to market jurisdictions

Comments
/ observations

a.
MNEs having consolidated global revenues (from all businesses) exceeding
€750mn as per consolidated financial statement (CFS) prepared at the parent
entity level under the applicable accounting standards; and

This addresses the factor of materiality
– small and medium-sized MNEs are proposed to be excluded from the Amount A
regime in order to ensure the compliance and administrative burden is
proportionate to the expected tax benefits

b.  MNEs engaged in ‘Automated digital service’
(ADS) and ‘Consumer-facing business’ (CFB); and

•   Given
globalisation and the digitalisation of the economy, these businesses can,
with or without the benefit of local physical operations, participate in an
active and sustained manner in the economic life of a market jurisdiction

•   ADS is defined
to mean services which require minimal human intervention on part of service
provider through a system (i.e., automated) and such services are provided
over internet or an electronic network (i.e., digital). To illustrate, ADS
cover online advertising services, digital

    content
services, online gaming

 

    services, cloud
computing services, etc.

•   CFB is defined
as businesses that supply goods or services, directly or indirectly, that are
of a type commonly sold to consumers, and / or license or otherwise exploits
intellectual property that is connected to the supply of such goods or
services. It primarily covers business of sale of goods and services which
are not regarded as ADS. It also extends to cover licensing and franchising
businesses

•   Specific
exclusion from Amount A is provided to certain sectors such as natural
resources; banking and financial services; construction, sale and leasing of
residential property; and international airline and shipping businesses

c.  MNEs earning revenues of more than €250mn
from ADS and CFB activities carried out outside the MNE group’s home
jurisdiction. Definition of MNE’s home jurisdiction is still being developed.
For instance, one option being explored is where the group is headquartered
or where the ultimate parent entity is tax resident; and

Where MNEs primarily earn revenue from
ADS and / or CFB businesses carried out in the home jurisdiction itself and
the business in market countries is only meagre, applying Amount A is likely
to have a limited tax impact because the Amount A formula may allocate
profits to the same jurisdiction that already has taxing rights under
existing tax rules

d.
MNEs earning more than routine profits. While the discussions are still
ongoing, a profitability ratio (i.e., ratio of profit to sales) of 10% is
being considered as routine profit and hence, MNEs which carry on in-scope
business but have losses3 or have profitability margin of less
than 10% as per books need not compute Amount A

MNEs that earn only routine profits are
outside the scope of Pillar One. Routine profit is a reward for undertaking
usual business taking risks. Usually, if there is physical presence of an MNE
group in any market jurisdiction for the purpose of effecting sales in the
market, under transfer pricing rules, routine profits are usually allocated
to such market jurisdictions

However, Pillar One is built on the
basis that where an MNE group earns bumper profits, market jurisdiction
contributes to accrual of more than routine profit to the MNE group
(irrespective of whether or not the MNE group has any physical presence in
such market jurisdiction) and hence,

 

market jurisdictions deserve a share in
such bumper profit. But if the MNE group does not earn super profits, the
issue of allocation of additional profits to market countries does not arise

 

 

3   If an MNE has losses,
such MNE need not compute Amount A but instead the losses may be allowed to be
carried forward. In this regard, a special loss carry-forward regime for Amount
A will be developed by OECD which is currently under discussion

MNEs who do not fulfil any of the above conditionswill be
outside the Amount A profit allocation rules. However, where the above
conditions are fulfilled, the MNE would need to determine Amount A as
per the proposed new profit allocation rules (which would be determined
on formulary basis at the MNE level, refer Para 7) and allocate Amount A
to eligible market jurisdictions as discussed in Para 6.

The above conditions on applicability of Amount A to MNE groups can be understood by the following examples:

Particulars

Scenario
1

Scenario
2

Scenario
3

Facts

Name of MNE group

ABC group

PQR group

MNO group

Nature of business

ADS

CFB

ADS

Home jurisdiction of group

France

Germany

Spain

Consolidated global revenue of the group

500 mn

1000 mn

1000 mn

Revenue earned by the group from outside
home jurisdiction

100 mn

200 mn

500 mn

Profitability ratio of the group

8%

15%

-5%

Analysis of satisfaction of conditions

Global revenue test (€750mn) as per
books

Q

R

R

Foreign revenues from ADS and CFB test (€250mn)

Q

Q

R

Routine profitability test (whether
profit as per books exceeds 10%)

Q

R

Q

Impact

Amount A not applicable to ABC group

Amount A not applicable to PQR group
since revenue from outside home jurisdiction is not more than €250mn

Amount A not applicable to MNO group
since group is incurring losses

6. AMOUNT A ALLOCABLE ONLY TO ELIGIBLE MARKET JURISDICTIONS

MNE
groups that pass all the tests mentioned in Para 5 will need to
determine Amount A and allocate the same to market jurisdictions.

(i) Sales, marketing and distribution activities pre-requisite to qualify as market jurisdiction:
At the outset it should be noted that Amount A is a specific regime for
allocation of super profits to market jurisdictions. Market
jurisdiction is defined as jurisdictions where an MNE group sells its
products or services, or in the case of highly digitalised businesses,
jurisdictions where the MNE provides services to users or solicits and
collects data or content contributions from users. Thus, if an MNE is
carrying out manufacturing function or research and development which
are completely unrelated to sales, marketing and distribution functions
in a jurisdiction and there is no sales function carried out there, such
jurisdictions would not qualify as a ‘market jurisdiction’ and, hence,
not eligible for Amount A.
(ii) Not all market jurisdictions will be eligible for Amount A allocation:
As aforesaid, Amount A is applicable only to the MNEs engaged in ADS
and CFB activities. Amount A will be allocable to a market jurisdiction
only where an MNE group has a reasonable level of ADS and CFB activity
in that market jurisdiction and such markets are termed as ‘eligible
market jurisdictions’. In order to determine a reasonable level of
activity, certain tests are proposed as discussed below.

6.1 Likelihood of threshold for ADS business per market jurisdiction

a.
To recollect, ADS business means services provided with minimal or no
human involvement over Internet or an electronic network. These
businesses may include online advertising services, online search
engines, social media platform, digital content service, etc.
b. The
very nature of ADS is such that these businesses will always have a
significant and sustained engagement with market jurisdictions remotely,
i.e., without physical presence. Hence, for ADS businesses a simple
revenue threshold test is being proposed to determine whether the MNE
has a nexus with that market jurisdiction. The revenue threshold that
can be prescribed is still being negotiated.
c. For example, assume
that per market nexus revenue threshold for ADS business is proposed to
be €50mn. In such a case, even where the MNE group turnover from the ADS
business may be €1000mn but revenue in India from ADS only €10mn, India
being a relatively insignificant market contributing revenue cannot be
considered as an eligible market jurisdiction to which Amount A is
allocable as chargeable profit.
d. Alternatively, if revenue in India
from ADS is €100mn (and the MNE fulfilled other conditions as stated in
Para 5), India qualifies as eligible market jurisdiction entitled to
tax a proportion of Amount A – regardless of the fact that there is no
physical presence in India, or regardless of the fact that the
traditional taxation rules would have failed to capture such taxability.

6.2 Likelihood of threshold for CFB business per market jurisdiction

a.
Unlike ADS, the ability of an MNE to participate remotely in a market
jurisdiction is less pronounced in the CFB model. MNEs usually have some
form of presence in market jurisdictions (for example, in the form of
distribution entities) to carry out consumer-facing businesses.
b.
Hence, countries participating in the discussions believe that a mere
revenue threshold test may not denote the active and sustained
engagement with the market jurisdiction and the presence of certain
additional indicators (‘plus factors’) may be necessary. These plus
factors which can be used to establish a nexus are still being debated
and developed at the OECD level.

Market jurisdictions that meet
the nexus test will qualify as ‘eligible market jurisdictions’ for the
MNE group and will be eligible for a share of Amount A of such MNE group
to be taxed in the market jurisdiction. Such allocation of Amount A
will yield tax revenue for that market jurisdiction irrespective of
whether the MNE group has an entity or PE in that market country, or
whether any profits are offered to tax in that market country under
existing tax laws.

7. DETERMINATION OF AMOUNT A OF MNE GROUP THAT WILL BE ALLOCABLE TO MARKET JURISDICTIONS

a.
The norms of profit allocation suggested in the Blueprint are very
different from the taxability norms which are known to taxpayers as of
now. Hence, the exercise suggested in the report should be studied on an
independent basis without attempting to rationalise or compare it with
the conclusion to which one would have arrived as per traditional norms
of taxation.

b. The philosophy behind the report is that no MNE
group can make sizeable or abnormal or bumper profit without the
patronage and support that it gets from the market jurisdiction. There
is bound to be some contribution made by the market jurisdictions to the
ability of the MNE group to earn more than routine4 (abnormal) profit.
Hence, in relation to MNE groups which have been successful enough to
secure more than 10% routine (i.e., abnormal / bumper profits), some
part of such bumper profits should be offered to tax in every market
jurisdiction which has contributed to the ability to earn profit at the
group level. Consequently, if the MNE group’s profits are up to routine
or reasonable, or if the MNE is in losses, the report does not seek to
consider any allocation of profits to the market jurisdiction.

c.
As to how much profit of an MNE group qualifies as normal or reasonable
or routine profit and how much qualifies as abnormal or bumper or
non-routine profit is yet to be decided multilaterally amongst all
countries participating in the Pillar One discussions. Currently, (but,
provisionally) the report suggests that countries are in favour of
considering a profit margin of 10% of book revenue as normal profits,
i.e., 10% profit margin will be considered as ‘routine profits’
warranting no allocation, and any profit earned by the MNE group above
10% alone will be considered as ‘non-routine profits’ warranting
allocation to the market jurisdiction.

d. For example, if the
consolidated turnover of an MNE group as per CFS is €1000mn on which it
has earned book profits5 of €50mn as per CFS, its profit margin is only
5%. Since the profit earned by the MNE group is only 5% (i.e., within
the routine profit margin of 10%), the MNE group is considered to have
earned profits due to normal / routine entrepreneurial risk and efforts
of the MNE group and nothing may be considered as serious or abnormal
enough to permit market jurisdictions to complain that, notwithstanding
traditional taxation rules, some income should be offered to tax in the
market jurisdiction.

 

4   The report uses the
expression ‘residual profits’ to convey what we call here abnormal or
non-routine or super profit

5   The report also proposed
adjustments to the book profits by adding back of income tax expenses, expenses
incurred against public policy like bribes, penalty, reducing dividend and
gains on transfer of asset, etc., to arrive at a standardised base of profits

e.
Alternatively, if the consolidated turnover of the MNE group as per CFS
is €1000mn on which it has earned book profit of €400mn as per CFS, its
profit margin as per the books is 40%. In such a case, the profits
earned by the group beyond 10% (i.e., 40%-10%=30%) will be considered as
non-routine profits. Some part of such non-routine profits will be
considered as having been contributed by market jurisdictions and need
to be allocated to the eligible market jurisdiction as discussed in the
Para below6.

f. Once it is determined that the MNE group has
received non-routine profit in excess of 10% (in our example, excess
profit is 30% of turnover), the report is intended to carry out an
exercise where a portion of the excess profit is to be allocated to the
market factor of a market jurisdiction.

g. It is the philosophy
that the consumers of the country, by purchasing the goods or enjoying
the services, contribute to the overall MNE profit and but for such
market and consumers, it would not have been possible to effect the
sales. However, at the same time it is not as if the entirety of the
non-routine or super profit is being earned because of the presence of
the market. There are many other factors such as trade intangibles,
capital, research, technology, etc., which may have built up the overall
success of the MNE group.

h. As per present estimates and
thinking discussed in the report, about 80% of the excess profit or
super profit (in our example, 80% of super profit of 30%) may be
recognised as pertaining to many different strengths of the MNE group
other than the market factor. It is the residual 20% of the super profit
component which is recognised as being solely contributed by the
strength of the market factor. Hence, the present report on Pillar One
discusses how best to allocate 20% of the super profit (in our example,
20% of 30%) to market jurisdictions. The report is not concerned with
allocation or treatment of the 80% component of the super profit which
is, as per the present text of Pillar One, pertaining to factors other
than market forces.

 

6   Throughout the article,
this is assumed to be the applicable fact pattern of excess or more than
routine profit

i. A tabulated version of the illustrative fact pattern and proposed allocation rules of Amount A is as under:

Particulars

Amount

Consolidated turnover of MNE group

1000 mn

Consolidated book profit

400 mn

% of book profit to turnover

40%

Less: Allowance for routine profit

(10%)

Excess profit over routine profit, also
loosely for abnormal or super profit

30%

Of this, 80% of super profit of 30% is
considered as pertaining to the strength of non-market factors and having no
nexus with contribution of the market jurisdiction (and hence out of Pillar
One proposal)

24% of 1000 mn

20% of super profit of 30% being
considered as fair allocation having nexus with contribution of market
jurisdictions – known also as Amount A recommended by the report – to be
allocated to different market jurisdictions

6% of 1000 mn

j. Some countries participating in the discussion are of the
view that allocation of 20% of non-routine profits to market countries
is minuscule and a higher margin should be allocated since the overall
success of the MNE group can be accomplished only as a result of
consumption in the markets. This article goes by the ball-park
recommendations of 20% discussed in the report for the purpose of
understanding the concept – though it may be noted that the
multilaterally agreed allocation percentage may be different.

k.
Even if under existing tax norms no profits are taxable in a market
jurisdiction (say due to no physical presence), Amount A will ensure
market countries get right to tax over 20% of non-routine profits of the
MNE group and that the market jurisdictions should not be left high and
dry without right to tax income.

8. CORRELATION OF INTERIM MEASURE ALREADY IMPLEMENTED BY INDIA, PENDING FINAL OUTCOME OF PILLAR ONE REPORT AND / OR BEPS ACTIONS

As
we are aware, even without waiting for the final outcome of the Pillar
One recommendations, India has already introduced in its domestic law
the equalisation levy which seeks to tax 2% of the digital or remote
sales as taxable profit of a non-resident and 6% of advertisement
services rendered by a non-resident.

It may be noted that all
countries participating in Pillar One discussions have agreed to
withdraw relevant unilateral actions introduced by them in their
domestic laws once Pillar One recommendations are successfully
implemented. Hence, India will hopefully withdraw the equalisation levy
once a Pillar One consensus-based solution is reached.

It is,
therefore, submitted that the Pillar One discussions may be studied as
an independent exercise rather than trying to compare them with the
interim measures. No attempt has, therefore, been made in this article
to explain or review the provisions of the equalisation levy. The
article concentrates on Pillar One proposals which are likely to
substitute the present levy.

9. FACTORS WHICH INFLUENCE QUANTUM OF ALLOCATION TO MARKET JURISDICTIONS
Broadly,
and with respect to marketing and sales activity, an MNE can carry out
operations in a market jurisdiction in the following manner:
(a)    Sales through remote presence
(b)    Presence in form of Limited risk distributor (LRD)
(c)    Presence in form of Full risk distributor (FRD)
(d)    Presence in dependent agent permanent establishment (DAPE).

Assuming
that there is no physical presence of the MNE group in a market
jurisdiction, say, India, Amount A of the MNE group determined as per
Para 7 above would be allocated to market jurisdictions on the basis of
revenue generated from each market jurisdiction. If, for example,
turnover from India is €100mn, 6% of India turnover, which equals to
€6mn, will be allocated for taxability to India.

However, if the
MNE group has a physical presence in India as well (say in the form of
LRD or FRD or DAPE), there may be a trigger for taxability in India even
as per existing taxation rules. In any such case, there could be some
variation in the rules relating to the allocation of Amount A to India.
Taxation of Amount A under each form of business presence is explained
below.

Sales is only through remote presence:
a.
Consider an example where an MNE group engaged in providing standard
online teaching services earns subscription revenue from users across
the world. In India, the group does not have any form of physical
presence and all the functions and IPs related to the Indian market are
performed and owned by a Swiss company (Swiss Co).

b. The financials of the MNE group suggest as under:

Facts:

MNE group turnover as per CFS

€1000 mn

Profit before tax (PBT) as per CFS

€400 mn

Group profit margin as per CFS

40% of group turnover

India turnover

€100 mn

c. Under existing tax rules, Swiss Co’s income is outside
the tax net [since the service is not in the nature of fees for
technical services (FTS) and Swiss Co does not have a permanent
establishment (PE) in India], thus all profits earned from the India
market (routine as well as non-routine) are taxed only in Switzerland in
the hands of Swiss Co.
d. Though India does not have taxing rights
under the existing tax rules (due to no physical presence), the
Blueprint would ensure that Amount A be allocated to India. As explained
in Para 7, Amount A recommended by the report to be allocated to
different market jurisdictions would come to 6% of the turnover. Since
turnover from India is €100mn, 6% of India turnover, equal to €6mn, will
be allocated for taxability to India.
e. However, an issue arises as
to which entity will pay taxes on Amount A in India. In this regard,
the report recognises that Amount A will co-exist with the existing tax
rules and such overlay of Amount A on existing tax rules may result in
double taxation since Amount A does not add any additional profit to the
MNE group but instead reallocates a portion of the existing non-routine
profits to market jurisdictions.
f. In the given example, all
profits (routine as well as non-routine) from the India business are
taxed in the hands of the Swiss Co under the existing tax rules. In
other words, the €6m allocated to India under Amount A is already being
taxed in Switzerland in the hands of Swiss Co due to the existing
transfer pricing norms. Hence, Swiss Co may be identified as the ‘paying
entity’ in India and be obligated to pay tax on Amount A in India.
Subsequently, Swiss Co can claim credit of taxes paid in India in its
residence jurisdiction (i.e., Switzerland).

9.2 Presence in form of limited risk distributor (LRD)
a.
There are a number of cases where an MNE group may not have full-scale
presence in the market jurisdiction but may have an LRD who is assisting
in the conclusion of sales. In a way, the LRD’s presence is
contributing to routine sales functions on a physical basis in such a
market jurisdiction. It is not a category of work which contributes to
any super profit but is taking care of logistics and routine for which
no more than routine profits can be attributed.
b. Consider an
example; a Finland-based MNE group is engaged in the sale of mobile
phones across the world. The headquarter company (FinCo) is the
intellectual property (IP) owner and principal distributor. The group
has an LRD in India (ICo) which performs routine sales functions under
the purview of the overall policy developed by FinCo. The financials of
the MNE group suggest as under:

Facts:

Group turnover as per CFS

€1000 mn

PBT as per CFS

€400 mn

Group profit margin as per CFS

40% of group turnover

India turnover

€100 mn

c. Under existing TP principles, assume that ICo is
remunerated @ 2% of India revenue for its routine functions and the
balance is retained by FinCo which is not taxed in India. In other
words, all profits attributable to non-routine functions are attributed
to FinCo and hence not taxable in India.
d. As explained in Para 7,
Amount A recommended by the report to be allocated to different market
jurisdictions would come to 6% of the turnover. Since the turnover from
India is €100mn, 6% of Indian turnover equal to €6mn will be allocated
for taxability in India.
e. India also has taxability right with
regard to the LRD function @ 2% of India turnover. This right is shared
by India so as to compensate for the routine functions carried out in
India. No part of the super profit element is contained therein, whereas
Amount A contemplates allocation of a part of the super profit.
Considering this, there is no concession or reduction in the allocation
of Amount A merely because there is taxability @ 2% of turnover for
routine efforts in the form of an LRD. The overall taxability right of
India will comprise of compensation towards LRD function as increased by
allocation of super profits in the form of Amount A.
f. Besides,
even if Indian tax authorities, during ICo’s TP assessment, allege that
ICo’s remuneration should be increased from 2% to 5% of India turnover,
there would still not be any implication on Amount A allocable to India
since ICo’s increase in remuneration for performing more routine
functions and no element of super profit forms part of such
remuneration.
g. While tax on compensation towards LRD function will
be payable by ICo, an issue arises as to which entity should pay tax on
Amount A allocable to India. Since FinCo is the IP owner and principal
distributor, existing TP rules would allocate all super profits
pertaining to the India market to FinCo. Thus, the super profits of €6mn
allocated to India under Amount A are already being taxed in Finland in
the hands of FinCo on the basis of the existing TP norms. Hence, the
Blueprint suggests that FinCo should be obligated to pay tax on Amount A
in India and then FinCo can claim credit of taxes paid in India in its
residence jurisdiction (i.e., Finland) against income taxable under
existing tax laws. Accordingly, ICo would pay tax in India on LRD
functions (i.e., routine functions) whereas FinCo would pay tax on super
profits allocated to India in the form of Amount A.

9.3 Presence in form of Full risk distributor (FRD)
a.
As a variation to the above, an MNE group may appoint an FRD in a
market jurisdiction. An FRD performs important functions such as market
strategy, pricing, product placement and also undertakes high risk qua
the market jurisdiction. In essence, the FRD performs the marketing and
distribution function in entirety. Hence, unlike an LRD, an FRD is
remunerated not only with routine returns but also certain non-routine
returns.
b. Consider an example where a French headquartered MNE
group engaged in the business of fashion apparels carries out business
in India through an FRD model. All key marketing and distribution
functions related to the Indian market are undertaken by the FRD in
India (ICo). Applying TP principles, ICo is remunerated at 10% of India
sales.
c. The financials of the MNE group are as under:

Facts:

Group turnover as per CFS

€1000 mn

PBT as per CFS

€400 mn

Group profit margin as per CFS

40% of group turnover

India turnover

€100 mn

d. To recollect, Amount A contemplates allocation of a part of
an MNE’s super profits to market jurisdictions, India being one of them.
Had there been no physical presence in India, as per calculations
indicated at Para 9.1, part of the super profits allocable to India as
Amount A would come to 6% of the India turnover (i.e., €6mn).
e. Now,
ICo as an FRD is already being taxed in India. This represents
taxability in India as per traditional rules for performing certain
marketing functions within India which contribute to routine as also
super profits functions in India. This is, therefore, a case where, in
the hands of ICo, as per traditional rules, part of the super profit
element of the MNE is separately getting taxed in the hands of ICo.
f.
In such a case, the report assumes that while up to 2% of India
turnover the taxability can be attributed towards routine functions of
ICo (instead of towards super profit functions), the taxability in
addition to 2% of India turnover in the hands of ICo is attributable to
marketing functions which contribute to super profit.
g. Since India
is already taxing some portion of the super profits in the hands of ICo
under existing tax rules, allocation of Amount A to India (which is a
portion of super profits) creates the risk of double counting. In order
to ensure there is no double counting of super profits in India under
Amount A regime and the existing TP rules, the Blueprint recognises that
Amount A allocated to India (i.e., 6%) should be adjusted to the extent
super profits are already taxed in the market jurisdiction. In order to
eliminate double counting, the following steps are suggested7:
(i)
Find out the amount as would have been allocable to market jurisdiction
as per Amount A (in our illustration, 6% of India turnover of €100mn).
(ii)
Fixed routine profit which may be expected to be earned within India
for routine operations in India. While this profit margin needs to be
multilaterally agreed upon, for this example we assume that additional
profit of 2% of India turnover will be expected to be earned in India on
account of physical operations in India. Additional 2% of India
turnover can be considered allocable to India in lieu of routine sales
and marketing functions in India – being the allocation which does not
interfere with the super profit element.
(iii) The desired minimum
allocation to market jurisdiction of India for routine and non-routine
activities can be expected to be 8% of the India turnover, on an
aggregate of (i) and (ii) above.
(iv) This desired minimum return at
step (iii) needs to be compared with the allocation which has been made
in favour of India as per TP analysis.

?    If the amount
allocated to FRD in India is already more than 8% of turnover, no
further amount will be allocable under the umbrella of Amount A.
?  
 On the other hand, if the remuneration taxed under TP analysis is <
8%, Amount A taxable will be reduced to the difference of TP return and
amount calculated at (iii).

?    However, if the return under TP
analysis is < 2%, then it is assumed that FRD is, at the highest,
taxed as if it is performing routine functions and has not been
allocated any super profit under TP laws. The allocation may have been
considered towards super profit only if it exceeded 2% of India
turnover. And hence, in such case, allocation of Amount A will continue
to be 6% of India turnover towards super profit elements. There can be
no reduction therefrom on the premise that TP analysis has already been
carried out in India. It may also be noted that since Amount A
determined as per step (i) above is 6% of India turnover, an allocation
in excess of this amount cannot be made under Amount A.

 

7   Referred to as marketing
and distribution safe harbour regime in the report

h. Once the adjusted Amount A is determined as per the steps above, one would need to determine
which entity would pay tax on such Amount A in India. In this case, since France Co and ICo both perform function
asset
risk (FAR) activities that result in revenue from the India market, the
Blueprint recognises that choosing the paying entity (i.e., entity
obligated to pay tax on Amount A in India) will require further
discussions / deliberations. Further, the report also recognises that
taxes may have been paid in the market country on royalty income.
However, whether and how such taxes paid can be adjusted against tax on
Amount A is currently being deliberated at the OECD level.

i. In the fact pattern below, ABC group, engaged in CFB business, carries out sale in India under the FRD model.

Facts:

Group turnover as per CFS

€1000 mn

PBT as per CFS

€400 mn

Group profit margin

40%

India turnover

€100 mn

TP remuneration to FRD in India

•     Scenario 1

•     Scenario 2

•     Scenario 3

 

10% of India turnover

5% of India turnover

1% of India turnover

Amount A allocable to India
(6% of 100 mn)

6 mn

Elimination of double counting of non-routine profits in India under different scenarios:

 

 

Particulars

Scenario
1

Scenario
2

Scenario
3

a.

Amount A allocable to India (as
determined above)

6%

6%

6%

b.

Return towards routine functions (which
OECD considers tolerable additional allocation in view of presence in India)

2%

2%

2%

c.

Sum of a + b (This is the sum of the
routine and non-routine profits that the OECD expects Indian FRD to earn)

8%

8%

8%

d.

TP
remuneration to FRD in India

10%

5%

1%

e.

Final Amount A to be allocated to India

No Amount A allocable since FRD in India
is already remunerated above OECD’s expectation of 8%

3%,

OECD expects Indian FRD to earn 8% but
it is remunerated at 5%. Hence, only 3% to be allocated as Amount A [instead
of 6% as determined at (a)]

 

6%,

No reduction in Amount A since OECD
intends only to eliminate double counting of non-routine profits and
where existing TP returns is less than fixed return towards routine
functions, it is clear that no non-routine profit is allocated to India under
existing tax laws

9.4 Presence in form of DAPE

a.
The report recognises that the MNE groups may have a presence in a
market jurisdiction in the form of PE as well. A DAPE usually is an
agent in the market jurisdiction who undertakes sales or secures orders
for its non-resident principal.
b. The manner in which Amount A would
be taxed in a market jurisdiction where an MNE group operates through a
DAPE model would depend on the functional profile of the DAPE. If the
DAPE only performs minimum risk-oriented routine functions, the
taxability of Amount A may be similar to the LRD scenario discussed at
Para 9.2. On the other hand, where the DAPE performs high-risk
functions, the taxability of Amount A would be similar to the FRD
scenario discussed at Para 9.3.

10. COMPREHENSIVE CASE STUDY ON WORKING AND ALLOCATION OF AMOUNT A
FACTS
?    ABC group is a German headquartered group engaged in the sale of mobile phones which qualifies as CFB activity.
?  
 The ultimate parent entity is German Co (GCo) which owns and performs
development, enhancement, maintenance, protection and exploitation
(DEMPE) functions related to the MNE group’s IP.
?    ABC group makes sales across the world. As per ABC group’s CFS,
o    Global consolidated group revenue is €1000mn
o    Group PBT is €400mn
o    Group PBT margin is 40%
?    ABC group follows a different sale model in the different countries in which it operates:

Particulars

France

UK

India

Brazil

Sales model

Remote presence

LRD

FRD

DAPE performing all key functions and
risk-related Brazil market

Sales

100

200

400

300

TP remuneration

NA

2%

10%

5%

? All countries (France, UK, India, Brazil) qualify as eligible market jurisdictions

Computation of Amount A at MNE level:

Particulars

 

Profit margin

Amounts

PBT of the group

(A)

40%

400

Less: Routine profits
(10% of €1000Mn)

(B)

10%

100

Non-routine profits

C = A-B

30%

300

Profits attributable to non-market
jurisdiction

D = 80% of C

24%

240

Profits attributable to market
jurisdictions (Amount A)

E = C-D

6%

60

Allocation of Amount A to respective market jurisdictions:
   

 

Particulars

France

UK

India

Brazil

 

Sales
model

Remote presence

LRD

FRD

DAPE

a.

Amount A allocable (as determined above)

6%

6%

6%

6%

b.

Fixed return towards routine functions
(as calibrated by OECD)

Marketing and distribution safe harbour
regime – NA since MNE has no presence or limited risk presence

2%

2%

c.

Sum of a + b

8%

8%

d.

TP
remuneration to FRD in India

10%

5%

e.

Final Amount A to be allocated

6%

6%

NIL since FRD in India is already
remunerated above OECD’s expectation of 8%

3%

OECD expects DAPE to earn 8% but it is
remunerated at 5%. Hence, only 3% to be allocated as Amount A

f.

Entity obligated to pay Amount A

GCo (FAR analysis would indicate that
GCo performs all key functions and assumes risk related to France and UK
market which helps to earn non-routine profits from these markets)

NA, since there is no Amount A allocated
to India

Depending on FAR analysis, Amount A may
be payable by GCo or DAPE or both on pro rata basis

11. UNITED NATION’S EFFORTS TOWARDS TAXATION OF DIGITAL ECONOMY
While
OECD is working with BEPS IF members to develop a solution to
effectively tax the digital economy, some members of the United Nations
(UN) digital taxation sub-committee have raised concerns on OECD’s
proposed solution. For example, concerns are raised that Pillar One will
introduce a great deal of complexity. Besides, the expected modest
revenue impact of Pillar One does not justify the large-scale changes in
the system of taxing MNEs8.

As an alternate solution, UN has
proposed to introduce a new Article in the United Nations Model
Convention which would apply to income from ADS (automated digital
services, i.e., services provided with minimal or no human involvement
over Internet or an electronic network). A specific inclusion of the ADS
article would ensure that such highly-digitalised services do not fall
under the general business profits article (i.e., Article 7) and hence
the source countries may be able to tax such income even in the absence
of a PE.

The ADS Article proposed by the UN is designed along the
lines of royalty, dividend, FTS articles, i.e., taxing rights to source
state, gross basis taxation, concept of beneficial owner, payer and PE
source rule, ALP adjustment, etc. Additionally, an optional net basis
taxation is proposed where the beneficial owner of the ADS income will
be taxed on a net basis instead of on gross income. Under the net basis,
the taxable amount will be determined on the basis of a normative
formula which is currently being discussed at the UN level.

A comparison of UN’s proposal for digital taxation and OECD’s Amount A proposal indicates as under:

Particulars

ADS
Article proposed by UN

OECD’s
proposed Amount A

Level of taxability

Entity level

MNE group level

Taxes remote presence beyond
conventional PE

Yes

Yes

Activities covered9

ADS

ADS and CFB

Monetary threshold for applicability

No threshold (countries may adopt local
thresholds if required)

Global revenue threshold and in-scope
foreign de minimis threshold

Gross vs. Net

Provides option to taxpayer to choose
between tax on gross consideration and taxation on net basis

Net basis (Amount A is a share of MNE
profits)

Taxable amount

Gross basis: Gross consideration

Net basis: Taxable amount to be
determined on formulary basis

Taxable amount to be determined on
formulary basis

Rate of tax

Gross basis: 3-4% of transaction value

Net basis: Domestic tax rate

Domestic tax rate of market jurisdiction

Taxing right allocated to

Source country

Eligible market jurisdictions

Source rule

Payer or PE-based source rule

Market jurisdictions that meet tests as
discussed in Para 6

Tax-bearing entity

Recipient or beneficial owner of ADS
income

MNE group entity identified as paying
entity

Treatment of losses

Gross basis: Not considered

Net basis: No tax in case of losses (No
clarity on treatment of past losses)

No Amount A allocation when MNE is in
losses, losses would be carried forward and past losses can be considered

Implementation

New MLI approach or bilateral

New MLI to be drawn to implement Amount
A

Dispute resolution

Existing MAP or domestic route

Customised tax certainty or dispute
resolution process being formalised

Inter-play with existing business
profits rule

Where Article 12B would apply, income
would fall outside PE taxation

Amount A to work alongside existing tax
rules

12. CONCLUDING THOUGHTS
The reports published by OECD
and UN as proposals to effectively tax the digital economy indicate that
international taxation norms are at the cusp of a revolution. MNEs will
have a daunting task of understanding the nuances of the proposals and
their impact on their businesses, though on a positive note there may be
relief from unilateral measures taken by countries to tax the digital
economy once the OECD / UN proposals are implemented.

While tax
authorities will be eager to have another sword in their armoury, it may
be noted that the OECD / UN proposals are still far from the finishing
line. Though the Blueprint released by OECD is more than 200 pages, the
report mainly provides the broad contours of the structure and working
of Amount A. Most of the aspects of Amount A are still under discussion
and debate. With 135countries participating in the OECD discussions, the
biggest challenge will be to achieve multilateral
consensus. While
countries have committed to arrive at a consensus-based solution by
mid-2021, it will be interesting to see how it is accomplished within
such a short span of time.

 

7   Referred to as marketing
and distribution safe harbour regime in the report

8   Note submitted by
Committee member Rajat Bansal as published in UN Doc E/C.18/2020/CRP.25 dated
30th May, 2020

9   Definition of ADS is the
same in the UN as well as in the OECD proposal

TDS – Sections 197 and 264 and Rule 18AA of IT Rules, 1962 – Certificate for Nil deduction or deduction at lower rate – Application by assessee for certificate for Nil withholding rate – Issuance of certificate at higher rate than Nil rate without recording reasons – Copy of order supported by reasons to be furnished to assessee – Matter remanded to Dy. Commissioner (TDS)

48. Tata Teleservices (Maharashtra) Ltd. vs. Dy. CIT [2020] 430 ITR 273 (Bom.) Date of order: 17th December, 2020 A.Y.: 2021-22


 

TDS – Sections 197 and 264 and Rule 18AA of IT Rules, 1962 – Certificate for Nil deduction or deduction at lower rate – Application by assessee for certificate for Nil withholding rate – Issuance of certificate at higher rate than Nil rate without recording reasons – Copy of order supported by reasons to be furnished to assessee – Matter remanded to Dy. Commissioner (TDS)

 

For the A.Y. 2018-19, the assessee was issued Nil withholding rate certificates u/s 197. However, those certificates were cancelled. The assessee filed a writ petition which was allowed, and the cancellation order was quashed. Thereafter, fresh certificates for deduction of tax at Nil rate were issued to the assessee for the A.Y. 2018-19. For the A.Ys. 2019-20 and 2020-21, the assessee submitted applications for tax withholding certificates at Nil rate. However, certificates u/s 197 were issued at rates higher than Nil rate. The assessee stated that it did not contest such certificates because it was focused on providing various wire-line voice, data and managed telecommunications services and therefore had opted for demerger of the consumer mobile business. Under the scheme of demerger, the consumer mobile business of the assessee stood transferred to BAL. The assessee filed an application seeking issuance of Nil rate tax withholding certificates u/s 197 on various grounds for the A.Y. 2021-22 and furnished the details that had been sought. However, the authorities issued certificates at rates higher than Nil. The assessee sought the order sheet / noting on the basis of which such certificates were issued but it did not get a response.

 

The Bombay High Court allowed the writ petition filed by the assessee and held as under:

 

‘i) The procedure for issuance of certificate u/s 197 for deduction at lower rates or no deduction of tax from income other than dividends is laid down in Rule 28AA of the Income-tax Rules, 1962.

 

ii) Since the authorities were required to pass an order u/s 197 either rejecting the application for such certificate or allowing such application resulting in issuance of certificates which may be at rates higher than Nil as sought by the assessee, such an order must be supported by reasons. Not only that, a copy of such an order had to be furnished to the assessee so that it could be challenged u/s 264 if it was aggrieved. Not passing an order to that effect or keeping such an order in the file without communication would vitiate the certificates.

 

iii)   The reasons for not granting Nil rate certificates to the assessee were not known. The contemporaneous order required to be passed u/s 197 was also not available. The order was set aside, and the certificates were quashed. The matter was remanded to the Deputy Commissioner (TDS) for passing fresh order and issuing consequential certificates u/s 197 complying with the requirements of rule 28AA.’

GOVERNANCE & INTERNAL CONTROLS: THE TOUCHSTONE OF SUSTAINABLE BUSINESS – PART I

‘Barings Bank
collapsed by rogue trader’, screamed media headlines in February, 1995,
shocking the world. Is this even possible? How can one person bring down a
two-century-old reputed bank and a banker to the Queen of England? But it did
happen. And not isolated, though – closer home, the country opened 2009 reading
the confession of the Satyam Chairman, Mr. Ramalinga Raju, saying ‘It was like
riding a tiger, not knowing how to get off without being eaten’. Mr Raju
admitted to inflating profits with fictitious positions in the balance sheet,
including inflated (non-existent) cash and bank balances, overstated debtors,
understated liabilities and accrued interest which was non-existent1.
He confessed to manipulating the books for several years which attained
unmanageable proportions to the tune of Rs. 14,162 crores through these devious
methods. Ironically, Satyam had just received the Golden Peacock Global Award
for Excellence in Corporate Governance in September, 2008! But this was revoked
soon after Mr. Raju’s confession.

 

Quite a few major
debacles have followed since – Enron, Tyco, Lehman Brothers, Kingfisher,
Café  Coffee Day, PMC Bank… Regrettably,
we are witnessing this not just in business ventures, but scams, or at least
alleged ones, are also surfacing in diverse spheres such as government spends,
sports arena and so on. That we live in a VUCA world dogged with volatility,
uncertainty, complexity and ambiguity only compounds the
issue.

 

Why do these occur?
Many factors could propel such events or behaviour including arrogance, power (nasha)
and greed. But what I would like to share here is my learning on two
fundamental drivers to a sustainable business – Governance and Internal
Controls. Broadly speaking, the former is all about ethos, culture, mind-set
and a way of life embedded in individuals, leaders and enterprises. Internal
Controls encompass the practices, processes and procedures which serve to
auto-generate and instil self-correcting operating mechanisms, thereby
functioning as a secure preventive measure. While effective internal controls
are integral to running operations, good governance is the edifice on which
great organisations are built. Leaders, therefore, while ensuring adequate
controls need to exhibit personal integrity and uphold high governance
standards to establish a sustainable business.

In recent times, a
lot has been written on these subjects and regulatory frameworks and awareness
levels have improved considerably. Yet, we witness cases of deceit cropping up
in numbers and magnitude which are discomforting. And at the core seems to be
intent and character. Given the ingenuity of the human race, if there is
a chosen intent to defraud, person/s acting unilaterally and / or in collusion will
find a way to do it. This ends up in a curative process and the learning from
each episode then gets calibrated in the system for improvements.
Investigations post the Barings Bank debacle revealed that a trader, Mr.
Nicholas Leeson’s greed and inadequate operational risk controls at Barings
made the bank collapse under a $1.4 billion debt. In Satyam’s case, Mr. Raju
wanted to divert funds to real estate which eventually fell through. It was, inter
alia, found that the cash and bank verification procedures were lacking. It
is customary now for auditors to seek balance certification from banks. The
Companies Act, 20132 has made corporate fraud a criminal offence and
lays out the responsibilities on fraud reporting. The Act also provides for a
rigorous framework for related party transactions. A Serious Fraud
Investigation Office (SFIO) which was set up under the Act has a statutory
status and now has the power to arrest as well. The SFIO has been actively
investigating cases relating to corporate fraud. The Securities and Exchange
Board of India published detailed disclosure requirements in 2015, applicable
to all listed companies3. This sets out stringent guidelines relating
to reporting / disclosure of material events and actual and suspected fraud.
The Institute of Chartered Accountants of India4 came out with a
Guidance Note on Reporting on Fraud.

HOW
IT PLAYS OUT: ENRON, A CLASSIC CASE

Enron was a company
headquartered in Houston, Texas which was dealing in commodities, energy and
services and ranked as America’s fifth largest company. In 2001, the company
filed for bankruptcy leading to shareholders losing $74 billion, thousands of
employees and investors losing their retirement accounts and many employees
losing their jobs. The CEO, Mr. Jeffrey Skilling, and the former CEO, Mr,
Kenneth Lay, kept huge debts off balance sheets. An internal whistle-blower, Ms
Sherron Watkins, helped to bring them to book as high stock prices stoked
external suspicions. How unfortunate! This company was named by Fortune
Magazine as ‘America’s Most Innovative Company’ six years in a row prior to
the scandal and lost its sheen overnight. A Committee entrusted to examine the
role of the auditors, Arthur Andersen, assessed that the firm did not fulfil
its professional responsibilities in connection with its audits of Enron’s
financial statements. Moreover, in 2002, Andersen was convicted of obstruction
of justice for shredding documents related to its audit of Enron. The Supreme
Court in 2005, however, reversed Andersen’s conviction but serious damage had
been done which practically wrecked the firm. Consequent to this scandal, new
regulations were designed to strengthen the accuracy of financial reporting for
publicly-traded companies, the most important being the Sarbanes-Oxley Act
(2002) which imposed criminal penalties for destruction, falsification or
fabricating financial records.

 

Having good
governance as the DNA complemented by sound internal controls are, hence, the
hallmarks of world-class enterprises. Let us examine each of them. This is
covered in two parts – Part I: Governance, and Part II: Internal Controls.

 

GOVERNANCE

Governance or
Corporate Governance comprises the suite of principles and processes by which
an enterprise is controlled, directed or governed in a manner balancing the
interests of the stakeholders, creating long-term sustainable value.
Stakeholders include customers, investors, workforce, suppliers, funders, the
government and the society at large. It is based on policies such as commitment
to conducting business with all integrity and fairness, being transparent by making
all the necessary disclosures and decisions, complying with the laws of the
land and discharging responsibility towards all the stakeholders.

 

Corporate Governance provides the structure for a company to achieve its
aspirations and hence encompasses every aspect of management, from operations
and internal controls to performance measurement and corporate disclosure. Most
companies strive to establish a high standard of Corporate Governance. For many
investors, it is not enough for a company to be just profitable; it also needs
to demonstrate good corporate citizenship through ethical behaviour, respect
for the environment and sound Corporate Governance practices. It is about
balancing individual and social purpose, as well as economic and sustainability
goals.

 

Clearly, there is a
level of confidence that is attached to a company practising good Corporate
Governance. Foreign investors accord weightage to this aspect, too. It is not
surprising, therefore, that the markets have demonstrated a positive approach
towards companies reputed for upholding good governance standards.

 

INSTILL
GOVERNANCE

Some people
consider that governance is an innate quality – you either have it or you
don’t! While this is true in some ways, great corporations also have a systematic
way of nurturing and reinforcing good Corporate Governance. Here, I draw upon
my experience associated over decades with the Unilever and Tata Groups to
highlight some codified best-in-class practices – Unilever Code of Business
Principles (CoBP5) and Tata Code of Conduct (TCoC6).

 

Both CoBP and TCoC
bring out clearly the way these world-class enterprises conduct their
businesses as well as expect their business collaborators to respect and behave
in dealings with their companies. It is expressly communicated that violations
to the Code are unacceptable. They go a step further to clarify that no grudge
will be held against any employee who may even give up a business benefit for
the sake of upholding the Code and not compromising it.

 

Instilling this culture
is a continuous process and also requires review and updation to reflect the
changing environment. Some of the building blocks to make this a living
document are:

 

(i)            
The Code Document: Publishing a written Code is an important step which helps as a good
reference point for all the enterprise stakeholders to guide their behaviour.
CoBP which was launched in 1995 now has 14 clauses in the Code supported by 24
policies. TCoC was first formalised in 1998 and the amended version of 2015
comprises detailed guidelines for all stakeholders. These Codes address varied
aspects from ethics to compliance to diversity to environment.

 

(ii)  Putting
to Work: A practice manual is quite useful wherein
live situations are enumerated explaining how one applies the Code in
day-to-day working, including Musts / Must nots and Q&A. Case
studies are shared. A fascinating format used is through performing skits.
These skits are done innovatively in town hall meetings or annual family day
functions through short engaging stories which convey the essence of the Code.
An impactful variation is the use of contests with several groups competing for
prizes with creative skits bringing out the ethos through interesting
sequences.

 

(iii)  Monitoring and Review: These entities have robust mechanisms to ensure that the Code is
communicated, explained and implemented. Apart from imparting training, some
simple steps such as a written annual confirmation from every employee, an
appropriate clause in contracts with business associates, feedback surveys, a
strong whistle-blowing mechanism, etc. facilitate to monitor the Code in
action.

 

(iv) Completing the Loop: An important
component is to Walk the Talk. A policy should spell out the
consequences for breach of the Code and the process followed to investigate any
allegation of Code violation. Once established, it is vital to implement the
outcome in an objective manner. Finally, sharing of such instances including
action taken is critical not only to demonstrate seriousness but also to raise
awareness levels within the organisation. However, communication is handled
sensitively given the personal ramifications of each case.

 

VALUE SYSTEMS AND BOARD ENGAGEMENT

Governance also
comprises not only voicing core beliefs but also making them integral to the
ways of doing business. The aspect of beliefs and value systems is tested right
upfront at the time of recruitment, assessing business collaborations, or in
acquiring businesses. In acquisitions, finding the right pedigree and therefore
cultural fit becomes the first filter even before business
considerations are put to play. I can quote Safety and Sustainability as great
examples of mettles of governance. These beliefs are embedded into the core of
the strategy rather than appearing on the periphery. Some simple but effective
actions of institutionalising behaviour are listed in the box below.

 

  •     Employment terms spelling
    out that Safety is a condition of employment.  This drives home that Safety is paramount.
  •     Wearing seat belts even
    while seated in the rear of a vehicle.   
  •     Holding on to the handrail
    and refraining from using a mobile phone, while climbing up or down the stairs
    is made into a conscious habit. 
  •     Building Sustainability as
    a mind-set and weaving it into all strategies and decisions made. Here a
    shining example is to consciously go for green buildings as a policy even if
    construction costs work out to be a tad higher.
  •     Keeping these as focus
    Internal Audit themes
  •     Compelling every employee
    particularly in locations such as factories to come  up with suggestions
    pertaining to Safety
  •     Recognising identification
    of near-misses reporting
  •     Encouraging innovation
    towards green manufacturing processes and products
  •     Prohibiting highway travel
    at night and restricting number of persons travelling on the same flight

 

Beyond operations,
I had the privilege of experiencing governance at a Board level. Many years
ago, we had introduced a practice of Board evaluation in a rather structured
manner. All Board members including independent directors were asked to share
their perceptions on a simple two-page questionnaire annually, with due ratings
followed by comments. As the Managing Director, I, too, filled in one and here
I put forth the management viewpoint on the functioning of the Board. I had the
privilege along with the Company Secretary to tabulate the forms both for the
rating as well as other comments. The summary showed the average rating score
against each question as well as comments on what went well and where we could
do better as a Board. We followed a ritual of a Board dinner post every Annual
General Meeting. But prior to the dinner, we had a chat session for about an
hour debating on progress from the previous year and the outcome of the
evaluation to decide on what to focus on going forward.  Actions such as expediting the Board meeting
agenda papers and minutes, field familiarisation for directors, exposure of key
personnel with the Board, etc. came out of such interactions. I found this
entire process delightful and this created a good bonhomie, too, amongst the
Directors. Of course, some of these actions and the Board evaluation processes
have become mandatory in recent years.

 

ESTABLISHING GOOD GOVERNANCE IS NON- NEGOTIABLE

The topic of
governance is wide and encompasses many other aspects – for instance, insider
trading, competitive intelligence, peer dynamics, compensation structures,
workforce conduct, etc. Every element has not been dealt with in this article.
There are legislative pronouncements, too, covering these. One can study the
Codes referred to above to comprehend the various ramifications of this
critical subject. Other companies, such as Johnson & Johnson, Google, Ford
Motor Company, IKEA, Starbucks, Toyota, etc., have their Codes available
publicly on their websites.

 

In sum,
establishing good governance is non-negotiable for any entity striving to
create sustained value while balancing and meeting the interests of multiple
stakeholders. A one-size-fits-all approach, however, may not work with
the modalities and structure varied to suit every enterprise given its ethos
and culture.

 

Do the right thing is what we see as the belief of great institutions. Even if it
means, in many situations, not just sticking to regulations but going beyond
the rule book and what is mandated! And… that is the test of good governance.

This is the second article in the series by V. Shankar
(The first in this series appeared in our issue of January, 2020)

 

_______________________________________

1.  7 January 2009: Satyam Chairman, Mr.
Ramalinga Raju’s letter to his Board of Directors

2.  The Companies Act, 2013: Sections 143,
211, 447

3.  Securities and Exchange Board of India (Listing
Obligations and Disclosure Requirements) Regulations, 2015

4.    The Institute of Chartered Accountants of
India: ICAI Guidance Note on Reporting on Fraud Under Section 143(12), 2016

5. Unilever.com: About | Who we are | Our Values & Principles |
Code of Business

Principles and related Code policies

6. Tata.com: About Us| Values & Purpose | Tata Code
of Conduct)

INSOLVENCY CODE VS. PMLA – CONFLICT OR OVERLAP?

