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Month: May

Where the sale price of CCDs issued by subsidiary company was linked to the holding period; CCDs were guaranteed by parent company; directors of subsidiary company had no powers of management; difference between the sale price and purchase price of CCDs held by Mauritian company was ‘interest’ and not ‘capital gains’ in terms of DTAA.

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‘Z Mauritius’, in re (2012) 20 taxmann.com 91 (AAR) Article 11, 13(4) of India-Mauritius DTAA; Section 2(28A) Income-tax Act Dated: 21-3-2012 Before P. K. Balasubramanyan (Chairman) and V. K. Shridhar (Member)
Counsel for applicant: Vinay Mangla, Gaurav Kanwin, Percy Pardiwala & Preeti Goel Counsel for Department: Poonam Khera Sidhu, R. K. Kakar

Where the sale price of CCDs issued by subsidiary company was linked to the holding period; CCDs were guaranteed by parent company; directors of subsidiary company had no powers of management; difference between the sale price and purchase price of CCDs held by Mauritian company was ‘interest’ and not ‘capital gains’ in terms of DTAA.


Facts:

  • The applicant (‘Z’) is a company incorporated in and tax resident of Mauritius. V Ltd. (‘V’) and S Ltd. (‘S’) are two Indian companies.
  • ‘V’ is parent company of ‘S’ and company ‘S’ was engaged in developing a real estate project in India.
  • The applicant, ‘V’ and ‘S’ jointly executed a Share Holders Agreement (‘SHA’) and Securities Subscription Agreement (‘SSA’).
  • Pursuant to SHA and SSA, the applicant and ‘V’ invested in ‘S’. The applicant subscribed to equity shares and CCDs.
  • As per SHA, CCDs were to be fully and mandatorily converted into equity shares after 72 months. The applicant had put option to sell certain shares and CCDs on specified dates to ‘V’ and ‘V’ had call option to purchase the said shares and CCDs from the applicant.
  • The respective options were to be exercised prior to the mandatory conversion date. ‘V’ exercised its call option to purchase shares and CCDs from the applicant.
  • The applicant contended that the capital gains arising from transfer was exempt from tax in India in terms of Article 13(4) of India-Mauritius DTAA. The contention of applicant was rejected by the Tax Department which held that:
  • The concept of optional conversion rate was incorporated in SHA to compensate for normal interest from debentures. Only small portion of investment comprised equity shares and balance was CCDs. To characterise the gain to have arisen from transfer of capital assets was improper. ? For interpreting agreements, its essence as a whole should be considered and not merely their form. Relying on LMN India Ltd., in re (2008)5, CCDs recognised the existence of debt till repaid or discharged. The two agreements were entered into to camouflage the true character of income from interest on loan to capital gains.
  • The applicant submitted that it was engaged in real estate business, but its only transactions in India were investment in ‘S’. Hence, alternatively, nature of income arising from the transaction should be business income.
  • As per current FDI Policy, optionally and partly convertible debentures and preference shares are to be treated as ECB. Debentures recognise the existence of a debt. It does not cease to be so simply because they are redeemed by conversion to equity shares and not payment. Thus, ECB is contrived to look like CCDs convertible into equity. A transaction where the parties have a common intention not to create the legal rights and obligations which they give appearance of creating, is sham6. Since the rate of return was predetermined 6 years before the exercise of option, there was no commercial purpose. Accordingly, the transaction was designed to avoid tax by taking advantage of Article 13(4) of India-Mauritius DTAA. It was the applicant’s contention that:
  • Investment through CCDs is not loan or advance and there is no lender-borrower relationship with ‘S’. Even if ‘S’ is assumed to be borrower, the consideration is received from ‘V’ for sale of assets. Any amount received over and above purchase price cannot be treated as interest7.
  • Gains on sale of CCDs have arisen because of the value of the underlying assets, namely, equity shares.
  • Applicant and ‘V’ are totally unrelated parties and hence, purchase of CCDs by ‘V’ cannot be regarded as redemption of CCDs.
  • Since the tax benefit would result to only one, there is no reason for parties involved to share a common intention to create legal facade.

Ruling The AAR observed and ruled as follows:

 (i) Reliance placed on CWT v. Spencer & Co. Ltd. and Eastern Investments Ltd. v. CIT8, to contend that a CCD creates or recognises the existence of a debt, which remains to be so till it is repaid or discharged.

(ii) Article 11(5) of India-Mauritius DTAA, includes any type/form of ‘income from bonds and debentures’ within the ambit of ‘interest’. Purchase price under call option was linked to the holding period. While CCDs were not to carry any interest, they gave option of conversion into shares at a different price. Conversion of debentures into equity shares at the end of the specified period amounts to constructive repayment of debt. While calculating the purchase price the conversion rates vary, depending upon the period of holding of CCDs. This is nothing else but ‘interest’ within the meaning of section 2(28A) of the Income-tax Act and Article 11 of India- Mauritius DTAA.

 (iii) To ascertain true legal nature of the transaction, and to appreciate true nature of the consideration received, ‘look at’ test needs to be applied by examining substance of the transaction, inter se relationship of the parties and the transaction as a whole. While ‘S’ and ‘V’ were two independent juridical persons, ‘S’ did not exercise any power in managing its affairs. The management powers of the directors of ‘S’ were taken away through various clauses of SHA. ‘V’ was developing and running real estate business of ‘S’. ‘V’ was the guarantor of investment made by ‘Z’. ‘V’ acknowledged CCDs as debt. Thus, ‘V’ and ‘S’ were different only on paper, but otherwise they were one and the same entity. ‘V’ had de facto control and management over ‘S’. Therefore the argument that the sale of CCDs is not to the debtor but to a third party and hence, what is realised cannot be said to include interest, cannot be accepted.

(iv) Article 11 is a specific provision dealing with treatment of income from debt claims of every kind, whereas Article 13 deals with capital gains. ‘V’ and ‘S’ are one and the same. ‘V’ has paid fixed pre-determined return to the applicant. Hence, the amount paid by ‘V’ is towards the debt taken by ‘S’ from the applicant and therefore, appreciation in value of CCDs is ‘interest’ under Article 11.

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Usance interest which is directly related to the period for which purchase price was due, is ‘interest’ in terms of section 2(28A) and consequently, it is deemed to accrue or arise in India u/s.9(1)(v) of ITA.

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Uniflex Cables Ltd. v. DCIT
(2012) 19 Taxmann 315 (Mumbai-ITAT) Section 2(28A), 40(a)(i) of Income-tax Act A.Ys.: 1999-2000 & 2002-03. Dated: 28-3-2012
Before R. S. Syal (AM) and N. V. Vasudevan (JM)
Present for the appellant: Rajan Vora
Present for the Department: Jitendra Yadav

Usance interest which is directly related to the period for which purchase price was due, is ‘interest’ in terms of section 2(28A) and consequently, it is deemed to accrue or arise in India u/s.9(1)(v) of ITA.


Facts:

The taxpayer, an Indian company (ICO), purchased raw material from several non-resident suppliers under irrevocable LCs payable within 180 days from the date of bill of loading. ICO was required to pay usance interest for the period of credit and the supplier raised a separate invoice in respect of such usance interest. During the years under consideration, on the ground that the usance interest was in the nature of interest and it had accrued and arisen in India, the Tax Department held it to be chargeable to tax in India. Further, as ICO had not deducted tax on such usance interest, the claim for deduction of such interest was disallowed u/s.40(a)(i) of the Income-tax Act. The disallowance was upheld by the CIT(A). Before ITAT, ICO contended that:

  • Interest within meaning of section 2(28A) of the Income-tax Act means interest payable in respect of moneys borrowed or debt incurred. Payment of interest for the time granted by non-resident supplier of raw material cannot be considered as payment in respect of money borrowed or debt incurred. Hence, such payment would not partake the character of interest as per section 2(28A) of the Income-tax Act.
  • The finance charges were for delayed payment of raw material purchases and hence would partake the character of money paid for purchase price of raw material. Therefore, no tax is required to be deducted. In support, ICO relied on various decisions3.
  • Reliance placed by the Tax Department on the Gujarat HC in the case of CIT v. Vijay Ship Breaking Corporation, (2003)4, where it was held that usance interest was not part of the purchase price, but was interest and the payer was required to deduct tax.

Held:

The ITAT rejected ICO’s contentions and held: Unlike certain cases cited by ICO, in ICO’s case, usance interest had no relation with the price of raw material purchased, but had direct relationship with the time when the payment became due. Hence, on facts, usance interest was in the nature of interest within the meaning of section 2(28A) of the Incometax Act. Consequently such interest would be deemed to have accrued or arisen in India u/s.9(1) (v)(b) of the Income-tax Act.

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Payment for development of Balanced Score Card (BSC) management tool is Fees for Technical Services under Article 12 of the India-Singapore DTAA.

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Organisation Development Pte. Ltd. v. DDIT TS 86 ITAT 2012 (CHNY)
Article 5, 7, 12 of India-Singapore DTAA; Section 9(1)(vi)/(vii)of Income-tax Act A.Y.: 2007-08. Dated: 9-2-2012
Abraham P. George (AM) and George Mathan (JM) Present for the appellant: Vikram Vijayaraghavan Present for the Department: K.E.B. Rangarajan

Payment for development of Balanced Score Card (BSC) management tool is Fees for Technical Services under Article 12 of the India-Singapore DTAA.


Facts:

Taxpayer, a company incorporated in Singapore (FCO), provided services to various clients around the world for development of BSC project. BSC is a strategic performance management tool which can indicate deviations from expected levels of performance. During the year under consideration, FCO rendered services to various companies located in India.

FCO contended that the receipts towards services were business profits under Article 7 of DTAA and in the absence of Permanent Establishment (PE) the same would not be taxable in India.

The Tax Department divided services for development of BSC into two segments viz. professional fees rendered to the clients and lump sum received for sale of software. The Tax Department held that the amount received towards the sale of software was taxable as ‘royalty’ for use of equipment, while the professional fees were taxable as ‘fees for technical services’ (FTS).

FCO contended that there was no ‘equipment royalty’ as the users had no domain or control over such software. Also the software downloaded by clients was not customised to suit any particular client. Furthermore, as FCO had not made available any technical knowledge, experience, skill, knowhow, etc. amount would not be taxable as FTS. The matter was referred before the Dispute Resolution Panel (DRP) which upheld the order of the Tax Department.

ITAT Ruling:

  • The ITAT held that the payments received by FCO would be taxable as FTS u/s.9(1)(vii) for following reasons: FCO had sent its team to help its clients in implementing licensed software which was required to develop BSC. The clients were required to make lump-sum payments for downloading such software from the designated sites and such software was to be used in various phases of developing the BSC system.
  •  In a BSC system each client has its own goals and different strategies to reach such goals. A team, which is evolving a BSC system necessarily, has to identify the measures that are relatable to the entity under study. This is not a type of service which can be used by any organisation by application of an off-the-shelf software.
  • Software is only a part of the total process for development of BSC. Fees received by FCO are linked to the downloading of software, but that is not sufficient to come to a conclusion that software is equipment from which FCO earned royalty. The Tax Department was not right in dividing the whole process into two parts one for the royalty and the other for FTS.
  • The provisions of DTAA with regard to the definition of the term ‘FTS’ are different from the definition provided u/s.9(1)(vii) of the Incometax Act. This is supported by AAR in the case of Bharti AXA General Insurance1. FCO is thus justified in availing benefit of treaty provisions and this is well supported by SC ruling in UOI v. Azadi Bachao Andolan2.
  • FCO made available technical knowledge and skill which enabled its clients to acquire the knowledge for using BSC system for their business and for meeting long-term targets.
  • Software was only a part of the management consultancy tool and was never considered as independent of the total system. The technical knowledge and skill provided by FCO remained with its clients. Thus, fees received for designing of BSC management tool falls within definition of FTS under Article 12(4) of the India–Singapore DTAA.
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Amendments in Schedules A, C and D w.e.f. 1-4-2012 — Notification No. VAT.1512/ C.R.40/Taxation-1 of MVAT Act, 2002, dated 31-3-2012.

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Vide this Notification amendments have been carried to entries in Schedule A, C & D.

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Rate of reduction in set-off in case of branch transfer — Notification No. VAT-1512/CR-43/ Taxation-1, dated 31-3-2012.

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From 1st April, 2012 in case of branch transfer that when goods are transferred from Maharashtra State to branch in other State then the set-off on the corresponding purchase of taxable goods will be reduced by 4% as against 2% till then.

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Profession Tax Act, 1975 — Procedure for online submission of application for obtaining registration and enrolment — Trade Circular No. 5T of 2012, dated 31-3-2012.

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From 1st April, 2012 application for registration (PTRC) and enrolment (PTEC) under the Profession Tax Act should be electronically uploaded in ‘Form I’ and ‘Form II’, respectively.

Remaining processes of obtaining registration/ enrolment such as verification of documents, etc. will remain the same. Manually filled forms will not be accepted on or after 1st April 2012 except for non-resident employer/person and Government departments. Procedure for online application has been explained in the Circular.

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Electronic refund of service tax paid on taxable services used for export of goods — Circular No. 156/7/2012-ST, dated 9-4-2012.

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By this Circular it has been announced that a Committee has been constituted to review the scheme for electronic refund of service tax paid on taxable services used for export of goods, made operational vide Notification 52/2011-ST, dated 30th December, 2011.

 The Committee has been instructed, as a part of the review, to

(a) evolve a scientific approach for the fixation of rates in the schedule of rates for service tax refund; and

(b) propose a revised schedule of rates for service tax refund, taking into account the revision of rate of service tax from 10 to 12% and also movement towards ‘Negative List’ approach to taxation of services. The Committee will submit its report before 20-6-2012. Views and suggestions may be posted at the e-mail address: feedbackonestr@gmail.com.

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Point of Taxation Rules — Clarification reg. airline tickets — Circular No. 155/6/2012-ST, dated 9-4-2012.

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In view of reports that some airlines are collecting differential service tax on tickets issued before 1st April 2012 for journey after 1st April 2012, causing inconvenience to passengers, this Circular clarifies that Rule 4 of the Point of Taxation Rules 2011 deals with the situations of change in effective rate of tax. In case of airline industry, the ticket so issued in any form is recognised as an invoice by virtue of proviso to Rule 4A of the Service Tax Rules 1994. Usually in case of online ticketing and counter sales by the airlines, the payment for the ticket is received before the issuance of the ticket. Rule 4(b)(ii) of the Point of Taxation Rules 2011 addresses such situations and accordingly the point of taxation shall be the date of receipt of payment or date of issuance of invoice, whichever is earlier.

Thus the service tax shall be charged @10% subject to applicable exemptions plus cesses in case of tickets issued before 1-4-2012 when the payment is received before 1-4-2012. In case of sales through agents (IATA or otherwise including online sales and sales through GSA), when the relationship between the airlines and such agents is that of principal and agent in terms of the Indian Contract Act, 1872, the payment to the agent is considered as payment to the principal.

Accordingly, as per Rule 4(b)(ii), the point of taxation shall be the date of receipt of payment or date of issuance of invoice, whichever is earlier. However, to the extent airlines have already collected extra amount as service tax and do not refund the same to the customers, such amount will be required to be paid to the credit of the Central Government u/s.73A of the Finance Act 1994 (as amended).

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Point of Taxation Rules — Clarification reg. individuals or proprietorships, partnerships, eight specified services — Circular No. 154/5/2012-ST, dated 28-3-2012.

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It has been clarified that for invoices issued on or before 31st March 2012, the point of taxation shall continue to be governed by the Rule 7 as it stands till the said date. Thus in respect of invoices issued on or before 31st March 2012 the point of taxation shall be the date of payment.

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Pandals, Shamiana liable to tax-clarification Circular No. 168/3 /2013 – ST dated 15 04 2013

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The CBEC clarified that the activity by way of erection of pandal or shamiana is a declared service under Section 66E 8(f) of the Finance Act, 1994.

It is further clarified that for a transaction to be regarded as “transfer of right to use goods”, the transfer has to be coupled with possession. Court rulings have upheld that when the effective control and possession is with the supplier, there is no transfer of right to use. It is a service of preparation of a place to hold a function or event & effective possession and control over the pandal or shamiana remains with the service provider, even after the erection is complete. Accordingly, services provided by way of erection of pandal or shamiana would attract the levy of service tax.

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ST-3 for July to September 2012 -due date extended Order No. 02/2013 –ST dated 12-04-213

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By this Order, due date for submission of the Service Tax Return in Form ST-3 for the period 1st July 2012 to 30th September 2012 has been extended from 15th April, 2013 to 30th April, 2013.

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State of Tamil Nadu vs. Marble Palace, [2011] 43 VST 519 (Mad)

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Sales Tax- Best Judgment Assessment- Addition of Sales – Based on Quotations Against Which No Sale Bills Raised-Not Justified, Tamil Nadu General Sales Tax Act,1959.

Facts
The dealer was assessed for the period 1991-92 under The Tamil Nadu General Sales Tax act, 1959 wherein the assessing authority levied tax on estimation of turnover of sales based on quotations raised against which no sale bills were issued. The Tribunal in appeal, observing that there was no material to prove that the assesse had sold any goods to any individual or contractor, passed the order deleting the levy of tax on estimated turnover of sales. The Department filed appeal petition before the Madras High Court against the impugned order of the Tribunal.

Held
As observed by the Tribunal, there was no material for treating the quotations as sale bills and estimating turnover on the basis of the quotation. As rightly held by the Tribunal, the assessing authority had not probed the matter beyond treating quotation book as sale bill. Accordingly, the High Court confirmed the order of the Tribunal and dismissed the appeal filed by the Department.

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DOW Chemical International P. Ltd., vs. State of Haryana and Others, [2011] 43 VST 507 (P& H)

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Central Sales Tax- C Forms – Failure to Produce at The Time of Assessment- Forms Obtained Subsequently- Can Be Produced Before The Authority, Rule 12 (7) of The Central Sales Tax (Registration and Turnover) Rules, 1957

Facts
In the assessment for the period 2004-05, the claim of the dealer for concessional rate of tax against form ‘C’ was disallowed for want of required ‘C’ forms but the Tribunal permitted production of ‘C’ forms received subsequently and the matter was remanded back to the assessing authority for verification of the forms. Subsequently, the dealer received four more ‘C’ forms and produced before the assessing authority with a request to consider those forms also. This prayer was rejected by the assessing authority on the ground that there was no evidence of those forms having been produced before the Tribunal at the time of hearing of the appeal. The dealer filed writ petition before the Punjab and Haryana High Court, against the refusal by the assessing authority to consider the claim of concessional rate of tax for production of additional ‘C’ Forms before him on the ground that forms can be produced at any stage.

Held
The explanation of the dealer was that the forms were issued by the purchasing dealers in question after the decision of the appellate authority and on that ground the same could not be produced earlier. As noted in the quoted part of the order of the Tribunal, during the hearing, the forms were sought to be produced, which was not allowed. In view of explanation given by the petitioner that the forms were received late, it could be held that there was sufficient cause for the petitioner for not producing the same before the assessing and appellate authority which was no bar to the same being produced before the Tribunal. Accordingly, the writ petition filed by the dealer was allowed by the High Court to allow the petitioner to produce the Forms in accordance with law.

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Additional Commissioner of Sales Tax, VAT III, Mumbai vs. Sehgal Autoriders Pvt. Ltd., [2011] 43 VST 398 (Bom)

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Value Added Tax- Sale Price- Sale of Motor Cycles- Separate Collection of Handling Charges For Registration- Not Forming Part of Sale Price, Section 2 (25) of The Maharashtra Value Added Tax Act, 2002

Facts
Dealer engaged in selling motor cycles collected service charges or handling charges from customer for registration of motor cycles under Motor Vehicles Act, 1988. The vat authorities levied vat on such amount which was contested before The Maharashtra Sales Tax Tribunal. The Tribunal held that such charges did not constitute a part of sale price within the meaning of ‘sale price’ defined in section 2 (25) of the MVAT Act, 2002. The Vat Department filed appeal before the Bombay High Court against the decision of the Tribunal setting aside the levy of vat on such handling charges collected by the dealer from the customer at the time of sale of motor cycles.

Held
The High Court held that the transfer of property in the goods in pursuance of the sale contract took place against the payment of price of the goods. Delivery of the goods was effected by the seller to the buyer. The obligation under the law to obtain registration of the motor vehicle was cast upon the buyer. The service of facilitating the registration of the vehicles which was rendered by the selling dealer was to the buyer and in rendering that service, the seller acted as an agent of the buyer. Therefore, the handling charges which were recovered by the respondent could not be regarded as forming part of the consideration paid or payableto the dealer for the sale. Those charges cannot fall within the extended meaning of the expression “ sale price”, since they did not constitute sum charged for anything anything done by the seller in respect of the goods at the time of or before the delivery thereof. The High Court accordingly dismissed the appeal filed by the Department and confirmed the order of the Tribunal.

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2013 (29) 605 (Tri.- Kolkata) United Enterprises vs. Commissioner of Central Excise & Service Tax

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Whether services of Consignment Agent such as loading and unloading of cargo, stacking, carrying out stock verification during storage at the stock yard etc. be classified under Cargo Handling service?

Facts:
Appellant was described as consignment Agent by M/s. SAIL as per the Agreement dated 30-03- 2001. The appellant registered and paid service tax under the category of “Storage and warehousing services” for the year 2001-2002 and part of 2002-2003. But, later they discontinued payment of service tax. A show cause notice was issued to them alleging that they were the consignment agents of M/s. SAIL and were liable for service tax as “Clearing & Forwarding Agent”. As per the agreement, the appellants were required to render the services of ‘unloading of materials at Danapur/Fatuha or any other nearest operating Public siding, transportation of materials and unloading at consignment yard in the appointed place, stacking (including marking/painting) of materials as per stacking plan/storage guidelines and loading into customers vehicles for delivery. As per the agreement, the appellants provided services of transportation of iron and steel products from Fatuha Rail Goods to Banka Ghat Stockyard, wherefrom, importers of such goods from Nepal could collect the said goods. Appellants raised invoices for unloading, transportation and loading of the export consignment. Appellants were neither clearing the goods from the factory of M/s. SAIL nor forwarded the goods to anybody else. They carried out the activity of transhipment of goods meant for export. Appellant was of the view that his activities were covered under the category of cargo handling service. Appellant also contended that, mere mentioning the appellant as consignment Agent in the Agreement, ipso facto, cannot be the criterion for classifying the activities under the heading C & F Agents for the purpose of service tax. The intention, purpose, and activities rendered by the appellants, were alone relevant. Appellant further contended that, activity of Consignment Agent did not come under the purview of Clearing and Forwarding Agents. Penalty on director was also levied.

Held:
The activities were not limited to just loading and unloading of cargo but also involved stacking, which included marking/painting, loading, into customers’ vehicles for delivery with weighment and necessary documentation, carrying out stock verification during storage at the stock yard clearly indicated that the services fall under the scope of “Clearing and Forwarding Agent Services” as per section 65(25) and 65(105)(j) of the Finance Act, 1994. Service of consignment agent is specifically included in the scope of Clearing and Forwarding Services. Section 65(25) and 65(105)(j) of the Act. As per section 65A of the Act, the sub-clause providing most specific description is to be preferred to sub-clause providing a general description. After reading the Agreement between M/s. SAIL And the appellant, it is clear that appellant was appointed as Consignment Agent, which is specifically included in the definition of Clearing & Forwarding Agent services. In contrast, claim of the appellant that they are rendering cargo handling service to M/s. SAIL and accordingly classifiable under the Heading Cargo Handling service, is more general in nature than the specific service of a consignment agent included in the definition of C & F service. Accordingly, they were C&F Agents. Since the authorities did not record specific involvement of the director in short/non payment of service tax warranting a personal penalty on him, except holding that he was overall in charge of the affairs of the appellant company, the penalty was set aside.

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2013 (29) S.T.R. 591 (Tri.- Del.) LSE Securities Ltd. vs. Commissioner of Central Excise

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Whether service tax is applicable to a Stock Broker on receipts such as turnover charges, stamp duty, BSE charges, SEBI fees and DEMAT charges paid to various authorities?

Facts:
Appellant filed appeal against the order levying service tax along with interest and penalty on the receipts of stamp duty, BSE charges and SEBI fees, which were deposited by the appellant with the authority under different statutes. Limitation ground was also pleaded.

Held:
Clause (a) of explanation to section 67 of Finance Act,1994 stipulates that aggregate of commission or brokerage charged by broker on sale or purchase of securities including commission or brokerage paid by the stock broker to any sub broker is liable to service tax. It cannot be expanded to levy tax on a receipt by implication or inference. It is an unambiguous charging section, which is to be construed strictly. No receipt other than commission or brokerage made by a stock broker, that being the consideration for taxable service, is intended to be brought to ambit of assessable value of service provided by stock broker, charge on such other items is arbitrary taxation and cannot be taxed in disguise – section 65(101) and 65(105) (a). Scope of section 67 cannot be expanded to have artificial measure for levy bringing a receipt by implication and not in accordance with the charging provision. It is intrinsic value of service provided which is taxed without any hypothetical rule of computation of value of taxable service. Bonafide belief was clear as there was no levy on receipts other than brokerage received by stock broker from investors. In such a case, suppression cannot be charged. Hence, extended period was not invokable. No subject can be made liable without authority of law and based on presumption or assumption. Provisions cannot be imported in statute so as to supply any deficiency. Appeal was thus allowed.

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S/s.- 5, 9, 40(a)(i), 195 – Payments made for online advertisement on search engines of Google/Yahoo are neither royalty nor FTS. On facts, no business connection; accordingly, not taxable in India and hence no tax withholding applies; websites do not constitute permanent establishment in India.

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8. TS-137-ITAT-2013(KOL)
ITO vs. right Florists Pvt. Ltd.
A.Ys.: 2005-06, Dated: 12-04-2013

S/s.- 5, 9, 40(a)(i), 195 – Payments made for online advertisement on search engines of Google/Yahoo are neither royalty nor FTS. On facts, no business connection; accordingly, not taxable in India and hence no tax withholding applies; websites do not constitute permanent establishment in India.

Facts
The Taxpayer, an Indian company, used search engines of Google/Yahoo for advertising its business. Payments were made to Google Limited (a company resident of Ireland) and Yahoo (a US based company) for displaying the Taxpayer’s advertisement when certain key terms were used on such search engines. No taxes were withheld as the Taxpayer was of the view that the payment was not taxable in India in the hands of the recipient non-residents.

The Tax Authority disallowed the advertisement expenses u/s. 40(a)(i) on the ground that taxes ought to have been withheld by the Taxpayer. CIT(A) ruled in favour of the Taxpayer as the non-resident recipients did not have any permanent establishment (PE) in India, no portion of the payments can be considered as taxable in India.

Held
The Tribunal based on the following ruled that the payment for online advertisement is not taxable in India and hence no withholding on the same was warranted.

Whether income accrues or arises in India:

The Tribunal drew reference to SC decision in the case of Hyundai Heavy Industries (291 ITR 482) wherein SC observed that in order to attract taxability in India u/s. 5(2)(b), income must relate to such portion of income of the non-resident, as is attributable to business carried out in India, and the business so carried out in India could be through its branches or through some other form of presence such as office, project site, factory, sales outlet etc which was collectively referred to as “PE of the foreign enterprise”

Whether Google/ Yahoo have a PE in India

• Traditional commerce required physical presence to carry out business in a country and the concept of PE had developed at a time when e-commerce was non-existent. • The ITAT concluded that a website per se could not constitute a PE in India under the Act for the search engine companies which was also the view taken by the High Powered Committee (HPC) .

• In a tax treaty context, reliance was placed on the OECD MC Commentary to conclude that a search engine, which has a presence through its website, cannot therefore, constitute a PE under the treaty unless its web servers are located in the same jurisdiction which is in line with the physical presence test.

• India’s reservations on the OECD MC Commentary merely state that the website may constitute a PE in certain circumstances, but it does not specify what those “circumstances” are in which, according to tax administration, a website could constitute a PE. Hence, the reservations do not really constitute “actionable statements” and there is difficulty in understanding somewhat vague and ambiguous stand of the tax administration on this issue.

Thus, conditions of income accrual u/s. 5(2)(b) as laid by the SC in Hyundai Heavy Industries are not satisfied to the extent no profits can be said to accrue or arise in India.

Whether income deemed to accrue or arise in India,

• On business connection, the ITAT held that there was nothing on record to demonstrate or suggest that the receipts were on account of business connection in India.

• Payment in connection with online advertising services is not in the nature of royalty – Reliance placed on earlier rulings in Yahoo India Pvt Ltd (140 TTJ 195) and Pinstorm Technologies Pvt Ltd [TS- 536-ITAT-2012(Mum)].

• Based on SC ruling in Bharti Cellular (330 ITR 239), it was concluded that payment is not fees for technical services (FTS) as “human intervention,” is essential for the service being characterised as FTS. As the whole process of online advertising is automated in which there is no human element, the same cannot constitute FTS.

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S/s. 195, 40(a)(i) – Reimbursement of expenses to holding company is not an income under the Act and hence not chargeable to tax; Expenses routed through holding company for payment to third party not in the nature of reimbursement of expenses and liable to withholding by evaluating tax implications in the hands of the third party.

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7. TS-132-ITAT-2013(Mum)
C. U. Inspections (I) Pvt. Ltd. vs. DCIT
A.Y. 2006-07, Dated: 06-03-2013

S/s. 195, 40(a)(i) –  reimbursement of expenses to holding company is not an income under the Act and hence not chargeable to tax;  expenses routed through holding company for payment to third party not in the nature of reimbursement of expenses and liable to withholding by evaluating tax implications in the hands of the third party.


Facts

The Taxpayer, an Indian company, was a subsidiary of a company incorporated in Netherlands (Parent Company). During the relevant AY, the Taxpayer made two types of payments to the Parent Company on which taxes were not withheld on the ground that the same amounted to reimbursement of expenses, viz :

(i) Payment in respect of common expenses borne by the Parent Company for various group companies in respect of accounting services, legal and professional services, communication, R&D etc.

These expenses were incurred by the Parent Company for and on behalf of the Taxpayer and other group companies and the same were recovered/allocated on the basis of arm’s length principle based on agreed parameters. As per the Auditor’s Certificate, allocation of such expenses was done without any income element. (Common expenses)

(ii) Payments in respect of expenses for training services availed by the Taxpayer from independent third party and for which the payment was routed through the Parent Company.

Such training services were arranged by the Parent Company which paid to the third party trainers and later on recovered the amount from the Taxpayer on actual basis. (Training expenses)

The tax authority was of the view that taxes were required to be withheld on the above payments and in the absence of tax withholding, such payments/ expenses were not allowed as deduction while computing taxable income of the Taxpayer under the Act.

The CIT(A) upheld the action of the tax Authority.

Held
• The payments towards common expenses incurred by the Parent company for and on behalf of the Taxpayer and group entities, amounted to reimbursement of expenses. Such reimbursement of expenses was not chargeable to tax in the hands of parent company and, hence, was not subject to withholding of taxes u/s. 195 of the Act.

• In connection with training expenses, it held that the payments were not reimbursement of expenses but remission of amount by the Taxpayer to the Parent company for finally making the payment to third party service provider and, hence, was a payment to third party through the hands of the parent company. Accordingly, provisions of withholding of taxes under Act will apply as if the Taxpayer has made the payment to such independent third party service provider.

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Article 7, 11 of India-UAE DTAA – Interest received by an UAE resident from an Indian partnership firm in which he is a partner is not taxable as business income, but as Interest income, owing to specific “Interest” article in the India-UAE DTAA; DTAA rate is not to be further enhanced by surcharge and education cess.

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6. TS-117-ITAT-2013(Mum)
Sunil V. Motiani vs. ITO
A.Ys.: 2008-09, Dated: 27-02-2013

Article 7, 11 of India-UAE DTAA – Interest received by an UAE resident from an Indian partnership firm in which he is a partner is not taxable as business income, but as Interest income, owing to specific “Interest” article in the India-UAE DTAA; DTAA rate is not to be further enhanced by surcharge and education cess.

Facts
The Taxpayer, resident of UAE, received interest income from partnership firms in India in which he was a partner. The Taxpayer offered such interest income to tax in India as per provisions of India-UAE DTAA (UAE DTAA). The tax authority, in addition to taxing the interest income at the rate prescribed in Article 11 of DTAA, also levied education cess and surcharge.

The CIT(A) ruled that as the interest income was in the nature of business income the same was taxable as per normal rates and the concessional rate as provided in the Article 11 was not applicable.

Held
• The specific Articles in DTAA dealing with taxation of income under different heads would govern the taxability of a specific income.

• Income from business is governed by Article 7 whereas interest income is governed by Article 11.

• Article 7(7) of the DTAA provides that in case specific provision deals with a particular type of income, the same has to be dealt with by those provisions.

• Thus, though interest income may be assessed as business income under the Act, in view of specific interest Article i.e. Article 11, interest income should be governed by the said Article 11.

• The term ‘Income Tax’ has been defined in Article 2 of the UAE DTAA to include surcharge. Therefore, tax rate provided in Article 11(2) dealing with interest income also includes surcharge.

• Based on Kolkata Tribunal decision in the case of DIC Asia Pacific Pte Ltd. v. ADIT(IT) [ITA No.1458/ Kol/2011], it can be held that education cess is in the nature of surcharge. Accordingly, both education cess and surcharge can be regarded as included in the treaty rate of 12.5%.

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S/s. 9, 10(23G) – Sale of shares of an Indian company by a Netherlands company to a Singapore company not taxable under the Act or India-Netherlands DTAA; Shares in the Indian company engaged in infrastructure activity is not “immovable property” so as to be taxed under Article 13(1) of Netherlands DTAA; Interest received for delay in payment of sale consideration by the Netherlands company which was received outside India, did not accrue or arise in India and cannot be taxed u/s. 9 of the Act.<

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5. TS-120-ITAT-2013(HYD)
Vanenburg Facilities B.V. vs. ADIT
A.Ys.: 2005-06, Dated: 15-03-2013

S/s. 9, 10(23G) – Sale of shares of an Indian company by a Netherlands company to a Singapore company not taxable under the Act or India-Netherlands DTAA; Shares in the Indian company engaged in infrastructure activity is not “immovable property” so as to be taxed under Article 13(1) of Netherlands DTAA; Interest received for delay in payment of sale consideration by the Netherlands company which was received outside India, did not accrue or arise in India and cannot be taxed u/s. 9 of the Act.

Facts
The Taxpayer, a Netherlands Company, made 100% equity investment in an Indian Company (ICo), which was engaged in the business of developing, operating and maintaining infrastructure facilities of an industrial park in India. Further, ICo was an approved infrastructure company u/s. 10(23G) of the Act, which exempts Long Term Capital Gains (LTCG) on investments made in infrastructure projects.

During the relevant AY, the Taxpayer sold its 100% shareholding in ICo to a Singapore Company (BuyCo). BuyCo also paid interest to the Taxpayer for delay in payment of sale consideration. Taxes were withheld by BuyCo both on LTCG and on interest paid. The Taxpayer claimed refund of the taxes withheld on the ground that, under the India-Netherlands Double Taxation Avoidance Agreement (Netherlands DTAA) LTCG was not taxable and the interest income did not accrue or arise in India. Alternatively, the Taxpayer also claimed shelter u/s. 10(23G) of the Act.

The tax authority rejected the claim made by the Taxpayer on the following grounds

• Article 13(1) of the Netherlands DTAA, which permitted taxation of gains arising on alienation of ‘immovable property’ and the same is applicable in the facts of the present case as transfer of 100% shares implied that the rights to enjoy the property of ICo vested with BuyCo.

• Exemption u/s. 10(23G) was not available as the approval to ICo was granted after the investment was made by the Taxpayer.

• Since interest is inextricably linked to base transaction, the same is taxable on the same lines as the base transaction.

The CIT(A) upheld tax authority’s order.

Held
The Tribunal based on the following, ruled that the LTCG and the interest received from FCo is not taxable in India in the hands of the Taxpayer.

On taxability under the Netherlands DTAA:

• Though the Act does not define ‘immovable property’ in section 2, it has been defined in a varied manner under different sections in the Act, which would be applicable specifically in a particular scenario. Therefore, it cannot be considered that ‘immovable property’ as defined for special purpose in sections like 269UA of the Act, 3(26) of General Clauses Act etc. has a general purpose meaning applicable to all provisions of the Act.

• A share held by a company cannot be considered as ‘immovable property’. In terms of Article 6 of the Netherlands DTAA immovable property shall have the meaning which it has under the law of the State in which the property in question is situated. Unless the conditions prescribed in Article 6 of Netherlands DTAA apply, the same cannot be considered as immovable property under Article 13(1) of the DTAA.

• Article 13(1) cannot be made applicable to the transfer of shares, as Taxpayer has not sold the immovable property or any rights directly attached to the immovable property.

• Article 13(5), which provides for taxability in case of alienation of shares (and consequential exclusive right of taxation to country of residence) is applicable to the facts of the present case, as per which the capital gains would be taxable in Netherlands. On exemption u/s. 10(23G):

• Since the Indian Company was already approved as an infrastructure company and was allowed deduction u/s. 80IA and further at the time of sale of shares the conditions as provided u/s. 10(23G) are satisfied, the sale of shares of an infrastructural company, is eligible for exemption as provided u/s. 10(23G).

• The fact that the approval was received post the date of investment is not relevant. On taxability of interest:

• As per Section 9 of the Act, interest is taxable in India if the same is towards a debt incurred or moneys borrowed and used for the purpose of a business or profession carried on by non-resident in India. In the facts, neither the Taxpayer nor BuyCo is carrying on any business in India, nor is the interest payable in respect of any debt incurred or moneys borrowed and used for the purpose of business in India. Therefore, the interest received by the Taxpayer which was paid and received outside India, cannot be taxed u/s. 9 of the Act.