The Insolvency
and Bankruptcy Code, 2016 (the Code) came into force on 28th May,
2016. It was enacted as a special statute to deal with important aspects of insolvency
and bankruptcy. Being a complete Code, it is to prevail over other laws so that
no person can take advantage of pendency of a proceeding under any other law to
stall insolvency and bankruptcy proceedings1. A specific provision
in the Code that confers overriding powers is section 238 which reads as under:

 

‘The provisions of
this Code shall have effect, notwithstanding anything inconsistent therewith
contained in any other law for the time being in force or any instrument
having effect by virtue of any such law’ (emphasis supplied).

 

A review of section
238 of the Code, particularly the non-obstante expression therein, shows
that provisions of the Code have overriding effect over the provisions of other
statutes which are inconsistent with the Code.

 

The Prevention
of Money-Laundering Act, 2002 (‘PMLA’) came into force on 1st
July, 2005. PMLA was enacted as a special statute to prevent money-laundering
and for matters connected therewith and incidental thereto. A specific
provision of the PMLA that confers overriding powers is section 71 which reads
as under:

 

‘The provisions of
this Act shall have effect notwith-standing anything inconsistent therewith
contained in any other law for the time being in force’ (emphasis
supplied).

 

Thus, a review of section
71 of the PMLA, particularly the non-obstante expression therein, shows
that the provisions of the PMLA have overriding effect over provisions of other
statutes which are inconsistent with the provisions of the PMLA.

 

TWO SPECIAL ENACTMENTS
– OVERLAP OR CONFLICT?

From a review of
the preamble to the Code and the PMLA which specify their respective
objectives, it is evident that both the Code and the PMLA are special Acts. The
moot issue for consideration is: when there are two Special Acts, how to resolve
overlap or conflict between the two?

This issue has been
addressed by Courts and other forums in the following manner: When there is
an overlap or conflict between any two Acts, both of which are special Acts,
then the Act which came later must prevail2.

 

Reiterating the
view that it is the subsequent legislation which will have the overriding
effect, the Supreme Court3 observed that it is possible that both
the enactments have the non-obstante clause. In that case, the proper
approach would be that one must be guided by the object and the dominant
purpose for which the special enactment was made.

 

Where the dominant
purpose of a law is covered by certain contingencies, even then the intention
can be ascertained by looking to the objects and reasons notwithstanding that
the law might have come at a later point of time.

 

OVERRIDING EFFECT OF
THE CODE

The overriding
effect of the Code has been examined in various decisions in the context of
specific legislations and proceedings thereunder. Thus, in respect of
proceedings under PMLA vis-a-vis the Code, the following important propositions
have been laid down:

 

(i)   PMLA is a statute which came into effect much
prior to the coming into force of the Code and, therefore, the Code has
overriding effect over the PMLA4.

(ii)   Where the properties of a corporate debtor
under liquidation were attached under PMLA, the question whether attached
properties were proceeds of crime or whether lenders were bona fide
lenders must be decided by the authorities under

 

PMLA. Besides, the
liquidator appointed under the Code has to approach the authorities under PMLA
for withdrawal of the attachment5.

(iii) Since the PMLA relates to a different field of
penal action regarding proceeds of crime, it can be simultaneously invoked with
the Code. Because of the absence of inconsistency, the PMLA has no overriding
effect over the Code and vice versa6.

(iv) Where prior to admission of the Corporate
Insolvency Resolution Process certain properties of a corporate debtor were
attached under the PMLA, the same could not be released as section 14 of the
Code does not have overriding effect on the PMLA7.

RECENT CASES

Keeping in mind the
afore-mentioned legal position, a few recent cases are examined.

 

PMT Machines case

In this case8,
in 2011-12, the debt-laden Sterling Biotech’s subsidiary, PMT Machines (‘the
company’) defaulted on its debt repayments following which the consortium of
banks, led by UCO Bank, initiated recovery proceedings in 2013 before the Debt
Recovery Tribunal.

In 2017, the
Enforcement Directorate conducted search and seizure under the provisions of
the Foreign Exchange Management Act and the Income-tax Act at the Mumbai and
Vadodara premises of the Sterling group’s promoters and the group companies. In
2018, the Enforcement Directorate (ED) passed orders for provisional attachment
of the properties of PMT Machines.

The company was
admitted for insolvency resolution by the Mumbai Bench of the National Company
Law Tribunal in 2018.

The Resolution
Professional approached the appellate authority under PMLA with the plea that
the properties were wrongly attached by the ED. This plea was made on the
premise that the attached properties were acquired before the ‘alleged
commission of offences and charges on the properties were created prior to the
date of alleged offences’.

The Resolution
Professional submitted that because of the attachment by the ED, the Corporate
Insolvency Resolution Process cannot achieve its objective of maximisation of
value of the stressed assets. He pleaded that the attachment of properties by
the ED was delaying the Corporate Insolvency Resolution Process of the company.

 

Upholding the
prevalence of the Code over the PMLA, the appellate authority (PMLA) released
the properties of the company which had been attached by the ED. The appellate
authority (PMLA) observed that since the properties attached had no relation to
the alleged crime committed by the management of the corporate debtor, the same
must be released to the Resolution Professional to ensure quick insolvency
resolution for the company.

 

Holding that the
recovery proceeding initiated by the banks was ‘valid and legal’ and that the
same could not be ‘blocked for years without valid reasons’, the PMLA appellate
authority observed that the ED is not precluded from attaching other private
properties and all other assets of the alleged accused.

 

The appellate authority, however, clarified that the ruling will ‘have
no bearing in any proceedings initiated against the alleged accused including
extradition proceedings pending or proposed to be initiated in any part of the
world’.

 

In response to the
ED plea that banks were the victim of the alleged fraud perpetrated by the
management of the corporate debtor and that the banks were entitled to recover
their dues, the PMLA appellate authority held that the banks should approach
the special court set up for that purpose.

 

The judgment, thus,
paves the way to achieve the desired objective of the insolvency process.

 

JSW Steel case

In the case of JSW
Steel (‘the Company’), the main issue was whether PMLA has overriding effect
on the Code?

 

The National
Company Law Tribunal (‘NCLT’) approved JSW Steel’s resolution plan for Bhushan
Power & Steel – one of the 12 big cases mandated by the Reserve Bank of
India for resolution under the Code. This should have ended the two-year-long
Corporate Insolvency Resolution Process for the stressed company. Instead, an
appeal was filed by JSW seeking protection from attachment and from the
liability resulting from criminal proceedings, highlighting conflict between
two apparently overlapping laws, the PMLA and the Code.

 

The company
explained its concern to NCLT about the main issue, viz., whether the PMLA
has overriding effect on the Code, in the following words:

 

‘What is concerning
us is that contrary judgments are coming up in some ongoing PMLA cases. Today,
no bidder is aware of criminal liabilities. Criminal liability will be on the
person who has done it and the new management in no way would be responsible
for it. But can the assets of the corporate debtor be attached, that is the
main question’.

 

The company’s offer
for Bhushan Power was Rs 19,350 crores. Certain issues about the overriding
provisions of the PMLA and the Code had caused apprehensions to the bidders and
creditors of the stressed steel assets under the Code.

 

One of the bidders
expressed concern over the attachment of assets under the PMLA. The bidder
sought to secure the bid amount and creditors were concerned about recovering
their money.

 

THE CODE AND PMLA – OPERATE IN DIFFERENT SPHERES

In Deputy
Director, Directorate of Enforcement, Delhi vs. Axis Bank9,
the Delhi High Court has held that both the PMLA and the Code have non-obstante
clauses but since they do not operate in the same sphere, they can co-exist.

 

It was observed
that the objective of the PMLA being distinct from that of the Recovery of
Debts Due to Banks and Finance Institutions Act, the SARFAESI Act, and the
Code, these three legislations do not prevail over the PMLA. By virtue of
section 71 of the PMLA, PMLA has overriding effect on other existing laws in
the matter of dealing with ‘money laundering’ and ‘proceeds of crime’.

 

In two differing
judgments, however, the NCLAT in Rotomac Global10 and
the PMLA Appellate Authority in PMT Machines11 had dealt with
the issue of overlap between PMLA and the Code. In the Rotomac Global case,
it was held by the NCLAT that section 14 of the Code (moratorium) is not
applicable to proceedings under the PMLA and that neither law has an overriding
effect on the other because both the laws operate in different spheres.

 

In the case of PMT
Machines, however, the PMLA appellate authority had upheld the prevalence
of the Code over the PMLA and set aside the order of attachment under PMLA and
released the properties on the ground that the properties were acquired much
prior to the date of the alleged offence of money laundering.

 

GROUND REALITIES

Indeed, banks will
have to establish that the security interest was created prior to the crime
period. The issue is: ‘Operationally, how would a creditor establish that
its charge on the property was created before the crime period?’

 

Bidders, too, are
awaiting clarity. In some cases, change of control had already taken place but
yet there was litigation. If the assets of the corporate debtor are allowed to
be attached, it will pose huge risk if, after paying a substantial sum, there
is no assurance about possession of the asset.

 

Sterling SEZ and Infrastructure Finance case

In this case12,
the Corporate Insolvency Resolution Process had commenced. The application of
the financial creditor initiating the Corporate Insolvency Resolution Process
was admitted, the Resolution Professional was appointed and moratorium was
declared.

 

The Enforcement
Directorate attached the assets of the corporate debtor. The Resolution
Professional informed the ED about the declaration of moratorium and sought
withdrawal of the attachment. However, the ED contended that the attached
properties constituted ‘proceeds of crime’ and, therefore, moratorium would not
be applicable to the proceedings under the PMLA. The adjudicating authority
under the Code was called upon to decide whether proceedings before the PMLA
Court in respect of attachment of properties were merely civil proceedings and,
accordingly, the adjudicating authority under the PMLA had no jurisdiction to
attach properties of the corporate debtor undergoing the Corporate Insolvency
Resolution Process.

 

After examining the relevant provisions of the Code and the PMLA, the
Adjudicating Authority under the Code held that the Adjudicating Authority
under the PMLA had no jurisdiction to attach properties of the corporate debtor
undergoing the Corporate Insolvency Resolution Process.

 

It also held that
the attachment order passed under the PMLA was non-est in law since it
was hit by declaration of moratorium under the Code. Accordingly, it was
finally held that the Resolution Professional could proceed to take charge of the properties as if there was no attachment order.

 

GOVERNMENT’S APPROACH

After completing
the resolution under the Code, several bidders faced demands from different
government authorities. The biggest concern, however, was the threat of
attachment under PMLA.

 

A number of
representations have been made by bidders to the Ministry of Corporate Affairs
on the issues pertaining to the PMLA, especially with regard to the attachment
of property.

 

In a holistic view
of the matter, it is suggested that the PMLA should either be amended or the
bidder should be allowed to revise the bid to the extent of the liability in
respect of the alleged ‘proceeds of crime’. The amount may be put in an escrow
account.

 

Government has taken cognisance of
this issue and has sought to amend the Code in December, 2019 to ring-fence the
prospective bidder for stressed assets against the liability for prior
offences.

 

__________________________________________-

1   Neeraj Jain vs. Yes Bank Ltd. (2019) 106
taxmann.com 35 (NCLAT)

2   Solidaire India Ltd. vs. Fair Growth AIR 2001
SC 958; Raman Ispat (P) Ltd. vs. Executive Engineer (Paschimanchal Vidyut
Vitran Nigam Ltd.) (2018) 97 taxmann.com 223 (NCLT-All).

3   Bank of India vs. Ketan Parekh AIR 2008 SC
2361; (2008) 8 SCC 148

4      Siddhi Vinayak Logistic Ltd. vs. Dy.
Director, DoE, Mumbai (2019) 101 taxmann.com 491 (PMLA-AT)

5   Anil Goel, Liquidator, Rotomac Global (P)
Ltd. vs. Ms Ramanjit Kaur Sethi, Dy. Director, DoE (2019) 102 taxmann.com 152
(NCLT-All)

6   Varrsana Ispat Ltd. vs. Dy. Director, DoE
(2019) 108 taxmann.com 96 (NCL-AT) Per contra Asset Reconstruction Co. (India)
Ltd. (ARCIL) vs. Dy. Director (2019) 109 taxmann.com 192 (NCLT-Hyd.)

7   Varrsana Ispat Ltd. vs. Dy. Director, DoE
(2019) 108 taxmann.com 96 (NCL-AT)

8      PMT Machines Ltd. vs. Dy. Director, DoE
(2019) 111 taxmann.com 362 (PMLA-AT)

9 (2019] 104 taxmann.com 49 (Delhi)

10 Rotomac Global (P) Ltd. vs. Dy. Director, DoE
[2019] 108 taxmann.com 397 (NCLAT)


11 PMT Machines Ltd. vs. Dy. Director, DoE (2019) 111 taxmann.com 362
(PMLA-AT)

12 SREI Infrastructure Finance Ltd. vs. Sterling SEZ
& Infrastructure Finance Ltd. [2019] 105 taxmann.com 167 (NCLT – Mum.)

Article 12 of India-USA DTAA; Section 9(1)(vi), (vii) of the Act – Payment received by American company for provision of cloud hosting services to Indian customers was not royalty or fees for included services within meaning of Article 12 since the assessee was in physical control or possession over, and operating and managing, equipment without having granted its lease to customers – Since the assessee did not have PE in India, income could also not be taxed as business profits

22 [2020] 113 taxmann.com 382 (Mum.)(Trib.) Rackspace, US Inc. vs. DCIT ITA Nos. 4920 & 6195 (Mum.) of 2018 A.Ys.: 2010-11 & 2015-16 Date of order: 28th November,
2019

 

Article 12 of
India-USA DTAA; Section 9(1)(vi), (vii) of the Act – Payment received by
American company for provision of cloud hosting services to Indian customers
was not royalty or fees for included services within meaning of Article 12
since the assessee was in physical control or possession over, and operating
and managing, equipment without having granted its lease to customers – Since
the assessee did not have PE in India, income could also not be taxed as
business profits

 

FACTS

The assessee was a
company incorporated in, and a tax resident of, the USA. During the relevant
year, the assessee had earned income from provision of cloud services (cloud
hosting and other supporting and ancillary services) to Indian customers. The
assessee had not filed return of its income.

 

The A.O. issued
notice u/s 148 of the Act. In response, the assessee filed the return of its
income and contended that cloud hosting services were not taxable as
‘royalties’ under Article 12 of the India-USA DTAA because of the following
reasons:

 

  •     The customers do not
    operate the equipment and do not have physical access to or control over the
    equipment used by the assessee to provide cloud support services.
  •     The assessee does not ‘make
    available’ technical knowledge, experience, skill, know-how, etc. to its
    customers. Further, the cloud support services are not in the nature of
    managerial, technical or consultancy services. Consequently, they do not
    constitute included services under Article 12 of the India-USA DTAA.
  •     Hence, income from cloud
    hosting services was business profits. Since the assessee did not have a PE in
    India under Article 5 of India-USA DTAA, the income was not taxable in India
    under the provisions of Article 7(1) of the India-USA DTAA.

 

However, in
accordance with the direction of the DRP, income from cloud services was
treated as ‘Royalty’ and taxed @ 10% under the India-USA DTAA.

 

HELD

  •     Customers of the assessee
    had only availed hosting services. They had not used, possessed or controlled
    equipment (which was owned and controlled by the assessee) used for providing
    hosting services. Hence, the payment for hosting services made by Indian
    customers did not fall within the ambit of the definition of royalty in
    Explanation 2 to section 9(1)(vi) of the Act.
  •     Amendment to the said
    definition by the Finance Act, 2012 clarified that irrespective of possession
    or control of equipment with payer, or use by payer, or location of equipment
    in India, any payment made for ‘use of equipment’ would be classified as
    ‘royalties’.
  •     Since the assessee was a
    tax resident of the USA, it qualified for beneficial provisions under the
    India-USA DTAA.
  •     The definition of royalties under Article
    12(3) of the India-USA DTAA is in pari materia with the pre-amendment
    definition of royalty under the Act. The definition under the India-USA DTAA
    being exhaustive and not inclusive, its meaning should be only that given in
    the Article.
  •     The assessee was providing
    hosting services to Indian customers. The data centre and infrastructure
    therein which was used to provide services belonged to, and was operated and
    managed by, only the assessee.
  •     The term ‘use’ or ‘right to
    use’ in the context of the DTAA contemplates that the payer has possession /
    control over the property or the property is at its disposal. However, the
    assessee did not give any equipment to the customers nor did it allow them to
    have control over equipment. Customers did not have physical control or
    possession over servers and other equipment used to provide cloud hosting
    services. Customers did not even know the location of either the data centre or
    the location of the server in the data centre.
  •     The assessee had provided
    cloud hosting services which were standard services provided to customers.
    Agreement between the assessee and its customers was only a service level
    agreement for providing hosting and other ancillary services simpliciter
    to customers and not for use, or hire, or lease, of any equipment.
  •       Accordingly,
    payments received by the assessee could not be said to be royalty within the
    meaning of Explanation (2) to section 9(1)(vi) of the Act and also Article
    12(3)(b) of the India-USA DTAA. Besides, in the absence of a PE of the assessee
    in India, in terms of the India-USA DTAA its income could not be taxed as
    business profits in India.

 

Articles 7, 14 and 23 of India-Spain DTAA – As gains from hedging were covered under Article 7 or 14 (though not taxable under those Articles), Article 23 is not applicable Article 14 of India-Spain DTAA – Merely because companies are engaged in real estate development, it could not be concluded that their assets ‘principally’ consist of immovable properties; therefore, capital gain earned on sale of shares of such companies not taxable under Article 14

21 [2019] 112
taxmann.com 119 (Mum.)(Trib.) JCIT vs. Merrill
Lynch Capital Market Espana SA SV ITA No. 6109 (Mum.)
of 2018 A.Y.: 2013-14 Date of order: 11th
October, 2019

 

Articles 7, 14 and
23 of India-Spain DTAA – As gains from hedging were covered under Article 7 or
14 (though not taxable under those Articles), Article 23 is not applicable

 

Article 14 of
India-Spain DTAA – Merely because companies are engaged in real estate
development, it could not be concluded that their assets ‘principally’ consist
of immovable properties; therefore, capital gain earned on sale of shares of
such companies not taxable under Article 14

 

FACTS I

The assessee was a
company incorporated in, and tax resident of, Spain. It was registered as a
Foreign Institutional Investor (FII) in India. During the relevant year, the
assessee had undertaken certain transactions to hedge its exposure in foreign
exchange on Indian investments and earned gains therefrom.

 

During the course
of assessment proceedings, the A.O. noticed that the assessee had earned gain
from hedging which it had claimed was exempt under Article 14 of the
India-Spain DTAA. The A.O. observed that being an investor, the assessee could
not carry on any business activity. Accordingly, the A.O. held that the receipt
was in the nature of other income, which was taxable in India in terms of
Article 23(3) of the India-Spain DTAA.

 

In appeal, the
CIT(A) followed the orders of his predecessors in the assessee’s own case.
Further, the CIT(A) also relied on the decision in Citicorp Banking
Corpn., Bahrain vs. ACIT (IT Appeal No. 6625/{Mum.} of [2009]). Accordingly,
the CIT(A) observed that hedging contracts had nexus with the investment in
India because forex transactions were to hedge investment in securities. Hence,
gains from hedging were capital gains. As investment income of the FII was not
taxable in India in terms of Article 14(6) of the India-Spain DTAA, gains from
hedging were also not taxable in India.

 

HELD I

  •     Article 23 comes into play
    only if an item of income is ‘not expressly dealt with’ in the preceding
    articles (i.e. Articles 6 to 22) of the DTAA. The Revenue has not contended
    that as the gains are not covered by Article 7 (Business Income) or Article 14
    (Capital Gain), they should be taxable under Article 23 (Other Income) which
    gives residuary taxation rights to source jurisdiction.
  •     Income cannot be brought
    within the ambit of Article 23 only because it cannot be taxed as the
    conditions for taxability in source jurisdiction were not fulfilled. However,
    income which is otherwise not covered under Articles 6 to 22 (such as alimony,
    income from chance, lottery or gambling, rent paid by resident of a contracting
    state for the use of an immovable property in a third state, and damages which
    do not pertain to loss of income covered by Articles 6 to 22, etc.) only will be
    covered by Article 23.
  •     Income from gains from
    hedging was covered by Article 7 or Article 14. It was taxable if conditions
    were satisfied. Hence, Article 23 would not have any application.
  •     If hedging contracts were
    entered into in the course of business, notwithstanding regulatory
    permissibility, such contracts could either be revenue or capital in nature.
  •     If gains were capital in
    nature, they will be capital gains and would be subject to Article 14 of the
    India-Spain DTAA. A perusal of Article 14(1) to 14(5) shows that none of the
    clauses could be invoked. Accordingly, in terms of Article 14(6), the gains
    were not taxable in source jurisdiction.
  •     If gains were revenue in
    nature, they will be business profits and would be subject to Article 7. They could
    be taxed in source jurisdiction only if the assessee has a PE in India. Article
    7 of the India-Spain DTAA merely mentions ‘profits of an enterprise’. The A.O.
    has mentioned that ‘as an investor, the assessee cannot carry out any business
    activity’ and, therefore, it cannot be said to be a business activity. However,
    Article 7 does not even remotely suggest compliance with regulatory conditions
    for qualifying under the DTAA. Whether with regulatory approval or without
    regulatory approval, and whether legal or illegal, business profits are taxable
    nevertheless.
  •     Even if these were not
    hedging contracts but the assessee was dealing in forward exchange contracts simplicter,
    by itself it could not make gains taxable under Article 7 if the assessee did
    not have a PE in India, or under Article 14 if the gains were not covered in
    Article 14(1) to 14(5). Merely because gains though covered under Article 7 or
    14 but not taxable, would not be covered by Article 23. Hence, gains from
    hedging could not be taxed as non-business income.
  •     Accordingly, the assessee
    was not liable to tax on gains under the India-Spain DTAA.

 

FACTS II

The assessee had invested in shares of certain companies engaged in
development of real estate. Shares of these companies were listed on the stock
exchange (and the taxpayer held them as portfolio investment such that the
holding in each company was less than 7%). During the relevant year, the
assessee earned capital gains on sale of these shares. In India, such gain
could be taxed in terms of the India-Spain DTAA only if the property of such
company, directly or indirectly, consisted of immoveable properties in India
and the shares of such company derived their value principally from such
immovable properties.

 

The A.O. observed that these companies were in the real estate sector,
including development of residential and commercial properties, and further,
the value of the shares of the companies was derived from the value of
immovable properties held by them.

 

Accordingly, the A.O. concluded that capital gain on the sale of their
shares was taxable in India under Article 14(4) of the India-Spain DTAA.

 

In appeal, the
CIT(A) observed that the assessee had minuscule shareholding which could not
have given any right, either in stock-in-trade of those companies, or to occupy
immovable properties of those companies. The CIT(A) further observed that
Article 14(4) was meant to cover cases of indirect transfer of immovable
properties through transfer of shares of companies holding properties. It would
not cover cases where commercial investments were made in shares of companies
engaged in the real estate sector. Hence, the CIT(A) held that gains on the
sale of shares were not taxable in India in terms of Article 14(6) of the
India-Spain DTAA.

 

HELD II

  •     The assessee had sold no
    more than 2% shares in any of the six realty companies. It did not hold any
    controlling interest or even significant interest in these companies which
    could provide any right to occupy properties. All the companies were engaged in
    the business of real estate development and not in holding of real estate per
    se    .
  •     Under Article 14(1), gains
    from immovable property may be taxed in source state. The purpose of Article
    14(4) is to cover gains from shares of a company holding immovable property
    which would not have been covered in Article 14(1).
  •     The India-Spain DTAA does
    not specifically define the expression ‘principally’. From clarifications in
    model convention commentaries, in the absence of anything to suggest a
    different intention, the threshold test should be 50% of total assets. Only
    such companies where holding of immovable property directly or indirectly
    comprises at least 50% of aggregate assets are covered.
  •     Merely because a company is
    engaged in real estate development it would not imply that over 50% of its
    aggregate assets consist of immovable properties. Apparently, the A.O. has
    presumed that just because these companies are dealing in real estate
    development the assets of these companies ‘principally’ consist of immovable
    properties.
  •     Accordingly, the CIT(A) had
    correctly held that cases where commercial investments were made in shares of
    companies engaged in the real estate sector were not covered. Hence, gains on
    sale of shares were not taxable in India in terms of Article 14(6) of the
    India-Spain DTAA.

 

Article 11 of India-Mauritius DTAA; sections 4, 92 of the Act – As per Article 11(1), interest can be taxed only if twin conditions of ‘arising’ (i.e., accrual) and ‘paid’ (i.e., actual receipt) are fulfilled – Transfer pricing provisions cannot apply to tax an amount which had neither accrued to, nor was received by, the taxpayer

20 [2020] 113 taxmann.com 79 (Mum.)(Trib.) Gurgaon Investment Ltd. vs. DCIT ITA Nos. 1499 (Mum.) of 2014, 7359 (Mum.) of
2016 & 6821 (Mum.) of 2017 A.Y.: 2008-09, 2011-12 & 2012-13 Date of order: 15th November,
2019

 

Article 11 of India-Mauritius DTAA;
sections 4, 92 of the Act – As per Article 11(1), interest can be taxed only if
twin conditions of ‘arising’ (i.e., accrual) and ‘paid’ (i.e., actual receipt)
are fulfilled – Transfer pricing provisions cannot apply to tax an amount which
had neither accrued to, nor was received by, the taxpayer

 

FACTS

The assessee was a
non-resident company incorporated in Mauritius. It was engaged in the business
of holding of investments. It was a member company of an international group of
financial management and advisory companies. The assessee had purchased
compulsorily convertible debentures (CCDs) of an Indian company (I Co) from its
AE based in Mauritius.

 

In course of transfer pricing proceedings, the assessee furnished
details of interest on debentures due from I Co. The assessee submitted that it
had waived interest that was due from I Co and I Co had also not claimed
deduction of interest on CCDs. Therefore, no income had accrued to the
assessee. The TPO observed that the assessee had waived interest to help its
AE. Therefore, such interest was to be reduced from the income of the assessee.

 

CIT(A) upheld the
transfer pricing adjustment made.

 

HELD

  •     Article 11(1) of the
    India-Mauritius DTAA reads: ‘Interest arising in a Contracting State and
    paid to a resident of the other Contracting State may be taxed in that other
    State.’
  •     The expression ‘paid’ has
    been used in several other DTAAs, in similar as well as different contexts.
    Several judicial authorities have interpreted the expression ‘paid’ and held1  that in such cases the relevant income is to
    be taxed on paid basis and not accrual basis.
  •     Article 11(1) of the India-Mauritius DTAA
    requires fulfilment of the twin conditions of ‘arising’ (i.e., accrual) and
    ‘paid’ (i.e., actual receipt) for taxability of interest. Unless both
    conditions are fulfilled, interest will not be taxable.
  •     Once interest is not
    taxable as per Article 11(1) of the DTAA, section 4 of the Act will have no
    application. Section 92 and other provisions in Chapter X are in the nature of
    machinery provisions, which are subject to charging provision in section 4 of
    the Act. If a particular item of income does not come within the purview of the
    charging provision, the machinery provisions would not be applicable.
  •     Chapter X containing TP
    provisions is in the nature of anti-avoidance provisions applicable in case of
    transactions between related parties. However, when income itself is not
    chargeable to tax because of DTAA provisions, there is no question of tax
    avoidance / evasion being applicable.
  •     It was only because of
    difficulties in the real estate sector that investee companies had requested
    for waiver of interest.
  •     For taxing interest, it was
    necessary to satisfy the twin conditions of accrual and payment. However, the
    TPO / A.O. had sought to tax what the assessee was supposed to
    receive     (but, factually had not received).
  •     Transfer pricing adjustment
    was made on this hypothetical amount. In Vodafone India Services (P.)
    Ltd. vs. Union of India [2014] 50 taxmann.com 30 (Bom.)    , the Bombay
    High Court held that even income arising from an international transaction must
    satisfy the test of income under the Act and must find its home in one of the
    charging provisions. The TPO / A.O. had not established that notional interest
    satisfied the test of income arising or received under the charging provision
    of the Act. Transfer pricing adjustment in respect of interest which was
    neither received by, nor had accrued to, the assessee could not be made.

_________________________________________________________________

 

1 DIT vs. Siemens Aktiengesellscharft, [IT Appeal No.
124 of 2010, dated 22nd October, 2012]
[India-Germany DTAA];
Johnson & Johnson vs. Asstt. DIT; Johnson & Johnson vs. ADIT [2013] 32 taxmann.com
102 (Mum.)(Trib.) [India- USA DTAA]; Pramerica ASPF 11 Cyprus Holding Ltd. vs.
Dy. CIT [2016] 67 taxmann.com 368 (Mum.)(Trib.) [India-Cyprus DTAA].

Section 56(2)(vii)(b) dealing with receipt of immovable property for inadequate consideration will not apply to a case where the agreement for purchase was made before amendment of this section, substantial obligations discharged and rights accrued in favour of assessee but merely registration was on or after amendment of said section Interest under sections 234A and 234B is chargeable with reference to the returned income and not the assessed income

12. Bajrang Lal Naredi vs. ITO (Ranchi) Pradip Kumar Kedia (A.M.) and Madhumita Roy
(J.M.) ITA No. 327/Ran/2018 A.Y.: 2014-15 Date of order: 20th January, 2020

Counsel for Assessee / Revenue: Anand Pasari
with Nitin Pasari / Nisha Singhmarr

 

Section
56(2)(vii)(b) dealing with receipt of immovable property for inadequate
consideration will not apply to a case where the agreement for purchase was
made before amendment of this section, substantial obligations discharged and
rights accrued in favour of assessee but merely registration was on or after
amendment of said section

 

Interest under sections 234A and 234B is
chargeable with reference to the returned income and not the assessed income

 

FACTS I

The assessee, in the year under consideration, registered in his name an
immovable property on 17th June, 2013 against the actual purchase of
property done on 15th April, 2011 in financial year 2011-12. The
purchase consideration was determined at Rs. 9,10,000 at the time of agreement
for purchase in financial year 2011-12; accordingly, the payment was made at
the time of such agreement to the vendor. The registration was, however,
carried out at a belated stage on 17th June, 2013 on which date the
stamp duty valuation stood at a higher figure of Rs. 22,60,000. The A.O.
noticed the alleged under-valuation in the purchase price of the property qua
stamp duty valuation and applied provisions of section 56(2)(vii)(b) of the Act
and worked out the adjusted purchase consideration of Rs. 18,89,350. The A.O.,
accordingly, treated the difference of Rs. 9,79,350 as ‘deemed income’ having
regard to the provisions of section 56(2)(vii)(b) of the Act as amended by the
Finance Act, 2013 and applicable from assessment year 2014-15 onwards.

 

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

 

HELD I

The Tribunal noted
that it is the applicability of section 56(2)(vii)(b) of the Act as amended by
the Finance Act, 2013 and applicable to A.Y. 2014-15 which is in question. The
Tribunal observed that as per the pre-amended provisions of section
56(2)(vii)(b) of the Act, where an individual or HUF receives from any person
any immovable property without consideration, the provisions of amended section
56(2)(vii)(b) of the Act would apply. This position was, however, amended by
the Finance Act, 2013 and made applicable to A.Y. 2014-15 onwards. As per the
amended provisions, the scope of the substituted provision was expanded to
cover the purchase of immovable property for inadequate consideration as well.

 

It observed that there is no dispute that purchase transactions of
immovable property were carried out in financial year 2011-12 for which full
consideration was also parted with the seller. Mere registration at later date
would not cover a transaction already executed in the earlier years and
substantial obligations already been discharged and a substantive right accrued
to the assessee therefrom. The Tribunal held that pre-amended provisions will,
thus, apply and therefore the Revenue is debarred to cover the transactions
where inadequacy in purchase consideration is alleged. The Tribunal deleted the
addition made by the A.O. and confirmed by the CIT(A).

 

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

 

FACTS II

The second issue in
the appeal filed by the assessee was raised by filing an additional ground. The
issue for consideration of the Tribunal was whether interest u/s 234B of the
Act is chargeable on assessed income qua return income.

 

HELD II

The Tribunal noted that an identical issue had come up before the coordinate
bench of the ITAT in ITO vs. M/s Anand Vihar Construction Pvt. Ltd. ITA
No. 335/Ran/2017 order dated 28th November, 2018. Having
noted the ratio of the decision of the coordinate bench of the Tribunal,
it held that interest under sections 234A and 234B of the Act is chargeable
with reference to returned income only.

 

 

Sections 32, 37, 45, 50 – Where the business of the assessee came to a halt, expenses incurred by the assessee for maintaining its legal status and disposing of the assets are allowable u/s 37(1) of the Act Assessee owned leasehold rights in the land and a building was constructed thereon; on transfer of the same, capital gains were to be bifurcated as long-term capital gains on transfer of land u/s 45 and short-term capital gains on transfer of building u/s 50 Unabsorbed depreciation is deemed to be current year’s depreciation and it can therefore be set off against capital gains

25. [2019] 202 TTJ (Bang.) 893 Hirsh Bracelet India (P) Ltd. vs. ACIT ITA No. 3392/Bang/2018 A.Y.: 2015-16 Date of order: 3rd July, 2019

 

Sections 32,
37, 45, 50 – Where the business of the assessee came to a halt, expenses
incurred by the assessee for maintaining its legal status and disposing of the
assets are allowable u/s 37(1) of the Act

 

Assessee owned
leasehold rights in the land and a building was constructed thereon; on
transfer of the same, capital gains were to be bifurcated as long-term capital
gains on transfer of land u/s 45 and short-term capital gains on transfer of
building u/s 50

Unabsorbed
depreciation is deemed to be current year’s depreciation and it can therefore
be set off against capital gains

 

FACTS

The assessee company was engaged in the
business of manufacturing wrist watch straps. The assessee had taken land on
lease for a period of 99 years and set up a unit for designing, importing,
exporting, dealing in and manufacturing wrist watch straps. In view of
continued losses and several operational difficulties, the business of the
assessee had to be closed down. The assessee had declared capital gains on the
sale of leasehold rights in land and building as short-term capital gain in the
return of income and, after adjusting current year’s expense and depreciation,
returned a total income.

 

During the course of the assessment
proceedings, the assessee claimed that sale of leasehold rights in land would
result in long-term capital gains. But the A.O. taxed the capital gains as short-term
and did not allow set-off of brought forward business losses. Further, the A.O.
had disallowed the expenditure u/s 37(1), contending that the same could not be
allowed as there was no business in existence.

 

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

 

HELD

The various expenses incurred by the
assessee were to maintain its legal status as a company until the assets were
disposed of and the liabilities paid. The Tribunal held that it was essential
for the assessee to incur these expenses and neither the A.O. nor the CIT(A)
has doubted the incurring of the expenditure. The assessee held leasehold
rights in land and it required permission from the Government for transfer of
such rights. This permission was received by the assessee only in the previous
year, 2013-2014. Therefore, even though the business of the assessee had come
to a halt in 2010, it was necessary to maintain the legal status until all the
assets were liquidated. Thus, the expenses incurred by the assessee were to be
allowed as a deduction in computation of income.

 

The assessee had made a claim for the
bifurcation of capital gains into long-term capital gains on transfer of
leasehold rights in land and short-term capital gains on transfer of building,
being a depreciable asset, in accordance with the provisions of section 50. The
assessee was entitled to bifurcate the capital gains and the provisions of
section 50 would be made applicable in computation of capital gains arising
from transfer of building.

 

Unabsorbed depreciation is deemed to be
current year’s depreciation and the same can be set off against capital gains
under the provisions of section 71.

 

These grounds of appeal filed by the
assessee were allowed.

 

Section 147, Explanation 3 & Section 154 – The powers conferred on the A.O. by Explanation 3 to section 147 cannot be extended to section 154 – Any discrepancy that was not a subject matter of reassessment proceedings cannot, subsequently, upon conclusion of reassessment proceedings, be brought up by the A.O. by recourse to section 154

24 [2019] 202 TTJ (Del.) 1014 JDC Traders (P) Ltd. vs. DCIT ITA No. 5886/Del/2015 A.Y.: 2007-2008 Date of order: 11th October, 2019

 

Section 147,
Explanation 3 & Section 154 – The powers conferred on the A.O. by
Explanation 3 to section 147 cannot be extended to section 154 – Any
discrepancy that was not a subject matter of reassessment proceedings cannot,
subsequently, upon conclusion of reassessment proceedings, be brought up by the
A.O. by recourse to section 154

 

FACTS

The assessee was a company engaged in the
business of trading, export and printing. For A.Y. 2007-2008 it submitted its
return of income and the same was processed u/s 143(1) of the Act. Reassessment
proceedings were initiated against the assessee for the assessment year in
question after recording reasons for the same. Certain travel expenditure
claimed by the assessee was disallowed and addition was made for the same. On
conclusion of the reassessment proceedings and perusal of the assessment
records by the A.O., he noticed a discrepancy in the amount of stock appearing
in the statement of profit and loss and in the notes to financial accounts. The
A.O. issued a notice u/s 154 to the assessee as regards the difference. The
assessee submitted that the amount stated as closing stock at the time of
preparation of accounts had been inadvertently missed out to be corrected
post-finalisation of accounts and stock reconciliation. The assessee also
submitted that after reconciliation the mistake was detected and corrected. The
A.O. made an addition for the amount of difference in the amounts of closing
stock stated at different values.

The assessee preferred an appeal with the CIT(A).
However, the CIT(A) did not agree with its contention and stated that under the
provisions of Explanation 3 to section 147, the A.O. was justified in assessing
/ reassessing the income which had escaped assessment. Further, there was
nothing wrong in the A.O. rectifying the mistake in the order under sections
147 / 143(3). The assessee then filed an appeal with the ITAT.

 

HELD

The issue relating to the discrepancy in the
value of closing stock was not taken up by the A.O. at the time of reassessment
proceedings u/s 147. A reading of section 147 shows that it empowers the A.O.
to assess or reassess income in respect of any issue which had escaped
assessment, irrespective of the fact whether such aspect was adverted in the
reasons recorded u/s 147. The A.O. had resorted to section 154 to make addition
in respect of the issue of discrepancy in closing stock on conclusion of the
reassessment proceedings. The powers under Explanation 3 to section 147, if
extended to section 154, would empower the A.O. to make one addition after the
other by taking shelter of Explanation 3 to section 147. It was also not the
case that the A.O. had invoked section 154 with respect to the original
assessment finalised u/s 143(3).

 

Thus, the powers of Explanation 3 to section
147 cannot be extended to section 154, and the addition made by the A.O. for
discrepancy of closing stock values upon conclusion of reassessment proceedings
was beyond his jurisdiction.

 

The appeal filed by the assessee was
allowed.

 

M/s JSW Steel Ltd. vs. Dy. CIT; [ITA Nos. 33, 34 & 35/Mum/2015; Date of order: 28th September, 2016; A.Y.: 2008-09; Mum. ITAT] Section 153A – Once the assessment gets abated, the original return filed u/s 139(1) is replaced by the return filed u/s 153A – It is open to both parties, i.e., the assessee and Revenue, to make claims for allowance or disallowance – (Continental Warehousing Corporation 374 ITR 645 Bom. referred)

16. The Pr. CIT-2 vs.
M/s JSW Steel Ltd. (Successor on amalgamation of JSW Ispat Steel Ltd.) [Income
tax Appeal No. 1934 of 2017] Date of order: 5th
February, 2020 (Bombay High Court)

 

M/s JSW Steel Ltd. vs.
Dy. CIT; [ITA Nos. 33, 34 & 35/Mum/2015; Date of order: 28th
September, 2016; A.Y.: 2008-09; Mum. ITAT]

 

Section
153A – Once the assessment gets abated, the original return filed u/s 139(1) is
replaced by the return filed u/s 153A – It is open to both parties, i.e., the
assessee and Revenue, to make claims for allowance or disallowance – (Continental
Warehousing Corporation 374 ITR 645 Bom. referred)

 

The assessee is a widely-held public
limited company engaged in various activities, including production of sponge
iron, galvanised sheets and cold-rolled coils through its steel plants located
at Dolve and Kalmeshwar in Maharashtra. The company filed its original return
of income on 30th September, 2008 for A.Y. 2008-09 declaring loss at
Rs. 104,17,70,752 under the provisions of section 139(1) of the Act.

 

During pendency of the assessment
proceedings, a search was conducted u/s 132 on the ISPAT group of companies on
30th November, 2010. Following the search, a notice u/s 153A was
issued. In response, the assessee filed return of income declaring total loss
at Rs. 419,48,90,102 on 29th March, 2012. In this return, the
assessee made a new claim for treating gain on pre-payment of deferred VAT /
sales tax on the Net Present Value (NPV) basis for an amount of Rs.
318,10,93,993 as ‘capital receipt’.

 

This new / fresh claim of the assessee
was disallowed by the A.O. while finalising the assessment u/s 143(3) r/w/s
153A of the Act by considering the same as ‘revenue receipt’ instead of
‘capital receipt’. The reasoning given by the A.O. was that the assessee had
availed of the sales tax deferral scheme and the State Government had permitted
premature re-payment of deferred sales tax liability on the NPV basis.
Therefore, according to the A.O., the assessee treated this as capital receipt
even though the same was credited to the assessee’s profit and loss account
being the difference between the deferred sales tax and its NPV.

 

However, the
primary question that arose before the A.O. was whether the claim which was not
made in the earlier original return of income filed u/s 139(1) could be filed
and considered in the subsequent return filed by the assessee in pursuance of
notice u/s 153A of the Act (which was consequent to the search action conducted
u/s 132). The A.O. held that the assessee could not raise a new claim in the
return filed u/s 153A which was not raised in the original return of income
filed u/s 139(1). Thereafter, the claim was disallowed and was treated as
‘revenue receipt’.

 

Aggrieved by the aforesaid order, the
assessee preferred an appeal before the CIT(A) who upheld the order passed by
the A.O.

 

Still aggrieved, the assessee filed an
appeal to the Tribunal. The Tribunal held that the assessee could lodge new
claims, deductions, exemptions or relief (which the assessee had failed to
claim in his regular return of income) which came to be filed by the assessee
under the provisions of section 153A of the Act.

 

But the Revenue, aggrieved by the order
of the ITAT, filed an appeal to the High Court. The Court held that in view of
the second proviso to section 153A of the Act, once assessment got
abated, it meant that it was open for both the parties, i.e., the assessee as
well as Revenue, to make claims for allowance, or to make disallowance, as the
case may be. That apart, the assessee could lodge a new claim for deduction,
etc. which remained to be claimed in his earlier / regular return of income.
This is so because assessment was never made in the case of the assessee in
such a situation. It is fortified that once the assessment gets abated, the
original return which had been filed loses its originality and the subsequent return
filed u/s 153A of the Act (which is in consequence to the search action u/s
132) takes the place of the original return. In such a case, the return of
income filed u/s 153A(1) would be construed to be one filed u/s 139(1) and the
provisions of the said Act shall apply to the same accordingly. If that be the
position, all legitimate claims would be open to the assessee to raise in the
return of income filed u/s 153A(1).

 

The Court further emphasised on the
judgment passed by it in the case of Continental Warehousing (Supra) which
also explains the second proviso to section 153A(1). The explanation is
that pending assessment or reassessment on the date of initiation of search if
abated, then the assessment pending on the date of initiation of search shall
cease to exist and no further action with respect to that assessment shall be
taken by the A.O. In such a situation, the assessment is required to be
undertaken by the A.O. u/s 153A(1) of the Act.

 

In view of the second proviso to
section 153A (1), once assessment gets abated, it is opened both ways, i.e.,
for the Revenue to make any additions apart from seized material, even regular
items declared in the return can be subject matter if there is doubt about the
genuineness of those items, and similarly the assessee also can lodge new
claims, deductions or exemptions or relief which remained to be claimed in the
regular return of income, because assessment was never made in the case /
situation. Hence, the appeal filed by the Revenue is liable to be dismissed.

 

DCIT-1(1) vs. M/s Ami Industries (India) Pvt. Ltd. [ITA No. 5181/Mum/2014; Date of order: 28th August, 2016; A.Y.: 2010-11; Mum. ITAT] Section 68 – Share application money – The assessee had furnished PAN, ITR of the investors to prove genuineness of the transactions – For credit worthiness of the creditors, the bank accounts of the investors showed that they had funds – Not required to prove ‘source of the source’ – Addition is justified [PCIT vs. NRA Iron & Steel 412 ITR 161 (SC) distinguished]

15. The Pr. CIT-1 vs. M/s Ami
Industries (India) Pvt. Ltd. [Income tax Appeal No. 1231 of 2017] Date of
order: 29th January, 2020 (Bombay High Court)

 

DCIT-1(1) vs. M/s Ami Industries
(India) Pvt. Ltd. [ITA No. 5181/Mum/2014; Date of order: 28th
August, 2016; A.Y.: 2010-11; Mum. ITAT]

 

Section 68 – Share application money –
The assessee had furnished PAN, ITR of the investors to prove genuineness of
the transactions – For credit worthiness of the creditors, the bank accounts of
the investors showed that they had funds – Not required to prove ‘source of the
source’ – Addition is justified [PCIT vs. NRA Iron & Steel 412 ITR 161
(SC) distinguished]

 

In the assessment proceedings, the A.O.
noted that the assessee had disclosed funds from three Kolkata-based companies
as share application money amounting to Rs. 34.00 crores (Parasmani Merchandise
Pvt. Ltd. Rs. 13.50 crores; Ratanmani Vanijya Pvt. Ltd. Rs. 2.00 crores and
Rosberry Merchants Pvt. Ltd. Rs. 18.50 crores).

The A.O. issued a
notice to the assessee on the ground that the whereabouts of the above
companies were doubtful and their identity could not be authenticated. Thus,
the genuineness of the companies became questionable.

 

After considering the reply submitted
by the assessee, the A.O. treated the aforesaid amount of Rs. 34 crores as
money from unexplained sources and added the same to the income of the assessee
as unexplained cash credit u/s 68 of the Act.

 

Aggrieved by the order, the assessee
preferred an appeal before the CIT(A). The CIT(A) held that the assessee had
discharged its burden u/s 68 by proving the identity of the creditors; the
genuineness of the transactions; and the credit worthiness of the creditors.
Consequently, the first appellate authority set aside the addition made by the
A.O.

 

Being aggrieved by the order of the
CIT(A), the Revenue filed an appeal to the Tribunal. The Tribunal noted that
the A.O. had referred the matter to the investigation wing of the Department at
Kolkata for making inquiries about the three creditors from whom share
application money was received. Though the report from the investigation wing
was received, the Tribunal noted that the same was not considered by the A.O.
despite mentioning of the same in the assessment order; besides, he had not
provided a copy of the same to the assessee. In the report by the investigation
wing, it was mentioned that the companies were in existence and had filed income
tax returns for the previous year under consideration but the A.O. recorded
that these creditors had very meagre income as disclosed in their returns of
income and, therefore, he doubted the credit-worthiness of the three creditors.

 

Finally, the Tribunal held that as per
the provisions of section 68 of the Act, for any cash credit appearing in the
books of an assessee, the assessee is required to prove the following: (a)
Identity of the creditor, (b) Genuineness of the transaction, and (c)
Credit-worthiness of the party. In this case, the assessee had already proved
the identity of the share applicants by furnishing their PAN and copies of
their IT returns filed for the A.Y. 2010-11.

 

Regarding the genuineness of the
transaction, the assessee had filed a copy of the bank accounts of the three
share applicants from which the share application money was paid and the copy
of the account of the assessee in which the said amount was deposited and which
had been received by RTGS. Regarding the credit-worthiness of the parties, it
has been proved from the bank accounts of the three companies that they had the
funds to make payments for the share application money and a copy of the
resolution passed in the meetings of their Boards of Directors. Regarding ‘the source
of the source’, the A.O. has already made inquiries through the DDI
(Investigation), Kolkata and collected all the materials required which proved
‘the source of the source’, though as per the settled legal position on this
issue the assessee need not prove ‘the source of the source’. The A.O. has not
brought any cogent material or evidence on record to indicate that the
shareholders were benamidars or fictitious persons, or that any part of
the share capital represented the company’s own income from undisclosed
sources. Accordingly, the order of the CIT(A) was upheld.

 

Aggrieved by the order of the ITAT, the
Revenue filed an appeal to the High Court. The Revenue submitted that it cannot
be said that the assessee had discharged the burden to prove the
credit-worthiness of the three parties. Further, it contented that the assessee
is also required to prove ‘the source of the source’. In this connection, the
Department placed reliance on a decision of the Supreme Court in Pr. CIT
vs. NRA Iron & Steel Pvt. Ltd.

 

The assessee submitted that from the
facts and circumstances of the case, it is quite evident that the assessee has
discharged its burden to prove the identity of the creditors, the genuineness
of the transactions and the credit-worthiness of the creditors. The legal
position is very clear inasmuch as the assessee is only required to explain the
source and not ‘the source of the source’. The decision of the Supreme Court in
NRA Iron & Steel Pvt. Ltd. (Supra) is not the case law for
the aforesaid proposition. In fact, the said decision nowhere states that the
assessee is required to prove ‘the source of the source’. Further, it is also a
settled proposition that the assessee is not required to prove ‘the source of
the source’. In fact, this position has been clarified in the recent decision
in Gaurav Triyugi Singh vs. Income Tax Officer-24(3)(1)2 dated 22nd
January, 2020.

 

The Court found that the identity of
the creditors was not in doubt. The assessee had furnished the PAN, copies of
the income tax returns of the creditors, as well as copies of the bank accounts
of the three creditors in which the share application money was deposited in
order to prove the genuineness of the transactions. Insofar as the
credit-worthiness of the creditors was concerned, the Tribunal had recorded
that the bank accounts of the creditors showed that they had funds to make
payments for share application money and, in this regard, resolutions were also
passed by the Board of Directors of the three creditors. Although the assessee
was not required to prove ‘the source of the source’, nonetheless, the Tribunal
took the view that the A.O. had made inquiries through the investigation wing
of the Department at Kolkata and collected all the materials which proved ‘the
source of the source’.

 

In NRA Iron & Steel Pvt. Ltd.
(Supra), the A.O. had made an independent and detailed inquiry,
including survey of the investor companies. The field report revealed that the
shareholders were either non-existent or lacked credit-worthiness. It is in
these circumstances that the Supreme Court had held that the onus to establish
the identity of the investor companies was not discharged by the assessee. The
aforesaid decision is, therefore, clearly distinguishable on the facts of the
present case. Therefore, the first appellate authority had returned a clear
finding of fact that the assessee had discharged its onus of proving the
identity of the creditors, the genuineness of the transactions and the
credit-worthiness of the creditors, which finding of fact stood affirmed by the
Tribunal. There are, thus, concurrent findings of fact by the two lower
appellate authorities. Under these circumstances, the appeal is dismissed.

 

Section 56 r/w Rule 11UA – Fair Market Value of shares on the basis of the valuation of various assets cannot be rejected where it has been demonstrated with evidence that the Fair Market Value of the assets is much more than the value shown in the balance sheet

22. [2019] 75 ITR (Trib.) 538 (Del.) India Convention & Culture Centre (P)
Ltd. vs. ITO ITA No. 7262/Del/2017 A.Y.: 2014-15 Date of order: 27th September,
2019

 

Section 56 r/w Rule 11UA – Fair Market
Value of shares on the basis of the valuation of various assets cannot be
rejected where it has been demonstrated with evidence that the Fair Market
Value of the assets is much more than the value shown in the balance sheet

 

FACTS

The assessee company issued 70,00,000 equity
shares of Rs. 10 each at a premium of Rs. 5 per share. The assessee company had
changed land use from agricultural to institutional purposes owing to which the
value of the land increased substantially. It contended before the ITO to
consider the Fair Market Value (FMV) of the land instead of the book value for
the purpose of Rule 11UA. However, the ITO added the entire share premium by
invoking section 56(2)(viib). He computed the FMV of shares on the basis of
book value instead of FMV of land held by the assessee company while making an
addition u/s 56(2)(viib) r/w Rule 11UA.

 

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

 

HELD

The Tribunal observed that the assessee took
refuge of clause (ii) of Explanation (a) to section 56(2)(viib). The counsel
for the assessee argued that the lower authorities have wrongly computed the fair
market value of the shares on the basis of the book value ignoring the fair
market value of the land held by the company; since the assessee had obtained
permission of the competent authority for change of land use from
‘agricultural’ to ‘institutional’ for art, culture and convention centre, its
market value increased substantially. The Tribunal, convinced by the fact of
increase in market value of land, held that valuation of the shares should be
made on the basis of various factors and not merely on the basis of financials,
and the substantiation of the fair market value on the basis of the valuation
done by the assessee simply cannot be rejected where the assessee has
demonstrated with evidence that the fair market value of the asset is much more
than the value shown in the balance sheet.

 

The Tribunal allowed the appeal filed by the
assessee.

 

Section 68 r/w/s 194J – Merely because an amount is reflected in Form 26AS, it cannot be brought to tax in the hands of the assessee where an error was made by a third person

21 [2019] 75 ITR (Trib.) 364 (Mum.) TUV India (P) Ltd. vs. DCIT ITA No. 6628/Mum/2017 A.Y.: 2011-12 Date of order: 20th August, 2019

 

Section 68 r/w/s 194J – Merely because an
amount is reflected in Form 26AS, it cannot be brought to tax in the hands of
the assessee where an error was made by a third person

 

FACTS

The assessee filed return of income,
claiming Tax Deducted at Source (TDS) of Rs. 6.02 crores whereas TDS appearing
in the AIR information was Rs. 6.33 crores. During the course of scrutiny
assessment, the ITO concluded that the assessee had not disclosed income
represented by the differential TDS of Rs. 30.88 lakhs. The income was
calculated by extrapolating the differential TDS amount (ten per cent of TDS
u/s 194J) and was taxed as undisclosed income in the hands of the assessee.

 

Aggrieved, the assessee preferred an appeal
to the CIT(A), claiming that the difference was mainly due to the error made by
one of the clients by wrongly furnishing Permanent Account Number (PAN) of the
assessee instead of that of one of their (other) clients. The assessee produced
all possible evidence to prove that the same was on account of a genuine error
made by its client. The CIT(A) deleted the addition partially and confirmed the
rest of the difference, on the ground that the same was irreconcilable.

 

Aggrieved, the assessee preferred an appeal
to the Tribunal.

 

HELD

The Tribunal observed that the assessee’s
client had erroneously quoted the assessee’s PAN in its TDS return owing to
which higher TDS was reflected in the assessee’s Form 26AS. However, the
assessee duly filed all the details to explain the difference between the TDS
amounts before the ITO during remand proceedings as well as before the CIT(A).

 

It produced evidence by way of emails
exchanged with its client to prove that the error took place while filing TDS
returns by the client. It also filed a revised TDS return as well as ledger
account of the client in the assessee’s books, as well as reconciliation
statements, and offered party-wise explanations. Thus, the assessee discharged
its primary onus as cast under the Income Tax laws.

 

Neither the ITO nor the CIT(A) conducted
necessary inquiries despite having all information in their possession
submitted by the assessee during appellate / remand proceedings.

 

It further observed that the assessee has no
control over the database of the Income-tax Department as is reflected in Form
No. 26AS and the best that the assessee could do is to offer bona fide
explanations for the differential which the assessee did in this case during
appellate / remand proceedings. The CIT(A) / ITO ought to have conducted
necessary inquiries to unravel the truth, but asking the assessee to do the
impossible is not warranted. No defects in the books of accounts are pointed
out by the authorities below nor were the books of accounts rejected by them.
No cogent incriminating material was brought on record by the authorities below
as evidence / to prove that the assessee has received / earned any income
outside its books of accounts.

 

Another important aspect which the Tribunal
considered was that though the principle of res judicata was not applicable
to assessment proceedings under Income tax law, from the assessment orders for
other assessment years indications can be drawn as to the behaviour pattern of
the taxpayer and modus operandi of the taxpayer adopted to defraud
Revenue / conceal income, if any. No such incriminating information is brought
on record by Revenue. Therefore, considering the totality of facts as well as
on the touchstone of preponderance of probabilities, the Tribunal held that no
additions to the income are warranted in the hands of the assessee on account
of the above difference.

 

The ground of appeal filed by the assessee
was allowed.

 

GOOGLE MAPS – GETTING BETTER AT 15!

Google Maps is the gold standard
as far as maps are concerned. Wherever you want to go, in any part of the
world, Google Maps guides you through accurately and, in some cases, even
beyond your imagination.

 

On its 15th birthday,
Google has announced further updates to this winner App. Here are some of the
updates it has announced. If you do not see some of them in your Google Maps
app, please be patient – they will be selectively rolled out when you refresh
the App from the Play Store within the next few weeks (plans are afoot to roll out in March, 2020), depending upon where you reside.

 

Google Maps thrives on the data
that it collects through crowd-sourcing, i.e., each of us who has Google Maps
installed, is directly or indirectly supplying data to the Google Maps central
server, to enhance the user experience for the entire population; for example,
when you look for the time estimate to reach a particular destination in real
time, Google has already collected data from thousands of commuters who are
already on that route, or have recently completed their journey. This data is
aggregated and then served to you as an estimate of how much time you will take
to reach your destination. And we all know how accurate that is. The updates
that Google Maps proposes to take this crowd-sourcing of data to the next
level. Let us see what the actual updates are going to be like:

 

Currently, there are three tabs
at the bottom of the App – Explore, Commute and For You. These
are now transformed into five tabs – Explore, Commute, Saved, Contribute
and Updates. Let us see what they represent and how they are different
from the existing tabs.

 

EXPLORE
AND COMMUTE

These remain largely unchanged.

 

Explore
allows you to explore places around you, at the current location. If you are
looking for a place to have lunch, go for a movie or to play games, Explore
will help you find the best place close by. Ratings, reviews and pictures of
more than 200 million places around the world are available, including nearby
attractions and city landmarks.

 

Commute
checks traffic around you and gives you the estimated time to reach your
favourite destination. If you are at work, it will show you the Commute
time to your home and vice versa. This happens in real time. There is also a
‘crowded-ness’ feature which tells you how crowded public transport is likely
to be at a particular time of the day.

 

Saved –
this new tab helps you locate your saved places instantly. Users have Saved
more than 6.5 billion places on their individual apps. This tab will help in
planning trips and making travel plans. It will also recommend places based on
the user’s map history.

 

Contribute: Here, again,
Google is looking at making crowd-sourcing more direct and interactive. You can
share information about a local area, traffic jam, diversions, reviews (for
hotels and businesses), photos, addresses, etc. You can add missing places,
too, and enrich the content of the maps. All your contributions would then be
pooled for the benefit of the entire user community. This could make sites and
apps like Yelp, TripAdvisor, etc. redundant.

 

Updates will
present to the user the latest trending and must-visit places near him / her.
The latest real-time Updates will always be available so that you do not
miss out on any of the new, popular places. In addition to discovering, saving
and sharing recommendations with your friends and family, you can also directly
chat with businesses and get more information about them.

 

To help you plan your journey,
Google has also added some cool new features such as:

 

Temperature –
you can check the current temperature at the destination before you start;

Women’s section –
this will help in commuting in areas where there are special sections for women
in the transportation system. For instance, it will indicate trains which have
women’s compartments, women’s specials, etc.;

Security –
this feature will guide you about security cameras, helpline numbers and
security guards available in a particular area;

Accessibility –
differently-abled people can find accessibility option also listed on the
places they plan to visit, such as special ramps, seating arrangements,
accessibility in public transport, etc.;

Live View – is a built-in feature, which
helps people to quickly decide which way to go, when they start walking with
Google Maps on. By combining StreetView’s real-world imagery, machine learning
and smartphone sensors, it can show you the way, using augmented reality.

Some of the above features are
available only in certain countries, depending on the information available in
the public domain or supplied by the users in their reviews.

 

In India, Google Maps now
provides information about public toilets around a particular location. The
company is also looking to introduce a mixed-mode commute feature across cities
in India that will show multiple public transportation modes available for
commuting to a specific destination.

 

Meanwhile, Alphabet and Google
CEO Sundar Pichai has sent his wishes through social media.

 

‘Happy 15th Birthday @GoogleMaps! Reflecting today on some of
the ways it’s been helpful to me, from getting around more easily to finding a
good veggie burrito wherever I am:) Thanks to the support of our users, Maps
keeps getting more helpful every day,’ Pichai tweeted.

 

 

 

WHEN LEARNING, RECREATION AND NETWORKING GO HAND-IN-HAND A REPORT ON 53RD BCAS-RRC

A brainchild of the BCAS, the RRC has metamorphosed into an outstanding avenue for collective learning, recreation and networking. The BCAS-RRC has constantly evolved with the changing times; it has brought many refinements over the past several years in its format, content and structure. The depth of technical content, the multi-faceted, integrated approach to burning issues, the experience of professional stalwarts and the actionable knowledge insights made available ensure that every event delivers far, far more than expectations. Now the flagship event of the BCAS, it is an ideal breeding ground for interactive learning where participants with varied seniority and from vastly different cultures, geographies and experiences come under one roof to facilitate some thought-provoking dialogue and discussions.

The 53rd Edition of the Residential Refresher Course (RRC) of the Bombay Chartered Accountants’ Society (BCAS) was no different. It was held at the pilgrim spot of Tirupati from Thursday the 9th to Sunday the 12th January, 2020. It attracted 138 participants from about 24 cities across the country.

The 2020 BCAS-RRC started with the promise of empowering the participants with the ‘Edge of Knowledge at the Cusp of the New Decade’. The participants reached the temple town of Tirupati on Thursday, 9th January and straightaway plunged into a unique ice-breaking session. This session was aimed at stimulating interaction between the participants in order to enable far greater bonhomie between them over the course of the next few days.

BCAS President Manish Sampat launched the inaugural session by welcoming the participants and giving them a brief overview about the Society. Narayan Pasari, Chairman of the Seminar, Membership and Public Relations Committee, spoke about the RRC and detailed the schedule. The esteemed Guest of Honour, Ashok Dhere, BCAS Past President, delivered an excellent address on Professional Ethics. Suhas Paranjpe, Vice-President, and Pradeep Thanawala, Co-Chairman and Convener of the Committee, also graced the opening session.

The inaugural session was followed by the curtain-raiser Integrated Panel Discussion wherein Umesh Gala, Sunil Gabhawalla and Khozema Anajwala discussed the intricacies of case studies dealing with burning issues across the domains of direct taxation, indirect taxation and accounting, respectively. The panel was steered by Raman Jokhakar, Past President, and Anand Bathiya. At the end of the discussion, a rapid-fire round followed which showcased the wit and astuteness of the panellists in the face of impromptu questions being shot at them.

The second day, Friday, was the one that many were eagerly looking forward to. A visit to Sri Venkateswara Swamy Vaari Temple (Tirupati Balaji) was specially arranged for all the participants and everyone was blessed with the opportunity to have darshan in traditional attire.

Later that day, it was back to business, with V. Ramnath’s presentation on ‘Taxation Aspects of Capital Receipts’. This was followed by a group discussion on ‘Expert Case Studies in Accounting, Auditing and Company Law’ devised by Santosh Maller and presented by Chirag Doshi. The group discussion truly satiated the knowledge needs on the subject at hand and lived up to expectations as one of the most efficient modes of learning.

The Theme of the 2020 BCAS-RRC was focus on ‘Emerging Areas of Practice’. Handpicked thought-leadership sessions were arranged on various emerging areas of practice of (a) Forensic and Fraud Detection by Chetan Dalal, (b) Financial Re-engineering by Shagun Kumar, and (c) Risk Advisory / Internal Audit by Nandita Parekh.

A unique ‘40-Under-40’ open session was held on Saturday evening wherein 40 young CA attendees had an open house town-hall style discussion and obtained some practical insights from Nandita Parekh. Saturday night featured an entertainment event with participants singing and dancing along some popular retro Bollywood and new-age numbers for the musical housie.

On the final day, the participants discussed the paper on ‘Expert Case Studies on Direct Taxes’ written and presented by T. Banusekar. The participants reported tremendous benefit from the challenging case studies and detailed explanations provided by the paper writer. The concluding session witnessed feedback by a few participants, specially the first-timers, and an extensive vote of thanks to all those who helped in the planning, conduct and success of the RRC.

An event like the RRC facilitates various agendas. It is a common ground for knowledge-sharing, networking and exploring. For the organisers and participants, it is an experience of a lifetime. One more successful RRC
to the credit of team BCAS – till the 54th RRC event next year!

REGULATION OF RELATED PARTY TRANSACTIONS – PROPOSED AMENDMENTS

BACKGROUND AND CURRENT STATUS OF
REGULATION OF RELATED PARTY TRANSACTIONS


Related party transactions are
transactions by a company with parties that are related to it or to certain
persons having some control over the company. Such transactions present a
classic case of conflict of interest where persons in control of the company
are in a position to approve such transactions where they have interest or
benefit. Related party transactions can thus be termed as a kind of corporate
nepotism. The objective of regulation is to ensure that there is oversight over
such transactions by independent persons, or that they are approved by other stakeholders,
or both. There are requirements also for extensive disclosures.

 

Thus, the Companies Act, 2013 (‘the
Act’) and the Rules made under it contain elaborate provisions for regulation
of related party transactions. SEBI, too, aims at regulating such transactions
independently through the SEBI LODR Regulations (‘the Regulations’). Since both
these sets of laws govern companies, there is obviously some concern about
conflicting provisions and even duplication / overlap which could result in
excessive compliance needs. Although attempts have been made to harmonise the
two sets of provisions,  differences
still remain.

 

SEBI has recently undertaken an exercise
to review the provisions and a report has been released containing
recommendations for change. After receiving feedback and consultation, SEBI
will notify the final changes.

 

SCHEME OF PROVISIONS


While this article concerns itself with
the proposed changes in the SEBI LODR Regulations, it is worth reviewing
briefly the scheme of provisions both under the Act and the Regulations.

 

To begin with, there is the definition
of a ‘related party’. Several persons and entities are listed specifically or
descriptively as related parties. These include relatives and also various
parties with which specified persons in management have control or association.
The Regulations, too, provide a definition which takes the definition under the
Act as the starting point and adds the definition under the relevant accounting
standard.

 

Then there is the definition of related
party transactions. The Act provides a list of transactions which, if
with a related party, would be subject to regulation. The Regulations, however,
provide a generic descriptive definition and thus are wider in nature.

 

Next, we have the manner of regulation.
This is in two forms. The first is the manner of approval required. This is
broadly at two levels. All related party transactions require approval of the
Audit Committee and generally the Board. Certain transactions also require the
approval of shareholders. Where approval of shareholders is required, related
parties cannot vote to approve such transactions. Secondly, there are
requirements for disclosures of such transactions which are extensive and also
supplement the disclosures required under the applicable accounting standard.

 

CONCERNS


The provisions have seen repeated
reviews and changes over the short period since they have been in existence.
SEBI had set up a committee under the Chairmanship of Mr. Ramesh Srinivasan, MD
& CEO of Kotak Mahindra Capital Company Limited, which submitted its report
on 27th January, 2020. SEBI has invited feedback on this by 26th
February, 2020 after which one may expect SEBI to implement the changes by
suitably amending the Regulations.

 

The Committee has reviewed nearly every
major area of the provisions including the definitions of related party and
transactions, the threshold limits, the manner of approval, disclosures, etc.
Amendments, major and minor, have been suggested. The report, apart from giving
a detailed background and reasoning for proposing the changes, also gives the
exact language of the amendments. There are several advantages of these. One
will be able to know the exact language of the proposed amendments in course of
time. Concerns over ambiguities, difficulties, etc. can thus be pointed out
well in advance. Importantly, it will be easier for SEBI to notify the
amendments quickly.

 

Let us see in the following paragraphs
some of the important amendments proposed.

 

DEFINITION OF RELATED PARTY TO NOW
INCLUDE ALL PROMOTERS


Unlike many countries in the West, India
has a very large proportion of its companies promoted and controlled by family
groups. They hold a significant percentage of the total share capital, often
nearly half. Needless to add, generally they control the company for all
practical purposes on most matters.

 

At present, the Regulations define a
related party in two parts. One is the definition under the Act / or applicable
accounting standard, which itself is broad and includes many entities with
which directors / others may be associated. The second part consists of any
promoter who holds 20% or more of the share capital of the company.

 

However, there is an important lacuna
here. Even these wide definitions may still not include many entities connected
with the promoters. It is proposed that all promoters and members of the
promoter group would be now treated as related parties. Further, any entity
that directly / indirectly, along with relatives, holds 20% or more of the
share capital would also be treated as a related party.

 

Interestingly, to be considered as a
related party, the promoter will now not have to hold any shares.
Further, the person holding 20% or more may be a total outsider not connected
with the management at all.

 

There could be difficulties for the
company to compile a comprehensive list of these newly-covered entities. The
list of promoters, of course, should be readily available. However, identifying
persons who hold 20% or more may present some difficulties. Fortunately, a good
starting point would be the disclosures received from persons holding 5% or
more of the shares under the SEBI Takeover Regulations. However, the
definitions under the two laws are different in detail and hence it may still
be difficult for the company to prepare an accurate list of related parties
covered by these amendments.

 

TRANSACTIONS BETWEEN RELATED PARTIES OF
PARENT AND SUBSIDIARIES


Currently, transactions between the
company and its related parties are covered and to some extent between the
company and its subsidiaries. The concern is that certain sets of transactions
may get left out.

 

It is now proposed that transactions
between subsidiaries of the company and a related party either of the company
or its subsidiaries will be deemed to be related party transactions. Thus, the
following would now be related party transactions:

 

(i) Between the company and its related party;

(ii) Between the company and any related party
of any of its subsidiaries;

(iii) Between the subsidiaries of the company
and any related party of the company; and

(iv) Between the subsidiaries of the company
and any related party of any of its subsidiaries.

 

TRANSACTIONS WHOSE PURPOSE IS TO BENEFIT
RELATED PARTIES


It is now proposed to
cover transactions with any parties, ‘the purpose and effect of which is to
benefit a related party of the listed entity or any of its subsidiaries’.

 

The intention
obviously is to cover those transactions ostensibly carried out with a
non-related party but the intention and also the effect is to benefit related
parties. In a sense, the intention seems to be to cover indirect transactions.
The requirement is that not just the actual effect, but even the purpose
of the transaction has to be benefit to a related party. Arguably, a
transaction with an unintentional benefit to a related party ought not to be
covered. However, this aspect may need clarification.

 

No guidance is given
as to how to determine or even detect such transactions. It is very likely that
the management or person who is the related party would know about the benefit
and thus the onus would be on such person to inform the company.

 

It is also not clear
whether the benefit should be for the entire amount of the transaction or part
of it. For example, a contract may be given to a non-related party X, who may
sub-contract a part of the contract to a related party. If other conditions are
met, it would appear that such a contract should also get covered.

 

MATERIAL MODIFICATIONS LATER TO RELATED
PARTY TRANSACTIONS


Related party
transactions may be approved and transactions initiated but later they may
undergo modifications. At present, unless the modification is in the form of
entering into a de novo transaction, the modification may not get
covered. To ensure that material modifications also get covered, it is provided
that they require approval in the same manner as original transactions. It is
not clear what does the word ‘material’ mean. As this term is not defined, one
will have to adopt alternative definitions and interpretations of this term.

 

In case where the
transaction is by a subsidiary with a related party, the modification will
require approval only if certain specified thresholds are exceeded.

 

PRIOR APPROVAL OF SHAREHOLDERS


Certain material
transactions with related parties that are above the specified thresholds
require approval of shareholders at present. It is proposed that such approvals
should be taken prior to undertaking such transactions. This requirement
will also extend to material modifications to such transactions.

 

MODIFICATION IN CRITERION FOR DETERMINING
MATERIAL RELATED PARTY TRANSACTIONS


Transactions above a
certain threshold are deemed to be material. It is now provided that the
threshold shall be the lowest of the following:

 

(a) Rs.
1,000 crores;

(b) 5%
of consolidated revenues;

(c) 5%
of consolidated total assets;

(d)  5%
of consolidated net worth (if positive).

 

This will
particularly affect very large companies for whom, as per the present
thresholds, even Rs. 1,000 crores of transactions were not ‘material’.

 

REVIEW REQUIREMENTS BY AUDIT COMMITTEE
AND DISCLOSURES TO SHAREHOLDERS


The Audit Committee
will now be required to mandatorily review certain aspects of the related party
transactions that are placed before it for approval. This, on the one hand,
provides guidance to the Audit Committee as to what specific factors to take
into account. On the other hand, it places responsibility on the Audit
Committee to go into these details.

 

It is also proposed
that the notice to shareholders for approval of material related party
transactions should give specific items of information. This again increases
transparency and enables the shareholders to take an informed decision on the
transactions. Interestingly, whether or not the Audit Committee approval was
unanimous has to be stated.

 

CONCLUSION


There are other
amendments proposed, too. And there are some other aspects of the amendments
apart from those discussed above. The final amendments as notified would be
worth going into in detail taking into account all the amendments.

 

As mentioned earlier,
SEBI has given some time for feedback on the proposed amendments. Considering
the past track record of SEBI, it is likely that the amendments may be notified
soon thereafter. It will have to be seen whether the amendments are put into
place immediately or phased out and also whether they are made applicable to
all companies or only to some.

 

The
responsibility of the company, and particularly of the Audit Committee, will
only increase after such amendments. Related party transactions are a source of
concern and even wrongdoings such as siphoning off profits / assets of
companies. The amended provisions may result in increased accountability by all
parties concerned.

 

For the Board
generally and for the Independent Directors / Audit Committee in particular, it
is not easy to determine whether all related party transactions are covered.
Ideally, the primary onus should be on the management / promoters and
particularly those persons with respect to whom the related party connection
exists with a counter party. If they fail to disclose their interest and
connection, it is possible that others may not even come to know. However, this
is not readily accepted in law and the Board / Independent Directors / Audit
Committee and even the Auditors will have to exercise diligence and care as
expected respectively from them. Their responsibility, and hence liability,
will only increase.  

 

WORKPLACE SPIRITUALITY

Workplace spirituality is a novel
concept with potentially strong relevance to the well-being of individuals,
organisations and societies. The common problems faced by most of the corporates
are stress, absenteeism, organisational politics, absence of teamwork and so
on. And all these can be attributed to the absence of spirituality in the
workplace. Although the term spirituality in the workplace has increasingly
gained popularity in the past few years, there still seems to be too much of a
misconception, predominantly among managers, confusing spirituality with
religion.

 

However, Workplace Spirituality
(WPS) and Religion are distinctly separate. WPS is more focused on the theme of
tolerance, patience, the feel of interconnectivity, purpose and acceptability
to the norms of the organisation, all of these integrated to shape personal
values; religion, on the other hand, is marked by a specific belief system, a
particular system of faith and set of beliefs1.

 

A study undertaken by MIT
University, USA, way back in 2010, wherein they interviewed senior executives,
HR executives and managers, defined ‘spirituality’ as ‘the basic feeling of
being connected with one’s complete self, others and the entire universe’. If a
single word best captures the meaning of spirituality and the vital role that
it plays in people’s lives, that word is ‘interconnectedness’. Those associated
with organisations they perceived as ‘more spiritual’ also saw their
organisations as ‘more profitable’. They reported that they were able to bring
more of their ‘complete selves’ to work. They could deploy more of their full
creativity, emotions and intelligence; in short, organisations viewed as more
spiritual get more from their participants, and vice versa. They believe
strongly that unless organisations learn how to harness the ‘whole person’ and
the immense spiritual energy that is at the core of everyone, they will not be
able to produce world-class products and services.

 

Benefits for the organisation
that adopts workplace spirituality:

(a) Enhanced trust among people;

(b) Increased interconnectedness;

(c)  Motivated organisational culture leading to
better organisational performance;

(d) Job satisfaction;

(e)  Positive task output;

(f)  Community sense.

 

Eventually, it leads the
organisation towards excellence.

 

It will be wrong to say that only
for-profit organisations need to adopt WPS. Contrary to conventional wisdom,
working in a non-profit organisation (NPO) does not automatically make a person
more spiritually inclined. Many NPOs have specific political goals and are even
more concerned with obtaining hard results in the secular world than many
for-profit corporates. Whether an organisation is more or less spiritual
depends on the specific organisation, not its profit status.

 

What do organisations such as the
Tata Group, HUL, Wipro or Dabur have in common? Apart from other
characteristics, they are among a growing number of organisations that have
embraced workplace spirituality.

 

Spiritual organisations bring in
a strong sense of purpose to their members. They connect with the values of the
organisation. This helps develop a sense of job security, trust and openness.

 

Spirituality in leadership also
helps organisations fulfil their goal of effectiveness. When the leader in an
organisation is spiritually strong, it means that the culture prevailing in
that organisation would also be healthy and he
would act as a bridge between the managers and employees (partnership) to
communicate effectively and to feel themselves to be equally responsible for
organisational goals.

 

One wonders why such an important
topic has been neglected. Though more and more organisations are now accepting
this theory, the academic research gap is vast. It is time that we embrace
Workplace Spirituality at each one of our organisations to achieve overall
organisational, personal and community well-being.  

 

_______________________________________

1 A study by Afsar & Rehman in 2015

 

‘SWATCHH HELL’

Four
men and four women died together. They were taken before Lord Yama, who does
ultimate justice to every human being after death. Depending upon the good or
bad work done in their lives, he sends them either to heaven or to hell. All
eight of them were pretty sure that they would go to heaven since they had done
a lot of genuine social service in their lives.

 

He
called the first gentleman and asked him about his deeds on earth. He said, ‘Lord,
I dedicated my entire life to spread education among common people. I founded
many educational institutions and made available value-based education in a
selfless manner. I received many honours from people as well as from the
government. I never accepted any capitation fees for admission. Thousands of
students still express their sense of gratitude to me.’

 

Lord
Yama asked his office administration about their views in the matter. The
secretary in Yama’s office said one of the trusts of this gentleman had
submitted his tax return two days late. Otherwise, he said, whatever was said
by the gentleman was true.

 

Instantly,
Lord Yama shouted ‘Send him to hell!’ The poor gentleman tried to explain that
the delay was due to circumstances beyond his control as there was an accident
in the trust’s office. But nobody heard his pleas.

 

The
second gentleman and a woman were doctors by profession and had been running a
charitable hospital for poor and indigent patients. They did not do any private
practice but only provided genuine health services to tribal people and needy
patients.

 

The
administration reported to the Lord that their audit report was not filed on
time in one of the years. The law had been changed, but Lord Yama sent them
also to hell. There was no question of hearing their arguments and requests.

 

Likewise,
all the others who really worked selflessly to serve the poor, the handicapped
and mentally retarded people, supporting destitute women, serving those
suffering from terminal diseases, orphans, preserving the environment and so
on, who had done many socially needed and beneficial things, had failed to
submit some form or other in the prescribed time. Obviously, all of them were
sent to hell.

 

Lord
Yama’s secretary declared: ‘Doing genuine social work hardly matters to us. How
many lives you saved is not important. Rather, you interfered with the work of
Yamadoots (Yama’s servants). How many poor people or unfortunate children and
women you helped is none of our concern. Even if people suffer or die, it is of
no consequence to us. You should submit all forms in time. We will never
condone any delay.’

 

Then,
he was overheard sharing a secret, that Lord Yama really wanted some genuine,
good social workers in hell. But he felt that these eight persons were not
enough. To encourage more people to go to hell, he pressured the Minister to
introduce the procedure of re-registration for all the charitable trusts and
their renewal every five years.

 

It is
reported that many trustees have either died of heart attack or committed
suicide after hearing of this new procedure. And it is believed that they are
also taking their respective CAs along with them!

 

I’m
sure this will facilitate the process of ‘Swatchh Hell’!  

 

 


TRANSMISSION OF TENANCY

INTRODUCTION


One of the biggest
questions that invariably crops up when preparing a Will is, ‘Can I bequeath my
tenanted property?’ This is especially true in a city like Mumbai where
tenanted properties are very valuable. Tenanted property could be in the form
of residential flats or commercial properties. A person can make a Will for any
and every asset that he owns. Hence, the issue which arises is, can a person
bequeath a property of which he is only a tenant? In the State of Maharashtra,
the provisions of the Maharashtra Rent Control Act, 1999 (the Act) are also
relevant. Let us analyse this important issue in more detail.

 

RENT ACT
PROVISIONS


Section 7(15) of the Act defines the
term ‘tenant’ as any person by whom rent is payable for any premises. Further,
when the tenant dies, the term includes:

(a) in the case of residential tenanted
premises, any member of his family who is residing with the tenant at the time
of his death; or

(b) in the case of a tenanted premises
which is used for educational, business, trade or storage purposes, any member
of his family who, at the time of the tenant’s death, is using the premises for
such purpose.

 

Moreover, in the absence of any family
member of the tenant, any heir of the tenant as may be decided by the Court in
the absence of any agreement will be the tenant. These provisions are
applicable to transmission of tenancy by the original tenant as well as by any
subsequent tenants.

 

The term family has not been defined
under the Act and, hence, the general definition of the term would have to be
taken. It is a term which is open to very wide interpretation and is quite
elastic. The Bombay High Court in Ramubai vs. Jiyaram Sharma, AIR 1964
Bom 96, has held that the term family would mean all those who are
connected by blood relationship or marriage, married / unmarried / widowed
daughters, widows of predeceased heirs, etc. The Black’s Law Dictionary
defines the term as those who live in the same household subject to general
management and control of the head. Another definition is a group of blood
relatives and all the relations who descend from a common ancestor, or who
spring from a common root, i.e., a group of kindred persons. Hence, it is a
very generic term.

 

From the above definition of the term
tenant under the Act, it is very clear that only those family members of the
tenant who are residing with him would be entitled to his tenancy after his
demise. It is also relevant to note that the family members need not
necessarily be legal heirs of the tenant and the legal heirs would get the
tenancy only in the absence of any family members and that, too, on
determination by a competent Court. Residing with the tenant means that the
family members must stay, eat and sleep in the same house as the tenant. This
is a question of fact as to whether or not a family member can be said to be
residing with the deceased tenant.

 

However, in the case of non-residential
premises, the family members must be using the property along with the tenant.
Thus, in case of such premises it is not necessary that they reside with the
tenant but they must use the premises for the purposes for which the tenant was
using the same. In the case of Pushpa Rani and Ors. vs. Bhagwanti Devi,
AIR 1994 SC 774, the Supreme Court held that when a tenant dies, it is
the person who continued in occupation of and carried on business in the
business premises alone with whom the landlord should deal and other heirs must
be held to have surrendered their right of tenancy.

 

The Supreme Court in the case of Vasant
Pratap Pandit vs. Dr. Anant Trimbak Sabnis, 1994 SCC (3) 481 has held
that the legislative prescription of this provision of the Act is first to give
protection to the members of the family of the tenant residing with him at the
time of his death. The basis for this is that when a tenant is in occupation of
premises, the tenancy is taken by him not only for his own benefit but also for
the benefit of the members of the family residing with him. Therefore, when the
tenant dies, protection should be extended to the members of the family who
were participants in the benefit of the tenancy and for whose needs as well the
tenancy was originally taken by the tenant. It is for this object that the
legislature has, irrespective of the fact whether such members are ‘heirs’ in
the strict sense of the term or not, given them the first priority to be
treated as tenants. All the heirs are liable to be excluded if any other member
of the family was staying with the tenant at the time of his death.

 

The Bombay High Court was faced with an
interesting question in the case of Vasant Sadashiv Joshi vs. Yeshwant
Shankar Barve, WP 2371/1997. Here, the tenant resided in a premises
along with his brother. The tenant and his brother were part of an HUF. After
the tenant’s death, the brother’s son contended that since the family members
were recognised as tenants, the joint family itself should also be recognised
as a tenant. The High Court negated this plea and held that the term only
included a single person as a tenant and it was not possible that every member
of the HUF would become a tenant. It held that when a landlord grants a tenancy
it is a contract of tenancy as entered into with a specific person (tenant).
The landlord expects fulfilment of legal obligations from the tenant. The law,
therefore, does not envisage that the landlord would be required to deal with
all members of the joint family.

 

Similarly, in Vimalabai Keshav
Gokhale vs. Avinash Krishnaji Binjewale, 2004 (1) Bom CR 839, the High
Court rejected the contention that the Bombay Rent Act would enable each and
every member of the tenant’s family to claim an independent right in respect of
the tenancy and held that any member would mean ‘any one member.’

 

The Bombay High Court in Urmi
Deepak Kadia vs. State of Maharashtra, 2015(6) Bom CR 354 considered
whether the Maharashtra Rent Control Act was contrary to the Hindu Succession
Act, 1956 since it provided protection only to those heirs of the deceased who
at the time of his demise were staying with him and not to others. It held that
the field covered by two laws was not the same but entirely different. The Rent
Act sought to prevent exploitation of tenants and ensured a reasonable return
for investment in properties by landlords. In some contingencies u/s 7(15) of
the Rent Act, certain heirs were unable to succeed to a statutory tenancy. To
this extent, a departure was made from the general law. In such circumstances,
the observations of the Apex Court in Vasant Pratap’s case (Supra)
were decisive. Hence, it concluded that the Rent Act did not interfere with the
Hindu Succession Act.

 

HEIRS OF
TENANT SUCCEED IN ABSENCE OF FAMILY MEMBERS


The Act further provides that in the
absence of family members, it is the heirs of the tenant who would succeed to
the tenanted premises. The term heirs has not been defined under the Act and
hence one needs to have recourse to the usually understood meaning. The Supreme
Court in the case of Vasant Pratap (Supra) has dealt with the
definition of the term heirs. It means the persons who are appointed by law to
succeed to the estate in case of intestacy. It means a person who succeeds,
under law, to an estate in lands, tenements, or hereditaments, upon the death
of his ancestor, by descent and right of relationship. The term is used to
designate a successor to property either by Will or by law. The Court further
held that a deceased person’s ‘heirs at law’ are those who succeed to his
estate by inheritance under law, in the absence of a Will.

 

The Supreme Court in the case of Ganesh
Trivedi vs. Sundar Devi (2002) 2 SCC 329 had held that the brother of a
male tenant would be his heir. However, an interesting question arose in Durga
Prasad vs. Narayan Ram Chandaani (D) Thr. Lr. CA 1305/2017 (SC) as to
whether the brother of a married female tenant could be treated as her legal
heir and thus become the tenant after her demise? In this case before the
Supreme Court, a person had taken a residential property on rent. After his
demise his son became the tenant and after his son’s demise, his
daughter-in-law became the tenant. The question arose as to who would become
the tenant on her demise as she did not have any children. Her brother claimed
that he was a part of the deceased tenant’s family and hence he should inherit
the property. This was a property located in UP, so the Apex Court considered
the provisions of the U.P. Rent Act. Under that Act, the heirs of a tenant residing
with him succeed to the premises on the tenant’s death.

 

The Supreme Court held that the
question falling for consideration was whether the brother of the tenant was an
heir under the U.P. Rent Act. Since the term heir was not defined under the
Act, it held that heir was a person who inherited by law. Section 3(1)(f) of
the Hindu Succession Act, 1956 defined an heir to mean any person, male or
female, who was entitled to succeed to the property of an intestate under the
Act. The word heir had to be given the same meaning as would be applicable to
the general law of succession. The deceased tenant being a Hindu female, the
devolution of tenancy would be determined u/s 15 of the Hindu Succession Act.
Sub-section (2) of section 15 carved out an exception to the general scheme and
order of succession of a Hindu female dying intestate without leaving any
children. If such a woman has inherited property from her husband /
father-in-law, then the property devolved upon her husband’s heirs. The Apex Court
held that since she did not have any children and the tenancy in question had
come from the tenant’s father-in-law to her husband and from her husband to the
tenant, the exception contained in section 15(2) of the Hindu Succession Act
would apply. Accordingly, since her brother was not an heir of her husband, he
was not entitled to succeed to the tenancy in question.

 

CAN THE TENANT
MAKE A WILL?


This brings us to the important
question of whether a tenant can will away his tenanted premises? In the case
of Gian Devi Anand vs. Jeevan Kumar, (1985) 2 SCC 683, a
Constitution Bench of the Supreme Court held that the rule of heritability
(capable of being inherited) extends to statutory tenancy of commercial as well
as residential premises in States where there is no explicit provision to the
contrary under the Rent Act and tenancy rights are to devolve according to the
ordinary law of succession, unless otherwise provided in the statute. In Bhavarlal
Labhchand Shah vs. Kanaiyalal Nathalal Intawala, referring to the
Bombay Rent Control Act, 1974, it was held that a tenant of a non-residential
premises cannot bequeath under a Will his right to such tenancy in favour of a
person who is a stranger, not being a member of the family, carrying on
business. In State of West Bengal vs. Kailash Chandra Kapur, (1997) 2 SCC
387, it was held that in the absence of any contrary covenants in the
lease deed or the law, a Will in respect of leasehold rights in a land can be
executed by a lessee in favour of a stranger.

 

Hence, if the Rent Control laws of a
State so provide, then a tenant cannot make a Will for his tenanted premises.
In that event, the tenancy would pass on only in accordance with the Rent
Control Act. This proposition is also supported by the Supreme Court’s decision
in the case of Vasant Pratap (Supra). In that case, the tenant
made a Will of her property in favour of her nephew. This was opposed by her
sister’s grandson who was staying with the tenant at the time of her death. The
Apex Court held that normally speaking, tenancy right would be heritable but if
the right to inherit had been restricted by legislation, then the same would
apply. It held that if the word ‘heir’ in the Rent Act was to be interpreted to
include a ‘legatee under a Will’, then even a stranger may have to be inducted
as a tenant for there is no embargo upon a stranger being a legatee under a
Will. This obviously was not the intention of the legislature. Accordingly, it
was held that a bequest could not be made in respect of a tenanted property.

 

The Supreme Court’s decision in the
case of Gaiv Dinshaw Irani vs. Tehmtan Irani, (2014) 8 SCC 294
succinctly sums up the position after considering all previous decisions on
this issue:

 

‘…in general
tenancies are to be regulated by the governing legislation, which favour that
tenancy be transferred only to family members of the deceased original tenant.
However, in light of the majority decision of the Constitution Bench in Gian
Devi vs. Jeevan Kumar (Supra), the position which emerges
is that in absence of any specific provisions, general laws of succession to
apply, this position is further cemented by the decision of this Court in State
of West Bengal vs. Kailash Chandra Kapur (Supra) which has allowed
the disposal of tenancy rights of Government owned land in favour of a stranger
by means of a Will in the absence of any specific clause or provisions.’

 

CONCLUSION


The law as it stands in the State of
Maharashtra is very clear. A tenancy cannot be bequeathed by way of a Will. It
would pass only in accordance with the Rent Act. However, the position in other
States needs to be seen under the respective Rent Acts, if any.  

 

UNCERTAINTY OVER INCOME TAX TREATMENTS

Ind
AS 12 Uncertainty over Income Tax Treatments (Appendix C) is effective
for the financial years beginning 1st April, 2019. An ‘uncertain tax
treatment’ is a tax treatment for which there is uncertainty over whether the
relevant taxation authority will accept the tax treatment under tax law. For
example, an entity’s decision not to submit any income tax filing in a tax
jurisdiction, or not to include particular income in taxable profit, is an
uncertain tax treatment if its acceptability is uncertain under tax law.

 

Uncertain
tax treatments generally occur where there is uncertainty as to the meaning of
the law, or to the applicability of the law to a particular transaction, or
both. For example, the tax legislation may allow the deduction of research and
development expenditure, but there may be disagreement as to whether a specific
item of expenditure falls within the definition of eligible research and
development costs in the legislation. In some cases, it may not be clear how
tax law applies to a particular transaction, if at all.

 

One
of the questions that was not clear in Appendix C was with respect to the presentation
of uncertain tax liabilities / assets. Whether, in its statement of financial
position, an entity is required to present uncertain tax liabilities as current
(or deferred) tax liabilities or, instead, within another line item such as
provisions? A similar question could arise regarding uncertain tax assets.

 

The
presentation of uncertainty over income tax treatments is very sensitive as it
may lead the Income-tax authorities to draw conclusions on the entities’
conclusion over the outcome of the uncertainty, or may provide information that
may lead to an investigation. Therefore, given a choice, entities would like to
combine uncertain tax provisions with another line item such as provisions.

 

AUTHOR’S RESPONSE


The
following points are relevant to respond to the question:


(i)
uncertain tax liabilities or assets
recognised applying Appendix C are liabilities (or assets) for current tax as
defined in Ind AS 12 Income Taxes, or deferred tax liabilities, or
assets as defined in Ind AS 12; and


(ii)
       neither Ind AS 12 nor Appendix C
contain requirements on the presentation of uncertain tax liabilities or
assets. Therefore, the presentation requirements in Ind AS 1 Presentation of
Financial Statements apply. Paragraph 54 of Ind AS 1 states that ‘the
statement of financial position shall include line items that present:… (n)
liabilities and assets for current tax, as defined in Ind AS 12; (o) deferred
tax liabilities and deferred tax assets, as defined in Ind AS 12…’

 

Therefore,
applying Ind AS 1, an entity is required to present uncertain tax liabilities
as current tax liabilities (paragraph 54[n]) or deferred tax liabilities
(paragraph 54[o]); and uncertain tax assets as current tax assets (paragraph
54[n]), or deferred tax assets (paragraph 54[o]).

 

Similarly,
Ind AS Schedule III to the Companies Act 2013 requires separate
presentation of current tax asset, current tax liability, deferred tax asset
and deferred tax liability. Additionally, General Instruction No. 2 for
preparation of financial statements of a company required to comply with Ind AS
clarifies that the requirements of Ind AS will prevail over Schedule III, if
there are any inconsistencies.

 

In
particular, one should note that:


(a)
       when there is uncertainty over
income tax treatments, Appendix C specifies how an entity reflects any effects
of that uncertainty in calculating current or deferred tax in accordance with
Ind AS 12. Paragraph 4 of Appendix C states (emphasis added):


‘This
Appendix clarifies how to apply the recognition and measurement requirements in
Ind AS 12 when there is uncertainty over
income tax treatments. In such a circumstance, an entity shall recognise and
measure its current or deferred tax asset or liability applying the
requirements in Ind AS 12 based on taxable profit (tax loss), tax bases,
unused tax losses, unused tax credits and tax rates determined applying this
Appendix.’


(b)
       An entity therefore applies
Appendix C in determining taxable profit (tax loss), tax bases, unused tax
losses, unused tax credits and tax rates when there is uncertainty over income
tax treatments. These amounts are in turn used to determine current / deferred
tax applying Ind AS 12, which in turn flow through to be current / deferred tax
liabilities if the amounts relate to the current or prior periods but are
unpaid / unreversed.

 

(c)
       Appendix C requires an entity to
reflect the effect of uncertainty in determining taxable profit, tax rates,
etc. when it concludes that it is not probable that the taxation authority will
accept an uncertain tax treatment (paragraph 11 of Appendix C). Consequently,
the taxable profit on which current tax, as defined in Ind AS 12, is calculated
is the taxable profit that reflects any uncertainty applying Appendix C. The
definition of current tax in paragraph 5 of Ind AS 12 does not limit the
taxable profit (tax loss) used in determining current tax to the amount
reported in an entity’s income tax filings. Instead, the definition refers to
(emphasis added) ‘the amount of income taxes payable (recoverable) in respect
of the taxable profit (tax loss) for the period’.

 

(d)
       Paragraph 54 of Ind AS 1 states:


‘The
statement of financial position shall include line items that present the
following amounts:…


(l)
provisions;…

 

(n)
liabilities and assets for current tax, as defined in Ind AS 12 Income Taxes;

(o)
deferred tax liabilities and deferred tax assets, as defined in Ind AS 12;…’

 

Particularly,
requirements in paragraphs 54(n) and 54(o) of Ind AS 1 will preclude an entity
from presenting some elements of income tax within another line in the
statement of financial position, such as provisions. In particular, paragraph
29 of Ind AS 1 states ‘…an entity shall present separately items of a
dissimilar nature or function unless they are immaterial’. Paragraph 57 of
Ind AS 1 states that ‘…paragraph 54 simply lists items that are sufficiently
different in nature or function to warrant separate presentation in the
statement of financial position.’ Consequently, liabilities for current
(or deferred) tax as defined in Ind AS 12 are sufficiently different in nature
or function from other line items listed in paragraph 54 to warrant presenting
such liabilities separately in their own line item (if material).

 

CONCLUSION

When
there is uncertainty over income tax treatments, paragraph 4 of Appendix C
requires an entity to ‘recognise and measure its current or deferred tax asset
or liability applying the requirements in Ind AS 12 based on taxable profit
(tax loss), tax bases, unused tax losses, unused tax credits and tax rates determined
applying Appendix C’. Paragraph 5 of Ind AS 12 Income Taxes defines:


(1)
       current tax as the amount of income
taxes payable (recoverable) in respect of the taxable profit (tax loss) for a
period; and


(2)
       deferred tax liabilities (or
assets) as the amounts of income taxes payable (recoverable) in future periods
in respect of taxable (deductible) temporary differences and, in the case of
deferred tax assets, the carry forward of unused tax losses and credits.

 

Consequently,
uncertain tax liabilities or assets recognised applying Appendix C are
liabilities (or assets) for current tax as defined in Ind AS 12, or deferred
tax liabilities or assets as defined in Ind AS 12.

 

Neither
Ind AS 12 nor Appendix C contains requirements on the presentation of uncertain
tax liabilities or assets. Therefore, the presentation requirements in Ind AS 1
apply. Paragraph 54 of Ind AS 1 states that ‘the statement of financial
position shall include line items that present:… (n) liabilities and assets for
current tax, as defined in Ind AS 12; (o) deferred tax liabilities and deferred
tax assets, as defined in Ind AS 12…’.

 

Paragraph
57 of Ind AS 1 states that paragraph 54 ‘lists items that are sufficiently
different in nature or function to warrant separate presentation in the
statement of financial position’. Paragraph 29 requires an entity to ‘present
separately items of a dissimilar nature or function unless they are
immaterial’.