• Even if interest were to be considered as part of consideration it would form part of the sale consideration and will be considered like capital gains.

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Section 2(22)(e) – Share application money is not “loan or advance” for the purpose of section 2(22)(e).

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4. DCIT vs. Vikas Oberoi
ITAT  Mumbai `F’ Bench
Before D. Karunakara rao (AM) and Vivek Verma (JM)
ITA Nos. 4362/M/2011  and 4 other appeals
A.Y.: 2002-03 and 2004-05 to 2007-08.     
Decided on: 20th  March, 2013.
Counsel for assessee/revenue: Murlidhar/A P Singh  

Section 2(22)(e) – Share application money is not “loan or advance” for the purpose of section 2(22)(e).


Facts
The assessee, was a partner/director/shareholder in various Oberoi Group entities. There was a search action on the assessee on 19-07-2007. In response to the notice issued u/s. 153A, the assessee filed return of income with no additional income as compared to return filed u/s. 139.

During the assessment proceedings u/s. 153A, the AO noticed that the assessee was a beneficial shareholder in both M/s Kingston Properties Pvt. Ltd (KPPL) and New Dimensions Consultants P. Ltd. (NDCPL). NDCPL had reserves and had contributed share application money into KPPL. KPPL was not the beneficial shareholder of NDCPL but the assessee was there in both the companies. NDCPL did not allot shares but the share application money was returned after the period of three years. The AO held that the assessee being a beneficial shareholder, had chosen this route to enrich his wealth by increasing net worth of KPPL, where he had beneficial interest. He rejected the book entries of both the companies by mentioning that it was a case of lifting of corporate veil. The AO assessed the sum of Rs. 1,40,03,700 as deemed dividend u/s. 2(22)(e) of the Act.

Aggrieved, the assessee preferred an appeal to CIT(A) who allowed the appeal in favor of the assessee.

Aggrieved, the revenue preferred an appeal to the Tribunal.

Held
Share application money or share application advance is distinct from ‘loan or advance’. Although share application money is one kind of advance given with the intention to obtain the allotment of shares/equity/preference shares etc, such advances are innately different form the normal loan or advances specified both in section 269SS or 2(22)(e) of the Act. Unless the mala fide is demonstrated by the AO with evidence, the book entries or resolution of the Board of the assessee become relevant and credible, which should not be dismissed without bringing any adverse material to demonstrate the contrary. It is also evident that share application money when partly returned without any allotment of shares, such refunds should not be classified as ‘loan or advance’ merely because share application advance is returned without allotment of share. In the instant case, the refund of the amount was done for commercial reasons and also in the best interest of the prospective share applicant. Further, it is self explanatory that the assessee being a ‘beneficial share holder’, derives no benefit whatsoever, when the impugned ‘share application money/advance’ is finally returned without any allotment of shares for commercial reasons. In this kind of situations, the books entries become really relevant as they show the initial intentions of the parties into the transactions. It is undisputed that the books entries suggest clearly the ‘share application’ nature of the advance and not the ‘loan or advance’. As such the revenue has merely suspected the transactions without containing any material to support the suspicion. Therefore, the share application money may be an advance but they are not advances which are referred to in section 2(22)(e) of the Act. Such advances, when returned without any allotment or part allotment of shares to the applicant/subscriber, will not take a nature of the loan merely because the same is repaid or returned or refunded in the same year or later years after keeping the money for some time with the company. So long as the original intention of payment of share application money is towards the allotment of shares of any kind, the same cannot be deemed as ‘loan or advance’ unless the mala fide intentions are exposed by the AO with evidence.

The appeal filed by the Revenue was dismissed.

Cases Relied upon :
1 Ardee Finvest (P) Ltd. vs. DCIT ITA No. 218/Del/2000 (AY 1996-97)(Del)
2 Direct Information P. Ltd. ITA No. 2576/M/2011 order dated 31.1.2012 (Mum)
3 CIT vs. Sunil Chopra ITA no. 106/2011 judgment dated 27-04-2011 (Del)(HC)
4 Subhmangal Credit Capital P Ltd. ITA No.7238/ Mum/2008 dtd 19-01-2010 (Mum)
5 Rugmini Ram Gagav Spinners P. Ltd 304 ITR 417 (Mad)(HC)

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S/s. 148, 150, 153, 254 – A notice u/s. 148 may be issued at any time for the purpose of making a reassessment in consequence of or to give effect to any finding or direction contained in an order. For the purpose of section 150(2), the “order which was the subject matter of appeal” is the assessment order and not the order of CIT(A). Reassessment may be completed at any time where the reassessment is made in consequence of or to give effect to any finding/direction of an order passed u/s. 254(<

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3. Sandhyaben A. Purohit vs. ITO
ITAT  Ahmedabad `C’ Bench
Before Mukul Kr. Shrawat (JM) and Anil
Chaturvedi (AM)
ITA No. 1536/Ahd/2011
A.Y.: 2004-05.   Decided on: 8th February, 2013.
Counsel for assessee / revenue: M. K. Patel /   D. K. Singh  

S/s. 148, 150, 153, 254 – A notice u/s. 148 may be issued at any time for the purpose of making a reassessment in consequence of or to give effect to any finding or direction contained in an order. For the purpose of section 150(2), the “order which was the subject matter of appeal” is the assessment order and not the order of CIT(A). reassessment may be completed at any time where the reassessment is made in consequence of or to give effect to any finding/direction of an order passed u/s. 254(1) of the Act i.e. an order of the ITAT.


Facts
The assessee sold a piece of land vide sale deed dated 21-05-2001. The consideration of sale was received before execution of the sale deed and possession was given simultaneous with the execution of the sale deed. However, the sale deed was registered on 30-07-2003. The Assessing Officer (AO) on getting information from the records of the purchaser, issued notice u/s. 148 for assessment year 2004-05. The AO collected information from the office of the Registrar and completed the assessment u/s. 144 by adopting the market value of the property sold.

Aggrieved the assessee preferred an appeal to CIT(A) who noted that the assessee had not offered capital gains on sale of property even in AY 2002-03. CIT(A) held that since the property was registered with the Registrar on 30-07-2003, transfer took place in AY 2004-05 and was correctly taxed by the AO.

Aggrieved the assessee preferred an appeal to the Tribunal and contended that the transfer u/s. 2(47) had taken place in the financial year relevant to assessment year 2002-03 and not 2004-05. Reliance was placed on decision in Arundhati Balkrishna & Anr. vs. CIT 138 ITR 245 (Guj) for the proposition that transfer is effective from the date of execution of the document and not from the date of registration. Revenue relied on the decision of the Apex Court in the case of Suraj Lamp & Industries 14 taxmann. com 103 (SC) for the proposition that transfer of an immovable property is enforceable only from the date of registration of the document.

On the possibility of making the assessment for AY 2002-03, it was submitted on behalf of the assessee that provisions of section 150 can only be attracted in respect of an order which is a subject matter of appeal and in this case order which is the subject matter of appeal is the order of cit9a0 which was dated 25-03-2011, hence the period of six years is to be computed considering the date of pronouncement of the order of CIT(A). Revenue contended that the assessment order is the subject matter of appeal which is dated 28-12-2007, hence direction can be given after considering the said date of assessment order.

Held
Considering the provisions of section 2(47)(v) and following the ratio of the decision of Bombay High Court in the case of Chaturbhuj Dwarkadas Kapadia v CIT 260 ITR 491 (Bom) the tribunal held that transfer had taken place in previous year relevant to assessment year 2002-03. It observed that since the decision of the Apex Court in the case of Suraj Lamps (supra) has been decided in a different context and the income-tax provisions were not adjudicated upon, the reliance placed by the revenue on the said precedent was misplaced.

The Tribunal noted the ratio of the decision of the Gujarat High Court in the case of Kalyan Ala Barot vs. M. H. Rathod 328 ITR 521 (Guj) and also the provisions of section 150 and observed that a notice u/s. 148 may be issued at any time for the purpose of making a reassessment in consequence of or to give effect to any finding or direction contained in an order. Further, in s/s. (v) of section 150, a limitation is prescribed that the clause of re-opening in s/s. (1) of section 150 shall not apply where any such reassessment relates to an assessment year in respect of which an assessment could not have been made at the time of order, which was subject matter of appeal, or as the case may be, was made by reason of any other provision of limiting the time within which any action for reassessment may be taken. The Tribunal held that assessment order is the order which is the subject matter of appeal. It also clarified that a co-joint reading with section 153(3) reveals that a reassessment may be completed at any time where the reassessment is made in consequence or to give effect to any finding / direction of an order passed u/s. 254(1) of the Act i.e. an order of the ITAT.

The appeal filed by the assessee was allowed subject to the direction mentioned above.

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Section 50C and Tolerance Band

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Issue for consideration

Section 50 C has been introduced by the Finance Act, 2002, with effect from 01-04-2003, to provide for substitution of the full value of consideration with the stamp duty valuation, in cases where such valuation happens to be more than the agreed value. As a result in computing the capital gains, on transfer of land or building or both, as per section 48, the assessee, in ascertaining the full value of consideration, is required to adopt the higher of the agreed value or the stamp duty valuation. The objective behind the introduction of section 50C is to eliminate or reduce the possibility of unaccounted element in the real estate transactions and it is on this account that the provision has been found to be constitutional by a number of high courts.

The provision contains an in-built safeguard, for authorising the assessee to seek a reference to the Valuation Officer, in a case where he is of the opinion that the stamp duty value does not represent the fair market value of the asset transferred by him. In spite of this statutory safeguard , it is usual to come across numerous cases where the assessee genuinely is aggrieved on the valuation put forth by the Valuation Officer.

It is also usual to come across instances, where the assessee is subjected to the additional taxes and interest in cases involving a marginal or insignificant difference. This difference, howsoever insignificant, arises mainly on account of the inherent element of estimation in valuation that is unavoidable. Realising this handicap in the past, while dealing with the similar provisions, the Supreme court held that a tolerance band of 15% be read in to such provisions by the authorities while applying such provisions, with the idea that no taxpayer is unjustly punished for the difference.

It is on this touchstone of avoiding unjust outcome of the literal reading of a statutory provision, one has to test the provisions of section 50C to ascertain,

whether it is possible to read therein, the existence of a tolerance band, to save the tax payers in cases of marginal differences form the noose of additional taxation. The Pune bench of the tribunal is in favour of reading such a tolerance band in the provisions of section 50C while the Kolkata bench holds a contrary view.

Rahul Constructions’ case
The issue first came up for consideration of the Pune bench of the tribunal, in the case of Rahul Constructions vs. DCIT, reported in 38 DTR at page 19, for assessment year 2004-05. In that case, the assessee firm had sold two units in the basement for the total sale consideration of Rs. 19 lakh. The stamp valuation authorities had adopted the value of Rs. 28.73 lakh for the said units. The AO invoking the provisions of section 50C, made a reference to the DVO, u/s. 50C(2), for valuation as per the law. The DVO valued the said units at Rs. 20.55 lakh. The AO adopting the said value of Rs. 20.55 lakh, substituted the full value of consideration and computed the capital gains at a higher amount than the one returned by the assesssee firm.

The explanations advanced by the firm to the AO and the DVO to the effect that the basement in rear building had no “commercial” value, the height was 8-1/2’ only, the units got waterlogged during the rainy season, they were old premises and were used by tenant/lessee and were sold on as is where is basis and the booking was in February, 2001, so valuation of 2001 be considered, were all rejected by them.

The said contentions were reiterated before the CIT(A) and in addition he was asked to apply the tolerance band due to insignificant difference between the agreed value and the DVO’s valuation. It was submitted that there was a marginal difference of Rs. 1,55,000 only, which was 8.5 per cent of the estimated sale value which was within the tolerance limit of 15 per cent for variation as was held by the Supreme Court in the case of C.B. Gautam vs. UOI, 199 ITR 530 (SC) under Chapter XX-C of the Act. The CIT(A) rejected the contentions of the firm to dismiss the appeal by observing that

the provisions of section 50C(1) of the Act were unambiguous and the AO was bound to take the rate as per the stamp valuation authorities and he was not empowered to go beyond the valuation made by the DVO. He distinguished the decision in the case of C.B. Gautam (supra) on the ground that the said decision concerned itself with the case of a purchase of property under Chapter XX-C of the Act. He upheld the action of the AO.

The firm aggrieved with such order of the CIT(A), appealed to the tribunal, inter alia, on the ground that on the facts and in law the learned CIT(A) erred in not appreciating that the difference between the sale consideration shown by the assessee and the value determined by the DVO was marginal and therefore, no addition was justified on account of the valuation determined by the DVO.

The counsel for the assessee reiterated the submissions as were made before the AO and the CIT(A). Referring to the DVO’s report he submitted that the difference between the value adopted by the DVO and the sale consideration received by the firm was less than 10 per cent and submitted that the consideration received by the firm should be considered as representing the fair market valuation and no addition was justified on account of the valuation by the DVO.

In reply the Departmental Representative submitted, that once the matter was referred to the DVO and the valuation adopted by the DVO was found to be less than the value determined by the stamp valuation authorities, the AO was bound to substitute the value determined by the DVO as the deemed sale consideration and the assessee could not challenge the same.

On due consideration of the rival submissions made by both the sides, the tribunal held that the valuation adopted by the DVO was subject to appeal and the same was not final. The value adopted by the DVO was also based on some estimate and that the difference between the sale consideration shown by the assessee at Rs. 19,00,000 and the FMV determined by the DVO at Rs. 20,55,000 was only Rs. 1,55,000 which was less than 10 per cent. It observed that the courts and the tribunals were consistently taking a liberal approach in favour of the assessee where the difference between the value adopted by the assessee and the value adopted by the DVO was less than 10 per cent.

The tribunal noted that the Pune bench of the tribunal in the case of ACIT vs. Harpreet Hotels (P) Ltd. vide ITA Nos. 1156-1160/Pn/2000 had dismissed the appeal filed by the Revenue, where the CIT(A) had deleted the addition made on account of the unexplained investment in house construction on the ground that the difference between the figure shown by the assessee and the figure of the DVO was hardly 10 per cent. Similarly, the Pune bench of the tribunal in the case of ITO vs. Kaaddu Jayghosh Appasaheb, vide ITA No. 441/Pn/2004, for the asst. yr. 1992-93, following the decision in the case of Honest Group of Hotels (P) Ltd. vs. CIT 177 CTR (J&K) 232 had held that when the margin between the value as given by the assessee and the Departmental valuer was less than 10 per cent, the difference was liable to be ignored. In the result, the appeal of the assessee was allowed by the tribunal.

Heilgers’ case

The issue again came up recently, for consideration of the Kolkata tribunal, in the case of Heilgers De-velopment & Construction Co. (P) Ltd. vs. DCIT, 32 taxmann.com 147 by way of appeal by the assessee, for the assessment year 2008-09, on the ground that the ld. CIT(A) erred in confirming the addition made on account of capital gains based on the value determined by the Stamp Valuation Authority that was higher than the sale consideration declared by the assessee which was wrong and needed to be deleted.

In that case, the assessee had sold two commercial premises admeasuring 3265 sq.ft. in aggregate, for the stated aggregate consideration of Rs. 2.12 crore against the stamp duty valuation of about Rs. 2.23 crore, in aggregate. The difference was attributed by the assessee to the long gap of 7 to 9 months between the date of agreement and the date of conveyance. It was argued that considering the difference in market value when compared with the consideration received by the assessee was less than 10%. And therefore the net difference of Rs. 10,98,980 should be ignored in computing the long term capital gains. None of these submissions found favour with the AO and the CIT(A).

In the further appeal before the tribunal, the assesssee’s counsel’s first and basic contention was that the provisions of section 50C could not be invoked at all where the difference in stamp duty valuation vis-a-vis stated sales consideration was less than 15% of the stamp duty valuation; that every valuation was at best an estimate and therefore under valuation could not be presumed when there was only a marginal difference between such an estimate and the apparent consideration declared in the sale document; that the Honourable Supreme Court, in the case of C.B. Gautam vs. Union of India, 199 ITR 530, had recognised a tolerance limit for pre-emptive purchase of property under Chapter XXC, at 15% of variation, mainly for a similar reason, even though no such tolerance band was prescribed in the statute.

Quoting from certain observations in “Sampat Iyen-gar’s Law of Income Tax” (Volume 3; 10th Edition) at page 4362, it was submitted that by the same logic that was employed by the Honourable Supreme Court in Gautam’s case (supra), section 50C was also subject to similar tolerance for the cases with the marginal difference. It was pleaded that the difference in valuation as per the sale deed vis-a-vis the stamp duty valuation being much less than 15% in the present case, the provisions of section 50C did not come into play at all.

The submissions of the assesssee failed to con-vince the tribunal. It noted that the submissions, howsoever attractive as they seemed at the first blush, were lacking in legally sustainable merits. The tribunal observed that ; when a provision for tolerance band was not prescribed in the statute, it could not be open to tribunal to read the same into the statutory provisions of section 50 C- no matter howsoever desirable such an interpretation was; what the provisions of section 50C clearly required was that when stated sales consideration was less than the stamp duty valuation for the purposes of transfer, the stamp duty value, subject to the safeguards built in the provision itself, should be taken as the sales consideration for the purposes of computing capital gains; casus omissus, which broadly referred to the principle that a matter which had not been provided in the statue but should have been there, could not be supplied by the tribunal as laid down in the case of Smt. Tarulata Shyam vs. CIT, 108 ITR 345(SC); the tribunal was itself a creature of the Income-tax Act and it could not, therefore, be open to it to deal with the question of correctness or otherwise of the provisions of the Act.

The tribunal also did not find any merits in the assessee’s claim of undue hardship being caused to the taxpayers and to avoid that a tolerance band be read into the provisions of the section 50C. The safeguard built in section 50C, the tribunal noted, did envisage a situation that whenever an assessee claimed that the fair market value of the property was less than the stamp duty valuation of the property and allowed for a reference to the DVO and at which point all the issues relating to valuation of the property – either on the issue of allowing a reasonable margin for market variations, or on the issue of time gap , could be taken up, before the DVO and, therefore, before subsequent appellate forums as well. This inherent flexibility, the tribunal held might rescue the assessee particularly in the case of marginal differences however, challenging the very application of section 50C was something which tribunal found to be devoid of legally sustainable merits.

Observations

The avowed legislative intention behind the introduction of section 50C is to bring to tax the unaccounted funds, used in the real estate transactions, involving land and/or building. There is no dispute about this aspect. The objective is certainly not to tax a tax payer in respect of the sterile transactions. In this background, any attempt to tax a clean transaction amounts to penalising the person for having entered in to a transaction and such attempt becomes punishing in a case where the difference is marginal.

The valuation, including the valuation by the stamp duty authorities, without doubt involves an element of estimation and can never be precise. Such a valuation, as has been repetitively held by the courts, is, at the most, a guiding factor and cannot be conclusive of the fact of the use of unaccounted funds. Interestingly, the ready reckoner rate, so famously applied by the authorities and blindly relied upon by the AOs, are nothing but the standard and generic rates annually prescribed by the stamp authorities. The prescribed rate is not even the ‘valuation’ of a specific asset. This rate is prescribed for an entire locality or an area and does not take in to consideration several factors that have a direct bearing on the price and therefore the valuation. Hardly does one come across a case where the transaction value exactly matches with the prescribed rates; it is either less or more and in most of the cases more. The values do match only in those transactions where it is so designed to match to avoid the attending issues.

It is therefore essential for the revenue to appreciate and concede that the stamp duty valuation or the DVO’s valuation is essentially an estimation that requires to be adjusted by some tolerance band. Once this wisdom, based on the ground reality, is allowed to percolate, resulting litigation or the fear or the threat thereof shall rest at least in half the cases.

One of the main reasons advanced by the Kolkata bench, for not allowing the case of the assessee, was the inability of the tribunal, as a body, to read down the provisions of the law. The bench stated in clear terms that their powers are circumscribed and the tribunal as a creature of the Income-tax Act cannot read down the provisions of the law so as to permit the application of a tolerance band. The bench expressed its helplessness and explained that such powers were vested with the courts. This also confirms that the last word on the possibility of applying the tolerance band is yet to be said.

The better course, with respect, in our considered view, for the tribunal should have been to accept that the agreed value, considering the insignificant difference, represented the fair market value.

On a careful reading of the provisions of section 50C, one gathers that a reference to the DVO is possible on the primary assumption that the stamp duty valuation exceeds the fair market value. It is also gathered that the job of the DVO is to ascertain the fair market value. The fair market value, so ascertained by the DVO, is subject to the scrutiny of the appellate authorities whose word about the correctness of the fair market value is the final word. In this background of the facts, we are of the considered view that the tribunal, in all such cases involving the marginal difference, shall accept the agreed value as the fair market value, independent of the statutory tolerance band.

Section 80 HHE – Deduction respect of profits from export of computer software – For the purpose of computation of deduction only the total turnover and export turnover of the eligible business is to be considered.

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2. Datamatics Technologies Ltd. vs. DCIT
ITAT Mumbai benches “D”, Mumbai
Before D. Manmohan (V.P.) and Sanjay Arora (A.M.)
ITA No. 5557 / Mum / 2011
Asst Year 2003-04.  Decided on 08-03-2013
Counsel for Assessee/revenue:  J. P. Bairagra /rupinder Brar

Section 80 HHE – Deduction respect of profits from export of computer software –  For the purpose of computation of deduction only the total turnover and export turnover of the eligible business is to be considered.


Facts
The assessee had claimed deduction of Rs. 55.99 lakh u/s. 80 HHE. The AO restricted the assessee’s claim to Rs. 8.02 lakh by taking into account the turnover of all the units of the assessee instead of the turnover of only the eligible units u/s. 80 HHE as claimed by the assessee. On appeal, the CIT(A) confirmed the AO’s order.

Before the tribunal, the revenue justified the orders of the lower authorities on the ground that if the contentions of the assessee were to be accepted, the whole premise or basis of the allocation of profits as prescribed per s/s. (3) of section 80 HHE would stand defeated inasmuch as the turnover of the assessee’s export unit would be its total turnover, rendering the apportionment as of no consequence. It also relied on the decisions of Kerala high court in the case of CIT vs. Parry Agro Industries Ltd. (257 ITR 41) and Mumbai tribunal decision in the case of Ashco Industries Ltd. vs. JCIT (ITA no. 2447 /Mum/2000 dt. 14-01-2003). The decisions in the above two decisions were rendered in the context of the provisions of section 80HHC. However, the revenue justified its reliance on the said two decisions on the ground that the two sections viz., 80 HHC and 80 HHE, are para material prescribing the same computational formula to compute profit attributable to the eligible export business.

Held
According to the tribunal, the issue to be decided was whether the ‘total turnover’ for the purpose of deduction u/s. 80 HHE would be the total turnover of only the eligible units or the total turnover of all the units.

The tribunal noted that unlike the provisions in section 10A, 10B, 80 IA, 80 IB, 80HH, etc. the deduction u/s. 80 HHE is not unit specific but is business specific, i.e. the business of export of computer software. Further, it referred to a decision of the Mumbai tribunal in the case of Tessitura Monti India Pvt. Ltd. (ITA No. 7127/Mum/2010 dt. 11- 01-2013 which decision was rendered in the context of section 10B. Relying on the said decision, the tribunal observed that the qualifying profit for the purpose of computing ‘profits and gains of business or profession’ as per Explanation (d) to the section would be the profits of the computer software business and correspondingly, it would be the export and the total turnover of the said business only that would stand to be considered for apportionment u/s. 80 HHE(3).

As regards the revenue’s contention that the formula to compute profit of the business should be given the same meaning as is given u/s. 80 HHC, the tribunal noted that the provisions of section 80 HHC also requires the adjustment of sales turnover of mineral resources from the total turnover or the adjusted total turnover, in case the assessee is also engaged in the said business. Further, referring to the various legislative amendments carried out in section 80 HHC, the tribunal observed that the same were only to neutralise the anomalies that arose in the wide variety of business situations.

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Financial Sector Reforms

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The last 45 days have witnessed several events that may have been of interest to the world of finance and have received considerable news coverage across the country. After years of political wrangling and months of rumours, India finally received its first tranche of FDI into the aviation sector when Jet Airways and Etihad announced their strategic partnership. The West Bengal based Saradha Group turned out to be yet another elaborate ponzi scheme that recycled deposits of vulnerable sections of the public. Worse, the financial institution went bust and cannot now return its investors’ money.

But one event of significance that went relatively unnoticed was the release of the report of the Financial Sector Legislative Reforms Commission (FSLRC). The Report recommends a paradigm shift in the regulation of our country’s financial system and is bound to evoke diverse reactions from different stakeholders. The FSLRC was headed by Justice B.N. Srikrishna (Retd.), who is a veteran of several key reports, and included several noted persons like Mr. Y. H. Malegam.

The present regulatory system has gaps, overlaps, inconsistencies and opportunity for regulatory arbitrage. The Report calls for several fundamental changes in the way financial sector is regulated in India. While some of these changes were long overdue, others are innovative and will require some debate before their acceptance. As noted by the FSLRC, financial regulators are unique in the sense that three functions – legislative, executive and judicial – are placed in the single agency. This concentration of power needs to go along with strong accountability mechanisms.

Unlike most commissions, the FSLRC’s Report includes a draft ‘Indian Financial Code’ that is the first step towards the consolidation of all existing regulations into a single piece of legislation. The Code proposes an equal regulatory environment that is non-sectoral and ownership neutral. This means that the same regulations would apply to all firms, irrespective of what sector they operate in, be it banking, securities or insurance. Further, all firms would be treated on par without regard to their ownership structure. So the regulator would not discriminate between private and public, Indian and foreign, private and government undertakings, or companies and cooperatives.

The Report recommends an overhaul of the existing regulatory agencies. This overhaul, though characterised only as “a modest step away from present practice” includes modifying the mandate for the RBI, setting up of a Unified Financial Agency (replacing SEBI, IRDA, Forward Market Commission and Pension Fund Regulatory and Development Authority), a Financial Sector Appellate Tribunal (replacing SAT), Resolution Corporation (replacing Deposit Insurance and Credit Guarantee Corporation of India), a Public Debt Management Agency, instituting a single unified consumer redressal mechanism comprising of a Financial Redressal Agency and giving statutory recognition to Financial Stability and Development Council. Other note-worthy recommendations in the Draft Code proposed by the Commission include legalisation of and bringing clarity to validity of non-exchange traded derivative contracts between sophisticated counterparties and an internal control system for all regulated firms that may involve compulsory reporting of some findings to the concerned regulator. FSLRC recommends setting up of Resolution editorial Financial Sector Reforms Bombay Chartered Acountant Journal, may 2013 7 editorial 139 (2013) 45-A BCAJ BCAJ Corporation to keep a check on the health and stability of financial firms and resolve swiftly problems arising out of the instability of one or more firms.

While the implementation of these path-breaking changes will no doubt address many of the problems and shortcomings of the existing regulatory regime, it will also have a cost. A large number of businesses have already been set up and transactions executed keeping in mind the existing regulations. Many of these may need to be reworked. Secondly, setting up of institutions staffed with qualified professionals is expensive. The present day RBI, SEBI and consumer fora are a result of evolution and years of institution building that required intensive investment into infrastructure and human resource development. This will have to be repeated all over again for the new institutions to be set up under the draft Code. Other non-monetary costs include the cost of developing new precedents and case-law on the new Code. The present legislations and regulations have been the subject of substantial litigation and it has taken years for the tribunals and Courts to clarify the scope, intent and interpretation of the various provisions of the existing laws. New laws will mean several rounds of long drawn litigation before the meaning of the laws become reasonably final.

The Commission recognises that its recommendations are ambitious and will require many of the Acts to be repealed or amended. There are also issues of jurisdiction, e.g. co-operative sector, chit funds come within the purview of the States. But these will also have to be regulated, being part of the financial sector.

The Commission has emphasised that piecemeal modifications to the existing system will not work and will not have the desired effect. The Finance Minister has indicated that no time limit can be set for taking action on the report. It is a mammoth work and a big exercise. If experience is any guide, change of such nature will take at least a few years before it sees the light of the day.

“The foundations of modern financial legal regulatory structures should be erected during peaceful times rather than wait for a crisis to unfold and then embark on a fire-fighting mode of institution building, which would be muddled and fragile”. – Report of FSLRC

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Financial Statement Disclo sures — How Much is Too Much

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Now that the IASB and the FASB’s joint projects are making steady progress in addressing key accounting areas, the two Boards are spending more time at the conceptual issues such as the presentation and disclosure in the financial statements. Earlier this year, the IASB hosted a public forum to brainstorm the topic while the FASB discussed a summary of the responses to its discussion paper on the disclosure framework.

Over the last five years, the size of annual reports of companies has increased substantially. One of the reasons attributed to the global financial crisis was the off-balance sheet exposures and the lack of adequate disclosures in the financial statements relating to these exposures by the companies. This pushed regulators, standard-setters, auditors, preparers and users of the financial statements alike in working overtime to bulge the size of companies’ annual reports without much deliberation around the usefulness of enhanced disclosures or their potential implications on loss of more relevant information among the resultant disclosure ‘noise’ in the financial statements.

Soon after, the solution began to emerge itself as a problem as preparers and auditors started feeling the burden of complying with these additional reporting requirements. Many organisations were forced to expand their financial reporting teams manifold to cope with the exhaustive data collection and analyses and to upgrade their financial reporting systems. This strain pushed forward the momentum around the Boards’ respective projects addressing the presentation and disclosure and is now creating a lot of traction among those affected.

As the participants from Africa, Asia, Europe and North America continue to debate possible solutions to the issue through the IASB and FASB forums, a message that has come out loud and clear is that while the preparers think there is too much required to disclose, users, on the other side, are suffering from information indigestion. There is a lot served, but of that there is very little that’s palatable. Much of the relevant information intended to address the needs of the key stakeholders is lost in this disclosure overload. However, if the constitution of the participants is to go by, the message is crystal clear that it’s the preparers who see this as a larger issue than users of the financial statements.

There are several ideas being mulled to achieve disclosure effectiveness, as there is also a scepticism around the practicability of these ideas. Some of these are:

• Materiality – How can this be applied to qualitative disclosures

• Principles-based guidance – Is it possible to have a single source of principles-based guidance providing conceptual framework for all disclosures

• Purpose and relevance – Is it possible to provide a ‘one-size-fits-all’ definition of purpose and/or relevance of the disclosure requirements

• Offer flexibility – Move away from the words such as ‘shall’ or ‘at a minimum’ from the disclosure requirements in the existing standards; let the preparers use discretion in deciding what’s relevant for their business

• Avoid overlap – There are areas requiring disclosures in the Management Discussion & Analysis (the front half) and also within the financial statements (the back half) of an annual report. A cross-reference mechanism may be developed to avoid repetition.

There is a high degree of engagement on this issue indicating wider approval to the disclosure framework project but a near unanimous view is that there isn’t going to be an easy fix to the disclosure problem.

The key challenges expected at this stage are:

• Finding the right balance to cater to all users with different needs

• Alignment with the overall financial statement conceptual framework

• Legal, institutional barriers

• Disclose more, not less – the cost of a disclosure failure is high

The debate continues but things seem to be moving in the right direction. The problem has been diagnosed; a solution will follow in due course. Standard-setters will need to work with regulators and other bodies who have a say in imposing the disclosure requirements and expand their outreach efforts to be able to cut the clutter effectively from financial statements without losing relevance and effectiveness from the disclosures. Let’s do our bit by getting involved in these discussions and work towards achieving a better world of financial reporting.

Thought to munch – There are so many of us who cannot find enough time to read an interesting book that’s more than 200 pages long. For an annual report with more than 200 pages!! Any takers?

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REVISED REPORTING REQUIREMENTS FOR AUDIT OF FINANCIAL STATEMENTS

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Introduction

An audit report is an opinion of an auditor regarding entity’s financial statements. It is the conclusion of an audit of financial statements is the audit report. It is only through the audit report that the statutory auditor communicates about the audit procedures followed, the auditing framework followed and whether the financial statements on which the report is given depicts a ‘True and Fair’ view.

The Institute of Chartered Accountants of India (ICAI) has promulgated several standards for the conduct of audit and reporting. The SAs are divided into 2 groups:

a) Standards on Quality Control (SQC) (which apply at the firm level) and

b) Standards on Audit (SA) which apply to audits of historical financial information. SAs are further categorised as standards dealing with:

i) G eneral principles and responsibilities (issued under 200 series);

ii) Risk assessment and response to assessed risks (issued under 300 and 400 series);

iii) Audit evidence (issued under 500 series);

iv) Using work of others (issued under 600 series);

v) Audit conclusions and reporting (issued under 700 series) and

vi) Specialised areas (issued under 800 series).

ICAI had issued a new set of SAs (under 700 series) which were to be applied for audits for financial statements for the period on or after 1st April 2011. However, in view of inadequate dissemination of information about the applicability of the series 700 SAs and consequent unawareness of the same, the applicability was postponed by ICAI for audits for financial statements for the period on or after 1st April 2012. Thus, audit reports for audits conducted for the financial year 2012-13 would be the first year of applicability of the series 700 SAs. ICAI has also issued “Implementation guide on Reporting Standards” to address the concerns, apprehensions and difficulties in relation to implementation of the new reporting standards.

This article discusses the Standards on Audit Conclusions and Reporting issued under 700 series.

The new SAs are listed as under:

SAs apply to audits of general purpose financial statements (GPFS). They do not apply to engagements other than audits, where the procedures performed are ‘reviews’ or ‘compilations’ or ‘agreedupon- procedures’. GPFS generally consist of balance sheet, statement of profit and loss (or income statement), cash flow statement, significant accounting policies and notes and where applicable, statement of changes in equity.

GPFS are Financial Statements are FS prepared in accordance with a Financial Reporting Framework (FRF) and is designed to meet common financial information needs of a wide range of users. The FRF may be a ‘fair presentation framework’ or a ‘compliance framework’. Broad differences between these two frameworks are given in the Table 1.

A question which arises is that apart from audit reports of companies, whether these SAs would also apply to reports issued under the Income Tax Act, 1961 (e.g. tax audit report issued in Form 3CB)? As mentioned in 6 above, SAs apply to audits of GPFS – hence if the financial statements for which the report is issued in Form 3CB, are GPFS, then these SAs would also apply for such reporting. Para 3.4 of the Preface to the Statements of Accounting Standards issued by ICAI in 2004 states that “the term ‘General Purpose Financial Statements’ includes balance sheet, statement of profit and loss, cash flow statement (wherever applicable) and statements and explanatory notes which form part thereof, issued for the use of various stakeholders, governments and their agencies and the public…”

Further, footnote 9 to SA 800 ‘Special Considerations – Audits of Financial Statements Prepared in accordance with Special Purpose Frameworks’ states that “In India, financial statements prepared for filing with income tax authorities are considered to be general purpose financial statements”.

In view of this specific assertion from ICAI, the audit report format prescribed by SA 700(R), SA 705, SA 706 and SA 710(R) would also apply to reports issued in Form 3CB under the Income Tax Act, 1961.

The ‘Financial Reporting Framework’ (FRF) is not defined in SA 700(R). However, para 22 of SA 700 (AAS 28) mentions: “Paragraph 3 of “Framework of Statements on Standard Auditing Practices and Guidance Notes on Related Services”, issued by the ICAI, discusses the financial reporting framework. It states: “ ….Thus, FS need to be prepared in accordance with one, or a combination of:

(a) Relevant statutory requirements, e.g., the Companies Act, 1956,

(b) Accounting Standards issued by ICAI; and

(c) Other recognised accounting principles and practices, e.g., those recommended in the Guidance Notes issued by the ICAI” (emphasis supplied)

The above Framework issued in 2001 has been withdrawn pursuant to the revised “Framework for Assurance Engagements” applicable from April 1, 2008. The revised framework does not define ‘Financial Reporting Framework’. Due to this, does it imply that the other recognised accounting principles and practices, e.g., those recommended in the Guidance Notes (GN) issued by the ICAI will not form part of FRF? ICAI needs to clarify this, since, if the GNs issued by ICAI do not form part of FRF, the very mandatory nature of these GN for members of ICAI comes in doubt.

SA 700(R) requires an auditor to form an opinion on whether the FS are prepared in all material respects in accordance with the applicable FRF. To form that opinion, the auditor has to conclude, whether reasonable assurance has been obtained that the FS as a whole are free from material misstatement, whether due to fraud or error. In order to come to such conclusion the auditor shall need to take into account the following:

i)    whether Sufficient Appropriate Audit Evidence (SAAE) has been obtained in accordance with SA 330 ‘Standard on the Auditor’s Responses to Assessed Risks’;

ii)    whether uncorrected misstatements are material, individually or in aggregate in accordance with SA 450 ‘Standard on Evaluation of mis-statements identified during the Audit’;

iii)    other required evaluations related to selection, consistent application and disclosure of the significant accounting policies and reasonability of accounting estimates by management; and

iv)    In case of fair presentation framework, evaluation to also include whether FS achieve fair presentation.

SA 700(R) requires that the auditor expresses an unmodified opinion if he concludes that the FS are prepared, in all material respects, in accordance with the applicable FRF. The auditor has to, however, give a modified opinion in two situations:

i)    When the auditor has obtained SAAE but he concludes that the FS taken as a whole are not free from material misstatement(s); or

ii)    When he is unable to obtain SAAE.

In either of the above situations the auditor must give a modified opinion as per SA 705.

In case of reporting under fair presentation frame-work, if the auditor concludes that the fair presentation is not achieved, he should discuss the matter with the management to resolve the issue and based on the outcome, decide whether he should give a modified opinion or not.