 

Similarly,
Ind AS Schedule III to the Companies Act 2013 requires separate
presentation of current tax asset, current tax liability, deferred tax asset
and deferred tax liability. Additionally, General Instruction No. 2 for
preparation of financial statements of a company required to comply with Ind AS
clarifies that the requirements of Ind AS will prevail over Schedule III if
there are any inconsistencies.

 

Accordingly, applying
Ind AS 1, an entity is required to present uncertain tax liabilities as current
tax liabilities (paragraph 54[n]) or deferred tax liabilities (paragraph
54[o]); and uncertain tax assets as current tax assets (paragraph 54[n]) or
deferred tax assets (paragraph 54[o]).  

 

Settlement of cases – Section 245C of ITA, 1961 – Black Money Act, 2015 – Jurisdiction of Settlement Commission – Undisclosed income of non-resident Indians – Charge under Black Money Act only from A.Y. 2016-17 – Pending reassessment proceedings order of Settlement Commission for A.Y. 2004-05 to 2015-16 – Order of Settlement Commission is valid

47. Principal CIT vs.
IT Settlement Commission; [2020] 420 ITR 149
(Guj.) Date of order: 8th
November, 2019 A.Ys.: 2004-05 to
2015-16

 

Settlement of cases –
Section 245C of ITA, 1961 – Black Money Act, 2015 – Jurisdiction of Settlement
Commission – Undisclosed income of non-resident Indians – Charge under Black
Money Act only from A.Y. 2016-17 – Pending reassessment proceedings order of
Settlement Commission for A.Y. 2004-05 to 2015-16 – Order of Settlement
Commission is valid

 

A search and seizure operation came to
be carried out at the residential and business premises of the B group of
companies of which the assessees were directors. Pursuant to the search,
notices under sections 148 and 153A of the Income-tax Act, 1961 were issued to
the three assessees for the A.Ys. 2005-06 to 2013-14, 2004-05 to 2015-16, and
2004-05 to 2015-16, respectively. In response thereto, the assessees filed
income tax returns disclosing undisclosed foreign income and assets.
Thereafter, they filed separate applications u/s 245C of the 1961 Act before
the Settlement Commission disclosing additional undisclosed foreign income and
assets. The Settlement Commission passed an order on 30th January,
2019 settling the cases and granting reliefs. On 18th February,
2019, the A.O. passed orders giving effect to the order of the Settlement
Commission and determined the additional tax payable and issued notices of
demand u/s 156 of the Act on the same day. Each of the assessees paid the
additional tax payable.

 

On a writ petition filed by the Department
on 30th May, 2019 challenging the orders passed by the Settlement
Commission as without jurisdiction since the Settlement Commission had no
jurisdiction to pass an order under the 1961 Act in relation to undisclosed
foreign income and assets covered under the 2015 Act, the Gujarat High Court
dismissed the petition and held as under:

 

‘i)   On a conjoint reading of sections 3 and 2(9)
of the Black Money (Undisclosed Foreign Income and Assets) and Imposition of
tax Act, 2015, it is clear that undisclosed foreign income or assets become
chargeable to tax from the A.Y. 2016-17. However, when undisclosed foreign
assets become chargeable to tax from the A.Y. 2016-17 onwards, the date of
acquisition of such assets may relate to any assessment year prior to the A.Y.
2016-17. Therefore, even after the coming into force of the 2015 Act, insofar
as assessment years prior to the A.Y. 2016-17 are concerned, the undisclosed
foreign income would be chargeable to tax under the relevant provisions of the
Income-tax Act, 1961.

 

ii)   What sub-section (3) of section 4 of the 2015
Act provides is that what is included as income and asset under the 2015 Act
cannot be included in the total income under the 1961 Act. The said sub-section
does not contain a non obstante clause ousting the applicability of the
1961 Act, insofar as undisclosed foreign income and assets are concerned. The
2015 Act is a taxing statute and provides for stringent penalties and
prosecution and it is by now well settled that a taxing statute must be
interpreted in the light of what is clearly expressed. The second proviso
to section 147 of the 1961 Act does away with the limitation of four years as
provided in the first proviso to section 147 in the case of undisclosed
foreign income. By virtue of clause (c) of sub-section (1) of section 149, the
time limit for reopening of assessments has been extended to sixteen years in
respect of any asset, including financial interest in any entity located
outside India, so that the bar applies for periods beyond sixteen years in such
cases. Clearly, therefore, the scheme of the Income-tax Act, 1961 is not meant
to tax only disclosed foreign income but also undisclosed foreign income.

 

iii)  It was an admitted position that the
residential status of two of the assessees was non-resident for the A.Y.
2016-17 and for the third for the A.Y. 2014-15 onwards. Thus, when the 2015 Act
came into force, the assessees were not residents. It could not be said that
the assessees fell within the ambit of the expression ‘assessee’ as defined
under clause (2) of section 2 of the 2015 Act as it stood prior to its
amendment by the Finance (No. 2) Act of 2019. The expression ‘assessee’ was
amended on 1st August, 2019, albeit with retrospective effect
from 1st July, 2015, and as on the date when the Settlement
Commission passed the order, namely, 30th January, 2019, the
assessees were not ‘assessees’ within the meaning of such expression as
contemplated u/s 2(2) of the 2015 Act and were, therefore, not covered by the
provisions of that Act. The search proceedings were conducted after the 2015
Act came into force and, consequently, the notices under sections 148 and 153A
of the 1961 Act were also issued after the 2015 Act came into force. The fact
that these notices under sections 148 and 153A of the 1961 Act were issued in
respect of undisclosed foreign income or assets could be substantiated on a
perusal of the reasons recorded for reopening the assessment for the A.Y.
2000-01.

 

The Revenue authorities were well aware
of the fact that the provisions of the 2015 Act covered undisclosed foreign
income only from the A.Y. 2016-17 onwards and, therefore, categorically
submitted to the jurisdiction of the Settlement Commission and requested it to
proceed further pursuant to the applications made by the assessees u/s 245C of
the Income-tax Act, 1961. It was only for this reason that notices under the
2015 Act were issued only for the A.Ys. 2017-18 and 2018-19. The A.O. had
issued notices under sections 148 and 153A of the 1961 Act for different
assessment years. Therefore, proceedings for assessment or reassessment as
contemplated under clauses (i) and (iiia) of the Explanation to clause (b) of
section 245A had commenced and were pending before the A.O. when the
applications u/s 245C of the 1961 Act came to be made. Therefore, the
requirements of the provisions of section 245C of the 1961 Act were duly
satisfied when the applications thereunder came to be made by the assessees.
Upon receipt of the applications made u/s 245C of the 1961 Act, the Settlement
Commission proceeded further in accordance with the provisions of section 245D
of the 1961 Act. At the stage when it was brought to its notice that notices
u/s 10 of the 2015 Act had been issued to the assessees, the Settlement
Commission gave ample opportunity to the Revenue to decide what course of
action it wanted to adopt, and it was the Revenue which categorically invited
an order from the Settlement Commission in respect of the undisclosed foreign
income and assets disclosed before it.

 

The record of the case showed that the
requirements of section 245D of the 1961 Act had been duly satisfied prior to
the passing of the order u/s 245D(4). The proceedings before the Settlement
Commission were taken in connection with notices issued under sections 148 and
153A of the 1961 Act and it was, therefore, that the Settlement Commission had
the jurisdiction to decide the applications u/s 245C of that Act, which related
to the proceedings in respect of those notices. If it was the case of the
Revenue that the undisclosed foreign income and assets of the assessees were
covered by the provisions of the 2015 Act, the notices under sections 148 and
153A of the 1961 Act, which mainly related to undisclosed foreign income, ought
to have been withdrawn and proceedings ought to have been initiated under the
relevant provisions of the 2015 Act. The Settlement Commission had the
jurisdiction to decide the applications u/s 245C.

 

iv)  The Settlement Commission, after considering
the material on record, had given a finding of fact to the effect that there
was a full and true disclosure made by the assessees and that there was no
wilful attempt to conceal material facts. If for the reason that issues which
pertained to past periods could not be reconciled due to lack of further
evidence, the assessees, with a view to bring about a settlement, agreed to pay
a higher amount as proposed by the Revenue, it certainly could not be termed a
revision of the original disclosure made u/s 245C of the 1961 Act, inasmuch as,
there was no further disclosure but an acceptance of additional liability based
on the disclosure already made before the Settlement Commission.

 

v)   Another aspect of the matter was that it was
an admitted position that prior to the presentation of the writ petition, the
order of the Settlement Commission came to be fully implemented. This was not
mentioned in the writ petition. Therefore, there was suppression of material
facts. The order passed by the Settlement Commission was valid.’

 

Refund – Withholding of refund – Sections 143(2) and 241A of ITA, 1961 – Discretion of A.O. – Scope of section 241A – A.O. must apply his mind before withholding refund – Mere issue of notice for scrutiny assessment for a later assessment year not a ground for withholding refund

46. Maple Logistic P.
Ltd. vs. Principal CIT; [2020] 420 ITR 258
(Del.) Date of order: 14th
October, 2019 A.Ys.: 2017-18 and
2018-19

 

Refund – Withholding
of refund – Sections 143(2) and 241A of ITA, 1961 – Discretion of A.O. – Scope
of section 241A – A.O. must apply his mind before withholding refund – Mere
issue of notice for scrutiny assessment for a later assessment year not a
ground for withholding refund

 

The petitioner, by way of writ petition
under Articles 226 and 227 of the Constitution of India, sought a writ in the
nature of mandamus directing the respondent to refund the income tax
amount on account of excess deduction of tax at source in respect of the
assessment years 2017-18 and 2018-19 and other consequential directions to
adjust the outstanding amount of tax deducted at source and the goods and
services tax payable by the petitioner-company against the pending refund
amount without charging of any interest for the delayed payments. The Delhi
High Court allowed the writ petition and held as under:

 

‘i)   U/s 241A of the Income-tax Act, 1961 the
legislative intent is clear and explicit. The processing of return cannot be
kept in abeyance merely because a notice has been issued u/s 143(2) of the Act.
Post-amendment, sub-section (1D) of section 143 is inapplicable to returns
furnished for the assessment year commencing on or after 1st April,
2017. The only provision that empowers the A.O. to withhold the refund in a
given case at present is section 241A. Now refunds can be withheld only in
accordance with this provision. The provision is applicable to such cases where
refund is found to be due to the assessee under the provisions of sub-section
(1) of section 143, and also a notice has been issued under sub-section (2) of
section 143 in respect of such returns. However, this does not mean that in
every case where a notice has been issued under sub-section (2) of section 143
and the case of the assessee is selected for scrutiny assessment, the
determined refund has to be withheld. The Legislature has not intended to
withhold the refunds just because scrutiny assessment is pending. If such had
been the intent, section 241A would have been worded so. On the contrary,
section 241A enjoins the A.O. to process the determined refunds, subject to the
caveat envisaged u/s 241A.

 

ii)   The language of section 241A envisages that
the provision is not resorted to merely for the reason that the case of the
assessee is selected for scrutiny assessment. Sufficient checks and balances
have been built in under the provision and have to be given due consideration
and meaning. An order u/s 241A should be transparent and reflect due
application of mind. The A.O. is duty-bound to process the refunds where they
are determined. He cannot deny the refund in every case where a notice has been
issued under sub-section (2) of section 143. The discretion vested with the
A.O. has to be exercised judiciously and is conditioned and channelised. Merely
because a scrutiny notice has been issued that should not weigh with the A.O.
to withhold the refund. The A.O. has to apply his mind judiciously and such
application of mind has to be found in the reasons which are to be recorded in
writing. He must make an objective assessment of all the relevant circumstances
that would fall within the realm of ‘adversely affecting the Revenue’. The
power of the A.O. has been outlined and defined in terms of section 241A and he
must proceed giving due regard to the fact that the refund has been determined.

 

iii)  The fact that notice u/s 143(2) has been
issued would obviously be a relevant factor, but that cannot be used to
ritualistically deny refunds. The A.O. is required to apply his mind and
evaluate all the relevant factors before deciding the request for refund of
tax. Such an exercise cannot be treated to be an empty formality and requires
the A.O. to take into consideration all the relevant factors. The relevant
factors, to state a few, would be the prima facie view on the grounds
for the issuance of notice u/s 143(2), the amount of tax liability that the
scrutiny assessment may eventually result in vis-a-vis the amount of tax refund
due to the assessee, the creditworthiness or financial standing of the assessee,
and all factors which address the concern of recovery of revenue in doubtful
cases. Therefore, merely because a notice has been issued u/s 143(2), it is not
a sufficient ground to withhold refund u/s 241A and the order denying refund on
this ground alone would be laconic. Additionally, the reasons which are to be
recorded in writing have to also be approved by the Principal Commissioner, or
Commissioner, as the case may be, and this should be done objectively.

 

iv)  The reasons relied upon by the Revenue to
justify the withholding of refund were lacking in reasoning. Except for
reproducing the wording of section 241A of the Act, they did not state anything
more. The order withholding the refund was not valid.’

 

Reassessment – Sections 147 and 148 of ITA, 1961 – Validity of notice u/s 148 – Conditions precedent for notice – Amount assessed in block assessment – Addition of amount deleted by Commissioner (Appeals) – Notice to reassess same amount not valid

45. Audhut Timblo vs.
ACIT; [2020] 420 ITR 62 (Bom.) Date of order: 27th
November, 2019 A.Ys.: 2002-03

 

Reassessment
– Sections 147 and 148 of ITA, 1961 – Validity of notice u/s 148 – Conditions
precedent for notice – Amount assessed in block assessment – Addition of amount
deleted by Commissioner (Appeals) – Notice to reassess same amount not valid

 

Pursuant to a search
action u/s 132 of the Income-tax Act, 1961, block assessment order u/s 158BC
was passed by the A.O. on 27th September, 2002 making an addition of
Rs. 10.33 crores as unexplained cash credits. The Commissioner (Appeals), by an
order dated 13th July, 2006, deleted the addition of Rs. 10.33
crores. On 13th September, 2006, the Department appealed against the
order of the Commissioner to the Appellate Tribunal. On 18th
October, 2006, the Department issued notice invoking the provisions of section
147 / 148 of the Act stating that this very income of Rs. 10.33 crores had
escaped assessment and therefore reassessment or reopening of assessment was
proposed for the A.Y. 2002-03.

 

The Bombay High Court allowed the writ
petition filed by the assessee challenging the notice and held as under:

‘i)   The A.O. can reopen an assessment only in
accordance with the express provisions in section 147 / 148 of the Income-tax
Act, 1961. Section 147 clothes the A.O. with jurisdiction to reopen an
assessment on satisfaction of the following: (a) the A.O. must have reason to
believe that (b) income chargeable to tax has escaped assessment and (c) in
cases where the assessment sought to be reopened is beyond the period of four
years from the end of the relevant assessment year, then an additional
condition is to be satisfied, viz., there must be failure on the part of the
assessee to fully and truly disclose all material facts necessary for assessment.

 

ii)   Since there was full disclosure and, in fact,
the amount had even become the subject matter of the assessment both u/s 158BC
and u/s 143(3), there could have been no reason to believe that the income
chargeable to tax had indeed escaped assessment. The notice of reassessment was
not valid.’

Penalty – Concealment of income – Search and seizure – Immunity from penalty – Effect of section 271AAA of ITA, 1961 – Assessee admitting undisclosed income during search proceedings and explaining source – No inquiry regarding manner in which income was earned – Immunity cannot be denied because of absence of such explanation

44. Principal CIT vs. Patdi Commercial and Investment Ltd.; [2020] 420 ITR 308 (Guj.) Date of order: 17th September, 2019 A.Y.: 2011-12

 

Penalty – Concealment
of income – Search and seizure – Immunity from penalty – Effect of section
271AAA of ITA, 1961 – Assessee admitting undisclosed income during search
proceedings and explaining source – No inquiry regarding manner in which income
was earned – Immunity cannot be denied because of absence of such explanation

 

The Tribunal deleted the penalty u/s
271AAA of the Income-tax Act, 1961. On appeal by the Revenue, the Gujarat High
Court upheld the decision of the Tribunal and held as under:

 

‘i)   Section 271AAA of the Income-tax Act, 1961
provides for penalty in cases of search. Sub-section (2) specifies that such
penalty will not be imposed if the following three conditions are satisfied:
(i) in the course of the search, in a statement under sub-section (4) of
section 132, the assessee admits the undisclosed income and specifies the
manner in which such income has been derived; (ii) the assessee substantiates
the manner in which the undisclosed income was derived; and (iii) pays the tax
together with interest, if any, in respect of the undisclosed income. In
accordance with the settled legal position, where the Revenue has failed to
question the assessee while recording the statement u/s 132(4) of the Act as
regards the manner of deriving such income, it cannot raise a presumption
regarding it.

 

ii)   Both the Commissioner (Appeals) as well as
the Tribunal had recorded concurrent findings of fact that during the course of
search the director of the assessee company had admitted undisclosed income of
Rs. 15 crores as unaccounted cash receivable for the year under consideration,
i.e., F.Y. 2010-11. The director of the assessee in his statement had explained
that the income was earned out of booking / selling shops and had specified the
buildings. Thereafter, the assessee could not be blamed for not substantiating
the manner in which the disclosed income was derived. The cancellation of
penalty by the Tribunal was justified.’

 

 

Capital gains – Unexplained investment – Sections 50C and 69 of ITA, 1961 – Sale of immovable property – Difference between stamp value and value shown in sale deed – Effect of section 50C – Presumption that stamp value is real one – Section 50C enacts a legal fiction – Section 50C cannot be applied to make addition u/s 69

43. Gayatri
Enterprises vs. ITO; [2020] 420 ITR 15
(Guj.) Date of order: 20th
August, 2019 A.Y.: 2011-12

 

Capital gains – Unexplained
investment – Sections 50C and 69 of ITA, 1961 – Sale of immovable property –
Difference between stamp value and value shown in sale deed – Effect of section
50C – Presumption that stamp value is real one – Section 50C enacts a legal
fiction – Section 50C cannot be applied to make addition u/s 69

 

The assessee purchased a piece of land.
He disclosed the transaction in his returns for the A.Y. 2011-12. This was
accepted by the A.O. Subsequently, the order was set aside in revision and an
addition was made to his income u/s 69 of the Income-tax Act, 1961 on the
ground that there was a difference between the value of the land shown in the
sale deed and the stamp duty value. The order of revision was upheld by the
Tribunal.

 

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

 

‘i)   Section 50C was introduced in the Income-tax
Act, 1961 by the Finance Act, 2002 with effect from 1st April, 2003
for substituting the valuation done for the stamp valuation purposes as the
full value of the consideration in place of the consideration shown by the
transferor of the capital asset, being land or building, and, accordingly,
calculating the capital gains u/s 48. Under section 50C when the stamp duty
valuation of a property is higher than the apparent sale consideration shown in
the instrument of transfer, the onus to prove that the fair market value of the
property is lower than such valuation by the stamp valuation authority is on
the assessee who can reasonably discharge this onus by submitting necessary
material before the A.O., such as valuation by an approved valuer. Thereafter,
the onus shifts to the A.O. to show that the material submitted by the assessee
about the fair market value of the property is false or not reliable. Section
50C enacts a legal fiction which is confined to what is stated in the
provision. The provisions of section 50C cannot be applied for the purpose of
making an addition u/s 69.

ii)   Section 50C will apply to the seller of the
property and not to the purchaser. Section 69B does not permit an inference to
be drawn from the circumstances surrounding a transaction of sale of property
that the purchaser of the property must have paid more than what was actually
recorded in his books of accounts for the simple reason that such an inference
could be very subjective and could involve the dangerous consequence of a
notional or fictional income being brought to tax contrary to the strict
provisions of Article 265 of the Constitution of India which must be
“taxes on income other than agricultural income”.

 

iii)  There was nothing on record to indicate what
the price of the land was at the relevant time. Even otherwise, it was a pure
question of fact. Apart from the fact that the price of the land was different
from that recited in the sale deed unless it was established on record by the
Department that, as a matter of fact, the consideration as alleged by the
Department did pass to the seller from the purchaser, it could not be said that
the Department had any right to make any additions. The addition was
not justified.’

 

 

Business expenditure – Disallowance u/s 40(a)(ia) of ITA, 1961 – Payments liable to deduction of tax at source – Charges paid by assessee to banks for providing credit card processing services – Bank not rendering services in nature of agency – Charges paid to bank not in nature of commission within meaning of section 194H – Disallowance u/s 40(a)(ia) not warranted

42. Principal CIT vs.
Hotel Leela Venture Ltd.; [2020] 420 ITR 385
(Bom.) Date of order: 18th
December, 2018 A.Y.: 2009-10

 

Business expenditure
– Disallowance u/s 40(a)(ia) of ITA, 1961 – Payments liable to deduction of tax
at source – Charges paid by assessee to banks for providing credit card
processing services – Bank not rendering services in nature of agency – Charges
paid to bank not in nature of commission within meaning of section 194H –
Disallowance u/s 40(a)(ia) not warranted

 

The assessee was in the hospitality
business. For the A.Y. 2009-10, the A.O. found that the assessee had not
deducted tax u/s 194H of the Income-tax Act, 1961 on payments made by it to
banks for processing of credit card transactions and disallowed the
corresponding expenditure u/s 40(a)(ia).

 

The Commissioner (Appeals) deleted the
disallowance and the Tribunal upheld his order.

 

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

 

‘i)   The Tribunal had not committed any error in holding
that the bank did not act as an agent of the assessee while it processed the
credit card payments and, therefore, the charges collected by the bank for such
services did not amount to commission within the meaning of section 194H. The
Tribunal was justified in upholding the deletion of disallowance made u/s
40(a)(ia) by the Commissioner (Appeals).

 

ii)   No question of law arose.’

 

 

Assessment – Notice u/s 143(2) of ITA, 1961 – Limitation – Date of filing of original return u/s 139(1) has to be considered for purpose of computing period of limitation under sub-section (2) of section 143 and not date on which defects actually came to be removed u/s 139(9)

 41. Kunal Structure
(India) (P) Ltd. vs. Dy. CIT; [2020] 113
taxmann.com 577 (Guj.) Date of order: 24th
October, 2019

 

Assessment – Notice
u/s 143(2) of ITA, 1961 – Limitation – Date of filing of original return u/s
139(1) has to be considered for purpose of computing period of limitation under
sub-section (2) of section 143 and not date on which defects actually came to
be removed u/s 139(9)

 

The petitioner is a company registered
under the Companies Act, 2013. For the A.Y. 2016-17, the petitioner had filed
its return of income u/s 139(1) of the Income-tax Act, 1961 on 10th
September, 2016. Thereafter, the petitioner received an intimation of defective
return u/s 139(9) on 17th June, 2017. The petitioner received a
reminder on 5th July, 2017 granting him an extension of 15 days to
comply with the notice issued u/s 139(9) of the Act and accordingly, the time
limit for removal of the defects u/s 139(9) of the Act stood extended till 20th
July, 2017. The petitioner removed the defects on 7th July, 2017
within the time granted. Subsequently, the return was processed under
sub-section (1) of section 143 of the Act on 12th August, 2017,
wherein the date of original return is shown to be 10th September,
2016. Thereafter, the impugned notice u/s 143(2) of the Act came to be issued
on 9th August, 2018, informing the petitioner that the return of
income filed by it for A.Y. 2016-17 on 7th July, 2017 has been
selected for scrutiny calling upon the petitioner to produce any evidence on
which it may rely in support of its return of income.

 

The petitioner filed a writ petition
under Articles 226 and 227 of the Constitution of India and challenged the
notice u/s 143(2) dated 9th August, 2018 and the proceedings
initiated pursuant thereto. The Gujarat High Court allowed the writ petition
and held as under:

 

‘i)   On a plain reading of sub-section (2) of
section 143 of the Act, it is apparent that the notice u/s 143(2) must be
served on the assessee within a period of six months from the end of the
financial year in which such return is furnished. Thus, if, after furnishing a
return of income, the assessee does not receive a notice under sub-section (2)
of section 143 of the Act within the period referred to in the sub-section, the
assessee is entitled to presume that the return has become final and no
scrutiny proceedings are to be started in respect of that return. It is only
after the issuance of notice under sub-section (2) of section 143 of the Act
that the A.O. can proceed further under sub-section (3) thereof to make an
assessment order. Therefore, the notice u/s 143(2) of the Act is a statutory
notice, upon issuance of which the A.O. assumes jurisdiction to frame the
scrutiny assessment under sub-section (3) of section 143 of the Act.
Consequently, if such notice is not issued within the period specified in
sub-section (2) of section 143 of the Act, viz., before the expiry of six months
from the end of the financial year in which the return is furnished, it is not
permissible for the A.O. to proceed further with the assessment.

 

ii)   In the facts of the present case, the
petitioner filed its return of income under sub-section (1) of section 139 of
the Act on 10th September, 2016. Since the return was defective, the
petitioner was called upon to remove such defects, which came to be removed on
7th July, 2017, that is, within the time allowed by the A.O.
Therefore, upon such defects being removed, the return would relate back to the
date of filing of the original return, that is, 10th September, 2016
and consequently the limitation for issuance of notice under sub-section (2) of
section 143 of the Act would be 30th September, 2017, viz., six
months from the end of the financial year in which the return under sub-section
(1) of section 139 came to be filed. In the present case, it is an admitted
position that the impugned notice under sub-section (2) of section 143 of the
Act has been issued on 9th August, 2018, which is much beyond the
period of limitation for issuance of such notice as envisaged under that
sub-section. The impugned notice, therefore, is clearly barred by limitation
and cannot be sustained.

 

iii)  For the foregoing reasons, the petition
succeeds and is, accordingly, allowed. The impugned notice dated 9th August,
2018 issued under sub-section (2) of section 143 of the Act and all proceedings
taken pursuant thereto are hereby quashed and set aside.’

 

Appellate Tribunal – Powers of (scope of order) – Section 254 r/w/s/ 144 of ITA, 1961 – Where remand made by Tribunal to A.O. was a complete and wholesale remand for framing a fresh assessment, A.O. could not deny to evaluate fresh claim raised by assessee during remand assessment proceedings

40. Curewel
(India) Ltd. vs. ITO; [2020] 113
taxmann.com 583 (Delhi) Date of order:
28th November, 2019 A.Y.: 2002-03

 

Appellate Tribunal – Powers of (scope of order) – Section 254 r/w/s/ 144
of ITA, 1961 – Where remand made by Tribunal to A.O. was a complete and
wholesale remand for framing a fresh assessment, A.O. could not deny to
evaluate fresh claim raised by assessee during remand assessment proceedings

 

For the A.Y.
2002-03, the A.O. passed best judgment assessment u/s 144 of the Income-tax
Act, 1961 without examining the books of accounts of the assessee. The Tribunal
set aside the said assessment and remanded the matter to the A.O. to pass a
fresh order after considering the documents and submissions of the assessee.
During remand assessment, the assessee raised a fresh claim regarding
non-taxability of income arising from write-off of liability by Canara Bank
which was earlier offered as taxable income. The A.O. rejected the said claim
holding that in remand proceedings the assessee could not raise a fresh claim.

 

The
Commissioner (Appeal) and the Tribunal upheld the decision of the A.O.

 

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

 

‘i)   The remand made by the
Tribunal to the A.O. vide order dated 10th March, 2011 was a
complete and wholesale remand for framing a fresh assessment. The remand was
not limited in its scope and was occasioned upon the Tribunal finding the
approach of the A.O. and the CIT(A) to be excessive, harsh and arbitrary. The
earlier assessment had been framed on the basis of best judgment without
examining the books of accounts of the assessee, which the assessee has claimed
were available.

ii)   That being the position, the
A.O. ought to have evaluated the claim made by the assessee for write-off of
liability by Canara Bank in its favour amounting to Rs. 1,36,45,525 and should
not have rejected the same merely on the ground of it being raised for the
first time. The reliance placed by the Tribunal on Saheli Synthetics (P)
Ltd. (Supra) is misplaced in the light of the scope and nature of
remand in the present case. The findings returned by the Tribunal in paragraphs
8, 9 and 12 of the impugned order are erroneous since the Tribunal has not
appreciated the scope and nature of the remand ordered by it by its earlier
order dated 10th March, 2011.

 

iii)  We, therefore, answer the
questions framed aforesaid in favour of the assessee and set aside the impugned
order. Since the A.O. has not evaluated the appellant’s claim regarding
non-taxability of income arising from write-off of liability by Canara Bank in
its favour amounting to Rs. 1,36,45,525 on merits, we remand the matter back to
the A.O. for evaluation of the said claim on its own merits.’

Rakesh Kumar Agarwal vs. ACIT-24(1); [ITA. No. 2881/Mum/2015; Date of order: 14th May, 2015; A.Y.: 2010-11; Mum. ITAT] Section 263 – Revision of orders prejudicial to Revenue – No revenue loss – Assessment was completed after detailed inquiry – Revision on same issue is not valid

17. The Pr. CIT-10 vs. Rakesh Kumar
Agarwal [Income tax Appeal No. 1740 of 2017] Date of order: 22nd January
2020 (Bombay High Court)

 

Rakesh Kumar Agarwal vs. ACIT-24(1);
[ITA. No. 2881/Mum/2015; Date of order: 14th May, 2015; A.Y.:
2010-11; Mum. ITAT]

 

Section 263 – Revision of orders
prejudicial to Revenue – No revenue loss – Assessment was completed after
detailed inquiry – Revision on same issue is not valid

 

The assessee is a builder and sells
plots of land on short-term as well as on long-term basis. For the A.Y. under
consideration, the assessee filed a return of income showing total income of
Rs. 7,47,25,768. During the assessment proceedings u/s 143 (3) of the Act, the
A.O. inquired into the accounts of the assessee and analysed the various claims
that had been made. The assessment proceedings were concluded by determining
the total assessed income of the assessee at Rs. 7,66,68,582.

 

However, the CIT invoked jurisdiction
u/s 263 of the Act on various discrepancies in the assessment order. Taking the
view that the order was erroneous inasmuch as it was prejudicial to the
interest of Revenue, the Commissioner of Income Tax set aside the assessment
order u/s 263 of the Act and directed the A.O. to pass a fresh order in the
light of the discussions made in the order passed u/s 263.

 

Aggrieved by this, the assessee
preferred an appeal before the Tribunal. The Tribunal took the view that the
CIT was not justified in invoking jurisdiction u/s 263 of the Act and set aside
the said order, allowing the appeal. Of the three issues, the Tribunal held
that the first issue did not result in any revenue loss and, therefore,
assumption of jurisdiction u/s 263 of the Act was not justified.

 

On the second issue relating to
non-disclosure of unaccounted cash of Rs. 6,85,000, the Tribunal held that the
said amount was already disclosed in the return of income filed by the
assessee. The said sum of Rs. 6.85 lakhs is part of the gross total amount of
Rs. 7,83,17,777. At the end of the assessment, the said amount was taxed by the
A.O. under the head ‘income from other sources’. Therefore, the Tribunal stated
that the Commissioner of Income Tax was not justified in treating the said
amount as part of undisclosed income and assuming jurisdiction u/s 263 when it
was already disclosed and assessed.

 

On the third issue, as regards
applicability of section 45(2), the Tribunal noticed that the CIT had accepted
applicability of the said provision and, therefore, it was held that there is
no error in the order of the A.O.

 

The Tribunal further held that an
inquiry was made by the A.O. into the disclosures made during the course of the
assessment proceedings by the assessee. When the issue was inquired into by the
A.O., the Commissioner ought not to have invoked jurisdiction u/s 263 of the
Act.

 

Being aggrieved by the order of the
ITAT, the Revenue filed an appeal to the High Court. The Court held that on a
thorough consideration of the matter and considering the provisions of section
263 of the Act, the impugned order passed by the Tribunal does not suffer from
any error or infirmity to warrant interference. The Department’s appeal was
dismissed.

 



ANALYSIS OF RECENT COMPOUNDING ORDERS

Here
is an analysis of some interesting compounding orders passed by the Reserve
Bank of India in the month of December, 2019 and uploaded on the website1.
This article refers mainly to the regulatory provisions as existing at the time
of offence. Changes in regulatory provisions are noted in the comments section.

 

FOREIGN
DIRECT INVESTMENT (FDI)

 

A.
Utkarsh CoreInvest Ltd.

Date
of order: 18th November, 2019

Regulation:
FEMA 20/2000-RB [Foreign Exchange Management (Transfer or Issue of Security by
a Person Resident Outside India) Regulations, 2000] and FEMA 20(R)/2017 (dated
7th November, 2017)

 

ISSUE

FDI
in Indian company engaged in business of investing in other companies and
taking on record transfer of shares of an Indian company between two
non-residents.

 

FACTS

Issue
1

(i) The applicant company was engaged in the business of micro finance.

(ii) Subsequently, it was issued license to set up a small finance bank
wherein one of the conditions stipulated that the applicant company should be
registered as an NBFC-CIC after transfer of its micro-finance business to the
bank.

(iii) Accordingly, the applicant company applied to RBI for
registering itself as an NBFC-CIC in December, 2016 and incorporated a
subsidiary company to which it transferred the micro-finance business in
January, 2017.

(iv) At the time of filing its application for license to set up a
small finance bank, the applicant company had foreign shareholding of around
84.1%. In order to bring the foreign shareholding below 50%, the applicant
company raised equity capital (by way of rights issue) which was offered to
both resident and non-resident shareholders in November, 2017. The applicant company
received FDI amounting to Rs. 28,68,95,310 at the same time which was not
permissible under the extant FEMA 20(R).

(v) Subsequently, in March, 2018, FDI up to 100% under automatic route
was allowed in investing companies registered as NBFCs with RBI.

 

Issue 2

(a) In August, 2017, International Finance Corporation (IFC), a
non-resident entity, had transferred 42,69,726 shares of the applicant company
amounting to Rs. 55,50,64,380, to another non-resident entity which was
recorded in the books of the applicant company without obtaining prior approval
of the Government.

(b) The Government of India, MoF, DEA, while according its approval for
another transaction in October, 2018 which involved share transfer between two
non-resident entities had, vide its letter dated 22nd October, 2018,
advised the applicant company to approach RBI for compounding for ‘past foreign
investments made in UMFL, including share transfers among non-residents,
without GoI approval’.

 

Regulatory
provisions

  •    Regulation 16(B)(5) of FEMA 20(R) in
    November, 2017 states that ‘Foreign investment into an Indian company,
    engaged only in the activity of investing in the capital of other Indian
    company/ies, will require prior approval of the Government. A core investment
    company (CIC) will have to additionally follow the Reserve Bank’s regulatory
    framework for CICs’.
  •    The above regulation was amended in March,
    2018 which allowed foreign investment up to 100% under automatic route in
    investing companies registered as NBFCs with RBI.
  •    Regulation 4 of the erstwhile FEMA 20, which
    stated that ‘Save as otherwise provided in the Act, or rules or regulations
    made thereunder, an Indian entity shall not issue any security to a person
    resident outside India or shall not record in its books any transfer of
    security from or to such person.’

 

CONTRAVENTION

Nature
of default

Amount
involved
(in INR)

Time
period of default

Receiving
FDI in Indian company which is engaged in investing in capital of other
companies

Rs.
28,68,95,310

Seven
months approx.

Taking
on record share transfer between two non-residents when foreign investment
itself was not permitted

Rs.
55,50,64,380

Total

Rs.
84,19,59,690

 

 

 

Compounding
penalty

A compounding penalty of Rs.
43,09,797 was levied.

 

Comments

It is interesting to note that
generally transfer of shares between two non-residents is not subject to any
reporting requirement by the Indian company. Form FC-TRS regarding reporting
transfer of shares of an Indian company is required to be filed only when
either the transferor or the transferee is an Indian resident. Thus, any
transfer of shares between resident to non-resident or vice versa is required
to be reported in Form FC-TRS but not any transfer of shares between two
non-residents.

 

However, where FDI itself is not
permitted under the 100% automatic route and is subject to prior approval of
the Government, any transfer of shares between two non-residents would also be
subject to prior approval. Hence, Indian companies engaged in sectors where
prior approval of Government is required should be cautious and ensure that any
transfer of shares between two non-residents is undertaken only after obtaining
prior approval of Government.

 

B. M/s Star
Health and Allied Insurance Co. Ltd.

Date of order:
29th November, 2019

Regulation: FEMA
20(R)/2017 [Foreign Exchange Management (Transfer or Issue of Security by a
Person Resident Outside India) Regulations, 2017]

 

ISSUE

Delay in allotment of shares
within 60 days of receipt of share capital.

 

FACTS

(i) Applicant company is engaged in the business of non-life insurance.

(ii) It received FDI from two Mauritian companies amounting to Rs.
30,50,00,079 in December, 2018.

(iii) Shares were allotted by the applicant company to the above
shareholders after a delay of three months and ten days (approximately) beyond
the stipulated time of 60 days from the date of receipt of the consideration.

 

Regulatory
provision

Paragraph 2(2) of Schedule I to
Notification No. FEMA 20(R)/2017-RB, states that capital instruments shall be
issued to the person resident outside India making such investment within 60
days from the date of receipt of the consideration.

 

Contravention

The amount of contravention is Rs
30,50,00,079 and the period of contravention three months and ten days.

 

Compounding
penalty

A compounding penalty of Rs.
15,75,000 was levied.

 

Comments

The above order highlights the
fact that RBI is taking a serious view of contraventions relating to delay in
allotment of shares to foreign investors. Hence, it is absolutely critical that
in respect of foreign investment, shares should be allotted within the
prescribed period of 60 days as per erstwhile FEMA-20(R) and even under the new
Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019
effective from 17th October, 2019.

 

EXPORT
OF GOODS AND SERVICES

 

C. H.F. Metal
Art Private Limited and Azoy Bansal

Date of order: 5th
November, 2019

Regulation: FEMA
23/2000-RB [Foreign Exchange Management (Export of Goods and Services)
Regulations, 2000] and FEMA 23R/2015-RB [Foreign Exchange Management (Export of
Goods and Services) Regulations, 2015]

 

ISSUE

(i) Failure to export goods within the prescribed
period of one year from the date of receipt of advance.

(ii) Failure to realise export proceeds within the
stipulated time period.

(iii) Contravention deemed to have been
committed by director who was in charge of the company at the time of
contravention.

 

FACTS

  •   The applicant company is engaged in the
    business of minting and supply of precious metal coins and bars, as well as
    high quality medals, gifts and promotional items in non-precious metals.
  •   The company received certain export advances
    between January, 2008 and July, 2011 amounting to Rs. 6,30,79,984 but was
    unable to make exports within the prescribed time limit. However, the company
    has adjusted the export advances against subsequent exports made during the
    period from August, 2013 to June, 2014.
  •   The company could not realise export proceeds
    against certain exports amounting to Rs 10,58,50,346 within the prescribed time
    period 2014-2018.

 

Regulatory provisions

  •   Regulation 16 of Notification No. FEMA
    23/2000- RB, where an exporter receives advance payment (with or without
    interest) from a buyer outside India, the exporter shall be under an obligation
    to ensure that the shipment of goods is made within one year from the date of
    receipt of advance payment.
  •   Regulation 9 of Notification No. FEMA 23/2000-
    RB and FEMA 23(R), the amount representing the full export value of goods or
    software exported shall be realised and repatriated to India within nine months
    from the date of export.
  •   Section 42(1) of FEMA states that, ‘Where a
    person committing a contravention of any of the provisions of this Act or of
    any rule, direction or order made thereunder is a company, every person who, at
    the time the contravention was committed, was in charge of, and was responsible
    to, the company for the conduct of the business of the company as well as the
    company, shall be deemed to be guilty of the contravention and shall be liable
    to be proceeded against and punished accordingly’.

 

CONTRAVENTION

Relevant
Provision

Nature
of default

Amount
involved
(in INR)

Time
period of default

Regulation
16 of FEMA 23/2000-RB

Failure
to export the goods within a period of one year from the date of receipt of
advance

Rs.
6,30,79,984

11
months to 4.6 years

Regulation
9 of FEMA 23/2000-RB & FEMA 23(R)

Failure
to realise export proceeds within stipulated time period

Rs.
10,58,50,346

One
day to seven months

Section
42(1) of FEMA

Being
director of company which committed above contravention of FEMA

Rs.
16,89,30,330

11
months to 4.6 years and one day to seven months

 

Compounding
penalty

Compounding penalty of Rs.
10,32,998 was levied on the company and Rs. 1,03,300 on the director
personally.

 

Comments

In the instant case, the company
had committed contravention by not exporting goods against advance received
within the prescribed time frame and also by not receiving payment for exports
within the prescribed time. However, the director who was in charge of the
company was also deemed to be guilty u/s 42(1) of FEMA and hence compounding
penalties were levied both on the company as well as the director in respect of
the contraventions. Accordingly, going forward, especially in cases of export
of goods, it is advisable that directors of companies are extremely vigilant
and ensure that their company adheres to the prescribed time lines failing
which both the company as well as the directors would be personally liable for
any contravention.

 

BORROWING
OR LENDING IN FOREIGN EXCHANGE

 

D. M/s Tulsea
Pictures Private Limited

Date of order:
28th November, 2019

Regulation: FEMA
4/2000-RB [Foreign Exchange Management (Borrowing or Lending in Foreign
Exchange) Regulations, 2000]

 

ISSUE

(i) Borrowings from NRI without issuance of NCDs through public offer.

(ii) Utilising borrowed funds for other than business purposes.

 

FACTS

  •   The applicant company appointed an NRI as one
    of the directors on its board.
  •   The company raised a loan of Rs. 32,96,432
    from the NRI director to meet its day-to-day expenses and other liabilities.
  •   The loan in INR had been availed from the NRI
    without issuing non-convertible debentures (NCD) through public offer.
  •   Out of the aforesaid amount, the applicant
    company had utilised Rs. 5,98,670 for paying the lease rentals for a
    residential premise taken for the NRI director and for meeting day-to-day
    expenses.
  •   The company was granted permission to convert
    the loan amount into equity, subject to lender’s consent and adherence to FDI /
    pricing norms for such conversion and reporting requirements.
  •   The company allotted 55,056 equity shares to
    the director on 5th July, 2018 against the outstanding loan amount
    of Rs. 26,97,762.

 

Regulatory
provisions

  •     Regulation 5(1)(i) of Notification No. FEMA
    4/2000-RB inter alia states as under:

‘Subject to the
provisions of sub-regulations (2) and (3), a company incorporated in India may
borrow in rupees on repatriation or non- repatriation basis, from a
non-resident Indian or a person of Indian origin resident outside India or an
overseas corporate body (OCB), by way of investment in non-convertible
debentures (NCDs) subject to the following conditions:

i.    the issue of Non-convertible Debentures
(NCDs) is made by public offer;…’

  •     Regulation 6 of
    Notification No. FEMA 4/2000-RB states that no person resident in India who
    has borrowed in rupees from a person resident outside India shall use such
    borrowed funds for any purpose except in his own business.

 

CONTRAVENTION

Relevant
Para of FEMA 4 Regulation

Nature
of default

Amount
involved

(in
INR)

Time
period of default

Regulation
5(1)(i) of Notification No. FEMA 4/2000-RB

Issue
1:
Borrowings from NRI without issuance of NCDs through public offer

Issue
1:

Rs.
32,96,432

 

Approximately
7 years

Regulation
6 of Notification No. FEMA 4/2000-RB

Issue
2:
Utilising borrowed funds for purpose other than business

Issue
2:

Rs.
5,98,670

Approximately
7 years

 

 

Compounding
penalty

A compounding penalty of Rs.
1,29,213 was levied.

 

Comments

It is important to note that
borrowings in INR by an Indian company from its NRI director, even though
permissible under the Companies Act, 2013, is not permissible under FEMA
regulations. Under FEMA, INR borrowings from NRIs are permitted only through
issuance of NCDs made by public offer under both repatriation as well as
non-repatriation route.

 

OVERSEAS
DIRECT INVESTMENT (ODI)

 

E. Ms Pratibha
Agrawal

Date of order:
11th November, 2019

Regulation: FEMA
120/2004 [Foreign Exchange Management (Transfer or Issue of any Foreign
Security) Regulations, 2004]

 

ISSUE

Acquisition of foreign securities
by way of gift from a person resident in India.

 

FACTS

  •    The applicant was a resident individual and
    the spouse of a senior management employee of Sterlite Industries India Limited
    from 2001 to 2008.
  •    The senior employee was offered 8,000 shares
    of Vedanta Resources Plc, London, in March, 2004 to be issued in two tranches.
    The first tranche of 4,000 shares was allotted in March, 2004 and second in
    February, 2005.
  •    The consideration paid for the shares allotted
    in the second tranche was equivalent to face value, i.e., USD 400 (INR 17,532).
  •    Out of the 4,000 shares of the second
    tranche, the senior employee gifted 3,000 to the applicant (Ms. Pratibha
    Agrawal) and, accordingly, share certificates for these 3,000 shares were
    issued in the name of the applicant.

 

Regulatory
provisions

As per Regulation 22(1)(i), read
with Regulation 3, a person resident in India being an individual may acquire
foreign securities by way of gift only from a person resident outside India and
not from another Indian resident.

 

CONTRAVENTION

 

Relevant
Para of FEMA 120 Regulation

Nature
of default

Amount
involved
(in INR)

Time
period of default

Regulation
22(1)(i)

Acquisition
of foreign securities by way of gift from a person resident in India

Rs.
22,49,232

Approximately
13 years

 

 

Compounding
penalty

Compounding penalty of Rs. 66,869
was levied.

Comments

In view of the peculiar language
of FEMA 120, it is advisable that appropriate care is taken in respect of gifts
of shares of foreign companies between residents and non-residents. Under the
existing provisions, an Indian resident can acquire shares by way of gift from
only a non-resident and not from a resident.

 

F. Masibus
Automation and Instrumentation Pvt. Ltd.

Date of order:
26th November, 2019

Regulation: FEMA
120/2004 [Foreign Exchange Management (Transfer or Issue of any Foreign
Security) Regulations, 2004]

 

ISSUES

(i) Sending remittances to overseas company without submitting Annual
Performance Report (APR);

(ii) Delay in submission of duly completed Part I of the Form ODI;

(iii) Overseas investment undertaken by a method of funding not
prescribed;

(iv) Delayed receipt of proof of investment;

(v) Delayed submission of APRs;

(vi) Disinvestment from the overseas entity without obtaining fair
valuation certificate prior to its divestment;

(vii) Disinvestment undertaken from the overseas entity when it had
outstanding loans;

(viii) Disinvestment without
prior approval of RBI when it was not eligible under the automatic route.

 

FACTS

  •    The applicant is engaged in the business of
    manufacturing of electrical equipment, wiring devices, fittings, etc.
  •    The applicant remitted SGD 990 on 4th
    July, 2008 towards 99% stake in the overseas JV, viz., Masibus Automation and
    Instrumentation (Singapore) Pte. Ltd. in Singapore.
  •    Subsequently, the applicant undertook ODI of
    SGD 5,000 on 4th July, 2008 by way of payment by the director of the
    applicant company in cash during his visit abroad.
  •    The applicant had sent seven remittances
    aggregating SGD 52,000 in 2010-11 without submitting APR.
  •    Further, the applicant submitted Part I of
    Form ODI with delay on 11th January, 2018 in respect of remittance
    of SGD 5,000 made through the director on 4th July, 2008.

 

  •    Share certificate for the aforesaid
    remittance of SGD 990 made in July, 2008 was received with delay (i.e. beyond
    the prescribed period of six months under FEMA 120) on 8th
    September, 2014.
  •    The applicant submitted APRs for the years
    ending 2009 to 2012 with delay on 12th January, 2018.
  •    Disinvestment from the overseas entity was
    undertaken on 11th April, 2012 without obtaining fair valuation
    certificate and when it had outstanding loans.
  •    Accordingly, as the applicant had outstanding
    loans, it was not eligible to undertake the disinvestment under the automatic
    route and should have sought prior approval of RBI before disinvestment.

 

Regulatory
provisions

  •    Regulations 6(2)(iv), 6(2)(vi), 6(3), 15(i),
    15(iii), 16(1)(iii), 16(1)(iv), 16(3) of FEMA 120.

 

CONTRAVENTION

 

Relevant
Para of FEMA 120 Regulation

Nature
of default

Amount
involved (in INR)

Time
period of default

Regulation
6(2)(iv)

Making
overseas remittances towards share capital without submitting APR of the
overseas entity

Rs. 18,46,500

Five
years

Regulation
6(2)(vi)

Overseas
investment made through director in cash was treated as investment of Indian
company, hence Indian company ought to have filed Part I of Form ODI for
making remittance. There was delay in submission of Part I of the Form ODI in
respect of the
above investment

Rs.
1,60,600

4th
July, 2008 to
11th January, 2018

Regulation
6(3)

Overseas
investment undertaken through cash payment made by director is not a
prescribed method of funding

Rs.
1,60,600

4th
July, 2008 to
13th May, 2019

Regulation
15(i)

Proof of
investment made in overseas entity should be received and filed with RBI
within six months of making remittance. There was delay in providing share
certificate to RBI in respect of overseas remittances made

Rs.
31,799

4th
July, 2008
to 8th September, 2014

Regulation15(iii)

APR of
the overseas entity based on its audited accounts has to be filed annually on
or before 31st December. Applicant delayed submission of APR in
respect of its
overseas entity

Not
applicable

1st
July, 2013 to
21st September, 2018

Regulation
16(1)(iii)

Any
divestment of overseas entity has to be undertaken at a price which is not
less than its fair value as certified by CA / CPA based on last audited
financials of overseas entity. In the instant case, applicant divested its
overseas entity without obtaining its fair valuation certificate from CA /
CPA

Rs.
31,799

11th
April, 2012 to
13th May, 2019

Regulation
16(1)(iv)

An
Indian party can undertake divestment of its overseas entity only when the
overseas entity does not have any amount payable to Indian entity. In the
instant case, the applicant had undertaken disinvestment of the overseas
entity when it still had outstanding loans payable to it

Rs.
23,56,703

11th
April, 2012 to
13th May, 2019

Regulation
16(3)

Indian
entity wanting to divest its overseas entity which has any amount payable to
it would need prior approval of RBI before undertaking divestment. In the
instant case, the applicant undertook disinvestment without prior approval of
RBI when not eligible under automatic route

Rs.
23,91,521

11th
April, 2012 to
13th May, 2019

 

Compounding
penalty

Compounding penalty of Rs.
3,61,126 was levied.

 

Comments

In view of numerous compliances
prescribed under FEMA 120 in respect of overseas investments, it is essential
that adequate care is taken by every Indian entity in respect of its overseas
investment. Specific care should be taken to ensure that overseas investment by
any Indian entity is routed only through Indian banking channels and not made
in cash by any person visiting overseas.

 

Further, Regulation 16(1)(iv) of
FEMA 120 states that at the time of divestment, the Indian party should not
have any outstanding dues by way of dividend, technical know-how fees, royalty,
consultancy, commission or other entitlements and / or export proceeds from the
overseas JV or WOS. This includes any amount due, including loan payable by the
overseas entity to an Indian entity. Hence, appropriate care should be taken to
ensure that the overseas entity does not have any amount payable to an Indian
entity at the time of its disinvestment.

 

G. Essar Steel
India Ltd.

Date of order:
22nd November, 2019

Regulation: FEMA
120/2004 [Foreign Exchange Management (Transfer or Issue of any Foreign Security)
Regulations, 2004]

ISSUES

(i) Effecting remittance without prior approval of RBI when the Indian
party (IP) was under investigation by the Department of Revenue Intelligence
(DRI);

(ii) Delayed submission of APRs;

(iii) Disinvestment without obtaining valuation.

 

FACTS

  •    The applicant company set up a wholly-owned
    subsidiary (WOS), Essar Steel Overseas Ltd., in Mauritius by remitting USD 1
    (INR 47) on 7th August, 2010.
  •    Since the applicant company was under
    investigation by the DRI at the time of effecting the remittance, it was not
    eligible to make ODI under the automatic route.
  •    The WOS was later liquidated on 9th
    March, 2012 and no valuation was done as required. The transactions were taken
    on record on 14th August, 2019.
  •     Further, the applicant had reported Annual
    Performance Reports (APRs) for the accounting years 2011 and 2012 with a delay
    on 15th June, 2013 and 17th December, 2013.

 

Regulatory
provisions

  •     Regulation 6(2)(iii) of FEMA 120 provides
    that Overseas Direct Investment under automatic route is permitted in certain
    cases provided ‘the Indian party is not on the Reserve Bank’s exporters
    caution list / list of defaulters to the banking system circulated by the
    Reserve Bank, or under investigation by any investigation / enforcement agency
    or regulatory body.’
  •     Regulation 15(iii) of FEMA 120 states that, ‘An
    Indian Party which has acquired foreign security in terms of the Regulation in
    Part I shall submit to the Reserve Bank, through the designated Authorised
    Dealer, every year on or before a specified date, an Annual Performance Report
    (APR) in Part III of Form ODI in respect of     each JV or WOS outside India…’. The specified date for filing APR currently
    is on or before 31st December every year.
  •     Regulation 16(1) provides that an Indian
    party may disinvest to a person resident outside India subject to the following
    conditions:

 

•     (iii)
if the shares are not listed on the stock exchange and the shares are
disinvested by a private arrangement, the share price is not less than the
value certified by a Chartered Accountant / Certified Public Accountant as the
fair value of the shares based on the latest audited financial statements of
the JV / WOS.

 

CONTRAVENTION

Relevant
Para of FEMA 120 Regulation

Nature
of default

Amount
involved (in INR)

Time
period of default

Regulation

6(2)(iii)

Effecting
remittance and incorporating overseas entity under the automatic route
without obtaining prior approval of RBI when the Indian Party (IP) was under
investigation by DRI

Rs.
47

Seven
years five months, to nine years and one month, approximately

Regulation
15(iii)

Delayed
submission of APRs

Regulation
16(1)

Disinvestment
of the overseas entity without obtaining fair valuation certificate from CA /
CPA at the time of disinvestment

 

 

Compounding
penalty

A compounding penalty of Rs. 83
was levied.

 

Comments

In the instant case, as the
applicant was under investigation by DRI and the Enforcement Directorate (DoE)
in Mumbai and Ahmedabad, the RBI had sought a No-Objection Certificate from the
DoE before proceeding with the compounding application. However, as no reply
was received from the DoE, RBI proceeded for the compounding without prejudice
to any other action which may be taken by the authority under any other laws.
Thus, RBI compounded the above contravention even though it did not receive any
NOC from the DoE.

 

Besides, Indian entities wishing
to make overseas investments should understand that if there is any
investigation pending against them by any regulatory body or investigation
agency, they cannot make an overseas investment under the automatic route and
need to obtain prior approval of RBI before making such investment.  

 

 

 

THE MCA CONSULTATION PAPER

The MCA paper examining the existing provisions and
seeking to make suitable amendments to enhance Audit Independence and
Accountability has been under discussion. Nineteen pages have laid out a
certain thought pattern and invited comments on questions arising out of that
thought pattern.

Over
the years, regulators, government, the corporate sector and auditors have not
been able to solve fundamental core issues about audit and auditors. Some beat
around the bush, others are infected by vested interests, some import and
impose a model from elsewhere, and so on.

Two
functions describe an auditor – a watchdog (or a sniffer dog if you wish) and a
judge – when he carries out the function of oversight and gives a considered
opinion after taking into account a number of factors respectively.

Looking
at complete independence, it’s not achievable because the client decides the
fees of the auditor for reporting on the client’s financial information.
Independence can only be brought to a level where the auditor’s objectivity is
not affected. Secondly, independence is a personal trait and two auditors under
the same circumstances may act differently.

The
paper bundles the two mammoth topics of Independence and Accountability into 19
pages (four are a reproduction from standards without giving any credit) and
believes that these are the only questions there ought to be. For example, an
auditor of a private non-public interest entity cannot be evaluated by the same
yardsticks as auditors of a public interest entity like IL&FS unless one is
absurdly socialist.

The
paper carries a whiff of ‘we have made up our mind’ when it asks questions
based on its thought pattern, which itself needs questioning. It is piecemeal,
not thought-through, has a flavour of control and seems to aim for a quick fix
without getting to the bottom of the whole problem. While urgency is critical,
not dealing with the root cause will only delay the cure. Such papers call for
‘comments’ but never publish what is received, what is accepted, what is
rejected and why. Therefore, they seem more like a ‘procedural formality’ or
‘consultation in appearance’ rather than an exploration of fundamental
problems. For such an important topic as Independence and Accountability,
the MCA should have a country-wide deliberation directly with 30 to 50 firms,
auditees and regulators rather than sending a questionnaire and seeking answers
to questions that it has framed in its (limited) wisdom.

In spite of the Prime Minister talking of creating the
next big 4 firms out of India, there is literally nothing that is being done
either at the strategic or the tactical level by the MCA. The paper has little
vision to offer on this front when auditors actually vet a large part of India’s
economic interests. The question asked is whether or not auditor groups need to
be essentially and substantially Indian? In fact, the MCA paper mocks this idea
by asking whether there are firms outside of the big four who can even carry
out large audits. If MCA had bothered to add up the loss of value and tagged
each debacle to the auditors at that time, they wouldn’t have asked this
question.

The
paper should have mentioned the need to create an ‘ecosystem’ that will
cultivate and protect objectivity. What should auditors do when they report
what should be reported or when they resign and then the auditee files a legal
case for losing market cap? The MCA has no answers, and no questions either,
about this.

Here is one fundamental issue that the paper avoids:
non-audit fees charged by group / network entities of the audit firms to the
clients in spite of a 30-page-long explicit mention in the NFRA Report 1 / 2019
dated 12th December, 2019. What about non-audit fees taken by audit networks
from group entities of an audit client? Perhaps we have come to a situation
where an auditor will need to give his own related party disclosure to the MCA,
to the Board and even to shareholders!

One can answer the questions in the MCA consultation
paper. But one wonders whether they are complete, whether they target the core
issues and whether an objective exploratory discussion is possible in the
spirit of partnership for nation-building!

 

Raman
Jokhakar

Editor

 

GST IMPLICATIONS ON BUSINESS RESTRUCTURING

INTRODUCTION

In changing
business dynamics, business restructuring has become a norm whereby businesses
undertake activities of merger – wherein two or more entities come together to
form a new entity, resulting in the old entities ceasing to exist; or
amalgamation – wherein one or more entities are subsumed into an existing
entity such that the subsumed entities cease to exist. The next mode of
business restructuring is de-merger, where only specific business divisions are
transferred to a new entity, or are sold to an existing entity. When the above
activities are undertaken as a corporate, the same are governed by the
provisions under the Companies Act, 1956 (now 2013). In the non-corporate
sector, the restructuring transactions are generally undertaken by way of business
transfer arrangements, lease, leave and license and so on, which may not be
governed under any other statute.

 

Generally, a
business transaction is structured in such a manner that there is transfer of
assets and liabilities as per the terms of the transfer of the business or part
thereof which is being transferred to the transferee. However, this transaction
has its own set of challenges under GST, ranging from whether the transaction
would be liable to GST u/s 9, liability of transferor and transferee in case of
such transfers, input tax credit implications, registration implications, etc.

 

In this article, we
will try to decode the above aspects and the issues which revolve around
business restructuring.

 

TAXABILITY
OF CONSIDERATION RECEIVED FOR BUSINESS RESTRUCTURING TRANSACTIONS

An important aspect
which needs to be looked into while dealing with business restructuring
transactions under GST is whether or not the consideration received for the
said transaction attracts levy of GST u/s 9. This is very important since the
consideration involved is substantial and the applicability of GST on such
transactions may be a game-breaker. To analyse the same, one needs to analyse
from two different perspectives, one being whether transfer of business can be treated
as supply of goods, or supply of services or not, and the second being whether
or not the same can be treated as being in the course or furtherance of
business?

 

Let us first
discuss whether the activity of sale of business, as part of business restructuring,
can be treated as sale of goods, or sale of services, or none of the two. For
this let us refer to the definition of goods as defined u/s 2(52) of the CGST
Act which is reproduced below for ready reference:

 

‘goods’ means
every kind of movable property other than money and securities but includes
actionable claim, growing crops, grass and things attached to or forming part
of the land which are agreed to be severed before supply or under a contract of
supply;

 

On going through
the above definition of goods, it is evident that for any item to be classified
as goods it has to be movable property. Therefore, the question that needs to
be analysed is whether or not a business unit is a movable property. While the
term ‘movable property’ has not been defined under the GST law, one can refer
to the decisions under the pre-GST regime which specifically dealt with this
issue. In this context, reference may be made to the decision in the case of Shri
Ram Sahai vs. CST [1963 (14) STC 275 (Allahabad HC)] wherein the
Hon’ble High Court held that ‘business’ is not a movable property and therefore
it is not covered within the meaning of ‘goods’.

 

Similarly, in a
recent decision the Hon’ble Andhra High Court in the case of Paradise
Food Court vs. State of Telangana [Writ Petition No. 2167 of 2017] had
held as under:

‘16. Two
important things are to be noted from the definition part of the Statute. (i)
The first is that the sale of a business as such is not covered either by the
charging Section, viz., Section 4(1) or by the definition of the expression
goods. While the sale of a business may
necessarily include a sale of the assets (as well as liabilities) of the
business, the expression business is not included in the definition of the
expression goods under Section 2(16).’

 

While the above
decisions were in the context of the sales tax / VAT regime, it is important to
note that the definition of goods was similarly worded and, therefore, the
principles laid down by the above judgments should continue to apply even under
GST. For these reasons, it can be concluded that the activity of business
restructuring, by way of amalgamation, merger, de-merger or transfer of
business unit, cannot be treated as supply of goods for the purpose of GST.

 

We shall now
proceed to analyse whether sale of business, as a part of business
restructuring, can be treated as supply of services. For this, let us refer to
the definition of service as provided u/s 2(102) of the CGST Act, 2017 which is
reproduced below for ready reference:

‘services’ means
anything other than goods, money and
securities but includes activities relating to the use of money or its
conversion by cash or by any other mode, from one form, currency or
denomination, to another form, currency or denomination for which a separate
consideration is charged;

 

On going through the above, it is evident that service has been very
loosely defined under GST. A literal reading of the definition indicates that
anything which is not classifiable as goods would be service. However, the
question that needs to be analysed is whether such literal interpretation of
the definition of supply can be done or not, or whether one needs to refer to
purposive interpretation. It would be relevant to refer to two decisions of the
Supreme Court to understand when purposive interpretation can be resorted to:

 

(i)    Periyar & Pareekanni Rubbers
Limited vs. State of Kerala [2008 (13) VST 538 (SC)]

28. Tax
liability of the business concern is not in dispute. Correctness of the orders
of assessment is also not under challenge. The Tribunal or for that matter the
High Court were, therefore, not concerned with the liability fastened upon the
dealer. The only question was as to what extent the appellant was liable
therefor. It is impossible for the legislature to envisage all situations. Recourse to statutory interpretations therefore
should be done in such a manner so as to give effect to the object and purport
thereof. The doctrine of purposive construction should, for the said purpose,
be taken recourse to.

 

(ii)   Tata Consultancy Services Limited vs.
State of Andhra Pradesh [2004 (178) ELT (022) SC]

68. It is now
well settled that when an expression is capable of more than one meaning, the
Court would attempt to resolve that ambiguity in a manner consistent with the
purpose of the provisions and with regard to consequences of the alternative
constructions.

See Clark
&Tokeley Ltd. (t/a Spellbrook) vs. Oakes [1998 (4) All ER 353].

69. In Inland
Revenue Commissioners vs. Trustees of Sir John Aird’s Settlement [1984] Ch. 382,
it is stated:

Two methods of
statutory interpretation have at times been adopted by the court. One,
sometimes called literalist, is to make a meticulous examination of the precise
words used. The other, sometimes called purposive, is to consider the object of
the relevant provision in the light of the other provisions of the Act – the
general intendment of the provisions. They are not mutually exclusive and both
have their part to play even in the interpretation of a taxing statute.

70. Although
normally a taxing statute is to be strictly construed, but when the statutory
provision is reasonable akin to only one meaning, the principles of strict
construction may not be adhered to.

[See Commnr.
of Central Excise, Pondicherry vs. M/s Acer India Ltd., 2004 (8) SCALE 169].

 

As can be seen from
the above, the need to resort to purposive interpretation arises only when the
literal interpretation results in ambiguity. It would therefore need to be
analysed as to whether according a transaction of business restructuring by way
of amalgamation, merger, de-merger or transfer of business assets as supply of
service would lead to absurdity? In general, depending on the terms of each
agreement, a transaction for business restructuring by any of the means referred
above would generally include transfer of assets, liabilities, employees, etc.
It would be difficult to perceive as to how a transaction, which involves
transfer of assets, liabilities, human resources, etc., would constitute
service, especially when there are identified elements of goods, transactions
in money, etc., involved. In other words, merely because all the above items
are sold as a bundle making the transaction take the character of a business
unit and going by the literal interpretation, since the transfer of business
unit is not classifiable as goods, it should be classified as service. This is
where the ambiguity / absurdity comes into the picture. Schedule II only deems
transactions of temporary transfer of right to use goods as service. This is
because in case of temporary transfer, the goods revert back to the owners. But
it is not the case here as the items being transferred would not revert back to
the owners. It is for this reason that such business restructuring activity
cannot be classified as service as well.

 

It may also be
relevant to note that notification 12/2017 – CT (Rate) exempts services by way
of transfer of a going concern, as a whole or an independent part thereof, from
levy of GST. However, merely because there is an entry in exemption
notification would not mean that the transaction was upfront liable to levy of
tax. However, if the entry is treated as valid, it would mean that the
transferor has made an exempt supply and, therefore, trigger the applicability
of the provisions of section 17(2) r/w/rule 42 / 43 of the CGST Rules.

 

Liability of
transferor vis-à-vis transferee – in case of
transfer of business by sale, gift, lease, leave and license, hire or in any
other manner whatsoever

 

In case of business
restructuring transactions, there is also a change of ownership. Section 85(1)
deals with liability to pay tax in such cases where the business restructuring
results in transfer of business by sale, gift, lease, leave and license, hire
or in any other manner whatsoever. The section provides that in case of
transfer of business, there shall be joint and several liability of the
transferor as well as the transferee to pay tax up to the time of such
transfer, whether determined prior to or subsequent to the said transfer.

 

Therefore, what needs to be analysed first is what is meant by the term
‘transfer of business’. This has been analysed by the Supreme Court in the case
of State of Karnataka vs. Shreyas Papers Private Limited [Civil Appeal
3170-3173 of 2000] while dealing with the scope of section 15(1) of the
Karnataka Sales Tax Act, 1957. In this case, the Court held that business is an
activity directed with a certain purpose, more often towards promoting income
or profit. Mere transfer of one or more species of assets does not bring about
the transfer of ownership of the business, which requires that the business be
sold as a going concern. The above view has been followed in multiple instances
wherein the Court has held that transfer of specific business assets cannot be
treated as transfer of business in itself. One may refer to the decisions in
the cases of Rana Girders Limited vs. UOI [2013 (295) ELT 12 (SC)],
Lamifab Industries vs. UOI [2015 (326) ELT 674 (Guj.)], Chandra Dyeing &
Printing Mills Private Limited vs. UOI [2018 (361) ELT 254 (Guj.)], Krishna
Lifestyle Technologies Limited vs. Union of India [2009 (16) STR 669 (Bom.)].

 

When comparing with
the provision under the Central Excise Act, 1944 (section 11), one important
distinction which comes to mind is that the proviso of section 11
required that the transferee should have succeeded in the business of the
transferor. This aspect was dealt with by the High Court in the case of Krishna
Lifestyle Technologies (Supra) where the Court held as follows:

 

‘16. Succession
therefore has a recognised connotation. The tests of change of ownership,
integrity, identity and continuity of a business have to be satisfied before it
can be said that a person succeeded to the business. The business carried on by
the transferee must be the same business and further it must be continuation of
the original business either wholly or in part. It would thus be clear from the
above that these tests will have to be met before it can be said that a person
has succeeded to a business. This would require the facts to be investigated as
to whether there has been transfer of the whole of the business or part of the
business and succession to the original business by the transferee.’

 

While the
provisions under GST do not require succession in interest by the transferee,
it remains to be seen whether the condition shall still be continued to be
applicable under GST, considering the decision in the case of Shreyas
Papers (Supra) wherein the Supreme Court has brought in the concept of
transfer of business as a going concern though no specific provisions were
contained in the Karnataka Sales Tax Act.

 

It would also be
relevant to note that there are instances where the business is transferred by
State Financial Corporations after taking over control of defaulting borrowers.
The statute under which the State Financial Corporations were incorporated
provided that in case of sale of such assets, though the sale would have been
executed by the State Financial Corporation, it would have been deemed that the
sale was being done by the defaulting borrowers and, therefore, the liability
to pay tax up to the date of transfer shall be on the transferee (refer Macson
Marbles Private Limited vs. UOI [2003 (158) ELT 424 (SC)].

 

Treatment of
Input Tax Credit in case of transfer of business, amalgamation, merger,
de-merger, etc.

Another GST aspect which revolves around the above set of transactions,
apart from the attached transfer of liability to the transferee, is the
permission to transfer the balance lying in the electronic credit ledger of the
transferor. Section 18(3) provides that in case of change in constitution of a
registered person on account of sale, merger, de-merger, amalgamation, lease or
transfer of business with specific provision for transfer of liabilities, the
taxable person shall be allowed to transfer the input tax credit which remains
unutilised in his credit ledger in such manner as may be prescribed. The manner
has been prescribed u/r 41 of the CGST Rules. While the provisions are silent
w.r.t. the manner of determining the credit appropriable to the transferee, it
provides that in the case of de-merger the input tax credit shall be
appropriated in the ratio of value of assets of new units as specified in the
de-merger scheme. However, in all other cases there is no method prescribed for
appropriating input tax credit. The only requirements prescribed for the
transfer of balance lying in electronic credit ledger are:

 

(1)   A copy of the chartered accountant’s
certificate certifying that the sale, merger, de-merger, amalgamation, lease or
transfer of business has been done with a specific provision for transfer of
liabilities;

(2)   Furnishing of Form GST ITC-02 by the
transferor which shall be accepted by the transferee on the common portal; and

(3)   Accounting for the inputs and capital goods so
transferred by the transferee in his books of accounts.

 

REGISTRATION
IMPLICATIONS IN CASE OF BUSINESS RESTRUCTURING

In case of
transactions of amalgamation or merger, one needs to take note of the fact that
there are two different dates, namely, the effective date from which the scheme
would be given effect (which has to be indicated while filing the application
for the amalgamation or merger) and, second, the date of order, when the scheme
is approved by the Court or Tribunal. Generally, the effective date precedes
the order date and under the Income-tax Act, while till the time the order is
received both companies continue to have separate existence, the receipt of the
order requires them to re-file their tax returns as the company which has
merged or amalgamated into the other company has ceased to exist.

 

However, it is not
so under the GST regime. Section 87(2) specifically provides that the companies
party to a scheme shall continue to be treated as distinct companies till the
date of receipt of the order, and the registration certificate of the
amalgamated or merged company shall be cancelled only with effect from the date
of the order approving the scheme. This specific provision will help in dealing
with the following situations:

(A) Supply of goods or services, or both, between
the companies which are part of the scheme, and

(B) Supply of goods or services, or both, by the
said companies to other persons who are not part of the scheme.

 

This would imply
that till the date of the order approving the scheme is received, each of the
companies party to the scheme shall continue to comply with the various
provisions of the law, including filing of periodic tax returns, annual returns
and reconciliation statements prescribed u/s 35.

 

Similarly, section
22(4) provides that any new company which comes into existence in pursuance of
an order of a Court or Tribunal, as the case may be, shall be liable to get
registered with effect from the date on which the Registrar of Companies issues
a certificate of incorporation giving effect to such order.

 

Therefore, in case of amalgamation /
merger, one needs to take the registration aspect very seriously, to the extent
that upon receipt of approval of the scheme, the application for cancellation
of certificate of registration of the company which ceases to exist in view of
the order, and the application for fresh registration of the company which
comes into existence, is done within the prescribed time limits, and all future
supplies are made / received under the registration certificate of the
continuing company / new company and the use of the GSTIN of the company which
ceases to exist is discontinued with immediate effect.


Sections 11, 12, 139, 148 – A failure on the part of the Trust to file its return of income u/s 139(4A) cannot lead to withdrawal of exemption under sections 11 and 12 – Having filed a return of income u/s 139, subsequently, where a return is furnished in response to notice u/s 148, it replaces the return filed u/s 139, including section 139(4A), and all the other provisions of the Act including sections 11 and 12 are applicable – There was no time limit prescribed for submission of return of income and audit report in respect of a Trust whose income before claiming the exemption exceeded the basic exemption limit Clause (ba) to Section 12A, which prescribes time limit for submission of return of income and audit report to be time available u/s 139(1), is effective from A.Y. 2018-19 and is prospective in its application

23. [2019] 202 TTJ (Del.) 928 United Educational Society vs. JCIT ITA Nos.
3674 & 3675/Del/2017 and 2733 & 2734/Del/2018 A.Ys.: 2006-2007 to 2009-2010 Date of order: 28th June, 2019

 

Sections 11, 12, 139, 148 – A failure on
the part of the Trust to file its return of income u/s 139(4A) cannot lead to
withdrawal of exemption under sections 11 and 12 – Having filed a return of
income u/s 139, subsequently, where a return is furnished in response to notice
u/s 148, it replaces the return filed u/s 139, including section 139(4A), and
all the other provisions of the Act including sections 11 and 12 are applicable
– There was no time limit prescribed for submission of return of income and
audit report in respect of a Trust whose income before claiming the exemption
exceeded the basic exemption limit

 

Clause (ba) to Section 12A, which
prescribes time limit for submission of return of income and audit report to be
time available u/s 139(1), is effective from A.Y. 2018-19 and is prospective in
its application

 

FACTS

The assessee was an educational society. The
A.O. had received information about huge investments made by the society in
land and building; however, no return of income had been filed. The A.O. issued
notice u/s 148, in response to which the assessee filed return of income
showing ‘nil’ income after application of section 11. There were two sets of
financial statements prepared, one for the purpose of obtaining loan and
another filed along with the return. In view of this, the A.O. ordered a
special audit to be carried out u/s 142(2A). Based on the report of the special
auditor, the A.O. made a computation of the total income of the society by
disallowing the benefit of exemption u/s 11. The income was assessed under the
head ‘Profits & Gains of Business or Profession’ and the assessee was
assessed in the status of an AOP.

 

Aggrieved, the assessee preferred an appeal
to the CIT(A) who gave partial relief to the assessee.

 

Still aggrieved, the assessee preferred an
appeal to the Tribunal.

 

HELD

The A.O. had denied the benefit of exemption
of section 11 to the assessee on account of the fact that the assessee had not
filed its return of income pursuant to section 139(4A). The assessee was a
society which had been granted registration u/s 12A; it engaged in activities
which were within the meaning of charitable purpose, and once so registered,
the computation of income had to be made in accordance with the provisions of
sections 11 and 12.

 

The fact that the assessee had filed its
return in response to notice issued u/s 148 and not under the provisions of
section 139(4A) cannot be a reason for not granting the benefit of exemption.
Once a return of income is submitted under the provisions of section 148, it
replaces the return filed u/s 139 and all other provisions of the Act,
including sections 11 and 12, become applicable as if it was a return filed
under the provisions of section 139. For a return filed under the provisions of
section 148, the relevant provisions of section 139 have to be applied along
with the procedure for assessment and computation of income, without
restricting it to exclude any procedure. Therefore, the trust was entitled to
claim the exemption u/s 11 in computation of income.

 

Clause (b) of section 12A mandates that
provisions of sections 11 and 12 shall not apply unless the accounts are
audited and a return is filed along with the audited accounts. Thus, as and
when computation was done these conditions had to be complied with. The issue
of whether or not the return was filed in time is not relevant for clause (b)
of section 12A.

 

The Finance Act, 2017 has amended section
12A and a new clause has been inserted specifying the time limit in case of such
trusts to furnish their return of income and audit report within the time
specified in section 139(4A). These provisions are prospectively applicable
from A.Y. 2018-19 onwards and cannot be treated as clarificatory amendments.

 

Note: Clause (ba) to section 12A as inserted
by the Finance Act, 2017 prescribes that the return of income and tax audit
report has to be submitted by a trust within the time provided by section
139(1). Consequently, the ratio of this decision will not apply post
insertion of clause (ba), i.e. for assessment years 2017-18 and thereafter.

 

The grounds of appeal filed by the assessee
were allowed.

 

JOSH OF CAN ACHIEVE : A KALEIDOSCOPIC VIEW

Stories inspire generations, have built civilizations and adorn cultures. Stories of valour, imagination, determination, and all that the human spirit is about! As we celebrate 50 years, BCAJ thought of bringing to you such stories – stories of people from diverse backgrounds and circumstances woven together into a colourful Kaleidoscope.

The stories below are of Chartered Accountants. Some did CA and went off running in another direction, chasing their chosen dream. Some belonged to a strong family tradition and yet went ahead to do CA. Some, in spite of ‘the impossible’ staring at them, went for their dream called CA. Some climbed mountains of difficulties every day and jumped off into an orbit of a new life they aspired to lead.

A true celebration is about the Human Spirit. No wall, no resistance, not even time can stop what is bound to happen. We had to write about them in this last issue of the 50th Volume. In these stories we celebrate colours and hues, dimensions and diversity, turbulence and triumph, barriers and dreams. And that is akin to the BCAJ journey. It is said: Man never made any material as resilient as the human spirit (Bernard Williams).

Each story is a unique jewel tied to a common thread of being a proud CA. CA stands for Chartered Accountant, but these stories give it a new meaning of Can Achieve! We hope you enjoy the stories of a vegetable vendor’s son, a third-generation violinist, a rickshaw driver’s daughter topping the exam, a bomb blast victim, five generations of CAs, an illiterate farmer’s son staying in slums to chase his dream and more! That is the JOSH! Hope you enjoy these GOLDEN NUGGETS as we close the Golden Year!

DIFFICULTIES ARE MEANT TO ROUSE, NOT DISCOURAGE

She changed his life for ever

In the late 1990s, there was a man who carried vegetables in a basket on his head and went from building to building in Dadar/Matunga, hawking his wares. He came from an illiterate family and had migrated from Mhow in Uttar Pradesh. He somehow made ends meet and sent his children to the Hindi-medium municipal school near by.

When his eldest son Moti completed his Seventh standard, he had to leave – because there was no further class in that school. The boy got admitted to the Eighth class at Shri Dayanand Balak Vidyalaya, run by the Arya Samaj in Matunga. Still studying in Hindi medium, something snapped in Moti’s mind. He realised that if he wanted to rise above poverty and to live a better life, he would have to get a proper education. Rather than grumbling about the dark, he started hunting for the lamp of knowledge. He searched for the company of the more studious boys who concentrated on their books.

Where could they find the place to study at late hours after school? Believe it or not, in the “gaps between buildings”! In those days, not all buildings had compound walls and there used to be a distance of eight to ten feet (or even more) between buildings. It was in these gaps that the boys sat to study. If there was insufficient light there, they would go across to the nearby garden and sit under the streetlights. His efforts bore fruit and he passed his SSC with 85% marks.

Once this milestone had been crossed, a “Guru Maa” entered his life in the shape of Ms Sulabha Joshi, a teacher. She used to interact with the boy and his family while buying vegetables from them. When Moti told her that he had passed his SSC and wanted to pursue further studies, she took him under her wings. She lived in a bungalow in Dadar and used to give tuitions. She asked him to join her other students. She would not charge him – and, wonder of wonders, she would also teach him English and Maths.

He took admission at the nearby Ruparel College so that he would be close to home and help in the family’s vegetable business. While at college he also did a software course (it was the rage at that time). Things moved very quickly after that. He soon realised that although software was “popular”, it would not be as paying in the long run. Ms Joshi helped him make a decision. As he was good at accounts, he considered doing his CA. He joined S.S. Ganpule & Co. for his articleship and started studying very hard. He passed his Inter at the first attempt; later, due to ill health he lost a year and a half, but he cleared the CA final in 2005.

It has been rather smooth sailing after that. He has worked with several leading companies, including Sharda Worldwide Exports, Bharti Airtel and Tata Power (for eight years) and joined Ion-Exchange (India) Ltd. as Senior Manager (Taxation) in July, 2018.

As the BCAJ spoke to him, Mr. Motichand Gupta said that he is a happily married man today with two daughters and a son; he has moved into a bigger house in Sanpada and lives there with his parents.

How could a person who was facing tough challenges overcome them and emerge successful? When he was finishing school, Mr. Motichand recalled, he realised that if he wanted to improve his station in life, if he wanted himself and also his family to lead a better life, then he had to choose the right path and work hard in that direction.

He could see that the software course that he was doing at that time, even though it was the most popular and sought-after, would not prove beneficial in the long run. He felt it could turn out to be just a fad (as it happened). So right then he chose something that would be longer-lasting and would help lift him and his family and help them lead a better life.

“I could overcome my challenges because I identified my goal and pursued it despite my circumstances, despite ill health and the loss of a year and a half. Finally, I was able to succeed.” Clearly, a firm resolve, accompanied by hard work, helped him overcome all challenges and to succeed.

A THIRD GENERATION VIOLINIST CAN BE A FIRST GENERATION CA

CA is like armour for her

Imagine a little girl growing up in a house where there were only two kinds of sound, birdsong and the notes emanating from the strings of violins. Any other child (especially one of today’s generation) would have covered her ears and stomped out of the house. But this one didn’t. She went with the flow, picking up a violin when she was just three years old and, after a lot of practice and riyaaz, debuted on stage at 8 and gave her first solo performance at just 13. Nandini Shankar, a young, vivacious and outspoken violinist – is also a Chartered Accountant!

Granddaughter of the legendary Dr. N. Rajam, Padma Bhushan and India’s best-known living violinist, she is the daughter of Chemical Engineer Shankar Devraj and ace violinist Dr. Sangeeta Shankar. It goes without saying that her sister Ragini Shankar is also a violinist.

After completing high school, Nandini had to make a decision, should she pursue engineering, medicine, law or something else? At that time, sane counsel (her own, she insists!) prevailed and she decided to go for commerce. It would not take up too much of her time, she would be able to continue her riyaaz and also tour the country (and the world) with her family and other troupes.

In retrospect, it was a very good decision, she says. While studying for and passing her CA in 2016 (she passed all her CA exams at the first attempt), she was also doing her M.A. in Music at SNDT University and passed that in 2017.
But even during those days and nights of books, notes, tests, studies and exams, she seldom missed her riyaaz and was always game for performances both in India and abroad. (Ms Nandini practises Hindustani classical music associated with the Gwalior gharana.)

Soon, Nandini landed a very good job with Kotak Wealth and life seemed settled. But there was something that was gnawing at her. She was in the midst of an existential dilemma. Coincidentally, something else happened at that time – she was offered an appointment to the faculty for music production at Whistling Woods International established by film-maker Subhash Ghai (the Tata Institute of Social Sciences is associated with Whistling Woods which offers a graduate degree in music).

So, three ‘M’s came to describe her life – music, more music and money! Something had to give. Anyone else would have given up music, but Nandini chose to give up money (her profession as a CA) and devote herself to music full time, both teaching and performing.

Nandini told the BCAJ that the best important part of doing CA was that it has given her an “armour”: Now, she says, no one can ever trick her or forage off her so far as money matters are concerned. She knows her money inside out! And it is a great help to a professional like her. Too many of her ilk have been victims of conmen and tricksters. She is immersed in her music today, but what will happen some years down the line? That’s a question to which she has no answer right now.

She says: “CA is academically tougher. It is intellectually stimulating and practising it makes you wiser. Had I not been involved with music and only been a CA, I would probably have done very well because I think I have a knack of interacting with people… Just follow your passion. Find the middle path. It would help CAs if they take a break from their work and turn to the arts, go for painting, dancing, music, theatre or anything to keep their creativity alive. These are natural expressions. CAs can also enjoy the beauty of the arts.”

Since she is associated with a film-making company, would she like a “body double” that would help her to be at two places at the same time – one on the stage giving a recital; and another sitting with balance sheets, P&L statements and the like?

“No, I would love to have a ‘mind double’ so that I can pursue both my careers simultaneously!” Nandini exclaims.

THE HUMAN SPIRIT IS STRONGER THEN ANYTHING THAT CAN HAPPEN TO IT

Tearing their books into two

Almost everybody in the world of Chartered Accountancy knows that Ms Prema Jayakumar, the daughter of an autorickshaw driver in Malad, Mumbai, topped the all-India CA exams conducted by the ICAI in January, 2013. Along with her, Dhanraj, her younger brother aged just 22 then, also cleared the exam. Those with good memories will also recall that she had stood second in Bombay University’s B.Com. exam, scoring 90% marks; that she did her articleship with Kishore Seth and Company in Borivli; and that she also gave tuitions to several B.Com. students all over the city (she usually left home at 6.30 am and returned by 10.30 or 11 at night).

BCAJ spoke to her to find out some interesting details about her which not everybody knows. Soon after the brother-sister duo started studying for the CA entrance exams, they struck up a novel idea to control the cost of their education. Since the books were quite expensive, they tore them into two halves – then, while the sister studied the first half, the brother took up the second half; and then they exchanged their halves. Thus the two managed not to tax their indigent parents too much.

Prema recalls that she and the family faced a lot of hardships while they were studying but they had never complained. Their parents supported them to the best of their abilities, making several sacrifices to ensure that the children were never disheartened. (Their father, Jayakumar, now 60 years old, had come to Bombay from Tamil Nadu in the 1960s and after working in a mill for some time, started driving an autorickshaw to earn a living. Their mother also worked for some time, then started paying full attention to the CAs-to-be.)

After the announcement of the results, several companies were virtually falling over each other to offer her a job. She was keen on working at a bank (preferably at the RBI), and when Indian Bank offered her an appointment letter on the spot, with a choice to work in Mumbai or in Chennai, she gladly accepted it.
Now happily married, Prema lives with her husband in Chennai and recently gave birth to a baby boy. Her parents are back in their village in Tamil Nadu, living a happier life, far from the maddening crowd of Mumbai.

Despite agreeing to a brief chat for this piece earlier, her brother CA Dhanraj suddenly clammed up when it was time to speak. Perhaps it was stage-fright, perhaps it was nerves, or panic, but the young 28-year-old apologised.

One can see that the two siblings overcame massive adversity. And Chartered Accountancy was the result of their efforts and cause of their new life.

THERE ARE TWO WAYS OF MEETING DIFFICULTIES: YOU ALTER DIFFICULTIES, OR YOU ALTER YOURSELF TO MEET THEM

From soil to slum to Sr. GM

Most city dwellers rarely encounter a “son of the soil”. If you are one of them, Mr. Kisan Daule is the man to meet. He is a real “son of the soil” – and a chartered accountant to boot. Here is the story he told BCAJ about his journey. The eldest son of unlettered farmers from Rajuri village in Junnar taluka of Pune district, Kisan could see his parents struggle with the elements, especially the weather gods, to eke out a living and put food on the table; of course, there was no table in their mud hut. But there was a fire in his father’s belly which made him goad his eldest son to somehow get an education (“at least become a graduate,” he said).

Fate decided to lend a hand; but Kisan had to go through the toughest of times before the gods finally smiled on him. He studied at the local Marathi school but after he passed his SSC, he was totally blank. What now? Stumped, he came to Bombay where a brother (working at the CTO on a very low salary) lived with his family in a Wadala slum.

It was July when he came to Bombay and junior college admissions had closed. He was simply turned away. Then he learned about Vikas Night High School in Kannamwar Nagar, Vikhroli. The Principal saw his zeal and gave him admission, even though the first-term exams were already over. Kisan studied like a maniac. Since he was good in accounts, he did very well and passed the XIth, and then the HSC exam with 68% marks.

Kisan recalls that even though he faced enormous hardships, living in a slum, in unclean and contagious surroundings, with no facilities for studies, no peace of mind, no money, no ambition and no encouragement, there were a few people who did help him along. His brother gave him a roof, his brother-in-law gave him some financial help and even the villagers of Rajuri pooled in their resources and sent him some money.

The Principal of Vikas Night School was clearly the “hero” of his story, because he saw Kisan’s resolve and determination and showed him a direction – “go for B.Com.”, he said. The youngster did just that and joined the N.G. Acharya and D.K. Marathe College in Chembur. Although he had already passed away when the youngster passed his HSC, his father’s wish was soon fulfilled and his eldest son became a graduate.

It was then that Kisan met another benefactor, Prof. Ramesh Iyer, Accountancy Professor at the college. Prof. Iyer was impressed by his accountancy skills and suggested that he should become a chartered accountant. Kisan knew absolutely nothing about chartered accountancy. Prof. Iyer explained its salient points and told him to join articleship. So he joined A.R. Krishnan & Co. in 1990.

Kisan recalls his first day at office. He had been told to attend the telephone. Mr. Krishnan himself called from another line, whereupon the new articled clerk picked up the phone and mechanically said, “Mr. Krishnan has gone out.” Mr. Krishnan laughed out loud! After completing his CA, Kisan continued with Mr. Iyer. “My entire growth happened in those seven years (with
Mr. Iyer).”

Destiny beckoned him once again. He joined Transworld Shipping as a junior executive in February, 1998. When he left 20 years later, he did so as Senior General Manager. That, in short, is the story of the man behind K.Y. Daule & Co., Chartered Accountants.

On January 26, 1998, Kisan Daule was felicitated by his old school and the entire Rajuri village for being the first CA from among the real “sons of the soil”. Had his father been alive on that day, he says wistfully, “he would have been the happiest man alive.”

SURMOUNTING DIFFICULTIES WITH A SMILE MAKES HEROES

A continuing miracle

Few people in the community of chartered accountants in Bombay city know that over 80% of the Income-Tax Offices are differently-abled-friendly. They have ramps for wheelchairs, proper ingress and egress for them and, to top it all, they even have a separate parking area for those who drive up in special vehicles. It’s not that they have never bothered to find out, but the truth is that they always took it for granted that there were bound to be arrangements for those not as able as the rest.

As it turns out, it was a pleasant surprise even for Mr. Chirag Chauhan whose mobility is assisted by a wheelchair and who drives a vehicle specially adapted for him when he visits the IT offices whether at Bandra or at Churchgate.

It was a soothing realisation for him. But that is leapfrogging his story by more than a decade. For, it was on July 11, 2006 that he became a victim of the series of bomb blasts in the city’s local trains. Rendered a paraplegic and paralysed below the waist at the age of 21, it was a miracle that he survived. And how! Today, his life is a continuing miracle: He has his own practice in suburban Kandivli; with friends he set up the website which offers innumerable services, such as finding the nearest CA, CS, lawyer, finance or any other professional; answering queries related to taxation, company formation and other needs. This site guides visitors to more than 4,000 CAs and has over 26,000 visitors. Mr. Chirag’s website hosts scores of articles, several of them written by him and neatly and systematically archived.

Interestingly, he recalls that one of his first articles, “How to save tax”, had received more than 35 lakh hits (that’s 3.5 million!) and, in a way, opened his eyes to the immense potential of the internet.

After the blast that has come to redefine his life, he had to struggle hard with his own body which would not heed his commands. But thanks to a loving mother, a devoted sister, a persevering physiotherapist and doctors and friends who would not let him wallow in self-pity (“Why me?” he often asked himself), Mr. Chirag completed his CA. He was with A.J. Shah & Co. at the time of the blast and fondly remembers Ms Nandita Parikh, the first women CA rank-holder in India, who encouraged him to resume his studies.

But that was easier said than done. It took two long years of painful rehabilitation (physical as well as psychological) for him to finally get back to his books. He had already cleared the first two exams (PE1 and PE2). Goaded on by those close to him, he decided to go for self-study and then appeared for the PE3 exam. He passed in the first attempt and became a CA in 2009. And then his life changed once again.

He worked with a CA firm for six months but the daily journey by autorickshaw from Kandivli to Chembur was a dampener, especially during the monsoons. A job switch saw him joining internal audit at Kotak Mahindra Bank. He soon adjusted to his discomforts and, before long, bought a car; he drove all the way to Lonavala, reassessed his abilities and came back convinced that he could live a life quite close to that of anyone else. But… there was a certain restlessness. So he quit his job and started his own practice. He remembers first client – the local newspaper vendor. That man is still his client and he helped spread the word around. His practice started to flourish and today, he says, “I am normal… my work-life balance is perfect.” Touché!

Chirag is active on all social media platforms. He has met the Prime Minister of the country and has over 8,000 followers. But one of the best things about him is that he has an infectious (and sometimes mischievous!) smile.

CAN CA BE PART OF DNA?

Five Generations and Eleven CAs!

Mr. Brij Mohan Chaturvedi, a leading CA practising in Bombay, belongs to a family that boasts of not two or three but full five generations in the same profession. This sounds too good to be true, so he pulls out a chart, complete with names and photographs, and explains the relationship between the generations.

The eldest, the late Bishambar Nath Chaturvedi, was the man who started the trend. He hailed from a family of Sanskrit scholars and was one of the first men from Mathura to do his graduation in English. He became a registered accountant in 1925 after working as an apprentice under one Irani & Co., an audit firm in Delhi. His two sons, the late Amar Nath and Dina Nath, also became CAs. In the third generation, the late Amar Nath’s three sons, Brij Mohan, the late Madan Mohan and Subodh, followed suit. Another of Bishambar Nath’s grandsons (his daughter’s son), Srikant, also became a CA.

In the fourth generation, the late Madan Mohan’s sons, Apurva and Rishabh, did not let down the team and passed their CA. One more CA in the fourth generation came in the shape of Tina Pankaj Chaturvedi (she is the daughter of the late Amar Nath’s daughter).

Finally, the latest. Mohini Gagan Chaturvedi, Mr. Brij Mohan Chaturvedi’s daughter’s daughter, passed her CA final in November, 2017, thus becoming the fifth generation of the Chaturvedi family to take up the profession. Thus, a total of 11 members from the Chaturvedi family are CAs.

No one forced the Chaturvedi boys and girls to do their CA. It just so happened that since the patriarch of the family and his sons were all CAs, the women of the household could see the benefits that the profession brought and came to believe that anyone who did their CA would be assured of a comfortable and respectable life.

As simple as that. Few women of the first and the second generation were well-read, most of them having studied only up to middle school, but they were suffused with great native wisdom. They didn’t want the youngsters to go astray. They would mockingly gnash their teeth and tell the children, “Study! Learn something! Then you will be able to occupy the chair of your father, otherwise you won’t even become office boys!”

Sitting in his plush office at Nariman Point in Bombay today, Mr. Brij Mohan Chaturvedi is proud that his family owns the world record of having five generations in the same profession. This is a record that he claims for himself as a right; it has not been officially conferred by any organisation. He has approached the people handling the Guinness Book of World Records but is yet to receive any certificate from them. Nor has he received any official recognition from the American Institute of CPAs, or the Institute of Chartered Accountants of England or Wales; nor, for the matter of that, from the Institute of Chartered Accountants of India. Almost all of them appear to be prevaricating, claiming that they don’t keep records of their members by way of family trees.

However, that doesn’t deter Mr. Chaturvedi in any way. The cheerful and ebullient gentleman appears incredulous about the fact that he belongs to such an illustrious family and is happy that the Indian media has been kind to him. The claim to fame of his family has been splashed in several newspapers and he is thankful for the coverage as he awaits the official world recognition that he believes is due to his family.

Post Script: Mr. Brij Mohan Chaturvedi claims that although his grandfather, the late Bishambar Nath Chaturvedi, has eleven direct descendants in the profession, at least nine of the children of his brothers and sisters (grandsons, great granddaughters and great grandsons) have also qualified as chartered accountants. That makes a total of 20 chartered accountants in one family.

NOT HAPPY WITH BEING A CA, HE WENT ON TO WIN A NATIONAL AWARD FOR PLAYING THE MAHATMA

Roller-coaster ride for this CA

Life has been a roller-coaster ride for Mr. Darshan Jariwala who has donned many hats during an illustrious career in theatre, films and television. Aged 60 today, he recalls that he bowed before the typical middle-class family’s “goal” to get a good education that would stand him in good stead.

Ironically, he got the CA degree but it seems to have got him neither bread nor butter. Instead, it was his acting prowess that saw him going places and earning some money for jam! He won the 2007 National Award for Best Supporting Actor for playing the Mahatma in the film Gandhi, My Father (2007). Apart from the Mahatma, he also played the eponymous role in Narsinh Mehta, a hugely successful Gujarati television serial. That made him one of the most successful Gujarati actors. Roles in films, on television and the stage chased him and he could pick and choose. He also acted in English films, TV serials and plays.

Born in 1958 into a family with artistic leanings (his mother also did theatre and worked for All India Radio; her brother was the celebrated film star, the late Sanjeev Kumar), he worked in theatre till 1976.

He became a CA in 1983-84 and then branched into financial services and even started practising; simultaneously, he was studying for the company secretary (CS) exam, but never appeared for the final. Along the way, he had a brush with the National Stock Exchange, too.

“But then I realised that I was not cut out for these things. My dalliance with acting was still going on, but it was only as late as in 1998 that I took the decision to concentrate on acting and not to do anything else.” What the world of chartered accountancy lost, the acting world gained.

Actually, he admits, he had burnt his fingers with the other pursuits that he had followed till 1998. The challenge was to resume earning and restore his financial well-being. God was kind to him. Thankfully, work had always been abundant because of his constant association with theatre. And those who valued quality came to him and offered him roles. “It was left to me to make the choice. It has been a good journey since the last twenty years or so.”

Darshanbhai believes that being a CA he is able to approach problems in a more analytical manner and is able to identify the right perspective to tackle them. “I do believe that certain of my faculties have been sharpened because of my doing chartered accountancy… Unfortunately, I never failed. If I had been an academic dud, maybe I would have been happier and a more credible actor than I am right now!” After he gave up all other work to concentrate on acting, he became financially comfortable and had no occasion to regret the shift.