As per the SA 700(R), the auditor’s report has to be in writing and should include the following:

Title

The title of an auditor’s report should clearly indicate that it is the report of an independent auditor like “Independent Auditor’s Report”. Unlike the earlier title ‘Auditor’s Report’ this title makes it very implicit that independence is one of the important considerations while doing the audit.

Addressee

The report should be addressed to those for whom it is prepared in line with the existing requirement. Typically, it is addressed to ‘the shareholders’ or ‘the members’ in case of the statutory audit under the Companies Act, 1956 or to the Board of Directors in case of Consolidated Financial Statements (CFS).

Introductory Paragraph

In this paragraph apart from identifying the entity, the title of each statements comprised in the FS and the period covered by each of the statements, a specific reference has to be made to the summary of significant accounting policies and other explanatory information given in the FS. The following illustration is given in the Appendix of the Standard:
“We have audited the accompanying financial statements of ABC Ltd, which comprise the Balance Sheet as at March 31, 20XX, and the Statement of Profit and Loss for the year then ended, and a summary of significant accounting policies and other explanatory information”.

Management’s Responsibility Paragraph

The SA requires the Auditor to describe, under a separate paragraph with heading ‘Management’s Responsibility for the financial statements’ that the management (or those charged with governance) is responsible:

•    for the preparation of FS in accordance with the applicable FRF; and

•    for the design, implementation and maintenance of the internal controls relevant to the preparation of FS which are free from material misstatement, whether due to fraud or error.

In cases where FS are prepared in accordance with a fair presentation framework, the report should refer to “the preparation and fair presentation of these FS” or “the preparation of FS that give a true and fair view”.

Auditor’s Responsibility Paragraph

The SA requires the report to state the following:

i)    that the responsibility of the auditor is to express an opinion on the FS based on the audit;

ii)    that audit was conducted in accordance with Standards on Auditing issued by ICAI and that these SAs require the auditor to:

•    Comply with ethical requirements;

•    Plan and perform the audit to obtain reasonable assurance about whether the FS are free from material misstatement.

The report should also describe an audit by stating that:

•    An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the FS;

•    The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the FS, whether due to fraud or error.

•    In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation of the financial statements in order to design audit procedures that are appropriate in the circumstances,

An audit also includes evaluation of Appropriateness of accounting policies used and Reasonableness of management’s accounting estimates; and

Overall presentation of FS

i)    Where the FS are prepared in accordance with a fair presentation framework, the description of the audit in the auditor’s report shall refer to “the entity’s preparation of FS that give True & Fair view”

ii)    The auditor’s report should also state whether the auditor believes that he has obtained SAAE to provide a basis for his opinion.

Auditor’s Opinion Paragraph

The SA requires the expression of opinion as under:

Unmodified opinion expressed

In case of Fair Presentation framework:

FS present fairly, in all material respects, in accordance with {applicable FRF}

Or

FS give a True & Fair view of in accordance with [applicable FRF]

The SA gives an illustration of an unmodified opinion in case of fair presentation framework under Companies Act, 1956 as under:

“In our opinion and to the best of our information and according to the explanations given to us, the Financial Statements give the information required by The Companies Act, 1956, in the manner so required and give a true & fair view of the financial position of ABC Ltd. As at March 31, 20xx and of its financial performance and its cash flows for the year then ended, in accordance with accounting standards referred to in section 211(3C) of the said Act”.

In case of Compliance framework:

FS are prepared, in all material respects, in accordance with [applicable FRF]

Other Reporting Responsibilities Paragraph

The SA mentions that sometimes the auditor is also required to report on other matters that are supplementary to the auditor’s responsibility to report on the financial statements. For example, report on additional specified procedures or to express an opinion on specific matters or under the relevant law or regulation. The SA provides that if the auditor addresses other reporting responsibilities in the auditor’s report on the FS that are in addition to the auditor’s responsibility under the SAs to report on the FS, they shall be addressed in a separate section in the auditor’s report that shall be sub-titled “Report on Other Legal and Regulatory Requirements,” or otherwise as appropriate to the content of the section. For e.g. reporting under CARO or for NBFCs as required by RBI, etc.. Unlike the current practice where different practices were being followed with reference to such reporting, SA 700(R) requires the same to be reported under a specific heading.

Signature

The Audit Report has to be signed in the auditor’s personal name and where a firm is appointed as auditor, report shall be signed in personal name and in name of audit firm. The report has to also mention membership number issued by ICAI and wherever applicable, the registration number of the firm, allotted by the ICAI.

Though it apparently appears from the SA that the signatures need to be in individual as well as in the name of the firm, the implementation guide to SA 700(R) issued by ICAI in Question 21 mentions that “the intention of the SA is not to have 2 separate signatures, one in personal name and one in firm name, but that the partner signing should sign in his personal name for and on behalf of the firm which has been appointed as the auditor with the name and registration number of the firm also mentioned as signatory”.

Date of Auditor’s Report

The SA mentions that the audit report cannot be dated earlier than the date on which auditor has obtained SAAE on which the auditor’s opinion is based. This is to inform users of the FS that the auditor has considered effect of events and transactions that have occurred upto that date.

Place of Signature

The SA requires that the auditor’s report has to specify location, which is ordinarily the city where the audit report is signed. Thus, in a case where the report is signed in a city other that the one where the Board has adopted the FS, the name of the city where the directors sign would be different from that where the auditor signs the report.

The SA mentions that the wording of an auditor’s report may sometimes be prescribed by the law or regulation applicable to the client. If the prescribed terms are significantly different from the requirements of SAs, SA 210 ‘Agreeing the Terms of Audit Engagement’ requires the auditor to evaluate:

•    whether users might misunderstand the assurance obtained from the audit, and if so,

•    whether providing additional explanation in the auditor’s report can mitigate such misunderstanding.

SA 705 – Modifications to the opinion in the Independent Auditor’s Report

SA 705 deals with the auditor’s responsibility to issue an appropriate report in circumstances when, in forming an opinion in accordance with SA 700(R), the auditor concludes that a modification to the auditor’s opinion on the financial statements is necessary.

SA 705 describes 3 types of modified opinions: (i) Qualified Opinion, (ii) Adverse Opinion and (iii) Disclaimer of Opinion

The decision on which type of modified opinion is appropriate depends on:

a)    Nature of matter giving rise to the modification i.e. whether the FS are materially misstated or in case of inability to obtain SAAE maybe materially misstated; and

b)    Auditor’s judgement about the pervasiveness of the effects or possible effects of the matter on the FS.

The SA mentions the circumstances when modification to opinion is required. It states that if the auditor concludes that based on the audit evidence obtained, the FS as a whole are not free from mate-rial misstatement, he can issued a modified report. This may be due to:

•    Inappropriateness of the selected accounting policies:

  •     Accounting Policies not consistent with applicable FRF;

  •     FS do not represent underlying transactions and events in a manner that achieves fair presentation;

•    Inappropriateness of adequacy of disclosures in FS

  •     FS do not include all disclosures required by applicable FRF;

  •     Disclosures not presented as per applicable FRF;

  •     FS do not contain disclosures necessary to achieve fair presentation

•    Inability to obtain SAAE

  •     Circumstances beyond control of entity; (e.g. records destroyed or seized by authorities)

  •     Circumstances relating to nature of timing of auditor’s work; (e.g. timing such that physical inventory cannot be taken )

  •     Limitations imposed by management (e.g. auditors prevented from obtaining external confirmations, etc.)

SA 705 lays down as under the criteria for deter-mining the type of modification which are given in Table 2:

The SA mentions that ‘pervasive’ effects are those that, in the auditor’s judgment:

•    Are not confined to specific elements, accounts or items of the FS;

•    If so confined, represent or could represent a substantial proportion of the FS

•    In relation to disclosures, are fundamental to users’ understanding of the FS.

The SA requires the auditor to disclaim an opinion when, in extremely rare circumstances involving multiple uncertainties, the auditor concludes that, notwithstanding having obtained SAAE regarding each of the individual uncertainties, it is not possible to form an opinion on the FS due to the potential interaction of the uncertainties and their possible cumulative effect on the FS.

SA 705 also gives the form and content of Auditor’s Report in case of Modified Opinion. It requires that

i)    In addition to other elements as per SA 700(R), the Auditor’s Responsibility statement is to be amended to provide description of matter giving rise to modification;

ii)    The placement of the same is immediately before the Opinion para with the heading “Basis for Modified Opinion”

iii)    The contents of the ‘Basis of Modification Para’ dependon the cause of modification.. The same are given in Table 3

SA 705 requires a Qualified Opinion to be given as:

“Except for the effects of the matter(s) described in the ‘Basis for qualified opinion para’’

•    In case of Fair Presentation framework:

The FS present fairly, in all material respects (or give a true and fair view) in accordance with the [applicable FRF]

•    In case of Compliance framework:

The FS have been prepared, in all material respects in accordance with the {applicable FRF}”.

SA 705 requires an Adverse Opinion to be given as:

“In the auditor’s opinion, because of the significance of the matter(s) described in the ‘Basis of Adverse Opinion para’,

•    In case of Fair Presentation framework: “The FS do not present fairly, in all material respects (or give a true and fair view) in accordance with the [applicable FRF]”.

•    In case of Compliance framework: “The FS have not been prepared, in all material respects in accordance with the [applicable FRF]”.

SA 705 requires a Disclaimer of Opinion to be given as:

“Because of the significance of the matter(s) described in the ‘Basis for Disclaimer of Opinion para’, the auditor has not been able to obtain SAAE to provide a basis for an audit opinion and accordingly, the auditor does not express an opinion on the FS.”

The SA also requires description of auditor’s responsibility to be amended when the auditor expresses a qualified or adverse opinion. In such cases, the description of the auditor’s responsibility has to be amended to state that the auditor believes that he has obtained SAAE to provide a basis for his modified audit opinion.

In case, the auditor has disclaimed an Opinion, he has to amend the introductory paragraph of the auditor’s report to state that he was engaged to audit the FS and amend the description of the auditor’s responsibility. The same should be as under:

“Because of the matter(s) described in the Basis for Disclaimer of Opinion paragraph, we were not able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion”

SA 706 – Emphasis of Matter (EOM) paragraph and Other Matter (OM) paragraph in the Independent Auditor’s Report

SA 706 deals with additional communication in the Auditor’s Report when auditor considers necessary to draw user’s attention to:

•    Matter(s) presented or disclosed in FS are of such importance that they are fundamental to user’s understanding of FS

Or

•    Matter(s) other than those presented or disclosed in FS that are relevant to user’s understanding of audit or auditor’s responsibilities or audit report

SA 706 has laid down the following requirements with respect to EOM para:

•    Auditor should obtain SAAE evidence that the matter is not materially misstated in the FS;

•    EOM para shall refer only to information presented or disclosed in the FS;

•    Widespread use of EOM para diminishes the effectiveness of the auditor’s communication of such matters, by implying that matter has not been appropriately presented or disclosed in FS;

•    It is to be placed immediately after Opinion para.

The SA requires that the EOM para must include a clear reference to the matter being emphasized, where the relevant disclosures that fully describe the matter can be found in FS and indicate that the audit opinion is not modified in respect of matter emphasized. An EOM para is to be included in the Auditor’s Report in the following circumstances:

•    An uncertainty relating to the future outcome of an exceptional litigation or regulatory action;

•    Early application (where permitted) of a new accounting standard that has a pervasive effect on the FS in advance of its effective date;

•    A major catastrophe that has had, or continues to have, a significant effect on the entity’s financial position.

As per the SA, if the auditor considers it necessary to communicate a matter other than those that are presented or disclosed in the FS that, in the auditor’s judgment, is relevant to users’ understanding of the audit, the auditor’s responsibilities or the auditor’s report and this is not prohibited by law or regulation, he shall do so in a paragraph in the auditor’s report, with the heading “Other Matter”, or other appropriate heading. This paragraph is placed immediately after the Opinion paragraph and any EOM paragraph.

SA 710(R) – Comparative Information – Corresponding Figures and Comparative Financial Statements

SA 710(R) deals with the auditor’s responsibilities regarding comparative information in an audit of financial statements. The nature of the comparative information that is presented in an entity’s FS depends on the requirements of the applicable FRF.

SA 710(R) mentions that there are two broad approaches to the auditor’s reporting responsibilities in respect of comparative information: (a) Corresponding Figures; and (b) Comparative Financial Statements.

The approach to be adopted is often specified by law or regulation or in the terms of engagement. SA710 (R) addresses separately the auditor’s reporting requirements for each approach.

SA 710(R) requires the auditor to determine whether FS include the comparative information required by the applicable FRF and whether such information is appropriately classified. For this purpose, the auditor has to evaluate whether:

a)    The comparative information agrees with the amounts and other disclosures presented in the prior period; and
b)    The accounting policies reflected in the comparative information are consistent with those applied in the current period or, if there have been changes in accounting policies, whether those changes have been properly accounted for and adequately presented and disclosed.

If the auditor becomes aware of a possible material misstatement in the comparative information while performing the current period audit, the auditor has to perform such additional audit procedures as are necessary in the circumstances to obtain SAAE evidence to determine whether a material misstatement exists.

The SA requires that when corresponding figures are presented, the auditor’s opinion shall not refer to the corresponding figures except in the circumstances described as under:

i)    If the auditor’s report on the prior period, as previously issued, included a qualified opinion, a disclaimer of opinion, or an adverse opinion and the matter which gave rise to the modification is unresolved, the auditor shall modify the auditor’s opinion on the current period’s financial statements. In such cases, in the ‘Basis for Modification’ paragraph in the auditor’s report, the auditor shall either:

•    Refer to both the current period’s figures and the corresponding figures in the description of the matter giving rise to the modification when the effects or possible effects of the matter on the current period’s figures are material;

Or

•    In other cases, explain that the audit opinion has been modified because of the effects or possible effects of the unresolved matter on the comparability of the current period’s figures and the corresponding figures

ii)    If the auditor obtains audit evidence that a material misstatement exists in the prior period FS on which an unmodified opinion has been previously issued, the auditor has to verify whether the misstatement has been dealt with as required under the applicable FRF and, if that is not the case, the auditor shall express a qualified opinion or an adverse opinion in the auditor’s report on the current period FS, modified with respect to the corresponding figures included therein.

iii)    If FS of prior period were audited by a predecessor auditor, and the auditor is allowed and decides to refer to the predecessor auditor’s report for the corresponding figures, then the auditor shall state in an OM para that the FS of the prior period were audited by the predecessor auditor, the type of opinion expressed by him along with the reasons for the same and the date of that report.

iv)    If the FS of prior period were not audited, the auditor has to state in an OM para that the corresponding figures are unaudited. However, it will not relieve the auditor from obtaining SAAE that the opening balances do not contain material misstatements that materially affect current period’s FS.

The SA also requires that when comparative financial statements are presented, the auditor’s opinion shall refer to each period for which financial statements are presented and on which an audit opinion is expressed.

As per the SA, when reporting on prior period FS in connection with the current period’s audit, if the auditor’s opinion on such prior period FS differs from the opinion the auditor previously expressed, the auditor will have to disclose the substantive reasons for the different opinion in an OM paragraph in accordance with SA 706. In case, however, the FS of prior period were audited by a predecessor auditor, the requirements as prescribed above in point 39 (iii) will apply, whereas if the FS of prior period were not audited, the requirements as prescribed above in point 40(iv) will apply.

What’s new in the revised audit report formats? The revised formats of audit reports given in the SAsare very specific formats for issuing unmodified reports [SA 700(R)], modified reports (SA 705) and giving Emphasis of Matter paragraphs in the audit reports (SA 706). Unlike current audit reports, where diverse practices were being followed in giving modified reports or giving emphasis of matter, the positioning of the various paras are also specifically mentioned in these SAs. This would make audit reports uniform across different audit firms and also achieve better comparability.

Conclusion

As can be seen from the above, the audit report will undergo a substantial change for audits for periods beginning on or after April 1, 2012. The new format of the report is very different from the old format and will require auditors to spend more time in redrafting their reports to be in line with SA 700(R), SA 705, SA 706 and SA 710(R). The specific elements as required by the revised report, should also, hope-fully, make reading and understanding reports easier for shareholders and analysts and have a better appreciate the role of auditors.

Our Endless greed

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“Earth provides enough to satisfy every man’s need, but not every man’s greed” – Mahatma Gandhi
We all, as children, have heard the story of Alibaba. Alibaba discovered the cave of thieves and came to know the magic password “Open Sesame”, which opened the door of the cave. Exercising this knowledge in moderation, he became rich. His uncle Kassim also managed to know the password, entered the cave and went mad with greed, piled up huge amount of gold, and treasure and then forgot the words to open the cave. He was found inside by the robbers, killed and cut into four pieces. Yes, we know the story alright. But have forgotten the moral of the story. Do not be greedy.

Some of us may also have read a story written by Tolstoy, called ‘How much land does a man need?’ The story is about a poor peasant, eking out a living from his small plot of land. He comes to know that beyond the mountains, fertile land is available at a very cheap rate. He sells his land and buys a bigger and more fertile piece of land, and starts living a better life. The same story is repeated and each time the peasant moves to a still distant land, each time he becomes richer and richer. Ultimately, he learns that behind the distant mountain range, there was a still better opportunity. The King of the place was giving all the land a person could cover by walking from sunrise to sunset, for a hefty amount to be paid in advance. The only condition was that if one could not reach the starting point by sunset, he forfeited his entire deposit. Our friend starts walking at sunrise, finding better and better land ahead. In trying to encompass as much as he could, he loses track of time and realises that it has become very late and may not be able to reach the starting point before the sunset. He runs and runs. He staggers to the starting point with his outstretched hand. He manages to finish. But he too is finished. The cheering crowd was stunned. In his greed to cover more and more land, he had overstrained himself so much that his heart gave way. The people had to dig a grave for him and it required just six feet of land to bury our peasant friend when ;

It is truly said that while a ship needs water to sail, if the same water enters the ship, the ship sinks. Money is necessary for our necessities and comforts. But if we blindly pursue money and allow it to become our master, it is then that the problem starts. We run the risk of sinking under the weight of our wealth.

What is true of money is also true of power. It has brought about the downfall of the high and mighty like both Napoleon and Hitler. Even Alexander the Great after conquering so many countries realised that at the end everyone has to go empty handed. He directed that when his body is taken for cremation, his hands should be displayed for people to see, to realise that even Alexander the Great went empty handed.

It would do good to all of us, if we pause in this race of getting more and more riches, and think as to what is required to be truly happy.

I would end with this passage from ‘Les Miserables’ by Victor Hugo:

“Indeed, is not that all, and what more can be desired? A little garden to walk, and immensity to reflect upon. At his feet something to cultivate and gather, above his head something to study and mediate upon a few flowers on the earth, and all the stars in the sky.”

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2013 (29)S.T.R. 499 (Tri- Ahmd) Shree Gayatri Tourist Bus Service vs. Commissioner of Central Excise, Vadodara.

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Is service tax attracted on hiring of vehicles where Cab provider is required to maintain the said vehicles and also required to do repairing, fuelling etc. under Rent a cab operator’s service?

Facts:
Service tax was demanded from the Appellant as Rent-a-cab operator. The scope of contract with the client stipulated that vehicles were required for transportation of personnel of client under their instructions/directions and vehicles would move on official duty to outstation, depending upon exigencies of client work for which no other extra charge was to be paid. Further, vehicles were provided normally on the basis of 12 hours of duty in a day.

Hiring charges were calculated for actual number of working days on pro rata basis and maintenance etc. was responsibility of the assessee and no extra charge was to be paid. Assessee was assured minimum fixed charges per vehicle per month yet was required to maintain log book and invoices had to be based on the usage.

Held:
Vehicles were not rented to client-had it been otherwise, client would have to ensure maintenance, repairing, proper running and fuelling of the vehicle. Possession and ownership of vehicle remained with assessee and he was only required to provide service for 12 hours in a day. In case of rent, owner of property is de-possessed and possession passes on to person who has taken it out for usage. It was immaterial whether hiring of vehicle is for a day or a month. The fact that payment had to be made after verification of log book showed that monthly payment may vary from vehicle to vehicle based on kilometres run and not on monthly rent basis.

Payment of minimum fixed charges per vehicle per month was only a safety measure to ensure some minimum payment to avoid nil payment, if client did not use the vehicle at all, and could not lead to conclusion that vehicle was let out on rent and liable to service tax u/s. 65(91) of the Finance Act, 1994- Section 65(105)(o).

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2013 (29) S.T.R. 648 (Commr. Appl.) In re: Sundaram Clayton Limited

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Whether realisation for forex a condition under Notification No.41/2007-ST?

Facts:
The appellant was a manufacturer exporter. The appellant sent certain documents, samples and goods via courier to their foreign client and claimed refund of service tax under Notification No.41/2007-ST. Courier services is specifically mentioned as one of the services under the said notification. The said claim was rejected only on the ground that the sending of documents, samples did not yield into realisation of forex. The appellant submitted that the realisation of forex was not one of the conditions to claim refund under the said notification. The refund is awarded to exporters with the intention to neutralise all taxes and duties borne by the exporter in the course of exports.

Held:
The appellant vide documentary evidence proved that the courier services were used for export of goods and thus the appellant was entitled to claim the refund of the service tax paid on courier services.

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2013 (29) S.T.R. 620 (Tri- Chennai) Commissioner of Service Tax, Chennai vs. Heidelberg India Pvt. Ltd.

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Remittance towards reimbursement of expenses incurred abroad not tantamounting to training abroad.

Facts:
The respondent was in the business of procuring orders for the company located in Germany for machineries supplied to persons in India and also installed and maintained the machinery during the warranty period. The respondent’s employees went to Germany for the training. Revenue demanded service tax on expenditure captured in forex alleging that it was towards the training fees paid to the parent company while the respondent submitted that it was reimbursement of expenses of the employees who went for training to Germany. The first appellate authority in the order recorded the finding that the respondent had produced evidence that no training fees were paid and it was supported by the certificates of the parent company. Further sample invoices were submitted by the respondent to support his contention that the payments were only reimbursement of expenses namely, travel, accommodation, etc. incurred during their stay in Germany and thus it cannot be contended that the balance amount pertained to training fees.

The demand was confirmed by invoking Rule 3(ii) of the Services (Provided from outside India and Received in India) Rules, 2006, whereby the service was held taxable if it was partly performed in India. The adjudicating authority had not recorded that the services were partly performed in India and hence the contention of the respondent was accepted. The first appellate authority also held that as the respondent filed returns for the relevant period, thus the department was aware of the activities of the respondent and hence the extended period was not invokable.

The Tribunal held that not finding any infirmity in the order and upheld the order and dismissed the appeal of the revenue.

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2013 (29) S.T.R. 521 (Tri- Ahmd) Commissioner of Service Tax, Ahmedabad vs. Sun- N-Step Club Ltd.

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Whether when tax was paid by reverse calculation on entry fees received from non-members would tantamount to unjust enrichment and thus denial of refund?

Facts:
Service tax erroneously paid by assessee club on entry fee received from non members by working backwards from the gross fee as the same was not collected. The invoices evidenced this fact. Both lower authorities held that the assessee club was not liable to service tax. The refund claim for the mistakenly paid tax was rejected by the department. However, the revisionary authority held that the respondent was eligible for refund. Relying on the case of V. S. Infrastructure Ltd. 2012 (25) STR 170 (Tri–Del) containing identical fact, it was pleaded that there was no unjust enrichment. Revenue filed an appeal on the grounds that the charges collected from both members and non-members were inclusive of service tax. Thus, service tax was said to be collected from the client. Thus, the amount so collected as representing service tax was required to be paid u/s. 73A(2) which was rightly done. Thus, subsequent refund of such amount did not arise as it would tantamount to unjust enrichment. According to the Respondent, the adjudicating authority, in his order specifically recorded the finding “copy of the invoice reflects that there is no service tax and consequently receipt of non-membership income is without service tax.”

Held:
The Respondent paid service tax on the income received from the non-members, working backwards to determine service tax liability. Adjudicating authority recorded a factual finding that the respondent did not charge service tax on any amount which had been charged to the nonmembers and the provisions of section 73A of the Finance Act, 1994 are not attracted. The facts of the case V. S. Infrastructure (supra) being similar to the facts herein, it is settled that the question of unjust enrichment does not arise.

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2013 (29) S.T.R.527 (Tri.- Del.) Commissioner of Central Excise, Chandigarh vs. Green View Land & Buildcon Ltd.

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Whether amendment of taxing activity of selling under construction flats retrospective in nature?

Facts:
The appellants engaged in construction of residential complexes sold the same to the prospective buyers. During the period October, 2005 to July, 2006 they did not pay any service tax for advances received during the said period for such activity. A Show Cause Notice was issued in this regard and adjudicated confirming a demand for tax amount of Rs. 14,50,311/- along with interest and penalty as revenue’s view was that service tax was payable on such activity u/s. 65(105)(zzzh) of the Finance Act, 1994 read with section 65(30a) of the Finance Act, 1994 during the stated period. The lower appellate authority set aside the adjudication order on the ground that the appellant had engaged their own labour and constructing buildings on lands owned by themselves and thus there was no service provided by the appellant to the prospective buyers and placed reliance on the clarificatory letter issued by CBEC vide F. No. 332/35/2006-TRU, dated 01-08-2006. The Revenue contending that the Respondent received advances from the prospective buyers for the flats and therefore there was a service rendered in terms of the explanation inserted u/s. 65(105)(zzzh) by the Finance Act, 2010. Revenue relied on the decision of the Punjab & Haryana High Court in the case of G.S. Promoters vs. UOI, 2011 (21) S.T.R. 100 (P&H).

Held:
The explanation added at the Finance Act, 2010 was not effective retrospective and this issue was already decided by the Tribunal vide Final Order No. ST/A/190-197/2012 of 13-03-2012 in Appeal No. S.T./463/2008 (Delhi) and Others in the case of CCE, Chandigarh vs. M/s. Skynet Builders, Developers, Colonizer and others – 2012 (27) STR 388 (T). It was held that the decision of Punjab & Haryana High Court in G S Promoters (supra) did not examine service tax liability for the period prior to the date of the explanation, therefore not applicable in the instant case. Appeal by the department was dismissed accordingly.

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2013 (29) S.T.R. 545 (Del.) Wipro Ltd. vs. Union of India

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Is Filing of declaration after date of export of services a non compliance as to disentitle exporter from rebate in terms of paragraph 3 of the Notification No. 12/2005-ST ?

Facts:
The appellant engaged in the rendering of IT- enabled services such as technical support services, back office services, customer care services etc. to its clients situated outside India were taxable services under the Act.

Rule 5 of the said Export Rules provided for “Rebate of Service Tax” which, interalia, provided that where any taxable service was exported, the rebate of service tax paid or duty paid on input services or inputs would be available subject to conditions or limitations as specified in the notification issued for the purpose. Accordingly, Notification No. 12/2005-ST dated 19-04-2005 provided that, rebate of the duty on inputs or service tax and cess paid on all taxable input services used in providing taxable service exported out of India will be granted subject to conditions and procedures specified. The appellant lodged two claims for rebate in respect of service tax paid on input services like night transportation, recruitment, training, bank charges etc. However, the declaration required to be filed in terms of the Notification was filed after the date of export of taxable service. The rebate claims were rejected on the ground of late filing of the declaration beyond the date of export.

Held:
The very bedrock of the business of Call Centre relates to attending of calls on a continuous basis. It is difficult to conceive of any possibility as to how the appellant could not only determine the date of export but also anticipate the call so that the declaration could be filed prior to the date of export. Further, filing of declaration after date of export of services is not such a non-compliance as to disentitle exporter from rebate. Nature of service is such that they are rendered seamlessly, on continuous basis without any commencement or terminal points, and it is difficult to comply with requirement ‘prior’ to the date for export, except for description of services. Estimation is ruled out because of the words “actually required”. However, if particulars in declaration are furnished to Service Tax authorities, within a reasonable time after export, along with necessary documentary evidence, and are found to be correct and authenticated, object/purpose of filing declaration would be satisfied and appeal, thus, was allowed.

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2013 (29) STR 557 (Ker.) All Kerala Association of Chit Funds vs. Union of India

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Amendment of Finance Act, 1994 in 2007 deleted the words “but does not include cash management’ from section 65(12)(a)(v) defining banking and other financial services – Later CBEC vide Circular No. 96-07-2007-ST dated: 23-08-2007 clarified that chit funds, was cash management service provided for consideration and, therefore, liable to service tax under “banking and financial services”- whether members of the chit fund association providing cash management services liable?

Facts: The appellants were running chit business in the State of Kerala and contended that they are not covered by the Kerala Chitties Act, 1975 as the Chit Funds Act, 1982 was not notified within the State of Kerala. Appellants also contended that service tax can be imposed only vide positive incorporation of the particular service and not by way of deletion vide a circular by invoking powers u/s. 37 of the Central Excise Act, 1984 read with section 83 of the Finance Act, 1994. According to the Appellants, Chit fund was a systematic and periodic contribution of fixed measure of funds deposited with a trustee. It was disbursed to needy persons through draw of lots (Chit/Kuri/Kurip). Trustee/ Foreman had his share as well as commission. It was not a money lending business and there was no debtor-creditor relationship between subscriber and foreman. It essentially was management of cash/fund generated and distributed without much time gap.

Held:
High Court held that liability to service tax of chit fund was sustainable as it was based on statutory provisions, and not on CBEC circular ibid. Plea that tax liability could not be imposed by deletion from existing provisions, rejected as power to tax includes amendment either by incorporation or by deletion. If statute grants power to tax particular instance, but gives some exclusion, and when the exclusion is deleted by amendment, it comes within the taxable net. After the amendment, all forms of cash management were liable for service tax, and it was not necessary to enumerate each of them. Reference to section 45(1) of RBI Act, 1934 was only made in the CBEC circular to show that financial institutions carried out the chit business as well. The plea that despite its existence since enactment of Finance Act, 1994 till the amendment in the year 2007, chit business was not made taxable does not provide any estoppel against the provisions of law. It was held that procurement of funds from different subscribers, putting it together, sharing dividend, disbursement of amount to prized subscriber after commission payable to foreman etc. was a service liable to service tax in the hands of a financial institution and power of exemption is inclusive of power to modify or withdraw it.

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Entry Tax on Goods

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Under The Maharashtra Tax on the Entry of Goods into Local Areas Act, 2002 (Entry Tax Act, 2002), tax is levied on notified goods imported from outside the state of Maharashtra. For example, if the building contractor imports tiles from Gujarat and uses it in his contract activity, the issue can arise whether he is liable for entry tax on tiles? The contractor must be discharging liability on such contract under the MVAT Act, 2002. On the above facts, the issue about levy of Entry Tax can be examined as under:

Under Maharashtra Tax on the Entry of Goods into Local Areas Act, 2002, tax is attracted on tiles imported from outside the State of Maharashtra for consumption, use or sale. The charging section 3 of the said Act provides as under:

“3 (1) There shall be levied and collected a tax on the entry of the goods specified in column (2) of the Schedule, into any local area for consumption, use or sale therein, at the rates respectively specified against each of them in column (3) thereof and different rates may be specified in respect of different goods or different classes of goods or different categories of persons in the local area. The tax shall be levied on the value of the goods as defined in clause (n) of sub-section (1) of section 2. The State Government may, by notification in the Official Gazette, from time to time, add, modify or delete the entries in the said Schedule and on such notification being issued, the Schedule shall stand amended accordingly;

Provided that, the rate of tax to be specified by the Government in respect of any commodity shall not exceed the rate specified for that commodity under the [the Value Added Tax Act] or, as the case may be, the Maharashtra Purchase Tax on Sugarcane Act, 1962:

Provided further that, the tax payable by the importer under this Act shall be reduced by the amount of tax paid, if any, under the law relating to General Sales Tax in force in the Union Territory or the State, in which the goods are purchased, by the importer:

Provided also that no tax shall be levied and collected on specified goods entering into a local area for the purpose of such process as may be specified, and, if such processed goods are sent out of the State.

Explanation – No tax shall be levied under this Act on entry of any fuel or other consumables contained in the fuel tank fitted to the vehicle for its own consumption while entering into any local area.

(2) Notwithstanding anything contained in sub-section (1), there shall also be levied a tax in addition to the tax leviable in accordance with sub-section (1) on the entry of Petrol and High Speed Diesel Oil in any local area for consumption use or sale therein at the rate of one rupee per litre.
(3) …
(4) …

(5) Notwithstanding anything contained in subsection (1) and (2), no tax shall be levied on the specified goods, imported by a dealer registered under the [the Value Added Tax Act], who brings goods into any local area for the purpose of resale in the State or sale in the course of inter-State trade or commerce or export out of the territory of India:

Provided that, if any such dealer, after importing the specified goods for the purpose of resale in the State or sale in the course of inter-State trade or commerce or export out of the territory of India, consumes such goods in any form or deals with such goods in any other manner except reselling the same, he shall inform the assessing authority before the 25th day of the month, succeeding the month in which such goods are so consumed or dealt with and pay the tax, which would have been otherwise leviable under sub section (1) or (2).

(6) If any dealer having imported the specified goods for the ostensible purpose of resale or, as the case may be, sale, deals with such goods in any other manner or consumes the same and does not inform the assessing authority as provided in sub-section (5) or does not pay the tax as required under sub-section (5) within the specified period, the assessing authority shall assess the amount of tax which the dealer is liable to pay under subsection (1) or (2) and also levy penalty equal to the amount of tax due. ….”

It may be noted that section 3(5) exempts from levy, the specified goods, which are for resale.

 Thus, if the tiles are held to be imported for resale, no Entry Tax can be attracted. The issue will be whether use of tiles in works contract will be considered to be ‘resale’, so as not to attract any liability under Entry Tax Act?

Section 2(2) of Entry Tax Act, 2002 provides as under:

“2 (2) Words and expressions used but not defined in this Act but defined in the [the Value Added Tax Act, or the Maharashtra Value Added Tax Rules, 2005] shall have the meanings respectively assigned to them under that Act or the Rules.”

Therefore the terms not defined in Entry Tax Act will carry the meaning as given in MVAT Act, 2002.

The term ‘resale’ is defined in section 2(22) of MVAT Act, 2002 as under:

“(22) ‘resale’ means a sale of purchased goods-

(i) in the same form in which they were purchased, or

(ii) without doing anything to them which amounts to, or results in, a manufacture, and the word ‘resell’ shall be construed accordingly;”

As per facts, as stated above, the tiles are used by contractor in construction activity and they will be used in the same form as they are ready tiles for fitting. It is also a fact that works contract is a ‘sale’ transaction. This position is clear from definition of ‘sale’ in section 2(24) of MVAT Act, 2002, which defines ‘sale’ as under:

““(24) “sale” means a sale of goods made within the State for cash or deferred payment or other valuable consideration but does not include a mortgage, hypothecation, charge or pledge; and the words “sell”, “buy” and “purchase”, with all their grammatical variations and cognate expressions, shall be construed accordingly;

Explanation,-—For the purposes of this clause,—

(a) a sale within the State includes a sale determined to be inside the State in accordance with the principles formulated in section 4 of the Central Sales Tax Act, 1956;

(b) (i) the transfer of property in any goods, otherwise than in pursuance of a contract, for cash, deferred payment or other valuable consideration;

(ii) the transfer of property in goods (whether as goods or in some other form) involved in the execution of a works contract including, an agreement for carrying out for cash, deferred payment or other valuable consideration, the building, construction, manufacture, processing, fabrication, erection, installation, fitting out, improvement, modification, repair or commissioning of any movable or immovable property…”

Thus it can be concluded that ‘works contract’ is a transaction of sale.

In works contract, tax is levied on the basis that there is sale of individual items used in the contract. It is due to the above position, the contractor is liable to pay tax under MVAT Act, 2002 as per goods involved and transferred during the execution of works contract. The net result is that there is sale of tiles by use in works contract and it is ‘resale’ within the meanings of section 2(22) of MVAT Act, 2002. Under the above circumstances, no Entry Tax is attracted on the contractor. This will be the position whether the contractor is discharging liability by statutory method of Rule 58 of MVAT Rules or under Composition method.

This position will apply to all notified goods which are used as it is in ‘works contract’ and on which tax liability under MVAT Act is discharged.

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Software: Taxable as Service or Goods or Both?

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Introduction:
The term ‘software’ is not defined in the Finance Act, 1994 (the Act). However, in Commissioner of Customs vs. Hewlett Packard India Sales Pvt. Ltd. 2007 (215) ELT 484, the Supreme Court referred to the meaning of software as given in Computer Dictionary by Microsoft 5th Edition:

“Software—Computer programs; instructions that make hardware work. Two main types of software are system software (operating systems), which controls the workings of the computer, and applications, such as word processing programs, spreadsheets, and databases, which perform the tasks for which people use computers. Two additional categories, which are neither system nor application software but contain elements of both, are network software, which enables groups of computers to communicate, and language software, which provides programmers with the tools they need to write programs. In addition to these task-based categories, several types of software are described based on their method of distribution. These include packaged software (canned programs), sold primarily through retail outlets; freeware and public domain software, which are distributed free of charge; shareware, which is also distributed free of charge; although users are requested to pay a small registration fee for continued use of the program; and vaporware, software that is announced by a company or individuals but either never makes it to market or is very late. See also application, canned software, freeware, network software, operating system, shareware, system software, vaporware, Compare firmware, hardware, liveware.”