Returning to the world of chartered accountancy, he makes a perspicacious statement when he says that, earlier, CAs were supposed to be watchdogs and not bloodhounds. But now the responsibilities of CAs so far as compliance was concerned had increased manifold. “I have always struggled with that particular credo, ‘certifying the true and fair view’. I think when you talk of fair sense, your personal set of ethics does come into the picture… You have to make the choice, are you going to stick to your charter of probity and maybe starve, or…?”

As Vice-President of the Cine Artistes’ Association (the actor’s union), he points out that many of its members receive their payments only 90 to 115 days after shooting. But in the meanwhile they are supposed to pay (professional) service tax as well as GST soon after raising their bills. They have to make these payments out of their pockets, pending receipt from the respective producers.

“We have started a movement to contact each production house and make them realise that payment has to be made within the GST deadline period. We don’t want to go out of pocket… We are asking producers to pay at least 25% of the invoice value in the first 30 days and the rest in the usual course. They (producers) have also to think about the fate of the technicians. We are willing to listen to their problems, because their broadcasters have to pay them… Perhaps we can do it in a tripartite manner.

“I am actively promoting information about personal tax returns, the Income-Tax Act and so on for our members; information on how to save tax, plan tax… obtain insurance. We have to take care of everything. We are doing workshops on these subjects.”

Darshanbhai says he will wholeheartedly welcome the assistance of the Bombay Chartered Accountants’ Society in organising such workshops.

FROM A BAREFOOT UNDERGRADUATE, TO M.COM., TO CA, TO PH.D., TO TRIATHLON – AND IT’S STILL NOT OVER YET!

We are told Dr. Ravindra Khairnar brought bad luck to the family the day he was born. His father suffered a grievous injury in both hands and virtually lost their use. His father’s brother continued with the family’s small tailoring shop. They lived in a dilapidated house in a poor neighbourhood. Between them, the two brothers had eight children: six daughters and two sons. Feeding all those mouths was not easy.

With his father unable to work, his mother joined Khandesh Mills as a labourer. To make things worse, Ravi’s father often went AWOL. He would disappear for weeks; when he did return, he was of no help in running the household. Ravi had to drop out of school after completing his Fourth standard.

Next to the family’s tailoring shop was a typing class whose owner often asked the little boy to run errands for him. Sometimes, he was asked to mind the shop. The boy fiddled with the typewriters to pass the time. A few years later, someone advised him to appear for the SSC examination externally. He went for it. And after a lot of effort he managed to pass. At the same time, he worked in the tailoring shop for 12 to 14 hours to supplement the family’s income.

And then the first miracle in his life occurred. When Ravi joined high school for the 12th Standard, he wore chappals for the first time in his life. He had been barefoot all his life. He still had little time for his studies. Working the pedal of the sewing machine resulted in his legs getting swollen. But he continued working and studying and finally completed his graduation.

That little typing class next door had both English and Marathi typewriters. Ravi learnt typing on his own and also a bit of stenography. In 1986, immediately after graduation, he got a temporary job as a steno-typist for two years in United Western Bank. But the tailoring continued. Simultaneously, he started preparing for his M.Com. (externally).

That was when the second miracle occurred. He secured the 2nd rank in the M.Com. exam of Pune University in 1988. He was still working at the tailoring shop, enduring the pain in his legs.

By now he was a steno-typist and joined the office of M.V. Joshi, a chartered accountant who shared his office with Mr Desai who was an eminent lawyer in Jalgaon. The lawyer had a great flair for drafting in English and Ravi was always ready with his pencil and notebook. It is another matter that Mr Desai was short-tempered. But that turned into a blessing because although he was scolded even for a minor spelling mistake, it polished Ravi’s English.

Then he learned about a cousin who lived in a slum area in Mulund, Bombay, with his sister. The brother-sister duo had lost their parents in early childhood. The brother had done his CA but one day he suddenly passed away. A relative (who also lived in Mulund) met Ravi at a family function in Jalgaon and suggested that he should try and do his CA.

The young Ravi was sceptical at first. But he saw reason and joined M.V. Joshi, CA, as an articled clerk on a stipend of Rs. 400 (more than the mandatory Rs. 150 per month). He gave up the bank job but did not stop working at the tailoring shop. Mr Joshi encouraged him to appear before the Income Tax authorities for scrutiny and other proceedings. This exposure gave him a lot of confidence.

Ravi could never afford reference books for his studies. He relied only on the study material at the Institute. Many articled trainees in Jalgaon used to attend coaching classes in Pune. But this young man could not do so. His evenings were spent in the tailoring shop.

And then the third miracle occurred, albeit in a round-about way, thanks to his tailoring skill. The family shop was the only one in Jalgaon that stitched coats. Several rich, well-to-do people were among its clients. One of them was a certain Mr Barve who was well connected in influential circles. He observed Ravindra’s struggles and saw how difficult it was for him to study in his dilapidated house.

To aggravate matters, Ravindra was married before his final CA exam and even had a baby girl. Mr Barve invited him to stay in his house at Pune for a month before the exams. Soon, this became a regular feature; he would go to Pune and stay there for a month before the group exam. Incidentally, he had never had even a cup of tea in a hotel before passing his CA! There was just no question of eating outside. He would carry provisions and cook for himself. But he cleared all the groups of intermediate and final CA without failing even once.

What after CA? His principal and benefactor, Mr Joshi, offered him assignments of charitable trusts, schools, etc., which were far from remunerative (such assignments are not remunerative even today!). But Ravindra was thrilled and started his “office” below the staircase of an old chawl in Jalgaon.

Today, miracle number four, Ravindra has a two-storeyed office of his own.

Despite the odds, he has got all his sisters and brother married. The greatest pleasure in his life is that he could build a good house and own a small piece of agricultural land where his parents spend their old age happily. Ravindra also likes farming and his parents are completely contented looking at the achievements of their son Ravindra.

All good stories should end at this point. But that’s not the case with Ravindra Khairnar.

In 2016, he earned a doctorate in taxation from North Maharashtra University, Jalgaon. His Ph.D. thesis is titled, “A study of Public Trusts in Jalgaon District with special reference to Finance and Operations”.

If that was miracle number five, here is the next one.
A well-know social and political leader, Mrs. Pratibha Patil, and her husband were popular figures in Jalgaon. She was a Member of Parliament and he a businessman. Whenever any dignitaries came visiting, they would call Ravindra to lend a helping hand. They had a lot of affection for him.

This was when the sixth miracle occurred. The Patils’ CA was becoming too old to handle work. On learning that Ravindra had already started practising as a CA, they handed over all their work to him.

When Mrs. Pratibha Patil became the President of India, Ravindra took the Western India Regional Council members to meet her. A photograph taken on the occasion appeared on the cover page of the CA journal that month.

But the story continues. And so do the miracles.

Ravindra had developed varicose veins because of his constant work on the sewing machine. As soon as he could, he underwent surgery to alleviate the pain. And then he turned to athletics!

Recently, he completed 9 marathons and the triathlon. In this, participants have to run 21 kilometres, cycle 90 kilometres and swim 2 kilometres in quick succession. Ravindra completed the feat in Hyderabad recently. He is now eyeing the Olympics in the veterans’ category (50 to 60 years). But that is some time away. At present, he has set his sights on representing India in the annual Ironman World Championship organised by the World Triathlon Corporation at Hawaii.

When he completes that championship, that will be miracle number seven. And, Ravindra says, he will then be on seventh heaven.

He is married with a son and two daughters. The elder one, who is doing her CA, is married to a CA
from Thane. But despite all the miracles he has wrought, Ravindra Khairnar still remains a humble, unassuming and low-profile man, always willing to help others.

Kaleidoscopic inputs provided by Ramesh Iyer, Raman Jokhakar, Sanjeev Pandit, Anmol Purohit, Mihir Sheth and C.N. Vaze.

AUDITOR RESIGNATION – PRESCRIPTIONS AND RESPONSIBILITIES

INTRODUCTION


Auditing is the core area of competence of a
Chartered Accountant. Audit of financial statements of public interest entities
such as listed companies, government companies, banks and insurance companies
is an exclusive domain area entrusted to our profession. The underlying trust
in assigning this responsibility to the members and firms (referred to as
“auditor” henceforth in this article) registered with the Institute of
Chartered Accountants of India (ICAI) needs to be preserved by diligent
discharge of our duties associated with such a responsibility. Audit of a
public interest entity should be accepted not merely as a professional opportunity
but with a sense of pride in safeguarding the stakeholder’s interest by
authenticating the financial statements audited. Viewed from this perspective,
it is a matter of concern that during the year 2018 numerous mid-term
resignations by statutory auditors of listed companies (hereinafter referred to
as “auditor”) were reported. No doubt, an auditor is legally entitled to resign
as per law under certain circumstances. However, the large number of
resignations occurring in recent times has become a cause of concern among the
stakeholders. In this article, all aspects relating to an auditor’s resignation
are dealt with for assimilation of the readers of the journal of the BCAS.

 

CHALLENGING ENVIRONMENT


With the passage of time, business practices
are getting complicated and the environment is quite challenging. New laws
envisaging stringent compliance mechanisms are demanding more time, attention
and cost for enforcing compliance. The business methodologies and practices are
becoming vulnerable to manipulation and the individual value system is
degenerating due to greed, on account of which many frauds and scams are
occurring. Cases of mismanagement and flouting of governance norms are getting
reported in the corporate world, where it is least expected. This also leads to
widening the gap between expectations of the stakeholders as against
performance by an auditor. Beginning with the Satyam case and followed by many
other scams including Nirav Modi’s case associated with Punjab National Bank
and till the current on-going investigation in the IL&FS group cases, the
accountability of the auditor who has attested the financial statements in
those cases has been the subject matter of scrutiny. In the Satyam case, the
auditor was banned by SEBI from auditing listed entities for two years. The
Companies Act, 2013 and the Chartered Accountants Act, 1949 provide for
stringent consequences if an auditor is found guilty in discharging his onerous
task. The Companies Act, 2013 has vested the right of class action suits in favour
of the shareholders posing a threat not only to management but to the auditor
as well. Hitherto, only a signing partner was liable for any consequence for
misdeed, but now, even the firm can suffer the consequences for lapses in the
discharge of the audit function—Section147(5).

 

LEGISLATIVE AND REGULATORY PRESCRIPTIONS


The provisions of section 139 of the
Companies Act, 2013 deal with the appointment of auditors. Rotation of every
individual auditor after a 5-year term and audit firms after two consecutive
terms of 5 years each is stipulated. The law lays down a procedure not only for
removal but also for resignation of an Auditor. But, either of this can be done
only by adhering to the procedure laid down in The Companies Act, 2013 read
with the Companies (Audit and Auditors) Rules, 2014. According to sub-section
(2) of section 140 of the Companies Act, 2013 the auditor who has resigned from
a company shall file within a period of 30 days from the date of resignation a
statement in Form ADT-3 with the company and the Registrar of Companies. In the
case of a government company or any other company owned or controlled by any of
the governments, the auditor shall also file such a statement with the
Comptroller and Auditor-General of India. The said form, apart from seeking the
basic details about the company and the auditors, requires reasons for
resignation and any other facts relevant to the resignation. Failure to submit
such a statement attracts a levy of penalty of Rs. 50,000 or an amount equal to
the remuneration of the auditor, whichever is less, and in case of continuing
failure, with a further penalty of Rs. 500 per each day after the first during
which the failure continues, subject to a maximum of Rs. 5 lakh.

 

Based on the
recommendations of the Kotak Committee on Corporate Governance many changes
have been made to the Listing Obligations and Disclosure Requirements (LODR)
and these have been made effective in a phased manner from 2018 onwards. The
changes encompass matters that relate to disclosure of auditor credentials,
audit fee, reasons for resignation of auditors as indicated below:

 

“The notice being sent to shareholders for
an annual general meeting, where the statutory auditor(s) is/are proposed to be
appointed/re-appointed shall include the following disclosures as a part of the
explanatory statement to the notice:

 

(a)   Proposed fees payable to the statutory
auditor(s) along with terms of appointment and in case of a new auditor, any
material changes in the fee payable to such auditor from that paid to the
outgoing auditor along with the rationale for such change

(b)   Basis of recommendation for appointment
including the details in relation to and credentials of the statutory
auditor(s) proposed to be appointed.

 

In case of resignation of the auditor of the
listed entity, detailed reasons for resignation of auditor, as given by the
said auditor, shall be disclosed by the listed entities to the stock exchanges
as soon as possible but not later than twenty-four hours of receipt of such reasons
from the auditor.”

 

CIRCUMSTANCES WHEN A RESIGNATION IS WARRANTED

Before accepting an engagement as auditor to
an entity, the auditor is expected to evaluate diligently about the entity, the
scope of the mandate, the resources (time, manpower and competence) available
to execute the audit and then take a conscious call to accept or not to accept
the engagement. After accepting an audit engagement, it is generally perceived
that the auditor would carry out the mandate adhering to the Standards and Ethical
framework governing the profession and issue an audit report with or without
modification. Resigning or withdrawing from an engagement to perform audit of
financial statements without issuing an audit report is an exceptional
situation and therefore needs to be backed by justifiable reasons and should
not be based on flimsy grounds.

 

An auditor entrusted with the engagement to
perform audit is required to comply with the requirements of SQC 1 in
performing audits, reviews of historical financial information and for other
assurance and related services engagements. As part of this responsibility, an
auditor should establish policies and procedures designed to provide reasonable
assurance that independence can be maintained. The auditor needs to evaluate
circumstances and relationships that pose threats to independence and to take
appropriate action to eliminate those threats or, reduce them to an acceptable
level by applying safeguards or if considered appropriate, to withdraw from the
engagement (Paras 18 & 22). Where the auditor obtains information that
would have caused to decline an engagement if that information would have been
available earlier: In such a situation, the auditor may examine if withdrawal
from the engagement or both from the engagement and the client relationship is
appropriate (Paras 34 & 35).

 

The overall objectives of the independent
auditor and the conduct of an audit in accordance with Standards on Auditing
are dealt with in SA 200. In case reasonable assurance cannot be obtained and a
qualified opinion in the auditor’s report is insufficient in the circumstances
for the purposes of reporting to the intended users of the financial
statements, the SAs require to disclaim an opinion or withdraw from the
engagement, where withdrawal is legally permitted (Para 12). If an objective in
a relevant SA cannot be achieved, the auditor shall evaluate whether it
prevents him from achieving the overall objective of the audit and then decide
either to modify the auditor’s opinion or to withdraw from the engagement (Para
24).

 

According to SA 210, agreeing to the Terms
of Audit Engagements, if the auditor is unable to agree to a change in the
terms of the audit engagement and is not permitted by the management to
continue the original audit engagement, the auditor shall withdraw from the
audit engagement where permissible as per law or regulation (Para 17). SA 220
on Quality Control for an Audit of Financial Statements provides that if the
engagement partner is unable to resolve the threat to independence with
reference to the policies and procedures that apply to the audit engagement, if
considered appropriate, the auditor can withdraw from the audit engagement
(Para 11 and A6). Where the applicable law or regulation does not permit
withdrawal of the auditor from the engagement, disclosure shall be made through
a public report of circumstances that have arisen that would have otherwise led
to the auditor to withdraw (Para A7).

 

If, as a result of a misstatement resulting
from fraud or suspected fraud, the auditor encounters exceptional circumstances
that bring into question the auditor’s ability to the perform the audit, the
Standard suggests the withdrawal from the engagement as one of the options,
subject to following certain procedures and measures — SA 240, the Auditor’s
Responsibilities relating to Fraud in an Audit of Financial Statements (Paras
38, A53, to A56). Again, when management or those charged with governance do
not take the remedial action that the auditor considers appropriate in the
circumstances, even when the non-compliance is not material to the financial
statements, the auditor can consider withdrawal from the engagement if
necessary. If such withdrawal is prohibited, the auditor may consider
alternative actions, including describing the non-compliance in the “Other
Matters” paragraph in the auditor’s report — SA 250, Consideration of Laws and
Regulations in an Audit of Financial Statements (Para A18). In a situation
where the two-way communication between the auditor and those charged with
governance is not adequate and the situation cannot be resolved, one of the
options available to the auditor is to withdraw from the engagement, if not
prohibited under the applicable law or regulation — SA 260 (Revised),
Communication with those charged with Governance (Para A53).

 

SA 705, dealing with “Modifications to the
Opinion in the Independent Auditor’s Report”, establishes requirements and
provides guidance in determining whether there is a need for the auditor to
consider a qualification or disclaimer of opinion or, as may be required in
some cases, to withdraw from the engagement where it is legally permissible –
SA 315, Identifying and Assessing the Risks of Material Misstatements Through
Understanding the Entity and its Environment (Para A108). Concerns about the
competence, integrity, ethical values or diligence of management, or about its
commitment to or enforcement of these, may cause the auditor to conclude that
the risk of management misrepresentation in the financial statements is such
that an audit cannot be conducted. In such a case, the auditor may consider,
where possible, withdrawing from the engagement, unless those charged with
governance put in place appropriate corrective measures — SA 580, Written
Representations (Para A24).If the auditor is unable to obtain sufficient
appropriate audit evidence, then the auditor is expected to determine the
implications thereof to decide whether to qualify the opinion or to resign. If
the auditor concludes that the possible effects on the financial statements of
undetected misstatements, if any, could be both material and pervasive and a
qualification of the opinion would be inadequate to communicate the gravity of
the situation, the auditor shall resign if not prohibited by law or regulation.
In the event of resignation not being practicable or possible, the auditor
shall disclaim an opinion on the financial statements —SA 705, Modifications to
the Opinion in the Independent Auditor’s Report (Paras 13, 14, A13 to A15).

 

In a rare circumstance where the auditor is
unable to withdraw from an engagement even though the possible effect of an
inability to obtain sufficient audit evidence due to limitation on the scope of
the audit is pervasive, the auditor may consider it necessary to include in
“other matter paragraph” in the auditor’s report a statement  to explain why it is not possible for the
auditor to withdraw from the engagement — SA 706, Emphasis of Matter Paragraphs
and Other Matter Paragraphs in the Independent Auditor’s Report (Para A10).
Similarly, if the auditor concludes that a material misstatement exists in
other information obtained prior to the date of the auditor’s report and the
other information is not corrected after communicating with those charged with
governance, the auditor shall take appropriate action. One option in such a
situation is withdrawing from the engagement, especially when the circumstances
surrounding the refusal to correct the material misstatement of the other
information casts such doubt on the integrity of the management and those
charged with governance as to call into question the reliability of
representations obtained from them during the audit. In case of certain
entities, such as Central or State governments and related government entities,
withdrawal from the engagement may not be possible. In such cases, the auditor
may issue a report to the legislature providing details of the matter or may
take other appropriate actions.

 

The Code of Ethics requires an auditor to
consider resigning/withdrawing from an engagement when the auditor is able to
conclude that the expectation or requirement envisaged by the Code of Ethics
cannot be fulfilled and there is no other option but to resign. It is also
possible that an auditor expresses inability to continue as statutory auditor
due to overdue past audit fees and disagreement on fees for future services. In
case the auditor cannot legally continue as auditor, then withdrawal becomes
inevitable. There could also be an unavoidable circumstance beyond the control
of the auditor due to which continuing the engagement is ruled out. 

 

TIMING OF RESIGNATION


As the resignation of an auditor from an
audit engagement is not a matter of routine and since it is not a recurring
act, it is difficult to suggest as to when is the appropriate time for
resignation. But considering the immense faith that the various stakeholders
including the regulators and shareholders have reposed on the profession, an
auditor must be abundantly cautious not to exercise this right in a casual
manner and that, too, when the audit is almost complete. Unless the situation
is grave and the circumstances adequately justify it, the resignation option
should be avoided. Instead, a disclaimer of opinion and adequate disclosures on
the circumstances that have resulted in such a disclaimer can be reported.

 

The ICAI has issued “Implementation Guide on
Resignation/Withdrawal” wherein the following guidance is given in this regard:

 

“16. The auditor is therefore advised,
particularly in case of listed entities, to comply as below:

 

(a) In case an
auditor has signed all the quarters (either limited review or audit) of a
financial year, except the last quarter, then the auditor has to finalise the
audit report for the said financial year before resignation.

(b) In other cases, the auditor should resign after
issuing limited review/audit report for the previous quarter with respect to
the date of resignation.

(c) To the extent information is
not provided to the auditor or the management imposes a scope limitation, the
auditor should provide an appropriate disclaimer in the audit report.”

 

DISCIPLINARY/ REGULATORY PROCEEDINGS AGAINST AN AUDITOR


Even when called in for questioning in a
later proceeding, the auditor should be able to defend with the proper documentation
done and with the audit evidence gathered and maintained prior to issuing the
audit report. It is possible that an auditor is called in the disciplinary
proceedings of the ICAI or in an appropriate proceeding by a regulator such as
SEBI or RBI. The auditor is required to respond and submit in a systematic
manner all the working papers that would explain the execution of the audit
engagement stage by stage, strictly adhering to the SQC 1, SAs and Code of
Ethics. An auditor must demonstrate that in a given situation how a
professional judgement was made based on proper reasoning and prudence and that
any other auditor in the same set of facts and circumstances could not have
reached a different conclusion. In my experience as Chairman of the Disciplinary
Committee of ICAI and subsequently as a member of the Appellate authority, I
have come across cases with simple charges wherein the auditor was held guilty
for want of proper working papers and documentation. On the other hand, there
have been complex cases with serious charges levelled but finally the auditor
was acquitted on the strength of the working papers, audit evidence and proper
documentation which demonstrated that the standard auditing procedure was
meticulously followed and professional scepticism and judgement were duly
exercised.

 

Even those who sit in judgment on the
professional conduct of an auditor must not judge the conduct based on
subsequent developments pertaining to the entity that have taken place post
signing of the audit report. They must evaluate the case based on the circumstances,
facts and records as were available to the auditor at the time of signing the
audit report and by verifying whether the applicable SAs and Ethical framework
were followed and due professional judgement was exercised. It is easy to hold
anyone guilty in hindsight but that would defeat the very purpose of fairness
and justice while reaching a conclusion on the performance of a professional.
It must also be appreciated that audit is not an investigation and an audit
cannot unearth all kinds of frauds that have been perpetrated upon an entity.
At the same time, an auditor cannot claim protection on this general premise in
all cases of fraud because, if proper audit process is planned and executed
with professional scepticism it is possible to find out certain types of
misstatements arising out of frauds. If a fraud, which could have been
unearthed by following standard audit procedures and exercise of professional
scepticism, was not detected on account of gross negligence or dereliction of
duty, then an auditor cannot defend on the generic ground that audit is not an
investigation. On the other hand, if there are instances of fraud which could
not have been detected even after proper conduct of audit procedure and best
practices then the auditor cannot be held guilty in such a case and needs to be
exonerated.

 

COMMUNICATION AND DOCUMENTATION


When
circumstances compel an auditor to contemplate resignation from an audit
engagement, he must communicate with the appropriate level of management and,
where appropriate, with those charged with the governance, and, where
considered necessary, inform the circumstances, evaluation on the implications
thereof and the conclusions drawn. The auditor may even seek time from the
Audit Committee Chairman and explain to him the circumstances and seek his
intervention either directly or through the Audit Committee. Once a
communication is so given by the auditor, the management and, where
appropriate, those charged with the governance should respond to the said
communication within a reasonable period of time. Management and those charged
with the governance that are put on notice should also take necessary steps to
remedy the situation and communicate the same to the auditor. The auditor
should evaluate the response received and then review his earlier conclusions
impacting the decision of resignation. Thereafter, either he may drop the
decision to resign and continue with the engagement in accordance with the
Standards and Ethical Code or he may persist with his earlier decision to
resign, in which case he must comply with the procedure prescribed by filing
the relevant Form ADT 3 as indicated above.

 

The Implementation Guide issued by ICAI
further delineates the effective mode of communication of the resignation and
the relevant portion is given herein below:

 

“19 Further, the auditor is also advised to
include the following in the letter of resignation, as applicable:

 

(a) If the withdrawal or resignation results from
an inability to obtain sufficient appropriate audit evidence, the reasons for
that inability;

(b)        The possible effects on the financial
statements of undetected misstatements, if any, could be both material and
pervasive;

(c) If the matter is related to a material
misstatement of the financial statements that relates to specific amounts in
the financial statements (including quantitative disclosures), the auditor
should include a description and qualification of the financial effects of the
misstatement, unless impracticable

(d)        If the withdrawal or resignation results
from the inability of the auditor/the firm to complete the engagement due to bona
fide reasons;

(e) The fact that the circumstances leading to
withdrawal or resignation from the engagement were communicated to an
appropriate level of management and, where appropriate, to those charged with
governance;

(f) The response from the management or those
charged with governance on the written communication made by the auditor. If
response is not received, state the fact

(g)        Prior to resignation, the last
audit/limited review report issued by the auditor.”

 

According to the Code of Ethics, any auditor
newly appointed by an entity, prior to accepting the position as auditor, is
required to communicate with the previous auditor (clause 8 of Part I of the First
Schedule to the Chartered Accountants, Act, 1949).The objective behind such a
pre-requisite is that the incoming auditor will have an opportunity to know
from his predecessor the circumstances that resulted in the change so that he
can take necessary steps to protect his independence and professional dignity,
besides adopting caution in safeguarding the interest of the stakeholders. In
view of this, the auditor who has resigned should respond to the communication
received from the new auditor promptly, furnishing the reasons that caused his
resignation. The auditor should share a copy of the resignation letter stating
the reasons as submitted to the Registrar of Companies.

 

The
auditor who has resigned should maintain the relevant documentation in order to
demonstrate compliance with the requirements of the Implementation Guide issued
by ICAI, SAs, SQC 1 and the Code of Ethics for a period of 7 years from the
date of resignation.



Conclusion


No doubt, the present business environment
is transforming into a VUCA world, implying that there is Volatility,
Uncertainty, Complexity and Ambiguity (VUCA)! In such an environment, it is
truly a challenge for an auditor to discharge the duties associated with
assurance and to  function by upholding
standards and values as the risk matrix is escalating. Nevertheless, we must
believe that challenges are given only to those who have the ability to handle
them. We must also remember that if one auditor resigns without signing a
financial statement, such financial statement will be ultimately signed by
another auditor, of course, after taking necessary measures and steps to
complete the audit engagement in accordance with the Standards and Ethical
Framework. Therefore, before exercising the right to resign, an auditor should
explore the possibility of due discussion/communication with the management and
those charged with governance so as to secure their support and co-operation
for the smooth conduct of the audit without compromising on independence. An
auditor should also examine the possibility of giving a modified report with a
qualified opinion or adverse opinion or disclaimer of opinion instead of
resigning.

 

As discussed above the right to resign by following proper
procedures, is vested with the auditor under the law. At the same time, an
auditor’s resignation should not give an impression to the society that there
is an abdication of the duties attached to an audit responsibility. Needless to
say, audit should not be perceived as just an opportunity but it should be
viewed as a challenging responsibility and handled with due care and
caution.  A profession like ours owes it
to society to possess the courage of conviction to perform our role as an
auditor in the best interest of the stakeholders in order to establish an
unblemished track record for posterity to inherit.

 

 

INTERVIEW – CHAIRMAN AND CEO OF THE INSTITUTE OF INTERNAL AUDITORS

BCAJ interviewed Mr. Naohiro Mouri [NM], Chairman and Mr. Richard Chambers [RC], Gobal President & CEO of the Institute of Internal Auditors, USA (IIA). In the following pages we present excerpts from the full interview. The aim of the interview was to understand individual stories and experiences of these two professionals and also to get a perspective on the emerging global internal audit canvas.

In this interview Mouri San and Richard speak to BCAJ Editor Raman Jokhakar and Nandita Parekh about their life experiences, their understanding of the Internal Audit profession around the world, corporate failures and role of internal audit, rebranding internal audit, future competencies, millennial generation and the profession of internal audit.

If you can recall and share your early professional journey and share with us 2 or 3 career milestones/experiences that shaped you? What is it that made you commit to a career in Internal Auditing and what other options did you consider?

(NM): I did not originally want to become an internal auditor. I started as an external auditor. I studied accounting in school and my career path was to become a CPA and then getting into one of the external audit firms. I passed CPA, and I became an auditor with Arthur Andersen. I thought it was the greatest profession in the world. But, as the second year passed, I became senior. Come third year, I was feeling a little complacent.

I started looking outside and took an offer to become a controller of a French bank operating in Tokyo, to replace someone who was to retire. I had no prior banking experience. So I went in and the bank was gracious enough to put me through two months’ training across different parts of the bank such as trading, settlement, credit, finance and compliance, legal etc. After two months, my boss called me up and said, “Mouri, your training is about to finish. But, the gentleman who is supposed to retire, decided not to retire. You have two choices. You either have to leave the bank or you start the internal audit department”.

I was very happy doing what I was doing, I did not want to leave the bank. So, I decided to just become the internal auditor and that was actually the beginning of my internal audit career. It turned out that it was the best opportunity for me because internal audit is different in each and every engagement. I’ve changed organisations – from French Bank to German Bank to American Bank and now I’m in insurance. But I have always been in internal audit and it always just excites me every day coming into the office.

(RC): You asked for two or three kinds of milestones that then ended up shaping the course of my career. And so, what I’ll probably do is sort of fast forward.

I came out of college and went into internal audit 43 years ago. So I have been in this profession for a long time. I worked in the US government – I was an auditor for over 20 years for the army – civilian auditor of the US Army. Then I spent some time in the US Postal Service where I was a Deputy Inspector General and then the Inspector General of the state-owned company The Tennessee Valley Authority, which is the largest producer of electricity in the United States. And then I had the opportunity to retire rather young. I was 47 years, and I took a retirement, had an opportunity to do that because of some wrinkles in the law governing civil service employment in the United States. So that was a really important milestone because at that point, I had to decide what was I going to do with the rest of my life because while I retired, I knew it was really more of a career change.

The President of the IIA at that time was a gentleman named Bill Bishop, who was quite an icon in the history of the IIA and he convinced me that I come to Florida and work at the IIA sort of the equivalent of the Chief Operations Officer. First, I was a little reluctant because I thought, okay, I have been in government. I am not sure, I want to go into a not-for-profit Association. But he was very persuasive. So the next thing I knew, we packed up and moved to Florida and I joined the IIA. That was in the year 2001. Three years later, he passed away very suddenly. It was a sad time for IIA. But it was time for me to think about doing something different and so, I took a reverse career path. Most people come out of college with an accounting degree like Mouri and they go into the public accounting field and then maybe later, they do internal audit. I spent my life doing internal audit and then, when I was 50 years old, I joined PwC. I spent five years with PwC in the United States and became the national practice leader for internal audit advisory services which was part of the internal audit practice that PwC had. So, that was the second milestone.

And then the third one was, at the end of my time at PwC, the IIA Board asked me to come back as the CEO; that was 10 years ago. So, I was back in the role of being a leader in this profession along with our Chairman. I served as a spokesman for IIA and a champion for internal audit in the world. So those are three milestones that just sort of jumped out at me, that sort of say – how did I get from there to here.

Richard, this questions is for you. You have been a prolific writer, speaker, two books, blogs for eight – nine years now, videos. How did you develop this art of communicating and being, sort of, the cheerleader for the profession of internal audit? And, being so disciplined to be able to publish week after week.

(RC): Actually, next month will be the 10th year that we put in the blog. So it’s been quite a journey. The last time I looked, we were already over 400 blogs since we started. When I wrote that first blog in February of 2009, I remember it was about the crisis, the impact of the financial crisis on internal audit. And I don’t think, I said then to myself, I am doing something that I will be doing for the next decade. But what I found was that members of our profession around the world starve for very contemporary, informal, short, digestible perspectives on things that are going on… Last year, I think, the blog was read more than 250,000 times. So it is an important way to communicate in the 21st century and then if you take the blog and leverage on social media, it has a wide reach and readership.

The books, I don’t know that I really ever expected I will write a book.

But way back in 2013, the Internal Audit Foundation, our publishing arm, came to me and said, you know, your blogs have been very popular, why don’t you share some perspectives via a book. I thought, I don’t know what I have to really share? But then, I started thinking that I have the privilege of being in this profession for 40 years. I started thinking what really I have to do, is a sort of package of these major lessons I have learnt in the course of 40 years into a book. We called it Lessons Learned on the Audit Trail. We published it and that is a very popular book. Then a couple of years later, the Internal Audit Foundation sensing that the first book had gone really well, came back and said “Would you write another book” and that is how this one – the second book, the Trusted Advisors book came about. I really sort of picked up where the first book left off (because I concluded “Lessons Learned on the Audit Trail” by talking about what does it take to be a Trusted Advisor in the 21st century).

After the book “Lessons Learned on the Audit Trail” was published, I really started reflecting and I thought that I had over-simplified the message about what does it take to be a Trusted Advisor. So we went back, we did some research, we gathered perspectives from Chief Audit Executives around the world and then we put this second book together “Trusted Advisors”, which was even more popular than the first.

We are now in the process of refreshing the first book “The Lessons Learned on the Audit Trail” because the last five years have taught us a lot about the speed of risk and how risk dynamics can change everything that an internal auditor needs to focus on. So the title of the refreshed edition is the Speed of Risk: Lessons on the Audit Trail. So we go back and we talk about some of those lessons that we explored in the first book and we overlay on it the impact that a dynamic risk environment has. We talk about auditing culture, we talk about the importance of innovation and how do you audit. It has been in process. That book will be out in March 2019.

The image of an internal auditor is often perceived to be uninspiring. How do you feel this image that people perceive should undergo a makeover? Is there anything that’s happening in this direction?

(RC): Oh! I think it starts with those of us in the profession. You know, like every profession, there probably are stereotypes about internal audit. But again, you can go to a lot of companies and they don’t see those stereotypes at all because their internal audit is alive, it’s vibrant, it’s dynamic, gets involved, engaged in all the key risks of the organisation. So I think, it’s up to each one of us in this profession worldwide, to make this profession not only meaningful for us but to be able to convey what the potential and the opportunity is, so that our boards and management and even the people in the organisation who are audited, begin to appreciate what internal audit really is. It has evolved, it’s gone beyond the bean counting. I say in the 21st century, we have to know how to do more than count the beans. We have to know how they’re marketed, how they’re grown, how they’re harvested, how they’re marketed, to know everything about the life cycle of beans. We have to know how they’re marketed, how they’re grown, how they’re harvested, to know everything about the life cycle of beans. And we have to be able to convey that in a way that gets people excited.

So, related to this, is a question – Does the name “internal auditor” do any disservice to the profession because there is a connotation of an auditor primarily being an accountant? The impression is that internal auditors are an extension of the accounting profession. There have been attempts to rename the profession as risk advisors or risk professionals or GRC professionals. Any views that you have – what is there in a name or how does it matter?

(NM): I have my personal view on this originally. To me, the name convention doesn’t really matter. What matters is what we do. Even if you are called internal auditor, if you are actually being very innovative, if you are providing value to your board or the committee in the senior management, doesn’t really matter to them. I have seen different name conventions like management reviews, the audit and risk reviews and different connotations. But you know, at the end of the day, if you are actually doing what is considered as bean counting, as opposed to helping the business, protecting the organisation, being strategic, being innovative, trying to do more with less, they will actually see it through, no matter how it’s called. So that’s just my opinion about the name convention.

(RC): I agree100%. I mean, you could change the name of an airline pilot to aircraft navigation engineer but it’s still an airline pilot, right? I think, what we really need to be doing is – we need to be focusing on what does it mean to be an internal auditor. You simply say, we are going to rebrand what we do, not rebrand who we are. But we are going to elevate the level of service that we provide. So I would like to think where we are going to be the Apple of the future.

Coming to internal audit, unlike in statutory audit or an external audit, there is no legal mandate to have an internal audit. Do you think this is an impediment to the work of an internal auditor? Should there be legal force given to the position of an internal auditor?

(RC): IIA has taken the position and I happen to personally agree strongly with that, that licensing of internal auditors, somehow creating a licensed profession, is not really in the best interest of the organisations. We very rarely find any statutes or regulations that license the person who’s the CFO in the organisation or license the other professionals, Chief Risk Officer and others. Organisations, particularly publicly traded organisations or corporations, I think should be free to decide how to manage their affairs, without the long arm of government reaching in and saying – No, here’s what you have to do – here are the credentials or the skills or the qualifications. Now, we were very big proponent of listing agencies, stock exchanges, and others saying – if you’re going to be traded on an exchange, you need to have an internal audit function. I don’t think we have a problem, even seeing government regulations saying that organisations and companies should have an internal audit function. But it’s getting into it, it’s sort of mandating, who can do it and who can’t and what qualifications and credentials, because I have seen how that gets stuck in the past. If we had something like that 20 years ago, it would be mandating that in order to be internal auditors, you have to be accountants and yet today, only a fraction of what internal audit does, has any relationship to accounting. So I think, the profession needs to be live and to evolve and companies should be free to decide how they’re going to resource it.

(NM): Internal audit is a management tool to self-regulate itself, self-correct itself, find the problem by your own and correct it so that companies’ sustainability is maintained. It is a wonderful training ground for anyone who actually wants to learn about organisations – how they make money, how they lose money, what is the control that needs to actually exist. So, a number of companies use internal audit to actually put people in for training for few years and put them back to the business, to take more senior level roles. Such free flow of people is important for internal audit and for the organisation.

You know, as the world around us is changing, the competencies and skill sets that internal auditors need to own has changed tremendously. So, what are the few things that the future internal auditor must add to his bucket of competencies, to remain relevant. I am talking of survival, I am not even talking of success.

(NM): So, future is now already and this is one of the Richard’s comments. I took it from his slide. But not just the internet, now everything is on smart phone. No one goes to the bank branch anymore. Banking transactions to travel booking to buying insurance, everything is done by phone and laptop! How do we actually deal with this situation as an internal auditor?

First, you have to be extraordinary and able to work across the organisation. Earlier, there were IT auditors (called EDP auditors) and Business Auditors and Financial Auditors within internal Audit. Now the lines have been blurred because there is no process existing without technology. Thus, today’s internal auditor needs to operate across all areas, technology being an important skill to have.

Facilitation skills, because audit is all about Listening, Thinking, and Communicating. So, you have to really facilitate the conversation that goes on. And in many organisations, once you start to incorporate self-assessment process as part of the audit process, you have to facilitate the discussion. When you talk about the agile process, the scrum meeting – you have to actually chair the scrum meeting and bring the information now from your auditee or risk management or compliance, legal, finance. All this actually helps to make the internal audit better, right? So that is the second characteristic or the skills you need to have – facilitation skills.

And finally, analytical ability of course, to think in-depth about what is the root cause of the problem? Why is it happening? Because if you don’t actually get the root cause right and if you just remediate superficially, the problem will come back. We don’t want that to happen because we actually embrace remediation. We need to kill that root cause and then move on. So those three things that I would actually think, that’s really the skill sets necessary,

(RC): I speak a lot these days about the importance of internal auditors being able to provide foresight. The profession, the origins of internal audit was totally behind – in the past. What happened last year? Were the records maintained correctly? Were controls adequate? But it was in the past.

Then as the profession evolved, we became more adept at talking about the present. Okay. Here are things that we see now, that need to be corrected. But as I look to the future, we are really going to have to be able to look to the future because the things that happened yesterday are yesterday, they’re not the things that we seek. I spoke earlier this week and I said, you know, you seek out experts for the future, not for the past. So I think, internal auditors as a profession and as individuals are going to have to become much more adept looking forward. We speak a lot about what are the threats that artificial intelligence presents to our profession. I often say, if you’re only providing hindsight, that’s something artificial intelligence can easily do. If you are only providing hindsight and insight, you are still likely threatened by artificial intelligence and some of the other technology that’s coming. The things that will make it more difficult for you to be disintermediated, are your ability to leverage your professional knowledge, your professional judgment and to give the organisation perspectives about what the future holds.

This question is about recent corporate failures and the role of internal audit. Couple of lessons that both of you may want to share for the internal auditors, seeing what has happened in the UK, in Europe, and of course, America, and closer home to IL&FS in India – Anything that internal auditors need to wake up to and learn from?

(RC): I shared my message this week and I talk about it a lot. The five scariest words in the English language are “where were the internal auditors?” And it almost always comes when there’s a major scandal or collapse or calamity. It may have nothing to do with the internal auditors. But somebody will ask a question and say, well, where were the internal persons?

First of all, I would say internal auditors can audit anything, but they cannot audit everything. Okay? So we always need to keep that in mind that it is perfectly plausible that a big collapse or scandal or fraud can occur. That internal audit was focusing on all the right things and just didn’t see it. I mean, we cannot audit everything unless you’re willing to give us thousands of people. Study after study has been done looking at what contributes what, which risks are the most lethal when it comes to shareholder value. It’s not financial risk. People think, Oh! well – financial reporting fraud is what kills companies. It’s not compliance risks. Those risks together account for fewer than 20% of decline in shareholder value. It is strategic risks, it is business risks, sometimes even operational risks. it is companies that don’t see what’s coming ahead. And that is where I think, get back to internal audit, being there to help the management identify what are the things that could cause the failures and the calamities to occur. Now, some of the examples you find in Europe and others elsewhere. Some of those were compliance failures, some of those were frauds that occurred. But you know what, if you look deep enough, you’re going to find that it was culture, it was culture in the organisation. It was culture in the organisation that caused the compliance failures or the fraud or all the other things that took the company down. The compliance failure or the financial reporting fraud was symptomatic of a bigger issue. And that’s where internal audit always has to have insight.

There is a lot of talk about engaging with the millennials, the younger minds. As a profession, how would we attract the most creative, the most difficult to engage with talent within the profession?

(NM): Please watch my video, it is for you millennials. Because we were trying to make it very simple, trying to relate to building the career by using the analogy of constructing the building. So, it was actually, essentially targeting for millennials, to really understand the concept of, how important the standards are, how important that certification programme is, in what sort of thing that internal auditors do? So, please watch my video.

(RC): In the interest of time, let me just say, we over-analyse sometimes what differentiates generations. I think, millennials are a lot more like baby boomers of my generation than they are different. I think, we have a lot of the same kinds of the interests. I can tell you, we were very ambitious too. When I was a young adult, people of my generation felt like we should own the world. I think, that’s a natural kind of phenomenon. One of my daughters falls into that millennial category. These are people that are motivated by a purpose. They don’t just want a job for money, they want a purpose. There’s no greater opportunity to serve a purpose than to be an internal auditor and to exercise your craft to make things better. So I think, millennials will be attracted and are being attracted to internal audit. And I think that’s something we will continue to work on.

(You can see the unedited interview on the BCAS You Tube channel.)

52ND RESIDENTIAL REFRESHER COURSE (RRC) — THE KUMBH OF KNOWLEDGE

The calendar year 2019 started on a high note with the Residential Refresher Course of The Bombay Chartered Accountants’ Society being experienced in its 52nd ‘avatar’ at Agra from the 3rd to 6th January, 2019. The pioneering flagship event of BCAS is in the truest sense – an annual pilgrimage for CA practitioners. The two-pronged differentiators of a) being an acknowledged knowledge platform and b) being relevant with changing times, has been the hallmark of BCAS-RRC for the last six decades.

The edge of knowledge was at its fullest display at the 52nd edition. The depth of technical content, the multi-faceted integrated approach to burning issues, the experience of professional stalwarts and the actionable knowledge insights, ensured the participants remained in a ‘state of awe’ throughout.

The BCAS-RRC platform has also been a close witness to the changing landscape of the accountancy profession since the RRC was first introduced. The format has consistently evolved itself to stay relevant and continues to add maximum value to its participants in contemporary times. The mere survival of the idea for six decades, is in itself a testimony to the adaptiveness and spirit. The 52nd edition continued its evolutionary journey and many ‘firsts’ were experienced. A four-and-half hour panel discussion on integrated issues, full-day presentation papers on Practice Management, video insights by internationally renowned practice management gurus, networking session for youth members were some of the most-appreciated ‘firsts’.

The auspiciousness of lighting the lamp kick-started the proceedings with opening thoughts by President BCAS, CA. Sunil Gabhawalla and Chairman, Seminar and Membership Development Committee, CA. Narayan Pasari. The tone for the next four days was firmly seeded in this address by the President and the Chairman. A galaxy of Past Presidents of BCAS graced the opening session.

Swiftly after announcing the inauguration of the RRC, the participants experienced a superlative panel discussion on Contemporary and Burning issues with a 360-degree perspective on Direct Tax, Indirect Tax and Accounting. The panel discussion was curated in the form of case studies that were posed by Moderator and Past President CA. Chetan Shah along with President CA. Sunil Gabhawalla to the three elite panellists being CA. Pradip Kapasi (Past President BCAS) dealing with direct tax aspects, Adv. K. Vaitheeswaran dealing with indirect taxes and CA. Sudhir Soni dealing with accounting aspects. The holistic approach of the panel discussion covering three subjects left the participants satiated to a great extent but at the same time they had the urge to imbibe more. In the words of CA. Nina Kapasi, it was truly a ‘Triveni Sangam of Gyan’.

The second-day promised to be a blockbuster day with the entire day being dedicated to Practice Management. With razor sharp focused topics, the day lived up to its expectations and enabled participants with ‘How-to-do and What-we-do’. The day was modulated into various sessions each dealing with a specific aspect of (i) Client Servicing being facilitated by CA. Vaibhav Manek, Technology and Human Resources being briefed by Past President CA. Ameet Patel, Networking and Mergers by Past President CA. Shariq Contractor, Succession Planning by CA. Nilesh Vikamsey and Ethics by none other than CA. Jayant Gokhale. The five stalwarts akin to ‘pandavas’ ably bridged the multi-faceted domain of Practice Management and opened the minds of the participants to newer ideas and reinforced the values that practitioners needs to stand by. International experts Mr. Lee Frederiksen and Mr. August Aquila also shared their insights on topics through a video snippet. These 6 sessions were chaired by our regular participant CA. Nilima Joshi and Past Presidents CA. Mayur Nayak, CA. Narayan Pasari, CA. Rajesh Muni, CA. Pranay Marfatia and CA. Ashok Dhere. The participants unwinded the day with singing and live karaoke.

The third-day was vintage direct tax group discussion on case studies with paper writer CA. Milin Mehta stirring the thought-process of the participants with immersive case studies. The session was chaired by Past President CA. Anil Sathe. The presentation paper on recent developments in auditing and accounting was presented by CA. Khurshed Pastakia. This session was chaired by Vice President CA. Manish Sampat. These sessions were chaired by Vice President CA. Manish Sampat and Past President CA. Anil Sathe. The day also allowed participants to visit the famed Taj Mahal and bask in glory of India’s history. Participants networked at the Taj while being awestruck with the monument and framed themselves in a lot of group pictures. Memory will be etched for a long time.

The ultimate day came to be calling with a focused group discussion and paper solving in Indirect Taxes by paper-writer Adv. V. Raghuraman. The session was chaired by Past President CA. Deepak Shah. A presentation paper by CA. Anup Shah on succession and estate planning was cherry on the cake. This session was chaired by our regular participant CA. Phalguna Kumar.

The closing session ended by Vote of Thanks to the Speakers, Participants, Hotel Management, the BCAS Staff, and of course the members of the organising team of the Seminar & Membership Development Committee who worked on this event over last 8 months and made it perfect for the participants at Agra. Chairman CA. Narayan Pasari invited the new participants at the RRC to share their insights and their experience to the audience where they described about the knowledge they gathered over the four days and how warmly the BCAS RRC was.

Past President CA. Uday Sathaye, while speaking at the vote of thanks, praised the history of Agra and the remembrance of RRC with his superlative poem in Hindi. The Kumbh of Knowledge has turned a chapter and the
quest for excellence continues until we meet next at the 2020 RRC.

 

THE LIGHT ELEMENTS

Always India

Saffron, white and green,

What does it, to you, mean?

You must be proud,

Shout out aloud,

Ye Indians arise,

Let’s reach for the skies

All you gals
and guys! 

There will always be an India,

While there are village lanes,

Wherever there are grazing deer

Or noisy,
jam-packed trains!

There will always be an India,

While there’s a crowded street;

Wherever there’s a saint and seer

Or dirt and dust
and heat!

We shall, ere long, have an India,

Where all can read and write;

Let’s vow to lead them, now and here,

From darkness
into light!

Let’s look forward to an India,

Where drunkenness is past;

Gulp down your fruit-juice, not your beer

To break your
morning fast!

Very soon, we’ll have an India,

Where the people are well fed;

Bidding goodbye to yesteryear:

With none hungry
to bed!

There will, one day, be an India,

Where disease is abolished, and,

right from the womb to the bier,

its nationals
well nourished!

One day, we shall have an India,

Which is aglow with health,

Where no one has any idea

Of an untimely
death!

There will always be an India,

Her people well clad and shod;

In all their doings, most sincere

Protect them all,
dear God!

There will always be an India,

Where oppression is dead;

Where the people laugh, from ear to ear,

With a roof above their head!

Before long, we’ll have an India,

Where unemployment’s gone;

With factories working in top gear,

And fields
bursting with corn!

 

We’ll, very soon have an India,

Where discipline pervades;

There’s something in the atmosphere,

So that
lawlessness fades!

 

There will, one day, be an India,

Where lawbreaking’s outlawed;

No doubt, it does sound very queer,

So, help us all,
oh Lord!

 

There will always be an India,

Democratic to the core;

Of tolerance the pioneer

 And for all, an open door!