Software under the description Information Technology Software (IT Software) was brought into the net of service tax with effect from 16th May, 2008 by defining the term “Information Technology Software” and introducing clause (zzzze) in section 65(105) of the Finance Act, 1994 (the Act) wherein various items were listed as taxable services in relation to IT software. From 1st July, 2012, under the new regime of negative list based taxation of services, “Development, design programming, customization, adaptation, upgradation, enhancement, implementation of information technology software” is specified in section 66E of the Act as one of the 9 declared services. In turn, the definition of ‘service’ includes a declared service in its purview. Service tax levied on IT software has been a matter of debate as it has been subject to multiple taxes. Under the VAT laws of the States, all types of software are treated as goods. This is because in a landmark ruling of the Supreme Court in Tata Consultancy Services vs. State of Andhra Pradesh’ (2004) 178 ELT 22 (SC) [TCS] where the question before the Court was whether Packaged Software was goods, the proposition argued before the Court was that software was intangible, and therefore not goods. The Court held as under :

“A software programme may consist of various commands which enable the computer to perform a designated task. The copyright in that programme may remain with the originator of the programme. But the moment copies are made and marketed, it becomes goods, which are susceptible to sales tax. Sale is not just of the media which by itself has very little value. The software and the media cannot be split up. Thus, a transaction of sale of computer software is clearly a sale of “goods” within the meaning of the term as defined in the said Act. The term “all materials, articles and commodities” includes both tangible and intangible/incorporeal property which is capable of abstraction, consumption and use and which can be transmitted, transferred, delivered, stored, possessed etc. The software programmes have all these attributes.”

The Central Government under the service tax law treats software as service except packaged or canned software. Section 65B(28) of the Act defines IT software as under:

“information technology software” means any representation of instructions, data, sound or image, including source code and object code, recorded in a machine readable form, and capable of being manipulated or providing interactivity to a user, by means of a computer or an automatic data processing machine or any other device or equipment”.

Chargeability to Central Excise Duty
Introduction of levy on Packaged Software

• Extracts from Finance Minister’s Budget Speech on 28.2.2006 :

Para 138 “I propose to impose an 8 per cent excise duty on packaged software sold over the counter. Customized software and software packages downloaded from the internet will be exempt from this levy”.

• Entry 27 – General Exemption Notification 6/06 – CE

“Any customised software (that is to say any custom designed software developed for a specific user or client) other than packaged software or canned software.”

Explanation: For the purpose of this entry packaged software or canned software means software developed to meet the needs of variety of users and it is intended for sale or capable of being sold off the shelf.”

In the TCS case, the Supreme Court has observed as under:

Para 26

“…….. We are in agreement with Mr. Sorabjee when he contends that there is no distinction between branded and unbranded software. However, we find no error in the High Court holding that branded software is goods. In both cases, the software is capable of being abstracted consumed and use. In both cases the software can be transmitted, transferred, delivered, stored, possessed etc. Thus even unbranded software, when it is marketed/sold, may be goods. We, however, are not dealing with this aspect and express no opinion thereon because in case of unbranded software other questions like situs of contract of sale and/or whether the contract is a service contract may arise”

For the purpose of Central excise, so long as software does not fit within the ambit of Packaged Software, which is capable of being sold off the shelf, there would be no question of excise duty.

Can the Concept of “manufacture” apply to Software at all?

Interestingly, even assuming software is considered as goods and packaged software is considered as excisable goods, excise duty can be imposed only if there is an “activity of manufacture” in terms of Section 2(f) of CEA.

The Supreme Court in the case of Seelan Raj and Other vs. Presiding Officer, First Additional Labour Court, Chennai – 2001 AIR SC 1127 was considering the issue under the Industrial Disputes Act. It was the contention of company that it was rendering computer services and developing customised soft-ware application. Dispute arose which was referred to the Labour Court and it was contended by the Company that it was a manufacturer of software and therefore it is not an establishment under the Industrial Disputes Act and much less a factory under the Factories Act and therefore the dispute should not be referred to Labour Court as it is not an industrial dispute under the Industrial Disputes Act. The Labour Court overruled the objection and held that legislation covers the establishment of the company and directed the reinstatement of the workmen back with wages. It was also held that the company was factory and had to comply with the Industrial Disputes Act. After various rounds of litigation, the matter landed before the Supreme Court. The Supreme Court observed that there is a distinction between packaged software and custom-built software. Standard Packaged Software is marketed as a standard product, to meet the requirements of a large number of users whereas customised software is meant to meet the particular requirement of the user. The hybrid form of software also exists whereby the standard package is altered so that it fits the customised needs more clearly adopting a basis of customisation. The Supreme Court, taking into account the debate on various aspects and the questions with reference to software, referred the dispute to the Larger Bench of the Supreme Court.

In the case of CCE vs. Acer India Ltd. (2004) 172 ELT 289 (SC) the following was observed by the Supreme Court:

“Para 81


We, however, place on record that we have not applied our mind as regards the larger question as to whether the information contained in a software would be a tangible personal property or whether preparation of such software would amount to manufacture under different statutes.”

CETA is aligned to the Customs Tariff and software is identically classified under entry 8523 80 20 as (Information Technology Software) under Chapter Heading 8523. Again, the CETA is only set out for tangible goods, and the software and the media cannot be split. Attention is drawn to Chapter Note 10 to Chapter 85 of CETA which states as under:

“For the purposes of heading 8523 ‘recording’ of sound or other phenomena shall amount to manufacture”.

In other words, the recording of software on a medium could be an activity of manufacture which would attract a charge of Central Excise duty.

CETA Classification for “Software” is entry 8523 80 20 (Information Technology Software). Information Technology software is then carved up into customised software (defined as custom designed software developed for a specific user or client) and packaged or canned software (defined as software designed to meet the need of variety of users and is intended for sale or capable of being sold off the shelf), and separate notifications set out the effec-tive rates of duty in respect of these two.

By Notification No. 6/2006-CE dated 1.3.2006, the effective rate for Customised Software is nil. Ac-cordingly, CVD on imports of Customised Software is also nil.

In this regard, attention is invited to the decision in Steag Encotec India Pvt. Ltd. vs. Commissioner of Customs (2010) 250 ELT 287 (Tri – Mumbai). In the facts of the case, the software, which was imported for use in coal based plants, required to be modified according to the needs to each of the plants on the basis of design and operating conditions which varied from one plant to another. The question before the CESTAT was whether such modification of the software would suffice to give it the character of customised software so as to qualify it for the aforesaid exemption. The CESTAT held that the exemption notification would not apply, as only software which “has to be developed from the basic building blocks, whereby a new software product should emerge as per the specific requirement of the client” would qualify as CS, and that software which has just been modified from PS would not.

Chargeability to Customs Duties

Section 12 of the Customs Act, 1962 [‘CA ’62] provides that customs duty shall be levied on goods imported into India. Section 2(22) of ‘CA ’62 defines goods to include “(a) vessels, aircrafts and vehicles; (b) stores, (c) baggage; (d) currency and negotiable instruments; (e) any other kind of movable property”. Therefore, for customs duties to apply on an import of software, it must answer to this definition of goods.

In Associated Cement Companies Ltd. vs. Commissioner of Customs (2001) 128 ELT 21 (SC), the Supreme Court had occasion to examine the scope of this definition. In the context of import of designs and drawings on paper, it was contended before the Court that the transactions were for a transfer of technology which was intangible, and that the medium was only a vehicle of transmission and incidental to the main transaction. It was accordingly contended that even though the technology was put onto a medium, it would not get converted from an intangible to a tangible thing which could be subject to customs duties. The Court did not accept these contentions, and held that all tangible movable articles would fall within the ambit of the definition of goods u/s. 2(22) (e) of CA ‘62, and that it was immaterial as to what types of goods were imported or what is contained in them or recorded thereon. In other words, if there was an import of tangible movable articles, there would be a levy of customs duty on these articles without any exclusion for an intangible contained in the articles. The Court went on to say, on the related subject of valuation of the imported goods, that once the intellectual property had been incorporated on the medium, the value of the medium would get enhanced, and customs duties would apply on this enhanced value. In the words of the Court:

“It is misconception to contend that what is being taxed is intellectual input. What is being taxed under the Customs Act read with Customs Tariff Act and the Customs Valuation Rules is not the input alone but goods whose value has been enhanced by the said inputs. There is no scope for splitting the engineering drawing or the encyclopedia into intellectual input on the one hand and the paper on which it is scribed on the other.”

The Supreme Court ruling in ACC’s Case seem to imply that, though the definition of “goods” in CA ‘62 is set out in the same terms as the Constitution and various Sales tax/VAT provisions, the goods must be tangible for a levy of customs duty to apply. Such a position appears to be inconsistent with the view taken in TCS and BSNL that the ambit of the term “goods” extends to intangibles. Then, a question arises as to why, the import of intangibles does not attract a levy of customs duty.

A possible answer could be that though intangibles are goods, as the taxable event of import, i.e. crossing the customs barrier, cannot arise (given the intangible nature of the goods), there cannot be a charge to customs duty. This would be in line with the Geneva Ministerial Declaration on Global Electronic Commerce, 1998 WT/MIN (98)/ DEC/2, according to which member countries are to “continue their current practice of not imposing customs duties on electronic transmission”.

What follows from above is that only software recorded on a tangible medium is liable to customs duty. In this connection, it is relevant to note that software is classified under Tariff Entry 8523 80 20 (Information Technology software) under chapter heading 8523 (Discs, tapes, solid-state non–volatile storage devices, “smart cards” and other media for the recording of sound or of other phenomena, whether or not recorded, including matrices and masters for the production of discs, but excluding products of Chapter 37) of the Customs Tariff. This classification accords with the position set out in TCS that the software and medium cannot be split up, and the implication that follows in respect of valuation of the medium. The classification also provides yet another answer as to why intangibles (like software), though constituting goods, are not liable to customs duty, i.e. the fact that the Customs Tariff Act, 1975 (“CTA”) is only set out for tangible goods. The Customs Tariff rate for entry 8523 80 20 (IT Software) is “Free”

This means that a packaged or a canned software is goods and when it is capable of being used by a large number of users, it also amounts to manufacturing of goods whereas customised software is fully exempt goods. Board’s Instruction F, no.354/189/2009-TRU dated 04-11-2009 also clarified in this regard that so far as excise duty/CVD is concerned, packaged software attracts duty @ 8% while customised software is fully exempted.

The question therefore arises is that if both packaged or canned software and customised software are ‘goods’ for the purpose of CEA, CA, 62, one dutiable and the other ‘exempt’, whether customised software can simultaneously be considered service for the purpose of service tax law?

Packaged/canned software vs. customised software:

So far as packaged or canned software is concerned, time and again, CBEC provided indication that it is considered goods and not exigible to service tax. Education Guide dated 20-06-2012 released along with the introduction of negative list based tax on services at Guidance Note No.6.4.1 & 6.4.4 has referred to the judgment of the Supreme Court in Tata Consultancy Services vs. State of Andhra Pradesh 2004 (178) ELT 22 (SC) and stated that sale of pre-packaged or canned software is in the nature of sale of goods and is not covered by the entry for declared service of development, design etc. of IT software. The Education Guide also states that the judgment of Tata Consultancy Services (supra) is applicable in case the pre-packaged software is put on a media before sale. “In such a case, the transaction will go out of the ambit of the definition of service as it would be an activity involving only a transfer of title in goods.” It is thus not a matter of doubt or debate that packaged or canned software is ‘goods’ both for the purpose of VAT laws of the States and the Central Excise law at least when canned/packaged software is made available on any tangible medium. The question however remains open in regard to customised software. In the Tata Consultancy’s case (supra) the Honourable Supreme Court did not decide as to whether unbranded software is considered ‘goods’ or not. This is mainly because whether uncanned software (unbranded software) were goods or not was not at all an issue before the Supreme Court in that case. However, the Court was in agreement with the submission made by the petitioner in the case that there was no distinction between branded and unbranded software. The majority opinion in the said judgment held that as they did not deal with the unbranded software when it is marketed or sold as goods and therefore did not express opinion on the same. In this regard however, the Supreme Court in Bharat Sanchar Nigam Ltd. & Another vs. UOI 2006 (2) STR 161 (SC) at Para 56 and 57 upheld that software whether customised or non-customised would become goods provided it satisfies the attributes of goods, namely (a) its utility (b) its capability of being bought and sold and (c) capability of being transmitted, transferred, delivered, stored or possessed.

Considering all the above, the issue that arises is:

When an item is specifically exempted under an exemption notification of the Central Excise Tariff Act, could it not mean that it is primarily ‘goods’ though exempted. Without having characteristic of goods, why would it find place as exempted item under the Central Excise law? Viewing this from another angle, we find similar inconsistencies in the service tax law also. For instance, process amounting to manufacture and trading in goods are listed along with other non-taxable services in section 66D when the activities per se do not have characteristic of a ‘service’, whether they can find place in the “negative list” of services. Under the earlier dispensation of law, notifying the value of goods and material sold by the service provider to the recipient of service as exempt under Notifica-tion No.12/2003-ST dated 20-06-2003 was also along the same lines. Nevertheless, this does not whittle down the fact that even customised software is more akin to being goods than a service as it can be utilised, transmitted, transferred, delivered and stored and possessed. As a matter of fact, it can be used only when it is stored on a tangible medium of the hardware. The Madras High Court in the case of Infosys Technologies Ltd. vs. Commissioner of Commercial Taxes 2009 (233) ELT 56 (Mad) relying on the decision in the case of TCS (supra) held that unbranded/customised software developed and sold by the petitioner, with or without obligation for system upgradation, repairs and maintenance or employee training, satisfies the Rules as ‘goods’, it will also be ‘goods’ for the purpose of sales tax. However amidst controversy, service tax is levied on customised software considering it as ‘service’.

Software: Can it be goods as well as service at the same time?

The question therefore arises is whether an activity or a transaction can be considered ‘goods’ as well as ‘service’ under different statutes and therefore exigible to tax more than once. Since the Central Excise law and Service Tax law are under a com-mon administration, dual levy generally here would not be attracted, yet by interpreting a transaction to be either ‘service’ or ‘goods’ and offering tax accordingly, one may have to face litigation from the administration of the other levy. In Yokogowa India Ltd. vs. Commissioner of Customs, Bangalore 2008 (226) ELT 474 (Tri.-Bang), the Indian company imported a software and claimed that it was a customised software, unique to only their usage and claimed exemption under Notification No. 6/2006-CE (referred above) for countervailing duty. The appellant in this case made a number of submissions in support of its claims that the software that it imported was not capable of being bought off the shelf and that this software was designed on the basis of their unique requirement. However, it was held that the software imported by the as-sessee consisted of several standard packages and only after further modification, it would acquire characteristic of custom designed software. What was imported was packaged software and therefore benefit of Notification No. 6/2006-CE was not available.

Later, however the Government issued Notification No. 53/2010-ST dated 21/12/2010 whereby packaged/ canned software was exempted subject to the condition that the value of such packaged/canned software had suffered excise duty when domestically produced or additional customs duty along with appropriate customs duty in case of imported packaged/canned and that the service provider made a declaration on the invoice that no amount in ex-cess of retail sale price declared on the said goods (packaged/canned software) is recovered from the customer. Similarly, the tug of war between the State law relating to VAT and service tax law of the Central Government being more intense, it makes tax compliant software businesses go through a rough bet of interpretation as to whether the transaction is of sale or of a service and have to bear consequent litigation cost for no fault of theirs. In the case of Sasken Communication Technologies Ltd. vs. Joint Commissioner of Commercial Taxes (Appeals), Bangalore (2011) 16 taxmann.com 7 (Kar.), VAT was demanded from the assessee who entered into an agreement for development of software for a client as per client’s specification & expressly agreed that software when brought into existence would be absolute property of the client. The Court observed that the assessee gave up their rights before software was developed. The agreement did not have any indication for purchase of software. It was provided in the agreement that all ideas, inventions, patentable or otherwise, as a result of programming or other services would be exclusive property of the client as it would be considered as work made on hire. The deliverable was entirely related to development. In short, software prior to being embedded on a material object, belonged to the client and the entire work was done through capable employees of the assessee & no indication existed in the agreement as to purchase of software even from the market and improvement thereon by the assessee. The court, therefore, held that the contract was for a service simplicitor.

The principle that a transaction cannot simultaneously be both for goods and services is recognised at various levels. The Supreme Court in All India Federation of Tax Practitioners 2007 (7) STR 625 (SC) observed that the word ‘goods’ has to be understood in contradistinction to the word ‘services’. In BSNL’s case (supra) it was categorically held that a transaction cannot be both for goods and services. Nevertheless, there being a thin line of divide between the two or both intertwined in many situations, there lacks clarity on the subject until a common code by way of Goods and Services Tax (GST) is implemented.

Software downloaded electronically:

The following is extracted from the Finance Minister’s Budget Speech on 28-02-06:

“Para 138

I propose to impose an 8% excise duty on packaged software sold over the counter. Customised Software and Software Packages downloaded from the internet will be exempt from this levy.”

In cases where the software is made available only through the medium of internet there is no express exclusion in Entry 27 stated above. However, the Explanatory Notes, which forms part of the Budget Papers read as under:

“Excise duty of 8% is being imposed on packaged software, is also known canned software on electronic media (software downloaded from the internet and customised software will not attract duty). [Serial 27 of Notification No. 6/2006)”]

The Central Excise Rules, 2002 contemplate payment of excise duty at the time of removal of excisable goods from the factory and at the rates prevalent on the date of removal from the factory. Where a customised software solution is sold to the customer through the medium of internet, the transaction can be considered as an e-commerce transaction and there is no physical removal of goods in a tangible form from the factory gate which is the requirement of levy of excise duty. Further, the software is not available in any medium for it to be considered as goods as per the rationale of the Supreme Court in TCS case.

The following judicial considerations need to be noted:

The Supreme Court in the case of Associated Cement Company vs. CC (2001) 128 ELT 21 held that where any drawings or designs or technical materials are put in any media or paper, it becomes goods. Hence, only if an intellectual property is put in a media, it is to be regarded as an article or goods.

In Digital Equipment (India) Ltd. vs. CC (2001) 135 ELT 962 Tribunal held that information transmitted via e-mail cannot be akin to import of record media in 85.23. In an e-mail transfer, no media as a movable article is crossing the international boundaries and there is no movable property movement involved. Therefore, transfer of information or idea or knowledge on e-mail transfer would not be covered within the ambit of goods under the Customs Act. If they are not goods, then they cannot be subject to any duty.

In Multi Media Frontiers vs. CCE (2003) 156 ELT 272 the Tribunal has observed that a software cannot exist by itself and for it to be put to use it has to necessarily exist on some suitable media such has floppy disc, tape or CD.

In Pantex Geebee Fluid Power Ltd vs. CC (2003) 160 ELT 514 (Tri), it was held that, a transfer of intellectual property by intangible means like email would not be liable to customs duty.

The Geneva Ministerial Declaration on Global Electronic Commerce Document WT/MIN (98) DEC/2 dated 25-05-1998 which is a declaration of an intent by members of WTO that they would continue their current practice of not imposing customs duty on electronic declaration.

Annual maintenance contract for electronically downloaded software:

When a software is bought and sold, annual or ongoing maintenance service is important for the user. Generally, under an Annual Maintenance Contract (AMC), upgradation or updation is done by way of installation of upgraded version of the software already sold or available with the user. It is common to provide license to such versions electronically vide internet or through paper licenses. Since this is part of the obligation of the AMC along with other maintenance services like debugging, troubleshooting etc. agreed to be provided during the currency of the AMC, the value of the licensed updation is also contained in the AMC and because it is difficult to determine the said value at the time of signing of AMC, it remains inseparable. Therefore, liability under both the laws is attracted, viz., VAT law of the State and the Service Tax law’], as the sale of license to use software is goods under deemed sale concept and providing upgradation, enhancement etc. is a ‘service’ with effect from 16-05-2008 as well as “declared service” with effect from 01-07-2012. In this context, Education Guide comments at para 6.4.4 are extracted for easy reference:

“6.4.4 Would providing a license to use pre-packaged software be a taxable service?

•    ‘Transfer of right to use goods’ is deemed to be a sale under Article 366(29A) of the Constitution of India and transfer of goods by way of hiring, leasing, licensing or any such manner without transfer of right to use such goods is a declared service under clause (f) of section 66E.

•    A license to use software which does not involve the transfer of ‘right to use’ would neither be a transfer of title in goods nor a deemed sale of goods. Such an activity would fall in the ambit of definition of ‘service’ and also in the declared service category specified in clause (f) of section 66E.

•    Whether the license to use software is in the pa-per form or in electronic form makes no material difference to the transaction.

•    However, the manner in which software is transferred makes material difference to the nature of transaction. If the software is put on the media like computer disks or even embedded on a computer before the sale the same would be treated as goods. If software or any programme contained is delivered online or is down loaded on the internet the same would not be treated as goods as software as the judgment of the Supreme Court in Tata Consultancy Service case is applicable only in case the pre-packaged software is put on a media before sale.

•    Delivery of content online would also not amount to a transaction in goods as the content has not been put on a media before sale. Delivery of content online for consideration would, therefore, amount to provision of service.” [emphasis supplied].

It is noted here that although in the Education Guide the Ministry of Finance has placed reliance on the TCS decision (supra), it has made it applicable in the manner it suits its own interpretation that mode of delivery of the software would determine whether it is ‘goods’ or the ‘service’. Thus, service tax is certainly made applicable as the license to use software is considered service. The ‘rationale’ as explained by the Education Guide that the manner of delivery of a software or a programme determines the character of the transaction is hard to digest.

Whether intangible nature of the ‘goods’ capable of being bought and sold, utilised, transmitted & transferred (electronically) and stored and possessed by the user ultimately loses its characteristic of being ‘goods’ and becomes ‘services’? The issue is certainly disputable. In practice, it can be observed that most of the AMCs entered into by IT sector carry both VAT and service tax at applicable rates.

Further, introduction of repairs and maintenance contracts in the execution of works contract vide Notification No. 24/2012-ST has added further confusion. Most contractors of AMCs treat AMCs as works contracts, given the fact that value of license or goods which is deemed sale as per VAT laws is inseparable. Accordingly, in many cases it is observed that persons entering into AMC charge and recover VAT at applicable rate (depending on whichever option under the VAT law is exercised) and service tax of 12.36% is charged and recovered on 70% value (effective rate of 8.652%) in terms of Rule 2A of the Service Tax (Determination of Value) Rules, 2006 introduced with effect from 1st July, 2012. Whether this practice is correct in terms of discussion here is an issue by itself as the service tax administration considers license to use software acquired electronically as pure service. In this sce-nario, would service tax be not demanded on full value of AMC considering it a service contract?

Applicability of VAT indeed would not be influenced by this interpretation as it independently treats the subject matter as sale of goods and therefore VAT is attracted at applicable rate. Thus, uncertainty and diverse practices would continue to persist till the issue is settled judicially as tremendous litigation would be generated on account of overlap. One such attempt made in Infotech Software Dealers Association vs. UOI 2010 (20) STR 289 (Mad) hardly provided any definite direction. In this case, the petitioner challenged legislative competency of the Parliament to levy service tax under the relevant clause section 65(105)(zzzze). The High Court in this case considered the incidental question that the transaction of the software in all cases amounted to sale or in some transactions, it could be considered ‘service’. The member of the Association in this case, supplied software to their customers pursuant to end user license agreements. To this, the High Court held that it is not sale of software but only the contents of the data stored in the software were provided and this amounted to service. It was further observed that to bring the “deemed sale” concept, there must be transfer of right to use any goods and when the goods as such is not transferred, the question of deeming sale does not arise and in that sense, transaction would be of service and not a sale.

The High Court further observed that the challenge to the amended provisions was only on the ground that software is goods and all transactions would amount to sale whereas the transactions may not amount to sale in all cases and it may vary depending upon the end user license agreement Therefore, competence of Parliament to levy service tax cannot be challenged so long as the residuary power is available under Entry 97 of the List-I and finally held “the question as to whether a transaction would amount to sale or service depends upon the individual transaction and on that ground, the vires of provision cannot be questioned”. The issue therefore remains open for interpretation when a dealer in software merely passes on license to the end user without any value addition to the license, whether it would still be treated as service.

Paradoxically, in spite of the fact that software sold electronically is notified as service, in case of Microworld Software Services P. Ltd. vs. CCE, MUM-I 2012-TIOL-1044-CESTAT-MUM, the company engaged into manufacturing software cleared packaged soft-ware on payment of appropriate duty. They also effected sale of software through internet. Central Excise authorities demanded and confirmed the duty and imposed penalties. At the lower appellate stage, 25% pre-deposit on duty and penalty was directed to be paid to hear the appeal. The pre-deposit of duty was paid and for the pre-deposit on the penalty portion, modification application was filed. Both modification application and appeal were dismissed for non-compliance of the order.

Appellant’s plea to CESTAT was that from F. Y. 2008-09, they had started paying service tax considering software cleared in tangible form attracted excise duty whereas Board’s Circular dated 29- 02-2008 clarified that service tax was payable on electronically supplied software. Further, they had informed revenue that they claimed exemption under Notification No. 6/06-CE for electronic supply of software. The revenue argued that Tariff heading 8524 covers software on floppy, disc/media/ CD Rom and also covers software on other media and the term “other media” covers electronically supplied internet. Based on the above submissions of the Appellant and considering their service tax payment and letter informing revenue about claim of the exemption under Notification No. 06/2006, the Bench found 25% pre-deposit of duty amount sufficient to hear the appeal and also found the case arguable and directed the Commissioner (Appeals) to hear the appeal on merits as the same was dismissed for non-compliance of section 35F without going into merits.

Considering the above process undergone by the Appellant, the following extract of TRU letter F. No. 334/1/2008 dated 29-02-2008 may be noted:

“4.1.3 Packaged software sold off the shelf, being treated as goods, is leviable to excise duty @ 8%. In this budget, it has been increased from 8% to 12% vide notification No. 12/2008-CE dated 01-03 -2008. Number of IT services and IT enabled services (ITES) are already leviable to service tax under various taxable services.

4.1.5 Software and upgrades of software are also supplied electronically, known as digital delivery. Taxation is to be neutral and should not depend on forms of delivery. Such supply of IT software electronically shall be covered within the scope of the proposed service.”

Relying on the above and taking action thereon and given the fact that both excise duty and service tax are administered by CBEC, it can be observed that litigation cannot be avoided by law-compliant assesses as well.

Conclusion:

Given various contradictions in interpretations by different agencies of the Government machineryas regards software, IT sector as a whole and consequently the economy is imparted by not only multiplicity of taxation but also by increasing frivolous and lengthy litigation process. This could be minimised if single Government agency deals with the concept of deemed sale, intangible goods and services for implementing fair tax system in the matter at different levels and avoid hardship of the tax payers considering that the tax payer is an important part of the system of revenue collection.

Checklist received from CIT (TDS), Mumbai listing basic details to be submitted alongwith the application u/s. 197 for lower deduction/ Nil deduction of tax at source.

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(a) Projected Profit and Loss Account for Financial Year 2013-14

(b) Annual Report for AY 2011-12, 2012-13 and 2013-14 (if not finalised, submit unaudited results)

(c) Tax Audit Report for AY 2011-12, 2012-13 and 2013- 14 (if finalised)

(d) Wherever there is delay in payment of TDS as per Tax Audit Report, attach proof of payment of interest.

(e) List of parties included in the projected receipts with their TAN and expected amount.

(f) If there is fall in net profit for Financial Year 13-14 as compared to earlier three years then reasons for fall in net profit.

(g) Copies of Provisional TDS statement of FY 2010-11, 2011-12 and 2012-13.

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Clarification regarding conditions relevant to identify development centres engaged in contract R & D services with insignificant risk – Circular 3/2013 dated 26th March, 2013

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Development centre in India may be treated as a contract R & D service provider with insignificant risk if the following conditions are cumulatively complied with:

(a) Foreign principal performs most of the economically significant functions involved in research or product development cycle whereas Indian development centre would largely by involved in economically insignificant functions;

(b) The principal provides funds. capital and other economically significant assets including intangibles for research or product development and Indian development centre would not use any other economically significant assets including intangibles in research or product development;

(c) Indian development centre works under direct supervision of foreign principal who not only has capability to control or supervise, but also actually controls or supervises research or product development through its strategic decisions to perform core functions as well as monitor activities on regular basis;

(d) Indian development centre does not assume or has no economically significant realised risks. If a contract shows the principal to be controlling the risk but conduct shows that Indian development centre is doing so, then the contractual terms are not the final determinant of actual activities. In the case of foreign principal being located in a country/territory widely perceived as a low or no tax jurisdiction, it will be presumed that the foreign principal is not controlling the risk. However, the Indian development centre may rebut this presumption to the satisfaction of the revenue authorities; and

(e) Indian development centre has no ownership right (legal or economic) on outcome of research which vests with foreign principal, and that it shall be evident from conduct of the parties.

Further, it has been clarified that all the above conditions should be actually proved by conduct of parties and not mere contractual terms.

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Clarification regarding selection of profit split method as most appropriate method – Circular 2/2013 dated 26th March, 2013

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The circular lists the factors to be borne in mind while selecting Profit Split method as most appropriate method, while determining the arms length price for transfer pricing purpose.

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AAR: Section 245R : Application for ruling: No requirement of recording reasons at stage of admission: Commissioner or his representative need not be heard at that stage: Hearing Commissioner or his representative before pronouncing advance ruling only if Authority considers necessary:

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DIT vs. AAR; 352 ITR 185 (AP):

The second Respondent sought an advance Ruling on the question whether the capital gains arising from the sale of shares of a French incorporated entity by the applicant, a French incorporated entity, was liable to tax in France or in India. Notice was given by letter to the CBDT. The Department objected that since proceedings had already been taken in terms of section 195 to 201 in the applicant’s case, the application was hit by the bar in proviso to section 245R(2) of the Income-tax Act, 1961. However, before the objections were received by the Authority for Advance Ruling, the Authority passed an order admitting the application.

In a writ petition filed by the Department, the following question was considered by the Andhra Pradesh High Court:

“Whether while allowing the application filed u/s. 245Q(1) it was essential for the Authority for Advance Rulings to consider the issue of admissibility as a preliminary issue, with regard to the threshold bar u/s. 245R(2), by recording reasons in writing and whether the Department was entitled to a hearing before allowing the application for pronouncing its advance ruling?”

The High Court dismissed the petition and held as under:

“i) S/s. (1) of section 245R, which contemplates forwarding of a copy of such application to the Commissioner, if necessary, calling upon him to furnish the relevant records, does not contemplate the filing of objections or response to the application so made. S/s (2) authorises the Authority, after examining the application and the records called for, by order, either allow or reject the application, but a rider is added by way of proviso that the Authority shall not allow application, inter alia, where the question raised in the application is already pending before any income-tax authority or Appellate Tribunal. The second proviso provides that no application shall be rejected unless an opportunity has been given to the applicant of being heard. If the application is rejected, reasons for such rejection shall be given as per the third proviso to section 245R.

ii) Nowhere does section 245R state that the Commissioner from whom records were called for is to be called upon to make his objections to the admission of application and record reasons when it allowed the application for an advance ruling.

iii) While exercising the jurisdiction under Article 226 of the Constitution, if the High Court is of the opinion that there is no other convenient or efficacious remedy open to the petitioner, it will proceed to investigate the case on its merits and if the Court finds that there is an infringement of the petitioner’s legal rights, it will grant relief, otherwise relief should be rejected.

iv) The entire exercise to be undertaken by the Authority for allowing the application is only to verify the records called for whether an advance ruling on the question specified in the application was required to be made or not. There is a clear dichotomy between the threshold stage of allowing the application for advance ruling and pronouncing of advance ruling. If the Authority admits the application for pronouncing an advance ruling recording of reasons at that stage is not at all required nor is hearing contemplated to the Commissioner or his authorised representative. Only on such admission before pronouncing its advance ruling hearing of the Commissioner or his authorised representative is provided if the Authority considers necessary to hear but not at the threshold stage of admitting the application.

v) The Director of Income-tax and the Additional Commissioner failed to substantiate the infringement of legal right conferred on them under the statute while allowing the application for advance ruling. The writ petitions were devoid of merit and were accordingly dismissed.”

iii) Therefore, the sum forfeited by the assessee to the Council was allowable u/s. 37(1).”

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Industrial Undertaking – Deduction u/s. 80IA – Texturing and twisting of polyester yarn amounts to manufacture.

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CIT vs. Yashasvi Yarn Ltd. (2013) 350 ITR 208 (SC).

A short question that arose for determination before the Supreme Court was whether texturing and twisting of polyester yarn amounts to “manufacture” for the purpose of computation of deduction u/s. 80IA.

The High Court had dismissed the appeals of the Revenue following its decision in CIT vs. Emptee Poly-Yarn Pvt. Ltd. (2008) 305 ITR 309 (Bom).

The Supreme Court dismissed the civil appeals of the Revenue holding that the question had been squarely answered by it in CIT vs. Emptee Poly-Yarn P. Ltd. (2010) 320 ITR 665 (SC).

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Exports – Profits on telecasting rights of a T.V. Serial are entitled to the benefit of section 80HHC

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CIT vs. Faquir Chand (HUF) (2013) 350 ITR 207 (SC)

The question that arose before the Supreme Court was whether the profit on telecasting rights of a T.V. serial are entitled to the benefit of section 80HHC.

The High Court had dismissed the appeal of the Revenue in view of its judgment in Abdul Gafar A. Nadialwala v. ACIT (2004) 267 ITR 488 (Bom).

The Supreme Court dismissed the civil appeal of the Revenue holding that the issued was squarely covered in favour of the assessee by its decision in CIT vs. B. Suresh (2009) 313 ITR 149(SC).

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Business Expenditure – Interest on borrowed capital by an assessee carrying on manufacture of ferro-alloys and setting up a sugar plant – where there is unity of control and management in respect of both the plants and where there is intermingling of funds and dovetailing of business the interest could not be disallowed on the ground that the assessee had not commenced its business.

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CIT vs. Monnet Industries Ltd. (2012) 350 ITR 304 (SC)

In 1991, the assessee had set up a ferro-alloys manufacturing plant in Raipur, which was engaged in both the manufacture of ferro-alloys, as also, trading of ferro alloys.

In the years 1994-95 and 1995-96, the assessee set up a sugar manufacturing plant at Muzaffanagar in the state of UP. The sugar plant had an installed capacity 2500 RD. The assessee’s trial in respect of sugar plant commenced on 20-03-1996. The assesee spent a sum of Rs. 5,66,79,270/- as pre-operative expenses in respect of the sugar plant which inter alia included financial charges of Rs.3,50,83,472/-.

In its return of income for the assessment year 1996-97, the assessee declared loss of Rs.7,23,18,949/- in which the assessee, inter alia, had claimed the aforesaid sum of Rs. 5,66,79,270/- as revenue expenditure.

The Assessing Officer disallowed the expenditure for the reason that the sugar plant constituted new source of income as it was not the same business in which the assessee was engaged.

The Commissioner of Income-tax (Appeals) came to the conclusion that the expenditure in issue was in the nature of revenue expenditure since the sugar plant project was in the same business fold.

The Tribunal allowed deduction of only that expenditure which was incurred towards finance charges, being a sum of Rs. 3,50,83,472/- incurred for setting up of sugar plant as revenue expenditure u/s. 36(1)(iii). In respect of the balance amount in the sum of Rs. 2,15,95,798/-, the Tribunal restored the matter back to the Assessing Officer to ascertain whether the expenditure was of capital or revenue nature.

On an appeal to the High Court by the Revenue, the High Court observed that the Tribunal had given the finding that there was unity of control and management in respect of the ferro alloys plant as well as the sugar plant and there was also intermingling of funds and dovetailing of business. The High Court held that in the circumstance, it could not be said that the assessee had not commenced its business and hence, interest would have to be capitalised. The High Court confirmed the order of the Tribunal.

The Supreme Court dismissed the civil appeal filed by the Revenue in view of the concurrent finding recorded by court below.

Note: W.e.f. 01.04.2004, the Finance Act, 2003 inserted proviso to section 36(i)(iii) which effectively, prohibits the deduction under this section in respect of interest on capital borrowed for acquisition of an asset for extension of existing business for the period up to the date on which such asset is first put to use.

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Shareholder Agreements — Bombay High Court Decides

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Shareholder groups of listed companies and even public companies often face a nagging problem. Many of them enter into agreements giving rights to each other of different kinds over the shares held by them. These may be in the form of restrictive or pre-emptive rights or rights to purchase the shares under certain terms and conditions. The concern that keeps bothering them is whether such rights and terms are valid under law or void or, even worse, whether these are illegal.

A recent decision of the Bombay High Court (MCX Stock Exchange Limited v. SEBI and Others, WP No. 213 of 2011, dated March 14, 2012) partially sets at rest — at least to the extent a High Court decision can — the concern whether an agreement giving certain options to purchase/sell shares is void and illegal being agreements for futures under the provisions of the Securities Contracts (Regulation) Act, 1956 (SCRA). This should help shareholders and investors of various hues who have entered into such contracts with other shareholders and faced the possibility that they may be held illegal/ void. As will be seen later though, a related issue has been kept open and so the question is not yet fully answered. Also, needless to emphasise, the decision is on facts of the case and one would have to see whether the agreements and surrounding circumstances in each case are such that the ratio of the decision may apply.

 To elaborate the issue further, before we go into the facts of the case, the SCRA, to simplify a little, was enacted mainly to regulate stock exchanges and trading on it. For this purpose, it was desired that trading in securities should take place only in regulated stock exchanges. Options, futures, etc. being securities were also required to be traded on stock exchanges. To ensure that parties do not carry out private transactions in such securities including by way of options and futures, such private transactions, subject to specified exceptions, were declared illegal and void. Stock exchanges provide a transparent mechanism for carrying out such transactions in securities also giving safety to counter parties and at the same time, other objectives such as control of undue speculation could be achieved. Hence, transactions through such exchanges were intended to be encouraged.

However, the manner in which the relevant provisions were worded resulted even in a very common set of private agreements being put to question. For example, major shareholders — particularly strategic investors — often enter into agreements whereby one or both are given an option to buy or sell the shares under certain circumstances. Such agreements are rarely assignable to third parties, are not standardised and have unique terms and conditions attached, are not generally severable into small units, etc. In other words, they do not resemble the typical options or futures that are traded on stock markets. However, the conservative view — and often endorsed by SEBI — was that such agreements amount to options/futures and hence may be held to be void and illegal.

The other provision that such private agreements fell foul of was the provisions relating to free transferability of shares. While the essence of private limited companies was restricted transferability of shares, public companies (including listed companies) required free transferability of shares. This, inter alia, enabled buyers of shares being freely able to buy shares — on and off the stock exchanges — without worrying about any restrictions the transferor may be facing. It also ensured that even the company was bound to register the transfer of the shares. Such private agreements providing for options, in a sense, created a restriction on the transfer of the shares. The question once again was whether such agreements fell foul of the law providing for free transferability of shares.

Arguably, the regulator and the law-makers had other reasons too to restrict agreements. These reasons went beyond the above purposes of ensuring trading in securities took place on stock exchanges only or to ensure that there is free transferability of shares for benefit of parties. Restrictions helped achieve other objectives such as limits on foreign holding, avoidance of benami holding of shares, etc. The problem was these provisions of SCRA which had other objectives to serve were also used and applied for such purposes. Thus, instead of making specific provisions to deal with specific concerns, they used the widely framed provisions of the SCRA. This thus resulted in bona fide and fairly common private agreements being subjected to the risk of being held illegal and void.

Coming to the Bombay High Court decision, a Company was formed by a Promoter Group for enabling trading in securities, etc. and thus required registration with the Securities and Exchange Board of India. Since a recognised stock exchange serves certain public purposes and it is not in the pubic interest that the ownership of such stock exchange is concentrated, the law provides that a group of persons acting in concert should not hold more than 5% of the share capital of such company. The relevant Regulations are in fair detail and various issues concerning it were the subject-matter of the Court decision. However, since the focus here is on the issue of validity of certain agreements relating to shares between shareholder groups, the other matters dealt with by the Court are not considered here.

 It appears that the Promoter Group originally held significantly more than 5% of the share capital of the Company. To ensure that it is in compliance with the law, a complex restructuring scheme was carried out. To simplify the matter to help focus on the issue of law, the restructuring can be explained as follows. The share capital of the Company was reduced under a court-approved scheme and further shares were issued to persons other than the Promoter Group. Further, certain shares held by the Promoter Group were transferred to other parties. The Promoter Group had entered into an agreement with certain parties holding shares in the Company whereby certain shareholders had an option to sell their shares to the Promoter Group under certain terms and conditions.

The issue was whether such an agreement amounted to options/futures and thus illegal and void. The Court analysed the nature and essence of the agreements and also the law on the subject matter. Firstly, it held that the agreements did not amount to contract of futures. Contract of futures necessarily involved agreements where the agreement to purchase/sale was concluded but only the payment and delivery was postponed. In the present case, since there was an option to sell, there was no current concluded transaction of purchase/sale. In fact, the transaction of purchase/ sale may not even arise in the future if the party did not exercise its option. Thus, the Court held there was no agreement of futures. The Court, however, did not deal with the issue whether the agreement amounted to an option, because this was not part of the allegations under the Notice issued to the aggrieved party. The Court asked SEBI, if it desired to raise that issue, to give an opportunity to the aggrieved party first.

Let us consider some extracts from the decision of the Court to consider the matter in context.

The Court described the nature of the agreements between FTIL (the Promoter) and PNB/ILFS (the counter parties) in the following words:

“The buy -back agreements furnish to PNB and IL&FS an option. The option constitutes a privilege, the exercise of which depends upon their unilateral volition. In the case of PNB, the buy-back agreements contemplated a buy-back by FTIL after the expiry of a stipulated period. But, in the event that PNB still asserted that it would continue to hold the shares, despite the buy-back offer, FTIL or its nominees would have no liability for buying back the shares in future. In the case of IL&FS, La -Fin assumed an obligation to offer to purchase either through itself or its nominee the shares which were sold to IL&FS after the expiry of a stipulated period. In both cases, the option to sell rested in the unilateral decision of PNB and IL&FS, as the case may be.”

Does the agreement amount to a contract of future so as to be violative of the law and hence illegal and void? The Court further analysed and observed as follows:

“In a buy-back agreement of the nature involved in the present case, the promisor who makes an offer to buy back shares cannot compel the exercise of the option by the promisee to sell the shares at a future point in time. If the promisee declines to exercise the option, the promissor cannot compel performance. A concluded contract for the sale and purchase of shares comes into existence only when the promisee upon whom an option is conferred, exercises the option to sell the shares. Hence, an option to purchase or repurchase is regarded as being in the nature of a privilege.
…

77.    The distinction between an option to purchase or (repurchase and an agreement for sale and purchase simpliciter lies in the fact that the former is by its nature dependent on the discretion of the person who is granted the option, whereas the latter is a reciprocal arrangement imposing obligations and benefits on the promisor and the promisee. The performance of an option cannot be compelled by the person who has granted the option. Contrariwise in the case of an agreement, performance can be elicited at the behest of either of the parties. In the case of an option, a concluded contract for purchase or repurchase arises only if the option is exercised and upon the exercise of the option. Under the notification that has been issued under the SCRA, a contract for the sale or purchase of securities has to be a spot delivery contract or a contract for cash or hand delivery or special delivery. In the present case, the contract for sale or purchase of the securities would fructify only upon the exercise of the option by PNB or, as the case may be, IL&FS in future. If the option were not to be exercised by them, no contract for sale or purchase of securities would come into existence. Moreover, if the option were to be exercised, there is nothing to indicate that the performance of the contract would be by anything other than by a spot delivery, cash or special delivery. Where securities are dealt with by a depository, the transfer of securities by a depository from the account of a beneficial owner to another beneficial owner is within the ambit of spot delivery.”

Finally, it concluded, with the following words, that the agreement was not in the nature of a futures contract:

“80. In the present case, there is no contract for the sale and purchase of shares. A contract for the purchase or sale of the shares would come into being only at a future point of time in the eventuality of the party which is granted an option exercising the option in future. Once such an option is exercised, the contract would be completed only by means of spot delivery or by a mode which is considered lawful. Hence, the basis and foundation of the order which is that there was a forward contract which is unlawful at its inception is lacking in substance.”

The next issue whether the agreements “would amount to an option in securities and, therefore, derivatives which were neither traded nor settled at any recognised stock exchange, nor with the permission of Securities and Exchange Board of India and therefore in violation of SCRA”. The Court noted that this allegation did not form part of the original notice and thus parties were not given an opportunity to reply to SEBI. Thus, SEBI was required to first give such an opportunity and then give its decision and then the question of appeal may arise.

The decision gives relief to parties who have entered into or propose to enter into such agreement at least from the concern that such agreement may amount to a futures agreement. Needless to emphasise, the decision was on facts. The other concern, though, remains open and that is whether such an agreement may amount to an option which is prohibited under law. It will have to be seen what course of action SEBI takes and whether the matter goes back to the Court.

However, it is time that the law-makers and even SEBI take the initiative and resolve the controversy. It does not seem that there can be any objection to such private agreements between two groups of shareholders where most of the elements of standardised over the counter futures/options contracts are absent. Such private agreements should be explicitly exempted and if desired, the specific areas where the law-makers have concern can be duly regulated.

A.P. (DIR Series) Circular No. 97, dated 28-3- 2012 — Overseas Investments by Resident Individuals — Liberalisation/Rationalisation.

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This Circular has proposed the following three changes:

(1) Acquiring qualification shares of an overseas company for holding the post of a Director A resident individual can now remit funds, within the overall ceiling prescribed from time to time under the Liberalised Remittance Scheme, for acquiring qualification shares for holding the post of a Director in the overseas company up to the extent required by the laws of the host country where the company is located.

(2) Acquiring shares of a foreign company towards professional services rendered or in lieu of Director’s remuneration General permission is granted to resident individuals to acquire shares of a foreign entity in part/ full consideration of professional services rendered to the foreign company or in lieu of Director’s remuneration. However, the value of such shares must be within the overall ceiling prescribed from time to time under the Liberalised Remittance Scheme.

(3) Acquiring shares in a foreign company through ESOP Scheme Permission has been granted to resident employees or Directors of an Indian company to accept shares offered under an ESOP Scheme in a foreign company, irrespective of the percentage of the direct or indirect equity stake of the foreign company in the Indian company, provided:

(i) The shares under the ESOP Scheme are offered by the issuing company globally on a uniform basis,

(ii) Annual Return is submitted by the Indian company to the Reserve Bank through the AD Category-I bank giving details of remittances/ beneficiaries, etc.

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A.P. (DIR Series) Circular No. 96, dated 28- 3-2012 — Overseas Direct Investments by Indian Party — Rationalisation.

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This Circular has proposed the following six changes:

1. Creation of charge on immovable/movable property and other financial assets

A charge can be created, under the Approval Route within the overall limit fixed (presently 400%) for financial commitment, on the immovable/movable property and other financial assets of the Indian Party and their group companies by way of pledge/ mortgage/hypothecation. However, a ‘No objection’ letter needs to be obtained from lenders to the entities on whose assets the charge is being created.

2. Reckoning bank guarantee issued on behalf of JV/WOS for computation of financial commitment

For calculating the financial commitment of the Indian Party to its overseas JV/WOS, henceforth, bank guarantee issued by a resident bank on behalf of the overseas JV/WOS of the Indian party will also be considered if the same is backed by a counter guarantee/collateral from the Indian Party.

3. Issuance of personal guarantee by the direct/ indirect individual promoters of the Indian

Party General permission is now granted to indirect resident individual promoters of the Indian Party to also give a Personal Guarantee on behalf of the overseas JV/WOS of the Indian Party.

4. Financial commitment without equity contribution to JV/WOS

An Indian Party can undertake, under the Approval Route, financial commitment by way of guarantee/ loan, without equity contribution, in the overseas JV/WOS if the laws of the host country permit incorporation of a company without equity participation by the Indian Party.

5. Submission of Annual Performance Report
In cases where laws of the host country do not prescribe mandatory audit of the books of account of the overseas JV/WOS, the Indian Party can submit the Annual Performance Report on the basis of unaudited annual accounts of the overseas JV/ WOS, if:

(a) The Statutory Auditors of the Indian Party certify that the unaudited annual accounts of the JV/WOS reflect the true and fair picture of the affairs of the overseas JV/WOS.

 (b) The un-audited annual accounts of the overseas JV/WOS have been adopted and ratified by the Board of the Indian Party.

6. Compulsorily Convertible Preference Shares (CCPS)

Henceforth, Compulsorily Convertible Preference Shares (CCPS) will be treated on par with equity shares (and not as loans) and the Indian Party will be allowed to undertake financial commitment based on the exposure to overseas JV/WOS by way of CCPS.

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Sales Tax — PSI units established under 1988 Scheme — Retrospective amendment to Rule — Providing calculation of CQB — Bad in law to that extent they are inconsistent with para 2.11 of 1988 GR — Rule 31AA of the Bombay Sales Tax Rules, 1959.

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(2011) 41 VST 436 (Bom.)
Prasad Power Control Pvt. Ltd. and Another v. Commissioner of Sales Tax, Mumbai and Others.

Sales Tax — PSI units established under 1988 Scheme — Retrospective amendment to Rule — Providing calculation of CQB — Bad in law to that extent they are inconsistent with para 2.11 of 1988 GR — Rule 31AA of the Bombay Sales Tax Rules, 1959.


Facts:

The dealer company, entitled to sales tax exemption under the Package Scheme of Incentives (PSI), 1988 under the Bombay Sales Tax Act, 1959 as per terms and conditions of Government Resolution, dated September 30, 1988 subject to maximum specified limit of notional sales tax liability to be calculated as per Para 2.11 of the said GR. Section 41B of the Act, inserted from May 1, 1994, empowers the Commissioner of sales tax to determine the cumulative quantum of benefits (CQB) received by any dealer to whom any certificate of entitlement is granted under various specified PSI at any time from January 1, 1980, in the manner prescribed by the Rules. Rule 31AA was inserted in the Bombay Sales Tax Rules, 1959 from March 24, 1995 providing for calculation of CQB for any period starting from January 1, 1980. The assessment of the dealer was completed for the periods 1994-95 to 1996-97 and the assessing authority calculated CQB as per Rule 31AA against which dealer filed appeals before the Appellate Authority as well as filed writ petition before the Bombay High Court challenging the constitutional validity of Rule 31AA providing for calculation of CQB to that extent they are inconsistent with Para 2.11 of GR dated September 30, 1988.

Held:

 (i) There can be no dispute that the State Legislature has power to make laws with retrospective effect, but if that law arbitrarily impairs or seeks to take away the rights vested in the citizens, then such law must be held to be bad in law to the extent it is made retrospectively.

(ii) In the present case, the petitioners had a vested right in computing CQB as per Para 2.11 of the 1988 GR and since that vested right is sought to be divested by introducing Rule 31AA retrospectively, it must be held that Rule 31AA to the extent it seeks to apply to the units established under the 1988 scheme prior to the insertion of said rule is bad in law.

(iii) When the PSI itself was to operate based on the exemption granted under the sales tax law, it is difficult to envisage that in calculating the CQB, the Scheme intended to ignore the exemptions available under the sales tax law. In any event, the language used in Para 2.11 of the 1988 GR does not directly or indirectly indicate that in calculating CQB the exemptions provisions contained under the sales tax law have to be ignored.

(iv) The calculation of CQB under PSI 1988, as per Para 2.11 of 1988 GR, has to be made with reference to tax payable, by a unit not covered under PSI 1988, at maximum rate of tax payable under the Act or rules including exemptions or concessions available under any other provisions of the Act, rules or notifications. Accordingly, the High Court allowed the writ petition filed by the company.

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Sales tax — TDS on works contract — At flat rate — On total contract value — Without any mechanism to determine taxable turnover, etc. — Constitutional validity — Invalid — Section 3AA of the Tripura Sales Tax Act, 1976.

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(2011) 41 VST 386 (Gauhati) Sri Pradip Paul v. State of Tripura

Sales tax — TDS on works contract — At flat rate — On total contract value — Without any mechanism to determine taxable turnover, etc. — Constitutional validity — Invalid — Section 3AA of the Tripura Sales Tax Act, 1976.


Facts:

The dealer entered into works contract for digging and development of tube-well for State PWD of the Tripura Government. Under the contract, pipes were supplied free of cost by the Department and some little materials were supplied by the dealer. The State PWD deducted sales tax from payment of bills to the dealer/contractor at flat rate as provided in section 3A of the Tripura Sales Tax Act, 1976. The dealer filed writ petition before the Gauhati High Court challenging constitutional validity of provisions of section 3A of the Tripura Sales Tax Act, 1976 providing for levy of sales tax as well as provisions of TDS at flat rate u/s.3AA of the act. The High Court following various decisions of SC and other High Courts upheld constitutional validity of section 3A of the act providing levy of tax at different rate of tax on sale of goods involved in execution of works contract but TDS provisions were held as invalid.

Held:

 (i) Under the contract, the dealer was to supply necessary fittings and some other material however little they may be, the contract is not a service contract, but works contract involving sale of those goods and liable for sales tax on corresponding turnover of sales.

(ii) No tax can be imposed and recovered in respect of sale arising out of works contract as per section 3A inasmuch as tax is leviable on turnover of sales, but the manner of computation of turnover has not been provided in respect of works contract in the Act making thereby assessment and computation of tax inapplicable in respect of works contract.

(iii) Section 3AA of the act and Rule 3A(1) of the rules are bad in law inasmuch as it permits deduction of tax at flat rate.

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Service tax demanded on construction of apartments for a client who in turn allotted it to its employees for residence — The issue highly debatable, however Board’s Circular No. 332/16/2010, dated 24-5-2010 in favour of appellant — Held: Activity covered by exclusion clause of the definition of ‘residential complex’ as per section 65(105) (zzzh) — Stay and waiver granted.

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(2012) TIOL 283 CESTAT-Bang. — Nitesh Estates Ltd. v. CCE, Bangalore.

Service tax demanded on construction of apartments for a client who in turn allotted it to its employees for residence — The issue highly debatable, however Board’s Circular No. 332/16/2010, dated 24-5-2010 in favour of appellant — Held: Activity covered by exclusion clause of the definition of ‘residential complex’ as per section 65(105) (zzzh) — Stay and waiver granted.


Facts:

The appellant constructed residential complexes during March, 2007-March, 2008 for ITC Ltd. who provided the apartments for residence of its employees. Invoking extended period in July, 2009, service tax was demanded and penalty was levied. The appellant contended that residential construction was done for personal use of ITC Ltd. and hence was covered by exclusion clause u/s.65(91a) of the Act and relied on Board’s Circular 332/16/2010, dated 24-5-2010, wherein it was clarified that residential complex constructed by National Building Construction Corporation Ltd. (NBCC) for officers of the Central Government was not taxable. Support was also placed on Khurana Engineering Ltd. v. CCE, (2011) 21 STR 115 (Tri.-Ahmd.) wherein residential complexes constructed by the assessee for PWD/Government of India for residential use of the Central Government employees were held to be covered by the exclusion clause. The Revenue, on the other hand distinguished the situation wherein a person building on one’s own and not through a contractor, only would fall within the ambit of exclusion clause.

Held:

The issue is highly debatable, however the Board’s Circular and Tribunal’s decision (supra) could be taken support of. Further, considering that the appellant also had good case on limitation, recovery of dues was stayed, but the case was posted for early hearing.

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Services of mining, loading, transportation and unloading — Whether cargo handling service or goods transportation service — Since tax paid as receiver of GTA service — Contract indicated small component of loading and unloading — Handling or transportation within factory or mining area does not amount to ‘cargo’ is well settled — In the contracts of appellants handling is incidental to transportation — Held revenue’s attempt to convert this to cargo handling appears far-fetched — Demand set as<

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(2012)   TIOL   290   CESTAT-Del.   — R. K. Transport Company v. CCE, Raipur.
    

Services of mining, loading, transportation and unloading — Whether cargo handling service or goods transportation service — Since tax paid as receiver of GTA service — Contract indicated small component of loading and unloading — Handling or transportation within factory or mining area does not amount to ‘cargo’ is well settled — In the contracts of appellants handling is incidental to transportation — Held revenue’s attempt to convert this to cargo handling appears far-fetched — Demand set aside.


Facts:

The appellant provided integrated services of mining for excavation of bauxite ore, loading it into trucks at stock yards and transportation of the same by road and unloading the same at a specified area for two aluminium companies during August, 2002- March, 2006. Revenue proceeded the case considering this as cargo handling service. From 1-1-2005, the appellant discharged service tax as recipient of GTA service on consideration received for transportation of goods. For services other than transportation. The appellant paid service tax from 16-6-2005 under Business Auxiliary Service as services in relation to production were covered under Business Auxiliary Service. According to the appellant, services covered under mining service were not liable prior to 1-6- 2007. Relying on several decisions including Sainik Mining & Allied Services (2008) 9 STR 531 (Tri.) and Modi Construction (2008) 12 STR 34 (Tri.), the appellant contended that handling of goods within factory or mines could not be considered handling of cargo. The Revenue contended that argument of the assessee that mining was a dominant activity was incorrect and relied in support on Gajanand Agarwal v. CCE, (2009) 13 STR 138.

Held:

The contracts indicated insignificant component of cargo handling service and main activities were mining and transportation. No separate rates were available for loading and unloading as available in the case of Gajanand Agarwal (supra). The Revenue’s attempt to convert such activity from transportation and deny abatement claimed appeared farfetched to find legal support. Loading and unloading combined with transportation service rendered in respect of transportation would not become cargo handling service. The appeal was accordingly allowed.

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Penalty — Education cess is for welfare of the state and appellant not entitled to credit of the same, hence no penalty leviable u/s.76 of Finance Act, 1994 (penalty for failure to pay service tax).

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(2012) 25 STR 594 (Tri.-Del.) — Pahwa International Pvt. Ltd. v. Commissioner of Service Tax, Delhi.

Penalty — Education cess is for welfare of the state and appellant not entitled to credit of the same, hence no penalty leviable u/s.76 of Finance Act, 1994 (penalty for failure to pay service tax).


Facts:
The appellant wrongly utilised credit for education cess against service tax. Education cess was meant for specific purpose i.e., welfare of the state.

Held:

The appellant was not entitled to avail credit of education cess against credit for service tax. The penalty u/s.76 of the Finance Act, 1994, upon the appellant was waived.

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Appellant, a labour contractor — Conversion process of tin plate to containers in the premises of M/s. NKPL — Tax levied on the appellant — The appellant was providing manpower recruitment or supply agency services — On the basis of facts it was held that there was no service tax liability.

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(2012) 25 STR 471 (Tri-Ahmd.) — Rameshchandra C. Patel v. Commissioner of Service Tax, Ahmedabad.

Appellant, a labour contractor — Conversion pro-cess of tin plate to containers in the premises of M/s. NKPL — Tax levied on the appellant — The appellant was providing manpower recruitment or supply agency services — On the basis of facts it was held that there was no service tax liability.


Facts:

The appellant was a labour contractor and was doing conversion of tin plate to containers to pet jars in the factory premises of M/s. NK Proteins Ltd. (NKPL). The machinery, space and all other facilities were provided by NKPL. The appellant was required to take the required labour to the factory of NKPL to undertake the conversion depending upon the requirement of NKPL. According to the agreement, the appellant was to pay specific amount determined on the basis of number of containers produced by the appellant. Proceedings were initiated against the appellant on the ground that the activity undertaken amounted to providing manpower recruitment or supply agency.

Held:

To determine whether the service is taxable under manpower recruitment or supply agency, first of all it should be provided by manpower recruitment or supply agency and secondly it should be in relation to manpower supply or recruitment. The appellant was doing only contract manufacturing work and there was no question of any labour supply or manpower supply or manpower recruitment agency. Nowhere in the agreement there was any mention with regards to manpower supply or recruitment and the agreement specifically talks about the products to be manufactured and payments to be made. The appellant was also registered with the labour department as a contract manufacturer and not as a labour supply or manpower supply or manpower recruitment agency. The Department totally failed to show in which manner the service provided by the appellant could be categorised under manpower supply or recruitment. Hence it was held that the appellant was not liable to service tax.

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Mutual fund distribution — Liability to pay service tax on commission — As per Service Tax Rules, 1994 such liability was on recipient of services i.e., mutual fund company — If they did not pay it, liability was not transferred to mutual fund distributor.

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(2012) 25 STR 481 (Tri-Del.) — Raj Ratan Castings Pvt. Ltd v. Commissioner of Customs & Central Excise, Kanpur.

Mutual fund distribution — Liability to pay service tax on commission — As per Service Tax Rules, 1994 such liability was on recipient of services i.e., mutual fund company — If they did not pay it, liability was not transferred to mutual fund distributor.


Facts:

The appellant was a distributor of mutual fund units who received commission from mutual fund companies or asset management companies. The commission received by the appellant from the said companies, was taxed by the authorities on the ground that it provided Business Auxiliary Services to the mutual fund company.

Held:

It was held that the liability to pay tax is of the service recipient i.e., the mutual fund company. If it was not paid by the company, proceedings have to be started against the company and the liability will not transfer to the mutual fund distributor.

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Tax liability — Relevant date — Rate of tax — Advance payment — Demand for differential tax due to subsequent change of rate of tax — Rate of service tax increased from 8 to 10.2% w.e.f. 10-9-2004 — Appellant received advance payment before 10-9-2004 — Appellant paid tax on full value received — Department did not take any objection to such payment in advance — Held, rate that was applicable at the time of receipt of value of service will apply in a case where the appellant chose to pay tax on

(2012) 25 STR 459 (Tri.-Del.) — Vigyan Gurukul v. Commissioner of Central Excise, Jaipur-I.

Tax liability — Relevant date — Rate of tax — Advance payment — Demand for differential tax due to subsequent change of rate of tax — Rate of service tax increased from 8 to 10.2% w.e.f. 10-9-2004 — Appellant received advance payment before 10-9-2004 — Appellant paid tax on full value received — Department did not take any objection to such payment in advance — Held, rate that was applicable at the time of receipt of value of service will apply in a case where the appellant chose to pay tax on advance amount received.


Facts:

The appellant was providing commercial coaching services during the year 2004. The rate of service tax increased from 8 to 10.2% w.e.f. 10-9-2004. The appellant received advance payment before 10-9- 2004 for providing services part of which were provided after 10-9-2004. They paid tax @8%, the rate prevalent at the time of paying service tax on the amounts received by them. The Department did not take any objection to such payment in advance. At a later date, the Department request ed the appellant to deposit the differential service tax on that part of the advance fee collected by them during the period 1-9-2004 to 9-9-2004 against which services were rendered during the period from 10-9-2004 to 31-3-2005. The appellant deposited the differential amount of service tax. The appellant later felt that they need not have paid tax at the higher rate as advised by the Department and they filed a refund claim for the same. The Department rejected the claim.

Held:

It was held that the appellants cannot recover the additional tax amount from their students in view of the fact that the contracts with students were concluded. The appellant paid tax on full value received. The Department did not take any objection to such payment in advance. So at the later date when the rate of service tax increased, there was no reason for the Department to claim that the appellant should not have paid tax in advance. The rate that was at the time of receipt of value of service will apply in case where the appellant chose to pay tax on advance amount received. Comments: The current provisions of Point of Taxation Rules are also in line with the above judgment. Where bill has been raised and payment is also received before change in the rate, the old rate will apply.

Section 66A — Import of services — Constitutional validity upheld — Charge of service tax created on services provided from outside India by a person having a business establishment/fixed establishment from which the services are provided and received in India by a person who has a place of business, fixed establishment, permanent address or usual place of residence in India and the Rules in respect thereof made under powers conferred by sections 93 and 44 r.w.s. 66A of the Finance Act, 1994 ar<

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(2012) TIOL 122 HC-ALL-ST — GLYPH International Ltd. v. Union of India & Others.

Section 66A — Import of services — Constitutional validity upheld — Charge of service tax created on services provided from outside India by a person having a business establishment/fixed establishment from which the services are provided and received in India by a person who has a place of business, fixed establishment, permanent address or usual place of residence in India and the Rules in respect thereof made under powers conferred by sections 93 and 44 r.w.s. 66A of the Finance Act, 1994 are not unconstitutional on both grounds; legislative competence and/or extra-territorial operation of laws.


Facts:

The petitioner, a software manufacturer and 100% exporter had an agreement with a US company whereby the US company would promote petitioner’s business activity in US. Service tax was demanded on the amount paid to the US company for the period 2008-09. The petitioner challenged the levy on the said US company’s services viz. AMC charges for upgradation of software and online support services. The grounds of the challenge were (a) constitutional validity of section 66A and Taxation of Services (Provided from Outside India and Received in India) Rules, 2006 (Import Rules) (b) extra-territorial jurisdiction of the levy based on the scope of section 64 of the Act which provides that the Act will extend to whole of India except State of Jammu & Kashmir. The petitioner contended that section 66A and the Import Rules create another taxable event/ incidence of tax from services provided to services received in India and which was against the legislative scheme. While challenging constitutional validity the petitioner in the context of Entry 92C of the Union list contended that services rendered in India which would form part of GDP were sought to be taxed as they significantly contributed to GDP. However, levying service tax on services rendered outside India being not part of GDP would be unconstitutional. The petitioner also contended that unlike the Income-tax Act, there did not exist double taxation treaty in service tax and therefore hardship in the form of multiple taxation on the same activity would be caused. They placed reliance upon All India Federation of Tax Practitioners v. Union of India, (2007) 7 STR 625 (SC). Discussing various parts of the said decision, it was contended that service tax is a VAT which in turn is both a general tax and destination-based consumption tax leviable on services provided within the country. Further reliance was placed on various decisions, including on Ishikawajma Harima Heavy Industries (2007) 3 SCC 481. The Revenue, on the other hand, contended that 66A was a valid provision and did not suffer from the vice of unconstitutionality and inter alia relied on Tamil Nadu Kalyan Mandapam Association v. UOI, (2004) TIOL 36 SC-ST (wherein constitutional validity of section defining Mandap Keeper’s service was upheld) and All India Federation of Tax Practitioners (supra) (wherein legislative competence of Parliament to levy service tax on chartered accountants, cost accountants and architects was upheld). Among other decisions, Indian National Shipowners Association v. UOI, (2009) 13 STR 235 (Bom.) was also referred to and noted.

Held:

Constitutional validity of the competence of Parliament to levy service tax has been upheld by the Supreme Court in Tamil Nadu Kalyan Mandapam Association (supra), All India Federation of Tax Practitioners (supra) and Association of Leasing and Financial Service Companies (2016) TIOL 87 SC-ST-LB. In the case under examination, the concern was for objection to the legislative powers of the Parliament on its extra-territorial operations, namely, the charge in respect of taxable events/ incidence of service tax on services provided outside India. Citing excerpts from the decisions such as Shrikant Bhalchandra Karulkar v. State of Gujarat, (1994) 5 SCC 459, State of Bihar & Ors. v. Shankar Wire Products Industries & Ors., (1995) Supp. 4 SCC 646 and GVK Industries Ltd. v. Income-tax Officer & Anr., (2011) 4 SCC 36, the High Court held:

As held in GVK Industries Ltd.’s case, Parliament does not have power to legislate for any territory other than territory of India or part of it and such laws would be ultra vires. It follows therefore that Parliament is empowered to make laws with respect to aspects or cause that occur, arise or exist or may be expected to do so within the territory of India and with respect to extra-territorial aspects or cause that have an impact on or nexus with India. Citing various terms in the agreement of the petitioner with the US company, it was concluded, “we find that taxable services provided from outside India are received and can be taxed in India u/s.66A(1)(b) of the Act.” Further that Import Rules made in exercise of powers conferred by sections 93 and 94 r.w.s. 66A of the Finance Act, 1994 do not suffer from the vice of constitutionality either on the ground of lack of legislative competence or on the ground of extra-territorial operation of laws.

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S. 37(1) — Capital or revenue expenditure — Whether the amount paid for handsets and for talk-time charges were capital in nature — Held, No.

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New Page 1

Part B :
Unreported
Decisions

(Full texts of the following Tribunal decisions are available at
the Society’s office on written request. For members desiring that the Society
mails a copy to them, Rs.30 per decision will be charged for photocopying and
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8 Radial Marketing Pvt. Ltd. v. ITO
ITAT ‘SMC’ Bench, Mumbai
Before R. K. Gupta (JM)
ITA No. 3868/Mum./2008
A.Y. : 2003-04. Decided on : 19-5-2009
Counsel for assessee/revenue : G. P. Mehta/K. K. Mahajan

S. 37(1) — Capital or revenue expenditure — Whether the
amount paid for handsets and for talk-time charges were capital in nature —
Held, No.

Facts :

During the year under appeal the assessee had claimed a sum
of Rs.24,500 paid for handsets and Rs.14,000 paid for talk-time charges as
revenue expenditure. However, the AO treated the same as capital expenditure and
allowed the depreciation.

Held :

The Tribunal referred to the CBDT Circular issued with
reference to the payments made under ‘Own Your Telephone’ scheme of MTNL. It
noted that as per the Circular the amount paid for the purchase of handsets was
allowable as revenue expenditure. In view thereof, it allowed the claim of the
assessee. As regards the amount paid for talk-time — it agreed with the assessee
that it cannot be treated as capital in nature as the same was not for any
capital assets.

Reference :

CBDT Circular No. 204/70/75-IT (All), dated 10-5-1976.

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S. 80-IA — Deduction in respect of profit of the power-generating undertaking — Power generated by the eligible unit captively consumed — Valuation at market price — Rates charged by the State Electricity Board, including the electricity tax levied thereo

fiogf49gjkf0d
New Page 1

Part B :
Unreported
Decisions

(Full texts of the following Tribunal decisions are available at
the Society’s office on written request. For members desiring that the Society
mails a copy to them, Rs.30 per decision will be charged for photocopying and
postage.)

 

 


7 DCW Ltd. v. ACIT
ITAT ‘D’ Bench, Mumbai
Before A. L. Gehlot (AM) and P. Madhavi Devi (JM)
ITA No. 126/Mum./2008
A.Y. : 2003-04. Decided on : 29-1-2010

Counsel for assessee/revenue : Salil Kapoor/R. N. Jha

S. 80-IA — Deduction in respect of profit of the
power-generating undertaking — Power generated by the eligible unit captively
consumed — Valuation at market price — Rates charged by the State Electricity
Board, including the electricity tax levied thereon, adopted as a benchmark to
arrive at the market value — Whether the CIT(A) was right in excluding the
electricity tax to arrive at the market value — Held, No.

Per A. L. Gehlot :

Facts :

One of the issues before the Tribunal was with reference to
the claim for deduction u/s.80-IA in respect of income from power plant. The
assessee was using power generated by its power plant for its own consumption.
In terms of the Explanation to S. 80-IA(8) — the assessee applied the rate
charged by the State Electricity Board and arrive at the market price of the
power used for captive consumption. The rate charged by the State Electricity
Board also included electricity tax levied by the State Government. According to
the CIT(A), since the electricity tax was a statutory payment, the same cannot
form part of the market price. For the purpose he relied on the decision of the
Mumbai Tribunal in the case of West Coast Paper Mills Ltd.

Held :

According to the Tribunal the issue before the Mumbai
Tribunal in the case of West Coast Paper Mills Ltd. was different than the case
of the assessee. In the case of the former, the issue was which rate was to be
adopted out of the two rates available on record. Referring to the Explanation
to S. 80-IA(8) defining the term ‘market value’, it observed that, the market
value could be understood by the simple fact viz., if the assessee was not
producing the electricity by itself and if it was purchased from the State
Electricity Board, the amount paid would be the market price which includes the
taxes levied by the authority. Therefore, it held that there was no reason for
exclusion of tax for the purpose of calculation of market price.

Case referred to :

West Coast Paper Mills Ltd. v. ACIT, 103 ITD 19 (Bom.).

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Explanation to S. 73 — For the purpose of deciding whether the case of the assessee is covered by exceptions provided in Explanation to S. 73, speculation loss is to be excluded while computing business income and arriving at the gross total income.

fiogf49gjkf0d
New Page 1

Part B :
Unreported
Decisions

(Full texts of the following Tribunal decisions are available at
the Society’s office on written request. For members desiring that the Society
mails a copy to them, Rs.30 per decision will be charged for photocopying and
postage.)

 

 


6 Paramount Information Systems Pvt. Ltd. v. ITO
ITAT ‘K’ Bench, Mumbai
Before P. Madhavi Devi (JM) and B. Ramakotaiah (AM)
ITA No. 921/Mum./2008
A.Y. : 1993-94. Decided on : 24-2-2010

Counsel for assessee/revenue : Jayesh Dadia/Anil K. Mishra

 

Explanation to S. 73 — For the purpose of deciding whether
the case of the assessee is covered by exceptions provided in Explanation to S.
73, speculation loss is to be excluded while computing business income and
arriving at the gross total income.

Per P. Madhavi Devi :

Facts :

The assessee incurred speculation loss of Rs.22,728. This
speculation loss was in addition to the loss on trading in shares amounting to
Rs.6,66,971 separately shown in P & L Account. While assessing the total income
u/s.143(3) of the Act, in order to ascertain whether the Explanation to S. 73
applies, and therefore the loss of Rs.6,66,971 on trading in shares is to be
regarded as speculation loss, the Assessing Officer (AO) treated speculation
loss of Rs.22,728 as such and excluded it from computation under the head
‘Profits and Gains of Business’. In the computation filed by the assessee, there
was a carried forward speculation business loss of Rs.22,728 and unabsorbed
depreciation of Rs.36,992 which was to be carried forward. The assessee
contended that depreciation on business premises of Rs.38,881 on new office
which was not put to use needs to be excluded since the same was claimed wrongly
and is not allowable since the new office has not been put to use. The ITAT
remanded this matter (of depreciation being not allowable) along with the issue
of application of S. 73 to the AO.

In reassessment proceedings, AO reiterated the contentions in
original assessment but the CIT(A) after admitting additional evidences and
remanding the matter back to the AO gave a finding that the assessee had not put
to use the office premises and the AO was directed to withdraw the depreciation
on the new building and recompute business loss. However, the CIT(A) worked out
gross total income by treating speculation loss of Rs.22,728 as part of business
income. He rejected the assessee’s contention that for computing gross total
income, speculation loss of Rs.22,728 should not form part of business income
and therefore also for arriving at gross total income.

Aggrieved, the assessee preferred an appeal to the Tribunal.
The question for consideration being whether the speculation loss of Rs.22,728
is to be included as part of gross total income or to be excluded while
computing business income and arriving at the gross total income.

Held :

The Tribunal after referring to the judgment in the case of
IIT Invest Trust Ltd. 107 ITD 257, held that under the scheme of the Act
whenever there is a separate loss which cannot be set off in the computation
under each head, the same cannot be included in the gross total income and it
does not enter in the computation of gross total income being a loss, unless set
off against income under any other head. The Tribunal held that the speculation
loss was to be treated separately under the provisions of the Act. Explanation 2
to S. 28 makes it mandatory that where speculative transactions carried on by
the assessee are of such a nature as to constitute the business, the business
shall be deemed to be distinct and separate from any other business. The
Tribunal held that the speculation loss of Rs.22,728 constituted a separate
business and it cannot be set off from other business loss or profit including
income from other sources. Accordingly, it was held that the same be excluded
while working out gross total income. Upon excluding the speculation loss of
Rs.22,728 the gross total income became a positive figure of Rs.2,957 and
accordingly income from other sources was more than business profits and
assessee’s loss on trading in shares was not attracted by provisions of S. 73.
The assessee’s case was held to be covered by first exception in Explanation to
S. 73. The Tribunal observed that this principle is also laid down in IIT Invest
Trust Ltd. 107 ITD 257 and also in Concord Commercial Pvt. Ltd. 95 ITD 117 (SB).