 

At all times, we’ll have an India,

Secular in each pore,

Outshouting the communal jeer

With an almighty
roar!

 

There will always be an India,

And India shall succeed;

With people, hailing from front and rear,

Of every caste
and creed!

 

There will always be an India,

United we’ll remain;

All communities will cohere

To seek their
common gain!

 

There will always be an India,

And harmony subsist;

No one can, at all, engineer

A conflict in its
midst!

 

There will always be an India,

Where amity shall reign;

Whether you are a mountaineer

Or living in the
plain!

 

There will always be, in India,

A pluralist structure,

From Kanyakumari to Kashmir

A well-blended culture!

There will always be, in India,

Different ethnic groups composed,

Ever ready to Volunteer

To Share Each other’s woes!

 

There will always be an India,

Cosmopolitan in mould;

But, all throughout, you’ll overhear:

“We’re one in the national goal!”

 

There will always be an India,

Non-violent we shall stay;

A quality we will revere

Along life’s crowded way!

 

May there, one day, be an India,

With poverty banished,

Where life has ceased, to be severe,

And destitution vanished!

 

There will always be an India,

And India shall progress,

If we resolve, this very year,

To ban all strife and stress!

 

There will always be an India,

And India shall flourish;

With peace and plenty, far and near,

As much as you can wish!

 

We shall shortly have an India,

Sweet-smelling as a rose;

That scene will, very often, appear,

Where milk and honey flows!

 

There will, one day, be an India,

Where hard work is the norm;

We’ll show the whole world that we are

A people that can perform!

 

There will always be an India,

Where good faith counts a lot;

In work, you can’t be insincere

But give it all you’ve got!

       

There shall, ere long, be an India,

With waste down to zero;

Where he, who leads the life austere,

Is the nation’s real hero!

 

There will one day, be an India,

Where dues are paid on time;

No sum remaining in arrear

Right to the smallest dime!

 

Ere long, we shall have an India,

Where corruption’s absent,

Where payments made are not 2-tier

And everything upfront!

There will always be an India,

Where charters we have signed

That, to principles, we shall adhere

To benefit
mankind!

 

There will always be an India,

Where truth shall hold its sway,

A land where you’ll constantly hear:

“Satyam eve
jayate”!

 

There will always be an India,

With honesty at heart,

And nothing causing it to veer

From the straight
and narrow path!

 

There will always be an India,

Its integrity unstained;

Our honour we shall ne’er besmear,

But keep it well
sustained!

 

There will always be an India,

Its people, so simple and kind;

No sophisticated veneer

 And with no axe to grind!

 

There will always be an India,

Hospitably inclined;

E’en the poorest keen to feed ya

Though they
themselves haven’t dined!

 

There will always be, in India,

People generous to a fault,

Who , like Santa Claus’s reindeer,

Give gifts at
every halt!

 

There will always be an India,

With goodwill everywhere;

No mud, another’s face to smear

Just genuine,
heartfelt care!

 

There will always be an India,

Where joyousness you’ll find;

Where misery is just a mere

Invention of the
mind!

 

There will always be an India,

Where merriment abounds;

Where the people couldn’t be happier

And smiles
outnumber frowns!

 

There will always be an India,

Where human rights rank high,

Where none may treat them with a sneer:

All must, with
them, comply!

 

Reproduced from BCAJ, 2001   

 

ACCOUNTING OF DIVIDEND DISTRIBUTION TAX

Started as “Accounting Standards” in
August, 2001. Dolphy Dsouza was the first contributor and had at that time
“agreed to write a series of eight articles on AS 16 to AS 23”. However, till
date – to the joy of the readers – continues as the sole contributor giving the
most important aspects of accounting standards. The feature got a suffix to its
name in July, 2002 – gap in GAAPs – and was called “Accounting Standards: Gap
in GAAPs”. Since the arrival of Ind AS it is renamed as at present.

This monthly feature carries
clarifications, commentary, comparison, and seeks to clarify about accounting
concepts and practices. The author says, “Accounting was never a debated topic
in India as much as tax is. Hopefully, my feature has a small hand in bringing
accounting to the centre stage” He shared another secret benefit: “People know
me because they have seen an unusual name in the BCA Journal for the last 18
years.  I once even got a hefty hotel
discount, as the hotel owner was a CA and an avid reader of the BCAJ!”

 

ACCOUNTING OF DIVIDEND DISTRIBUTION TAX

 

Prior to 1st June, 1997,
companies used to pay dividend to their shareholders after withholding tax at
prescribed rates. The shareholders were allowed to use tax deducted by the
company against tax payable on their own income. Collection of tax from
individual shareholders in this manner was cumbersome and involved a lot of
paper work. To make dividend taxation more efficient, the government introduced
the concept of dividend distribution tax (DDT). Key provisions related to DDT
are given below:

 

(a) Under DDT, each company distributing dividend
needs to pay DDT at stated rate to the government. Consequently, dividend
income will be tax free in the hands of shareholders.

(b) DDT is payable even if no income-tax is payable
on the total income, e.g., a company that is exempt from tax on its entire
income will still pay DDT.

(c) DDT is payable within fourteen
days from the date of (i) declaration of any dividend, (ii) distribution of any
dividend, or (iii) payment of any dividend, whichever is earliest.

(d) DDT paid by a company in this manner is treated
as the final payment of tax in respect of dividend and no further credit
therefore can be claimed either by the company or by the recipient of dividend.
However, dividend received is tax free in the hand of all recipients (both
Indian/ foreign).

(e) Only dividend received from domestic companies
is exempt in the hands of recipient. Dividend received from overseas companies
which do not pay DDT is taxable in the hands of recipient, except for the
impact of double tax relief treaties, if any.

(f)  No DDT is required to be paid by the ultimate
parent on distribution of profits arising from dividend income earned by it
from its subsidiaries. However, no such exemption is available for dividend
income earned from investment in associates/ joint ventures or other companies.
Also, no exemption is available to a parent which is subsidiary of another
company.

 

DDT accounting under Ind AS 12 involves
certain issues. The most important issue is that for the entity paying
dividend, whether DDT is an income-tax covered within the scope of Ind AS 12?
Will DDT be an equity adjustment or a P&L charge or this is an accounting policy
choice?

 

Consider that in the structure below,
company B distributes dividend to its equity shareholders, i.e., company A and
pays DDT thereon.

 

 

For DDT accounting in SFS and CFS of B, one
may consider paragraphs 52A/ 52B and 65A of Ind AS 12.

 

“52A     In
some jurisdictions, income taxes are payable at a higher or lower rate if part
or all of the net profit or retained earnings is paid out as a dividend to
shareholders of the entity. In some other jurisdictions, income taxes may be
refundable or payable if part or all of the net profit or retained earnings is
paid out as a dividend to shareholders of the entity. In these circumstances,
current and deferred tax assets and liabilities are measured at the tax rate
applicable to undistributed profits.

 

52B      In
the circumstances described in paragraph 52A, the income tax consequences of
dividends are recognised when a liability to pay the dividend is recognised.
The income tax consequences of dividends are more directly linked to past
transactions or events than to distributions to owners. Therefore, the income
tax consequences of dividends are recognised in profit or loss for the period
as required by paragraph 58 except to the extent that the income tax
consequences of dividends arise from the circumstances described in paragraph
58(a) and (b).”

 

“65A.    When
an entity pays dividends to its shareholders, it may be required to pay a
portion of the dividends to taxation authorities on behalf of shareholders. In
many jurisdictions, this amount is referred to as a withholding tax. Such an
amount paid or payable to taxation authorities is charged to equity as a part
of the dividends.”

 

One may argue that DDT is in substance a
portion of dividend paid to taxation authorities on behalf of shareholders. The
government’s objective for introduction of DDT was not to levy differential tax
on profits distributed by a company. Rather, its intention is to make tax
collection process on dividends more efficient. DDT is payable only if
dividends are distributed to shareholders and its introduction was coupled with
abolition of tax payable on dividend. DDT in substance does not adjust the
corporate tax rate, and is a payment to equity holders in their capacity as
equity holders. This aspect is also recognised in the IASB framework. Thus, DDT
is not in the nature of income-taxes under paragraphs 52A and 52B. Rather, it
is covered under paragraph 65A. Hence, in the SFS and CFS of company B, the DDT
charge will be to equity. The Accounting Standards Board (ASB) of the ICAI has
issued a FAQ regarding DDT accounting. The FAQ confirms this position with
regard to accounting SFS and CFS of company B. However, this position is very
contentious globally and there is a strong argument to treat DDT as an
additional tax in substance. Therefore, though there is no difference in the
Ind AS and IFRS standard on DDT, the practice applied in India may be different
from the practice applied globally.

 

In the SFS of the company receiving
dividend, i.e., company  A, net dividend
received is recognised as income. In CFS of company A, there is no dividend
distribution to an outsider. Rather, funds are being transferred from one
entity to another within the same group, resulting in DDT pay-out to an entity
(tax authority) outside the group. Hence, in the CFS of company A, DDT cannot
be treated as equity adjustment; rather, it is charged to profit or loss.

 

If company B as well as company A pay
dividend in the same year, company B will pay DDT on dividend distributed.
Under the income-tax laws, DDT paid by company B is allowed as set off against
the DDT liability of company A, resulting in reduction of company A’s DDT
liability to this extent. In this scenario, an issue arises how should the
company A treat DDT paid by company B in its CFS?

 

One view is that DDT paid relates to company
B’s dividend. From a group perspective, for transferring cash from one entity
to another, cash/tax was paid to the tax authorities. Hence, it should be
charged to P&L in company A’s CFS. The other view is that due to offset mechanism,
no DDT in substance was paid on dividend distributed by company B. Rather,
company A has paid DDT on its dividend distribution to its shareholders. Hence,
DDT should be charged to equity in company A’s CFS to the extent of offset
available.

 

The ITFG has clarified that second view
should be followed. Under this view, the following table explains the amount to
be charged to P&L and to equity in company A’s CFS:

 

Scenario 1

DDT paid by B

A’s DDT liability

Offset used by A

Equity charge in A’s CFS

P&L charge in A’s CFS

I

30,000

30,000

30,000

30,000

Nil

II

30,000

20,000

20,000

20,000

10,000

III

30,000

40,000

30,000

30,000 + 10,000

Nil

 

 

The above is a simple example where both
parent and subsidiary pay dividends concurrently.  It may so happen that a subsidiary has
distributable profits, but will distribute those, beyond the current financial
year.  In such a case, in parent’s CFS, a
DTL should be recognised at the reporting date in respect of DDT payable on
dividend expected to be distributed by the subsidiary in near future. Absent
offset benefit, the corresponding amount is charged as expense to P&L.
However, there is no direct requirement related to recognition of asset toward
offset available.

 

Considering the above, the ITFG (Bulletin 9)
has stated that at the reporting date, the parent in its CFS will recognise DTL
in respect of DDT payable on dividend to be distributed by subsidiary. The
corresponding amount is charged to P&L. In the next reporting period, on
payment of dividend by both entities and realisation of offset, the parent will
credit P&L and debit the amount to equity. Effectively, the ITFG views
require DDT on expected distribution to be charged to P&L in the first
reporting period which will be reversed in the immediate next period. The
authors believe that the ITFG view does not reflect substance of the
arrangement. Moreover, such an approach will create an unwarranted volatility
in P&L for two reporting periods which should be avoided. The standard
requires creation of a DTA if there is a tax planning opportunity in place. If
the parent company has a strategy in place to distribute dividends to its
shareholders out of the dividends it receives from its subsidiaries, within the
same year, then it will be able to save on the DDT. Consequently, corresponding
to the DTL, an equivalent DTA should also be recognised in the first reporting
period. We recommend that ITFG may reconsider its views on the matter.

 

ITFG (Bulletin 18) has subsequently changed
its position and clarified that accounting treatment of DDT credit depends on
whether or not it is probable that the parent will be able to utilise the same
for set off against its liability to pay DDT. This assessment can be made only
by considering the particular facts and circumstances of each case including
the parent’s policy regarding dividends, historical record of payment of
dividends by the parent, availability of distributable profit and cash,
etc.  The revised ITFG position is a step
in the right direction.

 

In light of the ITFG 18, a few important
questions and clarifications are given below:

  •     Firstly, whether the ITFG
    is mandatory? The answer to this would depend upon an assessment of whether the
    ITFG interpretation reflects a reasonable and globally acceptable
    interpretation of the standard. The view in ITFG 18, is in my opinion a
    reasonable and correct interpretation, and should therefore be considered
    mandatory.
  •     Secondly, when changing the
    practice to comply with ITFG 18, would it be a change in estimate or change in
    policy or an error?  In line with global
    practice with respect to issuance of IFRICs from time to time the author
    believes that the change is a change in an estimate rather than a change in an
    accounting policy or an error.
  •     Lastly, should the ITFG be
    implemented as soon as it is issued? This is more of a practical issue. It may
    not always be possible for entities to comply with an ITFG in the accounts of
    the quarter in which it is issued. 
    Nonetheless, entities should give effect to the ITFG in the following
    quarter.      

 

 

INTERCEPTION, INSPECTION, DETENTION OR SEIZURE, CONFISCATION

 

GST law had
promised to usher in a host of reforms on hastle free movement goods across the
country. Some of the promising features of GST involved abolition of
check-posts, common way bill management systems, uniformity in law enforcement
across the country thus boosting business efficiency in logistics. This has certainly
freed business enterprises from shackles of traditional law enforcement and is
on course to digitization of enforcement to improve the administrative
effectiveness and minimise hurdles to trade and commerce.

 

In-transit
inspection plays a critical role in law enforcement. Interception, detention
and seizure provisions of the GST law perform the function of administrating
law on a real-time basis to check tax evasion during movement of goods. Section
68 of Chapter XIV contains enforcement provisions and grants wide powers to the
tax administration. Active tax enforcement not only detects tax evasion but
also acts as a deterrent. This article is an attempt to elaborate provisions in
detail and identify the critical areas one needs to address in such matters.

 

GENERAL UNDERSTANDING OF INTERCEPTION, DETENTION & SEIZURE


‘Interception’ is generally understood as the act of preventing someone or
something from continuing to a destination. Black’s Law dictionary states: “the
term usually refers to covert reception by a law enforcement agency” and P
Ramanatha Iyer’s Law Lexicon states interception as “seize, catch or
stop (letter etc.) in transmit”.

 

‘Detention’ is understood as the act of taking custody over someone or
something. Black’s law dictionary states “the act or an instance of holding a
person in custody; confinement or compulsory delay”; Law Lexicon states
“the action of detaining, the keeping in confinement or custody, a keeping from
going on or proceeding”.

 

‘Seizure’ is understood as the act of capturing or confiscating something by
force (i.e. against the will of the person having possession). Black’s Law
states “the act or an instance of taking possession of a person or property by
legal right or process, esp, in constitutional law, a confiscation or arrest
that may interfere with a person’s reasonable expectation of privacy; Law
Lexicon explains seizure as taking possession of property by an officer
under legal process.

 

‘Confiscation’ means permanent deprivation of property by order of a court of
competent authority (Law Lexicon). Black’s Law states “seizure of
property for the public treasury”.

 

One would observe
from the ensuing paragraphs, that each term represents a different stage in a
proceeding and the rigours increase as the stage progresses. For eg.
Interception requires a simple reporting and release of goods but as soon the
goods are proposed for detention and seizure, the intensity of the powers of
the officer increasing. Same goes with once the goods enter confiscation
proceedings, the power of the officers over the goods are more stringent than
in cases of detention. Rights and obligations of the officer and the tax payer
are different at each level of the proceeding and hence one needs to be mindful
of the stage of the proceedings while addressing the questions of the officer.

 

IN-TRANSIT DOCUMENTATION U/S. 68(1) R/W RULE 138A


Section 68 provides
for carrying specified documents/ devices along with the conveyance of
consignment during the transportation of goods. The section empowers the
‘proper officer’ to intercept the conveyance at any place and require
the ‘person in charge’ of the conveyance to produce the prescribed
documents/devices for verification and allow inspection of goods. The term
proper officer has been defined to mean the officer who has been assigned the
powers of interception by the respective Commissioners of the CGST/SGST. While
determining the proper officer care should be taken that the said officer has
territorial and functional jurisdiction at the point of interception. ‘Person
in charge’ of conveyance has not been defined and should be understood as
referring to the transporter and driver of the conveyance performing the
movement of goods.

 

Rule 138A (inserted
w.e.f. 30-08-2017) provides for the requirement of carrying a tax invoice, bill
of supply, bill of entry or delivery challan and e-way bill (as applicable). In
terms of section 138A(5), the Commissioner in special cases is permitted to
waive the requirement of e-way bill. The contents of a tax invoice, bill of
supply, delivery challan and e-way bill are prescribed in Rule 46, 46A and 49.
In addition to the said manual documents, e-way bill requirements as generated
from the common portal were mandated vide Notification 27/2017-CT dt.
30.08.2017 w.e.f. from 01/02/2018 but ultimately implemented from 01-04-2018.
Certain States (like Karnataka) implemented these provisions even prior to the
Centre invoking the E-way bill provisions for intra-state transactions.

 

INTERCEPTING POWERS U/S. 68(2) R/W RULE 138 B


Section 68(2) r/w
Rule 138B grants the powers to the Commissioner or proper officer to intercept
any conveyance for verification of the e-way bill for all inter-state and
intra-state movement. Physical verification of the intercepted vehicle should
be carried out only by empowered officers. In terms of CBIC Circular
3/3/2017-GST dt. 05.07.2017, the Inspector of Central Tax and his superiors
have been granted powers of interception. The proviso of the said rule states
that in case of receipt of any specific information of tax evasion, physical
verification of the conveyance can be carried out by any other officer after
obtaining necessary approval from the Commissioner.

 

INSPECTING POWERS U/S. 68(2) R/W RILE 138 C


Section 68(2) r/w
Rule 138C requires that every inspection of goods in transit would have to be
recorded online by the proper officer within 24 hours of inspection and the
final report recorded within 3 days of inspection (in Form EWB-03). Sub rule
(2) states that where any physical verification of goods has been performed
during transit in one State or in any other State, no further physical
verification of the said conveyance should be carried out again in the State
unless specific information of evasion is available with the officer
subsequently. Rule 138D specifies that the detention of the vehicle for the
purpose of inspection should not exceed 30 minutes and the transporter can
upload the details in cases where the detention is beyond 30 minutes.

 

DETENTION & SEIZURE POWERS U/S.129


The proper officer
is empowered to detain the conveyance and the goods during its transit in case
of any contravention of the provisions of the Act (report of detention in Form
EWB-04). The detention proceedings require issuance of a notice, seeking a
reply and concluding the proceeding by way of a detention/seizure order. In
terms of the CBIC Circular dt 05.07.2017 (supra) detention powers can be
exercised only by the Asst/Dy. Commissioner of Central Tax. The goods would be
released by the proper officer only on payment of the applicable tax and
penalty or submission of a security in prescribed form.

 

The said section
also prescribes the procedure to be adopted on detention of the goods in
transit. In this regard, CBIC has issued circulars (Circular 41/15/2018-GST dt.
13-04-2018; No 49/23/2018-GST dt. 21-06-2018 and No 64/38/2018-GST dt.
14-09-2018) which specify the detailed procedure and forms to the followed
(MOV-01 to MOV-11) by the Central Tax officers in matters of interception,
inspection and detention. Key points emerging from the Circular are as follows:

 

  •     The jurisdictional
    Commissioner or the designated proper officer is permitted to conduct
    interception and inspection of conveyances within the jurisdictional area
    specified by the Commissioner. One should verify whether the locational
    Commissionerate of the region has issued any such trade notice assigning
    functional/ geographical jurisdiction.
  •     The proper officer believes
    that the movement of goods is with an intention of evading tax, he may directly
    invoke section 130 where a fine in lieu of compensation may be imposed.
  •     Where an order is passed
    under the CGST Act, a corresponding order shall also be passed under the
    respective State laws as well.
  •     Demand of the tax, penalty,
    fine or other charges would be uploaded on the electronic liability register
    and in case of unregistered persons a temporary ID would be created for
    discharge of the liability posted on the common portal.
  •     In cases of multiple
    consignments, only goods or conveyance in respect of which there is violation
    of the provisions of the Act should be detained while the rest of the
    consignment should be permitted to be released by the proper officer.
  •     Consignment of goods should
    not be detained where there are clerical errors such as spelling mistakes in
    name of consignor/ee, PIN code, locality, document number of e-way bill,
    vehicle number, etc. in cases of clerical errors, a maximum penalty of Rs. 500
    each under respective law could be imposed.
  •     Section 129 does not
    mandate payment of tax in all cases and the owner of goods scan exercise the
    option of furnishing a security (in prescribed form and a bond supported by a
    bank guarantee equal to amount payable).

 

CONFISCATION POWERS U/S.130


In cases where the
proper officer has formed the view that any of the five circumstances exists,
the goods are liable for confiscation – where any person:

 

i.    Supplies or receives goods in contravention
of the provisions of Act/ rules with intention of tax evasion

ii.   Does not account for goods liable for paying
tax

iii.   Supplies goods without obtaining a
registration number

iv.  Contravenes any provision of the Act with
intention of tax evasion

v.   Uses any conveyance as means of transport for
tax evasion unless the owner of the conveyance has no knowledge of this action

 

The fine legal
difference between detention and confiscation is that detention is invoked only
on suspicion over tax evasion whereas confiscation require reasons beyond doubt
that the goods are a result of tax evasion [Kerala High Court in Indus
Towers vs. Asst. State Tax officer 2018 (1) TMI 1313]

 

In terms of the
CBIC Circular dt 05.07.2017 (supra) confiscation powers can be exercised only
by the Asst/Dy Commissioner of Central Tax. In cases of confiscation, the title
over the goods shall vest upon the Government and the owner of the goods cannot
exercise any rights over the goods. Whenever any confiscation of goods is
ordered, the owner of the goods has the option to pay a fine in lieu of
confiscation which shall not exceed the market value of goods confiscated less
the tax chargeable thereon, and shall in no case be less than the amount
specified u/s. 129. In cases of confiscation of the conveyance itself, the fine
shall not exceed the tax payable on the goods under conveyance.

 

APPROPRIATE TAX ADMINISTRATION


Though GST has been
built on a national platform, legislative powers under IGST, CGST and SGST Act
have certain inherent geographical limitations. In addition to that, the Centre
and State have notified the respective workforce for administration. It would
be thus important to identify the ‘proper officer’ having geographical
jurisdiction over goods under transit.

 

We can take an
example of a case where goods under inter-state movement from Kerala (KL) to
Delhi (DL) are intercepted by a State officer in Maharashtra (MH) and detained
for lack of proper documentation. Whether the intercepting officer in MH could
be considered as the ‘proper officer’ for interception, detention, seizure,
inspection and adjudication of the goods under movement which is an inter-state
supply from KL to DL? The practical experience thus far is that the State
officers detain the goods and direct the assessee to open a temporary ID in
their State and discharge the taxes as if it is an intra-state sale within MH.

 

Primarily, three
theories can exist (A) Only Origin State authorities have jurisdiction over
interception; or (B) All state authorities (including origin and destination
state) have jurisdiction over the goods under transit as long as the goods are
physically present in their state boundaries during exercise of powers or (C)
While state authorities have powers of interception, the final assessment of
the tax involved would be made by the officer in the State of origin based on
the detention report.

 

A) Geographical
jurisdiction

Article 246A(1)
empower both the Centre and State to make laws pertaining to goods and service
tax imposed by the Union or State. 246A(2) grants exclusive powers to Centre to
legislate on matters of inter-state trade of commerce. Article 286 places a
clear embargo on the State to impose a tax on supply of goods or services ‘outside
a State’ and or ‘in course of import or export of goods or services’.
Article 258 provides for the Union to confer powers to the State or its
officers either conditionally or unconditionally, with consent of the President
of India and the Governor of the respective State, in relation to any matter to
which the Executive of the Union extends. Where such powers have been conferred
by the Union to the State, administration costs attributable to the staff
empowered would be payable by the Centre to State. The IGST has not invoked
Article 258 but empowered the State workforce through statutory provisions.

 

In terms of Article
286(2), the Centre has been placed with the responsibility to formulate the
principles of determining where the supply takes place. It is in exercise of
these powers that the IGST Act has formulated provisions for ascertaining the
character of supply (i.e. intra-state vs. inter-state) based on the place of
supply of such services: Chapter IV and V of the IGST Act read together answer
(a) the characterisation of the supply (inter-state or intra-state); and (b)
where locus of the supply. This is broadly akin to the provisions of section 3,
4 and 5 of the Central Sales Tax Act, 1956 (CST law).

 

In the context of
administration, the GST council has decided that Centre & State’s
administration would be a unified force. Discussions on cross empowerment in
GST council involved five options which were discussed at length and the fifth
option attained consensus only in the 9th GST Council meeting (para
28 of minutes of meeting). The key thrust of the decisions where (a) Unified
tax payer and administration interface;(b) Allocation of tax payer base between
the Centre and State based on statistical data for administering the CGST/SGST
Acts (b) Concurrent enforcement powers to Centre & State on entire value
chain based on intelligence inputs of respective field formations; (c) Powers
under IGST law to be cross empowered on the same basis as that of CGST/ SGST
Act. However, Centre has exclusive powers to administer issues around ‘place of
supply’, ‘export’, ‘imports’ etc. These decisions were translated into the CGST
and SGST Act as follows:

 

  •     Section 6 of CGST/ SGST
    cross empowers the corresponding officer as per the allocation criteria agreed
    at the GST Council (stated above). Further, it has been agreed that where an officer
    has initiated any proceeding on a subject matter under an Act, no proceeding
    shall be initiated by the officer of the corresponding administration on the
    same subject. This ensured that unified interface was maintained.
  •     In respect of the IGST Act,
    section 20 does not borrow the cross-empowerment provisions of the CGST Act.
    The IGST Act has a different mechanism of empowerment of both Central/ State
    officers. Section 3 grants powers to central tax officers for exercise of all
    powers of the Act. The CBIC has issued Circulars No. 3/3/2017dt 05.07.2017
    assigning powers to the Central Tax Officers. Section 4 also authorises
    officers appointed under the State GST Acts as proper officers under the IGST
    Act subject to exceptions and conditions of the GST Council.
  •     The Commissioner of the
    State would have thus issued appropriate notifications under their respective
    State laws assigning the jurisdiction of enforcement action to the officers and
    by virtue of the said notification, they would acquire enforcement jurisdiction
    even under the IGST Act. Therefore State officers who are empowered under the
    State GST to perform enforcement activity would also be empowered to perform
    the enforcement function under the IGST Act.

 

We may recollect
that CST law empowered the ‘appropriate state’ from where the movement of goods
commenced to collect and enforce payment of tax through their general sales tax
law (Section 9). This enabled the origin state to acquire jurisdiction on
inter-state sale movement and enforcement action. Transit states acquired
enforcement jurisdiction over such inter-state movement through transit pass
and way bill provisions which setup a presumption that the goods have been sold
within the State on failure to produce such documentation. The IGST Act is on a
different footing. Firstly, States do not have the same autonomous powers akin
to section 9(2) of CST Act in matters of collection and enforcement provisions.
The IGST Act is a self-sufficient Act containing its own collection and enforcement
provisions. Secondly, IGST Act has limited itself to appointing the State
officers as proper officers for the purpose the IGST Act (section 4) rather
adopting the provisions of the respective State law. Thirdly, IGST does not
provide for any presumption as to the sale of goods within a state in the
absence of any prescriptive documentation. In other words, the character of the
transaction being an inter-state transaction does not get altered during the
process of detention and/or seizure and tax due on such transaction should be
assessed from the Origin State. Even in case there is a dispute on the
inter-state character, the Centre has exclusive domain over examining its
nature in view of Article 286(2) and the decision of the 9th GST Council meeting.

 

The following
overall inferences can be formed from above analysis:

 

  •     Power of legislation is
    distinct from the power of administration and it is not necessary that the
    power of legislation and enforcement are with the same authority (eg. CST Act).
    The administrative provisions of IGST act are self-contained in the said
    enactment itself.
  •     IGST Act only borrows the
    work force of the State for implementing the Act. State work force is required
    to follow the Circulars, Notifications of the CBIC / Central Tax office while
    exercising their powers under the IGST Act. The statutory powers are not
    sourced from the State legislation independently like section 9(2) of the CST
    law (refer discussion below).
  •     There is no specific
    notification or circular issued under the IGST Act assigning the functions and
    territorial limits to the State workforce. In the absence of a specific
    notification or circular one may view that (a) each state workforce would
    operate within the respective State boundaries and the role assigned by the
    State Commissioner (enforcement, vigilance, audit, range, etc) in that boundary
    would operate equally for the IGST Act or (b) the State workforce would have
    pan India powers on inter-state transactions and would exercise these powers
    under IGST law in the absence of any geographical limits over the officers
    under the IGST law. The former seems to be a more plausible approach to
    resolving the issue on jurisdiction.

 

  •     The power of collection on
    inter-state supplies from State X lies with the Centre. However, State X in
    terms of Article 286 is precluded over imposing tax on supplies occurring in
    all other States or in import/ export transactions. Therefore intercepting
    officers in State X should refrain imposing any tax on inter-state     movement u/s. 129.

 

Coming to the issue
taken up earlier, MH State should not be considered as the ‘proper officer’ for
the inter-state movement from KL to DL as the jurisdiction of administration is
between the Centre/ State workforce operating from the State of Kerala. An
alternative view would be that the IGST Act being a pan Indian enactment has
borrowed the State officers across India for the purpose of enforcement in
their respective geographical area. MH State may not have administrative power
over the ‘transaction of supply’ but it could have powers over the ‘goods under
movement’ for the limited purpose of interception, inspection, detention and
seizure.



Though the above
powers of interception, detention and release would be exercised by the MH
officer under the IGST Act, the final assessment of the liability on the goods
will have to take place at the Origin State (KL) either by the Central/ State
administration depending on the allocation.

 

FUNCTIONAL JURISDICTION


Section 2(91) defines the proper officer to mean the person who has been
assigned the function by the Commissioner. CBEC has in its Circular No.
3/3/2017-GST dt. 05-07-2017 designated the Inspector of Central Tax with powers
of interception and the Asst./Dy. Commissioner of Central Tax with the powers
of adjudication over the matter of release of goods u/s. 129. These powers
would be exercised by the respective officers within the confines of the
geography assigned to the said officers. It is expected that similar
Circulars/notifications are issued by the respective State Commissioners
assigning the functional jurisdiction to their officers. Therefore, one would
have to carefully peruse the relevant notification/ circulars under the States
for consideration to establish the function and geographical jurisdiction over
a particular transaction/goods.

 

OVERALL SCHEME OF SECTION 129


Some important
questions arise on the overall scheme of section 129:

 

Whether
proceedings u/s. 129 is interim in nature and subject to the final assessment
in the hands of
the supplier?

 

Section 129
provides for detention, seizure and release of goods by following a prescribed
procedure of issuance of a notice, seeking a reply and furnishing a release
order. A key feature is that it permits release of the goods on furnishing a
security in the prescribed form, indicating that the goods are being released
on a provisional basis and the assessment would be finalised subsequently. But
the provision subsequently goes on to state that on payment of the amount, all
proceedings in respect of the notice would deemed to the concluded. There seems
to be a divergence in the way the provisions are drafted. One theory suggests
that the proceedings are interim in nature and subject to its finalisation
before the assessing authority who would take cognizance of the entire
proceeding u/s. 64, 73, 74 and complete the assessment of the supplier taking
into account the report of the inspecting authority. This was the manner in
which the VAT law was also being enforced across States. The other theory
suggests that the proceedings are conclusive and no further action needs to be
taken at the assessing officer’s end on the subject matter. Now there could be
instances where the supplier would have already reported the transaction in its
GSTR-3B/GSTR-1 and discharged the applicable taxes. If the goods in transit are
subjected to the said provisions and cleared on payment of applicable tax and
penalty, it would result in a double taxation of the very same goods which
clearly does not seem to be the intent of law. It appears to the author that
the scope of section 68 r/w 129 is to examine the completeness of documents and
provide information to the assessing authority, which could be obtained only
from real time enforcement, for finalisation of the assessment and not just to
conclude the entire proceeding at the place of interception. The term
‘contravention’ in section 129 should be understood contextually on with
reference to the compliance of documentation during the movement of goods and
not beyond that. The author believes that all these proceedings would finally
culminate by way of an assessment u/s. 64, 73 or 74.

 

How do we
harmoniously apply the penalty imposable u/s. 129 vs. 122(1) (i), (ii), (xiv),
(xv), (xviii) vs. 122(2) : specific vs. general : lower vs. higher penalty?

 

Both section 129
and 122 are penal provisions imposing penalty for offences under the Act. There
is an overlap of the scope of the said sections resulting in ambiguity. The
said sections are briefly extracted below

 

Section 129

Section 122(1) (i), (ii), (xiv), (xv),
(xviii)

Section 122(2)

Penalty for contravention of goods in
transit

Specific Penalties for movement of goods
without invoice/ documents, evasion of tax, goods liable for confiscation,
etc

Penalty where tax has not been paid or
short paid

100% of tax payable (in case of exempted
goods – 2% of value of goods) (OR)

50% of value of goods less tax paid (5%
in case of exempted goods)

Penalty of 10,000 or 100% of tax evaded
w.e.h.

Penalty of Rs. 10,000 or 10% of the tax
due w.e.h.

 

 

The field
formations are consistently applying the provisions which results in a higher
collection without assessing the applicable section under which penalty are
imposable. While certainly section 129 is specific to cases where goods are in
transit, section 122 also provides for cases of imposition of penalty where
goods are transported without cover of documents. One possible resolution to
this conflict may be as follows:

  •     Section 129 is specific to
    cases of non-compliance identified during transit and section 122(1)
    applies only to cases where the transportation has completed and the
    non-compliance is identified after the goods have reached their
    destination (say the registered premises)

 

  •     Section 122(1) is narrower
    in its scope in so far as it requires tax to be evaded for its application.
    There could be cases where goods have reached the destination without
    appropriate documents but duly accounted for in the books of accounts. In such
    cases, section 129 cannot be imposed and section 122(1) would apply to cases
    involving tax evasion.
  •     Section 122(2) on the other
    hand being a general provision for penalty should not apply since section
    122(1) and 129 are more specific contenders on this subject matter

 

PRACTICAL ISSUES ON INTERCEPTION / INSPECTION / DETENTION & SEIZURE

Apart from the
legal analysis, the trade and community are facing multiple challenges at the
ground level on matters of such matters. The issues are tabulated below for
easy reference:

 

S No

Issue

Possible resolution

1

E-way bill not containing key particulars such as
Invoice No., Taxable value, Tax , etc OR E-way bill not generated

Supreme Court in Guljag Industries (below) has
stated that mens-rea need not be examined in cases of statutory offences.
Therefore, tax & penalty can be imposed u/s 129 equivalent to the tax in
cases of such violations. Recent decision of MP High Court in Gati
Kintetsu Express Pvt ltd vs. CCT 2018 (15) GSTL 310 affirmed penalty in
case of violation and distinguished Allahabad High Court’s decision in VSL
Alloys (India) Pvt Ltd vs. State of UP 2018 (5) TMI 455.

2

E-way bill & Invoice is valid and containing
accurate particulars but quantity reported is higher than the physical
quantity in the conveyance (due to evaporation, wastage, water content, etc)

Taxable quantity/value being higher than the physical
quantity, there is no short payment of tax and hence detention would be
incorrect. At the most in case where there is an error, general penalty of
Rs. 25,000/- may be imposed for discrepancies.

3

E-way bill is valid and generated but invoice/ delivery
challan is not carried along with consignment – all particulars in e-way bill
match with consignment

Rule 138A and CBEC Circular require both the
self-generated document (invoice/delivery challan) and e-way bill to be
carried. E-way bill is a system generated document containing all particulars
of the invoice and a verifiable/non-destructible document and hence superior
in status vis-à-vis the invoice. Ideally no penalty should be imposed in such
scenarios.

4

E-way bill not reconciling with the some valuation
particulars of Invoice – such as Taxable Value, Tax etc but matching with
other particulars

Officers may disregard the e–way bill entirely and
state that conveyance is without e-way bill in which case the entire penalty
would be imposable. Alternatively, if it is established that e-way bill
relates to the very same consignment, then possibly e-way bill would be
considered for examination, ignoring the invoice and the physical
verification would be performed accordingly. Any excess stock/ value above
the e-way bill may be subject to penalty.

 

 

 

5 & 6

Delivery challan & e-way bill issued and officer contesting
that Invoice should be issued (OR) Wrong Tax Type recorded in the E-way bill
& Invoice i.e. IGST instead of CGST/SGST

Intercepting officer is only required to assess with
the prescribed documents are being carried and they reconcile with the physical
movment of goods. Any dispute on the type of documentation, etc., is not with
the domain of intercepting officer and is for the assesing authority to
examine and take a legal position on that front.

7

Goods sent on approval and at particular location for
sale within the six months time limit but e-way has expired

This is a tricky issue. Whether goods sent on approval
and retained by the recipient for approval for six months are required to be
under a live e-way bill. While one may say that this is incorrect another
argument would be that goods should be either under a live e-way bill or at
the registered presmises of the supplier and hence registration should be
obtained for places where goods are temporarily stored.

8

Alternative/ Wrong route adopted by the transporter but
e-way bill valid

Not a contravention of any provision and section 129
cannot be invoked unless the officer is establish tax evasion.

9

Difference between invoice date : e-way bill date
(could range from few months to year) especially in case of goods consigned
after auction

Inspecting officers are intercepting goods where
invoice is significantly prior to e-way bill. Section 31 permits invoice to
be raised on or before removal of goods. A tax invoice is a permanent
document & does not have any expiry date unlike e-way bill which has is a
temporary document. Therefore, such action is incorrect in law.

10

Owner of goods – Ex-works/ FOB contracts, etc.

Section 129 requires the owner to come forward for the
entire proceedings. There have been cases where the officer has rejected the
purchaser from hearing the matter. There have been cases where the officer
has called upon the purchaser rather than the seller since the purchaser
resides in the same State. This is a challenge since ownership is differently
understood from the term supplier and recipient.

11

Whether inspecting officer can question the veracity of
the delivery address (eg. Delivery at a fourth location not belonging to the
customer)

Section 129 is invoked only where there is a
contravention of provisions during movement of goods. Being tax paid goods,
there is nothing which is further payable irrespective of the destination of
goods. Unless there is specific information of tax evasion, the officer
cannot question the veracity of the delivery address.

12

Multiple consignment – detain only goods in respect of
violation : multiple invoice vs. multiple quantity

CBIC circular (supra) states that in case of multiple
consignments, detention proceedings should be applied only on the consignment
under which there is a violation. In certain cases where an invoice has
multiple line items and the discrepancy is only with respect to one line
item, equity demands that detention proceedings should be restricted only to
the said line item in respect of which there is a violation and the rest of
the consignment should be related without any delay.

13

Officers not accepting the security for release of
goods u/s. 129

This is clearly violation of statutory mandate by the
Officers.

 

 

SOME LEGAL PRECEDENTS


Some judicial
precedents on this subject are as follows:

  •     Failure to report material
    particulars on the statutory documents under movement is a statutory offence.
    Penalty is for this statutory offence and there is no question of proving of
    intention or of mens-rea as the same is excluded from the category of essential
    element for imposing penalty. Guljag Industries vs. CTO [2007] 9 VST 1 (SC).
  •     Declaration uploaded on the
    website after the detention of goods does not absolve the penalty of the
    assessee. The time of declaration is critical. Asst. State Tax officer vs.
    Indus Towers Ltd 2018 (7) TMI 1181    (Ker-HC)
  •     Squad / enforcement
    officers cannot detain goods over dispute on HSN/ classification. This is under
    the domain of the assessing authority. At the most, the squad officer could
    report this discrepancy to the assessing authority for further action at their
    end. Jeyyam Global Foods (P) Ltd., vs. UOI 2019 (2) TMI 124 (Mad-HC)
  •     Supreme Court CST vs. PT
    Enterprises (2000) 117 STC 315 (SC)     – The inspecting authority has the
    powers to question the valuation of the goods under the Madhya Pradesh Sales
    Tax Act. This decision was rendered in view of the specific requirement that
    inspecting authority could detain goods in case of evasion on the value     of goods.

 

CONCLUSION


Provisions of
interception, detention and seizure are open ended giving wide powers to the
officer. This could result in dual taxation of the very same goods without any
input tax credit in the hands of the recipient. Moreover, diverse practices are
being followed among the field formations across the country leading to
inequities in application of law. Certain legal provisions are overlapping
giving choices to the administration over the subject goods and the inclination
of the administration is to choose a stricter provision thereby making the other
provision practically redundant.  There
are multiple challenges on the front of administration, appeal, etc., which
needs to be addressed both at the macro and micro level by the GST council.
Therefore, it is imperative that the GST council and the Government take
proactive steps in cleansing the entire scheme in order to bring uniformity in
implementation of law across the country.

 

DEBT OF GRATITUDE

We are profoundly grateful to the members of the Editorial Board for their long and consistent years of guidance and single-minded dedication. Editorial Board was first formed in 1990. It consists of past editors and committed contributors. The Board deals with policy matters and serves as a brainstorming platform and a sounding board for the Editor. The Board also gives valuable critique to ensure that the Journal runs on basic principles and yet evolves with time.

Kishor B. Karia

Member since
November, 1990
till date

Ashok K. Dhere

Member since
November, 1990
till date

Kahan Chand Narang

Member since
August, 2000
till date

Gautam S. Nayak Member since
August, 2003 till date

Sanjeev R. Pandit

Member since
August, 2004 to
July, 2006 &
August, 2007 till date

Anil J. Sathe

Member since
August, 2004 to
July, 2009 &
August, 2011 till date

Anup P. Shah

Member since
August, 2008

Raman H. Jokhakar

Editor
Member since
August, 2016

Pooja Punjabi

Convenor of Journal Committee

Namrata Dedhia

Convenor of Journal Committee

Akshata Kapadia

Convenor of Journal Committee

Sunil B. Gabhawalla

Ex Officio

Manish Sampat

Ex Officio

BCAJ FEATURES

Features are the bedrock of the BCAJ. Some features report
and digest. Some others explain and analyse. Some provide inspiration or probe
unfairness in laws. The following list gives the statistics of continuing
features that are more than five years old:

 

 

Feature

Started in the Year

Number of years

1

Tribunal
News

1969-70

50

2

In
the High Courts

1971–72

48

3

From
Published Accounts

1980-81

39

4

Controversies

1981-82

38

5

Closements

1982-83

37

6

Miscellanea

1984-85

35

7

Is
It Fair

1996-97

23

8

Allied
Laws

1996-97

23

9

International
Taxation

1997-98

22

10

Corporate
Law Corner

1988-89 to 2006 &

2015-16 till date

18

4

11

Glimpses
of Supreme Court Rulings

2001-02

18

12

Ind
AS / IGAAP – Interpretation & Practical Application

2001-02

18

13

Light
Elements

1995-96 to 2004

2006-07 to 2012

2014-15

2017 till date

9

6

1

2

14

Laws
& Business

2002-03

17

15

Namaskaar

2002-03

17

16

Right
to Information

2004-05

15

17

Securities
Laws

2006-07

13

18

VAT
(Sales Tax Corner)

1995-96

24

19

Indirect
Taxes – Recent Decisions

2009-10

10

20

Ethics
& You

2012-13

7

 

 

LANRUOJ TNATNUOCCA DERETRAHC YABMOB EHT (JACB)

SPECIAL EDITORIAL

We bring you a special edition of the JACB journal.
The January, 2019 editorial carried these words of wisdom:

“Friends, the word of the year declared by two prominent dictionaries recently gives it away: Toxic and Misinformation. Both words articulate the stark realities of our times ….”.

This feature is based on the above theme.

If you have any comments/views on this feature please feel free to draft a mail to us, and keep it in your draft folder. Even if you send it, it makes no difference. To quote George Bernard Shaw, “The single biggest problem in communication is the illusion that it has taken place”.

Happy Golden Jubilee reading!
*ditor

*E Edited

GOLDEN CONTENTS AND ITS ECONOMIC IMPACT – EXTRACTS FROM WHITE PAPER

JACB brought to its esteemed readers Golden Contents over the course of the last twelve months to commemorate its golden jubilee. We have been overwhelmed with the responses received thereby encouraging us to come out with a white paper. We provide below extracts from the white paper that will shortly be published in full in resplendent colors. You may place orders for the same at
your own risk.

Abstract of White Paper – “Golden Contents and Its Economic Impact”

Introduction

Economic development is understood in many different ways but it is clear that there has always been a close correlation and vital linkage between human endeavor and civilisation’s economic relationships.

Golden Contents and Its Direct and Indirect Impacts

  • Cost Effective

No making charges on golden content

  • Economic Impact

Since the golden content cannot be used as a collateral to raise high-cost loans, subscribers have benefited significantly by not paying huge interest costs on such non-availed loans. There is significant social benefit too since these non-availed funds can now be utilised by banks to provide loans to critical sectors of the economy.
This in turn leads to economy, efficiency and transparency in functioning of our financial institutions and markets and reinforces investor confidence, thereby reducing the cost of capital and boosting private consumption expenditure and private investment positively impacting economic growth rates.This is expected to add 50 basis points to the economy’s GDP growth rate on a secular basis over the next 5 years. Tax revenues are also expected to increase marginally, in line with the contributory increase to GDP.

Conclusion

The velocity of an economy is limited by the speed at which innovation can take place. The Golden Contents, a path-breaking innovation, is expected to propel the economy towards its potential growth trajectory.

QUOTE OF THE MONTH

FROM THE DESK OF THE PRESIDENT

Subscribers to our JACB journal receive mailers “From the Desk of the President” much before they get to see the printed version of it in the journal. Readers have all along been eager to know what exactly is in that desk.
What we got from the desk of the President:

  • Old calculator (not functioning).
  • A blue ballpoint pen (functioning).
  • Income tax ready reckoner (AY 1987-88).
  • JACB journal (April, 2001 without front cover).
  • Old spectacle case of a former president.
    (sd/- Forensic auditors)

KNOW YOUR JOURNAL

The BCA Journal is also available in two formats, offering twin benefits.

GOLDEN CONTENT INTERVIEW: EMINENT PERSONALITY, YOUNGEST CA

JACB: Tell us a bit about yourself.

MM: I am CA Mutandis…..Mutatis Mutandis. Youngest CA. 83 years old.

JACB: How do you see the profession developing?

MM: Nemo debet esse judex in propria qusa. (No one can be a judge in his own cause)

JACB: Huh! Could you please share your views on ethics in profession?

MM: Ubi jus, ibi officium (Where there is a right, there is also a duty)

JACB: What are your views on usage of fair values in financial reporting?

MM: Nemo tenetur ad impossible. (No one is required to do what is impossible)

JACB: Sir, your responses using legal maxims makes it very difficult for me to understand. Since when did you get into this habit?

MM: Ab initio.

JACB: I do not understand what you are saying sir.

MM: Ignorantia legis jurisneminem excusat.

JACB: ***&%…..How long do you think we can go on like this?

MM: Ceteres paribus, in praesenti.

JACB: I better close this, Sir. Thank you very much for sparing your valuable time. In closing could you explain in plain English how you claim to be the youngest CA when you are claiming super senior citizen tax benefits.

MM: I cleared yesterday…. CA Results were announced yesterday you see.

TAX PLANNING – HOW TO SAVE TAXES (INDIVIDUAL ASSESSEES)

  • Resign from high-paying job and one saves taxes on income under the head salaries. The tax savings will be on monthly fixed salary, bonuses, perquisites, as well as on stock options.
  • If one has a second house, demolish it (if it is say an apartment on the 14th floor, we do understand you have a challenge) that is self-occupied so that you do not pay tax on notional income. Note: Our sympathies are with those who took our advice and demolished their second home considering the interim budget proposals. But take heart, it is just an interim budget.
  • We have refrained from providing any inputs for Business income since we understand all have expertise in saving taxes under the income head of business and professional income.
  • Attend AGMs of companies where you hold shares and vociferously protest dividend payments and exercise your right to disapprove board-recommended dividends. You save dividend taxes at 10% if your dividend income was expected to be above threshold.

GLIMPSES FROM SUPREME COURT

In Camera – In this issue we bring you photographs shot from various angles from different perspectives and using drones that provide good glimpses from the Supreme Court.

*ditorial note: Glimpse photos not published since the matter is sub-judice.

NAMASKAAR

FROM UNPUBLISHED ACCOUNTS

Compilation From Notes
Basis of Preparation of Financial Statements

  • These financial statements are prepared in accordance with the whims and fancies of our management under the historical cost convention on accrual basis except for most transactions and events that are reported on a convenience accounting basis.

Use of Judgments and Assumptions

  • The preparation of financial statements in conformity with the applicable accounting framework requires management to make estimates, judgments and assumptions. Management has made an assumption that users of financial statements can easily be tricked into believing the contents of the financial statements.
  •  Management estimates used in the preparation of financial statements are aimed at underestimating expenses and liabilities and overestimating income and assets.