The Tribunal allowed the appeal filed by the assessee.

It observed that the judgment of the Madras High Court is a
case of liability arising on account of a retrospective amendment, as in the
present case. It held that levy of interest in respect of the amount of deferred
tax deducted while arriving at the book profit in the return is invalid.

As regards the argument raised at the time of hearing that since powers of reduction/waiver are vested in the CBDT whether the Tribunal can examine the validity of the levy of interest, the Tribunal having noted that the Supreme Court has in the case of Central Provinces Manganese Ore (160 ITR 961) held that if the assessee denies his liability to pay interest the appeal on that point was maintainable. Based on the ratio of the decision of the Apex Court and also having noted that there is no express or implied restriction on the powers of the Tribunal while disposing of the appeal, it held that the appeal of the assessee is maintainable. It further held that the fact that the administrative relief can be obtained by the assessee cannot erode the powers of the Tribunal while dealing with a valid appeal before it.

 
The appeal filed by the assessee was partly allowed.

S. 234B — Assessee is not liable to pay interest u/s.234B when by retrospective amendment made later the amount becomes taxable. The fact that administrative relief can be obtained by the assessee cannot erode the powers of the Tribunal while dealing with

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New Page 1

Part B :
Unreported
Decisions

(Full texts of the following Tribunal decisions are available at
the Society’s office on written request. For members desiring that the Society
mails a copy to them, Rs.30 per decision will be charged for photocopying and
postage.)

 

 


5 Sun Petrochemicals Pvt. Ltd. v. ITO
ITAT ‘D’ Bench, Ahmedabad
Before R. V. Easwar (VP) and D. C. Agarwal (AM)
ITA No. 1010/Ahd./2009


A.Y. : 2006-07. Decided on : 5-6-2009 Counsel for assessee/revenue
: S. C. Jalan/ Abani Kanta Nayak

S. 234B — Assessee is not liable to pay interest u/s.234B
when by retrospective amendment made later the amount becomes taxable. The fact
that administrative relief can be obtained by the assessee cannot erode the
powers of the Tribunal while dealing with a valid appeal laid before it.

Per R. V. Easwar :

Facts :

The assessee company while computing book profit u/s.115JB of
the Act deducted the deferred tax amounting to Rs.4,94,21,478 and fringe benefit
tax of Rs.62,279. At the time when the assessee filed the return of income,
there was no specific provision in the Section to the effect that deferred tax
was not deductible while arriving at the book profit. However, by the Finance
Act, 2008 an amendment was made to the Section with retrospective effect from
1-4-2001, that is, w.e.f. A.Y. 2001-02, that the deferred tax cannot be deducted
in arriving at the book profit.

The Assessing Officer (AO) in the order passed u/s.143(3) of
the Act computed the book profits by adding back the amount of deferred tax and
fringe benefit tax to book profits computed by the assessee and gave a direction
to charge interest accordingly. Aggrieved the assessee filed an appeal to the
CIT(A) on the ground that levy of interest was illegal since the amount of
deferred tax became liable to be added to the book profit only because of the
retrospective amendment made to the Section which could not be anticipated by
the assessee.

The CIT(A) was of the view that levy of interest was
mandatory and power was vested with the CBDT to waive or reduce the same,
subject to certain conditions, one of which is that no interest can be charged
if addition or disallowance is due to a retrospective amendment in law. He
upheld the levy but held that it was open to the assessee to seek
waiver/reduction from the CCIT/DGIT.

Aggrieved, the assessee preferred an appeal to the Tribunal.

Held :

The Tribunal held that the following judgments support the
case of the assessee :

(1) CIT v. Revathi Equipment Limited, (298 ITR 67) (Mad.)

(2) Haryana Warehousing Corporation v. DCIT, (75 ITD 155)
(TM)

(3) Priyanka Overseas Ltd. v. DCIT, (79 ITD 353) (Del.)

(4) ACIT v. Jindal Irrigation Systems Ltd., (56 ITD 164) (Hyd.)

It observed that the judgment of the Madras High Court is a
case of liability arising on account of a retrospective amendment, as in the
present case. It held that levy of interest in respect of the amount of deferred
tax deducted while arriving at the book profit in the return is invalid.

As regards the argument raised at the time of hearing that
since powers of reduction/waiver are vested in the CBDT whether the Tribunal can
examine the validity of the levy of interest, the Tribunal having noted that the
Supreme Court has in the case of Central Provinces Manganese Ore (160 ITR 961)
held that if the assessee denies his liability to pay interest the appeal on
that point was maintainable. Based on the ratio of the decision of the Apex
Court and also having noted that there is no express or implied restriction on
the powers of the Tribunal while disposing of the appeal, it held that the appeal of the assessee is
maintainable. It further held that the fact that the administrative relief can
be obtained by the assessee cannot erode the powers of the Tribunal while
dealing with a valid appeal before it.

The appeal filed by the assessee was partly allowed.

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Section 254 — Ex-parte order passed for non-appearance as the assessee’s representative went to attend phone call when the matter came up for hearing – Whether reasonable and sufficient ground for non-appearance — Held : Yes.

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  1. Ajanta Offset & Packaging Ltd. vs. DCIT

ITAT
Delhi Bench ‘Friday’ New Delhi

Before I. P. Bansal (J.M.) and R. C. Sharma (A.M.)

MA No.459/D/08 in ITA No.1510/Del./2007

A. Y.
2001-02. Decided on 27.03.2009


Counsel for Revenue/Assessee : V. P. Gupta and Basant Kumar/B. K. Gupta

 

Section 254 — Ex-parte order passed for non-appearance as
the assessee’s representative went to attend phone call when the matter came
up for hearing – Whether reasonable and sufficient ground for non-appearance —
Held : Yes.

Per I. P. Bansal

Facts :

Vide
miscellaneous application the assessee has sought recall of the ex-parte
order passed by the Tribunal. According to the assessee, its director was
present in the Court for taking adjournment, as the counsel of the assessee
was busy in the High Court waiting for his turn. When the case of the assessee
was to come for hearing, the director had gone out of the Courtroom to attend
to the phone call and when he came back, the case was already decided as
ex-parte.

Held :

The
Tribunal was satisfied with the explanation and held that the assessee was
prevented by reasonable and sufficient cause for non-appearance before the
Tribunal. Accordingly, as per Rule 24 of the Appellate Tribunal Rules, 1983,
the ex-parte order passed was set aside.

Note :

All the decisions
reported above are selected from the website www.itatindia.com.

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Section 36 (i)(iii) — Allowance of interest paid — Where interest-free fund was more than the alleged investment in non-business assets, whether the interest paid could be disallowed —Held : No.

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  1. Almona Investment & Marketing Pvt. Ltd. vs.
    ITO

ITAT Mumbai
Bench ‘A’ Mumbai.

Before R. S. Syal (A.M.) and Asha Vijayaraghavan (J.M.)

ITA No. 4908/Mum/2006

A. Y.
2003-2004. Decided on : 30.03.2009

Counsel for
Assessee/Revenue : Hiro Rai/Sanjeev Jain.

Section 36 (i)(iii)
— Allowance of interest paid — Where interest-free fund was more than the
alleged investment in non-business assets, whether the interest paid could be
disallowed —Held : No.

 

Per R. S. Syal

Facts :

The assessee was a non-banking finance company.
As per its accounts, the accumulated loss was of Rs.52.2 lacs. It had claimed
deduction of Rs.4.37 lacs towards interest. The AO noted that the assessee had
invested Rs.40 lacs in shares, which according to it, was not for the purpose
of the business activity of the assessee company. Therefore, the entire amount
of interest of Rs.4.37 lacs was disallowed. On appeal the CIT(A) upheld the
order of the AO.

Held :

From the accounts of the assessee the Tribunal
noted that the assessee had interest-free loan and share capital aggregating
to Rs.1.26 lacs and after adjusting the debit balance in the Profit and Loss
account, the net interest free funds available at the disposal of the assessee
was of around Rs.53 lacs. As against this, the investment in the shares was
only to the tune of Rs.40 lacs. The Tribunal referred to the decision of the
Mumbai High Court in the case of Reliance Utilities & Power Ltd. where it was
held that if there were funds, both interest-free and interest bearing, then a
presumption would be that the investment would be out of the interest-free
fund generated or available with the company, if the interest-free funds were
sufficient to meet the investments. Relying on the same, it held that since in
the case of the assessee, the interest-free funds were more than the
investment made in shares, the sustenance of disallowance of interest by the
CIT(A) was not justified.

Case referred to :

CIT vs. Reliance Utilities & Power Ltd.,
(2009) 18 DTR (Bom) 1.

Editor’s Note :

During the relevant
assessment year, dividend income was taxable.

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Section 32 — Depreciation — Income assessed applying the net profit rate of 8% to the turnover — Whether the assessee’s claim for allowance of depreciation from the income so determined tenable — Held : Yes.

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New Page 1ACIT vs. Keshav Kumar Tiwari


ITAT Delhi
Bench ‘H’ New Delhi

Before G. C. Gupta (J.M.) and K. G. Bansal (A.M.)

ITA No.1386/Del/2005

A. Y.
1999-2000. Decided on : 13.03.2009

Counsel for
Revenue/Assessee : Jagdeep Goel/O. P. Sapra

Section 32 —
Depreciation — Income assessed applying the net profit rate of 8% to the
turnover — Whether the assessee’s claim for allowance of depreciation from the
income so determined tenable — Held : Yes.

 

Per G. C. Gupta

Facts :

The assessee
failed to produce books of account and supporting vouchers before the AO. He
applied the provisions of Section 44AD and assessed the income. He rejected
the assessee’s claim to allow depreciation out of the income estimated. Before
the CIT(A) the assessee contended that since his turnover was more than Rs.40
lacs, the provisions of Section 44AD were not applicable, hence its claim for
depreciation was justifiable. The CIT(A) accepted the assessee’s contention
and allowed the appeal of the assessee.

Before the
Tribunal the Revenue accepted the fact that the turnover was above Rs.40 lacs.
However, it justified the action of the AO in applying the provisions of
Section 44AD, as according to it, the correctness of the accounts statement
filed by the assessee was not verifiable and all the conditions for
application of the said provisions were present and satisfied. For the same,
it relied on the Board Circular no. 684, dt. 10.06.1994.

Held :

The Tribunal
accepted the contention of the assessee and held that since the turnover of
the assessee was more than Rs. 40 lacs, the provisions of Section 44AD were
not applicable. It also held that the Revenue was justified in rejecting the
book result and in applying a flat rate of 8%, though the issue admittedly was
not before it. However, as regards the allowance of depreciation, it held in
favour of the assessee by relying on the decision of the Allahabad high court
in the case of Bishambhar Dayal & Co. and upheld the order of the CIT(A).

Cases referred to :

CIT vs.
Bishambhar Dayal & Co., 210 ITR 118 (All.)

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Section 41(1) — Whether the sum of Rs.1,77,27,681 reflected in the Balance Sheet of the assessee as on 31.3.1996 and thereafter carried forward in all subsequent balance sheets till 31.3.2002, which sum represented untaxed income of A.Ys. 1995-96 and 1996

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New Page 1ACIT vs. Amit Anil Biswas


ITAT ‘F’ Bench, Mumbai.

Before Sunil Kumar Yadav (JM) and D. Karunakara
Rao (AM)

ITA No. 1019/Mum/2006 and ITA No. 5762/Mum/2006

A.Ys. : 1997-98 and
2003-04. Decided on : 30.3.2009.

Counsel for Revenue/Assessee : None/Arvind
Sonde

Section 41(1) —
Whether the sum of Rs.1,77,27,681 reflected in the Balance Sheet of the
assessee as on 31.3.1996 and thereafter carried forward in all subsequent
balance sheets till 31.3.2002, which sum represented untaxed income of A.Ys.
1995-96 and 1996-97, could be taxed in AY 2003-04 on the ground that upon
transfer to capital account during the financial year 2002-03 it has assumed
the character of income, as it was no more payable and did not represent
liability as falsely disclosed in the accounts by the assessee — Held : No.

 

Per Sunil Kumar Yadav :

Facts :

The assessee had received professional fees for
executing off-shore project during the financial years 1994-95 and 1995-96.
The gross bills raised in relation to the work were to the tune of
Rs.2,46,95,375 and after setting off various expenses and amounts written off,
the net professional fees were to the tune of Rs.1,77,27,681. This sum was
grouped under ‘current liabilities’ as off-shore project advances in the
balance sheet as on 31.3.1996 and then carried forward to subsequent years
till 31.3.2002. During the financial year 2002-03, this amount of
Rs.1,77,27,681 was transferred by the assessee to his capital account.

The Assessing Officer (AO) added this sum on a
protective basis to the income of the assessee for the AY 1997-98, after
reopening the assessment on the ground that the assessee had earned this
income in that assessment year and also made an addition on substantive basis
in AY 2003-04 on the ground that this amount had assumed the character of
taxable income, as it was no more payable and did not represent any liability
as falsely disclosed in the accounts by the assessee. The AO invoked the
provisions of S. 41(1) of the Act. He also held that the opening balance was a
Revenue receipt which was transferred to capital account in financial year
2002-03 and therefore this amount was taxed by him on a substantive basis as
income of AY 2003-04.

The CIT(A) decided the issue in favour of the
assessee and held that the income had accrued during the financial year
relevant to A.Y.s 1995-96 and 1996-97 and only because of transfer of receipt
to the capital account in the year relevant to AY 2003-04, it cannot be held
to be taxable in AY 2003-04.

Aggrieved, the Revenue preferred an appeal to the
Tribunal.

Held :

On perusal of the documents filed, the Tribunal
noted the following facts :

The agreement for rendering particular services
was executed on 23rd Feb., 1995 between the assessee and Mazgaon Docks Ltd.
and according to the work schedule, the required work was to be completed
pre-monsoon 1995. The invoices were raised between 23rd March, 1995 to 26th
April, 1995. The work was completed before start of the monsoon. The payments
were received by the assessee between 6.4.1995 to 1.6.1995. While making
payments, the payer had deducted TDS. Accounts were finally settled within
financial year 1996-97.

Based on the above facts, the Tribunal held that
as per mercantile system of accounting the income was earned by the assessee
in AY 1996-97, though the assessee had grouped this receipt as current
liability. The Tribunal observed that any nomenclature given to a Revenue
receipt would not change its character. It observed that it is unfortunate
that this income generated by the assessee was not noticed by the Revenue and
the treatment given by the assessee to this receipt was accepted by them. In
AY 2003-04 when the assessee transferred the amount to capital account, the
Revenue realised its mistake and tried to tax this as income in AY 2003-04 or
in AY 1997-98 by reopening the assessment. The Tribunal held that since the
income was not generated in those assessment years it cannot be taxed by
applying any method of accounting. The Tribunal observed that the Revenue
should be more vigilant to keep a check and make necessary verification if
they have any doubt, but they have no power to tax the income of a different
assessment year in a year in which they notice the mischief committed by the
assessee. The Tribunal held that the law in this regard is very clear that the
Revenue can make the assessment of any undisclosed income within the
permissible limit, but they cannot tax the income of different assessment
years in a year in which they notice it.

The Tribunal confirmed the order of the CIT(A).

Case referred :


1 CIT vs.
T. V. Sundaram Iyengar & Sons Ltd., 222 ITR 344 (SC).

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Section 36(1)(vii) r.w.s. 36(2), S. 28 — Whether loss due to irrecoverability of security deposit given for taking godown on rent is allowable as a business loss — Held : Yes.

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New Page 1

  1. ACIT vs. Foseco India Ltd.

ITAT ‘F’ Bench, Mumbai

Before R. S. Syal (AM) and V. Durga Rao (JM)

ITA No. 7307/Mum/2007 and CO No. 63/Mum/2008

A.Y. : 2003-04. Decided
on : 25.3.2009.

Counsel for Revenue/Assessee : J.
V. D. Langstich/H. P. Mahajani.

Section 36(1)(vii)
r.w.s. 36(2), S. 28 — Whether loss due to irrecoverability of security deposit
given for taking godown on rent is allowable as a business loss — Held : Yes.

Per R. S. Syal :

 

Facts :

The assessee had given a security deposit of
Rs.5,00,000 to one Mr. Agrawal for taking his godown on rent. The assessee
stated that the owner had not returned the money and accordingly claimed the
same as ‘bad debt’. This amount was written off by the assessee. The Assessing
Officer (AO) held that since the provisions of S. 36(2) were not fulfilled the
claim for bad debt could not be allowed. No relief was allowed in the first
appeal. On an appeal to the Tribunal,

Held :

Sub-Section (2) of Section 36 provides that no
deduction for bad debt shall be allowed unless such debt or part thereof has
been taken into account in computing the income of the assessee of the
previous year in which the amount of such debt or part thereof is written off
or of an earlier previous year, or represents money lent in the ordinary
course of business of banking or money lending which is carried on by the
assessee.

The Tribunal noted that this amount was not taken
into account in computing the income of the assessee of an earlier or current
year.

Satisfaction of the provisions of S. 36(2) is a
pre-condition for claiming deduction u/s. 36(1)(vii). Since the assessee had
not satisfied the provisions of S. 36(2), it was not entitled to claim
deduction u/s 36(1)(vii).

However, the Tribunal noted that the amount was
given as security for acquiring godown for carrying on the business. The
Tribunal noted that the Apex Court has in the case of Mysore Sugar Co. held
that loss due to irrecoverable advance/security given for the purpose of trade
is allowable. The Tribunal also noted that the Bombay High Court had in the
case of IBM World Trade Corporation held that the money advanced by the
assessee to the landlord for the purposes of and in connection with the
acquisition of the premises on lease was not recoverable, such loss of advance
was a business loss.

The Tribunal found the facts of the present case
to be on all fours with the facts of the case before the Bombay High Court. It
accordingly allowed this ground of the cross-objection.

Cases referred :



1 CIT vs. Mysore Sugar Co. Ltd., 46 ITR
649 (SC)

2 IBM World Trade Corporation Ltd. vs. CIT,
186 ITR 412 (Bom).

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Appellant claimed CENVAT credit — Based on delivery notes — Revenue’s contention — Delivery notes cannot be considered as valid documents for availment — Held, credit cannot be denied — Delivery notes valid for availment of credit.

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(2012) 25 STR 428 (Kar.) — CCE, Bangalore v. Saturn Industries.

Appellant claimed CENVAT credit — Based on de-livery notes — Revenue’s contention — Delivery notes cannot be considered as valid documents for availment — Held, credit cannot be denied — Delivery notes valid for availment of credit.


Facts:

The appellant claimed CENVAT/Modvat of the duty paid on the basis of the delivery notes. The Revenue in its appeal against the Tribunal’s order, contended that delivery notes cannot be considered as valid legal document for availment of the credit.

Held:

It was held that the benefit cannot be denied on the grounds of non-compliance with procedures when sufficient evidence about the duty payment on inputs was available on records.

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Basic design services provided by US entity which includes preparation of plan, concept design, schematic design, design development and other related consultancy services during construction phase are part of architectural services provided by the US ent

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New Page 1Part C : Tribunal &
AAR International Tax Decisions

8 HMS Real Estate
(2010) TIOL 17 ARA-IT
Article 12 of the India-US DTAA,
S. 115A & S. 195 of the Income-tax Act
Dated : 18-3-2010

Basic design services provided by US entity which includes
preparation of plan, concept design, schematic design, design development and
other related consultancy services during construction phase are part of
architectural services provided by the US entity. Payment received for such
services are fees for included services as it involved development and transfer
of technical plan and design. The agreement needs to be read having regard to
the predominant features of the contract and by taking into account crux and
substance of the contract.

Remittance made to the US entity for making payment to
consultants for the services rendered by such consultants directly to the
taxpayer represents reimbursement of actual expenses and does not represent
income chargeable to tax.

Facts :

The US entity entered into agreement with the Indian company
for providing architectural design services in connection with development and
management of commercial real estate project of ICO. In terms of the agreement,
the US entity was obliged to develop master plan, prepare concept design,
schematic designs, etc. Additionally, it was also obliged to :

(i) understand the specifications from ICO and get the
designs approved by ICO;

(ii) assist ICO in bidding and contractor selection
process;

(iii) observe construction progress;

(iv) provide alternative proposals for cost reduction; and

(v) co-operate with the local director in getting the
requisite approvals or modify the designs to conform with the regulations,
etc.

The agreement was for a fixed fee. The fee was payable on the
basis of the milestones achieved. The US entity was also entitled to
reimbursement of fees paid by it to the consultants who assisted the US entity
in rendering services if such consultants were appointed with the consent of ICO.

For rendering services, personnel of the US entity were
present in India for a period of 50 days. There was no dispute that the presence
of the US entity did not result in emergence of service PE in India.

ICO as a payer contended that substantial portion of the
consideration was for transfer and sale of designs on an outright basis. By
relying on the specific provision of the agreement, it was contended by ICO that
all the rights in designs, including right to use the designs for the other
projects vested in ICO. Hence, the contract was for sale of design which was
concluded outside India and hence not taxable, either under the IT Act or in
terms of DTAA.

AAR held :

  • The AAR rejected contention of the ICO that the agreement
    merely involved transfer of right, title and interest in the drawings, models
    and work product and that the transaction can be regarded as one of sale of
    designs. The AAR concluded that the contract was for rendering of services
    having regard to the following :

  1. The agreement needs to
    be read as a whole. The true scope and dominant object of the contract needs
    to be ascertained having regard to the predominant features of the contract
    and by taking holistic view of the matter.


  2. The US entity developed
    the designs after in depth interview with ICO and participated as an expert
    service provider at every stage from the conceptualisation till the stage of
    completion. This supported that the contract was a service contract.


  3. The role of the
    applicant did not end upon transfer of plans, drawings and designs.

  4. The substance
    and crux of the contract was rendering of services and the sale of designs
    was incidental. To contend that the essence of the contract was the sale of
    designs, models and that the services were to distort and stultify true
    nature and dominant purpose of the contract.



  • The consideration
    was for development and transfer of a technical plan and designs, which is
    specifically covered as fees for included services. Article 12(4)(b) covers
    transfer of technical plan or design which arises as a sequel to and as an
    integral part of the service contract.

  • The decision of
    the Calcutta High Court in CIT v. Davy Ashmore, (190 ITR 626) is
    distinguishable as that case involved transfer of designs which were already
    available on an outright basis and did not appear to be a case of tailor-made
    designs and drawings.


  • The remittance
    made to the US entity for reimbursements towards the fees of the consultants
    who assisted the US entity in rendering architectural services and who were
    appointed with the consent of ICO represented remittance towards reimbursement
    of actual expenses. Accordingly, it was not income chargeable to tax.

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Branch Transfer of Parts, Components vis-à-vis Inter-State Sale

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The issue whether transfer of goods from head office to a branch office is a branch transfer or inter- State sale is always highly debatable. As per section 6A(1) of the CST Act, 1956, when the transfer is not pursuant to a pre-existing contract of sale, it will amount to a branch transfer. However, whether the movement from head office to a branch or from one branch to another branch in another State is due to the pre-existing sale contract or not is a contentious issue and has to be decided on facts of the case. There are number of judgments, which throw light on the above subject.

Branch transfer of goods can be of two types, (a) finished goods and (b) intermediatory goods. In case of finished goods, there can be factual position that the goods have been moved because of a pre-existing sale order and hence it may amount to inter-State sale. However, in respect of intermediatory goods like parts and components, the situation may be different. Some aspects about transfer of components and parts can be examined as under:

Reference can be made to judgment of the Andhra Pradesh High Court in the case of Bharat Electronics Ltd. v. Deputy Commissioner (CT), No. II Division, Vijayawada & Another, (46 VST 179) (AP). The facts in this case are that the unit of the above appellant dealer at Machilipatnam in Andhra Pradesh dispatched certain materials to its branch in another State. The goods dispatched were manufactured goods at Machilipatnam, like night-vision devices, etc. The said goods were to be incorporated in the equipment manufactured at the branch in another State (where the goods were dispatched) and the finished goods were supplied by that branch to the customer. On the sale of finished goods, tax was discharged in the said State of sale. However, the Andhra Pradesh authorities disallowed branch transfer claim on the ground that such transfer was connected with pre-existing sale order and hence it G. G. Goyal Chartered Accountant C. B. Thakar Advocate VAT was inter-State sale. The issue was contested before the Andhra Pradesh High Court.

The High Court examined the nature of inter-State sale and its requirements. The High Court referred to observations in the case of K.C.P. Ltd. (Ramakrishna Cements) 1993 (88 STC 374) (AP) and reproduced following portion:

“that the company may have several units or divisions located at different places engaged either in the same line of manufacture or trading or in different manufacturing or trading activities. Normally, the units or divisions will have no separate identity of their own, much less a distinct legal entity. There may be separate establishments, separate planning and separate management, but these aspects by themselves do not detract from the basic characteristic of communion with the corporate body that had created these units or divisions. They can claim no independent existence apart from the company itself. The property of these units or divisions is legally held by the company. The profits generated by the units formed part of the company’s income and would go to the benefit of the general body of shareholders of the company. So also, the liabilities or losses incurred by the individual units, in the ultimate analysis, would have to be borne by the company. It was the company that could sue for the recovery of property or dues or be used for the outstandings due on account of dealing of the units. A single balance sheet was prepared by the company in respect of all the units and divisions owned and controlled by the company . . . .”

The Andhra Pradesh High Court also referred to law laid down by the Supreme Court in the case of Bharat Heavy Electricals Ltd. (102 STC 345) (SC) and reproduced the following observations:

“The Tribunal missed to note that the plant and equipment which is the subject-matter of contract such as boiler package or turbo-generator package is incapable of being manufactured and despatched as a finished unit. Necessarily, the equipment/components or assembled units have to be despatched to the customer’s site and installed there. The contract does not contemplate the dispatch of a readymade finished product to the customer’s place for instantaneous use in the power-plants, etc. On the other hand, it is clear from the terms of the contract, especially the price payment clause, that the components and parts forming part of the larger package should be supplied from time to time by BHEL. It is not at all possible to transfer the finished product such as ‘boiler package’ at a time. It may be noticed that the Tribunal itself has given a different reasoning for excluding the inter-unit transfers from the taxable net at paragraph 29, sub para 3. The Tribunal rightly puts it on the ground that the article transferred from the petitioner unit to the executing unit (Trichy, etc.) loses its identity as it is incorporated into a larger component or equipment. There is yet another closely allied reasoning to say that the goods sent to Trichy or other executing unit does not stand on the same footing as those sent direct to the customer’s site. In the case of the former, there is interruption of movement and the snapping of inextricable bond that should exist between the inter-State movement and the contract of sale. In regard to the goods sent to Trichy unit (or other executing units), the dispatch therefrom to inter-State customer takes place after assembling or processing and it is the sole concern of that unit. Trichy unit can even retain the goods for itself and divert them for any other use. There is nothing to indicate that the goods sent by Hyderabad unit to Trichy or other units are earmarked for any particular contract. The Hyderabad unit had no inkling of their ultimate utilisation and whether, how and when the goods will be moved to the customer’s place by Trichy unit. As far as Hyderabad unit is concerned, it is a case of pure and simple stock transfer to another unit under ‘F’ forms. At best, the inter-State movement, or to put it in other words, the inter-unit movement to Trichy can only be said to be for the purpose of fulfilling the contract, but not in the course of fulfilment of the contract of sale, a distinction recognised in the Tata Engineering & Locomotive Co.’s case (1971) 27 STC 127 (SC); AIR 1971 SC 477; (1971) 2 SCR 849. The movement to Trichy in our opinion is not a necessary consequence of the contract, nor is it incidental to the contract that goods of this nature should first be moved to Trichy. As already observed, there is no inextricable and uninterrupted bond between the contract and the movement of goods to Trichy or other sister units of the petitioner.”

After noting the above legal position, the High Court observed as under about the facts of the particular case before it:

“It is only if the goods, which move from one State to another, are sold as they are and are not incorporated in, or do not form part of, other goods would the question of such transfer of goods attracting levy of tax under the CST Act, as an inter-State sale, arise. It is not in dispute that the goods supplied by the Machilipatnam unit, to other units of BEL located outside the State, are merely components of, and are incorporated in, the goods manufactured by other units of the petitioner company locate outside the State of A.P., and the goods transferred by the Machilipatnam unit are not sold to the Armed Forces as they are. The transfer of goods by the Machilipatnam unit, to other units of the petitioner-company located outside the State, fall within the ambit of section 6A(1) of the CST Act, and are not inter-State sales exigible to tax u/s.6 of the Act. The order of the first respondent, holding that the transfer of such components by the Machilipatnam unit to other units of the petitioner-company situated outside the State constitutes inter-State sales under the CST Act, must therefore be quashed.”

Thus, the legal position emerges is that if the goods transferred are supplied as it is to the customer and link between transfer and such sale is established, then it may amount to inter -State sale from the moving State. However, if the transfer is of components and parts, then even if they are in relation to pre-existing order of finished goods in which such parts and components are to be incorporated, there is no possibility of inter-State sale of such parts and components from the moving State. This also clarifies the position that the movement should be linked with the ultimate goods to be supplied to the customer and not with the intermediatory goods which may be incorporated in the ultimate goods to be supplied. This judgment will certainly be a guiding judgment on the above-referred issue.

Circular on issuance of TDS Certificates in Form No. 16A downloaded from TIN Website.

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Circular No. 1 of 2012 [F.No. 276/34/2011-IT(B)], dated 9th April, 2012 — Copy available for download on www.bcasonline.org

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S. 140A(3) : Assessee offers explanation for failure to pay S.A. tax — Full tax and interest paid — Penalty not justified

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New Page 1

10 Dy. CIT v. Kamala Mills
Ltd.

ITAT ‘K’ Bench, Mumbai

Before G. E Veerabhadrappa (VP) &

Ms. Sushma Chowla (JM)

ITA No. 7775-77/Mum./2004

A.Ys. : 2000-01, 2001-02 and 2002-03.

Decided on : 31-10-2007

Counsel for revenue/assessee : Mohit Jain/

Jitendra Jain

S. 140A(3) of the Income-tax Act, 1961 — Failure to pay
self-assessment tax — Assessee deemed to be in default — assessee offers full
explanation for non-payment — Taxes fully paid together with interest — Whether
imposition of penalty justified — Held, No.

 

Per G. E Veerabhadrappa :

Facts :

The assessee had filed its return of income for A.Y. 2000-01
to 2002-03 in time, but did not make the payment of S.A. Tax. The AO asked the
assessee to explain as to why penalty should not be imposed u/s.221, read with
S. 140A(3) of the Income-tax Act. The assessee explained that it could not make
payment due to financial crunch on account of paucity of funds. The AO was not
satisfied with the explanation and imposed penalty of Rs.20 lacs for A.Y.
2000-01, Rs.50 lacs for A.Y. 2001-02 and Rs.20 lacs for A.Y. 2002-03.

 

Being
aggrieved, the assessee appealed before the CIT(A) who considered the
explanation offered by the assessee and deleted the penalty mainly on the
following grounds :

(1) Paucity
of funds at the material time when S.A. Tax was to be paid does constitute a
reasonable cause for the default of non-payment of S.A. Tax.

(2) The
assessee has paid the entire tax, together with applicable interest u/s.234B,
u/s.234C and u/s.220(2), before show-cause notice u/s.221 was served on the
assessee. This shows that the assessee had no mala fide intention to
withhold the payment of S.A. Tax.

(3)
Initiation of penalty proceedings after a long period is contrary to the
spirit of the provisions relating to bar of limitation for imposing penalties
and hence imposition of penalty was illegal.

 


The Department appealed to the ITAT.

 

Held :

The Tribunal examined the provisions of S. 220(4) and S. 221,
together with provisions of S. 140A(3) and came to a conclusion that in the
present case, the assessee has paid all the taxes, together with interest and it
cannot be held that the assessee is in default or deemed to be in default, and
as such, there is no merit in the levy of penalty u/s.221 of the Act, specially
when there is no clear provisions for imposition of penalty u/s.140A(3), after
the amendment in S. 140A(3) in the year 1987. The Tribunal therefore confirmed
the order of CIT(A) and dismissed the Revenue’s appeal.

 

Errata :

Attention of the readers is drawn to the Tribunal decision
reported at Sr. No. 26 in March 2008 issue of the Journal. The last line of the
said decision on page no. 638 should be read as “Accordingly, the assessee could
not be treated as an assessee in default.” The error is regretted.

 

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S. 263 : Assessed income higher than income determined by CIT — CIT’s order bad

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New Page 1

9 Bhuppindera Flour Mills Pvt.
Ltd. v. ITO

ITAT Amritsar Bench, Amritsar

Before Joginder Pall (AM) and

A. D. Jain (JM)

ITA Nos. 457 and 540/Asr./2005

A.Y. : 2000-01. Decided on : 15-2-2008

Counsel for assessee/revenue : P. N. Arora/

Tarsem Lal

S. 263 of the Income-tax Act, 1961 — Revision of
orders — Power of the Commissioner of Income-tax — Income assessed u/s.143(3)
higher than the income determined u/s.263 — Held, that the order passed u/s.263
by the CIT bad in law.

 

Per Joginder Pall :

Facts :

The assessee had filed its return of income
declaring loss of Rs.1.47 lacs. However, the assessee had not filed the accounts
hence, in the order dated 1-8-2001 passed u/s.143(1)(a), the loss returned was
disallowed by the Assessing Officer. Subsequently, the Assessing Officer
assessed the income u/s.143(3) vide his order dated 12-3-2003, determining a
long-term capital gain of Rs.46.07 lacs. On appeal the CIT(A) vide his order
dated 14-5-2003 deleted the addition made by the Assessing Officer. According to
the CIT, the order passed by the Assessing Officer u/s.143(3) was erroneous and
prejudicial to the interest of the Revenue inasmuch as the book profit u/s.115JA
of Rs.1.13 crore liable to tax was not considered by the AO. Being aggrieved,
the assessee appealed before the Tribunal.

 

Held :

According to the Tribunal in order to confer
jurisdiction on the CIT u/s.263, both the conditions viz., the order
passed by the Assessing Officer must be (i) erroneous; and (ii) prejudicial to
the interest of the Revenue, must be fulfilled. The Tribunal found that at the
time of making assessment u/s. 143(3), the income computed as per regular
provisions of the Act was higher at Rs.46.07 lacs as against income u/s.115JA of
Rs.33.93 lacs (30% of Rs.1.13 crore). Therefore, according to the Tribunal, the
provisions of S. 115JA were not attracted. Therefore, it held that the order
passed by the Assessing Officer cannot be said to be erroneous, because the same
was as per the provisions of the Act. It further held that the order passed was
also not prejudicial to the interest of the Revenue, because there was no loss
of revenue. Therefore, the assumption of jurisdiction by the CIT u/s.263 was bad
in law.

 

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Notification No. 14/2012 (F.No. 142/31/2011- TPL)/S.O. 626 (E), dated March 28, 2012 — Income-tax (third amendment) Rules, 2012 — Amendment in Rule 12 and substitution of Forms ITR 1, ITR 2, ITR 3 ITR 4S, ITR 4 and ITR V.

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The gist of the amendment is as under:

(1) An individual or HUF must file the return of income electronically for the A.Y. 2012-13 and in subsequent years if his/its total income exceeds Rs.10 lakh.

(2) A resident individual or a resident HUF must file the return of income electronically for the A.Y. 2012-13 and subsequent years, if he/it has: (a) assets (including financial interest in any entity) located outside India; or (b) signing authority in any account located outside India.

(3) The prescribed ITR Form SAHAJ — ITR 1 and SUGAM — ITR 4S cannot be used by a resident

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Section 40(a)(ia) — Disallowance of expenditure for failure to pay TDS within the time stipulated u/s.200(1) — Payment/expenditure was incurred throughout the year — Whether payment of TDS made after the end of the accounting year but before the due date for filing of return was allowable as deduction — Held, Yes.

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Piyush C. Mehta v. ACIT
ITAT ‘C’ Bench, Mumbai Before N. V. Vasudevan (JM) &
N. K. Billaiya (AM)
ITA No. 1321/Mum./2009
A.Y.: 2005-06. Decided on: 11-4-2012
Counsel for assessee/revenue:
Prakash K. Jotwani/Pitambar Das

Section 40(a)(ia) — Disallowance of expenditure for failure to pay TDS within the time stipulated u/s.200(1)

— Payment/expenditure was incurred throughout the year — Whether payment of TDS made after the end of the accounting year but before the due date for filing of return was allowable as deduction — Held, Yes.


Facts:

The assessee is an individual engaged in the business of building repairs, and construction works contracts. In the course of assessment proceedings the AO noticed that the assessee had not paid the TDS deducted on the labour charges/ advances paid to various contractors within the time stipulated u/s.200(1). The assesses had made payments/advances to the contractors throughout the year, but had deposited the TDS only on 31-5-2005. According to the AO, the assessee was required to deduct TDS on the dates the payments were made. Since that was not done, he held that in terms of provisions of section 40(a)(ia) the payments of Rs.1.41 crore were not allowable. On appeal, the CIT(A) confirmed the order of the AO.

Held:

According to the Tribunal, the amendment to section 40(a)(ia) by the Finance Act, 2008 made two categories of defaults, causing disallowance on the basis of the period of the previous year in which tax was deductible. The first category of disallowances included the cases in which tax was deductible and was so deducted during the last month of the previous year, but there was failure to pay such tax on or before the due date specified in section 139(1). The second category included those cases where tax was deductible and was deducted during the first eleven months of the previous year, i.e., till February, 2005 in the case of the assessee. In such case, the disallowance was to be made if the assessee failed to pay it before 31st March, 2005.

Then came the amendment by the Finance Act, 2010. The said amendment dispensed with the earlier two categories of defaults brought about by the Finance Act, 2008. It has not made any change qua the first category described above. With reference to the second category, the Tribunal noted that the hitherto requirement of paying it before the close of the previous year has been eased to extend such time for payment of tax up to the due date u/s.139(1) of the Act. The effect of this amendment is that, now the assessee, deducting tax either in the last month of the previous year or first eleven months of the previous year, shall be entitled to deduction of the expenditure in the year of incurring it, if the tax so deducted at source, is paid on or before the due date u/s.139(1). As regards the applicability of the amendment by the Finance Act, 2010 to the case of the assessee, the Tribunal relied on the decision of the Calcutta High Court in the case of Virgin Corporation (ITA No. 302 of 2011 GA 3200/2011 decided on 23-11-2011), where it was held that the said amendment was retrospective from 1-4-2005 and accordingly, allowed the appeal of the assessee.

As regards the applicability of the decision of the Mumbai Special Bench in the case of Bharati Shipyard Ltd. v. DCIT, where it was held that the amendment by the Finance Act, 2010 was prospective and not retrospective from 1-4-2005, the Tribunal relying on the Delhi Tribunal decision in the case of Tej International (P) Ltd. v. Dy. CIT, (2000) 69 TTJ (Del) 650 read with the Bombay High Court decision in the case of CIT v. Godavaridevi Saraf, 113 ITR 589 (Bom.), held that as per the hierarchical judicial system in India, the wisdom of the Court below has to yield to the wisdom of the higher Court. The fact that the judgment of the higher judicial forum is from a non-jurisdictional High Court does not alter the position. Accordingly, the decision of the Calcutta High Court prevailed over the decision of the Mumbai Special Bench.

In view of the above, the Tribunal held that the Amendment to the provisions of section 40(a)(ia) of the Act, by the Finance Act, 2010 was retrospective from 1-4-2005. Consequently, any payment of tax deducted at source during the previous years relevant to and from A.Y. 2005-06 can be made to the Government on or before the due date for filing return of income u/s.139(1) of the Act.

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Section 54EC — The limit of Rs.50 lakh referred to in the proviso to section 54EC is with reference to a financial year — If subscription for eligible investment was not available to the assessee during the period of six months, then investment made beyond a period of six months qualifies for deduction u/s.54EC.

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Aspi Ginwala v. ACIT
ITAT ‘C’ Bench, Ahmedabad
Before D. K. Tyagi (JM) and
A. Mohan Alankamony (AM)
ITA No. 3226/Ahd./2011
A.Y.: 2008-09. Decided on: 30-3-2012
Counsel for assessee/revenue:
S. N. Soparkar/S. P. Talati

Section 54EC — The limit of Rs.50 lakh referred to in the proviso to section 54EC is with reference to a financial year — If subscription for eligible investment was not available to the assessee during the period of six months, then investment made beyond a period of six months qualifies for deduction u/s.54EC.


Facts:

The assessee sold a house property on 22-10-2007. The long-term capital gain arising on such sale was computed and returned at Rs.1,30,32,450 after claiming exemption of Rs.100 lakh u/s.54EC, on account of investment of Rs.50 lakh each made in REC bonds (invested on 31-12-2007) and bonds of NHAI (invested on 26-5-2008). During the period from 1-4-2008 to 26- 5-2008 no subscription for eligible investment was available to the assessee. The Assessing Officer (AO) held that the assessee is entitled to exemption of up to Rs.50 lakh u/s. 54EC of the Act. He, accordingly, allowed exemption in respect of amount invested in bonds of REC and did not allow exemption in respect of amount invested in bonds of NHAI. 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 there is no dispute about the fact that the assessee could have invested the amounts in eligible investment within six months of the date of transfer i.e., on or before 21-4-2008 to avail of exemption u/s.54EC of the Act. Also, there is no dispute that during the period from 1-4-2008 to 26-5-2008 subscription to eligible investment was not available to the assessee and the assessee had subscribed on the 1st day of reopening of subscription. It also noted that the dispute which remained to be decided was whether as per the provisions of section 54EC, the assessee is entitled for exemption of Rs.1 crore as six months period for investment in eligible investment involves two financial years. If the answer to this question is yes, whether investment made by the assessee on 26-5-2008 beyond six months period is eligible for exemption in view of the fact that no subscription for eligible investment was available to the assessee from 1-4-2008 to 26-5-2008. It is clear from the proviso to section 54EC that where the assessee transfers his capital asset after 30th September of the financial year, he gets an opportunity to make an investment of Rs.50 lakh each in two different financial years and is able to claim exemption up to Rs.1 crore u/s.54EC of the Act. The language of the proviso being clear and unambiguous, the benefit available to the assessee cannot be denied, the assessee is entitled to get exemption up to Rs.1 crore in this case. Various judicial authorities have taken a view that delay in making an investment due to non-availability of bonds is a reasonable cause and exemption should be granted in such cases. Relying on the observations of the Mumbai Bench of the ITAT in the case of Ram Agarwal v. JCIT, (81 ITD 163) (Mum.) the Tribunal held that the investment s made by the assessee on 26-5- 2008 beyond six months is eligible for exemption in view of the fact that no investment was available from 1-4-2008 to 26-5-2008. The Tribunal allowed the appeal filed by the assessee.

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Section 40(a)(ia) — Per majority — Section 40(a)(ia) can apply only to expenditure which is outstanding as on 31st March and does not apply to expenditure which is paid during the previous year.

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Merilyn Shipping & Transports v. ACIT ITAT Special Bench, Visakhapatnam
Before D. Manmohan (VP),
S. V. Mehrotra (AM) and Mahvir Singh (JM) ITA No. 477/Viz./2008

A.Y.: 2005-06. Decided on: 29-3-2012 Counsel for assessee/revenue: Subramanyam/T. L. Peter and D. Komali

Section 40(a)(ia) — Per majority — Section 40(a)(ia) can apply only to expenditure which is outstanding as on 31st March and does not apply to expenditure which is paid during the previous year.


Facts:

The assessee-firm incurred brokerage expenses of Rs.38,75,000 and commission of Rs.2,43,253without deducting TDS. Of the aggregate amount of Rs.41,18,253 incurred during the previous year, the amounts outstanding as on 31st March were Rs.1,78,025. In the course of assessment proceedings the assessee’s representative agreed for disallowance. The AO disallowed Rs.41,18,253 u/s.40(a)(ia).

Aggrieved, the assessee preferred an appeal before the CIT(A) and contended that on a careful reading of the provisions of section 40(a)(ia) and also on going through the expert opinion, the disallowance u/s.40(a)(ia) should be Rs.1,78,025, being the amount of brokerage and commission outstanding as on 31st March on which tax was not deducted at source, and not the entire sum of Rs.41,18,253. The CIT(A) rejected the contention made on behalf of the assessee and upheld the action of the AO.

Aggrieved, the assessee preferred an appeal to the Tribunal. Since the Division Bench did not agree with the decision rendered by the Hyderabad Bench of the ITAT in the case of Teja Constructions, (ITA No. 308/Hyd./2009 relating to A.Y. 2005-06, order dated 23-10-2009), on which reliance was placed by the counsel of the assessee, it referred the matter to the President to constitute a Special Bench (SB). The President constituted the SB to decide the following question:

“Whether section 40(a)(ia) of the Income-tax Act can be invoked only to disallow expenditure of the nature referred to therein, which is shown as ‘payable’ as on the date of the balance sheet or it can be invoked also to disallow such expenditure which became payable at any-time during the relevant previous year and was actually paid within the previous year?”

Held:

The majority view (VP and JM) of the SB was as under:

By replacing the words ‘amounts credited or paid’, as proposed by the Finance Bill, 2004 with the ‘payable’, at the time of enactment (by the Finance Act, 2004), the Legislature has clarified its intent that only outstanding amounts or the provisions for expenses liable for TDS under Chapter XVII-B of the Act is sought to be disallowed in the event there is a default in following the obligations casted upon the assessee under Chapter XVII-B. Section 40(a)(ia) creates a legal fiction by virtue of which even genuine and admissible expenditure can be disallowed due to non-deduction of tax at source. A legal fiction has to be limited to the area for which it is created. The word ‘payable’ must be understood in its natural, ordinary or popular sense and construed according to its grammatical meaning. Such a construction would not lead to absurdity because there is nothing in this context or in the object of the statute to suggest to the contrary. The word ‘payable’ is to be assigned strict interpretation, in view of the object of the legislation which is intended from the replacement of the words in the proposed and enacted provision.

The majority view of the SB was that section 40(a) (ia) is applicable only to the amounts of expenditure which are payable as on 31st March of every year and it cannot be invoked to disallow the amounts which have been actually paid during the previous year, without deduction of tax at source.

The AM held that the object of section 40(a)(ia) is to ensure that the TDS provisions are scrupulously implemented without any default. The term ‘payable’ cannot be assigned a narrow interpretation. Section 40(ia) is to be interpreted harmoniously with the TDS provisions. Accordingly, section 40(a)(ia) applies to all expenditure which is actually paid and also which is payable as at the end of the year.

The SB, by a majority view, decided the question referred to it in favour of the assessee.

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Carry forward and set-off in case of Nil Return v. Reassessment at Loss — Unabsorbed depreciation entitled to be carried forward and set off even if return showing nil income was filed — Also, loss determined in Appellate proceedings and not claimed by assessee eligible to be carried forward.

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(2012) 67 DTr (Ahd.) (Trib.) 470
ACIT v. Mehsana District Co-operative Milk
Producers Union Ltd.
A.Y.: 1999-2000. Dated: 30-6-2011

Carry forward and set-off in case of Nil Return v. Reassessment at Loss — Unabsorbed depreciation entitled to be carried forward and set off even if return showing nil income was filed — Also, loss determined in Appellate proceedings and not claimed by assessee eligible to be carried forward.

Facts:

The assessee, a co-operative society had filed nil return of income u/s.139(1). The assessment was completed u/s.143(3) r.w.s. 147 at total income of Rs.48.19 crore. The assessee went into appeal and after Appellate proceedings, the income of the assessee was determined at loss of Rs.5.41 crore. The assessee vide application u/s.154 requested the AO to permit carry forward of such loss to subsequent year. The AO vide his order u/s.154 held that loss can be carry forward only if the same is determined in pursuance to return filed u/s.139(3). In this case as per return of income, the income declared was nil and the loss was determined only on giving appeal effect which was could not be carry forward as per the AO.

On further appeal, the CIT(A) upheld the stand of the AO. He further stated that in this case, the assessment was reopened by issue of notice u/s.148. Placing reliance on the decision of the Apex Court in the case of CIT v. Sun Engineering Works (P) Ltd., (198 ITR 297), the CIT(A) held that section 147 was for the benefit of the Revenue and the assessee cannot be allowed relief not claimed by him in the original assessment. However, out of the total loss of Rs.5.41 crore, sum of Rs.5.10 crore pertained to unabsorbed depreciation. The CIT(A) permitted carry forward of such unabsorbed depreciation referring to Explanation 5 to section 32 wherein benefit is allowed even if deduction not claimed by the assessee. Both the Revenue as well as the assessee went into appeal.

Held:

As per section 32(2), for carry forward of unabsorbed depreciation, the only condition is that full effect cannot be given to depreciation allowable u/s.32(1) on account of there being insufficient profit. Carry forward of unabsorbed depreciation as per section 32(2) is automatic. No other condition is required to be fulfilled by the assessee for carry forward of unabsorbed depreciation. Hence, assessee is eligible to carry forward unabsorbed depreciation even if not claimed in return of income. Regarding balance business loss, as per section 72, the assessee is not required to fulfil any conditions so as to be eligible for carry forward of loss. The only requirement is that the result of computation under the head ‘Income from Business or Profession’ should be loss. However, for denying the benefit of carry forward of loss, the Revenue has relied upon section 139(3). The Tribunal held that section 139(3) would have application only where the assessee files the return disclosing the loss. If the assessee files the return disclosing the loss, then he is required to file return as per section 139(1). In the given case, firstly, the assessee has not disclosed any loss in the return of income, so 139(3) should not be applicable. Even if applied, only condition u/s.139(3) is for filing return before due date as stated u/s.139(1) which has been filed by the assessee. So, benefit of carry forward of loss is to be allowed.

The judgment of the Supreme Court in the case of CIT v. Sun Engineering Works (P) Ltd., (supra) was distinguished since that case could have relevance during the assessment/Appellate proceedings. In the given case the assessment as well as Appellate proceedings are already completed. The AO has himself given effect to Appellate orders and determined the loss. Hence, once the orders of Appellate authorities have become final and the effect has been given and loss is determined thereby, the same has to be carried forward as per provisions of the Income-tax Act.

Hence, even though nil return of income was filed by the assessee u/s.139(1), he is entitled to carry forward entire loss as determined under Appellate proceedings.

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Section 80G — Approval for the purpose of section 80G cannot be denied simply because the trust is not registered as charitable trust.

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(2011) 131 ITD 117 (Hyd.)
Kamalakar Memorial Trust v. DIT (Exemptions)
Dated: 5-3-2010

Section 80G — Approval for the purpose of section 80G cannot be denied simply because the trust is not registered as charitable trust.


Facts:

The assessee was engaged in running of old-age home as a charitable trust and was claiming a deduction u/s.80G. On filing of application for renewal of exemption certificate, the Director of Income-tax (DIT) rejected the application stating that running an old-age home constitutes as business activity. Further the DIT observed that the assessee is not registered as a charitable trust under the Andhra Pradesh Charitable and Hindu Religious Institutions and Endowment Act, 1987. He thus held that the trust is not eligible for renewal of exemption certificate.

Held:

Running an organisation purely with the intentions of no profit cannot be termed as trade activity. The nature of activity depends not only on the economies of scale of organisation but also on the motives of organisation. In the given case, the assessee had applied for renewal of exemption certificate required for the purposes of section 80G which as per the Director of Income-tax is against the laws. The assessee contended that the fees charged by them for inmates are nominal fees for the services rendered for the inmates and further stated that these fees only fulfilled a partial amount of expenses which the organisation actually incurred for the inmates. Five members out of seventeen were admitted for free. Thus, there is no profit motive of the assessee, as there was no benefit from the fees charged from the inmates. Also it mentioned that for the year ended 31-3-2007 there was excess of expenditure over income of Rs.60,923 which shows that there is no intention of making profits. The assessee further relied on the decision given by the Nagpur Bench, in the case of Agricultural Produce & Market Committee v. CIT, (2006) 100 ITD 1.

Thus, in the light of the justifications presented by the assessee, it is clear that though it is not registered as a charitable trust, one cannot ignore its intentions and objectives of the organisation. Thus the DIT was directed to accept the application for renewal of approval u/s.80G within three months from the date of receipt of this order.

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Section 153A read with section 143 — Non-service of notice u/s.143(2) when a return is filed u/s.153(A), AO cannot make addition and is bound to accept income returned.

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(2011) 130 ITD 509 (Agra) Narendra Singh v. ITO-2(3), Gwalior A.Y.: 2001-02. Dated: 30-11-2010

Section 153A read with section 143 — Non-service of notice u/s.143(2) when a return is filed u/s.153(A), AO cannot make addition and is bound to accept income returned.


Facts:

The assessee filed return of income u/s.153A. The Assessing Officer completed the assessment wherein he made certain addition to the assessee’s income. On appeal, the assessee raised an objection that the assessment framed without issuing notice u/s.143(2) was void ab initio. The CIT(A) rejected the assessee’s objection. Aggrieved the assessee made an appeal to the ITAT.

Held:

Section 153(A) states that all other provisions of the act shall apply to the return filed in response to notice issued under this section as if such return is a return required to be furnished u/s.139. It does not provide for any methodology for making assessment. It only states that the AO shall assess or reassess the total income in respect of each assessment year falling within such six assessments. The section creates a legal fiction that all the provisions of the Act so far as they are applicable to return filed u/s.139 shall apply to the return filed u/s.153A. The provisions of both the sections 139 and 153A are under Chapter XIV. The word ‘shall’ makes it mandatory that all the provisions of this Act as are applicable to section 139 will apply to the return filed in response to notice issued u/s.153A.

According to section 143, the AO is permitted to process the return based on the return filed by the assessee. AO shall have no power to make an assessment unless he has issued the notice within the prescribed time.

Thus it was held that in the absence of service of such notice the AO cannot make addition in the income of the assessee and AO is bound to accept the income as returned by the assessee.

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Section 271(1)(c), read with section 10(13A) of the Income-tax Act, 1961 — Mere making of a claim, which is not mala fide but which is not sustainable in law by itself does not amount to furnishing of inaccurate particulars regarding income of assessee so as to attract levy of penalty u/s. 271(1)(c).

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(2011) 130 ITD 378/9 taxmann.com (Delhi) N. G. Roa v. Dy. CIT, Circle 47(1), New Delhi A.Y.: 2004-05. Dated: 7-4-2010

Section 271(1)(c), read with section 10(13A) of the Income-tax Act, 1961 — Mere making of a claim, which is not mala fide but which is not sustainable in law by itself does not amount to furnishing of inaccurate particulars regarding income of assessee so as to attract levy of penalty u/s. 271(1)(c).


Facts:

The assessee had claimed exemption u/s.10(13A) for two residential accommodations taken on rent. The assessee, in view of CIT v. Justice S. C. Mittal T.C. 32R 593 (Punj. & Har.), was under a belief that he was entitled to exemption with regard to both the residential accommodations held by him. Whereas, the Assessing Officer disallowed the exemption claimed with respect to one property, holding that exemption u/s.10(13A) could be allowed only qua one residential accommodation. Further, the Assessing Officer levied penalty u/s.271(1)(c). On appeal, the Commissioner (Appeals) also confirmed the levy of penalty. Aggrieved, the assessee went for second appeal.

Held:

(1) The factum of the assessee taking two residential accommodations on rent was not disputed. The only issue was whether by claiming exemption with regard thereto, the assessee had rendered himself liable to levy of penalty for furnishing inaccurate particulars of income.

(2) The meaning of word ‘particulars of income’ has been clearly laid down by the Supreme Court in CIT v. Reliance Petroproducts (P.) Ltd. As held in this case, there has to be a concealment of the particulars of the income of the assessee; the assessee must have furnished inaccurate particulars of his income; the meaning of the word ‘particulars’ used in the section would embrace the details of the claim made and to attract penalty, the details supplied by the assessee should in his return must not be accurate, not exact or correct, not according to the truth or erroneous. Also it was held that mere making of a claim which is not sustainable in law by itself will not amount to furnishing inaccurate particulars regarding the income of the assessee and there is no question of inviting penalty u/s.271(1)(c) for the same.

(3) The instant case of the assessee is squarely covered under the above decision. In the instant case, the assessee had accurately and truthfully disclosed all particulars of the residential accommodations rented and payments made. It was only, as such, a case of difference of opinion where the claim made by the assessee [exemption u/s.10(13A)] relying on earlier relevant decision was viewed differently by the Department. Thus, no concealment penalty was, in such situation, attracted. Thus the appeal of the assessee was to be allowed and penalty levied was to be cancelled.

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Section 140A r.w.s. 244A — Whether an assessee is entitled to interest on excess payment of selfassessment tax from date of payment upto the date the refund is actually granted — Held, Yes.

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2011) 130 ITD 305
11 ADIT v. Royal Bank of Scotland N.V.
A.Y.: 2007-08. Dated: 3-11-2010

Section 140A r.w.s. 244A — Whether an assessee is entitled to interest on excess payment of self-assessment tax from date of payment upto the date the refund is actually granted — Held, Yes.


Facts:

The assessee was into the business of banking. The return of income filed by the assessee, in the relevant assessment year was processed u/s.143(1) to determine the final income tax liability of Rs.272.93 crore. Against this, the credit of Rs.346.36 crore was allowed which was aggregate of T.D.S, advance tax and self-assessment tax. Accordingly the refund was issued, but as it didn’t include any interest element u/s.140A, the assessee filed an application u/s.154. On appeal the CIT(A) allowed the assessee’s claim.

Held:

The CIT(A) relying on the decision of the Madras High Court in the case of Ashok Leyland Ltd. (2002) (254 ITR 641/125) and Cholamandalam Investment & Finance Co. Ltd. (2008) 166 Taxmann 132, held that computation of interest on excess payment of selfassessment tax has to be paid in terms of section 244A(1)(b) i.e., from the date of payment of such amount up to the date on which refund is actually granted.

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Section 40(a)(ia) of the Income-tax Act, 1961 — Provisions of section 40(a)(ia) can be invoked only in event of non-deduction of tax at source but not for lesser deduction of tax at source.

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(2012) 49 SOT 448 (Mumbai)
Dy. CIT v. Chandabhoy & Jassobhoy
A.Y.: 2006-07. Dated: 8-7-2011

Section 40(a)(ia) of the Income-tax Act, 1961 — Provisions of section 40(a)(ia) can be invoked only in event of non-deduction of tax at source but not for lesser deduction of tax at source.

Accountants, had employed 18 consultants with whom it entered into agreements for a period of two years renewable further at the option of either parties. These consultants were prohibited from taking any private assignments and worked full time with the assessee. During the year, the assessee had paid an amount of Rs.26.75 lac to the said consultants by way of salary after deduction of tax at source u/s.192 and claimed deduction of the same. The Assessing Officer after analysing the agreements entered by the assessee-firm with the said consultants came to a conclusion that there was no employer-employee relationship and that the payment made to the consultants was in the nature of fees for professional services. He, therefore, held that the assessee should have deducted tax at source u/s.194J and, invoking the provisions of section 40(a)(ia), he disallowed the entire payment made to the consultants. The CIT(A) deleted the disallowance made by the Assessing Officer.

The Tribunal confirmed the CIT(A)’s order. The Tribunal noted as under:

(1) There is no dispute with reference to the deduction of tax u/s.192 and also the fact that in the individual assessments of the consultants these payments were accepted as salary payments.

(2) It is also not the case that the assessee has not deducted any tax.

(3) The assessee had indeed deducted tax u/s.192 and so the provisions of section 40(a)(ia) also do not apply since the said provisions can be invoked only in the event of non-deduction of tax at source, but not for lesser deduction of tax.

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Section 12AA of the Income-tax Act, 1961 — When assessee had not carried out any activity other than running school or hostel and all properties owned by it were held in trust for purpose of carrying on charitable activities, there was nothing unlawful in assessee acquiring assets and buildings and registration u/s.12AA could not be denied to it.

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(2012) 49 SOT 242 (Chennai)
Anjuman-e-Khyrkhah-e-Aam v. DIT (e)
Dated: 18-7-2011
The assessee-trust was running a school with hostel facilities. Its application for grant of registration u/s.12AA was rejected on the ground that the activities carried on by it were not charitable in nature. The Tribunal allowed the appeal of the assessee and directed the authority to grant registration u/s.12AA. This order was challenged before the High Court which remitted the matter back to the DIT(E) for fresh disposal. The DIT(E) considered the issue again and finally reached at a conclusion that the assessee was not eligible for getting registration u/s.12AA on the ground that the main activity of the assessee was to accumulate huge investments in purchase of assets and earn rental income from those assets without engaging itself in any charitable activities.

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

(1) It was true that the assessee-trust had been established since more than 100 years and it was running the school with hostel facilities attached to it.

(2) Amounts collected by the assessee-trust had been used for the purpose of running the school and hostel and also in constructing buildings. A major portion of the outgoings of the assessee-trust had been towards construction of buildings.

(3) If the object of the assessee-trust was to run educational institution and the assessee had been carrying on that activity alone, the construction of buildings and purchase of property could not be treated as a point against the assessee. The assessee might be purchasing properties and constructing buildings for the purpose of letting out to earn income necessary for carrying on the charitable activity in the nature of running the school and hostel.

(4) All the properties owned by the assessee-trust were held in trust for the purpose of carrying on charitable activities. There was nothing unlawful in the assessee acquiring assets and buildings.

(5) If the entire activities carried on by the assessee were charitable in nature, the expenses incurred for construction of buildings and purchase of assets also qualified to be considered as application of funds for charitable purposes.

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Should Gains be Recognised due to ‘Own’ Credit Deterioration

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Since the start of the global financial crisis in 2008, the credit risk of counter parties has become increasingly important. Globally, the financial environment has been very volatile and has created a lot of uncertainty in the minds of stakeholders as well as prospective investors.

 Volatility in credit worthiness of entities, not only has a significant impact on the business of these entities (ability to raise funds and capital at attractive rates), but has also resulted in a unique accounting implications.

This implication arises from provisions relating to gains/ losses due to ‘changes in fair value of financial liability due to changes in ‘own’ credit risk’ in certain cases.

The International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board’s (FASB) inclusion of own credit risk in liability measurement has proved controversial over the years. Several media articles have focused on the fact that due to EU accounting rules, banks may have systematically overstated their net assets and distributed non-existent profits as dividends and bonuses.

Let us take an example to understand how change in own credit risk, results in reflecting a better performance and increases the net assets for entities.

Balance sheet for Bank XYZ

*Measured at fair value through profit or loss account Keeping all other external parameters constant, if the creditworthiness of Bank XYZ decreases, it will result in an increase in its credit spreads (as the cost of funds for a more risky instrument will be higher). This in turn will result in a reduction in the fair value of the underlying instruments issued by the Bank. The revised balance sheet of XYZ may be as under (fair value is presumed to be Rs 800)

Balance sheet for Bank XYZ (Rs)

This reduction in the financial liability by Rs 200 is recorded as a gain in the income statement and has a favourable impact on reported PAT and EPS of the Bank.

Relevant accounting literature under IFRS supporting the aforesaid accounting treatment

IAS 39 “Financial Instruments: Recognition and Measurement” permits an entity to classify any financial liability into the category of “Fair value through profit or loss (FVTPL)” when:

• It is acquired or incurred principally for the purpose of selling or repurchasing it in the near term

• Part of a portfolio managed together and evident by recent pattern of short term profit taking

•    It contains more than one embedded derivatives.

Generally derivative liabilities, structured financial products etc are recognised by entities at fair value.

IAS 39 requires an entity to reflect credit quality in determining the fair value of financial instruments and related changes in fair value are accounted in the profit and loss account.

Impact on results

During 2011, a number of international banks reported positive earnings in spite of increasing credit spreads i.e., declining credit worthiness. This outcome was due to own-credit-risk adjustments allowed in terms of IAS 39 (referred above) and similar guidance under US GAAP laid down in FASB Standard No. 159 “Fair Value Option for Financial Assets and Financial Liabilities”. Own-credit risk adjustments can result in unrealised losses as well when banks’ creditworthiness improves.

Below is a summary of the impact, this provision had on the performance results of a few large banks

One can logically argue that it is misleading for an entity to report a gain on its liabilities as a direct result of its own creditworthiness deteriorating, particularly as the entity would not be able to realise this gain unless it repurchases its debt at current market prices. However, there is another view in support of fair valuation, which is based on the principle of “increase in shareholder value”. As per this view increase in shareholder value resulting from a credit downgrade is based on differing contractual claims of shareholders and bondholders. Under this approach wealth is transferred from the existing bondholders, who have already committed to a lower interest rate and thus bear the risk of changes in interest rates, to the shareholders. If bondholders had waited to purchase the obligations they may well have received a higher interest rate. Thus, the gain is attributable to the lower interest rate that the entity enjoys in the current period as compared to the market interest rate (for another entity with the present (deteriorated) credit rating).

In India, The Ministry of Corporate Affair (MCA) has issued accounting standards which are aligned to IFRS (known as “Ind AS’), to be notified at a future date. Ind AS 39 “Financial Instruments: Recognition and Measurement” prescribes that in determining fair value of a financial liability, which on initial recognition is designated at fair value through profit or loss, any change in fair value consequent to changes in the company’s own credit risk should be ignored. This was a concious difference from IFRS incorporated under Ind AS. This difference was because Indian standard setters were not comfortable with companies recognising ‘gains’ in the financial statements just because their credit worthiness has deteriorated.

Even Basel III rules, require banks to “derecognise in the calculation of Common Equity Tier 1, all unrealised gains and losses that have resulted from changes in the fair value of liabilities that are due to changes in the bank’s own credit risk.” This rule ensures that an increase in credit risk of a bank does not lead to a reduction in the value of its liabilities, and thereby an increase in its common equity.

Given the ongoing volatility in the economic environment, this is an area which needs to be closely monitored, particularly due to the implications on reported financial performance and capital adequacy considerations.

Section A: AS 29: Disclosures regarding provision for potential civil and criminal liability

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Section A: AS 29: Disclosures regarding provision for potential civil and criminal liability

Ranbaxy Laboratories Ltd Year ended 31-12-2011

From Notes to Accounts (Rupees in millions)

On 20th December 2011, the Company agreed to enter into a Consent Decree with the Food and Drug Administration (“FDA”) of United States of America (“USA”) to resolve the existing administrative actions taken by FDA against the Company’s Paonta Sahib and Dewas facilities. The Consent Decree was approved by the United States District Court for the District of Maryland on 26th January 2012. The Consent Decree establishes certain requirements intended to further strengthen the Company’s procedures for ensuring the integrity of data in its US applications and good manufacturing practices at its Paonta Sahib and Dewas facilities. Successful compliance with the terms of the Consent Decree is required for the company to resume supply of products from the Dewas and Paonta Sahib facilities to USA.

Further, the Company is negotiating towards a settlement with the Department of Justice (“DOJ”) of USA for resolution of potential civil and criminal allegations by DOJ. Accordingly, the Company has recorded a provision of Rs. 26,480 million ($500 million) which the Company believes will be sufficient to resolve all potential civil and criminal liability.

From Auditor’s Report

Without qualifying our opinion, we draw attention to note 2 of schedule 24 of the financial statements, wherein it has been stated that the management is negotiating towards a settlement with the Department of Justice (“DOJ”) of the United States of America for resolution of potential civil and criminal allegations by the DOJ. Accordingly, a provision of Rs. 26,480 million has been recorded which the management believes will be sufficient to resolve all potential civil and criminal liability.

From CARO report
According to the information and explanations given to us, the provisions created for FDA/DOJ for Rs. 26,480 million (as explained in Note 2 of Schedule 24) by the Company has resulted into long-term funds being lower by Rs. 21,754.09 million compared to long-term assets as at 31st December 2011. Accordingly, on an overall examination of the balance sheet of the Company as at 31st December 2011, it appears that short term funds of Rs. 21,754.09 million have been used for long-term purposes during the current year (without considering the impact of excess remuneration paid to Chief Executive Officer and Managing Director as explained in paragraph (d) of the audit report). As represented to us by the management, the shortfall is temporary in nature, hence resulting in long-term funds being lower.

From Directors’ Report

With regard to qualifications contained in the auditors’ report, explanations are given below:

i) Long term funds lower than long term assetsnote no. 2 of Schedule 24 to the financial statements.

The Company has made a provision of Rs. 26,480 million for settlement with the Department of Justice (DoJ) of U.S.A., which the Company believes will be sufficient to resolve all potential civil and criminal liability. This has resulted into long-term funds being lower by Rs. 21,754.09 million compared to long-term assets as at 31st December 2011. The Company believes that the abovementioned shortfall is temporary in nature.

From Management Discussions and Analysis statement

Regulators across the world have become stricter, in respect of compliance to requirements with even more severe consequences for non-compliance.

Ranbaxy signed a Consent Decree (“CD”) with the United States Food & Drug Administration (“US FDA”) in December 2011 to resolve the existing administrative actions taken by the US FDA against the Company’s Poanta Sahib, Dewas and Gloversville facilities. The CD was subsequently approved by the United States District Court for the Court of Maryland on 25th January, 2012. The CD establishes certain requirements intended to further strengthen the Company’s procedures for ensuring the integrity of data in the US applications and good manufacturing practices at its Poanta Sahib and Dewas facilities.

Specifically, the CD requires that Ranbaxy comply with detailed data integrity provisions before FDA will resume reviewing drug applications containing data or other information from the afore-mentioned plants. These provisions include:

1. Hire a third party expert to conduct a thorough review at the facilities and audit applications containing data from affected plants;

2. Implement procedures and controls sufficient to ensure data integrity in the Company’s drug applications; and

3. Withdraw any applications found to contain untrue statements of material fact and/or a pattern or practice of data irregularities that could affect approval of the application.

The Company will have to relinquish 180 days exclusivity for 3 pending generic drug applications. This will not have material impact on the performance of the Company. The Company could also be liable for liquidated damages to cover potential violations of the law and CD. The implementation of CD, is expected to put to rest the legacy issue that impacted Ranbaxy, and requires strict adherence.

The Company separately announced a provision of $500 Mn in connection with the investigation of the Department of Justice, which the Company believes will be sufficient to resolve all potential civil and criminal liabilities. The Company has taken corrective actions to address the CD concerns and is confident of working together with the regulators towards its satisfactory closure.

Ranbaxy Laboratories Ltd Year ended 31-12-2012

From Notes to Accounts (Rupees in millions)

The Company is negotiating towards a settlement with the Department of Justice (“DOJ”) of the USA for resolution of potential civil and criminal allegations by DOJ. Accordingly, the Company had recorded a provision of Rs 26,480 ($500 Million) in the year ended 31st December 2011, which on a consideration of the progress in the matter so far, the Company believes will be sufficient to resolve all potential civil and criminal liability. The Company and its subsidiaries are in the process of negotiations which will conclusively pave the way for a Comprehensive DOJ Settlement. The settlement of this liability is expected to be made by the Company in compliance with the terms of settlement, once concluded and subject to other regulatory/statutory provisions.

From Auditor’s Report
No mention

From CARO Report


Clause 10
The accumulated losses of the Company at the end of the year are not less than fifty percent of its net worth (without adjusting accumulated losses). As explained to us, these are primarily due to provision created for settlement with the Department of Justice (DOJ) of the United States of America for resolution of potential civil and criminal allegations by the DOJ (refer to note 8 of the financial statements). The Company has not incurred cash losses in the current financial year though it had incurred cash losses in the immediately preceding financial year.

Clause 17

According to the information and explanations given to us, the provision created for settlement with the DOJ amounting to Rs. 26,480 million (refer to note 8 of the financial statements) by the Company in the previous accounting year have resulted in long-term funds being lower by Rs. 5,558.22 million compared to long-term assets as at 31st December 2012. Accordingly, on an overall examination of the Balance Sheet of the Company as at 31st December 2012, it appears that short term funds of Rs. 5,558.22 million have been used for long-term purposes. As represented to us by the management, the shortfall is temporary in nature and action is being taken to have long term funds within a short period of the amount being actually paid.

From Directors’ Report
In continuation of signing of the Consent Decree with the USFDA, the Company is in the final stage of settlement with the U.S. Department of Justice (DOJ) to resolve civil and criminal liabilities.

With regard to comments contained in the Auditors’ Report, explanations are given below:

i)    The accumulated losses of the Company at the end of the year are not less than fifty percent of its net worth:

The accumulated losses are primarily due to provision of Rs. 26,480 million created by the Company in the year ended 31st December, 2011 for settlement with the DOJ for resolution of potential civil and criminal allegations by the DOJ.

ii) Short term funds used for long term purposes:

The Company had made a provision of Rs. 26,480 million in the previous accounting year for settlement with the DOJ. This has resulted into long-term funds being lower by Rs. 5,558.22 million compared to long-term assets as at 31st December, 2012. Accordingly, short-term funds of Rs. 5,558.22 million have been used for long-term purposes which are temporary in nature.

Reassessment: S/s. 147 and 148: A. Y. 2007-08: Where AO has acted only under compulsion of audit party and not independently, action of reopening assessment is not valid:

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Vijay Rameshbhai Gupta vs. ACIT; 32 Taxman.com 41 (Guj):

In the course of assessment proceedings u/s. 143(3), the Assessing Officer took a view that income earned by assessee from leasing out his restaurant was taxable as business income. Subsequently, the Assessing Officer initiated reassessment proceedings on the ground that aforesaid lease income was liable to be taxed as income from other sources and, thus, business expenses were wrongly allowed against said income.

The assessee filed writ petition challenging the validity of reassessment proceedings contending that the Assessing Officer was compelled by the audit party to reopen the assessment, though on the reasons recorded, the Assessing Officer was of the belief that no income chargeable to tax had escaped assessment.

The Gujarat High Court allowed the petition and held as under:

“i) From the series of evidence, it stands clearly established that the Assessing Officer was under compulsion from the audit party to issue notice for reopening. This is so because after the audit party brought the controversial issue to the notice of the Assessing Officer, he had not agreed to the proposal for reexamination of the issue. Thereupon, he in fact, wrote a letter and gave elaborate reasons why he did not agree to make any addition on the controversial issue.

ii) In the said letter, the Assessing Officer firmly asserted that the assessee’s income from lease was to be assessed as business income and not as income from other sources. Despite his firm assertion, the audit party once again wrote to the jurisdictional Commissioner that the reply of the Assessing Officer was not acceptable.

iii) Thus, it is apparent on the face of the record that the Assessing Officer was compelled to issue notice for reopening, though he held a bona fide he had accorded in the original assessment was as per the correct legal position.

iv) By now, it is well settled that even if an issue is brought to the notice of the Assessing Officer by the audit party, it would not preclude the Assessing Officer from acting on such communication as long as the final opinion to take appropriate action is that of the Assessing Officer and not that of the audit party. It is equally well settled however that if the Assessing Officer has acted only under compulsion of the audit party and not independently, the action of reopening would be vitiated.

v) In view of above, the impugned notice seeking to reopen the assessment was to be quashed.”