Disclosures

  • Included in land is a large parcel of land amounting to Rs. 14,000 crore measured using the revaluation model that actually belongs to our neighbouring company.
  • The fair valuation of our assets is based on stooping to levels that are lower than Level 3.
  • We have not disclosed many liabilities as well as contingent liabilities considering the material impact that it could have on our investors’ well-being and on the health of their investment portfolio.

NEW FEATURES THAT WE EXPECT TO INRODUCE SHORTLY IN YOUR JOURNAL

  • Birth Taxation
  • Inheritance Taxation
  • Inter-planetary Taxation
  • Internal audit of statutory audit
  • Independence movement of Independent Directors
  • And more!!!

JACB GOLDEN JUBILEE SPECIAL ANNOUNCEMENT

Section 40A(3) – No Disallowance u/s. 40A(3) when genuineness of the transaction is not doubted and incurring of such cash expenses was necessary as part of business expediency.

37.  [2018] 66 ITR (Trib.) 371 (Delhi-Trib.) KGL
Networks (P) Ltd. vs. ACIT ITA No.:
301/Del./2018 A.Y.:
2014-2015 Dated: 2nd July, 2018

 

Section 40A(3) – No Disallowance u/s.
40A(3) when genuineness of the transaction is not doubted and incurring of such
cash expenses was necessary as part of business expediency.

 

FACTS


The assessee-company
was a clearing and forwarding agent and had made payments to various reputed
airlines. The Assessing Officer (AO) noted from the tax audit report that the
assessee-company had incurred expenditure amounting to Rs.8,17,807/- in cash.
The A.O. accordingly disallowed the same in light of section 40A(3), being in
excess of Rs. 20,000/-.

The assessee-company challenged the addition
before the Ld. CIT(A) stating that payments were made to various reputed
airlines whose PAN had been duly submitted. The genuineness of the payment was
not doubted, therefore, no disallowance could be made u/s. 40A(3) of the Act.
The CIT(A), however, did not accept the contention of assessee-company and
noted that Rule 6DD had been amended in 2008. The CIT(A) held that the Rule in
its present form does not include any such circumstances like business
expediency or exceptional circumstances, under which, such cash payments could
be made as a business expenditure u/s. 40A(3).

Aggrieved by the order, Assessee Company filed
appeal to ITAT.

 

HELD


The
Tribunal relied on the decision of Attar Singh Gurmukh Singh vs. ITO (1991)
191 ITR 667 (SC) wherein it was held that section 40A(3) of the Income-tax
Act, 1961, is not arbitrary and does not amount to a restriction on the fundamental
right to carry on business. Consideration of business expediency and other
relevant factors are not excluded. Genuine and bonafide transactions are
not taken out of the sweep of the section. It will be clear from the provisions
of section 40A(3) and Rule 6DD that they are intended to regulate business
transactions and to prevent the use of unaccounted money or reduce the chances
to use black money for business transactions. The contention of the assessee
that owing to business expediency, obligation and exigency, the assessee had to
make cash payment for purchase of goods so essential for carrying on of his
business, was also not disputed by the AO.



It was also held that the primary object of
enacting section 40A(3) was twofold, firstly, putting a check on trading
transactions with a mind to evade the liability to tax on income earned out of
such transaction and, secondly, to inculcate the banking habits amongst the
business community. The ITAT concluded that Even though there was an amendment
in Rule 6DD of I.T. Rules as is noted by the Ld. CIT(A), but in section 40A(3)
of the I.T. Act, 1961 itself, an exception is provided on account of nature and
extent of banking facilities available, consideration of business expediency
and other relevant factors. The nature of business of assessee-company and the
agency carried on by the assessee-company on behalf of others clearly showed
that for business expediency in the line of business of assessee-company,
sometimes cash payments were made to complete the work on behalf of Principal.



The
assessee-company, under such compelling reasons, made payments in cash. The AO
and CIT(A) had not doubted the identity of the payee and the genuineness of the
transaction in the matter. The source of payment was also not doubted by the
authorities. ITAT mainly relied on the decision of ITAT, Delhi in the case of ACIT
vs. Marigold Merchandise (P) Ltd (ITA No. 5170/Del./2014).

 

Thus, in the
opinion of the ITAT no disallowance u/s. 40A(3) could be made when genuineness
of the transaction was not doubted and incurring of such expenses was necessary
as part of business expediency.

Section 40(a)(ia) – No Disallowance u/s. 40(a)(ia) for non-deduction of TDS u/s. 194C if no oral or written contract between the contractor and contractee.

36.  [2018] 66 ITR (Trib.) 525 (Vizag. – Trib.) ACIT vs.
A. Kasivishwanadhan ITA No.:
138/Viz/2017 A.Y.:
2012-13 Dated: 20th July, 2018

 

Section 40(a)(ia) – No Disallowance u/s.
40(a)(ia) for non-deduction of TDS u/s. 194C if no oral or written contract
between the contractor and contractee.



FACTS


In this case assessee was engaged in the business
which required large labour force within short notice of time. Assessee had
incurred labour expenses and payments were made through maistries who procured
the labour as per the need of the assessee. The Assessing Officer (AO) inferred
that there is a principal/agent relationship between the assessee and Maistry
and the transactions were in the nature of supply of labour contract and
accordingly held that such payments are liable for deduction of tax at source
u/s. 194C of Act. Since the assessee had not deducted TDS on labour charges,
the AO disallowed the expenditure u/s. 40(a)(ia) of Act.

 

Aggrieved by
the order of the AO, the assessee appealed before the CIT(A). The assessee
submitted before the CIT(A) that there was no agreement written or oral between
the assessee and the maistries and in the absence of any contract between both
the parties, it cannot be construed that there exists any principal agent
relationship/contract between them. The Assessee argued that the maistries were
not the labour contractors and they were randomly the first among the group of
few people claiming to be the leader of that group. They procured the labour
along with them as when required and for the sake of convenience, the assessee
made the payments to one of the maistries or group leader who in turn
distributed the payments to the rest of the group members. There was no implied
or express contract for supply of labour between the assessee and the maistry.
Thus there was no contract and the question of deduction of tax at source did
not arise. The CIT(A) observed that the labour maistries were not the labour
contractors and the payments made to labour maistries did not bear the
character of contract payment as contemplated u/s.194C of Act, accordingly held
that the payments made to the maistries did not attract deduction of tax at
source u/s. 194C of the Act and accordingly directed the AO to delete the
addition.

 

Aggrieved by the order, revenue filed appeal
to ITAT.

 

HELD


The Tribunal concluded that the assessee was
engaged in labour oriented industry which required labour at irregular
intervals yet urgently. It was not convenient to find individual labourers and
hence, the assessee identified some of the maistries or group leaders to
procure the labour who can work as per the requirement of the job. As stated by
the AR, the group leaders were only responsible for procuring the labour and
work was done under the assessee’s personal supervision. There was no written
or oral agreement or contract between the maistries and the assessee for
getting the work done through the maistry or to supply the labour as it was a
general practice used for convenience of obtaining distant labourers. Neither
there was a contract for supply of labour nor there was contract for getting
the work done through labour by the assessee with the maistries. The AO simply
considered the payments made to the group leaders and landed in a presumption
that there was contract in existence for supply of labour between the maistries
and the assessee. The AO did not examine the maistries before coming to such
conclusion. As per the provisions of section 194C of the Act, there must be
contract for deduction of TDS including supply of labour for carrying out any
work.

 

Thus, in the
opinion of the ITAT No Disallowance u/s. 40(a)(ia) for non deduction of TDS
u/s. 194C if no oral or written contract exist between the contractor and
contractee.

 

Section 153A – Copies of sale deeds of land found during the course of search operation which were already considered by the AO while framing the assessment u/s. 143(3) cannot be considered as incriminating material and, therefore, the assessment framed u/s. 153A on the basis of the contents of the same sale deeds is bad in law.

35.  [2019] 197 TTJ 502 (Delhi – Trib.) Lord Krishna
Dwellers (P) Ltd vs. DCIT ITA No.:
5294/Del/2013 A.Y.:  2006-07. Dated: 17th December, 2018.

 

Section 153A – Copies of sale deeds of land
found during the course of search operation which were already considered by
the AO while framing the assessment u/s. 143(3) cannot be considered as
incriminating material and, therefore, the assessment framed u/s. 153A on the
basis of the contents of the same sale deeds is bad in law.

 

FACTS


A search operation
was conducted at the premises of the assessee on 21.01.2011. Original return of
income was filed on 21.11.2006 and the assessment was framed u/s. 143(3) of the
Act vide order dated 13.05.2008. During the course of original assessment
proceedings the details of vendors from whom the land was purchased during the
F.Y. 2005-06 alongwith copies of land deed were furnished for verification.
After considering all this, the Assessing Officer framed the assessment. The
same sale deeds were found during the course of search operation and on the
basis of the very same sale deeds, the Assessing Officer came to the conclusion
that an amount of Rs.1.05 crore has been paid to various persons in cash.

 

Aggrieved by
the assessment order, the assessee preferred an appeal to the CIT(A). The
CIT(A) confirmed the same.

 

HELD 


The Tribunal
held that the sale deeds, transactions when duly recorded in the regular books
of account, could not be considered as incriminating material found during the
course of search operation. It was not the case of the Revenue that if the
search and seizure operation had not been conducted, the Revenue could never
have come to know that the assesse had entered into various purchase
transactions of land. The contention of the Departmental Representative that
though the deeds were before the AO, but he examined the deeds only to
ascertain the circle rate vis a vis the transaction rate and never went into
the cash transactions reflected in the land deed was not acceptable. Once a
document is filed before the AO during the course of search proceedings it is
assumed that he has gone through the contents of those documents and has
verified the same.

 

The copies of sale deed filed by the revenue
were the same which were considered by the AO while framing assessment u/s.
143(3). Therefore the assessment framed u/s. 153A was bad in law and was
quashed.

Section 54F r.w.s 50 – Deeming fiction of section 50 cannot be extended to the deduction allowable u/s. 54F and therefore, assessee is entitled for deduction u/s. 54F on the capital gains arising on the sale of depreciable assets as these assets were held for a period of more than thirty-six months.

34.  [2019] 197 TTJ 583 (Mumbai – Trib.) DCIT vs.
Hrishikesh D. Pai ITA No.:
2766/Mum/2017 A.Y.:
2012-13 Dated: 26th September, 2018

           

Section 54F r.w.s 50 – Deeming fiction of
section 50 cannot be extended to the deduction allowable u/s. 54F and
therefore, assessee is entitled for deduction u/s. 54F on the capital gains
arising on the sale of depreciable assets as these assets were held for a
period of more than thirty-six months.

 

FACTS


The assessee, a doctor by profession, had
sold a property, which was used by him for commercial purposes for his clinic and
on which depreciation was also claimed u/s. 32. The said property was held by
the assessee for a period of more than thirty six months before being sold.
Further, the assessee had purchased a new residential flat from the
consideration received from sale of the above property. The assessee claimed
deduction under section 54F on the capital gains arising from the sale of
aforesaid property.

 

The Assessing Officer treated the aforesaid
property as short-term capital assets within the deeming provision of section
50 and held that the assessee was not entitled for deduction u/s. 54F with
respect to short-term capital gains arising on sale of such short term capital
assets, as the deduction u/s. 54F was available only on the long-term capital
gains arising from transfer of long-term capital assets.

 

Aggrieved by the assessment order, the
assessee preferred an appeal to the CIT(A). The CIT(A) allowed the deduction
u/s. 54F to the assessee. Being aggrieved by the CIT(A) order, the Revenue
filed an appeal before the Tribunal.

 

HELD


The Tribunal
held that section 50 created a deeming fiction by modifying provisions of
sections 48 and 49 for the purposes of computation of capital gains chargeable
to tax u/s. 45 with
respect to the depreciable assets forming part of block of assets and there was
nothing in section 50 which could suggest that deeming fiction was to be
extended beyond what was stated in provisions of section 50 and it couldnot be
extended to deduction allowable to the assessee u/s. 54F which was an independent section operating in
altogether different field.

 

Thus, the assessee was entitled for
deduction u/s. 54F on the capital gains arising on the sale of depreciable
assets being commercial property.

 

In view of the aforesaid, the appeal filed
by the revenue deserved to be dismissed.

Section 23 – Assessee is entitled to claim benefit u/s. 23(1)(c) if assessee intended to let out property and took efforts in letting out of property and the property remained vacant despite such efforts made by the assessee.

33. 
[2019] 101 taxmann.com 45 (Delhi-Trib.) Priyankanki Singh Sood vs. ACIT ITA No.: 6698/Del./2015 A.Y.: 2012-13 Dated: 13th December, 2018

 

Section 23 – Assessee is entitled to claim
benefit u/s. 23(1)(c) if assessee intended to let out property and took efforts
in letting out of property and the property remained vacant despite such
efforts made by the assessee.

 

FACTS


In the course
of assessment proceedings, the Assessing Officer (AO) observed that the assessee
owned a property at Madras and that the assesse had not offered any income
under the head `Income from House Property’ in respect of the said house
property at Madras. The AO considered the annual value of the property to be
the sum for which the property might reasonably be expected to be let out and
after allowing standard deduction of 30% as per provisions of section 24(a) of
the Act, he made an addition of Rs. 49,849 under the head income from house
property.

 

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

 

Aggrieved, the assessee preferred an appeal
to the Tribunal,

 

HELD


The Tribunal
noted that the assessee purchased the said property in 1980 and the same was
continuously let out upto assessment year 2001-02 and thereafter from
assessment year 2002-03, suitable tenant could not be found and hence the
property remained vacant. The Tribunal observed that section 23(1)(c) was
attracted only upon fulfilment of the three conditions cumulatively. Upon cumulative
satisfaction of the three conditions the amount received or receivable shall be
deemed to be the annual value. The three conditions, according to the Tribunal,
are-

–  the property or part thereof must be let; and

–  it should have been vacant during the whole
or any part of the previous year; and

– owing to such
vacancy the actual rent received or receivable by the owner in respect thereof
should be less than the sum referred to in the clause

 

Further, the Tribunal also observed that
clause (c) would not apply in situations where the property was not let out at
all during the previous years or even if let out was not vacant during whole or
any part of the previous year.

 

The Tribunal observed that the property at
Madras which was in dispute remained vacant after assessment year 2002-03 till
date. The Tribunal noted that since the property could not be let out due to
inherent defects and the property remained vacant, the assessee had rightly
applied section 23(1)(c) of the Act. The said property after being vacant also
was not under self-occupation of the assessee. Further, it was not the case of
the revenue that the property was not let out prior to assessment year 2002-03.
Under the circumstances, the Tribunal, following the decision of the co-ordinate
bench in Premsudha Exports (P.) Ltd. vs. ACIT [2008] 110 ITD 158 (Mum.)
held that the assessee was entitled to benefit u/s. 23(1)(c) of the Act. The
appeal filed by the assessee was allowed.

CBDT Circulars – CBDT Circular No. 3 of 2018 dated 11th July, 2018 which specifies the revised monetary limits for filing appeal by the department before Income-tax Appellate Tribunal, High Courts and SLPs/appeals before the Supreme Court is applicable even in respect of the appeals filed prior to the date of circular

32. 
[2019] 101 taxmann.com 248 (Ahmedabad-Trib.) DCIT vs. Shashiben Rajendra Makhijani ITA No.: 254 and 255/Ahd./2016 A.Y.: 2009-10 and 2010-11 Dated: 17th December, 2018

 

CBDT Circulars – CBDT Circular No. 3 of
2018 dated 11th July, 2018 which specifies the revised monetary
limits for filing appeal by the department before Income-tax Appellate
Tribunal, High Courts and SLPs/appeals before the Supreme Court is applicable
even in respect of the appeals filed prior to the date of circular

 

FACTS


During the course of appellate proceedings,
the assessee submitted that the appeals filed by the revenue were to be
dismissed on account of low tax effect in view of the CBDT Circular No. 3 of
2018 dated 11th July, 2018.

 

HELD


The Tribunal observed that, indeed, the tax
effect in the instant appeals was less than the limit of Rs. 20 lakh prescribed
by CBDT Circular No. 3 of 2018 dated 11th July, 2018. The Tribunal
observed the assessee’s case was not covered within the exemption clause,
clause (10) of the said CBDT Circular and since tax effect was less than Rs. 20
lakh, the appeals were held to be not maintainable.

Section 56(2)(vii)(b) – Agricultural land falls within the definition of immovable property and covered within the scope of section 56(2)(vii)(b) irrespective of whether the same falls within the definition of capital asset u/s. 2(14) of the Act or otherwise.

This is the first
and oldest monthly feature of the BCAJ. Even before the BCAJ started, when
there were no means to obtain ITAT judgments – BCAS sent important judgments as
‘bulletins’. In fact, BCAJ has its origins in Tribunal Judgments. The first
BCAJ of January, 1969 contained full text of three judgments.

We are told that the first convenor of
the journal committee, B C Parikh used to collect and select the decisions to
be published for first decade or so. Ashok Dhere, under his guidance compiled
it for nearly five years till he got transferred to a new column Excise Law
Corner. Jagdish D Shah started to contribute from 1983 and it read “condensed
by Jagdish D Shah” indicating that full text was compressed. Jagdish D Shah was
joined over the years by Shailesh Kamdar (for 11 years), Pranav Sayta (for 6
years) amongst others. Jagdish T Punjabi joined in 2008-09; Bhadresh Doshi in
2009-10 till 2018. Devendra Jain and Tejaswini Ghag started to contribute from
2018. Jagdish D Shah remains a contributor for more than thirty years now.

While Part A covered Reported Decisions,
Part B carried unreported decisions that came from various sources. Dhishat
Mehta and Geeta Jani joined in 2007-08 to pen Part C containing International
tax decisions.

The decisions earlier were sourced from
counsels and CAs that required follow up and regular contact. Special bench
decisions were published in full. The compiling of this feature starts with the
process of identifying tribunal decisions from a number of sources. Selection
of cases is done on a number of grounds: relevance to readers, case not
repeating a settled ratio, and the rationale adopted by the bench members.

What keeps the contributors going for so
many years: “Contributing monthly keeps our academic journey going. It keeps
our quest for knowledge alive”; “it is a joy to work as a team and contributing
to the profession” were some of the answers. No wonder that the features
section since inception of the BCAJ starts with the Tribunal News!

31.  [2019] 101 taxmann.com 391 (Jaipur-Trib.) ITO vs.
Trilok Chand Sain ITA No.:
499/Jp./2018 A.Y.:
2014-15 Dated: 7th January, 2019

 

Section 56(2)(vii)(b) – Agricultural land
falls within the definition of immovable property and covered within the scope
of section 56(2)(vii)(b) irrespective of whether the same falls within the
definition of capital asset u/s. 2(14) of the Act or otherwise.

 

FACTS


The assessee, an individual, purchased three
plots of land and claimed that the said plots of land did not fall within the
definition of capital asset as per section 2(14) of the Income-tax Act, 1961
(“the Act”). The Assessing Officer (AO) invoked provisions of section
56(2)(vii)(b) of the Act and made addition of Rs. 1,51,06,224 being the difference
between the sale consideration as per the sale deed and the value determined by
the stamp valuation authority.

 

Aggrieved, the assessee preferred an appeal
to the CIT(A). The CIT(A) held that land in question being agricultural land is
not a capital asset and the said transaction of purchase of land did not
attract the provisions of section 56(2)(vii)(b) of the Act. He further held
that the assessee was in the business of sale/purchase of property and the land
so purchased was his stock-in-trade and since the stock-in-trade is also
excluded from the definition of capital asset, provisions of section
56(2)(vii)(b) of the Act were not applicable. He deleted the addition of Rs.
1,51,06,224 made to the total income of the assessee.

 

Aggrieved, the Revenue preferred an appeal
to the Tribunal.

 

HELD


Section 56(2)(vii)(b) refers to any
immovable property and the same is not limited to any particular nature of
immovable property. The Tribunal also held that the section refers to
`immovable property’ which by its grammatical meaning would mean all and any
property which is immovable in nature i.e. attached to or forming part of earth
surface. The issue as to whether such agricultural land falls in the definition
of capital asset u/s. 2(14) or whether such agricultural land is part of
stock-in-trade could not be read into the definition of any immovable property
used in the context of section 56(2)(vii)(b) of the Act and is therefore not
relevant.

 

The appeal filed by the Revenue was
dismissed by the Tribunal.

 

Section 56(2)(vii) – Provisions do not apply to rights shares offered on a proportionate basis even if the offer price is less than the FMV of the shares.


This is the first
and oldest monthly feature of the BCAJ. Even before the BCAJ started, when
there were no means to obtain ITAT judgments – BCAS sent important judgments as
‘bulletins’. In fact, BCAJ has its origins in Tribunal Judgments. The first
BCAJ of January, 1969 contained full text of three judgments.

We are told that the first convenor of
the journal committee, B C Parikh used to collect and select the decisions to
be published for first decade or so. Ashok Dhere, under his guidance compiled
it for nearly five years till he got transferred to a new column Excise Law
Corner. Jagdish D Shah started to contribute from 1983 and it read “condensed
by Jagdish D Shah” indicating that full text was compressed. Jagdish D Shah was
joined over the years by Shailesh Kamdar (for 11 years), Pranav Sayta (for 6
years) amongst others. Jagdish T Punjabi joined in 2008-09; Bhadresh Doshi in
2009-10 till 2018. Devendra Jain and Tejaswini Ghag started to contribute from
2018. Jagdish D Shah remains a contributor for more than thirty years now.

While Part A covered Reported Decisions,
Part B carried unreported decisions that came from various sources. Dhishat
Mehta and Geeta Jani joined in 2007-08 to pen Part C containing International
tax decisions.

The decisions earlier were sourced from
counsels and CAs that required follow up and regular contact. Special bench
decisions were published in full. The compiling of this feature starts with the
process of identifying tribunal decisions from a number of sources. Selection
of cases is done on a number of grounds: relevance to readers, case not
repeating a settled ratio, and the rationale adopted by the bench members.

What keeps the contributors going for so
many years: “Contributing monthly keeps our academic journey going. It keeps
our quest for knowledge alive”; “it is a joy to work as a team and contributing
to the profession” were some of the answers. No wonder that the features
section since inception of the BCAJ starts with the Tribunal News!


10. 
Asst. CIT vs. Subhodh Menon (Mumbai) Members:  R. C. Sharma (A. M.) and Ram Lal Negi (J. M.)
ITA No.: 676/Mum/2015 A. Y.: 2010-11. Dated: 7th Decmber, 2018
Counsel for Revenue / Assessee:  Tejveer
Singh and Abhijeet Deshmukh / S.E. Dastur

 

Section 56(2)(vii) –
Provisions do not apply to rights shares offered on a proportionate basis even
if the offer price is less than the FMV of the shares.

 

FACTS


The assessee was an executive director of
Dorf Ketal Chemicals India Pvt. Ltd. (“Dorf Ketal”). He filed his return of
income showing total income of Rs. 25.04 crore (revised).  On 28.01.2010 the assessee acquired 20,94,032
shares in Dorf Ketal @ Rs.100/- per share i.e. @ face value for a consideration
of Rs.20.94 crore. According to the A.O., under Rule 11UA(c), the fair market
value of the share of Dorf Ketal was Rs.1,438.64. Therefore, the difference in
share value was brought to tax u/s. 56(2)(vii)(c) and the total income was
assessed at Rs. 326.32 crore. According to the AO, the assessee being a
salaried employee, the shares allotted to him could also be treated as
perquisite or profit in lieu of salary u/s. 17. Reliance was placed on the
ratio laid down by the Bombay High Court in the case of CIT vs D. R. Pathak (99
ITR 14).  The CIT(A) on appeal, relying
on the decision of the Mumbai tribunal in the case of Sudhir Menon HUF vs.
Asst. CIT (I.T.A. No. 4887/Mum/2013 dated 12.03.2014) held in favour of the
assessee.  Being aggrieved, the revenue
appealed before the Tribunal.

 

Before the Tribunal, the revenue justified
the order of the AO and contended that:

 

  •  The assessee has not disputed the valuation of
    the shares at Rs.1,538.64 per share as on 31,03.2009, which was in accordance
    with the Rules. As regards argument of the assessee that after the date of the
    issue of fresh shares, the valuation of the shares has been drastically reduced
    with inclusion of the new contribution of share capital,  according to the revenue, the share value of
    the company has to be valued as on date of issue or prior to the issue date to
    determine the fair market value;
  •  The assessee was offered 21,78,204 shares at
    face value of Rs. 100. However, he accepted only 20,94,032 shares. Thus,
    according to the revenue, there has been disproportionate allotment in the case
    of the assessee and thus the decision of the Mumbai Tribunal in the case of
    Sudhir Menon HUF, relied on by the CIT(A), was distinguishable;
  •  The provisions of section 56(2)(vii) are in the
    nature of anti-abuse provisions and therefore should be interpreted strictly.
    For the purpose, it relied on the Circular No. 1/2011 dated 6th
    April, 2011 and the decisions of the Hyderabad Tribunal in case of Rain Cement
    Limited vs. DC IT (2017 1 NYPTTJ 362) and Kolkata Tribunal in the case of
    Instrumentarium Corporation Ltd. (2016 (7) TMI 760 – ITAT Kolkata);

 

HELD


According to the Tribunal, the issue under
consideration was squarely covered by the order of the Mumbai Tribunal in the
case of Sudhir Menon HUF.  As held under
the said decision, the Tribunal held that the provisions of section
56(2)(vii)(c) is not applicable to the facts and circumstances of the
appellant’s case.

 

As regards contention of
“disproportionate allotment” raised by the revenue, according to the
Tribunal, it is only when a higher than the proportionate allotment is received
by a shareholder, the provisions of section 56(2)(vii) get attracted. In the
instant case, the assessee applied for and was allotted a lesser than the
proportionate shares offered to him and his shareholding reduced from 34.57% to
33.30%.

 

The Tribunal further noted that the
transaction of issue of shares was carried out to comply with a covenant in the
loan agreement with the bank to fund the acquisition of the business by the subsidiary
in USA. Thus, the shares were issued by Dorf Ketal for a bonafide reason and as
a matter of business exigency. As per Circular No.1/2011 explaining the
provision of section 56(2)(vii) and relied on by the revenue, “the
intention was not to tax transactions carried out in the normal course of
business or trade, the profit of which are taxable under the specific
head of income”. Thus, the Circular supports the assessee’s case.

 

As regards the
alternated contention of the AO that the same should be considered for
taxability as perquisite u/s. 17, the tribunal held that the provisions of
section 17 do not apply to the shares allotted by Dorf Ketal to the assessee,
as the shares were not allotted to the assessee in his capacity of being an
employee of the company. The shares were offered and allotted to the assessee
by virtue of the assessee being a shareholder of the company. Therefore the
provisions of section 17 were not applicable. For the purpose, the Tribunal
referred to the Board Circular No. 710 dated 24th July, 1995 which
provides that where shares are offered by a company to a shareholder, who
happens to be an employee of the company, at the same price as have been
offered to other shareholders or the general public, there will be no perquisite
in the shareholder’s hands. In the instant case, the Tribunal noted that the
shares were offered to the assessee and other shareholders at a uniform rate of
Rs. 100 and therefore, the difference between the fair market value and issue
price cannot be brought to tax as a perquisite u/s. 17. 

 

In the result, the appeal filed by the
revenue was dismissed.

 

 

INSOLVENCY & BANKRUPTCY CODE, 2016 – SC’S BOOSTER SHOTS

It was started in September, 2002 with
Anup P Shah as its author. He continues to eloquently pen it every month since
then. BCAJ had several features on tax and accounting but very little of Law.
As auditors and advisors, CAs need to have a good working knowledge of laws
which impact business. Each article provided audit steps after covering the
legal aspects. The idea behind the feature is to educate CAs and even
businessmen about laws which impact a business and hence, the name “Laws &
Business”. Anup started writing on different laws and then moved on to
different legal issues. One notable change: When he started he was CA. Anup
Shah and now he is Dr. Anup P Shah.

You are about to read the 196th
contribution. So far the column has covered 82 Laws and 164 legal issues. Two
editions of compilation of Laws and Business have been published by BCAS. When
we asked the author, what keeps him going after sixteen years of monthly
writing: “Writing crystallizes thinking – while readers may benefit from the
Feature, I get a larger benefit since before one can write on a subject, one
must study and analyse it thoroughly. In addition, the desire to learn new
legal issues and a zeal to write keeps the keyboard pounding!”  Soon the feature will hit a double century!

 

Insolvency & Bankruptcy
Code, 2016 –  SC’s Booster Shots

 

Introduction


Rarely has a law witnessed
as many legal challenges in its initial years as the Insolvency &
Bankruptcy Code, 2016 (“Code”) has! Although, the Code is less
than three years old, it has seen numerous battles not just at the NCLT level
but even at the Supreme Court. In addition, the Code itself has been amended
many times to address changing circumstances and in response to Court
decisions. Hence, it has been an evolving legislation. Promoters of companies
under insolvency resolution have tried resorting to judicial forums to prevent
losing control over their companies but Courts have been wary of allowing their
pleas. However, each time the Code has emerged stronger and more robust than
before. In the last few months, the Supreme Court has on three occasions,
delivered landmark decisions, which have helped uphold the validity of the
Code. Let us examine these decisions of the Apex Court in the context of the
Code.

 

Case-1: Swiss Ribbons (P.) Ltd. vs. UOI,
[2019] 101 taxmann.com 389 (SC)


The Supreme Court by its
Order dated 25th January 2019, upheld the Insolvency and Bankruptcy
Code, 2016 in its entirety with some minor adjustments. This case was not fact
based since it involved a challenge to the Constitutional validity of the Code.
Some of the salient features of this path breaking decision are discussed
below. The main thrust of the petitioner’s argument was that the Code suffered
from various Constitutional infirmities and arbitrariness and hence, deserved
to be struck down. The Court held the primary focus of the legislation was to
ensure revival and continuation of the corporate debtor by protecting the
corporate debtor from its own management and from a corporate death by
liquidation. The Code was thus a beneficial legislation which put the corporate
debtor back on its feet and was not a mere recovery legislation for creditors.
The interests of the corporate debtor had, therefore, been bifurcated and
separated from that of its promoters / those who were in management. Thus, the
Corporate Insolvency Resolution Process (“CIRP”) was not
adversarial to the corporate debtor but, in fact, protective of its interests.

 

It observed that in the
working of the Code, the flow of financial resource to the commercial sector in
India had increased exponentially as a result of financial debts being repaid.
Approximately 3300 cases were disposed of by the NCLT based on out-of-court
settlements between corporate debtors and creditors which themselves involved
claims amounting to over Rs. 1,20,390 crore. The experiment conducted in
enacting the Code was proving to be largely successful.

 

Distinction between Operational and Financial
Creditors is Valid


It was argued that the
distinction between operational and financial creditors was Constitutionally
invalid and nowhere in the world was such an artificial bifurcation found. It
was quite likely that since operational creditors were often unsecured (e.g.,
creditors for goods and services) as compared to financial creditors (e.g.,
banks, NBFCs, etc.,) who may be secured, there might not be enough funds left
behind for the operational creditors after paying off the financial creditors.
Further, it was contended that operational creditors had no right to vote as
compared to financial creditors who alone could vote. Moreover, a financial
creditor could trigger a resolution application under the Code merely on a
default taking place. However, in the case of an operational creditor even if a
default takes place and an application is filed before the NCLT, the same would
be rejected if the debtor can prove that a dispute exists with the operational
creditor.

 

The Court noted that the
reason for differentiating between financial debts, which were secured, and
operational debts, which were unsecured, was in the relative importance of the
two types of debts when it comes to the objects sought to be achieved by the
Code. Giving priority to financial debts owed to banks and lenders would
increase the availability of finance, reduce the cost of capital, promote
entrepreneurship and lead to faster economic growth. The Government also will
be a beneficiary of this process as the economic growth will increase revenues.
Financial creditors from the very beginning are involved with assessing the
viability of the corporate debtor. They can, and therefore do, engage in
restructuring of the loan as well as reorganisation of the corporate debtor’s
business when there is financial stress, which are the things operational
creditors do not and cannot do. Financial creditors help in preserving the
corporate debtor as a going concern, while ensuring maximum recovery for all
creditors being the objective of the Code, and hence, are clearly different
from operational creditors and therefore, there is obviously an intelligible
differentia between the two which has a direct relation to the objects sought
to be achieved by the Code.

 

Further, the NCLAT has,
while looking into viability and feasibility of resolution plans that are
approved by the committee of creditors, always examined whether operational
creditors are given roughly the same treatment as financial creditors, and if
not, such plans are either rejected or modified so that the operational
creditors’ rights are safeguarded. Moreover, a resolution plan cannot pass
muster u/s. 30(2)(b) read with section 31 unless a minimum payment is made to
operational creditors, being not less than liquidation value.

 

The Regulations framed under
the Code have been amended to expressly provide that a resolution plan shall
now include a statement as to how it has dealt with the interests of all
stakeholders, including financial creditors and operational creditors, of the
corporate debtor. This further strengthens the rights of operational creditors
by statutorily incorporating the principle of fair and equitable dealing of
operational creditors’ rights, together with priority in payment over financial
creditors.

 

Hence,
the Court concluded that no discrimination resulted since it was demonstrated
that there was an intelligible differentia which separated the two kinds of
creditors.  

 

Section12A withdrawal of CIRP


In the
past, there have been instances where on account of settlement between the
applicant creditor and the corporate debtor, judicial permission for withdrawal
of the CIRP was required. The Supreme Court, under Article 142 of the
Constitution, passed orders allowing withdrawal of applications after the
creditors’ applications had been admitted by the NCLT. Thus, without
approaching the Supreme Court, it was not possible to withdraw an application
even if both parties consented to the same – Lokhandwala Kataria
Construction P Ltd vs. Nisus Finance and Investment Managers LLP,
CA No. 9279/2017 (SC) and Mothers Pride Dairy P Ltd vs. Portrait
Advertising and Marketing P Ltd, CA No. 9286/2017 (SC).

 

To remedy this situation,
section 12A was inserted in the Code which allows for the withdrawal of an
insolvency petition filed against a corporate debtor if 90% of the Committee of
Creditors (CoC) approve such a withdrawal. It was argued that this section gave
unbridled and uncanalised power to the CoC to reject legitimate settlements
between creditors and corporate debtors. The Apex Court held that once the CIRP
was triggered, the proceeding became a proceeding in rem, i.e., a collective
proceeding, which could not be terminated by an individual creditor. All
financial creditors have to come together to allow such withdrawal as,
ordinarily, an omnibus settlement involving all creditors ought, ideally, to be
entered into. This explained why 90%, which was substantially all the financial
creditors, have to grant their approval to an individual withdrawal or
settlement. In any case, the figure of 90%, pertained to the domain of
legislative policy. The Court further pointed out that there was an additional
safeguard by way of section 60 of the Code, which provided that if the CoC
arbitrarily rejected a just settlement and/or withdrawal claim, the NCLT, and
thereafter, the NCLAT could always set aside such a decision. Thus, the Court
upheld section 12A of the Code.

 

Role of RP

The
Court did not find merit in the plea that the resolution professional was given
adjudicating powers under the Code. It held that he was given an administrative
role as opposed to quasi-judicial powers. The Court distinguished between the
role of a resolution professional who had an administrative role versus a
liquidator who had a quasi-judicial role. Thus, the resolution professional was
only a facilitator of the resolution process, whose administrative functions
were overseen by the CoC and ultimately by the NCLT.

 

Section 29A: Relief to ‘Related Party’


A multi-fold attack was
raised against section 29A which disentitled certain persons to act as
resolution applicants. Firstly, it was stated that the vested rights of
erstwhile promoters to participate in the recovery process of a corporate
debtor were impaired by a retrospective application of section 29A. It was
contended that section 29A was contrary to the object sought to be achieved by
the Code, in particular, speedy resolution process as it would inevitably lead
to challenges before the NCLT and NCLAT, which would slow down and delay the
CIRP. In particular, so far as section 29A(c) was concerned, a blanket ban on
participation of all promoters of corporate debtors, without any mechanism to
weed out those who are unscrupulous and have brought the company to the ground,
as against persons who are efficient managers, but who have not been able to
pay their debts due to various other reasons, would not only be manifestly
arbitrary, but also be treating unequals as equals. Also, maximisation of value
of assets was an important goal to be achieved in the resolution process and section  29A was contrary to such a goal since an
erstwhile promoter, who may outbid all other applicants and may have the best
resolution plan, would be kept, thereby impairing the object of maximisation of
value of assets. Another argument which was made was that under the Code, a
person’s account may be classified as an NPA in accordance with the guidelines
of the RBI, despite him not being a wilful defaulter. Lastly, persons who may
be related parties in the sense that they may be relatives of the erstwhile
promoters were also debarred, despite the fact that they may have no business
connection with the erstwhile promoters who have been rendered ineligible by
section  29A.

 

The Supreme Court held that
the Code was not retrospective in application and hence, it was clear that no
vested right of the promoters was taken away by the application of section  29A. The Court held that it must be borne in
mind that section 29A had been enacted in the larger public interest and to
facilitate effective corporate governance. The Parliament rectified a loophole
which allowed a back-door entry to erstwhile managements in the CIRP. Hence,
the Court upheld the validity of section 29A. However, it held that the mere
fact that somebody happened to be a relative of an ineligible person was not
good enough to oust such person from becoming a resolution applicant, if he was
otherwise qualified. In the absence of showing that such a person was connected
with the business activity of the ineligible resolution applicant, such a person
could not automatically be disqualified. Hence, the expressions related party
and relative contained in the Code would disqualify only those persons who were
connected with the business activity of the resolution applicant.

 

Ultimately, the Supreme Court
upheld the validity of the Code in its entirety with a minor tweak for
relatives / related parties!

 

Case-2: Arcelor Mittal India Private
Limited vs. Satish Kumar Gupta, (2018) 150 SCL 354 (SC)


This decision pertained to
the bid for Essar Steel India Ltd. 29A of the Code contains several
disqualifications for bidders, one of which is that a person would not be
eligible to submit a resolution plan, if such person, or one acting jointly or
in concert with such person was disqualified. In this case, there were two
bidders – the erstwhile promoters and another resolution applicant. It so
happened that both the promoters as well as the resolution applicant were
disqualified by virtue of the various clauses of section 29A. Hence, both of
them modified their shareholding structures and reapproached the NCLT. The
issue finally reached the Supreme Court as to whether both these bidders were
eligible to bid?


The Court adopted a
purposive interpretation of the section and held that the legislative intention
was to rope in all persons who may be acting in concert with the person
submitting a resolution plan. The opening lines of section 29A of the Code
referred to a de facto as opposed to a de jure position of the
persons mentioned therein. This was a typical instance of a “see through
provision”, so that one was able to arrive at persons who were actually in
“control”, whether jointly, or in concert, with other persons. A wooden,
literal, interpretation would obviously not permit a tearing of the corporate
veil when it came to the “person” whose eligibility was to be
considered. However, a purposeful and contextual interpretation was necessary.
While a shareholder is a separate legal entity from the company where he holds
shares, for verifying the resolution plan, it is imperative to lift the
corporate veil and ascertain the constituents who make up the Company. The
Court upheld the doctrine of piercing the corporate veil as enshrined in LIC
of India vs. Escorts Ltd (1986) 1 SCC 264 and distinguished the legal
personality concept of Soloman’s case. It observed that a slew of
judgments has held that where a statute itself lifts the corporate veil, or
where protection of public interest is of paramount importance, or where a
company has been formed to evade obligations imposed by the law, the court will
disregard the corporate veil.

 

The Court held that seen
from the wide language used in the section, any understanding, even if it is
informal, and even if it is to indirectly cooperate to exercise control over a
target company, is included in the definition of persons acting in concert and
it is not merely restricted to cases of formal joint venture agreements. The
stage at which ineligibility is to be examined is when the resolution plan was
submitted by a resolution applicant. So long as a person or persons acting in
concert, directly or indirectly, can positively influence, in any manner,
management or policy decisions, they could be said to be “in control”. The
expression “control”, in section 29A, denotes only positive control, which
means that the mere power to block special resolutions of a company cannot
amount to control. The Supreme Court also examined the decision of the SAT in the case of Shubhkam Ventures vs. SEBI (Appeal No. 8 of 2009
decided on15.1.2010) which had taken a similar view.

 

The Court held that since
section 29A is a see-through provision, great care must be taken to ensure that
persons who are in charge of the corporate debtor for whom such resolution plan
is made, do not come back in some other form to regain control of the company
without first paying off its debts. One of the persons mentioned in section 29A
who is ineligible to act as an resolution applicant is a person prohibited by
SEBI from either trading in securities or accessing the securities market. The
Court held that it was clear that it was clear that if a person was prohibited
by a regulator of the securities market in a foreign country from trading in
securities or accessing the securities market, the disability would equally
apply.

 

Lastly, the court dealt
with the timeline for completing a CIRP. The time limit for completion of the
CIRP as laid down in section 12 of the Code is a period of 180 days from the
date of admission of the application by the NCLT. This is extendable by a
maximum period of 90 days only if 66% of the CoC approve of the same and the
NCLT agrees to the same. If no resolution takes place within such period of 270
days, then the only option is to liquidate the corporate debtor. The Supreme
Court held that the timelines mentioned in the Code are mandatory and cannot be
extended. Nevertheless, the Court also relied on a legal maxim, Actus curiae
neminem gravabit – the act of the Court shall harm no man. Accordingly, it
held that where a resolution plan is upheld by the NCLAT, either by way of
allowing or dismissing an appeal before it, the period of time taken in
litigation ought to be excluded.

 

Ultimately, the Supreme
Court held that both the applicants were ineligible under the Code but
exercising its special powers under Article 142 it granted one more opportunity
to them to pay off the NPAs of their related parties and then resubmit their
bids.

 

Case-3: Brilliant Alloys P Ltd vs. S Rajagopal, SLP
No. 31557 / 2018, Order dated 14-12-2018


Section 12A of the Code
allows for the withdrawal of an insolvency petition filed against a corporate
debtor if 90% of the Committee of Creditors (CoC) approve such a withdrawal.
However, Reg. 30A of the Insolvency and Bankruptcy Board of India (Insolvency
Resolution Process for Corporate Persons) Regulations, 2016 provides that an
application for withdrawal u/s. 12A shall be submitted to the resolution
professional before the issue of invitation for expression of interest. Hence,
a question arises as to whether if the debtor and creditor agree to it, can the
petition be withdrawn even after the expression of interest has been issued?

 

The Supreme Court allowed
the withdrawal and held, that this Regulation has to be read along with the
main provision section 12A which contained no such stipulation. Accordingly,
this stipulation could only be construed as directory depending on the facts of
each case.

 

Conclusion


The
Supreme Court has time and again stepped in to protect and augment the Code. It
has endeavoured to preserve the basic fabric of the Code and to uphold its
provisions. However, at the same time it has made amendments where it felt a
change was required. The Code is a complicated and intricate legislation dealing
with an extremely complex subject and hence, such an evolution is expected.
However, it is heartening to note that the Apex Court has been up to the
challenge and has done it in a very timely manner. The Supreme Court decisions
have acted as a booster shot in the arm to the Code. The success of the Code
can be best summed up by the Supreme Court’s observations in Swiss Ribbons
(supra), “The defaulter’s paradise is lost. in its place, the economy’s
rightful position has been regained.”

 

IS IT FAIR TO DENY BENEFIT OF TAX DEDUCTED AT SOURCE (TDS) IN ABSENCE OF SUCH TDS IN FORM 26AS

 

BACKGROUND


Section 199(1) of the Income Tax Act 1961 permits
claim of Tax Deduction at Source (TDS) when such payment is made to credit of
the Central Government. However, instances have come to the notice of several
persons including tax authorities that in spite of the fact that

  •    deductor has deducted tax at source and payment
    thereof is not made to the credit of Central Government     ( Consequently this
    will not reflect in the TDS return of the deductor and as such will not further
    reflect in 26AS of the deductee)

OR

  •    deductor has deducted tax at source and payment
    thereof made to the credit of Central Government but such deductor has
    defaulted in filing TDS Return     ( Consequently this will not reflect in 26AS
    of the deductee)

 

PROBLEM


Presently in either of the situations mentioned in
the preceding paragraph, deductee is denied benefit of TDS since in either case
such TDS does not reflect in 26AS of the deductee. With the electronic filing
of Income tax Returns being mandatory in respect of most of the assessees, deductee
( Assessee filing Return of Income) does not get credit of such TDS when return
of Income is processed by CPC . This results in

 

  •    Either reduction in Refund Claimed in the
    Return of Income

                                    OR

  •    or results in a demand when Return was filed claiming
    no refund.

 

UNFAIRNESS


1.  Reduction
in the refund claimed or resulting demand, consequent upon non- granting of
credit of TDS (either not paid / return of TDS not filed) is unfair for the
deductee because such demand remains as outstanding demand on the CPC Website
and such demands get adjusted with future refunds due to the assessee
(Deductee).


2.  In a
situation where Tax is deducted but not deposited, section 205 of the Income
Tax Act, 1961 comes to the rescue of the deductee. The said section reads as
under : 

 

Head Note of the Section: Bar against direct demand on
assessee.

 

205. Where tax is deductible at the source under
[the foregoing provisions of this Chapter], the assessee shall not be called
upon to pay the tax himself to the extent to which tax has been deducted from
that income.

 

3.  If we
paraphrase the above mentioned section, we can note that following ingredients
will emerge namely:

 

  •    Tax is deductible from the deductee
  •    Such Tax is deducted from the income
  •    Assessee shall not be called upon to pay the
    tax himself to the extent of such tax deduction

 

4. To
reiterate the rights of the Assessee in such situations, CBDT has issued
directions to the field officers vide reference number 275/29/2014-IT-(B) dated
01-06-2015. The relevant extracts are reproduced here:

  •    Grievances have been received by the Board
    from many taxpayers that in their cases the deductor has deducted tax at source
    from payments made to them in accordance with the provisions of Chapter-XVII of
    the Income-tax Act, 1961 (hereafter ‘the Act’) but has failed to deposit the
    same into the Government account leading to denial of credit of such deduction
    of tax to these taxpayers and consequent raising of demand.
  •    As per section 199 of the Act credit of Tax
    Deducted at Source is given to the person only if it is paid to the Central
    Government Account. However, as per section 205 of the Act, the assessee shall
    not be called upon to pay the tax to the extent the tax has been deducted from
    his income where the tax is deductible at source under the provisions of
    Chapter- XVII. Thus, the Act puts a bar on direct demand against the assessee
    in such cases and the demand on account of tax credit mismatch cannot be
    enforced coercively.

 

5.  It
appears that above mentioned instruction was not observed by the field officers
(Reasons well known) and hence CBDT again has issued an office
memorandum on 11-03-2016 (OFFICE MEMORANDUM F.NO.275/29/2014-IT (B), DATED
11-3-2016). Relevant Extracts of the said Memorandum reads as under :

 

  •    Vide letter of even number dated
    1-6-2015, the Board had issued directions to the field officers that in case of
    an assessee whose tax has been deducted at source but not deposited to the
    Government’s account by the deductor, the deductee assessee shall not be called
    upon to pay the demand to the extent tax has been deducted from his income. It
    was further specified that section 205 of the Income-tax Act, 1961 puts a bar
    on direct demand against the assessee in such cases and the demand on account
    of tax credit mismatch in such situations cannot be enforced coercively.
  •    However, instances have come to the notice of
    the Board that these directions are not being strictly followed by the field
    officers.
  •    In view of the above, the Board hereby reiterates
    the instructions contained in its letter dated 1-6-2015 and directs the
    assessing officers not to enforce demands created on account of mismatch of
    credit due to non-payment of TDS amount to the credit of the Government by the
    deductor. These instructions may be brought to the notice of all assessing
    officers in your Region for compliance.

 

CONCLUSION FROM
THE ABOVE


Thus, one will note from the above two
clarifications from CBDT that demand arising out of the situation of Tax
Deducted and not deposited, demand cannot be enforced from the assessee.

 

However, till date, the issue of TDS
being deducted, not deposited with central government by the deductor and
deductee ( Assessee) claiming such TDS and consequent refund in the return of
Income, is still not addressed by CBDT in spite of the fact that above
instruction/ office memorandum has been released .

 

SOLUTION


In the light of above, relevant rules should
authorise assessee to 

  •    Ask CPC to Block such demand from further
    adjustment on the website and for the purpose a specific option be permitted to
    be included in case of mismatch of TDS such as “TDS Mismatch since TDS
    Deducted but not deposited by the deductor”
  •    Assessee is permitted to send a proof of Tax
    Deduction by the deductor (If Available) as a response to outstanding tax (TDS)
    demand.
  •    Besides relevant Rules should provide for a
    proof of deduction to be submitted to the deductee on a Quarterly basis which
    will substantiate a claim of the deductee that TDS is deducted since
    entire hypothesis of the section 205 is based on the fact that “Tax is deducted”.
    This is essential since deductor is an agent of Income Tax Department and as
    such there is a privity between Tax department and the deductor which is
    unfortunately lacking between deductor and deductee. 
  •     Lastly a deductee may be permitted
    to lodge an online query when such deduction is not reflecting as a credit in
    26AS against such deductors. A deductee will have to at least obtain a PAN and
    TAN of the persons he deals with to lodge such queries.