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Penalty: Limitation: S/s. 271D and 275(1)(c): A. Y. 2001-02: On 27/03/2003 AO served show cause notice for penalty u/s. 271D: Matter referred to Jt. CIT on 22/03/2004: Jt. CIT passed order of penalty u/s. 271D on 28/05/2004: The order is barred by limitation u/s. 275(1)(c):

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CIT Vs. Jitendra Singh Rathore; 257 CTR 18 (Raj):

For the A. Y. 2001-02, the assessment was completed by an order u/s. 143(3), 1961 dated 25/03/2003. The Assessing Officer noticed that the assessee had accepted cash loans exceeding the limit specified u/s. 269SS to the tune of Rs. 4,00,000/- and the same being in contravention of section 269SS initiated penalty proceedings u/s. 271D of the Act and served show cause notice on the assessee on 27/03/2003. The matter was referred to the Jt. CIT on 22/03/2004, who was the competent authority to impose such penalty u/s. 271D. On 28/05/2004, the Jt. CIT passed an order of penalty u/s. 271D imposing the penalty of Rs. 4,00,000/-. The Tribunal cancelled the penalty holding that the order is barred by limitation.

In appeal by the Revenue, the following question was raised:

“Whether on the facts and in the circumstances of the case as well as in the law, the learned Tribunal was justified in deleting the penalty u/s. 271D holding that the penalty was not imposed within the prescribed period u/s. 275(1)(c) from the date of initiation by the AO ignoring the legal provision that the authority competent to impose penalty u/s. 271D was Jt. CIT and hence the period of limitation should be reckoned from the issue of first show cause by the Jt. CIT?”

The Rajasthan High Court upheld the decision of the Tribunal and held as under:

“i) Even when the authority competent to impose penalty u/s. 271D was Jt. CIT the period of limitation for the purpose of such penalty proceedings was not to be reckoned from the issue of first show cause by the Jt. CIT, but the period of limitation was to be reckoned from the date of issue of first show cause for initiation of such penalty proceedings.

ii) For the purpose of the present case, the proceedings having been initiated on 25/03/2003, the order passed by the Jt. CIT u/s. 271D on 28/03/2004 was hit by the bar of limitation.

iii) The CIT(A) and the Tribunal have, thus, not committed any error in setting aside the order of penalty. Consequently, the appeal fails and is, therefore, dismissed.”

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Penalty: S/s. 269SS and 271D: Amount received by assessee from her father-in-law for purchasing property: Transaction genuine and source disclosed: Penalty u/s. 271D not to be imposed:

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CIT vs. Smt. M. Yeshodha: 351 ITR 265 (Mad):

In the previous year relevant to A. Y. 2005-06, the assessee received a loan of Rs. 20,99,393/- in cash from her father-in-law for purchasing property. In the penalty proceedings u/s. 271D r/w. s. 269SS, the assessee claimed that the amount received in cash from father-in-law was a gift and not a loan. The Assessing Officer held that the assessee had received the amount as a loan and not as a gift, because the amount was shown as a loan in the balance sheet of the assessee, which was filed with the return of income. He therefore imposed penalty of Rs. 20,99,393/- u/s. 271D of the Act. The Tribunal held that the transaction was between the father-in-law and the daughter-in-law and the genuineness of the transaction in which the amount had been paid by the father-in-law for the purchase of property was not disputed, and the cash taken by the assessee from her father-in-law was not a loan transaction. The Tribunal, accordingly, deleted the penalty.

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

“i) The contention of the Revenue is that the amount received by the assessee from her fatherin- law has to be treated only as a loan and if it is a loan, then the assessee is liable to pay penalty u/s. 271D of the Act.

ii) Whether it is a loan or other transaction, still the other provision, namely, section 273B, comes to the rescue of the assessee, if she is able to show reasonable cause for avoiding penalty u/s. 271D. The Tribunal has rightly found that the transaction between the daughter-in-law and the father-in-law is a reasonable transaction and a genuine one owing to the urgent necessity of money to be paid to the seller. We find that this would amount to reasonable cause shown by the assessee to avoid penalty u/s. 271D of the Act.

iii) The Tribunal has rightly allowed the appeal. We do not find any error or infirmity in the order of the Tribunal to warrant interference. Accordingly, the substantial question of law is answered in favour of the assessee.”

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Exemption: Interest on tax free bonds: Section 10(15) : A. Y. 1988-89: Interest for period between application for allotment and actual allotment: Entitled to exemption: CIT vs. Bharat Heavy Electricals Ltd.; 352 ITR 88 (Del):

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For the A. Y. 1988-89, the assessee had claimed exemption of interest on tax free bonds u/s. 10(15). The Assessing Officer disallowed the claim for exemption in respect of the interest for the period from the date of application for allotment and the date of actual allotment. The Tribunal held that the assessee was entitled to exemption.

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

“i) In view of the amplitude of section 10(15)(iv), the fact that interest was paid for a brief period of about six days would not make it any less an amount of interest payable “in respect of bonds”.

ii) The assessee was entitled to exemption on the interest earned on tax free bonds between the date of their application by the assessee and the date of their allotment.”

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Double taxation relief: Section 91(1): A. Y. 1997- 98: Income earned in foreign country: Relief of taxes paid abroad: Relief not dependent upon payment of taxes being made in foreign country in previous year:

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CIT vs. Petroleum India International; 351 ITR 295 (Bom):

The assessee had paid taxes of Rs. 82 lakh in Kuwait on the income earned in Kuwait by it during the period relevant to the A. Y. 1997-98. Its claim for deduction of the said amount u/s. 91(1), was denied by the Assessing Officer on the ground that the payment of taxes in Kuwait was not made in the previous year relevant to the A. Y. 1997-98. The Tribunal allowed the assessee’s claim.

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

“i) There was no requirement that the benefit of section 91(1) would be available only when payments of taxes had been made in the previous year relevant to the assessment year under consideration.

ii) The object of section 91(1) is to give relief from taxation in India to the extent taxes have been paid abroad for the relevant previous year. This deduction/ relief is not dependent upon the payment also being made in the previous year.

iii) The payment of taxes on the income earned in Kuwait during the previous year had been examined and found to be correct. Therefore, the assessee was entitled to double taxation benefit for the taxes paid in Kuwait.”

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Depreciation(Unabsorbed): Carry forward and set off: A. Y. 2006-07: Effect of amendment of section 32(2) w.e.f. 01/04/2002: Unabsorbed depreciation from A. Y. 1997-98 to 2001-02 got carried forward to A. Y. 2002-03 and became part thereof: It is available for carry forward and set off against the profits and gains of subsequent years, without any limit:

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General Motors India (P) Ltd. vs. Dy. CIT; 257 CTR 123 (Guj):

In this case, the question for consideration before the Gujarat High Court was as to “whether the unabsorbed depreciation pertaining to A. Y. 1997-98 could be allowed to be carried forward and set off after a period of eight years or it would be governed by section 32 as amended by Finance Act 2001?”. The reason given by the Assessing Officer is that section 32(2), was amended by Finance Act No. 2 Act of 1996 w.e.f. A.Y. 1997-98 and the unabsorbed depreciation for the A. Y. 1997-98 could be carried forward up to the maximum period of 8 years from the year in which it was first computed. According to the Assessing Officer, 8 years expired in the A. Y. 2005-06 and only till then, the assessee was eligible to claim unabsorbed depreciation of A. Y. 1997-98 for being carried forward and set off. But the assessee was not entitled for unabsorbed depreciation of Rs. 43,60,22,158/- for A. Y. 1997-98, which was not eligible for being carried forward and set off against the income for the A. Y. 2006-07.

The Gujarat High Court held as under:

“i) Amendment of section 32(2) by Finance Act, 2001 is applicable from A. Y. 2002-03 and subsequent years. Therefore unabsorbed depreciation from A. Y. 1997-98 upto the A. Y. 2001-02 got carried forward to the A. Y. 2002-03 and became part thereof.

ii) It came to be governed by the provisions of section 32(2) as amended by Finance Act, 2001 and was available for carry forward and set off against the profits and gains of subsequent years, without any limits whatsoever.”

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Capital or revenue receipt: A. Y. 2003-04: Business of Multiplexes and Theatres: Exemption from entertainment tax under Scheme of Incentive for Tourism Project, 1995 to 2000 for giving boost to tourism sector: Scheme offering incentive for recouping or covering capital investment:

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Is capital receipt: Dy. CIT vs. Inox Leisure Ltd.; 351 ITR 314 (Guj):

The assessee was engaged in the business of operating multiplexes and theatres in Pune and Baroda. During the previous year relevant to the A. Y. 2003-04 the assessee received an amount of Rs. 1,14,47,905/- by way of exemption from payment of entertainment tax relating to its Baroda multiplex unit. The exemption was granted by the State Government under the New Package Scheme of Incentive for Tourism Projects 1995 to 2000. Likewise, the assessee also received a similar entertainment tax exemption of Rs. 1,85,06,998/- from the State of Maharashtra under its own incentive scheme for its multiplex unit at Pune. The assessee claimed that the incentives were granted for covering the capital outlay and, therefore, the receipt was capital in nature. The Assessing officer treated the receipt as revenue receipt. The CIT(A) and the Tribunal allowed the assessee’s claim.

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

“i) The character of receipt of a subsidy in the hands of the assessee has to be determined with respect to the purpose for which the subsidy is granted. In other words, one has to apply the purpose test. The point of time at which the subsidy is paid is not relevant. The source is immaterial. If the object of the subsidy is to enable the assessee to run the business more profitably then the receipt is on revenue account. On the other hand, if the object of the assistance under the scheme is to enable the assessee to set up a new unit or expand the existing unit then the receipt of subsidy would be on capital account.

ii) The salient features of the scheme showed that the incentive was being offered for recouping or covering a capital investment or outlay already made by the assessee.

iii) The Tribunal was right in holding that the entertainment exemption of Rs. 1,85,06,998/- and Rs. 1,14,47,905/- in respect of Pune and Baroda multiplexes, respectively, was a capital receipt, which was not eligible to tax for the A. Y. 2003-04.”

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Capital or revenue receipt: Entertainment subsidy: Object of subsidy to promote cinema houses by constructing Multiplex Theatres: Subsidy is capital receipt:

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CIT vs. Chaphalkar Bros.; 351 ITR 309 (Bom):

The following question was raised before the Bombay High Court in this case:

“Whether the entertainment duty subsidy given to the assessee by the State Government for construction of multiplexes is in the nature of revenue receipt or capital receipt?”

The High Court held as under:

“i) The purpose for which the subsidy was given is the relevant factor and if the object of subsidy was to enable the assessee to setup a new unit then the receipt of subsidy would be on capital account.

ii) Since the object of the subsidy was to promote construction of multiplex theatre complexes, the subsidy would be on capital account. The fact that the subsidy was not meant for repaying the loan taken for construction of multiplexes should not be ground to hold that the subsidy receipt was on revenue account because if the object of the scheme was to promote cinema houses by constructing multiplex theatres, irrespective of whether the multiplexes had been constructed out of the assessee’s own funds or borrowed funds, the receipt of subsidy would be on capital account.

iii) Therefore, the decision of the Tribunal that the amount of subsidy received by the assessee is on capital account could not be faulted.”

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Capital gains: Exemption u/s. 54/54F: A. Y. 2007-08: A residential house includes a building with a basement, ground floor, first floor and second floor constituting two residential units: Exemption allowable:

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CIT vs. Gita Duggal; 257 CTR 208 (Del): 214 Taxman 51 (Del): 30 Taxman.com 320 (Del):

Under a development agreement the assessee received by way of consideration Rs. 4 crore and a building consisting of basement, ground floor, first floor and the second floor constituting two residential units. In the computation of income for the A. Y. 2007-08, the assessee had computed capital gain with reference to the cash consideration of Rs. 4 crore. The Assessing Officer estimated the cost of construction of the said building at Rs. 3,43,72,529/- and included the same in the total sale consideration. The Assessing Officer rejected the assessee’s claim for exemption u/s. 54, but allowed the claim for exemption u/s. 54F in respect of one residential unit. The assessee’s reliance on the judgment of the Karnataka High Court in CIT vs. D. Anand Basappa; (2009) 309 ITR 329 (Kar) was not accepted by the Assessing Officer. Accordingly, he recomputed the capital gain and made an addition of Rs. 98,20,722/-. The CIT(A) allowed the assessee’s claim following the judgment of the Karnataka High Court. The Tribunal upheld the decision of the CIT(A).

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

“i) Fact that the residential house consists of several independent units cannot be permitted to act as an impediment to the allowance of the exemption u/s. 54/54F. It is neither expressly nor by necessary implication prohibited.

ii) Tribunal was therefore justified in allowing exemption u/s. 54F in respect of entire investment in construction of a building consisting of two residential units.”

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Business expenditure: Fines and penalties: Section 37(1) : A. Y. 2004-05: Dishonour of export commitment in view of losses: Encashment of bank guarantee by Export Promotion Council: Payment recorded as penalty in assessee’s books and claimed as deduction: Compensatory in nature:

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Deduction allowable: CIT vs. Regalia Apparels Pvt. Ltd.; 352 ITR 71 (Bom):

The assessee is a manufacturer of garments. The Apparel Export Promotion Council granted to the assessee entitlements for export of garments and knit ware. In consideration of the export entitlements, the assessee furnished a bank guarantee in support of its commitment that it shall abide by the terms and conditions in respect of the export entitlements and produce proof of shipment. It was also provided that failure to fulfill the obligation to export would render the bank guarantee liable to being forfeited/ encashed. In view of the fact that the assessee was incurring losses, it decided not to utilise the export entitlements. This led the Council to encash the bank guarantee. The assessee recorded the payment as penalty in its books of account. The assessee claimed deduction of the said amount u/s. 37 of the Income-tax Act, 1961 for the A. Y. 2004-05. The Assessing Officer disallowed the claim holding that it is in the nature of penalty. The CIT(A) and the Tribunal allowed the assessee’s claim.

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

“i) The finding of fact recorded by the Commissioner (Appeals) and upheld by the Tribunal was that the assessee took a business decision not to honour its commitment of fulfilling the export entitlements in view of losses being suffered by it. The Assessing Officer did not dispute the fact nor did he doubt the genuineness of the claim of the expenditure being for business purposes.

ii) In these facts the Tribunal held that the assessee had not contravened any provisions of law and, thus, the forfeiture of the bank guarantee was compensatory in nature u/s. 37(1) of the Act.

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Consortium of members formed for the purpose of joint bid does not constitute AOP if each of the members has specified responsibility independent of the other member and consideration flowing to each of the member is separate. Certain common covenants inc

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New Page 1

Part C : Tribunal &
AAR International Tax Decisions

7 Hyundai Rotem Co.
(2009) TIOL 798 ARA-IT
Dated : 23-3-2010

Consortium of members formed for the purpose of joint bid
does not constitute AOP if each of the members has specified responsibility
independent of the other member and consideration flowing to each of the member
is separate. Certain common covenants including agreeing to joint and several
liability for the comfort of the customer does not alter the situation.

Facts :


Five companies (one Korean, two Japanese and two Indian)
entered into a consortium named MRMB to bid for tender floated by Delhi Metro
Rail Corporation (DMRC). The bid was for designing, manufacturing, supplying,
commissioning, training and transfer of technology of 192 numbers of EMUs. The
contract was for a fixed consideration and was apportioned amongst various cost
centres and was linked to various milestones.

Responsibility of each of the member was clearly identified.
For example, Korean company was responsible for mechanical work, the Indian
company 1 was responsible for electric work, etc. Consideration of each one of
the members was clearly identified. Japco 1 was appointed as a consortium
leader. The amount collected from the customer was disbursed by the consortium
leader to the various members as per the pre-agreed ratio.

The tax authorities were of the view that the consortium
constituted an AOP on account of the following features :

(a) Joint participation of the consortium members in the
tender process.

(b) Bid having been submitted by the consortium.

(c) Execution of single contract.

(d) Appointment of common project director for planning,
organising and controlling execution of the project.

(e) Nomination of a consortium leader and its appointment
as a contact point between the customer and the members.

(f) Constitution of the project Board with nominee of each
member for overall planning, organising or controlling the execution of the
project.

(g) Furnishing of joint bank guarantee.

(h) Joint and several liability for the undertaking of the
contract. The overall responsibility of the consortium was to design,
manufacture, supply, etc. of 192 EMUs for which considerations was also
prefixed.

(i) All in all, there were collaborative efforts on the
part of the parties to undertake the contract which in view of the Tax
Department resulted in formation of the AOP.

AAR held :

  1. AAR noted that
    there is no definition of AOP in the IT Act or under the general law. It
    observed that AOP differs from the partnership and it falls short of a
    partnership, but the degree of distinction between the AOP or the firm is not
    clear.

  2. The constitution
    of AOP is fact-based and there are no hard and fast rules.

  3. In the context of
    IT Act, the association must be one the objects of which is to produce income,
    profits or gains by deploying assets in a joint enterprise with a view to make
    profit.

  4. The facts of the
    present case were akin to the facts before the AAR in case of Van Oord Acz BV
    (248 ITR 399). In view of the AAR, the present consortium did not constitiute
    an AOP on account of the following features :

(a) Nature of work undertaken and capable of being executed
by each member was materially different. Skill-set of each member was
different. Work of one member could not have been relocated to another.

(b) Bid evaluation by the costomer was done keeping in mind
competency of each member. There was no interchangeability or reassignment of
work or overseeing the work of each other.

(c) There was deduction in the original bid amount and the
discount agreed by each member was different. This was indicator of the fact
that economics of each of the members were detemined independently.

(d) In addition to the joint performance guarantee, each
member provided separate guarantee and undertaking.

(e) The agreement specifically clarified that there was no
intent between the parties to create any partnership or a joint venture.

(f) The covenant of joint and several liability was a
safeguard for the client to have better control over the consortium members.


  1. The facts of the case before AAR in GeoConsult ZT GMBH (304
    ITR 283) where the arrangement was regarded as giving rise to AOP were
    distinguishable. In GeoConsult’s case, there was intention to create a joint
    venture; the members had the same skill-set and scope of their work was
    overlapping. Also, the members had assisted each other in performance of the
    work and the members had unrestricted access to the work carried out by the
    other members, etc. The features in the present arrangement were different.

levitra

Payments made towards the share of the cost incurred in respect of research and development activities pursuant to cost contribution arrangement (CCA) is not the payment towards fees for technical services or royalty. Such contribution is not liable to ta

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New Page 1Part C : Tribunal &
AAR International Tax Decisions

6 ABB Limited
(2010) TIOL 94 ARA-IT
S. 2(24), S. 195 of the Income-tax Act,
Articles 5 & 7 of India-Switzerland DTAA
Dated : 15-3-2010

Payments made towards the share of the cost incurred in
respect of research and development activities pursuant to cost contribution
arrangement (CCA) is not the payment towards fees for technical services or
royalty. Such contribution is not liable to tax in the hands of the co-ordinating
agency.

There is no obligation of tax withholding if the amount does
not represent income chargeable to tax.

Facts :


The applicant is a company incorporated in India and part of
the ABB Group, which is a leader in power and automation technologies. The Group
has presence in more than 100 countries.

As per Group’s R&D policy, all basic R&D is coordinated and
directed through group entity in Switzerland (Swissco).

The group entities who wish to participate in basic R&D enter
into a CCA with Swissco. As per the terms of CCA, the entire costs of basic R&D
is shared amongst the participants based on a pre-agreed allocation key. The
participating entities are allowed a royalty-free unlimited access to the
research results, including any Intellectual Property Rights (IPRs) generated
from basic R&D. Any revenue earned from third party is reduced from the total
cost recovered from the participants. The research programme and policy is
decided by the research Board which has nominee from the participating entities.
The research Board decides on the research to be undertaken, the budgeted cost,
recovery to be made from various participants based on budget and adjustment to
be made based on the actual cost incurred and third-party revenue earned, etc.
The research Board gets the research carried out through various research
centres to whom the remuneration is paid on cost plus basis.

CCA made it clear that though the economic benefits of
research vest in various participants, for administrative reasons and
convenience, the IPRs generated are legally registered in the name of Swissco.

In addition to the cost contribution payments, each
participant also paid a ‘coordination fee’ to Swissco for its role as
administrator and coordinating agency under the CCA. Such fee was accepted to be
chargeable to tax in India and no question was raised on taxability of such
amount.

The applicant sought the ruling on the tax implications of
the contributions proposed to be made to Swissco. The primary contentions of the
applicant before the AAR were (i) that the CCA was merely a pooling and
coordinating arrangement and represented reimbursement of actual cost incurred
in carrying out the research jointly; (ii) the contribution did not partake the
character of income and was, therefore, not chargeable to tax in India; and
(iii) even if the contribution constituted income, it represented business
income of Swissco, which in absence of PE in India, was not chargeable to tax.

AAR held :

  • The payments made to
    Swissco are not in the nature of FTS since Swissco had not rendered any
    managerial, technical or consultancy service to the participants of CCA.
    Swissco did not deploy any personnel to perform any services in India.


  • The contribution was not
    payment on account of royalty. It is true that research results in creation of
    IPR in the form of information, technical knowledge and experience. However,
    payment made to Swissco was not for getting rights to such IPRs. The contract
    research organisation through whom the research board got the research carried
    out merely works as contractor without retaining IPR or right to commercial
    exploitation of the research.


  • Even though the IPRs
    generated from the research were to be registered in the name of Swissco,
    their economic benefits and beneficial ownership vested in the contributories.
    Admittedly, all participants had royalty-free and perpetual access to IPR.
    Also, amounts received from third party or from exploitation of IPR reduced
    the cost of the research to the participants. The arrangement was thus for the
    benefit of all the participants where the resources were pooled by various
    participants for undertaking R&D for common benefit.


  • The arrangement was such
    that each participant reimbursed the actual cost incurred by making the
    proportionate contribution. The OECD Guidelines on CCA arrangement also makes
    it clear that each participant is effective owner of the IPR generated through
    common pool and hence the contribution is not royalty paid to any other
    person.


  • The amount of
    reimbursement was not chargeable to tax in India and consequentially not
    liable to TDS.


  • The AAR clarified that
    its decision on non-taxability however does not preclude enquiry in
    appropriate proceedings about the nature of contribution on an armed-length
    basis.



levitra

No income arises to the foreign company in India in the course of deputing personnel to an Indian company, who work under the control and supervision of the Indian company and thus become employee of the Indian company. Amount of salary of deputed employe

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New Page 1Part C : Tribunal &
AAR International Tax Decisions

5 DDIT v. Tekmark Global Solutions LLC
(ITA 671/2007) (ITAT-Mum.)
Article 5(2), 7 of India-USA DTAA
Dated : 23-2-2010


No income arises to the foreign company in India in the
course of deputing personnel to an Indian company, who work under the control
and supervision of the Indian company and thus become employee of the Indian
company. Amount of salary of deputed employees reimbursed to the foreign company
is not taxable in India.

Facts :

Lucent Technologies Hindustan Private limited (ICO), an
Indian company, entered into an agreement with the assessee, a tax resident of
USA, to have their personnel deputed as per specifications of ICO.

ITAT considered the following terms of the contract between
ICO and the assessee to conclude that the arrangement between them was not for
providing of services by the assessee through its employees but that of
selecting and offering personnel for working as employees of ICO :

  • ICO provided
    specifications of the employees whom it (ICO) required pursuant to deputation
    arrangement.

  • The deputed personnel
    worked under the direction, supervision and control of ICO.


  • The assessee was not
    responsible for the work done or actions taken by the deputed personnel.


  • The lodging, boarding and
    other related expenses of deputed personnel were arranged by ICO.


  • The agreement made it
    clear that the agreement was for providing employees as per specifications of
    ICO and not for providing services to ICO.


The ITAT did note that the deputed personnel continued to be
on the payroll of the assessee and that the salary of the deputed personnel was
paid by the assessee for recoupment by way of reimbursement from ICO.

The Tax Department contended that the arrangement involved
rendering of services by the assessee to ICO through its employees in India and
that there was emergence of Service PE of the assessee in India. Accordingly,
the amounts were held chargeable in the hands of the assessee.

ITAT held :

The ITAT held :

  • No part of technical
    services were rendered by the assessee to ICO.


  • The deputed personnel for
    all practical purposes became the employees of ICO and carried out work
    allotted to them by ICO. The assessee had no control over the activities or
    the work performed by the deputed personnel. ICO alone had the right to remove
    the deputed personnel.


  • When the services
    rendered are independent of, and not under the control of, the assessee, the
    deputed personnel do not give rise to emergence of PE of the assessee in
    India.


  • In the circumstances, the
    amount received was reimbursement of salary which the assessee had disbursed
    as advance on behalf of and to the employees of ICO.


  • Even on an assumption
    that there is emergence of PE, there was no income embedded in the
    reimbursement of expenses.



levitra

Provisions of Section 195 are not attracted where the payment represents reimbursement of expenses having no element of income.

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Part C — International Tax Decisions




  1. Cairn Energy India Pty Ltd. vs. ACIT
    [2009-TIOL-220-ITAT-MAD] (Chennai)

A.Ys. : 1996-97 to 1999-2000

Date : 20.02.2009

Sections 40(a)(i), 42 and 195.

Issue :

 

@ Provisions of Section 195 are not attracted where the
payment represents reimbursement of expenses having no element of income.

@ Where income is computed under the special provisions of Section 42, no
disallowance can be made under Section 40(a)(i).

Facts :



Ø The assessee, an Australian company, was engaged in the
business of prospecting for and production of mineral oils in India. Since
the exploration and production activities carried out by the assessee were
covered by Production Sharing Contract (PSC) approved by the Parliament, the
assessee was admittedly covered by provisions of Section 42 of the Act.

Ø The assessee made certain reimbursements to its parent
company outside India in connection with business activity carried on by the
assessee in India. These reimbursements were claimed as expenditure under
Section 42. The AO disallowed the claim on the ground that assessee had
failed to deduct tax at source.

Ø The assessee submitted before the Tribunal that the
expenditure was in connection with petroleum operations and were charged to
the assessee on cost-to-cost basis in terms of the PSC. Since the charge was
at cost without any mark-up, withholding in terms of 195 was not required.
The assessee also argued that Section 42 had an overriding effect and is a
separate code by itself and accordingly the general computational provisions
of the Act cannot be applied. Reliance in this behalf was made to Supreme
Court decision in the case of Enron Oil and Gas India Ltd. [305 ITR 75].
Alternatively, based on judicial precedents it was submitted that there
cannot be any withholding on reimbursement where there was no element of
income.


Held :



Ø The Supreme Court in Enron (referred above) has
analysed the scope of Section 42 and held that the Section is a special
provision, is a code by itself for computing the income in respect of the
business of prospecting, extraction or production of mineral oils.

Ø In terms of Section 42, any expenditure which is
referred to in PSC, whether revenue or capital in nature is allowed as a
deduction. The scheme of Section 42 overrides all general computational
provisions including Section 40(a)(i). Hence, no disallowance can be made in
terms of Section 40(a)(i).

Ø As regards withholding on the payment, the Tribunal
held that the auditors of the parent company had certified that such payment
represented actual expenses and there was no reason to disbelieve such
certificate. Even, PSC provided and regulated that charges shall be equal to
the actual cost of providing services and shall not include any element of
profit. The Tribunal relied on decisions of CIT vs. Industrial Engg.,
[202 ITR 1014] (Delhi) and CIT vs. Dunlop Rubber Company, [142 ITR
493] (Calcutta) and held that no income accrued to the parent company from
payments representing reimbursement of expenses and hence provisions of
Section 195 did not apply.


levitra

Whether income earned from transportation of cargo in international traffic by aircraft owned, chartered or leased by other airlines is covered by Article 8 of India-USA Treaty.

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Part C — International Tax Decisions




  1. ADIT vs. Federal Express Corporation, USA
    [2009-TIOL-179-ITAT-Mumbai]

A.Y. : 1998-99 to 2000-01

Date : 29.01.2009

Article 8 of India-USA Treaty

Issue :

Whether income earned from transportation of cargo in
international traffic by aircraft owned, chartered or leased by other airlines
is covered by Article 8 of India-USA Treaty.

 

Facts :



Ø The assessee, a US company was engaged in integrated
air and ground transportation of time sensitive and time definite shipments
to various destinations worldwide (airport to airport services). It also
provided door-to-door delivery service for international shipment
(door-to-door delivery).

Ø The assessee had its own fleet of aircrafts, however,
in case of shipments which required express custom clearance it had entered
into interline arrangement with other airlines.

Ø In India, it was granted approval by the Director
General of Civil Aviation (DGCA) to operate air cargo services to and from
India. During the relevant year, in absence of approval from DGCA, the
assessee entered into interlines arrangement with other airlines for
carrying its cargo to India. In respect of monitoring of movement of cargo
within India, it entered into collaboration with Blue Dart Express which
performed actual pick-up and delivery of cargo. It established branches in
India and operated air cargo services to and from India.

Ø The Assessing Officer held that the assessee was
engaged in courier activities and not in the business of operation of
aircrafts in international traffic. Accordingly he denied benefit of
exemption of Article 8 of India-USA Treaty as claimed by the assessee. The
claim was however accepted by the CIT(A).

Ø The Department preferred appeal on the ground that
unless assessee establishes linkage between transportation of cargo carried
by other airlines with the carriage from the hub by the assessee, it cannot
be allowed the benefit of Article 8. Reliance was placed on Mumbai Tribunal
decision in the case of Cia de Navegacao Norsul [27 SOT 316]. The Department
argued that the term ‘profits from operation of ship or aircraft in
international traffic’ is defined in Article 8(2) of the Treaty and hence no
reference can be made to the commentaries and other support/guidance to
interpret. Article 8(2)(b) includes activities directly connected with
transportation of goods by the owners or lessees or charterers but would not
include cargo carried in international traffic by other airlines or inland
transportation of cargo.

Ø Before the Tribunal, the assessee submitted it had
entered into interline arrangements for transportation of cargo to a hub
from where aircrafts of the assessee were used for transportation of the
same in international traffic under slot arrangement. Reliance was also
placed on Mumbai Tribunal decision in the case of Balaji Shipping (UK) Ltd.
[25 SOT 325], where it was held that the expression ‘Profits from operation
of ships’ in UK Treaty would include not only profits from operation of
ships owned, chartered or leased, but also transportation through other
ships under slot arrangement. It further submitted that services of other
airlines were merely incidental to the main activity and hence covered by
Article 8. Alternatively it was submitted that the arrangements were pool
arrangement providing reciprocal services covered by Article 8(4) of the
Treaty.

Ø As regards inland transportation, assessee contended
that these activities were directly connected to the main activity of
transportation of cargo in international traffic covered by Article 8(2)(b).


Held :



Ø The assessee could be said to be engaged in the
business of transportation of cargo in the international traffic (and not in
courier services) as it is engaged in the business of transporting cargo
through a large fleet of globally-owned aircraft and it was recognised as
such by the authorities in India and in the USA. It was a registered member
of the International Air Transport Association.

Ø In the decision of Balaji, the Mumbai Tribunal referred
to OECD commentary since the term ‘profits from operation of ship’ is not
defined in UK Treaty. However, since the term ‘profits from operation’ has
been defined in Article 8 of US Treaty, relying on its decision in Delta
Airlines, where no reference was made to the commentary, the Tribunal held
that the benefit of Article 8 would be available only to the extent the
activity falls under the definition of Article 8(2).

Ø The transportation by aircraft, which is neither owned
nor leased by assessee would be outside the scope of the term ‘profits from
operation of ships or aircraft’ as defined in Article 8(2) of the US Treaty.
Accordingly, the Tribunal held that the income from operation involving
interline arrangement would not be exempt in India.

Ø The term ‘other activity directly connected with such
transportation’ would only mean transportation as referred in Article 8(2)
and as already concluded, the assessee is not covered by Article 8(2).
Accordingly, relying on decisions of the Mumbai Tribunal in Safamarine
Containers Lines [24 SOT 211] and Delhi Tribunal in KLM Royal Dutch Airlines
[307 ITR 142] (AT), the Tribunal held that inland transportation was also
not connected with the main activity and would be outside the scope of
Article 8.

Ø Where the income is not covered by the provisions of
Article 8, it would be treated as business profits under Article 7 of the
treaty and accordingly, the claim of the assessee would be examined under
Article 7.

Ø In respect of the alternative, claim of exemption under
Article 8(4) as pool arrangement, the Tribunal held that the same could be
examined by ascertaining whether the profits were derived from participation
in a pool, joint business or an international operating agency. Also, as the
claim of the assessee of having chartered the aircraft by booking some space
therein was made for the first time, it would have to be examined by the AO.
Further, as the meaning of the word ‘chartered’ as appearing in the Article
is not clear from the definition itself.

Whether royalty income earned by the taxpayer can be said to be ‘effectively connected’ with its permanent establishment (PE) in India, so as to be taxable as per the ‘business income’ article of the India-Australia Tax Treaty (Treaty).

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Part C — International Tax Decisions



  1. Worley Parsons Services Pty. Ltd.

[2009-TIOL-06-ARA-IT] (AAR)

Date : 30.03.2009

Article 12 of India-Australia DTAA

Issues :

Whether royalty income earned by the taxpayer can be said
to be ‘effectively connected’ with its permanent establishment (PE) in India,
so as to be taxable as per the ‘business income’ article of the
India-Australia Tax Treaty (Treaty).

 

Facts :



Ø A company incorporated in Australia (Ausco), is in the
business of providing professional services to the energy and resources
industry. Ausco entered into a contract with Reliance Petroleum Limited, an
Indian Company (ICo) for providing certain services in connection with the
ICo’s project of laying cross-country pipelines for the transportation of
hydro-carbons.

Ø Ausco entered into the following separate contracts
with the ICo :

G Basic Engineering and Procurement Services Contract
(BE&P), which was divided into two phases. Phase I was further divided
into 2 parts, viz., Basic Engineering and Procurement Services. In
respect of Basic Engineering services, 80% of the work was performed in
Australia and the balance was performed in India. In respect of the work
which was performed in India, Ausco’s employee had made short duration
visits to India for inspection, topography study, preparation of route
map, etc.).

G Ausco was entitled to a lump sum consideration for
all components under the BE&P.

G Project Management Services Contract (PMS). For this
Ausco’s employees were present in India for a significant period. The
employees were provided office space by the local engineering contractor,
for the performance of services under PMS.

G In terms of India-Australia Treaty, it was admitted
by the applicant that the amount was chargeable to tax in India under
Article XII of the Treaty as royalty income. The applicant also submitted
that it had PE in India.

Ø In its application, Ausco submitted before the AAR that
both (a) the contract BE&P and PMS were integral part of single contract and
hence entirety of royalty income was ‘effectively connected’ with the PE in
India; (b) In terms Article XII (4) (herein referred to as ‘the PE exclusion
rule’) of the Treaty, the amount was chargeable to tax as business income in
terms of Article VII of the Treaty; and (c) In terms of Article VII, only
that part of the profits, which was attributable to the PE, can be charged
to tax in India. For this, the applicant relied on the SC decision in
Ishikawajima Harima Heavy Industries [288 ITR 408], to contend that where
income is in respect of services rendered outside India, it is not liable to
be taxed in India in terms of the domestic law provisions.

Ø The Tax Department however contended that services
performed outside India in terms of Phase I of the BE&P were not
‘effectively connected’ with the PE of the Taxpayer in India and hence the
PE exclusion rule did not apply. Consequently, the royalty receipts were
taxable in terms of Article XII of the Treaty. The department obtained that
the SC decision in Ishikawajima’s case was distinguishable.


Held :

The AAR considered the taxability of the applicant under
Article XII and Article VII of the Tax Treaty. The AAR held :

1. Article VII (7), which paves way for the operation of
other specific articles of the Treaty, does not dilute the impact of the PE
exclusion Rule contemplated in terms of other Articles of the Treaty. If the
specific Articles provide for taxation of income under Article 7, the
receipt will be taxable as business income in terms of other provisions of
the treaty.

2. In case of royalty, the PE exclusion rule applies
where there is an ‘effective connection’ between the royalty generating
services and the PE. Mere presence of a PE for carrying out some other
activities is not sufficient for establishing an effective connection. For
royalty to be ‘effectively connected’ to the PE, the PE in India should be
engaged in the performance of royalty generating services and should
facilitate performance of such services.

3. ‘Effectively connected’ means ‘really connected’ and
the connection should not only be in ‘form’, but also in ‘substance’. A
pragmatic and purposive approach needs to be adopted for construing whether
or not an ‘effective connection’ exists between the PE and the royalty
income. The set-up, the functions, the purpose and duration of the PE, etc.
are relevant factors for determining this aspect.

4. The words ‘effectively connected with the PE’ are not
words of redundancy and should be given their due meaning. A real and
perceptible connection should exist to fulfil the condition before the
receipt can be treated as effectively connected with PE.

5. For the PE exclusion rule to get triggered, the PE
must have substantial activities and such securities must be carried out
over a period of time. A nominal establishment with skeletal staff,
attending to minimal or negligible work may not be sufficient to trigger the
PE exclusion rule on the ground of ‘effective connection’.

6. In the case of the applicant, BE&P and PMS contracts
are separate contracts covering different phases of the projects having
different rights and obligations. The nature of services and consideration
in respect of each one are separate and distinct. As a result, each
contract, although relating to the same project, needs to be seen
independently for determining the effective connection with the PE.

7. The SC ruling in the case of Ishikawajima cannot be
read to mean that the mere existence of a PE is enough to trigger the PE
exclusion rule and cause royalty income to be assessed as business income.
It does, however, imply that there may be situations where, though the
royalty may be ‘effectively connected’ with the PE, it may still not be
‘attributable’ to the PE.

8. The AAR observed that the SC decision is
distinguishable and not applicable to the facts of the present case. The AAR
held that the SC was concerned with the PE exclusion rule in respect of the
India-Japan Tax Treaty, which gets triggered when ‘right, property or
contract’ is ‘effectively connected.